The bond market is repricing the federal government’s fiscal folly. Congress knows it can’t touch the middle class and has no ideas about how to help them other than growing the debt–and it’s headed for a bad outcome thanks to bond vigilantes. The 30-year Treasury yield closed at 5.62% on September 30, territory last seen in 2002. The 10-year sits near 5.3%. The consequences for the budget are severe. Interest on the national debt reached $857 billion over the first nine months of the fiscal year, more than the government spent on Medicare or national defense. Before Washington responds, it should understand what the market is really saying.
One possible explanation is that investors are losing faith in the dollar. Gold has more than doubled in two years. Commentators talk of a “debasement trade,” in which bondholders flee paper claims ahead of expected inflation. On this view, rising yields and record gold prices are two symptoms of the same disease: Uncle Sam printing dollars to cover its debt.
It’s a tidy story, but other data disprove it. A bond yield has two components: expected inflation and the real, inflation-adjusted return. Comparing conventional Treasuries with inflation-protected securities lets us separate the two. The 30-year breakeven inflation rate, the market’s long-run inflation forecast, sits near 2.3%. That is unremarkable. The 30-year real yield, by contrast, has climbed above 3%, its highest level since before the 2008 financial crisis. Bondholders expect the dollar to hold its value tolerably well. What has changed is the real price of financing the government.
Supply and demand explain why The federal government is running deficits near $1.9 trillion, with the Congressional Budget Office projecting larger ones ahead. Meanwhile, private demand for capital is surging. The artificial-intelligence buildout requires enormous borrowing for data centers, chips, and electric power. Public deficits and private investment are competing for the same pool of savings. When the demand for savings outruns the supply, its price rises. That price is the real interest rate.
Some of this is good news. Real returns driven by productive investment indicate a growing economy. But deficits at this scale crowd out the very investment that raises future living standards. Worse, the arithmetic compounds. Higher yields raise debt-service costs, which enlarge deficits, which require still more borrowing at those same higher yields. A 3 percent long-term real yield means capital scarcity is binding again. Near-zero rates from 2008 to 2020 taught borrowers, Congress most of all, to treat capital as basically free. Those days are gone.
The Treasury Department’s response has been underwhelming. In August, Secretary Scott Bessent doubled the department’s buybacks of 10- to 30-year debt after months of weak demand for bonds. Yields fell on the announcement, but fully reversed within a day. Small wonder. A $4 billion operation cannot move a market measured in trillions. Improvised interventions undermine the “regular and predictable” issuance framework Bessent himself has championed. While debt management can smooth market liquidity, it cannot create savings. As Krishna Guha, Evercore’s head of economics and central bank strategy, recently observed, struggling sovereigns often resort to such tactics, and the United States “is not different without limit.”
The only real solution is to put fiscal policy on a sustainable trajectory. That will require a combination of tax increases and spending cuts. However, on the tax side, it’s important to realize we have limited room. Over the past 60 years, federal tax receipts as a share of GDP have ranged between 14.4 and 19.8 percent, with an average of 17.0 percent. Unless we broaden the tax base by raising taxes on the middle class—a proposal that works in Europe but is dead on arrival in the U.S.—there isn’t much more revenue we can squeeze out of the economy.
Government spending has increased proportionately more over the same period. And unlike tax receipts, which fluctuate within a range, spending follows a long-run positive trend. The Congressional Budget Office forecasts it will grow further, especially as entitlements and net interest outlays rise. Assuming broadening the tax base remains politically infeasible, most of the adjustment necessarily falls on spending. The immediate goal is to keep the growth rate of federal expenditures below the growth rate of the real economy. Modest tax increases can make the deficit adjustment process smoother.
There is a deeper lesson here about our fiscal condition. Congress has irresponsibly rejected every mechanism of self-restraint. It had many chances to adopt budget rules, enact spending caps, make unpopular but necessary revenue enhancements, and reform entitlements. Each time parochial interests triumphed over statesmanship.
Bondholders are the only remaining check on federal borrowing. And they are unforgiving. While they may tolerate profligacy for a while, they will eventually punish it, and there is little voters and politicians can do to prevent it. Nations that wait for creditors to impose discipline get crisis-driven austerity instead of deliberate reform. A self-governing society should embrace responsible fiscal rules before the bondholders impose harsh discipline.
High bond yields are an information signal. This one says the government absorbs too much of the nation’s scarce capital. Gimmicks such as buybacks won’t alter the reality the signal indicates. Only major fiscal reforms will. It’s up to the American public to ensure Congress and the President get the message.
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