After the tariff upheaval, Trump may use financial tactics against allied nations

With the ink barely dry on U.S. President Donald Trump‘s latest tariffs, many are already anticipating the next steps in his strategy to pressure trading partners into compliance. As the center of the global financial system and the issuer of the world’s reserve currency, the United States possesses various tools that Trump can utilize to influence other nations, ranging from credit mechanisms to the supply of dollars to international banks.

However, employing these unconventional tactics could come with significant repercussions for the U.S. itself and might even lead to unintended consequences. Analysts caution that such worst-case scenarios should not be overlooked, especially if the tariffs fail to decrease the U.S. trade deficit with other countries—a possibility many economists consider likely, given the current near-full employment in the U.S. that has resulted in severe labor shortages. “I can easily envision Mr. Trump becoming frustrated and resorting to unconventional ideas, even if they lack sound reasoning,” remarked Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley.

MAR-A-LAGO ACCORD

The U.S. administration’s somewhat covert strategy aims to rebalance trade by devaluing the dollar. One approach could involve collaborating with foreign central banks to adjust their currencies upward.

A paper authored by Stephen Miran, Trump’s nominee to lead his Council of Economic Advisers, suggests this could be part of a Mar-a-Lago accord, drawing parallels to the dollar-stabilizing Plaza Accord of 1985 and referencing Trump’s Florida resort.

The November paper indicated that the U.S. might leverage the threat of tariffs and the appeal of American security assistance to encourage foreign nations to strengthen their currencies against the dollar, among other concessions.

Economists express doubt that any agreement would gain momentum in Europe or China, given the significant differences in the current economic and political landscape compared to four decades ago. Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics, remarked, “I think that’s a really unlikely scenario.” He pointed out that tariffs have already been enacted, diminishing their effectiveness as a bargaining tool, and noted that the United States’ commitment to global security has been undermined by its ambiguous stance on Ukraine.

Obstfeld also mentioned that central bankers in the eurozone, Japan, and Britain are unlikely to agree to a deal that would compel them to increase interest rates, potentially leading to a recession. Additionally, Freya Beamish, chief economist at TS Lombard, contended that strengthening the yuan would contradict China’s need to stimulate its faltering economy.

In Japan, despite the government’s repeated interventions in the currency market to support the yen over the past few years, the lingering memories of 25 years of deflation, which has only recently subsided, may dampen any enthusiasm for a significant appreciation of the yen.

DOLLAR BACKSTOP

If a consensus cannot be achieved, the Trump administration may resort to more aggressive measures, leveraging the dollar’s position as the primary currency for global trade, savings, and investment.

This could involve threatening to restrict access to the Federal Reserve’s lending facilities for foreign central banks, which currently allow them to borrow dollars by providing collateral in their own currencies, as noted by Obstfeld and several supervisors and central bankers.

This funding source is crucial during crises when money markets become unstable and investors seek refuge in the dollar. Removing it would disrupt a multi-trillion dollar market for dollar credit outside the U.S. and significantly impact banks in the UK, eurozone, and Japan.

The Federal Reserve controls these swap lines, and there has been no indication from Trump that he intends to take charge of this influential monetary institution. However, his recent actions to replace key personnel, including those in regulatory bodies, have raised concerns among analysts.

Spyros Andreopoulos, founder of the Thin Ice Macroeconomics consultancy, remarked that it is now conceivable that this could be used as a significant bargaining chip in larger negotiations, potentially undermining the dollar’s reputation as a dependable global currency over time.

CREDIT CARDS

In addition, the United States has a significant advantage with its payment giants, such as Visa and Mastercard. While Japan and China have developed their own electronic payment systems to varying extents, these two American companies handle two-thirds of card transactions in the 20-nation eurozone. Furthermore, mobile payment applications, primarily led by U.S. companies like Apple and Google, account for nearly 10% of retail transactions.

This trend has placed European firms at a disadvantage in a vast market valued at over 113 trillion euros ($124.7 trillion) in the first half of last year. If Visa and Mastercard were to withdraw their services, as they did in Russia following its invasion of Ukraine, Europeans would be forced to rely on cash or cumbersome bank transfers for their purchases.

Maria Demertzis, chief economist for Europe at the Conference Board think tank, stated that the U.S.’s shift to a hostile stance represents a significant setback.

The European Central Bank has indicated that this situation puts Europe at risk of “economic pressure and coercion,” suggesting that a digital euro might offer a potential solution. However, the implementation of this digital currency has become mired in discussions, potentially delaying its launch for several years.

European leaders are contemplating their response to Trump’s actions but are cautious about provoking further tensions. They might consider imposing their own tariffs or taking more severe actions, such as restricting U.S. banks’ access to the European Union.

Nevertheless, such drastic measures could prove challenging due to Wall Street’s significant influence and the potential backlash against European banks operating in the U.S. Despite this, some international banking executives have expressed to Reuters their concerns regarding the possibility of repercussions from Europe in the near future.