Paul Diggle
Hello and welcome to Bytes the economics and politics podcast from Aberdeen. My name is Paul Diggle
Luke Bartholomew
And I'm Luke Bartholomew.
Paul Diggle
Is the US still economically exceptional? Is it the ‘city on a hill’ that has a higher GDP growth rate, more technological innovation, the world's biggest and best companies, which provides the global safe asset and reserve currency? Well, financial markets have started to question the notion of US economic and market exceptionalism.
That's the topic we are going to dive into on the podcast today. And I think the place to start, Luke, is by unpacking this notion of US exceptionalism, because as I was hinting at, there it can take a lot of different forms. I think the most straightforward version of economic exceptionalism is having stronger economic growth than the rest of the world.
The US is, of course, the world's largest economy. Depending on exactly how you measure, it has the highest per capita GDP of the very large economies, and it has an average growth rate, which is pretty high over the past five years. So a period that would include the Covid shock and then the rebound. So averaging through that period, the US GDP growth has been 2.4% per annum.
And that is substantially higher than eurozone growth averaging 1% over that period, the UK growth averaging 0.9 percent, Japan at 0.2%. In fact, 2.4% looks a little bit more like some emerging market growth rates - India about 5%, China 4.8%. It's actually stronger than growth in Brazil or Russia over that period. And US economic growth outperformance reflects its economic dynamism.
Having a more flexible labour market structure, more business-friendly regulation, having a more supportive, but maybe unsustainable, stance of fiscal policy, I think over the past five years, certainly it reflects the handling and then recovery from Covid. US policymakers prioritized maximum labour market flexibility, which saw the unemployment rate surge higher, employee supported with direct cash handouts from the government, but then allowed the re-formation of labour market matching as the recovery from Covid began, that perhaps adapted to the new structure of the labour market in economy, the more goods intensive structure that emerged subsequently, and that was contrasted with European furlough schemes, which perhaps were less flexible in their nature. And if you go further back, US growth outperformance reflects the handling and then recovery from the global financial crisis in more flexible labour markets, a painful but ultimately helpful bank recapitalization in the US, more monetary stimulus, less fiscal austerity. All these things, I think are played into relative US economic outperformance.
Luke Bartholomew
And then the second piece of US exceptionalism, and perhaps the one that's most well known to financial market participants, has been the ongoing outperformance of US risk assets compared to the rest of the world.
The cumulative total US equity market returns have essentially beaten all comers over many multi-year horizon, certainly over the last five years or so. But going back all the way to the financial crisis as well, the US equity market has just been the standout outperformer across global developed market equities. And that's partly related to some of the things that you were talking about Paul - the dynamism of the US economy, perhaps related to a better policy response as well. But I think perhaps the most famous or archetypal way of getting at this has been the dominance of US tech companies leadership across AI, most famously the magnificent seven companies that the US has been home to extraordinary tech innovation, its companies seem to have enormous corporate moats.
That is this idea that they had a durable competitive advantage provided by business models or corporate positioning or something like that. And that's what made the US home to some of the biggest, most important, seemingly most exciting companies in the world. And that's why investors wanted to be there. And they were rewarded, as I said, with extremely high returns.
Paul Diggle
Yeah. And the result of that, of course, has been the US has been the destination of choice for substantial amounts of global capital flows. Net foreign purchases of US equities over a whole post financial crisis period are substantially positive. The US runs a large capital account surplus. That is to say that foreigners are sending a lot of capital to the US, investing physically in the US infrastructure, but also buying financial assets in the US.
And that capital account surplus is, of course, the mirror image of the current account deficit - the trade deficit which the current administration is so concerned about. And then lots of institutional fund managers, global investors, talk about being overweight US assets. Now I’m more is a little bit dubious of this concept because of course for every buyer of any asset there must be on the other side a seller.
