How the Cost of Money Spikes Inflation

If you are an ordinary civilian, the words bond market are a guaranteed snooze. But this story should be keeping you awake big-time.

The government is now paying more to finance the public debt than at any time since the fateful year 2007, the eve of the 2008 financial collapse. Why have rates on 30-year Treasury bonds risen to more than 5.3 percent? Partly because investors think that inflation will keep creeping up, so they charge the government a premium for lending it money long-term.

And that’s not the only reason for rising interest rates. Conservatives have long warned that large public deficits and debts cause government borrowing to “crowd out” other borrowers and to raise interest costs for all. Under President Trump, the annual deficit has been running around 6 percent of GDP, and the public debt has grown to $39 trillion, more than the current GDP of about $33 trillion.

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But the other major source of crowding out is borrowing by tech bros. The AI bubble is not only raising trillions from investors. AI companies are also borrowing big. Their total debt is now around $3 trillion.

All of this debt combined with rising inflation expectations has two broader consequences. First, it raises interest costs for everyone. Thirty-year mortgage rates, which closely track 30-year Treasury bonds, have risen from around 3 percent in 2020 and 2021 to just under 7 percent and are likely to go higher. More expensive mortgages serve to compound the crisis of housing affordability.

Higher interest rates cycle through to hit everything from credit card debt to small-business borrowing costs to student loans. They serve as a major source of inflation. That in turn narrows the Fed’s room to stimulate the economy. The Fed can control short-term rates but not long-term rates, which are set by supply and demand in money markets. (In past times of inflationary crisis, the Treasury simply suspended the issuance of 30-year bonds.)

Politically, all this becomes one more election-year crisis for Trump, since his Iran war has caused shortages—raising prices, and leading investors to demand an inflation premium to finance the public debt. And there is one further, even more dire, scenario: the risk of a financial crash.

Several indicators suggest that financial markets are overdue for a collapse, politely known as a correction. The AI hype has bid up AI stocks to insane levels. The broad stock market is dangerously concentrated in tech. The backlash against data centers is only one part of the risk.

AI companies are heavily invested in each other’s stocks, giving the AI boom characteristics of a pyramid scheme. The New York Times recently reported that 65 percent of Amazon’s reported profits for the latest quarter came from its investment in Anthropic, while over 70 percent of Alphabet’s net quarterly income came from investments in other companies, notably Elon Musk’s SpaceX.

More generally, price-to-earnings ratios are astronomical, higher than in October 1929. Rising long-term interest rates add tinder to this potential bonfire, by making bonds a more attractive investment than stocks.

Even if a full-blown crash does not occur, rising inflation is problem enough. It’s easy to overstate the culpability of the high federal deficits. Other nations, with much lower deficit levels, are also having to pay more to sell government debts because of the worldwide inflationary impact of Trump’s war, and the imbalance of credit demand and supply.

It would be a mistake for Democrats to emulate fiscal conservatives and make the deficits the problem. The trouble with Trump’s deficits is mainly their composition—tax cuts for the rich, and an insane military buildup. If we used deficit spending instead to finance long-deferred investment in public infrastructure and serious spending for a green transition, the deficits would be entirely virtuous.

In the meantime, Trump reaps what he sows: rising inflation in an election year and the risk of a financial crash.