This is an audio transcript of the Unhedged podcast episode: ‘How bonds make — and break — nations

Ethan Wu
Shadow banking sounds pretty scary. This is the non-bank part of the financial system, which we’ve talked about before on the show. Private credit is one big growing part of shadow banking, but it’s not the only part [MUSIC PLAYING] and it’s certainly not the biggest part. Much larger is the bond market, over $100tn worldwide, and the bond market is playing an increasingly important role in financial crises. Bonds really can make or break a country.

This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu, here in the New York studio, joined today by FT Alphaville editor Robin Wigglesworth, who has written just a tome of a magazine piece. You know, 20 million thousand words on bonds, their history and why they should terrify us. Robin, is this the longest piece you’ve ever written and that I’ve ever read?

Robin Wigglesworth
I hope not (Ethan laughs). It definitely is the longest piece I’ve ever written. But it’s probably the longest piece I’ve written just on the bond market, which, you know, not everybody loves as much as I do, but I think they should, which is why I wrote the piece.

Ethan Wu
Yeah, yeah, yeah. Katie Martin and I, on some of these Tuesday episodes, we’ve talked about, you know, how bonds are hot again and how they’re the new trade. And I think it’s difficult to understand bonds as a threat to the financial system because they’re seen as stable, right? They’re seen as a place you put your money, you collect a sensible yield, you hold it to maturity, maybe you sell it or whatever. But it’s not like a stock that it’s gonna be down 50 per cent and then, oh, you’re broke. So what does that miss Robin? What is it about bonds that makes them go in the same conversation as a financial crisis?

Robin Wigglesworth
First of all, it’s just a bigger market. But like stocks can’t make or break the fate of a country, the bond market can and frequently has through centuries. And more recently, actually bonds are bigger than banks. So basically, for the past thousand years banks have kind of been the engine of capitalism. That’s where like credit is extended and credit’s kind of the fuel for the modern economy. But over the past, let’s say decade or so, bond markets actually extend more credit, make more loans, are more important than banks.

Ethan Wu
Yes.

Robin Wigglesworth
And I think that’s like this huge kind of change to the entire financial ecosystem that we don’t really have our arms around completely yet.

Ethan Wu
Yes. No, this is such an important point. And I just wanna highlight and reinforce that. Our mental model are in a very broad sense of people that have some awareness of finance is 2008, right? We had banks are holding all this crap and the banks are going down and they’re getting billed out and JPMorgan’s talking to the Treasury and all this stuff, it’s about banks. And I think people assume because banking crises have been an important part of financial history and because we have such a massive banking crisis so recently in modern memory, that’s how all financial crises originate. But that is perhaps decreasingly the case because of the move that you highlight in your piece, Robin, of risk from the banking system to the bond market. And we’ll get into this a little bit in more detail. But I wanna take us back, Robin, as you do so nicely in your magazine piece, all the way back to the 12th century, to the birth of bonds. You can’t talk about bonds without talking about war.

Robin Wigglesworth
Yeah, that’s right. The first bond was born out of a war, and it’s kind of accidental. Venice went to war against Constantinople, didn’t have money to pay for it. So the Doge, the ruler of Venice, issued a loan to all its citizens. They all had to lend him money at 5 per cent a year. But they could trade that loan. They could trade their pieces of it if they needed to raise cash. And unfortunately, Venice got his ass handed to it by Constantinople. So they lost the war. They weren’t able to repay the loan, so it became permanent. And that became the first ever bond, the prestiti. And since then, they kind of, because it was actually worked out, was a pretty good, nifty invention, good way for city-states or countries to fund themselves. It kind of evolved and grew in France, Netherlands especially, which is kind of a country that pioneered modern capitalism. And then to the UK, where it became the consol market, the UK government bond market, which literally helped it defeat Napoleon.

Ethan Wu
Wait, hang on, hang on. Bonds beat Napoleon. You’re gonna have to explain that.

