CNBC Special Report: America's Deficit Reckoning 7/7/25

0:29Hi, I'm CNBC producer Cameron Costa. just about how to fix it. But what could happen if we don't? Take a listen.

0:39There's no shortage of voices sounding the alarm about the national debt. Our fiscal situation is a 350-pound, two-pack-a-day smoker on the ICU table. The U.S. federal budget is on an unsustainable path. We're going to be broke really quickly unless we get serious about dealing with our spending issues. I do believe that fiscal policy needs to be put on a sustainable course. The U.S.'s borrowing levels are currently the same size as the entire economy and are expected to skyrocket from here. That's because America spends way more than it brings in and then borrows to cover that deficit. And there's plenty of debate on how to close that gap, raise taxes, cut spending, a combination of both.

1:27No doubt, any solution demands hard choices. But what are the actual consequences if the deficit gets out of control? I often liken this to the invisible dog fence, where you really don't want to hit it, but you won't know until you do. And it seems like the U.S. is almost intent on finding out where that tipping point is. That's Maya McGinnis of the Committee for a Responsible Federal Budget. Business leaders, politicians, economists, investors almost all share a common fear that the U.S. is playing with fire when it comes to its deficit, but less clear what the actual ramifications look like if we reach that tipping point.

2:05This is CNBC's goal here, to explore not how to fix the deficit, but rather what happens if we don't. Over the course of five months, we interviewed a dozen people for the project and even more off the record. We surveyed everyone from former Treasury Secretary Robert Rubin to PIMCO CIO Dan Iveson to former Chairman of the Joint Chiefs of Staff Michael Mullen about what they think will happen if the deficit gets out of control. We dug into the empirical research and the history of how we got here. We took the pulse of a Gen Zer who's among the younger generations that will likely face this issue head on if it's not reconciled soon.

2:42To begin, we'll share with you the backdrop in context of our debt. Then we'll tackle the potential fallout related to three key areas, the markets, the U.S. economy, and international relations. I'm Leslie Picker from CNBC, and this is America's Deficit Reckoning. The U.S.'s borrowing levels are about the same size as the entire economy. In just four years, the ratio is expected to exceed the historical peak It reached right after World War II and skyrocket from there. But debt in America is nothing new. It has been central since the beginning. In 1776, a committee of founders secured funding for the Revolutionary War by borrowing from France and the Netherlands.

3:27The first U.S. Treasury Secretary, Alexander Hamilton, said, quote, A national debt, if it is not excessive, will be to us a national blessing. The War of 1812, the Mexican-American War, the Civil War, the World Wars, they were each funded at least in part through public debt. But up until 1969, the U.S. at least aimed for budget surpluses, especially when there wasn't a war or economic crisis or other type of emergency. That changed under President Richard Nixon when deficit spending became the mainstay. The 70s were ripe with volatility, the deficit in part to blame, and yet the government kept running up its tab over the next few decades.

4:111990, 1991 were periods when there was a lot of uncertainty about our economy. I remember I was at that time co-senior partner at Goldman Sachs, and a lot of our clients were very uncertain what was going to happen, and deficits played a big role in that. This is Robert Rubin. He advised Bill Clinton on his presidential campaign, the transition, and later joined the administration. He ultimately served as the 70th Treasury Secretary. Rubin says the deficit was always a key focus. I'll never forget, we had a meeting of the economic team, what would be the incoming economic team, and we sat around with the president-elect, and we had a debate about fiscal policy, and at some point he looked at us and he said, this is a threshold issue.

4:54It's going to be difficult politically, but this is what we have to do, and that is indeed what we did. What was it that made him say that? What was it that made him realize the magnitude and the importance of the issue? He was deeply steeped in economic issues because he focused on these for many, many years. So I don't think it was that he came to realize something. I think that what we had to debate was other purposes that you can serve and then deficit reduction. And we wound up with a balance, which was the Deficit Reduction Program in 1993, which which was adopted by Congress, which was a combination of deficit reduction and at the same time had some room for the public investment that all of us felt we should do.

