USA: digging an ever deeper hole – ‘big beautiful bill’ prepares crisis of government finance

The past few weeks have brought the US government deficit into sharp focus. After decades of large budget deficits, the banks and insurance companies are starting to worry that even the US government is no longer a reliable borrower.

[To learn more about the implications of unprecedented levels of debt on the world economy, read this article by James Kilby]

Trump’s ‘One Big Beautiful Bill Act’ is estimated to keep the deficit at 6-7 percent of GDP after extending Trump’s first-term tax cuts for top and middle earners. At the same time, inflation remains above target, even if it has come down from its post-pandemic high. This has made banks, insurance companies, pension funds and others worried about future investment.

The bill heavily benefits the wealthiest Americans. The poorest 10 percent each stand to lose on average $1,600, mainly because of the loss of access to medical care. The wealthiest 10 percent stand to gain $12,000.

The fallout from the bill reflects the contradictions in the Trump government. It is one of the reasons for the massive bust-up between Musk, who represents the government's more libertarian, small-government wing, and Trump, who lacks the same commitment.

Musk wants more far-reaching cuts, and he most certainly doesn’t want to maintain a massive deficit. He probably doesn’t see the value of measures like abolishing the tax on tips either. He declared on Twitter:

“I’m sorry, but I just can’t stand it anymore. This massive, outrageous, pork-filled Congressional spending bill is a disgusting abomination. Shame on those who voted for it: you know you did wrong. You know it.”

The Republicans themselves have campaigned for years to lower the deficit. The predecessor to Trump’s movement, the Tea Party movement, was all about reducing the national debt and the deficit through cuts. Musk echoes that sentiment.

Most of the US government budget, however, provides a safety net for the poor, covering up for the pitiful wages a layer of the working class is asked to live on. And this heavily impacts some Republican-voting semi-urban areas. The Republicans and Trump, now in government, are not overly keen on attacking poor working-class Americans.

The cuts that the Bill proposes are very small in comparison to the whole budget, but will nevertheless mean millions of Americans will lose access to medical services.

As one mother from House Speaker Mike Johnson’s Louisiana district put it:

“[My 19 year-old son] has a job. But is the minimum wage going to go up? Is the pay going to go up so he can afford the insurance? Is he going to be able to make enough and live?”

And she added:

“[Johnson] needs to come down on our level and live like we do. He wouldn’t survive, I’m afraid.”

38 percent of the population in Johnson’s district are enrolled in Medicaid. No doubt, Republican Congressmen and women can feel the pressure from the working class, and this is the reason for their reluctance to go on an all-out assault on this layer of workers.

Whereas the cuts are too big for a whole layer of the working class, they are also too small for the US government’s lenders. Such is the contradiction that the US government finds itself in. They are not the only ones.

How central banks bankrolled governments

Ever since 2007, governments have been piling up debt like there was no tomorrow. From 64 percent of the value of GDP (the value of US production in a year), US public debt has now reached 120 percent. In the UK, debt has risen from 36 percent to 100 percent, and in France from 69 to 97 percent. This is in spite of inflation and some economic growth.

The Financial Times, in a recent documentary on the debt crisis, referred to the world as being “addicted to debt”, which is not a bad way of describing it.

The reality is that since the 1980s, contradictions have been building in the world economy, as productivity rises have not been matched by rises in wages. Workers have been squeezed and exploited more and more. In Marxist terms, the rate of exploitation was massively increasing.

The result was that it became harder and harder to find consumers to match the increasing capacity created in industry, because the workers simply couldn’t afford to buy back the products they were making. In other words, the way they got out of the crisis of the 1970s created a massive problem of overcapacity, or overproduction, in the economy.

To solve this problem, lending was massively expanded through deregulation and low interest rates. For example, it became legal in the 1990s for banks to lend to people who they knew could not pay back their debts. All this led to the crisis of 2007-2008 when bad credit caused a collapse in lending.

But as credit to households and, to a limited extent, companies was rolled back, someone had to pick up the slack. And that’s where governments stepped in. Far from following the dictum that governments should stay out of the economy, suddenly they became, as the Financial Times documentary put it, “the consumer of last resort”.

Ever since, governments have run budget deficits like they were in the midst of a recession, even when the economy was growing. The result is that government debt now is as bad as in 1945, at the end of a world war.

At the same time, central banks were keeping the wheels of credit turning with record-low interest rates and money printing (what they called ‘quantitative easing’), which made up for the unwillingness of banks and other institutions to lend money. This kept interest rates down for both corporations and governments, when under normal circumstances they would have shot up.

During the pandemic, this reached ridiculous proportions. Governments in the rich nations turned on the spending taps, and central banks turned on the electronic printing presses. It seemed, for a brief time, like there was free money to be had. It seemed like one could run deficits funded by money printing, and that it would have no consequences. Suddenly, the reformist utopia that the proponents of ‘Modern Monetary Theory’ had been attempting to sell for some time became fashionable.

But it came at a cost, which was seen as inflation took off. If you massively increase the total supply of money whilst production is stagnant, inflation is an inevitable consequence. You have a lot more money chasing the same amount of goods and services.

As a result, central banks had to cut back by raising interest rates and destroying some of the massive amounts of money they had created (which they refer to as ‘tapering’).

