Trump Isn’t the Only Reason the Price of Money Is Rising

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1:54Stephanie Flanders:I'm Stephanie Flanders, Head of Government and Economics at Bloomberg. And this is Trumponomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy, and what on earth is going to happen next. This week, we're talking about the price of money, why it's going up, and why that matters to all of us, and especially to governments with big debts like France, where it's part of why the government just collapsed. I also want to explain why this big shift in the most important price in the global economy is not entirely caused by Donald Trump, though he might be speeding the process up.

2:30Stephanie Flanders:Now, when I say the price of money, I mean the interest rate. So just like anything you buy, phones, fruit, money also has a price. But instead of paying for money with other goods, we pay for it with interest. And that price of money, that interest rate, matters because it touches everything. What you pay for a home, how much companies invest, where the prices rise too fast, even how strong a country's currency is. Who or what sets the price of money? Well, short term, yes, central banks play their part. We all write a lot about that piece. But long term, that price is set by a wide range of structural factors that we're going to get into in this show.

3:09Stephanie Flanders:And I thought we should talk about it this week, well, for a few reasons. First, it's a reminder that this would have been a challenging time for governments anyway, even without Donald Trump turning the world upside down. The second reason is we're seeing the consequences of a higher cost of borrowing play out in real time this month as bond yields, the government interest rates, go up in many countries. France, I've already mentioned, now pays more than Italy to borrow from the market. It's also arguably rising bond yields that is the one factor more than any other, putting serious financial pressure on the Labour government in the UK.

3:46Stephanie Flanders:But yes, I'll admit the final reason is because we at Bloomberg Economics have written a book that explains it all, The Price of Money, A Guide to the Past, Present and Future of the Natural Rate of Interest. It was published a few weeks ago by Oxford University Press and it is available, I'm told, at all fine bookstores. And my two lead co-authors, who, let's face it, did most of the work pulling that book together are here with me now. Jamie Rush, the Director of Global Economics at Bloomberg, who's here in London, and joining again from the Washington studio, Tom Orlick, who's Chief Economist for Bloomberg Economics.

4:21Stephanie Flanders:Jamie, Tom, thanks very much for being here to hawk our book. We don't usually get to say that. Thank you for having me. Great to be here, Stephanie.

4:38Stephanie Flanders:Tom, let me start with you. You know, I've said a little bit about it, but why is it important now to think about the long-term cost of money? Because for many people, it will seem pretty abstract. So I think there's a few factors at work, Stephanie. So the first is, this is a moment for the global markets. This is a moment where across Europe, across Japan, in the United States, long-term interest rates are high. And in many of those places, they're rising with far-reaching consequences for governments, for businesses, for households, for investors. I think the second reason is, well, there are some really long-term factors that drive the rate of interest.

5:20Things like demographics, for example. But there's also some important factors that are playing out right now. So think about Donald Trump and the end of the Pax Americana, the US security guarantee. That's forcing everyone from European NATO allies to Japan and Korea and Taiwan to significantly increase their defense spending. And when they do that, when governments borrow to increase defence spending, that puts upward pressure on interest rates. So it's a market moment, but it's also a kind of paradigm shift moment for the global economy. And I think that's one reason that makes this new book timely.

6:05Stephanie Flanders:Yes, we can see how many references in the book we can get in. Now, Jamie, looking at quite a lot of examples now where this is playing out, tell us just as an example of France, how some of these forces are pushing up the cost of borrowing and indeed helping to cause, you know, yet another government to collapse this week? Well, there are certainly a handful of economies globally which are sort of in the crosshairs of markets and they've seen interest rates go up by the most. So you mentioned France. Largely that's because the parliament is very fractured and it's going to be very, very difficult for them to pass any legislation which gets the budget under control.

6:41We saw in Japan that interest rates at the long end of the curve moved up. Why? Because the central bank has ditched yield curve control. And if you ditch yield curve control, you no longer have control of the yield curve. And in the UK, where there's a significant amount of gloom and pessimism about the government's ability to rein in debt. All of these things are serving to push up interest rates, but actually these idiosyncratic things are not the main source of the movement up in interest rates. If you look at which part is local and which part is global, you see there's a huge global element to rising borrowing costs around the world.

7:15And it's that part that we were trying to think about when we did our analysis.

7:19Stephanie Flanders:I guess this is partly just the supply of money and the demand for money. We think of the demand for money being things that you need to invest in or governments might be wanting to borrow. And the supply of money is the savings and other sources of cash that are sitting around the economy. Over the previous decade, people used to talk about the savings glut. There was a lot of money sloshing around and potentially fewer places for it to go. So governments were able to borrow very cheaply because there was a lot of money. But now that shift is churning. Talk us through that sort of demand and supply forces, because obviously it relates to what you just said.

