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Our fiscal situation is a 350 pound,
two-pack-a-day smoker on the ICU table.
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The U.S. federal budget is on an
unsustainable path.
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We're going to be broke really quickly unless
we get serious about dealing with our
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spending issues. There's no shortage of
voices sounding the alarm about the national
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debt. America's borrowing levels are
currently the same size as the entire economy
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and are expected to skyrocket from here.
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That's because the U.S.
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spends way more than it brings in and then
borrows to cover that deficit.
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There's plenty of debate on how to close that
gap,
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raise taxes, cut spending,
a combination of both.
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No doubt, any solution demands hard choices.
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But what are the actual consequences if the
deficit gets out of control?
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I often liken this to the invisible dog
fence,
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where you really don't want to hit it,
but you won't know until you do.
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And it seems like the U.S.
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is almost intent on finding out where that
tipping point is.
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Here we'll explore not how to fix the
deficit,
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but to figure out what could happen if we
don't.
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We'll focus on three key areas:
the potential market fallout,
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economic ripple effects,
and international implications.
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Even though debt has been central to America
since 1776,
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we haven't yet seen a tipping point.
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For much of the nation's history,
the U.S.
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tried to balance the budget.
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That changed toward the end of the 20th
century.
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1991, 1990 were periods when there was a lot
of uncertainty about our economy.
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I remember I was at that time co-senior
partner at Goldman Sachs, and a lot of our
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clients were very uncertain about what was
going to happen, and deficits played a big
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role in that. This is Robert Rubin.
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He advised Bill Clinton on his presidential
campaign,
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the transition, and later joined the
administration.
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He ultimately served as the 70th Treasury
Secretary.
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I'll never forget, we had a meeting of the
economic team,
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and at some point he looked at us and he
said, "This is a threshold issue.
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It's going to be difficult politically,
but this is what we have to do." And that is
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indeed what we did. Tonight at midnight,
America puts an end to three decades of
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deficits and launches a new era of balanced
budgets and surpluses.
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It was the first time since 1969,
but the surplus was short-lived.
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Since then, the U.S. has had several rounds
of tax cuts,
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multiple expensive wars,
a financial crisis and a pandemic,
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all contributing to an historic fiscal hole.
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It's very, very roughly about one-third from
tax cuts,
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one-third from spending increases and
one-third from emergencies.
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Those emergencies were the right time to
borrow. The other two,
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not so much. Kent Smetters' team at Wharton
creates models that show how policy changes
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impact the federal budget.
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What does the model tell you in real time
about the current state of our deficit?
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Fiscal policy is not sustainable.
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The economy essentially blows up.
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There is so much debt under current law that
fixed income markets,
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bond markets will collapse.
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Smetters' model shows that collapse could
happen within 20 years.
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If Congress really doesn't get its act
together and try to figure out some grand
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bargain that solves this problem,
then there's only one mathematical way of
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getting out of this, and that is for some
type of default to happen.
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A default is when a borrower can't make
payments on a debt.
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But that's unlikely to happen to America
because we have ways to get around it.
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The United States can pay any debt it has
because we can always print money to do that.
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If you print bonds in your own currency,
what happens to the currency can be a
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question, because you don't default.
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We just cranked up the printing press. That
now means there are more dollars in the
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economy that are chasing the same amount of
goods and services.
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That's where inflation comes from.
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And that's what we've seen throughout history
of other countries that have struggled with
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high debt. What do you
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think the likelihood is that the U.S.
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does experience a crisis related to its
deficit or debt levels?
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I think that there is more than a 50% chance
that in three years,
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give or take a year or two,
that we will experience a trauma if we don't
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deal with this well. Ray Dalio has been a
global macro investor for 50 years,
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known for starting Bridgewater Associates.
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He's been concerned about government debt
levels since the 2008 financial crisis.
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I think of myself being very much like a
doctor.
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I watch the plaque build up in the system.
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I always said it was unhealthy,
but I've not said before that the
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supply-demand picture is a very serious
picture as it is now.
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That's because Dalio has studied how
countries go broke,
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and says his research across centuries found
that there are cycles that have led to big
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debt bubbles and busts,
and he's deeply concerned about what he sees.
