How will the American version of "debt conversion" be interpreted in light of the China-Japan model?

Core Viewpoints

When the issue of fiscal balance becomes a potential obstacle to advancing tax reduction policies, the American version of "debt conversion" may be approaching. With both increasing revenue and reducing expenditure, the process of deleveraging may lead to changes in economic expectations, and a slight recession may become a potential path. In the financial market, U.S. stocks may face multiple pressures, and the downward space for U.S. Treasury yields is expected to open up.

1. Review of China's Macro Department Leverage Ratio: The overall process can be divided into three stages: "first increase, then reduce, and finally stabilize." From 2008 to 2015, there was a comprehensive increase in leverage; from 2016 to 2019, there was a comprehensive deleveraging; since 2020, it has been a period of stabilizing leverage. Currently, the leverage ratio pattern of "government rising, residents and enterprises stabilizing" in China may be maintained for a period of time.

2. How to view the American version of "debt conversion": The leverage ratio of the U.S. government sector is high, while the leverage ratio of the real economy is relatively healthy. "Debt conversion" may focus on the government sector. When the issue of fiscal balance becomes a potential obstacle to advancing tax reduction policies, how to increase revenue and reduce expenditure becomes a real issue facing the Trump administration, which may also be an important consideration for the Trump administration in promoting the American version of "debt conversion," with increasing revenue and reducing expenditure as the main approach.

3. Impact Geometry: If the American version of "debt conversion" continues to advance, U.S. economic expectations may change, and a slight recession may become a potential path. U.S. stocks may face multiple pressures, and the downward space for U.S. Treasury yields is expected to open up.

Main Text

1 Introduction

On March 10, 2025, U.S. stocks experienced a significant decline again, with the Nasdaq index falling 4.0% in a single day, marking the largest single-day drop since 2023. The S&P 500 index and the Dow Jones Industrial Average also fell by 2.7% and 2.1%, respectively. As of March 12, supported by the unexpectedly low CPI, U.S. stocks finally halted their decline, but overall market sentiment remained relatively sluggish.

The main reason for the weakness in U.S. stocks may be attributed to Trump not ruling out the possibility of a U.S. economic recession during an interview, which triggered panic over the accelerated collapse of the "American exceptionalism" narrative.

We previously suggested that the macro narrative of "the East rising and the West falling" is accelerating, with the main factors constraining the U.S. economy being its massive fiscal deficit and debt pressure, making deleveraging urgent. We believe that the domestic deleveraging process may help in gaining foresight on the U.S. debt issue.

2 Review of Changes in China's Macro Department Leverage Ratio

Reviewing the changes in China's macro leverage ratio, the overall process can be divided into three stages: "first increase, then reduce, and finally stabilize." From 2008 to 2015, it was the leverage increase stage, where the macro leverage ratio of multiple sectors, represented by non-financial enterprises, rose rapidly; from 2016 to 2019, it was the deleveraging stage, where the leverage ratios of other sectors, except for households, remained stable or slightly decreased;

Since 2020, it can be seen as a period of stabilizing leverage or structural deleveraging, where households and non-financial enterprises face bottlenecks in increasing leverage, and the overall leverage ratio remains stable or even decreases during certain periods, while local governments, central governments, and other government sectors have become the main force in increasing leverage

• 2008-2015: Period of Comprehensive Leverage

Using leverage to respond to counter-cycles. After the outbreak of the 2008 financial crisis, developed countries in Europe and America were the first to be affected, facing severe downward pressure in both financial markets and the macro economy, which also had a certain negative impact on the export-oriented domestic economy. China chose to actively respond by increasing leverage and expanding domestic demand, launching a "4 trillion" fiscal stimulus package at the end of 2008, with monetary policy also being loosened simultaneously.

In response to the potential fiscal pressure faced by local governments, local government financing platforms were once again favored by policies and developed rapidly under policy support.

A typical example is in March 2009, when the central bank and the former China Banking Regulatory Commission jointly issued the "Guiding Opinions on Further Strengthening Credit Structure Adjustment to Promote Stable and Rapid Development of the National Economy," which clearly stated, "Encourage local governments to attract and incentivize banking financial institutions to increase credit support for central investment projects through various means such as increasing local fiscal interest subsidies, improving credit reward and compensation mechanisms, and establishing compliant government investment and financing platforms."

