It's the Bonds market, stupid.

An absolute Idiot's guide to Tariffs and the Bonds market, Part II.

When Donald Trump announced his 90 Day pause on the tariffs, people were quick to point out that there had obviously been insider trading going on. Some people called it “the biggest pump and dump scheme in human history”, thereby reducing the entire financial market to the meme it had inevitably become under Trump. And surely, profits have been made – Trump wasn’t shy to brag about it publically, when he pointed out that Charles Schwab made $2,5 billion in a single day after his decision to reverse the tariffs.

Still: Though one shouldn’t put it past Trump to engage in the shadiest schemes (and indeed The New Yorker’s Political Scene just now pointed out how personal profiteering is one of the big topics of this administration - listen here on Spotify) , it is unusual for him to flinch in a stand-off, if only for the fact that his limited imagination deprives him of any shame or good sense for negative consequences of his actions. And yet, there we were, after a week of brazen announcements that the tariffs were here to stay and a spontaneous transformation of the Republican party into Pseudo-Buddhists that renounced all material possessions , putting the tariffs on hold after all.

What was it that ultimately brought him to back down? While his sycophants maintained for quite some time that all of this had been the plan all along and while he himself argued that it was “instinct, more than anything else”, many experts pointed towards the developments in the Bonds market as the straw that broke the camels back. (The New York Times published a fairly comprehensive piece on the varying explanations that had been given in the wake of Trump’s retreat.)

Why was it the Bonds market of all things that could reverse a decision that had been seemingly set in stone? And what, if anything, can be concluded from this? It has been a while since I began working on this and consequently other people have been trying to bring everyone up to speed as well. Specifically the recently defunded NPR produced a great feature about the US national debt and why it might become finally relevant. It is an extremely insightful piece that I recommend everyone listens to, as it contains a great historical primer on the Genesis of the bonds market and its significance in the economical framework we have been operating in so far.

While the NPR feature focuses on this question, I want to try and zero in on the systemic relevance of the bonds market and its current movement in the crisis.

The Bonds Market is essentially a market that allows you to buy government debt. If you wonder now why the hell you would want to buy debt, try to think of the many tropes in movies or books or even your life when somebody owes you a favor: this may be indeed quite the advantageous position to be in. While the favor that any old Mafia don might owe you may allow you to get rid of that annoying neighbor that mows his lawn way too early in the morning, Government favors that can be routinely bought are obviously significantly more limited. In fact, they are purely monetarily: if you own a bond, you are entitled to receive a specific sum after a specific agreed-upon time. On top of that, bonds pay out according to a fixed interest rate every once in a while – usually twice a year.

If your impulse in this regard is now to say: “This sounds an awful lot like I’m just loaning the government money?” – then congratulations, you have grasped the most basic function of a Bond already. The basic idea is indeed that the US Treasury – which is to say, a part of the Government – sells part of its debt in order to acquire money that it can then infuse into the economy. The important part to note here is that this transaction does not involve the “printing of money” but rather a mere acquisition of liquid funds through foreign or domestic investors.

This mechanism exists in order to avoid inflationary effects of money creation. I believe that the inflationary power of money creation should be obvious to anyone, but in case that it isn’t consider the following scenario: At any given moment, a certain amount of goods exists in any given economy. Simultaneously, a certain amount of money exists: that is, a certain amount of a certain good which acts as a permission to purchase the other goods at an approximately fair rate. To use the oversimplifying technique of a Robinson Crusoe economy: let us assume two producer-consumers, one of which spends a day on acquiring four fishes, whereas the other spends a day on acquiring two rabbits. Let us further assume that they have implemented a system that allows them to trade on days when one of the two has not had any success in acquiring their prey. On one day, our rabbit hunter could not find anything, yet, he needed to eat, so he offered our fisherman 2 shells as an IOU to access one of his rabbits on another day in exchange for 2 fishes. The situation is now this: The fisherman holds 2 remaining fishes that he will consume along with 2 shells that everyone knows have been exchanged for 2 fishes, the hunter also has two fishes that he consumes in order to be able to have a reinvigorated hunt the next day.

