Welcome to No More Risk Better, a Credit Sites Podcast. Across the global strategy team, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets. As the macro makes headlines, we leverage our network of experts across fictions to better understand economic trends, rates, gyrations, geopolitical events, and how these factors impact corporates. At Credit Sites, we understand that credit investing comes down to picking winners to generate alpha and avoiding losers.
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This is Winnie Caesar, Global Head of Strategy at Credit Sites. And today, we have a special edition episode that I have dubbed Terrific Tariffs, maybe they're terrific, maybe they're terrible, who knows. But today, we have Cedric Chihad, who is the chief economist for BMI, a Fitch Solutions Company, and a credit site's sister company. Who's going to tell us if the tariffs are terrific or terrible or another T-word terrifying.
We have all sorts of words that we can pick to discuss, Teriffs. Cedric, thank you for joining me today. Thanks for having me, it's great to be here. And I would say maybe another idea is what's the deal?
Oh, I like. Rather than terrific tariffs. I like what's the deal. I'm really looking forward to the leverage buyout of Greenland.
That's going to be great. I did see that Apollo threw an account or offer that whatever the US bids they're going to be topping. So, you know, we're expecting a busy year for deal-making activity. Greenland and the Panama Canal were not on our bingo card, but it's something fun to talk about.
So, let's bring it back to the US economy and, you know, absent purchases of Canada or Greenland or many other territories around the globe, countries around the globe. What is the outlook for the US economy? I think that you can paint a really kind of diverse picture depending on which data you decide to look at. Yeah, I think that's right.
So, we're in a bit of a strange point for the US economy. I think kind of like we're a bit of a wait-and-see period with some pretty big trends coming together all at once around monetary policy, the dollar, the new Trump administration, tariffs, and fiscal policy. So, we're seeing a lot of questions hanging over, I think, most market participants. Now, from a growth perspective, the economy seems to be holding up well.
The Atlanta Fed is tracking about 2.7% for Q4. That's well above trend. We saw some positive data come out recently. So, survey data, show that small businesses are much more optimistic, as I guess they're looking forward to tax cuts and deregulation.
The manufacturing ISM was a little bit better, still in contraction, but better. But it's the ISM's services component that really jumped with new orders quite strong. Earlier this week, we had the initial claims where they were at 200, and that's really low, right? The openings rate picked up a little bit.
And as you know, there's been a ton of new issuance, right, in the first few days of the year. So, there's lots of strength. But as you alluded to, it's a little bit mixed. There are kind of some weak data, too.
So the housing market remains quite soft, as mortgage rates remain high, and this means that starts are quite low. And I mentioned claims earlier, and they show a tight labor market. But if you look at the edges, there's some other elements of the labor market, which don't look so great. So, if you're unemployed and you've been out of the job for a while, it's harder and it's taking longer to get back into the job market.
So, actually, the payrolls data today are going to be important to watch, I think. And then, you know, if you look at financial markets, bond yields have risen quite a bit since December, this is raising the cost, the financing costs for businesses, mortgages, consumer borrowing, the dollar strength might also impact corporate earnings, right? If you look at the earnings of the kind of largest and most profitable tech companies, about 30 to 60 percent of their earnings come from abroad. So, the dollar strengthens, those earnings translated back into dollars are worth less.
So, I guess this is a very long way of saying, you know, there's a lot of mixed data, but the economy is still good. And if we have to put a number on our forecast, which of course we do, we think the US economy grows by about 2.7 percent this year, then as we go into net, well, no, sorry, 2.7 percent last year. So, you know, this is the start of the year already, and then 2.1 percent for 2025. And that's broadly in line with consensus.
It's still pretty great figure, right? 2.1 percent that's trying to grow. So, another thing to consider is, the US is going to outperform most other major markets as well, right? Your zone will be lucky if it grows by about 1.4 percent.
Yeah. So, I think that the growth figure is really interesting because that the composition of that figure, you know, looking at what's been kind of driving GDP for the past few quarters, it's still been a lot of consumer spending, a lot of PCE, but it's been a bit less kind of discretionary in the PCE categories, at least then from what we've looked at, you know, more housing and utilities and those types of things. And then, fiscal has still been kind of a nice tailwind to GDP as well. And then it's been more the industrial and manufacturing side of the economy that's lagged with residential construction just being kind of very sluggish.
