US Government Deficits and Bonds: America can’t go broke. It’s worse than that
Exploring the nexus between government spending, the bonds market, domestic entropy and global financial fragility
Prefatory comment: In previous essays I have to varying extents touched on questions of American government spending, the bonds markets, the nature of its financial institutions and such like. In response to queries from readers, what follows is a more structured and reasonably comprehensive exploration of these rather complex issues with a focus on questions of American government financial operations and their institutional linkages into the financial system and political economy. Domestic and international dimensions are discussed. The basic argument is that all the handwringing about America on the cusp of going ‘belly up’ under a mountain of unsustainable debt is off the mark. There is no technical insolvency risk. The problems are worse than this.
Scott Bessent’s recent assertion that the U.S. government cannot default on its debt obligations to the bond markets got tongues wagging. The impending need to rollover and refinance some $8 trillion of Treasury bonds has commentators speaking of untold impending financial meltdown. Ray Dalio argues that the U.S. is on the cusp of going broke. Moody’s recently downgraded the US Government on the back of solvency concerns.
This essay responds to all of this ‘Chicken Little’ diagnostics with some monetary reality. I say ‘Chicken Little’ not to underestimate the severity of the American economic and financial problems, but to draw attention to the fact that talk of ‘solvency’ is a misplaced diagnosis. Unsurprisingly, therefore, the prognostics is also off the mark.
The public debate over U.S. government debt is dangerously off course. The prevailing narrative - that America is drowning in unsustainable debt and risks insolvency - is empirically false and institutionally illiterate. The United States, as the issuer of its own sovereign currency, cannot involuntarily default on its debt. That fundamental fact renders fears of bankruptcy incoherent. Interest payments can always be made in dollars that the government itself creates.
But that doesn’t mean there are no problems. It simply means that we’ve been looking in the wrong direction. The problem the U.S. faces isn’t government solvency. It’s economic and social entropy.
Let’s break it all down by way of some direct questions and answers. What follows explores the key issues through 18 Q&As. The focus is on government spending and bonds, and the mechanisms and networks of circulation that are embedded in the nexus between government spending on the issuance of US Treasuries. I do not explore the place of private credit creation, and why arguably, this is where there are even more severe systemic stresses and fragilities. I hope this Q&A format helps readers understand what is at stake and what isn’t. Debt is a loaded word, often invested with strong moral overtones, but what it means within the economic system depends on the legal and institutional character of debt and its effects.
Flushing out the issues
Q1: In the U.S. institutional environment, where does the first dollar come from?
A: There are two principal sources of new money into the circulation system. They are:
Congressional appropriations - that is, when Congress passes a spending bill, it authorises the Treasury to spend by instructing the Fed to credit bank accounts. This creates new government-issued money.
Commercial bank lending - that is, banks create money when they extend credit. This is endogenous money creation, as loans create deposits.
In both cases, new money is introduced into the economy. No prior stock of money is required, just legal authority (in the case of government) or creditworthiness (in the case of banks). Put plainly what we understand to be money does not exist prior to its creation by way of Congressional appropriations or by credit creation by legally authorised chartered banks.
Q2: Why does the Treasury issue bonds if appropriations already create money?
A: Treasury bond issuance is not a funding necessity but a legal and policy choice, rooted in legacy frameworks. Legally, the U.S. Treasury is required to match its net spending with bond issuance due to statutes like the Public Debt Act and the requirement to maintain a balance in the Treasury General Account (TGA) at the Fed.
This requirement reflects a carryover from gold standard thinking, when gold reserves were (supposedly) needed to back spending. But even under the gold standard, central banks and chartered banks created credit well beyond their physical reserves. The system has always had a fiat dimension.
Today, the link between deficit spending and bond issuance is arbitrary. The government could spend without issuing debt securities; it simply chooses not to. It does so because of laws that Congress passed decades ago. What Congress passed, Congress could change. This choice to not change from this system benefits capital markets and institutional investors who rely on Treasuries as safe, interest-bearing assets. I will return to this feature or effect later.
Q3: In this system, is money actually scarce? If not, why do people insist the government could run out of money or default?
A: Money is not inherently scarce in a fiat monetary system. It is created by policy decisions, either by Congress (public money) or banks (private credit). The idea of the government “running out” of money is a category error, confusing households or firms (which must earn or borrow) with the issuer of the currency. The government ‘owes’ what it itself creates. Let that basic proposition sink in. It has foundational ramifications to the mental model of how reality actually works.
The persistence of this myth reflects:
A deep cultural legacy of gold standard thinking;
Political narratives that emphasise fiscal “discipline” while obscuring distributional politics; and
A misunderstanding of the monetary system’s accounting logic.
