The US is unlikely to face a bond crisis

Anyone who thought that government bonds would provide a safe haven from the turmoil in global stock markets has just had a rude awakening. While bond yields initially fell after Donald Trump’s “Liberation Day”, yesterday they rebounded, with the yield on 10-year US Treasury bonds hitting 4.5 percent – higher than they were before the crisis began.

To put it another way, anyone with holdings in US government debt would initially have seen the value of their bonds rise, but now they, like most equity investors, are sitting on a paper loss.

The movements in Treasury bonds have led some to wonder: could the rest of the world bring the US government to its knees by dumping its debt, and indeed, is that what is happening in retaliation for Trump’s tariff wars? Given China’s announcement of 50 percent retaliatory tariffs on US goods – in addition to 34 percent already announced – it does rather look like an all-out trade war.

Tempting though it might be to imagine that this is what is happening, the facts do not support such a theory. It is true that the US government benefits from the dollar being the reserve currency. When the world sees your debt, and your currency, as an ultra-safe investment, it is easier and cheaper to borrow. Thanks in part to that, the U.S. government has become severely indebted. Government debt stands at $36.2 trillion, equivalent to 123 percent of U.S. GDP. The federal government also spends 16 percent of its overall budget servicing this debt.

It is also true that China is a big holder of US Treasuries. If it decided to sell them all at once it would cause mayhem on markets. But to put it into perspective, China holds $768 billion worth of US government debt: 2.1 percent of the total. The biggest overseas holder of Treasuries is not China but Japan, which owns $1.1 trillion worth of them. But by far the biggest holders of US government debt are American pensioners and investors, who hold $28.9 trillion worth of it. A further $7.3 trillion is held by other public bodies in the US, such as state governments.

When Mark Carney was governor of the Bank of England he famously described the UK government as being “reliant on the kindness of strangers” in that it could only function at its current size so long as foreigners kept buying up its bonds. His phrase has also since been applied to the US. It never was a good description – global bond investors are not being kind; they just want a return on their capital. But the idea of the US government relying on overseas investors is also somewhat overdone. Much though we might like to think of Trump’s administration as being at the mercy of global investors, especially China, there is a limit to how much damage they could do by dumping their US government bonds. Moreover, they would be doing themselves a tremendous amount of harm if they tried to do so, because they would be selling at fire-sale prices. If the world wants to punish Trump it will have to find another way.

But China, like Britain, is somewhat hampered in its ability to harm the US with its new tariffs because its single biggest import from the US – accounting for 13 percent of the total by value – is fuel. China will be harming its own industries if it drives up the price of energy.