And so, when I'm thinking about the expectations for growth, I have a hard time thinking like, kind of where are the offsets going to be? But, you know, going from 2.7 percent in 2024 to 2.1 percent in 2025, that is a material downshift for sure. It's still good growth, but it's not nearly, you know, the punchy levels that we have been in the US for the past few years. Yeah, I think that's right.
And the risks, I would say, well, the risks are both to the upside and downside, depending what we get from a policy perspective. So, if you just think about it from a carryover momentum, then the risks are to the upside. Right? If you think from a policy perspective, they're probably to the downside.
I guess the way to think about it is if you get a little bit of a weak quarter that acts as a bigger drag. So, if you get, if the first quarter is weak, then that acts as a bigger drag than let's say, if the last quarter is weak. And we think that because of policy uncertainty and the lagged impact of monetary tightening, we think probably Q1 is a little bit weaker and then it picks up throughout the year. So, as we get more information from the policy perspective, as we get more interest rate cuts that cumulatively feed through, then I think you have a pickup in the second half.
And household balance sheets are in a really good position to really take advantage of lower borrowing costs in the next six months or so. We know household debt has a share of GDPs come down quite a bit. Assets to liabilities, really high savings rates, still good, real wages, positive around 1.3 on a year on your basis. So, you mentioned the consumer story.
That's been driving the US economy, you're right. And we think it'll continue to do so. Just we think it might do so a little bit less as some of these savings are eroded, as some the labor market weakens at the edges, as things start to normalize. Normalization, not contraction, is the way to think about the trajectory.
So, on the monetary policy front, there's a lot of policy moving pieces. And I think that we have some thoughts on the monetary policy side of things, for sure. You mentioned monetary policy being tight, still tight. The implications of the rate cuts that have already occurred have not necessarily moved through the financial system or the economy.
But, treasury yields are rising. This is a very strange cycle, right? The Fed has cut by 100 basis points and bond yields are higher, especially the long end of the curve. What are your thoughts here?
Yeah, so we've been surprised at how much markets have actually repriced, both in terms of bond yields, which are up by about 80 basis points from their September lows, but also interest rate expectations. If you look at monetary policy, we think it's a little bit tight. If you look at across different metrics, so small borrowing costs for small businesses remain very high, around 9%. That's very high.
If you look at spreads on mortgage rates, they remain high, for example. But if you look at the Taylor rule, policy seems to be about right, but the Taylor rule is just a rule. So, it's kind of hard to put it all together, because it's a bit, you know, what Trump says, you know, it's about feeling the market almost, which I like in terms of an expression, because there are lots of moving parts. So I would say, look, we're January 10th here in Singapore, so we have about 12 months ahead of us.
So it's hard to have a lot of conviction in terms of what's going on, just because, you know, if you look at interest rate expectations and bond markets, the volatility lately has just been crazy across the 12 month calendar year, right? So it's hard to have a lot of conviction. But we think that there are a few trends that are continued to unfold, which will help to see or which will allow the Fed to ease further. So first of all, is that growth will slow, then we continue to think that the labor market will continue to weaken at the edges.
We think inflation will ease this year. That's going to benefit from slowing wage growth and falling rents, as we've been seeing. And if you look at the PCE numbers for November, on the month on month, annual basis, they're pretty good, right? And I think something important is we don't think that the Trump tariffs are going to be as bad as people think, and hence it won't be as inflationary.
It might still be a little bit inflationary, but if the tariffs aren't as bad, then the pass through is not as bad. Waller from the St. Louis Fed recently said that tariffs don't have a significant or persistent effect on inflation over kind of the longer-term guessing. I'm not sure if that was a comment on the size of the tariffs or really about the kind of feed through, but it sounded a little dovish to me.
So if we're right about our assumptions, then we think the Fed can cut, you know, has room to cut more than 50 basis points, so possibly 75 basis points, 100 basis points, and that's much more than what's being priced. And now I think there are a few other things to consider when thinking about it. So in terms of the messaging of the Fed, I actually think the Fed took the opportunity in December to not commit itself to a dovish path and kind of provide itself more flexibility just so that it can still take, you know, meeting by meeting stance. And my reading was that because of that, it's less hawkish than what others maybe thought, but of course, you know, this is reading the TV was almost.
Second, I would say that the dot-tot does show kind of an average of two times 25 basis point cuts, but the range of views is large from no cuts to five cuts, depending on, you know, which participant offered their suggestion. And so we have to remember it's an average. Third, I think the rise in bond deals and the stronger dollar means that policy has tightened since September and that can have an impact for growth going into this year. And lastly, I'm assigning large upside risks to our view, right?
