The world has put too many financial eggs in a country run by a basket case

US president Donald Trump has followed policies that are undermining not strengthening the dollar.

It’s doubtful that Don Trump has read Don Quixote. If he had, he’d avoid putting all his eggs in one basket, something Cervantes warned about in his early 17th century classic. What held true in the great Spanish bonanza of the 1600s, when Imperial Spain was dripping in Aztec gold and Inca silver, applies equally today. The expression perfectly describes the current situation in global financial markets where the US – home to 4 per cent of the world’s population – attracts roughly 60–65 per cent of all the world’s money going into stock markets, about 40 per cent that goes into bond markets and about 70 per cent of all the world’s private capital. All the world’s financial eggs are precariously perched in one highly speculative basket, in a country run by someone who could be described – sticking with the basket analogy – as a complete basket case.

This concentration of global risk in one country is a source of enormous jeopardy, particularly when you consider that the US only accounts for 2 per cent of the world’s population under 18. By definition, the US can’t absorb all this money profitably. Bizarrely, since the 2008 global financial crisis, when a catastrophe that originated in the US and was the result of poor regulation, dodgy financial oversight and a finance system that was out of control, the world has doubled down on its American bet. You’d expect the US to be punished and shunned by investors for orchestrating the greatest financial calamity since 1929, but the opposite has happened. On the eve of the collapse of Lehman Brothers, $10 trillion of foreign money was deployed in US shares, real estate and bonds. Today that figure is $30 trillion. Rather than recoiling from the country that caused the global financial crisis, investors flocked to the US with the result that almost two decades later, there is now three times as much foreign money invested there.

On any basis, this is a monumental concentration of global financial risk in a country whose global position, whether in terms of demography, trade dominance or income, is faltering relative to the rest for the world. For many years the accumulation of risk in the US was justified by the fact that the US was extremely innovative and run by people who were, more or less, mature, predictable and rational.

However, the assumption that the country is run by rational individuals is no longer the case. The present administration has threatened investors, directed tariffs at long-term partners, undermined the independence of the Federal Reserve and followed policies that are undermining not strengthening the dollar. Until recently, the imbalance between the US population as a percentage of the world’s total and the amount of foreign capital in the US relative to the world’s total, could be ignored or explained away. Today, the antics of Trump make this imbalance impossible to ignore.

A realignment of global risk is on the cards and this means money leaving the US and returning home. Typically what happens in these cases is money follows the Hemingway rule. When asked how he became bankrupt, Ernest Hemingway replied at first slowly and then very quickly. That is how these things play out. Initially money leaves a risky country or person, slowly, then once people realise they might not be repaid or might not get back as much as they put in, they panic and pull all their cash out overnight. Empires tend to go bust more slowly but they can go bust (or at least lose their position) as investors realise that risk is over-concentrated in yesterday’s power or yesterday’s assumptions.

For years the rising dollar, pushed up by the inflow of capital, inflated returns for foreigners in their local currency. Once a currency starts to wobble, itself a reflection of the “smart money” leaving, the gap between underlying productivity and demographics and risk opens up. At the end of the day, only productivity growth and population growth drive economic growth and if both of these are faltering relative to the rest of the world, the over-concentration of risk becomes apparent – and quickly.

Before we get to this stage, the fact that investment isn’t justified by productivity or innovation means that lots of the foreign money finds its way into inflated assets, like real estate, government debt or one of the many Silicon Valley “unicorns” – those companies valued at astronomical levels without profits or even income to justify these valuations. Such “hope” value can only be sustained as long as more and more foreign money comes in at the bottom of the pyramid to maintain valuations at the top. Once that changes, the ramifications are enormous, because momentum changes and in a market where hope is more important than reality, momentum matters. Even small percentage changes in capital flows can have huge ramifications when we are dealing with trillions.

At the core of all this is the notion that US government debt was seen as “risk-free” for decades, meaning the US government would always honour its debts and the dollar would always remain pre-eminent. Until recently no one doubted this premise. But with US national debt heading towards 120 per cent of GNP and its budget deficit running at above 5 per cent annually, it’s not hard to see how things could get out of control, particularly with an erratic administration declaring trade wars on partners on a weekly basis.

History shows us the gradual but permanent collapse of sterling as the world’s pre-eminent currency during the 1920s – a decade that was characterised by recurring sterling crises. Such financial trauma would have been unthinkable in Britain only a few years before.

In 1914 Britain was the world’s banker, controlling about $20 billion of foreign assets. London was the epicentre of global money, accounting for about two-thirds of all trade in international capital. The first World War changed all that. European powers, including the UK, borrowed heavily from the one big player that stood aloof until close to the end: the US. The US emerged from the war as the world’s undisputed creditor. Not only was it owed billions, but Americans snapped up European assets at bargain basement prices as the war progressed. This global shift in the power of money from London to New York would define the world’s monetary relations for the next century. Once the world’s creditor and pre-eminent financial power, the UK became a debtor unable to control its economic destiny. Today, the US is the world’s greatest debtor.

Could the 21st century dollar go the way of 20th century sterling? It is already down 9 per cent since new year and is crashing against gold and silver, sure warning signs. As for those eggs, don’t mention the overflowing basket!