Could Trump devalue the dollar with a "Mar-a-Lago Accord"?

Paul Diggle

Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle

Luke Bartholomew

And I'm Luke Bartholomew.

Paul Diggle

Could the Trump administration engineer a weaker dollar? Why would it want to? Could the US convene another Plaza Accord similar to the 1985 agreement between the US and a variety of other countries to depreciate the dollar? And should we take the Trump administration seriously when it talks about the confluence of economic and foreign policy and domains beyond the currency, such as with tariffs oil prices, even territorial expansion into the likes of Greenland or Panama or Canada?

Well, those are some of the questions we're going to try and answer on the podcast today. They're big, difficult topics. But let's get into it. And I wanted to start Luke by talking a little bit about why the Trump administration's economic policies would be expected in the first instance to lead to a stronger dollar. And indeed, that has been the price action in markets, as Trump's winning odds increased and then as he's become the president. And there are at least three sort of obvious transmission channels.

One is through tariffs. Increasing tariffs would be expected to put upward pressure on the dollar and downward pressure on the tariff countries. And that is indeed the typical pattern that you saw in the previous trade war, in the past episodes of sharp tariff increases, the currencies move to partially offset the impact of the tariff increase. Or perhaps a little bit more formally, the demand for the tariffed country’s currency declines - and therefore the price of it declines and the dollar, by contrast, appreciates in price - because the demand for that country's currency is going down, because the demand for its exports are declining. And meanwhile, demand for dollars is increasing. And, you know, there can be inflation and policy interest rate effects as well. Tariffs might increase domestic inflation and therefore interest rates. So that's one very important transmission channel.

Second one would be in fiscal policy. If the Trump administration does pass fiscal stimulus tax cuts that might boost U.S. growth, inflation, interest rates and therefore push upwards on the dollar.

And the third perhaps more general point is a continuation of an environment of US growth exceptionalism would be expected to support the dollar. The dollar has this kind of ‘smile’ pattern, where it often does very well when the whole world is in recession and there is a flight to the safety of dollars. But it also does very well when the US is outperforming the rest of the world and demand for dollar assets is strong. And that certainly seems to be the environment. And if Trump's agenda is supportive of growth, deregulation supports growth and that could also be dollar accretive.

Luke Bartholomew

And the paradox with that policy mix, or at least the difficulty for market participants in figuring out what the Trump policy mix means for the market, is that whilst that, as you described Paul, would tend to put upward pressure on the dollar, Trump himself and I think many senior economic policy advisers around Trump would like to see a weaker dollar. And I think we should think of that as more than just a preference for a slightly different exchange rate. We should think of that as a view that is the result that stems from a wholesale critique of the current international economic order, which members of the Trump administration believe leads to a systematically overvalued US dollar and a weaker US economy. And that position essentially stands on its head the normal argument that is made about the ‘exorbitant privilege’ that comes from the US being the issuer of the global reserve asset. I mean, we've talked about this on the podcast before, but essentially, the US reserve status means that there's this huge price insensitive demand for US assets. That means that US interest rates, both for the government but also for the economy as a whole, are lower than they otherwise would be, and that during periods of crisis or economic downturn, that there is this ‘flight to safety’, to want to buy US assets, and that tends to push down interest rates, even if the US is the source of the crisis, the uncertainty, the bad economic news. And so in a sense, there's a sort of stabilising logic built into the system. And also that there's a strong dollar role in the global financial system gives the US traction to be able to implement aspects of its foreign policy through the financial systems, sanctions and the like. And that that is the so-called ‘privilege’ that comes from being the reserve asset issuer.

But it's important to note that the strong demand for US assets keeps the dollar elevated as well, and that strong dollar squeezes US exports and encourages imports. And in that sense, you can think of it as creating the current account deficit, which is the natural, necessary mirror image of the capital account surplus that comes from being the reserve issuer. And in particular, it's the manufacturing sector that tends to suffer the most from that stronger dollar. It is the most trade-exposed part of the economy. And it's sort of like a reverse mirror image to that logical stabilisation I was describing around interest rates. There's a sense in which the dollar has the impact of compounding the pain for the manufacturing sector during times of economic weakness. Not only does the manufacturing sector get hit by the fact that the economy is weaker, it is also hit by the fact that the dollar tends to be stronger during recessions due to this global flight to quality. So this is a double whammy on the manufacturing sector. And that, the argument goes, is actually the ‘burden’, the ‘exorbitant burden’ that the US has to carry.

