Dollar dominance means tariffs are not the only game in town

One other week, one other wave of untamed threats from US president-elect Donald Trump. On Tuesday, he pledged to “tariff Denmark at a really excessive degree” if it didn’t conform to promote Greenland to the US.

Then on Wednesday, studies emerged that he was contemplating the declaration of a nationwide financial emergency to slap commerce sanctions on quite a few nations.

Little doubt but extra sabre-rattling will comply with quickly. Welcome to a world of indignant mercantilism, the place energy politics guidelines supreme.

There’s a sure irony right here, nonetheless. In his speeches, Trump sometimes focuses most of his threats on tariffs linked to traded items. However this isn’t essentially his major supply of leverage.

In spite of everything, as a new report from the World Capital Allocation Challenge (a joint hub between Stanford, Chicago and Columbia universities) notes, it’s China that truly has hegemonic energy over world manufacturing, by way of its dominance of many provide chains.

The place America does have hegemonic energy, nonetheless, is in finance, by way of the dollar-based system. Or, because the GCAP says: “Because the US-led coalition controls a dominant share of world monetary companies, typically exceeding 80 or 90 per cent in lots of nations, this near-total management of the worldwide monetary system permits the US coalition to regularly use finance as a software of coercion.”

Thus the query that world traders must be asking now. Will Trump’s group use these “coercive” instruments to punish rivals or to chop offers? Tariffs, in different phrases, are usually not the one — and even the primary — recreation on the town.

This problem isn’t, after all, totally new: the American authorities has been weaponising its forex to a rising diploma lately by in search of to exclude perceived enemies, reminiscent of Iran and Russia, from the dollar-based monetary system. It has additionally imposed sanctions on monetary establishments that defy this. Marco Rubio, secretary of state nominee, has pushed MSCI, the US-based index provider, to exclude Chinese language teams.

Trump’s group will virtually definitely double down on this. As well as he has threatened retribution towards nations — reminiscent of Brazil, Russia, India, China and South Africa — which may attempt to scale back their dependence on the greenback by launching their very own joint forex.

There are different, much more hanging, concepts floating round in Mar-a-Lago. Scott Bessent, Treasury secretary nominee, urged final yr that the world was heading for “Bretton Woods realignments”.

This suggests that he might need to revalue currencies, most notably to weaken the greenback as a way to assist American exporters. This would possibly embrace an try to duplicate the 1985 Plaza Accord, when America bullied others right into a revaluation — a parallel that’s hanging for the reason that greenback is now close to its 1985 trade-weighted levels after surging towards the yen and renminbi.

Bessent has additionally urged that nations with army safety from America must be pressured to purchase extra greenback debt, as a quid professional quo. “Is there some type of statecraft to do the place you go to [these countries] and say now we have these 40- or 50-year army bonds [to buy]?” he said, citing Japan, Nato members and Saudi Arabia.

These could also be empty threats. In Trump’s first time period his bark was typically worse than his chew. And if his group did use these “coercive instruments”, they could backfire.

It’s unclear, say, how Washington might agree a brand new Plaza Accord if China is set to unleash aggressive devaluations. And the extra that Trump tries to weaponise the greenback, the extra this may occasionally push nations to hunt options.

Certainly, as an IMF blog recently noted, there are already indicators that many non-American central banks are diversifying away from the greenback — albeit very slowly and modestly from a excessive base, and largely into minor currencies.

Extra intriguingly, the GCAP calculates that between 2015 and 2022 the share of Russian monetary companies imports managed by the US and allies fell from 94 per cent to 84 per cent — which meant that “the American coalition’s monetary energy over Russia was roughly halved, contributing to the muted impact of the imposed monetary sanctions”.

That reveals one other key level: with hegemonic energy, small declines can have outsized results. Or because the GCAP says: “Transferring the share from 95 per cent to 85 per cent can dissipate quite a lot of energy, generally as a lot as shifting from 85 to 50 per cent.”

In idea, this could make the Trump group cautious of radical strikes, significantly provided that America’s “exorbitant privilege” — ie the greenback’s standing as reserve forex — is what has enabled the nation to run such huge deficits so far. In observe, although, this sample would possibly really make them much more aggressive as a way to defend their energy.

Both approach, traders ought to brace for (at greatest) forex volatility earlier than offers are struck — and (at worst) an even bigger monetary shock. The tail dangers in markets are rising — and never simply due to tariffs.

gillian.tett@ft.com