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The Future of the US Dollar Depends on What Trump Does, Not What He Says

This is the most important question for 2017.

The Gavekal team—led by co-founders Charles Gave, Louis-Vincent Gave, and Anatole Kaletsky—have a knack for asking the right questions. (I’ve highlighted their research in my free publication, Outside the Box, many times)

This month, Gavekal published “Our Top 12 Questions for 2017.” The first question in their list is one of the most important: Will the US dollar continue its strong rally?

This is the most important question for 2017.

So many other things hinge on what happens to the dollar this year. Charles and Anatole both think the dollar rally will continue, though Anatole thinks it will not strengthen against the euro.

Louis has a more nuanced opinion, which I’ll quote in full.

Many Things That Will Determine the Future of the US Dollar Are in Question

It all depends on what happens to return on invested capital. Whether the US dollar rises or falls will be the primary driver of performance for almost any asset class in 2017.

And behind that question of the dollar lies the broader outlook for the US economy; specifically, can President Trump manage to raise the return on invested capital (ROIC) in the US? The answer to that question sets up the following decision tree:

If no, then the dollar falls back, US equities underperform, and emerging market debt outperforms big-time.

If yes, then we have to ask why US ROIC is rising:

  • Is it at the expense of ROIC outside the US (i.e., protectionism)? If so, then the concern is that we are seeing a rearrangement of the post-World War II world order. In this case, the US will no longer be willing to provide excess liquidity when needed through a widening current account deficit. Investors should start worrying about a global depression and consider buying long-dated treasuries pretty soon.
  • Is it through tax cuts and deregulation? If so, then real rates should rise, and the whole world will grow faster. In this environment, sell all assets that have done well from financial engineering, scarcity assets (gold, art, collectibles), and private equity; and buy cyclicals and financials everywhere.

So far, the market is clearly pricing in this latter scenario.

Markets May Be Too Optimistic

I agree with this logic, and I think the full answer is still pending. In my view, people are focusing too much on President-elect Trump’s rhetoric and not enough on his actions.

Yes, he intends to demand better trade terms from other countries, but I think his threats are mostly a negotiating tactic. He has placed fellow deal-maker Wilbur Ross in charge of trade negotiations because he wants to make deals.

They will favor the US more than current arrangements do. However, Trump and Ross don’t expect to get everything they demand. They will make deals that promote US employment without rearranging the post-war order, as Louis calls it.

Tax cuts and deregulation are a bigger question mark, mainly because they must go through Congress. We are already seeing substantial division on the Republican side on other issues.

The sausage making could easily end somewhere far short of what markets currently expect.

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