Almighty Dollar: Trumpet or Strumpet?

American ‘exceptionalism’ can’t last for ever

By: Philip Bowring

Much has been heard recently of American exceptionalism. The US dollar has been exceptionally strong, notably against Asian currencies and the yen in particular, while US stocks have been in an extended boom driven by but not exclusive to the so-called Magnificent Seven – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla. More broadly, profits have been rising too on the back of a sustained period of economic growth. But the price-to-earnings ratio of the leading index, the S&P 500, currently stands at 27.5. Even an equally-weighted index which reduces the impact of a few large glamor stocks is at a level seldom seen before.

All the while most foreign economies and markets have been in the doldrums, as with most of Europe, and or facing severe indigestion as in China with its massive overinvestment in both property and manufacturing, Elsewhere, Japan has an overly weak currency offsetting stock market gains, Korea now has domestic political problems, Taiwan international ones, ASEAN markets are slim and unexciting and dominated by family and quasi-state oligopolies. India has been shining but may need to pause, while markets of large countries like Brazil and Turkey get scant foreign attention. With a few exceptions, mineral prices are weak, which hurts Australia and Canada.

The fact is that almost all these alternative places offer plenty of large stocks with solid earnings records, moderate valuations and are in currencies currently cheap compared to the dollar despite enjoying the large current account surpluses that should be the envy of a US. America’s period of strong growth and strong dollar has been based on ever-rising levels of government debt and foreign borrowing which have kept interest rates relatively high.

Now the word from Wall Street is that perhaps even better times lie ahead thanks to Trump’s promise of a bonfire of regulations which will enable a surge in takeovers and a flood of new investment, notably into oil and gas drilling. The US may be seen too as a safe haven from the tariffs with which it threatens trade partners China, Mexico, Canada, and Europe. As the biggest bully on the block, it has the ability to extend exceptionalism by rejecting the global free trade policies it long promoted and from which it greatly benefited. Similarly, the US dollar has been boosted by the tariff damage assumed to be done to others’ economies and their currencies. And by the prospect that Trump’s tax policies will keep interest rates from falling further.

Yet there is something bizarre about the combination of a strong dollar, strong Wall Street, and the Trump-inspired boom in the price of Bitcoin and other Disneyland currencies. Similarly, the dollar has been boosted by the tariff damage assumed to be about to be done to other economies and their currencies. And by the prospect that Trump’s tax policies will keep interest rates from falling further. If Wall Street thinks that Trump's threats against allies Canada, Mexico Greenland/Denmark, and his equally out-of-control pal Elon Musk are a recipe for prosperity, then the future surely lies more with China and its growing number of friends outside East Asia.

Of course, the US has much to boast about at the corporate level and its leadership in so much new technology in particular whose earnings have partly offset the enormous US merchandise trade deficit. It also has an immense range of steadily profitable, debt-light, dividend-paying companies, which investors should be happy to hold through gyrations in sentiment, however wild.

But at the national level, exceptionalism can’t forever support levels of stock market valuation and current account and government deficits which would be impossible to reach in most of the rest of the world. Indeed, both deficits are worse than those which led to the 1997-99 Asian crisis which devastated economies from Korea to Thailand and Indonesia. That ended a decade of exceptional growth for those economies partly built on the belief that current account deficits of 4 percent a year could be continued indefinitely. Likewise, China’s decade of exceptionalism ended with the buildup of debt, mostly domestic, which financed unprofitable projects.

Just as an illustration of market perceptions, Tesla stock sells at about 100 times earnings while its Chinese rival BYD, which recently overtook it in terms of electric vehicle sales, sells at 20 times earnings. While there may be sound reasons for some of the gap, much is accounted for by investor sentiment in the US and China respectively. Likewise, tech stocks in Taiwan have not kept up with their US equivalents. In a different level, the largest foreign-listed Chinese state bank has a dividend yield of 10 percent, and Citigroup 3 percent.

Quite when there will be a tipping point is of course unknown. But one can be sure of the long-term damage which is being put in place for the dollar, and indeed the US more generally. The use of the dollar’s position as a political weapon, most obviously against Russia, has already led to questioning among central banks with heavy holdings of US treasuries. China has reduced its holdings and it may be past time for other Asian holders to diversify. Overall current foreign holdings as a percentage of treasuries have fallen slightly but only because of the rapid rise in the total debt but despite some intervention to steady the yen by selling dollars Japan’s total has still inched up. Foreign ownership generally is now 29 percent of the total and roughly divided between official and private holdings.

In a situation of still rapidly rising debt, that foreign percentage is clearly potentially much more volatile than domestic holdings. Japan may have relatively bigger government debt but only a tiny amount is foreign-owned.

The impact of major new US trade restrictions will stimulate three possible responses: counter restrictions aimed at businesses in which the US is now competitive; incentives for regional trade pacts which de facto discriminate against the US; pressure to boost domestic demand elsewhere – notably consumption in China.

As for the US current account deficit, it is unclear whether Trump’s tariffs, whatever they prove to be, will do much to rebalance trade and bring the deficit down to a sustainable level. The dollar’s privileged position which enables it to run such huge deficits as of now is under increasing scrutiny. The only forces which can bring it down are a serious recession, lower interest rates, lower returns to capital, and an accompanying steep and sustained fall in the dollar which would do more than Trump tariffs to reduce the deficit. All are inevitable. The only question is: when?