Trump’s Endgame is Debt Monetization
The ultimate outcome of Trump's economic strategy, intentional or not, could very well be the monetization of U.S. Treasury debt through Federal Reserve purchases. Although this is unlikely to have been Trump's explicitly intended endgame, it is a plausible consequence of his administration's protectionist trade policies.
The Trump administration's protectionist stance—particularly through the imposition of tariffs—is ostensibly aimed at reducing the U.S. trade deficit by making domestically produced goods more competitive relative to imports. While this might appear logical on the surface, such a strategy overlooks crucial implications regarding capital flows. A persistent trade deficit reflects in general an increase in the country’s net debtor position relative to the rest of the world. Consequently, switching from a deficit to a surplus would imply repaying accumulated external debt.
This is the insightful perspective—and the key to understanding the economic challenge: viewing the issue as a matter of repaying debt.
To repay debt, the U.S. must increase savings. Given that the Treasury is unlikely to contribute significantly to national savings, U.S. consumers would bear this responsibility. Without an accompanying rise in income, consumers must cut consumption—a scenario likely to require higher real interest rates and possibly lead the economy into recession.
An easier alternative to outright repayment or default is currency depreciation—something increasingly observable as the dollar weakens against major currencies. For example, a depreciation from 1.10 to 1.60 against the euro would represent approximately a 50% loss in value, severely impacting international investors holding U.S. equities and bonds. Anticipating such a loss, investors could rapidly withdraw funds, exacerbating currency depreciation and driving up Treasury yields further.
Consequently, financing the U.S. Treasury debt under these conditions becomes increasingly problematic. Higher yields might attract savings domestically, but at the cost of reduced consumer spending—again, a potentially painful adjustment. Alternatively, the Federal Reserve could resume quantitative easing to maintain low long-term interest rates and avert a financial crisis.1 Interestingly enough, such an action, effectively monetizing debt, would provide the administration with financing needed to pursue the desired tax cuts on their agenda.
This scenario—debt monetization and tax cuts coupled with substantial dollar depreciation—would inevitably fuel inflationary pressures, and adverse effects on economic activity cannot be ruled out. Nonetheless, it would achieve the desired outcome: the trade balance would eventually shift to a surplus!