QQQ - Weekly Commentary: Train Wreck
2025-03-08 03:30:35 ET
Summary
- The term exorbitant privilege refers to the benefits the United States has due to its own currency (the US dollar) being the international reserve currency.
- In the U.S., policymakers overcame bouts of speculative excess and fragility, ready to mitigate market dysfunction with aggressive liquidity backstops and Fed-orchestrated bailouts.
- Our overheated Credit system floods the world with liquidity, a seemingly harmless dynamic with financial flows so easily recycled right back to U.S. Treasury/Agency Securities and American stocks/corporate bonds.
- The Bloomberg "MAG 7" index, having now given up the entire post-election rally, sank 4.5% this week, boosting its y-t-d decline to 10.7%.
Wikipedia's definition will suffice: "The term exorbitant privilege refers to the benefits the United States has due to its own currency (the US dollar) being the international reserve currency. For example, the US would not face a balance of payments crisis because their imports are purchased in their own currency."
My first observation of "exorbitant privilege" dates back in 1986/87. I was a Treasury Analyst falling head over heels for macro analysis at Toyota's U.S. headquarters in Southern California. It was a fascinatingly unstable environment, with company management alarmed by the growing backlash against the U.S.'s ballooning trade deficit with Japan (along with the rapidly inflating Japanese Bubble). Offering U.S. consumers much higher quality and reliable automobiles, Toyota's sales were booming.
Following the Volcker-led taming of the inflation beast, ten-year Treasury yields were below 7% in 1986, half the mid-1984 level. In general, a significant loosening of financial conditions, huge "twin deficits" - large fiscal deficits (5% in 1986) and record trade ($170bn in 1986) and current account deficits, along with a strengthening lending boom, were stoking over-consumption, and heightened speculation that culminated in 1987's speculative blowoff and subsequent "Black Monday" crash.
Rather than countering U.S. imbalances domestically (with tighter "money"), Washington imposed "exorbitant privilege" on our closest Asian ally. Japanese officials were basically forced to aggressively loosen (supposedly to stimulate consumption and U.S. imports) already precariously loose conditions. It was a fateful policy blunder, as Japan's formidable Bubble (real estate, in particular) inflated in catastrophic "terminal phase excess." Japan suffers to this day.
Following Alan Greenspan's post-crash assurances, U.S. and Japanese Bubble excess attained powerful momentum. Japan's Nikkei almost doubled from post-crash lows to end 1989 at 38,916 - a record high that would stand for almost 34 years (until last year). In the U.S., the craziness would crystallize the "decade of greed."
Bursting Bubbles then left Japan in tatters and the U.S. banking system severely impaired. Greenspan's aggressive early-nineties reflationary measures unleashed hedge fund speculative leverage, GSE balance sheets, securitizations, and Wall Street finance - the monumental shift to U.S. dominated market-based finance. This highly unstable financial structure took on a life of its own. Crushed by boom-and-bust dynamics on steroids, the emerging markets (i.e., Mexico, the "Asian Tigers," Russia…) emerged from devastating collapses determined to buttress their currencies and systems with much larger Treasury holdings (solidifying U.S. exorbitant privilege).
In the U.S., policymakers overcame bouts of speculative excess and fragility (i.e., 1994 bond crash and 1998 LTCM implosion) ready to mitigate market dysfunction with aggressive (GSE) liquidity backstops and Fed-orchestrated bailouts. Wall Street finance - with all its critical shortcomings - took on a life of ever bigger Bubbles, busts and policy reflations. From the 1987 stock market crash to the culminating AI and "everything Bubble" - and everything in between.
Especially during recent peak mania excess, there has been a lot of focus on "American exceptionalism." I'm not dismissing U.S. technological prowess. But there is a lack of appreciation for the financial and policymaking elements critical to our "exorbitant privilege." We've run perpetual trade and Current Account Deficits for decades, while enjoying myriad strong dollar benefits. Our nation has been able to habitually trade IOUs for imported goods and services. "Ripping us off"?...
Weekly Commentary: Train Wreck