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The supply that's going to be produced by
deficits is greater than the demand for that
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debt, like watching somebody having a
circulatory system condition,
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you can measure those things and it's getting
very severe.
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To raise money and help pay for the growing
deficit,
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the U.S. government issues and sells
treasuries.
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When investors start getting jittery about
too much debt flooding the markets and the
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risk of inflation, they'll insist they get
paid even higher rates to buy treasuries.
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Ed Yardeni first started noticing this
behavior in the 80s,
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a response to the raging inflation from the
prior decade.
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There was a lot of fear among investors that
they could get burned again.
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And as a result of that,
I coined the phrase "bond vigilantes" with
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the notion that if the Fed and the government
weren't going to be responsible,
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weren't going to be the sheriffs in town to
manage the economy in a way that would keep
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inflation down, that the bond vigilantes
would do it.
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Yardeni wrote in his newsletter in 1983 that
the vigilantes were concerned about a $200
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billion deficit. Today,
the levels are ten times that.
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The bond vigilantes are more powerful than
ever,
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and the question is, are they going to use
that power,
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that extraordinary impact that they could
have on the bond market,
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which is now more important than ever,
and push bond yields up to levels that cause
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a recession in order to bring inflation down?
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One country that experienced a mini-debt
crisis in the fall of 2022 was the United
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Kingdom. Liz Truss, who was then the prime
minister,
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unveiled a plan to cut taxes by 45 billion
pounds.
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I have a bold plan to grow the economy
through tax cuts and reform.
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Immediately the pound collapsed,
investors dumped UK bonds,
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the local pension funds were forced to sell
to manage their risk,
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all of which threatened a downward spiral.
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The Bank of England had to come in and
stabilize the market,
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and the government quickly undid the tax
cuts.
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But Prime Minister Truss never regained
credibility and she resigned after just six
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weeks in the role. But can that type of
crisis where the market quickly loses
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confidence happen in the U.S.?
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It's a risk that we think remains low in
terms of the probability of this occurring
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here in the United States.
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PIMCO is the world's largest bond manager,
overseeing $2 trillion.
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Back in December, PIMCO said it was cutting
exposure to long dated U.S.
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debt because of deteriorating deficit
dynamics.
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Can you explain more about your positioning
there and just your overall concern as it
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pertains to the deficit? The U.S.
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continues to be the global reserve currency.
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We have an incredibly dynamic economy. We
have very strong institutions.
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So we will likely continue to attract a
significant share of global capital.
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We do see other countries sovereign debt that
looks at least as good as the rate levels in
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the United States, and is running much more
prudent overall fiscal policy.
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So, we're not running from U.S.
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treasuries, we're just looking to diversify
into other areas of the world.
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Economists try to estimate how much investors
will want to be compensated for longer-term
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risks, like the federal budget and inflation.
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That's something called the "term premium."
If that is rising,
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it may mean investors are experiencing more
uncertainty about macro conditions,
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whereas if it's declining,
there's likely more stability.
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It's not a perfect statistic,
and models tend to vary,
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but in January, the term premium hit its
highest level in more than a decade.
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It's pulled back a bit since then,
but remains elevated.
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If we don't see signs of attempting to get
debt under control,
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those probabilities of a more crisis
level-type situation occurring will steadily
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go higher with time. And then again,
when people worry about these tail scenarios,
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including PIMCO, we want to get paid a little
bit more to combat against those types of
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risks. The more expensive borrowing costs
become,
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that has broad ramifications for the economy.
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Because it could affect our economy,
the health of our economy,
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and the growth of our economy. Thanks to a
combination of soaring debt and higher rates,
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the U.S. is expected to spend the most it
ever has nearly $1 trillion on interest
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payments this year. The Congressional Budget
Office expects net interest costs in 2025 to
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surpass spending on Medicare,
Medicaid and national defense.
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Squeezing out other parts of the budget,
whether it's tax cuts you want,
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whether it's higher defense,
whether it's higher social spending, all of
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those things get squeezed out when your
interest piece of the pie is growing as it is
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now. The cost to service the U.S.