Support conditional local governments to establish investment and financing platforms, issue corporate bonds, medium-term notes, and other financing tools, and broaden the financing channels for matching funds for central government investment projects. Local government financing platforms began to enter a rapid development stage.

Short-term effective support for the macro economy, but the local government debt issue is becoming increasingly severe. As the "4 trillion" policy gradually took effect and effectively leveraged, China's policy of increasing leverage to hedge against the financial crisis achieved good results, with capital formation represented by infrastructure becoming the number one driver of GDP growth from 2008 to 2010, and GDP growth rate returning to double digits in 2010.

In contrast, the scale of local government debt gradually expanded, especially with the increase in the number of local government financing platforms, the issue of implicit debt became increasingly severe. From 2011 to 2014, the Audit Office conducted three rounds of audits on local government stock debt, and by the end of 2014, local government debt totaled 15.4 trillion, with contingent liabilities reaching 8.6 trillion, significantly increasing the necessity for local governments to deleverage.

• 2016-2019: Comprehensive De-leveraging Period

The shift in growth rate combined with capacity release has made the supply-demand mismatch increasingly prominent. Driven by objective laws, after 2010, China's economic growth rate gradually transitioned from high-speed growth to medium-high-speed growth, and the shift in growth rate constrained the expansion of domestic demand.

At the same time, the capacity gradually released from previous stimulus policies continued to expand on the production side, and under the combination of the two, the domestic supply-demand mismatch problem became increasingly prominent, with industrial enterprises' capacity utilization rate and production prices continuing to decline. The traditional quantity-based economic growth model of "exchanging price for volume" faced challenges.

Against this backdrop, the Central Economic Work Conference in 2015 officially proposed supply-side structural reform, clearly outlining the main tasks of reducing capacity, destocking, deleveraging, lowering costs, and addressing weaknesses, marking the official arrival of the comprehensive de-leveraging period.

Focusing on overcapacity industries, reducing capacity and deleveraging proceed simultaneously. In February 2016, the State Council issued the "Opinions on Resolving Overcapacity in the Steel Industry and Achieving Sustainable Development" and the "Opinions on Resolving Overcapacity in the Coal Industry and Achieving Sustainable Development," officially promoting the task of reducing capacity, focusing on the steel and coal industries, which faced relatively serious overcapacity issues and had a high proportion of state-owned enterprises.

Correspondingly, in September 2016, the State Council issued the "Opinions on Actively and Steadily Reducing Corporate Leverage," proposing seven paths to promote the active and steady reduction of corporate leverage, including mergers and reorganizations, improving modern enterprise systems to strengthen self-restraint, revitalizing existing assets, optimizing debt structures, orderly conducting market-oriented bank debt-to-equity swaps, legal bankruptcy, and developing equity financing.

Combining easing and tightening, comprehensively standardizing the development of local government financing platforms. Local government financing platforms played an important role in financing for local governments during the comprehensive leveraging period. However, after the new budget law was revised in 2014, local governments were granted independent borrowing powers. Considering the series of issues existing in local government financing platforms, regulatory policies began to gradually shift from support to restriction, comprehensively standardizing the development of local government financing platforms through a combination of easing and tightening In May 2017, the Ministry of Finance issued the "Notice on Further Regulating Local Government Debt Financing Behavior," comprehensively organizing the cleanup and rectification of local government financing guarantees. It strictly prohibited local governments from providing guarantees for urban investment companies and from injecting public assets and reserve land into financing platform companies, marking the beginning of a new round of tightening regulatory policies on financing platform companies.

Shifting from the real economy to the financial sector, financial deleveraging takes over. During the process of capacity reduction and deleveraging in the real economy, financial demand has relatively decreased, forcing funds to circulate idly in the financial sector, which has led to the rapid development of off-balance-sheet non-standard assets represented by shadow banking. To effectively address issues such as idle fund circulation caused by excessive leverage in the financial sector and to promote the flow of funds to small and micro enterprises, the central bank and other financial regulatory departments began to advance financial deleveraging.

