While investors are justifiably focused on what may be the opening crescendo of a long overdue sell-off in stocks, there is not, as of yet, as feverish a discussion of the parallel sell-offs in bonds and the U.S. dollar, which have been underway for at least a year and a half in bonds and 14 months for the dollar. I contend that this should be widely understood as the root causes of the jittery Dow, and are ultimately far more important. A continued decline in the dollar and bonds holds the potential to ignite inflation while increasing mortgage rates, borrowing costs, and federal deficits. These developments would strike at the very heart of the economic foundation that has supported the country since the Financial Crisis of 2008, and threaten to push the economy into a recession that the Fed may be powerless to confront.
Secretary of the Treasury, Steve Mnuchin, stunned markets late last month when he said that a cheaper dollar would be a welcome development for the U.S. economy. The dollar sold off sharply as Mnuchin's words appeared to be taken as proof that the Trump Administration overtly embraced a weaker dollar. To quell the uproar, President Trump himself, freshly arrived in Davos, Switzerland, had to "clarify" the Secretary's comments, explaining, as only 'the Donald' can, that by "weaker" Mnuchin really meant "stronger."
The exchange did provide a fresh twist on our decades-old "strong dollar policy," which traditionally works like this: The President and/or senior Fed officials refer all questions about the health and trajectory of the U.S. dollar to the Secretary of the Treasury, who proclaims loudly and clearly, with no trace of irony, that "a strong dollar is in the national interest." These comments reassure the markets, the dollar rises, and the operation is complete. Although this protocol is one of the simplest Washington has to offer, the Trump Administration managed to get it wrong on its first try.
Despite the fact that Trump's vocal support for a "strong dollar" was not accompanied by any indication that he would actually do anything to support it, his words temporarily reversed the dollar's 24-hour skid. But apart from reacquainting us to the absurdity of a "policy" that is simply based on mouthing a canned phrase, the episode raises a couple of key issues. Trump claimed that the economy is surging and, as a result, the dollar will keep getting stronger and stronger. The problem with these assertions is that neither is true.
Last week's newly released Q4 GDP report from the Bureau of Economic Analysis (BEA) shows that the economy grew at 2.6% in the Fourth Quarter, bringing the entire year's GDP growth rate to 2.4%, only .2% higher than the 2.2% GDP growth that we have averaged over the prior three years (2014-2016). And while 2.4% is marginally higher than the average growth we have had since the end of the 2008 financial crisis, it is still significantly below the average over the past century, and even weaker than two years of Obama's second term.
The news is also surprisingly weak on the trade and employment fronts, another two areas for which Trump has shown particular enthusiasm. Contrary to the supposed "record job creation," average monthly job gains in 2017 were 17% slower than the combined averages in 2015 and 2016, based on data from the Bureau of Labor Statistics. In fact, job growth in 2017 was its slowest pace since 2010. Similar disappointments can be found in America's trade balance, which, according to Trump, has improved dramatically due to his "tough" negotiations and our resurgent manufacturing sector. But according to the U.S. Census Bureau, average monthly 2017 trade deficits (through November) were 11% wider than 2016, and 14% wider than the average over the prior 4 years. What's worse is that these increases come at a time when a falling dollar, in theory, should have narrowed the gap!
Given all this, one would be hard-pressed to find the "boom" Trump describes, especially if one is also claiming that such windfalls were not occurring under Obama. But since when have facts ever mattered in Washington or on Wall Street?
So if Trump is wrong about the economy, jobs, and trade, what should we make of his view that "the dollar will get stronger and stronger?"
While the financial media has been focused on the stock market, most have dismissed the significance of the declining dollar. 2017 saw the first annual; decline in the dollar in five years and its largest decline in 14 years. 2018 is off to an even worse start, with the dollar registering its steepest January decline since 1987. In fact, against the Chinese yuan, January was the weakest month for the dollar since 1994. The current decline in the dollar index that began in December 2016 is now the longest continuous decline in the last 12 years. And while other recent declines have been steeper (see chart below), this one is distinct because it is occurring against a set of economic conditions that should be bullish for the dollar. Economic growth is assumed to be strong, consumer confidence is high, and the Fed is expected to keep raising interest rates and actually shrink its balance sheet (which would diminish the supply of dollars).