And I think it's important to say that, like the standard economic take against that argument is to be a - relatively relaxed about current account deficits, but to be especially so about the impact on cross-sectoral differences. And, you know, the manufacturing sector being particularly badly hit. The thought is that this is just the process of competition, comparative advantage, efficiency gains, productivity improvements, doing their work. And whilst the manufacturing sector could be hit, this is beneficial for the wider economy. And I think the way that the Trump administration people would resist that argument is to say that there are two, at least two, very big externalities that are being missed in that analysis. First of all, the manufacturing sector is an absolutely crucial component of national security, that the ability to be able to manufacture certain material, armaments, whatever it might be, but then also to withstand, if it comes to it, a sustained economic blockade, are a crucial part of national security.

And then second, manufacturing decline in certain parts of the country can have this sort of non-linear cascade effect, where the decline of one industry then leads to the wholesale economic, and in turn social, collapse of certain parts of the country. And obviously, some of the people most affected by that are now a crucial component of the Trump electoral coalition, which is what gives this some of its political salience. But where the Trump administration people might take the logic even further is to argue that this exorbitant burden of the dollar system is of a piece with a global system that doesn't fairly share the burdens of keeping the international system going, both, in terms of economics, but also in terms of security contributions as well. So we should think of the Trump administration's view about the dollar policy. As I say, it's more than just a preference for exchange rates right now. It comes from a sense in which the entire economic order, international order, needs to be re-established in a way that more directly benefits US interests

Paul Diggle

And people. Talk about the possibility of another Plaza Accord in order to bring about the dollar depreciation that the Trump administration desires. So, I mentioned earlier, that the Plaza record was this 1985 agreement signed in the Plaza Hotel in New York between the US and four of its Cold War allies, the UK, France, Germany and Japan. It was an agreement to appreciate their currencies against the dollar to address US trade imbalances, reduce, the US trade deficit and the context was not only were they Cold War allies, but they these countries had only recently transitioned to broadly floating exchange rates. So that was institutional government memory of managing currencies. So, sort of, it was it was a lot easier to think about and do a large currency intervention at that point. And, you know, that is indeed what they did. Other countries directly intervened to buy dollars, sell their currencies. The US Treasury was doing likewise, and the dollar depreciated significantly against the yen, against deutsche mark. It was down something like 25% in pretty short order from its mid-eighties peak. The trade weighted dollar was as much as 40% off at its low point. And people say, or venture, that this could occur again. You know, a Plaza Accord 2.0 - and the cool kids call it a ‘Mar-a-Lago Accord’ - the idea that this time around it could be signed in Trump's Florida resort at Mar-A-Lago.

Luke Bartholomew

So I guess it's worth reflecting, then, on some of the similarities and differences between now and then to assess whether such a Mar-a-Lago accord is particularly likely. And I think one crucial difference between now, and then, as you say, Paul, is that the signatories of the Plaza Accord were all us Cold War allies. There was significant goodwill between these countries, and they were happy to do things that, you know, advanced US interests in that case, as part of a sense in which it was advancing broader Western interests as part of the Cold War. Well, it's far from clear that's the case now, right? I mean, probably where the US most obviously wants a currency revaluation is against China, which rather than being an ally, is, of course, a geopolitical rival. So it's not obvious that they'll want to do anything that helps the US out there. And then with regards to Europe, well, maybe there is still, a geostrategic bond, but it is worth stressing just how weak the European economy is right now. And it's far from clear that they would want the stronger economy - sorry, the stronger currency - that would come from such an agreement. And finally, I think it is important to understand that there is this sense in Japan and many Asian economies that the Plaza Accord was maybe the beginning of the end for the ‘Japanese miracle’, the post-war boom that Japan enjoyed, that the big revaluation of the yen, stronger squeezed Japanese exports, maybe in some way helped cause the asset price bubble that then eventually burst. But one way or another, it was responsible for, you know, the period that's often called the ‘lost decades’ in Japan. And I think, you know, there are reasons to disagree with that economic history, that economic analysis. But I think it is important to recognize that that that kind of argument is taken seriously amongst, economic policymakers across Asia. And so given that history, it's less obvious that there would be a desire to repeat it again.

Paul Diggle

Well, so those are some reasons why a ‘Mar-a Lago Accord’ might be unlikely, but I do think it is worth us giving some treatments and air-time to why actually it could be entirely plausible. And one point I think that jumps out at me is that tariff policy might not just be the source of dollar strength, but could also be the negotiating leverage that the US, that the Trump administration, uses to bring countries together in some sort of coordinated appreciation against the dollar. So the removal of tariffs or dropping the tariff threat could be, you know, the stick - or perhaps the removal of them as the carrot - to force a sort of coordinated effort to appreciate the dollar. And of course, we've had as I’m recalling very recently this experience we've watched with Colombia, where Trump has immediately used this idea of tariffs as leverage, as negotiating leverage, to force Colombia to accept US military planes taking Colombian deportees out of the US back to Colombia.