7:57Yes, exactly. So it's the balance of saving and investment in the global economy that matters for global interest rates. And they're all determined with that global factor in mind. And for many years, the global cost of borrowing was falling. And the reason for that was because investment was getting cheaper. We had all these cheap goods coming from China, much cheaper to upgrade your technology, for example. You don't have to spend so much on investment. That was one of the byproducts of globalization. On the savings side, you have the baby boomers socking away their paychecks into their savings accounts, preparing for retirement.

8:34that also helped push down the cost of money and defense spending, for example. Well, after the Cold War, we thought the world seemed relatively safe. And so governments saved. They reduced their military budgets and they saved the money. All of these things are now starting to spin into reverse. So globalization, which helped keep investment goods cheap and actually inflation down. Well, that's not going to be proceeding at the same pace as it was. Defense spending, well, we don't live in a safe world. it's becoming much more dangerous. We need to ramp up defence spending, like Tom was describing.

9:07And the demographic side of things, well, yes, the baby boomers are now retiring. So they're going to be drawing down their savings rather than pushing money into them. And so all of these factors are shifting that fundamental balance between saving and investment in the global economy. And that is going to help push interest rates up.

9:24Stephanie Flanders:Tom, we've said it's not all down to Donald Trump. And you could just hear from that list, it's clearly not all down to Donald Trump, much though he might like to make the political and economic weather while he's in office. But you can also hear in that list a number of things which are at least being given the kind of extra impetus by his policies. And I guess we also have the possibility for sort of supply chain issues, a reverse in globalization, which you would think, given that it was contributing to falling prices in previous decades, if that's contributing to rising prices and potentially coming up more variability in prices, more kind of shocks for central banks to manage, well, that too might be a way in which he's contributing to higher rates overall.

10:08Stephanie Flanders:Is that right? Yeah, I think there's multiple dimensions on which the Trump administration is driving interest rates higher, Stephanie. Perhaps the first of them, as you mentioned, is the shock to the global system. It was the integration of a billion low-cost Chinese workers into the global trade system, which helped keep a lid on inflation in the US through the great moderation. I think many people expected the addition of a billion Indian low-cost workers to extend that trend in the decades ahead. Donald Trump, with his tariffs, is signaling, well, that's just not going to happen. Borrowing in the United States is really high.

10:49Trump's big, beautiful bill adds very significantly to the fiscal deficit over the next decade, some$3 trillion added to U.S. debt, according to the Congressional Budget Office. And when the U.S. Treasury is issuing more debt, well, they're going to have to pay more to borrow. And that means interest rates go up as well. Lastly, of course, there are the attacks on Fed independents. Now, the impact on interest rates there is a little bit complicated. If Trump gets his way and gets a more pliant Fed chair and a more pliant Fed board, well, he could get short-term interest rates down. And the impact of that ripples through the yield curve.

11:29So it also has an impact on long-term rates as well. The bigger impact, though, would likely be a blow to the Fed's credibility as an inflation fighter. And that would mean that investors would demand a premium to lend to the US government, to the US Treasury. And that too is a force pushing up longer-term borrowing costs.

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14:29Stephanie Flanders:We've mentioned the UK, we've mentioned France, and we know from previous episodes that the borrowing in the US has continued to be very high. And the government deficit is very high for a country that is actually not in the middle of a recession. It's been running this sort of 4%, 5%, 6 % of GDP budget deficits. And we've just had that big, beautiful bill, as he called it, passed in Congress, which added enormously to future debt. And yet I was amazed to see the other day that of one of the few developed countries that has seen its sort of 10-year borrowing rate go down slightly since the beginning of the year is actually the US.

15:10Stephanie Flanders:So Tom, how is the US getting away with that? I mean, yields are obviously higher and they're higher than when Donald Trump took office or when he was elected, but not as much higher. We haven't seen the kind of impact that you might have expected. Yeah, so a few thoughts on that. The first one is if we sort of extend the span of history a little bit longer, the big picture is very much very low 10-year borrowing costs before the COVID shock, very low 10-year borrowing costs at the end of the 2010s, and significantly higher borrowing costs today. So yes, absolutely, the US has been one of the countries that has had that 10-year rate nudge down since the start of the year.

