opinion
Ben Harvey: Donald Trump made me jump on the bandwagon by breaking economics

Journalists tend to get a hyperbolically shrill when talking about the American President’s agenda and policies. I have avoided joining the pile-on (I detest reporters who hunt with the hounds and run with the wolves) but something has forced me to join the mob. Donald Trump, you see, has just broken economics. Sounds hysterical, right? Hear me out. And before we go further, a warning: you are about to read about the mechanics of international debt markets and it may cause drowsiness. Do not operate heavy machinery within an hour of consuming this column. In a perfect world I would have Margot Robbie narrate this column whilst in a bubble bath like she did when explaining toxic debt and mortgage-backed securities in The Big Short. Unfortunately for all of us, Margot wasn’t available. And I was reluctant to replicate the scene lest children see it and have nightmares about overweight chimpanzees drowning. So, here we go. THE WORLD’S MOST IMPORTANT NUMBER The single most important figure in international finance is something called the risk-free rate. That’s the interest rate you get on the safest investment in the world. It sets the rate for everything else, acting like a north star of economics. Your mortgage, credit card bill, car finance and business loan are all dictated by the risk-free rate, as is the value of every house and every company in the world. For as long as anyone can remember, the safest investment in the world has been something called a US 10-year treasury note. This financial instrument amounts to a promise by the government of the United States: if you give the American treasury $100 (that’s the value of each note) the US government will pay you a set amount of interest every six months for 10 years, at which time the note “matures” and you get back your original $100. The interest rate the US government pays is considered the risk-free rate because the US government is considered the safest institution in the world. The thinking is that if Washington fails to pay its bills then don’t worry about buying gold, there’ll be a run on canned food and shotguns. A couple of weeks ago international investors started thinking that the US could welch on its bets. WHY GOVERNMENTS ARE LIVING ON IOUs When government spending on important things like hospitals, schools and race tracks at Burswood exceeds government income from taxes and royalties, the shortfall or “deficit” is financed by treasury notes and bonds. Bonds have longer maturity dates than notes but the otherwise act the same way. They’re collectively known as “government debt” and are like lines of credit for politicians. American legislators have enthusiastically availed themselves of these lines of credit over the past few decades. Bill Clinton was the last American leader who balanced a budget and there weren’t many presidents before him that managed to do that. The difference between Washington’s income and its expenditure is mind-boggling. Australians are fretting about a budget deficit of $40 billion. America’s is $US1.3 trillion. Right now, there is close to $US30 trillion worth of US treasury notes and bonds on issue. The long-term average interest rate on all that debt is a bit over 4 per cent. People who buy US treasury notes (banks, other governments and superannuation funds) accept the low rate because it’s safe. OR IS IT? The inverse relationship between treasury notes and stock markets is one of economics’ most fundamental principles. When times are good, investors drop boring old government debt in favour of the high returns from publicly listed companies on a bull run. When shares are in freefall, money managers seek the security and certainty of the US treasury. It’s always been thus. Until this month. When world stock markets took a tumble after Trump’s tariff announcements, demand for US treasury notes actually went down. The previously unfathomable idea that America will default on its debt is apparently on the table. WHY SHOULD WE CARE? We aren’t reaching for canned food and shotguns just yet but there is going to be a quid pro quo to these ructions. Your hip pocket nerve is about to twinge. When demand for US debt drops, the US government has to pay a higher rate of interest or yield to attract investors. That $US1.3 trillion dollar hole in the budget needs to be filled somehow and until Elon’s chainsaw starts working it gets filled with credit. America might be the richest country on Earth but it needs people to lend it money more than any other nation does. On April 4, US 10 years paid 3.99 per cent. Three days later, after some more tariff mania, the rate was 4.2 per cent. By April 11, with the share market a sea of red, it was 4.5 per cent. The inverse relationship between demand for US treasury bills and demand for publicly listed stocks is no more. Good on ya, Donald. You broke it good. That phenomenon will spawn 1000 economic PhDs, which none of us will care about. We will care when our mortgages go up though, which they will, because when the cost of “zero risk” increases, the cost of every other form of debt everywhere in the world is proportionately re-priced. Up.

opinionBen Harvey: Donald Trump made me jump on the bandwagon by breaking economics

opinion
Ben Harvey: Donald Trump made me jump on the bandwagon by breaking economics