A Friendly Response to Alex and Tyler's Discussion About the Debt

Listen to their discussion here. As with everything they do, it’s worth the time.

The summary is that Alex is worried, Tyler isn’t, and he is trying to convince Alex he shouldn’t be either, or is it this: if Alex really believed the fiscal doom story, he would short the 30-year bond, not just talk about it? Tyler’s evidence is that real rates are low. Alex admits this is puzzling.

We do have an issue with it, though. Our main problem is the way they frame whether we should be worried about the debt, and, effectively, their idea of what a debt crisis looks like. They treat a debt crisis as a binary event: markets panic, yields spike, and the government formally defaults. In Tyler’s view, because there are no signs of those two things happening, we are, apparently, still in the zone of calm fiscal waters. Moreover, he believes that because markets know there is plenty of private wealth to confiscate through taxation (or fiscal repression) if needed, it functions as private backing, hence there will never be a US default on the debt. He isn’t denying that there is “deadweight loss” or “distortion” resulting from the debt (or the spending). But as long as markets are calm, he isn’t worried.

But this is an upside-down way of thinking about this issue, and it misses the main reasons we worry about and fight against this debt accumulation today. In advanced economies with deep financial markets and reserve currencies, debt crises almost never show up through hard defaults. They show up through unexpected increases in the price level when investors realize that some portion of new debt has been issued without sufficient fiscal backing.

As we mentioned, this is a common mistake. How many times have you heard people say, “Well, I guess we were wrong about the debt. We thought something would have happened by now with this super level of debt to GDP, but nothing has happened”. What do you mean, “nothing has happened”? We just lived through the sharpest burst of inflation in forty years, an inflation that many economists confidently insisted would never materialize or would be transitory.

Our point here is that we shouldn’t say that we have accumulated tons of debt and nothing has happened. Our recent inflation was the expression of our fiscal problem. Inflation is what happens when investors recognize that the government has flooded the system with nominal liabilities that future policy is not positioned to support. And while Tyler may think inflation is in the past, it’s worth remembering that inflation isn’t back to where the Fed believes it should be. It’s also ticking back up. Also, interest rates are higher than they were when economists said interest rates would always stay low because investors would always buy as much debt as we would sell. Foreign investors have reduced their share of holdings of US debt. In the last year, we have had a bunch of weak auctions. And, never mind that countries can usually borrow at low rates until they can’t (more on that later).

If you ignore all the signs that we should worry about the trajectory of our debt, with the exception of interest rate levels, then it creates a dangerously false sense of security about the underlying fiscal trajectory.

Also, as classical liberals, as economists, as policy scholars and as Americans, we should want to prevent all the harmful consequences of and bad policies resulting from excessive debt, including lower growth, higher inflation, bracket creep, higher taxes and erosion of savings, not just the cinematic ones involving bond traders screaming on CNBC because of a default. And we don’t get any comfort from knowing that the government could have access to the nation’s private wealth and turn it into fiscal resources.

It is precisely because of the likely consequences of having all this unfiscally backed debt, including future taxes and more inflation, that we should care about the trajectory of our debt now. Tyler’s posture here echoes the critics who mocked us for our warnings about interest-rate risk a decade ago. They insisted that because rates were low, borrowing was cheap, and anyone who worried about debt accumulation was being hysterical. Yet the fact that rates were low didn’t mean interest payments wouldn’t get so big as to become a problem, and certainly never guaranteed they would stay that way. Way back then, we could see the trajectory of the debt, and even with low rates, the trajectory of interest on the debt and the impact on growth (all those things that Tyler shrugs off as deadweight loss). That’s why we called the accumulation of debt during good times irresponsible.

The same is true here. If the prediction is that higher taxes, financial repression and inflation are in our future as Tyler and Alex predict, then we do have a debt problem.

This is true, even if, of course, there is a chance that growth, thanks to AI or other factors, can put us on a better path.

