Transcript: A drastic solution to exploding US government debt

This is an audio transcript of the Unhedged podcast episode: ‘A drastic solution to exploding US government debt’

Ethan Wu
The US government has a big $1tn line item this year. But it’s not for food stamps. It’s not for Medicare. It’s not for the military.

[MUSIC PLAYING]

It’s for interest payments. Big debt, big deficits and rising interest rates are putting pressure on the US government’s finances. Today on the show, why people are talking about the US busting out a radical wartime policy to deal with the debt. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu, joined here today in the New York studio by US markets editor Jenn Hughes, who recently went to a conference that I think can only fairly be described as the last, last safe space on earth for men wearing bow ties.

Jennifer Hughes
Hi there, Ethan. And I might not disagree with that.

Ethan Wu
(Laughter) You were just at a conference hosted by Jim Grant of the legendary Grant’s Interest Rate Observer, which, for people that don’t know, it’s like reading a highbrow literary magazine. But like, in finance.

Jennifer Hughes
Yeah. The New Yorker for finance, I’d call it. So I went there recently and Jim Grant is famous for his bow tie, for being bearish. His cartoon in the magazine is actually a bear with a bow tie. And there were many, many, many other bears in the room who all worry about the same things — slowing US growth, rising US deficits, the debt problem as they see it in the US. You come out of that after a day and you’re quite scared about the economic outlook, let’s put it that way.

Ethan Wu
Yeah. Did you come back feeling rattled by all the pessimism?

Jennifer Hughes
Well, it was the other day, in fact, a few weeks back. So I’ve recovered now. Your optimism has helped me.

Ethan Wu
OK. I do my best, I do my best. And you’ve written about this conference and some of the ideas that you gleaned from it in today’s Unhedged newsletter, which was very good. And I think we want to get to some of those ideas. But maybe we should take a second and just back up to why people are worried about the debt and US fiscal policy and the deficit and so forth. And I think a couple of things have changed, right? One is that the politics, I think, have started to look a little worse. Once upon a time, and maybe this is just a fairy tale, but it used to be, you know, Democrats were the spending party and Republicans were the, you know, fiscal conservatism party. You know, that may or may not have been true. But Donald Trump’s presidency really, I think, put an end to that notion, because he passed a big, you know, $1tn-plus deficit-increasing tax cut. And so now you have kind of a situation where both political parties are inclined to add to the deficit. That’s one issue.

A second issue is that interest rates, as we talk about on pretty much every episode of Unhedged, have gone up a lot. And that really matters for debt and deficits because you want to have, ideally, interest rates lower than your growth rate. That means your capacity to pay back debt grows faster than the debt itself. If those start to become closer or if potentially interest rates even exceed your growth rate, then you’re in a little bit more trouble. You’re in a situation where the debt could grow faster than your ability to repay it. And I think those two things changing have given a lot of investors anxiety about where’s this really gonna end.

Jennifer Hughes
Absolutely. And this is what this conference was talking about a lot — the idea that spending is unlikely to come under control in the next year or so. We’ve got election. Politicians campaigning and running for office don’t usually talk about cutting spending or raising taxes. So you’re gonna have a growing deficit. It’s certainly not gonna get cut.

Ethan Wu
So at Jim Grant’s conference, I mean, what sorts of scenarios are we really talking about that would get them so scared about the debt and deficits? Like, what do they have in mind that could go wrong here?

Jennifer Hughes
It’s really a change in market sentiment at some point. It could be a shock to the market. It could be unexpected expenditure, political problems. And there’s enough of those in Washington right now. Heaven forbid another war somewhere that the US needs to start funding or wants to get involved in. A politician gets ill. Who knows what happens? But there’ll be some shock, the bond market will react, prices of bonds will fall and their yields will rise. And the risk is that in this sort of jittery, scared environment, they rise more quickly. They become what the central bankers would call disorderly. And a market out of control freaks everybody out, especially when it’s the US Treasury market.

Ethan Wu
And I think that brings us to some of the more radical fixes being discussed at Jim Grant’s conference. And one in particular is yield curve control, as you write about in your piece. And just to explain this, this is a central bank policy where essentially they make an open-ended commitment to buy however much government debt is necessary to cap yields, to peg yields to where they want it to be. So, for example, the central bank could declare the 10-year yield will rise no higher than 1 per cent. And if markets say we don’t believe you; we’re going to, you know, sell bonds at 1.05 per cent, then the central bank jumps in and purchases whatever quantity of bonds is necessary to force the market back down to 1 per cent. It’s a really intense form of monetary intervention.

Jennifer Hughes
It’s also a point where the central bank and the government are almost acting together. So central bank independence is also an issue. But that’s a separate discussion for a politics podcast sometime.

Ethan Wu
But how did yield curve control in a US context come up at this conference?

Jennifer Hughes
It didn’t surprise most people in the room, but it did surprise me, at least not from the people I looked around at, because I think of yield curve control as what you do in the case of Japan to try — and which Bank of Japan is still involved in — in trying to spur an economy that’s gone nowhere for two decades and been struggling with deflation. Australia introduced it briefly during Covid to try and boost the economy there in the early days of pandemic lockdowns. So it’s part of the economic jump-start toolkit.

And you look at the US and sort of, hang on, we’ve got growth, this isn’t our problem. But here, the way it came up in the conference was this sense that, like it was used in world war two in the US, where because government spending is so high, you need to suppress the cost of that government spending. So you control the yield curve. This is what the US did in world war two that they didn’t actually explicitly tell the bond market that’s what they’re doing at the time. But that’s a whole different scenario. And that’s why it fits with the whole worry about too much spending and spending out of control.

