December 13, 2024

By Invitation - In a debtor's prison

America's debt cannot keep stacking up, says

Jeffrey Gundlach
The "King of Bonds" sees the risk of a debt restructuring with global repercussions

I
N “THE SUN ALSO RISES”, Ernest Hem-
ingway’s first novel, Mike Campbell, a
jaded war veteran and inveterate drunk,
is asked how he went bankrupt. “Two ways,”
he replies. “Gradually and then sudden-
ly”. America’s government—like Mike, no
stranger to serial binges and futile wars—
is on its own way to bankruptcy. We have
lived through the gradual part. Under the
next few presidential administrations, the
national debt will mushroom beyond the
government’s ability to service it, perhaps
even beyond the credulity of the country’s
creditors. In the coming years expect dollar
debasement, debt restructuring or both.
America’s sovereign-debt spiral has been
building since Washington embarked on
large budget deficits in the 1980s. As the ILLUSTRATION: DAN WILLIAMS
tab rose from about 30% of GDP towards
100% in the 21st century, the Treasury con-
tinued to find willing creditors. The dollar rals—unless, that is, lower rates are engi- cessionary decline in tax revenue, the gov-
still rules as the world’s reserve currency. neered by the Federal Reserve, which would ernment’s probable reflex would be a return
Inflation and bond yields tracked lower for cause inflation. There will be no road left to to money-printing. Politicians would bor-
decades. And since 2008, under the anaes- kick the can down. row more to fund the wider gap, taking for
thetic appellation “quantitative easing”, the A recession would propel this debt spi- granted debt monetisation by their central
Federal Reserve has shown its readiness to ral into crisis. The government is running bank. The scale of money-printing, how-
print more dollars to monetise away govern- annual deficits approaching $2trn, more ever, would dwarf that of past bouts of Fed
ment debt. So why can’t the band play on? than 6% of GDP, even with positive growth bond buying. Yields would rise to discount
An interplay of forces is going to break the and four years of low unemployment. This repayment in a depreciated currency.
bank. Yields on Treasury bonds fell and fell breaks with the Keynesian bargain which Let’s run the numbers. Projections to 2034
for nearly 40 years, with the 10-year yield prevailed from the end of the second world from the Congressional Budget Office (CBO)
hitting all-time lows in 2020. America has war until the middle of the past decade: run assume no recessions, an average primary
since entered a secular environment of ris- large deficits to offset economic weakness, deficit of 2.6% of GDP, plus 3.6% from debt
ing interest rates, so the costs of servicing shrink them in times of robust growth. With expense (the latter assuming an effective
the national debt are rising rapidly. As secu- the deficit at recessionary levels already, the interest rate on government debt of 3.5%).
rities issued at interest rates as low as 0.5% hit to tax revenues in an actual recession In the next ten years, under those assump-
mature, the principal is being rolled into the would drive America yet further into the red. tions, America’s debt-to-GDP ratio would
higher rates of the spot market, at the mo- As in the past, a recession—or fear of it— rise from 99% to 122%.
ment 3.7 percentage points higher. Higher should drive investors towards perceived But those assumptions are optimistic.
interest expenses feed into deeper deficits, safe havens, including Treasury bonds: a America’s economic expansions after the
sparking more borrowing, driving heavier rate-lowering movement that may already second world war have lasted an average of
debt loads. This is how the debt spiral spi- have played out. Once confronted with a re- 21.8 quarters; the current one has spanned
 The Economist December 13, 2024

17. Timing economic cycles is difficult loads of 175-200% would be sustainable only maswamy is the most encouraging sign I
but for the sake of argument, let us accept under the most favourable assumptions, have seen of a fiscal awakening in Wash-
the CBO’s recession-free outlook. The 2.6% and a belief that Washington will prevent ington. I doubt DOGE will touch the entitle-
primary-deficit premise, though, is another the debt burden from rising further. “Once ments, where much of the imbalance lies,
matter. Since the financial crisis of 2007- financial markets believe otherwise,” says but let us hope this begins a trend in the
2009, it has averaged 4.9%. As for the effec- the research group, “financial markets can right direction.
tive rate, consider 3.5% a rosy view. Rates of unravel at smaller debt-GDP ratios.” When external pressure at last forces
6% are certainly within the experience of the Something will surely give before such America’s leadership into hard choices, I
past 30 years; for a world breaking with past hypothetical nightmares play out. Earlier believe the first move will be dollar debase-
inflation norms, 9% is not unimaginable. this year, the CBO itself and the Interna- ment. Congress may one day impose taxes
In either case our debt-spiral model, as- tional Monetary Fund issued their own ex- on assets—ineffective but gratifying to some.
suming nominal growth stays the same, plicit warnings. Phillip Swagel, the head of And there is the real possibility of a qua-
shows this situation compounding into fis- the CBO, even warned that the “unprece- si-default by the Treasury, through debt re-
cal catastrophe. By 2034 debt service at 6% dented” escalation of America’s debt bender structuring beyond what today’s consensus
rates would consume 45% of all tax revenue; risked a kind of market reckoning that cur- would dare to contemplate. In the upheaval
at 9% rates it would eat up 83%. The budget tailed the government of Liz Truss, briefly to come, few are likely to be spared. n
deficit would balloon from 6% of GDP to 11% Britain’s prime minister.
or 18%, respectively. These numbers imply President-elect Donald Trump’s plan Jeffrey Gundlach is founder, chief executive
debt-to-GDP ratios of 147-184%. The Penn for a Department of Government Efficien- officer and chief investment officer of Double-
Wharton Budget Model has shown that debt cy (DOGE) led by Elon Musk and Vivek Ra- Line Capital, a US-based asset manager.

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