Hi and welcome to Ones and Twos, FP's economics podcast. Every week we take a couple data points, use them to try to explain the world. I'm Cameron Abadi, FP's deputy editor with you in Berlin, Germany. Joining us as always is FP's economics columnist and Columbia University professor Adam Tooze, this week also in Berlin. Hi Adam.
So in the second half of the show, we are going to be talking about the Venice Biennale, the biannual art event that happens there and is happening now. In fact, stick around to hear about that major art event and all the economics behind it. But first, another data point, that is 5.33%. That is where the yield on the 30-year US Treasury bond peaked about a week ago or so. That is the highest that the yield has been on US treasuries in 19 years. And we've talked a lot about treasuries on this show, you know, maybe not recently, but in some ways this is a normal mechanism of the market at work. As the prices of bonds go down, the yields go up. And so, you know, the laws of supply and demand may be in effect as those yields go up. But, of course, when we're talking about US treasuries, it's inevitably anything but normal, so to speak. This is a vast market that makes the plumbing of the international financial system work in the first place. And so it wouldn't be fair to describe it as just a simple market mechanism, and the personalities at work here are also anything but, you know, normal, I guess it's fair to say. There's a good deal of irony that the person who has assumed responsibility for responding to that number I mentioned, those high yields of over 5%, is Scott Bessent, the US Treasury Secretary. I say ironic because he notably has a past in working with George Soros and specifically is known for having broken the Bank of England in circumstances, you know, broadly similar to the ones he's now being obliged to respond to on the other side. So, you know, he is someone with some experience acting on the bond markets, but now he's an official and assuming responsibility in ways that are, I think, fair to say unusual in the United States context. So yeah, to kind of take a look at this unusual circumstance at this moment, we thought we'd dig in. And yeah, Adam, to start off with the basic question that came to mind is: why exactly are yields rising? I mean, we've talked about this in general terms before. Prices of bonds go down, their yields go up. There are broad kind of supply and demand mechanisms that affect the prices and yields of bonds. But is this right now a matter of too much bond supply that is reducing the prices of them? That is to say, too much US debt that is being issued to fund the US government. Or is this something happening on the other side? Is there a kind of softening of demand that is reducing prices? And yeah, how can we tell exactly what's at work?
Yeah, I mean it's a truly important news story that's really developed with real urgency over the summer this year, which is this global move in yields. It's happening across the board with the vast majority of advanced economies, which are big issuers of government debt. And as you say, it's counterintuitive, so it's worth repeating the logic that you spelled out so clearly just a second ago: as the relative attractiveness of bonds falls, and so therefore their price falls, as what you pay to get a $100 bond falls, the effective interest rate, the yield on that bond, goes up, because you end up paying $98, $97, $95 for $100 worth of bond, which then pays you a coupon of $4 a year in interest. And then all of a sudden you're looking at a much more attractive interest because you bought it for less than the $100 face value. And so what's happening in global markets—and we're talking about gigantic markets, tens of trillions of dollars—so people may have seen, you know, there's two figures out there for government debt in the US right now. One is $40 trillion. That's the total of debt that's been issued, of which about 8 trillion is held by other government agencies. So this is debt owed by the American government to itself. About $32 trillion is in the hands of the market, and that is almost exactly the same as US GDP. So we've crossed two critical thresholds: $40 trillion for overall debt, and $32 trillion, 100% of GDP, in the hands of the market.
And even those numbers by themselves, I mean they are oceanic. That is huge. A trillion is a million million. Those markets are being moved by just the awesome flow of new debt into the markets. And on the other hand, the growing anxiety around the persistence of inflation and the availability of other types of asset that are attractive by comparison with debt, treasuries, equities, and private debt. And all three of those forces are acting at the same time. So there is a huge issuance of private sector debt, notably AI-related debt, by very, very highly rated, very high-quality business names, which attracts a bid. There is persistent anxiety about inflation, unsurprisingly, because we've had a series of shocks starting with COVID, then Russia's invasion of Ukraine, then most recently Israel and America's war against Iran, which have triggered surges in price. The inflation rate is now 3.7%. And if you're holding a bond with a nominal face value, every inch, every percent of inflation eats away at the value of your bond. So that makes bonds less attractive, reducing the bid.
