America’s national debt would have horrified Ronald Reagan. When he inherited a nation on the cusp of an unnerving milestone of $1 trillion in debt in 1981, he described it as a problem that had grown “literally beyond our comprehension.”
“We can leave our children with an unrepayable massive debt and a shattered economy, or we can leave them liberty in a land where every individual has the opportunity to be whatever God intended us to be,” Reagan said in his first televised address on the economy.
Fast forward to the present, and America’s total federal debt burden recently eclipsed $36 trillion, bigger than the entire economy. Over the past four decades, brief stretches of deficit-cutting enthusiasm have been overwhelmed by a largely bipartisan urge to overspend. Most surprising is how small a price we’ve paid for our improvidence. The children that Reagan worried about are now in their 40s and 50s, and they’ve fared much better than expected. Mortgage rates are less than half of the 1981 levels Reagan blamed on soaring debt, and inflation is about a quarter as high. Foreign creditors continue to turn out en masse to buy our bonds at auction and finance the deficit.
What the 1980s deficit hawks didn’t quite appreciate was the extraordinary trust that creditors were already placing in America’s ability, as the world’s greatest economic and military force, to make good on its promises. In academic jargon, this faith is part of what’s often called the “exorbitant privilege.” Foreign entities around the world trade in dollars and save in interest-bearing US Treasury securities, creating a permanent bid for American assets and driving down borrowing costs for the nation. The term dates to a critique from the 1960s by Valery Giscard d’Estaing, then finance minister of France and later president, that the US had attained an unfair advantage. Since then, the exorbitant privilege has become even more ingrained in the global financial psyche as the US emerged from the Cold War as the world’s premier superpower; its financial markets became deeper and more dominant; and inflation disappeared for 40 years.
The exorbitant privilege allows us to spend above our means to, for instance, combat the potentially catastrophic economic effects of the Covid-19 pandemic. And it acts as a deterrent to adversarial nations who know that the US can borrow its way to victory in any war of attrition.
But this faith isn’t unshakeable. It hinges on investors’ ability to grasp the risks ahead and their confidence in the political system to restore fiscal balance before some crisis unfolds. That’s why the US was able to avoid confronting the deficit problem for much of the 2010s. It’s also why the situation suddenly feels more perilous as we embark on yet another year of outsized budget shortfalls, overseen by a fractious Congress that hardly seems focused on finding ways to shrink the deficit. Our political leaders don’t need to balance the primary budget next year or the year after. But they need to set out a realistic path and a credible timeline.
Before the US, the British had the world’s premier currency and bond market, and before them was the Dutch. Fiscal deterioration stripped both of that advantage. Many have long feared that China was positioning itself to seize the throne from the US, at least before its recent economic struggles. Others have speculated that cryptocurrency could unseat the buck, though Bitcoin is far too volatile, and the popular dollar-pegged “stablecoins” seem only to reinforce the greenback’s supremacy. In practice, bond vigilantes — as Ed Yardeni famously called the market’s fiscal scolds — have rebelled from time to time to protest reckless government policy. These spasms in the Treasury market have so far been short-lived, but the spending and inflation of the post-pandemic years have brought a fresh urgency to the question of how far that lenience will go.
President Joe Biden’s administration forecasts that the federal budget deficit will be in excess of 6% of gross domestic product for a third straight year in 2025 — unprecedented at a time when the economy is thriving. The deficit ballooned to $1.83 trillion in the fiscal year ended Sept. 30, and net interest costs have more than doubled since 2020 to $882 billion. Ultimately, a country can keep its finances from completely unraveling if the rate at which it must borrow stays below economic growth, and the primary deficit is held at modest levels. Unfortunately, we can no longer count on low interest rates.
An October assessment of Donald Trump’s campaign pledges from the Committee for a Responsible Federal Budget estimated that the president-elect’s agenda would add $7.75 trillion to the debt through 2035. Under those estimates, the extension and modification of the 2017 Tax Cuts and Jobs Act constitutes the biggest cost. Of course, much depends on Trump’s ability to find offsets and how the proposals affect economic growth. As recently as 2022, the bond market rose up to protest then-Prime Minister Liz Truss’s unfunded tax cut proposals for the UK, sending yields soaring and setting in motion the collapse of her government.
There’s also worry that Trump’s tariff and deportation plans could, if taken at face value, stall the disinflation trend and push up interest rates in a year when the US has about $9 trillion of debt coming due. The massive task of refinancing maturing debt and plugging new shortfalls could test the world’s typically insatiable appetite for US securities.
The View From Abroad
For all America’s imperfections, there’s still no serious competitor in global currency and debt markets. Major foreign holdings of US debt stood at a stunning $8.7 trillion as of September, about a third of Treasuries in the hands of the public, and of that roughly half is held by governments.
The dollar also stands alone in foreign exchange. Some 90% of global foreign exchange transactions involve the US currency, according to Bank of International Settlements data, with the euro a distant second. While the Chinese renminbi has made some gains, it’s partially come at the expense of the euro and the Japanese yen. The dollar is also the chosen currency for the majority of international debt issuance and loans and, while falling, it still accounts for well over half of the world’s official foreign exchange reserves. To the extent that it’s losing influence, it’s because a few upstarts have taken share at the margin — not because another dominant power is on the verge of unseating us.
