Bond market sell-off sends warning to countries running high debt | DW News

There is a market tonight that can make governments change course without a single vote being cast. I'm talking about the bond market. When governments spend more than they take in, they borrow the difference, often by selling bonds. Now that creates government debt. If investors become less willing to buy those bonds, bond prices fall and interest rates, known as yields, they rise. And that means governments have to pay more the next time they borrow. Now that eventually affects almost everyone. Mortgages, business loans, taxes, pensions, and how much governments can afford to spend. The U.S. political strategist James Carver once famously said that he used to think if there was reincarnation, he'd want to come back as the president, the pope, or a baseball star. But now he'd want to come back as the bond market, he says, because you can intimidate everybody. U.S. Treasury Secretary Scott Bess, and he certainly feels the ominous power of the bond market. He's trying to put the brakes on the global sell-off of U.S. debt. Last month, Bess announced the doubling of a buyback scheme for U.S. bonds from $2 billion to at least $4 billion. Many financial analysts dismissed the intervention as, quote, a drop in the bucket. President Trump was asked about it as well. Did you direct Secretant? No, not at all. No, he's a very capable man. He wanted to do it. He's very good at it. He is a good touch. Very good natural touch for the bonds and interest. And he did that, yeah. The yields have come back up since then. How do you see what we're doing? We have many types of intervention. That's one. The ultimate intervention is our military. And if we have to use that, we will, yeah. Well, the president may think that the use of military might can make U.S. debt more affordable, but the markets do not seem to agree at all. This week, the American 10-year treasury yield is approaching 5%. Japan has crossed 3% for the first time in 30 years. German and British borrowing costs are also at levels not seen in more than a decade. Behind it, war, oil, inflation, enormous government borrowing, and a growing question about whether the world has simply taken cheap money for granted for too long. Joining me now to talk about this is Karsten Brzeski. He's global head of macro research and chief economist at ING Germany. Before joining ING, he worked at the Dutch finance ministry and the European Commission. Karsten, it's good to have you on the program. You know, we just heard President Trump jump from intervention in the bond market to what he called the ultimate intervention, which he means, of course, is the U.S. military. What do you make of that? I think he's probably too much into war terms right now because I don't know how the military would ever intervene in the international and the global bond markets other than also using military money to purchase bonds. But luckily, this is a market where military action will never work. But we do have to say he is speaking to a truth that's older than you, older than I. American military power and the dominance of the dollar, they've gone hand in hand for decades now. Does that geopolitical power, does it help keep the world willing to finance American debt? Well, that indeed has been the recipe for success since World War II. We started with the gold standard. Then we had the U.S. dollar standard. So clearly the U.S. dollar had been the dominant international currency. And that also attracted foreign money and made there a big demand for U.S. debt and allowed the U.S. government to clearly pile up debt year by year. I wouldn't go as far as saying that this dominance of the U.S. dollar is over because for that to be over, we would also need to see an alternative. And right now, despite all the efforts that Europe is doing, the European capital market is not yet an alternative to the U.S. market. Other countries like China or other emerging economies are not able and partly also not willing to play that same role. So that is why I think investors, even though they are currently afraid by higher inflation, they are afraid a bit or concerned about the sustainability of U.S. government debt, they will always return to the U.S. at least as long as the U.S. is also economically growing. And the U.S. with its military, though, and waging war, that can also push the other direction, right? I mean, it drives up energy prices, inflation, borrowing costs. And I wonder, does using military power eventually make that power more expensive to finance? Definitely. Well, just look at what Congress decided. Congress decided on an additional budget to actually finance currently the U.S. military action, waging the war in the Middle East. Just one step back, yes, indeed, if a country wants to have a dominant global currency, it means really a strong capital market, but it also means the ability and the willingness to eventually defend its currency. And that is what the U.S. has always done in the past. Looking at it right now, the war in Iran has clearly pushed up energy prices. As long as the Strait of Hormuz is not open, oil prices will remain high. This means higher inflation. And this also means that central banks, including the American Fed, will have to increase policy rates. That's what explains higher rates. From a fiscal point of view, these higher expenditures clearly mean that there are no signs at all that the high fiscal deficit and high government debt in the U.S. will be reversed anytime soon. Yeah. I know that we have seen U.S. Treasury Secretary Scott Besson. He has been trying to calm the bond markets, but yields are back up. And I wonder, can governments, can they really intervene their way out of this situation right now? It's fascinating, at least for our financial market experts, because normally it is central banks intervening in bond markets, in capital markets, and not the Treasury. What the Treasury or what Mr. Besson tried to do was here to lower the U.S. government's interest payments by purchasing long-term or long-dated bonds and replace them by shorter-dated bonds at lower interest rates. But, you know, any textbook will tell you, whether it's a central bank, whether it's a government, intervening in global capital markets would only succeed if it is followed up by really substantial policy changes. In this situation, it means it would only work if the U.S. government would also announce sounder fiscal policies. Then such an intervention could work. Otherwise, and that's what we're currently seeing, such an intervention just goes up in smoke. You know, you have said that markets can ignore worsening public finances for years, I would say decades in the case of the U.S., and you also say then they suddenly wake up. Is that what we are seeing right now? Yeah, I think we're seeing a combination. We see a combination where bond markets are waking up to the reality that in the Middle East we're currently witnessing almost a forever war and not only a five or seven days war. This means financial markets have now completely repriced, as it's called, their inflation expectations. Also, what they expect central banks will do, namely hike interest rates much more than financial market participants expected a couple of weeks ago. So this is a main explanation of why interest rates have gone up. Then with these higher interest rates, this all of a sudden also draws attention to fiscal sustainability, to the high government level, and then will bring up also questions about, hey, how sustainable is this debt situation in the U.S. and in other developed economies? There wasn't a single trigger from the fiscal side now really explaining the surge in bond yields of the last couple of days. In the past, remember financial crisis, remember European sovereign debt crisis, there was always a trigger. For example, all of a sudden some unexpected kind of fiscal deficits, black holes in statistics. So there wasn't budget overruns. There was not this single explanation this time around. I want to ask you before we run out of time a little bit just about Europe. We know that Germany now is no longer this country that has balanced budgets. It's also running a deficit. And I'm wondering, when you look at Europe, does Europe now face a real guns versus butter problem? The end of the welfare state, as we've noted. I mean, you've got more defense spending on one side. You've got pensions, health care, social spending on the other. If cheap money, if that's over, then something has to give, right? You're fully right. And governments have to get used to that. Because in the past, when interest rates were close to zero, there was cheap money. And it looked as if you could give out gifts to everyone. Now, as money is no longer coming for free, governments are facing a big demand for additional spending. And you mentioned them all. There is the additional defense spending, not only in Europe, but also in Europe. There is health care spending. There is pension spending. There is indeed a need for more investments in infrastructure, in education. So a long list of additional spendings without the willingness of governments, at least up to now, to save money elsewhere. Just pile up debt, because it would require tougher political decisions to make a choice. Now, with higher interest rates, indeed, this probably means that there is an end to simply debt-fueled economic growth. So governments, I'm not saying that we are now entering a sovereign debt crisis. But what I'm saying is that this is a clear signal that governments will have to make choices, because money is no longer for free. Yeah, the bond markets are telling us, as they like to say here in Germany, that the fat years are over. Mr. Brzezinski, good having you on the show. We appreciate your insights tonight. Thank you.