Q4: What happens if private markets refuse to take up U.S. government bonds on issue? Does that imply a loss of “market confidence”?
A: The fear that financial markets might one day “refuse” to buy U.S. Treasuries is a recurring theme in various fiscal narratives. But in reality, there is always a buyer of last resort: the Federal Reserve, which can purchase Treasuries directly or indirectly, and foreign central banks, which can support purchases through various mechanisms. The issue, as always, is that there’s never a ‘free lunch’.
There are three key stabilising channels:
The Federal Reserve’s secondary market operations. While the Fed is technically restricted from buying directly at Treasury auctions, it can and does purchase massive quantities of Treasuries in secondary markets. This ensures price stability and liquidity for U.S. debt markets even if private demand weakens.
Legal flexibility and emergency tools. During financial crises or fiscal dislocations, the Fed has used Section 13(3) emergency powers to backstop markets, create SPVs, or provide direct liquidity. The distinction between primary and secondary markets can be administratively blurred in practice, making direct support feasible.
Allied central bank cooperation. The Fed has currency swap lines with other major central banks (e.g. ECB, BoJ, BoE), which can be used to create synthetic demand. A central bank abroad can issue its own currency to purchase dollars via swap lines, and then use those dollars to acquire U.S. Treasuries. This creates a liquidity recycling circuit - a “daisy chain” - where foreign public institutions support U.S. bond markets without relying on private investors.
In short, a failure of private bond market uptake does not imply an imminent fiscal crisis or default scenario. The institutional infrastructure of dollar hegemony and central bank coordination eliminates the risk of technical insolvency. What’s at stake isn’t the government’s ability to fund itself, but the political economy of who holds the bonds, who receives the interest, and how the system’s stability is maintained.
Q5: If the government cannot voluntarily become insolvent, what does it mean to say that the debt is “unsustainable”?
A: The claim that U.S. federal debt is “unsustainable” is misleading when used in a financial sense. The government is a monetary sovereign; that is, it issues the currency in which its debts are denominated. It cannot go broke, unless it chooses to default. And that’s a political decision.
Common metrics like the debt-to-GDP ratio imply a household-style constraint, but these ratios are only meaningful as political signals or in reference to inflation, distributional effects or interest rate dynamics. They don’t go to questions of solvency. There is no meaningful upper limit on government debt in nominal terms. Sustainability, in this context, is not about whether the government can pay, but about the effects of how it pays and who benefits. I come back to these below. Questions of sustainability come back to bite in other, far more serious, ways.
Q6: What are the financial implications of commonly cited “debt-to-GDP” ratios?
A: These ratios are often used to imply a limit or constraint; but in a fiat system, they do not represent a solvency threshold. Japan’s debt-to-GDP ratio is over 250%, and markets still view Japanese government bonds as in effect risk-free. The real implications of high debt-to-GDP depend on factors such as:
The composition of the debt (who holds it, on what terms);
The interest rate relative to growth (who’s accumulating real gains and by how much); and
The distributional consequences of interest payments (why does it matter who gets what?).
So long as the government controls its currency and inflation is stable, these ratios do not signal financial unsustainability.
Q7: If interest rates rise and the government must refinance maturing Treasuries, is this a sustainability problem?
A: Not in terms of solvency. The U.S. government can always pay interest in dollars it creates. However, rising rates affect other things. For example, they cause mark-to-market losses for existing bondholders. They also shift more interest income toward wealthier asset holders, exacerbating inequality. They can, as such, crowd in bondholder wealth at the expense of productive or redistributive spending. And, lastly, they can tighten financial conditions for households and firms reliant on private credit.
So the issue isn’t whether the government can pay. The real issues are about distributional effects, economic priorities and political choices.
Q8: What are the distributional effects of rising interest rates and bond market dynamics?
A: Higher interest rates transfer wealth to existing bondholders, who receive higher yields, from the general public, through increased debt service costs (indirect taxes, reduced services) and higher borrowing costs. Bondholders benefit from higher yields. They are not at risk; they gain more income. This perpetuates inequality with baked in financialisation. Rising rates also inflate the value of bond portfolios for those already holding large financial assets, accelerating wealth concentration. Meanwhile, small savers or low-income households get little benefit and may face higher costs. Households and enterprises with variable-rate debt suffer, especially those with limited income growth.
The federal government can always pay, but the proportion of spending going toward interest increases, unless offset by monetary operations or fiscal balance changes. Financial markets may reprice other assets, leading to credit tightening, asset sell-offs, or instability.
The impacts are distributional and systemic, not existential. So the real issue isn’t government sustainability but the inequality and fragility built into the current structure of credit, debt and asset ownership.
