APRIL 13, 2025
Donald Trump has created a hair trigger in US Treasury markets that threatens to again let loose at any moment – Sean Thew/Shutterstock
Well done, President Donald Trump. Though he doesn’t seem to realize it, he has just given a textbook lesson on how to spark a financial crisis.
By partially retreating from the imposition of retaliatory tariffs, Mr Trump has for now managed to defuse the doom loop of selling that last week engulfed US Treasury markets. But it’s an uneasy quiet that has descended, and he may already have done irreparable damage.
From world superpower to Latin American basket case in one fell swoop – it’s quite an achievement. I exaggerate for effect, obviously, but it’s fair to say that Trump has overnight managed a degree of financial destabilization likely to haunt US financial markets for years to come.
The best way of thinking about last week’s events is as a combination of the dash for cash that occurred at the onset of the pandemic, and the later liability-driven investment debacle that unseated the UK prime minister Liz Truss.
It contained elements of both. Worryingly for Trump, the lesson from the Truss affair is that partial withdrawal from economic policies that markets think wayward doesn’t necessarily correct the problem.
Realising her peril, you will recall, Ms Truss did a screeching about-turn at the Conservative Party conference by abandoning plans to abolish the top rate of income tax.
The amount of money involved was, in the scale of things, not that significant, but the policy had become symbolic of perceived, wider fiscal incontinence, so in a partial withdrawal, she axed it.
This seemed to do the trick – for all of a day. But then the selling pressure in bond markets resumed, and it wasn’t until she and her chancellor, Kwasi Kwarteng, had resigned and the whole policy agenda had been reversed, that markets began to settle.
Even so, it proved impossible to entirely undo the damage; the UK has never fully recovered the fiscal credibility it lost in financial markets in those brief few months.
Today, the UK Government is forced to pay more for 10-year money than almost anywhere else in Europe, including Greece.
It’s possible that Trump’s tariff bedlam has inflicted a similar blow to credibility in the US, and that as with Ms Truss’s climbdown on the higher rate of income tax, his pause on reciprocal tariffs won’t be enough.
What he’s done is create a hair trigger in US Treasury markets that threatens to again let loose at any moment, prompting a further wave of selling.
With a president as unpredictable as Trump, and the prospect of fiscal deficits of 6pc of GDP or more stretching as far as the eye can see, renewed trouble is likely to come soon enough.
There used to be an old rule of thumb in financial markets that really serious financial crises only happen once every 40 years, which is about as long as it takes for all institutional knowledge of the last one to die out.
As memories fade, and those who were involved in the crisis retire or die, guardrails are lowered, excess once more takes hold, and eventually it all blows up in everyone’s face anew.
Most of us can still vividly recall the last such crisis, which was little more than 15 years ago, so if the rule were to hold true, we would not be due another for at least a further 25 years.
But in today’s world, everything has been speeded up, and in any case, there is a sense of the root causes of the last crisis – the fault lines created by excessive debt – never having been properly addressed in the first place.
The truth is that the whole system is fundamentally unstable; it’s a castle built on sand with the US as its epicentre.
For sure, the banking system has been made safer than it was, but that’s not where the problem chiefly lies.
The explosive growth in money in recent years has been in public and non-banking forms of finance and credit.
Negative real interest rates have added rocket fuel to the mix, such that according to analysis by S&P Global, financial assets held in shadow banks had mushroomed to nearly 80pc of global GDP by the end of 2022. Further growth has taken place since then.
Add in public debt, which has similarly risen off the scale since the financial crisis, and you get to numbers never before seen in history with total debt swollen to three or four times global GDP.
It is this monstrous overhang that provides the backdrop to many of today’s imbalances and economic weaknesses, and makes the world acutely vulnerable to renewed financial crisis.
In some respects, we are in an even more perilous position today than we were in 2008, when the last major financial crisis broke on a largely unsuspecting world.
Part of the job of financial markets is to price the future. They act as a lightning rod when things turn ugly. But they struggle to adjust in an orderly fashion to sudden transformational change.
In circumstances such as Trump’s wholly unhinged tariff assault, they can equally quickly go into a doom loop of forced selling, where falling prices beget more selling which begets more selling, and so on.
All the tell-tale signs of a developing financial crisis have been on display in US bond markets over the past week. The last time this happened was in the so-called dash for cash at the start of the pandemic, when taken unawares by a global shock, investors similarly dumped government bonds to answer margin calls on over-leveraged trading positions.
All of a sudden, liquidity dries up, with traders unable to borrow more to finance their positions because lenders are nervous about the value of the collateral. So they sell their most liquid assets instead. So-called “amplification mechanisms” soon come into play, inducing a domino effect of cascading selling pressure.
As prices fall, retail investors likewise demand their money back, forcing fund managers to further sell their securities to satisfy redemptions.
Even US Treasuries, traditionally regarded as the go-to safe haven asset at times of crisis, lose their attraction in the consequent dash to the perceived greater safety of cash. Hey presto, nobody wants to lend.
It takes a special kind of genius to actively induce such a panic, but that’s what Trump has just done with his worldwide tariff shock.
Rumours abound of Chinese efforts to magnify the selling pressures by reducing its $750bn (£574bn) holding of US Treasuries.
Thus does trade war spill over into financial war. The calculation is that China can inflict more pain on Trump through bond markets than he can inflict on China through tariffs. If that’s what China is doing, it’s a nuclear first-strike approach.
Underpinning it all is the notion that US Treasuries are no longer as safe as they were, with a president who seemingly revels in chaos and disparages the old, rules-based order. As I say, quite an achievement.
Courtesy/Source: The Telegraph
