The US is the world’s largest economy (in absolute US dollar gross domestic product [GDP] terms) by far — more than 1.5 times that of China, which is the next largest economy. It still makes up one full quarter of world GDP, despite the emergence of large economies like China, India and Brazil in recent decades. The US also has a higher per capita GDP (translation: purchasing power) than all other major developed countries including Germany, the UK, Japan, France and Canada (see Table 1 and Chart 1).
The US wields this economic strength and prosperity, which also underpin its military dominance — it spends 3% to 4% of GDP on its defence budget each year — in its relations with the rest of the world. It is the source of its outsized influence, both economically and politically, in world affairs and leadership role, including in global organisations such as the United Nations, International Monetary Fund, World Bank, and North Atlantic Treaty Organization (NATO). It is, therefore, no surprise that US foreign policies, its interactions with other nations, are shaped to ensure that it remains the pre-eminent economic superpower in the world. We all understand this.
We have seen it play out in historical and current events, whether through its trade pacts or trade barriers (tariffs and restrictions) and sanctions, strategic alliances, military protection and direct-indirect interventions in the politics of foreign countries, and more recently, in the weaponisation of the US dollar. Ultimately, geopolitics is about economics.
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Make no mistake, the US will always act in the best interest of the US, to raise American standards of living and enable continued government spending to further expand its military and economic-political influence. And this has important implications and consequences for the rest of the world.
US consumption is the key driver for global economic growth
The health of the US economy has significant spillover effects globally, not only because of its size but also because the US is the world’s largest consumer market. As we mentioned, Americans have high consumption power (GDP per capita) as well as high propensity to spend. Consumption accounts for more than two-thirds of its economy and has been the key driver for growth historically (see Chart 2).
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Over the past few decades, the US economy transitioned from manufacturing to services-based, outsourcing manufacturing operations to emerging countries with lower labour costs. Other factors such as the decline in unionisation (that reduced worker bargaining power and attractiveness of manufacturing jobs in the US) as well as proliferation of free trade agreements and rise of containerisation reduced import costs and spurred global trade. These eventually led to the hollowing out of the US manufacturing sector and increasing dependence on imported goods.
Many countries, including Asean member states, depend on the export of manufactured goods to the US to drive domestic economic development and growth, and create jobs for the people. The export-oriented manufacturing economy playbook has lifted hundreds of millions out of poverty. In short, the growth in US consumption drives the global economy.
But this insatiable appetite for consumption by both consumers and the government (through its spending) means an ever-ballooning trade deficit. Case in point: The last time the US had a budget surplus was more than 20 years ago (in 2001), and since then, fiscal deficit has been growing, to 6.2% of GDP in 2023. The US trade deficit for goods now totals almost US$1.1 trillion, though this is due in part to the massive size of its economy. Indeed, goods trade deficit is still only 3.9% of GDP. There are countries with larger deficits in percentage terms, including the UK and France. India has a goods trade deficit of 3.8% of GDP (see Chart 3). Additionally, the US is a net exporter of services. Trade balance for both goods and services is lower at -2.9% of GDP. In other words, its trade deficit is far from being as critical a problem as some have made it out to be. In fact, the massive trade deficit in absolute terms that is equivalent to a more modest percentage of GDP underscores its economic size, strength and resilience, which should never be underestimated. There is no question that the US will continue to dominate as the economic centre for quite a long while yet, at a minimum.
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But huge trade deficits must eventually be addressed
The US has a trade deficit — imports exceeding exports — with many countries (see Chart 4). Through the 1980s to 1990s, Japan was the largest net exporter of goods to the US. In other words, the country had a corresponding large trade surplus with the US. Since then, China — with its economic reforms and opening, and especially after joining the World Trade Organization in 2001 — has become an even larger net goods exporter, feeding the consumption growth in the US.
We have previously written about how the US engineered the US dollar hegemony post-World War II, which supported US consumerism. For example, its substantial influence in the SWIFT payment system reinforces the dominance of its financial institutions and the US dollar’s central role in global financial markets. By boosting demand for the greenback — as the settlement currency for global trades and financial transactions, safe haven asset and reserve currency — the US is able to borrow (from the rest of the world’s savings) at much cheaper costs than it would otherwise.