We understand that we're out of consensus and we think the Fed may ultimately cut by much less because of, let's say, higher than expected inflation, because growth maybe or tariffs. And so for that reason, there's a big kind of caveat to this view. I mean, I think that if your view proves correct, that's going to be prime time for financial markets, right? Like that is the exact sweet spot where you have enough easing to push investors into other stuff, into duration, into credit, into equity still, but it's not so much easing that the Fed is being perceived as chasing something or having to kickstart an economic cycle, provide liquidity to the market in a more emergency type situation.
I, on the credit side of things, we've been talking about no cuts this year, which I think was out of consensus until that December Fed meeting. And now I'm seeing that more frequently. And I think that really, as I am making my thoughts a little bit more clear on what the year may hold, we're either getting no cuts or we're getting 200 basis points of cuts. It's going to be one or the other.
And maybe we get no cuts until September and then we get a lot of cuts. It'll be a really interesting year because I think that on the tariff side of things, I don't know that I disagree with Waller talking about how tariffs don't necessarily have a significant or persistent effect on inflation, but tweets and headlines and geopolitical consternations have significant impact on market liquidity. And that's where I start to get a little bit worried about how people are talking about policy and kind of calming the market down because I go back to December of 2018 when you had this perfect storm of perceived Fed mistake with a hike that the market didn't like, plus a lot of geopolitical on the China US trade war and it resulted in a pretty significant re-pricing of markets. Now we're underweight credit risk, so we'd love to see spreads go a little bit wider so we can get positive again.
But that's definitely how we're thinking about things. So on the tariff side of things, what's kind of your base case for where Trump goes with tariffs? There have been a wide range of forecasts put out there even by the Trump administration or the people that we think are going to be in the Trump administration. Where do you think they're going?
So this is a speculative answer, of course, and it's just so hard to have a strong view. But I think there's some constraints to Trump and I think if we start there, then you can almost work backwards a little bit. So we acknowledge, of course, that him and his cabinet are much more inclined to adopt tariffs while he's cabinet as well and then previous administrations. I think there's a general consensus that tariffs are good.
But I think the approach they're taking is these high numbers that they're throwing out are maximalist positions to start negotiating and his cabinet is more middle of the road than Trump is. Right, Scott Bessin, for example. In addition, we think that Trump's using these tariffs as leverage to obtain non-tariffin sessions. So that could be curbing immigration, curbing grub flows, as well as getting others to spend more on defense.
So this is a negotiating tactic. Not necessarily mean that it's going to happen. And Trump is going to have to devise a policy, a trade policy that doesn't result in a very strong response from trade partners because that could have been knock on effects back to the US story through inflation and growth, as well as the stock market. And we must remember that Trump monitors the stock market very closely.
And if you have a period of very high interest rates and a lot of volatility, that's not very good for the stock market, especially as the kind of rule of thumb of late is if bond yields are around four and a half, four eight equities really start to struggle. And that's where they are now, kind of thing. So the current average rate is about 3%. And that's pretty much double where it was before Trump came to power the first time.
And we think that averaged tariff rates could probably rise by maybe around 3 to 5 percentage points around there without hurting the US economy too badly. But these tariffs would probably have to be spread out over time and implemented slowly for them not to have kind of a big shock on the US economy. But I think there's room for tariff rates to increase on an aggregated basis. So on the average tariff rate, for example.
Yeah, I think that's very true. There is definitely room. And the way that the plans are rolled out and enacted will be pretty significant. I look at Scott Pessent's plan, his 333, where we're driving GDP growth, we're pumping more oil and producing more energy and we're also narrowing the deficit to 3%.
That sounds great to me. Then I kind of scratched my head as to how do we actually do that? Or even Elon Musk coming out today and the US saying, well, actually $2 trillion in cost saves might be a little bit more difficult than Doge initially thought it was. So always the differences between the campaign promises and the realities.
So why is it though that if we're doubling the tariff rate, why is that not going to hurt the US economy? Because a broad perception is that tariffs seem bad from most economists on the street. I think that it's a kind of it's a cost and it's a burden to the US economy. But I think if you increase the average tariff rate by about 3% to 5% of points, so they're about and this is a bit of kind of back of envelope math, it doesn't impact so much because there are going to be adjustments that happen which help to diffuse the impact.