And, you know, another very obvious piece of negotiating leverage the US could have is that it could bring the future of the security relationship into currency policy. So you were talking earlier about how there's possibly this grievance in the Trump administration that the burden of the security blanket, the security umbrella, across Europe unfairly free-rides on the US, and that the dollar is a result of some of that international free-riding as well. Why not bring them together and demand currency appreciation against the dollar as a quid-pro-quo for, continued security blanket from the US alongside the clear demand that the administration has for European countries to increase NATO defence spending.

Luke Bartholomew

And I think all that's true. So let's grant, for the sake of the argument, that by hook or by crook or by whatever reason, the US manages to convince these countries that they do want to engage in a re-valuation of their currency against the dollar, then the next question becomes, well what can they actually do about that?

Because another difference to stress between now and the Plaza Accord is, as you noted back then, this was a context in which, intervention in foreign currency markets was much more normal. It was a standard part of economic policymaking. You know, we were still relatively new to the era of free-floating exchange rates. That's just not as true anymore. Foreign exchange markets are vastly bigger, and therefore government control over them is commensurately smaller. I mean, it is true that maybe China has the levers to bring about that re-valuation. It is of course, a managed currency, although it's, you know, I think the criticism that the US administration would want to make is that the management keeps the RMB artificially too low to encourage Chinese exports. And maybe that was once true, but that really isn't the case anymore. If anything, you know, if there was free floating of the currency, the capital account was opened up in China, there would probably would be downward pressure on the RMB. It would probably make the currency weaker, not stronger. So now the intervention would be pushing even harder, against those, those natural market forces. But then in Europe, I think the question is even harder. You know, if the French government, the German government wanted to bring about, a stronger euro, how on earth would they do so? You know, euro policy to a large extent is set by the European Central Bank, which amongst European treaties is effectively constitutionally independent. It is an independent inflation targeting central bank. It's just not like the Chancellor of Germany or the President of France can phone up the President of the ECB and bring about the changes in monetary policy that could lead to a much stronger euro. Those kind of policy possibilities don't exist in the same way anymore. And, you know, it might be the case that independent inflation-targeting central banks are themselves, a contingent feature of the post-Cold War period - that they arose in the 1990s and that's not a coincidence. But if that is the argument, then that involves a far more wholesale changing in economic policymaking, economic architecture, than just a shift to a weaker dollar. This is quite radical changes that we're talking about in that case.

Paul Diggle

Well, indeed. And, Trump himself intervened verbally in US monetary policy setting and in Fed policy, and, you know, the US, Trump administration can't control the dollar with an independent central bank in the form of the Fed as well. And all else equal, the reaction of the Federal Reserve to a sustained dollar depreciation would be to lean against it, because a weaker currency, would be somewhat inflationary, would push up the price of imported goods. It would mean, all else equal, higher interest rates, and that is going to potentially bring Trump and the Fed in into conflict - leaving the possibility, a very real possibility, that political intervention in the Federal Reserve is only going to increase. And Trump is likely to exert that power somewhat through nominations on to the Fed board, although the turnover on the board is such that that's a somewhat limited power at this point. But I think most of all through the use of the ‘bully pulpit’ of rhetorical pressure, moral suasion on Powell, who we know he's not particularly happy with. Powell is, of course, a Trump era appointee that Trump has now expressed dissatisfaction with. And I think that's really going to be a clear trend of influence, pressure on the Fed to push interest rates, in a lower direction, which Trump would favour.

Luke Bartholomew

And it's also worth noting that outside of these kind of multilateral arrangements, there are possible paths that the US could go down to unilaterally try and bring about, a weaker dollar. And indeed, part of that is, as you were describing there Paul, influence on the Federal Reserve. But another way that's actually been talked about by Steve Moran, who will be, assuming he gets Senate approval, the head of the Council of Economic Advisers, an important policy adviser to Trump. And he has talked about this in a policy paper he wrote before his nomination that one thing that the US could do is put, as he called it, ‘service charges’ on the use of, or the investment in, US Treasury securities. And ‘service charge’ there is effectively just a euphemism for tax on the coupons that the Treasury pays to people outside of the US who hold treasuries. You don't call it a ‘tax’ I think, in this telling, because of legal reasons, treaty reasons. But effectively that is what it is. And the thought is that by taxing capital inflows to the US, you make those less attractive. And therefore, you know, the hope is that without too much of an influence on interest rates, you're able to reduce the bid for the dollar and make it weaker that way.

I think there is a sense that you do have to be careful what you wish for here, that at a time where US deficits are extremely large and there are going to be very big financing demands that the US government needs, it needs a large inflow of capital to be able to finance its deficits. To put a tax on that might end up leading to an undesirable increase in interest rates, in particular via the term premia. And I suppose in the ‘limit case’, it could end up undermining this very reserve status thing that despite concerns about currency valuation is still something I think the Trump administration wants to cling on to. After all of these moves of the dollar, they still would like to see the dollar as the reserve currency. And there is a risk that if you push this service charge thing too far, it rather undermines that status.

