Hager, S. B.

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              City, University of London Institutional RepositoryCitation: Hager, S. B. ORCID: 0000-0002-1205-3623 (2017). Trump and the Bond Market. Foreign Affairs, This is the published version of the paper. This version of the publication may differ from the final published version. Permanent repository link:  https://openaccess.city.ac.uk/id/eprint/19668/Link to published version: Copyright and reuse: City Research Online aims to make research outputs of City, University of London available to a wider audience. Copyright and Moral Rights remain with the author(s) and/or copyright holders. URLs from City Research Online may be freely distributed and linked to.City Research Online:            http://openaccess.city.ac.uk/            publications@city.ac.ukCity Research OnlineDecember 22, 2017Trump and the BondMarketWhy a Flight From U.S. Treasuries Is UnlikelySandy Brian HagerKEVIN LAMARQUE / REUTERSU.S. President Donald Trump and Treasury Secretary Steven Mnuchin at theTreasury Department in Washington,  April 2017.Donald Trump’s presidential campaign frightened bondmarket investors around the world. Trump pledged to slashfederal income taxes and spend up to $1 trillion upgradingthe United States’ infrastructure. Investors worried that hisvictory would lead to massive federal deficits and runawayinflation, eroding the value of their holdings. The title of anApril 2016 article in Forbes captured the mood: “PresidentDonald Trump Would Destroy the Bond Market.” The anxiety was particularly acute among foreign investors,who own around 40 percent of the $14 trillion worth ofoutstanding U.S. Treasury securities. When Trump hintedduring the campaign that he would “make a deal” withcreditors to reduce the value of their Treasuries, punditsasked whether the Chinese and Japanese central banks wouldbegin to sour on the U.S. debt they had been stockpiling aspart of their foreign exchange reserves. To be sure, foreign confidence in U.S. Treasuries had waveredlong before the 2016 election. In recent years, budgetdeficits, quantitative easing, and the political dramassurrounding the debt ceiling and other fiscal issues had putthe creditworthiness of the U.S. federal government in doubt.Still, the prospect of Trump’s victory introduced a newdynamic altogether, leading some observers to fear that apanicked selloff of Treasury securities could be around thecorner.The stakes were high. The U.S. Treasuries market is thelargest and most liquid financial market in the world, and asthe world’s premier low-risk assets, U.S. Treasuries are abenchmark against which most other assets are priced. U.S.regulators require banks to hold Treasuries as part of the safeassets on their balance sheets, and investors turn toTreasuries as safe havens in uncertain times. Treasuries havealso been the linchpin of U.S. global financial power: steadyforeign demand for them has allowed the United States tocheaply finance big deficits.In the week after the November 8 election, around $1 trillionwas wiped off of global bond markets as investors movedaway from U.S. and other government debt. But that was nopanic, and for a few reasons, U.S. Treasuries will probablyremain the world’s premier risk-free asset. The first is a lackof attractive alternatives from other governments: the U.S.bond market is the best of a questionable batch. The second isthat the big companies and superwealthy families in theUnited States hold a disproportionately large share of thecountry’s domestically owned public debt and would resistpolicies that would disrupt the bond market. Jonathan Ernst / REUTERSU.S. President Donald Trump celebrating with Congressional Republicans after the U.S. Congress passed a taxoverhaul, Washington, December 2017.NOWHERE TO RUNThe U.S. economy can seem dysfunctional. But investmentdecisions are always relative, and compared with thealternatives, U.S. Treasuries look like beacons of stability.There are two challengers that might supplant U.S.Treasuries in the long term—eurozone government debt andChinese government debt. Neither is especially attractive.Eurozone bond markets are still reeling from the sovereigndebt crisis in southern Europe, driven by Italy’s brokenbanking system and the prospect of a Greek default. TheUnited Kingdom’s decision to leave the European Union hascast further doubt on the future of the European project andthe monetary union it supports. And unemployment, slowgrowth, and inequality have created the potential for anotherpopulist wave on the continent, which would compromise thesecurity of eurozone government debt.If not the eurozone, then what about China? As part of itsrecent financial reforms, Beijing has sought to open upforeign access to China’s interbank bond market. The reformsare meant to promote the international use of the renminbi(RMB) and increase China’s global financial influence. InNovember 2015, the International Monetary Fund announcedthat it would include the RMB alongside the U.S. dollar, theeuro, the yen, and the pound sterling in the basket ofinternational currencies used to value the Special DrawingRight.Yet China has a long way to go before it can rival the UnitedStates as the world’s top source of safe assets. Investors stillfret over China’s opaque institutions, its slowing economicgrowth, its volatile stock market, its use of capital controls,and its growing piles of private and public debt. The size ofthe Chinese bond market, which is worth about $4 trillion,pales in comparison with that of the U.S. Treasuries market,and foreign ownership of China’s public debt remains verylow. And despite Beijing’s efforts, the RMB’s use ininternational transactions fell between 2015 and 2016 byalmost 30 percent. All of this uncertainty reinforces therelatively safe status of the U.S. Treasuries market.As emerging markets drive global growth in the coming years,the value of the dollar will probably undergo a gradual fall.Central banks in Beijing and Tokyo could limit their losses byselling some of their U.S. Treasuries