So this impact is absorbed by adjustments in the exchange rate, by adjustments in exporters margins who may take a little bit of hit, by importer margins who also may take a little bit of a hit and then of course by consumers. So it doesn't necessarily mean that the impact is fully felt by consumers. If it's distributed across several actors, then it helps to diffuse the overall impact on inflation and the hit to purchasing power. So that's why I think a small increase in the average tariff rate is perfectly manageable through this lens because you've already seen the dollar appreciate by about 8% to 9% in September and that's because it's pricing in the potential for tariffs, higher inflation and higher interest rates.
Now the problem is if Trump goes for broad tariffs on a very large number of countries, as well as very high tariffs on countries that he thinks are bad actors, then the tariff rate starts to rise very quickly and it's harder for these different channels to absorb or diffuse the change in prices and that could lead to more macro and financial market volatility. So the question for Trump's team will have or what they have to solve for is how do you get the right mix of tariffs that are both targeted and broad but don't lift the overall tariff rate too much? And I think the answer is difficult because if you want to go broad, then maybe you can't target China and other kind of big surplus countries too aggressively because that'll just push up the tariff rate quickly. So I think the answer is somewhere in the middle and that's kind of one of those constraints that Trump will have to face unless he thinks, yes, we can triple the tariff rate and it doesn't hurt and then we'll just all have to wait and see.
Yeah, it's interesting because so much of this is going to be wait and see but from a at least number perspective, right, we won't know how margins are changing after tariffs are enacted for a couple of quarters. We won't know how consumer demand is changing for probably more than a couple of quarters and these things take a lot of time to play out but markets tend to be very knee-jerk in their reactions. So one thing that has come up quite frequently, especially from Trump's cabinet picks is the line that tariffs are not in fact inflationary. Is this true?
Can we say that with certainty? Well, I don't think you can say anything in economics with certainty but accept a few rules. But yeah, I've been hearing this and I think this broad view stems from three lines of reasoning as far as I can tell. So first they argue that inflation did not increase in 2018 when Trump implemented the first round of tariffs.
The good old days. Remember those days? Yeah, yeah. Second, some like Scott Besant claimed that tariffs changed the relative price of goods and this matters but say under an income constraint.
And what he means as far as I can understand is that if you only have $100 to spend and imported goods are now slightly more expensive, then you just end up buying fewer goods because you can spend more. And they argue, I think the argument is that you need additional demand to create that excess inflation. So here's the thing with this argument. So from a consumer perspective, sure, but there are a lot of corporates that are importers so that they can do things like make cars and machines and other things like that.
So the analysis is not quite that simplistic for many importers, right? Yeah, I don't think this argument is that good because prices do change. You can pay more and get less and that's inflation. And also, you know, if you think from a consumer perspective, that's assuming an income constraint, but I guess people could borrow and spend more.
And then I think the point was very much that he was criticizing a lot of the stimulus under Biden. And then there's two kind of ideas got mixed together in his statements. But the other thing to think about is that people say, and it's kind of technically correct, is that your tariff shock will have an impact on the short term. So in the month of their implement, there's a one-off increase on a month on one perspective, but then you don't get another month on month increase the next month.
And then what happens is on a year basis, they kind of start washing out over 12 months, right? The impact starts. Unless we have a phased in tariff schedule. Yeah, exactly.
So I think I'm a little bit less, or I'm a little bit more skeptical in terms of the, it's not inflationary argument. So if you look at the tariffs in 2018, they were very targeted rather than being broad-based, and they were also targeted at a lot of intermediary goods. In the end, if you just calculate it from the data that the customs receive in terms of the revenue, the average tariff rate rose from about 1.5% to 3%. So it's not much, actually.
And that was more than offset by movements in the exchange rate. So in that sense, you could say it was an inflationary. But if you look at where the tariffs were imposed on consumer goods like household appliances, if you remember prices, they rose very quickly. So you couldn't see that pass through.
And then the other thing is, if you think about going back to kind of what Scott Besson said, it's open to interpretation how you think about it. So we still have a lot of fiscal policy. We're going to have monetary easing. We have households that can take on more debt.
And so maybe they push through their income constraint and they say, yep, we're going to spend more and we're just going to have higher prices. So I'll be on the side of the fence that says tariffs might be more inflationary than I think, particularly if there's a pick up in inflation expectations. Because if it gets in the psyche of the consumer and wage setting, et cetera, and small businesses, they actually go to raise prices to defend their margins. And that in effect could lead to higher prices, even if it just starts from an expectations angle.
