Wharton’s Franklin Allen discusses how recent events could affect the U.S. dollar.
President Donald Trump’s early statements on international trade and currency valuations left many concerned about rocky times ahead: After winning the election, Trump continued to accuse key U.S. trading partners of unfair practices, following up on comments he made during the campaign. By making one of his first acts as president calling the Taiwanese president, Trump seemed to call into question the “one-China” policy (which entails diplomatic, official recognition of China, with an unofficial relationship with Taiwan), in an apparent snub to the mainland.
Mexico and Japan also came in for criticism for alleged manipulation of currency and trade regimes. Even Germany was put in the cross hairs for carrying a perceived trade surplus deemed too large. But more recently, in a phone call with China President Xi Jinping, Trump walked back any threat to abandoning the one-China policy. Then, his meeting with Japan’s Prime Minister Shinzo Abe last week seemed to suggest more cooperation than confrontation. That followed an announcement by Japan’s Government Pension Investment Fund, the world’s biggest, that it would invest in U.S. infrastructure projects that could create hundreds of thousands of American jobs. Still, trade tensions with Mexico and elsewhere remain unresolved.
To better understand how recent events could affect the U.S. dollar and international trade, [email protected] spoke with Franklin Allen, an emeritus professor of finance at Wharton who is also a professor of economics and finance at Imperial College in London, where he is executive director of the school’s Brevan Howard Centre for Financial Analysis.
An edited transcript of the conversation follows.
[email protected]: I’d like to discuss the U.S. dollar, which could be used as a lens, in some ways, for analyzing some of the key issues in world markets. The value of the dollar, of course, has big implications for world growth, and very importantly, emerging market dollar-denominated debt. Also, many people view the dollar as a bit of a proxy for how the U.S. is performing overall, including the new administration. So, if people lose faith in the dollar, they might sell the dollar off and buy gold, or other currencies, or other investments.
At the same time, if the dollar appreciates too much, that can affect the level of growth here in the U.S. There was a recent Financial Times article that said if the U.S. dollar went up by 10%, that could knock a half percentage point (0.5%) off of GDP growth. There are a lot of pointers in the direction of the dollar getting stronger, such as: economic growth has been pretty strong, and it looks like it’s going to get stronger; especially if the administration passes a stimulus package. They’re also talking about deregulation, lower corporate and personal taxes and corporate tax forgiveness. All these things could put upward pressure on the dollar. The stock market has been doing well — that seems to draw money in and increase the dollar. And of course, the Fed has been talking about wanting to raise interest rates — that makes for a stronger dollar.
On the other side are the politics. President Trump has been talking about an interest in a weaker dollar. He is also saber-rattling about trade with some of the U.S.’s major trading partners; Mexico, China, Japan, Germany and other euro countries.
Given all of that, there’s a lot of contradictory stuff. What’s your view of the landscape? How important is it to look at the dollar, to figure out what’s happening in the world, and what’s likely to happen going forward?
Franklin Allen: I think it’s fairly important. I don’t think it’s hugely important, but it’s certainly one of the important things. Probably, the main driver is the difference in interest rates around the world, for the short run, at least. And, how things like a stimulus package, and so on, will play into that. If [the U.S.] does pass a big stimulus package, then my guess is that the Fed will raise rates faster than they otherwise would have done, and that will have an effect. We’ll see whether that gets passed; what the timing of that is, how the expectations for that play out.
The other thing, which I think is important, is what happens in the other countries, in terms of interest rates. In particular, in the Eurozone; whether that continues to stay where it is, or whether the growth that started to emerge leads to some ending of the quantitative easing, and raising of rates going forward. All of those, I think, will be very important for where the dollar ends up.
I think the trade policy of Trump will also play an important role. We’ve seen, clearly, some aggressive moves against Mexico, in particular, but also towards Germany, and to a lesser extent, maybe Japan. And then, of course, the big one is China. That’s been a little bit on the back burner, with everything that happened after he was elected; in particular, the call from the president of Taiwan, and the issue about the “one-China” policy, and whether it would be continued.
“The notion that China is manipulating it is somewhat valid, but they’re manipulating to keep it valuable, rather than to keep it undervalued.”
Hopefully, the talk [February 9] between President Xi and President Trump will mean that now that issue is off the table and we can focus on trade. I think there are lots of things going on, as your introduction indicated. But I would stress, most of all, the interest rate movements, and also the trade movements.
[email protected]: One key thing is that if the dollar were to appreciate quite a bit, then there are a lot of emerging market countries out there that have a lot of dollar-denominated debt. We know that in the past, the Asian financial crisis of the late 1990s, and the Latin American crisis of the early 1980s — the dollar had a role in those problems. They had a lot of dollar-denominated debt, which suddenly became very expensive when they had big devaluations of their currencies. Could you talk about the risks in emerging markets right now?
Allen: I think that potentially, is something to worry about. The key issue is the extent to which they have dollar-denominated income from exports, and various other sources, to offset their dollar debt. I think it’s the net positions, rather than the gross positions, that are important there.
A country like South Korea, I think it’s less of a problem than some of the other countries which are borrowing in dollars…. I would say there’s wide variation in that. But I think that’s something people need to keep an eye on over the next year or two.
[email protected]: We’ve seen that President Trump is very concerned about trade with Mexico…. There’s talk of putting some kind of tax, or tariff, on imports. I’m wondering what effect this would have, both on Mexico and the U.S., and as a chilling effect on trade in general? Part of what I’ve read suggests that it won’t be very effective, because the dollar may just adjust in a way that