Trump Pops the Debt Bubble?
March 14, 2025
Investors are well aware of the effects that the U.S. trade war is having on equity markets over the near term. In about one month, we have seen an almost 10% drop in the S&P 500 at the time of writing. Ten-year U.S. Treasury yields have declined about 30 basis points to about 4.3%. Bond prices rallying when equity markets flop is usually a result of a “flight to quality” trade as investors sell stocks and flee to the relative safety of bonds.
Investors also anticipate central bankers cutting rates if the stock plunge is a precursor of economic weakness. Self-appointed investment gurus will point out that this did not happen in the aftermath of the Covid lockdown period when economic output struggled while bond prices crashed, and interest rates spiked. They therefore submit that the old “flight to quality” argument no longer holds. This is confirmation bias to the extreme. There are exceptions to everything and that was during a period of four-thousand-year lows in interest rates; an extraordinarily exceptional and unsustainable period coincident with most of the labor force effectively being under house arrest for a sustained period. Also, the Federal Reserve printed over $6 trillion U.S., increasing the money supply by 40% in only two years. It seems that in 2020, those people who tend to be the type that launch personal attacks on me in the comment section of the outside publications I write for, were world-class immunologists during the lockdowns. They morphed into Nobel Prize winning monetary economists during the bond bear market. Currently, these polymaths have become international trade economists specializing in the effects of tariffs. Good grief, arrogant dumb people ruin everything they touch.
The lockdowns, wild money printing, the bursting of the bond bubble, the continuation of the U.S. equity bubble, and this tariff war have led us to a precarious situation economically. The government debt situation which is usually ignored by politicians of all persuasions and investors may very well soon enter a crisis stage.
The U.S. debt to G.D.P. ratio at the end of 2024 was about 122%. The deficit to G.D.P. ratio in 2024 was 6.3% of G.D.P. Debt is massive by historical standards to a degree usually only seen after major wars. These situations were addressed in various ways, usually resulting in unpleasant situations. The deficits the U.S. has experienced over the last few years have been large relative to previous recessionary periods. They are almost unprecedented during a period of growth. To put this in context, the yearly low in the deficit to G.D.P. ratio since the Great Financial Crisis of 2008 was 2.4% in 2015. When looking objectively at the data, neither Obama, Trump I, nor Biden have anything to be proud about. We shall see if the strategy of Trump II works, but things are not looking great. Cutting spending via DOGE, and Trump’s promised revenue gains from tariffs will not be enough to balance the budget.
When President Reagan and Fed Chairman Volcker broke the back of the inflation/recession cycle in the early 1980’s, the financial situation of the U.S. was very different than now. After a severe recession from 1981 to 1982, the deficit peaked at 5.7% of G.D.P. At that time, the debt to G.D.P. ratio stood at 37%. Some of us were worried the U.S. could not sustain this and Reagan was considered reckless by many. We didn’t know how good we had it back then. Debt to G.D.P. increased to around 60% in the early 1990’s and remained there, plus and minus 5% until the G.F.C.
Then the Great Financial Crisis happened, and debt soared as deficits hit almost 10% of G.D.P. in 2009. Interest rates were set at artificially low levels to bail out banks and give Wall Street a license to print money, and the money supply soared. We never fully recovered from that period and then Covid happened. The Biden administration never addressed the situation. Here we are today. Debt is double that of the 1991 to 2008 period, deficits are at levels only seen during acute downturns, and yet a potential recession may just be beginning. Blame it on Biden; blame it on Trump; or choose not to blame anyone at all, but if it’s going to happen, it will happen.
Given our current situation, what would likely happen if the global economy in general and the U.S. economy goes into recession? The deficit would explode as tax revenues implode as unemployment rises and corporate tax revenue declines. The debt to G.D.P. ratio would soar. It is difficult to say with any degree of certainty how dire this scenario would be because it is totally unprecedented in modern financial history. The U.S. is the world’s reserve currency, but investors may lose confidence in its creditworthiness. The U.S. will need to raise $7 trillion in debt this year. This will increase if the economy tanks. The U.S. has $37 trillion in debt, and that will increase. At current rates, that is almost $1.5 trillion a year in interest payments, or almost 5% of G.D.P., forcing the government to collect significant more in taxes than it pays out in programs. The total tax to G.D.P. ratio is about 16%. The current math looks bad and will worsen if the economy slows.
No wonder Trump wants lower rates. He also wants a lower U.S. dollar so that imports will be more expensive, and exports will be cheaper to address the trade deficit. About 30% of all U.S. debt is held outside the U.S. The logical question one should ask is why would foreign investors buy bonds with artificially low yields, especially if inflation remains high or increases denominated in a sinking currency? Why would domestic investors not sell their U.S. Treasuries for the relatively higher yielding bonds of nations with lower debt levels and lower inflation and are denominated in rising currencies? There are foreign opportunities are in nations with better financial positions as the U.S. may try to print its way out of this quagmire. People need the U.S. dollar as it is the world reserve currency and the unit of exchange in international trade. They might not need dollars to the extent that the U.S. administration believes and if, thanks to Trump’s tariff policy its negative effect of trade volume, demand for U.S. dollars may go down naturally.
Would the Trump administration be foolhardy enough to try and print its way out of this situation? One would think not but these are the same economic geniuses that started this global trade war. As Bette Davis said in the classic film All About Eve, “Fasten your seatbelts, it’s going to be a bumpy night.”