And then there is absolutely gigantic issuance. So $40 trillion is the amount outstanding, but America actually has to roll—that is, reissue to replace outstanding debt—about somewhere between 8 and 10 trillion a year because a lot of the debt is rather short-term. It's running a deficit of 6% of GDP, which amounts to $2 trillion in new issuance. And so there is a huge volume of new paper coming onto the market all the time. The daily churn in this market is over a trillion dollars. All of these numbers are important to put, say, Bessent's interventions in perspective. And so not only is this oceanic in size, but it is currently rather turbulent and being disturbed by these profound forces: huge flow in alternative things you can buy and overall pressure on the market. And the whole thing adds up to this shift, which is affecting not just the US, but everyone, really—French government debt, British government debt (we've spoken about that a couple of times on the show), even German, even Japanese. The only country whose bonds have not seen a substantial increase in yield is basically China, I think, where they operate in a relatively closed financial system and there's no inflationary pressure. So that gives you an idea really of how capacious this is.
That's a useful sketch of what's going on and the scale. But to narrow down this a bit, I mean, you're describing these actors in this market for US government debt, and they, through their judgments about these bonds, are affecting these prices. And that obviously has all sorts of ripple effects for the US and the global economy. But yeah, whose judgment exactly is being expressed here? You know, when we talk about bond markets, it always strikes me that there used to be this reference to bond vigilantes, basically—actors kind of willfully trying to manipulate bond markets in order to turn a profit, seeking out vulnerabilities for the sake of profiting directly from movements in the bond markets. But are these actors participating in this mechanism right now vigilantes at all in that sense? Or what exactly are they expressing? Are they expressing a real rational judgment about US fiscal policy and its sustainability, or are these actors being driven by something else entirely? Are they being driven by other needs that they have and being forced into these actions in the marketplace?
Yeah. I mean, we should just focus in on what's so political about this right now. Why are we talking about this? We're talking about this in part because one of the great fears of the Trump administration was that interest rates will go up. Trump hates high interest rates. He's a man who's lived with that all his life. It will slow down economic growth if interest rates go up, and this is an election year; no one wants to see that. On the other hand, Trump appointed as Fed chair, new Fed chair, Kevin Warsh, who, as we've discussed on the show, is actually a conservative who has rather clearly committed himself to pulling the Fed out of large-scale buying in the bond market, which of course reduces the bid and therefore tends to drive the price down, especially if the central bank is actually selling. And the central bank, the US central bank, holds about 10% of all the US treasuries that are outstanding—an even larger share if we look at the 32 trillion which are out there in the market.
And so there's a downward pressure on prices and an upward pressure on yields coming from the Federal Reserve, which was appointed by Trump, and he's obviously involved in legal struggles with the Fed and so on. And at the same time, his Treasury Secretary has taken it upon himself to intervene in this market using a rather technical fund normally devoted to liquidity stabilization—that is, providing liquidity to the market at any given time—to seemingly try and manipulate downwards the price of the 30-year, the long-term bonds, by buying them, driving their price up and driving the yield down. He has justified this. The position of the Fed is we should let the market do its thing. As you started by saying, Cam, this is an entirely natural process. There's a bunch of issuance out there, there's a bunch of other things you can invest in, which is a sign that there's growth in the economy, and there's inflationary pressure in the economy, another sign of growth. So therefore, it's entirely appropriate for interest rates to go up.
The Treasury is actually taking the opposite position. So it's not just actively intervening; it is justifying its interventions by saying there is a misperception in the market. People don't understand the long-run trajectory of fiscal policy, so they are underestimating the determination of the Trump administration at some point to deliver tough fiscal medicine. And so the Treasury needs to get ahead of this and push the market in the right direction by driving the prices up, because as bonds get scarcer, as the deficits go down—this is what, you know, Bessent has drunk the Kool-Aid and believes this is going to happen—so if that's the case, then the market really should be scurrying towards buying the debt, which will be scarcer in future and therefore more valuable, and therefore yields should go down. And he just sees himself—or, you know, I'm making the case here—as shepherding the market towards its own best interest.
