- 27 minutes ago
Governments can win elections and promise tax cuts, new infrastructure or stronger defence. But delivering those promises often means borrowing from investors who can demand a higher price.
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00:00You can win an election, promise to slash taxes, build homes, and strengthen your country's defences.
00:06But there is a shadowy, unelected force that can blow up your pledges before you start.
00:11The markets that lend money to governments.
00:15And now the cost of borrowing is exploding across the world on the back of an oil supply crunch.
00:20Even the US is feeling the heat.
00:23So who holds the power when voters want one thing and lenders demand another?
00:28And can governments fight back?
00:30Welcome to The Dip, your podcast for money, power, and consequences.
00:34I'm Daniel.
00:37So joining us to decipher this are two of the best financial minds.
00:41We've got Kathleen Brooks, who has spent decades watching financial markets and making sense of what moves them.
00:47She joins us from XTB, research director there.
00:50And Karsten Bjeski has spent years following German and European economies from central banks to the bigger political and economic
00:58forces shaping them.
00:59He is a global head of macro at ING.
01:01Kathleen and Karsten, welcome to The Dip.
01:04I think I'm going to start with a quote.
01:06I normally don't do this.
01:07But James Carville, advisor to Bill Clinton in 1993, said, and you'll have heard this one before,
01:13I used to think that if there was reincarnation, I wanted to come back as the president or the pope.
01:18But now I want to come back as the bond market.
01:20You can intimidate everybody.
01:23So Kathleen, how intimidated should the average person on the street be by the bond market, by the rising cost
01:30of borrowing for governments?
01:32Well, it all depends on how much you borrow.
01:34If you have a mortgage, if you have a lot of debt, then that's a big problem.
01:39It's not just the individuals who are, who get, you know, highly indebted individuals who are stressed.
01:45Look at governments.
01:46If you're like the UK government and you've got a lot of debt, it's costing you a lot of money
01:51to keep borrowing and to keep funding your activities.
01:56So all of a sudden, you've got to work on a budget and you've got to try and rein that
02:00debt in.
02:02You know, I think most people on the street, as long as you have a, you know, a sensible financial
02:08budget at home, you don't need to be worried.
02:11But the minute things don't become sensible, it doesn't matter if you're a man on the street or you're, you
02:15know, the head of the biggest government.
02:17You're going to have you're going to have to be worried of the bond market.
02:19OK, and Kirsten, take us inside government, because you've worked inside more than one government, the Dutch and European level.
02:28Did you ever see a moment where the there has been cause for intimidation, cause for panic inside the governments
02:36when they're looking at what kind of what can we spend on?
02:38What can we what can we borrow?
02:40Can we actually, you know, make good on our pledges?
02:45Well, Daniel, I worked government and the Dutch are clearly known for being extremely frugal, so they had never any
02:52concerns with the bond market.
02:54To the contrary, bond markets love the Dutch and they're very happily giving their money to the Dutch government.
03:00So there has never been any panic in the Dutch government.
03:03But when you look at the European level, obviously, we all remember the European sovereign debt crisis, the Greek crisis
03:11starting in 2010.
03:13So there was clearly a moment in which there was panic because there was a moment in in which bond
03:19markets said they are no longer giving money to southern European economies and giving no money to southern European economies
03:27or governments clearly meant that those governments, those countries were getting into financing troubles.
03:33So this is where panic was very high.
03:36Yeah, and things are a sign of the times.
03:39Things are getting so tricky at the moment that now the Greek finance minister said that the German economy needs
03:43to reform.
03:44So it just goes to show how much things have changed.
03:46And Carsten, governments are struggling in so many kind of factors at the moment.
03:51We're seeing interest rates rise right now.
03:53Governments are spending far more than they raise.
03:56They're adding ever more to their enormous debt piles.
03:58And now on top of that, of course, the cost of borrowing for governments is rising rapidly, too.
04:04And this is being covered by the newspapers all over this week.
04:06And The Economist said big borrowers are about to discover just how painful those debt piles can be when interest
04:14rates can no longer be ignored.
04:16Are you worried?
04:19I am worried, but let me take one step back, Daniel.
04:22I think what the bond market is currently telling us is mainly that there is still a war in the
04:28Middle East, that there are extremely high oil prices, that there is inflation, which will remain higher for longer.
04:35And that the bond market is also expecting big central banks like the American Fed, like the European ECB, to
04:44increase their policy rates, their interest rates much more than previously thought.
04:49So this is one of the stories that the bond market is currently telling us.
04:52So expectations about the future.
04:54The other story, the bond market is telling us that we are indeed living in a very indebted times.
