The Trump administration’s trade policies continue to monopolise attention. The implications are multidimensional. Among other things, they affect the course of the dollar, as well as the exchange rates of major currencies, including the euro.

In the medium term, the imposition of tariffs is expected to lead to a reduction in imports and a narrowing of the US trade deficit. This is one of the main objectives of the Trump administration in its effort to promote the relocation of industries to the US through import substitution. Most analysts believe that this strategy is misguided and will have serious adverse implications, mainly for the US, but also, more broadly, for the global economy.

In reality, the initial reaction of businesses was to accelerate imports, with a consequent increase in the US trade deficit, in an attempt to avoid, in the short term, the burden of higher import tariffs. Moreover, uncertainty increased in international markets, a development that under normal circumstances would lead to a shift to investments in so-called ‘safe haven’ assets; such assets are generally expected to retain or increase in value during times of turbulence and typically include gold and US government bonds.

Under such circumstances, one would expect an appreciation of the dollar. In contrast, the US dollar has been fluctuating and depreciating. Exchange rate developments are complex and extremely difficult to predict. It is, therefore, too early to draw firm conclusions. Some analysts expect in the long term a weakening trend of the dollar, driven by the erosion of the attractiveness of US government bonds as a safe investment asset.

The question that arises is whether, and to what extent, there are alternative investment options that could replace the dollar’s international role as a safe investment asset and as the dominant global currency, with a share of almost 60 per cent in foreign exchange reserves and over 70 per cent of global trade transactions. The euro could potentially play an expanded role, although it is not feasible to fully substitute the dollar, mainly due to limited liquidity compared to US government bonds.

Under certain conditions, it is possible to increase liquidity of euro-denominated assets through a stronger presence of the euro in international bond markets. Suggestions in this direction include: (a) refinancing, rather than repaying, the debt issued by the European Commission for financing the national Recovery and Resilience plans, and (b) the issuance of new common debt for the purposes of strengthening the EU’s defence capacity and financing investments in cutting-edge technologies, based on the recommendations of the Draghi report.

Essentially, these suggestions imply the adoption of an expansionary fiscal policy at the European level, instead of only in Germany, as is currently observed.

The coming weeks will indicate whether the objections to adopting such a policy shift, which stem mainly from Germany, could be overcome. Achieving the necessary consensus remains difficult, but not impossible, in light of the new realities that Trump’s policies create for Europe.

Andreas Charalambous and Omiros Pissarides are economists and the views they express are personal