Over the past decade, the US has implicitly allowed the greenback to strengthen. Chart 5 shows the real effective exchange rate (REER) of the US dollar — the value of the US dollar weighted by the trade balance with its major trading partners and adjusted for inflation. The US dollar appreciation reduces the cost of imports for consumers and businesses, thus keeping a lid on inflation even as the country undertakes fiscal and monetary expansion to stimulate the domestic economy after the global financial crisis (GFC) and during the Covid-19 pandemic.
Growing consumption — particularly of cheaper and cheaper manufactured goods — underpins improving American standards of living. But inevitably, the ever-widening trade imbalance becomes an economic and political issue.
The US is now entering the reverse cycle, gradually pulling back stimulus (quantitative tightening) to achieve a soft landing for the economy. That will allow the Federal Reserve to lower the interest rate and reduce the cost of debts, including for the government. Will it now want a weaker US dollar — to boost export competitiveness — or, at the very least, force foreign countries to buy more US products?
In the 1980s, the US recorded consistently huge trade deficits with Japan, and to a lesser extent, Germany. That triggered concerns over the loss of US manufacturing jobs and rise in economic nationalism, which ultimately led to the signing of the Plaza Accord in 1985. To correct the trade imbalance, the US, Japan and Germany (as well as the UK and France) agreed to intervene in the currency markets — if necessary, among other measures to weaken the US dollar — and boost the competitiveness of US exports, thus improving the trade imbalance. The measures worked, at least for a few years. US trade deficit reduced but soon began increasing anew, this time with emerging China. In 2018, the US, under the Trump administration, started a trade war with China, ostensibly to rectify its huge trade deficit as well as China’s unfair trade practices and intellectual property theft. The US imposed trade tariffs on a wide range of Chinese imports. Protectionist policies widened further under President Joe Biden.
Question: Who would be in its crosshairs in the future, its next target? Asean, and especially Vietnam, which has seen trade surplus with the US balloon in the last few years as businesses diversify their supply chains out of China? Or India, which is now attracting significant foreign direct investments for manufacturing, and likely to see its trade surplus with the US grow in the near future? We suspect odds are that trade restrictions will come when a country’s economy grows to a size that presents a threat to the US’ economic dominance.
It is always the economy — and US economic dominance
Robust US consumption and economic growth is positive for the global economy — providing a major export market for others, and especially important for emerging countries in their economic development. But as history has shown, eventually, a lopsided trade balance must be addressed.
Reducing trade deficits by reducing demand (consumption) will lead to economic recession and lower the people’s living standards. No elected US politician will ever choose this route. Therefore, others would have to bear the cost — that is, US deficits will be reduced by other means.
In the case of Japan, it was by depreciating the US dollar against the yen under the Plaza Accord, to boost US export competitiveness. In more subtle cases, the US would wield its soft power, political and economic influence, to drive the sale of its own products (raise exports), primarily military hardware and tech to strategic allies, as well as industrial machinery, transportation equipment, commercial aircraft, financial and professional services, and such. There are also other forms of transfers, such as pushing for market liberalisation that allows for US investments in foreign countries, thereby extracting profits.
The US stock market now trades at higher average valuations compared to most other major markets in the world. For instance, based on the valuation metric favoured by Warren Buffett — and commonly known as the Buffett Indicator — US total market cap is now nearly twice its GDP. That puts it well into historical bubble ranges, indeed higher than during the dotcom bubble and right before the GFC (see Chart 6).
And herein lies our main reason for this article — why we continue to invest in US stocks, even as valuations go up. Because the US economy can keep growing faster, is more resilient and sustainable than other nations — for all of the above-mentioned reasons. That includes profitability of Corporate America.
US consumers can keep spending, increasing sales and profits for businesses. Companies can also keep exporting their products. The US will attract more and more investments, including through its robust capital markets, which account for more than 40% of the size of global equity and debt markets. Investments will drive productivity gains and innovation — and further expand sales, margins and profits.
