“The Dollar is our currency, but it’s your problem.”
-U.S. Treasury Secretary John Connally, 1971
When charged with getting up early and working against the clock to produce a daily strategy missive, sometimes you throw up some duds. You are, however, afforded the “exorbitant privilege” of serving as creator, curator and editor-in-chief of your own content.
With KM in London, alongside a general dearth of domestic economic data this week, we’re afforded the opportunity to hit the Macro rand() button and survey some broader, top-down topography.
So, on with the binary dud or stud content creation....
Valéry Giscard d’Estaing, the French Finance Minister in 1960, coined the term “exorbitant privilege” in rebuking the U.S.’s ability to issue external liabilities (ie cheap treasury debt) at a discount to the global cost of capital while earning higher returns on foreign equity, debt and FDI holdings.
Simply, as venture capitalist to the world and sole beneficiary of dollar hegemony – we get to borrow low and lend high.
…and borrow we have.
Over the last 34 years, on our way to becoming the biggest debtor nation in history, we have borrowed some $10.4T, with an average annual deficit-to-GDP ratio of ~3.2%.
What does that mean exactly and what are the consequences of such a massive imbalance in the global flow of goods, services, income & assets?
In short, it means we’ve borrowed and/or sold accumulated wealth to finance consumption in excess of income – with the tailwinds of globalization and financial integration helping us do so in unprecedented magnitude.
The global flow of commerce and capital can appear complex and convoluted but, in large part, the same dynamics and constraints that drive spending and borrowing decisions for the individual or household apply to sovereigns as well.
If national expenditures (C+I+G) are greater than domestic output (GDP) – if spending is greater than income – that difference is financed by borrowing from abroad; either by direct issuance of debt or via dissaving and the selling of domestic and external assets.
A creditor/surplus country whose expenditures are less than its income lends that difference to a deficit country by buying the deficit country’s debt/assets. From the opposite perspective, a debtor/deficit nation finances consumption expenditures in excess of income by selling assets or issuing debt to a surplus nation.
Such trade balances have important implications for national wealth because a country’s net investment position with the rest of the world (ie. how many foreign assets a country owns vs. foreign claims on domestic assets) defines a nation’s external wealth – and, in the (very) long run, it’s a country’s level of wealth plus its level of income (ie. GDP) that determines its long-run capacity to spend.
Since ~1980, the U.S. has incurred a persistently negative trade balance, financing current consumption by dissaving and borrowing from abroad.
Interestingly, however, U.S. external wealth has declined disproportionately less than the cumulative trade deficit. Indeed, we have been a net exporter of assets to the tune of ~$600B per year via the trade deficit but our external net wealth has declined only modestly, even risen significantly in many years.
How can a country increase its net wealth? Again, the same as an individual or household:
- Save more (ie. the trade balance: reduce/reverse the trade deficit)
- Be the beneficiary of gifts of assets (ie. the capital account: not really a factor for the U.S.)
- Benefit from capital gains (ie. high positive ROI on external assets)
For a country that is a net debtor, the singular path to earning positive net interest income is by receiving a higher rate of interest on its external assets than it pays on its liabilities.
For the U.S. a few primary factors have driven this:
- The US gets to borrow low: reserve currency, deepest/liquid market, risk-free rating, etc
- The US exports a significant amount of capital to foreign markets: EM and developing market risk premiums are higher but, longer-term, returns are better also. For the U.S., the benefit comes in the form of higher relative capital gains
- EM & Developing Countries borrow high and lend low: This is an oversimplification but it's broadly true. Cost of capital for EM and developing countries is comparably higher and, to the extent a higher proportion of investment capital flows to US/DM treasury debt (vs equity or FDI), the returns are comparably lower.
How do the above factors impact net external wealth and play to the benefit of the U.S.?
Here’s the textbook equation for change in external wealth over a given period:
Change in External Wealth = Trade balance + interest paid/received on prior period external wealth + interest rate differential + capital gains
It’s the two terms on the far right side of the equation that have provided an incremental net benefit to the United States and have underpinned her Exorbitant Privilege for nearly a century.