15:50But if we pull the historical frame back a bit, the US is still very much in the group of countries which had very low borrowing costs a few years ago and much higher borrowing costs today. Now, So why haven't US borrowing costs gone up so far this year? Maybe it's useful to think about kind of three different groups of countries. You've got your fragile emerging markets that are very dependent on portfolio capital flows. And there's big questions about the quality of their institutions. Places like Turkey or Argentina, if they make a policy error, all the money flows out straight away, interest rates spike higher, currencies plunge lower, and the impacts are very real and very rapid.

16:34Then you've got advanced economies where the quality of institutions is stronger and investors have a higher degree of confidence, but they're still small relative to the size of the global economy. And so when they make policy missteps, they face some pretty rapid and severe consequences as well. Think about the UK under the Trust Administration. The US perhaps is in a category of its own, right? The world's biggest economy, the world's deepest financial markets, the world's most powerful military, a history of good governance, even if there are growing concerns about erosion of institutions right now.

17:10And for a country like the United States, the issue of the world's reserve currency, I think what you have is just much more capacity to play fast and loose with the rules before facing the real consequences. Perhaps this is an opportunity for me to surface my favourite quote from The Great Gatsby, how did you go bankrupt, first slowly, then all at once?

17:34Stephanie Flanders:Well, we've been pointing to some ways in which that might happen on this show. Jamie, I want to tick off a couple of things because we've gone through a lot of factors, but there'll be some people listening who will think of other ways in which the world's changing and will be interested to know how this affects the cost of money. One thing we do talk about in the book is inequality. And one thing that seems destined to continue, although individual countries have had different experiences, but the sort of emergence of the sort of super wealthy and apparently much more unequal division of wealth.

18:06Stephanie Flanders:You know, wealth obviously plays a big part in savings and investment. How is that going to affect the cost of money? The mechanism at play here is that people at the top end of the income distribution save more. Their earnings have gone up faster than their capacity to buy CPOTS, and so they're putting that in their bank accounts. And so over the past few decades or so, as income inequality has moved upwards, that has contributed more to savings and helped to contain borrowing costs or push them down. Looking ahead, our view is that income inequality is not likely to rise by as much as it has over the previous few decades, largely because it has risen so much already, and it would require significant policy change.

18:45But clearly, with the direction of travel in US policy, it's likely to climb a little further. And again, that will continue to exert some downward pressure on interest rates going ahead.

18:54Stephanie Flanders:And if we move more slowly or faster towards a net zero goal when it comes to the carbon transition, how does that affect things? Because that's obviously one of those areas where we've had to, in the book, we've had to have a pretty big range of uncertainty. Yeah, so I think that the impacts of climate change on rates, or at least the research into it still in its infancy, So you have so many unknowns, not just about economics, but the impact of global heating on the economy. And so I think you need to think about it through two lenses. One is, what are the physical damages that climate change does to the global economy?

19:30Because the more damage it does, the slower growth will be, the lower the inherent rate of return in the economy will be, and that'll push down on interest rates. But going in the opposite direction, if the world gets serious about tackling climate change, it's going to take huge investment in energy infrastructure to green the economy. And if you look at what New Economy Finance has been there for saying at Bloomberg, we're talking about trillion dollar investments here. And so that extra spending that's required, that extra investment, will push interest rates up. And we think that if there is a significant push, then the net effect is more likely to be upwards on borrowing costs than downwards.

20:09Stephanie Flanders:That raises an interesting point. And actually, it's one of the things I think a bit about in the final chapter of the book, when you sort of think about what are the implications of this change for governments, for businesses and others. I mean, we've tended to describe the cost of money going up as like a negative thing, a challenge, a headwind. And it certainly is for governments, if you have a lot of debt. It could also happen, as we describe, for reasons that we could be quite happy about. It could be a world of higher interest rates, could be a world in which we all might prefer to live in.

20:40Stephanie Flanders:I mean, obviously, savers, it's better for them if they have higher interest rates. We've already seen in a kind of small way, companies find it a bit easier to cover their pension obligations because that higher interest rate means that future money that they're promised to pensioners is worth a bit less in today's money than it was in the period where rates were extremely low and we had all those big holes in pension funds. But what else could be better about a higher rate world. Think about AI as an example here, specifically. So what will AI do to the natural rate? Well, to realize the promise of this technology, you have to pile a huge amount of money into it.

21:16And that will tend to push interest rates up. But at the same time, the benefits could be huge and growth could be faster, income growth could be faster, people could be better off. So in spite of the higher interest rate environment, people will be on the whole quite significantly better off. So I think that's kind of a good example of how interest rates can move for good reasons, they can move for bad reasons, and it's not always clear which is which.