5:36In 1998, President Clinton announced the first balanced federal budget since 1969. Tonight at midnight, America puts an end to three decades of deficits and launches a new era of balanced budgets and surpluses. The surplus was short-lived. Since then, the U.S. has had several rounds of tax cuts, multiple expensive wars, a financial crisis, and a pandemic. If you look at how we got here from when we had budget surpluses, it's very, very roughly about one-third from tax cuts, one-third from spending increases, and one-third from emergencies. Those emergencies were the right time to borrow, the other two not so much.

6:17So there's lots of blame to go around. And the situation is becoming more dire by the day, says Kent Smetters. his team at the Penn Wharton Budget Model found that the U.S. has a maximum of 20 years to fix the deficit. Fiscal policy is not sustainable. The economy essentially blows up in the sense that there's so much debt under current law that fixed income markets, bond markets basically will collapse. If Congress really doesn't get its act together and try to figure out some grand bargain that solves this problem, then there's only one mathematical way of getting out of this, and that is for some type of default to happen.

6:59Smeter says there are two types of defaults. There's an explicit default, meaning the Treasury doesn't make full payments on its interest. Most economists believe that's extremely unlikely because before that happens, the Federal Reserve would step in. If Congress doesn't fix it and Treasury doesn't default, mathematically the only option left is that we pay back the debt by printing more currency. In other words, there's essentially no chance the U.S. goes bankrupt. Here's former Fed Chair Alan Greenspan from 2011. The United States can pay any debt it has because we can always print money to do that.

7:38So there is zero probability of default. And Berkshire Hathaway's Warren Buffett from 2020. If you print bonds in your own currency, what happens to the currency is going to be a question because you don't default. Now, this is a privilege that the U.S. and some other large economies enjoy. When you issue debt in your own currency, you have the option of creating money to pay back borrowed money. That's not the case for smaller economies like Argentina and Greece, which have each gone through technical defaults and sovereign debt crises. So if the U.S. can't actually go broke, why should anyone take these levels of debt seriously?

8:23If the Fed can just print money and solve the problem, why should anyone care about an implicit default? After all, we've heard for years that this is an issue, and so far, nothing has happened. I asked this question to former Treasury Secretary Rubin. I've said this before, a different moment, because we are on the threshold or on the cusp of this uncharted territory we've never been in before. I think that these dangers are real, and I think all of the discussion that has taken place in the past, although it hasn't had an effect at the time, maybe, hopefully, somewhat better prepares us to deal with what might lie down the road.

8:59The concern is that excessive money printing could lead to inflation, which would push up interest rates, and that could create issues in the bond and foreign exchange markets, slow down the economy, and suck up too many resources to pay that interest. The current Treasury Secretary Scott Besant has said that the issue is a top priority of the Trump administration. When I look in the mirror, I see a deficit hog. Secretary Besant's goal of bringing the deficit-to-GDP ratio down to about 3 % is one that McGinnis of the Committee for a Responsible Federal Budget applauds. I like the goal set up by the Secretary of Treasury, which is bringing our deficit down to 3 % of GDP.

9:39I think that Secretary Besson's goal of 3 % of GDP is both an ambitious one and a doable one. We'd have to save about$7.5 trillion over a decade. But so far, the deficit trajectory appears to be headed in the opposite direction, thanks to the tax and spending legislation that just passed. The nonpartisan CBO estimates that the One Big Beautiful Bill Act would increase the deficit by trillions over the next decade. Absent the hard work of budgeting, are there other ways to chip away at the deficit? The Department of Government Efficiency aimed to cut costs by$2 trillion, a goal quickly reduced to$1 trillion and then just$150 billion, which skeptics say is still too optimistic.