The data is somewhat mixed and open to debate, but the BEA estimates the US has been the beneficiary (due to the confluence of factors highlighted above) of a positive interest rate differential of ~1.5% and a positive capital gain differential of ~2% for the last 3 decades.
In other words, Exorbitant Privilege has provided an ~3.5% offset to the trade deficit.
In recent years, global central bank policies aimed a lowering interest rates and inflating financial asset prices have served to further perpetuate that privilege.
Indeed, recall the circular flow of QE mechanics:
The Treasury issues debt --> the Fed buys the debt --> the Treasury pays the Fed interest --> the Fed gives the money back to the Treasury.
In addition to directly lowering the cost of U.S. external liabilities via large scale asset purchases, remittances from the Fed – at ~$80B/yr and equivalent to ~35% of federal net interest expense – takes the effective cost of capital for the Treasury further towards 0%.
Since 1450 the mean length of dominance for a particular global reserve currency = 94 years.
The current duration of reign in US dollar supremacy? Yup…94 years.
$USD correlation risk in markets currently is acute and for the investible future, the dollar will remain the Fx alpha male.
But alongside the fledgling internationalization of the renminbi and accumulating bilateral swap agreements across the BRIC and Asian axes, the anti-dollar coalition is ascendant.
The dollar is our currency, and the cost of cumulative excess afforded under a century of privilege will be our problem during its descendancy.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.38-2.49%
Brent Oil 91.18-95.16
To free lunches, perpetual short-termism and blissful ignorance,
Christian B. Drake
the macro show
what smart investors watch to win
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.
Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.
CLICK HERE to view the document. In today’s edition, we highlight:
- Why a stronger US dollar is likely here to stay with respect to the intermediate term (hint: #Quad4)
- Why consumer discretionary stocks are not a buy on the now-consensus, but nonetheless brilliant "crude oil is breaking down" thesis
Best of luck out there,
Associate: Macro Team
TODAY’S S&P 500 SET-UP – October 7, 2014
As we look at today's setup for the S&P 500, the range is 41 points or 1.42% downside to 1937 and 0.67% upside to 1978.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.88 from 1.89
- VIX closed at 15.46 1 day percent change of 6.25%
MACRO DATA POINTS (Bloomberg Estimates):
- 7:45am: ICSC weekly sales
- 8:55am: Redbook weekly sales
- 10am: JOLTs Job Openings, Aug., est. 4.7m (prior 4.673m)
- 10am: IBD/TIPP Economic Optimism, Oct. est. 45.1 (prior 45.2)
- 11:30am: U.S. to sell 4W bills
- 1pm: U.S. to sell $27b 3Y notes
- 3pm: Consumer Credit, Aug., est. $20.0b (prior $26.006b)
- 2:30pm: Fed’s Kocherlakota speaks in Rapid City, S.D.
- 3pm: Fed’s Dudley speaks in Troy, N.Y.
