Honey, we shrunk the government
No recession risk yet - but wise to take down risk for now
TL;DR
The economic policies of the current administration aim to transition the U.S. economy away from dependence on government-driven growth toward a more sustainable, private-sector-led expansion. Central to this approach is a strategic willingness to endure short-term economic discomfort—an "engineered recession"—to achieve structural reforms and longer-term economic stability. This represents a significant shift in priority from Wall Street to Main Street priorities.
The problem
For decades, the US has benefited from dollar dominance and the resulting ability to consume beyond its means by selling assets to the rest of the world. This arrangement appears increasingly unsustainable.
Julian Brigden has outlined why this is a problem:
The US has become increasingly reliant on wealth effects and financialization (bouyant stock market) to drive consumption, rather than productive investment and income growth.
As a result of strong stock market performance, foreign investment has increasingly flowed into US equities rather than direct investments or factories, creating dependency on continued market outperformance.
As a result, the net international investment position (the difference between US-owned foreign assets and foreign-owned US assets) has grown to -$23.6 trillion (over 80% of GDP), creating a dependency on these foreign capital flows.
Furthermore, the current account deficit has ballooned to over 4% of GDP, requiring foreign investors to fund this gap annually through asset purchases or loans. This is pushing bond yields up and making hard to finance our deficits.
The solution
The administration’s response is to shrink the size of government (and deficits).
“The market and the economy have become hooked, become addicted, to excessive government spending, and there’s going to be a detox period” - Scott Bessent (Treasury)
The administration is taking the problem seriously. As Scott Bessent's "detox" metaphor suggests, the administration views the economy as having become dependent on unsustainable fiscal stimulus, government spending, and continued foreign capital inflows. The policy responses now being considered – whether coordinated currency interventions, tariffs, or strategic asset acquisition – represent attempts to manage this transition without surrendering global economic leadership.
One of the most consequential aspects of this strategy is the administration's apparent indifference to stock market fluctuations:
The "Trump Put" Has Expired - If US assets underperform international markets, capital will naturally flow toward better opportunities. Unlike previous administrations that quickly pivoted to supportive policies when markets declined significantly, the current administration appears willing to accept market weakness as part of its broader strategy.
Policy Relief May Come Later Than Expected - Market weakness is an intentional feature rather than an unintended bug (e.g. a domestic economic slowdown would mechanically reduce the current account deficit). Because of this, the administration might allow a deeper and more prolonged correction before introducing supportive measures
Are we headed to a recession?
Clear indicators of economic deceleration have emerged. GDP growth has fallen, services PMI has fallen precipitously, and financial market stress has intensified, with volatility spiking as asset prices fall.
This is deliberate. The economic weakening aligns with several policy objectives:
Tackling Inflation: Core PCE inflation, currently at 2.6%, remains above target. Inducing economic slowdown reduces aggregate demand, weakens wage pressures, and facilitates quicker disinflation, thereby directly addressing the administration’s priority of easing cost-of-living pressures.
Rebalancing Trade via a Weaker Dollar: Economic slowdowns traditionally trigger currency depreciation. A weaker U.S. dollar would enhance export competitiveness, discourage imports, rebalance trade, and strengthen negotiating positions with international trade partners, all aligning with the administration’s broader economic agenda.
Forcing Rate Cuts: The current administration appears focused on lowering the 10-year Treasury yield as a means to reduce rates and benefit average Americans. By engineering economic weakness, the administration creates compelling justification for Fed rate cuts, potentially overcoming the Fed's hesitation due to still-elevated inflation. Lower rates would support administration priorities:
Reducing mortgage rates to improve housing affordability
Lowering borrowing costs for smaller businesses, a key constituent base
Reducing federal interest payments on the $36 trillion national debt
Eventually supporting asset prices once the initial correction happens
However, I don’t think we are in (or are headed toward) an actual recession, defined as two consecutive quarters of negative GDP growth. The likely case is lower than baseline growth (1-2%) and moderate inflation (see more in last week’s post here)
Timeline and Trajectory
If the thesis above is correct, we might expect the following to occur:
Current Phase (Q1-Q2 2025): Continued economic deterioration, market volatility, and policy uncertainty as the "detox" process proceeds. The administration likely remains comfortable with this weakness as it advances strategic objectives (increase cash reserves; limit exposure to market)
Middle Phase (Q3-Q4 2025): Fed capitulation with rate cuts once growth weakens sufficiently and inflation moderates further. However, bond markets face secular headwinds in H2-2025. At least $6-9 trillion of debt needs to be refinanced, which could create trouble in the Treasury market. Competition for funding will intensify as traditional sources of excess savings (China and Japan) reduce their purchases of global bonds (slowly increase exposure to the market, but watch bond auctions and manage risk)
Later Phase (Q4 2025-2026): Economic stabilization and potential recovery as the benefits of lower rates, restructured trade relationships, and sector-specific support begin materializing. The economy emerges with lower inflation, more balanced trade, and potentially more sustainable growth drivers (risk-on)
I like the outline of the problem and I hope your version of the soft landing can be achieved. But in policy terms, I think there are is a few things I would like to note: 1) I don't think currency interventions are necessary or recommended, especially if many other policies are right. 2) Tariffs do not change the trade balance, only the savings investment balance does that. Therefore, your emphasis on federal borrowing and debt makes sense.
But so far the Trump Administration and Congressional Republicans have shown no desire to lower deficits, on the contrary. The so-called DOGE effort has so far yielded no significant savings from spending; and the recently passed Budget Resolution envisions an increase of $3.5 trillion of debt over 10 years (from a base of about $25 trillion).