By Willem H. BUITER &Anne C. SIBERT
America’s financial outlook has darkened under Donald Trump’s leadership. All three major credit-rating agencies now rank US federal debt one notch below triple A, and Jamie Dimon, the Chairman and CEO of JPMorgan Chase, warns of a crack in the US bond market.
With the ten-year US Treasury yield still only 4.41% on June 13, 2025 – while the 30-year rate is at 4.9% – holders of nominal US debt should be prepared for significant real losses.
The principal risk is not US sovereign default, but rather unexpected increases in medium- and long-term interest rates, owing to market expectations higher inflation. Fiscal policy under Trump is unsustainable, as it was under Joe Biden, but even more so if the administration’s “big, beautiful” budget passes in anything like its current form.
The January 2025 Financial Report of the United States Government makes this clear. The US ratio of federal debt held by the public to GDP at the end of the 2024 fiscal year was around 98%, although $4.7 trillion of the $28.3 trillion in federal debt was held by the Federal Reserve – meaning it is erroneously categorized as held by the “public,” when really the central bank’s accounts should be consolidated with those of the federal government.
Under current policy and based on the report’s assumptions, federal debt held by the public would reach 535% of GDP by 2099. Stabilizing the US debt-to-GDP ratio requires that the annual primary federal deficit (excluding interest payments) fall by an average of 4.3% of GDP over the next 75 years.
And yet, the federal deficit and primary deficit were 6.4% and 3.3% of GDP, respectively, in fiscal year 2024 – far above what can be justified with the economy near full employment.
With the US Congress so dysfunctional, no one has any faith that it will deliver the required deficit reduction. Democrats do not do permanent spending cuts, and Republicans do not do permanent tax increases.
The federal government does own about 28% of US land (roughly 640 million acres), as well as other real commercial assets that could yield significant additional non-tax revenues if properly managed.
But neither party – nor even the misnamed Department of Government Efficiency – appears to have considered this option, so the federal deficit as a share of GDP is likely to rise over the next few years.
With no foreseeable improvement in fiscal policy, there are two possible outcomes. First, the government could default. There has long been a small, but recurrent, risk of a technical, short-lived default if Congress fails to raise, suspend, extend, revise, or abolish the federal debt ceiling on time. Fortunately, it has averted this scenario 78 times since 1960, and we expect it to continue doing so.
As matters stand, the debt ceiling (including debt held by federal agencies) is set at $36.10400 trillion, and debt subject to the limit is $36.10397 trillion. If needed, the Treasury has a highly liquid asset (the Treasury General Account held with the Fed) worth $332.9 billion that it can use to meet its obligations; and it may temporarily use “extraordinary measures to continue to borrow additional amounts for a limited time.”
The second, more likely, possibility is that the Fed will monetize enough federal debt to prevent default. Since US federal debt is serviced in dollars, “printing money” is always an option. But, as the Fed well knows, a large-scale monetization of federal debt would result in significantly above-target inflation. We believe the Fed will do this without its operational independence being revoked by Trump.
To get the Federal Open Market Committee to do something it does not want to do, the President would need to control the majority of its 12 voting members. These include the seven members of the Federal Reserve Board of Governors and five (out of 12) regional Reserve Bank presidents who vote at any given FOMC meeting.
Neither the president nor Congress can appoint or fire Reserve Bank presidents. The Board of Governors must approve them, and only the Board can remove them. The president nominates Board members, but the Senate must confirm them.
Board members’ current term limits imply that, assuming none are fired, Trump will have the opportunity to nominate only two new members.
True, with the power to fire Board members “for cause” – meaning “inefficiency, neglect of duty, or malfeasance” – Trump could try to replace a majority of the members with loyalists. But this seems unlikely. Whether the “for cause” criterion has been met will be contested in the courts, and the Senate would have to confirm Trump’s appointees.
Similarly, Congress could revise the Federal Reserve Act to replace the Fed’s monetary-policy objectives with a mandate to buy or sell sovereign debt according to the wishes of the Treasury. But this, too, is unlikely. And the same goes for a scenario in which the Treasury sets a rapidly depreciating exchange-rate target for the dollar that can be achieved only through large-scale Fed purchases of US public debt that generate high inflation.
However, fiscal dominance – indeed, fiscal capture – is very likely, because the need to avoid a domestic and global financial crisis will force the FOMC’s hand.
It will do whatever is necessary to prevent a sovereign default, because the Fed’s financial-stability mandate (the Financial Stability Act of 2010 mentions the Fed 179 times) undoubtedly trumps its monetary-policy mandate of maintaining maximum employment, stable prices, and moderate long-term interest rates.
The Fed cannot credibly threaten to refuse to monetize debt and deficits to compel fiscal retrenchment by the Treasury, let alone Congress. Thus, the Fed will have no choice but to engage in sovereign debt purchases that it knows to be incompatible with its monetary-policy objectives.
With nominal interest rates for medium- and long-term US sovereign debt far below the levels consistent with realistic expectations of future inflation, serious capital losses on nominal debt instruments (public and private) are likely.
The inflation surge could be no more than three years away. As the prospect of fiscal capture comes into view, investing in Treasury Inflation-Protected Securities (TIPS) and other indexed public and private debt instruments will become an increasingly attractive option.
Willem H. Buiter, a former chief economist at Citibank and former member of the Monetary Policy Committee of the Bank of England, is an independent economic adviser. Anne C. Sibert is Professor Emerita of Economics at Birkbeck, University of London.
