The bond market is beginning to expose what governments have desperately tried to hide. Britain’s 30-year yield has now reached 6.036%, the highest since 1998. The US 30-year yield reached 5.7041%, its highest level in 24 years, while France’s 10-year yield has pushed above 5%. This is happening across the developed world because governments borrowed endlessly when money was cheap and somehow convinced themselves that interest rates would remain artificially low forever.
This is precisely how a sovereign debt crisis begins. It does not require a government to announce that it is bankrupt. Capital simply begins demanding more interest to lend that government money. The higher the interest rate rises, the more expensive it becomes to refinance the existing debt, which creates an even larger deficit that requires even more borrowing. Government then enters a vicious cycle of borrowing simply to service what it already borrowed.
France is becoming the one to watch in Europe. Citadel’s Ken Griffin said France now has “no room for mistakes.” Investors are beginning to distinguish between European governments rather than treating every euro-denominated bond as essentially the same risk. Money has been moving toward Germany, Switzerland and the Netherlands while France comes under pressure. Italy and Spain are naturally being watched for contagion.
This exposes one of the fundamental flaws behind the euro. Brussels created one currency but never created one government, one debt, or one economy. A German bond is not a French bond simply because both are denominated in euros. When confidence begins to crack, capital looks at who actually owes the money. That is when spreads widen and all the political promises about European solidarity mean very little.
The same problem is unfolding in the United States. Washington has accumulated more than $40 trillion in debt and must continuously roll over enormous amounts of old debt while issuing still more to finance current deficits. The Treasury cannot dictate what investors must accept forever. If the market wants 5%, 6% or more to absorb government paper, then that becomes the cost of borrowing regardless of what some politician or central banker would prefer.
This is also why people waiting for the Fed to magically return everything to pandemic-era interest rates do not understand the bond market. The Fed controls the short end directly. It does not simply decree where the 10-year or 30-year Treasury must trade. Those rates reflect inflation, supply and demand for government debt, currency expectations, fiscal credibility and international capital flows. The government can intervene, buy bonds and manipulate the market temporarily, but eventually somebody has to own the debt.
Governments enjoyed decades of declining interest rates and behaved as if that were a permanent feature of civilization. They expanded welfare states, pensions, bureaucracies and military spending while refinancing yesterday’s promises at cheaper rates. Now the refinancing works in reverse. Debt issued at 1% or 2% matures and must be replaced at 4%, 5% or 6%. Nothing new has to be purchased for the interest expense to explode. They are simply paying more for the same old debt.
This is where the political crisis begins because governments will not voluntarily admit that they created promises they can no longer afford. They will raise taxes, cut services, raid pensions, impose regulations on capital, and blame speculators before admitting that the problem was their own borrowing. The taxpayer will be told to sacrifice because politicians spent money for decades without ever asking who would ultimately pay the bill.
The bond market is beginning to answer that question. It is pricing governments according to confidence, and confidence cannot be legislated into existence. When capital starts questioning sovereign debt, politicians can give all the speeches they want. The market ultimately decides what their promises are worth.