Q9: Conversely, if the Fed lowers interest rates now, how will that affect the attractiveness of U.S. Treasury bonds, especially in the context of refinancing maturing debt?
A: A rate cut by the Federal Reserve will make existing Treasury bonds more attractive in the secondary market, but it will not necessarily support the attractiveness of new bond issuance, especially when large volumes of maturing debt must be refinanced. The main effects are:
1. Existing Bonds Benefit (Secondary Market Rally):
Lower rates increase the market value of existing bonds with higher fixed coupons;
This creates capital gains for current holders and stimulates trading activity; and
Investors seeking safety and price appreciation may pile into older issues, increasing liquidity and speculation in the secondary market.
2. New Bonds Become Less Appealing (Primary Market Challenge):
Newly issued bonds will carry lower yields, making them less attractive to income-focused investors;
At a time when the Treasury must refinance trillions in maturing debt, this could pose a problem: private investors may demand compensation elsewhere (e.g. in other asset classes or currencies); and
The gap may need to be filled by the Fed itself or allied central banks, reinforcing their role as buyers of last resort.
There are, however, structural implications. While rate cuts reduce government borrowing costs in accounting terms, they may weaken demand for new issuance, especially in an environment of high issuance volume and declining global confidence. The U.S. ends up increasingly reliant on public or politically aligned institutions to absorb its own debt, which could be read as a sign of deeper systemic fragility rather than as a marker of financial strength.
Therefore, a rate cut will boost the price and trading of existing bonds, but undermines the yield appeal of new issues, making it harder to attract private capital for refinancing needs without central bank intervention.
Q10: Without market discipline (i.e., bond markets enforcing limits), won’t unconstrained government spending inevitably cause inflation?
A: This is the central trope of monetary conservatism: that government spending, left unchecked, will devalue the currency and drive inflation. But both theory and historical evidence reveal that this claim is, at best, ambiguous, incomplete and often just wrong.
The conventional view is that bond markets act as a brake on fiscal recklessness. In mainstream models, bond markets are seen as enforcing fiscal “discipline” by penalising excessive spending with higher interest rates. The idea is that without this check, governments would overspend, flooding the economy with money and triggering runaway inflation.
As simple and alluring as these claims are, however, this model assumes that inflation is always and everywhere a function of money supply, ignoring the role of real resource constraints, market structures and institutional dynamics. It also assumes that bond market reactions reflect underlying economic fundamentals, when in fact they often reflect narrative shifts, herd behaviour, or policy expectations. In recent decades, we’ve seen massive fiscal expansions (e.g., post-2008, COVID relief) that did not lead to sustained inflation - until supply chains were disrupted and energy shocks hit. Japan has run high deficits with little to no inflation for over two decades. The Eurozone, by contrast, imposed austerity and experienced stagnant growth and deflationary risk. The key point is that government spending doesn’t automatically cause inflation. What matters is what the money is spent on, and whether the economy can absorb that spending productively.
Ironically, even Austrian economist Ludwig von Mises, no champion of fiat money, acknowledged that inflation was ultimately about relative scarcity. He criticised the view that inflation can only be fixed through deflation, and argued that the production side of the economy must be the focus. The takeaway is that inflation results from excess nominal demand relative to real supply, not simply from the presence of government spending.
In a fiat system, money is not scarce. What, arguably, is scarce is productive capacity, labour, energy, infrastructure and coordination. Inflation happens when nominal demand outpaces what the economy can actually produce or deliver in the short term. Therefore, the way to control inflation isn’t to cut spending blindly, but to expand productive capacity: invest in logistics, renewable energy, public transport, housing, health and education. Inflation is not about money alone. It is about how, where and when money enters the economy and whether the economy is structured to respond by generating additional real output. Market “discipline” via the bond market is a crude and regressive tool.
Q11: If Congress fails to pass appropriations (e.g., due to hitting the debt ceiling), and the Treasury in effect voluntarily defaults on some payments, what are the implications and likely responses?
A: A failure by Congress to raise the debt ceiling or pass appropriations in a timely manner can result in a technical default. This is not because the U.S. lacks money or the capacity to pay, but because it has legally tied its own hands. This kind of default is a political failure, not a reflection of financial insolvency. However, it can still have serious short- and long-term implications, both domestically and globally. For example:
1. Short-Term Implications:
There will, unsurprisingly, be the risk of market shock: Even a short-lived default could trigger extreme volatility in bond markets. U.S. Treasuries are widely used as collateral for global financial transactions; their perceived safety underpins much of the modern financial system. A default, even temporary, could force margin calls, dislocation in repo markets, and heightened credit spreads globally;
Then, we have the risk of the flight to safety… somewhere else, anywhere else: Ironically, some investors might still buy U.S. Treasuries in a panic (as happened in past debt ceiling episodes), but others may shift to gold, the Euro, or even other sovereign debt (e.g., German bunds or Japanese government bonds), reducing U.S. influence in capital markets;
Let’s not forget the possibilities of downgrade and repricing: Credit rating agencies could downgrade U.S. sovereign debt. This may increase borrowing costs for the Treasury in future auctions and force institutional investors with strict rating requirements to reduce holdings; and
There’s always the domestic fallout: The Treasury might have to prioritise payments, delaying salaries, benefits, or vendor payments. This would act as a form of backdoor austerity, hurting households and businesses that rely on federal flows.
