As the economy suddenly had to grind to a screeching halt from the COVID-19 lockdowns, the bond market froze up until the Federal Reserve stepped in with enough stimulus "in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy". This loose monetary policy, coupled with the already large budget deficits brought on by the current administration and past administrations, culminated with the large trade deficit, has spooked investors with USD denominated assets - as fears of devaluation and inflation stem from big headline developments. Or has it?
To understand how both a large trade deficit and a large budget deficit can ever be sustained and lead to prosperity, we must take a lesson from history to when it worked in the past. Billionaire investor George Soros wrote about what he called Reagan's Imperial Circle decades ago in the investment classic The Alchemy of Finance, where he explained exactly how this seemingly contradictory idea can actually make sense.
An International Debt Boom Came First
But before we dive right into the economics of Reaganomics 1.0, we need historical context on the preceding period first. As Soros shared, it all started with the first oil shock of 1973. From the Federal Reserve's website, which summarized the situation more succinctly than I could (emphasis mine):
On October 19, 1973, immediately following President Nixon's request for Congress to make available $2.2 billion in emergency aid to Israel for the conflict known as the Yom Kippur War, the Organization of Arab Petroleum Exporting Countries (OAPEC) instituted an oil embargo on the United States (Reich 1995). The embargo ceased US oil imports from participating OAPEC nations, and began a series of production cuts that altered the world price of oil. These cuts nearly
