How will the U.S. government mitigate its sovereign debt risk?
The U.S. public debt has reached $36.22 trillion, with a nominal GDP of $27.37 trillion, resulting in a debt-to-GDP ratio of 132.33%. The spread between 10-year and 2-year U.S. Treasury yields has widened to 36 basis points, and the market is beginning to pay attention to sovereign debt risks. Sovereign debt risks are primarily resolved through currency depreciation or rising prices, but the uniqueness of the U.S. dollar renders currency depreciation ineffective. The expansion of U.S. sovereign debt will lead to an increase in long-term bond yields, while non-U.S. countries will need to defend currency stability
Introduction
Currently, the scale of public debt in the United States is large, reaching $36.22 trillion. At the same time, the nominal GDP of the United States in 2023 is $27.37 trillion, resulting in a ratio of 132.33%.
On the other hand, the yield spread between 10-year and 2-year U.S. Treasuries continues to widen, reaching 36 basis points, indicating that the bond market has begun to measure sovereign debt risk. Generally speaking, there are two ways to default on sovereign debt risk, 1. Relying on rapid depreciation of the currency; 2. Relying on significant price increases. Many investors mistakenly believe that the U.S. dollar can rely on currency depreciation to mitigate sovereign debt risk; in fact, this path is fundamentally unfeasible. This is mainly because the U.S. dollar has its own uniqueness.
Essential Differences Between the U.S. Dollar and Non-U.S. Currencies
As shown in the figure above, assuming there is only one currency in the world, the sovereign risk of different countries would be reflected in the different long-term bond yields. The greater the sovereign risk of a country, the higher the long-term bond yield of its government bonds, and the lower the price of its government bonds.
Therefore, the most direct manifestation of a country's sovereign risk is the price of that country's long-term U.S. dollar bonds.
However, in the real world, the vast majority of countries issue government bonds denominated in their local currency.
Therefore, the sovereign risk of non-US countries mainly focuses on exchange rates. If a country allows its currency to depreciate significantly, international investors will suffer severe losses—equivalent to these sovereign debts being defaulted on.
As a result, non-US countries will do everything possible to defend the stability of their currency value, because they are defending their sovereign credit.
However, investors are not fools; they will not only pay attention to the stability of the spot exchange rate, but also to the growth rate of local currency debt. Only when the growth rate of local currency debt shows sustainability will investors believe that the value of the local currency will remain stable in the long term.
It is precisely for this reason that, in order to stabilize the value of the Renminbi, we have suppressed the growth rate of Renminbi debt from two aspects: 1. Maintain a reasonable fiscal deficit; 2. Maintain a low credit growth rate.
As shown in the figure above, if a country's sovereign debt supply expands from S1 to S2, then the price of that country's sovereign debt denominated in US dollars will decrease from P1 to P2, which will bring significant exchange rate pressure to that country.
However, for the US government, this concern does not exist, as they do not face exchange rate issues; the expansion of sovereign debt supply will simply translate into an increase in long-term interest rates.
Therefore, the exchange rate tool is a double-edged sword:
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Non-US countries that can default through currency depreciation are constrained and need to strictly control the growth rate of local currency debt to gain the trust of international investors;
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The US, which cannot default through currency depreciation, can instead expand its debt on a large scale.
Ultimately, the root of everything lies in the fact that the US dollar is the base currency of all currencies, and ten-year US Treasury bonds are denominated in US dollars.
Debt reduction through declining purchasing power
Although the US government cannot reduce debt through the depreciation of the dollar, they can reduce debt through the decline in the purchasing power of the dollar. , which is lower than the international price P*, then**the exporting country will maintain a large surplus. Assuming that the exporting country keeps P unchanged, but the United States continues to guide the international price P* to rise, then the surplus of the exporting country will further expand. Symmetrically, the United States' deficit with other countries will also further expand. Therefore, relying on rising prices to reduce debt has a huge flaw, which is the issue of expanding trade deficits. If the United States can interfere with the economic policies of other countries and require them to expand their domestic demand, then the issue of trade deficits will be resolved; if the United States cannot interfere with the economic policies of other countries, then the issue of trade deficits will always be a flaw.
Therefore, the United States' debt reduction issue ultimately transforms into an international trade issue. For the United States, the optimal solution is to _force exporting countries to significantly raise their prices P_**, which is equivalent to the exporting countries "signing off" on the United States defaulting on part of its debt. However, exporting countries are not fools; why should they casually give up their hard-earned money??
Thus, the United States chooses to take a second-best approach, attempting to make its allies repay the debt through increased tariffs—bearing the trade deficit. In general, only by understanding the impact of international price differences on international trade can we comprehend why the Trump administration placed such great emphasis on international trade balance, because international trade issues are an extension of the United States' debt issues The Significant Reference Meaning of the Plaza Accord
The above discussion tells us that the U.S. government's debt problem will transform into a domestic inflation problem in the U.S., and the domestic inflation problem will then transform into the U.S.'s huge trade deficit problem. Only by solving the trade deficit problem can the U.S. government's debt problem be fundamentally resolved. So, how can we solve the trade deficit problem? There are two methods: First, force exporting countries to significantly appreciate their currencies; second, force exporting countries to stimulate domestic inflation. Most people will only remember that the Plaza Accord was an unfriendly agreement towards the Japanese and will not pay attention to the elephant in the room—the entire backdrop of the story— the rapid rise in prices severely damaged the international competitiveness of American products. Thus, the American solution was to force other countries to appreciate their currencies, allowing allies to castrate themselves.
Ultimately, with the efforts of several countries, the U.S. dollar significantly appreciated against the currencies of major countries, and the U.S. transferred its risks abroad.
As shown in the figure above, during this process, the yen appreciated wildly against the dollar, bearing a significant cost. , but to help us understand the United States, specifically how the U.S. is managing its debt. The story before and after the Plaza Accord tells us that the final piece of the puzzle for the U.S. in managing its debt must be solving the trade deficit issue, otherwise, the U.S. will inevitably face a second inflation.
Conclusion
Overall, the basic operation of the U.S. in managing its debt is to shift the burden onto its neighbors, allowing its trading partners to help digest the massive debt. Therefore, the return of Trump, who likes to wield the tariff stick, is not a coincidence; even without Trump, another tough figure would emerge to complete the final piece of debt management—balancing the trade deficit. It is important to note that the current U.S. control over the world is far lower than it was in the 1980s, and radical debt management schemes like the Plaza Accord are unlikely to reappear. Thus, the U.S. has no choice but to seek solutions internally. We are quite familiar with this inward approach to debt management, which consists of two moves: 1. Lowering interest rates; 2. Reducing government spending. Of course, cutting government spending is quite difficult and will encounter significant resistance. Therefore, in the near future, the Trump administration will oscillate between external and internal solutions. The ultimate goal is singular: to manage debt. ps: Data from Wind, images from the internet About the December interest rate meeting and the risk of stagflation This article is sourced from: Cang Hai Yi Tu Gou (ID: gh_2b9f00c52678), author of the Wall Street Journal column, original title "How Will the U.S. Government Resolve Its Sovereign Debt Risks?"
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