April 11, 2025 - 5:00pm
With tentative stability between Europe and the US on tariffs, the changing exchange rate will play an even more significant role in transatlantic trade. The euro has increased in value against the dollar by around 10% since Donald Trump took office in January, the result of fundamental shifts in global financial flows. From the perspective of a European exporter, this is the equivalent of a 10% tariff, since a weakening dollar will cause increased prices in America for the same European products.
If you include the actual 10% tariff, European firms face a 20% rise compared to when Trump became president. If you include the special tariffs for some sectors, such as cars, steel and aluminium, and soon pharmaceuticals, it will be close to 25% for the economy as a whole. So critics should be careful about prematurely celebrating Trump’s retreat. Even if the so-called reciprocal tariff were to turn into a baseline tariff of 10% against the rest of the world, the combined economic impact would still be large.
Exchange rates are a far more effective instrument in rebalancing the global economy than tariffs. They act on both sides of the balance of payment: financial flows and trade. Tariffs only act directly on imports, but not on exports. They are not a great rebalancing tool; but as the fallout of “Liberation Day” made clear, they can have a very large effect on export-reliant trading partners. The tariffs will, for example, drive Germany’s economic model over the edge. It has become heavily reliant on the US market to find consumers for its over-productive industry. So if tariffs — especially the higher tariffs on car manufacturers — cut this off, German firms will have a significantly reduced market to sell products.
Unlike tariffs, though, the exchange rate acts on both imports and exports simultaneously. More importantly, it acts on financial flows. If you look at Germany from the perspective of trade and currency only, you see a competitive economy that is one of the world’s largest exporters. But if you look at the imbalance from the perspective of financial flows, now the natural perspective of investors in a globalised economy, you see that China and Germany are generating massive savings surpluses that they invest abroad. You see countries which do not know how to invest their surplus savings. So in order to enact structural realignment that resets this, as Trump’s administration is pursuing, the most effective tool is a shifting exchange rate.
It looks, then, like Trump staged a tactical retreat only. Treasury Secretary Scott Bessent appears to have won the internal power battle in the Trump administration and is now in charge of the policy. This suggests that the emphasis of the US’s external financial policies will shift from a full focus on tariffs to a broader-based strategy, in which tariffs act as a tactical weapon and the exchange rate is the strategic intercontinental missile. This will lead to a broader realignment that could include a further devaluation of the US dollar.
This is an edited version of an article which originally appeared in the Eurointelligence newsletter.
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