Much of the world has been waging a cold currency war since the autumn of 2016, and so far the winner is Donald Trump. The dollar rally that followed the U.S. election is over, and this past week the U.S. Dollar Index (DXY, which tracks the dollar’s value versus a weighted basket of major currencies) sank to its lowest level in more than a year. While the U.S. administration and the Republican majority in Congress are yet to deliver on most of their policy goals, they have succeeded in making the dollar more competitive. How? By putting an end to the decades-long official mantra that “a strong dollar is in our interest” and by threatening other nations, implicitly and sometimes explicitly, with protectionist policies. In short, all this trade bullying has killed the dollar bull.
Monetary policy and exchange rates: a recent history
Back in December 2016, I argued that a new cold currency war had started, replacing the “Shanghai co-op” – the common understanding from February 2016 to stabilize the dollar. In the fall of 2016, the Bank of Japan (BOJ), the People’s Bank of China (PBOC) and the European Central Bank (ECB) all turned into cold currency warriors: The BOJ fixed the 10-year yield on Japanese government bonds at 0% at a time when global yields were rising, thus helping the yen to depreciate; the PBOC allowed the yuan to depreciate faster against the U.S. dollar; and the ECB introduced a “stealth rate cut” by removing the deposit rate floor of −0.4% for its bond purchases, which pushed European bond yields lower.
However, the Trump administration didn’t take long to fight back. A new phase in the cold currency war started early this year with President Trump, his trade advisor Peter Navarro and Treasury Secretary Steve Mnuchin all pushing back verbally against U.S. dollar strength and issuing veiled threats of protectionist actions. Since then, China has stabilized the value of the yuan, the BOJ has kept policy on hold and the ECB has removed its easing bias and is inching closer to tapering its bond purchases. And with the dollar sinking in response, the Trump administration has had no reason to turn aggressively protectionist. Mission accomplished.