Will Upcoming Elections in U.K. & Geopolitical Tensions Weaken U.S. Dollar?
The U.S. dollar 2017 may be too strong. That’s what U.S. President Donald Trump said. In fact, the American currency has started to slip toward levels not seen since the U.S. elections that Trump won in 2016. This context has supported gold prices, which have been recovering ground. The upcoming elections in the U.K. and geopolitical tensions could weaken the U.S. dollar (USD) further.
As for the U.K., Prime Minister Theresa May has called a snap election to strengthen the government as it presides over Brexit. The market reaction is indicative. The British pound has gained on the news against all major currencies like the dollar and the euro. Meanwhile, Trump’s sudden penchant for geopolitical games raises uncertainty for the United States. While the pound gains, the dollar loses strength.
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Thus, what Trump should worry about is the question: is the U.S. dollar weak? The U.S. president has yet to adopt any specific economic policies. But, given his electoral agenda and speeches, he wants to reduce America’s imports. Economic isolationism means that America’s current major trading partners, from China to the EU, will apply the principle of reciprocity.
In other words, as much as the U.S. raises tariffs against foreign goods, so too will American goods be slapped with tariffs. Thus, a stronger dollar would not bring any benefits to the U.S. economy. John Q. Public working in a Pennsylvania coal mine would also have nothing to gain from a higher dollar.
That said, there are unwanted pressures on the U.S. dollar. It’s one thing to have your currency drop as part of a deliberate policy. It’s quite another to have that currency drop because of external factors. In the first case, you have control and investors can expect the kind of predictability that helps them manage risk.
In the second case, the markets could respond as if faced by an onslaught of risk. In other words, they become bearish. The external factors have already arrived in the form of rising political tensions at a global level.
Meanwhile, it’s unclear what the U.S. Federal Reserve wants to do. Even after raising rates in January 2017, Fed Chair Janet Yellen appears not to have changed her view that more rate hikes are coming. Higher rates mean a higher dollar. Yet the same Yellen has also suggested that there is no hurry to raise rates.
Apparently, the U.S. Federal Reserve wants to get clearer indications from China. China would prefer for the Fed not to raise rates; it needs a weaker dollar. It’s counterintuitive because a stronger dollar increases demand for imports. That’s why Japan is desperately trying to prevent its currency, the yen, from gaining against the USD.
But the Chinese yuan is pegged to the dollar. That means, whenever the dollar goes up, so does the yuan. This hurts China’s exports, which remain the main engine of its economic growth. Meanwhile, Chinese investors seeking higher rents or gains on their savings tend to invest abroad when the dollar is higher. That has fueled the real estate asset bubbles in Canada, the United States, and beyond. Asset bubbles tend to lift mortgage rates.
Unexpected Geopolitical Tensions Weaken the Dollar
The political uncertainty might please China now, because it puts pressure on the value of the USD. A number of elections in Europe may almost certainly affect the value of the dollar. As a gauge of the dollar’s performance, the euro is handy. Their values are similar. More significantly, the dollar has been trading ever closer to the euro.
Many analysts—myself included—were almost sure that the dollar and the euro would reach parity in 2017. That possibility still exists. But its probability is slimmer. Indeed, the results of the French elections are crucial. There is near-unanimity that if the National Front party, led by Marine Le Pen, wins, the dollar would catch up to the euro.
The latest indications suggest that the French election could yield a surprise no bigger than the American presidential election of 2016. Many have expected the anti-euro Le Pen to win, but the pro-EU parties have gained strength in the past few weeks. The centrist Emmanuel Macron has gained strength against Le Pen.
A Le Pen win would doubtless signal the markets to go bearish on the euro. Le Pen wants to pull France out of the eurozone, which would achieve a total collapse of the European monetary project. Such a development would, at the very least, push the dollar to parity with the euro. On the contrary, should the pro-euro Macron win the first round of the French presidential vote, it would reduce the chance of a USD/EUR parity in 2017.
Support for anti-EU politicians can no longer be assumed. The geopolitical events of the past few months have shown that there are too many risks of leaving the EU. Individually, the EU member states would get lost in the quagmire that the world has become. Moreover, Trump has shown there are no certainties.
