Pop Goes the Debt Bubble
April 8, 2025
The world has been understandably preoccupied with the Trump tariff fiasco and the recent plunge in world stock markets. Many serious economic analysts are now predicting an over 50% probability of a recession. The economy was already looking tired and overextended even before the latest drama began. According to Bill Dudley, former head of the New York Federal Reserve, stagflation is now the “best case” scenario. Stagflation is a prolonged period of increasing prices and slow economic growth. This type of situation puts central bankers in a difficult situation. Lower rates may exacerbate inflation; higher rates would slow down the economy even more.
The tariff issue could go away quickly if the Trump administration came to its senses. However, America has a problem that is not as easily solved and that is the debt bubble that began after the 2008 Great Financial Crisis and accelerated in the aftermath of the Covid lockdowns. The U.S. debt to G.D.P. ratio ranged from 54% to 65% from the end of 1990 to the second quarter of 2008. Certainly not indicative of prudent economic stewardship but not terrible. The debt to G.D.P. ratio proceeded rise to 105% during the Obama administration where it remained until the Covid lockdowns and now stands at 122%. As if this was not concerning enough, ten-year Treasury yields rose from a low of about half a percent in the summer of 2020 to about 4% today, creating a spike in interest payments as a percent of G.D.P. This metric rose from 2.3% to 3.8%, an increase of 65%. This will go higher as old low coupon debt matures.
On some level, the Trump administration may even understand this problem. However, their apparent strategy for solving the debt problem is fiscal recklessness based on economic illiteracy to the point of malfeasance. Their current strategy will drive debt-to-G.D.P. and interest payments-to-G.D.P. levels to catastrophic levels if they do not reverse policy. Deficits are already over 6% of G.D.P. and could go above 10% in a worst case scenario. Total federal receipts as a percentage of G.D.P. is about 17%. At some point in the not too distant future, almost one-third of all taxes collected in the U.S. could go to servicing the debt.
This scenario would precipitate some sort of sovereign debt crisis as investors question the creditworthiness of the U.S. The U.S. would not be able to stabilize the situation without resorting to some very painful alternatives and some sort of soft or even hard debt repudiation. The fact that Trump, in the past, has bragged about reneging of his companies’ bond obligations should cause us concern. Anyone unhinged enough to adopt this current tariff policy make one day believe that a U.S. debt default is “good business.” We may be seeing the beginning of the end of the U.S. dollar as the world’s transactional currency. The Euro is the heavy favorite to succeed the greenback despite Europe’s problems.
Trump’s tariff policy is not antithetical to dealing with the debt problem but a vital strategy for addressing it in his mind. It may be completely illogical, irrational, and ridiculous but there is a strategy. The Trump administration will never admit this, but the tariff program is one of the most massive tax increases in American history. The Trump administration and their surrogates have convinced MAGA supporters that it is not a tax, and if it is, it will be 100% paid for by the dirty foreigners who have been “raping and pillaging” (Trump’s words, not mine). High paying manufacturing jobs by the millions will be created in the U.S. and those jobs will be filled by unskilled, poorly-educated Trump voters.
This is false. The consumers from the nation putting on tariffs pay for almost all the tariffs. Foreign suppliers only have so much leeway to absorb the costs themselves. Most businesses are not Hollywood studios who seemingly can afford to produce products at staggering losses. The “dirty foreigners” are supplying American consumers products that Americans prefer on a cost/value basis, otherwise they would not be bought. It will take many years to open factories in the U.S. There will not be enough available capital for them anyway since investors do not typically put money into non-economic ventures.
Trump believes his tariffs, which are a tax, will be paid by foreigners and raise tax revenue. Soon to be implemented tax cuts to Americans will actually stimulate the economy and create more tax revenues. This is a complete misunderstanding of the Laffer Curve. In Trump’s world tax revenues overall will soar, and the incomes of working class Americans will rise. The deficits will decline or perhaps even become surpluses and at about 3% inflation and 5% economic growth, the debt to G.D.P. ratio will fall dramatically to levels of the 1990’s, if not lower. High school dropouts who now live in trailer parks in Appalachia will soon move to their three-thousand square foot homes with Olympic size swimming pools in the backyard.
The truth is that Trump’s policy will have the opposite of its intended effect. Americans will pay more for goods, especially for food and clothing. For example, Americans spend $110 billion of coffee alone a year. Hawaii’s total production is less than 0.1% of that total and it doesn’t all end up on the mainland. Americans will become poorer. This results in lower G.D.P. Unemployment will spike raising the annual deficit. Tariff revenues will be dwarfed by the increase in social benefits paid out to unemployed Americans and for programs like food stamps for the working poor as the prices of necessities soar.
Higher deficits, lower tax revenue, low or even declining G.D.P. growth will result in a soaring debt-to-G.D.P. ratio which will at best, destroy prosperity for a generation as has been the case in Japan after the bubble popped in 1989, and at worst a catastrophic debt crisis where some sort of default, whether by debt restructuring, outright repudiation, chronic inflation, or some combination of those will result. I doubt if the Trump administration sees an austerity program similar to what Canada went through in the 1990’s as an alternative. That would be the honorable thing to do. I will change my cynicism about the President’s character when he repays the bondholders he left holding the bag. That will never happen. A President that can so easily repudiate trade deals he himself pushed for and signed might also repudiate America’s debt obligations.