A victory by Republican candidate Donald Trump in the U.S. presidential election in November 2016 would be expected to provoke some reaction in the economy and the dollar. In particular, it's because Trump and the Republican Party are seen introducing changes in economic policy currently run by the Democratic Party.
Exchange Rate Trends In Republican Administrations
In certain Republican administrations—Ronald Reagan in 1980 and George W. Bush in 2000—the dollar has strengthened, at least initially, and then later weakened following some changes in direction of policy introduced midway through their durations.
During Reagan's tenure, the strong dollar became detrimental for the U.S. economy, and in 1985 the government coordinated with major economic partners in the group of five to allow the dollar to weaken globally. Similarly, at the outset of the Bush administration the dollar gained strength, but it soon weakened under the influence of a large U.S. current account deficit and interest rate easing carried out by the Federal Reserve.
Republican Party Positions
The Republican Party platform in 2016 follows the general lines of traditional GOP proposals favouring austerity and budget control. However, it differs in some respects with the proposals put forth by the party's presidential candidate, Donald Trump, who appears willing to sacrifice certain economic goals in the short term in favour of longer-term adjustments.
There is an apparent division and, at times, contradictions between some currents of thought within the GOP on foreign trade. According to its 2016 platform, it envisions "a worldwide multilateral agreement among nations committed to the principles of open markets, which has been called a 'Reagan Economic Zone.'" At the same time, the party calls for "better negotiated trade agreements that put America first," thus adding a protectionist tone to more traditional free trade policy orientation.
The party's vision also seems to contrast with that of Trump. He has called some major trade agreements and proposals into question, such as the North American Free Trade Agreement and the Trans-Pacific Partnership. While the party does speak in favour of trade deficit reduction, it does not suggest that it would move strongly in that direction, and the overall impact of its trade platform on currency would appear to be neutral.
While some Republican administrations have publicly backed a "strong dollar" policy, the party has advocated for a stable value for the dollar in its 2016 platform. It's also proposed a committee to investigate ways to set a "fixed value" for the currency. Technically, the Federal Reserve is independent from the federal government, but it could be influenced through future appointments by a Republican administration.
Although the party doesn't indicate a specific preference for monetary policy in its platform, it does admonish the use of political pressure for "easy money and loose credit," suggesting it would be inclined to allow the increase of interest rates that have remained near zero for the past several years. Further, certain Republican administrations have shown a preference for strong inflation control and more hawkish interest rate policy, a factor that could be conducive to the strengthening of the dollar.
In its 2016 platform, the Republican party has proposed a reduction in the corporate tax rate, in line with a proposal by Trump. It has also proposed a "territorial system of taxation" allowing profits earned and taxed abroad to be repatriated for local investment.
As part of their traditional discourse, the Republicans have favoured a general reduction of budget deficits and debt. However, this hasn't necessarily occurred in practice The administrations of Ronald Reagan and George W. Bush—in addition to Republican caucuses in Congress—allowed the expansion of debt to accommodate military spending and ongoing tax reductions.
In its 2016 platform, the party has proposed imposing caps on future debt, implementing spending restraints, and accelerating the repayment of debt accumulated to date. A reduction of the debt would help favour a stronger dollar. Republican congressional initiatives to impose a debt ceiling and reduce the debt during the last two presidential terms were unsuccessful, however, in the face of the Obama administration's resistance to implementing that policy.
Trump's proposals are generally in line with the platform of his party, though they stand apart in terms of intensity. And, in some areas such as foreign trade, they appear to diverge somewhat. He has spoken in favour of a weaker dollar, but it's not clear that his proposed policies would produce that effect.
Revisiting An Open Trade Stance
In his campaign, Trump has championed a protectionist trade stance. He said would exercise caution in negotiation of more free trade deals with other countries and regions and possibly re-negotiate existing trade deals. It would be under the premise that this position could help reduce the foreign trade deficit and favour a return of industry and jobs to the U.S.
In particular, Trump has attacked trade relations with countries like China and Mexico, asserting that they and others have gained an unfair edge in trade. The U.S. trade deficit has recently reached a level of around US$500 billion annually. The reduction of the trade deficit is a factor that would reduce the supply of dollars in the world economy and thus help strengthen the value of the dollar.
A More Aggressive Federal Reserve?
In line with Republican tradition, Trump has hinted that he would allow for an increase in interest rates if elected. The policy would favour a strengthening of the dollar, because it would likely attract foreign currency into the economy from investors seeking rising yields. However, the Fed would also likely be constrained from implementing a strong increase in rates as that could:
- pressure debt service costs,
- discourage foreign investment in U.S. equities,
- raise domestic borrowing costs
- and possibly slow economic growth.
Lowering the Tax Burden
Generally, Trump favours tax cuts as a manner to stimulate the economy. For individual taxpayers, he proposes to collapse the seven existing tax brackets into three, to be set at 12% for household income up to US$75,000 annually, 25% for income up to US$225,000, and 33% for income over US$225,000. Additionally, his plan would lower the business tax rate to 15% from a current 35% and maintain the capital gains tax rate at a maximum of 20%.
One proposed tax measure that could have a visible effect on the exchange rate is the proposed repatriation of corporate money held overseas with a discounted tax rate. The measure would bring a net inflow of dollars back into the economy. When a similar measure was implemented in 2005, the dollar reacted by strengthening around 5%.
Budget Controls: Pinching Pennies?
Trump has stood in favour of a general reduction in the national debt, which is set to end 2016 at around US$20 trillion. As part of his campaign proposals, he pledges to reduce spending by one cent per dollar under a so-called "penny plan" that would allegedly shave about US$1 trillion off the debt over a period of 10 years. However, the immediate effects of tax reductions included in Trump's proposals have been calculated by some analysts to add between US$5-10 trillion to the debt. A net debt increase over time would have a weakening effect on the dollar, but that might be neutralised over time by the effect of tax reduction stimulus and increased growth of the economy.
Policy Proposals At Odds with Intentions?
The possibility of a stronger dollar may be at odds with Trump's stated intentions to boost revenues and employment domestically, because it would encourage imports, make exports less competitive and possibly discourage both incoming direct and portfolio investments. Considering this, an incoming Trump government (like some of its Republican predecessors) may eventually be persuaded to revisit its currency-related policies at a later date depending on whether they are conducive to its goals.
If the Republican candidate wins the presidential election, the proposed policies suggest a possible strengthening of the dollar versus other major currencies. In particular, a move toward higher interest rates could encourage an influx of currency from abroad, bidding up the value of the dollar. However, the U.S. economy is facing a restrictive situation, with high indebtedness and sluggish economic activity. This suggests that any change in monetary policy would have to be carried out in a gradual manner and that any corresponding strengthening would also be gradual.
Additionally, the amount of strengthening may be tempered by the amount of support that the president could obtain for his proposed policies within Congress. A larger Republican majority in the Senate and in the House of Representatives could favour the implementation of debt reduction policies, which would encourage strengthening of the dollar; while a split Congress or Democratic majorities could lessen that effect.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…