With tentative stability between Europe and the US on tariffs, the changing exchange rate will play an even more significant role in transatlantic trade. The euro has increased in value against the dollar by around 10% since Donald Trump took office in January, the result of fundamental shifts in global financial flows. From the perspective of a European exporter, this is the equivalent of a 10% tariff, since a weakening dollar will cause increased prices in America for the same European products.

If you include the actual 10% tariff, European firms face a 20% rise compared to when Trump became president. If you include the special tariffs for some sectors, such as cars, steel and aluminium, and soon pharmaceuticals, it will be close to 25% for the economy as a whole. So critics should be careful about prematurely celebrating Trump’s retreat. Even if the so-called reciprocal tariff were to turn into a baseline tariff of 10% against the rest of the world, the combined economic impact would still be large.

Exchange rates are a far more effective instrument in rebalancing the global economy than tariffs. They act on both sides of the balance of payment: financial flows and trade. Tariffs only act directly on imports, but not on exports. They are not a great rebalancing tool; but as the fallout of “Liberation Day” made clear, they can have a very large effect on export-reliant trading partners. The tariffs will, for example, drive Germany’s economic model over the edge. It has become heavily reliant on the US market to find consumers for its over-productive industry. So if tariffs — especially the higher tariffs on car manufacturers — cut this off, German firms will have a significantly reduced market to sell products.

Unlike tariffs, though, the exchange rate acts on both imports and exports simultaneously. More importantly, it acts on financial flows. If you look at Germany from the perspective of trade and currency only, you see a competitive economy that is one of the world’s largest exporters. But if you look at the imbalance from the perspective of financial flows, now the natural perspective of investors in a globalised economy, you see that China and Germany are generating massive savings surpluses that they invest abroad. You see countries which do not know how to invest their surplus savings. So in order to enact structural realignment that resets this, as Trump’s administration is pursuing, the most effective tool is a shifting exchange rate.

It looks, then, like Trump staged a tactical retreat only. Treasury Secretary Scott Bessent appears to have won the internal power battle in the Trump administration and is now in charge of the policy. This suggests that the emphasis of the US’s external financial policies will shift from a full focus on tariffs to a broader-based strategy, in which tariffs act as a tactical weapon and the exchange rate is the strategic intercontinental missile. This will lead to a broader realignment that could include a further devaluation of the US dollar.

This is an edited version of an article which originally appeared in the Eurointelligence newsletter.

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Wolfgang Munchau is the Director of Eurointelligence and an UnHerd columnist.

EuroBriefing

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China is trying to catch up with America on artificial intelligence. The Wall Street Journal has reported that Zhipu AI — one of China’s six “AI tiger” LLMs — has released a new model that can rival leading US systems, including Anthropic’s Mythos, in cybersecurity tasks such as pinpointing security bugs. While this marks a milestone in China’s drive to catch up with Western AI capabilities, strong performance on a single benchmark does not mean it has taken the lead. Chinese models still lag behind their Western counterparts in broader capabilities, such as autonomous operation. Skepticism is therefore warranted before resorting to hysterical conclusions, but complacency about the geopolitical implications of China’s AI advances would be an even greater mistake.

On the infrastructure side, Chinese AI is still constrained by access to advanced chips, with American labs way ahead in computing capacity as well as investment. Analysis from earlier this year suggests that Chinese models are likely to be at least a few months behind those in the US. But they are still continuing to make progress, or that the geopolitical importance of AI will be decided only by whose LLM has ventured deeper into the technological frontier. The practical applications of AI, countries’ to capture foreign markets, and the application of AI into the real economy will matter just as much.

Here, China may hold an advantage. As with its dominance across many critical supply chains, Beijing may not need to produce the most advanced AI systems — only those that are affordable and widely deployable. In doing so, it could consolidate global influence by supplying functional, low-cost AI at scale.

Beijing seems to be pursuing exactly that path, developing an AI “open-source” strategy that offers affordable, widely available AI models for companies and individuals to use and modify as they wish. The production of the DeepSeek AI model, which matched the performance of Silicon Valley tools such as ChatGPT at a fraction of the cost for users, created goodwill among Chinese models with developers.

The four most popular models on OpenRouter, an AI hardware platform for developers, are now all Chinese. The goal for China is not only to win the frontier-model race, but to make its systems the default layer of AI adoption across industries and global markets. For most economies, the choice is increasingly between an affordable tool they can deploy now and a more robust one that may be out of reach.

And while the countries adopting Chinese models may be exposed to political pressure and cyber threats from Beijing, safer and more capable alternatives matter little if they are unaffordable. American AI companies are already under pressure to monetize products whose operating costs are rising. If Chinese open-source models become the cheap default for startups, universities, governments and businesses across the developing world, then America’s AI lead will be eroded from below.

Perhaps more concerning for America in the long run is how AI can give Chinese manufacturing even more strength, through the ongoing integration of AI as a general-purpose technology. China’s new Five-Year Plan mentioned AI more than 50 times and includes an “AI+” action plan aimed at spreading AI across the economy.

Beijing has been pioneering automation of its critical infrastructure for years, with promising recent results in increasing warplane production capacity. In that regard, China’s open-model strategy and manufacturing dominance will reinforce each other. Cheap, adaptable models accelerate deployment across the real economy while those deployments generate real-world data and use cases that can feed back into further model improvement.

The United States should not dismiss the importance of its lead in the AI race. That lead worries Beijing, not least because a more automated Chinese economy would also become more vulnerable to AI-generated cyber threats. But nor should Washington assume that China cannot catch up with American capabilities over time.

This AI competition represents part of a broader struggle over tech supply chains and geopolitical influence. Decisions over whether to adopt US or Chinese models could produce a more fragmented global reality, with different regions relying on different cloud providers, chips and security structures. The result will likely be a global economy which is divided into competing spheres, rather than one which produces a single winner.

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Miquel Vila is a political and geopolitical risk consultant focusing on industrial strategy, critical infrastructure and global supply chains.

miquelvilam

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