A slightly nervous look at America’s financial future
The Story So Far: Everything is Fine(ish)
In recent days, I have been asked to write about public debt in the USA. So here we go…
If we start by looking at the development of the public finance deficit, we can see from the first graph that there has been an almost consistent deficit in US public finances – with the exception of a period in the late 1990s during Bill Clinton’s presidency.
The Numbers That Keep Me Awake at Night
It is also noteworthy that the deficit has simply grown larger year after year – even in a period like now, when the economy is growing quite strongly, unemployment is close to its lowest levels ever, and American stock markets are close to all-time highs.
The ongoing and increasing deficits are clearly reflected in the public (gross) debt, which has risen from about 40% of GDP 50 years ago to now a full 120% of GDP. For comparison, public debt in Denmark is around 30% of GDP.
The Good Old Days: When Interest Rates Were Your Friend
Despite the rising public debt, US government bond yields have generally been falling since the early 1980s. At that time, the 10-year government bond yield was 14% (nominal), but it steadily declined until 2020, when we reached as low as half a percent.
When interest rates are as low as they were leading up to 2020, it becomes very easy to take on debt. This is evident in the figures for US government interest expenses.
Interest expenses as a share of GDP reached around 5% of GDP in the early 1980s. However, the temporary stabilisation of government debt under Clinton and the falling interest rate levels meant that interest expenses as a share of GDP fell very sharply during the 2000s and up to 2020. This was despite the rising public debt.
In other words – American politicians were not punished for their irresponsibility.
The Global Financial Dance: It Takes Two to Tango
One might ask oneself why this didn’t happen? And the simple answer is globalisation.
In 1989, the Berlin Wall fell, and in 2001, China joined the World Trade Organisation (WTO). These events were a massive boost to global trade, and it also meant that there were more and larger buyers of US government bonds.
Over the past 30 years, China has thus built up an enormous foreign exchange reserve – and that reserve is filled with US dollars. And US government bonds. And the same story applies to other Emerging Markets.
When the Music Stops: China’s Exit from the Dance Floor
But that story has now turned. China is in crisis – and the country is no longer accumulating a growing foreign exchange reserve. On the contrary. And the same applies elsewhere in the world. Public finance problems are, for example, growing in Europe.
Thus, the demand for US government bonds is suddenly no longer structurally growing, but rather declining.
And this problem becomes significantly larger if Trump insists that US trade deficits with the rest of the world must be reduced. Because the trade deficit is the other side of the coin.
If someone is to buy US government debt, they must, so to speak, have a surplus to buy from. If there is no surplus, then there is also no demand for US government bonds.
Trump’s Greatest Hits: The External Revenue Service Edition
And even worse – within the last few days, Trump has announced that he will replace the Internal Revenue Service (IRS) with an External Revenue Service. In other words – he is more or less saying that he will replace all taxes and duties in the USA with taxation of foreign products – and perhaps duties on international capital movements.
This is an absolutely insane idea – if you have to raise tariffs as much as would be needed to, for example, abolish the federal American income tax, it would in practice mean that there would be no imports at all – and then we’re back to square one, because then there would be no revenue. And yes, then the public debt would truly explode.
It should also be noted that Trump has shown no interest whatsoever in doing anything about US government debt.
The Department of Magical Thinking
And yes, he talks about a Department of Government Efficiency (DOGE) that under Elon Musk’s leadership will find huge savings, but when you look at it, it’s extremely vague, and Trump has simultaneously said that he will under no circumstances touch the major fixed expenses such as Social Security and defence spending.
And now government bond yields have started to rise quite dangerously, and if we project the US government’s interest expenses as a share of GDP, we will soon hit 5% of GDP.
This also means that interest expenses will become an increasingly dominant part of US public spending.
The Demographic Plot Twist
Finally, it doesn’t exactly help the equation that Trump wants to throw hundreds of thousands of immigrants out of the USA.
This could potentially disrupt the otherwise positive demographic outlook for the USA and thus contribute to making the debt problem even larger.
The Trust Fall: When Bond Markets Get Nervous
So far, panic hasn’t really set in in the bond market, but I must admit that although I have previously been relatively calm about US fiscal policy, I must say that Trump is now really playing with fire, and it’s worth remembering that bond market pricing is largely built on trust.
And if that trust disappears, things can get very intense very quickly. And then US government bond yields will shoot up dramatically.
The Last Resort: When All Else Fails, Call the Fed
If that happens, the USA will rapidly move towards a situation where it won’t be able to repay its debt. And then there’s only one option left – call the Federal Reserve. In that situation, the Fed will be forced to buy government bonds to keep interest rates down. If that happens, the dollar collapses. And yes, inflation will explode.
The Not-So-Comforting Conclusion
I should emphasise that we’re not there yet, but I must say that when I hear Trump speak, he increasingly sounds like Turkey’s President Erdogan (or actually worse). And so far, the market has probably interpreted it as though once Trump becomes president, he will stop all this noise. But will he?
I’m no longer so sure.
Note: Yeah, that’s me in an AI created illustration done with fal.ai/FLUX.
If you want to know more about my work on AI and data, then have a look at the website of PAICE — the AI and data consultancy I have co-founded.