US on Perilous Fiscal Course as $2tn Deficit Tests Global Markets

The United States is on a perilous fiscal trajectory, with a structural deficit that has placed its finances on an unsustainable footing. Washington is on track to borrow a staggering $2tn this year, a figure that has doubled in a single year and represents more than 6 per cent of its economy.

This alarming surge in borrowing, occurring not during a deep recession but amidst a period of robust economic growth, has laid bare the structural fissures in the nation’s finances. The combination of intractable political dysfunction and a deteriorating fiscal outlook recently led the rating agency Fitch to downgrade US sovereign debt from its top tier AAA status, a move that underscores eroding global confidence in the country’s capacity for sound governance.

A Crisis of Political Will

At its core, America’s debt problem is not economic but political. The Fitch downgrade was explicitly attributed not to an inability to pay, but to a predictable "erosion of governance" and a "steady deterioration in standards of governance over the last 20 years." This is most visible in the repeated debt limit standoffs and last minute resolutions that have brought the US to the brink of default, undermining faith in the political system itself.

According to Kenneth Rogoff, a professor of economics at Harvard University, there seems to be "little political will in either party to fix it until a major crisis occurs." This paralysis stems from a political consensus, spanning decades and administrations, that has conditioned voters to expect fiscal largesse without sacrifice. Since the budget was last balanced at the end of the 1990s, both Republican and Democratic leaders have, in his words, "tripped over themselves to run ever larger deficits, seemingly without consequence."

This trend is exemplified by major legislative actions that prioritise short-term political gains over long-term fiscal health. The "One Big Beautiful Bill Act," for instance, preserved the tax cuts from Donald Trump’s first term. While proponents argued these cuts spurred growth, extensive evidence from similar policies dating back to the Reagan era suggests they do not nearly pay for themselves. The Congressional Budget Office, the non-partisan fiscal scorekeeper, concluded that this bill alone would add an additional $2.4tn to the debt over the next decade. Furthermore, the bill was laden with what Rogoff called "highly distortionary add-ons" such as tax exemptions on tips, overtime, and social security that further erode the revenue base.

This is not a uniquely Republican phenomenon. The willingness to finance tax cuts with debt is mirrored by a bipartisan consensus to fund vast spending programmes without corresponding offsets, particularly in response to economic shocks like the 2008 financial crisis and the Covid 19 pandemic. The result is a political dynamic where each party decries the deficit when out of power, only to contribute to it upon returning to office. Ray Dalio, the founder of Bridgewater Associates, likens the situation to being on a boat where "everybody knows we’re headed for the rocks," but the political actors are so busy arguing "whether to go left or right, so they’re going straight into the rocks."

The Treasury's High-Wire Act

This political failure has forced the US Treasury into a high stakes gamble to manage the government’s immense financing needs. The current strategy, a continuation of a policy from the prior administration, involves relying heavily on the issuance of short-term Treasury bills. The Treasury’s need to raise $1tn in a single recent quarter highlights the sheer scale of the operation.

By issuing debt that matures in a year or less, the Treasury can satisfy the government’s voracious appetite for cash without immediately causing a spike in the yields on long dated bonds, which act as the benchmark for borrowing costs across the global economy. This approach, however, is fraught with danger. It creates immense "rollover risk," forcing the government to constantly refinance its liabilities at prevailing interest rates. With the Federal Reserve having pushed rates higher to combat inflation, the cost of servicing the nation’s $37tn debt is soaring and is projected by the CBO to hit a record 3.3 per cent of GDP by 2030. Some economists, including Nouriel Roubini, have labelled the tactic "stealth quantitative easing," arguing the Treasury is improperly encroaching on the central bank's monetary policy role.

An Inevitable Reckoning

For a country that can print the world’s reserve currency, an outright default is not the most probable endgame. Instead, experts point to two more insidious possibilities. The first, and more likely, is a de facto default through inflation. Dalio argues that countries in this position historically choose to "print the money to prevent the default and then greatly devalue the money." Politically, this is often the path of least resistance, as it functions as a hidden tax on savings rather than an explicit and unpopular decision to raise taxes or cut benefits. This would represent a slow-motion crash, eroding the real value of savings and US dollar-denominated assets.

The alternative is a period of Japanese-style "financial repression," where the government would be forced to artificially hold down interest rates. While this might contain the government’s borrowing costs, it would come at the expense of stifling economic growth and dynamism for years, if not decades.

The Fraying of ‘Exorbitant Privilege’

This domestic fiscal crisis is unfolding as the dollar’s long-held hegemony shows signs of fraying. The "exorbitant privilege" of issuing the world’s reserve currency has long afforded the US a deep and reliable pool of demand for its debt. But this privilege is now being tested by both the sheer scale of borrowing and by deliberate policy choices.

Geopolitical tensions are a key accelerant. The weaponisation of the dollar through sanctions has prompted rivals such as China to seek alternatives, while the unpredictable nature of US politics is giving even allies pause. As large foreign holders of US debt, from sovereign wealth funds to central banks, become justifiably concerned that their assets could be taxed or frozen, the incentive to diversify grows. The tangible result is a quiet but steady accumulation of gold reserves by central banks worldwide, a clear signal of a move to hedge against a US dollar centric financial system.

While a technological leap in AI could boost productivity, few believe it can solve what is fundamentally a crisis of governance. Without a significant change in course, the US is not merely risking a bond market crisis; it is putting its long-term economic prosperity and its global leadership position at stake.