As economists scour the globe for nations repeating Japan’s mistakes, the U.S. has become a standout in at least one way: Washington’s view on debt.
There are, of course, many takes on how to tackle a national debt now topping $33 trillion. Never mind the divide between Democrats and Republicans; the intra-party fictionalization surrounding debt dynamics is plenty dizzying all its own.
Add in a pro-Donald Trump contingent among Republicans in the House of Representatives itching to shut down the government. Might such chaos be the last proverbial straw that prompts Moody’s Investors Service to yank away America’s one remaining AAA credit rating?
These imponderables are adding momentum to the increase in U.S. Treasury yields to 18-year highs. The disorientation is even resurrecting bitcoin and other crypto products, which are back in rally mode. That’s an ominous sign all its own.
The real driver, though, is exponential growth in Washington’s balance sheet as politicians fiddle and engage in petty squabbles. If Washington does have a collective strategy for reducing the national debt, it’s hastening economic growth. Japan stands at the ready to remind both Congress and President Joe Biden’s White House that the plan is doomed.
Japan, after all, has been playing this game for the better part of the last 30 years. And losing badly as Tokyo’s debt-to-gross-domestic-product approaches 260% despite “fiscal consolidation” pledges by a dozen-plus governments since the mid-1990s.
Of course, some might argue Tokyo is “winning,” so much as it’s added mountain after mountain of fresh debt without yields skyrocketing. Japanese officials aren’t thrilled to share a Moody’s rating with China, Estonia and Kuwait. But the economy with the most crushing debt burden in the developed world hasn’t fallen into a full-blown crisis.
Even so, Japan had proven government after government, decade after decade, that huge, globalized economies can’t grow their way to fiscal health. Only bold policy changes can do that.
The U.S. used to know this, back in the 1990s when Janet Yellen was a Federal Reserve governor and President Bill Clinton’s chair of the Council of Economic Advisers. The Clinton White House balanced the U.S. budget with a spending and revenue deal with Congress.
Now, Yellen is heading the Treasury Department at a moment when the federal budget deficit is $1.7 trillion for fiscal year 2023, an increase from $1.38 trillion in 2022. Good luck growing America’s way out of that.
“Given current projections for large primary deficits, demographic trends, and Federal Reserve policy focusing on controlling inflation, the United States should not be expected to grow out of its debt simply through rapid growth of GDP,” the Peter G. Peterson Foundation argues in a recent report.
As a result, the research group adds, “approaching an all-time high for the debt-to-GDP ratio should be a wakeup call for lawmakers, and there are many available policy solutions designed for the current fiscal and economic outlook.”
According to the Congressional Budget Office, America’s debt-to-GDP ratio will hit 98% by the end of this year. The current trajectory, as the Peter G. Peterson Foundation reckons, is for the U.S. to reach 107% by 2029. That would be an all-time record, topping the 106% ratio hit after World War II.
In the years that followed, the U.S. did manage to grow its way back toward fiscal sobriety. That was thanks to a postwar economic boom that won’t be repeated anytime soon.
The Fed’s aggressive rate hikes, meanwhile, are complicating Washington’s fiscal position at a moment of peak political dysfunction at home and a cacophony of geopolitical risks abroad.
One risk is just how many U.S. securities are sitting on the balance sheets of Asian central banks. Japan alone holds more than $1.1 trillion. China has about $810 billion. If traders got the slightest whiff of Tokyo or Beijing dumping dollars it could be game over for global credit markets.
The U.S. gets any number of special benefits thanks to the dollar’s reserve currency role. This “exorbitant privilege,” as 1960s French Finance Minister Valéry Giscard d’Estaing famously called it, allows Washington to live far beyond its means.
At some point, though, the dollar’s special status might not be enough to avoid a reckoning. One possible catalyst is Fed over-tightening that kills an institution or two bigger than Silicon Valley Bank.
Another is that the former President Trump’s allies in Congress sabotage government functions to the point where Moody’s joins S&P Global and Fitch Ratings in downgrading the U.S. Also, the risk of a deepening crisis in the Middle East eliciting U.S. military involvement can’t be ruled out.
These and other risks are making Yellen’s job harder by the day. The common thread is the need to maintain investors’ trust in Washington’s ability to handle an unthinkably large debt load. The U.S. debt is now 56% larger than it was in 2011 when S&P downgraded Washington.
If Yellen’s team has a plan to reduce the national debt—be it tax hikes or spending cuts—it might want to start making it official. Or at least begin signaling policy changes to come, lest bitcoin rally even further on fears of a U.S. debt reckoning.
To understand why bold action is needed, look no further than Japan, where the national debt continues to take on a life of its own.