Trump and the Dollar - BBH

Analysts at Brown Brother Harriman noted that although in office less than a fortnight, the new US Administration is showing a disregard not only for the domestic convention but international agreements like on refugees and its talk about the dollar. Some observers had argued that the conduct of monetary policy was tantamount to currency manipulation, but the G7 and G20 offered a more nuanced understanding.

Key Quotes

"Today, the head of Trump's new National Trade Council, Peter Navarro, told the Financial Times that the euro was |"grossly undervalued." He warned that euro was like an "implicit German mark" and its low valuation gave German an advantage over its trading partners. Navarro said Germany was one of the main obstacles to a trade deal with the EU. He confirmed what has been suspected: TTIP, the Transatlantic Trade and Investment Partnership negotiations, will not be going forward under Trump."  

"On balance, many of the comments from Trump officials have expressed concern about the strength of the US dollar or, as Navarro, complained about other currencies being undervalued. The OECD confirms. Its models see the euro at nearly 25% undervalued, sterling almost 16.5% undervalued and the yen 11% under-valued. The Mexican peso, whose marked depreciation has been exacerbated by comments by Trump, is undervalued, according to the OECD, by 147%." 

"At the same time, we argue that reason the dollar is strong is not that European, Japanese, and Mexican officials want a weak currency, though some officials clearly do. Rather the dollar's strength is not built on wishes but the incentive structure created by actual policy. In particular, the divergence of monetary policy, broadly understood, has been, arguably, the single biggest force lifting the US dollar."  

"There is some anticipation of a more supportive policy mix. Fiscal policy has been neutral to a drag in recent years, but it has been clear since last summer that regardless of the election outcome US fiscal policy would be more accommodative. That policy mix of looser fiscal and tighter monetary policy is associated with currency appreciation. Looser fiscal policy includes tax cuts (reform), infrastructure spending, and some supply-side deregulation. Alone, such fiscal efforts would also likely be understood by investors as favorable for the dollar."   

Markets - Get ready for a surprise!

"Looser fiscal and tighter monetary policy was the policy mix under Reagan-Volcker that led to a dramatic dollar overshoot in the early 1980s and was the first dollar rally since the breakdown of Bretton Woods in 1971. It was also the policy mix in Germany when the Berlin Wall fell. The fiscal laxity needed to finance the leveraged buyout of East Germany was offset by the tightening of monetary policy by the Bundesbank. The Deutschemark overshoot that resulted spurred an ERM crisis that ultimately paved the way for monetary union."  

"Policymakers did not recall the lesson of the Great Depression and weakened the financial pipes before the financial crisis. Policymakers did not recall the lessons of the 1920s about the disparity of income and wealth and the political blowback that could result. Policymakers did not recall the limits of a country's willingness and ability to service foreign debt from current production. Policymakers may be forgetting the disastrous consequences of protectionism (taxing imports and exempting exports) and beggar-thy-neighbor currency policies."  

Trump administration sacrifices the dollar on the bullish equity and commodity altar