Why US ‘white swan’ debt can't be wished away by cuts

Government bonds are popular for their attractive yields and degree of safety, in part owing to the debt ceiling, which can only be raised through a vote by the US Congress. Not doing so would mean that the US government could not raise the funds it needs in the markets to maintain operations, which would trigger budget cuts in healthcare, social security, the judiciary, defence, and education.

Read more: Why the Pentagon is turning to AI startups

If the mood turns

The commonly cited federal debt figure includes about $7tn that the federal government 'owes to itself' through trust funds, subsidies, and other obligations. Economists, therefore, focus on 'debt held by the public' to assess its economic impact, making sure it does not exceed a certain percentage of GDP. 

Federal debt has driven US economic growth since 2007, contributing to GDP-per-capita growth of 19.2% (compared to 7.6% in the Eurozone). But the debt-to-GDP ratio is now at its highest level since the Second World War and its continued expansion could undermine America's global leadership by forcing cuts in its military, diplomatic, and humanitarian activities around the world.

The accumulated federal debt also risks becoming a burden on the economy, for example, if growth falls below the real interest rate or if investors lose confidence in federal debt as the rising interest burden reaches nearly half the deficit. Moody's rating agency expects this to happen in 2026, which would limit Washington's ability to correct its fiscal path. 

At that point, investors may become unwilling to finance US debt without higher interest rates, leading to higher borrowing costs that would require spending cuts or sudden and painful tax increases, similar to those proposed in the 2010 Simpson-Bowles plan to place debt on a downward trajectory. 

Trump's plan 

US President Donald Trump's plan focuses on reducing public spending (in contrast to the Democrats, who typically call for higher taxes on the wealthy). As part of this, he has created a Department of Government Efficiency (DOGE) and appointed American billionaire entrepreneur Elon Musk to head it. Musk has said that the US is headed for "bankruptcy," adding: "It's not optional to reduce federal expenses. It's essential."

In parallel, Trump has issued executive orders to freeze funding for numerous domestic and foreign aid programmes and laid off thousands of federal employees as part of a broader effort to reduce the size of government. This included scrapping several federal departments and auditing the Treasury's debt payments to search for possible fraud.

The focus on spending cuts has drawn criticism over its impact on agriculture, the environment, transportation, healthcare, and social security. Critics say not enough is being done to boost revenue, such as through corporate tax rises. If Trump extends the tax cuts he implemented in his first term (2017-21), this could add trillions more dollars to the debt. 

American economist and Nobel Laureate in Economics Joseph Stiglitz said, "Trump might be able to postpone the day of reckoning further, but only briefly. With an average monthly fiscal deficit of $150bn in 2024, it won't be long before the current debt ceiling is breached, or default is declared."

The federal debt ceiling has been raised 104 times since it was first set in 1939, including three times during Trump's first term. "Congress must get rid of, or extend out to, perhaps, 2029, the ridiculous Debt Ceiling," Trump posted on social media, later adding: "No one knows for sure what will happen if it were to someday be breached, whether it will be a catastrophe or meaningless." 

Late last year, the House of Representatives passed a bill to avoid a federal government shutdown by funding the government until mid-March 2025. Reaching the debt ceiling marks the beginning of the countdown to default, as the Treasury can no longer sell more bonds and other securities to cover its past deficits or raise cash to pay for its other expenses.

Pondering a default

William Silber, professor of economics at New York University, notes that Trump has boasted of resorting to Chapter 11 Bankruptcy several times to restructure mounting debt at four of his companies. 

There is now a belief that he could default on interest payments, or even the principal debt, to deal with its growing size, just as he did with his businesses, in the belief that this would let him negotiate a better deal with the country's major creditors. Defaulting would destroy the image of US debt as a safe investment, but that would not stop Trump, who says in his book, The Art of the Deal, that profit requires risk. 

The catastrophic consequences of a default would include a fall in the dollar's exchange rate, a rise in interest rates, and a slowdown in growth, with the impact rippling through international financial markets. This would lead to record gold prices, which are already historically high. This would drive the value of the US gold reserves (the largest in the world) to unprecedented levels, effectively reducing realised losses and, at the same time, revealing Trump's true agenda.

Economist Desmond Lachman says, "The key economic lesson Trump should have taken from his first term is that trade deficits aren't determined by tariffs but by a country's spending relative to its production." Or, as British 20th-century economist John Maynard Keynes put it, the trade deficits are driven by the gap between savings and investment. As long as a country saves less than it invests, it will run a trade deficit, regardless of how high its tariff wall is.

In summary, Trump is once again on the verge of another fiscal deficit failure. According to Oxford University's Professor Ngaire Woods, this cannot just be addressed by cutting public spending, nor by withdrawing from the IMF and World Bank (or limiting funding to them). It also requires taxing the rich. But in 2017, Trump cut the tax they pay and plans to do so again.