But this has unleashed the biggest debate about the bond market that we've seen for a long time anyway, because this is a really unusual situation for the Treasury to be intervening. And it does indeed beg the question of how are these prices formed? What is the basis on which demand is shaped? And the place you started from, Cam, is to say this is exactly what you would expect. And this is also the Fed's position broadly speaking: there's a lot of bonds out there, there's other things you can invest in, and there's inflationary pressure, so obviously yields should go up. Bessent's view is that people are not really reading the tea leaves correctly and they need to be hurried. Another view would be that this is the bond market trying to boss the government. The bond vigilante image is a further image really, because if you think about vigilantes, the role of vigilantes is not to kidnap people and extort people for ransom. The role of vigilantes is to impose the law in a space in which the government is no longer active. This is at least how Yardeni, who introduced the term in the 1980s, explained it, right? So this is a moment of anarchy where the government isn't doing its job of stabilizing and it will be the role of the bond vigilantes to step in. And this is the sort of classic story of bond markets versus irresponsible governments.
But for that to be really a compelling narrative of the current moment, you'd actually have to see some wild action in the bond market. You'd have to see debt issuance failing. You'd have to see serious pullbacks by buyers. And for all of Bessent's huffing and puffing and insisting that he needs to intervene, no one really buys it because we're not seeing any of that. What we're actually seeing is a fairly predictable, very broad-based adjustment across all advanced economies, from Japan to the United States. Everyone is seeing this move. There's no real reason to believe that there's any malfunction of any type whatsoever. And so in the end, this just looks like a remarkably clumsy and ill-designed intervention, which above all just doesn't have the heft that it would need.
So, you know, during the COVID episode in March 2020, when the bond market really did look like it was going to fail, the Federal Reserve bought on some days a hundred billion dollars in bonds a day. So over the course of two weeks, you could clock up over a trillion dollars in purchases. That's a significant amount of money in relation to the overall deficit, in relation to the total bond market. Bessent is talking about maybe buying 10 billion over a period of months. It's peanuts. So it's a typically Trumpian kind of mismatch between the scale of the problem, which is quite real and has quite fundamental causes, probably a slightly conspiratorial, highly voluntarist reading that the markets have got it wrong and we need to correct them, and then you get out your magic wand and it turns out to be $5 billion in a market which is 40 trillion large. And there's these amazing graphics going around the financial media just going: does he understand the size of the market, the scale of the intervention? Like, this can't work. It's a very, very strange moment that we're living through. And to me, it's reminiscent of many other areas of Trumpian policy where you just have a kind of profound disconnect between diagnosis and reality.
Yeah. And I did use the word irony before, advisedly, because in Bessent's case, I do think that word applies. I mean, in Trump's case, there's a kind of consistent blowhard aspect to Trump's worldview, right? You know, this kind of willingness just to kind of brash things out a bit. But Bessent, as I mentioned, was someone who in the 1990s was seemingly on the other side of these kinds of mechanisms. I mean, he identified situations where a government didn't have the ability to hold a bond market at a certain price, and he kind of bet that they couldn't and profited from that. And one would think that that would inform how he's approaching the situation now that he's a responsible government official. But in your view, how is this approach that Bessent is taking reflective, or is it not reflective at all, of his earlier experience as a trader with George Soros?
I mean, I think a lot of the Trump people are kind of caught in a cleft stick. On the one hand, they have some degree of technical competence, otherwise they wouldn't be in the jobs they're in. And on the other hand, you can't be a Trump underling without being basically a sycophant. So you've got to sort of follow the boss's story, and then they in various contorted ways try and twist narratives around that. And the foreign policy people do that in various ways. And what we're seeing with Bessent is a guy who, you know, he was not a terribly successful hedge fund guy, he's no macroeconomic superbrain, but he's somebody who does have a deep understanding of how Treasury markets work, at least at the kind of superficial technical level.
And so he oscillates—it's really bizarre watching—between technical justifications for his various interventions, which have included swap lines for Argentina and supporting the Japanese currency by selling euro without telling the Europeans first, and now this intervention. When he's pushed, he havers between a position which says, "Oh, this is just a technical intervention. There's some mispricing in the long end of the bond market. We should pop in there and make some little tweaks, and I'm just doing a technical thing. Nothing to see here. Let's move on." And on the other hand, this bombast then when it's exposed that really they're talking very loud, they've got a teeny-tiny stick, they've got nothing really to do here. They then start briefing the media, as they've done this week, to say, "Well, actually, you know, there's this thing called the general account that the Treasury has with the Fed, which is basically the current account of the US government. You know, there's a trillion dollars in there, and we could use those."
