Donald Trump's Dangerous Game
By Tim Bartz and Martin Hesse
Despite a booming economy, U.S. President Donald Trump is calling for a weaker dollar, a move that threatens to jeopardize Europe's fragile economic upswing. There's very little the European Central Bank can do to fight back.
For the past 15 years, Rolf Philipp has manufactured "bones for airplanes" in the town of Übersee on Bavaria's Chiemsee lake. That's what the founder and CEO of Aircraft Philipp calls the aluminum and titanium parts his company produces for the aerospace industry. His company has a combined 250 employees in Bavaria and at a second German plant in Karlsruhe -- and business is going well, with the family-owned enterprise bringing in over 60 million euros in revenues last year.
Recently, though, developments overseas have been making life more difficult for Philipp. Within the past eight months, the United States dollar has lost more than 10 percent of its value, with the exchange rate now standing at $1.24 to the euro. Just one year ago, Aircraft Philipp found itself profiting from an exchange rate of under $1.10 to the euro.
Philipps' most important customers, Airbus and Boeing, sell the majority of their aircraft in dollars, and their sheer power in the marketplace allows them to pass the currency risks on by also paying suppliers in dollars. If the dollar loses value against the euro, Aircraft Philipp's profits also drop because the company's costs are generated largely in euros.
"We have a technological edge in Germany, but that doesn't help much when the dollar falls on us like a hammer," says Philipp. He says that if the euro exchange rate was to rise to $1.35 or higher over an extended period of time, it would become increasingly attractive for customers to make purchases elsewhere.
In principle, of course, the euro's rise, which began around a year ago, is good news. It signifies the degree to which the economy on the Continent has recovered after years of weakness. That development has been bolstered by the growing willingness to cooperate among the European Union's core countries that has become visible since the Brexit vote -- primarily because of France's new president. "Skepticism of Europe has disappeared since Emmanuel Macron's election," says David Folkerts-Landau, chief economist at Deutsche Bank. "The major investors have returned to Europe because they see that things are running again."
Donald Trump's Controversial Cocktail
But the European developments that have strengthened the euro represent just one side of the coin. The flip side is Donald Trump's "America first" policies: his open interest in a weak dollar as well as a controversial cocktail of supply and demand policies -- lowering taxes, rolling back regulations and the repatriation of wealth that has been parked abroad. The president's policies are laden with enormous risks.
Even though the U.S. economy has already been growing robustly for years and, with an unemployment rate of just 4.1 percent, is approaching full employment, Trump is continuing to stimulate growth -- a focus that could result in an overheated economy, which would present a danger to the entire global economy.
On the surface, everything appears to be in good shape. America, Europe and Asia alike are producing, consuming and investing more, and the International Monetary Fund just issued an upward revision of its forecast for worldwide economic growth to 3.9 percent for 2018 and for 2019.
But the speed with which euphoria can turn into panic was on full display at the beginning of last week, when fear suddenly began to spread among markets over excessive government deficits, inflation and interest rate increases, sparking the largest point loss in Wall Street history.
Even if the percentage slide on the markets was less dramatic, it is still likely that it bothered Trump a great deal. But when it comes to the weak dollar, his administration has literally talked it into existence. Trump wants to weaken the currency to promote exports, curb imports and to reduce his country's current accounts deficit -- one of the central pledges he made during the election campaign.
At the World Economic Forum in Davos, U.S. Treasury Secretary Steven Mnuchin said that a weak dollar was good for the U.S. economy. Trump himself may have sounded a little more conciliatory later on, but the genie was already out of the bottle, and Mnuchin's verbal intervention was already having an effect. The dollar fell rapidly, and the nasty term "currency war" could suddenly be heard in the hallways of Davos.
Irritated, But Relatively Powerless
"There is no longer any doubt that the U.S. government is not only waging a currency war, but is also in the process of winning it," Joachim Fels, chief economist at mutual funds giant Pimco, says. Trump's policies represent a threat to Europe's recovery, a situation that has displeased the European Central Bank (ECB). But there isn't much the ECB can do about it.
By pursuing economic policies that ignore the needs of America's trading partners -- an approach economists refer to as "beggar-thy-neighbor" -- Trump has revisited an old American tradition. In the early 1970s, it was Treasury Secretary John Connally who raised the prospect of a budget deficit of $40 billion -- a massive sum at the time -- and justified it as "fiscal stimulus." In response to concerns voiced by his European counterparts, worried as they were about the weak dollar, he responded with his legendary line that the dollar "is our currency, but your problem."
