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Global finance leaders urge US to tackle soaring national debt before crisis hits

Natale Labia
By Natale Labia
22 Oct 2024
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In terms of post-pandemic growth, as well as labour productivity growth, the US has left Europe and even China in the dust. Yet, that is only part of the story. The US is not only the leading global economy, it is also dominating global borrowing and spending.

Global finance chiefs have yet to even arrive in Washington DC for the annual meetings of the International Monetary Fund and World Bank this week, but already the message is clear. It is time to tighten the belts. While this is a general message for all attendees, arguably the country that should heed the advice most is the least likely to: the host nation of the US.

Governments all over the world have been borrowing and spending too much money since the financial crisis, and not enough of it has resulted in productivity and growth. The net effect is clear; inexorably rising debt to GDP figures.

The International Monetary Fund’s Fiscal Monitor on Wednesday will feature a warning that public debt levels are set to reach $100-trillion this year. Borrowing surged during the early stages of the Coronavirus outbreak as economies were locked down. Many governments, including that of the world’s largest economy, have yet to bring spending under control.

International Monetary Fund chief Kristalina Georgieva, in a speech on Thursday, 17 October 2024, stressed how that mountain of borrowing is weighing on the world. 

“Our forecasts point to an unforgiving combination of low growth and high debt — a difficult future,” she said. “Governments must work to reduce debt and rebuild buffers for the next shock — which will surely come, and maybe sooner than we expect.”

The US leads the way in fiscal recklessness


Many argue that the US is an economy that other countries should emulate – indeed The Economist this week devoted much of an entire magazine to just this topic, declaring it the “envy of the world”.

It is true that, at least in terms of post-pandemic growth, as well as labour productivity growth, the US has left Europe and even China in the dust. Yet, that is only part of the story. The US is not only the leading global economy, but it is also dominating global borrowing and spending.

The non-partisan Congressional Budget Office reports that federal debt is currently far above its historic average. The office projects that next year, 2025, the national debt will be greater than 100% for the first time since World War 2. In 1946, the ratio of debt to annual GDP was 106.1%. The office projects that the debt will top that amount in 2027 and will rise to 122.4% by 2034. It is expected to be on a steady climb thereafter.

The root cause of this issue is clear: the US has a spending problem. While both tax revenue and government expenditure are expected to rise over the next decade, spending is projected to grow much faster. Specifically, rising costs in three key areas – social security, Medicare, and interest payments on the national debt – are driving this. Notably, the Congressional Budget Office projects that the US will spend more on interest payments than on defence by 2024. According to historian Niall Ferguson, this is an early sign of an empire in decline.

How debt hurts an economy


High levels of debt harm the economy in two ways. First, there is a slow burn, long-term impact. As economist Michael Strain of the American Enterprise Institute notes, “each percentage point increase in the debt-to-GDP ratio raises long-term real interest rates by one to six basis points”. Already this is playing out in rising long-term yields. The US 10-year yield is now around 4.2%, with traders arguing that this is due to rising supply and tepid demand.

The Congressional Budget Office estimates that for every dollar increase in the budget deficit, private investment declines by 33 cents. Lower private sector investment shrinks the nation’s capital stock, which in turn lowers worker productivity, depresses wages, and reduces workforce participation. Over time, these effects compound.

What makes it worse is that the US is borrowing primarily to finance current consumption rather than making productive investments. Large budget deficits are thus undermining long-term economic growth and future living standards, as they prioritise today’s spending — particularly on middle-class retirees — over the needs of tomorrow.

The second effect is an eventual fiscal crisis. As Nicolai Tangen, the head of Norway’s wealth fund, the largest sovereign wealth fund in the world, has said: “accumulating too much debt is like smoking; you know it is bad for you, but it is impossible to know exactly when it will make you sick”.

Such happened almost exactly two years ago in the UK when a careless budget by the ill-fated Liz Truss administration crashed the value of UK government debt and sent its currency spiralling, trashing the economy. A similar event in the US would be catastrophic for the global economy.

Of course, the counter-argument is that the US has the privilege of borrowing in the world’s reserve currency, and US treasuries remain the world’s ultimate benchmark “risk-free” security. But one does not have to be a “dollar denialist” to see that already many countries — and not just China and Russia, but even allies such as Europe and Japan — have publicly stated the need to diversify foreign exchange holdings and the dangers of dependence on the greenback.

As with any addiction, the first step to solve the budget problem is to acknowledge it. Other similar economies, such as Europe and the UK, are all going through painful post-Covid-19 budgetary rationalisation.

‘Debt’ not mentioned once in presidential debate


But at US Vice-President Kamala Harris and former president Donald Trump’s presidential debate last month the word “debt” was not mentioned once. According to the Penn Wharton Budget Model at the University of Pennsylvania, Trump’s set of tax breaks would add $5.8-trillion to US debt over a decade, versus Harris’s package of Bidenomics, which would add $1.2-trillion. Neither are willing to even entertain budget cuts.

Something will have to give. Either it will be a shift in Congress towards more measured and prudent economic policy, or the US can look forward to higher yields, slower growth, and the possibility of a (hopefully distant) fiscal crisis. One does not have to be “left wing” or “anti-American” to argue this; these are basic economic realities advocated by the International Monetary Fund.

Regardless of who wins next month’s US election and who is then appointed as treasury secretary, they will not, after this week’s meetings, be able to pretend that they were not warned. DM

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