Paul Diggle

But I want to pivot us slightly to thinking about some of the other ways in which the Trump administration is going to combine economic policy with foreign policy and other aspects of its policy agenda. I've spoken a little bit about how the Trump administration may use the threat of tariffs to increase European defence spending - so that's using an economic tool to pursue a foreign policy, a military aim. We've talked a little bit about Colombia and how the use of tariff policy there is, is helping to pursue immigration policies of the Trump agenda. But we saw Trump at Davos deliver a speech in which, amongst many other things, he asked OPEC countries to increase oil production and lower the price of oil. Again, this is, I think, a combination of economic policy, foreign policy. But look, an area where a lot of attention has been focused is on what Trump has said about Greenland, Panama, even Canada - that the US would seriously consider military action and territorial expansion into those areas to pursue economic policy aims. And I think the point we want to make, Luke, is let's not instinctively reactively snigger, sneer and dismiss that rhetoric. That is to say, fail to take him seriously. I think we can just about safely not take him literally on that stuff. Maybe. Hopefully. But I think it is dangerous not to take him seriously. And I think a lot of people have spoken after the first Trump administration about this framework of taking Trump seriously, but not literally, that being most analytically helpful approach to understanding the Trump policy agenda. And look, here's the best articulation of how to take Trump seriously but not literally when he talks about U.S. territory expansion to Greenland and Panama. Greenland especially, but the Panama Canal as well, are crucially geostrategic positioned in North America. The Panama Canal, as a shipping lane that obviously connects the Atlantic and the Pacific. Greenland, as an enormous expanse of land in the North Atlantic where there is already a significant US military airbase, where additional shipping lanes through the Arctic may well be opening up through the course of climate change, and when also related to climate change, resource extraction becomes ever more possible. Greenland is thought to be rich not just in oil and gas, but also in a wide range of the critical minerals that are essential to the energy transition. So understanding that there is a geostrategic and resource extraction logic to the Trump administration talking about the importance of Greenland, Panama, and to some extent Canada, I think that's the right frame to actually take that seriously.

Luke Bartholomew

And on this topic of taking things seriously, I mean, I think what the Trump administration would say is that it's Denmark that's not treating Greenland with the appropriate, seriousness, given its geostrategic importance, its position on the map, especially given climate change. And it's just not acceptable from a US position how Denmark have treated Greenland, both in terms of the military resources that are allocated to it and the sense in which they're there's been a drift towards independence in Greenland. And, you know, from a realist perspective, outside of moral concerns, it is just not realistic to think that Greenland, with a population of 57,000 people, can be a sovereign entity with no real capacity to provide for its own defence on a piece of land, which is geostrategic ‘hot property’, that is a source of competition between Russia, China and the US. That's just not serious from Denmark's perspective, to think in those terms. That's what realism demands - that you think in those terms. And I suppose an interesting question to ask is how that kind of thinking squares with, you know, this thing that's often said about the Trump administration, and indeed, I think, you know, at times he would say it himself, that he wants to avoid foreign adventurism. He wants to have a policy which sees the US less involved in many foreign policy ‘adventures’, as they might put it. And I think isolationism is the wrong word for that. But certainly, it is a policy, as I say, in Trump's own terms, which would see the US doing less things abroad than it currently has been doing. So how do you square that with these claims around Greenland? And Panama? And I think, you know, the logic of the Trump administration on foreign policy is one of great powers having control over their own sphere of influence. And then the question becomes, what is your sphere of influence? You get to be the boss of your own backyard. So what is your backyard? And the US government seems to be asserting very strongly right now that Greenland and indeed Panama are their backyard, and they have claims to that.

Paul Diggle

Yeah. And perhaps an eventual plausible outcome from all that could look something like more military bases and resource extraction rights in Greenland. Denmark putting Greenland's gradual drift towards independence to bed. In Panama and the canal it could be some sort of joint control over the canal or cheaper shipping transit rates for the US. So that might be, you know, let's hope to some extent the literal eventual outcome. But I think the point we want to make is there is a serious logic to understanding why the administration is interested in those locations.

Luke Bartholomew

Yeah. And moreover this US administration is up for using the full array of American hard power to achieve both its economic and foreign policy aims, and that is across tariffs, that is across currency policy and that is across territorial claims as well. And look, I often say at the end of these podcasts that no doubt we will come back to these topics and talk again, but these definitely feel like topics we will be coming back to. But for now, that is all we have time for this week. So, as ever, please do like and subscribe wherever you listen to your podcast. And all that remains is for me to thank you all for listening. So thank you very much and speak again soon.

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