"Look at the Mar-a-Lago Pact"...2025 Stock Market Outlook [International Economy Reading by Han Sang-chun]

Election, war, abnormal climate, Donald Trump's election, the collapse of the French government for the first time in 62 years, impeachment, etc. The eventful year of 2024 is coming to an end. From the perspective of the global stock market, this year is summarized by the United States and Korea. Among the 38 OECD member countries and the G20, the U.S. ranked first and Korea ranked last in terms of the increase rate of representative indices converted to dollars.

This year, the U.S. stock market surpassed the Goldilocks market of the late 1990s, when stock prices soared due to the myth of a high-growth, low-inflation new economy, leading to the emergence of the new term 'fire market.' Since early November, when Trump was elected, the stock prices of related stocks such as Tesla and Palantir have risen another notch, leading to a 'skyrocketing market.'

Despite the growth rate and policy (base) interest rate being in the 2% and 4% range, far below the 5-6% range of the late 1990s, U.S. stock prices have risen more than at that time due to the concentrated inflow of global funds into the U.S. stock market. As of the end of October this year, about 60% of global funds flowed into the U.S., and after Trump's election, the proportion increased to 70%.

Since World War II, the period when global funds were concentrated in the U.S. coincided with the period of 'Great Divergence (GD)' in international interest rates. Looking at the situation after the GD first appeared in the late 1990s, the U.S. Federal Reserve raised the policy rate from 3.75% to 6% in just one year after 1995. During the same period, Germany's Bundesbank lowered its rate from 5% to 4.5%.

Due to the GD in policy rates, a strong dollar era unfolded, known as the 'Rubin Doctrine era.' After the reverse Plaza Accord in April 1995 to boost the dollar's value, the yen-dollar exchange rate surged from 79 yen to 148 yen. Emerging markets, which suffered from capital outflows due to high interest rates and a strong dollar, were plagued by the 'Greenspan-Rubin shock,' leading to the Latin American debt crisis in 1994, the Asian financial crisis in 1997, and Russia's national default in 1998.

However, this year, central banks in each country have pursued a pivot to lower policy rates. In the late 1990s, the GD in policy rates would not have allowed funds to flow into the U.S. In the process of pursuing the 'wag the dog' pivot, where the tail (emerging market central banks) wags the body (advanced economy central banks), the Fed's late participation allowed funds to flow into the U.S. due to the difference in policy rates.

The problem is the 'conundrum' phenomenon that has emerged after the Fed pursued a pivot. After the Federal Open Market Committee (FOMC) meeting in September, the policy rate was cut by 1 percentage point, but the 10-year Treasury yield surged by 1 percentage point. During the same period, most countries' Treasury yields, except for the U.S., fell. Unlike the 1990s, a GD in market rates is occurring.

As the dollar's value rises rapidly, countries other than the U.S. are defending their exchange rates daily, but only depleting foreign currency. Japan's Ministry of Finance intervened three times in large-scale exchange rate defense, but the yen-dollar exchange rate returned to pre-intervention levels. The won-dollar exchange rate, compounded by internal issues, has broken through the first defense line of 1,400 won and the second defense line consecutively, bringing the 1,500 won range into view.

For economic agents, the policy rate is an 'invisible rate,' but the Treasury yield is a 'visible rate.' Looking at the carry trade, which has been leading international capital movements since the British pound crisis, it reacts more sensitively to market rates than policy rates. Unlike the late 1990s, the U.S. is absorbing up to 70% of global funds for this reason. Emerging markets, which have to repay more than $400 billion in debt annually due to high interest rates and a strong dollar, are once again facing an uncontrollable crisis.

If the Trump administration takes office, the GD in market rates is likely to continue. This is because inflation is expected to rise further on both the demand and supply sides due to tax cuts, New Deal policies, high tariffs, and the crackdown on illegal immigration. In terms of Treasury supply and demand, the issuance of Treasuries is inevitable due to fiscal deficits and national default concerns, as the federal debt ceiling has already clashed with Congress.

Excessive global fund inflows, surpassing fundamentals and policy rates, leading to rising stock prices, inevitably lead to bubbles. The big tech stocks that have led the U.S. stock market have long been overvalued by traditional stock valuation metrics such as the price-to-earnings ratio (PER) and price-to-book ratio (PBR). The upward trend in big tech stocks is being extended as their future potential value is highly evaluated by new stock valuation metrics such as the price-to-sales ratio (PSR), price-to-intangible asset ratio (PPR), and price-to-dream ratio (PDR).

The first year of the Trump administration's U.S. stock market is likened to the 'Harrod-Domar knife-edge growth theory.' Just as a shaman walking on a knife's edge gets severely injured if they fall, the balance between the 'fire market' and 'bubble collapse' must be well maintained. The lesson from 2018, when domestic securities firms focused on overseas commercial real estate investment like a trend, resulting in significant losses that have not yet been recovered, should be remembered.

