America Needs to Break Its Debt Addiction — Crisis or Not

This suggests that the US can carry higher levels of government debt because the rest of the economy is borrowing less — at least on a relative basis. Otherwise, it’s hard to explain why the Treasury Department has as much success selling bills, notes and bonds now as it did when debt-to-GDP figures were much lower. Just a couple of weeks ago, the Treasury received bids totaling $105.3 billion for the $39 billion of notes being offered. At 2.70, the so-called bid-to-cover ratio was the highest since mid-2016!

Clive Crook: You’re right that fiscal doom-mongers have generally been proved wrong — so far as the US is concerned, anyway. It’s possible to exaggerate the risks. I might have to plead guilty to doing this once or twice. I also agree on the need to put things in context, and that the US is a special case: For reasons I’m sure we’ll go into, it clearly has more fiscal room for maneuver than other countries. But as I’ll try to persuade you, even the US can eventually run out of space, and that’s the course it now seems to be on.

Turning to our first chart, I don’t find it all that reassuring. For a start, the 20-year “norm” of total US debt it describes is hardly one to be recommended. It happens to include the crash of 2007-09. In 2005, on this measure, total debt was a little below 300% of GDP; today it’s about the same. The intervening period saw financial mayhem and enormous economic losses. So, I don’t know how you get from this chart to “All is well.”

RB: You’re correct about the mayhem and losses, but that was mostly due to the subprime financial crisis and all the risky lending by banks tied to that, not government borrowing. We can’t forget that these elevated levels of debt also coincided with the longest peacetime expansion on record, lasting from mid-2009 to January 2020. If the pandemic hadn’t happened, perhaps we’d be heading into a 16th year of economic expansion.

My point is that the US is an extremely rich country with more than enough capacity to service its debt. Over the past 10 years, household net worth has risen by $83.3 trillion to $168.8 trillion, according to the Federal Reserve. That exceeds by almost five times total US government debt of $36.1 trillion, providing a massive source of funding.

CC: It seems we agree that the aggregate debt figures don’t tell you very much. They certainly don’t give you a good summary statistic of financial fragility, because that depends on sectoral weaknesses. Too much household debt, as you note, can eventually tank the economy — and that might happen even if businesses were deleveraging quickly enough to bring aggregate debt down. Aggregate debt doesn’t measure financial fragility, and it doesn’t measure the capacity to service debt. Of course, the US is a rich country whose taxpayers can afford to service a lot of public debt, which is currently what they’re doing. But the chart doesn’t measure wealth or debt-carrying capacity. It measures the existing level of debt.

One more thing about this chart. When the sectoral shares of debt shift, you need to ask why. In the past few years, as you say, federal debt has been trending higher and the share of business and household debt has been falling. The spike in inflation doubtless pushed private debt down (and restrained what would otherwise have been a bigger increase in public debt). But it might also be that higher public debt is keeping interest rates higher than they’d otherwise be and discouraging private borrowing and investment. This crowding out could be bad for growth — and slower growth, if it happened, would raise the aggregate debt ratio all by itself.

Which brings me to what I expect will be my core point in this discussion. Debt sustainability is not about what debt has been in the past or where debt, however measured, stands right now, it’s about the future. The trajectory of public debt is unsustainable if future public borrowing, future interest rates and the future rate of economic growth mean that the ratio of debt to output will rise without limit. No question, all those things are uncertain and nothing is pre-determined. But if plausible assumptions yield a debt trajectory like that, you’re asking for trouble. As things stand, plausible assumptions say a crisis is brewing.

RB: The idea that all this debt has kept interest rates higher than they’d otherwise be feels too theoretical. The textbooks teach that idea, but the fact is that during most all of this period of elevated borrowing, say 2009 through 2021, the US enjoyed some of the lowest borrowing costs on record. The yield on Treasuries of all maturities was around 1.50% over that time, versus the average of 5.60% going back to 1973, based on the Bloomberg US Aggregate Treasury Index. And those low yields were mostly due to inflation being under control.

