There’s nothing magic about the $40 trillion number,” says US Treasury secretary Scott Bessent. He is right about that – in the sense that an American national debt of, say, $39,999,999,999,999 isn’t, in economic terms, materially different if it increases by the single buck it would take to breach that notional threshold.
Markers can be irrational in all manner of ways, but panicking because of a round number is one of the least defensible.
Difficult as it is to comprehend anything with 13 zeros in it, neither is the $40 trillion figure of federal debt intrinsically scary. Record-breaking though it is, it represents about 125 per cent of US national income, and is much lower than Japan’s, and comparable to other advanced economies, such as France.
It was also at roughly these ratios during the Second World War. The problem now is that it has grown so rapidly in recent years, roughly doubling in a decade, and even faster than the American economy has.
The markets – international investors – are getting concerned about America’s ability to service its debt as it stands. The worries centre on inflation and, thus, the outlook for the interest rates that the world’s central banks use to restrain demand and price rises.
The global demand for funds from similarly high-borrowing large economies, and increasingly from corporates seeking investment to “hyper-scale” AI and data centre activities, is pushing market interest rates so high that they threaten the ability of nations to service their debts and avoid a crisis. Not even China can provide the funds necessary to find such a demand for capital, and especially after it has been weakened by US tariffs.
The latest victim is Japan, unable to boost growth and hit especially hard by the latest spike in (imported) energy costs and the effects of tariff wars. Washington has sought to assist Tokyo to prop up the value of the yen, but their coordinated efforts have proved at best temporary – because market sentiment is so poor – and seen $32bn of Japanese-owned US Treasury securities dumped onto the market.
There is another $1 trillion where they came from. The cost of borrowing for the United States government, supposedly the ultimate guarantor of global financial stability, is at a 30-year high of well over 5 per cent. With growth stumbling and oil prices so volatile, that is not a sustainable position.
This is a pattern that, with a few exceptions, afflicts every advanced economy in the world, and it is ominous that among the G7 largest advanced economies, the US is only the second-worst affected. For Britain, whose government faces the highest borrowing costs of all within this group, the outlook is even more grim.
There is little comfort from the fact that the UK is not alone in this predicament – because there is then less scope for friendly partners and agencies such as the IMF to lend to see the country through any resulting fiscal crisis.
The unwelcome news that UK government borrowing in July came in sharply above expectations, at £1.8bn for the month, was an indicator of just how precarious the situation is.
The Budget this October will be just as difficult as any in recent years. Even if the new chancellor, John Healey, manages to design a package of tax rises and public spending cuts, the clear risk is the UK descends into a “doom loop” where a fiscal and monetary squeeze strangles growth and worsens the situation so badly that another deflationary package becomes necessary – a downward spiral.
The UK is not there yet, and in reality the immediate prospects for the world economy depend crucially on decisions made in Washington, not London. If Donald Trump settled the war in Iran, on almost any terms, the inflationary pressures that are now building would dissipate rapidly, and there would be an immediate boost to confidence on the part of consumers, businesses and investors – as has been seen on the numerous occasions when a deal and peace seemed at hand, and oil and gas could again flow freely.
It would also be helpful, if the president was in the mood, for him to scale back his tariff schedules, which have hurt American consumers so much, and fuelled US inflation. After that, and venturing further into the realms of fantasy, he might consider a plan to stabilise the federal budget deficit, set it on a downward path and restore faith in the dollar and the US Treasury’s IOUs.
If, however, Mr Trump remains stubborn, then the devaluation of US government bonds could be so dramatic and spread to other sovereign debt so widely as to damage the savings of millions of households, and devalue the balance sheet of every commercial bank.
It would be a credit crunch not seen since the 1930s. With no scope to stimulate depressed economies, governments would be helpless as a slump took hold. The world is threatened with the biggest credit crunch in history
But it is also one that is tragically simple to avert. All it would take is for Mr Trump to do the right thing and fulfil investors’ working assumption that, when markets turn bad, “Trump always chickens out”. This would be the biggest TACO of all.
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