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American Treasury bonds are probably not much safer now than German, British or French bonds…

U.S. Treasury bonds have long been touted by financial markets as the "ultimate safe haven" in the global market. However, in recent years after the outbreak of the COVID-19 pandemic, the actual performance of U.S. Treasury bonds has cast doubt on this label:The trend of US Treasuries seems to be no different from that of bonds issued by countries such as Germany, Britain, France, and even large companies.

That was the main finding of a new paper presented at the annual gathering of global central banks in Jackson Hole, Wyoming, U.S., last Friday.

The research paper examines shifts in investor behavior during this period, raising questions about the “exorbitant privilege” long enjoyed by the U.S. government., that is, despite the widening federal budget gap, the US government is still borrowing heavily in global markets.

This is a very realistic study, because no matter who becomes the next US president, the US government deficit will almost certainly increase...

What does the paper discuss?

The title of this paper is "Government Debt in Mature Markets, Safe or Risky?" and one of the authors of the paper, Professor Hanno Lustig of Stanford University, gave a presentation at the Global Central Bank Annual Meeting.

The paper states that in response to the COVID-19 pandemic, U.S. Treasury investors appear to have shifted to a riskier debt model to price Treasury bonds. Policymakers, including central banks, should take this shift into account when assessing whether bond markets are functioning properly.

The researchers studied the behavior of Treasury securities during the 2020 coronavirus lockdown, when not only did U.S. Treasury yields soar, but yields on bonds issued by countries around the world also soared.

They found that investors did not rush to buy U.S. Treasuries, pushing up their value, as they had done in previous periods of global financial stress. Instead, investors pushed down prices, just as they had done with bonds of other countries.

Meanwhile, the Fed’s response to the surge in Treasury yields suggests it is the result of a market failure, with the central bank buying bonds to restore order to the typically most liquid debt markets, as it did during the global financial crisis.

"In a risky debt scenario, valuations will respond to government spending shocks, which can lead to large swings in bond yields," the researchers said, noting that they found market volatility to be particularly pronounced on days when the U.S. government announced fiscal stimulus measures.

“In this environment, large-scale asset purchases by central banks in response to large-scale government spending increases have adverse consequences for public finances,” he said.“While providing temporary price support, these purchases harm taxpayers while subsidizing bondholders and potentially prompting the government to overestimate its actual fiscal capacity,” they wrote.

Controversy

Apparently, once the paper was released at the annual meeting of global central banks, it aroused opposition from US Treasury officials and some other participants.

These opponents believe that the paper is too one-sided and should take into account the uncertainties caused by the epidemic, the hundreds of billions of dollars in fiscal funds to deal with the epidemic crisis have not encountered any problems so far, and the recent decline in U.S. bond yields even though the U.S. government is continuing its massive deficit spending.

Nellie Liang, Treasury’s undersecretary for domestic financial affairs, said in comments at the conference that the document did not reflect “the uncertainties that exist in (special) events.”

She noted that "with the passage of the coronavirus aid bill, there was over a trillion dollars in debt... and even in March and April (2020) when governments around the world were beginning to respond to the health crisis, there were no signs that there were problems."

Of course, no matter who is right, the issue of the safety of the huge US debt did spark a lot of heated discussion at this year's Jackson Hole Central Bank Annual Meeting. Data released by the US Treasury Department at the end of last month showed that the US national debt has now reached 35 trillion US dollars, breaking this level for the first time in history.

Swiss Finance Minister Karin Keller-Sutter also said in a newspaper interview published on Saturday that debt levels in the United States and Europe were a risk to international financial stability and to Switzerland.

In an interview, Keller-Sutter praised Switzerland's "rigorous" fiscal situation, saying it enabled it to effectively respond to economic challenges posed by the coronavirus pandemic and the conflict between Russia and Ukraine. In contrast, other countries are so heavily indebted that they can barely take action, she said, citing France as an example. "Or look at the United States. The United States is a time bomb. The short-term stock market crash in early August was a wake-up call."