Threat of the US debt spiral

The country that once dominated the global economy is now grappling with a severe debt crisis. The United States, with a GDP of $28 trillion, is burdened by a debt of $36 trillion. This disparity between the country’s income and debt is not only unusual but also alarming. The sheer magnitude of this debt, exceeding the combined GDP of China, Japan, India, the UK, and Germany, has raised concerns about its potential impact on the global economy. The International Monetary Fund (IMF) has cautioned the US about its debt crisis, and major credit rating agencies have sounded alarm bells, sparking fears of another global economic downturn similar to the 2008 ‘Great Recession’.

The US Treasury Secretary has acknowledged that the government is running out of time to address the issue, as tax revenues are insufficient to manage the massive debt burden. Experts describe the situation as a late-cycle debt crisis, which could have catastrophic consequences for the global economy. The situation is considered direr than the aftermath of World War II, and the world is increasingly concerned about the impact of the crisis. The effects are likely to be felt globally, including in India, making it essential to understand causes and implications of this economic turmoil. We need to accept four harsh realities. The first reality is that the crisis in the United States is not just a spending problem; it is a generational spending disorder.

Advertisement

Just like a person earning $1,000 a month might buy $10,000 shoes and struggle to pay the EMIs, America spends between $800 billion to $1 trillion annually on its military, regardless of its financial capacity. This excessive spending on defense, peacekeeping, and global interventions has led to the current crisis. The federal budget deficit in the US has been increasing year after year, and the country is spending more on defense and global dominance. Economic theory suggests that governments should spend more during good times and reduce spending during bad times, but the US is doing the opposite. The Congressional Budget Office (CBO) reports that the 2023 budget deficit stands at $ 1.7 trillion, with a significant portion going towards paying interest on national debt.

The US defense budget exceeds the combined defense budgets of the next top 10 countries, according to SIPRI. In 2023, the US spent $877 billion on defense. Despite this massive spending, the country has faced setbacks, such as its defeat in Afghanistan to the Taliban. The US spends heavily on promoting democracy and global dominance, but this has contributed to its economic woes. The second reason for America’s current economic crisis is its rapidly aging population, a problem also faced by Japan. By 2050, 22 per cent of Americans will be over 65 years old. As the population ages, the workforce’s productivity declines, while pension, healthcare, and social security costs continue to rise.

The Covid-19 pandemic led to trillion-dollar funding packages, and additional expenses for military aid to Ukraine and Israel, as well as domestic infrastructure projects, have further strained the economy. As a result, the US is spending far more than it earns, leading to a situation where it is “living on borrowed money”, where expenses exceed income, and this gap continues to widen. This is not just an economic failure but also a political one and the consequences of this failure could lead to global economic instability.

The third reason for America’s economic woes is the inequality in its tax system. The tax system has historically favoured the wealthy, and this continues to be the case. According to a 2023 report by the CBO, the top 20 per cent of earners in the US receive 65 per cent of tax breaks, with the top 1 per cent receiving 17 per cent. Meanwhile, those who truly need tax relief are being deprived year after year. This inequality can be attributed to the ‘trickle-down economics’ theory, which was introduced in the 1980s during Ronald Reagan’s Presidency. This theory posits that reducing taxes for the wealthy will lead to increased spending and investment, ultimately benefiting the poor.

However, this system has only widened the wealth gap, with the rich getting richer and the poor getting poorer. The 2017 Tax Cuts and Jobs Act, which reduced corporate tax rates from 35 to 21 per cent, is an example of this policy. Experts, including the Brookings Tax Policy Center and Oxfam, have confirmed that this policy has exacerbated income inequality in the US. The high level of income inequality is reflected in its ‘Gini coefficient’, which has been increasing since 1990. ‘Gini coefficient’ is a measure of income or wealth inequality within a population. The wealthiest individuals, such as Elon Musk and Jeff Bezos, have seen their fortunes grow exponentially, while millions of Americans live near the poverty line. The government’s excessive spending, fuelled by borrowing, has created a budget deficit, which is financed by issuing bonds to the public.

