Trump’s Tariff War Just Went Nuclear
In a Nutshell
Trump is using tariff threats against half of America’s trading partners as leverage to force the Fed to slash interest rates, since the government’s mandatory spending on interest, Social Security, Medicare, and veterans benefits already exceeds tax revenue. Foreign central banks are quietly exiting US Treasuries and repatriating gold, forcing the Treasury and Fed into “financial repression”: shifting debt issuance to the short end, compelling banks, stablecoins, pensions, and money-market funds to absorb it, and offering cheap loans to key holders so they don’t sell. The goal is to keep long-term yields from spiking, preserve the dollar’s reserve status, and hide the scale of monetary accommodation until after the September 16 Fed meeting.
These notes were generated by AI and may contain inaccuracies.
Donald Trump threatened to stop trading with about half of America's trading partners, including Mexico, Canada, China, Japan, Germany, South Korea, India, and Taiwan. This represents approximately $300 billion per month in trade. The rationale given is that some countries are paying half a point while the US pays four points, and if the US does not trade with them, they will not have money to pay their bills. The US could eliminate its trade deficit by simply not trading with deficit countries.
Lender nations are increasingly pulling their gold out of the US and walking away from US debt. A trade deficit occurs when countries sell America more than they buy from it. For 80 years, those countries bought US treasuries with those dollars, which allowed the US to continue buying from them. Trump threatening every country the US runs a deficit with means threatening countries that hold America's debt, which is the whole world.
The story presented is that the president is now at war with his own central bank and is using trade as a nuclear option to get lower interest rates. Each point in interest costs the US $650 billion, and the US should be at 1% or half a percent rather than 4%. Other countries are at half a percent despite the US preventing their bankruptcy.
The US government collects taxes as income, with three bills it cannot stop paying: interest on the debt, Social Security, Medicare, and veterans benefits. These add up to what Luke Groman calls the true interest expense, which is currently 105% of everything the government takes in. This spending is growing at twice the speed of tax revenues. Every time interest rates go up, the debt gets worse.
Kevin Worsh, the Federal Reserve chairman, cannot publicly agree with Trump and lower interest rates because diesel refinery rates have tripled since the Strait of Hormuz closed, the commodity index broke out to a 10-year high, and businesses are reporting the highest prices paid in about four years. If the Fed lowers interest rates while prices rise, the bond market will demand higher yields to hold US bonds. Long-term rates would go up on their own, making mortgages, car loans, and corporate borrowing more expensive.
Kevin Worsh needs interest rates to go lower because of the true interest expense, but cannot raise rates either because it could blow up the stock market by repricing trillions of dollars of loans on the balance sheets of American life insurance companies. The market is pricing in a 40% chance he holds and a 60% chance he increases interest rates on September 16th.
Germany, France, and the Netherlands are moving their gold out of New York. Japan potentially sold more US debt in one month than ever before. The United States plans to keep borrowing without those lenders and without it showing up in the data. The US owes more than it can afford, and the people who lent it money are starting to leave that system.
The plan involves the Fed acting tough on inflation and possibly raising interest rates slightly so bond investors think they're being responsible. Behind the scenes, the Treasury will move debt from long-term bonds where investors decide the rate to short-term bills where the Fed decides the interest rate. Using policy changes, banks, stablecoins, pension funds, and money market funds will have to buy that debt whether they want to or not.
Anyone trying to leave the dollar system will be lent money at favorable terms so they never have to sell their US treasuries. Anyone not playing ball will face sanctions. This is effectively quantitative easing, but this QE will not show up on the Fed balance sheet chart as printing money. It will have the same effect: the power to set America's interest rates will move from the bond market to the central bank, and the bill will be paid by anyone holding dollars or bonds at a rate below inflation.
This process is called financial repression. The government does not get to pick the yield on bonds - the buyers, the people lending the money, determine it. If enough people want US bonds, the government can offer a lower rate. If fewer people want to buy them, the government must offer a higher yield to incentivize purchases.
The yield on a US Treasury represents a real-time vote by everyone who lends money to America, based on how much lenders want to be paid to trust the nation. The 10-year Treasury yield determines rates for mortgages and everything else. The bond market effectively controls a nation because presidents come and go, but capital drives their actions.
The 10-year yield is at 4.76%, the 30-year is above 5.2%, and mortgages are at 7%. These are the highest rates since before the financial crisis. The long end of the bond market is seeing yields go up because people who used to buy are slowly starting to sell. The total of interest, Social Security, Medicare, and veterans benefits is now 105% of everything the government makes.
