- US debt will become unsustainable in roughly 20 years if it doesn't change course, a Penn Wharton Budget Model determined.
- After that, no amount of tax hikes or spending cuts could prevent default "whether explicitly or implicitly."
- An implicit default would include debt monetization that produces significant inflation.
Sign up to get the inside scoop on today’s biggest stories in markets, tech, and business — delivered daily. Read preview
Thanks for signing up!
Access your favorite topics in a personalized feed while you're on the go.
Advertisem*nt
The US has roughly 20 years to change course on the size of its debt, or else a default of some form will be unavoidable, a Penn Wharton Budget Model determined in October.
Analysts looked at the $26.3 trillion of US debt held by the public, which excludes money the federal government owes itself in the overall outstanding debt total of $33 trillion.
"Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation)," the report said. "Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the US and world economies."
The 20-year timeline is actually on the optimistic side because it includes a future fiscal policy that will stabilize the debt. For now, PWBM's approach found that US debt must not surpass 200% of GDP if the worst is to be avoided. Right now, it's at about 98%.
Advertisem*nt
But a more plausible red line is closer to 175%, and even that assumes the government will implement fiscal policy corrections, authors Jagadeesh Gokhale and Kent Smetters wrote.
"Once financial markets believe otherwise, financial markets can unravel at smaller debt-GDP ratios," they warned.
Bond yields will have to continuously rise in order to attract buyers of government debt, the analysts said.
Earlier in the fall, long-dated yields broke above 5% threshold amid a lack of Treasury buyers, spurring a collapse that is among the worst crashes in market history. Since then, the Treasury Department itself acknowledged mounting demand concerns.
Advertisem*nt
As this pushes borrowing costs up, the debt pile further expands, and the cycle continues — eventually, interest rates would reach such a high that they trigger a crisis.
If borrowers realize this, they will demand higher interest rates earlier, as a premium for the risk of default. This would cause the downward spiral to occur ahead of PWBM's 20-year timeframe.
Solutions to forego this include tax hikes, and a cut on federal spending, but this has to happen ahead of time.
While bond yields have fallen sharply since October, US debt has become an increasing concern for both policymakers and investors alike. Net interest payments will soon surpass the government's defense spending, and are estimated to become the biggest single federal expenditure by 2051.
Advertisem*nt
PWBM points out that debt projections have been growing more extreme with time, as faster-than-expected rises in entitlement spending, such as on Social Security or Medicare, have eclipsed previous estimates. Added to that,US debt has become less consistent with policy changes.
"Put differently, US debt is on a secular upward path and past projections have, if anything, underestimated that increase, regardless of the reason," they wrote.
This story was originally published in October 2023.
