US national debt exceeded 40 trillion dollars this week, a historic milestone that has sounded economic alarm bells amid celebrations of the nation's 250th anniversary. While Americans are distracted by singer Taylor Swift's wedding and the World Cup, economic warning signs are mounting.
According to Maya MacGuinness, chair of the Federal Budget Committee, it took nearly 200 years for national debt to reach one trillion dollars for the first time in 1981. MacGuinness cited a televised speech from then-president Ronald Reagan: "If we need a warning as a nation, let this be it". She pointed out that the government now spends far more just in interest payments on the debt at the nation's 250th birthday.
Debt has doubled in size in the decade since Donald Trump took office in 2016, when it was below 20 trillion dollars. According to the Congressional Joint Economic Committee, debt increases by approximately 90,000 dollars every second, or 7.8 billion dollars daily. Administrators of both the Trump and Joe Biden administrations increased public spending, while tax revenues fell due to tax cuts and responses to crises such as 2008 and the COVID-19 pandemic required greater borrowing.
Rising interest rates in response to recent inflation have worsened the situation. Eric Swanson, professor of economics at the University of California and former chief economist of the Federal Reserve Board, noted that "what is completely different now compared to a decade ago is the level of interest rates". Long-term interest rates in the United States are at their highest levels in decades, driven by concerns about inflation and investor anxiety over excessive levels of borrowing by the US government.
Mohammed El-Erian, professor at the Wharton School of Business, explained that when interest rates rise, "financing the deficit becomes more costly". Interest payments on government debt are 15 percent higher than a year ago and represent approximately 20 percent of tax revenues, surpassing defence spending. Congress projects that debt will reach around 64 trillion dollars by 2036, according to the Congressional Budget Office.
Although economists say the situation is not yet critical, they warn of potential dangers. El-Erian argued that the United States' position as the world's largest economy and the status of the dollar as the world's reserve currency gives it "much more time to continue with financial mismanagement" compared to other countries. "We are close to a point where it becomes a flickering yellow light. It is not a flickering red light," he added. Swanson warned that investor appetite for lending money to the US government through bond purchases "is shrinking", creating a vicious cycle that requires the government to continually offer higher yields to maintain investor purchases.
Charlie Bean, professor emeritus of economics at the London School of Economics, pointed out that if the US debt-to-GDP ratio reaches a certain point, it could trigger a fire sale of US bonds and disruption in financial markets. "There probably is a point somewhere, but unfortunately we do not know exactly where it is," he said, clarifying that there is no fixed number at which guaranteed catastrophe occurs.
Economists warn that families will likely face higher interest rates on mortgages, car loans and credit cards, with particularly damaging effects for low-income households. There is also an indirect effect on consumers, as companies often pass on higher borrowing costs through higher prices. MacGuinness said: "So the impact of debt works its way into people's pockets one way or another".
Although the US economy has slowed in recent months, it continues to grow at a solid pace. Economic growth is important because it increases tax revenues that can finance public spending and debt interest payments. El-Erian indicated that with sufficient growth, the debt problem is mitigated. However, if growth is insufficient, the United States might be forced to consider other options, such as reforming the tax and spending system, implementing austerity, or restructuring the debt.
So far, the strategy has been a kind of financial engineering. Last Wednesday, the Treasury Department intervened to buy back government debt, which increased demand for bonds and reduced short-term borrowing rates. However, the effect was short-lived, with long-term borrowing rates rising again a day later. With the upcoming midterm elections for Congress, the White House will seek to demonstrate its ability to deliver positive economic results. El-Erian expressed scepticism about the government's willingness to consider more serious measures, saying: "I do not see anything happening that would significantly reduce the deficit over the next two or three years. If we look at political discourse, we will see that it is about cutting taxes".