Former Treasury Secretary warns 'vicious' bond crash coming soon

By TheStreet Roundtable

4 days ago

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Former Treasury Secretary Henry Paulson, the man who steered the United States through the 2008 financial crisis, has seen market chaos up close.

And when he uses the word "vicious," it is worth paying attention.

In a recent interview on Bloomberg Television's Wall Street Week, Paulson issued a stark warning about the $31 trillion United States Treasury market.

What is the Treasury market?

The U.S. Treasury market is the marketplace where the U.S. government borrows money from investors by issuing debt securities, commonly known as Treasury bonds, bills, and notes.

When the U.S. government needs to fund its operations, paying for everything from defense to social programs, it cannot always rely solely on tax revenues. The shortfall, known as the budget deficit, is covered by issuing Treasury securities.

Investors, ranging from foreign governments and central banks to pension funds and everyday citizens, purchase these securities in exchange for regular interest payments and the return of their principal at maturity.

The U.S. Treasury market is considered the bedrock of the global financial system. U.S. Treasuries are widely regarded as the safest investment on earth, backed by the full faith and credit of the U.S. government.

The 10-year Treasury yield is used as a global benchmark interest rate, influencing borrowing costs for mortgages, corporate loans, and sovereign debt around the world.

When the Treasury market experiences stress, the ripple effects are felt across every other asset class, from equities and real estate to currencies and cryptocurrency.

The 'doom loop' is no longer just a theory

Budget experts have warned for years about a potential "doom loop" in U.S. sovereign debt.

It is a scenario where investors demand higher yields to compensate for rising fiscal risk, which in turn drives up the government's interest payments, widens the deficit further, and triggers even higher yield demands.

As of April 16, the U.S. national debt stands at $38.9 trillion. This means the U.S. Treasury market is carrying more weight than it ever has before.

Paulson warned the authorities to prepare a contingency plan before a potential collapse in demand for government debt forces their hand. This, he added, would have “vicious” effects.

"We need an emergency break-the-glass plan, which is targeted and short-term, on the shelf, so it's ready to go when we hit the wall," Paulson said.

Paulson compared the current scenario to 2008 and explained why he believes the next crisis could be harder to contain.

During the 2008 financial crisis, the government still had fiscal room to maneuver. But a U.S. public debt crisis does not offer such luxury.

In a public debt crisis, debt is already unsustainably high. This makes markets lose confidence, borrowing costs surge, and issuing more debt becomes impossible or self-defeating.

The very tool used to fight the crisis becomes unavailable.

If the Treasury is unable to find buyers for its debt, and the Federal Reserve becomes the only purchaser while prices fall and interest rates rise, Paulson warned that it will become a "dangerous thing."

The fix exists, but the political will does not

Paulson was careful not to present the situation as hopeless.

"There is good news — we're a rich country, and so there's plenty we could do if we begin to act," he said.

He suggested that the solution is a mix of multiple steps, which includes raising revenues by closing tax loopholes, overhauling Social Security, and restructuring healthcare spending.

However, he warned that is a political obstacle.

"I’ve worked with Congress before, and Congress doesn't like to do unpleasant things until there is an immediate crisis," he said.

Peter Schiff slams Paulson's comments

Long-time Bitcoin critic and gold advocate Peter Schiff slammed Paulson's comments.

He wrote on X,

"Where was Paulson when he was actually in a position to help avert the crisis? It’s too late now. Just buy gold!"

What this crisis means for crypto

A U.S. Treasury market crisis would send shockwaves across every asset class and crypto would not be spared.

In the short term, a bond selloff that spikes interest rates would likely trigger a risk-off exodus, pulling capital out of Bitcoin (BTC) and altcoins just as it did during the Fed's 2022 rate-hiking cycle, when Bitcoin dropped nearly 65%.

However, the longer-term picture is more nuanced. If the Federal Reserve were forced to step in as an emergency buyer of Treasuries, effectively restarting quantitative easing under crisis conditions, that would mean a significant expansion of the money supply.

Historically, that is the environment in which Bitcoin's inflation-hedge narrative gains the most traction.

The very scenario Paulson is warning against, a Fed forced to monetize debt while the dollar weakens, is precisely the macro backdrop that drove institutional Bitcoin adoption between 2020 and 2022.