2. Medium-Term Institutional Responses:
First, there’s Federal Reserve intervention: In the event of market dysfunction, the Fed could stabilise markets by buying Treasuries, even defaulted ones, if necessary. While the Fed is not legally allowed to fund Treasury operations directly, it has broad powers to maintain financial stability. These powers were exercised creatively in 2008 and 2020; and
We can expect to see global Central Bank coordination: Friendly central banks in particular may step in with swap lines and coordinated interventions to prevent a liquidity spiral. Some might even act as indirect buyers of Treasuries, in a “daisy chain” fashion discussed earlier;1
3. Long-Term Structural Implications:
Loss of credibility is a real challenge for a system that depends on credibility: Even if a default is short and patched over, it chips away at the presumed neutrality and reliability of U.S. government debt. Over time, investors may demand higher yields or reduce reliance on Treasuries as their reserve asset of choice;
The reserve status of the US dollar and the dollar system is likely to erode further: The global dollar system functions on trust. It is not based on some commodity or metals base nor is it founded in fiscal surpluses. If that trust erodes, alternative global monetary arrangements (e.g. multipolar reserve assets or CBDC blocs) gain appeal; and
Domestic reforms will be forced onto the domestic agenda: Repeated crises may force a constitutional or legislative reckoning. This could involve abolishing or revising the debt ceiling entirely (which U.S. President Donald Trump has just flagged support for), restructuring the appropriations and bond issuance relationship (to which I return below), and revisiting the role of the Fed and Treasury in stabilising long-term fiscal-monetary coordination.
A technical default is not evidence that the U.S. government is “broke” or fiscally insolvent. The risk is not that the U.S. “runs out of money”, for the simple and straightforward reason that it creates the money it owes. The risk is political. Erosion of trust in U.S. institutions, both from within and abroad cannot be ignored. The dollar’s strength is in part a bet on U.S. governance. When that breaks down, the entire architecture is at risk. This is compounded by material realities that a growing proportion of global cross-border transactions involve states other than the U.S., further reducing any objective need for the use of the dollar as an intermediary currency. I’ve discussed the evolution towards currency multipolarity on many occasions.
Q12: If global confidence in U.S. Treasuries and the U.S. dollar begins to erode, forcing the Fed and allied central banks to absorb more Treasury issuance, what are the implications for the U.S. domestic economy?
A: While the U.S. cannot “go broke” in a technical sense due to its monetary sovereignty, a forced pivot to rely more heavily on internal demand for Treasuries carries serious domestic consequences. These consequences are economic, social and political in nature. The challenge is not financial insolvency, but systemic fragility born from the misallocation of capital, worsening inequality and eroding international leverage.
Let’s not forget that when the Fed or other domestic institutions absorb a growing share of Treasuries, it means more interest payments are effectively recycled to the top of the wealth pyramid - that is the rentiers; the bondholders, institutional investors and banks. This leads to a regressive fiscal distribution, whereby the government, through interest outlays, channels public resources toward already capital-rich entities, exacerbating inequality.
Public investment also becomes politically constrained; or at least there’s a heightened risk of this being the case. The more the Treasury market becomes a domestic artefact, the more politically visible deficit spending becomes, especially if critics argue the Fed is “monetising the debt.” This perception can fuel austerity pressures, even when the real constraints are distributional or productive, not financial e.g., concerns about crowding out real investment or stoking inflation. As such, the public sector becomes hesitant to fund long-term infrastructure, education, health care, or climate transition programs, even though the capacity exists.
Inflation management can also become more blunt and punitive. As the Fed absorbs more Treasuries, its balance sheet remains bloated, complicating interest rate policy and liquidity operations. Raising rates in such an environment has disproportionate effects. Households with variable-rate debt suffer, while bondholders gain. It becomes a tool that hurts the poor while enriching the asset-holding class. The Fed risks being trapped between underwriting fiscal stability and trying to cool inflation without clear fiscal coordination.
