U.S. Treasury Bonds. Let’s admit it — they’re not terribly exciting.
Ask the average person on the street about bonds, and if they have an opinion at all, they’ll probably respond with something related to being a safe investment for retirees who live on fixed income.
But, as we’ll see, bonds and their markets are much more.
Like the responsible member in the financial family, the bond market is less flashy than the stock market but essential for keeping things running smoothly. It quietly funds governments, builds roads, and keeps corporations afloat, while the stock market hogs the limelight with its wild mood swings. Without the bond market, governments would be like someone at a fancy dinner who forgot their wallet—awkward and concerning. It’s also the referee for economic discipline, raising an eyebrow to reckless borrowing and sternly saying, “Behave, or I’ll raise your yields!”
In the wake of recent U.S. policies, economists around the world observed a potentially troubling change in market dynamics. On April 4, 2025, when the Dow dropped 2,231 in a single day and subsequent trading remained volatile through the month, there was a simultaneous flight from both U.S. Treasuries and dollars, which have historically been the first-line “safe haven” assets. They have exhibited these dynamics since 1945 and as recently as the Covid-19 panic. Katie Martin, writing for the Financial Times, opines that U.S. stocks are now exposed to political risks, U.S. bonds no longer exhibit the characteristics of being entirely risk-free, and the dollar is not attracting investors during times of stress nor reflects optimism about future American economic growth.
For the average consumer investor, treasury bonds are primarily used for long term savings directly with the U.S. Treasury, often offering a better rate than private savings. But Americans love to spend money, buy on credit and tend to save less. The U.S. household savings rate is around 4%, which is a stark comparison to 35% for South Koreans, 30% for Sri Lankans and 25% for Swedes, and 13% among households in the Eurozone. While Americans improved their saving habits during the pandemic, Federal Reserve data shows that only around half of Americans have enough savings to cover three months of expenses, and only 45% could manage a $400 expense using funds from their checking or savings accounts.
Americans have an insatiable appetite for credit that has roots in colonial times when money was scarce and credit was required for daily commerce. The Economist magazine reported in February that delinquency rates on credit cards suddenly shot up to their highest rate in thirteen years and now American consumers owe a record $1.21 trillion on their credit cards.
We don’t often think of the dynamic between prices and credit, but low interest rates and easy access to financing have historically inflated prices on big ticket goods. In an all cash economy, prices would likely be lower. The separation of financial institutions and sellers means that you don’t get a better deal on an appliance, a car or a house when you pay cash instead of financing. The seller doesn’t assume the risk and is paid either way.
According to Consumer Affairs, U.S. household debt reached an all-time high of $17.5 trillion in the fourth quarter of 2023. However, despite this increase, debt payments as a percentage of personal income have trended downward since peaking in 2007. This saw a sharp decline in early 2021 due to pandemic-related payment pauses and has risen slightly since, though it remains lower than at any point in the last 40 years.
Beyond financing goods, cars and homes, what are Americans otherwise doing with their savings?
They’re investing it.
Over the past decade, bonds have been less attractive to retail investors thanks to the remarkable returns in U.S. equity markets, while bond market funds have lost money or struggled to keep up with inflation. After all, why would anyone choose an investment returning three or four percent annually when cryptocurrencies and hot tech stocks have recently returned multiples, and even a simple S&P 500 index fund has boasted a 10-13% annualized return?
But make no mistake, one can buy a treasury bond directly from the U.S. Treasury today that will guarantee, with the full faith and backing of a government that has “never” defaulted on a debt, that you will get your money back plus a fixed rate of annual interest. Besides an FDIC insured savings account, it’s the closest thing you may find to a “risk-free rate” of return on your principal.
But when we dig a bit deeper, we discover that U.S. treasuries are far more than just another market traded asset or a means to earn predictable interest on savings; they form a crucial part of the bedrock of the global financial system and serve as a benchmark for financial security and broader economic health.