10:23Even the libertarian think tank, the Cato Institute, recently said, Doge was never going to close the deficit without Congress. Former Secretary Rubin is also skeptical. I think Doge is not a thoughtful, I think it's a massively counterproductive effort for all kinds of reasons, the effect it can have on our growth and our economy and standards of living and everything else. Furthermore, the debt ceiling is supposed to keep the debt in check, but it's been raised 90 times since 1959. In fact, the debt ceiling doesn't actually limit spending, but rather it authorizes the Treasury Department to fund commitments the government has already made.

11:05In recent years, the debt ceiling has been weaponized for political purposes and has yet to meaningfully address the nation's fiscal situation. McGinnis says this is emblematic of the, quote, "...dangerously polarized moment we're in where partisan politics seem to be far more important to lawmakers than actually governing." It's going to be very difficult to turn this fiscal situation around without also looking at the underlying political challenges and huge levels of partisanship that are really keeping us from making any of the difficult but clearly necessary choices that we should be making in governing.

11:39Representative Jody Arrington, a Texas Republican and chair of the House Budget Committee, recently wrote in a Wall Street Journal op-ed, quote, Washington has a surplus of possible avenues, but a deficit in political will to get the job done.

11:57This year, the budget deficit is estimated to surpass 6 % of GDP. That's about 63 % higher than the average level from the past 50 years, a particularly severe statistic considering there's no recession or war or natural disaster that justifies the spike. Most investors, particularly bond investors, are on alert right now because budget deficit levels are starting to become uncomfortably high. Let's dive into the potential market fallout that could stem from the future fiscal picture. What do you think the likelihood is that the U.S. does experience a crisis related to its deficit or debt levels?

12:37I think that there's more than a 50 % chance that in three years, give or take a year or two, that we will experience a trauma if we don't deal with this. Ray Dalio has been a global macro investor for 50 years, known for starting Bridgewater Associates, the world's largest hedge fund. He says he's been concerned about government debt levels since the financial crisis in 2008. But over the last couple of years, they've become more problematic in his view. I think of myself being very much like a doctor and a mechanic that is looking at that. I watch the plaque build up in the system, and I watch the numbers, and I have not said before, I always said it was unhealthy, but I have not said before that the supply-demand picture is a very serious picture as it is now.

13:35So it was really over the last, I would say, three years as we started to see the mechanics that I felt really compelled to explain the mechanics. Dalio recently wrote a book, How Countries Go Broke, studying debt bubbles and busts. He says he's found patterns across 750 markets that have existed since 1700. Drawing from that research, Dalio says the U.S. is showing classic signs of the later parts of the cycle, given the supply and demand dynamic of the nation's debt issuance. You start to see that there's a supply-demand problem and a debt-maturity problem. In other words, the supply that's going to be produced by deficits is greater than the demand for that debt.

14:21These are classic signs that happen in that progression. So that one gets by following these numbers and seeing these things, one can see that progress like watching somebody having a heart condition or circulatory system condition. You can measure those things and you can see right now it's getting very severe. To fund a growing deficit, the U.S. government has been issuing more treasuries. But introducing additional supply into the market often pushes down bond prices and increases rates. When demand doesn't match supply, investors insist they get paid even higher rates to buy the debt, making the cost of borrowing more expensive.

15:07Investor jitters stem from concerns about an implicit default. Smetter says even the prospect of cranking up the printing press to pay back our debt could instigate a bond market revolt. I tell policymakers in D.C., you might have your big, beautiful plan, but fix income markets through the Mike Tyson. You might have your big, beautiful plan until you get punched in the face because they often are not polite. They often just break instead of bend. Here, Smetters details what goes on in the mind of a bond investor as debt levels rise. I know that now interest payments by the government are going to go up in the future.

