U.S. election outcome and the dollar

9 November 2016

The U.S. presidential election should serve as a reminder that it is very risky for the international economy to rely on a national currency. Donald Trump’s win surprised markets and it is unclear what it means for the continuity in U.S. economic policies and therefore the dollar. In Trump’s surprisingly conciliatory victory speech he indicated that he will work with all nations in partnership. That is positive. However, the potential downside or considerable uncertainty a Trump presidency may cause remains disconcerting. The dollar may just have become much more a national currency and this should greatly concern the international economy.

The dollar has been the dominant international currency at least since World War II. It has had many advantages but also increasingly disadvantages. There has been increasing apprehension about the external effects of U.S. monetary policy. The election probably will now result in a more inward-looking U.S. It will also have repercussions on monetary policy conduct. The Fed will not subordinate its national policy objectives to international concerns about the dollar. This may now matter even more.

The seemingly more general trend in the U.S. and Europe towards a more nationalist agenda is at odds with the use, almost exclusively, of a dominant international currency. The dollar as the principal key currency was propelled by international treaty through the Articles of Agreement to establish the International Monetary Fund (IMF) at the Bretton Woods Conference of July 1944. It was then part of a bold U.S. vision to foster international economic integration. U.S. Treasury Secretary Henry Morgenthau and President of the Bretton Woods Conference remarked in his address to the Closing Plenary Session in July 1944:1

“There is a curious notion that the protection of national interests and the development of international cooperation are conflicting philosophies—that somehow or other men of different nations cannot work together without sacrificing the interests of their particular nations. Yet none of us has found any incompatibility between devotion to our own countries and joint action. Indeed, we have found on the contrary that the only genuine safeguard for our national interests lies in international cooperation.”

International fragmentation was the central concern of Bretton Woods. Edward Bernstein, a key U.S. Treasury official at Bretton Woods wrote in December 1944:2

“The world is in desperate danger of reverting […] to economic isolation that will inevitably breed political isolation. Those who talk […] of bilateral agreements with one or two countries, are in fact proposing that we do nothing, that we allow the world to drift back to the restrictions and the disorders of the prewar decade. [There is a] fundamental principle that international economic problems are an international responsibility that can be met only through international cooperation."3

Fragmentation seems a real and present danger today. The use of the dollar makes sense only if the U.S. sees itself as leading and involving the rest of the world on key international economic issues. It does not do that very much recently despite TTIP and TPP. Trump’s very nationalist rhetoric suggests that there may now be even less of it. His campaign pledge to label China a currency manipulator is likely to upset and cause broader unease for international economic relations. The IMF may struggle more to gain support for any increases in financial resources from the U.S.

The dollar is a public good but not in the public domain. The greater the divergence of interests of the U.S. and the rest of the world the less the dollar is a public good. The more the dollar becomes a tool to achieve national objectives, the more perilous it will be for the international economy to rely on the dollar.

President Trump may therefore be a good reason to urge reforming the international monetary system. The system represents the monetary side of the international economy. It is based on the reserve currencies held by central banks used to manage international liquidity and support orderly international transactions and external adjustments. The system does not work as intended amid repeated bouts of sharp exchange rate volatility and large persistent external imbalances that threatens overall economic stability. The dollar is partly to blame.

If the dollar is to become more national, the rest of the world needs to look harder for other international currencies. National currencies of a nationalist country are not meant to serve the international economy. The greater the number of international currencies the less dependent the world will be on the outcome of general elections in any given country This should be the most important international monetary lesson for the markets.

1 Department of State, United Nations Monetary and Financial Conference, Final Act and Related Documents, Publication 2187, U.S. Government Printing Office, Washington, D.C., 1944, pages 7-10.

2 The text was to promote ratification of the Bretton Woods agreement by the U.S. Congress. The U.S. Congress ratified the Bretton Woods agreement in December 1945.

3 Edward Bernstein, Monetary stabilization: The United Nations Program, address to the Graduate School of Public Administration, Harvard University, 11 December 1944, page 13.