U.S. Treasury yields are a global reference point for pricing other financial instruments. In the U.S. economy, bond prices have a radiating effect on interest rates for credit cards, mortgages, business loans and every other type of borrowing. The spread between U.S. treasuries and other bonds can signal market expectations about economic conditions, monetary policy, and risk perceptions. U.S. Treasuries form the largest and most liquid bond market, with $27 trillion USD in securities outstanding. The size of the U.S. market creates smooth trading and investing opportunities for millions of individuals and institutions who want to preserve wealth.
Part One: The Fed & The Treasury
It’s easy to conflate the U.S. Treasury Department with the U.S. Federal Reserve Bank, as they work together to manage the financial system. Recent memes of Federal Reserve Chair Jerome Powell at a podium furiously firing money out of a hand cranked printing press seemed to imply that the Federal Reserve could independently spend money into existence, which isn’t exactly how it works. The Federal Reserve is a fully independent entity within the government that has a limited set of tools that influence short term lending rates within the banking system. It’s actually the U.S. Treasury, under the executive branch that issues bonds at an auction to finance budget spending approved by congress.
When the Treasury issues bonds, it’s technically like any bond I.O.U. issuance. It announces the maturity date, face value (usually $1,000), and the annual interest rate the bond will pay to holders, called the coupon rate.
The U.S. Treasury doesn’t directly set the interest rates (yields) on Treasury bonds; instead, these rates are primarily determined by market demand and economic conditions.
In summary, money creation happens through issuance of debt, either by the Treasury in the form of bonds, by the Federal Reserve through the purchase of assets on the open market, or by the banking and private financial system in the form of credit and lending.
Part Two: How the U.S. Treasury Issues Debt
The Auction:
- Treasury bonds are issued through auctions, where investors bid on the bonds based on the yield they are willing to accept.
- The final yield is determined by competitive bidding — what the market is willing to pay for the bonds at that time.
The Market Factors:
- Interest rates are influenced by broader economic factors such as inflation expectations, the Federal Reserve’s monetary policy (e.g., the federal funds rate), and overall investor sentiment.
- If investors are confident in the economy or inflation is expected to rise, yields generally increase because investors demand a higher return to compensate for perceived risk.
- If there’s economic uncertainty or a flight to safety, yields tend to decrease as more investors buy bonds.
The Treasury’s Role:
- The Treasury controls the issuance of bonds. It decides how many and how often bonds are auctioned, which has a direct impact on the supply of bonds in circulation.
- While the Treasury doesn’t set interest rates directly, it affects them indirectly by determining the volume and types of securities to issue (e.g., short-term bills vs. long-term bonds). The supply of bonds influence demand and, subsequently, yields.
Based on the news media it’s easy to assume that the independent Federal Reserve controls interest rates. It doesn’t… directly. The Fed controls the interest on reserve balances held by commercial banks in their reserve balance accounts at the regional Fed banks. This helps them target a rate that banks charge each other for overnight loans of federal funds. This is called the Federal Funds Rate. While this friction significantly influences interest rates, they are determined by the market.
Thus — both the interest rates on the federal funds in the money supply and treasury bonds are ultimately dictated by global market forces — not the government.
You may have heard the term, “Bond Vigilante.” We like to imagine bond vigilantes are like the financial world’s cowboys. Armed with spreadsheets instead of six-shooters, these investors “punish” countries for fiscal misbehavior by selling off bonds, driving yields higher, and shouting, “Get your debt house in order!” In reality these so-called bond vigilantes aren’t an organized cabal and may comprise many interests around the world, including hedge funds, financial institutions, pension systems, or national governments that have large holdings of U.S. treasuries.
Bond investors have used their leverage several times throughout history, most recently during the Trump Administration’s Tariff policy and before that, during the Clinton administration in 1994. Bond vigilantes act as a regulating force against fiscal mismanagement by governments or excessive borrowing by corporations. Essentially, these institutional investors signal their dissatisfaction with economic policies or financial risks by selling bonds. This behavior drives up bond yields and lowers their prices, making it more expensive for entities to borrow money.