Perversely, the structural reliance on financial assets is reinforced. If Treasury markets are increasingly sustained by public and semi-public institutions, it means that the price of the most important asset in global finance is being managed more directly. This results in further financialisation of the economy: the expansion of credit and investment gets increasingly linked to central bank behavior, not underlying productive capacity. Market participants take this as a green light to chase leverage and speculative gains, deepening the divide between finance and the real economy.
All of this builds pressure on the social contract. Rising interest income for the wealthy, visible constraints on real public investment, and a narrative of fiscal limits (despite monetary reality) produce perceived and real unfairness. This fuels political polarisation, cynicism about governance institutions, and opens the door for populist narratives that channel anger away from structural reform. The result is a slow drift into social entropy; that is, a breakdown in institutional trust and political cohesion, despite the theoretical availability of policy tools to address these issues.
Q13: Some analysts now suggest the U.S. may eventually need to implement capital controls. Is this plausible, and what would drive such a move?
A: While the idea of capital controls in the United States may seem unthinkable in today's liberalised global finance regime, it is becoming a topic of serious (if still marginal) speculation. That alone signals how far the system has drifted from presumed stability. Capital controls would not be implemented casually, but in a context of dollar erosion, retreat from USTs, and persistent fiscal-monetary imbalance, the political rationale for selective restrictions could emerge.
So, why would capital controls be considered? If foreign demand for Treasuries collapses, and the U.S. must increasingly rely on domestic institutions (e.g., the Fed, pensions, banks) to absorb bond issuance, there may be pressure to retain domestic capital within Treasury markets. In the face of rising outflows, falling dollar credibility, and domestic inflation risks, capital controls might be viewed as a backstop against financial destabilisation. Controls could also serve to prevent speculative attacks on the dollar or guard against sudden, large reallocations of institutional portfolios away from Treasuries.
Capital controls, in this context, are prima facie unlikely to be a hard firewall. However, they may take the form of macroprudential restrictions on foreign financial flows or offshore dollar liquidity, the introduction of incentives or mandates for domestic institutions (like retirement funds) to hold minimum levels of USTs buttressed by tighter disclosure, taxation, or exit penalties for U.S. capital moving offshore. We may also see dollar-based restrictions on foreign access to key U.S. asset classes, under the guise of national security or financial stability. These would function as soft capital controls, aimed at managing volatility and protecting the Treasury market under strain.
While talk of capital controls remains at the fringes of the public debate, it is conceivable that a more serious debate about capital controls could arise if there is a failed Treasury auction (or series of weak auctions) that requires emergency Fed intervention. Alternatively, persistent dollar depreciation and rising import-driven inflation could raise concerns to a level where capital controls move from the fringes of intellectual discussion to centre stage. We could also see capital controls emerge in discussions in response to a marked retreat by major foreign holders of U.S. debt, especially if coupled with a new reserve asset or currency bloc. Of course, domestic political pressure to ensure “America’s savings serve American priorities” could drive capital control discourse in an environment of fiscal stress and domestic unrest.
All of this is not inconsequential. The imposition of capital controls would signal the end of U.S. financial exceptionalism. It would mark a formal admission that the dollar is no longer reliably self-sustaining as a global anchor. This would likely accelerate de-dollarisation, fragment global capital markets, and undermine U.S. influence over global financial governance. Domestically, it would further bind the economy to the Treasury market, tightening the link between public debt dynamics and private capital availability. If the U.S. moves toward capital controls, it won’t be because it’s “broke”, but because the existing system of global dollar circulation and bond market dependence has entered a terminal phase of dysfunction. The irony is profound: a country that can’t go broke may resort to coercive measures to stop its wealth and credibility from bleeding away.
Q14: U.S. Treasuries (USTs) are widely seen as the bedrock of the global financial system, serving as the benchmark against which other assets are priced. If global buyers lose confidence in USTs and USDs, with demand increasingly plugged by domestic institutions like the Fed and allied central banks via currency swap “daisy chains,” what are the cascading implications for (1) bond values, (2) other global assets, and (3) capital flows?
A: If international confidence in U.S. Treasuries erodes, and global private demand declines, the implications unfold across multiple levels of the global financial architecture. But these implications are not about technical insolvency—they are about value, perception, and the systemic pricing structure that the dollar-dominated order depends on.
Let’s first consider the implications for bond values. As global investors begin to reduce their holdings of USTs, pricing power in the secondary bond market shifts. If the Fed and allied central banks absorb the slack, they may stabilise nominal prices, but this comes at a cost. These purchases are politically and institutionally sensitive, and may be perceived as monetary manipulation or an erosion of “market-based” discipline. This can undermine confidence in the credibility of U.S. fiscal management and monetary independence. Yields may remain elevated, not because the U.S. is at risk of default, but because the market increasingly prices in liquidity risk, political risk, and exit risk. This undermines the “risk-free” status of USTs and weakens their role as benchmark instruments.
