It is difficult to know exactly what US President-elect Donald Trump will do when he takes office in January. But he is all but guaranteed to pursue tax cuts and increased infrastructure spending. As a result, financial markets are anticipating faster growth in the United States – a perception that is boosting the dollar’s exchange rate against most currencies, including the renminbi, and triggering capital flight from emerging economies.
Notwithstanding Trump’s vow to impose tariffs on China, a resurgent dollar will hurt America’s trade competitiveness. After all, according to the International Monetary Fund, the dollar was already about 10 to 20 per cent overvalued in June.
But that is not all. While trade is supposed to be the primary driver of exchange rates, which should rise or fall to correct countries’ external imbalances, capital flows have grown to the point that their role in guiding exchange rates is now much larger. In this context, market optimism about US growth could lead to ever-larger imbalances and possibly disrupt the international monetary system.
This article first appeared in Project Syndicate on November 23, 2016.Please click on the link to access the entire article.
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