Donald Trump has spent much of his second term probing the limits of presidential power. This week, he has discovered another means by which to test them: by promising every American adult $5,000 in the event Republicans retain both houses of Congress. The proposal would cost around $1.2 trillion: representing around 3 percent of Americaâs $40 trillion in national debt. Washington is likely to reject the idea, but even if they approve it, there is one constituency who is likely to ensure that it remains untenable. That constituency would be the people and institutions expected to lend the United States money.
As a deficit mushrooms to a projected $1.9 trillion, there is still little appetite in Washington for any sort of fiscal course correction. Republicans want reduced taxes, a bolstered military, an industrial renaissance, and robust entitlements. While Democrats might disagree over how the money ought to be spent, they are hardly austere themselves, ultimately promising much of the same by way of social programs. Washington has long quenched its thirst for âmoreâ by using debt; the problem is that borrowing is no longer as cheap as it once was.
The bond market subscribes to no particular ideology, and as such, it imposes an unusual check on populist politics
Yields on 30-year Treasuries recently climbed above 5 percent, while the ten-year is heading towards the same figure. There are reasons for this unrelated to the Trump administration: notably, persistent inflation and expectations for Federal Reserve policy, the private sectorâs enormous capital demands, and a global sell-off and repricing of sovereign debt. Investors’ valid fiscal concerns only uncover one part of the narrative. Fed Governor Christopher Waller has warned that the erosion of the safety premium typically associated with Treasuries is driving the neutral interest rate higher, and that structural changes are required in order to correct it. Waller has also questioned whether the Treasuryâs expansion of a long-duration bond buyback program can meaningfully suppress yields. This is significant because the American bond market imposes a form of discipline unlike that of any other institution in the country.
While Congress and the judicial system wield their respective powers, bond investors impose their own order through price. Each Treasury auction is a reflection of a negotiation between Washington and the buyers of Americaâs debt. When investors become less comfortable with macroeconomic conditions, they demand a higher yield to hold American bonds. Higher borrowing costs eventually ripple throughout the economy, translating into more expensive mortgages, corporate loans, and financing for infrastructure. The US government has demonstrated that it will take well-intentioned, albeit misguided half measures in an attempt to mitigate these effects (such as the 50 year mortgage), but because the government has proven incapable of weaning itself off of debt, higher interest obligations will continue to feed into future deficits. Thus, a fiscal feedback loop is created, making it progressively harder for a nation to extricate itself from crippling liabilities.
This is where Britainâs short-lived prime minister Liz Truss enters the story. In September of 2022, Trussâs government announced the tax-slashing âmini budgetâ independent of Britainâs Office for Budget Responsibilityâs oversight. Gilt yields soared, exposing structural vulnerabilities within the highly leveraged British pension ecosystem, forcing an intervention by the Bank of England. Her government was forced to backpedal and, after only 49 days in office, Truss resigned. The bond market couldnât directly remove her from office, but it did reprice the cost of Trussâ political ambition until they became untenable.
Nevertheless, America is not Britain. The dollar remains the worldâs reserve currency, and the market for Treasuries is larger and more liquid. The US borrows in its own currency, and ultimately cannot be forced into a default via a shortage of dollars. This is all to say: anyone waiting for Trump to experience a repeat of Trussâs crisis will be left waiting. The American reckoning is likely to be slower and more insidious.Â
As the cost of borrowing grows, a larger portion of federal revenue will be devoted to servicing outstanding debt. Eventually, Washington will have to confront the compromises and subsequent consequences it has spent decades deferring. The bond market subscribes to no particular ideology, and as such, it imposes an unusual check on populist politics: it is irrelevant to investors whether another trillion dollars is justified in the name of social justice, or national greatness. The marketâs one job is to price the claims America makes on her future income.
Like an enabling parent indulging a petulant child, Washington has learned that difficult choices can be averted by borrowing whatever is necessary to placate the American public. A $5,000 check is a very simple promise for a politician to make; the challenging part is financing such promises. The bond market is the less fun, responsible parent in this arrangement, ultimately determining how much longer the indulgence can continue. Politicians will always be tempted to ask for more, but investors get to decide what âmoreâ will cost.Â
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