So I'll be a little bit more worried. Yeah, absolutely. I don't think that we have seen the old wage-priced spiral in this inflationary period. It was inflation, I think, has been attributed to a number of different sources, but not necessarily wages just kind of perpetuating inflation more broadly.
But we could shift into that type of mentality, I think, from a consumer and business perspective, depending on how these headlines around tariffs evolve. So the dollar is something that we get asked a lot about, and I am certainly not an FX person. But I do see that it is much stronger. And I do know for multinationals based in the US who generate income abroad, not necessarily a helpful thing for their earnings.
How are you thinking about the dollar? And where do we go from here? Yeah, that's a good point. On the dollar.
And as I mentioned earlier, it's gone up like 8, 9% in September. And we think the dollar is about 15% over value now. There are about 15 estimates, which are similar to this range. Having the irony is that this actually worsens the trade dynamics for the US.
It makes imports cheaper and exports more expensive, which is the opposite of what Trump is trying to get to. So it's a not one. We've been talking about the dollar index trading within the 100 to 108 range over the past few years. And that's played out quite well.
Now, of course, it's at the upper end of that range. It's breaking out a little bit. We're still not in the camp that's going to say we're going to have a surge in the dollar from here, because we already have a surge in the dollar. We think it could probably pause a little bit before making its next move.
And I think we're more at an inflection point. And that will, I think, depend on tariffs. So tariffs could push the dollar through two channels. So first, the currencies that get hit with the tariffs would likely depreciate slightly, or even a lot, given the potential for weaker exports.
And this was the case in 2018, the Chinese Yuan weekends by quite a bit against the greenback as the tariffs were announced. So imagine if tariffs are announced against the Eurozone and Japan, then the dollar index, which is heavily weighted towards that. And Canada built all their currencies, but we can quite a bit. So that just pushes the dollar index up.
Second, we're talking about inflation. If you have higher inflation or higher inflation expectations, a less-dovish fed them leads to a relatively higher yield environment in the US. And that puts upside pressure on the dollar compared to those lower yielding currencies, which, for example, in the Eurozone, Swissy, Japan, they're going to face a more difficult growth environment. So their monetary policy is going to probably diverge even more.
So that's going to probably push up the dollar in that sense. So in the event that Trump does compose large tariffs, we can see a re-pricing of rates and see the dollar index pushed to the 110 to 115 area from about 108 now. But if tariffs actually come in in a more measured manner, and there's less macroeconomic and financial market volatility, then I think the dollar index will likely trade back to the mid-range of the 108. So probably a little bit, maybe higher than before, in terms of maybe not going so much to the lower end of the range.
But I think that's a fair range. It's a wide range, but the dollar is moving in a very wide and a manner for the past few years or so. This is also interesting because there's that old saying that when the US news is the rest of the world catches a cold. And in this conversation, it seems like a likely outcome is that within the global economy, there are already a number of countries and regions that if they don't have the poll on flu yet, it feels like that is coming.
Germany's been facing issues. We all see what's going on in the sterling market lately. China has been really struggling for quite some time now. At what point do these kind of contagions around the world start to come back to the US because the US exceptionalism has become the narrative?
It's the base case expectation for pretty much everyone at this point, irrespective of what's been going on in the global economy. And I worry about that a little bit because in 2018, the concern was not so much here in the US, things are bad. It was China is in trouble and that is going to lead to a global recession and that is going to be a problem. Yeah, I think it's a really interesting point because if I think what you're alluding to in large part is the world isn't looking that great.
And so if you take that assumption is right with kind of Eurozones not doing great China slowing down and you're in a very high interest rate environment, it's usually when interest rates are high that something breaks. So we got lucky over the past few years that things didn't break, well, SBB broke, but other things didn't break in a big way even though interest rates rose. And you can say that the reason for that was because of all that fiscal stimulus impulse which helped to offset the monetary tidying. Corporate had basically turned out their debt financing and so they weren't impacted too much by the rise in bond yields.
Actually they did quite well because they parked all their cash in money market funds. The household sector had a lot of savings, but that might not be as much the case going forward. So I think high interest rates pose more of a risk now than they did last year or two years ago. And I'm not trying to be a Debbie Downer here, but I just think as you get to the later stage of the economic cycle, as you get more challenges, the higher interest rate environment might be more taxing on the economy.