For example, if a government adopts inflationary policies or fails to manage debt responsibly, bond markets may respond by withdrawing support from the country’s debt market. Their actions send a warning signal that markets demand higher returns to compensate for the perceived risks. This mechanism helps maintain financial discipline and ensures that policymakers remain accountable, as they are keenly aware of the cost implications of market disapproval. The vigilance of these actors underscores the interplay between political decisions and market dynamics, making them an influential force in shaping economic outcomes.
But these so called bond vigilantes have limited power. In a standoff between The Treasury and bond vigilantes, The Treasury could make a policy decision to pause or reduce the supply of new bonds, which could bring bond markets to heel.
Part Three: The Fed Can Buy U.S. Debt
The Federal Reserve has the power to purchase the treasury’s outstanding debt in circulation with U.S. dollars. This is called debt monetization through Open Market Operations.
This is one of the primary methods the federal reserve uses to control the supply of money. The U.S. treasuries market is incredibly liquid, with tens of trillion in securities outstanding any given day. Once purchased, these bonds are added to the Federal Reserve’s balance sheet, where they are held as assets. The Fed regularly reports on its holdings, and the balance sheet reflects the accumulation of these securities.
So, one might ask, if the U.S. Treasury has such a massive debt service problem, why doesn’t the Fed simply just buy all the debt? Well, there is more treasury debt in the market than the Fed could purchase without egregious distortions. If we think of the velocity of money, long-dated bonds, while highly liquid, are certainly not as liquid as cash. Aggressive bond purchasing would pump massive amounts of cash into the economy, which could result in inflation or even hyperinflation, which could further exacerbate issuance of private debt, creating a vicious cycle. Inflation is utterly devastating to economies and wealth preservation. The Federal Reserve Act mandates that, above all things, the Fed keeps inflation under control.
The Fed is tasked with managing monetary policy, not fiscal policy. U.S. law prohibits the Fed from directly financing government debt. When the Fed buys Treasury securities in the open market as part of its monetary policy operations, it earns interest on these securities, which it returns to the Treasury after covering its operational costs, effectively making it interest-free for the Treasury.
As of April 9, 2025, the Federal Reserve’s balance sheet totals approximately $6.73 trillion. This figure includes various assets, such as U.S. Treasury securities, mortgage-backed securities, and other financial instruments that it can simply hold indefinitely, sell back into the market, or use for monetary operations.
Variations of these Open Market Operations we often hear about are Quantitative Easing (buying all types of assets to input dollars) and Quantitative Tightening. Quantitative Easing was “invented” by the Federal Reserve Bank of Japan and employed by U.S. Fed chair Ben Bernanke following the 2008 financial crisis to clear the markets of “bad” debt like Mortgage Backed Securities and inject money into the stalling economy. During a recession there is a low demand for goods and labor, and that “slack” in the economic system hypothetically allows for an increase in the money supply to spur private investment and spending without immediate inflation. However, QE didn’t immediately expand growth. It did begin a long phase of asset price inflation that mostly benefited investors and the financial industry.
Mark Blyth, in an interview on the Can We Please Talk podcast, brilliantly summarizes the relationship between the Independent Fed, the Treasury and the Bond Market.
“There’s a guy I know who’s a Scotsman like me. His name is Bill Blaine. He’s in London, and he’s one of the first bond traders of Euro bonds from years ago. The guy knows his stuff, and he has a way of looking at the world—he calls it the ‘virtuous sovereign trinity.’
What is that? When you’re buying debt from a country, you want to know—technical term here—is it information invariant? What does that actually mean? It means it doesn’t matter what the news is; you’re going to get your money back. That’s why you buy this stuff. You buy equities—up and down, up and down. You buy crypto—up and down, up and down. But when you buy a good bond, it doesn’t matter; it’s the same thing.