So the world can't be in aggregate overweight or long any particular asset. But I think it is the case that the size of price appreciation that you were talking about Luke in the US relative to the rest of the world means that US holdings are just a very large part of most global investment benchmarks now they make up a large share of many investors’ portfolios.
Luke Bartholomew
And then the final piece of US economic exceptionalism, and it's also tied up with geopolitics and it's an expression of American power in the world, and indeed, a source of that power, is the fact that the US issues the reserve asset - Treasuries - and the reserve currency, the US dollar. We've talked about that concept many times on this podcast before.
But to recap, for many people, this is a so-called ‘exorbitant privilege’. It gives the US lower yields, lower government borrowing costs than it otherwise would have, because there's this extra demand for Treasuries as a reserve asset above and beyond simple economic reasons for owning the asset, and in particular in crises, yields on government, borrowing, government debt in the US tend to fall.
And that can be an important stabilising mechanism. On top of that, the dollar also tends to appreciate in downturns, in crises, even if those originate in the US. And again, that can be an important stabilising mechanism. And the third thing, as I alluded to there, is that reserve status gives the US extraordinary foreign policy power. They're able to leverage control over the global financial system to achieve various foreign policy objectives through sanctions and the like.
But as we've also talked about on the podcast, some people actually increasingly see this as maybe is an ‘exorbitant burden’ rather than privilege, that, as you were talking about, there Paul, the capital inflow to the US, has as its necessary counterpart a current account deficit and a stronger dollar to make that happen. And that's tended to squeeze out the manufacturing sector, which some people think of as being politically and economically undesirable, given the consequences for inequality, regional economic development, and perhaps for long term strategy and geopolitical competition as well.
But I think one other thing to note about this kind of exceptionalism, the reserve asset exceptionalism, is that there is no necessary connection between that and the other forms of exceptionalism that we were talking about - growth and financial market outperformance exceptionalism. In fact, there might be a bit of a theoretical and historical puzzle, or at least a bit of a surprise in that, because for sure the reserve currency issuer would typically be the most important economy in the world with deep, liquid financial markets.
But there's no need why that has to be associated also with the best growth prospects in the global economy. In fact, you might think that the most exciting growth places are not going to be in super developed leading economies, they’re actually going to be in emerging markets that need to do catch up growth, as that's where capital can be most efficiently employed.
And in a sense, that's kind of what happened during the 19th century British imperial history, because the UK, the British government, was the issuer of the reserve asset, the safe asset, but it was not the home of the most exciting, attractive returns. In fact, the UK was a net exporter to capital, to various British colonies and indeed, frankly, the US as well as those were the most exciting places for growth.
So yeah, in a sense, perhaps the truest expression of US exceptionalism up to this point at least, is that it has been able to be at the same time, the issuer of the safe asset and also the issuer of the risky asset of choice, that in a sense, it's given investors in the US a chance to have their cake and eat it.
Paul Diggle
Great. So that's the different forms that US exceptionalism can take. But let's talk about some of the threats to US exceptionalism, because these too span a spectrum of different types from the near-term cyclical growth deterioration that may be about to get under way through to the US being a structurally less attractive destination for capital. And then in extremis, that the dollar may lose its status as the global reserve currency of choice.
Treasuries may lose their status as the ultimate safe haven asset. And that spectrum looks progressively more serious, but perhaps progressively less likely. Well, let's take each in turn. The immediate challenge is that the near-term US economic growth outlook is deteriorating. We Luke, like many economic forecasters have been downgrading US growth forecasts. The US grew 2.8% last year, as I said, 2.4% over the previous five years.
And we now expect it to grow by 1.3% in 2025. Now, I sometimes like to joke that economists include decimal places in their GDP forecasts and their numbers to show they have a sense of humour. So don't take that 1.3% too literally, but the point is that the US economic outlook is deteriorating - only just starting to deteriorate in the growth data, we'll learn more about that in coming weeks and months. That would still be stronger than some other DM economies - 1.3%. We've been making downgrades elsewhere, but they're probably largest in the US. It's not a negative number. It's not recession in the base case. There are still some tailwinds to come, perhaps from tax cuts, perhaps from deregulation giving the economy a bit of a fillip.
