Asia Times

Stock plunge could become dollar death spiral

America's soaring trade deficit, now running at a record $1.32 trillion annual rate, requires the US to sell paper to its foreign suppliers in return for goods. Most of the paper the US sold to for...

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America’s soaring trade deficit, now running at a record $1.32 trillion annual rate, requires the US to sell paper to its foreign suppliers in return for goods. Most of the paper the US sold to foreigners during the past few years was equity in US corporations, rather than government or corporate bonds. Valuations in the US stock market soared as the Federal Reserve forced interest rates lower, by reducing its short-term lending rate to zero and by purchasing $6 trillion of Treasury securities.

The result of this exercise is the worst inflation in forty years and a collapse of labor productivity that portends shrinking corporate profits. As the Fed raises interest rates (in the mistaken belief that higher rates will reduce inflation) and inflation eats into profits, the valuation of US stocks is falling. That raises the ugly prospect of a deficit death spiral.

With a net foreign asset position of $18 trillion, the United States can’t go on selling its assets to foreigners indefinitely. At some point the orderly sale of US assets might turn into a fire sale.

Foreign holdings of US stocks jumped from $8.5 trillion in early 2020 to $13.5 trillion today, while foreign ownership of US Treasuries barely increased. The Fed, that is, bought $6 trillion in Treasuries, real yields collapsed, and equity valuations soared. Foreigners shunned record low yields on US government paper and bought into the equity boom.

But the tech-heavy NASDAQ index has lost 21% during the year to date. Market leader Amazon showed its first loss in seven years in the first quarter, Netflix is losing subscribers, and Facebook and Google are struggling to maintain margins. Inflation is eroding profit margins. And the US registered a 7.5% annualized drop in output per manhour during the first quarter, the worst result since 1947. The discount rate on corporate cash flows (namely the term yield on Treasury securities) is rising, and earnings prospects are weakening.

What if foreigners stop buying US equities?

Several things can happen (and all of  them the probably will). First, the US will have to sell more bonds to foreigners, and at more attractive yields. That means real yields will have to rise even further, putting more pressure on equity valuations.

Frightening situation!  

What if foreigners stop buying US equities? Several things can happen (and all of  them the probably will).

First, the US will have to sell more bonds to foreigners, and at more attractive yields. That means real yields will have to rise even further, putting more pressure on equity valuations.

Terribly  shocking outcome for all countries!