Trump's tariff war to breakdown the global dollar? Dollarized countries heading for crises? What options do they have?

 

Article's purpose and background

This article is to predict the possibility of a new global monetary order that may evolve in response to the new tariff policy declared by the US President Donald Trump (announced on 2 April 2025 to be effective from 9 April 2025). Therefore, the article does not comment on its viability or fairness from any perspective (The second article on this subject is accessible here).

• The present global monetary order has evolved on the US dollar as the global reserve currency created largely through free and facilitative trade and balance of payment (BOP) deficits of the US economy with the support of its allies and the US-sponsored international institutional network.

• However, Trump's new tariff policy is to hack it radically by an attempt to have zero trade balances of the US with individual countries through the imposition of reciprocal tariffs and trade barriers variant on the US trade deficit with each country.

• Accordingly, Trump's new tariff policy is aimed at a zero trade balance with each country and eventually for the US. If the new tariff policy is to prevail, a new global monetary order has to evolve soon because the dollar cannot function as the major reserve currency as its supply is frozen by the balanced trade.

Key features of the new US tariff policy

It has four major tariff categories effective from 9 April 2025 as highlighted below.

• A universal 10% tariff for imports from all countries

• A reciprocal tariff for imports from each country based on the US trade deficit with the respective country. The tariff rate is calculated as follows.

• (US trade deficit with the country/US imports from the country x100)/2

• 25% tariff on cars and selected imports from selected countries such as China 

• 145% tariff on imports from China (Initially at 34%, but increased several times so far to 54%, 84%, 104%, 125% and 145% in response to Chinese retaliations)

The rationale for the design of the reciprocal tariff is as follows.

• The US trade deficit calculated as the percentage of the US imports from the respective country is defined as the total loss to the US caused by tariffs, trade barriers, subsidies, tax incentives, exchange rate manipulations, etc. by the country against the US. This is also interpretted as the effective tariff imposed by countries against the US. Therefore, the US trade deficit is unfair.

• Accordingly, the half of that percentage is imposed as the reciprocal tariff or discounted tariff for each country. This is intended to force each country to take necessary measures to reduce its trade surplus with the US towards zero.

• The above percentage for Sri Lanka is 88% which is the effective tariff charged by Sri Lanka from the US as interpretted above. Therefore, the half of it, i.e., 44%, is the reciprocal tariff for Sri Lanka.

• The total trade deficit/total imports of the US is 37% and the half of it is 18.5%. Therefore, the universal tariff of 10% has been imposed on all countries, irrespective of trade deficit or trade surplus with each country. Therefore, countries such as Singapore who run a trade deficit with the US also are subject to the10% universal tariff rate.

Given the global panic caused by the new tariff policy, the effective date for reciprocal tariff rates was postponed on 9 April 2025 for 90 days to allow for the country authorities to agree on trade deals with the US authorities as to how the respective trade deficits would be resolved in the US interest. However, the 10% universal tariff rate is effective from 09 April 2025 as imposed.

What is the magnitude of the US trade deficit to invoke this tariff war?

The new tariff policy highlighted above is based on the US trade deficit in the BOP (see the Table below). Accordingly, the President Trump wishes to reduce the US trade deficit towards zero.

The US BOP highlights in 2024 are as follows.

• Imports of goods (item 1 in the Table) were US$ 3,296.2 bn accounting for 11.1% of GDP.

• The trade deficit (balance column in the Table) was US$ 1,213 bn which is 4.1% of GDP.

• The current account deficit (Item 6 in the Table) (i.e., goods, services and income) was US$ 1,133.6 bn representing 3.8% of GDP. In macroeconomics, the current account deficit is the country's excess of investment over its domestic savings.

• Overall BOP deficit (Item 7 in the Table), i.e., US$ 1,128.3 bn, shows the total amount of net borrowing of the US from the rest of the world to finance the BOP deficit in 2024. This net borrowing is the amount of US Dollars created by the US banking system to finance the BOP deficit. As the US is the printer of the US Dollars being the most popular global reserve currency, the US can run any amount of BOP deficit as long as the demand for the Dollar from the rest of the world remains strong.

