What the US dollar tells us about the next administration
Plus, the X-odus to Bluesky
A basic principle of market monetarism is that financial market innovations in the wake of a policy shock tell you most of what you need to know about the macro implications of that shock. The continued strength in the US dollar in the wake of Trump’s election is particularly interesting from that perspective because it goes against the stated policy preferences of the incoming administration. In other words, markets are saying the administration is going to get the opposite of what it is asking for when it comes to the exchange rate.
In real terms, the US dollar was already at historically high levels going into the election.
On the plus side, this is a vote of confidence in a regime of continued monetary rather than fiscal dominance. Markets expect that monetary policy and the exchange rate will have to offset some of what is being proposed in terms of expansionary fiscal and tariff policy. As Scott Sumner has long argued, the fiscal multiplier is approximately zero in a regime of monetary dominance.
That could change, of course, and markets will keep a close eye on prospective appointments to the US Federal Reserve. Trump’s appointment of Jay Powell over Janet Yellen in his first administration proved to be an inspired choice. The fact that Trump now wants to see the back of Powell only serves to underscore his capacity to inflict economic self-harm.
The chart of the nominal broad US dollar index above somewhat undersells the breadth of the US dollar appreciation in the wake of the election. As Joshua Aizenman and Jamel Saadaoui note in a new paper, in a sample of 73 currencies, virtually all of them depreciated sharply against the US dollar immediately following the election and this depreciation was even more pronounced a week later for 26 of them. This is all very consistent with the market monetarist approach to narrative identification using high frequency data.
Their more interesting finding is that depreciation is positively correlated with institutional quality as measured by the PRS Group’s International Country Risk Guide. This result is statistically significant in presence of a bunch of reasonable controls for exchange rate valuation. The obvious interpretation of these results is that the better a country’s institutional quality, the tougher things will be under Trump.
