Prepare For the Bond Market Fight

When Prime Minister Liz Truss announced a major tax restructuring that amounted to a tax cut in Great Britain, the bond market went nuts. It cost her both her tax cuts and her tenure in office.

Every one-tenth of one percent increase in the cost of borrowing in the United States adds $300 billion in interest expenses over the next decade. With a smaller and more stagnant economy in Britain, those asked to buy debt were left with the impression that Truss and the Tories were not serious about long-term debt and worried ever greater debt could hurt Britain’s private sector even as the nation still grappled with Brexit.

In this country, the GOP wants to extend and modify Donald Trump’s tax cuts. In addition, Trump wants to add tariffs to offset some cuts, which most economists view as inflationary. Such an inflationary act would raise interest rates, affecting bond interest rates and federal debt service payments.

When the government cannot pay its bills, which our government cannot, it issues bonds. As the debt grows, even though the United States guarantees the full faith of the United States in paying back the debt, bondholders could become more weary of buying bonds. If that happens, the interest rate on bonds would go up. That makes the debt service payments increase. That, in turn, reduces available money for the rest of the federal budget. If interest rates go up, the federal budget will be strained by increasing debt service payments and reducing what is available to the government for everything else.

Now, let me pause here and add a point from a friend and expert I asked to review this piece. He points out that fiscal irresponsibility does not necessarily raise bond yields. In fact, for thirty years, the US, EU, UK, and Japan have seen bond yields collapse even with fiscal insanity running amok. A separate friend chimed in on this and agreed, but also noted we have not had the debt to GDP ratio we now have in this country, and that could spook bondholders in ways they have not been spooked before. However, the bottom line is that fiscal insanity does not necessarily drive up bond interest rates.

But everyone agrees that as more people buy bonds, they are diverting cash from the private sector to the public sector. As the public sector debt grows, bonds funding the government take money away from the private sector and private investment. The $10,000.00 spent to buy a government bond is $10,000 not invested in the private sector.

As government debt grows, the private sector shrinks. This reduces the amount of money in the federal treasury, which means either more debt must be issued or taxes must go up.

This is why the GOP must be cautious with its tax cuts. Not all tax cuts produce the same economic stimulative effect. The GOP could cut taxes, but if it does not cut spending, it will have to borrow more, and the debt spiral will recklessly suck more and more growth from the private sector.

There is a way forward for the GOP.

If Republicans focus on the most economically stimulative tax cuts, i.e., cuts that incentivize investment in the private sector and not just income tax cuts, they can kick-start a significant economic recovery that generates greater GDP. If the American gross domestic product increases, the debt as a percentage of GDP automatically goes down, giving the GOP more wiggle room.

I appreciate that I am no expert, but I know enough, read enough, and talk to enough experts to give you the basics. The bottom line is that our national debt has grown so much that it is eating into economic productivity in the private sector, slowing the economy. Congress has to cut spending. It can delay, but not avoid, spending cuts by prioritizing tax cuts that are economically stimulative.

But we are headed towards a fiscal crisis.

In addition, if Donald Trump does implement major tariffs, he will have a couple of years of wiggle room, but the net multi-year effect will be inflationary because tariffs raise the cost of goods. In turn, that will slow the economy and cause interest rates to rise, which could destabilize the economy.

The bond market brought down Liz Truss’s government. Because of how our terms in office are structured, the bond market cannot bring down an American presidential administration. But a sharp spike in bond rates could wreck the economy, and the GOP, in charge of everything, will be blamed. Likewise, more debt with no spending cuts will shrink the private sector economy, starving the treasury of tax revenue and alienating workers in a stagnant economy. The GOP will shoulder that blame, too.

Yesterday, Donald Trump’s Treasury Secretary nominee, Scott Bessent, began his confirmation process. His core competence reassured me, and he is probably the best person to navigate Trump through what is coming economically. A bipartisan group of big spenders has put Donald Trump and his team in a tough spot, and he will have to navigate the coming challenges skillfully. This will not be easy.