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Investors and businesses are trying to figure out what, exactly, the US’s endgame is with tariffs against its three biggest trading partners. US stocks are down again, even after another round of tariff relief was proposed.
TS Lombard’s Steven Blitz offers a new comparison for the US in a note this week: The distressed debtor.
The US is not a distressed debtor, by any means. But it does face a few challenges highlighted by Council of Economic Advisors nominee Stephen Miran, who wrote about a possible Mar-a-Lago Accord in a now-widely circulated paper.
Miran’s paper discusses tariffs at length, both as both a “stick” to be used in trading negotiations, and as a driver of government revenues. And hey — the USMCA is up for review and possibly renegotiation in 2026! The paper also suggests a “graduated” approach with “forward guidance”, in the style of the Federal Reserve.
This week’s back-and-forth on tariffs does kind of fit with that . . . fiscal forward guidance adapted for the era of reality television. Maybe the their eventual implementation shouldn’t be so surprising after all.
And TS Lombard’s Blitz reminds us that the (potential) revenue-driving feature of tariffs also serves a purpose for the Trump Administration as well. With his emphasis:
Regardless of what percentage of imposed tariffs get passed into final prices, 100% of the tariff goes into Federal coffers and this is what’s behind the urgency to enact them. In playing this card, the Administration is, however, underplaying the risk of trade disruption disrupting capital flows. It is near impossible to untie the Gordian knot of dependence on foreign inflows of capital to reset the dollar to reshore domestic production without reducing Federal debt. To this end, current budget proposals fall well short. Cue the Mar-a-Lago accords – a cram-down forcing captured debt holders to accept a US debt-equity swap. I have a modest counter proposal – make the Fed hold nonmarketable, noninterest bearing non-maturing Treasury debt instead . . .
For the US, tariffs are, in effect, FX intervention with the benefit of financing the budget deficit. Tariffs alone are, nevertheless, insufficient to drive the reshoring activity Trump wants to see. Untying this Gordian knot of needing foreign inflows to finance the budget deficit, but at yields that allow the US economy to keep growing, while also keeping the dollar stable enough to sustain those inflows, is no easy task. The problem with the US unwinding all of this unilaterally is the size of the US budget deficit and, more to the point, outstanding US Treasury debt. In other words, against this backdrop how to weaken the dollar without raising interest rates or, in turn, increasing financing instability.
One solution, as proposed by Miran’s paper (citing old friend of Alphaville Zoltan Pozsar), is to issue “special century bonds” to forex reserve managers, as a way of refinancing outstanding debt. These bonds would presumably also carry relatively low coupons.
Blitz puts it in a slightly different light: Instead of simply proving its state capacity and taxing its population, the US seems to want to use different tools (its global security umbrella) to force its creditors to extend the maturity of the debt they hold.
He calls it a “classic cram down”. With our emphasis this time:
Cue the “Mar-a-Lago accords” – a classic cram down. This is right up Trump’s alley of experience, what to do when firms become too leveraged to generate the cash flow needed to repay the debt and run the business. One could argue the US is in this position… The cram down solution is to force debt holders to recognize they own equity disguised as debt and make them swap their holdings for debt with new terms (much longer maturity, for example) or take in equity, meaning giving up their standing in the stack of creditors in the event of liquidation. The US is not going bankrupt, and it could tax itself enough to run a balanced budget by raising taxes, but chooses not to, believing instead that lower taxes generate the growth to pay for forward obligations. History has proven otherwise.
Debtor-on-creditor violence in sovereign debt markets?! This is classic Alphaville stuff. Very exciting.
Blitz is sceptical about the success of this effort, however. Why would a creditor accept a special century bond? It also raises a risk of the US’s security sphere becoming a one-member club:
The biggest debt holders are outside the US sphere of influence (China), and Trump is pushing out those that are on the inside and hold a lot of US debt (Japan, Germany).
In addition, some nations, such as Japan, need US yields to finance their pension obligations – they have no incentive to trade out into long term paper.
Either everyone choses to be on the inside, make the US defence commitment unworkable and eliminating the trade surplus other nations depend upon — or everyone choses to be on the outside willing to trade out of holding US paper and accept higher tariffs, leaving the US in a much worse position.
So he proposes an alternative: The US could simply do this type of swap at home, and have the Fed trade out its portfolio for non-marketable zero-coupon bonds. With our emphasis:
In the immediate moment, 15% of US debt could become zero-coupon, a sizable reduction of debt servicing costs. Treasury would then have to pay the banks, through the Fed, the interest on reserves, which they are effectively doing now anyway because the Fed is running at a loss. Monetary policy then becomes managing the outstanding supply of marketable UST using IORB as the lever. This could be long-term preferable, because it eventually means management of the economy goes to where it belongs, the fiscal side.
It’s a quick win and a steep reduction of US debt servicing costs . . . though it’s also unclear that it would achieve the stated goal of restructuring the global trading system.
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