“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope… But now I would like to come back as the bond market. You can intimidate everybody.” This was said in the early 1990s, by an adviser to Bill Clinton. Thirty years later, rising bond yields are back — but this time the economy is in a much worse state.

In the last decade, governments were borrowing money at 1 or 2% — that’s easy money. You can cut taxes, run deficits, it barely matters, the interest bill is relatively low. A lucky generation bought houses at 2% mortgage rates, which is why prices rose through the 2010s. But that era of cheap money is vanishing fast.

Take UK 30-year gilts. They have risen from 1% to a peak of 5.93% within seven years. But last week the Bank of England responded by suspending 30-year gilt sales for six months, and as a result yields fell sharply to 5.76%.

Governments like the UK and US are replacing long-dated borrowing with short-term money — this buys you a little time, but as we shall see, today’s bond crisis can become tomorrow’s problem.

Governments don’t like rising bond yields. President Trump has said the US should have interest rates of 1%. But 10-year Treasuries broke past 5% on 14 September, and with inflationary pressures in the US mounting, Kevin Warsh bowed to the inevitable, voting to increase US interest rates — with more to come (FT: Donald Trump fails to bend the Federal Reserve to his will).

All major rich countries are seeing higher bond yields. The median rich-world average on a 10-year yield is now above 4% — four times the 2015-21 average (The Economist). Both Japan and Germany have moved from zero interest rates to over 3% — that’s a big shock.

The knock-on effect of higher interest rates is reverberating around the economy. Potential homebuyers are struggling to buy at elevated interest rates, and house prices are sliding in the UK. The easy-money decade led to a rise in borrowing and the growth of zombie firms — companies that survive only because of low interest costs. When rates rise, these firms feel it directly, since this is riskier debt that’s more sensitive to interest rates.

Higher interest rates also threaten the AI boom. Tech giants are now borrowing vast sums, but the longer interest rates remain elevated, the riskier that investment becomes.

But it’s governments who face the much higher interest bill — no wonder the President would prefer interest rates of 1%. US interest payments are currently 14% of federal spending, or $1 trillion. The CBO projects that to nearly triple to $2.7 trillion by the decade’s end, at which point it would be more than Medicare. But this projection was made before this year’s rise in bond yields — if yields keep rising, the cost will be even higher. The Economist puts the same $2.7 trillion figure at 2030.

Even before the Iran crisis, debt levels were rising — US debt has increased to $40 trillion in recent years. The Center for American Progress points out that the substantial tax cuts under Bush and Trump have led to a missing $10 trillion of revenue. Without those tax cuts, debt would only be 60% of GDP.

But it’s not just tax cuts. An increase in the old-age dependency ratio will put more pressure on finances. Since 2000, the ratio of retired to working-age people in the US has risen from 18.3 to 27.7, and is forecast to reach 35 by 2050. That means more automatic spending on pensions and healthcare. In fact, the US has a much better forecast than Germany, at 59.6, and Japan, which peaks at 75.3. When you have this kind of decline in the working-age population, it matters a great deal when your 30-year bond yield rises.

One reason for the ultra-low interest rates of the 2010s was, in fact, feeble economic growth across the global economy. Growth rates have been falling for decades, and lower growth leads to a relative decline in tax revenue. We can no longer grow our way out of debt the way we could in the 60s and 70s.

The slower growth, combined with higher wealth inequality, has left many people feeling worse off than the previous generation. This fuels frustration — and pushes voters toward populists promising tax cuts, not reform. So despite record budget deficits, reducing them is not a political priority.

The final problem is that on top of high debt and low growth came the current inflation shock. Diesel prices have soared. Goldman Sachs recently admitted they no longer know what happens next, because they had assumed gasoline at $4 and bond yields at 5% would create enough political pressure to force a resolution in Iran. It’s this inflationary pressure that’s behind much of the rise in bond yields.

But this creates a negative loop: higher yields lead to higher interest expense, which leads to larger deficits, which can in turn push up bond yields further on fears over fiscal stability. UK debt interest payments have jumped in recent years, not helped by the Bank of England reversing QE — which has contributed to the UK being an outlier in terms of high 10-year bond yields.

There is a temporary solution to reduce borrowing costs. The UK and US are replacing long-dated borrowing with short-term money — this buys a little time, because short-term yields are lower than long-term ones. If you want to finance debt more cheaply, sell more short-term bonds.

Nearly a quarter of US debt is now Treasury bills with a maturity of less than one year. The average maturity of US debt is now under six years — only a little longer than a typical emerging market. Developed economies are now using the template of Latin America.

This matters, because that small reduction in current interest costs means there will be more debt that regularly needs refinancing in future. The problem with short-term bills is that you need to keep refinancing them — finding new buyers each time, and remaining exposed to fluctuations in market rates. If a government sold 30-year bonds in 2015 when rates were near zero, it locked in low payments for three decades. But debt sold today is priced at market rates, so a future rise in rates has a much bigger impact on government finances.

To be clear: the state can accept market discipline and cut budget deficits, or it can try to suppress the cost of money by switching to short-term financing and financial repression.

Trump’s 1% demand is the secret wish of every politician — cheap borrowing. But interest rates of 1% don’t work when inflation is 4% and rising. Keep rates too low and inflation risks accelerating; once that happens, markets demand higher rates anyway, and it becomes impossible to repress bond yields.

This week the Federal Reserve was unanimous in hiking rates for the first time since 2023. One member declared “inflation is too high and has been for too long.” But the worrying thing is that higher interest rates don’t solve a supply shortage. Just yesterday, Saudi Arabia had to cancel shipments of crude oil to Europe — inflationary in its own right, and not something interest rates can fix.

People might ask: are we going to see a debt crisis? Not for a while. Governments have many options for deferring the problem into the future. But the future looks increasingly worrying. Current projections assume no changes to tax rates or the tax code — and if higher debt does materialise, it will increasingly be financed with short-term bonds, meaning any future shock will be more problematic still.

• Financial Times — No easy end to easy money
• Financial Times — Donald Trump fails to bend the Federal Reserve to his will
• The Economist — Soaring bond yields, gaping deficits and towering debts: what could go wrong?
• Center for American Progress — Tax Cuts Are Primarily Responsible for the Increasing Debt Ratio