The most welcome aspect of the Trump Presidency thus far has been his executive order to massively roll back the Dodd-Frank legislation which has stifled and inhibited the American financial services industry, the real economy of the US and, by implication, the global economy.
Although Dodd-Frank is well-intentioned in terms of consumer protection (such as the much-needed Consumer Financial Protection Bureau in the US), there are many stifling aspects such as capital requirements, liquidity requirements and disclosure requirements that artificially constrain agents’ expectations-management techniques.
On the somewhat bright side for Americans (at least one that the author is aware of), some would say that alternative investment fund managers in the US got off relatively lightly when compared to the Alternative Investment Fund Managers’ Directive (AIFMD) implemented in Europe.
The First-mover Advantage
To begin with, the Federal Reserve was the first central bank to begin quantitative easing and to lower interest rates following the outbreak of the mortgage defaults and ensuing financial crisis in the US. This was followed by action from the Bank of England and the European Central Bank but nevertheless, in game-theoretic terms, the Fed had the first-mover advantage (let’s not pretend that the world is mired in anything other than currency wars!). Conversely then, the Fed also has the first-mover advantage as it is the first to begin raising interest rates (even if these rate rises are incremental and gradual).
Coupled with the fact that the American economy is showing the strongest signs of recovery amongst developed countries, these rate rises and expectations of further rate rises will work to increasingly strengthen the dollar against other currencies. For the Chinese yuan, for example, the following 1-year exchange rate chart shows that the dollar is clearly and positively strengthening against the yuan.
Similarly, the euro exhibits a trend of general depreciation against the dollar over the past year (that is, since April 2016):
When it comes to the dollar versus the yen, the trend seems to be a more gentle strengthening over the past year (that is, from April 2016 to present) but the appreciation is far more significant, consistent and marked from around September 2016 onwards (with a notable rally from October 2016 until January 2017 in particular):
Unsurprisingly, the pound to dollar rate has seen a particularly sharp decline over the past year and it is yet to recover since the Brexit referendum result:
Interestingly, however, the rupee has generally held steady against the dollar (although the dollar has been weakening against the rupee since December 2016 – despite the demonetisation and what Narendra Modi’s critics had to say about it):
In general, therefore, Trump can expect to deliver on his election promise to reduce the United States’ trade deficit because of the largely strengthened dollar.
Dodd-Frank, Interest Rates and a Moderate Boom
On the one hand, low-interest rates have meant that borrowers face low borrowing costs. The issue is that it also disincentivises lending to some degree because lenders do not make as much profit from the same loans as they did when interest rates were higher.
Arguably, therefore, even if interest rates are raised even slightly after a prolonged period of abnormally low-interest rates, lenders will be incentivised to take advantage and lend more. It can be counter-argued that lenders may still withhold increasing their loan volumes in expectation of a further rate hike but the fact that Trump is planning to roll back Dodd-Frank significantly makes this unlikely to be the case for very long.
Reviewing and rolling back Dodd-Frank alongside a gradual, incremental rise in interest rates from the Fed will initially lead to a moderate boom in the United States – both credit and economic more generally. Of course, this will be financially unsustainable when considering that an imposed monetary monopoly, central banking, and the essential absence of monetary freedom does cause systemic financial instability over time, but it will also be seen as some welcome respite for a sluggish global economy.
Not All Rosy
The issue is that the potential for an impending OTC Interest Rate Derivatives crisis has not dissipated even if Trump’s policies toward the financial services industry look as if they might delay it (the fundamental problem regarding a lack of monetary freedom persists, after all). Wherever this financial crisis occurs (and this looks increasingly as if its origins will be in Europe and, more specifically, the Eurozone) – and many agree one is long overdue – it is likely that it will offset the positive impact of the moderate boom. On the flip side though, it will also dampen the negative fallout from the financial crisis.
In the medium term though, this could create significant political and legal uncertainty because if a financial crisis coincides with or shortly follows the rolling back of financial regulation, it will be the financial services industry that shoulders the blame yet again and not the entire monetary and financial system that it operates within. This would likely lead to the further restriction of the industry and, therefore, even greater difficulties for the global economy following that crisis.