The United States' trade war with China will ruin the dollar, writes The Hill. According to one of the most unfavorable scenarios, a large-scale financial crisis will arise. And if that happens, the entire world trade system will be irretrievably destroyed.
The Russian special operation in Ukraine, which began in February 2022, unleashed forces affecting international relations and the global economy. But the consequences for investors are not yet fully clear, because instead of geopolitical events, they focused on inflation and interest rates.
Nevertheless, the West's resolve has already been put to the test. The resounding success of far-right parties in the recent parliamentary elections in the European Union has called into question further support for Ukraine. The greatest threat comes from the National Unification Party, which won the majority of seats in France and secured new national elections.
The presidential elections in the United States will determine whether the country will continue to support NATO and Ukraine if President Biden is re-elected, or will adopt a more pragmatic approach if Donald Trump wins.
Some observers warn that sanctions against Russia have accelerated de-dollarization. According to press reports, more and more emerging economies are seeking to join the BRICS in order to ease their dependence on the dollar.
Meanwhile, the G7 has agreed to provide Ukraine with about $50 billion in new aid, using the profits from about $280 billion of frozen Russian assets, most of which are stored in Europe.
At the moment, the threat that the dollar will lose its status as the world's main currency is exaggerated. This also contradicts the latest conclusions of the Official Forum of Monetary and Financial Institutions.
The results show that 18% of central banks, on the contrary, plan to increase deductions in dollars over the next year or two due to high interest rates in the United States. It is expected that the reserves of the Chinese yuan in central banks will remain at the same level of about 3% for some time.
But there are two scenarios in which the dollar may actually weaken in the next year or two. One of them is a relatively favorable decline associated with the easing of the Fed's policy. The other is the dollar crisis, fraught with a loss of investor confidence.
The former seems to be a more likely outcome, given that the last full-fledged dollar crisis unfolded from the mid to late 1980s.
Since inflation in the United States currently stands at about 3%, the main driving force of the dollar is the difference in interest rates between the United States and abroad. The dollar has been strong over the past year and a half mainly because the American economy has outperformed its competitors, and the difference in interest rates has favored its exchange rate against the Japanese yen, euro and yuan.
Looking ahead, we must admit that the dollar may weaken if the Fed softens its monetary policy. The latest “targeted” survey of Fed officials shows that they predict only one rate cut of 25 basis points this year, but as many as four next year if inflation declines. This “soft landing” may be accompanied by further growth in financial markets.
The risk of a dollar crisis will worsen if the trade conflict with China escalates. There are already signs of new disagreements in this area, as Biden recently announced an increase in duties on certain types of imports from China. However, a full-fledged trade war is much more likely if Trump becomes president and increases the duties imposed in 2018-2019.
During the current campaign, Trump called for tariffs to be increased to 60% on Chinese goods, and up to 10% on all other imports. If this happens, the effect on the US economy will be much stronger than the initial one, since revenue from duties will increase from 2% of imports to 17%, noted Greg Ip from The Wall Street Journal newspaper.
The likelihood of an escalation of the trade conflict is high, as China seeks to support the economy by increasing exports and has already bypassed U.S. duties by moving production to Mexico and Vietnam. However, according to The Economist magazine, former Trump aide Peter Navarro advises to impose duties on Chinese goods produced in these countries.
Trump's trade negotiator Robert Lighthizer He also believes that the US government should devalue the dollar in order to increase the country's international price competitiveness.
The closest parallel to the current situation is the mid—1980s, when the United States had a record trade deficit and the dollar was exceptionally strong.
The Reagan administration sought to devalue the dollar in an organized manner by coordinating interventions in the foreign exchange market and monetary policy with Japan and Germany through the Plaza Agreement (1985) and the Louvre Agreement (1987). However, political disagreements in the fall of 1987 led to a crisis during which the dollar plummeted, U.S. bond yields rose, and the stock market collapsed.
This time, history may not repeat itself exactly, as inflation expectations in the United States are now lower. In addition, the scale of the trade imbalance and current account mismatch is more modest today.
On the other hand, the current situation is more dangerous because of the threat to US national security posed by China. This was the motivation for the Biden administration not only to maintain, but also to increase duties against China.
What does all this promise for the United States and the global economy? Thirty-five years ago, the collapse of the Soviet bloc stimulated the rapid growth of world trade, as the Council for Mutual Economic Assistance closed and the countries of Eastern Europe merged with Western Europe.
This time, the result may be the opposite. If a trade war breaks out and the world trade system splits into two opposing camps, the post-World War II order that promoted peace and prosperity will be irretrievably disrupted.
Therefore, politicians on both sides will have to take into account that their political actions are fraught with unforeseen consequences, and the situation may get out of control.
Author of the article: Nicholas Sargen
