The Taiwan Banker

Former US President Donald Trump had a point when he criticized the Federal Reserve under Jerome Powell for prematurely increasing rates in 2018, long before inflation had begun its generational resurgence. “I think the Fed has gone crazy,” he said at the time, in remarks which triggered fears over the loss of Fed independence. Shortly thereafter, by the end of the year, markets forced the Fed to halt its hiking cycle. By the middle of the next year, which was still well before COVID hit in 2020, the Fed was forced to start a rate cut cycle, seemingly vindicating Trump’s complaint. Trump was a president of easy money. With the severe under-reaction to the 2008 financial crisis still in mind, markets were originally expecting a slow response to the pandemic, indicated by a stock market crash upon its outbreak, before Congress and the Fed had swung into action. Trump later went on to pioneer the use of cash stimulus in the form of direct payments. Any president would have probably done the same – and the policy still did not lead to his re-election – but the experience likely reinforced the importance of a hot economy to him. Financial markets and international monetary authorities are waiting to see what will happen when either Trump or the current president Joseph Biden are sworn in for their respective second term next January. Of the two, Trump would decidedly create more uncertainty, however there are indications from his own comments, as well as those of his close advisors, that he would continue to pursue pro-inflationary policies. Nevertheless, it is also important to keep in mind that despite four years of observation, prognostication on a potential second Trump term remains as dangerous an exercise as ever. Inflation is bad for buyers, good for sellers Trump has apparently not forgotten that earlier episode with the Fed. Earlier this year, when the possibility of several rate cuts for the year was under discussion prior to several months of higher inflation statistics, Trump called Powell “political” and said that he would seek someone else for the position. Originally having been appointed by Trump himself, as a non-economist, Powell had been a non-traditional choice for Fed Chair. Despite this complaint, however, Powell may in fact be the most significant obstacle to the re-election of the incumbent President Biden. The economy has become one of the top two issues this election seas, along with immigration. A widely-circulated February paper by Lawrence Summers, a former economic advisor under presidents Clinton and Obama, along with several other economists, indicates that recent poor consumer sentiment has been impacted not only by inflation, but also independently by the rate hikes in response to that inflation. This new monetary policy regime has added to loan servicing costs for durable goods like housing and cars. Homes have suffered from a double-whammy of both markups in sales price as consumer cash arising from a hot economy collides with fixed supply, along with an explosion in mortgage interest costs from their near-zero base. It is also worth noting that the new price regime creates clear winners and losers, as those who already own a house with a fixed or paid-off mortgage have seen large increases in net wealth. Inflation has more complex politics than practically any other issue, creating unlikely coalitions of winners and losers. One of the winners is also one of Trump’s favorite constituencies. Exporters tend to benefit from a weaker domestic currency – at least under certain conditions, assuming that the currency weakness didn’t originate from their own production costs. This appears to be a coherent economic plan on the part of the challenger candidate. Global imbalances persist One of the unique economic features of the post-covid era is that the dollar is reflecting different valuations internally versus externally. In 2022, the Dollar Index (DXY) broke above the benchmark 100 level on a sustained basis, for the first time since the dot-com bubble (Figure 1). The Fed’s hawkish stance has left the US increasingly isolated on the world’s stage as the ECB starts an easing cycle, while Japan has barely yet to start its hiking cycle. Figure 1: The dollar index (DXY) By this measure, notwithstanding the household price squeezes that have dominated the popular discourse, the US is currently in the midst of a deflationary bout. This conclusion makes more sense when considering its trade deficit – more precisely, China has kept its interest rates high in order to prevent too large a divergence with the US. While China is experiencing this deflation directly, it is also exporting it to the US through its trade surplus, hence the recent complaints about “overcapacity.” The trade deficit is the single issue on which Trump has been most consistent over the years. True to form, he has promised draconian tariffs if he is reelected: 60% on imports from China, and 10% from all trading partners, including allies. Although first initiated by Trump during his first term, the trade war on China has now become a bipartisan consensus, and Biden recently implemented 100% tariffs on Chinese EVs. The more comprehensive tariffs however would go beyond practice to challenge the global economic structure, including even the Bretton Woods II system. Under this paradigm, the US serves as the global consumer of last resort, while its import suppliers invest the US dollars they earn back inside the US. It is hard to escape the currency implications of balanced trade, not the least because an important part of the competition would take place outside of the borders of the US, in various non-aligned countries. Thus, in a 2023 book No Trade is Free, Robert Leightheizer, US Trade Representative under Trump and one of his closest advisors, proposed a multilateral currency accord. The proposal draws inspiration the 1985 Plaza Accords between the US and Japan. It is also likely that Taiwan would come in the cross-hairs again in this case, having been last put on the currency manipulator watch list by the Trump administration in 2020. Change from within If Biden wins, on the other hand, it is easy to anticipate continuity. There are however indications that having focused his attention on the manufacturing industrial base in his first term, he would pivot in his second term to housing market problems behind the recent inflation. Housing is one of the largest and most persistent drivers of inflation in most indices, particularly after eliminating volatile food and energy prices. Construction has never recovered since the 2008 financial crisis, which was triggered by housing crashes in markets like Las Vegas, which is located in the current swing state of Nevada. That was where Biden gave a major speech in march introducing his 2025 budget proposal which includes $258 billion for housing. $20 billion of that focuses on incentives for local governments to change their housing policies to allow more construction. Housing policy in the US is controlled locally, and the sector is not set up to be a macroeconomic lever as it might be used in China. Thus, the issue has the potential to create a “local versus federal” struggle of the sort which has historically torn the country apart. It is important to emphasize that housing supply adjustment would be a long-term strategy, and it is not destined to succeed. Housing affordability is a multiplicative problem, and construction is now being hampered by the high interest rates caused by this same unaffordability. The same construction workers needed to build new housing are also having their own problems finding housing, driving up labor costs. Supposing Biden is successful, however, it could remove a long-term driver of inflation, reduce the need for the Fed to pre-emptively demonstrate credibility, and bring the dollar back down to encourage exports. Thus, while approaching the overvaluation of the dollar from the very different perspective, Biden’s approach also has coherent guiding points. For the host of the global reserve currency, the “crowding out” effect toward other capital investments caused by frictions in housing investment can become a global issue. At stake in this election is the US role in the world, in a larger sense as well as specifically regarding global trade and finance. Will it take attempt to incrementally fix the existing system, or create an entirely new one? For the US, the answer to this question will likely come down to several tens of thousands of voters spread over a handful of states. Taiwan, meanwhile, can think about hedging for a possible fall in the dollar – whether due to market forces or through diplomatic pressure to appreciate the Taiwan dollar. At worst, banks will end up investing more of their abundant capital in domestic targets, helping the country prepare for an increasingly uncertain world.