The Great American Buy-In
How the rest of the world poured capital into the US and made Americans rich.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
TLDR Summary
When the emerging market bubble started popping two decades ago, the US became the only game in town for foreign investors because of its unique ability to convert capital into profits. They have poured $9tn into the country since 2010. This investment is now worth $24tn giving foreigners a sizeable chunk of the US economy. At first glance, it seems like the last 15 years have been the Great American Sell-Out, a bad thing that has to be fought by erecting trade barriers.
However, Americans have actually greatly benefited from this capital. Their own net worth has grown by $106tn over the same period. They have retained the lion share of the wealth creation. The US economy and its stock market have vastly outperformed the rest of the world.
Running trade deficits must be viewed like applying leverage to an investment. As long as your unlevered return exceeds the cost of leverage, your levered returns will be higher. Foreigners have grown the pie more than the slice they received for their investment. Americans get the residual. They haven’t sold out. They simply allowed others to buy into their success.
Economic leverage through trade deficits
To understand how trade deficits work, it is helpful in my opinion to think of them as leverage. Leverage can greatly amplify financial success if used wisely. If your unlevered return on an investment exceeds the cost of leverage you would have to pay to an outside investor, it's rational to accept that additional capital to juice up returns.
A trade deficit is a capital surplus. It makes outsiders participate in your economy. This doesn’t need to be in the form of debt as the term leverage may suggest. It can be any form of capital, incl. equity capital.
If you pay foreigners less than what you earn from accepting their capital, you will benefit. The most important indicators to determine whether that is the case are unemployment, FX and GDP/capita. If a trade deficits comes with high unemployment, a weak domestic currency and poor GDP performance, it means that the domestic population is not benefiting from the foreign capital. Their unlevered return is lower than what they pay to foreigners.
Greece is an infamous example where exactly that happened. Consistently running 5-10% trade deficits every year for decades, they imported vast amounts of capital from abroad. This capital however did not create value for them. Instead, it gradually sold out the entire economy to foreigners, effectively making the Greeks slaves to those foreigners. The cost of the leverage exceeded the unlevered returns of the Greek economy and its assets. Over time, this wiped them out like an overleveraged Robinhood trader. Political instability is a very unsurprising result of that process. The Greek population is obviously highly dissatisfied with this development.
The case of the US is very different. Foreign capital grew the economic pie more than its own compounded value, leaving the residual to Americans. This is evident America’s strong labor market, the strength of the US Dollar and its superior GDP development, the most result being the amazing performance of the US stock market.
It’s an incredible deal (and one that didn’t even require a deal artist in the White House). Foreigners gift goods and services (and their labor by extension) for the privilege to invest in the US. They do that happily because it generates high returns.
Americans accommodate that happily because it generates them even higher returns. And the US won’t even care if it stops generating adequate returns for them. They have received the labor from abroad already. Good luck reclaiming the financial assets created from that labor against the strongest army in the world.
Trillions of Dollars of trade deficits have made the US an empire. Most countries of the world have become their colonies and billions of people have become their slaves. Americans fought a few wars to get there. But for the most part this empire has been forged without weapons. It has been forged through the amazing ability of the US economy to convert capital into profits.
I hope all of this makes sense from a qualitative perspective. I have discussed it in similar words before. But it would also be nice to substantiate this quantitatively, wouldn’t it?