CC: Agreed. This is the crucial question: If the outlook is so bad, why does the government find it so easy to sell debt? On to our next chart.

RB: This next chart may seem like it has nothing to do with debt, but it is actually a critical piece of the puzzle: I’m referring to the dollar. The good ’ol greenback’s share of global currency reserves stands at a commanding 58%, far outstripping the euro, which is in the No. 2 position with 19.8%. Next comes the yen at a paltry 5.6%. This is nothing new for the dollar, whose share has ranged from a post-1980 low of 45% in 1992 to 73% in 2001. The dollar is used in almost 50% of global transactions, according to SWIFT, the member-owned financial messaging service that operates across 210 countries. The euro’s share is 23%.

This is what people mean when they talk about America’s “exorbitant privilege.” In other words, the dollar’s role in the global financial system is so essential and so entrenched that it allows the US government to run persistent trade and budget deficits because the rest of the world must hold and do business in greenbacks. And those greenbacks must be put into something, and that something is, by and large, US government debt. America’s fiscal trajectory is no secret, and yet foreign holdings of its debt continue to rise, soaring to $8.67 trillion as of September, according to the Treasury Department.

CC: Yes, it would be hard to exaggerate the economic and fiscal benefits the US derives from issuing the world’s reserve currency. It’s also true that economists have been saying this status is in danger for years, if not decades. And it hasn’t happened. Efforts to dethrone it — which is how the euro was conceived — have been conspicuous failures. Without a doubt, this means the US can comfortably carry more public debt in relation to its GDP than other countries. But I think two points are worth bearing in mind.

First, it would be rash to assume perpetual reserve-currency status. Right now, the US has no plausible rival as global economic hegemon. In their different ways, Europe and China would like to change that, but their prospects look bleak for the foreseeable future. An issue that gives me pause, though, is the current fashion for global economic fragmentation. The dollar established itself as the favored currency of an integrated global trading and financial system. If global markets for goods and capital start to splinter, its utility in that role will diminish. You could say, US-led globalization gave the dollar its heft. For the moment, reports of the death of globalization are exaggerated, but who knows what the next four years will bring?

Second, even if the dollar’s standing stays unchallenged — as is likely — that doesn’t mean the US’s debt-carrying capacity is unbounded. Again, this comes down to investors’ judgments about future risk and return. The US government has to sell its debt and investors have to buy it. They buy it because they expect a return commensurate with the risk. The bigger the public debt gets, the more it will cost to service (even if interest rates don’t rise), and the greater the risks investors face — especially if the Fed starts coming under pressure to print money to fund deficits (in what’s called fiscal dominance). The exorbitant privilege alters the debt-sustainability formula but doesn’t repeal it.

RB: If you believe in efficient markets and the idea that markets are forward-looking, then you must ask why investors aren’t demanding a much higher return to lend to the US government commensurate with the risk of unsustainable debt and deficits? And maybe the answer is that they see relatively little risk. Just look at the so-called term premium, which is essentially the extra compensation investors demand to hold long-term bonds rather than holding and continually rolling over short-maturity securities such as Treasury bills. The Federal Reserve Bank of New York’s widely followed model shows that premium is just 0.28 percentage point, compared with the average 1.46 percentage points going back to the early 1960s. It’s also far below the average of 1.29 percentage points in the late 1990s and early 2000s when the US was running budget surpluses.

By that measure, the market sees owning US debt as less risky. But why? There are many answers, not least of which is probably the idea that the Fed, which has already crossed the Rubicon and engaged in quantitative easing through its purchases of Treasury and related securities, would do so again if investors went on a “buyer’s strike.” Or maybe it’s related to my observation earlier about how the US’s immense wealth allows it to sustain abnormally high amounts of debt and wide deficits. The thinking here is that the US is actually a low-tax country and has the capacity to raise federal revenue by a lot if needed. The US collects 25.2% of GDP as tax revenue, or $7.40 trillion in 2023. The average among OECD countries is 33.9%. So, if the US matched that average, it would result in $9.95 trillion of tax revenue, which more than covers the annual budget deficit.

