In the pantheon of famous economists, Knut Wicksell is hardly a household name. Unlike Adam Smith, the Swedish interest-rate expert never made it to the face of a banknote. Yet a theory he developed more than a century ago is suddenly relevant again. In 1898, Wicksell shared the idea that inflation and economic instability stem from an imbalance: It occurs when market interest rates (set by the Fed and by banks) are out of sync with “the natural rate of interest.” The “natural” rate, Wicksell proposed, is the level of return investors get from investing in the economy as a whole (for instance via stocks) as opposed to the interest they might get from cash deposits or bonds. The U.S. economy is so strong that its natural rate is far above its official rates, which is why interest on American debt is relatively low given its size.
Deutsche Bank believes an updated version of Wicksell’s theory explains why investors can’t quit the U.S., despite the fact that many indicators of its economic health are flashing red: The might of the U.S. economy coincides with its eye-watering debt: some $39.77 trillion at the time of writing, requiring service payments of $24 billion a week.
So far, lenders to the U.S. haven’t demanded wildly higher rates of return on their loans, reflecting the dollar’s unique role in global finance and confidence in America’s economy. However, if growth rates remain dwarfed by deficit levels, perceptions of risk may shift, prompting a market recalibration, as JPMorgan Chase CEO Jamie Dimon has previously warned.
In a note by Deutsche Bank’s chief investment office, Dr. Ulrich Stephan, Dr. Dirk Steffen, and Elena Ahonen, write that these sustained deficits show a country that is “fundamentally living beyond its means,” but that America’s role in the international financial system has so far allowed it to “enjoy risk-free market interest rates that were below its estimated natural rate of interest.”
That advantage is narrowing, the trio writes.
The silver bullet
The risk balance of investing in the U.S. vs simply keeping money in the bank has meaningfully shifted in a world of AI led by U.S. hyperscalers, the Deutsche team argues.
“The high return on equity (ROE) available on some U.S. sectors (e.g. tech) is now complementing or, to some degree, supplanting the structural/geopolitical factors which have so far supported inward investment in the U.S. during the post-WW2 period,” the trio writes. “To oversimplify: you could argue that U.S. deficits are, in effect, being increasingly funded by its tech sector.”
They explain: “In the last few years, investor interest in the U.S., and thus its ability to sustain deficits, has … been supported by the country’s relatively high productivity growth and high return on equity, largely the result of the country’s successful technology sector and dominant position in artificial intelligence.”
Arguments from the likes of Bridgewater Associates founder Ray Dalio that the U.S. is living beyond its means remain “fundamentally true”, the team adds, but suggest investors are now happy to funnel funds into U.S. deficits because, as a country, it offers higher returns on investments compared to other destinations.
Yet this dominance creates a fiscal loop: If the U.S. government stopped investing in AI, then confidence in the sector would shake. This spending, in itself, requires further borrowing. “The U.S. economy can therefore be seen, in some ways, as both a gainer and a victim of its own success,” the team concludes.
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