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debt is expected to be 18% of total tax
revenue this year.
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In 2022, that figure was less than 10%.
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You've borrowed so much that your interest
payments are growing as a share of the
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federal budget, and your debt is growing as a
share of the economy,
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and it leaves you in a situation where it's
slowing economic growth.
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The tax and spending legislation that just
past has garnered mixed reactions about what
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it may mean for the deficit.
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The nonpartisan CBO has estimated it would
increase the deficit by trillions over the
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next decade. I tell policymakers in D.C.,
You might have your "Big Beautiful plan," but
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fixed income markets they're the Mike Tyson.
You might have your Big Beautiful plan until
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you get punched in the face. Because they
often are not polite,
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they often just break instead of bend.
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But some Republicans believe the One Big
Beautiful Bill Act will spur economic growth
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thanks to tax cuts. I don't believe in the
CBO forecast.
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Let's just look at common sense and logic
that if the bill for some reason hadn't
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passed, we would've had the biggest tax hike
in history.
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Treasury Secretary Scott Bessent,
who was unavailable to be interviewed for the
00:11:31
piece, says the administration's focus is to
grow the economy faster than the debt.
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His long-term goal is to cut in half the
current 6.7% deficit to GDP ratio,
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which is the highest outside of a war or
recession.
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That question has left bond vigilantes on the
sidelines for now.
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I think the bond vigilantes are essentially
correct.
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The U.S. should not be running a deficit like
this,
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but for whatever reason,
we're not at the levels yet where debt
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sustainability is a question. But that could
change quickly.
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And if debt levels go unchecked,
the U.S.
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risks leaving a weaker economy to the next
generation.
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It used to be that people would say,
"It's okay. It's okay to borrow from the
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future generations, because they're going to
have a higher standard of living anyhow." But
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right now, it's a very risky moment where
it's quite clear for younger generations:
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they don't know exactly what they're
inheriting. Very excited to talk to
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everybody. Kyla Scanlon is an author and
content creator focused on economic issues.
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On this day, she was speaking at George Mason
University to a crowd of faculty and
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researchers. What structural issues do you
see as the most significant threats to
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economic stability or growth in the next
decade?
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What's your view of debts and deficit in that
assessment? I think the debt and the deficit
00:12:53
have to be analyzed. The interest payments
are quite a weight and rates probably aren't
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going down anytime soon.
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Scanlon says young people risk not ever
having access to Social Security,
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Medicaid and Medicare.
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Not only are they not going to have access to
those services,
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but they're also going to have to pay for
those who did before them.
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And so it's kind of this double-edged issue.
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A growing debt load also limits the
government's ability to fight off an
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emergency, should there be one.
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2008 financial crisis,
Covid, we actually used debt to get our way
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out. People got used to those checks in the
mail and other types of benefits and so
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forth. What happens now when debt itself is
the problem?
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You can't use debt to get out of the debt
problem.
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It's too late at that point.
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One thing that the past years and the growing
geopolitical environment have shown us is
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that we should assume there will be future
emergencies.
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We are not in an emergency-free moment.
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When Admiral Michael Mullen was asked back in
2010 what he thought was the biggest threat
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to national security,
his answer shocked the nation.
00:14:03
I responded that the most significant threat
was our national debt,
00:14:06
which was a bit of a surprise. The reporter
and others actually would have expected some
00:14:11
kind of weapon system or some kind of country
or something like that.
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Mullen served as the chairman of the Joint
Chiefs of Staff under Presidents George W.
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Bush and Barack Obama.
00:14:20
Typically, each year,
the Defense Department budget takes up about
00:14:25
half of that uncommitted money.
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As interest rates possibly would go up as our
debt continued to increase and we pay off our
00:14:34
debt with some of that uncommitted money as
well,
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it would just squeeze the defense budget at a
time of increasing international and
00:14:42
geopolitical concerns,
where it was my view of the defense budget
00:14:46
really needed to at least be maintained or
rise over time.
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This year, the U.S. is expected to spend
about $93 billion more on interest payments
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than on defense. The great part is spending
more on interest payments than on defense.
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It won't be great for very much longer.
