Should the United States Pursue a "Strong Dollar" Policy?

Many of us have had those questions or concerns that have kept us up throughout the night. Only by calling a friend, family member, or colleague to talk it through do we feel better, usually enough where we can get some sleep shortly thereafter. The Huffington Post reported President Trump recently had one of those moments. Trump reportedly made a 3am call to his National Security Advisor, General Michael T. Flynn, and asked Flynn if a strong dollar or a weak dollar is better for the economy.

On the one hand, I don't know why Trump called General Flynn. While the General has an MBA in Telecommunications, Flynn's expertise is in counterterrorism, not macroeconomics. I am also perplexed because you would think that an international businessman would at least have a basic understanding of foreign exchange rates and how they work. I do question Huffington Post's allegation because Trump was complaining about a strong dollar last month. On the other hand, it is nice to see that Trump is consulting someone on an economic issue. Regardless of whether this conversation between Trump and Flynn actually took place, the question is still a good question to ask: "Should the United States pursue a strong or weak dollar?" In everyday conversation, we hear the word "strong" and automatically equate it with being good or powerful, whereas "weak" has the connotation of being bad or inadequate. When discussing currency in foreign exchange rates, the terms "strong" and "weak" do not have the same meaning. Trump's alleged question is a good one because it is not as simple as "a strong dollar is good" and "a weak dollar is bad." As I will elaborate upon in the upcoming paragraphs, the answer to the question is more complicated than a simple "yes" or "no."

Before continuing, here is a basic explanation of foreign exchange rates. As the name suggests, the exchange rate expresses the price of a nation's currency in terms of another currency. The exchange rate can either be expressed directly in terms of the domestic currency or indirectly in terms of the foreign currency. To use the exchange rate between the United States dollar (USD) and Canadian dollar (CAD) as an example, this exchange rate has historically fluctuated between 0.6CAD/USD and 1.1CAD/USD. What we see here is how many Canadian dollars it takes to exchange for a United States dollar. When the exchange rate is something like 0.6CAD/USD, the dollar is considered weak because it takes more than one United States dollar to exchange for a Canadian dollar. If the exchange rate is 1.1CAD/USD, the dollar is considered strong because it now takes more than a Canadian dollar to purchase a United States dollar. When the United States dollar strengthens, it becomes more valuable relative to other currencies, a process known as appreciation (the opposite being depreciation). As we see from the example, any two currencies can be compared with a foreign exchange rate to express the relative value and strength of a certain currency.

There is no simple answer as to whether there should be a stronger dollar because much of whether a certain president, Congress, or business wants a stronger dollar depends on overall policy goals. There are both winners and losers under a stronger dollar. To illustrate that point, what I would like to do now is review who generally benefits and suffers under a stronger dollar, and then go into what the implications of a stronger dollar would be.

Who Benefits Under a Stronger Dollar?

• American consumers. When the dollar appreciates, the purchasing power of American consumers abroad also increases. This affects when Americans want to purchase foreign goods, as well as when Americans travel abroad because the dollar is worth more in other countries (75 million foreigners visited the U.S. in 2014; tourist statistics also here). 
• American producers that import and non-American producers that export. Foreign goods and services become cheaper under the strengthening of the dollar. American companies that base their business on imports, such as Wal-Mart and Target, benefit as a result of cheaper imports. 
• Foreign companies with lots of business in the United States. Foreign companies that have a large number of sales in the United States (e.g., BASF, Airbus, Bayer) earn that revenue in dollars, which translate to gains on their balance sheets. 

Who Suffers More Under a Stronger Dollar?