What about the value of other global assets? USTs function as collateral in global repo markets and as the benchmark for pricing sovereign and corporate debt worldwide. If their status declines, volatility increases across asset classes. Dollar-denominated emerging market debt becomes more expensive to service and refinance. Risk spreads widen, forcing capital reallocation and often triggering contagion effects, especially in the Global South. Investors seeking alternatives to U.S. assets may shift into commodities, gold, or select currencies, but no like-for-like substitute currently exists. This increases systemic fragility, as asset pricing becomes less anchored to a global standard.
Last but not least, there are implications for capital flows. It is likely that capital will still flow into the U.S., but increasingly through portfolio channels that demand higher risk premia, or into real assets (e.g. real estate, private equity) rather than public debt. Emerging markets may attempt to insulate themselves via capital controls, bilateral swaps, or greater use of alternative reserve currencies, particularly the RMB or Euro. It’s no surprise that ECB head Christine Laguarde has recently talked about the present conditions representing an opportunity for the Euro to play a greater role. This signals a further fragmentation of the global financial order. The dollar’s role as the global reserve currency continues to erode.
None of this leads to U.S. insolvency. But it raises the cost and reduces the autonomy of U.S. fiscal and monetary action. The Fed can still mop up excess issuance, but this process risks accelerating the perception that the dollar is no longer neutral, global, or credible as a store of value. In effect, the U.S. transitions from being the issuer of the world’s premier safe asset to the manager of a domestically supported instrument whose global reach is contracting. This doesn’t collapse the system but it erodes it.
Q15: Given that linking bonds issuance with government spending operations is a legal / policy choice, if we de-link deficit spending from bond issuance, what are the risks?
A: Unlinking the deficit–bond nexus challenges a foundational part of the global financial architecture. There are a myriad of risks and uncertainties. Global bondholders (especially central banks) may, for instance, reassess the value of Treasuries if they believe the U.S. is abandoning fiscal restraint. The dollar’s store-of-value function could weaken, even if it remains a major currency used for trade settlement. Financial markets could see turbulence as the bond market’s size, function or interest rate structure changes.
These are not economic risks in the sense of default. They are geopolitical and psychological risks, centered on belief in the U.S. institutional system.
Q16: So why should we worry about large government deficits at all?
A: Not because of solvency. But there are other reasons why there are serious downside risks to be sensitive to.
Firstly, as touched on already, there are the distributional effects of the existing institutional set-up. Most bonds are held by the wealthy and institutions. Interest payments redistribute public money upward. Rising interest rates disproportionately harm indebted households and small businesses.
There are also serious questions about the use of funds. Money creation is only beneficial if directed toward productive capacity, foundational services and inclusive development. If deficit spending fuels asset bubbles or rent-seeking, it inflates inequality without real economic gain.
This then leads to the core risk, namely social sustainability. If vast fiscal capacity is used to serve capital rather than citizens, the political legitimacy of public money is eroded. Long-term impoverishment of the lower 50% creates political instability, not just economic inefficiency.
Q17: If global trust in U.S. Treasuries and the U.S. dollar begins to erode forcing domestic and friendly central banks to absorb more of the issuance, what are the implications for other countries, especially those in the Global South or with heavy dollar exposure?
A: The global financial system is structured around the U.S. dollar and the instruments denominated in it, particularly U.S. Treasuries. Any sustained shift away from these as the central pillars of global liquidity and valuation would have profound systemic consequences for other countries. The effects are asymmetrical, hitting some harder than others based on their dollar dependencies and external balances.
To begin with, we can expect increased financial volatility and risk premia. Countries that rely on dollar-denominated debt or trade financing will face higher borrowing costs as the perceived stability of the dollar system weakens. This creates financial instability in developing economies, many of which already suffer from fragile capital accounts and pro-cyclical capital flows. As U.S. assets reprice and the demand for safety shifts, volatility in emerging markets increases, even without changes to their domestic fundamentals.
We can then confront risks of dollar liquidity shortages. A weaker global role for USTs means reduced availability of safe dollar assets. This tightens liquidity conditions globally, especially in crises when demand for dollars spikes. The daisy-chain central bank swap system may offset some of this temporarily, but it is a fragile workaround, dependent on political alignment and strategic interests. Countries outside favored alliances or geopolitical blocs may find themselves locked out of swap lines or forced into unfavorable terms.
Then, we have exchange rate pressures and imported inflation risks. If the dollar loses value globally, the currencies of countries with large dollar liabilities (e.g., in foreign debt, energy imports) will come under pressure. These countries may face balance-of-payments crises as capital flees and import costs surge, triggering domestic inflation and social instability.
