King Trump vs. the bond market
SAN FRANCISCO – In the Middle Ages, anyone who dared to speak uncomfortable truths to the king was often called the court jester. Today, in President Donald Trump's mock court, that role falls to the bond market.
As Trump's "big and beautiful" fiscal and tax bill moves toward passage in Congress, it is already clear that it will do nothing to control the 6.4% of GDP fiscal deficit recorded in 2024 under his predecessor, Joe Biden. On the contrary, the likely outcome of Trump's budget is a total deficit of 7% of GDP, or more, for the remainder of his term (assuming no major shocks such as a pandemic, financial crisis, or war, all of which have the potential to further increase the deficit).
International investors have always had a seemingly insatiable appetite for U.S. Treasury bonds, generally considered the ultimate safe haven. But with federal government debt at 122% of GDP (and a good portion of it due for refinancing in the coming months), that appetite may not last much longer. The yield on 30-year U.S. bonds is hovering around 5%, and that on 10-year bonds is close to 4.5% (both about two percentage points higher than a decade ago). As a result, interest payments on existing debt are rising and have already outpaced defense spending.
By now, it should be obvious that those who believed that borrowing would have little or no impact on long-term growth were ignoring basic economic realities. As I have long argued, a normalization of interest rates was inevitable. It was a mistake to assume that ultra-low interest rates would last forever, let alone to stake the country's economic future on that assumption.
Even the most fanatical debt deniers have finally grasped this reality. So how is it that it doesn't register with Trump, who (at least in his first term) was generally pragmatic on economic issues and willing to change course when his policies didn't yield results?
The answer is that Trump is also a political realist. He understands that the American public isn't ready to accept anything resembling "austerity," a term used by progressives whenever someone suggests there might be a tension between the immediate benefits of debt-financed stimulus and its long-term costs.
Trump and his followers argue that the “big, beautiful bill” will boost economic growth and generate enough tax revenue to offset the across-the-board tax cuts. But these claims lack much historical support. While the growth of the US debt over the past two decades is attributable to both Democratic spending sprees and Republican tax cuts, the bulk of that increase is due to the latter. Moreover, the idea that tax cuts pay for themselves was already discredited in the 1980s, when, under Ronald Reagan, they led to rising deficits rather than sustained growth.
Will the mounting US debt eventually cause a full-blown crisis? Perhaps, but what's more likely is a continued rise in long-term interest rates. A problem Trump won't solve by pressuring the Federal Reserve to cut short-term rates. Unless the economy falls into recession, the Fed has little room to lower rates without stimulating inflation; and rising inflation will only accelerate the rise in long-term rates.
The rise in real interest rates is due to rising global debt, geopolitical instability, expanding military spending, the fracturing of multilateral trade, the energy demands of artificial intelligence, and populist fiscal policy. While countervailing forces such as inequality and demographics may exert some downward pressure on rates, they are unlikely to immediately offset these structural and political factors. Furthermore, rising inflation expectations will be inevitable if governments fail to demonstrate the ability or willingness to control debt.
Another factor that could put upward pressure on interest rates (especially in the United States) is Trump's attempt to shut down the US economy. After all, a persistent trade deficit is typically offset by the inflow of foreign capital that helps finance it. If that inflow is reduced, interest rates will rise even further.
Of course, it's not just Trump. Interest rates were already rising sharply during the Biden administration. If the Democrats had won the presidency and both houses of Congress in 2024, the US fiscal outlook would likely be just as bleak. While a crisis has yet to arrive, there is little political will to act, and any leader attempting fiscal consolidation risks losing the next election.
What might such a crisis look like? As I explain in my recent book, Our Dollar, Your Problem, the answer depends on the nature of the triggering shock and how the government responds. Will Trump resort to financial repression (with a stifling effect on growth), as Japan, and to a lesser extent Europe, has done? Or is another bout of inflation likely to happen? In any case, bondholders are sounding the alarm: Trump's "big, beautiful" debt will ultimately hurt both the US economy and the dollar. As uncomfortable as it may be, it's a truth Trump can't afford to ignore.
Translation: Esteban Flamini
The author
Kenneth Rogoff, a former senior economist at the International Monetary Fund, is a professor of economics and public policy at Harvard, winner of the 2011 Deutsche Bank Prize in Financial Economics, co-author (with Carmen M. Reinhart) of This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2011), and author of Our Dollar, Your Problem (Yale University Press, 2025).
Copyright: Project Syndicate, 2025
Eleconomista
