U.S. Treasury Secretary Scott Bessent speaks during a press conference, as finance ministers and central bank governors from G20 countries meet in Asheville, North Carolina, on Tuesday.Sam Wolfe/Reuters
The global bond sell-off that hit financial markets this week was a warning to governments everywhere that they are running out of time to get runaway debt and deficits under control. As yields on U.S., Japanese and European bonds spiked, investors signalled they are increasingly worried about the ability of these sovereign borrowers to repay their debts.
For now, the hedge funds, pension funds and asset managers that hold trillions of dollars worth of U.S. Treasury Bonds, Japanese Government Bonds (JGBs), French Obligations assimilables du Trésor (OATs) and British Gilts are demanding higher interest rates to offset the risks of persistent inflation, sluggish-to-no economic growth and growing geopolitical chaos.
A painful reality is gripping governments that borrowed heavily after the 2008 global financial crisis (GFC) and during the COVID-19 pandemic – which is pretty much all of them – as they move to refinance debt issued when interest rates hovered near zero or borrow more to cover ballooning pension costs, health care spending and defence expenditures.
The U.S., France and Britain now face long-term borrowing costs that are near or above 5 per cent. The last time rates were this high, in the early 2000s, government debt levels were reasonably low. They have skyrocketed since then. So have interest payments.
The U.S. federal debt last month surpassed the US$40-trillion level, or about 125 per cent of the U.S. gross domestic product. Washington’s debt load has doubled since Donald Trump was elected President the first time, in 2016. And it continues to snowball with annual budget deficits hovering around 6 per cent of GDP and showing no sign of slowing down.
What to know about the sell-off in world bond markets
“The world is awash in debt post-GFC, post-COVID, and the only way for us to get out of this is to grow our way out of this,” U.S. Treasury Secretary Scott Bessent said at this week’s meeting of G20 finance ministers.
Good luck with that. The United States might have better prospects for growth than most advanced economies, thanks to a boom in artificial intelligence. Even so, its economy is not growing fast enough to erase its twin trade and budget deficits. Indeed, for now, the AI boom is exacerbating the trade deficit, amid soaring imports of semiconductors and electronics, and putting upward pressure on interest rates as tech companies go on a borrowing binge.
As for Europe and Japan, where aging populations are pushing spending on pensions and elder care through the roof, the prospect of growing their way out of debt is non-existent. Any Canadian trade-diversification strategy that ties itself to these markets has its limits. They can never replace the U.S. consumer and face decades of demographic stagnation.
Of course, the backdrop to this week’s sell-off in government bonds remains the massive imbalances in merchandise trade between China and the developed world. China continues to run a gigantic trade surplus, nearing US$1.2-trillion in 2025 alone, while the United States runs an intractable trade deficit that last year topped US$900-billion. The U.S. budget deficit is, in part, the result of the country’s trade deficit.
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Mr. Trump’s trade wars have not made a dent in that shortfall, mainly because they focus on the wrong problem (the loss of U.S. manufacturing jobs) rather than the fundamental mismatch between U.S. consumption (which is too high) and U.S. production (which is too low). But make no mistake, Mr. Trump’s trade policies are not only the product of one man’s deranged mind. They are part of his administration’s attempt to force other countries, including Canada, to share the burden of reducing the global trade imbalances that they helped create by letting China become the world’s factory for the past quarter century.
Demands that Canada align its trade policies (particularly toward China) with the U.S. emerged as a sticking point, if not a deal breaker, in last month’s trade talks between Ottawa and Washington. But it is important to remember that former president Joe Biden’s administration made similar demands regarding electric vehicles. And we should expect future American administrations, regardless of political stripe, to press for even broader trade-policy alignment. This is a reality all U.S. trading partners will need to accept as the U.S.-China superpower rivalry intensifies in years to come.
In the meantime, Washington’s attention will increasingly be directed toward averting a bond-market meltdown that could trigger the next global financial crisis. Mr. Bessent’s attempt to calm the markets by increasing the amount of bonds the U.S. Treasury buys back each week has had the opposite effect.
The bottom line for governments everywhere is that the days of record-low interest rates are over for the foreseeable future. They need to adjust their budget policies accordingly and reform unsustainable spending programs. Few governments have mustered the political courage to do that on their own. The bond market is now putting them on notice.