Now, what makes that possible? Number one, you’ve got an independent central bank that’s miles away from the politicians and does what it needs to do with interest rates and such to ensure stability. Then, underneath that, there’s something nobody ever thinks about—a debt management shop that buys and sells these bonds, resells them, and manages the entire stock of debt in such a way that interest rates remain exactly as they are so the central bank can do its job.
The third leg of the stool? A bunch of politicians who have no idea how this works but are smart enough to stay away from it. Once you break that, you break the other two. And when you have the world’s largest debt market—which means everybody else buys your stuff as their savings asset—you want your savings asset to be information invariant. It shouldn’t matter what the news is.”
Part Four: Private Debt vs. Public Debt
Modern Monetary Theorists and post-keynesian economists argue that, while large public deficits are problematic when they result in high inflation, deficits and debt are not necessarily bad and should be seen as the “other side of the ledger” — representing a public surplus as a result of government’s economic policy and money creation. Both conservative and liberal governments run large deficits, with the former usually cutting taxes and continuing to spend to spur private investment and the latter via tax increases, wealth redistribution and industrial or infrastructure policies.
Sovereign governments may finance debt for centuries. The United Kingdom carried debt from the Napoleonic Wars and the South Sea Bubble until 2015. Thanks to inflation, the principal erodes and the debt becomes ever easier to refinance and repay.
Who Owns U.S. Treasury Debt?
According to USAFacts.org, as of April 2024, the five countries owning the most US debt are Japan ($1.1 trillion), China ($749.0 billion), the United Kingdom ($690.2 billion), Luxembourg ($373.5 billion), and Canada ($328.7 billion).
Investors from Russia, China, and Indonesia saw sharp drops in US Treasuries over the last several years due to sanctions and short-term capital needs, among other reasons.
For example, Japan and China have recently liquidated significant holding of U.S. debt to finance government spending for pandemic stimulus programs and to balance the value of their currency in foreign exchange markets. China has been aggressively reducing its holdings of treasury debt over the past decade to diversify holdings into equity markets, shift to BRICS and to fund major initiatives for infrastructure, corporate subsidies and its ambitious Belt & Road Initiative, which may prove to be a boondoggle for the Chinese government and its partners.
According to the Peterson Foundation, approximately two thirds of U.S. debt is held domestically. Domestic holdings of federal debt have increased, rising from $6.0 trillion in December 2011 to $19.4 trillion at the end of December 2023. The Federal Reserve holds the largest portion on its balance sheet. In other words, the Fed has monetized significant portions of the debt.
Sovereign debt owed to itself or its citizens is different from debt owed to other countries or entities. Approximately 75% of the total U.S. debt is held by the public, while the remaining 25% is intragovernmental debt, such as funds owed to government programs like Social Security.
Before 1980, U.S. debt grew at an average annual rate of about 2% to 3% relative to GDP. After 1980, the U.S. adopted aggressive supply-side economic polices that saw the debt growth rate accelerate significantly, often exceeding 10% annually during periods of increased spending and economic stimulus measures
The cost of servicing national debt can grow exponentially as interest compounds on increasing debt. Rising borrowing needs and higher interest rates can create a cycle of escalating debt payments, straining fiscal sustainability.
Every U.S. administration has engaged in at least some level of deficit spending with the exception of the Clinton administration. The budget surplus from 1998 to 2001 was achieved through a combination of higher taxes on the wealthy, reduced spending, and a booming economy. This led to the largest surplus in U.S. history, allowing the government to pay down significant national debt.
But despite this brief period of fiscal constraint, the level of public debt soared, arguably causing a recession in 2001 and a financial crisis in 2008.
Economist Steve Keen, Distinguished Research Fellow at the Institute for Strategy, Resilience & Security, in his book The New Economics: A Manifesto criticizes mainstream economics for underestimating the impact of private debt in financial crises.
