Pre-Election Thoughts on the Dollar

October 31, 2016

Election Day will not be a Rubicon. That river has been crossed already. Whatever verdict voters hand down, the world and the subset of world investors may not perceive the United States with quite the same esteem and trust that existed before this nasty, undesirably long and petty election campaign. The conventional wisdom believes that Clinton will win the presidency, Republicans will retain control of the House of Representatives, and control of the Senate is too close to call. Continuing gridlock is an odds-on bet if those presumptions play out.

America’s tarnished image needn’t depress the dollar. Other economies have economic problems and political dysfunctionalities of their own. China’s slowdown seems to have flattened, but strengthened growth there is not expected. Japan hasn’t shaken the remnants of deflation. Europe’s common currency experiment hasn’t fulfilled the dream of tighter political cohesion and faster economic growth. Quite the contrary on both scores. Great Britain, which didn’t adopt the euro, has now embarked on the bolder course of leaving the European Union, which presents enormous long-range uncertainties affecting the entire region. Similar political fractures to those in the United States will be on display in the French presidential election next April-May and Germany’s parliamentary election next September or October.

Because of bad politics all around, America is just one of many advanced economies that has employed insufficient fiscal support for too many years, thereby keeping the monetary lever at full throttle to a point where such is achieving diminishing results and risking possible more harm than good.

2016 was expected to be a good year for the dollar as monetary policy tightened in the United States while remaining unchanged or easing elsewhere. The big surprise was how little the Fed changed. Relatively greater polarization at the short end should emerge next year, but continuing low inflation likely will produce less diversity in longer-term interest rates. Inflation this century is proving to be more global than in the last one. Lessening differentiation of price trends across countries in turn has curbed the role of inflation as a key driver of currency movement.

The first year after a U.S. election has often been a volatile one for the dollar. Fixed dollar rates ended in 1973. The dollar soared in 1981 when the Federal Reserve reverted to an aggressively restrictive stance, literally doing matched sales on the Wednesday that followed Election Day 1980. The G5 Plaza Accord in 1985 gave an official blessing to a nascent dollar reversal, transforming such into a powerful three-year slide. The incoming Clinton administration of 1993 wasted little time jawboning the yen higher.

For the record, evidence is quite compelling that the dollar performs better when the president is a Democrat. Against the Deutsche mark and euro after 1998, the dollar fell 7.6% per annum when Nixon, a Republican, was president.  Under other Republican administrations, it dropped 2.9% during the Ford years, 1.0% per year with Reagan, 3.5% per year during Bush senior’s four-year stewardship, and 4.1% per year in the Bush43 period. While the dollar lost 4.4% a year against the mark under Carter, it appreciated 3.5% when Bill Clinton was president and has risen 2.2% per year in the 7-3/4 years since Barack Obama took office.

The current ultra-high level of homegrown and global uncertainties serve as a warning not to assume any outcome in the dollar based upon historical political cycles. Clinton haters will continue to throw everything they’ve got to discredit and incapacitate her administration, even if it means dragging down the United States role in the world. Governments in China and Russia have become more authoritarian politically and mischievous in their relations with the rest of the world. No doubt, they will test the new president early in a variety of ways.

As noted, many of America’s frictions are mirrored abroad. In numerous ways, the U.S. still looks the part of the one-eyed man in the land of the blind. But the dollar is not like other currencies. It’s been the lynch pin of the international monetary system for several decades. Being the king of the hill means there’s much more room for it to fall if the politics, economics or both appear to go seriously haywire. One needs only to look at what happened to the previous global currency hegemon, sterling, after it relinquished the role to the dollar to grasp what can happen to a currency transitioning away from a previous role that created massive offshore holdings.

Finally, one cannot entirely rule out the risk of a recession. By the middle of 2017, the U.S. will be entering its ninth year. If the business cycle were to pass a tipping point during the coming twelve months, it would be like no previous downturn. Interest rates are below their lows in prior cycles., and one cannot conceive any circumstances when the Tea Party wing of the Republican Party would ever agree to an intentional fiscal reflation, however badly such is needed.

Copyright 2016, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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