Ethan Wu
That’s a great point. And just to reiterate, yield curve control in a modern context is almost like a monetary defibrillator. You use it when the economy is like flatlining and you need like a shock monetary policy, the most extreme you can really get. Historically, in the US, it’s only ever been used in wartime, like you said. And you can kind of understand why it would be used in wartime. You’ve got these new massive military spending commitments that are, you know, are of prime importance to the government. And you want the monetary authority, the central bank, to essentially ensure that all that government borrowing needed to finance the war effort gets digested in an orderly way. But, you know, now today we are talking about historic peacetime fiscal deficits. And I think that’s probably why yield curve control is on the margins, back in the discussion a little bit in the US.

Jennifer Hughes
Yeah. I should add that it’s nobody’s central scenario that we have this next year. And if we ever got to yield curve control, it’s a very extreme case. But that’s why it’s good to have the discussion now before it becomes a likely part of the toolkit.

Ethan Wu
Yeah. And I want to underline your point that it’s not anyone’s base case, because if there was a big increase in long-term Treasury yields because markets were scared of the fiscal outlook, probably one has to imagine what would happen is, well, you have an increase in borrowing costs for companies and you have an increase in mortgage rates and it’s actually hitting real people’s finances. And that puts pressure on politicians to either raise taxes or cut spending or some combination of both to get the fiscal trajectory back on a more sustainable course. We’re talking about a situation where the politics are so deadlocked, which, you know, not totally implausible, that political pressure is not exerted or no consensus can be come to. And you need a more extreme monetary intervention to prevent markets from melting down.

Jennifer Hughes
Yeah, because the one thing that none of us want to see, nobody in the world should really want to see is a complete meltdown in the US Treasury market. The big thing in its favour is it’s the reference market for the entire world. All other debt is normally priced in relation to Treasuries. So having a meltdown there would have global consequences.

Ethan Wu
Should we be scared of yield curve control in the US? Should we be scared of that scenario? Right? Like I traditionally associate talking about this type of stuff with like, the panicked financial blogs, like ZeroHedge or whatever it is. Should we be reassured by this? I mean, it’s like, seems like a tool in a toolkit if necessary, but not in the most basic case.

Jennifer Hughes
Well, we’re talking about this in a world where you could say that monetary policy hasn’t been sort of textbook style since the global financial crisis, since 2008. The Fed has still got a massively bloated balance sheet from all the bonds it’s bought through quantitative easing when it was keeping interest rates at zero, buying bonds, etc, etc. So we’re not in a sort of a textbook situation at the moment. We’re still trying to get out of all that mess. So, yes, having a world where the Fed could step in and do something like this is better than not having it. But even better still would be politicians realising that they can’t keep spending and the deficit comes under some sort of control. That would be, to me, a far better solution. It may be not the most likely.

Ethan Wu
Yeah. I think it’s worth saying that, you know, in the Japanese context of yield curve control, I think there have been, you know, the policy has stabilised Japan. Japan is not melting down, right? That much is clear. But there have been costs. One cost is to Japanese households who hold their wealth in bank accounts. You know, if you peg long-term interest rates very, very low, then banks are not going to pay you for leaving your cash in a savings account. And, you know, in Japan, a huge number of Japanese households own no financial assets, no stocks, no bonds. They have all their money in the bank and they’re not getting paid. If there was a less interventionist monetary policy. A big chunk of Japanese households would be getting some interest on their savings and that presumably could contribute to their lifestyle, to their consumption habits. So it’s not as if this is free, right? In some ways, you can think of it as a transfer from household savers to the government.

Jennifer Hughes
And it will probably create inflation as well.

Ethan Wu
Possibly, yeah.

Jennifer Hughes
Savers lose out and quite possibly we all lose out if we see more inflation. I mean, the last couple of years have been our first real experience of inflation in so long. I don’t really want to see more like that. Inflation in somewhere, whether it’s financial assets or more generally in the economy and consumer prices, would seem like another outcome. So yeah, it’s got very high cost to it.

Ethan Wu
Well, I think we all hope this is just a hypothetical and we will not have to get into the messy trade-offs of yield curve control. And the problem can just be solved by level-headed politicians who come to a, you know, reasonable consensus on the future path of government spending. Right? (Laughter)

Jennifer Hughes
I look forward to those discussions next year.

[MUSIC PLAYING]

Ethan Wu
Land value tax now. Let’s do it. All right, Jenn, we’ll be back in a moment with Long/Short.

Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Jenn, you long or short something?

Jennifer Hughes
I’m gonna go long cats because I’ve just persuaded my husband we might be able to get a third cat.

Ethan Wu
(Laughter) What was wrong with the first two cats?

Jennifer Hughes
My first two cats were wonderful. I got the second one to keep the first one company. The first one didn’t want a friend. The second one wants a friend. So I get a third one. (Ethan laughs) Can you see where this goes in a year or two?

Ethan Wu
Much like the government debt. Exponential growth from here. I am short Ray Dalio chewing on tape. This was a detail included in Rob Copeland’s new book about Ray Dalio and Bridgewater called The Fund. And there’s a lot of disturbing details that Copeland reports in this book, but I read this one on New York Magazine the other day that Ray Dalio has a habit of chewing on tape, and I just find that rather distasteful. That is all.

Jennifer Hughes
I would agree.

[MUSIC PLAYING]

Ethan Wu
It was just a parenthetical in Copeland’s piece, but it just stuck with me. It was so vivid that I couldn’t get it out of my head. I’m short that. Please don’t do that. Alright, Jenn, thank you for being here. We’ll have you back soon and listeners, we’ll be back in your ears on Tuesday with another episode of Unhedged. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

[MUSIC PLAYING]