But there are still actually substantial recession risk too. They might be close to 50% if the high point of the US weighted average tariff rate is not yet being seen. If tariffs rise again, if the reciprocal tariff pause is just that- a pause - and they come back on. If business uncertainty, consumer uncertainty, remains exceedingly elevated, I think it's quite plausible to see an economic recession in the US, and that would be coming alongside, an at least temporary rise in inflation as well as tariffs raise prices.
So it's a ‘stagflationary’ combination into which the Fed is going to face some policy dilemmas. I think the Federal Reserve will still be cutting interest rates a couple of times this year - more next year, but it may start that process more slowly than otherwise given the inflationary threats as well.
Luke Bartholomew
So let's move along the spectrum that you were laying out there Paul and move on to the second challenge, which is that the US is perhaps becoming a structurally less attractive destination for capital.
And I think in turn, this has several parts as well. And the first is the idea that potential growth in the US might be lower, You were of course talking about growth in a cyclical sense just there, recession yes or no, and certainly tariffs, trade uncertainty, d have economic consequences over that kind of time horizon. But I think where the consensus around how trade policy really gets its economic bite is over the long run and the impact that it has on potential growth.
And I think there is a pretty clear consensus that increasing protectionism leads to lower potential growth, because there's less gains from trade, less gains from comparative advantage and the efficient allocation of economic resources and capital, there’s smaller economies of scale to be reaped, there's less competitive pressure, and so in turn, less economic dynamism as firms can hide behind these protective trade barriers.
And so if the US exceptionalism was in part a story of its potential growth rates being higher, and this is weighing on US potential growth, presumably that must be in some senses also eroding that US exceptionalism. Now, of course, it is important to stress that that might be a perfectly reasonable policy choice to make that you are trading off efficiency for maybe greater resiliency, or maybe to protect particularly industries that you think of as being especially politically or strategically significant.
That is a perfectly reasonable political choice. But it is just that - a choice. And it has trade-offs, and that trade-off is lower potential growth. And then the second way in which the US might be becoming a less attractive destination for capital is that policy uncertainty, which has been of course extremely high recently, might be just a permanent feature, or at least a long-lasting feature of the US economic backdrop.
We have, of course, still four more years of Trump to go, President Trump to go, and the way in which policy has been set so far in this administration suggests that policy uncertainty is going to remain extremely high just around the way it is that decisions are made in the administration and the sense in which there can be relatively quick reversals on policy.
But also more fundamentally, perhaps, Trump has introduced a governing style which involves a more forceful executive and a more pliant legislature and judiciary and that introduces more uncertainty as well, and more risks around the way in which policy will go. But even looking beyond Trump, I think you can make an argument that there are some structural changes to the US political environment in general that should make policy uncertainty higher.
And in part, those are somewhat related to Trump. Maybe there has been institutional degradation in the US, norms have been eroded. And so as Trump has behaved, perhaps his future political successors from either party might behave as well. And then on top of that, perhaps there's also been this greater political polarisation as well, which has also had the effect that the stakes seem to be higher at every election and the possibility of big swings in policy is that much greater. To put it in a way that it’s sometimes expressed, the so-called Overton Window is wider. This is the idea that at any one time, there's only a relatively specified, quite narrow band of policies that are imaginable or permissible in the current political order.
And as that window has seemingly got wider, the range of political outcomes that can flow from any election or change in government has got bigger. And so there's greater uncertainty around that. Now it is worth saying that another way of saying a greater premium needs to be put on US assets because of this uncertainty is also to say that the expected return has to be higher as well.
The premium is just a way of generating return, and that return is necessary to compensate for the risks. So in equilibrium, in steady state, perhaps expected returns on US assets will look higher. But two things to say about that. First, as I say, that is to compensate for the risk. It's not like it's a free lunch. And the second that the way in which that premia gets built into US asset prices is that asset prices have to fall or at the very least perform less well. And so that's another way in which this exceptionalism and very strong US asset market performance may now be fading.