In April 2018, the central bank and four other departments jointly issued the "Guiding Opinions on Regulating the Asset Management Business of Financial Institutions," aimed at standardizing the asset management business behavior of financial institutions through means such as breaking the rigid payment, restricting non-standard financing, and prohibiting multi-layer nesting, thus carrying out supply-side reform in finance.

As financial deleveraging gradually deepens, off-balance-sheet business is entering a stage of standardized development, and the issue of idle fund circulation has been alleviated to some extent. The year-on-year growth rate of social financing and M2, which has been continuously declining since the deleveraging of the real economy, has also begun to show signs of stabilization.

Deleveraging can be understood as "exchanging quantity for price," trading short-term "pain" for long-term development. If the main purpose of leveraging is to support the economy through counter-cyclical expansion to prevent excessive economic slowdown, then deleveraging goes against this by shifting from a pursuit of "quantity" to a pursuit of "quality." It can be understood as a form of "exchanging quantity for price," actively reducing backward and excess production capacity to promote industrial clearing and structural upgrading, laying the foundation for subsequent high-quality development.

China's GDP growth rate has been gradually declining since the first quarter of 2010, indicating that the effects of previous stimulus policies are gradually fading. After comprehensively advancing capacity reduction and deleveraging and other supply-side reforms in 2016, economic growth first declined and then rose, stabilizing in the range of 6.7%-7.0%, with industrial enterprise profits experiencing a significant rebound In the process of promoting economic structural transformation, the real estate industry has effectively played a stabilizing role. On one hand, with the relaxation of regulatory policies, the real estate market has entered a new round of rising trends, prompting real estate companies to continuously increase land acquisition and investment efforts. This not only provides strong support for local government finances during the gradual exit of financing platforms through land fiscal revenue but also drives other industry enterprises through the real estate industry chain, achieving a certain buffer for the deleveraging process of enterprises.

On the other hand, the continuously rising real estate prices have further ignited residents' enthusiasm for home purchases, making the household sector the main force behind China's leverage increase from 2016 to 2019, supporting the stability of terminal demand in the industrial chain and the demand for housing credit. The leverage of households and non-financial enterprises has "increased and decreased," becoming an important support for stable economic growth during the deleveraging phase in China.

The equity market is calm, while the bond market experiences a long bull and short bear. In the second half of 2015, the equity market plummeted from a high position, causing a significant blow to market sentiment. From 2016 to 2019, the equity market showed a relatively weak oscillating trend overall, with core assets and track investments gradually becoming mainstream.

The bond market has distinct thematic trends. In 2015, driven by the stock-bond seesaw effect, liquidity easing, and rapid development of interbank business, the bond market continued to strengthen until the fourth quarter of 2016 when policies clearly targeted the suppression of capital turnover, coupled with an increase in expectations for fundamental improvement, leading the bond market into a bearish phase. After 2018, the Sino-U.S. trade friction gradually became the main trading logic in the market, and the bond market once again entered a slow bull market.

• Since 2020: Period of Stable Leverage

The public health event in 2020 had a significant impact on the pace of economic development in our country. Driven by the core demand for stable growth, our country shifted from deleveraging back to stable leverage, leading to structural changes in leverage levels across different sectors.

The leverage ratio of the household sector and non-financial corporate sector has remained basically stable, with limited space and willingness to increase leverage. Home buying is the main purpose for households to increase leverage. Since 2021, the real estate market has gradually entered a downward adjustment cycle, with frequent occurrences of debt defaults and bankruptcies among real estate companies. The resulting unfinished projects have significantly impacted residents' willingness to purchase homes, and the relatively weak income expectations in the future have also caused additional disturbances to residents' home buying behavior.

The core factor hindering non-financial enterprises from increasing leverage is the relatively weak overall demand. The production-driven stable growth model has led to a re-emergence of the issue of overcapacity. Coupled with insufficient confidence in the future economy, enterprises lack the willingness to increase leverage and expand capacity. The mantra of "cash is king" and "survivors are kings" has become the new essence of enterprise production and operation.