For the next few months everything works pretty well and in order, each day they each consume their two rabbits and 4 fishes respectively, our fisherman holds on to the two shells, until finally he decides he wants to really let loose. He consequently says: “Look, there will be no fish for you today, but I’d like to give you your two shells back in order to have another rabbit for me today.” The money-commodity (“Shell”) has not had any change in quantity, which is why the exchange rates remain fundamentally the same: One rabbit equals 2 fish equals 2 shells. Our market participants also agreed that money doesn’t grow on trees, nor is it found on the beaches: their agreed upon money-commodity were these two shells specifically, rather than any amount of shells they could find. This is basically already implicitly the key to understanding the inflationary effect of simply infusing new money into the economy. Let’s assume that in the meantime, our fisherman found two sufficiently equal shells. He might then say: “Look, I will give you these four in order to acquire all your rabbits.”

This might be met with one of the following objections. Either our hunter remembers that they agreed that just two very specific shells were to be used as an IOU, in which case he would insist that only two of those shells are valid currency in the first place or he does not remember this but points out that he will still need something to eat. He might then very well say: “Look Man, it’s all nice and good with your four shells but I have to get through the day. I can’t give you more than one rabbit, even if you gave me all of your shells.” Note that independently of the volition of the market participants, each shell has lost in value, merely by virtue of being related to the supply in goods at all.

So, how does the trade in debt differ from this? Let us continue to assume that the productive capacities of our two producer-consumers remain steady as they were. Our fisherman does not find the two additional shells, the money-good supply therefore remains equal to its former state, yet, on another day, he suggests the following: “I think,” he says, “that in a year from now I will be able to fish six fishes per day, if I just get to work a little bit more nourished. Would you give me a rabbit now? Honestly, I know that this is a bit of an ask, but let’s say that in half a year I give you one of my shells as a thank you for your belief in me and then another shell together with the paying back of your loan in form of two fishes.”

Note that at the end of the year, the hunter will have two shells – that are able to acquire two fishes – and his usual yield of two rabbits, one of which he can customarily exchange. Operating under the assumption that indeed our fisherman’s venture will have been successful however, he will by then have six fishes that day – quite the successful expansion of operations, given that only one rabbit was invested, but let’s brush that objection aside as this is merely a matter of principle and because Robinson Crusoe Economies are silly to begin with, yet, fundamentally underlying the beliefs that we are subconsciously subscribing to while we remain in a capitalist framework. Since he has now six fishes, he is able to honor the entirety of the value of the shells as they were “priced” at the beginning plus to pay out the two fishes that were initially loaned (even though, at the time, they came in form of a rabbit).

It is noteworthy here that the supply of the money commodity at the end of the year not only hasn’t changed: it has appreciated in value, as it is now related to an economy that produces a higher output in goods. (Two surplus fish when compared to the status quo ante.)

However, this entire operation is predicated upon our hunter’s somewhat justified belief that our fisherman would indeed be able to deliver on his promise that he would be able to satisfy his demands down the line. This is exactly what the bonds market essentially is: a rather safe investment that is backed by the US government’s promise to satisfy its creditors’ demands according to the agreed upon terms in the bonds. US Treasury bonds count as one of the safest investments available as the US government is known to have never defaulted on its debt. Though this is a to a certain extent a misconception, it is true enough to still be informing international investors reasoning. To put it simply: historically, it was rarely a reckless bet to agree to give a rabbit to the US government, as it would always supply your shells on time and give you back your rabbit eventually.

What, then, is the bonds market? Let’s first have a look at how actual bonds work. Each and every government bond issued has a face value. This is basically what you’re promised to be repaid. Usually they are issued in $1000 denominations, though your mileage may vary on this: some bonds are also issued as $100 or $10000. It is often sold with a 10 year maturity, which is to say that after 10 years, you will be repaid your face value as such. On top of that, it is given out with a coupon rate, which is a fixed interest rate that is paid on the face value. For example, a 5% Coupon on a $1000 bond would pay out $25 semiannually (Or, obviously, $50 p.a.)

So, let us now assume that you aren’t necessarily strapped for cash and can afford to have some of your net worth bound up like this. However, other market participants may very well have a similar reasoning and therefore also strive to have such a safe investment. Other market opportunities only present on average – say - 4% yield (so $40 p.a.), which is why they might decide they would rather have that wonderful 5% yield that you are being paid. You may then decide to sell your bond at a premium: You might, for example, say that you are very much willing to part with your bond (and therefore your 5% yield) for $1200. You are then selling your bond at a so-called premium: However, this results in effectively a lower yield for your buyer: since he acquired the bond at 1200 but still receives a semiannual payment of $50, he effectively only has a yield of 4,16% - which is still above his general market rate of 4% on his investments, which is why he may very well agree to the trade.

