EU: A ‘Bureaucratic Consortium’, ‘Vehicle For German Interests or Simply a Tired-Out Project?

Financial market actors are opportunists, and they focus very much on the short-term. Even though the Dow Jones Industrial Average is a rather meaningless index as it covers only tiny parts of the US-economy, the first-time-ever jump over the 20,000 point mark shows that financial investors love what they see: A version of deregulated capitalism that will benefit the riches. There is no empirical evidence at all that financial markets or for that reason individual capitalists would know how a macroeconomy works. What they know is what a good deal looks like – in particular a deal where they came gain from or move out quickly if expectations are not met. In this regard, the Trump presidency promises a good deal, short-term.

All this optimism should result in a stronger US-Dollar. Why then was Trump uttering that he does not believe in a strong exchange rate of the USD? The answer is straightforward: Any further appreciation of the USD against key currencies makes his plan to increase manufacturing output and jobs much more difficult as imports will get relatively cheap and US-exports relatively expensive. There are at least three reasons why we should expect a stronger USD if Trump follows through with his announcements. First, the output-gap of the US-economy is already pretty small and the plan for a more expansive fiscal policy by means of tax rate reductions and public infrastructure program will increase the inflation rate. Given the already started policy change of the Federal Reserve, an increase of the inflation rate will force the Fed to speed up the increase of the lead interests rate. The result will be a inflow of hot foreign capital, and thus a upward pressure on the exchange rate. Second, the planned tax cuts in combination with the suggested increase of expenditures for national security and for infrastructure, including the infamous Wall, will increase domestic demand, contribute to upward price pressure and make import goods via USD-appreciatiopn even more cheaper. Again, the Fed will have to deal with the rise of inflation. Additionally, the trade balance will move further into red territory. Third, should the Trump administration get serious with the introduction of border tax adjustments and import tariffs, then potential import goods would get more expensive. This would increase the demand for domestic goods. In a situation of close full employment, the result is a rise of the overall price level, which then again requires action by the Federal Reserve. Higher interest rates will create an appreciation that then add downward pressure on prices of import goods. Higher interest rates also will undermine the optimism of financial markets, and add serious problems to marginal lenders and over-leveraged actors. Soon we are back in a situation of a twin-deficit in combination with financial fragility.

What then? One way to avoid all those turbulences would be to move towards full protectionism. This would include not only tariffs and border tax adjustments but also the introduction of capital controls to deal with exchange rate appreciation effects. This is not a unheard of manoeuvre, and has been practiced by Republican Presidents in the past. Is Trump ready to go for it? Nobody knows but it may be always a good idea to prepare for the worst.