You’ve heard warnings for years about how a fiscal crisis was brewing in the United States because the debt is unsustainable — and financial markets would eventually protest. However, the logic was often vague and the risk hypothetical.
Guess what? The Trump administration has made obvious the real source of risk. It isn’t federal borrowing grinding ever higher. The true risk is our political leaders doing something wildly irresponsible that unnerves financial markets.
President Trump has brought budgetary chaos with extraordinary speed. In just his first week in office, his administration threatened to withhold payments of trillions of dollars of congressionally enacted spending. Days later, he appeared to reverse course. Then he allowed staff members of the newly formed Department of Government Efficiency, or DOGE, to gain access to critical Treasury payment systems, prompting the resignation of a senior official with decades of public service. New threats to withhold federal payments now come daily. At least one agency, the U.S. Agency for International Development, may no longer be operative.
Those who have spent years scanning the horizon for risks of a fiscal crisis should fix their sights on the president’s malpractice. When Mr. Trump asserts he can pick and choose which payments to make, regardless of laws enacted by Congress, it is not impossible to imagine the president declaring he can pick and choose which holders of United States Treasury securities should be paid.
During his first term, senior officials from Mr. Trump’s administration reportedly considered the idea of canceling some of the payments on U.S. Treasuries held by China as retribution for its purported role in the pandemic. Now, with DOGE itching to meddle in Treasury payment systems, the president may soon have the means to withhold payments at his personal whim. “We’re even looking at Treasuries,” he told reporters ominously when discussing his plans to commandeer the payment system. “It could be that a lot of those things don’t count.”
Why is this a potential crisis in the making? The $28 trillion market for Treasuries — by far the most important financial market in the world — depends first and foremost on trust. By that we mean confidence that the United States Treasury will pay its interest and principal on time and that American politicians won’t drive the economy off a cliff. Because of that trust, Treasuries are viewed as risk-free assets. They serve as the benchmark for interest rates on all kinds of loans such as mortgages, business loans and borrowing by other governments. That trust is why American retirees and overseas pension funds put their money in Treasuries when they can’t risk losing it. It’s the bedrock of America’s economy.
Imagine if Mr. Trump threatens to withhold debt payments to China, prompting the Chinese to sell their nearly $1 trillion portfolio of U.S. debt. The sell-off would be likely to make financial markets jittery. But would it end there? Would other foreign investors, who together hold nearly a third of outstanding Treasuries, worry they might be next?
Political blunders have always been the more concerning potential trigger for an American fiscal crisis. We are not discounting the economic costs of carrying a nearly $2 trillion deficit, one that is likely to increase over time. Rising federal borrowing competes with private-sector investments for people’s savings. To entice investors to lend increasing amounts to the federal government, Treasury rates have to rise. That pushes up interest rates across the economy, which means businesses have to pay higher rates when they borrow. As a result, there is less private investment and ultimately less wealth for future generations. Those effects are unfavorable, but slow and predictable.
The political threat is more acute and builds on years of dysfunction in how the government manages the country’s finances. In 2023, Fitch Ratings downgraded the long-term U.S. debt, noting that “there has been a steady deterioration in standards of governance over the last 20 years,” especially because “repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”
What happens if investors conclude there is default risk in the largest and most liquid financial market in the world? Ernie Tedeschi at the Yale Budget Lab, a nonpartisan policy research center, shows that interest rates would rise if investors priced in the risk of a default, which would slow U.S. economic growth, even if the financial sector remained healthy.
However, the financial sector probably would not remain healthy. An abrupt and sustained increase in Treasury rates of, say, three or four percentage points would likely cause a crisis. Remember, the interest rate on a bond moves in the opposite direction of its price. Investors worried about default risk in Treasury bonds would value those bonds less. To maintain demand among potential buyers, the price of bonds would fall and thus the interest rate would have to rise. Every financial institution, investor and household holding Treasuries would simultaneously take huge losses.
Recall the bank failures in 2023, when rising interest rates cost financial institutions billions of dollars. In the financial crisis scenario we describe here, widespread failures of financial institutions would reverberate through the economy. In the 2008 financial crisis, Treasury rates fell as investors worldwide sought refuge in the safety of those assets. That helped finance America’s deficit spending. Instead, in this scenario, interest rates would rise significantly.
Mr. Trump is bringing chaos to one economic sector after another. More disruption is sure to come. While we can’t predict what’s going to happen, we know for sure that the risk of a fiscal crisis is higher than it was just four weeks ago.
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