Robin Wigglesworth
Yeah. Bonds beat Napoleon, right? Almost the unvarnished truth (Ethan laughs). But basically, it boils down to the fact that, you know, in war, sometimes generals can win it — strategy, tactics — but quite often it’s like who can last the longest. And the UK had a smaller economy and fewer people than France. So how was it able to withstand so many years of warfare against a much larger country? Well, it was able to maintain armed forces, pay for its ships, pay for its soldiers much better because it issued bonds.

Ethan Wu
Yeah.

Robin Wigglesworth
It issued long term bonds to people in the UK.

Ethan Wu
Yeah.

Robin Wigglesworth
France couldn’t really do that. They had some banks in Paris they could borrow money from. It was mostly more short-term debt so it’s harder for France to muster the full might of its economy, while the UK was able to do so. So in a meaningful way, bonds did help beat Napoleon.

Ethan Wu
Got it. So just, you fast forward a few centuries and for the most part we’re talking about sovereign bonds, bonds issued by governments to fund wars, to fund public works projects, whatever it might be. But then in the later part of the 20th century, it’s not just sovereigns that are issuing bonds anymore. It’s also corporations.

Robin Wigglesworth
Yeah. For basically, almost a thousand years it’s all governments. I mean, a few big companies so the first corporate bond was actually in Amsterdam, is a Dutch East India Company. But it was almost all governments until basically the modern era — the sixties and seventies and especially eighties. Things started to change quite radically because first of all, bigger companies, more big companies started issuing bonds in Europe as well after World War II. They need to rebuild their countries. And then in the eighties, you had the birth of junk bonds.

Ethan Wu
Right.

Robin Wigglesworth
So non-investment grade bonds — kind of riskier bonds — that was pioneered, not invented, but really championed by a guy called Michael Milken, who was a bit of a controversial figure. An insider trading probe, he got snagged by that in the late eighties.

Ethan Wu
And he was pardoned by Donald Trump just a couple of years ago. I mean, this guy is very much still around.

Robin Wigglesworth
Oh very much still around. He runs a big global conference. And frankly, to his credit, like what he did, he turned a kind of sketchy market for dodgy companies into a very legitimate funding . . .

Ethan Wu
Yeah.

Robin Wigglesworth
. . . avenue for hundreds of thousands of companies around the world. I guess it’s literally a multitrillion dollar market, that is a valuable component of the financial system.

Ethan Wu
Yeah.

Robin Wigglesworth
And then also around the same time you had the birth of securitisation. Again, like the technique basically had been around for a while. You take lots of individual loans, packaged them up in a big bond.

Ethan Wu
Yes.

Robin Wigglesworth
But in the eighties that really started evolving and took off and, you know, ended in tears. As we know in 2008.

Ethan Wu
You mentioned at the top, Robin, bonds can make or break a country. Could you talk about what you mean there?

Robin Wigglesworth
So let’s deal with the making side. I mean, if you look at the modern world around us, it is to a very large extent, an under-appreciated extent, made by bonds. So the US financed the purchase of Louisiana with bonds.

Ethan Wu
Mmm.

Robin Wigglesworth
The railways were built with bonds. Tesla’s cars are financed by bonds. It’s not the stock market that finances the building of these cars. Tesla borrows money in the bond market to make these cars make its factories. Netflix borrows money from the bond market to make its content.

Ethan Wu
Yeah.

Robin Wigglesworth
But also sometimes, because bonds are quite often a cheap, easy way for big companies and countries to borrow money, you know, some countries aren’t as disciplined as maybe they should be. So debt crises have been around for millennia. Literally, the first debt crisis I know was in something like 4th century BC in Greece. There were some statelets in Greece that borrowed money from a big local rich temple, and then they all defaulted and the temple (Ethan laughs) went bankrupt. But today, literally like countries like Zambia, Ghana, Pakistan, Sri Lanka are in debt crises. And to a large extent, that is caused or at least the main symptom is they . . .

Ethan Wu
Yes.

Robin Wigglesworth
. . .  borrowed a lot of money through bonds.

Ethan Wu
Right.

