Beware the bond markets

My book with Max Rangely set out how monetary policy has created an even larger bubble than that which burst in 2008. President Trump's actions threaten to pop it.

Governments borrow by issuing debt instruments called bonds. There’s a good primer here. The market in which bonds are traded is critically important: if bonds are being sold off, the effective interest rate – the yield – rises, causing immense financial pain to governments and households.

It is for good reason that the bond market intimidates everybody.

Beware the bond market

Yesterday, Bloomberg reported Bond Markets Retreat as US Treasuries Lead Yield Jump Worldwide:

A pullback from US Treasuries sent longer-term yields surging by the most since pandemic struck in 2020, deepening losses in what’s supposed to be a haven from financial turmoil and roiling markets abroad as investors sold government bonds to raise cash.

This morning, the Telegraph reports, How Trump was forced to bow to reality of markets meltdown:

Just as the UK’s former prime minister Liz Truss was forced to reverse her unfunded tax cuts after a bond vigilante rebellion in September 2022, Trump has suddenly about-turned on his “reciprocal” tariffs in the face of a looming global financial meltdown.

The White House claims this was the plan all along: to announce tariffs to drive countries into negotiations. That may be true but if so, it was an immensely dangerous manoeuvre to so shock the bond markets.

As if a trade war and “equity meltdown” were not enough, there is grave risk in the bond markets: governments and households are heavily indebted, sensitive to interest rates and in need of refinancing and yet there is a huge bubble in the bond markets, deliberately inflated by policymakers since the 2008 Global Financial Crisis and worsened during the pandemic as central banks bought bonds with new money.

Former Bank of England Chief Economist Andy Haldane said in 2013:

Let's be clear. We've intentionally blown the biggest government bond bubble in history. We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.

Does anyone suppose in the intervening years that bubble was safely deflated? No. Of course it was further developed by vast money creation to get us through the pandemic.

Danger lies ahead but not danger arising from a free society.

The fundamental problem is that for just over 50 years, governments have relied on the creation of new money ultimately to fund government spending. That’s why this long run price index from the Office for National Statistics and House of Commons Library is so stark¹:

A clear lesson from history and theory is that a free society with a just market economy is founded on honest money: money with integrity, that is, money which holds its value, ensuring the exchange of reliable value for reliable value. We have not had that throughout my lifetime since the post-World War Two Bretton Woods system was ended by President Nixon, severing the last link to gold. Since then, expanding the supply of money as bank credit has been chronic.