Cracks are emerging in the idea of America's economic exceptionalism
Over the past two years, the notion that the U.S. economy and its stock market was outperforming the rest of the advanced world gained salience and came to be widely interpreted as a new form of American exceptionalism. Last October, The Economist claimed that the U.S. economy was the “envy of the world” and that it had “left other rich countries in the dust.”
The election of a purportedly pro-business president and the Republican sweep in last November’s elections reinforced expectations that America’s economy and equity markets would continue to standout in 2025, especially in comparison to a supposedly moribund Europe and a sluggish China.
However, initially high expectations for a Trumpian boost to economic growth, based on anticipation of significant deregulation and tax cuts, have since floundered as the reality of heightened policy uncertainty and protectionist measures hit consumer sentiments and business confidence.
The Trump administration’s crude but significant shift towards foreign policy realism, along with its haphazard execution of economic threats and trade tariffs, have ushered in a more transactional world order. It is forcing key European and Asian economies to get their acts together and undertake much-needed policy reforms and enact critical stimulus measures.
Though the U.S. economy ended last year on a high note, its performance this year may be significantly hobbled by a surge in policy uncertainty, a sharp decline in consumer sentiments, a delay in business investment and a gradual weakening of the labor market.
The sudden and sharp reversal reversal in the bond market, coming after a 100-basis-point surge between mid-September 2024 and mid-January 2025, offers confirmation of a dramatic shift in market sentiments. Fears of an economic slowdown have overtaken concerns surrounding sticky inflation.
The recent underperformance of U.S. equities suggests that previously ebullient investors are having second thoughts about the bull case for American stocks. Surprisingly, the previously underappreciated (and relatively undervalued) Asian and European equity indices have outgained their American counterparts so far this year.
To attain a deeper understanding of recent developments, it is helpful to take a step back and evaluate the drivers of recent “U.S. exceptionalism.” Since the end of 2019, the U.S. economy sharply outperformed its G7 advanced economy peers. One crucial but underappreciated reason for the outperformance is that the U.S. deployed an extraordinary amount of fiscal stimulus between 2020 and 2024.
As Jesper Rangvid has highlighted on his blog, through the Cares Act, the Consolidated Appropriations Act and the American Rescue Plan Act, the U.S. government added $6 trillion of stimulus (equivalent to about 25 percent of GDP). The Biden administration juiced the economy further with the Inflation Reduction Act and the CHIPS and Science Act.
Of course, the U.S. possesses key underlying advantages relative to its European peers on the regulatory, productivity and demographic front, and it also has an innovative and vibrant tech sector. Furthermore, the shale revolution has made the U.S. the world’s leading producer of oil and natural gas and largely immunized the domestic economy from external energy shocks.
The Ukraine conflict and the resultant curtailment of Russian energy supply to Germany and its neighbors generated a far bigger adverse supply shock for European consumers and producers than it did for their American counterparts.
However, it is hard to undersell the role of debt-fueled fiscal transfers to consumers and businesses that sustained high-levels of consumption and investment spending in the U.S. and muted the impact of higher interest rates in 2023 and 2024. During fiscal 2024, the U.S. federal government ran a budget deficit of over $1.83 trillion (6.4 percent of GDP), even as economic growth remained robust and labor market stayed tight.
Not only were initial government stimulus measures of a smaller magnitude in Europe but many resorted to fiscal belt tightening in 2023 and 2024. This was one of the key reasons for the underperformance of the Euro Area.
Even the extraordinary decade-long U.S. equity market outperformance appears at risk. At the end of 2024, U.S. equities accounted for nearly 70 percent of the MSCI AC World Index (up from around 30 percent share in the 1980s). The U.S. equity market also had become extremely top heavy — the top 10 stocks accounted for around 38 percent of the entire S&P 500 market capitalization. Last December, Ruchir Sharma warned that U.S. equity markets were potentially “over-owned, overvalued and overhyped to a degree never seen before.” Recent events appear to validate his concerns.
Over the past month, several crucial developments have made global investors reconsider the soundness of the “U.S. exceptionalism” thesis. China’s AI industry has shown that it is capable of challenging Silicon Valley’s dominance and raised questions about the staggering levels of capex spending by American tech giants. China has also announced policies to boost domestic consumption and protect itself from Trump tariffs.
Meanwhile, recent German elections have led to an extraordinary sea change in the fiscal and strategic stance of Europe’s largest and most powerful economy. Expectations that Germany and the broader Euro Area will engage in increased spending on defense and infrastructure have already generated European stock market and currency gains.
Intriguingly, the Trump administration’s “bull in a China shop” approach to policymaking has forced the rest of the world to undertake much needed reforms that will ultimately reduce their reliance on the American consumer and, potentially, even on the American financial system.
Vivekanand Jayakumar, Ph.D., is an associate professor of economics at the University of Tampa.
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