Ground News is an app that shows the same story from hundreds of outlets simultaneously, indicating which lean left, right, or center. An example is Europe and Canada's new partnership covering trade, defense, supply chains, and raw materials, covered by 60 news sources. Left-leaning outlets frame it as Canada responding to an assertive United States with defense cooperation. Right-leaning outlets frame it as a counterweight to both the US and China, warning Canada could become a de facto European protectorate.
The process began around 2014 when Russia annexed Crimea and the US hit it with sanctions. Foreign central banks and sovereign funds held about 4.1 trillion of US debt at the end of 2014, and 11 years later they held about 3.9 trillion. Meanwhile, US debt went from 18 trillion to roughly 40 trillion. Private investors, hedge funds, and the Japan carry trade filled the gap. As measured in gold, long-term treasuries have lost 85 to 90% of their value since 2014.
Scott Bessant stated that the Strait of Hormuz will be bypassed in 2 years and become worthless as a choke point. For 80 years, the dollar was also a choke point that the United States used as a weapon against everyone, including its allies, which is why they are now gradually leaving that system.
Norway's $2.3 trillion sovereign wealth fund announced a cut of about $80 billion in US Treasury holdings. Europe is launching a savings and investments union to invest €300 billion worth of savings that currently leaves the continent each year. All 27 EU members signed the new savings and investment plan. Xi Jinping signed a declaration with Russia, India, and Pakistan condemning US strikes and sanctions on Iran. China put a 20% tax on dividends from foreign stocks and is auditing offshore trusts.
The Netherlands moved 86 tons of gold out of New York to London. France took 129 tons back to Paris between last July and January. Germany brought 300 tons home and is debating what to do with the remaining 1,200 tons still at the Fed. Japan sold about $88 billion worth of foreign securities in August, the biggest monthly sale in Japan's history. The Bank of Japan pushed its 10-year yield to 3%, the highest since 1996.
The dollar's share of global reserves is now less than 57%, the lowest on record. The share held in currencies outside the big four is at an all-time high.
Scott Bessant hinted at using the Treasury General Account (TGA) to buy back US debt. The TGA currently holds about $950 billion. If nations trim just 10% of their US treasury holdings, that would exceed the entire TGA balance.
The US is selling from the strategic petroleum reserve to push oil prices down. The reserve is now at 287 million barrels, the lowest level since 1982. China is the new big buyer entering the market. China has a $1.2 trillion annual trade surplus. Shanghai crude crossed $100 a barrel while China is paying $5 more than everyone else for Brent crude. China's imports dropped by a third when the Strait of Hormuz closed, but now their storage is running low.
Scott Bessant allowed Japan to borrow up to $60 billion a day against its treasuries instead of selling them. The UAE got the same deal to park treasuries at the Fed and get dollars. Saudi Arabia got a $58 billion loan under the same arrangement. All these measures are the US paying nations to incentivize them not to leave the system.
The market is split into two camps. Camp one believes the Fed and president are separate entities, with the Fed caring more about inflation and the bond market than Trump, so rates will stay the same or go up on September 16th. Camp two believes they are working together, with Trump having picked both Kevin Worsh and Scott Bessant to get interest rates down. The Fed cannot just lower rates immediately because the bond market would punish them and long-term rates would go up anyway. They need an excuse like a breaking jobs number, stock market crash, World War III, or massive food shortages from an Iran-driven oil crisis.
The bond market could break so hard that the Fed has to step in to restore order the same way the Bank of England did in 2022. Trump's tariff threats could be that cover. Threaten to shut off half the world's trade, and growth forecasts get cut in half. The Fed would then have its reason to lower rates.
For now, it looks like the market believes the Fed is going to raise their interest rates. The likely action will be to increase interest rates by the lowest possible amount, a quarter percent if anything, or possibly keep it the same. The Treasury will continue to shift the long-term debt to the short end while the Fed holds or creates the illusion of being tough on inflation.
The way to know what the Fed's real intention is going to be is to pay attention to what they're actually doing because they will be very sneaky about it. They don't want the bond investors to realize this is happening by looking at some simple chart like the Fed balance sheet. Don't expect the Fed to just start buying bonds to lower rates because that would be visible in this data. Investors would catch that and they would demand a higher rate.
The strategy that the Fed will most likely use to hide this mechanic was the same one that was used after World War II, which was to change the rules so that banks, insurance companies, and pension funds had no choice but to hold the debt. They loosened the rule that limited how many treasuries big banks can hold. They even passed a law that forces every stable coin to be backed by treasuries. They're racing to get the Clarity Act approved as fast as possible. They're also lending to nations like Japan and the Gulf so that those countries don't sell our debt.
On September 16th, the Fed could be like, "Look, our balance sheet is getting smaller. We're not printing money because we care a lot about our bond investors." And it'll be partially true. They'll have the plausible deniability, but the big print will have moved somewhere people are not looking. This approach is called financial repression.
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