In recent decades, the American economy has expanded more rapidly than other major economies, creating substantial wealth. This phenomenon is often called "American Exceptionalism." While the economic and financial results are not in dispute, the reasons behind them are. A deeper look shows that the period of "American Exceptionalism" was driven not only by fundamentals but also by large-scale and unconventional fiscal and monetary policies that were unprecedented in their reach and magnitude. The Trump administration, eager to extend America's exceptionalism, plans to impose taxes (i.e., tariffs) on our major trading partners. Will this strategy work or is the era of "American Exceptionalism" over?
Advocates of "American Exceptionalism" often overlook or downplay the most extensive fiscal policy in history that has bolstered the economy in recent decades. For instance, the US federal debt has risen from $7 trillion to $36 trillion over the past twenty years. Essentially, the federal government has spent, on average, over $1 trillion annually beyond what individuals and businesses paid in taxes. Consequently, the US economy reaped the benefits of government spending without imposing equivalent taxes on its citizens or businesses. No other nation globally could maintain this for such an extended period.
Unlike households, businesses, and other countries, the US government has a printing press that enables it to spend beyond its means. However, there are limitations to this ability. Niall Ferguson, a British historian, suggests that a government is no longer a great world power when it spends more on interest payments than on defense. The US surpassed this threshold last year, indicating that the story's script has already been written, with the conclusion possibly unfolding very soon.
Also, monetary policy had a significant influence on the economic and financial outcomes over the last 20 years. For example, in half of those years, policymakers kept official rates near zero, and in about one-third of the years, the Federal Reserve spent over $8 trillion on securities purchases to stabilize financial markets and support economic recovery. These direct asset purchases, called quantitative easing, lead to demand-pull asset inflation by pushing investors to swap risk-free fixed income assets for risky assets, typically equities. Consequently, the surge in wealth was partly fueled by monetary policy.
Although it may appear to be an obvious observation, if a nation increases its government debt five times over twenty years and its central bank follows a "crisis-type" policy for half of that period—spending a third of the time directly purchasing financial assets to artificially boost equity values—can this truly be considered an era of "American Exceptionalism"? Would it be more precise to call it a "folk tale"?
The Trump team aims to extend the real or fabricated narrative for as long as possible. Their primary goal is to make the 2017 tax cut permanent. The challenge they encounter is that by only partially offsetting the cost with spending reductions, they lock in significant fiscal deficits. This heightens the likelihood that the so-called "Ferguson Law"—which suggests that when governments spend more on interest payments than on defense, they lose their status as a major power—becomes a reality.
At the same time, Trump plans to increase federal revenues by implementing tariffs on a broad range of imports. Imposing tariffs on imports is seen as an easy way to raise revenue in the short run with the larger objective of increasing costs of imported products, thereby encouraging a shift in supply. This strategy aims to persuade importers to relocate production to the US or face the potential loss of sales.
However, establishing a new ecosystem will be neither simple nor inexpensive. This is because it would require a substantial and lasting rise in tariffs to force a change in production sites. Even so, success is not guaranteed due to concerns about cost and profitability. If people cannot afford the increased prices caused by tariffs and the higher production costs in the US, they will buy less, resulting in decreased sales and profits for businesses. Moreover, US companies might risk losing international markets as other nations retaliate.
Warren Buffett, a renowned investor, has consistently maintained the stance to "never bet against America." However, betting against "American Exceptionalism" is not the same as betting against America, particularly if the past was "exceptional" only because of unique and unrepeatable fiscal and monetary policy measures.
Investors ought to be concerned about the "Ferguson Law," as the narrative is already set. The conclusion may arrive soon as the Trump administration either misunderstands or disregards the repercussions. If "American Exceptionalism" unravels, revealing it as more myth than reality, it could lead to significant and swift changes in US financial markets. This is because the value of US financial assets, especially stocks, is based on a growth narrative that is neither accurate nor sustainable.
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