Having this very basic understanding of what bonds do, what happened during Trump’s tariff shock announcement? The interest rates of US government debt rose, which was an absolutely alarming signal to everyone – up to and including Trump.

As the stock markets were hit with the dangers that came with absolutely unexpected tariffs, the normal expectation had been that the prices for treasury bonds would rise, as this would be a signal for investors to move their investments to a comparatively safe haven, thereby pushing the price for bonds up and the corresponding yield down: but instead, it seemed that people were scrambling to get rid of their treasury bonds.

While some people reported that this might be to foreign state investors mass-selling their assets – notably the Canadian “shock jock” Dean Blundell that alleged that incoming PM Mark Carney had orchestrated a sell-off together with Japan and Germany - the actual reason seems to be significantly less of a political powerplay and more of an economic necessity: which is ultimately a way more frightening proposition.

The actual underlying issue in this regard seemed to be a consequence of the so-called Basis trade. While this kind of trade is in principle able to be applied to any sort of asset, it is particularly vibrant in the government bonds market. As this is a sort of primer for – as the title says – absolute idiots, it probably isn’t necessary to go into the depths of how the basis trade works. If you still care to know, Bloomberg explains its basics here , while the Market Risk Advisory Committee gives a somewhat more technical explanation in the PDF linked here.

For our purposes it is sufficient to say that the basis trade is a type of financial instrument that hedge funds utilize to realize vanishingly small gains by exploiting small price differences between a stock and its corresponding future: each of these trades usually gains fractions of a cent, which is why they are usually done highly leveraged. This means, basically, that they borrow large amounts of money in order to do the trades in question, which they will then pay back with the profits from the trade. (For a deeper dive on leverage and liquidity cf. this piece of Crises Notes )

While both an increase in Treasury Bond Prices and a decrease can be utilized in order to facilitate a basis trade, what cannot be easily swallowed is a high volatility. This lead to hedge funds deleveraging their assets which in turn triggered a wave of market participants also trying to get rid of their treasury bonds which sent them into a free fall.

I take it that someone who is reading a complete Idiot’s guide on the bond market is not an investor or highly engaged in the financial trade. I further assume that most people that read this substack in particular are rather on the Activist side of things. So the question at the end of the day is: what are your takeaways from all of this?

First off: Unlike what some people like Dean Blundell have been trying to tell you, this was not a galaxy brain political move in order to put a targeted pressure on Trump but rather a systemic risk that was caused by high volatility. This also means that there isn’t any political calculation that may stop a financial crisis from happening if another of these trade shocks hits the financial system. This in turn means that you should be prepared for stepping in with mutual aid efforts as things get rocky – potentially as well outside the US.

Secondly: While the Trump policies have been very successful in enriching the Trump family and a close group of their protegés, the markets as such have been and are very much averse to their policies and stand to lose a lot from a continuation of Trump’s whims. And even though most of the bourgeoisie is – contrary to their proclaimed narrative – very much averse to all sorts of risk, this may present opportunities to more openly lobby them against the systematic slashing of the regulatory apparatus as it is being proposed by authoritarians everywhere.

Thirdly: As things stand, the still-on-the-agenda return to tariffs might very well lead to another spike in the bond yields. As their yields increase, they will drag other borrowing costs up with them and lead to compounded problems in servicing debt. While a potential default on US National debt – which isn’t entirely out of the question as the NPR feature linked at the beginning of this article points out – would open an entirely different can of worms, the mere problems for consumers and mortgages may also result in additional problems regarding social cohesion. As treasury bonds are used as a safe haven around the globe, a rise in their yields also affects borrowing costs everywhere, leading to increased calls for Austerity everywhere: the wave has already hit Sri Lanka, Egypt, Nigeria last time around, it might hit others as soon as it comes back. When it does, it’s worth reminding everyone that the strain on the economy is not put there by anyone exploiting the Social Security system, but rather by the greed of a very select few in the global North.

Finally: as people will try to continue to sane-wash Trump’s policies, it is worth to remind them how close they brought the international financial system to a meltdown and how coincidental it was that they could eventually be stopped.

According to many accounts, it was simply by marching into the Oval Office – specifically by Bessent and Lutnick – while the tariff czar Navarro was in another wing of the White House. This is not how a lemonade stand should be run, much less how the global economy should be allowed to work. Yet, here we are. And it’s up to us to make it clear to everyone how absolutely batshit insane this is.

And to loosen all of this up a bit… Have we tried this yet?