Trump’s Tariffs have Wide Global Implications

To: Trade war watchers
From: Brenda González-Hermosillo
Date: May 15, 2025
Re: Trump’s Tariffs have Wide Global Implications

The world economy and financial markets are at their highest level of stress since the 2008 global financial crisis and the COVID-19 shock. The narrative is largely focused on the impact of frequently modified announcements of large US tariffs on specific industries and countries.

Ignored in these announcements by the Trump administration, is that the international trade of goods is a piece of a larger system with implications for international financial transactions, which in turn has implications for exchange rates.

A weaker currency makes imports more expensive and exports cheaper (and vice versa). The US dollar has weakened since the start of the so-called “tariff wars” – down more than 8 percent since the beginning of the year against a basket of other currencies. Canada is on the front line of Mr. Trump’s tariff hits – yet its currency is up by more than 3 percent against the U.S. dollar.

Looking simply at trade flows, this decline in the US dollar makes sense. Of course, it is the net exports (exports minus imports) of goods and services that matter, not just goods. So, putting tariffs on imported goods leaves out the question of what happens to trade in services. In 2024, the US had a merchandise trade deficit with Canada of $70.6 billion (all figures US) and with the world of $1.2 trillion. But a services trade surplus of $34.9 billion with Canada and $295 billion with the world. The US economy is largely driven by services, so the merchandise trade focus.

When adding interest payments and transfers to the balance of goods and services, we get the current account of the balance of payments (BOP). The United States has a large current account deficit due to its deficit in goods, and net transfer payments to other countries offsetting a big chunk of its services trade surplus. This can be conceived as money flowing “out” of the country.

The current account deficit means that the United States effectively borrows the same financial sum from the rest of the world – or needs to deplete its stock of international reserves such as gold – and in that sense the balance of payments always balances – in this case due to the willingness of agents in other countries to acquire US assets.

The foreign exchange rate is determined in financial markets. Typically, a large current account deficit or the loss of international reserves would lead to a weaker currency – though many other factors determine the value of a currency including expectations.

The US dollar behaves differently because it is a “reserve currency” due to its liquidity and the unit of account for most global financial transactions. Reflecting the capital and financial accounts accumulated over years, foreigners own $19 trillion of US equities and $7 trillion of US Treasuries, roughly equivalent to the country’s GDP. Around 54 percent of all global export invoices are denominated in US dollars, as well as 60 percent of all international loans and deposits, and 70 percent of all international bond issuance.

In turn, this status allows the United States to “print” currency, in effect issuing an IOU, in exchange for goods and services from the rest of the world – a benefit called seigniorage, worth by some estimates $90 billion annually to the United States. At times of financial and economic stress, a run for liquidity has often translated into a stronger US dollar, because of its reserve currency status and great liquidity, and lower US Treasury bond yields due to their “safe haven status.”

Not this time.

Why is that? Investors may be catching on to the fact that, despite protestations to the contrary, the United States is ready to weaken the role of the dollar, as the necessary consequence of trying to reduce its trade and hence current account deficits.

The frequent changes in the announced magnitude and scope of tariffs may also create a lack of trust in US policies, all leading to fears of inflation and lower willingness on the part of foreigners to acquire US assets. These sea changes are behind the strength of other economies’ currencies against the US dollar – though like Canada, these economies are being weakened by US tariffs. In the long run, they may signal the need for a new reserve currency, although it is not obvious what could replace the US dollar, perhaps digital currencies, or China deciding to make the yuan more convertible.

Tariffs will certainly not reduce the US current account deficits. Letting go of the US dollar reserve currency status would help reduce them. Be prepared for exchange rates to be part of major trade negotiations still to unfold this year.  

Brenda González-Hermosillo is member of the C.D. Howe Institute Trade Crisis Working Group.

To send a comment or leave feedback, email us at blog@cdhowe.org.

The views expressed here are those of the author. The C.D. Howe Institute does not take corporate positions on policy matters.

Want more insights like this? Subscribe to our newsletter for the latest research and expert commentary.