00:15:04
The U.S. crossed that threshold last year.
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Ferguson says the debt burden draws in scarce
resources with less for national security,
00:15:12
which leaves an otherwise great power
vulnerable to a military challenge.
00:15:16
Less interest rates come crashing down,
which they haven't yet done,
00:15:20
that means that interest payments are going
up.
00:15:23
So, that is a really major problem for a
superpower that it is in a game of chicken
00:15:29
with another superpower.
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Do our adversaries pay attention to our debt
levels and our deficits,
00:15:37
and see that as a potential vulnerability and
a potential weakness in light of all this
00:15:42
instability? I would think that Putin in
Russia,
00:15:45
Xi Jinping in China see this as a
vulnerability.
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And you've heard President Xi in China over
the last certainly decade plus talk about the
00:15:55
United States being in decline.
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The irony is China is one of the largest
foreign holders of U.S.
00:16:02
treasuries, although it's been steadily
reducing its stash.
00:16:05
International holdings of U.S.
00:16:07
treasuries were near a record $9 trillion in
April.
00:16:11
Experts have warned that foreign creditors
theoretically could use their bonds as
00:16:15
financial leverage in a geopolitical
disagreement.
00:16:19
We don't know exactly how many treasuries
they have. Certainly it's probably about $800
00:16:24
billion, but there's more that's not even
transparent. It's not clear that this would
00:16:27
happen, but you could dump treasuries if one
wanted to create a lot of different fiscal
00:16:33
risks at one time. ...Though,
dumping treasuries is unlikely as the country
00:16:37
would have to accept steep losses.
00:16:41
Japan, one of the largest exporters to the
U.S.,
00:16:44
holds more than $1 trillion worth of U.S.
00:16:46
debt: the most of any foreign country.
00:16:49
It really, really took off in the late 70s
and the 80s,
00:16:53
as Japan was an exporting nation accumulating
dollars over time through the trade balance
00:16:59
side of things, and they had to reinvest that
money.
00:17:02
Here's an example of how that works.
00:17:04
When a Japanese automaker sells a car to a
U.S.
00:17:07
consumer, the company receives,
let's say, $30,000.
00:17:11
The automaker needs to then convert that cash
to Japanese yen to pay its expenses like
00:17:17
workers and suppliers.
00:17:18
The money goes to a Japanese bank to help
with the exchange.
00:17:21
The bank then invests the dollars it receives
into U.S.
00:17:24
treasuries because they're safe and easily
traded.
00:17:29
As the Trump administration reworks global
trade relationships,
00:17:32
there's a looming question around how it all
could shift foreign appetite for treasuries.
00:17:37
The White House says higher tariffs will
generate additional revenue to shrink the
00:17:41
budget deficit. It's our turn to prosper and,
00:17:44
in so doing, use trillions and trillions of
dollars to reduce our taxes and pay down our
00:17:50
national debt. And it will all happen very
quickly.
00:17:55
The Tax Foundation estimates that a 10%
universal tariff could bring in trillions of
00:18:00
dollars, but that revenue would diminish when
accounting for the broader economic impact.
00:18:06
Eventually, the solution to the deficit is
likely to come down to the hard work of
00:18:10
budgeting. Dangerously polarized moment that
we're in,
00:18:14
where partisan politics seems to be far more
important to lawmakers than actually
00:18:18
governing, has led both parties to adopt all
of the easy things.
00:18:22
They both love cutting taxes and growing
spending.
00:18:25
I think it's going to be very difficult to
turn this fiscal situation around without
00:18:29
also looking at the underlying political
challenges.
00:18:33
Do you still see this as the biggest threat
to national security?
00:18:37
Great question. And my answer is no.
00:18:39
I actually think the political division in
the country has risen to our biggest threat.
00:18:46
The debt is one, education is another,
the healthcare issue,
00:18:50
the Social Security issue.
00:18:52
That is going to take bipartisan support.
00:18:56
It's going to take leaders from both sides of
the political aisle to agree.
00:19:00
And I think to compromise in order to
generate solutions which can move us ahead.
00:19:04
And with the political divide seemingly
increasing,
00:19:08
that becomes harder and harder.