05:00You mentioned it, a long list of demands, what governments should do.
05:04And in the past, governments all over the world, especially all over the developed world, have continued to spend investing,
05:14consumption, and interest rates hardly ever played a role.
05:20Ten years ago, bond markets were giving European governments money for free.
05:25We had negative interest rates.
05:27So now, borrowing is no longer for free.
05:31And this brings an end or limits to what, in my view, I would call deficit or debt-funded growth.
05:39So now governments will have to make a choice.
05:43They will have to decide, well, can I do this spending here?
05:46Or shouldn't I cut my expenditures somewhere else?
05:49Or should I have to increase taxes somewhere else?
05:53But this idea that money is for free and I can just spend like I want as a government, these
05:58days are over.
06:00Okay.
06:00And Kathleen, just digging into that a little bit more.
06:03So the cost of government borrowing is rising in major economies, US, UK, France, Germany.
06:09Though Germany is actually comparatively still quite cheap as it goes in Europe.
06:14But what's going on here that – how is the effect hitting different economies in different ways?
06:20Because obviously it affects the US very differently than it might affect the UK, for example.
06:26Yeah, it does.
06:27I mean, the US is in a very privileged position because it has the world's reserve currency.
06:32It obviously has the treasury, which is, you know, the most widely held government debt.
06:37But it has experienced ructions in recent weeks and months because of – partly because of what Carson has said.
06:45It makes it easier for the US to have a $40 trillion debt load.
06:49But even the US is creaking under that.
06:51In the UK, however, we don't have that privilege.
06:54And we've seen in a number of occasions over the last four years that if you try any unfunded tax
07:01cuts, big deficit spending, that the bond market is going to, you know, really – they're going to punish the
07:11government and force them into a different course of action.
07:14And we've seen that Liz Truss, our prime minister in 2022, she had to resign after a budget wasn't well
07:20received by the bond market.
07:22And our current prime minister, Andy Burnham, had said in the past that he wouldn't worry about the bond market.
07:29Well, now, a month out before our next budget, he is very much concerned about the bond market.
07:35So it has a huge impact on how governments are behaving, but particularly governments aside from the US.
07:42OK, and it sounds like this kind of vague, amorphous, shadowy group, you know, the bond market, the lenders.
07:49But who are leaders trying to convince?
07:52Who are the lenders?
07:54What do we mean when we talk about who is buying up this government debt?
08:00I mean, there are multiple sources.
08:03You have pension funds traditionally have been a really big buyer of government debt, particularly here in the UK.
08:09In fact, they were mandated for many years to buy a lot of government debt.
08:13Insurance companies are.
08:15And you do also have some hedge funds as well.
08:17So we know that one issue with the UK bond market is that it is heavily that there are a
08:23lot of leveraged positions.
08:25So a lot of investors or traders really are involved in UK government bonds.
08:32They own UK government bonds because they really like the volatility.
08:36And that can actually make the volatility worse and can make it quite bad for our government.
08:41The UK is a bit different, but certainly in Europe and Japan, it's a lot of, you know, pension funds,
08:46insurance funds, institutional buyers, very solid buyers, actually.
08:51Yes. And, you know, when we were planning this episode, it was always going to be about government debt.
08:58But then several other big factors kind of got in the way.
09:01And we've just seen, for example, the oil shock get a lot worse.
09:05And, Carson, I want us to kind of address that elephant in the room of energy prices right now.
09:11What just happened to push those energy prices up?
09:15We knew that there was factors in the Strait of Hormuz, which were stopping shipments of oil leaving.
09:19But now things have got worse.
09:21And how does this affect government's ability to borrow money at the rates that they would prefer?
09:27Yeah. Well, you mentioned already, of course, this is becoming a forever war between the US and Iran.
09:33This is not where it stopped.
09:34In recent days, we also had now military escalation blockages of the Red Sea, which now means that the transportation
09:43routes in the entire Middle East are clogged, are closed, are disrupted.
09:49And this has pushed up oil prices further.
09:52There was also news that, for example, Saudi Arabia apparently was not able to produce as much oil as they
09:59intended to in August.
10:00Well, seen or received as a signal by markets that maybe some of the production facilities of oil in Saudi
10:08Arabia in the Middle East have been destroyed during the war.
10:11So, this is what pushed up oil prices above $100 per barrel.
10:16And now, how is this affecting the bond market?
10:18Well, now, with these higher oil prices, it is obvious that energy prices for all of us here, for us
10:27as consumers, for companies, will also go up.
10:31Well, you know this where you just go and fill up your car.
10:34Gasoline prices across the world have gone up to almost record highs.
10:39So, this is costing income of households.
