America’s national debt, which currently stands at more than $36.2 trillion, is increasingly rising on economists’ agendas. Their fear is that as the nation’s debt burden increases, alongside the interest payments to service the debt, the economy will not grow fast enough to sustain the spending.
As Deutsche Bank’s Jim Reid put it in a note seen by Fortune this morning: “Yesterday felt like we were somewhere along the line of a ‘death by a thousand cuts’ with regards to the U.S. fiscal situation. Hard to know where in that thousand we are but probably much nearer a thousand than at zero even as yesterday saw an initial sell-off reverse as the session went on.
“At the end of the day the loss of the final U.S. triple-A rating late on Friday night doesn’t change anything much immediately but it keeps the drip, drip, drip of poor fiscal news building up against the debt sustainability dam in the background.”
But Trump is maintaining a delicate balance in the deliverables his campaign promises: cutting costs and reducing taxes, which, in turn, reduces the revenues needed to rebalance government spending.
The Trump cabinet is currently encouraging Congress to pass this “big, beautiful bill” of tax cuts. Some of this includes an expansion of the 2017 tax cuts, which are due to expire at the end of 2025, with notable additions such as axes to taxes on tips and overtime pay.
The Trump administration argues that the bill will actually help rebalance the debt-to-GDP ratio. Administrations have two choices to bring the balances into order: reduce the debt or increase GDP.
This would be 63 points higher than long-term baseline projections without the cuts.
In the event of U.S. debt buyers losing confidence in the country’s ability to repay, America does have a card it can play in the form of the Fed.
The central bank could employ quantitative easing, a move that would likely raise eyebrows, to lower longer-term interest rates and make it easier for the government to continue borrowing.
While the bond market reacted fairly minimally to Moody’s downgrade, UBS adds that should volatility increase at some point, the Fed would likely act.
In a note sent to Fortune today, UBS’s chief investment officer Mark Haefele wrote: “Overall, we view this latest credit action as a headline risk rather than a fundamental shift for markets. We would also expect the Federal Reserve to step in if there were a disorderly or unsustainable increase in bond yields.
“So while the downgrade may lean against some of the recent ‘good news’ momentum, we do not expect it to have a major direct impact on financial markets.”
