Two Important Structural Shifts Shaping the Economy

The world economy is undergoing many secular changes, from the advent of artificial intelligence to de-globalization. Here, we look at two shifts occurring in the U.S. that will shape economic growth and policymaking for years to come

U.S. interest costs hit a post-WWII record in May.

One of the most frequently asked questions to hit our desk is around the U.S. budget deficit and the sustainability of the U.S. debt. As to the question of when deficits and/or debt begin to really matter, we’ve come to the conclusion that no one has a great answer. Accordingly, we went back into the historical data and found that it’s the interest costs of servicing the debt that actually matter for both financial markets and public policy. More specifically, we’ve identified that when interest costs hit 14% of tax revenue, a critical change occurs in Washington. When interest costs are below 14% of tax revenue, the U.S. government enters a regime of fiscal stimulus, which guided policy from 1995 to 2023. Conversely, when the interest cost exceeds 14% of tax revenue, the U.S. goes into austerity. In July 2023, that critical threshold was crossed and the 10-year Treasury raced from 3.7% to nearly 5.0% in three months until Treasury shifted to financing the deficit with shorter-term debt.

Last year, President Trump imposed one of the largest tax increases in American history by instituting tariffs to pay for an extension of tax cuts that were set to expire. We note this because the U.S. government was making progress on the deficit and rates before the Iran conflict began. But the conflict in Iran has set back some of that progress. Last month, net interest costs hit 19% of tax revenue, marking a new post-World War II high.

U.S. trading patterns are shifting rapidly under our feet.

We are not quite there yet, but by next month the U.S. will likely import more goods from Mexico than the E.U., more goods from Taiwan than China (right), and more goods from South Korea than Japan. This structural shift in U.S. trade patterns represents ongoing de-globalization, the push to bring supply chains closer to North America, and a need to wean the U.S. off China’s chokepoints. These trends do not account for transshipment, but are symbolic nonetheless. The shift toward a multipolar world that began a decade ago is now fully in motion. We see the Trump administration policy as a three-step effort: 1) Impose tariffs globally; 2) Incentivize domestic production; and 3) Fuel a weaker currency (akin to 20 years ago).

The first step is complete, with President Trump’s tariffs from last year getting things started and the full IEEPA replacement plan (in response to the SCOTUS ruling) likely to be in place by this summer. Step two is now in motion with Congressional passage of 100% expensing for capital expenditures, research & development, and factory building. But ultimately, we believe a weaker dollar will be necessary for reindustrialization to fully succeed.

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