Strong U.S. dollar threatens a Trump promise

The U.S. dollar is surging in value against currencies around the world following the election of Donald Trump, triggering factors that could test the president-elect's vow to make U.S. manufacturing more competitive.

The dollar's strength has been especially dramatic against the Chinese yuan, which Trump repeatedly targeted in his campaign, accusing the Chinese government of currency manipulation to benefit its economy.

The U.S. dollar has raced nearly 2% higher against the yuan over the past month. One dollar can now buy 6.8667 yuan, the most powerful the dollar has been in a decade, says Bloomberg News. The dollar isn't just strengthening against the yuan. The Bloomberg Dollar Spot Index, which measures the dollar against a basket of 10 leading global currencies, has risen 3.1% since last week, Bloomberg News says.

"It's been a lightning rod year," says Amo Sahota, chief currency analyst at currency firm Klarity FX, who points out the dollar has been strong against currencies ranging from the Mexican peso to the euro. The Chinese currency, meanwhile, has been relatively stable against most of its Asian trading partners, he says.

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The weaker yuan and stronger dollar can be a positive for U.S. consumers and businesses buying goods made in China. On the flip side, when the dollar is strong, U.S. exports become less competitive and more expensive for Chinese nationals to buy. This divergence could reopen more of a push to put in tariffs and other measures to make foreign imports into the U.S. more expensive despite the stronger dollar, says Mohamed El-Erian, economic adviser at Allianz in his Bloomberg column Thursday. "The dollar's strength could also set the stage for the return of protectionist rhetoric," he says.

During the presidential campaign, Trump threatened to slap tariffs on countries like China, which he claims are gaining an unfair trading edge due to poor trade deals or purposely depressing their currencies.

But tariffs could cause problems as consumers lose the benefit of lower prices while the U.S. might not gain much, says John Lonski, managing director at Moody's Analytics. While Americans buy many Chinese-made goods, including many sold by U.S. companies, China buys only 7% of the United States' exports, according to a 2015 report by Jay Bryson, global economist at Wells Fargo Securities. Roughly 12% of goods bought by U.S. consumers are imported by China, which is a much larger amount given the size of the U.S. consumer market.

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"Not sure you can make (U.S.) manufacturing great again by punishing Chinese exports," Lonski says. "These will be difficult promises to fulfill" as the currency market is working against the policy goals of boosting U.S. manufacturing. Tariffs on Chinese goods would likely simply benefit other low-wage countries like Vietnam and Malaysia, he says.

The dollar was already strengthening this year as investors anticipated hikes in short-term interest rates, says Lonski. Most investors now expect the Federal Reserve to increase short-term interest rates next month and at least twice in 2017, Lonski says.

The race to buy dollars — fueling the dollar rally — has only intensified following the election of Trump, as foreign investors sell low-yielding investments at home for higher-yielding U.S. assets. Trump's vow to borrow and spend on domestic projects, such as upgrading the nation's highways and bridges, has helped push long-term interest rates to their highest levels of the year as investors expect higher short-term interest rates and inflation. Investors expect the Trump administration to borrow money by selling Treasuries, which could hurt their prices and increase yields, as the supply would be greater.

It would take 24 months before consumers will see any long-term effects from the stronger dollar, Sahota says. Policy changes could be difficult to actually implement for other reasons than the danger of a trade war, he says. China and Japan are major buyers of U.S. debt, and they will be needed for the new administration to finance the planned domestic spending, he says.

"We have a lot of debt. Who purchased most of our debt is Japan and China," he says. "If we go on a big spending spree and borrow, we need someone to (buy our debt)."