The Podcast of the Lotus Eaters - July 01, 2025


PREVIEW： Brokenomics ｜ Where Does The Debt Go？

PREVIEW： Realpolitik #2 ｜ The Geopolitics of Iran Golden Ages ｜ Interview with Johan Norberg

Episode Stats


Length

12 minutes

Words per minute

171.11

Word count

2,069

Sentence count

13

Harmful content

Hate speech

2

sentences flagged


Summary

Summaries generated with gmurro/bart-large-finetuned-filtered-spotify-podcast-summ .

In this episode of Brokernomics, I discuss how the bond market works, who actually owns all this debt, why do they buy it, how big is it and how much is it worth? I also talk about the process of pricing and clearing the bids.

Transcript

Transcript generated with Whisper (turbo).
Hate speech classifications generated with facebook/roberta-hate-speech-dynabench-r4-target .
00:00:00.000 Hello and welcome to Brokernomics. Now in this episode it is extremely hot in the studio and I'm going to be talking about bonds because I tell you the most common question that I think I get asked looking through the comment bit is because I keep referencing the debt but I don't really kind of go into how the bond market works or anything like that and the most common question I get asked is well who owns all this debt and some variation of how big are these numbers then because
00:00:30.000 you know we know the US debt has recently passed 37 trillion but you know what the hell is a trillion I mean no one's really got an intuitive understanding of that so what I'm going to do in this episode and I'll try and make it a little bit more short and condensed because it is a bit of a it's not the most Hollywood of stories the bond market so I'll try and keep it tight but important so we do head of the bond market work
00:01:00.000 who actually owns this debt why do they buy it how big is actually a trillion and you know where do we go from here a bit of that so without further ado the story all starts with the bond auction and you know it's the US government I'm going to use the US government for this rather than the UK government because the numbers are bigger and a bit more impressive
00:01:22.000 and also they kind of dominate because they're you know the world's leading currency they that's where all the action is but you know process is similar for any other country so it all starts with the bond auction and for the US Treasury they basically you know put out on their website that they announced that they're going to be doing an auction and these happen fairly regularly anyone can go on the Treasury website and see what's coming up so they might say you know look we've got we're going to be doing a
00:01:50.000 a 60 billion issuance of two year notes come place your bids now basically pretty much anyone is allowed to bid but there were two classifications of bidders there's the big institutions banks hedge funds asset managers that sort of thing and they are allowed to submit what's called competitive bids
00:02:11.000 which basically means they will set which basically means they will set what rate they are willing to accept on the debt that they are taking on that will vary over time between them willing to accept quite a low yield on their investment and other times they will demand a much higher yield as is what has been going on more lately everybody else can submit non-competitive bids and that basically means that you just get whatever the whatever the clearing
00:02:41.000 price was how do they work out that clearing price I hear you ask well it's done by a Dutch auction so what happens is everyone submits their bids and they get filled from the bottom up so the lowest yield first so the government wants to pay the US Treasury wants to pay the lowest possible yield out that it has to because it wants its future cash flow obligations to be nice and low so it starts from the lowest yield and then it goes up until it gets to the basic
00:03:10.940 basically what they call the stop out yield which is where they've basically filled you know in this case 60 billion and then everybody pays that stop out rate so even if you you know even if you said look I'll accept a 2% yield which would be a bit excessive but you could say that but the thing actually stopped out at 4.1% then everybody is going to get that 4.1% so you don't lose out by submitting a lower bid if you submit to higher bids say you know
00:03:40.940 I want a yield of 8% well you're unlikely to get an allocation then unless things have gone seriously wrong and if you're above the stop off yield you basically get you don't get your allocation and I should also mention the backstop in this process which is the primary dealers so there's a special group about 25 banks and brokers and they're called primary dealers and these guys are basically required to show up to every auction and buy their fair share even if the demand is otherwise
00:04:10.920 weak and this basically is a little bit of protection of the government that you know they give these guys a bit of extra extra access but by the same time they don't want their auctions to fail because you know then they couldn't do whatever it is that they need the money for paying welfare or bombing somewhere or you know whatever all the important work that the government does so they want to make sure they always get these auctions away
00:04:40.920 you know these primary dealers but you know these primary dealers but you know these primary dealers but you know in theory it could do
00:04:44.820 demand on this stuff is generally pretty good that's measured by something called the bid to cover ratio
00:04:54.680 so a ratio of 2.5 would mean that for every um one dollar of debt issued there was two and a half dollars um making the attempt to get hold of get hold of that one dollar's worth
00:05:10.140 so bid to cover um in fact uh the example that i picked up before the one i looked up was was the 60 billion issuance
00:05:17.980 that was um last month and the bid cover on that was 2.66 so um you know it's pretty good even with the
00:05:27.420 the 10-year notes it's still normally above you know um 2.4 although that is down from years past
