Tariffs and the U.S. dollar hegemony
Trump’s second term in office has launched with a whirlwind of changes to the status quo in Washington, DC, and to U.S. relations with the world. Trump’s tariffs may not be the most shocking foreign policy overture of his second administration, but they may well end up being the most consequential in the long run.
Like all his headline-generating foreign policy moves, his plan for tariffs is also part of his overreaching game plan to reshape the U.S. economy. He says he will be imposing tariffs on Europe, China and everyone else that trades with the US to bring manufacturing back home, and “Make America Great Again”.
But in this instance, Trump’s boldness is unlikely to bring him closer to his long-term goals due to the inadvertent impact these tariffs will eventually have on the U.S. dollar. Manufacturing costs in the U.S. are far higher than they are even in Europe, let alone Asia, and thus the immediate effect of his tariffs and threats of tariffs would inevitably be to raise inflation expectations as well as begin a new cycle of U.S. dollar strength versus other leading currencies. While it may seem that a stronger dollar would weaken inflation, tariffs and the threat thereof add additional costs to trade, which minimize this potential benefit. Additionally, the U.S. Federal Reserve has paused its rate-cutting cycle even as other top central banks, such as the Bank of England and the European Central Bank, push ahead with their cuts, as their fears of renewed inflation have been supplanted by the need to stimulate growth in the face of trade threats.
The structure of the international monetary system in which the U.S. dollar already dominates, however, means that higher yield expectations for US assets will only further strengthen the dollar. For so long, global demand for the U.S. currency has meant that its primary export has been its currency and related financial products. This unique exorbitant privilege is what has enabled Washington to run both trade and fiscal deficits without any major drag on the economy.
Trump has increasingly realized the importance of protecting this system, threatening 100 percent tariffs and other action against countries that seek to de-dollarize and embrace the Russia and China-backed BRICS organization. Trump today sees his task as not just one of reordering fiscal policy to support US domestic manufacturing, but one of establishing new rules of the international monetary order as well. Trump wants to ensure that the U.S. dollar can trade at a weaker value compared with other currencies while not undermining the centrality of the currency, and in particular US government securities, in the international monetary system.
This has led to a discussion of whether the Trump administration is aiming to reach new dollar stabilization deals with other governments and their central banks akin to those the Reagan administration made in the 1980s. Yet such a move will be extremely difficult because, in contrast to the Reagan-era dollar stabilization accords, where the focus was on Japan, today any such accord would have to focus on China. Back then, the U.S. saw the perceived weakness of the Japanese yen as a threat to its interests and acted to correct it. This was not a big challenge as Tokyo was, and still is, a close U.S. ally. China, however, is nothing of the sort. It is far less interested in any such negotiations, and the legacy of those 1980s’ deals, in Japan, the strengthening of the yen because of those accords is more often than not seen as a core factor in the country’s subsequent “lost decades”.
Trump is willing to weaponize this system to secure concessions and achieve its long-term goals, even when they have nothing to do with trade. Even the most steadfast U.S. allies must prepare for threats that go far beyond tariffs. This was foreshadowed in his late January threat of treasury, banking and financial sanctions against Colombia if it did not accept military aircraft delivering deportees, moves typically reserved for rogue states like North Korea and Iran.
The Trump administration’s willingness to use such threats against allies means that it has little hope of entering any negotiations with China with its allies supporting it economically. Beijing and other supporters of eroding the dollar system will seek to exploit these weaknesses. Trump is trying to reorder the international monetary system to the U.S. benefit, but so far his actions signal that his understanding of it is limited.
The U.S. dollar system has never been entirely an American one. It was in large part birthed in Europe, where banks began to issue loans in dollars in the 1950s to meet regional financing needs and demand. As such, by upending the foreign policy unity between the U.S. and Europe supposedly to “Make America Great Again”, Trump may end up inadvertently upending the dollar system that has been responsible for much of America’s power and greatness for decades.
The major difference between those countries that are members of the BRICS bloc and European states is that BRICS members are almost all massive earners of international trade surpluses, exporting more than they import, while they also almost always maintain significant capital controls.
Europe’s trade strength, on the other hand, is not enough to sustain levels of government expenditure in most of the European Union or the UK. Nor is it in Japan, whose debt-to-GDP figure is well in excess of any other leading economy. In turn, after the U.S., these historic allies are the main borrowers on international capital markets, while capital from the surplus-earning nations, such as many BRICS members, are those who seek to invest in them. This is why China is the number one holder of US treasuries despite the Washington-Beijing geopolitical rivalry.
Trump’s moves such as tariffs and annexation threats directed at allies, tend to undermine this system. His geopolitical threats that aim to reorder the monetary system may be targeted at Beijing, but his approach risks not just breaking the political alignment between the U.S. and its historic allies, but also their economic alliance.
Were Trump to be successful in his approach, it likely would have some benefits for U.S. manufacturing. Growth from manufacturing’s current 10.2% of U.S. gross domestic product would certainly appeal to his base. But the risk is that in aiming to do so, he blows up or at least disrupt the U.S. dollar system. And that would be negative for the U.S. economy, likely triggering not only inflation but also a potential recession.