US debt crisis looms
If the US government continues to ignore the country’s ballooning debt, America could face a Liz Truss-style market shock, is the stark warning from the director of the Congressional Budget Office.
The US federal burden is on an “unprecedented” trajectory, Phillip Swagel, the head of Congress’s independent fiscal watchdog, told The FT, after the CBO published new projections that the country’s already vast debt pile is set to keep on climbing, far beyond any previously recorded level.
At the end of last year, the US debt pile amounted to $26.2tn, or 97 per cent of GDP. According to the CBO, debt-to-GDP levels will reach a new all-time-high in 2029, smashing the previous Second World War record of 116 per cent of GDP.
By 2054, debt levels are projected to rise to an astonishing 166 per cent of GDP. In this respect, there is a big difference with the post-war economy: debt that was run up during the Second World War was largely paid back within the generation of the people who fought the war. But, as Swagel points out, “The fiscal burdens being generated today are not ones the current generation is going to bear the burden of.”
“The danger, of course, is what the UK faced with former prime minister Truss, where policymakers tried to take an action, and then there’s a market reaction to that action,” he added. For anyone who has blocked the sorry affair from their memory and needs a quicker recap: Liz Truss quit in 2022 after just 45 days as UK prime minister after her plan to fund deep tax cuts with more debt backfired, sparking a run on the pound and spike in the country’s borrowing costs.
The US is “not there yet”, Swagel hastened to add. Nevertheless, as higher interest rates raise the cost of paying its creditors to $1tn in 2026, bond markets could “snap back”.
Much has been made of America’s impressive post-pandemic recovery, aided in large part by the Biden Administration’s huge stimulus spending. But it has come at a cost.
Of course, America’s vast debt pile can hardly be blamed on Bidenomics alone. As elsewhere, rising interest costs in the US – to tame inflation – have increased debt. And even prior to Biden’s generous package, debt shot up following sweeping tax cuts imposed by then-President Donald Trump in 2017. Trump has pledged to renew these cuts – due to expire in 2025 – if he defeats Biden in this year’s presidential election, a renewal that would add another $5tn to US federal debt between 2026 and 2035.
Back in June, the world looked on anxiously as teams representing Democrat Biden and the Republican then-House Speaker Kevin McCarthy raced against time thrash out a deal to stop the US defaulting on its debt. The debt ceiling deal, agreed just in the nick of time, lifted the cap on how much government can borrow to pay its bills completely until January 2025.
Exactly what would have happened if the US had defaulted on its debt is unclear – we would have been in uncharted territory. But we can be sure that there would have been some fairly grave global ramifications. Over $500bn in US debt gets traded every day. If investors start to see US debt as risky, they will charge the US more to borrow money – and this in turn, could make borrowing more expensive everywhere. If unsustainable levels of federal debt eventually sent the US crashing into a recession, its economy would hardly sink alone.
The deal to avert US debt default back in June was met with global relief. But, as Anthony Peters wrote in Reaction at the time, “permitting a critically overborrowed federal government to borrow more is not exactly a resolution.” Rather, the resolution to the Democrat-Republican debt ceiling standoff merely kicked the can further down the road.
Today’s warning about the trajectory of US debt is a reminder of just this.
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