This is an entry (the first) in a series of blogs on news articles telling you “WhatYouNeedToKnow”
Publisher: New York Times
Author: @Neil Irwin
- The Trump administration’s behavior on currency & financial markets has been different from historical Presidential administrations.
- Historically, administrations say boring sentences like, “The currency is something the Treasury Secretary talks about.”
- Normally, the Sec. of Treas says, “A strong dollar is in the interest of the United States.” Period.
- Boring ‘platitudes’ are said to keep a stable, consistent, steady message to markets, investors, and businesses.
- Mixed messages – and plenty of additional commentary – is coming from the Trump Administration
- DJT has been implying that the dollar is too strong and “its killing us”, and “every other country lives on devaluation…and we look like dummies.”
- Steve Mnuchin, nominee for Sec of Treas, who is contradicting DJT somewhat, said in his confirmation hearing that “..I think (DJT’s) comment was not meant to be a long term comment.”
- (opinion) Mnuchin is midly commenting in the direction of “strong dollar”
- Other commentary – about the wall and NAFTA – have been influencing the Mexican Peso and the Canadian Dollar.
- The (floated? discussed? mentioned? retracted?) 20% tariff on imported goods from (?Mexico? ?Everywhere?) will likely cause a rise in the value of the dollar (per the article).
- Future events which may cause the dollar to rise – infrastructure spending, and the Fed increasing the interest rates (speculation/expectation)
I wrote a comment in the NYTimes article, but I need to write more.
This is potentially very *VERY* dangerous, and everyone needs to understand this. Everyone.
The NYT article was solid if not spectacular at setting the table, explaining what happened and how it is a change/difference from historical. Bravo. Short and well written.
One of the most important things about America and her Greatness (today) is her financial strength and the things that the world believes about us as a nation, as a people, as a society, and, effectively, the credit rating of our Government at paying its bills.
In this, we are #1, we are awesome, and there really is little to no dispute. Yay! Go us! We do finance well!
First, a quick story about belief from George R. R. Martin’s “A song of Ice and Fire”: A mercenary warrior is in a room with a King, a High Priest, and a very wealthy merchant. All three of them bid the mercenary to use his weapons to kill the other two. Who holds the power?
Answer: wherever the Mercenary believes the power resides.
Uncle Sam – the government of the USA – has the *BEST* reputation in the world for financial dependability and consistency. *THE BEST*. When financial panic happens, most institutional investors (think: hedge fund managers, and people who manage other people’s money professionally) – they often switch to increase investment in T-Bills. That means that they buy contracts for debt of the US Government. It is called, “Flight to safety”. What it means is that deep in the psyche of these traders of multi-million (billion?) dollar fund managers is “when I’m scared, and the markets are in true chaos, I trust the US Government the most. I won’t lose money there, and I can just park there in safety until the right time to move back into a position.”
All throughout the world, people who manage money for a living believe deep in their psyche that the US economy and the US Dollar are the most stable, most secure, most trustworthy place to be when there’s an economic storm at sea.
That’s an asset. It is not on any balance sheet. It is not an easy thing to qualify. But it is an asset. In fact, it may be the most valuable asset in the world. It is the behavior of the markets based on the belief systems of the fund managers. It is based on what they believe and what they perceive.
They believe in it because the US dollar is stable. Some countries just give up their own currency and everyone there uses the US Dollar. And no, they don’t need Uncle Sam’s permission. In 2006, there was about $753,991,000,000.00 USD ($750B) in circulation outside the USA.
PROOF – go see what happened to T-bills after one of the credit rating bureaus downgraded the USA from AAA rating during a Congressional Debt Ceiling impasse.
DJT is commenting on “the dollar is too strong” and “everyone else is devaluing their currency” and “we’re like dummies” – is behavior that can light a fire.
Fire cannot be intimidated. Fire doesn’t care what you put on Twitter. Fire doesn’t care how wealthy or poor you are. Fire doesn’t care. Once you set a fire, it will burn whatever it can.
DJT is thinking, “Hmmm….if the dollar is too strong, (*and everyone else is devaluing their currency*) well, then devalue the dollar.” Ugh!!! Google competitive currency devaluations. Or read investopedia’s entry – which says that while it may benefit the local economy (more exports, less imports, surge in economic growth), it is a “beggar thy neighbor” approach – it ships unemployment overseas. When everyone does it at the same time, it is a currency war. Global trade halts, and then *Everyone’s economy suffers*.
This happened in 1931, in the early days of the great depression. England, France and the USA all had recently gone off the gold standard, and all lowered their currencies in attempt to stimulate their economies. The Great Depression got worse because of it.
Second, it is not true that “Everyone is devaluing their currency.” (“First” was about belief) No. There was risk of it right after the Great Recession – in 2010, the Brazilian Finance Minister Guido Mantenga claimed it had happened. By the end of 2011, everyone backed down.
Third, let us learn from Argentina and Greece. Put “Argentina Currency Crisis ” into google, and the suggestions will give you choices: 2001, 2002, 2012, 2014, 2016. This is not because Argentina does not have well trained finance ministers. It is because every state government in Argentina can overspend and the national government has to pick up the tab.
Here’s what typically happens:
- Argentina is recovering from the last crisis, and on its way
- But they have debt. A lot of it. The IMF knows their finance minister by name. They use several tranches. (Google it)
- These debt overruns impact their ability to pay back existing loans (to huge banks, or the IMF, or whomever). Their credit runs out.