Lloyd Bentsen, treasury secretary under Bill Clinton, informed the Japanese in 1993 that he urgently desired a stronger yen in order to stem the Asian trading partner's high export surpluses.
With "America First," Trump has now elevated "beggar thy neighbor" to the status of administration doctrine.
The first part of Trump's economic policy agenda envisions stimulating the economy through tax cuts and public infrastructure investments. That would help American companies, and the rest of the world could also profit initially if the U.S. economy were to grow more rapidly and companies in Europe or Asia were to receive more orders.
But it's the second part of the Trump program that reveals the real strategic thrust. During the same weak that the treasury secretary could be heard preaching the virtues of a weak dollar, the U.S. government imposed steep import tariffs on washing machines and solar cells. The combination of a weak dollar and protectionist measures are aimed at creating a competitive advantage for American companies versus their competitors from around the world.
"The government clearly wants a weak dollar right now because inflation is moderate and a weaker dollar will make it easier for the manufacturing sector to grow," says Barry Eichengreen, a professor for economics at the University of California at Berkeley.
Loose fiscal policy does in fact create downward pressure on the currency. If taxes are lowered and the government increases its spending, households then have more money at their disposal. Demand increases for goods from abroad, thus weakening their own currency. Domestically, higher demand drives prices upwards, especially when cheap imports are slapped with tariffs, so that the purchasing power of the dollar sinks.
Playing with Fire
Unless, of course, the Federal Reserve steps in to counter that development with higher interest rates. That would attract investors from abroad looking for better returns and the dollar would be strengthened, but it would also jeopardize the upswing. The situation in the economy and on the financial markets is so tense right now that Trump's policies are tantamount to playing with fire.
His policies have the potential to overturn years of delicate crisis management on the part of the central banks in the U.S. and Europe and to force them into an abrupt change of course. "It's not the right time for that kind of fiscal policy program," says one of the world's most influential central bank heads.
Few past upswings have been as completely dependent on low interest rate policies of the kind put in place after the global financial crisis a decade ago. In addition to getting the economy back on track, they also drove up stock and real estate prices. Indeed, astronomical prices are once again being paid for company acquisitions -- prices of the kind last seen in 2007.
The crash in stock prices seen on Feb. 5 also revealed that banks and hedge funds are once again playing with risky bets on the financial markets that can magnify upheavals if the markets get spooked. So-called exchange-traded notes (ETN) valuing in the billions are a bet on calm market conditions and minimal changes in stock prices, but they suddenly lost all their value in last Monday's turbulence and also intensified the downward market trend.
Fear is now rampant that the best of all imaginable worlds for companies, governments and speculators may soon come to an end -- a world of zero percent interest rates, making debt almost completely unproblematic, investments unbelievably cheap and financial investments of all kind seemingly without risk.
An Impossible Task
The volatile situation has transformed Jerome Powell into one of the most interesting appointees in Washington at the moment. His predecessor Janet Yellen has left behind an almost impossible task for the new head of the Federal Reserve.
Powell likely already sensed what he was up against on this first day of work at the massive Fed headquarters on Constitution Avenue, just four blocks from the White House. Right at the start of his new job, global stock markets collapsed. It's possible the central banker might face the same challenges as his predecessors Alan Greenspan and Ben Bernanke did when they were appointed. Greenspan had barely been in office for two months in 1987 when he had to deal with the biggest market crash seen since 1929. In 2007, meanwhile, just a year after his appointment, Bernanke was tasked with saving the country from the consequences of the subprime mortgage crisis and the massive recession that followed.
The Fed is scheduled to make its first interest rate decision under Powell in March and it's possible he will be forced to signal to the markets whether he expects to increase interest rates at a higher frequency than the three times that have been forecast for 2018.
"The risk of inflation in the U.S. is increasing, the interest rates for the bond markets are far too low," says Folkerts-Landau, who regards Powell as an independent thinker. "He's very pragmatic and is unlikely to just do what others want."
Given the high sovereign debt level, it's unlikely that Trump wants either higher interest rates or a stronger dollar. Experts estimate that Trump's tax plan could increase the budget deficit over the next 10 years by an additional $1.5 trillion.
The question as to whether Trump prevails, or Powell puts up a forceful challenge to the president is also of major importance for Europe. If interest rates remain low and Trump maintains his weak dollar policy, the Europeans will have a problem.
'New Headwinds'Inside the European Central Bank skyscraper in Frankfurt, the mood is more charged than it has been in a long time. Members of the ECB's powerful Governing Council only recently stated that they were close to the benchmark goal of 2 percent inflation, but they now worry about the fruits of their labor.
