Another week, another wave of wild threats from US president-elect Donald Trump. On Tuesday, he pledged to “tariff Denmark at a very high level” if it did not agree to sell Greenland to the US.
Then on Wednesday, reports emerged that he was considering the declaration of a national economic emergency to slap trade sanctions on numerous countries.
No doubt yet more sabre-rattling will follow soon. Welcome to a world of angry mercantilism, where power politics rules supreme.
There is a certain irony here, however. In his speeches, Trump typically focuses most of his threats on tariffs linked to traded goods. But this is not necessarily his main source of leverage.
After all, as a new report from the Global Capital Allocation Project (a joint hub between Stanford, Chicago and Columbia universities) notes, it is China that actually has hegemonic power over global manufacturing, via its dominance of many supply chains.
Where America does have hegemonic power, however, is in finance, via the dollar-based system. Or, as the GCAP says: “Since the US-led coalition controls a dominant share of global financial services, often exceeding 80 or 90 per cent in many countries, this near-total control of the global financial system enables the US coalition to frequently use finance as a tool of coercion.”
Thus the question that global investors should be asking now. Will Trump’s team use these “coercive” tools to punish rivals or to cut deals? Tariffs, in other words, are not the only — or even the main — game in town.
This issue is not, of course, entirely new: the American government has been weaponising its currency to a growing degree in recent years by seeking to exclude perceived enemies, such as Iran and Russia, from the dollar-based financial system. It has also imposed sanctions on financial institutions that defy this. Marco Rubio, secretary of state nominee, has pushed MSCI, the US-based index provider, to exclude Chinese groups.
Trump’s team will almost certainly double down on this. In addition he has threatened retribution against countries — such as Brazil, Russia, India, China and South Africa — that might try to reduce their dependence on the dollar by launching their own joint currency.
There are other, even more striking, ideas floating around in Mar-a-Lago. Scott Bessent, Treasury secretary nominee, suggested last year that the world was heading for “Bretton Woods realignments”.
This implies that he may want to revalue currencies, most notably to weaken the dollar in order to help American exporters. This might include an attempt to replicate the 1985 Plaza Accord, when America bullied others into a revaluation — a parallel that is striking since the dollar is now close to its 1985 trade-weighted levels after surging against the yen and renminbi.
Bessent has also suggested that countries with military protection from America should be forced to buy more dollar debt, as a quid pro quo. “Is there some kind of statecraft to do where you go to [these countries] and say we have these 40- or 50-year military bonds [to buy]?” he said, citing Japan, Nato members and Saudi Arabia.
These may be empty threats. In Trump’s first term his bark was often worse than his bite. And if his team did use those “coercive tools”, they might backfire.
It is unclear, say, how Washington could agree a new Plaza Accord if China is determined to unleash competitive devaluations. And the more that Trump tries to weaponise the dollar, the more this may push countries to seek alternatives.
Indeed, as an IMF blog recently noted, there are already signs that many non-American central banks are diversifying away from the dollar — albeit very slowly and modestly from a high base, and mostly into minor currencies.
More intriguingly, the GCAP calculates that between 2015 and 2022 the share of Russian financial services imports controlled by the US and allies fell from 94 per cent to 84 per cent — which meant that “the American coalition’s financial power over Russia was approximately halved, contributing to the muted effect of the imposed financial sanctions”.
That reveals another key point: with hegemonic power, small declines can have outsized effects. Or as the GCAP says: “Moving the share from 95 per cent to 85 per cent can dissipate a lot of power, sometimes as much as moving from 85 to 50 per cent.”
In theory, this should make the Trump team wary of radical moves, particularly given that America’s “exorbitant privilege” — ie the dollar’s status as reserve currency — is what has enabled the country to run such big deficits thus far. In practice, though, this pattern might actually make them even more aggressive in order to defend their power.
Either way, investors should brace for (at best) currency volatility before deals are struck — and (at worst) a bigger financial shock. The tail risks in markets are rising — and not just because of tariffs.