The Misreading of Signals: Real Rates, Inflation, and Market “Calm”

Tyler’s central comfort comes from one observation: with inflation at 3% and nominal yields around 3.4%, the U.S. is borrowing at a real rate under 1%, and therefore “the market is telling us this is okay.” His conclusion, “it couldn’t look better”, depends entirely on believing that low real rates reflect fiscal strength.

If you accept this reasoning, then it shouldn’t matter if nominal borrowing costs climb to 4%, 5%, or 6%, as long as inflation matches them. By that logic, any country could solve any debt problem simply by letting inflation run hot enough to keep real rates low. (Obviously, we think this is a bad idea). But also we know from history this is not how the world works. In the 1970s, high and persistent inflation didn’t keep real borrowing costs cheap; it forced investors to demand even higher nominal yields to compensate for uncertainty and inflation risk. And, by the way, rates remained high long after inflation had gone. Governments do not get to borrow indefinitely at low real rates simply because they tolerate inflation. Markets adjust—and often strongly—when they lose trust in fiscal discipline.

Greece could borrow cheaply until one day it couldn’t. In 2021, inflation expectations were well anchored until they weren’t. Markets said there was no problem until the moment the problem revealed itself. As Arnold Kling reminded us back in 2010, a man falling off a roof can say “so far so good” all the way down, but the absence of extreme pain at the midpoint is not evidence that he will land gently.

There is also the obvious danger that this comfort amounts to a blank check for fiscal dominance. If we tell politicians that as long as inflation is high enough, the debt is “sustainable,” we invite Congress to use inflation as a substitute for real budget choices. That is a path to political and economic instability, not reassurance.

Even if we assume (generously) that real rates stay at 1% indefinitely, a heroic assumption, math alone tells us that with a primary deficit of roughly 6% of GDP, the debt ratio still rises by 5 percentage points per year. And that’s before recessions: in downturns we run double-digit deficits. Tyler’s relaxed attitude toward real rates ignores the arithmetic of long-run compounding.

The Wealth-to-Debt Argument: Comfort by Accounting Trick

Tyler’s claim that a 200% debt-to-GDP ratio is only a 40% debt-to-wealth ratio—and therefore comparable to a household mortgage—is both irrelevant and misleading. If we are going to switch from flow metrics to balance-sheet metrics, then the federal balance sheet must include all federal liabilities, including the present value of unfunded Social Security and Medicare obligations—roughly $200–300 trillion depending on the discount rate. That yields a liability-to-wealth ratio not of 40%, but between 130% and 200%. The numbers immediately stop being comforting.

But the deeper fallacy is conceptual: private wealth is not federal fiscal capacity. The government cannot and will not confiscate private assets to fund its promises. Saying “America is wealthy” tells you something but not everything about the government’s ability to run primary surpluses. And it tells you nothing about the cost we will pay the day it resorts to these measures. It’s that potential future we would like to avoid by worrying today about the debt.

Nominal Yields: The 2010s Are Over

Tyler’s suggestion that low nominal yields will persist is also a gamble on forces that no longer exist. The 2010s were defined by insatiable foreign demand for Treasuries, global deflationary pressures, and demographic stagnation. Those forces are weaker today. It was this same belief in permanently low nominal rates that led Larry Summers and Jason Furman to assert in 2020 that markets saw a 72% probability of near-zero or negative rates five years out. They were wrong. The 10-year Treasury has averaged over 4% for the past three years.

Markets can be wrong about interest rates. The advantage markets have over governments is that they eventually adjust.

Conclusion:

The real danger in Alex and Tyler’s framing is that it lulls us into complacency precisely when vigilance is most needed. The past 4 years have already signaled a warning that they claim has not arrived. Markets might look calm today, especially if you overlook the inflation we just had and still have, as well as other signs. More importantly, calm is never a verdict; it is a phase. If we care about preserving prosperity, avoiding arbitrary wealth transfers, restraining the growth of government, or preventing the next inflationary surprise,not just avoiding a US default, the time to act is now, not when the roof has already fallen in.