In this context, we are likely to see the acceleration of monetary and financial fragmentation. Unsurprisingly, the erosion of dollar dominance invites efforts to create regional alternatives, notably through currency blocs, clearinghouses, or digital settlement mechanisms. We are seeing this happen already. The Chinese RMB, for instance, may gain further ground in bilateral trade, especially if backed by state-led guarantees or commodity convertibility. Regional currency zones may proliferate (e.g. BRICS+, ASEAN digital payments), leading to a multipolar system, but one that is more politically fractured and less liquid.
Many developing countries structure fiscal and monetary policy around foreign reserve accumulation, mainly in USTs. If those reserves lose value or liquidity, this reduces policy space and forces difficult choices between inflation control, growth, and external stability. Development plans that rely on stable dollar funding will become more fragile, increasing dependence on multilateral institutions (IMF, World Bank) or regional alternatives (China, EU).
The unraveling of global confidence in U.S. Treasuries and the dollar has significant systemic consequences beyond U.S. borders. While the U.S. does not face insolvency, some other countries may well do. That’s because they cannot issue the global reserve currency and are subject to balance-of-payments constraints.
Q18: Why is the U.S. stuck in a policy and institutional vice, and why is severing the bond-deficit nexus the only real way out?
A: Domestically, the U.S. faces a fork in the road: it can cling to the fiscal orthodoxies of the past - tied to the illusion of financial scarcity and debt “sustainability” - or it can restructure the institutions of public finance to better match the realities of a monetary sovereign in a shifting global order. Failing to make this shift doesn’t lead to technical default. Rather, it leads to a kind of political-economic decay, where the country cannot effectively mobilise its resources to meet public needs, even as nominal “money” is abundant.
The U.S. is trapped between two politically constrained and economically damaging pathways. The current architecture of public finance - where every net appropriation must be offset by bond issuance - forces a false binary between “fiscal responsibility” through austerity and “reckless expansion” through debt accumulation. Neither path offers long-term stability or prosperity, and both are structured by outdated institutional constraints.
Current policy choices are firstly a commitment to austerity to appease bond markets. In a bid to maintain confidence in U.S. Treasuries and the dollar, policymakers may embrace spending cuts or tax hikes to shrink deficits. But this strategy reduces aggregate demand, slows growth, undermines public services and deepens socioeconomic divides, especially in already-struggling communities. The result is systemic entropy: fraying infrastructure, declining living standards and rising disillusionment with American institutions of governance. Political extremism flourishes in such an environment.
Alternatively, policy makers could elect to pursue fiscal expansion under the current bond regime. That is, the government may continue running large deficits to support households, invest in infrastructure or stimulate growth. But under current law, this means issuing more bonds, which increases supply-side pressure on the Treasury market at a time when global demand is softening. This can trigger higher interest rates, growing debt servicing costs and further expansion of central bank balance sheets (via market interventions or swaps with allied central banks). The net effect is a slow erosion of global confidence in the U.S. dollar as a neutral reserve asset, prompting a potential rebalancing of global capital away from U.S. financial instruments. The consequence is not technical insolvency, but reduced American purchasing power, rising import prices, and ultimately a lower standard of living.
Thus, the U.S. is stuck in a structural bind defined by the deficit-bond nexus. This dilemma arises because of a self-imposed legal and institutional arrangement: for every net dollar Congress appropriates, the Treasury must issue a bond to “offset” it.This is a legacy of gold standard thinking, a holdover from when money creation had to be backed (in theory at least) by some tangible reserve asset. But in a fiat currency regime, where the federal government spends by marking up bank accounts at the Fed, this linkage is unnecessary. It’s an accounting fiction that has become entrenched as policy dogma.
The way out is to sever the nexus. The only way to cut the Gordian knot is to decouple fiscal policy from bond issuance. This would mean allowing the Treasury to spend under Congressional appropriation authority without being required to issue debt instruments to match spending. Bonds could still exist as monetary policy tools or savings instruments, but not as a prerequisite for public investment. Such reform would eliminate artificial scarcity of money in the face of real resource needs, and remove the structural channel through which interest income flows regressively to the already wealthy. At the same time, the severing of the nexus would restore fiscal sovereignty, enabling democratic decisions about public spending to be made based on real capacity and social priorities, not market fears.
The real risk to the U.S. is not “going broke.” It is misdiagnosing the nature of its constraints, and in doing so, either gutting its public sector or hollowing out its international position. Without structural reform, every fiscal decision is a zero-sum political contest between austerity hawks and deficit doves, both trapped in the same destructive framework. Severing the nexus offers the opportunity to rebuild a sustainable, inclusive, and resilient domestic economy, while maintaining international credibility through strategic restructuring rather than reactive tightening.
