Trump in bondage

A consensus is emerging that the biggest reason for Trump's climb-down on tariffs last week was the reaction of the bond market.  We haven't heard the last of this issue.

For those who are not familiar with the bond market, here is how it works.  The sale of Treasury bonds is how the US government borrows money.  A bond's value at maturity is fixed; its initial sale price is lower and is determined by supply and demand, with the difference between sale price and maturity value being the interest paid by the government to the investor.  For example, if a bond is worth $100 at maturity, and you buy it for $95, then the $5 difference is the interest you get on the investment, effectively paid to you by the government.  If you are less confident that the bond is a good investment, and you pay only $90, then your return is $10 when the bond matures, and the government is having to pay twice as much interest to borrow the money from you.  In practice, the sale price of Treasury bonds is set by supply and demand and reflects investors' collective level of confidence in the US economy at any given moment.

So any drop in bond prices automatically means a rise in the interest rate the government pays for borrowing money, which is considered a Bad Thing.  Bondholders who are losing confidence can also sell their bonds to other investors, which naturally lowers the price at which the Treasury can sell new ones.  This is considered a Very Bad Thing.

This is what started to happen last week as it really looked like Trump was going to stick with his demented tariffs this time and crash the US economy.  In effect, bondholders lost confidence in their investment in the US economy and started trying to get out of it.

The reason this matters for the future of Trump's befuddled trade and foreign policy is that huge quantities of US bonds are owned by foreign governments.  Japan holds over a trillion dollars worth of them, China holds $760 billion, the UK holds $720 billion, Canada holds $380 billion, and many others also hold substantial amounts.  Even by the standards of the US federal budget, these are very large amounts of money.  And these governments have now learned that turmoil in the bond market can get Trump to back down even when nothing else can.

If a foreign government with large holdings of US bonds were to start selling them off, or even announced it was considering doing so, the impact on the US Treasury would likely be disastrous, depending on how many bonds the foreign government was proposing to dump.  Other investors would likely follow suit.  The price of new bonds sold by the Treasury would plummet and the interest cost of borrowing money would skyrocket.  No president could ignore this.  And foreign governments are perfectly capable of taking such actions for reasons other than purely investment confidence.  If Trump does something that seriously pisses off, say, Japan -- such as imposing another round of ridiculous tariffs, harassing Japanese companies that do business here, threatening to annex Godzilla, etc -- then that trillion dollars worth of US bonds Japan holds will constitute a ready-made cudgel to force him to back down.  Selling off bonds would lose them some of the return on their investment, of course, but they might well judge this an acceptable price to pay for squelching a US policy change that would do them greater harm, or simply asserting the principle that they refuse to be bullied.  And even the mere threat to dump bonds might be enough.

The US is a very powerful country, economically and otherwise.  But Trump thinks it's an 800-pound gorilla that can intimidate every other country into submission if it just waves its fists around threateningly enough.  It isn't.  Others have power too, in various forms.  He seems to be gradually figuring that out.