00:05:35.680 especially decades ago when the when the when the bid uh bid ratio was was significantly higher than it is
00:05:41.800 now so fewer people are turning up but there are still plenty of people turning up for this stuff
00:05:46.400 so anyway the the auction closes the bonds are issued and settled um you know the securities land in their
00:05:54.500 accounts um the the cash is taken out the money goes to the uh u.s treasury um goes in their general
00:06:01.740 reserve and then they can then they can spend it on whatever that happens uh that you know they need it
00:06:06.160 four now um it might as well what happens if you know you say there's a good bid to cover ratio
00:06:11.700 but what happens if the auction does flop um well i mean firstly they've got those primary
00:06:18.380 dealers in order to prevent that but also the yields could basically just rise on it so let's say
00:06:25.220 that um you know they're doing a new issuance and something has materially affected the world's view of
00:06:32.740 lending money to the u.s you might just find that it goes through at a higher percentage so so so that
00:06:39.280 the the the the cutoff bid will be up at say five percent or six percent you know maybe even seven or
00:06:45.020 eight percent but there's there's probably always going to be somebody who is willing to lend that money
00:06:51.660 at a rate that rate just might get punitively high um the u.s government for a long time sort of post 2008
00:07:01.400 or so was able to get away with lending uh you know borrowing money uh at rates that the you know
00:07:07.900 functionally zero you know a little bit above zero and now they're having to pay you know four or five
00:07:13.820 percent and this is starting to get a little bit more unwieldy so um what what is what is going on
00:07:21.240 with these prices uh so this market the depth and size of this market because the u.s treasury market
00:07:27.840 is um simply enormous it is it is the biggest and most liquid uh you know financial market in the
00:07:37.480 world bar none every weekday it shifts around uh 1.1 trillion in trading volume and that's just
00:07:47.840 cash bonds if you add in uh futures and over light lending you're probably looking at about
00:07:53.880 six trillion a day is going through this so this is by no means you know a side room of wall street
00:07:59.760 this is the main room of wall street you know you you might think it's stocks or you know derivatives
00:08:05.840 or something else but no no it is it is it is bonds that's that's where all the action is um
00:08:11.340 worth noting that not all of the treasury bonds are necessarily fungible they're not they're all
00:08:18.640 necessarily or they are fungible but they're they're not quite seen as equal so imagine you've
00:08:24.840 got two um two 10 year bonds maturing in in yeah maturing in 10 years and they both pay the same
00:08:33.060 interest um you might think that they're they're identical uh but actually the newer one is considered
00:08:38.940 to be on the run uh which is the term uh that they that they use meaning that is the one that the
00:08:45.060 traders want because it's newer it's more liquid um it trades in slightly tighter spreads uh everybody
00:08:52.720 knows its price and it's easier to sell instantly it's got it's got a slight liquidity premium to it
00:08:57.980 so people pay slightly more uh for newer stuff because you know they they can turn it around if they need
00:09:05.360 to right um oh the other thing is um who's doing the buying of this because you might be imagining you
00:09:16.400 know chaps in blazers um and and glasses screaming into a phone and all that sort of stuff um 0.98
00:09:24.280 more than half of it these days is um high frequency trading firms um
00:09:32.520 you know the citadel securities um jump trading you know all all of all of those type of people
00:09:41.520 um that they are they are on this and um yeah half of it is it's it's just a computer it's just it's
00:09:48.020 just an algorithm at this point um and the rest of it is being lined up by you know chaps 0.99
00:09:52.860 behind computer screens i don't think much of it is done by phone these days
00:09:56.920 um in fact in fact um in fact any of you can can participate in this market they've got a website
00:10:02.540 um did i mention that earlier um treasury direct so you you you can go and place a bid if you wanted
00:10:10.220 to um the the reason they use trading trading algorithms is because they can feed the news flow
00:10:17.220 into this stuff and they they've already worked out you know what what reaction they want it to have
00:10:23.400 to you know latest cpi numbers or news or whatever it else and then the algorithm can react faster
00:10:30.340 and they do a lot of buying and selling of this stuff um basically to just to extract a tiny margin
00:10:38.400 but they do it at scale and very very fast and therefore that tiny margin accumulates quite nicely
00:10:48.060 over the course of time um i mean to the point where if if you are doing one of these um high frequency
00:10:56.780 trading stuff there is there is a scrabble to get your internet connection connected um as as close as you
00:11:07.700 possibly can to the exchange uh for the reason that microseconds actually counts on this stuff because you
00:11:16.340 want to be you want to be a microsecond ahead of your competitor not a microsecond behind your
00:11:21.040 competitor um the other thing we should talk about is that the big players they generally aren't using
00:11:27.820 their own in fact quite frequently quite rarely are they using their own cash to buy these treasuries
00:11:33.380 um what what they actually do is is borrow the money um and then use the treasuries that they've just
00:11:42.260 bought with the borrowed money as collateral on the loan they took to buy the treasuries okay i hope
00:11:49.840 that makes sense um this is basically a a repurchase agreement or repo everybody just calls it a repo
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