Harvard Professor: Hard Truths for the U.S. Treasury Market (AI Translation)

【周刊提前读】哈佛教授：美债市场逆耳忠言

The article draws a parallel between medieval court jesters—who were uniquely positioned to tell uncomfortable truths to monarchs—and the role played by the U.S. bond market in offering warnings to President Donald Trump, whom the author likens to an ambitious contemporary "monarch" [para. 1]. As Trump’s administration champions the "Beautiful Act," which is likely to pass Congress soon, it becomes clear that the legislation fails to address America’s ballooning fiscal deficit. The U.S. deficit rate is projected to reach 6.4% in 2024 and may increase to 7% or higher during Trump’s term. Unexpected shocks such as pandemics, financial crises, or wars could further exacerbate the deficit [para. 2].

For decades, U.S. Treasury bonds have been seen by global investors as the "ultimate safe haven." However, this perception may be fading. Federal debt now stands at 122% of GDP, and a significant portion will mature in the coming months [para. 3]. Recently, 30-year Treasury yields have hovered around 5%, and 10-year yields at 4.5%, both about two percentage points higher than a decade ago, driving up interest payments to the point that they now surpass defense spending [para. 4].

The notion that debt is a “free lunch” with minimal long-term effects ignores basic economic realities. A return to normalized interest rates is unavoidable—no one should expect ultra-low rates to persist indefinitely, nor should the nation's economic future be gambled on such an assumption [para. 5]. Even the most staunch debt advocates now face this reality [para. 6]. Despite being a political pragmatist who was willing to reverse course when policies faltered during his first term, Trump seems undeterred by these developments. This is largely because American voters are ill-prepared for “austerity” and recoil when the trade-off between short-term stimulus and long-term costs is raised [para. 7].

Trump and his supporters argue that the "Beautiful Act" will spur economic growth and generate enough revenue to offset large-scale tax cuts. However, historical precedent offers little support for this view. Over the past two decades, both Democratic-backed spending expansions and Republican tax cuts have added to the U.S. debt, with tax cuts producing larger deficits. The hope that tax cuts pay for themselves was disproven by President Reagan’s 1980s policies, which led to surging deficits rather than sustainably higher revenues [para. 8].

Will ever-increasing U.S. debt trigger a full-scale crisis? While this is possible, a sustained rise in long-term interest rates appears more likely. Trump is unlikely to force the Federal Reserve to cut short-term rates, and with minimal room for rate reductions—unless a recession hits—rates are more likely to rise, especially if inflation worsens [para. 9]. Various factors are pushing real interest rates higher, including skyrocketing global debt, geopolitical instability, increased military spending, trade fragmentation, higher energy needs due to AI, and increasingly populist fiscal policy. While some mitigating forces exist, such as wealth inequality and demographic trends, these cannot offset rate pressures in the short term. Without government action to control debt, inflation expectations will rise [para. 10].

Another driver of U.S. rates could be Trump’s attempt to reduce foreign trade. The U.S. traditionally matches trade deficits with inbound foreign capital—if capital inflow shrinks, rates will climb [para. 11]. Nevertheless, this is not just a Trump-era issue: interest rates rapidly increased under President Biden as well, and had Democrats won the 2024 election and Congress, the fiscal outlook might be similarly bleak [para. 12][election_info].

The ultimate form of crisis, should it come, will depend on the type of shock and the government’s response. Trump could opt for growth-dampening financial repression, like in Japan or Europe, or the U.S. could face another inflation spike. Regardless, bond market investors are sounding the alarm that Trump’s "Beautiful Act" will drive deficits higher and ultimately hurt the U.S. economy and the dollar—a frank but vital warning [para. 13].