A question arises: who lends money to America? The answer is that America prints bonds with a promise of a specific interest rate and sells them. Bonds are similar to the certificates given during fixed deposits. Wealthy Americans buy these bonds, meaning the US government borrows from its own rich citizens. Additionally, other countries’ governments also buy these bonds. According to the US Department of Treasury, in 2024 alone, America spent $800 billion, nearly $1 trillion, on interest payments. The cycle works as follows: the government spends more, increasing the budget deficit, which requires borrowing. Borrowing necessitates interest payments, which in turn require more borrowing, further increasing the budget deficit.

This cycle has been eating away at the economy for two decades. Interestingly, the US has a debt ceiling, a limit on how much it can borrow. However, since 1960, this limit has been raised over 70 times, rendering it ineffective and turning it into a political drama. The issue with continuously increasing debt lies in the bond-market. When the government needs funds, it issues treasury bonds, typically bought by wealthy Americans and countries like China, Japan Qater, and the UAE, due to their perceived safety. China is no longer buying US bonds at the same rate as before. Instead, they are cashing in their bonds and taking out dollars. China had $1.3 trillion worth of US bonds in 2012, which has now decreased to $759 billion. Japan’s holdings have dropped from $1.84 trillion to $1.06 trillion. This trend indicates that the world is gradually losing confidence in US debt, resulting in what is known as ‘bond yield’ in economics. ‘Bond yield’ refers to the increased interest rates the US government must pay due to decreased demand for its bonds.

This creates a vicious debt cycle where the US takes on high-interest debt, struggles to pay the interest, and ultimately needs to borrow more. According to statistics, if Donald Trump continues borrowing at the current rate, the US debt burden will go up from $36 trillion to $52 trillion by 2030. This would lead to an annual budget deficit of $2.9 to $3.3 trillion and $1.8 trillion in interest payments alone, pushing the total debt-to-GDP ratio to 125-129 per cent. Instead of addressing the debt crisis, Trump is exacerbating it. The declining global confidence in US Treasury bonds, and the reluctance to purchase these, has triggered a series of concerning events. Major credit rating agencies have begun to downgrade US Treasury bonds, causing investors to demand higher interest rates.

Consequently, the US is forced to borrow at higher interest rates, leading to a vicious debt cycle. This cycle poses a significant threat to the US economy. Renowned investor Ray Dalio has long warned about this impending economic crisis, terming it an “economic heart attack”. Given the interconnected nature of globalization, a US financial disaster would likely have far-reaching implications, impacting countries worldwide, including India. The impact of the US debt crisis on India would be significant. Firstly, the Indian stock market would likely experience a sharp decline due to the substantial foreign investment in the market. If interest rates on US bonds rise, foreign investors might withdraw their funds from India and invest in Treasury bonds, similar to what happened in 2011. During that time, the Indian stock market plummeted by 10 per cent within a few months. Secondly, the value of the Indian rupee would decline, leading to inflation.

India’s foreign exchange reserves hold a significant amount of US bonds, worth approximately $237billion. If the value of these bonds decreases, the value of the rupee would also decline. A weaker rupee would increase import costs, leading to higher inflation, as seen in 2011. Economists are concerned about a similar scenario unfolding now. Experts are exploring ways to address this issue. One possible solution is for the US to employ ‘quantitative easing’, a monetary policy tool that could help mitigate the crisis. It is used to stimulate economic growth by injecting liquidity, lowering interest rates, and increasing money supply. This approach might provide temporary relief, but its long-term implications would depend on various factors.

However, it is certain that if America cannot manage its debt properly, the economy will inevitably collapse sooner or later. This debt-fueled spending spree cannot sustain itself indefinitely. When the debt-bomb bursts, the entire world will face a massive economic downturn. That is the harsh reality. Our only hope is that this downturn does not affect us, especially now that India has surpassed Japan to become the world’s fourth-largest economy in 2025.

America’s fiscal inability poses a significant threat to its economy, with the national debt ballooning and interest payments exceeding national defense spending. Without meaningful reforms, the country risks losing its reputation as a safe haven for investors. To mitigate this risk, policy makers propose solutions like a fiscal commission, Social Security reforms, and new taxations reforms. The CBO has suggested 17 deficit-reduction ideas. With the debt-to-GDP ratio projected to surge, urgent action is necessary to prevent a debt crisis and ensure the nation’s economic stability.

(The writers are, respectively, Associate Professor and Head, Political Science, Chandernagore Govt. College, and Associate Professor, Political Science, Galsi)