“I was so far from wishful thinking that I hardly thought anything true unless it contradicted my wishes.”
C. S. Lewis
Labor Arbitrage
I forget…
Are tariffs supposed to eliminate the income tax, help reduce our fiscal deficits, or simply serve as a negotiating tactic to achieve something else? Maybe a new reason will emerge later today…
You would be forgiven if you had lost the plot. There seems to be a new twist on the core objective with each passing day. Wait, what is the core objective again? The fact that it’s hard to remember is why I suspect that the true core objective remains unspoken. See Feed Post, “The World’s First Trillionaire” for that hypothesis…
Anyway, it has always seemed to me that a key component of “free trade” was labor arbitrage since labor costs are typically the largest expense of any business. Labor arbitrage has been a thing since the Egyptian pyramids were built – although back then it was known as slavery…
China. India. Vietnam. Costa Rica. These places had – and still have – lower standards of living and lower costs of living than the US, and therefore, can pay their people far less than what US workers expect and need…
And, of course, process automation – whether it be a mechanical process on a Ford Motor Company assembly line or an information process on a J P Morgan “assembly line” – goes hand in hand with labor arbitrage…
If people in middle America are looking for someone to blame for the decline of their livelihoods, they should look no further than their former employers; the ones who decided to ship jobs overseas while, in many cases, maintaining ownership of those operations as profit margins expanded…
Of course, this is an oversimplification. But, in our current hail storm of internet-enabled content, I find it helps to regularly restate what we think we know – like a mantra…
The Spokesman
I had to chuckle when Scott Bessent was nominated to be US Treasury Secretary. Another former Democrat from the Clinton era – and potentially the highest ranking openly gay person in US government history (even above Pete Buttigieg) – was about to become a critical figure in Trump’s “manosphere” administration…
It’s an odd combination – amongst a wider group of odd combinations…
I met Scott years ago when I used to travel in hedge fund circles. In fact, I interviewed to be his personal assistant while he was at Soros Fund Management. Clearly, that gig wasn’t meant to be for me…
Notably, when Scott began to criticize Janet Yellen’s handling of the composition of US debt, I wasn’t sure if he was serious or if he was gaslighting. I suspected that their had been (Democratic) political influence in the employment data ahead of the 2024 election (along with the rate cuts), but I wasn’t so sure about the motivation behind the heightened usage of Treasury bill issuance to fund the national debt…
So, Alphacution dug down on that data…
US National Debt Composition
The following is an analysis of US Treasury marketable debt issuance over the past ~25 years that is intended to serve as a backdrop to Alphacution’s ongoing analysis of foreign holdings of US securities – which is itself a backdrop to our ongoing analysis of liquidity in US equities…
The highlights of the next 7 charts illustrate that:
- Recent T-Bill issuance (2023 – 2024) has been no greater – as a share of total – than it was prior to 2008;
- Rolling annual refinancing levels are currently $7.2 trillion and rolling quarterly refinancing levels are currently $1.9 trillion (before any impacts from recession or other deficit-increasing events);
- Total net marketable borrowing is increasing to a pace of about $500 billion per quarter;
- Combined T-Bill and ~10y T-Bond issuance represent a majority of overall Treasury debt issuance since 2007;
- Average maturity of total outstanding marketable Treasury debt is at the high end (5.92 years*) of a 25-year range;
- Average monthly interest rate on interest-bearing Treasury debt (including Bills, Notes, Bonds, FRNs, and TIPS) is 3.3%*, which is below the mid-point of the 25-year range; and,
- According to FRED data through March 2025, the fiscal deficit is estimated to approach an average of $200 billion per month over the next year, all else being equal…
[* Note that average maturity and average interest rate figures below are not weighted.]
Key Takeaway: This analysis suggests that higher levels of T-Bill issuance seem to occur during periods of heightened bond volatility – such as around the GFC (2008 – 2009) and the COVID pandemic (2020) – because haircuts are lower for T-Bills being used as collateral (such as, in Repo markets) during these periods…
Does Bessent already know this? If so, is he gaslighting when being critical about the preponderance of T-Bill issuance? And, if not, given his apparently impeccable credentials, why not?
Lo and behold, it appears that Mr. Bessent can’t abandon the massive and increasing pace of T-Bill issuance until longer term rates come down – which may not happen in the foreseeable future without a significant crisis…
Foreign Holdings of US Securities
With the US national debt composition and management thereof as backdrop, let’s now turn to look at the potential impacts of tariffs on foreign holdings of US securities:
The following series of charts is based on data from the US Federal Reserve. In most cases, it includes the 13-year period beginning January 2012 and ending December 2024. To set the stage, the first chart, below, shows total foreign holdings of US securities growing from $12.1 trillion for Jan 2012 to $31.7 trillion as of year-end 2024. This is an annualized growth rate of 7.64%.
