Donal Trump's spending plan and rising deficits are set to push the US closer to fiscal crisis. Photo / Getty Images
Donal Trump's spending plan and rising deficits are set to push the US closer to fiscal crisis. Photo / Getty Images
Opinion by Bryce Wilkinson
Bryce Wilkinson is a Senior Fellow at The New Zealand Initiative
THREE KEY FACTS
Moody’s downgraded the US credit rating from AAA to AA1 due to rising debt concerns.
The US House of Representatives passed President Donald Trump’s spending bill, which could increase borrowing by US$4 trillion ($6.7t).
High debt levels in major countries, including the US, threaten global financial stability.
On May 12, US President Donald Trump’s government spending and revenue bill was published. With characteristic panache, the President calls it his “Big Beautiful Bill”.
On May 16, Moody’s, a US credit rating agency, did something it had not done for over 100 years. It dropped itscredit rating for US federal Government debt from AAA to AA1. Meanwhile, 11 prosperous countries retain their AAA status – for now. They include Australia and New Zealand.
In the early hours of May 22, the US House of Representatives passed the bill, but only by a one-vote margin. Next stop in the bill’s journey is the Senate.
The bill is a sweeping proposal to cut some taxes and spending but to increase other spending by even more. That means the Government will have to borrow more. The US Congressional Budget Office puts the extra borrowing at US$4 trillion ($6.7t) between 2026 and 2034. Debt in 2034 could be 8% of GDP higher as a result.
From a debt perspective, the situation is beyond big – it is bloated. The beauty aspect is imaginative.
Moody’s press release succinctly summed up the situation. It expects “mandatory spending, including interest expense[s] ... to rise to around 78% of total spending by 2035 from about 73% in 2024″. It assessed that the planned extension of expiring tax cuts would add around US$4t to federal borrowing over the next decade.
Moody’s forecast the federal Government’s Budget deficit would be 9% of GDP by 2035, up from 6.4% in 2024. The federal debt burden would rise to about 134% of GDP by 2035, compared to 98% in 2024.
This debt measure – debt held by the public – was 106% of GDP after the end of World War II (1946). To exceed this in peacetime is extraordinary.
As everyone with credit card debt knows, the more you owe, the more interest payments swallow your income. Unchecked, your morale and options suffer.
Moody’s expects US deficits to reach 9% of GDP by 2035, up from 6.4% last year. Photo / Getty Images
The interest payments on US federal debt in 2025 will absorb approaching US$1 in every US$5 of federal revenue. They exceed US defence spending. Only social security spending is greater. And the interest proportion will soon exceed 20% of revenue as things stand.
The US federal debt track looks unsustainable. And this is even without the onset of World War III or some lesser set of conflicts or crises.
In 1992, European nations agreed what an upper limit on general government gross debt ratio should be. They set it at 60% of GDP in the Maastricht Treaty.
General government comprises all layers of government. For the US, this combines federal, state and local public debt.
It also put a ceiling of 3% of GDP on fiscal deficits. How unrealistic that looks today.
High debt ratios can be sustainable if incomes rise faster than interest burdens. That is a dicey “if”.
Sustainable does not mean prudent. A prudent level is lower. It provides a cushion for things that could go wrong. Things like pandemics, natural disasters, or the need to spend more on defence.
Ireland provides a sobering example of the need for a buffer. It bailed out its banks during the last Global Financial Crisis. Its gross public debt rose from 24% of GDP in 2007 to 119% in 2012. This was on the Maastricht Treaty measure.
The US and too many of Europe’s biggest countries are far above the Maastricht Treaty’s 60% of GDP upper limit. The debt ratios for Italy, France, the UK and Spain exceed 100%. The Euro currency area average is 91%. Germany is less dicey at 66%, but this is still uncomfortably high. (These are all OECD secretariat estimates for 2025. Its estimate for New Zealand on a related measure is 62% of GDP.)
These debt levels and ongoing deficits for major countries threaten global financial stability. New Zealand Initiative co-researcher Leonard Hong and I explained this in a 2019 report, Walking the Path to the Next Financial Crisis.
To see the US in such debt trouble is particularly worrying. The US dollar underpins international trade and finance.
Although Moody’s down-rating of the US was expected, prices on US government debt fell (increasing the cost of borrowing). The market’s assessed default risk on US federal bonds also rose marginally.
The US depends on global investors and others to fund its future deficits. The extent of its need weakens its global influence.
What does this mean for New Zealand? First, the global risks that concerned me in 2019 weigh more heavily now.
Second, readers should not take comfort from New Zealand’s more modest public debt ratios. That major countries are more indebted than before makes us less safe.
As Ernest Hemingway wrote in The Sun Also Rises:
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”
It happens suddenly when lender confidence dissipates. The US is not there yet, but it is on the way.
Bryce Wilkinson is a Senior Fellow at The New Zealand Initiative (www.nzinitiative.org.nz).
