Former U.S. Treasury Secretary Warns of the Risk of a “U.S. Treasury Crash”; Federal Reserve Trader: The Real Threat Is a Collapse of the Dollar

Former U.S. Treasury Secretary Paulson (Henry Paulson) has recently urged the government to draw up an emergency response plan for a U.S. Treasury crisis in advance, warning that the consequences of a market collapse would be “extremely severe.” However, former Federal Reserve trader Joseph Wang believes that, technically, the U.S. will not trigger a Treasury crisis in the way people fear; but the cost of printing money to rescue the market may instead lead to a collapse of the dollar’s own credit.

Paulson’s concern: Weak demand for U.S. Treasuries; after a crash, the consequences would be “extremely severe”

In a recent interview with Bloomberg TV, Paulson said the U.S. government should first have a contingency plan for an emergency response to a Treasury crisis, to address risks accumulated from long-term fiscal deficits:

We need an emergency response plan—one that is targeted, short-term, and prepared in advance, so that once we hit a wall, it can be activated immediately.

He noted that this potential crisis differs in nature from the 2008 financial crisis he faced when he led the Treasury Department 20 years ago. Back then, even though the situation was dire, the government still had enough fiscal room to carry out rescues; but if a Treasury crisis erupts in today’s environment of weak demand, the Federal Reserve could end up as the only buyer, and interest rates would likely stay high and be difficult to reverse:

If it happens, it would be very severe, so we must prepare in advance.

The risk of a “death spiral” emerges, with debt possibly reaching 108% of GDP by 2030

The “death spiral” mechanism Paulson is concerned about refers to investors demanding higher yields because government debt keeps swelling, which raises the government’s interest expense and further enlarges the deficit, creating a vicious cycle. Currently, the U.S. fiscal deficit has averaged about 6% of GDP over the past three years; this figure is generally seen only during wartime or in the later stages of a severe recession.

According to projections by the Congressional Budget Office, this level is expected to continue for the next decade, and it is projected that in 2030, U.S. debt as a share of GDP will reach a record high of 108%, exceeding the 106% level during World War II.

In response, the solutions Paulson proposes include: increasing fiscal revenue by closing tax loopholes, cutting government spending, and carrying out structural reforms to social security and healthcare coverage systems.

Former Federal Reserve trader: A Treasury crisis won’t happen, but the dollar will likely pay a price

In response, Joseph Wang, a senior trader at (Open Markets Desk) in the Federal Reserve System, believes that because U.S. Treasuries are denominated in dollars, and the dollars themselves are issued by the Federal Reserve, the Fed can technically purchase Treasuries indefinitely and set interest rates at any level needed: “Therefore, the literal ‘Treasury market crisis’ is almost impossible to occur under the current monetary system.”

He pointed out that the real risk lies in an “FX crisis.” When the Federal Reserve prints large amounts of money to buy bonds, diluting the dollar’s purchasing power, it could shake foreign investors and trade partners’ confidence in the dollar, leading to a sharp depreciation of the exchange rate, surging prices of imported goods, and runaway inflation.

A deeper threat is the fundamental undermining of the dollar’s position as the global reserve currency, and this kind of crisis also cannot be resolved through “debt restructuring.”

Two perspectives: U.S. fiscal risk will eventually erupt in some form

The viewpoints of Paulson and the former Federal Reserve trader appear, on the surface, to be at odds, but they actually point to the same core issue: the risks accumulated from long-term U.S. fiscal imbalances will ultimately be reflected in the markets in some form. The difference is whether it will be a liquidity crisis in the bond market or an FX crisis.

Bloomberg strategist Ira Jersey admits that as the debt-to-GDP ratio keeps climbing, the room for a rebound in the Treasury market in the future will become increasingly limited, while each downturn will be more severe. Against the backdrop that the U.S. fiscal deficit cannot fundamentally improve in the short term, the form of this crisis is already drawing significant attention.

This article, “Former U.S. Treasury Secretary Warns of the Risk of a ‘U.S. Treasury Crash’; Federal Reserve Trader: The Real Threat Is a Collapse of the Dollar,” first appeared in Lian News ABMedia.