Illustration: Peter C. Espina/GT
When US President Donald Trump was confused about the dollar movements, he made a phone call to Michael Flynn - who has since resigned as national security advisor - according to the Huffington Post on February 7, who told Trump it didn't belong to his area of expertise and that he should seek advice from economists instead.
In this case, I'll share some insight on the advantages of a strong greenback versus a weak one, and the prospect of the dollar and movements of the yuan exchange rate in the Trump era.
Under current economic circumstances in the US, a strong dollar can benefit the country in several ways. The first is helping maintain the dollar's leading position in global foreign exchange reserves. Since 2014, the greenback entered a new cycle of appreciation, which was then followed by increases in dollar assets represented in global foreign exchange reserves.
Correspondingly, a strong dollar will allow the Federal Reserve, the US central bank, to profit substantially from printing the currency.
Further, a strong dollar will attract foreign capital to the US. Trump's tax-cut and infrastructure moves are both expansionary fiscal policies, which in the short term will substantially increase US debt.
In the 1980s, president Ronald Reagan adopted a strong dollar policy to attract international capital back to the US so as to finance its expanding government debt. The dollar index during Reagan's administration once climbed from 90 to 165, leading to huge amounts of petro dollar and international capital to flood into the US.
Similarly, rising government debt during the Trump administration requires the same financing demand. Trump's plan to invest $1 trillion in infrastructure in the coming decade needs involvement from foreign capital, and a relatively strong dollar will encourage this influx.
Although the dollar at the moment is gaining strength, it may embark on a depreciation trend, of which the biggest benefit is to US exports.
Since the establishment of the WTO in 1995, US exports have decreased substantially. This, due to adjustment in the division of international industries, has been a sore point for Donald Trump and the US government.
A relatively weak dollar will elevate the competitiveness of the US export sector and boost export volumes, which is in line with Trump's goals of revitalizing US manufacturing and boosting the real economy. Statistics from information provider Wind show that the US had recorded 20 consecutive months of negative growth in exports since 2015 before turning positive in August 2016. Since then exports have been on an upward trend, which has to do with the fact that the US dollar index decreased by 5 percent in the first half of 2016.
Since the fourth quarter of 2016 the dollar began appreciating and is expected to put more pressure on the exports in the first half of 2017. This could explain why Trump attempted to seek Michael Flynn's advice and has frequently accused the central banks in China, Japan and the EU as currency manipulators as he cannot intervene in the Fed's decision on interest rates.
Trump may face a dilemma regarding the dollar. The US economy currently has several difficulties, including record-low growth, a slowing trend in labor productivity in the real economy, a new low in manufacturing and industrial output, dilapidated infrastructure and a widening income gap. But a strong dollar is unlikely to help solve these problems.
In the long term, the Trump administration likely won't hope for a too-strong dollar, but will seek to maintain a stable or comparatively weaker dollar.
Interest rate hikes from the Fed have served as the main driver of the dollar in recent years, but historical data show a rate hike does not necessarily lead to a strengthened dollar. For instance, in the beginning of 1993 and the second half of 2004, interest rate hikes didn't change the trend of two-way fluctuations in the dollar.
In this respect, the magnitude and pace from the Fed's rate hike will serve as the key influencing factor on the dollar index, but in the mid-to-long run the room for a continued strengthening dollar is limited.
In China, with the current yuan exchange rate formation mechanism, the main policy target for China's central bank lies in the stability of the yuan exchange rate index, and the yuan movement against the dollar will largely be determined by the dollar.
Looking at China's economic fundamentals, its economy is drawing an "L-shaped" growth. China is a major economy with a relatively strong growth and a surplus in its current accounts, which are beneficial to maintaining a comparatively stable yuan exchange rate.
On the policy level, strengthened measures have been adopted since the beginning of the year targeting capital outflows related to fraudulent trade and investment. As long as there is no sharp appreciation in the dollar, the yuan is unlikely to passively depreciate. In addition, in order to avoid a psychological impact on markets and investors, China's central bank is expected to make efforts to sustain a certain threshold of the yuan against the dollar.
The author is the director of the Macroeconomic Center at the Suning lnstitute of Finance. email@example.com