now. But that too isunlikely, thanks to a dynamic that the economist EswarPrasad has called the “dollar trap.” By selling theirTreasuries, Beijing and Tokyo could set off a panicked flightfrom the Treasuries market—and that would be bad news forbig exporters such as China and Japan, since it would furtherweaken the value of the dollar and make U.S. exports morecompetitive.Jason Lee / REUTERSThe headquarters of the People's Bank of China in Beijing, June 2013.MONEY TALKSThere is another reason that U.S. Treasuries will likely retaintheir safe status: their powerful domestic owners will seek toprotect them.In recent years, domestic ownership of the United States’public debt has become increasingly unequal: the richestAmerican families and the biggest financial corporations haveacquired a disproportionate share of U.S. Treasuries. AmongU.S. households, the share of public debt held by the richestone percent climbed from around 20 percent in 1969 to 56percent in 2013. Meanwhile, in the corporate sector, the top2,500 companies’ share of the debt jumped from 65 percent inthe period between 1977 and 1981 to 82 percent in the periodbetween 2006 to 2010. Highly concentrated mutual fundshave expanded their holdings of U.S. Treasuries as pensionfunds, which are more widely held, have lost some of theirshare. All of this has aligned the interests of the richestAmericans with those of the biggest financial firms.This concentration of public debt is the result of the four-decade evolution of what the economic sociologist WolfgangStreeck has called the “debt state.” In the case of the UnitedStates, rising federal spending and stagnating federalrevenues—themselves a result of increasingly regressive taxpolicies—have produced ever-deeper levels of public debt.The United States’ wealthies families and biggest companieshave waged a successful political battle to reduce their taxburdens; they now pay less tax relative to their income thanthey did a few decades ago. That has produced moreinequality—and more savings for the rich to invest in risingpublic debt. In effect, the federal government is borrowingfrom powerful domestic groups instead of taxing them. IfTrump ever seriously threatened he safe status of U.S.Treasury securities, these powerful domestic owners wouldprobably rise up in opposition.  At this point, there are few signs that Trump will try todisrupt the debt state. To the contrary: the tax reformsbacked by his administration could add up to $1.5 trillion tothe deficit over the next decade. Because the bulk of the taxcuts will benefit top earners, the reforms would furtherentrench the power of domestic groups with interests in astable Treasuries market.IN THE LONG RUNThis assessment applies only to the short term. In the longerrun, a financial crash, a natural disaster, domestic unrest, ora major war could quickly bring about systemic changes,unraveling the global financial order and ending the U.S.Treasury market’s role as a safe haven. More optimistically,Trump could deliver a sustained economic recovery, reducingthe U.S. deficit and placing the onus on other governments tosupply the global financial system with safe assets. Wouldn’tthat, too, disrupt the position of U.S. Treasuries?Perhaps. But there is reason to be skeptical of Washington’sability to produce such an outcome. First, Trump’s proposalsfor recovery have hinged mainly on his pledge to increaseinfrastructure spending. With such large tax cuts in theoffing, however, it is unlikely that Republicans will throwtheir support behind an expensive infrastructure plan.Second, Trump’s fiscal strategy appears to contradict theother component of his blueprint for growth: a weaker dollar.Increased deficit spending could lead to rising interest rates,which attract capital inflows. To the detriment of U.S.exporters, those inflows would strengthen the dollar andwiden the current account deficit far more than the tax cutswould on their own.Nor is this all. The political economists Shimshon Bichler andJonathan Nitzan have shown that since the 1940s, risingemployment rates tend to be followed by falling pretaxcorporate profits and falling stock prices relative to wages.Unemployment is already falling, and if Trump delivers on hispromises to create even more jobs, profits and the stockmarket would fall even further than they would otherwise.Having appointed the wealthiest cabinet in U.S. history,Trump will likely be reluctant to aggressively pursue policieswith such potentially detrimental consequences for thesuperrich.Domestic ownership of the United States’ public debt hasbecome increasingly unequal.Bichler and Nitzan identify yet another factor that mightdampen enthusiasm for a Trump-style recovery: the effect ofemployment growth on interest rates. Since the 1960s, theynote, “employment growth has become a nearly perfect five-year leading predictor for interest rates.” As employment rosein the 1960s and 1970s, interest rates climbed; since the early1980s, both employment growth and interest rates havefallen. Substantial growth in employment today could sendinterest rates soaring and bring an end to the bull market thatcheap credit has encouraged.Trump’s election made investors justifiably nervous. But amass exodus from the U.S. Treasuries market is unlikely, bothbecause the United States remains the most relatively safeinvestment option in a perilous world and because Trump’spolicies will entrench the power of the superrich owners ofTreasuries. The existence of an influential bloc of domesticowners should offer some solace to foreign investors rattledby the new administration’s nationalist rhetoric. But perhapsthe main lesson for the holders of U.S. Treasuries is that theinertia in the global financial system is strong—even in theface of a change like Trump.SANDY BRIAN HAGER is a Lecturer in International Political Economy at City, University ofLondon. © Foreign Aﬀairs

Trump and the Bond Market

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Trump and the Bond Market

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