For generations, global capital has followed a bird-like migratory pattern: Surplus capital from the U.S. and other developed countries invested abroad in higher-growth markets.

Meanwhile, surplus capital from developing countries flowed largely to U.S. treasuries and the developed world, seeking both safety and yield. The vast emerging middle class in countries like Korea, and then China and India, combined with high consumer savings rates, created a tsunami of capital that could not be absorbed at home.

It turns out the U.S. may have trouble absorbing them, too. At least, at historically moderate valuations. Chinese and Indian families and businesses are depositing their savings in banks (and in the massive Chinese “shadow banking” system. But they aren’t borrowing to fund consumer consumption at home. These banks have little choice but to seek yield and safety in the West.

These are massive, secular capital flows that can last for many years. And for years, the U.S. has relied on this foreign investment to finance both public and private debts.

Demand for U.S. debt is what fueled the Real Estate Bubble of the mid-2000s, and it has also financed the U.S. government’s massive deficit spending since the 1980s, even as yields have remained low.

There are now some indications that things are starting to shift.

For example, the People’s Bank of China has been lightening up its exposure to U.S. treasuries, while advising its member banks to do the same.

Meanwhile, central banks around the world have doubled their gold allocation as a percentage of their reserves. In fact, central banks have been net gold buyers every month for fifteen months in a row.

Just as global demand for U.S. debt has fueled asset bubbles in the past, this institutional buying has also pushed gold prices above $5,000 per ounce - up from $1,894 at the beginning of 2021.

These are slow-moving, tectonic trends that play out over years, not days. But over time, the trends are unmistakable: Over the last decade, net global institutional gold buying is up, the allocation to U.S. Treasury debt is down.

There are multiple reasons for this.

It’s not just that U.S. yields are low. We’ve been here before, and yet foreign investors still flocked to U.S. Treasury debt because of its high credit quality and because, unlike gold, treasury bonds at least generated some yield.

But at the risk of revisiting a historically very dangerous phrase in the investment world, “this time it’s different.”

In the past, emerging and developing economies had few safe alternatives but to finance U.S. spending. But increasingly, U.S treasuries, mortgages, and other institutional investment destinations are facing increased competition.

This puts substantial upward pressure on interest rates, downward pressure on bond prices, and may throw a wet blanket on U.S. growth prospects going forward. Yes, the dollar remains dominant in trade settlement and global funding markets. But going forward, U.S. bond markets may have to sweeten the yield to attract the flow of foreign investment the American consumers and the government have come to rely on.

Again, we’ve been there before. But the Dow wasn’t 50,000 at the time. Additionally, the S&P 500 wasn’t sitting at a valuation rivaling Internet Bubble numbers, as measured by the Shiller P/E ratio, which adjusts earnings numbers for inflation:

So the inflow of developing market capital that has been supporting high asset prices in the U.S. may be starting to slow. If these trends continue, it would put downward pressure on stocks, bonds, and real estate simultaneously. Correlations may increase. And smart U.S. investors may be looking for alternatives.

Until next time,

The Navigator