Trade wars may be morphing into something more dangerous: financial wars.
With Turkey facing a currency crisis, President Trump last week poured fuel on the fire by doubling tariffs on imports of its steel and aluminum to offset the effects of its weaker currency or force the country to release an American pastor. (Mr. Trump’s motive remains unclear.)
In the hierarchy of things afflicting Turkey, this isn’t that high: The country’s problems are mostly self-inflicted, from its large current-account deficit and steep dollar debts to the politicization of its central bank.
But it is the latest example of how the U.S. and other countries are weaponizing international finance in ways that could destabilize the global economy and fray the intricate web of relationships that sustain it.
While trade wars aren’t good for growth, rarely do they induce a recession, or even a noticeable slowdown. The infamous Smoot-Hawley tariff of 1930 was at most a minor contribution to the Great Depression. By contrast, there’s a long record of international financial disruptions fueling economic stress, from the Depression to the bankruptcy of Lehman Brothers nearly 10 years ago.
The origins of such crises usually lie in private-sector excess (lending too much to risky countries or home buyers), but the catalyst is often government policy somewhere: France’s hoarding of gold helped precipitate the Depression, while then-Federal Reserve Chairman Paul Volcker’s determination to slay inflation triggered the Latin American debt crisis of the 1980s.
The U.S. government has long seen it in the country’s long-term interest to tamp down crises abroad. It came to Mexico’s aid in 1982 and 1995, and worked with the International Monetary Fund in 1997 to contain the Asian financial crisis. In 2008, the Fed assisted foreign central banks in propping up banks in their countries that were hit by the mortgage crisis.
When the U.S. deliberately inflicts economic pain it is typically for geostrategic reasons and, where possible, it acts in concert with allies. In recent years, Washington has exacted enormous damage on North Korea and Iran by cutting them off from the dollar-based banking system. European and U.S. sanctions on Russia for invading Ukraine, interfering with U.S. elections and poisoning a former Russian spy and his daughter living in Britain have wrought havoc on the Russian economy.
Mr. Trump’s deployment of financial warfare against Turkey breaks with tradition in several key ways.
First, while relations between Turkey’s increasingly autocratic President Recep Tayyip Erdogan and the West have been deteriorating for years, his recent transgressions—such as detaining pastor Andrew Brunson—aren’t the sort of threat to the U.S. or its allies’ security that typically draws such a response.
“Geostrategically, it’s insanity” to react so harshly, says Benn Steil an expert on sanctions at the Council on Foreign Relations. Turkey remains a member of the North Atlantic Treaty Organization and a key partner in managing the crisis in Syria and the flow of refugees to Europe. Turkey has, since the end of the Second World War, been a vital U.S. interest because of its geographical position.
Second, using tariffs to neutralize the Turkish lira’s decline, like Mr. Trump’s increasing tariffs on China because it let the yuan drop, could aggravate instead of mitigate financial turmoil. Currencies respond to the relative performance of economic growth, interest rates, inflation and trade balances. The dollar is rising now because the U.S. economy is strong, capital is flowing in and interest rates are going up, which means the U.S. trade deficit should widen. The lira is falling because capital is fleeing, interest rates are too low and Turkey’s trade deficit needs to shrink. Mr. Trump is effectively trying to short-circuit this adjustment. But by undermining Turkish and Chinese growth, his tariffs have intensified downward pressure on those countries’ currencies against the dollar. It raises the prospect of an open-ended cycle of protectionism and devaluation.
For now, a global meltdown looks unlikely. Few markets share Turkey’s vulnerabilities, and global banks are relatively insulated from foreign defaults. But Washington’s willingness to stand by or even pile on in a crisis is a new factor to consider for investors deciding whether to flee when another country gets into trouble.
Mr. Trump tends to see other countries’ economic suffering as an advantage for the U.S., boasting earlier this month that his tariffs had helped tank the Chinese stock market. Thus, he is likely to repeat the exercise, and others will follow suit. Last week, Saudi Arabia retaliated against Canadian criticism of its human-rights record by freezing trade and dumping Canadian bonds, a move the U.S. declined to criticize.
Just as the size of the U.S. market gives Mr. Trump the advantage in any trade dispute, America’s control over dollar-based banking and the depth of the Treasury market give it the advantage in any financial conflict. Any country, including China, that threatens to dump U.S. securities would hurt itself more than it hurts the U.S. Yet if relations deteriorate further, such tactics would no longer be off limits.
And in financial wars, like trade wars, the “winners” pay a price. If crises hit emerging economies, they’ll buy less from the U.S. A Chinese slowdown and bungled devaluation in 2015 hurt commodity prices and the U.S. oil patch. And just as trade wars force others countries to seek alternatives to U.S. suppliers and customers, financial wars will encourage them to seek alternatives to the dollar. In both cases, the result will be a less integrated world and diminished American influence.
Write to Greg Ip at greg.ip@wsj.com