Yeah, I think that that's really interesting thinking about that rundown of liquidity, of excess liquidity that had been sloshing around in the system from monetary easing, from fiscal easing, from all of those things. People really underappreciated all of that liquidity say in 2022 and we averted this recession. And now I think that people have gotten a little bit too comfortable and we're looking at the next couple of years and saying, all right, it's time to make a deal. It's time to get away from this balance sheet defense that I've been in and maybe I'm okay with a little more leverage because growth has been good and that's just going to stay the same.
And to your point, historically, that's where in the cycle you start to get into a little bit of trouble or sometimes a lot of trouble. I think one thing which is really positive, right, is, and I've been heart-beaked on about this is productivity. So it's hard to measure this because as economists, we don't do a very good job measuring it. But if you think about three major trends since the pandemic, digitization, robotics and AI, I think that has the real potential to lift productivity growth over the coming years.
And we haven't yet seen it in the numbers, but I suspect that companies are benefiting from this already. And I think they will continue to benefit over the coming quarters and years. And that could be a real tailwind. It's just very hard to measure.
Yeah, it's very hard to measure. And it's also hard to measure or forecast the collateral damage to jobs, right? One of the top Bloomberg headlines for the past couple of days has been how equity research analysts are going to basically all lose their jobs because of AI. And as a research analyst, I don't love that headline.
I'm not going to lie. And historically, we know that technological innovation, it changes jobs. It doesn't necessarily fall out, you know, eliminate jobs. But who knows?
This could be different. Maybe the bots are coming for me. If so, this has been a joy. And I will be teaching yoga in the Caribbean to other former finance professionals.
And that will be just fine. Yeah. I mean, from a long term perspective, technology drives productivity and creates more jobs. We know that it's just kind of the short term rub where you need retraining or big industries or are kind of dislodged.
And that causes, you know, a lot of pain for households and families, right? And I think the other thing to think about is how do businesses manage that process? And how do governments address it? Because in an environment where there's a lot of political fragmentation, then it's harder to have a very strong view on actually what type of policies do we need to support to implement these changes, especially in Europe where, well, you, you know, you have a Republicans have the executive and the two houses.
So less of an issue there. But in Europe, for example, where they're lagging in terms of kind of innovating and figuring this out, I think that could be more of an issue. I mean, it's even within the US, though, we may have had a red wave, but that majority in the house is the narrowest. It's basically ever been.
So everyone has to fall in line. And we know that once deals start to get put together and constituencies start chiming in, you know, a Republican from the state of California is not the same as a Republican from the state of Alabama. It is not how life works. So you know, I think that you kind of alluded to something earlier around this kind of conundrum around dollar strength and tariffs and how dollar strength actually kind of undermines what Trump is going for.
Also, you know, the US dollar system is pretty good for America when we talk to clients about Treasury yields and fiscal deficits. And you know, at what point is the music going to stop? The dollar being the reserve currency is kind of our fallback answer of, well, people are going to still be okay buying US Treasuries because the dollar is the reserve currency. And while Bitcoin has done quite well in recent months, I'm not sure that we're necessarily ready to move on to crypto as the global reserve currency.
So how do you interpret the whole narrative of other countries need to spend more and pay their fair share from a Trump perspective? Yeah. So I actually spoke to Zach last year on the podcast about the dollar, if you remember, and that was really fun. So of course, you know, the fact that the US dollar is the reserve currency and the US is kind of the global superpower, those major advantages to the US, right?
So that's what they call the exorbitant privilege. So this allows the US to run large recurring trade and fiscal deficits, which without having to rebalance the US, they say enjoys lower government bond yields because of, you know, this demand for US assets and it has significant global economic and political clout as well as the ability to kind of use sanctions, financial sanctions as an extension of its military power. So the US has all these major advantages. But the US also pays certain costs to have these privileges.
So for example, as most countries will choose to hold US dollars as reserve assets or other trade related and financing purposes, it means that there's excess demand for US dollars and well, that's good if you're holding treasuries because it pushes down the yield. It pushes up the value of the dollar, which is perennially overvalued according to this line of reasoning and a perennially overvalued dollar causes problems in terms of the trade deficit, right, which we spoke about. And if you're a president who's focused on the trade deficit, then this is a problem. But it's also a factor behind massive job losses in the manufacturing sector because it erodes your relative competitiveness.