Paul Diggle
Yeah. Another way in which the US could be becoming a structurally less attractive destination for capital is that the corporate moats that you were talking about Luke, the durable competitive advantage that large US firms, especially technology firms have, could be narrower and shallower than the market previously thought.
You know, markets had previously thought that things like network effects or economies of scale, the size of capital expenditure required to purchase and build the GPUs, the chips that are involved in training large language models, that these created such large barriers to entry that those particular firms’ competitive position was secure. But developments such as Deepseek, the Chinese AI model, which has been developed at considerably less expense than the US counterparts, using a generation or two behind the ‘bleeding edge’ of chips.
by using innovative algorithms and techniques - things like System of Experts which is a way of training a large language model which is less computationally intensive, that that development has shown that US corporate moats are shallower than previously thought. Pre Trump during the Biden era, people also worried about threats to US tech firms from regulation. Antitrust and possible break up. I think those could still come back at some point as also ways in which, you know, corporate America's moat, its durable competitive advantages could be smaller than previously thought.
Okay. But let's move on Luke to the biggest challenge to US exceptionalism, which would be if the dollar were no longer the global reserve currency, and if US Treasury bonds were no longer the global safe asset of choice, the ultimate form of sort of protecting your money, insulating it from risk.
And I think the way that a threat as profound as that could develop, would be that US policy uncertainty gets so deep that it verges into meddling in the institutional architecture itself. The set of economic policy institutions that are the foundation stones on which having the dollar as the reserve currency, having Treasuries as the safe asset, are built and certainly some of the financial market price action post Trump’s tariff ‘Liberation Day’ look like price action that's starting to contemplate that risk.
So there were days, painful days, post ‘Liberation Day’ when US bond yields were moving higher i.e. bond prices are moving lower, US stock prices were moving lower (and by more than in the rest of the world), and the US dollar was selling off against other currencies. And it was sort of a so-called ‘sell America’ trade or set of correlations was developing in financial markets. And that's a set of correlations that look a little bit more like an emerging market having crisis, a currency crisis or a balance of payments crisis, than it looks like the correlation structure of the provider of the global safe asset.
Luke Bartholomew
And whilst I think no one in the Trump administration wants there to be a currency crisis or anything like that, I think it is worth saying that for some policymakers, the idea that the US reserve status is going to be eroded is a feature, not a bug, that that's actually part of the intent, not an unpleasant side effect.
I've talked already about how there is a growing sense among some economists, policymakers around Trump that the US reserve status is an exorbitant burden, not a privilege that needs tackling. And we've discussed on the podcast before the so-called ‘Miran Plan’ - Stephen Miran’s paper, he's now Chairman of the Council of Economic Advisers in the Trump administration, ways to potentially tackle, as he sees it, some of the issues of US reserve status and some of the things that are talked about there would involve really quite profound upheaval to the US Treasury market and the way in which reserves currently exist within the global financial system. He's talked about so-called user charges on overseas holders of Treasuries - and that's just a fancy way of saying tax to be frank. So an extra tax on US Treasuries. The other thing that’s sometimes talked about is effectively forced debt swaps. So existing US government debt would be swapped by the administration with perhaps century-long bonds.
So the US debt is termed out and presumably it would be termed out at an interest rate that is below market interest rates. And it's quite difficult to look at either of those two things and not think that they rather smell of default. And again, given just the vast importance of Treasuries in the global financial system, even if you think that doing something about US reserve status is a feature, not a bug, I think you ought to be somewhat concerned about some of the other bugs that that might spread across the global financial system. It is potentially profoundly systemically damaging I think.