"We are confident, but at the same time vigilant because our monetary policy is working and has made the upswing more robust, which is bringing us closer to our goal," says ECB Chief Economist Peter Praet. "But there are a number of international risks and we are watching them very closely."
The Governing Council considers the weak dollar to be the greatest risk. For years, the ECB kept the key interest rate under 0 percent and bought up large quantities of government and corporate bonds to stimulate the economy. Even if the ECB always stressed that it was not engaging in exchange-rate policy, it too was deploying its currency as an economic weapon. A (desired) side effect of its policies, after all, was weaker euro, with the European currency even approaching parity with the dollar a year ago.
The euro's rapid rise since then has been inopportune for the ECB, which explains the unusually curt reaction from Frankfurt to the American comments that sent the dollar into a tailspin. "The last thing the world needs today is a currency war," Benoit Coeure, a member of the ECB Governing Counsel, groused recently at the World Economic Forum in Davos. And speaking in front of the European Parliament in Strasbourg at the beginning of last week, ECB head Mario Draghi said that the strong volatility in the euro exchange rate had created "new headwinds."
"A currency war works like this: If you don't react to a thrust of the kind America has just made, then the assailant will be emboldened to continue doing it," says Ulrich Kater, chief economist at Germany's DekaBank. "That's why the ECB has to respond quickly and strongly, and it has done so."
At the moment, it remains a war of words, but it has the potential to escalate.
"A stronger euro could slow growth, especially in the periphery countries," says Deutsche Bank Chief Economist Folkerts-Landau. "That's why the ECB could see itself compelled to delay its exit from ultra-loose monetary policy if the dollar continues to fall."
U.S. economist Eichengreen thinks that the Trump administration's toying with the exchange rate is dangerous for another reason. A moment could come when investors have doubts about the U.S. government's determination to maintain a high credit rating. "Then they could push dollars onto the market, leading the dollar to fall faster than expected. That wouldn't be in anyone's interest."
Mid-Size Businesses Could Take Hit
Particularly not in the interest of European businesses.
At the moment, the dollar hasn't yet become a problem for the European economy. Most experts view the fair exchange rate as being between $1.25 and $1.30 to the euro. But that picture will change if the U.S. currency continues to weaken.
"For European exports, things will get difficult with a euro exchange rate of $1.35 or $1.40 -- and it is very possible that the rate will continue to move in that direction," says economist Folkerts-Landau. He also says a weak dollar won't be such a problem for firms on the DAX index of German blue chip companies, but it would present significant difficulties to the mid-sized businesses that form the backbone of the German economy. Their profit margins tend to be lower. Companies in Italy in Spain would likewise be affected, says Folkerts-Landau, because they "export products that tend to be slightly lower quality and are more likely to compete on the basis of price."
DAX index companies like Fresenius, SAP, Daimler, Bayer and Linde can draw up to 20 to 50 percent of their revenues from the United States, often even more than they generate in Germany. But they no longer suffer as strongly from currency fluctuations as they used to, before globalization had advanced this far.
"We have strongly internationalized value creation in the past 10 years and thus considerably reduced the risk created by fluctuations in the dollar and other currencies" says Norbert Mayer, senior vice president of finance and group treasurer at BMW. He learned his lesson shortly before the global financial crisis, when the euro had risen to a rate of $1.50 to the euro, which led BMW's business in the U.S. to suffer considerably. BMW and many other companies made major changes in response to the currency fluctuations, beefing up or establishing plants in the dollar area.
The result is that in 2017, BMW sold 353,000 vehicles in the United States, but manufactured around 400,000 at its plant in Spartanburg, South Carolina. Despite this shift, the company still has a dollar risk in the single-digit billions, in part because the company also sells engines in the U.S. in addition to vehicles. But because BMW purchases raw materials in dollars and also hedges its currency risks through financial market mechanisms, its remaining risks are manageable.
For mid-sized companies like Airbus supplier Rolf Philipp, however, manufacturing abroad usually isn't worthwhile. And the lower your position in the supply chain, the harder it is to, for example, procure raw materials in dollars, Philipp explains. The only option really available to him and many other companies is to hedge the currency risks for as many of their orders as possible through the bank. But doing so is expensive, and it will get even more so the longer the weak dollar continues and the further the exchange rate falls.
Even worse than a weak dollar -- for Philipp, for other corporations and for the entire global economy -- would be if Trump's risky policies led to inflation, higher interest rates and an abrupt end to the economic boom. That would mark the end of a cold war -- and everybody would lose.Related SPIEGEL ONLINE links:
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