10:43At the same time, we will also see that some firms will no longer be able to produce because, for
10:50them, producing has become too expensive with these higher energy prices.
10:54So, we're seeing that inflation will remain with us for longer than expected.
11:00And this is something a bond investor will also have to take into account.
11:06So, his money, his investment is losing value much faster due to inflation.
11:12And consequently, he or she will also ask a higher interest rate on giving money to governments.
11:19And this explains why we've now had this increase in interest rates in government bond yields.
11:24When we look at gas stocks in Europe, they seem to be woefully low in continental Europe as well as
11:31in the UK.
11:32And prices are rising, as we've just heard.
11:35If it's like a particularly cold winter ahead in Europe, could the energy shock also turn into a kind of
11:42a debt shock?
11:43Because governments try to support households and support industries to get through what could be an energy supply crunch through
11:51winter?
11:52Or is debt shock a bit overplaying things, would you say?
11:57I think it really does depend on a lot of factors at the moment.
12:00Number one, yes, there's no denying that supply levels are really, really low.
12:04It's very hard for us to store in advance when the price is good.
12:07So, we have to take the price as and when we need to use it.
12:10And it's just a very, you know, very sad turn of events in one way that the prices are going
12:17up just as we're trying to build our stocks for winter.
12:20But in terms of will that cause a debt shock, I think it depends on how long the price rises
12:25increase.
12:26And secondly, some countries, I would include the UK in that, they don't really have the bandwidth to provide another
12:34energy support package.
12:35They provided lots of energy support packages after the Russian invasion of Ukraine.
12:41We saw, you know, a large increase in debt to fund those packages.
12:46But right now here in the UK, for example, we've been offered £13 a year off our bills.
12:52And that's seen as being generous from the government.
12:55But essentially, supply shocks, like what we're seeing with energy prices, they are very economically disruptive.
13:01And if the energy prices stay high for the coming months, then I think we'll see just how destructive they
13:08are.
13:10OK, and Kathleen, I want to move over to the US now because, you know, if they sneeze, the whole
13:15world catches a cold, of course.
13:17And its borrowing costs a few days ago hit the highest since 2007, I think it was.
13:23And America currently spends more on paying off its debts per year than it spends on its military.
13:30By the end of this decade, if borrowing costs stay where they are, those costs could triple.
13:37It could get to the point of paying $2.7 trillion in interest payments alone.
13:44And this is a rising bill which, even for an economic superpower, is concerning, isn't it, Kathleen?
13:52Yeah, it's very concerning because the US is a high growth economy, certainly comparatively to other developed economies.
13:59And it's still in this position.
14:01So really, you know, they have to level with the fact that they can't grow their way out of this
14:07debt bubble.
14:09The issue, I think, for them is that by the time they hit, I think it's 2032, they're going to
14:15potentially not be able to come good on all of their, of what they've promised individuals.
14:23So social security payments, for example, they won't necessarily be met because there's been economic mismanagement across developed worlds, but
14:32particularly in the US, certainly in the UK as well, whereby, you know, the coffers that were meant to hold
14:38all of the social security payments that workers pay in throughout their lifetimes, they've actually been emptied.
14:44Okay, so it's a big concern in the US.
14:47And Karsten, why is US borrowing rising so much?
14:51Why is the deficit rising so much?
14:53I mean, Kathleen touched on some of the parts there.
14:56What's causing this?
14:59Well, it is causing that there have been too many tax cuts, tax relief, tax gifts to citizens, which were
15:08not balanced by enough revenues.
15:10Also, recently, clearly, with the war in Iran, this is also pushing up military expenses in the US.
15:17So also, as long as you don't cut expenditures elsewhere.
15:21So this is also keeping the deficit very high.
15:24And this big, beautiful bill, remember the one that we had last year, was also doing nothing to bring down
15:32the annual fiscal deficit.
15:34So this is kind of a US government always trying to continue with a growth party and being extremely afraid
15:44to take away the party bowl.
15:47And we are now getting closer to a moment in which these policies are no longer sustainable and in which
15:54then a US government will have to agree to some kind of measures in order to bring down first the
16:01annual deficit and then longer term and consequently also the entire government debt position.
16:07And, Karsten, Trump has long talked about America first, and he wants to increase America's position in the world.
16:14But a big buyer, traditionally, of US government debt has been China.
16:20Is there some sort of risk to the US by China holding so much of its debt?
16:27For example, if Beijing just decided to sell it all off, is that a threat to the US?
16:35It used to be, it has been, but as Kathleen nicely explained, the bond investors are normally in for a
16:42longer time period.
16:43So bond investors do not go in and out of their investment.