Pulling the Threads Together
The real concern is not government solvency, but structural fragility and distributional dysfunction leading to exacerbated economic and social entropy. The current institutional machinery, anchored by the historical nexus between congressional appropriations and Treasury bond issuance, funnels public money creation through mechanisms that entrench inequality, empower rentier interests and ironically, expose the U.S. dollar to long-term erosion as a global reserve currency.
The core structural flaw is this: the U.S. insists on issuing bonds to match net government spending, even though appropriations themselves create the money. This is a policy choice, not an economic necessity. It is a legacy of the gold standard era, which was never fully real and is now long defunct. Yet the institutional habits remain, sustaining a bond market that disproportionately benefits the wealthy and concentrates financial power. When interest rates rise, as they have in response to inflationary pressures, the bond market becomes even more regressive in its effects. Wealthy holders of government debt receive ever-larger interest flows, while ordinary households suffer under the weight of more expensive private debt and stagnant wages. And if the private sector balks at holding U.S. debt, central banks, including the Federal Reserve and allied foreign institutions, are increasingly forced to step in and sustain the market. This backstop function does not threaten solvency, but it deepens the political and distributional fragilities of the system.
So the U.S. faces a dilemma. On the one hand, if the U.S. responds to the debt “crisis” by embracing austerity, it will constrain aggregate demand, destroy jobs and erode economic capacity thereby repeating the self-inflicted wounds of past decades. If, on the other hand, it continues to expand public spending through the same dysfunctional institutions, it will also amplify wealth inequality and hasten the international move away from the dollar. That outcome doesn’t look like a default; it looks like long-term decline in U.S. living standards and economic power.
Neither path is sustainable. What’s needed is not less spending, but different mechanisms for public money creation and distribution. The system must be overhauled to break the bonds-appropriations nexus, redesign financial flows to serve productive ends, and re-anchor the dollar’s legitimacy not on financial engineering but on real economic value. Without such a structural rethinking, the United States isn’t heading toward a debt cliff. It’s actually drifting into social and economic entropy. The symptoms may not show up in bond yields or credit ratings, but they will appear in rising precarity, political volatility and the fraying of global trust in the dollar. Misdiagnosis will only hasten that decline.
The American Trilemma: Three Roads to Decline
All of this points to a sobering reality: the U.S. is caught in a structural trap of its own making, a trilemma from which there is no painless exit. There are only paths of redistribution, disruption or decay. And from there, possibilities of renewal.
The Austerity Road
The U.S. could chose the pathway of austerity, to demonstrate fiscal discipline and rectitude. If the U.S. chooses this path to satisfy the bond market’s appetite for “fiscal responsibility,” the consequences will be declining public services and infrastructure (already in a parlous state); ongoing rising inequality and mass precarity; slower growth overall and diminished economic dynamism; and consequently, a deeper social entropy as public trust, institutional legitimacy, and political stability erode.
America gets poorer, and the system frays.
The Expansionary Road (Without Reform)
If the U.S. keeps expanding deficits through the current bond-financed system, it drives interest payments to the wealthy accelerating inequality. This also triggers global market backlash, higher rates and currency instability. The dollar’s status may continue to erode slowly or suddenly, but the net effect is the same: American pays more for imports, they pay more for private debt and the country sees its real wealth diluted. Unsurprisingly, social cohesion continues to unravel and existing divisions solidify. (The asset rich won’t be directly affected, of course.)
Again, America as a whole gets poorer and the system frays.
The Reform Road (Severing the Nexus)
If the U.S. takes the bold step of cutting the legal and institutional link between government spending and mandatory bond issuance, the upside is that it regains monetary flexibility and can target investment where it’s needed most. But it also undermines the foundational logic of the U.S. dollar as the world’s notionally neutral reserve asset, backed by a “market-disciplined” Treasury market. This may trigger accelerated de-dollarisation, hasten the rise of parallel financial systems and eventually lead to the need for capital controls. The U.S. becomes just one among many, without special privilege or leverage.
Again: America gets poorer. Over time, American can work at becoming more self-reliant and its political economy reconfigures accordingly.
No Return to the Old Normal
The postwar fiscal-monetary order, built around USTs and the dollar, cannot be resurrected. The U.S. cannot continue to act like a household, nor can it count on markets to underwrite the old illusions forever. The question is not whether America gets poorer. It’s how it does. And as it does, we wonder whether it uses that transition to rebalance, democratise and rebuild, or whether it allows the current institutional inertia to pull it deeper into a vortex of inequality, unrest and decline.
Thanks for Kathleen Tyson for this observation.