The disruptive and unpredictable nature of President Donald Trump’s various tariff announcements, not least his imposition of “Liberation Day” reciprocal tariffs on April 2, has, among various consequences, led to a sell-off in the US Treasury market.
The sell-off, which commenced on April 5, stemmed in part from tariff-related inflation fears and from overleveraged hedge funds facing margin calls. But most significantly, it marked a sudden market recognition that Trump is serious about introducing massively disruptive economic policies.
After the boldness of the Liberation Day tariffs, investors now believe that anything is possible under Trump. A so-called “Mar-a-Lago Accord“, suggested by Stephen Miran, who is now chairman of Trump’s Council of Economic Advisers, stands out as potentially the most disruptive proposition, though this also makes it unlikely to be implemented, at least for now.
A Mar-a-Lago Accord would seek to address what Miran considers the biggest problem for the American economy – the overvaluation of the US dollar hampering American manufacturing and export competitiveness, thereby widening the US trade deficit.
His solution would be nothing less than a restructuring of US sovereign debt by swapping short-term US Treasuries held by foreign investors into very long-term, if not perpetual, non-tradable zero-coupon obligations at a much lower implicit yield. The result would not only be to lower the cost of funding for the US government but also to weaken the dollar.
The apparent simplicity of this proposal contrasts with its likely devastating consequences, which would be a potential technical default on US Treasury bonds. US Treasuries are today considered the world’s safe asset and happen to be denominated in the world’s reserve currency: the dollar.
The disruption that such a move could cause would be so great that Miran’s proposal has generally been derided or dismissed, but Trump’s astoundingly high reciprocal tariffs – currently on pause for 90 days except for China – were not expected either.
Some investors thus fear a possible US sovereign debt restructuring. It should be noted that US Treasury swaps are not the only option within a potential Mar-a-Lago Accord framework to weaken the dollar while lowering the cost of funding for the US Treasury.
Miran also suggested the Federal Reserve could facilitate the reduction of debt servicing costs in coordination with the Treasury. Miran did not fully develop how such coordination would result in lower US Treasury yields, but history offers some examples.
In particular, the Federal Reserve introduced explicit yield control in 1942 and 1951 to help fund US war efforts. But the international monetary system then had no resemblance to today’s, not only in terms of its interconnectedness, with foreign investors holding close to 30% of US sovereign debt, but also because there were foreign exchange controls and capital account restrictions then.
The severity of the Liberation Day sell-off and Trump’s swift decision to pause most of the reciprocal tariffs to stop the collapse of US markets, including the ditching of US Treasuries, should have been a clear wake-up call for the president and his economic team.
In principle, this should make it even less likely that Miran’s envisaged Mar-a-Lago Accord will ever see the light of day. But Trump’s unpredictability is such that no option can be discounted.
Consequently, US Treasuries can no longer be regarded as the safest assets in the world, benefiting from the US’s exorbitant privilege as issuer of the world’s reserve currency. The virtuous circle by which the US manages to finance its trade imbalance and bloated fiscal deficit with foreign capital is now at risk. So, too, is the dollar’s future as the world’s almighty reserve currency.
Flirting with the dollar’s reserve currency role is even riskier than imposing sky-high tariffs on trading partners, as the Treasuries sell-off demonstrated. Indeed, market forces seem to be the best protection the US economy has against ill-considered and bad policies, assuming those forces will still be allowed to operate freely in the future.
Alicia Garcia Herrero is chief economist for Asia-Pacific at Natixis, senior research fellow at Bruegel and adjunct professor at Hong Kong University of Science and Technology