And in addition, the US pays much more in defense spending than other economies and has done so for many decades. So look, US is in a fantastic space, right? I'm not complaining about the US in that regard, but it does has this cost. And what Trump is trying to say is, look, we have a huge cost burden, everybody's free writing and we want to shift some of this burden to other countries.
So they shoulder more of this cost. And I think it's particularly important because the US dollar as a share of the global economy is not as big as it used to be, let's say, 20 years ago, right? So the cost to the US might be increasing in terms of the magnitude of the job losses or the amount of overvaluation, just because the US economy is not as big as it used to be. So its impact is felt more.
So our last key question here. So if the US decides we're going to adjust policy, we're going to do what we're going to do to hack with the rest of the world until we can start buying up Canada and Greenland and the Panama Canal. And I feel like buying the multives would be nice. I would like to head on over.
This won't be the first time that the US goes its own way and adjusts policy unilaterally, right? We have kind of a history. Yeah. So it wouldn't be the first time.
We saw a version of this about 50 years ago. So back in the 1970s, we had the Bretton Woods system. So the US dollar was pegged to gold at $35 an ounce and then other major currencies would peg to the dollar. But you had elevated inflation combined with wide trade and fiscal deficits associated with the Vietnam War.
And that saw a huge rise in US dollar liabilities globally. So a lot more dollars sloshing around the world. And in turn, this started to put downside pressure on the US dollar versus gold as central banks and other actors. They were saying, well, actually we won gold instead of dollars, right?
And because of these mounting pressures on the US dollar in mid 1971, President Nixon prohibited the exchange of US dollars for gold at that price at $35 an ounce and actually imposed a temporary 10% surcharge on doable imports. So this essentially acted as a tax on major trade partners similar to what Trump is trying to achieve today. And by the end of the year, by the end of 1971, the Smithsonian agreement was signed and that saw the valuation of the US dollar against gold to $38 against for one ounce. And that effectively raised the cost of US imports, which is similar to a tariff.
So we have seen this type of policies which are enacted unilaterally. All right. A lot to consider. I need to dust off some of my history books.
I would say that flare style or bell bottom pants are back in style. So we are clearly going back to the 70s in fashion and perhaps we'll be going back to the 70s in policy. Hopefully not in inflation because things got pretty pretty wild in the 70s. So, Derek, I have one last question for you.
Okay. You could have lunch with any president who's still alive. Who would you pick? I'm still alive.
Oh, I've never thought about that. You have Obama. You have George Bush. Yes.
I mean, you could pick a global president. I mean, I'm an American. So I think that the US president said the ones who count, but you could pick someone else too. You know what?
So I would pick and this is very controversial, President Malay because he's gone completely against the grain. And I think the media was super anti-malay because of his kind of reforms that he was trying to do to curb inflation. But when you look at the history books, whether it's Weimar Germany, Poland, Hungary, and kind of in the 20s, and then if you look at the inflationary episodes in 1980s in Latin America, they all follow the same playbook. And my question to him would be about to have lunch with him just to understand like how, like how, for example, without a political majority, how do you convince everybody to take such difficult decisions?
And the reason why I think Malay is so interesting is because, and we've spoken about this before, with a political, well, he doesn't have a majority, right? How has he been able to convince people to take such difficult fiscal decisions? And actually to make it to this in recent years where you consolidate your fiscal accounts because no other country can do it. And part of it is kind of the political impetus, part of it, maybe the leadership from the top.
And so I'm really curious about that element because for all the fiscal top that there is in the US and the Eurozone, no one seems to be making the difficult decisions. I love that answer. My answer was just I want to go have lunch with President Trump because I want to know what the heck's going on. Although who knows what he would tell me at lunch, probably what I want to hear.
So the other reason is I was born in Argentina. And so I'm keen to learn more about it as well. I didn't live there for many years. I was just born there.
So it'd be nice to kind of rekindle that connection. Well, I will happily take a diligent strip to Argentina anytime. All right, Cedric, thank you so much for joining me today. I think that this was a really fun conversation.
I always learned a lot talking to you. If anyone has questions for Cedric, you can always follow up by shooting me an email on the askananalystonthecrotitesites.com website and we can connect you or you can reach out to your Fitch Solutions Sales Representative and they will connect you with Cedric on the BMI team. Thank you so much for listening and Cedric, thanks again for joining. Thanks for having me.
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