Where everyone just kind of goes in the markets, "You've got to be kidding," because that is the American government's current account; that is not a bond trading account. And B, it's a trillion dollars, and that's what this market turns over every single day. And the only thing that's really going to impress this market if you do actually want to move it is a limitless, bottomless, literally unchecked account. And the only actor which, given our current institutional arrangements, has that kind of firepower is the central bank, not the Treasury. Now, MMT people will say—Modern Monetary Theory people, who we haven't talked about in a while—will say, "Well, this is all terribly artificial. The Treasury could print dollars too. It could just create its own purchasing power," which is true, but it would overturn all existing institutional structures and it would massively destabilize the financial status quo in the US. So that's not on the cards.
So then you ask yourself: what is Bessent's endgame here? When people call his bluff, where's this going to go? And the answer seems to be just kind of goldfish, goldfish: "Don't worry, people have forgotten. No one really cares. The boss said we should do something, I did something. That's all that really matters here. No one will remember. No one will remember." And the bond market isn't like that. I mean, it doesn't have a deep, distant—it's not a historically wise thing, but this is going to come at a price, this intervention, I think, especially because it also puts the Federal Reserve in a really, really tight spot.
Yeah, you've put your finger on something that I think is interesting here because to some extent that's a theme of our show: that when you sort of dig into these financial and economic questions, to some extent you inevitably hit some basic fundamental political questions as well. And the question of who ultimately is at the foundation of this international financial lubricant that is the US treasuries market, again, that is responsible for the conditions in the US economy and the global economy more broadly—the question of what political actor is ultimately at the foundation of that, I think, seems to be also an issue here. Because as you suggested, it seems like normally if there's going to be an intervention to correct something in this vast global market, it would be the Fed, and Kevin Warsh in this case, the new Fed chair, that would have responsibility for intervening. But should we be seeing Bessent's intervention as also a kind of intervention in governance here as well? Is Bessent encroaching on Warsh's territory here in terms of the financial actor of the US Treasury encroaching on the kind of territory that Warsh oversees at the Fed?
Yeah, this is really one of the dramatic aspects of what's been going on. And it'll be interesting to know in retrospect whether the Fed was actually informed of what the Treasury was going to do, because we now know that the Americans, the Treasury, did not inform the ECB and the Europeans of the sale of euros to support the yen. So who knows whether they communicated with the Fed over this? Both Warsh and Bessent come out of the stable of Druckenmiller, the famous investor. So they actually have a kind of genealogical link. They're both proteges of that figure, who's disowned Bessent in the pages of The Wall Street Journal in an AI-assisted column that he wrote there. So this is getting pretty incestuous.
And this is a moment of quite high drama, and we may end up having to do a show about this again next week, because this week is the occasion of the Jackson Hole meeting, which is the great rallying moment of the central banking clique. We've done shows about Jackson Hole several times in the past. And so in this moment where Kevin Warsh is having to establish himself as Fed chair—and it's not been going terribly well so far; his second press conference in particular was widely rated to have been a disaster because Warsh is trying to move the Fed to a regime of much more tight-lipped, much less garrulous, much less explicit navigation of the relationship with the bond market—and here comes Bessent making these clumsy interventions, which are widely being interpreted as a sign really of panic and of mounting insecurity on the part of the Treasury, which is the last thing the Fed needs.
And so the question now is: what is Warsh going to say? His speech will be on the day this show is released, on Friday this week. And in some ways, you know, he could, if he was ultimately going to play the political cards, he could align or he could avoid making any comments on Bessent's intervention. Or on the other hand, if he actually wants to establish his bona fides with the market, he's now in a position where he almost needs to say something about Bessent's intervention, which will put him explicitly at odds with the executive branch, which is not where the Fed is going to want to be. So whether or not Bessent and that crew intended to raise the pressure on Warsh, they absolutely have, because fundamentally this is not Treasury business; this is Fed business.
The relationship between the Fed and the Treasury on these issues was really fundamentally worked out after World War II, where America had similarly high levels of debt and there was huge pressure on the Fed to manipulate interest rates so as to enable the budgetary balance to be easier to strike, because the lower the interest rate, the less interest payments you have to make. And in the end, in the aftermath of World War II, this led to a continuous tug of war between the Fed and the Treasury that was resolved by an agreement in 1951, which effectively separated these two issues and established what we might now think of as the modern regime of Fed independence. And we are challenging the limits of that in this current moment.