Keen argues that in any crisis, private debt drives the downturn, while public debt, to some degree, helps resolve it — akin to two opposing sides of a see-saw. Conventional economic theory, however, fundamentally misinterprets this dynamic. It largely dismisses the role of private debt and views government debt not as a remedy, but as an issue to be avoided.
The standard economic perspective asserts that private debt merely shifts spending power between individuals. When money is borrowed, the debtor’s ability to spend increases, while the creditor’s spending power grows as the debt is repaid. Overall, these effects are said to balance out: as the borrower’s spending rises during a debt increase and falls when the debt decreases, the creditor’s spending follows an opposing trend. Consequently, it is argued that changes in private debt levels have minimal impact on the broader economy. As Ben Bernanke stated in essays on the Great Depression, “pure redistributions should have no significant macroeconomic effects.”
Keen notes that neoclassical economics sees government debt as “crowding out” the private sector, by competing with private borrowers for the available stock of “loanable funds”, and thus driving up the interest rate—the price of borrowed money. Excessive government deficits add to the demand for money, drive up interest rates, and therefore reduce private investment, and hence the rate of economic growth. As Gregory Mankiw puts it in his influential textbook, “government borrowing reduces national saving and crowds out capital accumulation”
Keen counters this perspective. He notes that bank lending creates money, which boosts demand. However, when debt is repaid or defaults occur, money is destroyed, reducing demand and potentially triggering economic downturns. High levels of private debt relative to GDP lead to speculative bubbles and eventual crashes. For example, in the U.S., private debt has grown significantly since the 1950s, increasing the burden of debt servicing.
Keen highlights how excessive private debt, particularly in the housing sector, led to the 2008 financial crisis, and the subsequent quantitative easing that increased money supply didn’t spur growth, but raised equity prices. He points to the rapid growth of mortgage debt in the U.S. and other countries as a key factor in creating unsustainable bubbles that eventually burst.
He argues that Japan’s economic stagnation since the 1990s was caused by high levels of private debt accumulated during the 1980s bubble economy. The subsequent deleveraging process has kept growth subdued for decades.
Shadow Banking
The rise of shadow banking’s role in private debt introduces several new risks that may have far-reaching consequences. The shadow banking system refers to a network of non-bank financial entities that operate outside traditional banking regulations. According to S&P Global, as of the end of 2022, shadow banking institutions collectively managed approximately $63 trillion in financial assets across major economies, equivalent to a stunning 78% of global GDP—marking a sharp increase from the $28 trillion and 68% of global GDP reported in 2009.
Unlike traditional banks, shadow banking entities operate outside conventional regulatory frameworks, which can lead to unchecked risk-taking, insufficient transparency, and potential financial instability. Many shadow banking instruments, such as securitized debt or private credit arrangements, can be highly illiquid, meaning investors may struggle to exit positions in times of market stress. Shadow banks often engage in complex financial transactions that intertwine with traditional banking systems, creating unseen vulnerabilities that amplify financial crises.
Part Five: Revenue & Budgets
Government revenue is remarkably nuanced and complicated, but fundamentally it works by taxing the output of the economy through different means.
According to the Tax Policy Center, since 1950, individual income tax has consistently contributed nearly half of total federal revenue, while other sources of revenue have fluctuated over time. For instance, excise taxes accounted for 19 percent of federal revenue in 1950, but their share has diminished to roughly 2 percent in recent years. Similarly, corporate income tax, which generated about one-third of revenue in the early 1950s, has decreased to less than 10 percent annually since the early 1980s. In contrast, payroll taxes have grown significantly, providing nearly one-third of federal revenue since the early 1990s, compared to under 15 percent in the 1950s.
Any shortfall in revenue is of course made up by borrowing. As we saw earlier, around two thirds of that debt is simply owed to the American public and its institutions. Excessive debt can create several challenges for the U.S. government. As debt grows, the cost of servicing it increases, requiring higher interest payments that can consume a significant portion of the federal budget. This reduces the availability of funds for essential programs like healthcare, education, and infrastructure.
