BEIJING: In 2025, the dollar index, which measures the greenback’s strength against a basket of major currencies, fell by roughly 9.4%. Over the same period, the United States’ average effective tariff rate rose by around 14.4 percentage points, from 2.4% to 16.8%, according to the Yale Budget Lab. Taken together, these shifts imply that, in the import trade domain, the US experienced an effective exchange-rate depreciation of around 24%.

Such a scenario is politically attractive to the US, because it protects manufacturing competitiveness and generates additional tariff revenue, while the dollar remains relatively stable. That stability, in turn, helps support the prices of US Treasuries and other dollar assets, reducing the risk of a vicious cycle of broad depreciation, unmoored inflation, capital outflows, and financial-market stress.

But the balance-of-payments “mirror” remains. So long as the dollar is the world’s reserve currency of choice, persistent net capital inflows into the US – which necessarily correspond to America’s current-account deficit – are unlikely to disappear, making structural imbalances hard to resolve. In fact, this dynamic may generate additional costs, which will likely fall disproportionately on non-US economies, especially emerging markets.

Historically, the dollar has weakened when the US Federal Reserve eases monetary policy, US long-term yields fall, and global investors’ risk appetite improves – conditions that loosen international financing constraints and expand offshore dollar liquidity. But this time around, the dividend from a weak dollar may be sharply discounted, because tariffs act as a wedge that “pre-adjusts” relative prices in international trade, reducing the nominal exchange-rate depreciation required for external rebalancing.

That shift has three consequences for the rest of the world. First, trade and investment slow together, weakening the microfoundations of dollar liquidity spillovers. US President Donald Trump’s reciprocal tariffs have dragged down growth in global goods trade. And when trade flows contract, corporate demand for dollar-denominated trade finance and supply-chain credit falls, and cross-border dollar creation slows accordingly.

Moreover, in October 2025, United Nations Trade and Development (UNCTAD) noted that global foreign direct investment has remained weak – down 3% in the first half of 2025 – and that persistent tariff uncertainty has driven investors to adopt a wait-and-see stance. This implies that even if the greenback weakens in nominal terms, the periphery may receive less effective dollar liquidity than it does in a typical depreciation cycle.

Second, tariff-induced price pressures push up inflation expectations and amplify policy uncertainty in the US, which may impede declines in long-term yields and the term premium, thereby constraining the fall in global interest rates for risk-free assets. Heightened uncertainty can also lift risk premia worldwide, dampening the spillover effects of a weaker dollar, including higher risk appetite and renewed capital inflows into emerging markets.

Historically, the dollar has weakened when the US Federal Reserve eases monetary policy, US long-term yields fall, and global investors’ risk appetite improves – conditions that loosen international financing constraints and expand offshore dollar liquidity.

To be clear, the effective exchange-rate depreciation of around 24% reflects the relative price distortion on the trade side; it does not suggest that import prices mechanically rise by that amount. Even so, its effects on inflation and monetary policy may appear with a lag and become more visible in 2026. The International Monetary Fund found that tariff pass-through to prices has so far been relatively mild, but that the effects could be delayed. At the same time, it emphasized that higher tariffs and uncertainty complicate the trade-offs faced by central bankers.

Third, emerging markets will struggle with asymmetric shocks and shrinking policy space. As I have previously argued, “reciprocal” tariffs will widen the North-South divide, because lower-income countries are often hit with higher rates. In this situation, weaker exports and declining capital inflows more readily lead to slower growth and currency depreciation – a trap from which policymakers struggle to escape.

Currency depreciation on its own can trigger imported inflation or increase the burden of dollar-denominated debt, placing central bankers in the challenging position of balancing interest-rate spreads, exchange-rate stability, and foreign-exchange intervention. This means that financial conditions may not improve as much as one would expect in a weaker dollar environment.

In short, this is not simply another round of protectionism. Instead, adjustment pressures have been reallocated: For the US economy, the trade side receives an “effective” depreciation through the tariff wedge, while the financial side seeks stability. Whether such an arrangement can persist, however, depends on four conditions.

First, tariff-driven advantages must translate into real additional capacity and productivity gains, rather than remaining a temporary redistribution of rents. Second, inflation must be contained. If tariffs entrench core inflation over time, the Fed will have much less room for maneuver, and term premia could rise, undermining the financial stability that the strategy is meant to preserve.

Third, non-US economies must continue to comply; otherwise, an increase in retaliatory action would eat away at America’s trade-side gains and create more uncertainty. Fourth, the world must continue to believe that US debt is a safe asset. If term premia continue to rise amid mounting concerns about America’s fiscal sustainability, the financial side’s “relative stability” will weaken and could spill back into the real economy.

If any of these conditions is not met – if reshoring fails to deliver, inflation proves sticky, or external retaliation escalates – the dollar’s effective depreciation on the trade side and its continued stability on the financial side may begin to work against each other, forcing the US economy into a painful rebalancing. But until that day arrives, non-US economies should not assume that a weaker greenback will deliver the usual relief. We may be entering a tariff-era version of what then-US Treasury Secretary John Connally famously described in 1971 as “our currency, your problem.”

Qiyuan Xu, a senior fellow at the Chinese Academy of Social Sciences, is the author of many books, including Reshaping the Global Industrial Chain: China’s Choices.

 Copyright: Project Syndicate, 2026.
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