"My basic approach is that the foreigners are out to screw us," a presidential advisor said. "Our job is to screw them first."
As contemporary as that may sound, the advisor was John Connally, Richard Nixon's treasury secretary, and he made the remark 46 years ago. In the name of jobs and votes Connally was pushing a neo-mercantilist agenda of higher tariffs and a devalued dollar. In the name of jobs and votes Nixon signed on.
In August of 1971, Nixon formally ended the convertibility of the dollar into gold, which had underpinned the Bretton Woods system of fixed exchange rates since the end of World War II. By late 1973, Bretton Woods was dead. The U.S. dollar and most other major currencies were floating freely; central banks no longer intervened to support predetermined fixed rates. Exchange rates were set by the market.
We live with the results today. Granted, vestiges of Bretton Wood remain. A dozen or so smaller countries still peg their currencies at fixed rates to the dollar and China has a "managed float" policy. (The Bank of China allows the currency to rise and fall within a preset range; it intervenes to hold down or, as it has recently, to prop up the yuan.) But for the most part it's a floating-rate world.
With markets in the saddle, currency trading has exploded. Foreign-exchange trading was in the tens of billions of dollars a day a half century ago. Today it averages more than $5 trillion a day. No other financial market comes close to forex in size; the futures markets for equities and commodities sees less than a tenth as much trading (http://tiny.cc/…). And in this vast, sprawling forex market the dollar is involved in nearly 90% of the trades.
Trading volume aside, the parallels between 1971 and 2017 are striking: An uncomfortably strong dollar. Influential advisors to the president advocating mercantilism. A Republican president who doesn't know much about international monetary policy and doesn't want to know much, but who cares greatly about winning and holding office and about being seen to "do something" to create jobs.
One big difference is the reason for the dollar's strength. In 1971 the culprit was the adherence of governments to rates of exchange that no longer reflected economic reality. Since World War II the U.S. had run a balance of payments deficits even though, until 1971, it exported more goods than it imported. The payments deficit was the result of dollar outflows for foreign investment, aid and travel.
At first the U.S. had run these deficits gladly in the interest of helping the world recover from the war. As Europe and Japan regained competitiveness in the 1960s and with the U.S. mired in an inflationary war in Vietnam, the deficits worsened and the mood soured. The U.S. was bleeding dollars. To maintain the fixed exchange rate, foreign central banks had to sop dollars up, buying them by printing more of their own currencies. We were, European countries and Japan complained with some justice, exporting inflation. Connally responded unapologetically: "The dollar is our currency but your problem."
Allen Matusow outlines the options Nixon's advisors offered him in his 1998 book "Nixon's Economy" (http://tiny.cc/…). The president could do nothing and let the foreigners complain; devalue the dollar by raising the price at which the U.S would buy gold from $35 an ounce; suspend gold convertibility, also known as "closing the gold window;" or try to get by with incremental reforms. Encouraged by Connally and hoping to act before being forced to act, Nixon announced a "temporary" suspension of gold convertibility, along with a 10% border tax on imported goods.
Nixon calculated these measures would give him negotiating leverage to pry concessions from trade partners. The negotiations were unsatisfying. The eventual settlements -- there were several -- broke down, one after the other. The temporary suspension became permanent. The eventual outcome was floating rates.
Donald Trump faces a very different sort of strong-dollar challenge. To oversimplify, the dollar is strong today because the U.S. is an attractive place for individual and institutional investors, foreign and domestic, to park their money. The U.S. economy isn't as robust as Americans would like, but it has recovered from the 2008 financial crisis more convincingly than most other industrialized economies. The Federal Reserve is raising interest rates, making American financial assets even more valuable.
Though the dollar has tumbled in recent days from its 14-year high in the weeks after the election, the currency may not have not seen its highs. Trump doesn't want that, but his policies might grease the skids for it. Whatever else policies like raising tariffs, lowering corporate taxes slashing regulations and jawboning companies to move factories to the U.S. might achieve, they risk sending the dollar through the stratosphere.
If that happens the implications for jobs will not be pretty. The market would eventually self-correct if allowed to, but would the administration have the patience to let it? Faced with a soaring currency, the temptation to intervene further, to lunge at quick dollar-depressing fixes, to look for the equivalent of a gold window to close, will be irresistible.
Trump has already shown he's willing to talk down the dollar, something previous presidents avoided. A few days before his inauguration, he told the Wall Street Journal the currency is "too strong." The market promptly fell 1.3% (http://tiny.cc/…).
Alas, talk will not trump economic fundamentals for long. Action will be needed. In a floating-rate world, Trump doesn't have as many options as Nixon had. The big one is a leaf out of China's book: Treasury or Federal Reserve intervention in the markets. But with the world awash in dollars, the U.S. would need to coordinate its interventions with Europe and Japan, and that coordination would have to be negotiated.
James Carville, an advisor to President Bill Clinton, once said he wanted to be reincarnated as the bond market because "You can intimidate everybody." If Trump takes on the foreign-exchange market, we'll see who intimidates whom.
Urban Lehner can be reached at email@example.com
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