The dollar risk of Trump tariffs

Trump has threatened to slap 100% tariffs on imports from countries that try to move out of the dollar. His ire was particularly directed at the Brics bloc that has been talking about developing an alternative to the dollar.This raises two questions. Why does Trump want to protect the dollar? And why does Brics want to de-dollarise?Dollar hegemony confers US huge advantages | Today, the US dollar reigns supreme in global economy and finance. Much of international trade is settled in dollars and a vast proportion of central bank reserves are held in dollars. Exchange rates between pairs of currencies are set via their parity with the dollar. The sentiment on Wall Street and the decisions of the US Federal Reserve affect markets and economies around the world.Because of this dominance of the dollar in the global financial system, America enjoys ‘exorbitant privileges’. It’s able to borrow cheap in world markets simply because the rest of the world needs dollar assets and is therefore eager to lend to America. If you have a hundred dollars in your pocket for example, it is in effect an interest-free loan to America of a hundred dollars. The world is incurring an exorbitant cost so that America can live beyond its means perpetually without any consequences.The world’s dependence on the dollar also gives America enormous geopolitical clout. It’s able to weaponise the dollar by slapping sanctions on what it believes are rogue countries, such as Venezuela, Iran and, most recently, Russia.The reason Trump wants to jealously safeguard the dollar is therefore straightforward. He is loath to lose these exorbitant political and economic privileges that the dollar dominance gives America.Why Brics, most EMs want to de-dollarise | On the other side, Brics, and indeed most emerging economies, are eager to de-dollarise mainly for two reasons.First, they believe that dollar dominance is a threat to their financial stability. Consider the Global Financial Crisis of 2008, which was caused by reckless risk-taking in the US financial system. If it were an emerging economy, its currency would have crashed. In the case of the dollar though, what happened was the exact opposite. Instead of losing value, it strengthened because American capital invested around the world fled back home in a manifestation of the ‘safe haven effect’.That has not been a one-off. There have, in fact, been several instances over the last two decades when emerging markets were held hostage to dollar volatility.Emerging markets have also resented America’s increasing resort to weaponising its currency for political ends. The sanctions against Russia by way of impounding its foreign assets were seen as a fitting punishment for Russia’s thuggish act of invading Ukraine. Nevertheless, it ignited fears among them that America might use its outsized power capriciously and thereby impair their economic security.Brics common currency a tall order | Even as the motivation for Brics to escape the dollar hegemony is strong, a Brics common currency is an unlikely prospect because of both politics and economics. It’s inconceivable that member countries, not least India, would be willing to give up their monetary policy autonomy and become hostage to a common currency that is vulnerable to instability anywhere in the bloc.Moreover, because of its huge economic and financial muscle, China would easily dominate Brics and hence the fortunes of the common currency. No matter the rhetoric about a new world order, it would be ironic if, to escape the dominance of the dollar, the Brics members succumb to the alternative of an authoritarian regime with a dubious reputation for institutional integrity, transparency and rule of law.Finally, would a Brics common currency dominated by China be accepted in the non-Brics world? If not, what’s the use of a Brics currency?Rival to dollar could emerge in future | Equally, slapping tariffs on countries simply because they are trying to de-risk themselves from the dollar won’t be easy for Trump. It’s not as if the dollar has been anointed as the world’s reserve currency by an international treaty.The dollar reigns by virtue of the strength of the US economy, the depth and openness of its financial markets and the credibility of American institutions of governance. For sure, the greenback can be dislodged if a strong and credible rival emerges. That, however, has not happened so far.But that past record is no guarantee that the dollar will continue to reign. Pushed to the wall, Brics may decide that the costs of moving out of the dollar are less than the costs of staying with it.More than a half century ago, an American treasury secretary told the G10 finance ministers: “The dollar is our currency, but it’s your problem.”If Trump carries out his threat, would the rest of the world turn back and tell America, “The dollar is your currency, and it’s your problem?”The writer is a former RBI governor