Can American democracy really survive its debt tipping point?

AS US borrowing costs rise, the country has reached a tipping point where it may have to issue new debt just to pay interest on existing obligations.

If democratically elected politicians don’t change course, bond markets might force their hand, putting democracy itself at risk.

As the axiom goes, the US Congress is a place where Republicans want lower taxes and Democrats want higher spending.

Instead of negotiating, they often reach a compromise: lower taxes and higher spending.

As a result, US government debt has recently topped US$40 trillion, roughly doubling under the presidencies of Donald Trump and Joe Biden.

That partly reflects some justified pandemic-era crisis spending, but also many questionable fiscal decisions.

To please voters in the present, many politicians have no problem borrowing from the future.

One of the key strengths of democratic systems is their responsiveness and efficiency in reacting to people’s wishes.

But this responsiveness to voters’ desires can lead to fiscal imprudence, creating long-term vulnerabilities that can undermine a country’s resilience – its ability to withstand normal downturns and shocks.

The current rise in long-term US government bond yields to levels not seen in many years highlights this risk.

The 30-year Treasury yield recently hit 5.25% – just shy of its August peak of 5.30%, but a staggering jump from 1.67% in December 2021.

Investors have to look all the way back to May 2004 to find long-term borrowing costs this high.

Scary forecast

The days of a balanced US budget are long gone.

While it’s debatable whether a large developed economy should seek to run a balanced budget, few would argue that running ever-widening deficits is desirable or sustainable.

Over the last 25 years, the US federal deficit has ballooned to 5.8% of gross domestic product (GDP) and is projected to average 6.1% of GDP over the next 10 years, according to the nonpartisan Congressional Budget Office (CBO).

Even the primary deficit, which excludes interest costs, is projected to average 2% of GDP over the same decade.

Expanding deficits should lead to an ever-higher debt burden.

CBO projections for a rising debt-to-GDP ratio are well-known.

But what many may not know is that the Treasury’s own forecasts paint an even worse picture.

While the nonpartisan CBO projects that US debt will reach 150% of GDP by 2048, the Treasury expects this milestone to be reached as early as 2040.

The difference lies in the two institutions’ forecasting methodologies.

The CBO bases its projections on current laws, accounting for sunset provisions on tax cuts or government spending programmes.

The Treasury, by contrast, assumes that current policies will not change.

Either way, the trajectory threatens to leave the country more fragile moving forward.

Debt spiral

If there is one chart that exemplifies how fiscal folly has made the US economy and government less resilient, it is the share of government revenues spent on servicing the country’s debt.

Currently, the Treasury is spending roughly one-fifth of its revenue on interest expenses alone.

This is a much larger share than in Japan, Britain or Germany. It’s also more than the government can afford.

Mandatory spending on Social Security, Medicare, Medicaid, and other entitlement programmes swallowed up US$4.2 trillion in 2025, about 80% of America’s US$5.2 trillion in total revenue.

That means – barring any major changes to the budget moving forward – the United States will now have to borrow just to pay its existing debt.

This could be a dangerous tipping point, putting the United States at risk of falling into a debt spiral of ever-higher interest costs and even more borrowing.

To be fair, the United States is not alone in its fiscal problems. Other developed countries, most notably Japan, are also raising investor concerns about unsustainable fiscal dynamics.

US yields are also not that high compared to pre-2008 averages, and the term premium on the 10-year has not moved much in the past year, suggesting investors are not yet panicking about US finances.

Still, US Treasury Secretary Scott Bessent was alarmed enough to announce a plan last month to potentially increase bond buybacks to push down long-term yields.

Washington, which has the privilege of issuing the world’s reserve currency, may be able to get away with deficit spending far longer than any other nation without running into trouble.

But that only makes the United States the cleanest dirty shirt.

US public sector finances are becoming increasingly fragile, with few politicians willing to confront voters with the tough choices needed to increase resilience, namely raising taxes or cutting entitlements.

If democratically elected politicians fail to act, the bond market might do it for them.

The result may be severe economic pain that could undermine Americans’ already low trust in government.

We’ve seen this occur in the past, most notably in 1930s Germany.

The rise of an authoritarian leader in Russia after its external default in 1998 and the chaos of the late 1990s is another example.

More recently, democratic backsliding occurred in Hungary and Poland after the financial crisis of 2008 and the European debt crisis of 2011, propelling populist politicians into government who enacted authoritarian-leaning policies. — Reuters

Joachim Klement is an investment strategist for Panmure Liberum. The views expressed here are the writer’s own.