• Foreign consumers. What is true for American consumers is oppositely true for foreign consumers. An appreciation of the dollar makes American goods more expensive for those that do not use the United States dollar as their currency, as well as making tourism in America more expensive for foreigners.  
• American producers that export and non-American producers that import. Since the dollar becomes stronger, American goods become more expensive for foreigners and thus less competitive in the global market. This also means that American companies that export their goods or services are going have a more difficult time to compete based on price. The American manufacturing sector is more likely to be adversely affected since they more heavily rely on exports. A stronger dollar means that American manufacturers will export less and have greater incentive to move production elsewhere. When the Japanese yen appreciated in the 1980s, the yen got stronger, and as a result, Japanese companies were moving production and corporate headquarters outside of Japan. This is important for Trump to keep in mind, particularly since he made a campaign promise about bringing manufacturing jobs back to the U.S.
• American companies with lots of business abroad. American companies that have a large number of sales abroad (e.g., McDonalds, Coca-Cola, Phillip Morris) earn that revenue in other currencies, which translate to losses on their balance sheets. 
• Foreign countries with lots of debt in U.S. dollars. Because a high percentage of foreign reserves are in U.S. dollars, drastic U.S. monetary policy has real potential to cause a global financial crisis. As the dollar rises, the cost of servicing the debt also rises, which really affects emerging countries with too much dollar-denominated debt. If the debt becomes too expensive and burdensome, it could lead to insolvency issues. 

What Should Trump Do?
Whether a strong dollar is a good idea depends where the economy is, the composition of the dollar, and why the dollar is appreciating. A strong dollar usually indicates that the American economy is doing well, but a weak dollar makes American goods look relatively cheap, which can boost the economy since foreigners will buy more American exports, especially during a recession when we need to boost employment and exports. If the Federal Reserve jacked up interest rates, it would appreciate the dollar. If inflation were out of control, that would be smarter policy than if the dollar were approaching deflation. The effects of a strong dollar also depend on what consumers spend their dollars on, and how they react as the dollar appreciates. This still doesn't quite answer what Trump should do.

Given the effects of a stronger dollar, it creates a quandary for the Trump administration. First, Trump's foreign policy is that trite, populist notion of "America First." His policy focus is less on how do we benefit everybody, and much more on how to benefit the American people above all else. As already mentioned, greater purchasing power for Americans through a stronger dollar would help.

However, we do have to remember that in addition to putting America first, Trump also harped on trade deficits during his campaign. Since a stronger dollar makes American exports more expensive, a stronger dollar widens trade deficits. If Trump's primary goal is to lower trade deficits, Trump is going to run into a bigger problem based on the policies he is planning to implement. Trump is looking to cut taxes, preserve entitlements, and increase spending in infrastructure and defense. In economic terms, using tax cuts and/or increased government spending is referred to as expansionary fiscal policy. Congress is also looking to pass the border adjustment tax, and as I explained last month, that would also lead to strengthening of the dollar. These intended policies on taxing and spending are going to lead a stronger dollar, which means that the trade deficit would get bigger under President Trump. Trump could try imposing capital controls, but that would in all probability cause financial panic in the global markets.

Trump is in a quandary because he will not be able to keep his campaign promise of reducing the trade deficit and expansionary fiscal policy, whether that is in the form of tax cuts or increased government spending. Trump will have to come to terms with what he would like to do, but based on what he has lined up, the dollar is going to become stronger.

As things currently stand, we shouldn't worry too much if the dollar is stronger. While the dollar has been appreciating, the Federal Reserve's price-adjusted Broad Dollar Index shows that the dollar has not been this strong since 2003, and is still below its peak in the 1980s. Another reason not to be worried: if the dollar gets too strong, American goods will be too expensive and foreign goods and services will look really good in comparison. In the short-run, that would increase demand for foreign goods and services, which would appreciate foreign currencies. Because of the economic concept of the J-curve, the dollar will eventually depreciate and reach enough an equilibrium to offset being too strong.

What I worry about is that Trump will use the "strong dollar/weak dollar" dichotomy to justify protectionist policies and raise the risk of trade retaliation. A drastic turn towards protectionist policy, the Federal Reserve increasing interest rates, or other forms of sudden policy can appreciate the dollar so quickly that it could send shockwaves across the global economy, especially for emerging markets. Given that the global currencies (i.e., the euro, Japanese yen, and Chinese yuan) are going through their own issues, screwing the global economy for some vague sentiment of "America first" would end up screwing over everyone, including the United States. Having stability during this volatility is a wise decision, according to macroeconomic consulting firm Capital Economics. Trump should be less focused on whether the dollar is strong because it is adequately strong at the moment, and instead should focus more on what will make for good policy. Making America great again would not be through retaliatory currency policy or protectionist trade policy, but through liberalized trade and for Congress to pass a more tempered fiscal policy than Trump was promising on the campaign trail.