Additionally, when the government borrows heavily, it can lead to higher interest rates in the broader economy, making it more expensive for businesses and individuals to borrow, which can potentially slow economic growth. Investor confidence may also be affected if debt becomes too large relative to the government’s ability to repay it, leading to higher borrowing costs or difficulties in raising funds during crises.
Excessive debt, especially if financed by money creation, may contribute to inflation, increasing pressures on the economy. Moreover, high debt levels limit the government’s ability to respond effectively to future emergencies or economic crises, as fiscal space becomes constrained. If the economy’s growth rate lags behind the interest rate on the debt, the debt-to-GDP ratio could spiral upward, raising concerns about long-term sustainability.
While government debt can be a useful tool in managing downturns and stimulating growth, maintaining it at a sustainable level is vital to mitigate these risks.
Part Six: The Triffin Dilemma
The current U.S. administration’s policy is perhaps best understood as an attempt to address the Triffin Dilemma, which refers to the economic conflict that arises when a country’s currency serves as the global reserve currency.
The U.S. dollar’s role as the global reserve currency demands massive liquidity, as countries use it for reserves, trade, and international contracts. Oil, the lifeblood of global energy, is transacted in dollars. This strengthens the dollar and makes U.S. manufacturing less competitive, contributing to trade deficits.
Persistent trade deficits can erode industrial competitiveness, shift economies to value-add and service sectors and undermine confidence in the currency over time.
In its modern form, the Triffin Dilemma highlights the tension between global financial stability and the economic health of the reserve currency’s issuing country.
Up to this point, market participants and politicians have downplayed the relationship between the trade deficit and the reserve currency status.
While some sectors like tech and finance benefit, others, like manufacturing, face challenges. Structural issues, such as high healthcare costs and a loss of manufacturing expertise, further exacerbate these economic imbalances.
Tariffs and protectionist policies will address symptoms but may not mitigate the root cause: the dollar’s global reserve status.
Tariffs represent a multi-hundred-billion-dollar tax increase, outweighing proposed tax cuts and tightening fiscal stimulus — but there may be an upshot, the devaluation of the dollar and a demand for higher interest to buy the U.S.’ “risk free bond” may lead to emerging alternatives that eventually displace the U.S. dollar as the world’s reserve currency. It’s unlikely that transition would be without significant economic strain.
The revenue from tariffs, paid by American companies, goes directly to the U.S. Department of Treasury and enters the general affairs budget where it can be used at the president’s discretion. The general affairs budget is controlled by the Office of Management and Budget (OMB), which assists the President of the United States in overseeing the implementation of budgetary policies across the Executive Branch. OMB evaluates agency programs and sets funding priorities, ensuring alignment with the President’s objectives.
While we can’t predict the future, and uncertainty can be stressful, it’s probably not wise to bet against the United States’ resilient democracy, reasonably secure system of rules and laws, long tradition of innovation and deep capital markets. However, whether it’s private institutions or sovereign government, borrowing money is like a game of Jenga – if you keep taking pieces, eventually everything will come crashing down.
Many have speculated how the U.S. will ultimately tackle an “immanent” debt crisis. Ray Dalio has a rather simple prescription: reduce spending and raise taxes to around 3% of GDP, which he advises would strike the best long-term balance to tame deficits and manage the debt. Others suggest that a crisis will unfold that will force the Federal Reserve to aggressively monetize the debt, which would trigger a prolonged period of high inflation like was seen during the 1970s into the early 80s. While this could be positive to GDP, it would be extremely challenging to wealth preservation. This would gradually erode the debt back down to manageable levels.
In the Fall of 1981, U.S. Treasury bonds returned a stunning 15.84% coupon. While that might sound like an investors paradise, it wasn’t. Runaway inflation had reached a record high of 14.8% in March of 1981, the highest since the post U.S. wartime economy of 1947.
Whether you consider gold prices to be a leading or lagging indicator of currency and economic health, the inflation adjusted value is noteworthy.
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