In the recent US election, Americans were fixated on major issues like immigration, inflation, abortion, and trade policy. Surprisingly absent from the debate was a critical economic issue: the ballooning national debt. While other topics took center stage, the way the government manages its finances went largely unmentioned. But among economists and business leaders, the federal deficit is a recurring concern, and rightly so. To understand if this concern is warranted, let’s unpack the numbers, consider the implications, and explore whether the deficit truly matters in the long run.

The Current State of the Deficit and Debt

The US federal deficit—the gap between government spending and revenue—reached an estimated 6.7% of GDP in the last fiscal year, according to the Congressional Budget Office. Historically, deficits at this level have been seen during times of crisis, like wars or deep recessions. Yet, the US economy is currently strong, with low unemployment and economic growth close to full capacity. This level of deficit spending during prosperous times is rare and might be a harbinger of future financial pressures.

Three Ways to Measure the Debt

1. Total National Debt: As of 2022, the debt-to-GDP ratio was 123.4%, slightly down from its pandemic high of 127.7%. This total includes all debt, whether held by private entities or government agencies.
2. Debt Held by the Public: Excluding government holdings like the Social Security Trust Fund, public debt stood at 97% of GDP in 2022 and likely close to 99% by now.
3. Debt Excluding Federal Reserve Holdings: The Federal Reserve’s holdings rose significantly during the 2008 financial crisis and the 2020 pandemic. When excluding this, public debt was 74.5% of GDP in 2022. While lower, it’s still significant by historical standards.

Should We Be Concerned?

High debt levels can have serious economic repercussions, yet the US has not yet faced a crisis. Typically, large-scale government borrowing increases competition with private investors, pushing up interest rates and stifling private investment. However, rates have stayed relatively low, and inflation hasn’t surged out of control—at least not yet.

But could investor confidence eventually wane? If buyers start doubting the government’s fiscal stability, it could lead to a financial crisis, similar to those seen in Greece in the 2010s or, on a smaller scale, the hyperinflations of Argentina or Zimbabwe. However, the US has some unique advantages that may cushion the fallout.

The “Exorbitant Privilege” of the US Dollar

Unlike other countries, the United States issues the world’s dominant currency. The demand for US dollars is massive and global, providing the US with an “exorbitant privilege.” This means the government can sell debt in its own currency and enjoy stable demand from international investors, especially during times of global uncertainty. Japan, for example, has managed a much higher debt-to-GDP ratio with relatively low borrowing costs, suggesting that advanced economies can carry substantial debt without immediate consequences.

Yet even with this advantage, America may not escape debt consequences forever. Unchecked spending eventually requires more substantial fiscal reform. Even in the 1980s, fiscal conservatives warned of imminent crises, though they did not materialize. This pattern suggests the US might sidestep immediate debt catastrophes, but only time will tell.

Potential Solutions and Long-Term Challenges

The factors driving America’s debt are complex and intertwined. Notably, demographic shifts play a substantial role. The aging population has increased entitlement spending on Social Security and Medicare, while a relatively smaller workforce limits revenue growth. In this scenario, fiscal options include:

• Raising the retirement age
• Cutting entitlements
• Increasing taxes
• Reducing other types of government spending
• Encouraging more immigration to boost the labor pool

Although politically challenging, a combination of these approaches could help stabilize future debt levels. Advances in technology, like AI, may also improve healthcare productivity, possibly reducing Medicare and Medicaid expenses.

Waiting for a Short-Term Crisis?

American leaders have historically avoided tackling debt issues until crises emerge. For example, in the 1990s, political advisor James Carville famously quipped that he’d like to “come back as the bond market” to wield the power to pressure politicians into fiscal responsibility. If investors grow wary of the mounting debt, the bond market could, in Carville’s view, “intimidate everybody” into action. For now, the crisis remains hypothetical, but it’s a reminder that markets have the power to force government action when alarm bells start ringing.

Federal Reserve’s Monetary Policy and Fiscal Impact

Currently, the Federal Reserve is cautiously easing monetary policy by reducing interest rates to avoid stalling economic growth. Yet, fiscal policy heavily influences the Fed’s decisions. As inflation stabilizes and the economy remains resilient, the Fed is carefully watching for any ripple effects from fiscal policy changes.

The Fed also keeps a close eye on financial stability. A shift in commercial property values due to hybrid work trends has stressed the mortgage market, revealing some economic fragility. Interest rate reductions may ease this strain, but if fiscal policy triggers more volatility, the Fed’s balancing act will become even more challenging.

Productivity Gains: A Bright Spot

Amid these challenges, the US has seen strong productivity growth, particularly in the services sector, which is helping to keep inflation under control while driving economic growth. The surge in productivity, driven by advancements in labor-saving technology, is a boon, reducing inflationary pressures. If this trend continues, it could provide the Fed with greater flexibility to keep interest rates moderate, which would, in turn, ease some debt servicing pressures.

Final Thoughts

While the current high debt and deficit levels don’t pose an imminent threat, they raise important questions about the future of US fiscal policy. As entitlement spending grows and the debt-to-GDP ratio climbs, the nation faces difficult choices. The federal government’s “exorbitant privilege” of issuing debt in a globally desirable currency offers some leeway, but it’s not a permanent shield. For now, the debt might not be urgent enough to prompt dramatic reform, but the US could eventually face limits to how much it can borrow without consequence.

The issue remains a background concern, yet policymakers will likely address it only when short-term pressures emerge. Until then, the US will continue to operate under the assumption that its “exorbitant privilege” will hold. However, in the long run, fiscal discipline will be necessary to ensure economic resilience in the face of inevitable demographic and economic changes.