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November 19, 2019

US Treasury Department does not need a dollar policy

dollar policyThe US finance ministers generally prefer to comment as little as possible the trend of the dollar, which is wise, as they do not have a reliable way to control it. When dare to comment, it is usually to say that they believe in a strong dollar in the very same way that defense ministers say they believe in a strong army.

Here comes Finance Minister Steven Mnuchin, who has accelerated the three-year decline of the dollar last week, saying that “a weaker dollar is good for us as it relates to trade”. Mnuchin’s comments are certainly unusual, but they are not a sign of a new policy toward the dollar, but rather of a new policy of talking about the dollar.

Indeed, the US currency is neither an instrument nor a (usually) target of the economic policies. Rather, it is an indicator whose significance varies depending on the circumstances. At the moment the message it sends is not a cause for concern.

Within the three years to 2016, the Bloomberg dollar index rose by approximately 25%. Since then, it has fallen nearly half. The earlier appreciation was mainly due to the fact that the US economy was recovering better than the rest of the economy. The recent downturn is not because of the slower progress in the US, as the economy continues to perform well, but because of the strong growth in other places.

This expansion of world economic recovery is the encouraging for the International Monetary Fund’s (IMF) positive economic forecasts released this week. The expectations for global growth in this and next year were pushed up again. For the most part, currency movements reflect this positive expansion.

One of the factors that complicates the situation is that the effects of currency movements affect the economy, particularly affecting demand. Steven Mnuchin is right – the cheaper dollar is fueling foreign demand. The depreciation is similar to relieving financial conditions and may increase inflationary pressure. The Fed will ensure that the fall in the dollar, along with the strengthening of the labor market, will not lift inflation faster than desired. If Fed sees this happening, it will have to speed up his plans to tighten monetary policies this year.

What the Treasury should worry about is the long-term financial health of the US government. The combination of stronger economic expansion and mild monetary conditions increases optimism, which risks becoming out of control. When the next big obstacle comes – and that will surely happen – the governments will need the financial opportunity to support demand for tax cuts and increased public spending, and financial institutions will need strength to overcome the difficulties. It is now time to improve these defenses.

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