The American debt mountain: Sham problem or ticking time bomb?

At first glance, the US debt-to-GDP ratio doesn’t seem that bad on a global scale. In 2023, it was 123% lower than the average of the G7 countries and about half that of Japan, the world’s largest debtor. In Japan, the national debt is as much as 255% of gross domestic product (GDP).

However, in a recent analysis for Cointelegraph, Lucas Kiely highlights why the US national debt should still be a cause for concern.

In this article we explore whether America has a debt problem and, if so, how serious this problem is.

Is there even a debt problem for America?

If you just look at the numbers, you might think there is no cause for concern. After all, Japan has managed to control its growing debt mountain for years. The economy remains stable and the Nikkei 225 index is up about 31% over the past year (as of May 10), outperforming the S&P 500.

Yet the American and Japanese economies are vastly different, and what works in Japan may not work in America.

The biggest difference between the two countries is the composition of their creditors. In Japan, nearly 90% of debt is held by domestic citizens and institutions, while about a quarter of U.S. debt is held by international creditors.

The US must keep its debt attractive to these international investors by offering high enough interest rates, especially as debt reaches increasingly high percentages of GDP, making it riskier to lend to the US government.

Consequences of higher debt

Last year, Fitch Ratings downgraded the US government debt from AAA to AA+. This was dismissed by US officials at the time as “arbitrary and based on outdated data”. Later in the year, Moody’s lowered its outlook for US government debt to negative, which was largely ignored by the market.

Investors should pay more attention to this, because the US cannot afford to let its debt rise to the level of Japan. If U.S. Treasury yields rise, the cost of borrowing will increase, which could put further pressure on the economy.

Fight inflation or detonate the debt bomb?

Japan has also suffered much less from inflation than the United States. Inflation in Japan currently stands at 2.7%, after peaking at just 4.3% in January 2023. This is in stark contrast to the 9.1% that the US achieved in June 2022.

The Federal Reserve is still struggling to control persistent inflation, which makes skyrocketing debt levels particularly dangerous as they could actually fuel inflation.

The standard response to inflation is tight monetary policy. But higher interest rates mean higher interest costs, dissatisfied consumers and – ultimately – a slowing economy. The Fed (US central bank) is dealing with all these problems.

Consumer confidence is starting to falter, America paid more than $1 trillion in interest costs last year, and economic growth in the first quarter of this year was lower than expected.

In fact, the situation is so worrying that there are now rumors of stagflation – a particularly undesirable economic situation in which inflation continues to rise while economic growth stagnates. Here too, high debts pose a problem, as they limit the government’s ability to use its fiscal power to support a slowing economy.

During election years, keeping interest rates high for too long can cause dissatisfaction among voters. Yet both Democratic and Republican candidates seem to prefer to ignore the growing US national debt. Neither party has proposed meaningful policy measures to address this problem.

With a debt-to-GDP ratio now well above 100% and expected to continue to rise rapidly in the coming decades, sooner or later the government will have to pay the price.