The continuing rise in government debt threatens inflation, high interest rates and an economic crisis.
Jamie Dimon, the CEO of JPMorgan Chase, was more tantalizing than illuminating when he recently said, regarding the nation’s fiscal trajectory, “You are going to see a crack in the bond market.” Details, even if hypotheticals, would be helpful concerning the market where U.S. debt is sold.
Twenty-five percent of Treasury bonds, about $9 trillion worth, are held by foreigners, who surely have noticed a provision in the One Big Beautiful Bill (1,018 pages). Unless and until it is repealed, the provision empowers presidents to impose a 20% tax on interest payments to foreigners. The potential applicability of this to particular countries and kinds of income is unclear. It could be merely America First flag-waving.
But foreign bond purchasers, watching the U.S. government scrounge for money as it cuts taxes and swells the national debt in trillion-dollar tranches, surely think: What the provision makes possible is possible. Such a significant devaluation of foreign-purchased Treasury bonds would powerfully prod foreign investors to diversify away from Treasurys, which would raise the cost of U.S. borrowing an unpredictable amount.
Concerning which, Kenneth Rogoff is alarmingly plausible. Before he became an intergalactically famous Harvard economics professor, and a peripatetic participant in global financial affairs, he was a professional chess player. Hence his penchant for thinking many moves ahead.
“I have observed that, although the financial system evolves glacially,” he writes in his new book “Our Dollar, Your Problem,” “the occasional dramatic turn is to be expected.” What is expected is considered probable. The nation’s exploding indebtedness could presage a “dramatic turn.”
“The amount of marketable U.S. government debt,” Rogoff says, roughly equals “that of all other advanced countries combined; a similar comparison would hold for corporate debt.” Furthermore, when in 2023 Silicon Valley Bank and some other small and medium-size banks became actuarially bankrupt because of rising interest rates, the Federal Reserve created a facility that implicitly backstopped potential capital losses of all banks, estimated to be more than $2 trillion.
The facility has gone away, but the mentality that created it remains. Therefore, so does another potential large increase in government debt. “The U.S. government has continually increased the size and scope of its implicit bailout guarantees,” Rogoff writes, “creating what might be termed ‘the financial welfare state.’”
Those of the “lower forever” school of thought regarding interest rates are serene about the challenge of servicing the national debt. Rogoff, however, notes that when Ben Bernanke left as Federal Reserve chair in 2014, Bernanke, then 60, “reportedly began telling private audiences that he did not expect to see 4% short-term interest rates again in his lifetime.” Eight years later, such rates reached 5.5%, and long-term rates have risen significantly.
Rogoff thinks today’s higher rates are likely the new normal, resembling the old normal, for many reasons, including “the massive rise in global debt (public and private).” And “if the worldwide rise in populism leads to greater income redistribution, that too will increase aggregate demand, since low-income individuals spend a higher share of their earnings.” This would be an inflation risk.
Rogoff warns that many believers in “lower forever” interest rates express the human propensity to believe in a “supercheap” way to expand “the footprint of government.” The nation is, however, “running deficits at such a prolific rate that it is likely headed for trouble.”
He rejects “lazy language” about U.S. government debt obligations being “safe.” Debt is a temptation for inflation, which is slow-motion repudiation of debt compiled in dollars that are losing their value. (Ninety percent of U.S. debt is not indexed for inflation.) When President Franklin Roosevelt abrogated the gold standard backing the currency, the Supreme Court ruled it a default. Also, holders of U.S. bonds were not safe from significant losses during this decade’s post-pandemic inflation, or from huge losses during the 1970s inflation.
Investors watching U.S. fiscal fecklessness might increasingly demand debt indexed to inflation. “How sure are we,” Rogoff wonders, “that no future president would seek a way to effectively abrogate the inflation link out of frustration” that it impeded “partial default through inflation.” A president could call this putting America first.
Projecting the exact arrival of an economic crisis is, Rogoff writes, “extremely difficult,” an uncertainty shared with medicine. Physicians can identify factors that increase risks of heart attack in patients who nevertheless escape them. And low-risk patients can suffer attacks after being deemed fit as fiddles. Still, today reasonable fiscal physicians discern not just a risk but a high probability of a debt and/or inflation crisis.
George F. Will is a columnist for the Washington Post.
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