U.S. Mid-Term Election and the Dollar

October 31, 2018

The result of the U.S. election on November 6th can be viewed in binary terms. Either President Trump and the Republican Party will emerge still controlling all three branches of the federal government or political power to some extent will be shared. Because authoritarian leadership tends to become more deeply entrenched as more and more time passes without it being seriously checked, the likelihood of an eight-year Trump presidency should and in fact will be perceived as much greater if the Republicans remain in the majority in both houses of congress than if shared power results.

Although President Trump has stirred up a load of controversy and uncertainty, the dollar has actually performed comparatively well in the approximately two years since he was elected in 2016. The table below considers the dollar changes over this period versus the euro and/or D-mark, the yen, and a trade-weighted index against all other major currencies, and it compares such with how the U.S. currency performed in the equivalent periods of the previous four newly elected U.S. presidencies, that is between the value when elected and the value at the time of the mid-term election two years later.

Dollar versus (%chg)                       Euro       Yen        TWI

Bush41                                              -17.1      +2.0       -12.3

Clinton                                                -3.5      -21.4        -2.7

Bush43                                              -14.3      +13.5       -8.6

Obama                                               -8.6      -16.3      -13.5

Trump                                                 -2.5        +7.8      -0.8

Monetary policy is unlikely to be affected significantly by the election’s outcome. Assuming the U.S. economy evolves as Fed officials anticipate and that there are no other huge surprises, the path toward policy neutrality is set to continue next year and into 2020. Jay Powell’s term as Chairman extends beyond the next presidential election. Policy normalization has lent considerable support to the dollar, especially since neither the ECB nor BOJ have begun to raise their interest rates.

The dollar has also benefited from fiscal stimulus, which tends to lift nominal long-term U.S. interest rates, and from lessening government regulation, which bolsters investor confidence in future U.S. productivity and economic growth.

Trump’s contentious trade policies are generating a lot of investor anxiety and unlikely to reduce the U.S. global trade deficit. But indirect effects of U.S. protectionism have seemingly buoyed the dollar. Trade wars aren’t lifting U.S. growth in the near term — net foreign demand subtracted 1.8 percentage points from third quarter GDP growth — but seem to be depressing other advanced and especially developing economies even more acutely. As protectionist measures intensify next year, so will the upward force on U.S. inflation and the Fed’s compulsion to tighten its policy stance.

Other Vaderesque elements of Trumpism similarly did not weigh on the dollar over the past two years. These include U.S. cultural divisiveness, the chaotic nature of daily Washington news, ethnic  and racial violence in the streets and in cyberspace, an Alice-in-Wonderland foreign policy that has overturned numerous long-standing conventions, and policies that promote rather than address income and wealth inequality in America.

It is in this latter respect where the election result may matter most. If Republican political power remains omnipotent, the last two years are likely to be remembered as the good old days next to what follows, and for the dollar that risks a flash point being crossed, a breaking point if you will in which investors may no longer ignore long-term dangers in favor of sound short-term economic momentum. Trump’s policy predispositions on immigration, new technologies, education, and climate change, for example, will given enough time have adverse implications for America’s competitiveness in emerging 21st century industries.

The fiscal deficit in the absence of a potent legislative opposition will likely grow even faster, and Trump will be tempted to be an even more outspoken critic of the Fed raising interest rates. And if the Fed doesn’t heed his pressure, it’s not far-fetched to imagine more blatant rhetoric calling the dollar overvalued.

The dollar’s continuing entrenched position as the world’s dominant paper currency hinges mainly on the TINA argument made famous by former British Prime Minister Thatcher: There is No Alternative. However, Trump is steering a path that undermines key elements that reserve currencies generally offer. It takes a long time for a critical mass to emerge in search of a different international monetary system. It’s only been two years since Trump was elected. If the Republicans as in 2016 dodge the prediction of an election defeat, the public will recalculate the probable durability of the present deviation in U.S. behavior, and investors are apt to become more determined in searching out other options. It may feel like a deal gone bad.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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