At the start of the year, we didn’t know how Trump policy would shape up. We still don’t. Nor did we know how markets would react. And we still don’t. First markets rallied, then after tariffs were imposed and Liberation Day, everything sold. Then, as President Trump pulled back on tariffs, equities rebounded.
The concern now is shifting to the biggest market of all, the $29 trillion market for U.S. Treasuries. The Treasury market is where macroeconomics and politics meet, in their purest form, and when it begins to wobble, it is a real cause for concern.
Unlike stocks, the Treasury market deals in one asset — U.S. government debt — of various vintages. In the model that most market players have in their heads, on the side of macroeconomics, there is inflation, where a high rate makes bonds less valuable. On the side of politics, there is Congress’s ability (or lack thereof) to balance the budget.
In between macroeconomics and politics stands the Fed with its power to set interest rates and, in extremis, to buy Treasuries en masse. Given the Fed’s ultimate power, it makes little sense to worry about default on U.S. debt. Assuming there isn’t willful interference from the White House or Congress, the bills will always be paid. But if the Fed is printing money to do so, the value of the currency you get paid in, and hence the value of the outstanding pile of $29 trillion in debt, could change drastically.
And that is why we are beginning to see jitters in the Treasury market.
The downgrade of U.S. Treasuries from a perfect AAA score by the ratings firm Moody’s doesn’t help matters. But it reflects market anxiety rather than being a cause of it. Inflation isn’t the big worry right now, either. At below 3 percent, inflation is under control.
The real issue is politics. The market is waking up to the scale of Republican deficits — rising up to 7 percent of gross domestic product from under 6 percent; the party’s complete refusal to consider serious measures to raise revenue; the state of denial, reminiscent of Saddam-era Baghdad, that pervades Trump administration communications around the issue; and what appears to be a concerted effort to dissuade investment of foreign money in America by depreciating the dollar. There is even talk of a tax on foreign capital inflows.
In light of recent U.S. political history, you might shrug and ask: “Aren’t deficits normal? Aren’t all politicians like this? What are the markets worried about? The sky won’t fall.” This is also the jaundiced view of the conservative brand of fiscal economics known as “public choice economics,” which predicts that the short-term interests of elected officials will lead them into debt by prioritizing spending and flinching from tax increases.
But, despite the apparent obviousness of such “democratic deficits,” history tells us a different story. At least until the 1970s, advanced societies generally followed prudent fiscal rules.
They ran up large deficits during wars and major arms races — the Napoleonic wars, the U.S. Civil War, World War I, World War II and the Cold War. They also ran up debts when they were under serious societal pressure. When not paid back, such debt more often than not resulted in revolution and hyperinflation — the Russian Revolution and the early Weimar Republic being cases in point.
The norm for largely conservative political elites has been to engage in fiscal restraint. This was true in good times and bad, whether great powers were on the up, or in terminal imperial decline.
Britain, after World War II, struggling to keep the wheels on the imperial bus, ran a tight fiscal ship. After 1945, the British more or less invented the modern use of the term austerity. They may have enjoyed a new welfare state, but it was bare bones.
The United States, too, after the huge deficits of World War I and World War II, which helped it become a global hegemon, engaged in substantial debt repayment. And following the Reagan-era deficits, the Clinton administration also balanced the books in the 1990s.
In Europe, following the debt surges of the 1970s and 1980s, fiscal rules have been tight. Before accounting for interest charges on legacy debts, the “spendthrift” Italy has in fact run roughly two decades of rarely interrupted primary surpluses.
One country that has run big deficits for years is Japan. But its economy has been growing slowly for decades, and the Bank of Japan oversees a closed-circuit public debt market, quite unlike the fast-moving and internationalized U.S. Treasury market.
You have to go deep into the ranks of fiscal reprobates — think Argentina — to find countries running truly large persistent deficits, especially when their economies were humming along. This is what makes the U.S. experience in the past decade unique. The problem is not that deficits blew out in 2008 or 2020. Faced with the financial crisis and the Covid pandemic, fiscal stimulus was exactly what the doctor ordered. The real issue is what happens, under Republican majorities, when the United States is at or close to full employment. The G.O.P.’s tax cuts of the early 2000s were egregious. But questions really began to be asked after the 2017 round, which saw deficits balloon even as unemployment continued to fall to record lows.
The United States is a rich economy with a good credit rating. It can bear large debts. And there are many things that would be worth greater U.S. borrowing — green investments, or a huge push on child care and human capital. But America’s deficits aren’t driven by an expansive view of future investments. They are driven by the unwillingness of the richest Americans, who pay by far the most tax, to pay even the modest levels that would be necessary to fund America’s far-from-generous public sector.
What makes the country unique is that even as the economy hums along and the wealthiest prosper as never before, a party calling itself conservative is actively conspiring to cut the sinews of the fiscal state.
This isn’t normal. And markets are finally, slowly waking up to this fact. To be clear, the point is not that America today is Weimar, or Italy in the 1970s and 1980s. The situation is more puzzling and in some sense worse than that. Those societies, after all, were dealing with objectively difficult social and political crises. By contrast, our fiscal dilemmas today are gratuitous. It is not the historical antecedents, but the vertiginous novelty of this impasse that should give us pause.
We don’t know how this story ends. It is a decision tree with many forks.
Can the United States find buyers for new Treasury bonds being issued at a pace of around $2 trillion a year? Probably. Will it mean that interest rates on long-dated Treasuries stay above 5 percent for the first time in years? Probably. Will that be good for investment? No. Will foreign buyers still want U.S. debt? Maybe. But it won’t help if the dollar is declining and the Trump administration is cheering. Could the Fed intervene? Yes. Would the Trump administration like the Fed to raise rates? No. Is there likely to be a fight with the White House? You bet. Would that be good for confidence? Certainly, not.
None of these outcomes look attractive to investors, or for the U.S. economy at large. At the very least they add to uncertainty, which damps investment.
To restore normality, many opponents of Mr. Trump are secretly hoping for the bond market to do its worst. But is it healthy for self-styled defenders of democracy to be cheering on the bond vigilantes? Surely not.
The inability of the American political class to develop decisive majorities for a coherent and strategic fiscal policy — whether orientated toward a major national investment program or a balanced budget — corrodes not just credit ratings but also democratic legitimacy. No taxation without representation has a corollary. What defines a civilized collective is its ability, through democratic means, to decide who pays for what.
Adam Tooze is a professor of history at Columbia University, the writer of the “Chartbook” newsletter and the author of “Shutdown: How Covid Shook the World’s Economy.”
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