US Fiscal Irresponsibility Is Everyone’s Problem
Far from being only domestic matters for the US government, the dollar and dollar-denominated financial instruments affect the entire global economy. By eroding trust in them, President Donald Trump and congressional Republicans could unleash widespread financial turmoil.
Paola Subacchi
PARIS – As Donald Trump’s “big, beautiful” tax bill heads to the US Senate, investors everywhere are growing increasingly uneasy.
On May 16, the credit-rating agency Moody’s downgraded US sovereign debt from its long-held triple-A status to Aa1 – following similar decisions by Standard & Poor’s (in 2011) and Fitch Ratings (2023).
Given the sheer volume of US debt – which now stands at $36 trillion, or 124% of GDP – and rising interest costs, these institutions have concluded that US debt metrics are no longer in line with those of similarly rated sovereigns.
That means America is no longer part of the elite group of ultra-safe borrowers: countries like Germany, Switzerland, and Singapore.
Instead, it has been demoted to the second tier, alongside Austria and Finland.
Members of this group remain highly creditworthy, with minimal risk of default; but they are not as bulletproof as the top-rated countries.
Although US debt is still fundamentally safe, the growing alarm over the Trump administration’s aggressive fiscal stance – which centers on massive deficit-financed tax cuts, unsupported by adequate fiscal space – is not baseless.
According to the Committee for a Responsible Federal Budget, the tax bill that the House of Representatives just passed (by a single vote) would add $2.5 trillion to the primary deficit (which excludes interest payments on current debt) over the next decade, adding $3.1 trillion to public debt.
Thus, Moody’s projects the US debt-to-GDP ratio to hit 134% by 2035.
But like the global trade war that Trump launched in April, the fate of his fiscal agenda is written on the Treasury market’s walls.
Unlike the stock market, where volatility can be attributed to investor jitters over bloated valuations, turmoil in the bond market is deadly serious.
If it lasts, it can have far-reaching consequences for a state’s day-to-day functioning, not to mention its broader effects on the global economy.
One major concern is the interplay between rising US debt and the cost of servicing it, now that higher interest rates (since 2022) have significantly increased federal borrowing costs.
In 2024, interest payments reached $881 billion, making them one of the largest components of the US federal budget – even surpassing spending on defense and Medicare.
Without meaningful fiscal consolidation (spending cuts or higher revenues from tax increases), managing this burden would require both strong economic growth and stable inflation.
Yet both outcomes seem unlikely, given the Trump administration’s erratic, unpredictable, ineffective, and destabilizing approach to policymaking.
Another concern stems from the widespread perception of Treasury bills as the world’s preeminent safe asset.
No other currency boasts a market as large or as liquid.
International investors, especially managers of official reserves, have long regarded Treasuries as the cornerstone of financial security.
The previously unquestioned confidence in Treasuries reflected trust in US institutions, governance, and rule of law.
But Trump’s unsound, inconsistent decision-making has quickly eroded that trust (another factor in Moody’s decision to downgrade).
International demand for Treasuries underpins the dollar’s dominance and grants the United States an unparalleled advantage in global finance.
By keeping interest rates low, the greenback’s primacy has afforded the US far more fiscal space compared to other advanced economies, allowing the federal government to run persistent budget deficits – 6.4% of GDP in 2024 – without alarming creditors.
But if confidence in Treasuries, and thus in the dollar, falters, investors may demand a premium for holding US debt, implying higher borrowing costs.
In fact, long-term Treasury yields – representing what the US must pay you to hold its debt – have already risen, with the 30-year yield climbing above 5% in response to the proposed tax bill.
True, we should be careful not to interpret rising yields as an unambiguous sign of investors’ dwindling confidence in the safety of US debt; overall demand has proven resilient.
And yet, investors are beginning to price in greater risk and to consider diversification.
European and Chinese monetary authorities will be watching these new trends closely, given their own ambitions to expand their respective currencies’ international footprints.
The upshot is that the dollar and dollar-denominated financial instruments are not only domestic matters for the US government.
They are global issues that affect everyone.
By undermining confidence in the currency that serves as the world’s primary medium of exchange, unit of account, and store of value, Trump and congressional Republicans could unleash widespread financial instability.
As borrowing costs rise even more, developing countries that rely on dollar-denominated debt would be among the hardest hit (as always).
In an interconnected global economy – even one trending toward fragmentation – the US government’s actions have profound international repercussions.
But convincing Trump to care about the risks reflected in the latest fiscal measures may be the most difficult task of all.
Paola Subacchi is Professor and Chair in Sovereign Debt and Finance at Sciences Po.
0 comments:
Publicar un comentario