The Issue:

Peter Navarro, the head of the new National Trade Council, told the Financial Times that Germany – a country with which the U.S. has a large trade deficit– uses a “grossly undervalued” euro to its advantage. The charge is that Germany and other U.S. trading partners are making their currencies artificially cheap in order to sell more exports to the U.S. and import fewer American goods. These statements would seem to indicate that the Trump administration is focusing on making the value of the dollar cheaper with respect to other currencies as part of its strategy to increase U.S. exports and reduce the country’s trade deficit. But how much power does the President, or any other leader, have over setting the exchange rate?

The Facts:

• The dollar has been rising since 2011 and is at its highest value since the summer of 2003 as measured by a broad currency index, and even higher according to a narrower index that just compares the dollar against major currencies (see chart).
• There is some confusion about what the U.S. policy towards the value of the dollar should be. The U.S. Treasury has publicly favored a strong dollar through successive administrations since the mid-1990s. In this view, a strong dollar is in the interest of the United States because it supports the sale of U.S. government debt, enabling the government to finance its budget by selling assets internationally.
• On the other hand, a strong dollar means that U.S. exports are more expensive abroad, which hurts companies that produce for international markets and hinders job creation in those sectors.
• Exchange rates largely reflect underlying economic conditions. The recent strength of the dollar is a reflection of relatively robust U.S. growth, as compared to the performance of other economies, as well as the stance of its monetary and fiscal policies compared to those of other countries.
• Politicians’ statements (or those by central bankers, or treasury secretaries) may have some short run effect on currency values and increase volatility, but typically not the long-run effect that is necessary for the change in the currency value to have an effect on exports or imports.
• While the Trump administration is giving signals that it would like to see a weaker dollar internationally, U.S. domestic policies seem, at least in the near future, directed to an even stronger dollar. Government policies that drive up interest rates, like tax cuts, spending increases, or monetary tightening, make dollar assets more attractive, increasing the demand for dollars and strengthening the dollar against other currencies.