Global trade capital flows and the US dollar
Record US deficits and the dollar’s global role
A key goal of the current Trump administration is to narrow the current account gap through a large rebalancing in global trade and a weakening of the dollar. However, a sustained narrowing of the US external deficits would ultimately require a reduction in the fiscal deficit – a scenario that seems unlikely at this stage, especially after the recent approval of substantial tax cuts under the OBBBA.
A cornerstone of US economic exceptionalism in recent decades has been its ability to attract foreign capital, evidenced by the significant expansion of its net international investment position (NIIP) alongside substantial purchases of US Treasuries by foreign investors to finance its deficit.
However, sustaining this level of financing depends on maintaining strong investor confidence in the country’s economic outlook – a confidence that has recently shown signs of wavering, prompting some foreign investors to reassess their exposure to US securities.
Foreign holdings of US equities and fixed income securities
This shift may drive downward pressure on the dollar while driving interest rates higher, potentially triggering a debt spiral and increasing hedging costs, which could narrow the gap in the NIIP.
Nevertheless, foreign investors face limited alternatives. The European capital market remains limited, and some investors remain dubious about the Chinese market. While we expect large outflows from US assets into the rest of the world, the process is unlikely to reach a breaking point, nor the dollar to be replaced as the dominant reserve currency.
Meanwhile, large current account surplus countries, including China, Europe or Japan, may find it hard to rebalance their economies swiftly.
US net international investment position
Even if they succeed in doing so, this protracted process will still leave them with large surpluses to be absorbed by the rest of the world, including the US consumer, which remains at the heart of global trade flows. Globalisation may be slowing among the major blocs, but it’s also evolving, with supply chains reshuffling, rerouting across countries and decoupling from China for strategic goods. Diversifying exposure away from US markets will likely be a gradual process, allowing the country to retain its exceptional status for the time being – albeit with growing vulnerabilities.