A new crisis looming

Now, if large government debts and deficits are just about sustainable at interest rates of 1 or 2 percent, they suddenly become a lot less sustainable at 4 or 5 percent rates of interest. To make matters worse, the central bank has begun trying to sell the government and corporate debt it already accumulated.

Government debt mainly consists of bonds, which are like ‘I Owe Yous’, with a date by which they must be paid back and an amount on them. Whenever the bond ‘matures’ – in other words, when it comes due – the government has to issue a new bond and to sell it to some investor. In addition, it has to issue bonds to cover the deficit in the government budget. This is what they call the primary bond market. The secondary market is when the investors sell these bonds to someone else, and that’s typically the market that is quoted in the press.

With the status of the dollar being undermined by US foreign policy and its relative loss of imperial power, this is not as much of a help as it once was / Image: Chairman of the Joint Chiefs of Staff, Flickr

This primary market in itself is massive. Every year before the pandemic, something like $10 trillion (10 thousand billion) of government bonds were created. Now, it is something like $20 trillion. The US alone accounts for half of that. It is estimated that this year it will need to issue $9.2 trillion worth of debt to cover maturing loans and another $1.9 trillion to cover the deficit.

The way in which governments borrow money also means that the interest rate takes some time to feed through the system. The average interest the US is paying at the moment on its debt is 3.3 percent, but any new borrowing will have to be done at 4-5 percent. So with every bond that matures, a new one has to be sold to fill its place at the new rate and the interest payments go up.

Of late, 10-30 year bonds are becoming very hard to sell because investors are feeling unsure about US growth (which is what gives them the room to repay the debt) and the US inflation rate. It is one thing to lend the government money at 4 percent interest if the expectation is that inflation will be 2 percent. It is a whole other thing to lend to the government when inflation is at 6 or 10 percent. If that were the case, it would be safer to put it in some asset like gold or in the stock market, where the value tends to follow inflation.

Furthermore, it is abundantly clear that at some point in the not too distant future there will have to be a reckoning on the budget. In 2024, for every four dollars the government spent, it borrowed one. In other words, to balance the books, they would have to raise income by 37 percent or cut expenditure by 25 percent. Add to that the ever-increasing cost of interest payments. Next year, it is estimated that the US federal government will have to spend $1.1 trillion on interest alone, which is more than one-fifth of all its revenue.

For decades, the US has been able to sustain this deficit on the basis of its large economy, but also because the dollar is a ‘reserve currency’, which leads to a constant flow of money into the dollar, including the bond markets. Being the reserve currency of the world also means that when the US Central Bank prints money, it doesn’t lead to a collapse in the value of the currency, in the way that it would for other central banks.

The fact that the US government, corporations and consumers could borrow at a lower rate than the rest of the world they called the US’ ‘exorbitant privilege’. But, with the status of the dollar being undermined by US foreign policy and its relative loss of imperial power, this is not as much of a help as it once was.

At a certain point, the investors will say: “This is unsustainable, I risk not getting my money back, or when I do, it will be worth a lot less than when I lent it.” In the business press, they have even coined a term for such investors: ‘bond vigilantes’. The fact that Moody’s downgraded the US’ debt rating from AAA – it was the last of the big ratings agencies to do so – is symptomatic.

A recipe for class struggle

Naturally, any attempt to redress this imbalance in the budget would provoke the working class. Already, with these relatively small cuts to medical care, the Republicans are feeling the heat. If they had to carry out the programme of cuts that is necessary to bring finances back on track, they would face a whole different level of pressure.

Already, with these relatively small cuts to medical care, the Republicans are feeling the heat / Image: The White House, Flickr

The same is true of other governments around the world. The British government has taken massive hits in popularity for its attempts to reduce the deficit, and has been forced to reverse course on one particularly unpopular policy. Macron’s government collapsed after he forced through the pension reforms to placate the markets. He has been unable to form a stable government since.

Oliver Blanchard, who was chief economist at the IMF between 2008 and 2015, commented on the French situation: “It may well require the kind of crisis that makes people sit down and be willing to accept cuts.”

In other words, he doesn’t believe that any French government will be able to avoid a debt crisis, and it will require such a reckoning to get the books balanced. The same very much seems to be the case in the USA.

The means the ruling class has of dealing with the debt are all unappetising. They can raise taxes, typically on the slightly better off layer of the working class, which would mean a significant cut to their living standard. It would also reduce the ability of this layer to consume, buy cars, holidays, etc. Thus, it would threaten to push the economy into recession.

They can, of course, carry out cuts to the welfare state. But after 15 or so years of austerity, many public services are on the brink of collapse. More cuts would definitely push them over the edge.

There are more unorthodox solutions, which they are now openly discussing. For example, they could inflate away the debt by printing money, thereby stoking inflation. Incidentally, the only time government debts shrank since 2008 were in the years of 8-10 percent inflation.

But such a policy would also wreak havoc on whatever fragile political stability there is. Maintaining significant inflation over a long time would destroy savings. It would ruin the pension funds and insurance companies that rely on interest for much of their income. And it would provoke massive class struggle, as workers fight to maintain their wages, eaten away by inflation.

In this sense, the whole of the economic crisis finds its expression in the crisis of government finances. It is, on the one hand, a reflection of the crisis, but it is now also increasingly a source of instability in the economy as a whole. If the world has been relying on governments to keep the wheels of the industry turning, it is clear that they will soon no longer be able to do so.