Robin Wigglesworth
And bonds are different from the old loans. They used to borrow money from other countries or from banks. And that’s painful as well. But at least you can fundamentally get all those bankers into a room and kind of work something out sooner or later.

Ethan Wu
Right.

Robin Wigglesworth
With bond market, it actually makes things a lot more complicated.

Ethan Wu
Yeah, you got a million people to talk to.

Robin Wigglesworth
Yeah.

Ethan Wu
It’s, you know, way more fingers in the pot. So I like this point. And that kind of brings us to today, Robin. Bonds are a cornerstone of the financial system. Pretty much every government uses them to borrow. Pretty much every company uses them to borrow. So what’s the problem? What’s the other side of bonds today, and why are you writing a book on it?

Robin Wigglesworth
Well, it’s a very good question (Ethan laughs), because it is a fairly nerdy subject. I mean, I love the subject because I think it’s important. And I think it’s important because we have seen a shift towards bond markets globally for several decades now. But after the financial crisis, there’s been a step change. A huge shift has happened that the big lesson we took out of 2008 is that banking crises are incredibly painful, because banks aren’t just institutions that trade bonds or make loans. They do the payments, they sort out salaries, they take out deposits. So they are hugely important to society. And when they go belly up, that is exceptionally painful. So we essentially have strengthened the banking sector. And it might not seem that way because obviously we’ve seen a few US banks go kind of belly up and Credit Suisse was being Credit Suisse and finally kind of keeled over as well. But broadly speaking, the banking sector is vastly stronger today than it’s been for generations. That doesn’t mean that there won’t be banks that fail, but they’ll fail in more manageable ways. It will be fewer of them and it won’t cause as many systemic problems, at least for the time being.

Ethan Wu
Yeah.

Robin Wigglesworth
But we’ve kind of squeezed risks out of the banking system and pushed it into the bond market. And that’s a great home for it. That’s a great place for it. But it doesn’t mean that that risk has disappeared. It’s just kind of morphed and changed its nature and become more decentralised, which is good. But it means it’s harder to monitor. And when things break bad, they kind of break bad in a quite nasty way. And they’re very hard to tackle because the bond market . . . 

Ethan Wu
Yes.

Robin Wigglesworth
 . . . is more decentralised than banks were.

Ethan Wu
You had a very nice line on this in your piece that I think drives the point home. “In finance, risk is like energy. It cannot be destroyed, only shifted from one place to another. As it gets shunted around, its consequences can morph in little understood even dangerous ways”. And I think that’s the point here. It may not be that risk has increased because the bond market has grown in prominence. It may just be that risk has been transferred from the banking system to the bond market after we’ve seen all these post-2008 regulations tightening controls around the banking system. And that’s kind of the point about talking about shadow banking, right? Shadow banking is like — and a lot of people have said this — it’s a really amorphous, broad term that includes a bunch of stuff that doesn’t share characteristics. It literally just means not banks (Ethan laughs), right?

Robin Wigglesworth
Yeah, exactly.

Ethan Wu
But the point is, exactly that, we don’t know quite where the risk lies, right? We know now in hindsight that risk was in the banking system in 2008 and now it’s not exactly clear where it is. And that’s the scary part, right?

Robin Wigglesworth
I think you nailed it, Ethan. That’s exactly it. It’s not knowing that is kind of the scary part. But I think the bond market is a positive thing, right? It has helped reduce risks or at least ameliorated the overall riskiness of the financial system because, like I said, we have centuries of horrible experiences of banking crises. They’re not fun at all. They’re extremely painful for individuals and for economies as a whole. And bond crises, you know, they can also be very painful. You could argue that 2008 was at least partially a bond crisis.

Ethan Wu
Yeah, yeah.

Robin Wigglesworth
We came very close to a bond crisis in 2020 when the banking system actually held up pretty well when Covid rattled financial markets. But broadly speaking, this is a good thing, right? It’s good that risks have kind of been squeezed out of banks and into markets. Markets kind of, that’s where risks should be. But, you know, these things have unintended consequences. And I think, they might be inherently unknowable or so difficult to fix that the fixes are unpalatable. We will never be able to stomach them or get enough global agreement to do so.

