If you’re a supply sider, monetarist or nominal GDP target economist, we’re about to enter familiar territory that, frankly, should never have been abandoned. The reality is, its not 2017 but 1973 and Congress, the media and entire swaths of the professional ‘chatter class’ is about to reboot Reagan’s fiscal agenda except this time the opposition acknowledges familiar terrain; this kind of strength may endure but it will not help them win over future voters. Multinational companies housed in the U.S. are bracing for major tax reform that will enable them to expense options immediately instead of drawing out lengthly depreciation dates; a bill that favors equity over debt and an environment that openly fosters liberty. As we enter March, we need to brace for impact because the culture wars are about to heat up.
The U.S. dollar has experienced its sharpest rise ever since the lows of 2011. Treasury yields have risen to nearly 2.5% and capital flows are increasing. Even global financial and credit markets have exploded in size; the greenback, unlike the yuan, is more pivotal than ever. This is evidenced in witnessing the surge the dollar has become in foreign financing. We’re no longer seeing U.S. pension funds purchase foreign U.S. denominated debt, but the reverse in capital flows back to the U.S. is testing the resolve of foreign central banks.
A stronger greenback is reversing a cycle that began with ZIRP. With zero interest rate policy plying money abroad in search of interest, it has returned with a vengeance; we’re witnessing foreigners husbanding local currencies to finance rising costs, as capital flows out, assets prices fall. The result: capital markets and indigenous credit markets are more dependent on the fortunes of the U.S. economy than every before. The truth is: we’re carrying everyone. The downside: authoritarian nation states like Turkey and Russia have large foreign denominated debt, mostly in short term T-bills.
It isn’t all good news for us either. We should anticipate a widening of our trade deficit, only to be offset with massive capital inflows, low inflation, high productivity and social mobility. Its happened before, it can happen again this spring.
The trick is to wade into currency arbitrate, carry trades or covered-interest-parity knowing full well that currency volatility is now unhinged from market fundamentals. This was previously fixed with the Plaza Accord, but the underlying geopolitical rhetoric of the past two years has killed off any possibility of having an accord today.
The gloves are off, and the dominant political parties in D.C. are reaching for total reform of our tax code for growth; we’re moving toward a full scale downsizing of Keynesian ideology.