Under the drive of counter-cyclical adjustment, government departments have become the main force in increasing leverage, with the central and local governments stabilizing or becoming the core tone. Since 2020, the intensity of fiscal policy has significantly increased compared to previous years.

Constrained by a relatively limited macroeconomic background, the growth rate of local fiscal tax revenue has come under pressure. The land transfer income, which was previously a major component of local finance, has experienced three consecutive years of year-on-year negative growth since 2022. While facing pressure from unpaid collections, local finances still need to expand fiscal expenditures to stabilize the overall economy, leading to increased pressure from fiscal mismatches.

Against this backdrop, our country's fiscal policy has begun to show differentiation. The relatively strong central government has taken on the main task of increasing leverage by expanding fiscal expenditures through raising the deficit ratio and issuing special government bonds. Local governments, on the other hand, focus on stabilizing leverage, reducing debt, and preventing risks, striving to achieve development through debt reduction.

**Overall, since 2008, our country has basically gone through a relatively complete leverage cycle, experiencing a development stage from comprehensive leverage to deleveraging and then to stable leverage. We believe that the current leverage change pattern of "government rising, households and enterprises stabilizing" may be maintained for a period of time, with the core turning point likely depending on when the real estate market stabilizes and when economic expectations improve **

3 How Will the American Version of "Debt Conversion" Play Out?

Drawing on China's deleveraging journey, we hope to use this as a reference to make forward-looking judgments on the potential arrival of the American version of "debt conversion." To do this, we first need to clarify the leverage levels of various sectors in the United States and attempt to answer key questions such as whether the U.S. really needs debt conversion, how to implement it, and what the impacts might be.

Government leverage is high, while the leverage of the real economy is relatively healthy. A horizontal comparison shows significant differences in leverage levels across sectors between China and the U.S. In China, the leverage levels of non-financial enterprises and households are relatively high, while the leverage of central and local governments is relatively low. In contrast, in the U.S., the government sector has become the main driver of leverage, especially since 2020, when its leverage ratio has risen to over 110%, while during the same period, the leverage ratios of households and non-financial enterprises have shown a downward trend.

Does the U.S. need "debt conversion"? When the issue of fiscal balance becomes a potential obstacle to advancing tax reduction policies, how to increase revenue and cut spending becomes a real challenge for the Trump administration. The reason the Trump administration needs to promote the American version of "debt conversion" may stem from its core policy proposal to make the 2017 TCJA Act permanent.

On one hand, since 2022, the scale of the U.S. fiscal deficit has been widening year after year, with the fiscal deficit accounting for 6.4% of GDP in 2024, making fiscal sustainability an increasingly pressing concern. As the two sides of the fiscal balance scale, if Trump wants to implement further tax cuts, it may lead to a decline in fiscal revenue, thereby exacerbating fiscal deficit pressure.

On the other hand, after the 2024 presidential election, although the Republican Party successfully secured both the House and Senate, its majority is not significant, with a 53:47 lead in the Senate and only a 220:215 lead in the House. If Trump wants to smoothly promote tax reduction legislation, he not only needs to ensure comprehensive support from Republican lawmakers but may also need to seek bipartisan support from individual Democratic lawmakers in the face of internal opposition. A relatively healthy and balanced fiscal state may be key for Trump to garner additional votes.

From this perspective, the tax reduction legislation, as the main focus of the Trump administration, is crucial for attracting voters and building popularity for both himself and the subsequent Republican Party. A good fiscal state helps increase the probability of successfully passing the tax reduction legislation, which may also be one of the important considerations for the Trump administration in promoting the American version of "debt conversion."


How to "debtify"? Increase revenue and cut expenses, a dual approach to promote deleveraging. The main body of China's deleveraging is non-financial enterprises, which mainly clear excess capacity in industries such as steel and coal through administrative orders, tighten financing restrictions on local government financing platforms, and promote the decline of corporate leverage ratios.

The leverage ratio of American households and non-financial enterprises is not high; instead, the main body of deleveraging is the government sector. Generally speaking, the main purpose of government bond issuance is to cover fiscal deficits, and increasing revenue and cutting expenses have become the main means for the Trump administration to promote deleveraging.