- 4:30pm: API weekly oil inventories
- 4:30pm: Fed’s Potter speaks in New York
- Senate, House out of session
- 8am: FCC Chairman Wheeler lecture at Newseum event
- 8:45am: Treasury’s Lew speaks at Peterson Institute on global economy ahead of IMF/World Bank meetings in Washington
- 8:45am: CFPB’s Thomas Kearney, FTC’s Malini Mithal speak at American Bar Assn conference on consumer financial svcs
- 10am: Supreme Court hears case involving religious rights in prison
- 1pm: Woodrow Wilson Center holds discussion on “The Politics and Process of Keystone XL”
- U.S. ELECTION WRAP: Senate Debates in N.H., Colo.; Gay Marriage
WHAT TO WATCH:
- IBM Said to Resume Talks to Offload Chip Unit to Globalfoundries
- Time Warner’s Turner to Eliminate 10% of Jobs to Boost Profit
- Paulson Says AIG Harsh Loan Terms Needed as Geithner to Testify
- U.S. Banks Said to Face Another Round of Charges by DOJ: NYT
- Banks Face 25% Loss-Absorbency Rule in FSB Too-Big-to-Fail Plan
- Lundin Agrees to Buy Freeport Chile Copper Mine for $1.8b
- Allergan Asks Judge to Block Ackman From Voting Stock at Meeting
- AT&T Says Employee Gained Unauthorized Access to Customer Data
- HP Going It Alone in PCs Faces Tough Suppliers, Shrinking Market
- HP Seeks Judge’s Approval of Revised Autonomy Deal Settlement
- U.S. Holiday Sales Seen Rising Most Since 2011 on Job Gains
- Amazon Said to Face EU Antitrust Probe Over Luxembourg Tax Deal
- German Industrial Output Drops Most Since 2009 as Risks Rise
- Samsung Earnings Slump 60% as Galaxy Smartphones Sales Struggle
- Bank of Japan Sees Wider Dissent on Inflation Language
- Tesla Seen Adding All-Wheel-Drive Model S Version by Analysts
- Sanofi Notifies U.S. Authorities on Bribery Allegations
- Hong Kong Tensions Ease on Talks as City Weighs Cost of Protests
- Social Finance to File for $200m-$250m IPO Next Yr: WSJ
- International Speedway (ISCA), 7:30am, $0.01
- Yum Brands (YUM) 4:15pm, $0.83
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Brent Crude Falls With WTI as German Output Fans Growth Concern
- Palm Production in Malaysia Seen Declining Most Since February
- Gold Trades Above 2014’s Low Before China Returns From Holiday
- Rio Tinto Jumps After Saying It Rejected Glencore Approach
- Copper Declines Amid Concern European Demand Is Set to Weaken
- Cotton Glut Eroding Cost for Gap as China Buys Less: Commodities
- Soybeans Drop From Two-Week High in Chicago on Rising Reserves
- Palm Oil Climbs a Second Day as Malaysian Output Seen Dropping
- Indonesia’s Tin Exports Climb Most in Four Months in September
- Iron Ore Futures Volume in Sept. Seen by TSI Overtaking Swaps
- Chile Top Renewable Market on Sunny Desert, Windy Shores: Energy
- EU Manufacturing Reaps $2.5 Billion Permit Win: Carbon & Climate
- Occidental Said to Seek Buyer for $3 Billion Bakken Oil Business
- Glasenberg’s Designs on Rio Tinto Hinge on China Inc.’s Approval
The Hedgeye Macro Team
Takeaway: In this Black Book, we dive into everything from Dept Store current trends (survey) to what the group will look like in the next eco cycle.
Please note NEW DATE/TIME for our Deep Dive on Department Store Fundamentals and Stocks. Our call will be next Thursday, October 16th at 11:00 am ET. Relevant tickers: JCP, M, KSS, DDS, JWN, SHLD, TGT, WMT, TJX, and GPS.
Key Topics Will Include:
1. What will the Department Store Landscape look like (physically and financially) when we transition into the next economic cycle?
2. Detailed Revenue analysis for all the Department Stores – by category, consumer, and demographic. Who has the most risk/upside based on where we are in the economic cycle?
3. Margin Sustainability: Who has the most defendable margins and levers to pull in the event of a sales downturn?
4. The importance of Financial Engineering to earnings algorithms.
5. Current Business Trends: Results from our detailed 1,000 consumer survey. This is the 4th iteration of the survey that we started back in 3Q of 2013
- Visitation statistics
- Dot.com and Mobile trends
- Buy Online/Pick Up in Store – does anyone really use this? Which retailers have the competitive advantage?
- Detailed category analysis – what retailers are top of mind in each category
- Who wins on price, sales, selection, and quality
6. Real Estate Deep Dive
- What does the competitive matrix look like across the space
- Winners & losers from a demographic and spending vantage point
- Are department stores over or under-indexed to their target customer?
- The JCP and SHLD affect – what do more store closures mean for other names in this space
7. E-commerce – we’ll be releasing a much more in depth look at e-commerce across the retail space in a Black Book due out in the next couple of weeks – but we will preview that work with a focused look on the department store space. Most importantly which retailers have invested the capital needed to drive growth in this channel.
Call details to follow
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