Still, many observers have worried that growing geopolitical tensions could lead to upheaval. After Russia invaded Ukraine, the US and its allies froze about $300 billion in Russian assets held abroad, a step that could have the unintended consequence of leading other nations to rethink their savings in dollars. If unbridled enthusiasm for the greenback has been a symptom of decades of relative peace, rising tensions around the world could push the trend in the opposite direction. In an extreme scenario, perhaps no currency and debt would reign supreme, but the economic and financial world would instead splinter.
Enter Trump, who has pledged to put “America first.” He’s signaled that he wants to avoid foreign military entanglements but also exhibits a brash negotiating style that could very well start some new ones. His top economic priority seems to be the empowerment of domestic manufacturing and exports (which would benefit from a weaker currency), yet he also assails foreign nations thinking of abandoning dollar-based trade. All in all, Trump represents a rare risk to the status quo — but it’s hard to pin down exactly what kind.
On the optimistic end, Trump’s pick for Treasury secretary, Scott Bessent, is a hedge fund manager and economic historian well versed in the dangers of high and rising debt. Bessent suggested at a Manhattan Institute event in June that the US still has a “last chance to grow our way out of this problem.” But while there is some evidence that the TCJA boosted investment and growth, it wasn’t enough to completely offset the fiscal cost. Even more important, the 2017 economy had space to accommodate the fiscal stimulus without sparking unwanted inflation. The 2025 economy, with its high deficits and low unemployment, simply doesn’t.
The Path Ahead
There are some familiar elements to the latest bout of debt worries. Like Reagan, Trump has made overtures about addressing the problem. He’s tapped Elon Musk, the world’s richest man, to lead a “Department of Government Efficiency,” which sounds similar to Reagan’s “Grace Commission,” headed by chemical industry tycoon J. Peter Grace. Much like Reagan did, Musk and sidekick Vivek Ramaswamy have floated plans to reduce federal payrolls, in their case by demanding that remote and hybrid workers return to their offices. Ramaswamy has said the strategy would prompt a quarter of federal workers to resign.
But the Grace Commission ended mostly in disappointment. In 1984, it turned in a 23,000-page report with 2,478 ideas to make the government more efficient, claiming to have identified more than $420 billion in savings over three years by doing things as obvious as paying bills sooner. But the Congressional Budget Office and General Accounting Office found that many of the savings were exaggerated, and most others simply failed to garner sufficient enthusiasm in Congress. Ultimately, federal payrolls ended up growing during the Reagan administration.
To be clear, at no point soon will the US find itself unable to pay its debts. In a worst-case scenario, Congress’ routine antics around raising the debt ceiling may one day lead to an accidental default, and past episodes in 2011 and 2023 saw lawmakers engage in down-to-the-wire theatrics that led to the nation’s loss of its previously pristine credit ratings from S&P Global Ratings and Fitch Ratings. All of this could ultimately precipitate further credit-rating downgrades and lots of short-term hysteria, but it would be an example of the cavalier and selfish attitudes of our lawmakers, rather than a classic case of financial distress. It probably wouldn’t see America’s position in the world plummet, but it would add to a slow erosion of faith.
Among other things, America has extraordinary underlying wealth. Japan is another developed nation that has famously struggled with high debt-to-GDP levels, but it also holds large positions in equities and other assets on its balance sheet, so its net liability position isn’t nearly as bad as meets the eye. The US doesn’t directly invest in equities, but it boasts many of the world’s most exciting and innovative companies. After two years of exceptional gains, the market capitalization of all US-traded companies is now about double the national debt. Any effort by the government to try to access that wealth — through taxes or any other means — would have severe consequences, but America’s creditors can take heart in knowing it’s there. More important, the US can always print more money. If the government is going to knowingly punish its creditors, it would most likely be in the form of more inflation, effectively cheapening the value of their bonds in real terms. But that would be terrible for Americans, too. By the time the US resorts to such remedies, the market’s faith in its bonds would already be unraveling.
So what can our leaders do to avoid that outcome? No one’s calling for austerity, but political leaders need to start by at least sending the right signals. It’s not enough just to assume that the productivity fairy will wave a magic wand and help the US to grow its way out of its debt-to-GDP hole. Nor is it enough to launch buzzy efficiency task forces — with names like DOGE that make a joke of the matter by echoing Musk's favorite cryptocurrency — without a clear plan to navigate the hard political realities of cost cutting. One starting point is a recent publication by the Penn Wharton Budget Model, a research initiative at the University of Pennsylvania, which analyzed 13 tax and spending reforms that it found could cut the deficit while boosting growth. They include major overhauls to Social Security, Medicare and the health-care system as a whole, as well as ideas to simplify the tax code.
Any such effort is bound to span years and different presidential administrations, and the messaging itself is critical to show markets that their patience will be rewarded.
It’s hard to overstate the significance of investors’ faith in US bonds, and that privilege should help us get through this rough patch. But we can’t assume that faith is unbreakable and allow our leaders to kick the can or even exacerbate the problem. For all the developments that they failed to anticipate, Reagan-era hawks were right to assume that we couldn’t go on like this forever.
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