August 04, 2017
Landon Thomas Jr. had an NYT piece noting the peculiar divergence between the stock market, which has risen sharply since Donald Trump’s election and the dollar, which has fallen. The article claims this is peculiar since both tend to move in the same direction, rising in a strong economy and falling in a weak economy.
Actually, this is not really true. There have been many long periods where they have gone in opposite directions. For example, the dollar peaked in the mid-80s and then fell through the rest of the decade. The stock market did crash in the fall of 1987 but then rose through the rest of the decade. The dollar fell against most currencies from 2001 to 2007 even as the market recovered from its crash beginning in the summer of 2002.
A weaker dollar can be good news for U.S. corporate profits since it means that domestically produced goods and services become relatively more competitive internationally. This could be a reason the two would move in opposite directions.
However, there is another story in this case which could plausibly explain the divergence. President Trump and the Republicans have made reducing corporate income taxes a priority. Trump has proposed outlandish treatments of pass-through corporations, which would allow them to pay just 15 percent on their income.
This is a total joke proposition: no serious economist thinks this is a way to treat these companies. It essentially allows every rich person in the country to pay a 15 percent tax rate on the bulk of their income, as opposed to the 25 percent rate currently paid by teachers and fire fighters and other middle-class workers. Almost none of them are so stupid that they can’t figure out how to have their income show up in a pass-through corporation and the ones that are too stupid have accountants that can figure out how to tie their own shoes.
Anyhow, this is a clear signal that “tax reform” under Trump means giving more money to rich people, which means that corporations can count on a much lower tax bill. If corporations pay less in tax, other things equal, a share of stock is worth more.
Note that this has nothing to do with investment and growth. The relationship between corporate profits and investment has always been weak. In fact, the strongest period for investment (measured as a share of GDP), was the worst period for profits (the late 1970s and early 1980s). So there is little reason to believe that the Trump tax cuts will spur investment and growth.
This story would be entirely consistent with the rise in the stock market and the fall in the dollar. Investors in both markets are betting that Trump will have a tax cut that gives more money to shareholders but does nothing to spur investment and growth. This is also consistent with the low interest rates we see on long-term bonds.
It would have been helpful if the piece had included the views of corporate executives who made investment decisions, instead of just people who speculate in financial markets. These executives could have provided some insight into the question of whether the expected tax cuts would lead to more investment and growth.
Addendum
I should have also mentioned the explanation the piece gives for the fall in the dollar. It sees it as the result of Trump’s comments implying that he would like to see a lowered valued dollar to make U.S. goods and services more competitive internationally.
I sort of like this explanation, but I don’t think it applies here. The idea is that if an administration is clear about its agenda, simply talking can have an effect on the value of the dollar. The best case where this may be true was in 1996 when Robert Rubin became Treasury secretary and proclaimed his strong dollar policy, in direct contradiction of his predecessor.
The dollar did in fact rise, although it rose much more as a result of the onerous terms he imposed through the I.M.F. for the countries afflicted by the East Asian financial crisis. That resulted in a sharp run-up in the value of the dollar, which led to the explosion in our trade deficit, which created the problem of secular stagnation (a.k.a. insufficient aggregate demand).
I have argued that talk can have a big impact on currency values, especially if there is a clear threat that it can be backed up by action. I doubt this can explain the recent fall in the dollar since I don’t think anyone, including Trump, is clear on what he wants. He has not presented a consistent policy and seems confused himself on which way he wants the dollar to go. (According to press accounts, in the first weeks of the administration he called then National Security Adviser Michael Flynn at 3:00 in the morning to ask whether we want a high dollar or low dollar.) While I think a consistent and clearly articulated goal of bringing down the value of the dollar could actually work to bring down the value of the dollar, we have not seen that from the Trump administration.
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