- When they stop paying, the *market perception* of risk in Argentina goes way up. Credit score goes down. Interest rates for the Argentina government go up. Existing debt becomes much much more expensive!!! (ouch!)
- This rise in interest rates hits businesses. They now pay higher rates, too. Businesses can’t expand. Can’t hire. Can’t invest. They slow down and rot economically.
- People lose jobs. Unemployment soars. Tax revenues fall even further. Government expenses go up (assistance to the unemployed, etc., etc.)
BOOM! Economic collapse. And how do you recover?
- De-value the currency. Yes, that’s almost an economic act of war. In Argentina’s case, with riots in the streets and defaulting on debt, everyone says, “Well…I hope they make it.” Neighbors (Brazil, Chile, Uruguay, etc) hope their economy can handle it and that the contagion doesn’t spread.
- Exports skyrocket, because the currency is now at 1/4 of its original value. Argentinian beef is cheap and plentiful. Imports dry up (they are 4x more expensive) Can’t buy foreign goods. Exporting industries bring in hard cash (Euro, Yen, Dollars, Pounds), giving much needed life to the Argentinian economy.
- Depending on risk appetite, some international investors send capital inflows into Argentina. The currency is cheap…yes. The currency is likely to go up…yes. For how long? More on this below. But FDI – Foreign Direct Investment – is always desirable. Always.
- Eventually, things stabilize. The currency slowly rises as the exporting industries power Argentina out of the last crisis, and they resume making payments on whatever debt they have…until….(lather, rinse, repeat)
Now back to DJT.
One can only guess that he sees the trade deficit and thinks, “we are suckers”. And a weak dollar is an “obvious” solution.
By weakening the dollar, imported goods (Walmart) get expensive. That means Trump voters far and wide will get bit. And exports? They boom.
Foreign direct investment might come in because the dollar is cheap. *But the existing foreign direct investment is now angry*. The USA has enormous amounts of FDI. Say you’re a wealthy investor from South Africa. Where are you investing your money? China? Japan? Germany? Britain? Russia? India? USA?
Many times, you’re investing in the USA, because the dollar is consistently strong. In fact, if the dollar rises relative to your currency, you profit – your investment is in dollars.
If the dollar drops say 20% in one day – that would be a huge global shock. Of course, the sentence, “The dollar dropped 20% today” is incomplete. It has to be *relative to other currencies*. But if the dollar dropped 20% in one day vs other major currencies, Katie bar the door.
If the dollar dropped 20% in one day, and you were a small investor from South Africa with investments in the USA, what would you do? Maybe, you’d sell. Maybe, you’d be worried about more drops. And the value of your investment just lost 1/5 of its value. Poof! Gone.
Now…the global economy is in shock. People are scared. They’re pulling their money out of places. Where do they go?
Where do they believe they have safe harbor now?
If the world comes to believe that Trump will destabilize the dollar….will the markets still believe that the USA is the safe harbor?
Here’s what likely happens next. Borrowing costs for the USA government go up. You know all of that debt that people sometimes freak out about and tends to grow each year? The US Government, which today can borrow money cheaper than any other thing in this universe, might no longer have the best borrowing rates. T-bills are below inflation. That’s almost a zero interest loan.
But when the world no longer believes in the USA markets and financial stability?
The prime interest rate goes up. Businesses have a harder time getting capital and their borrowing costs go up. So do consumer credit cards. People spend less money. The economy slows down. The federal debt grows. The deficit grows. And maybe…just maybe….the trade deficit shrinks. Or not.
The #1 thing that Trump cannot intimidate is a financial market. The market is like water flowing down hill – except it flows to the best, most profitable position given the perceptions of the money manager. Thomas Friedman writes about it like an enormous herd of Buffaloes that are stampeding. Get out of the way or they will run you over.
To Trump, almost everything is a negotiation. And in many business cases, being perceived as “crazy” can be an advantage in negotiation.
But one cannot negotiate with Fire. One cannot negotiate with water flowing in a riverbed. One cannot negotiate with international FDI capital flows. *They cannot be intimidated*
America is the biggest kid on the block when it comes to finances. We are indeed #1. And even when China’s economy passes the USA, you still will not choose to immediately prioritize FDI into China – why? – because there are restrictions on currency outflows and how you can get your money out (or not). You had better know what you’re doing if you put FDI into China. In the USA, you can count on fair proceedings in accord with the rule of law, and you’ll get your money out quicker than it got in, and you’ve got a stable currency that will likely only rise.
One of America’s responsibilities in this global finance system is tolerating the trade deficit. But a clear benefit from being the perceived, believed leader is that our borrowing costs are the lowest of anyone’s. The lowest in the universe.
So there are benefits, too.
Who knew international currency rates and finance could be so hard?
If you like Trump, I *REALLY* need you to understand this article. Finance is not a partisan thing.
WHAT YOU NEED TO KNOW:
- The world trusts the stability of the US Dollar, the US economy, and the US gov’t financial machinery and US case law to drive global investments and as a refuge in crisis.
- The Trump Administration’s running commentary has the potential to start undermining that trust.
- The commentary is divergent from almost every administration before which said boring statements like, “the US likes a strong dollar.”
- Undermining that trust may well damage the economic wealth and inheritance of our children, and may take money out of your pocket very soon.