Trump and Elizabeth Warren have the same very bad idea about the dollar

  • Both President Trump and presidential hopeful Senator Elizabeth Warren have floated the idea of weakening the dollar to help sell US exports.
  • This is a very stupid, dangerous idea.
  • Weakening the dollar would scare the world away from US assets, hurt already weakening confidence in the US government, and potentially start a race to the bottom currency war with China that no one will win.
  • Visit Business Insider’s homepage for more stories.

President Donald Trump and Democratic presidential hopeful Sen. Elizabeth Warren have the same idea about the dollar, and it is very bad.

Both Trump and Warren would like to see the United States intervene in global currency markets to weaken the US dollar. Both say this would help US workers by making Americans exports cheaper, as foreign currencies would be able to buy more dollar denominated goods for less.

For Trump, this move would help to accomplish one of his most precious but pointless goals – lowering the US trade deficit. According to the Wall Street Journal, Trump has floated the idea to his advisers who have so far ruled it out.

Warren expressed her desire to weaken the dollar in her US Jobs plan released back in June. She – like economist Robert E. Scott, who wrote in support of this proposal in the New York Times – believes that the strong dollar has made US exports too expensive and thus uncompetitive. That’s why you see factories moving overseas, so that they can produce cheaper goods for foreign buyers.

Scott argues other countries were able to entice blue collar jobs away from the US thanks to the strength of the dollar, and then they pressed this advantage by manipulating their currencies lower.

The economist also complains that the strength of the dollar has attracted investors who then buy the currency. This flood of private and foreign capital to US dollars and assets, he calls “currency misalignment.”

Others call this a market.

One of the reasons an investor would buy the US dollar over, say, the Thai baht, is because it’s a global reserve currency – central banks hold it. They hold it because it’s trustworthy – so far we haven’t had a tin pot dictator run around manipulating its value. That trust is ultimately what makes the dollar so liquid, which investors love. In this way, the dollar’s stability is important for the entire world, not just the US.

“Foreigners buy US stocks and bonds (which are denominated in US dollars, of course) because they believe these financial assets (and the currency in which they are denominated) are not going to be randomly manipulated by some impulsive and unprofessional government,” Carnegie Mellon economist Lee Branstetter told Business Insider via email.

“If the US sought to systematically manipulate the value of its currency, that could negatively impact the home currency returns received by foreigners investing in our assets. A cheapening dollar makes U.S. stocks a less attractive investment. Foreigners would think twice about investing in our assets if any capital inflow that drove the dollar up was met with an attempt by the US government to push the dollar back down.”

A weaker dollar would also cause a slew of other headaches from making it more difficult to pay down the national debt to increasing mortgage rates.

On top of all of this is the question of how we’d move to dollar lower. One way is to just lower interest rates, which the Federal Reserve has been doing. That doesn’t seem to be working fast enough for President Trump, though, which means he may use the the 1934 Gold Reserve Act to intervene in the market by selling dollars. A lot of dollars.

“Since we print our dollars, we could, in principle, print so freaking many that their price goes down,” Branstetter continued. “If implemented, it could literally cost us tens of trillions of dollars in lost wealth.”

The Xi factor

And right now, in the middle of a trade war with China and with central banks working feverishly to ward off deflation, there are even more pressing complications that would come with weakening the dollar. Namely, kicking off a race to the bottom.

Thanks in some part to Trump’s trade war the Chinese economy is weakening. For the first time in 3 years producer prices fell in August. That means manufacturing profits will fall. At the same time, the country is going through a pork shortage that is pushing consumer prices up. Targeted government stimulus measures haven’t been doing enough to spur growth. It’s a toxic mix.

Industrial production growth china
Industrial production growth has slowed dramatically in China across sectors. Societe Generale

A weaker economy means a weaker Chinese yuan, which has a peg that is set daily by the People’s Bank of China (PBOC). And as the economy slows prices in China are falling. All of this is acting as a deflationary force that China can export to the rest of the world.

We’ve worried about this before. Back in the beginning of 2016 – as all of the world’s elites gathered at the World Economic Forum in Davos to worry about their money – China’s economy was puking. Money was leaving the country hand over fist and this was pushing the yuan down.

“I think the Chinese situation with the currency is very important. Very important,” Ray Dalio, the billionaire founder of the world’s biggest hedge fund, said at the time. “If there is significant currency weakness for the Yuan that will mean more imported deflation and it will make things more difficult.”

Because the dollar is in such high demand as a reserve currency, to move it down one would have to make a massive intervention in markets. Even then, though, economists think that it could very well only less ubiquitous, emerging market currencies.

China – currently in the throes of a swiftly weakening economy – could just respond to a weaker dollar by setting its peg lower. This would then kick off a race to the bottom with the US and China weakening their respective currencies back and forth.

Now of course there are limits to what China would do. Set the peg too weak and money will start to leave China like it did back in 2016. That kind of capital flight could set the yuan heading down too rapidly for the PBOC’s taste. But on the other hand China needs to sell exports.

So if the US starts a race, China may want to finish it.