The strengthening dollar and weakening yuan are shaping up as powerful crosscurrents for global growth.
Their divergence could amplify tensions between the US and China over a persistent trade deficit that President-elect Donald Trump has promised to shrink through tariffs and by labelling China a currency manipulator, risking a trade war between the world’s biggest economies. It’s a scenario both sides are keen to avoid.
China doesn’t want excessive yuan weakness because it would prompt companies and savers to shift money out of the country at a destabilising pace. America doesn’t want unbridled dollar strength that would hurt exporters. While the problem could self correct if the greenback loses steam, there are also worries that it won’t.
“Should the Chinese authorities allow the yuan to depreciate faster in the months ahead, it could be a red rag to Trump’s bull, encouraging him to do his worst on tariffs,” said Russell Jones, a London-based partner at the Llewellyn Consulting research group.
“The danger then is of a trade war, where no one wins, and many emerging economies will just be crushed between the hammer of an increasingly closed US domestic market and the anvil of retaliatory action on the part of Beijing.”
One solution could be a “Trump Tower Accord” modelled on the 1985 Plaza Accord named after the New York hotel where it was signed. Like that pact, a new agreement would seek to put a lid on the dollar’s gains.
Talk of such an agreement surfaced earlier this year as Group of 20 finance ministers gathered to meet in Shanghai. But instead of the famed Plaza Hotel, policy makers should instead look to Donald Trump’s residence on Fifth Avenue for inspiration, according to economists Andrew Sheng, who previously worked at the Hong Kong Monetary Authority and Malaysia’s central bank and Xiao Geng, a professor of finance and public policy at the University of Hong Kong.
They argue in an essay for Project Syndicate that a stronger US dollar will only suck in more savings from the rest of the world and worsen existing imbalances.
“A Trump Tower Accord is needed to bring some coordination into the international financial system to avoid the unnecessary negative shocks and uncertainty of uncoordinated policies,” Xiao said in emailed remarks.
The likelihood of a new global currency pact are mere fodder for analyst notes until the views of Trump’s Treasury secretary nominee — Steven Mnuchin according to people familiar with the decision — are better understood. And the global monetary system appears a long way from the kind of pact agreed in 1985, when the world was still divided between centrally planned and market economies.
“I don’t see a lot of interest by our partners to say, ‘We are willing to depreciate the dollar to the detriment of our own economy,”’ said Ed Al-Hussainy, senior interest-rate strategist at Columbia Threadneedle Investments in Minneapolis. Still, he warned that “a strong dollar in previous cycles has usually broken things” by causing financial crises.
The build-up of dollar credit in the form of bond issues and bank loans to non-US, non-financial corporate borrowers is a worry, said David Beckworth, a research fellow at the Mercatus Center at George Mason University in Arlington, Virginia. The stronger the dollar gets, the more expensive it becomes for these companies to service their debt.
Dollar appreciation “is a real serious noose around the neck of the global economy,” Beckworth said.
The risks are especially acute in Asia, home to the world’s fastest-growing economies. A weakening yuan — it fell to an eight-year low versus the dollar last week — will pressure regional currencies just as the Fed gears up to lift interest rates for only the second time in a decade.
That combination will strain government’s international reserves and pressure companies who borrowed dollar denominated debt.
China’s currency has slumped almost 6 percent against the dollar this year with little fanfare as geopolitical and economic risks elsewhere have kept the spotlight off Beijing. But even if the world hasn’t been paying attention, the weaker yuan matters.
“There is a real economic impact on international trade,” said Jeffrey Frankel, a professor at Harvard University’s Kennedy School of Government. “The depreciation will reinforce China’s trade surplus.”
If the picture is complicated in Asia, there are plenty of moving parts in the U.S., too.
The post-election dollar rally — it’s up more than 4 percent since Nov. 8, according to the Bloomberg Dollar Spot Index — is a problem for Federal Reserve officials.
The U.S. economy is close to the central bank’s mandate of full employment, while some price measures are near its 2 percent inflation target. Futures markets have priced in a 100 percent probability of at least a quarter-point hike in December, a move that is likely to underpin the dollar’s gains.
“The reality is there is only so much more tightening the Fed can do before that noose begins to put a crimp on the global economy and all that dollar-denominated debt becomes a problem,” Beckworth added.
Indeed, perhaps the most important information from the December Fed meeting will be what Chair Janet Yellen and Fed officials say about their future rate path.
One message that Yellen has to get across is that uncertainty is high, said Jon Faust, a former adviser to the Federal Open Market Committee who now directs the Center for Financial Economics at Johns Hopkins University in Baltimore.
Just how Trump’s economic plan translates into actual policies — right now it is a mix of tax cuts, deregulation, fiscal spending and a tough stance on trade — isn’t really known. If the Trump plan results in stronger growth, then further gains in the dollar would be “hard to stop,” Faust said.
Because such a move could worsen the trade deficit, and work against the President-elect’s stated intention to keep American jobs from migrating overseas, “it is hard to rule out” currency intervention as something a Trump treasury department might find politically expedient, Faust said.
But if the U.S. were to go it alone in symbolic intervention, the effects would likely be modest. “The reason people think the Plaza Accord mattered is that policy makers around the world were united in signaling a change in policy,” Faust said. “Where things stand today, it is difficult to imagine such a united front.”
For the U.S., any effort to weaken the world’s reserve currency would upend a so-called “strong dollar” policy — a stated preference for a currency that reflects the fundamentals of a robust economy. Through both two-term administrations of George W. Bush and Barack Obama, the American government has tried to convince other nations that exchange rates are best left set by markets. The U.S. hasn’t intervened in FX markets since 2000, when it acted with other countries to help boost the fledgling euro.
Still, such orthodoxies may be junked in favor of something more radical.
“All bets appear to be off under a President-elect Trump,” said George Magnus, senior independent economic adviser at UBS Group AG. “Even on his most temperate, least Twitter-involved of days, I have to imagine that further weakening of the yuan against the dollar will not sit well.”
Tags: China's currency, Group of 20 finance ministers, Hong Kong Monetary Authority, lobal currency pact, Malaysia's central bank, put a lid on the dollar’s gains, Steven Mnuchin, Trump Tower Accord, University of Hong Kong, US dollar, weakening yuan, Xiao Geng