• The trade deficit is the key driver in the US current account and overall BOP as services, income and capital trades are not that significant.

• Overall, it is the US BOP deficit that supplies US Dollars to the rest of the world. This Dollar supply adds to foreign reserves of the countries which will be invested back in US banks and financial markets.

• Therefore, the US benefits from the BOP deficit with the rest of the world twice. First, imports of real resources to enhance the US economy and living standards. Second, reinvestment of US Dollars created to finance the BOP deficit back in the US. This has helped the US government to fund a budget deficit (US dollar 2 trillion at orsent) and rollover of national debt (US dollar 36 trillion or 124% of GDP at present) to keep the momentum of the economy and living standards. 

Therefore, the proposed tariff and trade policy will shake up not only the US economy and its living standards but also the global economy and global living standards. It is because the intended reduction in US trade deficit is nothing but an arranged cut in US domestic investment to match its lower level of domestic savings, which will depress the US economy and have its contagion over the global economy. This a simple macroeconomic fact.

How did the present dollarized global monetary order evolve?

The present dollar-based global monetary order is a result of the global trade and institutional network sponsored by the US and and its allies centered around the US economy and geopolitics. The major components of the institutional network are as follows.

• 1944 Bretton Woods exchange rate system built on the dollar-gold convertibility where exchange rates of other currencies were pegged to the Dollar and convertible into gold through the Dollar. This helped the Dollar to emerge as the global reserve currency where the US gained the world monetary power to print dollars without limits for domestic objectives.

• The end of Bretton Woods system as the US suspended the dollar-gold convertibility on 15 August 1971. This freed the discretionary money printing and BOP deficit in the US as the Dollar had already gained the world's monetary power for the US.

• The emergence of IMF (International Monetary Fund), World Bank, United Nations, UNHRC (United Nations Human Rights Council), UNCTAD (United Nations Conference on Trade and Development), US AID (United States Agency for International Development), GATT (General Agreement on Tariff and Trade) and WTO (World Trade Organization) facilitating competitive trades and investments and democracies across the world. This led to a rapid globalization inclusive of the breakdown of communist governance systems towards transparency and human rights aligned to democratic values. This network sponsored by the US was instrumental in promoting the US as the global power house in all facets.

Therefore, these geopolitical developments led to largely free trade arrangements with lower tariffs and dollar-based international payment system where the US became the world power to enjoy the command and benefits.

Accordingly, developing countries became highly dollarized through the international trade and dollar reserves despite their sovereign currencies where the US became the dominant power in the world in both geopolitics and economic management. Accordingly, the developing world reformed their economic systems to earn dollars through exports to the US and its allies as well as borrowing from them. As a result, the global economy was dichotomized between the center with the US and its allies and the periphery of the developing world as the feeder to the center. 

In fact, the US trade deficit agitated by the President Trump is the conduit used for this dollarized global trade and monetary order operating with the support of the global institutional network as stated above to the greater benefit of the US. Therefore, the US trade or BOP deficit has been the premium enjoyed by the US on its globalized dollar and underlying geopolitics.

Therefore, if the new tariff policy is to prevail, global institutions such as IMF, World Bank and WTO who promoted the present global trade and monetary order will soon become dormant as there will not be a room for their objectives and operations as agreed at present.

What impact is expected from the new tariff policy on countries?

In modern global economy and living standards, tariffs are brutal. As tariffs are paid by people of the importing country, they are the first victim because tariffs will raise domestic prices of imports and goods and services produced from imported inputs. The eventual effect is dependent on the import content in the economy and the price elasticity of demand for imports. If trade partner countries are to retaliate, there will be a global trade war that will shock the global economy, inflation and living standards through global supply chains. This part of tariff story is simple economics although tariffs are geopolitics.

