RABO: "The US would effectively cut China out of the Dollar system"

If the United States tells other countries that the price for providing global public goods like the US security umbrella and the US Dollar as the global reserve asset is a common tariff against China…would effectively cut China out of the Dollar system'“

Could Trump Cut China Out Of The Dollar System?

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By Benjamin Picton, senior strategist at Rabobank

To whom much is given...

US stocks were a rollercoaster yesterday. Having closed at 5062 on Monday evening, the S&P500 opened Tuesday trade 130 points higher and spent the next 45 minutes rallying up to the 5267 daily high as markets reacted enthusiastically to comments from Trump and Bessent suggesting that there might be room for some countries to cut deals for lower tariffs. Stocks were then sold steadily for the remainder of the trading day as markets reacted to President Trump’s promise to hit China with an extra 50% tariff (104% total) from midnight.

The additional tariffs comes in retaliation to the retaliation for the reciprocal tariffs that were apparently imposed in retaliation for long-term cheating on trade. The absurdity of this sequence should make it abundantly clear that the world’s two largest economies are engaged in a tit-for-tat that could conceivably halt bilateral trade altogether. Neither side appears ready to blink; Chinese officials had earlier said that they were prepared to “fight to the end”.

Australian economist Warwick McKibbin (a former RBA Board member) recently commented that “the whole world is not having a trade war here. It’s just 20 per cent of the world (the USA) attacking the other 80 per cent.” That characterisation might be (somewhat) true for now, but the situation is likely to metastasize as Europe and others beef up anti-dumping measures on Chinese goods to protect their own industry. The trade war will really go global if the United States tells other countries that the price for providing global public goods like the US security umbrella and the US Dollar as the global reserve asset is a common tariff against China. That would effectively cut China out of the Dollar system, and make it exceedingly difficult for China to raise Dollars to pay for its food and energy imports.

China is taking policy measures of its own. CNH weakened to 7.43 yesterday – the highest reading since the establishment of the offshore market in 2009 – and the PBOC fixed the onshore Yuan at its weakest level since September 2023. If the onshore Yuan fixes above 7.2258 in coming days it will be the weakest since before the crisis of 2008. Chinese authorities are clearly allowing the currency to depreciate to offset some of the pain inflicted by US tariffs. This will only further inflame tensions with the White House, given that currency manipulation is one of the US’s major grievances with countries running large trade surpluses. China-adjacent AUD and NZD are trading close to 5-year lows this morning as the tariff deadline approaches.

10-year Treasury yields rose 11bps on Tuesday to close the day at 4.29% and yields are up another 4.5bps in Asian trade to 4.335%. That’s a 48 basis point lift in yields since the lows last Friday. Up until yesterday the rise in yields had occurred in tandem with a rally in the DXY index, suggesting investors were actually repatriating funds into the USA and a great deal of the Treasury selling pressure may have been domestic. That dynamic flipped yesterday as the DXY closed lower and yields continued to soar, which perhaps supports views that China (and/or others) is dumping its Treasury holdings to pressure US yields higher and make like difficult for Trump and Bessent.

Brent crude active futures were down 2.16% yesterday and are down a further 2.58% to $61.18/bbl today. It’s a perfect storm for crude prices as tariff-induced recession fears collide with much higher supply from OPEC+ producers. Also lurking in the background is Donald Trump’s ‘Big Beautiful Bill’ which contains provisions to slash red tape for US producers to encourage more supply into the market and lower oil prices further. We’re a little sceptical on the efficacy of those ‘Drill, Baby, Drill!’ measures due to the high production breakevens of US producers, but given that Trump recently signed executive orders to boost domestic coal production under powers granted by the Defence Production Act it would be foolish to argue strongly that a similar thing won’t happen with oil.

As the Dollar weakens, Gold appears to have found support around the $2,980/oz level and may be poised for gains down the track as US inflation breakevens lift and the probability of a ‘Mar-a-Lago Accord’ to devalue the US Dollar rises. US officials are saying that more than 70 countries have contacted the White House desperate to make a deal on trade. Could a ‘grand bargain’ on weakening the US Dollar be the only deal offered? That would be very Luke 12:48 for US allies.

Just in case the penny hasn’t yet dropped, there is little distinction between economics and geopolitics in the current environment. The Trump Administration is aggressively deploying trade and financial policy to achieve foreign policy goals in similar fashion to what China has been doing for years. This is economic statecraft, make no mistake.

To highlight the new Cold War dynamic at play, Volodymyr Zelenskyy overnight said that Ukrainian forces had captured two Chinese soldiers fighting alongside Russian troops in Eastern Ukraine, and that he had information that “significantly more Chinese citizens” were serving in Russian military units. This follows earlier news that North Korean soldiers have been embedded alongside Russian forces in Kursk. Zelenskyy’s claim has not been independently verified, and it is not yet clear whether the Chinese soldiers were volunteers or fighting at the behest of the Chinese government, but Zelenskyy has directed his Foreign Minister to contact Beijing demanding answers.