And people have long forecast that it would come like this. I think most people imagined it would be in the manner of Trump bullying that we've seen plenty of, after all, and the legal war on the Fed is still continuing. But I don't think we anticipated the Treasury stepping in as an activist player in its own right and so egregiously and openly seeking to manipulate the price of the US Treasury and doing so with such patently inadequate tools. So it's either doomed to fail or begging for somebody else to come and sort it out. And the Fed right now is not minded to make that move. A considerable body of opinion on the FOMC that makes the monetary policy decisions actually wants to raise interest rates, because they, like the market, see that the American economy—they, in their view, think the American economy could do with tighter monetary, tighter credit.
I mean, just to clarify this issue a bit, what is at stake in terms of which government body has this authority? I mean, is the fact that the Fed was responsible for this seen as the appropriate answer because they're kind of one step removed from our normal democratic politics, and the Treasury by contrast is much more directly accountable to the president and to other elected officials? Is that why, beyond this personal question of who is responsible—and theoretically, I guess it could be either government agency or body that has this authority—what is ultimately sort of at stake in which body enjoys that ability?
Yeah, and this is a really fundamental question and goes to the heart, I think, of the democratic legitimacy of these procedures. It's at first sort of rub a puzzling question: isn't this so technical? Does this really belong within the purview of democratic oversight? Would we want Congress to be having a voice in this? Would we want the executive branch to be doing this? I think the general feeling was exactly as you were suggesting, Cam, that this is so technical, it's such a fast-moving operation when you want to do it effectively, and you need really unlimited financial power, that the only actor that really sensibly could exercise that role is the Fed, because that's its designated place in the modern constitution.
It may not have been spelled out as such, but the Supreme Court with its recent judgments has come pretty close to arrogating—to conferring on the Fed, though this has no standing in American constitutional jurisprudence, a special position. In other words, the key figures in the Fed are protected from presidential intervention in a way that other federal agencies are not, according to the Supreme Court, which reflects, I think, the Supreme Court's understanding that the Fed sits in a fundamentally different relationship to major social forces, notably the financial markets, than any other body of the American government. So I think that's where this conventional sense comes from, that Bessent has overstepped a line, that really it is the Fed that properly deals with this stuff. But the problem, of course, is that that judgment itself is highly conventional, not to say contentious, because ultimately what we're talking about here are nothing more nor less than huge distributional questions, right? The whole debt issue is fundamentally a distributional question. There isn't...
The majority of American debt is held domestically. So it's owed by Americans to Americans in the name of the American government to be paid by American taxpayers. So this is an internal American issue, and there isn't a real limit to how much debt you can pile up other than the fact that as you raise the volume of debt, as interest rates go up, you have to churn larger and larger amounts of money through the tax system, through the fiscal apparatus, and pay that out again as interest payments. And almost by definition, the people who hold large quantities of financial assets, including Treasuries, tend to be wealthier. So what you're doing is taking from a relatively broad tax base and distributing to people who receive interest on government debt. And this is obviously politically delicate. Right now, we're already churning more through on interest payments than we are on the Pentagon's budget, which is already hugely inflated. So this is a very delicate balancing act.
So if you view it that way, manipulating the interest rate at which those bondholders are compensated is a huge political intervention. It's a form of tax. So in the most contentious interventions we've seen in the last week, Citadel Securities, Druckenmiller, people like that have essentially openly accused Bessent of what they call financial repression, which is really a technical term for a way of managing the financial system, managing the relationship between interest rates and inflation, but not improperly in this context is actually taking on a highly political connotation. In other words, what you're doing is shifting the balance of interest here through artificial interventions to the benefit of taxpayers and to the detriment of those who are investing in financial assets. Right? That's what you're doing. You're artificially squeezing the price up and squeezing the yield down. So, existing holders benefit, future lenders will get lower yields. It's a huge operation on the American distribution of income and wealth that you're engaged in. And what they're saying is you shouldn't be doing this. It should just be the market that does this, which of course is its own kind of value judgment. Personally, I think financial repression, as we've spoken about on the show, is probably the best way out of America's fiscal dilemmas. But if you're going to do it, you're going to have to do it with more purpose and more coherence and with bigger instruments than the ones that Bessent is mobilizing.
