As measured by the Dow Jones Industrials US equity benchmark suffered their first loss in 7 weeks. Are these signs of fatigue or are these signs of an overheating or climaxing bubble?
My impression is should US markets begin to wilt in earnest, then current downdraft in Asian markets are likely to intensify.
The US reportedly posted a substantial 22% reduction in the deficits of her trade balance owing to record exports and to a shrinking oil import bill according to the Wall Street Journal[1].
Shrinking US trade deficits can signify a symptom of unsustainable imbalances from the current monetary order, the US dollar standard.
The US dollar remains the largest international foreign exchange reserve with over 60% share (right window[2]).
International currency reserves are over $10 trillion with the US Dollar also having the biggest share (left window). Perhaps a big segment of the undisclosed reserve currency may also be in US dollars.
Over 50% (right window) of the $12 trillion (left window[3]) of international debt securities has been denominated in US dollars.
The point of this exercise is to demonstrate of the world’s continuing dependence on the US dollar as medium of exchange and as reserve currency.
Yet the US dollar standard seems to operate on the principle of the Triffin Dilemma, formulated by the late Belgian American economist Robert Triffin.
The eponymous theory by Mr Triffin elucidates of the economic conflict emanating from a world reserve currency particularly on meeting short term-domestic interests as against long term international objectives[4]
Under the Triffin dilemma, the issuing reserve currency makes it easy for a nation to consume more goods and services via an overvalued currency.
The same overvalued currency easily allows for financing of either budget deficits and or trade deficits, aside from having more latitude in “determining multilateral approaches to either diplomacy or military action”[5].
In short, a reserve currency provides the issuer the privilege of an interim “free lunch” or to quote the French economist Jacques Rueff “deficit without tears”[6]
One of the other side effects of the Triffin dilemma has been the intense deepening of the financialization of the US economy[7].
Instead of producing goods, the US economy evolved towards shuffling of financial papers partly required by foreigners to recycle their dollar holdings. As one would note, the gist of expansion of financialization came as the US dollar became unhinged from the Bretton Wood System in August 1971.
Of course the other side effect of the Triffin dilemma has been the growing frequency of global bubble cycles as evidenced by the greater incidences of global banking crises since the Nixon Shock of 1971
Aside from the massive accumulation of reserve currency by foreigners that would eventually undermine the reserve currency status, a dynamic which the world seems headed for, an equally detrimental factor to a reserve currency status is the proportional devaluation that would shrink these deficits.
Mr. Triffin actually articulated the problems of the Bretton Woods System where the failed system seemed to have validated his thesis.
In a testimony before the US congress in November 1960, Mr Triffin argued that “If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.[8]”
Given the deep reliance by global markets and global economy on the US dollar system, improving US trade deficits are likely to extrapolate to reduced liquidity in the ex-US global system. Such dynamic will only provide more muscle or ammunition for bond vigilantes, and equally, would mean a tightening of a system deeply dependent on the largesse of US dollar steroids from US authorities.
In the recent past, a reduction in the deficits of US trade balance coincided with strains in the global ex-US equity markets as measured by the MSCI[9] (lower pane)
Diminishing trade deficits here functioned as symptoms to dot.com bubble bust and to the 2008 Lehman bankruptcy. When financial markets collapsed as consequence to a bubble, international trade grinded to a near halt. This led to a substantial reduction of US trade deficits. Thus the narrowing trade balance coincided with recessions.
The causal flow may or could be reversed today; perhaps reduced liquidity from US exports of her currency the dollar may incite instability in the global financial markets.
The effect of shrinking liquidity on the global system will likewise affect US corporations. With 34% of the revenues of US S&P 500 companies coming from non-US sales[10], the adverse effect is that shrinking global liquidity will eventually land on US shores.
And it’s not just trade deficits that has contracted, US budget deficits have also dwindled to 4.2% of the GDP from 7.7% a year ago[11]. So this could be a one-two punch against the global markets and economy. And should the FED taper, such will exacerbate on the effects of the Triffin Paradox.
Will the European Central Bank, the Bank of Japan, the Bank of England and the People’s Bank of China fill in the vacuum from improving US twin deficits?
Or will Triffin’s ghost haunt the global financial markets?
Interesting times indeed.
[1] Wall Street Journal Oil Boom Helps to Shrink U.S. Trade Deficit by 22% August 6, 2013
[2] The European Central Bank THE INTERNATIONAL ROLE OF THE EURO July 2013 p.19
[3] The European Central Bank, op cit., p23
[4] Wikipedia.org Triffin dilemma
[5] See The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency April 20, 2009
[6] Jacques Rueff, The Monetary Sin of the West, Mises.org
[7] Wikipedia.org Financialization
[8] IMF.org The Dollar Glut Money Matters: An IMF Exhibit—The Importance of Global Cooperation System in Crisis (1959-1991)
[9] MSCI.com World Ex-US MSCI Index Performance
[10] Businessinsider.com CHART: The S&P 500 Is Not The US Economy, May 10, 2013
[11] National Forex Calculated Risk; US Deficit is Shrinking August 10, 2013
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