Strength Isn’t Always Good

With the dollar strengthening rapidly relative to other currencies, in part as a result of Donald Trump’s election victory, consider this irony: The price of imports will fall, making them more attractive to consumers—just as the incoming president prepares to clamp down on imports.

Hopefully, he’ll put aside his protectionist instincts and be persuaded by his advisors to enable American consumers to enjoy a few bargains. Otherwise, we’ll be experiencing the downside of a strong dollar without enjoying the upside.dollar

The downside is that a strong dollar makes American goods more costly abroad. The weak dollar that prevailed through most of the Obama presidency enabled American companies to compete abroad, even though corporate America is taxed at the highest rate in the industrialized world.

But add on a stronger dollar and American exports will drop, increasing our trade deficit, reducing corporate profits and making it more difficult for the economy to grow. That would cause a drop in employment and American workers would, yet again, have to wait to see their salaries increase.

It will be difficult for President Trump to convince foreign countries to buy more American goods if the dollar continues to strengthen. It will also be difficult for him to convince most of us to buy American when French wine becomes more reasonably priced than California wine.

Perhaps President Trump can use the strengthening dollar as leverage to pass tax reform quickly. Instead, though, he may use it to argue for trade barriers, which could potentially damage the economy. It’s worth noting that the dollar’s strength has been especially dramatic against the Chinese yuan, which helps the president-elect build his argument that the Chinese government is guilty of using currency manipulation to benefit its economy.

It’s All Relative

So why is the dollar strong?

“The main reason is the U.S. economy is doing better—not necessarily better compared to its own historical performance, but better compared to everyone else these days,” Jeff Spross wrote in The Week. “And when the economy is doing (at least relatively) well, that makes it an attractive investment opportunity: Putting money into U.S. ventures and business is more likely to earn you a better return. But to invest in the U.S. economy you need U.S. dollars. So demand for U.S. dollars goes up relative to other currencies, and the U.S. dollar gets stronger.”

Spross wrote his article in July, but the dollar started strengthening relative to other currencies when the Federal Reserve Board stopped buying bonds through its quantitative easing program, which weakened the dollar.

The dollar further strengthened—and the stock market hit new highs—with the election of President-elect Trump, because investors believe he will be good for the economy. That may also be relative, as Hillary Clinton was expected, if elected, to carry on the socialistic programs of President Obama, with leftward guidance from U.S. Senators Elizabeth Warren and Bernie Sanders.

The dollar is also strengthening because of the near certainty that the Federal Reserve Board will finally begin raising interest rates in December. Interestingly enough, the stock market has been rising steadily in spite of that belief.fed-dollar

Inflation or Deflation

Most pundits, economists, media and other alleged experts are predicting that a Trump presidency will lead to higher inflation, which would be expected as the economy improves. But I wouldn’t put my money on it—these are the same people who predicted that Hillary would win the election.

A stronger dollar is deflationary, as lower-priced imports cause domestic producers to also reduce the cost of their goods to remain competitive. In addition, as interest rates rise, consumers will have less money to spend, which will also cause prices to drop.

“It’s the lead domino in the deflation of asset prices,” according to Hedgeye CEO Keith McCullough. “The U.S. dollar breaking out from here is ‘uber deflationary.’ Those are the right two words to use.”

Then again, currency values fluctuate and can be unpredictable. As the dollar strengthens, it becomes more costly for foreigner investors and governments to buy or service assets or debt that’s priced in dollars, which should reduce demand for the dollar, causing it to weaken.

“For the record, countries around the world have loaded up on an astonishing $9 trillion in US-dollar denominated debt,” Hedgeye noted. “That’s extremely risky in a strong dollar environment. So too are commodities like oil, since they are also priced in dollars.”

As servicing all that debt becomes problematic, the risk of default will rise.

“It’s a double whammy,” according to Hedgeye’s Darius Dale. “Not only are debt servicing costs rising when the dollar breaks out but all the empirical evidence shows currencies break down versus the dollar and the incremental supply of portfolio investment, particularly fixed income markets, dwindles. So not only do you have an issue with existing debt service but you also have a problem with incremental credit which brings on higher levels of default risk and sharper slowdowns in credit allocation, which is also negative.”

Recently, the U.S. dollar index was up 4.6% since the Nov. 8 election (and up 5.6% for a three-month period). It’s not a coincidence that emerging market stocks (EEM) were down 7% since the election and 7.8% over three months.

The strong dollar is just one more problem the Trump administration is inheriting from the Obama administration. It’s what happens when you put central bankers in charge of your economy.

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