Paul Diggle
Yeah, and another way in which the US institution architecture could be threatened, changing in addition to treasuries Luke, is that threats to central bank independence. the Federal Reserve's independence, have been increasing under Trump. Now, Trump's of course, launched scathing rhetorical attacks against the Fed and Chair Jay Powell, as he did during the first term. But these have stepped up during the second term. He's put out a post saying that Powell’s termination cannot come soon enough. Now he has since rolled that back a little bit and said that he has no intention of firing Chair Jay Powell, that he will wait until his term is up in May 2026. I imagine that Treasury Secretary Scott Bessant has had some words with Trump and explained the potential dire consequences of directly interfering in Federal Reserve independence.
Trump may just be pre-emptively shifting the blame for the coming economic slowdown from the administration's tariff policies onto the Federal Reserve. But what gives these attacks particular bite, I think, is this court case currently going through US court system to be considered by the Supreme Court- Trump v Wilcox it's called - where it's going to test the president's ability to fire without cause, independent federal officials. It will test a ruling known as Humphrey's Executor, which had previously protected independent officials from the whims of the executive. And if that ruling goes Trump's way, which is quite possible, they'll be ruling likely before the summer recess, if there's no specific carve out protecting Federal Reserve and FOMC officials independence that could, I think, give Trump ammunition should he wish to use it to fire Powell, to really step up intervention in the setting of monetary policy.
And that would take different degrees. We're at intense rhetorical pressure - tick. We could move to having a stooge, a sort of Trump lackey, in place at the head of the Federal Reserve, whether it's by firing Powell, or just by replacing him, when his term is up as Chair next year. And it could go all the way through to replacing the whole of the FOMC, the Fed's rate setting committee, or just bringing interest rates directly under presidential control.
Luke Bartholomew
And then, at the risk of over harping on about this Miran Plan or perhaps even to suggest that there is more of a plan than is really going on. But nonetheless, I think it is worth stressing that, you know, there are aspects of that so-called plan that would require, if they were implemented, a whole scale restructuring of, the role of the Fed.
So if the administration really does want to bring about a sustainably lower dollar and perhaps to do that via agreements with other countries, the so-called ‘Mar-a-Lago Accord’, it's almost certainly the case that that would require monetary policy coordination as well. The Fed would need to be involved in that and set interest rates and monetary policy more broadly in a way that brought the dollar lower.
And it's quite possible that that would not be consistent with its current dual mandate for full employment and a stable price level, which it interprets as 2% inflation. It could be that that kind of policy would lead to inflation consistently above 2%. And so, as currently constituted, an independent central bank wouldn't be able to do precisely the currency policy that might be required of the plan.
So if we take the plan seriously, perhaps we should also take the idea that central bank independence needs to change seriously as well.
Paul Diggle
And taking it further still, one could worry about the US ending the Fed ending dollar swap lines, which has provided dollar liquidity to other central banks during periods of acute liquidity crisis they've rolled out in financial crises in the past.
If the US really wanted to push this line of rewriting the rules of the global financial system, that could be another place to go. Look, I think ultimately Luke the end of dollar reserve status, the end of US Treasuries as the global safe haven is probably a little bit of a straw man. There are very powerful network effects which come together to create the dollar's status as the global reserve currency.
There's a lot of inertia in the system, which means that it's very costly to move away from a sort of global dollar standard. There's a lack of alternatives. China doesn't run an open capital account, doesn't issue enough debt to the rest of the world to be able to serve as the provider of the global safe asset in reserve currency.
But global reserve currencies come and go over the long sweep of history. Their status is often linked to the global military and economic hegemon, and we are in a position in a period of transition from a unipolar to a bipolar global economy and over a long period of time that is going to come, I think, with a gradual shift away from the dollar, from Treasuries and the gradual erosion of US exceptionalism.
Luke Bartholomew
Well, with that gesture to the grand sweep of history, I think that is all that we have time for this week. So, as ever, please forgive me if I ask you once again to, like, subscribe wherever it is that you get your podcasts from. And then all that remains is for me to thank you for listening. So thanks very much and speak again soon.
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