tariff
When countries engage in trade wars, the most visible and common battles in today’s age are usually fought through tariffs, the extra taxes placed on imported goods to increase their cost. But the story doesn’t end at higher prices for cars, electronics, or steel. Trade wars spill over into the world of finance, especially in how currencies behave.
Currencies are the backbone of international trade because they determine how much one country’s money is worth in relation to another’s. And during trade conflicts, exchange rates, the value of one currency compared to another, often start swinging up and down unpredictably. Economists call this currency volatility, and it creates serious challenges for governments, businesses, and ordinary people alike.
To understand why trade wars affect currencies, let us first break down a simple idea: currencies rise or fall depending on supply and demand. If people across the world want more of a country’s goods and services, they need to buy its currency, and its value goes up. If demand falls, the currency weakens. Now, imagine that a major trade partner suddenly imposes tariffs on those goods. Exports become less attractive, foreign buyers need less of that currency, the demand for the good goes down, and its value often drops. But markets are not always rational or steady, meaning they react to expectations, rumors, and politics. So instead of a calm decline or rise, currencies often bounce around, making life uncertain for businesses that depend on stable prices.
Uncertainty itself is another key reason currencies get unstable in trade wars. Even before tariffs are put in place, announcements or threats of tariffs can cause investors to panic or speculate. For example, during the trade tensions between the U.S. and China in 2018–2019, studies showed that just the news of possible tariffs caused currencies to swing, even if the policies were delayed or watered down.
This happens because financial markets are forward-looking, they are futuristic, and respond not only to what is happening now but also to what might happen next. For newcomers to finance, it helps to think of it like this: exchange rates are a bit like the stock market, moving as much on “what could be” rather than “what is.”
Trade wars also affect capital flows. Capital flows simply means the movement of money across borders, whether through investments, loans, or trade payments. When tensions rise, investors tend to pull money out of countries seen as risky and move it into “safe-haven” currencies such as the U.S. dollar, the Japanese yen, or the Swiss franc. These currencies are called safe havens because investors trust that, no matter the global turbulence, their value will hold relatively steady. The result is that vulnerable economies see their currencies weaken, not necessarily because of their own domestic mistakes, but because global money is rushing to perceived safer shores.
The numbers make this story very real. According to the Bank for International Settlements, which tracks global financial markets, the average volatility of major currency pairs rose by 25% in 2019 when trade wars were at their peak.
In India, for example, the rupee’s volatility surged in April 2025 as new tariffs were announced, climbing to its most unstable level in nearly two years. For importers and exporters, such movements are not just statistics; they can decide whether a shipment brings profit or loss. A sudden drop in the value of a local currency makes imported raw materials more expensive, while a sudden rise can hurt exporters by making their goods less competitive abroad.
So how do governments deal with this turbulence? This is where exchange rate management comes in. At its core, exchange rate management means the ways in which a country tries to stabilize or influence its currency’s value. There are several tools, each with its own strengths and weaknesses.
One approach is direct intervention, where a central bank uses its foreign reserves, usually U.S. dollars or other strong currencies, to buy or sell its own currency. If the local currency is falling too quickly, the central bank might sell dollars and buy its own money to push its value back up. Think of it as the bank stepping onto a seesaw that is tilting too far on one side. By putting its weight down, it helps bring the seesaw back to balance.
Another method is managed depreciation. Sometimes, a country deliberately allows its currency to fall slightly in value to make its exports cheaper and more attractive in global markets. But this has to be done carefully. If the currency weakens too much or too fast, it can scare off investors and spark inflation, since imports become more costly. It is a balancing act, supporting exporters without creating panic.
Monetary policy tools, such as changing interest rates, are also used. In simple terms, higher interest rates make a currency more attractive because investors earn better returns by holding assets in that currency. So, if a currency is weakening too sharply, a central bank might raise rates to keep money from leaving the country. The downside, however, is that higher rates can slow economic growth at home, making loans more expensive for businesses and households.
Sometimes, governments also use communication and signaling. This might sound less powerful than raising rates or buying currencies, but in financial markets, words matter. When a central bank announces its commitment to maintaining stability or sets an official reference rate for its currency, it shapes expectations. For example, if traders believe the bank will not tolerate sharp declines, they may be less likely to bet against the currency in the first place.
Lastly, there are capital controls, which are restrictions on how money can move in and out of a country. These can be used in extreme cases, for instance, limiting how much foreign currency citizens or companies can buy. While such measures can provide temporary relief, they often discourage foreign investors and can harm long-term confidence. That is why most countries treat them as a last resort.
Despite all these strategies, there are limits to how much governments can control exchange rates in a globalized economy. Trade wars often involve the largest economies in the world, and their ripple effects spill across borders. A country might defend its currency successfully for a short while, but if global investors see risk rising, the pressure can mount again. Policymakers must weigh trade-offs: supporting exporters versus protecting consumers from inflation, stabilizing the currency versus keeping growth steady, or preserving foreign reserves versus allowing some depreciation.
The bigger picture is that trade wars are not just about goods and tariffs; they are about confidence, trust, and perception in the global financial system. Currencies, being at the heart of this system, respond quickly to shifts in sentiment. For businesses, the lesson is clear: hedging against currency risk becomes essential in times of trade conflict. For ordinary people, the effects show up in the cost of imported goods, fuel prices, and sometimes even job security, as companies adjust to unstable markets.
In conclusion, trade wars create an environment where currency values swing more sharply than usual, unsettling both economies and individuals. Exchange rate management becomes a constant balancing act, as governments try to protect their economies from excessive volatility without introducing new problems. While tools like intervention, interest rate changes, and signaling can help, no strategy offers a perfect shield. As long as trade wars remain part of global politics, the challenge of managing exchange rates will remain at the center of economic policymaking.
By: Ananya Patel
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