For our stock market, which has faced trials this year, to recover in the new year, the most urgent task is to stabilize the won-dollar exchange rate. In the era of 'Neo Pax Americana,' where the U.S.-centered global economic order is being revived, the relationship with Donald Trump, the highest leader of a specific country, is an important issue not only economically but in all aspects.

After the Trump administration officially takes office on January 20, the U.S.-China relationship will coexist with 'optimism' and 'pessimism.' The former is based on 'Xi Jinping's surrender' to 'Trump's pressure.' Considering Trump's negotiation style of pushing through once he gains the upper hand, it is expected that the economic hegemony battle with China will be led according to the U.S.'s intentions.

The latter view is that there will be no significant change in the current situation. The global economic hegemony battle itself is a decoupling issue, far from 'settlement' or 'agreement.' De-risking also has its limits. Given the vastly different stages of economic development and import-export structures between the two countries, it is not easy to reduce the U.S. trade deficit with China, regardless of the method used.

The question is whether there is a middle ground between these extremes. As experienced during the first term, if the 'Trump risk' persists for a long time, fatigue symptoms will accumulate, increasing the likelihood of Trump making the same mistakes as he dreams of the presidency again four years later. If the conflict with the U.S. grows and the economy does not recover, Xi Jinping's already weakened leadership will inevitably be shaken.

The re-emergence of the 'Second Plaza Accord' debate, which had been dormant for a while, is also due to this. The Plaza Accord refers to an agreement in the early 1980s between the U.S. and Japan to induce a stronger yen, which was the main cause of international balance of payments imbalances. Under the Plaza system, which lasted for ten years, the yen-dollar exchange rate plummeted from 240 yen to 79 yen.

The appreciation of the yuan is a task Trump has long awaited. During his first term, he promised to designate China as a currency manipulator, and failing to fulfill this promise was one of the reasons he did not get re-elected. If the U.S.-China trade deficit does not decrease during his second term, it could become a burden for the Republican Party in the midterm elections two years later.

China also feels the need for yuan appreciation. Since the Xi Jinping administration took office, efforts have been made to elevate the yuan's status through the inclusion in the IMF's Special Drawing Rights (SDR) and the establishment of the Asian Infrastructure Investment Bank (AIIB). To establish a Pax Sinica system centered on China, the yuan's status as a safe currency must be elevated.

The current international monetary system, formed naturally by market forces since the Kingston meeting in 1976, is not supported by inter-country treaties or international agreements, and is referred to as a 'non-system' or 'jelly system.' In such conditions, a 'national treaty' is necessary to adjust the U.S.-China trade imbalance.

The key is how much the Trump and Xi Jinping administrations can accept the depreciation of the dollar and the appreciation of the yuan. With the growth rate falling below the target line of 5%, a significant yuan appreciation is difficult for China to accept. However, if the yuan is excessively weakened to boost growth, trade friction with the Trump administration will inevitably intensify.

The Trump administration is in a similar position. No matter how urgent it is to reduce the trade deficit during the second term, accepting a significant dollar depreciation would result in more 'loss' than 'gain.' The U.S. export-import structure does not meet the Marshall-Lerner condition ((foreign currency-denominated export demand price elasticity + domestic currency-denominated import demand price elasticity) > 1), making it difficult to improve the trade deficit even if the dollar weakens.

Excessive dollar strength is also a burden. Since Trump's election, the dollar index has surged to '107.' It is a strong phase that deviates more than 5% from the long-term trend calculated by the Hodrick-Prescott filter. According to the Federal Reserve's econometric model 'Ferbus (FRB + US),' if the dollar's value rises by 10%, the U.S. economic growth rate will fall by 0.75 percentage points two years later.

Estimating the appropriate level of the yuan's value using the current account balance model and exchange rate structure model, it is estimated to be around 6.5 yuan. This is higher (appreciated) than 6.8 yuan eight years ago. This is because China's economic status has risen. In the future, the U.S. and China are expected to aim for this level as a 'sweet spot' that well reflects their national interests.

If an explicit agreement cannot be reached in the current non-system international monetary system, this level must be maintained implicitly. During the first term, it was the 'Shanghai Accord.' If Xi Jinping, who was invited to the inauguration of the 47th U.S. president, meets at Trump's estate, where everything has been happening since the election, and there are results, it is more likely to be a 'Mar-a-Lago Pact' than a 'Second Plaza Accord.' The new year's won-dollar exchange rate and our stock market are also expected to be influenced by the Mar-a-Lago Pact.

Han Sang-chun / Korea Economic TV Commentator and Korea Economic Daily Editorial Writer