TL;DR

The intensifying trade wars between China and various global economies, particularly in the electric vehicle (EV) sector, are reshaping international trade dynamics.

These conflicts are not just about commodity price dislocations, tariffs and trade balances; they have far-reaching implications for global currencies, inflation rates, and economic policies.

But most of all, EV, chip, energy and natural resource wars stoke demand for the USD (the dollar).

And as sovereigns continue to fire off blunt instrument tariffs and sanctions and engage in reshoring/friendshoring and re-regionalisation, get yourself ready for the return of Dollar Vader, potential credit crunches, and the opportunities this might bring.

The impact of tariffs on EVs and other goods

Recent moves by the European Union, Turkey, and the United States to impose higher tariffs on Chinese-made EVs and other goods mark a critical escalation in the trade war. For instance:

• Volvo shifts production: Volvo Car AB is relocating its EV manufacturing from China to Belgium due to impending EU tariffs on Chinese EVs.

• Turkey's new tariffs: Turkey has announced a 40% tariff on all vehicle imports from China.

• US tariff hikes: The Biden administration has increased tariffs on Chinese EVs to 100% and on semiconductor-related products to 50%. You can get a refresher here.

These measures, aimed at reducing dependence on Chinese imports and promoting domestic industries, are significantly raising the costs of goods.

Tariffs block the benefits of globalisation - deflationary goods.

Increased demand for the dollar

In addition to higher domestic demand, dollar demand from the Eurodollar market is mooning.

1. Costlier imports and higher USD demand

   • As tariffs make Chinese other goods more expensive, countries and companies will need more dollars to pay for the increased value of these imports. The dollar, being the primary global trade currency, sees heightened demand.

2. Reshoring and friendshoring

   • The push towards reshoring (bringing production back to home countries) and friendshoring (moving production to allied countries) involves significant costs. Establishing new manufacturing facilities, training workforces, and integrating supply chains will require substantial investments, predominantly financed in dollars.

3. Higher interest rates and the Eurodollar market

   • The Federal Reserve's higher interest rates, aimed at controlling domestic inflation, make dollar-denominated assets more attractive to investors. This drives up demand for the dollar.

   • The Eurodollar market (dollar denominated debt held outside the U.S.), where USD is borrowed and lent also sees increased demand for the dollar as global trade and finance require more dollar liquidity to manage higher costs and tariffs. This additional demand further strengthens the dollar, with dollar swap lines being the only relief valve.

The Inflationary spiral

For many years, China’s factory exported deflationary goods, contributing to a higher standard of living in many importing nations, including Australia. It was a key benefit of globalisation, via nation state supply chain comparative advantage.

Regrettably, tariffs and sanctions are reversing these benefits and instead, creating mor ingredients for higher inflation for longer.

1. Decrease in deflationary goods

   • China has been a major exporter of deflationary goods, keeping global prices low. With reduced Chinese exports due to tariffs, the supply of these low-cost goods will dwindle, leading to higher prices globally.

2. Increased goods Consumer Price Index (CPI)

   • The higher cost of imports will contribute to an increase in the CPI for goods. As everyday items become more expensive, overall inflation rates will rise.

3. Higher interest rates for longer

   • Central banks will likely respond to sticky inflation by maintaining higher interest rates for an extended period. This approach aims to curb inflation but can also slow economic growth. That said, last week Canada became the first G7 country to lower official interest rates. The European Central Bank also made its first cut.

The Dollar Vader effect

The culmination of these factors leads to something that’s reminiscent of the dark side of the force, or what I’ve been calling "Dollar Vader", which in economic terms means the following.

• Higher USD demand and value

  • The increased need for dollars to finance more expensive imports and investment in new production facilities drives up the value of the dollar.

  • The combination of higher interest rates in the U.S. and the additional demand from the Eurodollar market creates a reinforcing cycle, pushing the dollar even higher.

• Global economic strain (the wrecking ball)

  • A stronger dollar creates financial stress in countries with significant dollar-denominated debts. As the dollar appreciates, repaying these debts becomes more costly, leading to potential credit contractions.

• Tradeable inflation

  • With higher import prices and rising domestic production costs, inflation spreads across borders, affecting many countries. This ‘tradeable’ goods inflation leads to increased prices for goods, globally.

Simply put, Dollar Vader!

Conclusion

The ongoing EV, chips and energy trade warring is an example of the broader trend of escalating trade tensions and their profound economic impacts. But as tariffs, protectionism, re-shoring/regionalising comparatively disadvantaged supply chains drive up costs, the demand for the dollar will continue to increase and put upwards pressure on inflation and inflation rates.

This relationship highlights the interconnectedness of global economies and the far-reaching consequences of trade policies. It’s also why Dollar Vader can have a devastating effect on sovereigns, particularly emerging markets with weak economies (and currencies).

This is also why the de-dollarisation narrative is a false narrative. There’s nothing remotely on the horizon that could unseat the dollar.

Rather, the world is in the midst of growing demand for the dollar and the ‘China versus the rest of world’ EV/chips/manufactured goods trade war, is a key accelerant of this secular.

Dollar demand is likely to accelerate again as Eurodollar debt stacks are refinanced, rolled and ultimately monetised on central bank balance sheets because they can’t be repaid.

For China, a trade war win means a de-dollarisation loss, and a cap on capital efficiency. But for the U.S., it’s win/win.

Who are you betting on?

See you in the market.

Mike