The Dollar Under Political Pressure
The euro, the dollar and Trump. In the days leading up to the fall midterm elections in the US, the ECB is bound to navigate rough seas. To understand why, the starting point is asking what determines the dollar's performance.
The Fed's Independence in the Crosshairs of Populism
Monetary policy decisions certainly play a central role, which in turn depend on the Fed's degree of independence from political power. It should be immediately clarified that the Fed certainly doesn't have the level of independence that distinguishes, for example, the ECB. Therefore, analyzing the makeup of those who lead the nation — on the one hand — and those who govern the central bank — on the other — is crucial. The current president of the United States is a populist. Populists seek to maximize consensus, like other politicians, but their distinctive feature is their use of "exclusive" policies, which prioritize the needs, real or even perceived, of certain categories of households and/or businesses, who feel harmed by traditional parties.
Populists thus end up on a collision course with all institutional rules that limit their ability to pursue exclusive policies. This is the case with central bank independence: a populist would like to have full control over government liquidity and the level of interest rates; therefore, the presence of an independent bureaucracy becomes an obstacle to be neutralized. A populist monetary policy is therefore characterized by two facets. On the one hand, populists want to control the currency, interest rates and exchange rates. On the other hand, and by extension, they want to reduce the independence of the central bank. This is the dual nature of Donald Trump, ever since his first term.
Trump, Powell and the Digital Currency Challenge
For Trump, the dollar must be weak to favor the manufacturing sector, and interest rates must be kept low at all times. Low interest rates are popular with businesses, and they also provide relief for the cost of managing US public debt. At the same time, Trump used media aggression as a political pressure tool, systematic in method and violent in verbiage, against Fed Governor Jerome Powell — and not only that. Trump went so far as to call Powell a "moron" and a "numbskull."
To further weaken the Fed, Trump is exploiting the opportunities opened up by new digital currency technology, with two moves. First, he is banning the Fed from issuing digital dollars, unlike what is happening in the EU, where we will have the digital euro. Second: he is legalizing "pseudo-stable" private digital currencies to sate a financial lobby close to him, not only electorally but also personally. The result? The effect of a systematic battle between the chief of the executive and the central bank is to augment uncertainty; very bad news in an increasingly complex international economic and geopolitical landscape.
Warsh: Hawk, Dove or Heron?
But uncertainty will be further fueled by the fact that the Fed has a new chair, appointed by Trump in June: Kevin Warsh. His CV says he is a "hawk," that is, a central banker that closely monitors inflation trends and is therefore oriented toward monetary discipline, i.e. a policy of high interest rates. However, during Trump's first term as president, as well as on the eve of the elections that sealed his second mandate, he repeatedly criticized Powell's Fed for being too restrictive on monetary policy. Consequently, his successor’s profile is more that of a heron, the name given to central bankers changing sides, who can be both hawkish and dovish.
Rough Seas Ahead for the ECB
The next few weeks seem tailor-made to see whether Warsh will be a hawk or a heron who switches sides. From an economic standpoint, the Middle East crisis translates into an aggregate supply shock, simultaneously triggering both the risk of inflation and the risk of stagnation. From a political standpoint, midterms are in the fall, and Trump has already started playing the flute of low interest rates since 7 June. A flute that will turn into a trombone as autumn approaches, unless rising inflation makes the president fear his voters will turn their backs on him. How will hawk Warsh avoid angering dove Trump? He seems to have had an idea: he argues that artificial intelligence is a positive supply shock to the US economy, whose effects balance out those of the Middle East crisis, so rates need not be raised. Could this be true? In his first official statement in June, Warsh certainly played the heron: by keeping the Fed rate unchanged, he effectively followed the same dovish course as Powell, but played the hawk in rhetoric. And the dollar reversed its downward trend. But we're only at the beginning, and the equation will certainly be: Trump plus Warsh equals uncertainty about the dollar, and therefore the euro. The forecast is rough seas ahead for Lagarde and her colleagues. Safe sailing to them.