Additionally, many of its largest companies have global reach. For instance, 40% of sales for the S&P 500 companies are derived overseas. In other words, profits for US companies do not just reflect the growth and opportunities in the US alone, but globally. This also means that the current Buffett Indicator is quite likely overstated, as its denominator should not be limited to US GDP. US businesses can, therefore, grow earnings faster while cost of capital will continue to be kept relatively low. It is a positive feedback loop, founded on the nexus of military, politics and economics.
In short, the US extracts massive benefits from its economic dominance in the world. Clearly, it will do what is necessary to maintain this status, no different than what an incumbent company would do to defend its market position against competitive threats.
The Plaza Accord caused severe disruptions to the Japanese economy, which has grown rapidly post-WWII, to become the second largest in the world — and perceived by many in the US as a growing threat. Japan’s investments in research and development were paying off and it was making huge leaps forward in technological advancements and innovation. Japanese companies, the likes of Sony and Toyota, became global leaders, dominating industries such as auto, electronics, consumer goods and robotics. Post-Plaza Accord, the yen appreciated sharply against the US dollar. As part of the agreement and to compensate for reduced export competitiveness, the government implemented expansionary domestic policies (fiscal and monetary) that led to the asset (real estate and stock market) bubble, and Japan’s lost decades after the bubble burst.
China has leapfrogged Japan and is now the world’s second-largest economy. Growing wealth has allowed the country to expand its political and economic influence globally, through trade and investments (like the Belt and Road Initiative), particularly in developing countries in Asia, Africa and Latin America. And like Japan before it, the country is making great strides in new high-tech sectors, including communications (5G), artificial intelligence (AI) and consumer tech, electric vehicles and batteries, renewable energy (solar and wind power), drones and robotics, biotechnology and advanced manufacturing.
Unsurprisingly, the US is imposing an ever-widening range of measures, including export and investment restrictions, to hamper China’s technological advancement. It is also using its soft power to sway others, such as the Netherlands, Japan and South Korea, to adopt similar restrictions on the flow of technologies, equipment, materials and chips critical to China’s high-tech ambitions. Yes, China’s structural reforms should include measures to boost domestic consumption and reduce its trade surplus with the rest of the world. But the US trade war with China has little to do with simply trade deficits and all about technological supremacy. Leadership in next-generation AI, in particular, will be key to future economic dominance in the digital age. As we said, ultimately, it is always the economy.
Foreign policies, including trade, will always be based on national interests. Whether the US or any country, it must serve its own people. The global question, however, is whether we aim for relative or absolute prosperity. Look at the difference between the GDP per capita of the rich world versus others (Table 1). Is it not easier — bearing in mind the poor have higher marginal propensity to consume (they spend a higher percentage of income) — and more fruitful to grow the economy of the rest of the world? And with it, the size of the global economy, which will increase demand for all products and services, from rich and poor countries alike — thereby generating rapid growth in employment, wages, savings, investments and productivity. In some respect, this is what China is doing as it expands investments and trade with African and Asian nations. But this threatens the West. The West should likewise invest in and help grow these economies. A rising tide lifts all boats. Unfortunately, their focus mostly appears to be on making relative gains instead of absolute gains. To quote ancient Greek playwriter- philosopher Aeschylus, “It is in the character of very few men to honour without envy a friend who has prospered”.
The Malaysian Portfolio gained 0.7% for the holiday-shortened trading week ended April 9. We underperformed the benchmark FBM KLCI, which was up 1.1%, primarily due to our high cash holdings. Shares for Insas and Insas-WC were up 2.9% and 2.0%, respectively, while UOA Development was down 0.5%. Total portfolio returns now stand at 192.4% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 15.1%, by a long, long way.
Meanwhile, the Absolute Returns Portfolio fell 0.1%. The top performers were Tencent (+1.8%), OCBC (+1.8%) and DBS (+1.4%), while the top losers were Airbus (-3.1%), Berkshire Hathaway (-2.6%) and Vanguard S&P 500 ETF (-1%). Total portfolio returns now stand at -0.2% since inception.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
