There seems to be a lot of confusion over recent Tweets and calls by the President for the Federal Reserve to take aggressive action on interest rates. He’s been on a tear and judging by responses, many Americans aren’t sure what he’s talking about. Today was his clearest Tweet thread on the issue, yet it’s still a series of three Tweets that are not garnering his average levels of engagements in likes and retweets.
Even the comments seem a bit detached and often confused. Here are the Tweets:
….in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?
— Donald J. Trump (@realDonaldTrump) August 8, 2019
Quantitative tightening? Fed cuts? Strong dollar bad? The economic terms in which the President is and has been Tweeting aren’t difficult concepts, but they do require a bit of basic explanation and Twitter isn’t giving him enough room to do it. It’s time for the White House to put forth a plan, or at least an explanation, on the need to weaken the dollar for a relatively short period of time. Until they do, here is a brief translation of what the President wants.
Weaker dollar means more exports
It may seem counter-intuitive, as the President noted in the beginning of his Tweet thread, for a President of the United States to want the dollar to be weaker. We like strength. We’re America! But in some instances, strength has its drawbacks, and a strong dollar means more buying power and less selling power on the international markets.
The stronger the dollar is relative to other currencies, the higher the other countries’ costs are to import goods from the United States. I’ll illustrate this shortly, but buying power and selling power in the world of trade head in opposite directions based on currency strength.
Here’s a basic example. Let’s say, for the sake of easy math, that the dollar and the yuan are currently equal. $1 = ¥1.
Now, imagine two products, the Widget and the Wodget. In the US, the Widget sells for $500 and the Wodget sells for $600. In China, the Widget sells for ¥600 and the Wodget sells for ¥500. In this balanced scenario, it makes sense for American companies to buy domestic Widgets while importing Chinese Wodgets. The opposite is true for China who will import Widgets and export Wodgets. Make sense so far?
But something happens. China’s yuan is weakened by 20%. Now, ¥1 is only worth $0.80. The stronger dollar is great, right? America loves strength. But there’s a problem. Now, the $500 Widget the Chinese were importing from America when the currencies were balanced used to cost them ¥500. But their weaker currency means it will now take ¥625 to equal the $500 American cost. So it makes sense for them to buy their own Widgets for ¥600.
Conversely, the Widget American companies were buying domestically for $500 now costs more than importing the Widget from China. Even though it’s still the same ¥600, the drop in their currency strength means American companies can buy it with dollars at a rate of $480.
The stronger dollar means we have more buying power for imports. But it also means we have less selling power because it takes more of the other country’s currency to compensate for the dollar’s strength.
In short, a strong dollar is good for keeping costs lower for imports but makes it harder for American companies to export their goods. This is what the President was referring to when he Tweeted the strong dollar is “making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field.”
China’s devaluing their yuan
In an effort to win the trade war, China has been devaluing the yuan. It finally eased up yesterday after the White House condemned them for currency manipulation, which has been frowned upon by the international community for decades. But China has never shied away from things that are frowned upon.
Their weakened currency means their people have less buying power internationally, but the government hopes they won’t notice. And they’re probably right. Despite being a mass exporter, China has been practically isolationist when it comes to importing goods. They like to keep things Made in China and they don’t mind forcing their people to do the same.
To win the trade war faster, President Trump needs the dollar to drop. Tariffs can only do so much and focus on specific goods, while currency manipulation is a universal shift on all imports and exports. With the lower yuan, China is essentially telling the world now’s the time to buy as much from China as possible, stabilizing their economy temporarily as they struggle to cope with the President’s tariffs.
If the President can lower the dollar, it will counteract the effects of the yuan’s devaluation and make it easier for American companies to export. The trade off, of course, is that it makes it harder for American companies to import goods. This is a very bad thing in the long term; we are a consumer-driven nation. We need imports. But in the short term as we struggle through the trade war, it’s an acceptable trade-off.
Why the Fed has to do it
For the sake of brevity, let’s forgo any discussions of the Bretton Woods agreement, gold standard, and the dollar as the world reserve currency. Let’s just encapsulate it all into one statement: The world would not react well to direct U.S. government action to devalue the dollar.
The President needs the Fed to lower interest rates so dollars will be sold. We don’t have the designated funds available to influence the yuan or we would. So that means the fastest path to devaluing the dollar is through the Fed backing down rates relatively rapidly.
They could do more quantitative easing as they did during the Obama years, but that would be tantamount to unnecessary currency manipulation, so the President is simply calling for an end to quantitative tightening.
It’s still very likely we would win the trade war even with China devaluing their currency, but it’s unlikely we could do so before the 2020 election. The President wants a deal before then. The Chinese want to wait and hope the President loses the election. But they may be in for a shock even if that happens. They seem to forget that Bernie Sanders and other Democrats have been fans of tariffs on China since Donald Trump was on The Apprentice. This may be Trump’s trade war, but it’s conspicuous that few Democratic candidates are focused on that aspect of the President’s policies. China may find they don’t like what they get if the President is replaced.
As for the people, it’s important that we support the trade war even if we’re free traders. I am. But I also recognize that we’re in this trade war now and there’s nothing beneficial about screaming “free trade, free trade!” I’ll do that later. For now, whatever it takes for America to come out on top, I’m all for.
This is one of the few examples where Twitter isn’t enough. The President needs to lay out a written plan because he’s right about how to address this economic issue. Many of his supporters simply don’t understand it.
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