LOne of the most surprising policy ideas in the United States in recent times is that the new American president, Donald Trump, and his team would consider actively depreciating the dollar in an effort to boost the competitiveness of American exports and reduce the deficit commercial. If Trump tries, will he succeed? And what could go wrong?
The most brutal method would be to rely on the Federal Reserve (Fed) to ease monetary policy. Trump has certainly given up on replacing Fed Chairman Jerome Powell, but he could push Congress to change the Federal Reserve Act to lessen its independence. The dollar exchange rate would weaken considerably, the desired goal. But a looser monetary policy would lead to an acceleration in inflation, which would neutralize the impact of the fall in the dollar exchange rate. There would be no improvement in American competitiveness.
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Another possible path: The Treasury Department could use the federal International Emergency Economic Powers Act to tax foreign official holders of Treasury securities, by withholding a portion of their interest payments. This would discourage foreign central banks from accumulating dollar reserves, which would lower demand for greenbacks. Problem: reducing demand for US Treasuries to weaken the dollar would also increase interest rates. Furthermore, the risk of seeing foreign investors overreact and completely liquidate their dollar assets cannot be ruled out.
-More conventionally, the Treasury could also use dollars from its exchange stabilization fund to buy currencies. But increasing the supply of dollars in this way would be inflationary. The Fed would therefore react by withdrawing these same dollars from the markets, and thus sterilize the operation.
The price to pay
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