Ethan Wu
Yup.

Robin Wigglesworth
Certainly absent another crisis like after 2008, we’re able to do all these things with banks because there was a very strong political conviction across the world that that cannot happen again. It will happen again at some point when we’ve forgotten the lessons. But for the time being, I think we should more look towards the bond market and maybe see what we can do there to make things a little bit better.

Ethan Wu
Yeah.

Robin Wigglesworth
I think for everybody’s sake.

[MUSIC PLAYING] 

Ethan Wu
Good things can be scary, too.

Robin Wigglesworth
Yes.

Ethan Wu
All right, Robin, thank you very much. We’ll be back in a minute with Long/Short.

[MUSIC PLAYING]

Ethan Wu
Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Robin, we did the show with Katie Martin last week on the case of the soft landing. Man, I’m reversing course. I’m short the soft landing. I think this narrative has gone way too far. And the problem is the same problem it’s always been, which is inflation, which is wage growth is still high. And we have just never seen in US economic history wage growth that we’re getting right now, consistent with what the Fed wants, which is 2 per cent inflation. I think inflation’s probably going to stabilise a little higher than people are comfortable with and it’s going to create some difficult choices for the central bank, which could include, you know, like raising the inflation target or a variety of other creative measures. But I think, people are thinking too narrowly and too simplistically about the soft landing. And whenever a market narrative goes this far, you gotta short it.

Robin Wigglesworth
Yeah, I mean, that’s quite compelling. I have to admit, I’m long soft landing, I’m team no landing. But I think that was well put. So I think my long is Nintendo.

Ethan Wu
OK.

Robin Wigglesworth
On the personal side, look, I’m playing Zelda: Tears of the Kingdom with my kids and I’ve been playing Nintendo games on and off for most of my life and it blows me away how a company that old, so storied, can still just be just a creative juggernaut.

Ethan Wu
Mmm.

Robin Wigglesworth
It is so interesting and vibrant and fun and creative. And seeing my kids rediscover the joys of some of these characters I grew up with has been magical. But with a slightly more pragmatic hat on, I think the Mario film, which I haven’t actually seen yet, kind of shows that Nintendo is maybe starting to monetise its intellectual property a little bit more aggressively.

Ethan Wu
Yeah.

Robin Wigglesworth
You don’t see that many Mario films or Zelda films, you don’t see mobile games, even though everybody knows they would sell. Nintendo’s always been very conservative and careful about these things. And if they start even tapping into some of the potential of this, I mean it’s huge. Because people forget that as much as we talk about Barbie or an Oppenheimer, it’s the big blockbusters this summer, or a longer run like the Marvel Cinematic Universe and the grip it has over modern cinema, other franchises like Star Wars or even Mickey Mouse. The biggest franchise in history, the biggest-grossing franchise in history is Pokémon. And it has zero cultural clout among us adults, right? I don’t get it. I had to buy my son like a gold Nintendo Pokémon card in metal gold in France this summer and it’s in Spanish. He doesn’t understand it (Ethan laughs). But it’s his prized possession. He’s shown it to all his friends and he loves it. And like they have just printed money through T-shirts, toys, caps, Pokémon cards and all that jazz.

Ethan Wu
Yup.

Robin Wigglesworth
And frankly, it seems that this is something that has more staying power than some of the stuff that I grew up with.

Ethan Wu
You got to catch them all in English, Japanese and Spanish. That’s the quest (inaudible).

Robin Wigglesworth
Exactly.

[MUSIC PLAYING]

Ethan Wu
For the record, Tears of the Kingdom, amazing game. Where is Mario Odyssey 2? Where is it, Nintendo. Please deliver. Thank you very much.

Robin Wigglesworth
Amen (Ethan laughs).

Ethan Wu
Robert, thanks for being here. We’ll have you back very soon. And listeners, we’ll be in your feed again on Thursday with another episode of Unhedged. Catch you then. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free; a 90-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

[MUSIC PLAYING] 

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