America has a problem. A lot of them, actually. Don’t get me started. We’ll be here all day. And night.
No but seriously, Republicans are (pork)barreling towards a tax bill that’d add something like $2.5 trillion to the deficit over 10 years.
As any longtime reader will attest, I’m the furthest thing from a deficit hawk, but there are two issues with this.
First and foremost, just because you can run large deficits by virtue of the dollar’s reserve status and all the exorbitant privileges that go along with it, doesn’t necessarily mean you should. Certainly not for the sheer hell of it, and particularly not if you intend to behave in ways which jeopardize the exorbitant privilege.
Second, if people think deficits matter, they do. And the market generally thinks they matter. Therefore — and to the first point — it helps if you have a good reason for spilling red ink all over the federal ledger. I’m not sure extending tax cuts for millionaires counts.
Notwithstanding the protestations of his supporters, Donald Trump’s absolutely unnerving foreign investors by exhibiting a penchant for erratic behavior on the global stage and democratic backsliding at home. That, in turn, makes foreigners less willing to finance America’s deficits, or at least less willing to finance them at “exceptionally” favorable rates.
So, America has a problem. And as it turns out, the Trump administration doesn’t actually have the stomach for a “solution” which entails plugging budget holes by taxing the holy bejesus out of imports, an approach which anyway wouldn’t have worked because i) it would’ve made foreign nations even more averse to US debt and ii) it would’ve caused a recession, which means less in the way of tax revenue.
This situation, Deutsche Bank’s George Saravelos argued, in a note published Thursday, “is brewing a major problem for the dollar and potentially the US bond market too.” America’s NIIP is obviously negative, and enormously so. The figures below, from Saravelos’s note, give you some context.
America’s a debtor nation, and before we go any further it’s important to note that’s by design to a certain extent. Treasurys are the collateral which makes the world go ’round. Treasurys are more than just “debt.” They’re interest-bearing dollars and the system depends on them.
That said, anything — no matter how foundational or essential — can become a caricature of itself. Saravelos on Thursday suggested the current trajectory, which has the US running wider and wider fiscal deficits, demanding foreigners buy more and more US Treasurys, resulting in a larger and larger pile of foreign liabilities, isn’t sustainable anymore.
Common sense dictates that the more money you owe, the less willing people will be to loan you more. The US is a partial exception, but Saravelos thinks America’s pushing the envelope — taking the exorbitant privilege for granted, if you will.
The figure above illustrates the risk. If in fact “the dollar has lost some of its ‘special’ status’,” Saravelos wrote, the US may no longer enjoy a discount to the yield implied by its external balance. If that discount disappears, 10-year US yields should be well north of 5%.
So, what’s the solution? One idea would be for Congress to work, in a bipartisan way, towards allaying concerns — overblown or not — that America’s fiscal trajectory is ruinous. In my view, the problem isn’t so much the numbers as it is the perception that compromise is impossible given the fractious nature of US politics in 2025.
Assuming that’s out — i.e., assuming neither party’s interested in austerity nor any sort of cross-aisle rapprochement — another option is for the Trump administration to dial back the hostility towards America’s allies in the interest of shoring up foreign demand for US Treasurys and/or project a little more in the way of respect for democratic norms at home so the world can be confident in the preservation of the rule of law in America.
If you assume none of that’s likely — that Congress will remain a Hieronymus Bosch hellscape and that Trump will be Trump both as it relates to domestic affairs and foreign policy — then you’re left to search for a market solution. On that score, Saravelos says the message is clear.
“The non-dollar price of US Treasurys needs to decline, either via currency depreciation or a drop in the price of the bonds,” he wrote Thursday, adding that because the latter would only make America’s debt dynamics worse, “the only solution” is dollar weakness.
In the past, USD weakness has tended to be bullish for US equity prices as an expression of +ve risk sentiment, but I think that this kind of USD weakness won’t necessarily be.
Absent the +ve sentiment factor, seems like mechanically – USD –> + US inflation + US yields + large/small – US asset px.
Good points JL. Perhaps we need to start looking at UST partly as EMG bond investors look at their world?
Problem is I barely know how US bond investors look at their world, much less EM . . . just an equity simpleton here.
And now we’re back to taking gold…
*talking.
You got it. This couldn’t be more straightforward and no one has any idea. Trump of course had it ass-backwars at this inaugurationthat day was the end not the beginning. Thr U.S. has so many natural advantages that we should pull it out in 20 to 40 years. Thr U.S, has screwed it up by overspendig but Jacques, John Exter and thei buddies know that being the gold pivy was the way to destruction. H. I expect toill fight you to the death on gold or some so far unknown neuter asset must be the way out of what Trump is likely to do. Trump 2.0 is dead, Trump 1.0 will not be nough – if that is true, then the printing press follows. And, then….
There is an out in the long term, as democracy, social-democracy, is the best gowervment and this oountry has great physical assets and great borders to allow striving new immigrants in to make us stronger. .
Damn John. I respect your performance record and breadth of experience which almost matches mine.
But I resent how your posts sometimes challenge mine when it cpmes to spelling errors which lead to “confusing” conclusions. At least for me.
I agree – my proofing is the worst. I will try harder.
🙂 I’m your nasty old 7th grade English teacher brought back to life!
Won’t this just lead to eventual yeld curve control? The fed making US banks hold more treasury’s on thier balance sheets, which would also lower lending by those same institutions.
I think the bank capital requirements, e.g. Supplementary Leverage Ratio, can and will be changed to permit banks to hold more Treasuries without impacting their lending.
From following some banks, my sense is bank lending capacity isn’t the problem. Demand for loans is weak.
I know Prince Donald of the Very Tiny Hands is not logical but I need some help here. Tariffs were supposed to pay for budget needs and tax cuts. They won’t apparently. DOGE was supposed to reduce waste, blah blah. All it accomplished was an under-the-radar attack on the worst of the “libs” and other meddlesome priests, without saving anything material. Now comes the “huuuge” bill with a corresponding huuuge addition to the deficit. So all this pain to cut down the Prince’s enemies list a bit just leave us far worse off fiscally. Finally, given the need for the weaker dollar, we get a rise in interest rates, not the decline devoutly to be wished by the Prince. I never liked marco economics much. The problem with macro econ is one you can never get two things one desires at the same time. Econ is more of a Newtonian Physics kind of dismal science. The Prince not only hates democracy, but he also hates the inexorable power of economic markets.