Central banks prepare for an age of uncertainty after USA's tariff moves

A new world economic order is emerging as a result of US tariff decisions, prompting central banks to consider options to handle the situation

The United States’ (US) intent in recent steep trade tariffs is not just fiscal: it seeks to set up a new economic order.

 

Starting with trade reset, a correction has commenced that is global and not nation-specific. A new world economic order is still emerging. It will have unpredictable consequences with no clarity as to what that will entail. Many central banks are considering a variety of options to handle the evolving complex and dynamic situation for discovering the new normal.

 

The shape and structure of global economic order will change, with no principles or rules having yet evolved. It’s now clear that tariff shock is designed to restructure and redirect trading patterns and check deficits. Two nations stand out for trade-driven imbalances: the US (large deficit) and China (large surplus), both in the region of $1 trillion each. Every nation’s trade and current account imbalance is unique and it is going to be reset with the emerging new economic and trade order. The caveat being that the trade pattern needs to deliver prosperity, be mutually beneficial, and sustainable.

 

A number of countries have expressed their intent to relook their trade with the US — a step which will have global ramifications. Options suggested include zero-for-zero tariffs, buying US products in return, or not retaliating with counter levies. Mutually beneficial bilateral trade and investment arrangements will take precedence. Rebalancing will impact existing arrangements as new trading patterns emerge. The shakeup is creating uncertainty. Alongside central banks, multilateral financial institutions — the International Monetary Fund (IMF) and the Asian Development Bank — have work to do. The Bank for International Settlements is ascertaining impact by using net invoice currency-weighted exchange rates alongside trade-weighted exchange rates.

 

Unbalanced trade patterns, irrational consumer exuberance and moving factories offshore for profits are seen as culprits, where bad economics overtook good. Tariffs are driven by all or a combination of fiscal, current account, and trade deficits. The credibility and ideology of trade-driven currency reserve accumulation arrangements and sovereign wealth funds’ offshore investments have been questioned.

 

Are national banking and financial systems prepared? Countries will now aim for some form of trade-determined equilibrium. There will be sovereign credit rating implications for individual countries and offshore trade patterns: deficits or surpluses, current account balances, tightening financial conditions, capital flows, external financing, adequacy of currency reserves, and consumer sentiment. The US recently lost its last triple-A credit rating after a downgrade by Moody’s Investors Service.

 

Will US dollar hegemony be affected? Will trade reset impact global financial stability and currency exchange rates? 

 

These are moot questions until revised trading and investment patterns emerge. Outcomes may impact payment and settlement patterns, fixed exchange rates, investments, liquidity, discretionary consumer spending, currency reserves and how savings are invested. In recent years, gold has made inroads as an incremental component of currency reserves. Economists have predicted growth risks. The IMF has revised its 2025 world GDP growth forecast to 2.8 percent from 3.3 per cent in 2024.

 

Central banks will be looking for vulnerabilities in the financial system, deciphering the intersection point between trade reset and monetary policy. India’s advantage is its domestic manufacturing vision and self-sufficiency in agriculture. Macro-prudential outcomes in public interest will take precedence over micro-prudential outcomes. India’s soft power and desired influence is likely to gain. The Reserve Bank of India’s monetary policy during disinflation momentum, trade reset, cross-border collaboration, and reserve accumulation stance will be keenly watched by the global south. Central banking will take centrestage.

 

The writer is a former senior staff of Asian Development Bank Philippines. Views are personal. The column has been edited for space