The US election and the dollar

Although the intensification of the financial market crisis remains a key focus, attention will soon shift more squarely to the US presidential and congressional elections on November 4. As recent events have unfolded and government intervention in the financial markets has clearly increased, the outcome of the elections has taken on even greater weight.

After considering the probable outcome of the election, financial markets attempt to consider the policies the new administration will employ and the likely impact on the economy, financial markets, geopolitical developments and other factors they think might impact market prices.

Economic policies top the list of priorities for financial markets. The candidates do have significant differences in their broad economic platforms. In some ways, what is known about the policies each candidate would likely pursue if elected conform to traditional liberal and conservative biases. Of course, the ability of a new President to enact campaign pledges depends on a compliant Congress (where Democrats are expected to maintain control of both the House and Senate).

So the bottom line in the Congressional races is that Democrats may control both Houses of Congress again in 2009, and potentially with greater majorities than in this past session. In theory, that increases the chances for passing the legislative agenda of an Obama presidency, while it also diminishes the chances that a President McCain will have in advancing his legislative goals. Hence, when attempting to assess the likely performance of the dollar in light of the US political backdrop, it is important to consider political control of the White House and Congress.

Foreign exchange policy is a big focus and perceptions of that policy can have a material impact on how market participants trade the dollar. Recall the market's shock when President Bush imposed tariffs on imported steel in March 2002. That event, along with others, suggested an increase in protectionism by the Bush administration and some thought the administration may have favoured a weaker dollar as one method of helping the economy recover from the combined effects of the stock market decline, recession and the September 11 terrorist attacks.

Another example was during the Clinton presidency, when the dollar fell to then historic lows in the first two years (1993-1995) due to a host of factors, not least of which were perceptions that the administration was attempting to use the dollar as a tool to gain advantage in international trade. The dollar's fortunes changed several months into the tenure of Treasury Secretary Robert Rubin (he took over in January 1995) and the introduction of the 'strong dollar policy'.

That example and others indicated that we should not only look at the dollar's performance in relation to the political mix in the White House and Congress, but also consider specific changes at the head of the US Treasury.

There has been some discussion that either candidate would ask the current Secretary, Hank Paulson, to remain in his post given his detailed knowledge of and involvement in the resolution of the current crisis. Paulson made clear early on that his intention was only to serve through President Bush's term and no more, and that still seems the most likely outcome. However, if pressed by the new President-elect, it is plausible that he could be persuaded to stay longer to provide continuity.

In terms of USD policy specifically, Obama was quoted by Reuters discussing the dollar earlier this summer. He said that he is "not somebody who thinks we should spend a lot of time manipulating our monetary policy or fiscal policy simply to strengthen the dollar. What I want to do, though, is strengthen the economic fundamentals in such a way that the dollar, of its own accord, ends up being strong". One element of Obama's campaign discussions, the intention to revisit existing trade agreements (such as NAFTA) to garner better terms for the US workers is potentially of concern if it raises protectionist sentiments. A material rise in protectionist sentiments would be bearish for the dollar.

When asked about what his policy toward the dollar and currency intervention would be, McCain said recently that he would "stop mortgaging our economy to China", eliminate dependence on foreign oil, keep taxes low and reign in spending so that "we're not running up massive debts that are held by other countries including China". He said he supports a "strong dollar" but like his predecessors, he will be focused on creating the underlying economic conditions that should support the currency over time.

The bottom line is that the public comments and past policies of both candidates do not suggest an 'interventionist' type approach to dollar policy but rather an intention to focus on improving the underlying fundamentals of the economy in a manner that will support a strong dollar. While some market participants may be sceptical that either candidate will maintain such a pragmatic approach once they take office, there is no reason to doubt their intensions at this stage.

This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.