Bond market nightmares

0:01NPR.

0:11This is The Indicator for Planet Money. I'm Adrian Ma. And I'm Waylon Wong. The bond market recently gave us a good scare. This is after President Trump's Liberation Day announcement last month. You may remember that there was a sell-off in U.S. government bonds. Yeah, that was alarming because U.S. treasuries are usually this safe haven in times of economic uncertainty. These bond market jitters reportedly spooked Trump so much that he paused some of his big tariff plans. and the scariness of what happened with treasuries has actually stayed with us. Like the lingering dread you might feel after watching a horror movie.

0:51I'm still sweating, Adrian. So today on the show, we confront our fears about the bond market. We enter a twilight zone of nightmare scenarios for U.S. treasuries. Come with us, if you dare, after the break.

1:14This message comes from NPR sponsor, Capella University. Sometimes it takes a different approach to pursue your goals. Capella is an online university accredited by the Higher Learning Commission. That means you can earn your degree from wherever you are and be confident your education is relevant, recognized, and respected. A different future is closer than you think with Capella University. Learn more about earning a relevant degree at capella.edu. This message comes from BetterHelp. As a dad, BetterHelp president Fernando Madera relates to needing flexibility when it comes to scheduling therapy.

1:50I have kids under 18, so time is very limited. That's why at BetterHelp, our therapists try to have sessions sometimes at night, depending on the therapist or during the weekend. And so I think that's what we need to tell the parents. You're not alone. We can help you out. If a flexible schedule would help you, visit BetterHelp.com slash NPR for 10 % off your first month of online therapy. The U.S. Treasury market is massive. We're talking almost$30 trillion worth of outstanding bonds. That's money the U.S. government has borrowed from investors. And it uses that money, along with tax dollars, to fund everything the government does.

2:34Now, most of these bondholders are in the U.S., but investors all around the world are usually clamoring to hold U.S. treasuries. They know historically that the U.S. pays its debts on time. And therefore, investors don't demand a high interest rate from the U.S. government. This is part of what's known as the U.S.'s exorbitant privilege. Mark Williams is an economist at a firm called Capital Economics. It advises central banks and corporations on investment decisions. And Mark says investors' healthy appetite for treasuries keeps prices for these bonds high and interest rates for government debt low.

3:09You really do want there to be a large pool of investors who are happy buying it. As it goes, the price is going to go down and the interest rate on U.S. government debt is going to go up. So the U.S. government really doesn't want to be in a position where you have much higher interest rates on that debt. Last month, the Treasury market got a taste of what happens when this arrangement breaks down. Bond prices fell, along with stocks and the dollar. And what that suggests is that rather than people being worried about the outlook and piling into the bond market, which is the normal thing they do, they just have been deciding, you know what, I don't want to have anything to do with U.S.

3:46markets at all. I'm looking elsewhere. And so we saw that the currencies of Japan, the euro, all strengthening. That's kind of the scary, slightly unusual bit. So what would happen if the bond market got spooked again, maybe for longer? Now we are entering the twilight zone, a realm of the hypothetical where we confront our worst nightmares about U.S. Treasuries.

4:14Picture, if you will, a dim hallway with three doors. Each door leads to a scenario for U.S. debt. Behind door number one, what happens when investors do not want U.S. Treasuries anymore? Uh, there is some scary stuff happening here, okay? The U.S. Treasury is trying to sell new bonds, but no one's showing up to buy them. And there are also investors who already own Treasuries who are dumping them. They're running away. Yeah, a version of this did play out during last month's Treasury market freakout. Rumors swirled about whether foreign central banks or governments were doing the selling. There have been stories that it was the Japanese were selling, the Canadians, Europeans, the Chinese.

4:58Mark doesn't think foreign governments did much selling. This is because central banks typically act slowly. So that leaves private investors like insurance companies or hedge funds as the ones who most likely got spooked. And Mark says investors yanking their money is typically something you see happen to emerging economies, not the U.S. The U.S. is usually the place actually you go to when you're worried about the future. It's not the place you flee from. When investors flee treasuries, interest rates on U.S. government debt go up. And that spells trouble for the government. That's according to Me Too Galati.

5:34He's a law professor at the University of Virginia and an expert in what happens when governments can't pay their debts anymore. Our debt load, the largest in the world, is in the trillions. So a tiny increase in our borrowing costs means that if we have a lot of money coming due and we need to borrow again, that money has to come from somewhere. Governments who need money can borrow it by selling bonds. That's usually what the U.S. does. It's like this revolving door where it borrows new money to pay older debts. But in our bond nightmare scenario, investors are running away from treasuries. So there aren't enough buyers for new government bonds.

6:20Me Too also points out that the Trump administration is loathe to raise taxes. And it doesn't want to fuel inflation by printing money. Then you have no new money coming. And that will produce pressure to come up with creative solutions. One such creative solution lies behind door number two. And some investors would probably consider this a nightmare scenario. So this idea recently popped up in a paper written by Stephen Myron. He's the current chair of the White House's Council of Economic Advisors, which means he has the president's ear. Mayran wrote this paper in November before he joined the administration.

7:03And in it, he proposed a debt swap. He said the U.S. could approach foreign governments who are holding short-term treasuries. These would be bonds that come due in two or three years. He proposed saying to them, you should take your short-term treasuries and exchange them for 100-year bonds that have the payout coming 100 years from them. Oh, so there's no annual coupon payment. You just you wait 100 years to get your money back. Yes. And by then, presumably, this current government is not going to be in place. And so that's someone else's problem. Now, this is a very extreme option, something Me Too says would only happen if the Treasury market were in shambles.

7:50And even proposing a debt swap would be tantamount to the U.S. defaulting. It's basically admitting that the government needs more time to pay back its debts. And what investor would want to take that deal? Well, this hypothetical nightmare actually gets worse. Potentially, if things go belly up yet further, interest rates will rise. And we'll be in a situation of having to do this on a slightly involuntary basis. Involuntary, meaning the U.S. government would just say to bondholders, this is happening whether you like it or not. That two-year bond in your portfolio is now a hundred-year bond.

8:33And Michoud says the U.S. government can do this because, as far as he knows, there are no actual contracts for treasuries. There are only regulations, and those can be changed. I don't get a piece of paper with the terms on it? No, and nobody ever asked for a piece of paper. It's just a regulation that, in theory, the U.S. can change whenever it wants. For now, a U.S. debt exchange is still highly unlikely. So let us turn our attention to door number three. Behind this door are what MeToo describes as more reasonable policy options for tackling the massive debt load. I think we're still in a safe space.

9:16like the market has panicked, but it has kind of unpanicked a little bit. The realistic scenario, I think, would be we would just A, raise taxes and B, spend less, and then we could get out of it. We are rich enough to get out of such a situation. Do we have the willingness to raise taxes and tighten our belt? That's an altogether different question. And that's more of a political question. Honestly, raising taxes is some people's worst nightmare. It's worse than anything else we've described here. I would say the Trump administration's answer to that political question is kind of the opposite, to promise tax cuts and increased spending.

10:04Well, as we know, there's been massive cuts to the federal government, potentially more to come. But the administration wants to spend significantly more on defense and border security.

10:17This episode was produced by Lily Kuros and engineered by Kweisi Lee. As fact-checked by Sierra Juarez, Kicking Cannon edits the show and The Indicator is a production of NPR.

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