If US inflation takes off again in the second half of next year, rates will be rising, not falling.
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Trump’s tariffs would shrink global trade volumes and cause falls in the currencies of tariff-affected exporting countries to offset the increased price of the exported goods in US dollars – strengthening the US dollar’s value in the process.
The trade-induced effects would be exaggerated by any tightening of US monetary policy and increase in US interest rates in response to the deficit-funded boost to growth, the increased cost of goods to consumers resulting from the tariffs, and the higher labour costs driven by the smaller workforce as huge numbers of low-cost migrant workers are deported.
The combination of Trump’s policies would export inflation (via currency depreciation) and financial instability to the rest of the world.
Depreciation makes exports more competitive and would help blunt some of the impact of Trump’s tariffs, but it makes imports more expensive, creating inflationary pressures that could force a general rise in global interest rates.
For those countries that have borrowed heavily in US dollars, mainly emerging economies, it makes servicing and repaying their debt more expensive.
A strengthening US dollar/depreciating local currency also promotes capital outflows – capital flows towards the higher interest rates and currency appreciation in the US – while adding to the depressing effect of the tariffs on global growth.
The threat posed by US dollar strength is particularly acute for emerging economies, but even advanced economies can be buffeted.
Senior Japanese financial officials are referring to the yen’s depreciation as “drastic,” saying they are watching the developments “with utmost urgency” and are ready to take action – intervention in the market to support the yen, or higher interest rates, or both – if required.
The prospect of a trade war and potential retaliation by major economies like China and the European Union adds to the global anxiety over the implications of Trump’s resounding win.
The falls in the oil and copper prices are reflective of the concern about the global growth outlook. Less growth, particularly within an already weakened China, the primary target for Trump’s trade policies, means less demand for oil and commodities such as iron ore.
If China, the main driver of global growth in recent decades, ever implements the much-discussed fiscal “bazooka” to lift domestic consumption levels, it might soften the impact of a new trade war, but its economic growth, already weakening, would still be less than it might have been without new trade hostilities.
The fall in the gold price, which had been on a massive run of its own ahead of the election, is a direct response to the rise in the US dollar and expectations of higher US interest rates next year. Gold generates no income, so there is logic to a switch to rising US bond yields, even if gold has historically been seen as a hedge against inflation.
Trump has vacillated when talking about the US dollar. Sometimes he says he wants it to be lower to make US exports more competitive, and at others he says that he wants it strong as a signal of US economic strength.
Indeed, in response to the talk about “de-dollarisation,” he has threatened to impose tariffs of 100 per cent on countries than shun the dollar – even as some of his advisers, concerned that the dollar’s strength could expand the US trade deficit – discuss ways to force a depreciation, including pressuring other countries to take action to strengthen their currencies.
A manufactured weakening of the US dollar would have consequences of its own, adding to US inflation, jeopardising the dollar’s positioning as the world’s reserve currency and the dominant currency in global trade and finance, and undermining America’s ability to use that dominance to enforce sanctions.
The seeds of the notion that the US could coerce its major trading partners into artificial currency appreciations that is at the centre of the Trump advisers’ thinking – while threatening its major trading partners and waging a trade war against them – lie in the 1985 Plaza Accord, where the threat of tariffs helped convince the UK, Germany, France and Japan to intervene in foreign exchange markets to steadily force an over-valued dollar down.
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Given that experience – the strengthening of the yen post the accord played a role in Japan’s decades of economic winter that began in the late 1980s and the country’s broader trepidation about the implications of a second Trump term – it is unlikely that America’s trade partners would be keen to co-operate and surrender to coercion from an administration not regarded as a supportive ally, unlike its predecessor.
It is conceivable that the dollar’s strengthening will continue until the consequences of America’s fiscal profligacy – profligacy that would be turbocharged by Trump’s agenda – either come home to roost and the US economy is forced into recession by the Fed and the dollar slumps or, if Trump gains influence and control over the Fed, US monetary policies lose all credibility and foreign capital flees.
Either outcome would be messy and destructive for the US and the rest of the world.
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