The World Just Got an Expensive Reminder About U.S. Debt
Peter Reagan

Bloomberg recently reported that foreign demand for U.S. government debt weakened in March. Major lenders Japan and China reduced their debt holdings as inflation concerns led to doubts about the longer-term value of federal government debt. (China, in particular, slashed holdings to an 18-year low.

That sounds like a story for economists and central bankers. It isn’t.

It’s a story about trust – specifically, what happens when the world’s creditors start questioning whether America’s promises are still worth what they used to be.

Government debt is often described as one of the safest assets in the world. But “safe” doesn’t mean painless. When inflation rises, older debt paying lower rates can lose value quickly. And that is exactly the uncomfortable reminder foreign creditors received this spring.

The world didn’t abandon U.S. debt overnight. But it did get a very expensive lesson: even America’s safest promises can punish their owners when inflation changes the math.

What happens when trust breaks down?

What happens when trust breaks down between buyers and sellers is that transactions stop happening and the economy slows down.

Here’s how it works: When interest rates are low and you have good credit, you can borrow $300,000 on a 30-year mortgage at, say, 4%. To the bank making the loan, that’s an asset – they have an IOU from you promising repayment. (There are complex ways to pinpoint the exact value of that loan as an asset, but let’s not get sidetracked here.) 

The bank made a good loan to a prime borrower – they’re happy. You got a 4% mortgage, so you’re happy. 

But then, inflation jumps (like it did in 2022). To curb inflation, the Federal Reserve raises interest rates – and all credit products across the economy, from payday loans to 30-year mortgages, get more expensive. New mortgages to prime borrowers now cost 7.5%.

Presumably, you, the borrower, are still happy with the deal you signed.

What about the bank? Well, now they’re stuck with 4% payments when they could’ve gotten 7.5% payments on the same capital. Maybe they’ll take your mortgage and try to sell it, to free up capital so they can make more loans at higher rates.

But when they go to sell it, guess what? Your mortgage is now worth 30% less than before. Because buyers know that higher yields are available. Now, the bank can decide to hang onto your mortgage – they’ll still get repaid – but it’s going to take a long time to recover their capital.

This is how the value of debt changes. The lender may still get paid back – counterparty risk hasn’t necessarily increased. Even when both sides honor the terms of contract, the value of the contract, of the debt itself, has declined.

Now, sovereign debt is a little different. Lots of people consider it “safe” because governments that borrow in their own currency can always print more currency. Unlike a household, a government cannot simply “go broke.” 

That doesn’t mean sovereign debt is risk-free. Today, the risk is inflation – which changes the math. 

The inflation scare

Since the conflict with Iran and the closing of the Strait of Hormuz, global energy prices have surged (about 30% last time I checked). That sends prices on just about everything (at least, everything that’s mined, grown or transported) moving upward.

That changes the math for lenders (banks and investors alike). If inflation is 3.8% a year, you need to get paid at least 3.8% per year to break even. Right? And since U.S. government debt costs are set at auction (not by the Federal Reserve, but in open market auctions), lenders have a voice in how much they want to be compensated. 

Today, when Treasury Secretary Bessent announces a new debt auction, lenders are demanding the highest rates in nearly two decades, according to Bloomberg. It’s challenging to keep track of this number, though, because it changes daily. Partially because the Treasury Department auctions off debt every business day. Partially because traders are always buying and selling federal debt (that’s called liquidity, and the federal debt market is slightly more liquid than the gold market).

Over the years 2016-2025, the average rate for federal government borrowing was 3.36%, according to the Treasury Department’s ever-helpful website Debt to the Penny. Today, costs are as high  as 5.11%. 

That’s how “safe” debt can punish investors: When inflation rises, and rates rise too, the value of their assets fall. Even if they hold them to maturity, they’re getting paid back in dollars that buy less than they did before. 

Now, the good news is that there is still a market for U.S. government debt, so I’m not suggesting that the country is going off the rails tomorrow. But that downward tilt could be an early sign of a trend that could build momentum and put the U.S. federal government in a bind.

What can you do?

With concerns about inflation raising prices and rising interest rates potentially slowing the economy, the options available to you to deal with the potential pitfalls coming our way are limited.

The good news is that one asset class has a long historical track record of being inflation-resistant, maintaining its purchasing power regardless of inflation while also being highly liquid, which could help to minimize the need for a loan in a pinch and the pain of higher interest rates that can go with a loan.

What is this asset class? Physical precious metals. So, if you’d like to begin your due diligence by educating yourself on why you may want to own physical precious metals, that’s a great place to start, and if you already know that you’re ready to diversify into precious metals, simply give us a call at (877) 749-7738.

 

 

Peter Reagan is a financial market strategist at Birch Gold Group. As the Precious Metal IRA Specialists, Birch Gold helps Americans protect their retirement savings with physical gold and silver.

 

 

 

www.birchgold.com