The Bond Market Is Flashing a Major Warning | Steve Hanke

**Steve Hanke** (0:00)
The inflation genie is out of the bottle. I mean, we've already lost the war. I think the bond market is going to call a turn. Higher interest rates usually are associated with bubbles popping.

**Maggie Lake** (0:20)
Hi, everyone, welcome to Wealthion. I'm Maggie Lake. Joining me today to discuss the US economy and geopolitical outlook is Steve Hanke, Professor of Applied Economics at Johns Hopkins University and author of Making Money Work. Hi, Steve, it's great to have you back on.

**Steve Hanke** (0:34)
Yeah, good to be with you, Maggie.

**Maggie Lake** (0:37)
There are an awful lot of threads to pull on here and a lot of, it seems like risks facing the global economy. What's top of mind for you right now as you look across the events that we've sort of digested even over the weekend?

**Steve Hanke** (0:52)
Well, I think the main thing is that the markets seem to be quite complacent about all these risks. We can go through a long laundry list of risks and they don't seem to be priced in, to make a long story short.

**Maggie Lake** (1:08)
Yeah, it does seem like that. What do you, so let's...

**Steve Hanke** (1:12)
Yeah, I think one thing that is interesting and will ultimately work its way into the markets and prices is the bond vigilantes seem to have come out of hibernation and bond yields have gone up significantly in just the past week. That's been a combination of, I think, really three things going on. One is that the inflation genie is out of the bottle and they're not going to be putting it back anytime soon, in my view. And I think that's a background piece of information that's important because significant changes in the money supply affect nominal GDP changes, with a lag, of course. Big change in the money supply, you get a big change in nominal GDP. And nominal GDP includes real growth rate plus the inflation rate. So the money supply broadly measured has, in fact, been increasing steadily for about the last 18 months. And now the Divisia M4 measure, which you can get it from the Center for Financial Stability, which is, I think, the best measure and the broadest measure is growing at 6.7 percent per year. And that's above a range that's consistent with hitting the inflation target of 2 percent. That range would be something like 5 to 6 percent.
So we've got the inflation genie out of the bottle. If the inflation genie is out of the bottle, that means the bond yields are going up and bond prices are going down. The other thing, I think, you've got Trump's tariffs. That works into the picture. And then the next thing is the U.S.-Israeli war on Iran and all the effects of that. So those three factors are starting to actually get priced into the market.
And the bond yield is going up. And of course, that affects mortgage rates because everything is geared off the 10-year bond yield, the US government 10-year bond yield, and including obviously mortgage rates. Mortgage rates are as high as they've been since before the great financial crisis in 2008 And the housing market is, by the way, quite flat.
It's not doing anything. So what happens, just to kind of finish the thing, if you have these elevated interest rates and they keep going up and the bond vigilantes are on guard, you have a situation where we know one thing happens. Investing in bonds is not a very good idea, because if the yields go up, the bond price goes down. They're inversely related. And the other thing is that the discount rate that's used to calculate the present value of free cash flows or profits or whatever the flow is, if the discount rate goes up, what goes down, down the present value.
So this is kind of in the background a threat, shall we say, that might be something that eventually starts either popping bubbles or, you know, letting the air come out of bubbles.

**Maggie Lake** (4:58)
Yeah, this is why we talk about, when we have a community that is very interested in real assets, but when you're at a juncture like this, this is where rates become kind of the center of the universe, because if you start to see that move very quickly, it breaks things. Let's talk about, we're talking about some of the implications of those high yields in a second, but let's talk about those, some of those issues that are pushing yields up that you just mentioned, inflation tariffs, Iran war.
With the Iran war, the market has a way of looking through geopolitical events, right? They think that you'll, there'll be some effects, but they'll fade. And especially with the Iran war, there are all these warnings of, you know, really high oil prices and shortages in places. And through the first six months that we did see elevated prices, but we didn't really, those worst-case scenarios really didn't seem to come to fruition. Are we in a new chapter with this war? Is there a risk that this drags on longer than expected, or that some of the damages to the supply chain become more permanent? How are you thinking about that situation?