Written by Jamie MacGyver
ORLANDO, Fla. (Reuters) – The U.S. dollar may be the only “winner” from a potential all-out trade war between the West and China.
Uncertainty over global trade policy is at its highest since 2018 and 2019, when tensions between the Trump administration and Beijing peaked. It hasn’t reached that peak yet, but it will be a focus of greater attention as the U.S. presidential election approaches.
Regardless of who wins in November, more tariffs on Chinese imports and possible retaliation seem inevitable. China is already warning that Europe’s move to join the tariff train would constitute a “trade war.”
Trump’s return to the White House would raise the stakes significantly.
Rising protectionism and shrinking cross-border trade may dampen growth everywhere, but the United States – the world’s economic and currency superpower – enjoys layers of protection that other countries do not enjoy.
These reasons include the relatively closed nature of the economy, the global importance of U.S. stock and bond markets, and the prevalence of the dollar in international reserves.
But this does not mean that the United States will not suffer – growth will slow and inflation rates may rise. But higher inflation would delay or perhaps even reverse Fed interest rate cuts, and growth in Europe and Asia would become more vulnerable than growth in the United States.
In short, the pain is likely to be most acute in other currencies, none of which enjoy the safe-haven status that the dollar does. And in the world of exchange rates, everything is relative.
Three times the hit
Goldman Sachs economists attempted to identify risks to growth in the US and eurozone by analysing the 2018-19 trade war and its aftermath through three lenses – US and European corporate commentary on trade uncertainty, stock returns around tariff announcements and cross-country investment patterns.
They find that a rise in trade policy uncertainty to 2018-19 levels would likely reduce U.S. GDP growth by three-tenths of a percentage point. The estimated hit to euro area growth would be three times larger.
For a region already expected to grow much more slowly than the US, with growth of just 0.8% this year and 1.5% next year, according to the International Monetary Fund, that would be a huge blow. It could be followed by aggressive monetary easing by the European Central Bank, which would undermine the euro.
“Further increases in trade policy uncertainty pose a significant downside risk to our global growth forecasts in the second half of 2024 (2H24) and 2025… with larger impacts in the economies where they are represented,” economists at Goldman Sachs wrote on Tuesday. Exports are a larger share of GDP. .
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The US economy is much less open than its European or Chinese counterparts, meaning any disruption to trade would have a relatively limited impact.
According to the World Bank, US exports of goods and services reached 11.8% of GDP in 2022, compared to about 20.7% in China. Eurostat data show that goods exports in the eurozone last year were worth 20% of GDP.
The persistent and deteriorating trade deficit for years was seen as a major drag on the dollar, as the United States had to attract huge amounts of foreign capital to plug the gap and keep the dollar from depreciating.
But the US trade deficit last year was 2.8% of GDP, much lower than the previous year and half what it was in the mid-2000s. Repatriation, energy self-sufficiency, and the push to revive domestic manufacturing all suggest that the deficit will not be the drag on the dollar that it once was.
That’s before any tit-for-tat tariff escalation further reduces U.S. imports.
Euro parity?
China’s domestic economic problems and geopolitical position are enough to make foreigners wary of investing in the country. But it is no coincidence that foreign direct investment flows into China are falling at their fastest pace in 15 years as trade tensions rise again.
Chinese stocks have been weak, barely in positive territory for the year and after a tough 2023. Beijing is struggling to hold the yuan, which has hit a seven-month low against the dollar.
European stock markets and the euro did not react positively to recent headlines regarding tariffs imposed by Brussels on some imports from China. Given how close trade relations between the eurozone and China now are, this should not be surprising.
The eurozone imports more goods from China than anywhere else in the world, and the yuan’s trade-weighted weight in the euro rivals that of the dollar. Trade tensions between China and Europe would certainly hit the euro hard.
Since the euro accounts for about 60% of its weight in the broader global economy, it is natural that there is a strong inverse correlation between the fate of the euro and the dollar.
Analysts at Deutsche Bank expect the dollar to remain “stronger for longer” this year and next, although the momentum may fade as the cycle lengthens.
But whoever wins the White House in November, a more aggressive stance on trade would be a major positive development for the dollar, and perhaps push the euro lower toward parity.
“The dollar underestimates the risks posed by US protectionism,” they wrote on Wednesday.
(The views expressed here are those of the author, a Reuters columnist.)
(Writing by Jimmy McGeever, Editing by Paul Simao)
