Debt Denial Has Always Been a Delusion, Now It’s Dangerous
Previous debt deniers are now joining the fight against reckless government spending
Rogé Karma’s recent Atlantic article, “The Debt is About to Matter Again” is a bracing read, but it feels like déjà vu for those of us who have warned about America’s mounting debt for years. The premise of the article is simple: For many years, people worried about the debt, but that worry was misplaced. But now, it is fair and reasonable to worry about debt again. Circumstances have changed, and we are told it is time to wake up.
Indeed, for more than a decade, prominent economists such as Larry Summers, Jason Furman, and Olivier Blanchard assured us that high debt levels were harmless as long as interest rates remained below the rate of economic growth. As the theory went, when r < g, countries could theoretically roll over debt continuously without the debt-to-GDP ratio becoming unsustainable – more growth naturally reduces the relative size of debt. True enough on paper.
Unsurprisingly, many in Washington saw this as permission to run record deficits, expand entitlements, and launch new industrial policy schemes, all without realistic payment plans. In large part, this is because many – including economists – believed that interest rates had been low for decades and would remain low for the foreseeable future, if not forever. Summers and Furman indeed based their confidence in this theory on perpetually low interest rates.
Jack Salmon and I always considered this assumption dangerous. Even under optimistic scenarios, our debt projections quickly pointed upward thanks to politicians repeatedly promising generous payments to special interests with no credible plan to fund these promises. In addition, most projections of our future debt underestimated the impact that debt itself had on interest rates. Our warning to legislators was that interest rates would eventually rise, as foreign investors would not indefinitely finance our debt at a low cost. That meant that even if interest rates were low at a given time and borrowing was cheap, pretending that unlimited borrowing could permanently fund expanding government spending was always a dangerous assumption.
Even if interest rates never rose, there were still other important reasons to remain cautious about increasing debt. For instance, even when interest rates applied to enormous debt balances are low, interest payments are still significant. Moreover, it's well-known that government spending can distort markets, crowd out private investment, and impede economic growth. A large body of economic literature also demonstrates similar risks associated with high levels of debt itself. Therefore, even persistently low interest rates would not eliminate the serious negative consequences stemming from accumulating such massive debt.
But interest rates did rise, much sooner than anyone expected, thanks to the significant increase in debt during the COVID pandemic and the subsequent reckless spending spree of the Biden administration. Inflation, the fight against inflation, and the fact that much of the Covid debt was paid on the back of bondholders means that we still face higher interest rates than most experts would have predicted only a few years ago.
To be sure, the Trump administration's renewed embrace of tariffs and deficit-financed tax cuts is adding fuel to the fire, but it didn’t start the fire alone – contrary to what Karma implies. But the truth is that today's instability is deeply rooted in both Republicans and Democrats willingly embracing the illusion that borrowing was painless and unlimited.
Even the most optimistic "deficits don’t matter" theories included warnings that policymakers ignored. Blanchard explicitly stated that debt rollovers only work if governments stop running primary deficits, something the U.S. hasn't achieved in over two decades and shows no intention of doing. America now faces debt-servicing costs higher than at any point in modern history. All while, demographic trends are driving Social Security and Medicare spending toward unsustainable heights.
But that’s not all, much of America's debt is short-term. Over half of Treasury securities mature within three years (18%of the debt even has a maturity of less than 3 months). Every interest rate hike, weak bond auction, or inflationary signal immediately increases borrowing costs. This isn’t theoretical; it’s happening now. Interest payments are surging. Treasury auctions are faltering. Foreign demand for U.S. debt is weakening significantly.
Karma warns that America might be headed toward stagflation or a debt-driven financial crisis. He's right. But the recent downgrade wasn't needed to foresee this outcome. For one thing, Moody was late to the game as S&P and Fitch had already downgraded the U.S. years ago. And contrary to Karma’s ideological effort to blame it all on Trump, the real crisis is the bipartisan unwillingness to address the structural drivers of our debt—entitlement promises that we can't afford, coupled with a political class that chooses fantasy over fiscal reality.
Debt always mattered. I should be happy that those who failed to care when the debt build-up was happening are joining the fight now.