16:47So they are long-term investors.
16:49And also don't forget, so even if the Chinese now were to sell their bond investments, they would go out
16:58with a loss, with a financial loss.
17:00So this will probably keep the Chinese also invested in the US.
17:04Normally, lenders give the USA a bit of a discount because of its position as an economic superpower.
17:11But this discount that it has over other countries has been reducing and eroding.
17:17What's behind that?
17:19Yeah, I think it's, you know, a cumulative debt load.
17:23You know, they have $40 trillion in debt.
17:25People are starting to wake up to the fact that there's just continuous spending, as Karsten said, that no one
17:30is willing to reduce the deficit.
17:33So that just changes the whole picture for investing.
17:36There's also a lot more bond issuance out there, for example, from the hyperscalers, those big tech firms.
17:44They have been selling debt, a huge amount of debt this year, to fund their AI ambition.
17:51Well, could I just jump on that for a second?
17:53So is it that these AI companies, that they're competing for investors with governments and that investors are choosing to
18:04go with the AI companies in some cases?
18:06Yes, that's the case. Definitely.
18:08Certainly, this year, AI debt has looked a lot more attractive than sovereign debt.
18:14Look at the balance sheets of some of these companies.
18:17You know, a Microsoft, an Alphabet, a Meta even.
18:20They're looking strong.
18:22Now, they are also racking up debt at a very fast pace.
18:25But they, you know, they look incredibly strong.
18:28And you might be looking at the US and saying, well, actually, we don't know what the future is going
18:32to hold.
18:33Are they going to pay back all this debt?
18:34OK, and Kathleen, let's make you advisor to Donald Trump on his economic strategy.
18:40What does he have to do to turn this situation around to ease the pressure that's coming from these rising
18:46borrowing costs?
18:47Well, the first thing would be to find some sort of ceasefire deal with Iran to get oil supplies going,
18:55getting through so that we could bring down refined fuel and fuel costs to reduce inflation and inflation expectations.
19:05And I think the second thing is actually, you know, reinstating the US's position as, you know,
19:13a really the leading light, the main power for the liberal world order,
19:18because I think that has also upset bond markets, not having that anchor of stability in the US.
19:24Yeah. And I think cutting some of that deficit spending, increasing taxes a little bit might help to reversing this
19:33big, beautiful bill, essentially.
19:34But I have a feeling that Trump isn't going to do that because it might mean that he has to
19:38admit failure.
19:39Well, Carson, I want to kind of pivot now to this idea of what governments can do in a bit
19:45more detail.
19:46So when markets turn against a government, so to speak, though, that puts a bit too much animus into the
19:53markets as if they're, you know, it's an ego thing.
19:56But how much can the central bank do to protect that government and protect that economy?
20:05What can they do?
20:09Theoretically, any central bank could simply also start buying government debt.
20:13They could also buy bonds.
20:15And we've been there before.
20:17So this could be helped.
20:19So first of all, then you have a new buyer of government debt.
20:22So which brings down the borrowing costs for governments.
20:25And you also have this kind of symbolic reputational effect that other investors are saying,
20:31you know, well, if the central bank is buying government debt off country X, Y, Z, then this country's fiscal
20:38position must be sustainable.
20:41Yeah.
20:41And it's something that Japan did for a while, talking about the central bank buying up government debt to keep
20:48that cost of borrowing down.
20:49And it worked well for Japan for a while.
20:53But it seems that it's not something that's open to all central banks in equal measure.
20:58But if we look at the spending side of things now, one obvious thing to do, Carsten, would be to
21:03tell France to stop spending money on its generous pension obligations.
21:08Stop telling Germany to build bridges and roads.
21:11But obviously, they can't just do that.
21:14In France, it's politically unfeasible.
21:16In Germany, the bridges are crumbling in places.
21:18So when you can't stop spending, what is the way forward, for example, for Germany?
21:26Well, Daniel, ask the Greek.
21:29And the Greek will tell you, if you really have to stop something, you can stop.
21:33So it is not that you can stop.
21:35If there is no money, you will stop.
21:38Markets will force you to stop.
21:41Again, check the European sovereign debt crisis.
21:44Then all of a sudden, governments were not able to pay the salaries, wages of civil servants.
21:51So this can happen.
21:52So how should you do this?
21:53You mentioned France, which is for Europe, the elephant in the room.
21:58So you will have to find compromises.
22:03You cannot just stay in a situation in which you say, no, I don't want to do economic reforms.
22:08And I just want to continue as I did in the past.
22:12So this is clear with these kind of interest rate levels, this strategy no longer works.
22:19So, which means there will have to be economic reforms that somehow bring some relief for government finances.
