Treasury Dept., Industrial Policy: Weak Dollar & The Consequences

Having the U.S. dollar appreciate nearly 20% over the last six months is a boon to anyone struggling, it is a serious fiscal problem for governments saddled with unreformed economies and highly leveraged multinational firms who work within the Keynesian matrix of favoring debt over equity.  No one knows how this will play out out, but I would not expect team Trump to upend Treasury longstanding U.S. industrial policy of favoring cheap money.

Here are a few points to ponder IF this problem shows up:  a rising currency can be a stimulant and a falling one a depressant.  This is because their is a negative relationship between changes in GDP and currency shifts discerned in the trade channel.  This evidences that net trade adds to economic growth during depreciation and it detracts growth when the currency appreciates.  For extremely large nation states like America, our trade channel shapes the components of our GDP more than any financial channel.  So mixing around with exchange rate regimes is almost always futile.

Here’s a simple rule:  a stronger exchange rate, on balance, will speed up the economy; a weaker exchange rate will slow it.

What underwrites all this arcana is the growing influence of the global financial cycle/FDI/capital flows that rapidly respond to discrete shifts in appetite for risk.  This is why interest rates matter.  It also proves that prices in risky assets move in lockstep with global capital flows; this in effect is shaped by monetary policy which influences the scale of borrowing in dollars.  This entire cycle is playing out today.  When the federal reserve lowers its interest rate, it makes borrowing cheaper, but it also drives up foreign assets, driving up the value of collateral; its a boon for foreign markets trying to raise capital.

All of that is now in reverse and the only ones favorably positioned are those political economies with sound social bases, with credible institutions.

What should Beijing and others take away from this insight:  it should shape policy from within the confines of knowing that cheap money will not boost a failing economy.  And technocrats credentialed from fine universities should know that fiddling with the exchange rate is akin to accounting; it makes sense on paper but it resolves nothing related to the financial channel, the main tributary that amplifies the credit cycle.

'Don't worry. The pound has devalued, so you've actually lost weight.'


About William Holland

Systematic Theologian/International Relations
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