With the Turkish lira in free fall, Chinese yuan down by 8 per cent in July alone, and ₹70 required to buy one dollar, experts warn that the trade war might soon escalate into trade plus currency war. But the ‘law of unintended consequences’ may not be at work here. Securing the interest of the US currency may be a less discussed yet real agenda behind the current trade war.
Trump is trying to deal with two serious concerns facing the American economy: Counter the threats to the dollar’s status as the reserve currency, and retain the near monopoly in Digital and Hi-Tech space. These issues, central to the US power and eminence, are now under serious challenge.
First the dollar issue. The dollar’s status as a reserve currency the world trusts is the primary reason for the US economic supremacy. Other countries need to export something to earn dollars. Not the US, which can print as many as it wants and buy any property, technology or pay for its massive imports. Also, it can invest a large amount of venture capital to buy any firm anywhere. Individual countries may face inflation if they print more local currency, not the US as the excess dollar is absorbed happily by the world.
Consider China-US trade. China sells all type of products to the US. In return, the US just prints dollars and gives them to China, which beyond a point has no use of these. So China deposits unspent trillions of dollars again with the US Treasury or buys firms and properties around the world.
The dollar has become the reserve currency because over 70 per cent of world trade happens in dollars. This may look strange as the US share in world trade is less than 15 per cent. The US manages this by ensuring that large trade contracts for commodities like crude oil are always denominated in dollars. Also, large US banks operating globally ensure that most export contracts are made in dollars even though it is not the currency of the buyer or seller.
Iraq example
And the US goes great lengths to deal with any threat to the reserve status of the dollar. In 2003, the US army captured Iraq and hanged its President Saddam on allegations that Iraq had Weapons of Mass Destruction (WMD). No WMDs were ever found. And we soon learned that Saddam started the process of denominating oil contracts in Euro and other currencies.
The dollar’s position as the reserve currency is under strain again. Many countries including China are taking steps to denominate their trade contracts in local currency and reduce dependence on the dollar. China plans to denominate all Belt and Road Initiative (BRI) contracts in local currencies. No wonder China is the primary target in the trade war.
The Saudi royal family has since the 1970s ensured that all OPEC oil contracts are denominated in US dollars. In return, the US ensured the continuation of the royal rule and fought Saudi enemies in the Gulf region. And this explains Trump’s action of isolating Iran. Since Iran is an enemy of Saudi, Trump announced sanctions to cripple Iran. Anyone buying from Iran after November would also face sanction.
Threat to hi-tech
Trump’s second concern is to retain the US lead in digital and high tech space. It is under threat from China which is going all-out to become a leader in Artificial Intelligence and high technology by 2025. Loss of US monopoly in digital space is a worry too.
Many of China’s home-grown firms are large unicorns ready for global operations in direct competition to the US firms. Worse, the China model of not allowing entry to Google and Facebook is being copied by Russia, Brazil, and many others. The EU is also thinking of creating an EU wide internet. All this would mean an end of the dominance of the US firms in digital space.
The US tariffs on imports from China will impact not only its exports to the US but to all countries. Most of China’s exports are produced in the tariff-free global supply chains (GVC) where collaborative manufacturing happens among a group of countries. Tariffs by partner countries will delay numerous Customs clearances and significantly reduce the effectiveness of GVCs. The US would love to think that this will rock the Chinese boat and force them to a compromise.
Discrediting WTO
The question remains, why discredit the WTO which served the cause of world trade well and pursued the earlier US priorities. A smart strategy is at work here. Trump is using tariffs as primary tools for trade war because raising tariffs requires no investments and they do the most damage in a world where trade accounts for more than a quarter of world GDP. He needs to raise tariffs, but doing so violates the WTO rules because the US has in 1995 tied its hands by agreeing to maintain very low tariffs (less than 3 per cent). So the solution is clear. Raise the tariffs, but discredit the WTO as being unfair to the US.
So these could be the real reasons for the trade war. Reasons such as imports posing a threat to national security or the US exports facing high trade barriers may just be used by Trump to buy peace with the WTO, humour rust belt voters and distract everyone else.
The US reasons for the trade war may look selfish, and harm world trade, production, and employment globally. But that’s what the US script is. And no other US President could have played this better. It required the persona of Trump to make everything look so real.
The writer is an Indian Trade Service officer. Views are personal.