As shown in the exhibit, below, the largest segment (currently nearly half) of foreign holdings of US securities – which include both US stocks and bonds – are concentrated in European nations. The remainder is largely split between the Asia-Pacific region and North America (ex-US). South America and Africa – two large regions contained within what has come to be known as the “Global South” – represent less than 1% of the value of foreign holdings in US securities…
The exhibit, below, illustrates the foreign share of US securities by product – which includes holdings in stocks, long- and short-term Treasuries, corporate bonds, and agency bonds. Over the 13-year period, the share of holdings in bonds (across all product classes) has declined while the share of holdings in stocks has increased dramatically. As of year-end 2024, US stocks represented 58.2% of the total value of foreign holdings; a nearly 50% spike from ~40% concentration in US equities that began – as you might guess – at the beginning of the pandemic era in early 2020…
This brings us to the next chart which illustrates overall foreign holdings of US securities by product where US equities represent $18.5 trillion and US Treasuries represent $7.3 trillion as of year-end 2024. A deeper analysis would show that the short-term Treasury (T-Bill) component of this figure was $1.2 trillion and the long-term Treasury (T-Note / T-Bond) component of this figure was $6.1 trillion at year-end 2024…
The breakdown of these figures by country is fascinating because it begins to contextualize investment relationships and trade relationships between the US and each country. In the chart, below, Alphacution illustrates that the top aggregated foreign investments in US securities come from entities based in the UK ($3 trillion), Canada ($2.7 trillion), Japan ($2.6 trillion), and China ($1.3 trillion). The other high ranking foreign domiciles – Cayman Islands, Luxembourg, Ireland, Switzerland, and Belgium – are believed to be based on funds from high net worth individuals through tax havens into alternative investment vehicles, like hedge funds…
Note that China is unique in its declining holdings of US securities over the 13-year period. Alphacution also assumes that the growth in investments domiciled in Ireland have been impacted by BREXIT…
As shown in the chart, below, when it comes to the US Treasury market – a target of intense focus in the current economic climate – Japan ($951 billion), China ($699 billion), and the UK ($645 billion) are significant standouts relative to the remaining countries, like Canada, France, and Taiwan (which fall in the $250 – $350 billion range)….
Again, here, we see a significant decline in US Treasury holdings by China, far less change by Japan, and a notable increase over the period by UK-based investors…
The breakdown of foreign holdings in the US equity market is much different than the US bond market where the tax havens play a more outsized role. Also, China shows up in a much different place in US equity rankings…
Now, for those of you who’ve been following along closely, the findings in the next chart are somewhat at odds with the findings presented in the recent Feed post, “Blood Bath: Foreign Holdings of US Equities by Domicile, YE 2024.” In that post, Alphacution’s foreign share of US equity market capitalization was based on a Goldman Sachs analysis…
Alphacution has since reviewed and discussed the data used by the Goldman team and have initially arrived at different conclusions that we may expand upon later. The bottom line, however, is that the foreign share of US equity market capitalization is likely much higher than the 18% cited in the Goldman research. (They are essentially using a different – significantly larger – denominator from the US Federal Reserve for US equity market capitalization that includes private equity and appears to double count investments through hedge funds and ETFs.)
If we use US equity market capitalization that is based more closely on data from the World Federation of Exchanges, the foreign share of US equity market capitalization is as shown in the chart below…
In the final analysis, we expect Goldman’s share to be closer to a minimum and the figures below to be closer to a maximum. The actual share is likely somewhere in the middle…
This is where the plot not only thickens, but gets quite spicy too: As most of you know, US equity market structure is configured to fragment liquidity. One of the most notable fissures in US equity liquidity is between on-exchange and off-exchange venues. Retail liquidity is almost exclusively off-exchange (via wholesale market makers’ SDPs) and institutional liquidity is largely on-exchange. (The key “error term” in institutional liquidity for US equities is the extent to which multi-lateral dark pools play a role; a component of research that Alphacution is currently refining.)
The chart below shows a comparison between the growth in foreign holdings of US equities and the decline in the on-exchange share of average daily value traded over the 10-year period beginning Jan 2015 and ending Dec 2024…
Now, the decline in the share of on-exchange value traded is relevant to both domestic and foreign institutional investors. However, given the “Trump Trade War” – and the impact it is having on global asset values, including currencies – we are merely making the argument that foreign holders of US securities may have extra near-term motivation to re-assess their exposures. The chart below – an estimate of “days to cover” for foreign holdings in US equities – is a benchmark that is at a 10-year (and maybe all-time) high…
Meaning: US equity liquidity is currently not well-suited to accommodate a sustained selling spree, much less an outright panic, if one were to arise for some reason…
Baghdad Bob
Mohammed Saeed al-Sahhaf was Saddam Hussein’s Information Minister in the lead up to the Iraq War. He earned the nickname Baghdad Bob for his daily media appearances where he offered colorful denials and pronouncements about the unfolding conflict that were wildly at odds with reality. In hindsight, he may have been the modern Godfather of gaslighting…
In parallel with this reference, Wall Street is notorious for its mythology. Combine extreme wealth with a code of extreme secrecy and real accomplishments are easily exaggerated, especially given proximity to other people’s wealth and/or greatness…
I’m a couple steps past beginning to wonder if Scott Bessent is a product of such mythology…
I agree that perpetual “strategic uncertainty” is a hallmark of Mr. Trump. Moreover, I don’t expect him to preside over a sustained period of calm. There is no precedent for it. The perpetual uncertainty hallmark only serves the objectives of one person. I’m also not sure Mr Bessent understands what “anti-fragile” means. Of course, someone else wrote his speech. He doesn’t appear to be all that comfortable as a public speaker…
Certain types of individuals – like Mr. Trump – can gain from disorder, but objects of coordination and cooperation – like US securities markets and the US economy – most certainly cannot…
If the current account deficit declines (due to the tariffs), then the offsetting factor that funds that deficit – the capital account surplus (which is the money that flows into the US to fund that current account deficit) – will decline, as well. That means less inflow into US assets from foreigners, most of which has been into equities…
This is not a controversial statement. It’s simple math…
Furthermore, unless domestic savings is increased to offset the shift in trade, US asset values will eventually be lower as a result of the proposed tariff policies…
This is all an elaborate way to say that there’s likely a different objective at play here – and the extraordinarily insane headline risk of the moment is a temporary gift to the complacent…
Until next time…