On the revenue side, the Trump administration proposed the concept of reciprocal tariffs under the pretext of reducing the trade deficit, wielding the tariff stick against multiple countries or regions such as Europe, Canada, and Mexico. The tariff policy has shifted from verbal threats to actual implementation.

For the United States and its opponents, imposing tariffs on each other can be described as a mutually destructive situation, with the ultimate burden gradually shifting to consumers in various countries. However, for the Trump administration, tariff revenue can be fully counted as fiscal revenue, which may help promote fiscal balance. At the same time, the tariff policy may force companies from other countries to invest and establish factories in the United States, increasing new tax sources while promoting American re-industrialization.

On the expenditure side, the Trump administration promoted the establishment of the Department of Government Efficiency (DOGE), led by Musk, launching a large-scale cost-cutting movement within the government. According to data from the DOGE official website, it is expected to achieve approximately $105 billion in expenditure savings through a combination of multiple strategies such as asset sales, contract cancellations/re-negotiations, and interest savings.

At the same time, the Trump administration continues to push for reforms in federal bureaucratic agencies, closing institutions such as the Consumer Financial Protection Bureau, and maximizing fiscal savings through increased layoffs and reduced hiring.

In addition, the total scale of over $36 trillion in U.S. Treasury bonds and their payable interest constitutes the core challenge of America's "debtification." The new Treasury Secretary, Becerra, recently publicly stated Trump's focus on the 10-year U.S. Treasury yield, suggesting that the yield should naturally decline with the implementation of policies. Coupled with Trump's continued pressure on the Federal Reserve to promote further interest rate cuts, this may reflect his policy consideration of reducing the refinancing costs of U.S. Treasury bonds to alleviate interest payment pressures.

Moreover, in conjunction with the Trump administration's recent practice of demanding "protection fees" from Ukraine and NATO countries, the approach of exchanging U.S. Treasury bonds for protection may become one of the potential paths for America's "debtification."

What is the impact? Economic expectations may change, and a slight recession may become a potential path. If the U.S. version of "debtification" continues to advance, it may directly impact the U.S. economy by affecting fiscal revenue and expenditure The U.S. economy is primarily composed of personal consumption expenditures, but government consumption expenditures and total investment should not be underestimated. Based on the average since the first quarter of 2021, their impact on the year-on-year GDP growth rate is approximately 0.32 percentage points. If we further consider the leverage effect of fiscal spending on transfer payments to the private sector, its impact on the economy may be even greater.

Previously, the market generally believed that the Trump administration would maintain a relatively high intensity of fiscal spending. However, based on the path analysis of the U.S. version of "debt reduction," we believe that the Trump administration may adopt a "small government" approach.

Fiscal contraction not only directly affects the U.S. economy but may also cause additional disturbances to market expectations. Coupled with the seemingly escalating external trade frictions, high domestic inflation expectations, tightening immigration policies, and the push for government downsizing by DOGE, this may ultimately lead to a potential path of slowing U.S. economic growth or even a slight recession.

U.S. stocks may face multiple pressures, and the downward space for U.S. Treasury bonds is expected to open up. Reviewing China's deleveraging process, the overall trend has shown a calm equity market and a long bull-short bear characteristic in the bond market. We believe that in the next phase, U.S. stocks and Treasury bonds may show divergent trends.

For U.S. stocks, the rising expectations of a U.S. recession are the main reason for the recent pullback in the stock market. If the recession narrative turns from expectation to reality, it may significantly suppress investors' risk appetite. Coupled with the impact of China's rise in AI on the narrative logic of technology stocks, this may lead to the gradual end of the technology narrative that began in 2023.

For U.S. Treasury bonds, although the risk of secondary inflation still exists, with the recession narrative gradually heating up, expectations for Federal Reserve interest rate cuts rising, and the Trump administration promoting the U.S. version of "debt reduction," the downward space for Treasury bond yields may further open up.


Author of this article: Qin Han, Cui Zhengyang, Source: Qin Han Research Notes, Original Title: "Debt Relief from a Chinese Perspective"

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