Trump started out his presidential term with an “America First” message. His inauguration speech was very much on point. But it seems that after the ouster or demotion of key advisors such as Mike Flynn and Steve Bannon, Trump has changed his tune. He has attacked Syria, even though he had delivered crystal-clear tweets and statements against anything of the sort until merely hours earlier.
Trump has also reversed his friendly overtures to Russia, while maintaining an ambiguous policy with China. Against this convoluted framework, Trump has picked a fight with North Korea. All these things are great for the military-industrial complex. It’s no wonder that defense stocks have been among the best-performing on Wall Street.
But the uncertainty does not help the dollar. The White House and the Fed could lose control of the American currency, which raises the question, will the U.S. dollar collapse in 2017? China would like that, as would the commodities markets. But would the U.S. benefit? Certainly, Japan would suffer because Americans would have less purchasing power for its products.
That, combined with the rising tensions with North Korea, will worry Tokyo. Japan would be a main target of a North Korean reprisal to an American attack. But, as much as the U.S. dollar 2017 seemed headed for a hike, important obstacles have appeared. Thus, it’s important to understand what that could mean for the U.S. dollar forecast in 2017 and the U.S. economy.
Economic Consequences of a Weak Dollar
The prospects of a more inward-looking United States and a higher dollar, driven by rate hikes, have lost steam. There’s an advantage to that. The higher value dollar has crushed the U.S. manufacturing industry, which has suffered a recession for some time. The Fed has some tough choices ahead. It can’t raise rates too quickly and it can’t risk an excessive U.S. dollar devaluation.
Assuming that Europe will remain united in 2017, averting the populist onslaught, the euro will gain over the U.S. dollar. Therefore, if the Fed continues to raise rates, it would only make European goods more competitive in the American markets. Forget any “America First” effects. Should Trump respond by imposing higher tariffs, it might hurt European manufacturers.
But it would also hurt China and Japan. American businesses that rely on exports—including Boeing Co (NYSE:BA), the largest American exporter by value— will lobby against any unreasonable tariffs that would spark reciprocal measures.
The problem, as mentioned above, is more than the dollar being too high or too low. Under any circumstance, the U.S. must retain control over the value of its currency. Yes, if the dollar is too high, American exporters suffer. But, if the dollar is too low, the difficulties for the U.S. economy increase.
It all comes down to U.S debt, personal and public. The U.S. economic model both depends on, and suffers from, debt. Maintaining a reasonably strong dollar is key to that system. Pushing it too high or too low alters the balance and exposes the weaknesses of the economy. The recent geopolitical uncertainties and its effects on the dollar have forced many to go bearish on the U.S. economic outlook for 2017.
Indeed, one of the backbones of the U.S. economy is the fact that the dollar is the principal international reserve currency. Over the past few decades, China’s willingness and ability to buy dollars in large quantities has reinforced the dollar. It might even be suggested that Chinese imports are important to Americans.
The United States has been China’s largest export market over the last 30 years. But, the very cheap price of Chinese consumer goods—which now include higher-end products—has been one of the most important factors contributing to maintaining a reasonable cost of living.
That was crucial during the worst years of the Great Recession. It allowed Americans to maintain a certain level of consumption, reducing the psychological impact of the crisis. It also kept the retail sector alive. If you need any reminder of how important that is, consider that Wal-Mart Stores Inc (NYSE:WMT) remains the world’s largest company by revenue.
Rather than manipulating its currency, as Trump accuses, China did the opposite. It was buying U.S. Treasury Bonds to increase the value of its currency, the yuan, against the dollar. As to why that is, that’s difficult to ascertain, but geopolitical motives and equilibrium seem like the likeliest motivations.
China has important strategic goals. It has an ongoing territorial dispute in the Pacific, and North Korea on its border. Now, as U.S. naval forces accumulate in its oceanfront, while raising tensions with Russia (a Beijing ally), the balance has changed. Trump must be careful to keep China on his side.
That means Trump might want to reverse his plans for isolationist trade policies and focus on not getting the U.S. mixed up in foreign wars again. If he doesn’t, the dollar will suffer an abrupt devaluation, which could devastate the U.S. economy.
