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wsj.com
James Freeman
Oct. 18, 2023

Government Bubble Burst
Treasury bond investors have been taking a historic beating.

pic-—Secretary of the Treasury Janet Yellen’s signature appears on bills at the Bureau of Engraving and Printing’s Western Currency Facility in Fort Worth, Texas in 2022. PHOTO: LM OTERO/ASSOCIATED PRESS

Stung by historic losses in recent years, long-term bond investors are showing a diminishing desire to lend to the U.S. government. Or maybe it’s just that the government is trying to borrow too damn much. Even in the congressional chamber controlled by Republicans, the leadership debate revolves around how many spending expansions the next speaker will jam into another debt-fueled bill.

Interest-rate math hasn’t yet intruded into politics even though it has already meted out severe punishment in the markets. Investors are now demanding more compensation in return for financing Washington’s historic fiscal recklessness. The Journal reports:

The benchmark 10-year U.S. Treasury yield topped 4.9% intraday Wednesday for the first time since July 2007.

The Journal’s Sam Goldfarb notes:

In recent months, the Treasury Department has both increased its borrowing forecasts and boosted the size of its longer-term debt auctions by more than investors had been expecting.

During the unprecedented monetary adventures following the mortgage crisis of 2008, the U.S. and other governments around the world drove interest rates down to near zero. They managed this feat in part by having their own central banks buy up government debt issued at such rock-bottom rates—and also by using regulation to encourage large institutions to buy this paper.

Some overseas locales even embraced the insanity of negative interest rates, in which bond investors had to pay government borrowers for the privilege of loaning them money. In 2016 James Grant of the indispensable Grant’s Interest Rate Observer noted that such a situation had not previously occurred in all of recorded history.

At the time, your humble correspondent called it the “5,000-Year Government Debt Bubble” but now vindication is not much fun when pondering the dangers of the current moment. The massive debt piles accumulated while governments were artificially holding interest rates at or below rock bottom are quickly becoming much harder to bear.

In the U.S., the Committee for a Responsible Federal Budget recently noted:

Although most of our national debt was issued when interest rates were low, that debt is quickly rolling over into a high-rate debt environment, and further borrowing continues. Without corrective action, interest costs could total more than $13 trillion over the next decade and $1.9 trillion per year by 2033.

Relying on the CRFB’s work, Neil Irwin at Axios writes:

If current rates stay high and fiscal policy matches current forecasts, the cost of servicing [federal debt] will surpass defense spending in 2025 and top Medicare spending in 2026.
In the current fiscal year, interest spending is on track to surpass $800 billion, more than double 2021’s $352 billion figure. In 2026, the government’s net interest expense would reach 3.3% of GDP, the highest on record.

As for Mr. Grant, next month he will publish the 40th anniversary edition of his eponymous newsletter and he freely admits that he didn’t expect the era of extremely low interest rates to last as long as it did. But he’s come to appreciate that Rome “wasn’t unbuilt in a day.”

In the U.S., the long unbuilding project has involved massive government spending and borrowing enabled by the Federal Reserve’s artificially easy money. Trying to tame the resulting inflation then necessitated the Fed’s rapid increase in interest rates and a halt to its bond-buying binge. So now outside investors have more say in the price of credit, and the price says that they’re less eager to be Washington’s creditor.

Mr. Grant recently wrote about the virtues of market-based interest rates versus those manufactured by governments:

In the first place, a proper price, i.e., one discovered in the market, conveys information. To be sure, it is kaleidoscopic information, volatile and fast-changing, but it’s information drawn from people who risk their money to express an opinion. An arbitrary price also conveys information, but only the static, uninteresting kind that tells you what the rate-setters intended when they fixed the price (without, of course, writing a check for the privilege).

He’s now hoping for a day when a new gold standard will replace the current “Ph.D. standard” guiding U.S. monetary policy. Until then, let’s hope the country can find a way to muddle through despite Washington’s titanic mistakes. Of course Washington must first acknowledge these mistakes and start debating how to reduce, not increase, federal spending.

Mr. Grant for his part has learned that interest-rate cycles tend to last a very long time, so anyone hoping for an imminent return to the era of rock-bottom interest rates may be deeply disappointed.

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James Freeman is the co-author of “The Cost: Trump, China and American Revival” and also the co-author of “Borrowed Time: Two Centuries of Booms, Busts and Bailouts at Citi.”

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