US China Trade and the Dollar

The US China trade dispute has been the main motif of the global economy for almost two years. The Federal Reserve, the European Central Bank, the IMF and the World Bank have cited its actual and potential risks numerous times.  

Politicians have headlined its dangers, economists have explored its details and commentators have expostulated on the foolishness of its pursuers. Fed Chairman Powell has mentioned trade time and again in the FOMC news conferences.  It is said to be the most serious threat to global prosperity since the financial crisis.

If the trade war is an economic calamity, then the currency of its chief progenitor, the United States, might be expected to pay the price of its economic ignorance.   

The trade dispute with China was instigated and promoted by the United States. It is Washington and President Donald Trump who are trying to change the terms of trade between the two nations. China would have been perfectly happy to continue as before.

The curious fact is that in all this time, the US dollar has strengthened against all majors except the yen.

Reuters

Since the stronger dollar is a fact we must consider two possibilities. The first is that the trade war is nothing of the sort, that its actual effect on the US economy is due more to sentiment than actuality.

If the current tariff regime became permanent, the US economy and then China and the world would adjust quickly with growth proceeding as it had before though perhaps in different channels.   This topic will be explored in my next column.

The second is that the results of the trade conflict, now in dispute but also in a potential settlement accrue to the US Dollar.

When the first set of tariffs on Chinese goods was announced by the White House on January 22^nd 2018 the dollar had already been sliding for six weeks. President Trump imposed additional tariffs in March and China responded in the first week of April with her own impositions on US goods.

The dollar reached its bottom shortly after the US tariffs began and for four months it bounced around at the bottom of its three year range.  Near the end of April the dollar broke out and it has not looked back since.

Starting from April 25^th 2018 the Dollar Index (DXY) has gained 8.5% to Friday’s close. The euro has lost 9.4% versus the dollar in the same period and the aussie 10.5%.

There are a number of reasons for the ascent of the dollar throughout this year and a half, the strength of the US economy and the tightening policy of the Fed being primary. 

But what is clear is that the waxing and waning trade dispute with China, including new US tariffs in July and September and retaliatory Chinese exactions and a continual war of words, has not had a negative impact on the dollar.

The American currency benefits from an unassailable position as the world’s reserve currency and because of the size and economic and political stability of the United States, it is the safe haven of choice for global markets.  Because of the vitality of its economy it is also often the choice for competitive investment.

Markets have been uniform in assuming that the trade dispute between the world’s two largest economies is a drag on economic growth, individually and for the globe and that an agreement would be the solution for the world’s doldrums.  

The early assumption that the logic and size of the commerce between China and the US would almost automatically produce an agreement has proven to be false.  Beijing and Washington, not surprisingly, have economic goals and practices that their governments have refused to surrender. As the optimism for a deal has faded the benefit has gone to the US economy and the dollar.

In an environment of ebbing economic growth at the long side of a decade's recovery, with most of the world’s central bankers in no position to offer meaningful support, the United States and the Fed are the best candidates for investment, expansion and return.  

The more the trade war between the US and China appears permanent, or amenable to only  limited improvement, the better the United States looks as a destination for discretionary funds.

But that is not the only advantage for the US. Were there a comprehensive deal between President’s Trump and Xi, the resulting acceleration in American business spending and the overall economy would likely propel the States back to 3% and higher growth.

The Fed’s worries would soon shift from decline to restraint. The rate pause would vanish and rate normalization II would be the new market watchword. Rising US interest rates and a booming economy would soon make the dollar more desirable than ever.