Therefore, if Trump's new tariff policy which is designed for making the US trade balance zero or small is to win, the dollar flow to the world will freeze and, therefore, the present dollarized global monetary order has to collapse.

The transition of the new tariff policy will panic many countries and the global economy as seen in the last two weeks. The adverse impact predicted by economists is well clear in text books. Foreign reserves to fall, currencies to depreciate, inflation to rise, interest rates to rise, economies to fall and unemployment to rise are the key predictions. 

In the event the President Trump expands its new trade policy to intervene in international flows of investment and income, the global economy will freeze and dollarized debt-ridden developing countries like Sri Lanka will have no option but to collapse. In addition, dollarized monetary and fiscal policies of these countries will fail to protect or revive respective economies in the absence of dollar debt inflows disrupted or frozen by the US balanced trade policy and underlying trade barriers.

All these predictions depend on how markets, political leaders and people will respond to the new US policies. Therefore, the 90-day period given for trade negotiations with the US will entail significant volatilities across the world's economy and geopolitics. Some developing countries may confront political and economic crises and a new round of defaults during this period.

Why the new tariff policy will push for a new global monetary order?

The present dollarized global monetary order is a geopolitically designed system by the US and its allies. Therefore, given the present trade war conditions and grave uncertainties, the US will not be able to continue with the existing world order due to stiff retaliation of its allies and other global trade leaders such as China, Japan and South Korea who have already developed own reserve currencies in sizable magnitudes. Further, emerging world powers are already in an explicit de-dollarization agenda to engage in trade on own currencies.

The President Trump also has declared a new agenda of a dollar-based cryptocurrency system through the US banking system and new legislation is in the process. Accordingly, banks have been proposed to issue own cryptocurrencies pegged to the dollar and trade them. Therefore, the President Trump seems to be planning a new global dollar system linked to own cryptocurrencies. This will delink the dollar value from real trades and currency speculations.

However, the difficulty in finding an alternative reserve currency for a sustainable global monetary order is the non-availability of a currency with an institutional system to trust the currency and its geopolitics as compared to the US dollar that has evolved during several decades. In that context, if the President Trump wishes the dollar to continue as the global reserve currency and the monetary order, he has to abandon his balanced trade policy and allow the dollar outflow to the rest of the world. Otherwise, the global economy will undergo several rounds of currency crises before markets finding a new system or a global equilibrium.

Given grave uncertainties in global trade and payments caused by Trump's trade war, countries may look for contracts on exchange of goods and services in old fashion without involving currencies. This will help resolve geopolitics of trading currencies.

The present global order of trade and currencies is a geopolitical outcome. It has got no economics. Economists only can analyze and dispute over the past. Their predictions are highly erratic on geopolitical events. Therefore, economists cannot propose any solutions to the Trump's trade war or a new global trade and monetary order in the event the President Trump wins the trade war. Therefore, political leaders who try to follow economists will only delay the process and expose countries to crises.

In that context, national leaders of many developing countries in the global periphery have no option but  to wait and see what political leaders of the US and its allies will agree on and then to follow suit passively. Finally, in the absence of bargaining powers, they will have to accomplish or deliver what the US authorities require them to do.

However, all national leaders have got a new opportunity for a fresh round of politics in respective countries for them to agitate and flourish. In that context, the President Trump's tariff policy is a disguised blessing to them who always look for such escapegoats.

(This article is released in the interest of participating in the professional dialogue to find out solutions to economic issues affecting living standards. All are personal views of the author based on his research and knowledge on the subject and, therefore, the author has no intension to personally or maliciously discredit views and characters of any individuals.)

P Samarasiri

(BA (Hons) in Economics and MA in Economics)
(Former Deputy Governor, Central Bank of Sri Lanka)

(Former  Deputy Governor, Assistant Governor, Secretary to the Monetary Board, Compliance Officer and Director of Bank Supervision of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 13 Economics and Banking Books and a large number of articles published.)