How high can US debt go before it triggers a financial crisis?

A US tax cut bill, projected to add up to $4.5 trillion to the national debt by 2034, is raising concerns about the sustainability of US government finances, particularly as interest costs already exceed defense spending at $882 billion annually. The bill, coupled with potential weakening of economic growth and a recent credit downgrade by Moody's, could further pressure interest rates and deter foreign investment due to provisions like the "revenge tax" on foreign investors. This situation raises the risk of "fiscal dominance," potentially compromising the Federal Reserve's independence and leading to higher inflation if it is pressured to support the government's fiscal position by keeping interest rates low.

Analysis

The proposed US tax cut bill, described as potentially adding US$3 trillion to US$4.5 trillion to US debt by 2034, is intensifying concerns over US fiscal sustainability. Current US public debt, which constitutes about 80% of the total US$36 trillion government debt, is already at 121% of GDP and could reach 128% if certain tax initiatives become permanent. A critical development is the surge in US government interest costs to approximately US$882 billion annually, now exceeding defense spending, which threatens to crowd out other essential expenditures unless offset by tax increases or further spending cuts. This fiscal strain is exacerbated by policies such as President Trump's tariffs and the proposed "One Big Beautiful Bill Act," which includes a controversial "revenge tax" on foreign investors that could deter foreign capital inflows. Foreign investor confidence appears to be wavering, as indicated by the US dollar's muted reaction to recent geopolitical events that typically trigger a flight to safety, and concerns voiced by figures like Greg Combet of Australia's Future Fund. Moody's recent downgrade of US government debt, citing worries about federal debt growth, further underscores the precarious situation. The article highlights the risk of "fiscal dominance," where the Federal Reserve's independence might be compromised to support the government's fiscal position, potentially by keeping interest rates artificially low or engaging in debt monetization, thereby risking significantly higher inflation, a concern amplified by President Trump's pressure on Fed Chair Jerome Powell.

Key Decisions for Investors

• Investors should closely monitor the legislative progress of the US tax cut bill and its potential impact on the US fiscal deficit, debt-to-GDP ratio, and consequently, on Treasury yields and overall market sentiment.
• It is advisable to re-evaluate exposure to US Treasuries and the US dollar, considering the rising debt burden, increased interest servicing costs now at US$882 billion annually, and the potential for diminished safe-haven appeal due to fiscal concerns and specific deterrents like the 'revenge tax' on foreign investors.
• Portfolios should be assessed for resilience against a scenario of fiscal dominance, where potential pressure on the Federal Reserve to accommodate fiscal deficits could lead to higher sustained inflation and increased interest rate volatility in the US economy.