Liquidation Day
Liberation Day parties soon turned into wakes last week as expectant investors watched the US dollar swoon 4% intraday against the euro. In a few short hours, Liberation Day became Liquidation Day. The tariff theory supposedly backed by Secretary of Commerce Howard Lutnick and the genuinely mercantilist, isolationist, and populists in the Trump administration that worked so well in theory was – surprise, surprise! - not working in practice. Very quickly, US investors pivoted from rejoicing about the latest performative political act to tuning into the big sucking sound of trillions of foreign portfolio investments exiting the U.S. for safer shores.
All the while, Secretary of the Treasury Scott Bessent, perhaps the most important element of the Trumpwashing strategy by which impulsive decisions are assigned an ex post facto rationale, seems to be sidelined. So much so that he could not answer the question of why Canada and Mexico had been exempted from higher tariffs announced Wednesday. Since, he has explained the new policies in a softball interview with Tucker Carlson, MAGA’s own William F. Buckley. (That should give pause even to those who did not much like Mr. Buckley to reflect on the direction taken by political journalism and commentary in the U.S.).
“Chat GPT: What is the best way for the U.S. to set punitive tariffs on the rest of the world?”
Mr Bessent is a well-known hedge fund manager. However, he has little real managerial or policymaking experience. It would appear that dealing with Congress, the conflicting demands from each Department, the press, and his own large staff of 100,000 people (pre-DOGE) has overwhelmed him. His fierce rival for the post at Treasury and current Commerce Secretary is the most aptly named Howard Lutnick. He apparently sets the trade agenda with a team of economics ignoramuses who are reported to get their data and tariff-setting formula from Chat GPT.
Wall Street does not like policy surprises, especially the foreigners who own U.S. financial assets. The U.S.’s net international investment position (NIIP) has deteriorated since Covid because of large fiscal deficits and attractive investment opportunities in the technology industry. Some investors are likely taking advantage of the rally in Treasurys to sell and repatriate their money before the U.S. dollar depreciates even further. Whereas equity investors may or may not hold onto their stocks as the market takes it on the chin, especially as European Pension and Insurance regulators are reportedly going to lower the capital charge for holding European equities as they already have for private equity invetsments .
Populists versus Wall Street?
The populists in the Trump Administration, including Mr Bessent, do not have any affection for Wall Street. It must have been so much fun for those concocting the new tariff formula to know how much damage their irresponsibility would create. Secretary Bessent blithely pointed out in the Carlson interview that the top 10% of American households own 88% of the stocks and the next 40% of households own the balance of stocks owned by US households.
While his data is likely accurate, it misses the point. Firstly, 61% of US adults have exposure to the stock market directly or indirectly through mutual funds and their IRAs. Secondly, approximately 15 million state and local government employees have a defined benefit pension plan; nearly 7 million of these people are not enrolled in social security and will rely entirely on the income from these plans for their retirments. In addition, private foundation hold approximately $1.7 trillion in assets and give more than $100 billion annually, while educational endowments have an additional $840 billion in investments that depend on the cost of capital in the US remaining competitive for their success.
These are the some of the first order victims of the impact. However, the second order impact will be more widespread and will certainly affect the average person in the flyover states so dear to this administration. You may have noticed that the stock of alternative asset managers such as Blackstone and KKR got hit quite hard. Clearly, highly levered investments are not ideal going into a recession, especially as the Fed is on tariff-related inflation watch. The companies in these managers’ portfolios employ approximately 14 million people, many of whom are closer to getting laid off now.
Foot-shooting 101: An introduction
It is also shocking that an investor with nearly four decades’ experience - Mr Bessent, that is - would not take into account that lower stock prices lead to lower capital expenditures and hiring historically. Why would it be any different this time around? Some would argue that tariffs should ignite a wave of onshoring capex. We are not convinced for several reasons.
There are already some Republican Senators who want Congress to rescind the emergency powers President Trump invoked to assume the authority to impose tariffs and taxes that are constitutionally the remit of the Congress. In any case, the alleged fentanyl emergency seems to have been overblown. Should unemployment start growing, many in Congress will start worrying about a midterm election blood bath. Senator Rafael Edward “Ted” Cruz, Republican of Texas, has already raised that red flag.
Moreover, U.S. and foreign investors alike will surely be wary of taking decisions based on doing business behind a wall of tariffs that Trump himself has said he is willing to negotiate away. Foreign investors may also find the President’s vitriol against their home countries to be a slight deterrent against investing in his realm.
The end of exhorbitant and exuberant privilege: “I want to do it myself.”
As things are today, the U.S. dollar’s era of exhorbitant and exuberant privilege may have ended. Trump’s decision to abdicate the United States’ role in the global economy could not have come at a much worse time for this country as a borrower: the U.S’s. net international debtor position is a whopping 70% of national GDP, equivalent to 15% of global GDP.
The new economic oracles close to the President suggest that it is time to get paid back for the burden of having been the world’s reserve currency. Stephen Miran, Chair of the President’s Council of Economic advisors, a hitherto little-known Harvard trained economist, enumerates some of the policy options in his November 2024 paper, ”A User’s Guide to Restructuring the Global Trading System.” If anybody needed any more reasons to sell their U.S. dollars, Dr Miran will convince the most sanguine holdouts. His “plan” is a tour de force collection of esoteric economic theories from obscure economists few people had ever heard off and hare-brained ideas such as forcing central banks’ to exchange their holdings of short-term Treasury securities for zero-coupon perpetuities (ie, defaulting on U.S. government debt).
Some market participants expect a massive outflow of foreign portfolio investment from the US. This coupled with massive deficit financing needs and the very short average maturities of U.S. Treasury debt, a legacy of Janet Yellen, all suggest an almost perfect storm. However, the initial rally in US Treasurys has been taunted by some as evidence of the success of the tariff policy. Those who get their financial analysis from such sources, for example the “All in” podcast, should be aware that those people do not manage money in public markets.
The tides will turn, eventually
The first order derivative investors expect is massive flows into the euro and the Japanese yen. However, there are second order derivatives to take into account. The likely appreciation of these two currencies coupled with the new tariffs bode ill for economic growth in those areas. The European Central Bank will likely start easing sooner and faster to mitigate the potential decline in employment ensuing from tariffs. Conversely, a weaker dollar and higher rates as the Fed waits to see the impact of tariffs on prices may soon make U.S. investments more attractive again.
The reason why Europeans and Japanese investors were willing to finance the U.S.’s current account deficit with portfolio and foreign direct investment is that U.S. firms have better returns on invested capital and provide significant more innovation. These two characteristics will not disappear overnight.
Trumponomics may be very costly to the U.S. dollar for years. To paraphrase Warren Buffett, it took 200 years to build the U.S. dollar’s reputation and just a few minutes to ruin it.
Perhaps, the single most worrying aspect of this self-inflicted crisis is the slow flow of commentary from Wall Street. Such is the fear in this new regime, that Michael Cembalist the Chief Investment Officer at JP Morgan Asset Management announced that he had self-censored his piece on the new tariffs. Should this climate of fear persist, we will have lost one of the most precious achievements of the American Revolution and the US Constitution.