Dear Investors and Friends,
This month’s letter departs from our ongoing “Why Bonds, What Bonds, and How Bonds” series. After a volatile April, we felt compelled to pause and address a deeper issue that’s been quietly reshaping markets and politics for decades: the global economic machine. Specifically, we’ll walk through why the U.S. runs persistent trade deficits, how the dollar came to dominate global finance, and how these imbalances are now shaping both policy decisions and voter sentiment.
Much of this thinking is inspired by the recent work of Lyn Alden, whose newsletter we highly recommend (link here). Her work offers the clearest explanation we’ve seen of the structural issues shaping America’s economic path, and we give her full credit for many of the insights below.
Understanding Trade Deficits and the Global System
- What is a trade deficit? A trade deficit occurs when a country imports more than it exports. That shortfall is paid for by sending money abroad, in our case, U.S. dollars. It’s not inherently bad. But whether it helps or hurts depends on what the money is used for.
- A healthy case: India. India has run trade deficits for decades—but with a key difference: it uses foreign capital to fund productive investment. The result? India’s GDP has grown faster than its trade deficit, and the country’s economy has become more self-sustaining.
- A problematic case: The U.S. The U.S. has run continuous trade deficits since the 1970s, but unlike India, much of the imported capital goes to consumption, not productive investment. That’s a big deal. Worse, the deficit has hollowed out our industrial base. Jobs that once paid well in the Midwest disappeared, while asset prices soared in coastal financial centers. In short: we’ve traded appreciating assets for depreciating goods and services.
- What happened in 1971? In 1971, President Nixon closed the gold window, ending the convertibility of the dollar into gold and launching the modern fiat system. This foundational shift laid the groundwork for the persistent trade deficits we see today.
- What it means to be the global reserve currency. Today, the dollar plays four critical roles in global finance:
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- Unit of Account: Most global trade contracts are priced in dollars—even between countries that don’t use the dollar domestically. For example, a Japanese company buying oil from a Saudi supplier will often settle the transaction in dollars.
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- Funding Currency: Trillions in global loans are denominated in dollars, even when no U.S. bank or borrower is involved. A Turkish company might borrow from a Swiss bank in dollars, not lira or francs, because dollar markets are deeper and more liquid.
- Reserve Asset: Central banks around the world hold dollars—mostly in the form of U.S. Treasuries—as part of their foreign currency reserves to back their own currencies and defend against crises.
- Exchange Medium: About 90% of global foreign exchange transactions involve the dollar. This includes currency trades where the U.S. isn't a party at all—like an Egyptian importer converting pounds to Korean won by first exchanging into dollars.
The dollar’s global role extends far beyond America’s borders. Most Americans don’t realize how central the dollar is to everyday business and financial stability across the world. This network effect reinforces itself - the more the world uses dollars, the more entrenched the system becomes, and the more structurally overvalued the dollar becomes, making U.S. exports less competitive.
How Reserve Status Shapes Trade and the Dollar
- How reserve status impacts trade. Because global demand for dollars is high, the dollar stays strong, making U.S. exports expensive and imports cheap. This makes our trade deficit worse. To put it plainly: being the reserve currency forces the U.S. to run trade deficits. That’s how the rest of the world gets the dollars it needs to operate.
- Why the world needs dollars. Every year, the U.S. runs a trade deficit of $500 billion to $1 trillion. That’s how dollars “leak” into the global system and fund international trade, debt, and reserves.
- Why the world needs more dollars over time. We live in a debt-based global system. As debt grows, so does the need for new dollars to service that debt. In a fiat-based system, where most money is created through lending, nominal growth becomes essential. Without a growing supply of currency units to service rising debt levels, the system faces stress. According to the BIS (Bank for International Settlements, the central bank for global central banks), there are over $120 trillion in dollar-denominated liabilities globally, but only $5.8 trillion in base money to support it. That’s a leverage ratio of more than 20:1. If dollar flows slow or contract, the pressure builds quickly, and liquidity crises can emerge, as we saw in March 2020.
- Why it’s in the U.S.’s interest to supply dollars to the rest of the world. By running persistent trade deficits, the U.S. ensures global dollar liquidity, keeping the system functioning. If the U.S. doesn’t supply enough dollars, global dollar shortages emerge, and foreign holders of U.S. debt and assets may be forced to sell, creating destabilizing pressures in our own capital markets.
Stress Tests and Unintended Consequences
- What happened in March 2020. March 2020 was a wake-up call: when global demand for dollars isn’t met through trade, financial assets become the release valve, and that hits home quickly. In March 2020, global trade froze because of the pandemic and dollar shortages spiked. Foreigners began dumping Treasuries to get cash, breaking the market. The Fed responded by opening emergency swap lines with foreign central banks and buying trillions in Treasuries and MBS to stabilize markets. This wasn’t altruism, it was self-preservation. The U.S. had to keep the dollar system alive to protect its own financial system.
- Is reserve status a blessing or a burden? For most RCM readers, asset owners, it’s likely been good: growing capital markets, strong travel power, stable currency. But for much of the country, while it has been a key variable in cheaper and more readily available goods and services over the last 50 years, it has also meant lost jobs, shuttered factories, and regional decline. In the Rust Belt, in particular, it has meant industrial erosion and regional economic pain. The system has domestic winners and losers.
Politics, Policy, and the Path Ahead
As investors, we approach these dynamics apolitically. We’re not endorsing policies or candidates, but understanding the political response to economic imbalances helps us anticipate potential market shifts.
- A genuine voter mandate. There appears to be a genuine political mandate to address the structural trade deficit. The “blue wall” states - Wisconsin, Michigan, Pennsylvania - have shifted politically because the old system no longer works for them.
- Trump’s tariffs and structural forces. One prominent example of this shift has been the renewed emphasis on tariffs. Whether this strategy succeeds remains to be seen, but the voter sentiment driving it is real. And for the first time in decades, trade deficits are a mainstream political issue.
- The real question: Can we unwind the system without breaking it? There is no easy off-ramp. Rebalancing trade, weakening the dollar, or reducing global dollar use would involve trade-offs: higher inflation, weaker assets, and possible recession. But the alternative is to let the imbalances grow.
Investment Implications
Understanding the global machine helps us position portfolios:
- Expect volatility. Structural transitions are messy, and the coming decade could bring new winners, new risks, and new narratives.
- Diversification matters. If the dollar weakens structurally over time, international and real asset exposure may benefit.
- Short-duration fixed income is a cornerstone of our approach. It preserves optionality, reduces price sensitivity to interest rate fluctuations and changes in credit spreads, and provides steady income without locking in long-term risk. Especially in uncertain macro environments, flexibility is power.
Thank you, as always, for your continued trust. We look forward to returning to our regular investment commentary next month, but given the long-term importance of these structural forces, we felt this detour was both timely and essential.
Warm regards,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.