The Congressional Budget Bureau warned in its latest predictions that their federal government is on course from 97% of GDP last year to 116% of GDP by 2034 – higher even than in World War II. The real prospects are probably worse. From tax revenue to defence spending and interest rates, the Congressional Budget Bureau forecasts published earlier this year are based on rosy assumptions. Taking into account the current market view of interest rates, the debt-to-GDP ratio increases to 123% in 2034. Then assume – as most in Washington do – that former President Donald Trump’s tax cuts remain mainly in force, and the burden becomes even higher. With uncertainty about so many variables, Bloomberg Economics carried out a million simulations to assess the fragility of debt prospects. At 88% of the simulations, the results show that the ratio of debt to GDP is on an unsustainable path – defined as an increase over the next decade. The Biden government says its budget, including a number of tax increases on business and wealthy Americans, will ensure fiscal sustainability and manageable debt service costs. “I think we should reduce deficits and remain on a fiscal sustainable path,” Finance Minister Janet Yelen told Members in February. Biden government proposals offer “a significant reduction in the deficit that will continue to keep the level of interest spending at comfortable levels. But we should work together to try to achieve these savings,” he said. The problem is that the implementation of such a plan will require action from a Congress that is bitterly divided into party lines. Republicans, who control the House of Representatives, want deep spending cuts to reduce the growing deficit, without specifying exactly what they will cut. Democrats, who oversee the Senate, argue that spending contributes less to any deterioration in debt sustainability, with key factors being interest rates and tax revenue. Neither party is in favour of compressing the benefits provided by the major rights programmes. In the end, it may take a crisis – perhaps a mischievous fall in the government bond market caused by the degradation of US credit capacity, or a panic over the exhaustion of Medicare or Social Security trust funds – to be forced to take action. This is a game with fire. Last summer he gave a preview of how a crisis could begin. During two days in August, the downgrading of US credit capacity by Fitch Ratings and the increase in long-term sovereign debt issuance focused investors’ attention on the risks. The yields of the 10-year reference bonds climbed by one percentage point, reaching 5% in October – the highest level for more than a decade and a half. As to how things may end, Britain’s autumn 2022 experience provides a glimpse of the abyss. Then Prime Minister Liz Trass’ plan for unfunded tax cuts sent the purchase of gold bonds to tartars. The returns increased so quickly that the central bank was forced to intervene to eliminate the risk of a direct financial crisis. The action of the bond “vengeful” forced the government to cancel the plan and Truss to give up its office. For the US, the central role of the dollar in international funding and its status as a dominant reserve currency reduces the chances of a similar collapse. It will take a lot to shake investors’ confidence in American public debt as the ultimate secure asset. If, however, the erosion of the dollar position evaporates, it would be a turning point, with the US losing not only access to cheap funding but also global power and prestige.
Bloomberg: The real prospects of American debt are even worse than predicted
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