CC: Since you bring it up, I don’t believe in the efficient markets theory — not in the strong sense I think you mean. Financial markets are remarkably powerful processors of information, but that doesn’t mean they don’t make mistakes. Booms and busts happen, and market psychology matters. Be that as it may, investors still think US government debt isn’t risky. So, I agree, one has to ask, why?

Any or all of the points you mention could help explain it. I just don’t happen to find them persuasive. The US is wealthy, but the government doesn’t resort to financial repression or capital controls, so investors can put their savings into more appealing assets at home or abroad if their preferences shift. And I think the Fed might bridle at the idea that it stands ready to buy bonds investors have decided aren’t safe. On this view, QE isn’t just for delivering stimulus when the policy rate is zero but is also a way to monetize government debt if investors panic. This is the very threat of fiscal dominance I mentioned earlier. That the Fed can be called upon to engineer a default through inflation should not, in my view, inspire confidence.

The tax argument cuts both ways. To judge by other countries, the US is seriously under-taxed. If the government raised taxes by another eight or nine percentage points of GDP, the overall US tax rate would be roughly average and our fiscal problems would evaporate. You have to factor in the effect of higher taxes on growth — keeping in mind the denominator of the debt-GDP ratio — but setting that aside for the moment, higher taxes should certainly be part of the fiscal solution.

Trouble is, US government revenues are low for a reason: This country has a far-greater-than-average loathing of taxes. With the economy at full employment and public debt still setting records, President-elect Trump has promised to cut taxes — and substantially. Depending on how you score her various ideas, Kamala Harris had proposed, at most, only a modest net increase, much smaller than her promised boost to public spending. The gap between US tax rates and those of other countries is a measure not of fiscal capacity waiting to be tapped but of Americans’ unusually determined refusal to pay up.

But I’ll meet you halfway on this. My own answer to the question of why investors aren’t worried is, in part, because they’re assuming the fiscal crisis predicted by the current debt trajectory will be averted before it happens. And tax capacity surely figures in this. At some point, before panic sets in, wiser heads are expected to prevail. Spending will be reined in and taxes will be raised. The debt will stop rising; at worst, it will stabilize at a high but still affordable level. Indeed, if fiscal conservatives such as myself win the argument, that’s exactly what will happen. (Paradoxical, isn’t it, that for you to be right that there’s no problem, I have to win the argument?)

That’s why we should ask whether there is a fiscal point of no return — a level of debt above which it’s no longer possible, short of default, to stop the ratio rising further. If investors start to panic before that point is reached, the situation is retrievable. If they only start to panic after that point, it’s too late. I suspect we’re closing in on that point.

RB: And I’ll meet you halfway on this: The trajectory of debt accumulation by the US government is alarming and demands that we understand where exactly is the fiscal point of no return — because there has to be one. Would it be when the federal debt gets so high that tax revenue is insufficient to cover interest expense, and the government is forced to borrow just to meet those payments — a scenario that economists refer to as a “debt bomb”? It is concerning that the $1.13 trillion the US spent on gross interest expense in 2024 amounted to 4% of GDP, rising from 2.4% in 2020.

The good news is that the percentage is still comfortably below the 5% of GDP the US was paying during the budget surplus days of the late 1990s. Not only that, but nominal GDP growth at 5% exceeds the average interest rate of 3.76% on US Treasury debt. As Treasury Secretary Janet Yellen has noted, so long as nominal growth exceeds those debt rates, the situation is well under control. And with the incoming Trump administration laser-focused on running a high-pressure economy while cutting waste, perhaps Treasury secretary nominee Scott Bessent’s goal of reducing the budget deficit to 3% of GDP isn’t crazy.

And speaking of deficits, dare I say that the situation isn’t exactly as dire as the headlines suggest? The metric of fiscal health that economists prefer is the primary deficit, which is the shortfall before interest expense. It makes sense to focus on this number, which is not out of line with historical levels, because history shows it can quickly go from a deficit to a surplus in a hot economy such as the one we had in the second half of the 1980s.