22:26And there will also have to be some strategies to reduce spending and to maybe also increase revenues.
22:34Well, if you are a country like France, where from the back of my head, I think government expenditures account
22:40to more than 55% of GDP, if I'm not mistaken.
22:45There is some slack and there should be some room.
22:48If you talk about more than 55% of your entire economy, there will be ways to cut expenditures.
22:54Okay, but you mentioned the Greek model.
22:56What if governments just don't pay it back?
23:02Then you lose trust of financial markets.
23:05And then you are in a situation that Kathleen knows even better than I do.
23:09So then you are in a situation in which you really go into insolvency.
23:15So this also means, this is like, if you as an individual, you owe money to someone and you decide
23:24not to pay back, well, will your friend ever give you money again?
23:29Well, doubtful.
23:30And that is the similar situation.
23:31So if a government decides not to pay back the debt, investors will ask even higher interest rates and will
23:41not be very willing to hand out any money to these governments anytime soon.
23:45Okay.
23:46Kathleen, we've heard that the bond markets can break governments in some cases.
23:51What does that actually look like when we talk about this breaking?
23:57And when does a government kind of lose this freedom to do what it wants?
24:02Is it even compatible with democracy to be borrowing so much money and therefore having to do what the markets
24:09tell you instead of what voters tell you?
24:12I think that's a really, really good point.
24:14What we saw in 2022 was about a two-week period of really intense pressure on the UK bond market
24:24after that Liz Truss budget, which then forced her to resign, which then we didn't elect.
24:32We don't elect a prime minister here.
24:34The Conservative Party had won the elections.
24:37They were able to bring in a new leader, which was Rishi Sunak, with Jeremy Hunt as his chancellor.
24:42They were a much more measured, more palatable ruling pair compared to Liz Truss.
24:50And they came in, they did an emergency budget.
24:53And one of the first things that they did, and they reversed everything that Liz Truss had put in her
25:00budget, that notorious budget that she did.
25:04So they reversed the tax cuts and they scaled back the energy package.
25:08So it's back to what Carson said.
25:10If the bond markets require it, governments can make changes.
25:16You're right.
25:17It's not democratic.
25:18When you have a situation with the bond market, there's so much pressure on a government balance sheet that it
25:26cannot.
25:26You know, you see these incessant rises in bond yields day after day, that they have to bring in new
25:32government.
25:33They have to bring in new emergency budgets.
25:36It's not a pleasant experience for anybody.
25:39But you've got to get the finances back onto an even keel.
25:43So you've got to get the spending and, you know, the tax take correct.
25:47OK, and Kathleen, I mean, both of you be very generous with your time.
25:51So I just want to give you both a kind of a wrap up question.
25:54So, Kathleen, we've got borrowing costs, energy costs, massive spending programmes.
26:00Are we entering a period of permanently high or higher than before inflation, permanently higher borrowing costs?
26:09How do you see it?
26:11It does seem like we are in a new paradigm post-COVID, whereby we're more vulnerable to inflation spikes.
26:21There is an inflation premium on developed world economies, developed market economies, and that is going to keep inflation very,
26:29very high, I think, for at least the rest of this decade.
26:31Because there hasn't been enough progress to make us less reliant on energy imports, particularly in Europe, which means that
26:41we have – the cost of that is higher inflation and a higher interest rate.
26:46OK, and Karsten, I just want to, you know, lighten the mood with this sense of a doom loop.
26:53So investors get nervous about a government's debt, so they demand much higher interest.
26:58That makes the government's debt bill even bigger, which makes investors more nervous, so borrowing gets more expensive again.
27:03And as the old debt starts to mature, the bill rises even further.
27:10Is this a risk of a debt doom loop something that we need to take seriously?
27:16Well, if you call this a bit more neutral, a snowball effect, then you're fully right.
27:22Well, is it really a doom loop?
27:25Well, I think there are at any time governments can just stop this doom loop.
27:30It starts with the U.S. government, for example, stopping the war in the Middle East.
27:35It continues with other governments really doing more austerity measures in order to stop this doom loop.
27:42But you are fully right.
27:44So once, and that's the whole thing, once this snowball effect gets going, it is much harder to stop it.
27:52And it's also much more painful to stop it.
27:55But lesson of the last decade has always been that most governments rather get an action when they are with
28:04their backs against the wall
28:05and not so much anticipating what is coming next.
28:09A cheerful end to a wonderful interview.
28:13Thank you very much to you both, Carsten and Kathleen.
28:16Very informative.
28:17Thank you so much for joining us on The Dip.
28:20Well, that's it this week on The Dip.
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