Risk of a capital war?

As we have explained before, a trade deficit reflects deficient domestic savings. Foreign investors make up the shortfall by purchasing US financial assets as well as direct investment. A smaller trade deficit means that the US needs fewer foreign savings. So rather than a trade war that the US wants to win, this is a capital war that the US needs to lose.

On the surface, it might seem that the US Administration does not want a capital war, or at least not one that it might lose. President Trump likes to win and, in his eyes, winning means getting increased foreign direct investment into the US by promising that foreign firms won’t have to pay tariffs if they make their products in the US.

However, if FDI does increase in the US, the need for reduced savings inflows to match any reduction in the trade deficit will have to come from lower investment into US financial assets. And here there are a number of hints from the US Administration’s words and actions that this is exactly what they want.

The first is the so-called ‘revenge tax’; something that Republicans in both the House and the Senate want to push through to punish non-US firms and individuals based in the US whose governments have tax policies that unjustly hit US firms abroad. For instance, countries with a digital service tax are in the firing line alongside those who favour a global minimum tax.

Of course, it is quite possible that the Trump Administration creates such a vibrant economy, with even more US ‘exceptionalism’ that foreign firms and foreign investors are more than happy to flock to the US in spite of a higher tax rate on their earnings. But, on the face of it, this is a policy that might be designed to alter tax policy abroad but could end up depleting foreign capital inflows into the US.

While this might be the most obvious sign that the US is trying to lose a capital war, there are other clues as well. Playing fast and loose with the budget at a time when all and sundry, including Fed Chair Powell are saying that debt is on an unsustainable path could be cynically construed as another attempt to scare foreign investors away from the US, and specifically away from the Treasury market.

In addition, attacks on Fed policy risk undermining the credibility of the bank and so weaken US asset prices, specifically treasuries. Tariff policy has clearly made US firms appear less attractive to overseas investors as equities underwent a steep slide relative to other markets. Some of that has been clawed back more recently but there seems little doubt that there’s been a wholesale change in global investor appetite for US equities relative to other developed markets and even emerging markets. So again, if there is a capital war going on, the US is losing here too.

And finally, there is currency policy. For while President Trump has not been as verbose yet about the excessively strong US dollar as he was during his first term, there seems to be little doubt in the markets minds that the US Administration favours a weaker greenback. It is something that certainly seems to fit the narrative of winning the trade war, but it is also something that could help it lose a capital war, as global investors will be more reticent to put money into US assets if they fear that there could be large currency losses.

Besides, others, notably the eurozone, have seized on the US’s apparent desire to lose the capital war by suggesting that the eurozone, and the euro in particular, could be the major beneficiary, particularly if it can get its act together in areas such as shared debt issuance and a banking . “Many aspects of US policy may seem odd. After all, we are more used to policymakers undertaking measures to attract capital inflows, not shun them. But when you consider that the US needs to lose a capital war to meet its external policy aims, its decisions appear far more rational”, said Steven Barrow, Head of Standard Bank G10 Strategy.