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As the Trade War Unfolds Keep an Eye on the Dollar

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As the trade war continues to unfold, investors should keep an eye on the dollar

Heated rhetoric between the US and China continued as negotiators from the two countries prepared to sit down for the latest round of trade talks. Pres. Donald Trump accused the Chinese of “breaking the trade deal.” Meanwhile, the Chinese threatened to retaliate if the US increases tariffs. Trump has said he will move ahead and hike tariffs to 25% on $200 billion worth of Chinese imports at the end of this week.

Stock markets have reacted negatively to this turn of events. The Dow fell 473 points on Tuesday as the trade war rhetoric heated up.

What we can infer from this exchange is that in reality, the trade war may continue to linger on for quite some time, with a long path ahead before a potential resolution can be made.

One aspect of the ongoing trade war that investors should keep an eye on is the impact on the dollar.

As negotiations appeared to take a turn for the worse late last week, the dollar fell.

There are two reasons which can explain this drop.

One reason is that the economic uncertainty in the US economy could lead to a devaluation of the dollar, which is linked to decreased demand from fewer exports. Another reason is that when participating in a trade war, countries might intentionally decrease the value of their own currency (eg: printing more money), which would, in theory, minimize the negative effects of a potential tariff by helping the exporting country maintain market share in foreign markets.

This fiscal policy, also accompanied by a lowering of interbank lending rate (Federal funds rate in the US; aka the Fed rate), is known as “Abenomics” and is sometimes seen as currency manipulation. Trump accused the Chinese of this practice last July when they devalued the yuan. In response to Trump’s accusation, the dollar index itself fell 1% with many investors believing the US could follow suit and seek to devalue its own currency.

The following chart shows the US Dollar Index this past week, with a large drop following Trump’s announcement that he was willing to move forward with tariff increases. (Source: Investing.com).

It is evident that the trade wars do not favor the US dollar in most contexts, with a devaluation prompted by investor fear, as well as other factors. However, unlike the dollar, gold might have a more favorable outcome from the trade war regardless of how it turns out.

In the past, when most believed the negotiations would end with a trade deal, the price of gold bullion rose on the sentiment that China would be buying more gold jewelry as its economy expanded. Now, with more tensions in the trade war raising the specter of unfavorable ending (if there even is an ending in sight), gold is being viewed as a safe haven.

This report was prepared by SchiffGold intern commodities analyst Jason Mezhibovsky. Jason is a sophomore at Binghamton University studying finance.

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