Bessent's Grand Strategy: The Great Shift of U.S. Debt
Against the backdrop of worsening deficits in the United States, Deutsche Bank has proposed the "Pennsylvania Plan," aimed at reducing reliance on foreign capital and absorbing deficit financing needs through domestic resources. This plan could lead to a steeper U.S. Treasury yield curve, a weaker dollar, and exacerbate the fiscal pressure on the Federal Reserve. The U.S. faces a dual deficit dilemma, and the direct approach to solving this issue is to tighten fiscal policy, but the political environment lacks the willingness to do so. Deutsche Bank believes that the "Mar-a-Lago Agreement" is unfeasible, and any attempts at debt adjustment will only worsen the situation
Against the backdrop of the increasingly severe deficit issue in the United States, Deutsche Bank has proposed a policy framework called the "Pennsylvania Plan" — the path most likely to be chosen by the current Treasury Secretary, Janet Yellen.
Recently, the U.S. budget bill is about to pass through voting legislation, and several Federal Reserve officials unexpectedly mentioned the possibility of a rate cut in July, while the Federal Reserve Board also plans to discuss easing bank regulatory requirements.
According to news from the Wind Trading Desk, Deutsche Bank analyst George Saravelos recently released a research report indicating that these seemingly unrelated events actually herald a major transformation in macroeconomic policy, with the core goal of reducing dependence on foreign capital and absorbing massive deficit financing needs through domestic resources.
Saravelos named this policy framework the "Pennsylvania Plan," corresponding to Pennsylvania Avenue, where the U.S. Department of the Treasury is located. The plan aims to strategically redistribute ownership of U.S. Treasury bonds from foreign investors to domestic investors, implement domestic financial repression, and vigorously promote stablecoins.
The report further points out that the "Pennsylvania Plan" may lead to a steeper U.S. Treasury yield curve, a weaker dollar, and exacerbate the fiscal dominance pressure faced by the Federal Reserve.
The United States' "Double Deficit" Dilemma, the "Mar-a-Lago Agreement" Cannot Solve
The report indicates that the current issue facing the United States is not merely a fiscal deficit problem, but a dual dilemma of fiscal deficit coexisting with a trade deficit.
More seriously, the U.S. net foreign asset position is severely negative, making it highly dependent on foreign funds, which fundamentally constrains the sovereignty and independence of the United States. Just weeks ago, the U.S. experienced a "sudden stop" in capital inflows, forcing the government to make a sharp turn in trade policy, fully exposing this vulnerability.
The report further states that the most direct way to solve the "double deficit" problem is to tighten fiscal policy, but the political environment shows a lack of willingness to do so.
Regarding the "Mar-a-Lago Agreement" proposed by Economic Advisory Council Chairman Stephen Miran, which aims to address the imbalance in U.S. finances through global debt restructuring, Deutsche Bank believes this solution is unfeasible.
The report analyzes that without improvement in the deficit issue, any attempts to adjust the nominal value of debt through extending maturities or tax adjustments will only worsen the existing financing environment for the deficit, and international creditors will not participate.
What Are the Core Strategies of the "Pennsylvania Plan"?
In response to the unwillingness of foreign investors to participate in debt restructuring and the domestic political impotence regarding deficit reduction, the "Pennsylvania Plan" proposes an alternative path, which is to coordinate through the U.S. Department of the Treasury to promote a historic transfer of U.S. Treasury bond holders from foreign investors to domestic investors.
It can be said that the core goal of this plan is to find new buyers for U.S. Treasury bonds, specifically divided into two main strategies.
First, reduce dependence on foreign buyers. The report points out that foreign investors currently hold a record exposure to U.S. sovereign duration risk, but due to the retreat of the U.S. global geopolitical and economic leadership, ongoing fiscal deficits, and increasing budget deficits in other countries, foreign demand for U.S. Treasuries is declining.
The solution is to adapt to changes in demand preferences, shortening the duration exposure of foreign investors, for example, by attracting foreign capital through dollar stablecoins (backed by short-term U.S. Treasuries).
Secondly, increase domestic absorption of U.S. Treasury duration risk.
The report notes that the U.S. private sector balance sheets are robust, with high cash holdings, which have the potential to absorb sovereign credit risk. Policy measures include incentives for domestic purchases of long-term U.S. Treasuries through regulatory exemptions (such as relaxing banks' supplementary leverage ratio requirements for U.S. Treasuries), tax incentives, and issuing special bonds.
When incentives are insufficient to significantly increase domestic absorption, mandatory requirements to purchase more long-term U.S. Treasuries will be the next step. For example, promoting retirement plans to absorb more government debt or tightening liquidity requirements for banks and insurance companies.
Market Impact: Erosion of Federal Reserve Independence and Weakening of U.S. Treasury Dollar
Although the "Pennsylvania Plan" does not fundamentally address the twin deficit issue, by mobilizing domestic savings resources, the U.S. government may gain more time.
However, the cost of this strategy will be higher U.S. Treasury yields and erosion of the Federal Reserve's policy independence.
The report analyzes that if the domestic savings pool is significantly pushed toward long-term fixed-income assets, the Federal Reserve will face greater pressure to maintain a steep yield curve and avoid financial stability risks.
At the same time, if foreign investors fund the U.S. external deficit through short-term dollar cash and bills, they will be more sensitive to absolute yield levels. Interest rate cuts may trigger larger capital outflows and dollar depreciation.
Given that a weaker currency will help rebalance the U.S. external deficit, this may not necessarily be a bad outcome economically.
The report concludes that in the absence of a willingness to improve fiscal conditions, the path most likely chosen by the U.S. government is to promote domestic investors to absorb more fiscal deficits through the "Pennsylvania Plan."
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