The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Unintended Consequence

08/21/2019

Traditionally, American politicians jump on a soap box, rip their shirt off, and pound their chest about a “strong dollar.”  It is a “flag, motherhood, and apple pie” kind of thing.  Every President has wanted a strong dollar, until President Trump.  That is one reason he has been so critical of the Fed.  He has a good point, as the dollar is up 11% over the past year.  The problem may be more complicated than he understands.

Money flows toward higher interest rates, like water.  Increasing interest rates attracts more money, pushing that currency higher.  Conversely, decreasing interest rates normally causes currency values to decrease.  However, when the Fed cut interest rates last month, as the President wanted, the dollar actually appreciated.  This unusual behavior reflects the different roles of money.  First, it is a unit of value.  Second, it is a store of value.

When the Fed reduced the rate, it confirmed U.S. economy is slowing down.  In other words, the economic engine for the world is slowing down.  Money looked for a safe haven, which is always America.  To move their euros, pesos, yen or whatever to the U.S., they had to sell their currencies, pushing down those values, and buy the dollar, pushing up that value.  In addition, “flight capital” from Asia in general and Hong Kong in particular has pushed up the dollar, gold, and bitcoin over the last few months.

There are a few advantages to a strong dollar.  For example, you can increase your imports more cheaply.  You can also travel abroad more cheaply.  You can brag about it!

There are many advantages to a weak dollar.  You can export more, because the price of your “stuff” is cheaper for foreign clients.  That improves your GDP growth and increases jobs, which is the reason every nation wants to devalue their currency.  One really delicate problem is that emerging nations often have to borrow in dollars, because nobody wants their currency.  When the dollar appreciates, the cost of re-paying in dollars goes up.

Bottom Line:  The President demanded that the Fed decrease interest rates, which they did, and which caused the dollar to go up, at least temporarily.

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