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Trump's trade war could evolve into a 'damaging' currency war

Dion Rabouin
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If U.S. President Donald Trump is unable to bring China to submission with tariffs, it’s possible and “highly likely” his administration would launch a currency war, experts tell Yahoo Finance.

Having already placed tariffs on $34 billion worth of Chinese goods exported to the U.S. and threatening to add tariffs to at least $400 billion more, some currency analysts believe Trump could move to devalue the dollar in a bid to further punish China and help U.S. companies gain an edge.

“As this lingers on and we keep increasing the level of tariffs where we get to a point where it really escalates I think it’s highly likely that the U.S. Treasury would then move to devalue the dollar and use it as a tool in this war,” said Keith Bliss, executive director of DriveWealth in New York.

“Let’s be candid here,” Bliss added. “There’s no telling what this administration will do from a policy standpoint and they’re not afraid to do it, despite what the rest of the world may think.”

J.P. Morgan Chief Economist Michael Feroli said that while it’s not his base case, he and his team “cannot rule out a turn toward a more interventionist currency policy, particularly since the current Administration has, at times, hinted at a preference for dollar weakness or objected to perceived Chinese currency manipulation.”

Unintended consequences

That could be a major problem, not just for China and the United States, but the rest of the world as well.

“This policy would raise market uncertainty and could provoke countermeasures from the Chinese that, in turn, increase the risk of unintended consequences seriously damaging global trade and financial markets,” Feroli wrote in a note to clients. He said he expects the U.S. Federal Reserve would go along with directives to weaken the currency.

US President Donald Trump (L) sits with Chinese President Xi Jinping (R) during a bilateral meeting at the Mar-a-Lago estate in West Palm Beach, Florida, on April 6, 2017. (JIM WATSON/AFP/Getty Images)
US President Donald Trump (L) sits with Chinese President Xi Jinping (R) during a bilateral meeting at the Mar-a-Lago estate in West Palm Beach, Florida, on April 6, 2017. (JIM WATSON/AFP/Getty Images)

Intervening in currency markets would be a breach of a long-held pact between the U.S. and other countries around the world. The push for that agreement was led by the United States, so violating it would be a major blow to U.S. credibility, analysts say.

“I don’t know if even Trump has really thought about doing that or what the consequences would be but I think it would be a very big deal,” said John Doyle, vice president of dealing and trading at Tempus Inc in Washington. “You can’t really point the finger at China and say ‘You’re a currency manipulator,’ if you’re literally doing it at that moment.”

‘Trump is a very reactive actor’

It also is largely without precedent for a U.S. leader to unilaterally weaken the dollar in such a way.

Further, argues Shaun Osborne, currency strategist at Scotia Bank in Toronto, the administration doesn’t need to intervene directly – by selling dollars for Treasury securities to increase the supply on the market and therefore lower their value – to reduce the dollar’s value.

“With this administration you never say never but I don’t really see the point of utilizing reserves in that way,” Osbourne told Yahoo Finance. “I think it would be a last resort and I don’t really see what good it would do, particularly at a time when the Fed is raising interest rates … that probably wouldn’t have that much effect.”

With the U.S. economy growing strongly there’s little reason to devalue the dollar, strategists say. But if the economy were to turn, a currency war is a definite possibility.

“Trump is a very reactive actor,” said Boris Schlossberg, managing director of FX strategy at BK Asset Management in New York. “He’ll make a lot of different outrageous claims but really won’t do anything until and unless there’s serious economic distress. Then all bets are off because he’ll be like a trapped animal.”

See also:

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The dollar’s status as the world’s funding currency is in question

The bad bets and hazards already in the market that could trigger the next recession

Dion Rabouin is a global markets reporter for Yahoo Finance. Follow him on Twitter: @DionRabouin.

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