President Trump tweeted on Monday complaining about something which is normal, expected, and the way the world works. Someone, somewhere, therefore needs to explain this currency exchange rates thing to him. If the United States continues to raise interest rates, the U.S. dollar will rise against the Chinese yuan and the Russian ruble.
This isnât a mystery, itâs not a plot, itâs both the way things are and the way theyâre supposed to be â we have an interest rate higher than we used to and our currency will rise in relation to others.
Yet Trump complains:
Russia and China are playing the Currency Devaluation game as the U.S. keeps raising interest rates. Not acceptable!
— Donald J. Trump (@realDonaldTrump) April 16, 2018
Seriously, this is the way itâs supposed to work.
This isnât part of a deliberate attempt by these countries to devalue their currencies, itâs the logical market reaction to those rising U.S. interest rates. It also rather contradicts the Treasuryâs report which didnât name any major trading partners as currency manipulators. The dollar is even down 3.4% against the yuan for the year.
As to what is actually happening, itâs just normal markets. The value of one currency with respect to another (the exchange rate) is determined by how profitable it is to hold one in relation to the other. If interest rates â and we must think of real interest rates, after inflation â go higher in one currency, then that currency will rise in value. If I can earn 1 percent in U.S. dollars and 1 percent in Chinese Yuan, then the exchange rate will be one number. If the next day I can make 2 percent in the U.S. dollar, then the exchange rate of the dollar against the yuan will rise. Because some number of people will sell yuan and buy dollars to gain that higher interest rate.
Much the same happens if inflation rates are different. If Chinese inflation is 5 percent and U.S. inflation is 2 percent, then the yuan will lose value against the dollar. Because you lose 5 percent of your money each year in the yuan and only 2 percent in the dollar, thatâs why.
So, why is the yuan, over a reasonable time scale, falling against the dollar? Because the inflation rate over there is higher than it is here. Money is just worth less each year over there, thatâs what inflation itself means. So the value of money is falling, the yuan damn well should be falling against the dollar.
Itâs not a great surprise to find that I differ, as do most economists, with Trump on the benefits of trade and what constitutes winning at it. But to find that the president differs with reality is another thing, and a rather more worrying thing at that.
Tim Worstall (@worstall) is a contributor to the Washington Examiner’s Beltway Confidential blog. He is a senior fellow at the Adam Smith Institute. You can read all his pieces at The Continental Telegraph.