I’m sure you’ll remind me that the incoming administration’s math doesn’t add up. Bessent is talking about cutting the deficit at the same time as Trump wants to prevent his Tax Cuts and Jobs Act of 2107 from expiring next year, which the Congressional Budget Office estimates would cost $4.6 trillion over the following decade. But we still live in a democracy and these laws are not set by decree but through (hopefully) healthy debate.

CC: I think we agree, after all, on the variables that matter — but maybe not entirely on what values to plug in. The increase in the debt-GDP ratio going forward will depend on the primary deficit as a share of GDP, and the difference between the long-term real interest rate and how quickly real GDP is expanding. At the moment, the primary deficit projected by the Congressional Budget Office for 2025 is roughly 3% of GDP, the long-term inflation-adjusted interest rate is a little over 2%, and the CBO’s estimate for long-term growth is a little under 2%. That’s why the CBO projects that federal debt held by the public will rise — from the current 99% of GDP to 122% of GDP by 2035 — and then keep rising. If the real interest rate and the long-term growth rate turn out to be roughly the same, holding the debt ratio constant requires a primary deficit of zero. Bear in mind, as well, that the CBO assumes that Trump’s 2017 tax cuts will be reversed in 2026; if that doesn’t happen, the primary deficit will be bigger than currently projected, and the debt ratio will rise faster.

So yes, a lot depends on the outlook for the primary deficit. This is significantly worse, I think, than you say. True, hot economies often deliver primary surpluses, but we already have a hot economy, and a big primary deficit to go with it. This is emphatically not the historical norm. Another recession would put further upward pressure on the primary deficit, and growth would take a hit as well. On current policies, we can’t expect the primary balance to swing into surplus and the debt-GDP ratio to moderate, much less fall.

Regarding the point of no return, this happens if or when fiscal adjustment (short of default) can no longer stabilize the debt. The bigger the debt gets, the more it crowds out private investment, which lowers the projected growth rate, shrinks the tax base and increases the tax hike necessary to reduce the deficit. And the bigger the needed fiscal adjustment, the bigger the hit to growth if it’s applied. Last year, economists with the Penn Wharton Budget Model estimated that for the US, with all its advantages, a plausible upper limit might be 175% of GDP — assuming, all the while, that as the economy approaches this number, investors remain unperturbed and interest rates don’t spike. That 175% is a lot higher than where we are right now. But recall that following the recession of 2008, the debt ratio increased by 40 percentage points.

The bottom line, in my view, is that fiscal adjustment is urgent — not least, to provide the fiscal space for stimulus come the next recession. I’m not advocating panic. The situation is retrievable, but it sure needs attention. And it isn’t going to take care of itself.

RB: This conversation only scratched the surface when it comes to US debt and deficits. And although we may differ on the urgency around the need for fiscal adjustment, we both agree the sooner the better. The longer the US government waits to get its fiscal house in order, the more severe the fixes that will be required. Those fixes would surely include painful austerity such as cuts to entitlement programs including Social Security and Medicare — programs that millions of Americans rely on.

In a recent paper for the Aspen Institute, Jason Furman, the Harvard University economics professor and former White House chief economist under Barack Obama, calculated that based on variables including interest rates and productivity growth, an adjustment of between 0.7% and 4.6% of GDP in the form of higher taxes and/or lower non-interest spending is needed to stabilize debt over the next decade. That’s equivalent to between $2 trillion and $11 trillion in adjustments, a wide range that emphasizes just how uncertain the future is. (The CBO’s estimate, by the way, is well toward the upper end of this range.) Big numbers, indeed, and they only get bigger the longer we wait.

History provides many cautionary examples of great empires and countries that are no more because of their propensity for fiscal profligacy. And when the money spigots are turned off, the populace revolts. It’s discouraging that few in Washington are taking the issue seriously, deciding to govern in the moment rather than with an eye on the future. Just because the US is the undisputed leader in the global economy now, there’s no guarantee it will be in the future.

America has come back from excessive debt and deficits in the past, including in the early 1800s, and after both world wars. We can do it again. The first step is admitting the problem.

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