NPR This is The Indicator from 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 US government bonds. Yeah, and 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. I'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.
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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. Now, most of these bondholders are in the U.S., but investors all around the world are usually clamoring to hold U.S. Treasurer.
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.
Mark says investors' healthy appetite for treasuries keeps prices for these bonds high and interest rates for government debt low. You really do want there to be... large pool of investors who are happy buying it as it goes the price is going to go down and the interest rate on US government debt is going to go upside
The US 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 US markets at all. I'm looking elsewhere. And so we saw the currencies of Japan the euro or 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 US Treasuries. Picture, 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 US Treasuries anymore?
Uh, there is some scary stuff happening here, okay? The US 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 the Japanese were selling, the Canadians, Europeans,
the Chinese. Mark 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 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 MeToo Galati. He'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 dads.
But in our bond nightmare scenario, investors are running away from treasuries, so there aren't enough buyers for new government bonds. MeToo also points out that the Trump administration is loath 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 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 Advisers, which means he has the president's ear.
Myron wrote this paper in November before he joined the administration. And 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 now. 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 and even proposing a debt swap would be tantamount to the US 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. And Michu 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. 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. 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. Well, 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. This episode was produced by Lily Kuros and engineered by Kwesi Lee. It was fact-checked by Sierra Juarez. Kicking Cannon edits the show and The Indicator is a production of NPR.