15:42Well, how are they going to make those interest payments? They're going to pay me back. I also know they're going to crank up the printing press to pay me back. So now I say, you know what, I really need a much higher return in order to, that is even lower price, in order to make that investment. But if I'm really smart and other investors in this market are smart, they're like, but wait a minute, how is the government going to cover that even higher interest payments in the future? They're going to crank up the printing press even more. And so if we're smart, we come back and say, oh, therefore, I should want even a lower price.

16:22And that's where this price spiral comes from. And that is the price goes down. It's a confidence issue. It's a confidence issue. In this scenario, treasury prices would go lower, yields higher, and the dollar devalued. Inflation would spike with the additional money in circulation, and all of this volatility would bleed into other markets, according to Dalio. It would be bad for both the bond market and the dollar. Okay. And those markets, the bond market and the dollar, they're one and the same in that a debt is a promise to receive currency. You know, in other words, the money. And you hold, if you're saying I'm holding a currency, you hold it in the form of debt.

17:09And so that will be devalued, and that'll be devalued to produce inflation pressures and so on. That market is the backbone of all capital markets. So if you devalue that, you're going to see the effects on all markets, and that'll be very disruptive. Edgar Denny first started noticing this bond investor behavior in the 1980s. Ten years prior, there had been raging inflation, and many of them had lost a ton of money. So this time, they were on guard for the next spike. There was a lot of fear among investors that they could get burned again. And as a result of that, I coined the phrase bond vigilantes with the notion that if the Fed and the government weren't going to be responsible, weren't going to be the sheriffs in town to manage the economy in a way that would keep inflation down, that the bond vigilantes would do it.

18:10Yardeni wrote in his newsletter then that the vigilantes were concerned about a$200 billion deficit. Today, the levels are 10 times that. The bond vigilantes are more powerful than ever. And the question is, are they going to use that power, that extraordinary impact that they could have on the bond market, which is now more important than ever? and push bond yields up to levels that cause a recession in order to bring inflation down. One country that experienced a mini budget crisis in the fall of 2022 was the United Kingdom. Liz Truss, who was then the prime minister, unveiled a plan to cut taxes by 45 billion pounds without a way to pay for it.

18:52I have a bold plan to grow the economy through tax cuts and reform. Immediately, the pound collapsed. Investors dumped U.K. bonds. The local pension funds were forced to sell to manage their risk, all of which threatened a downward spiral. The Bank of England had to come in and stabilize the market, and the government quickly undid the tax cuts. But Prime Minister Truss never regained credibility, and she resigned after just six weeks in the role. I have therefore spoken to His Majesty the King to notify him that I am resigning as leader of the Conservative Party. But can that type of crisis where the market quickly loses confidence happen in the U.S.?

19:35It's a risk that we think remains low. This is Dan Iveson, the group CIO of the world's largest bond manager, PIMCO, which oversees$2 trillion. If we don't see signs of attempting to get debt under control, those probabilities of a more crisis-level type situation occurring will steadily go higher with time. And then again, when people worry about these tail scenarios, including PIMCO, we want to get paid a little bit more to combat against those types of risks. I know that back in December, PIMCO said it was cutting exposure to long-dated U.S. debt because of deteriorating deficit dynamics. Can you explain more about your positioning there and just your overall concern as it pertains to the deficit?

20:21The U.S. continues to be the global reserve currency. We have an incredibly dynamic economy. We have very strong institutions. So we will likely continue to attract a significant share of global capital. We do see other countries' sovereign debt that looks at least as good as the rate levels of the United States and is running much more prudent overall fiscal policy. So we're not running from U.S. treasuries. We're just looking to diversify. When Iveson says the U.S. is the global reserve currency, what he means is that the dollar is widely used outside of the U.S. It's a big part of global trade, it's held by central banks, and it's the currency of choice for many international transactions, in everything from oil to gold.

21:08This privileged status allows the U.S. to borrow more cheaply because the dollar's wide-ranging use means there's steady demand, even when the fiscal picture is messy. Most economists believe the U.S. will continue to hold the largest reserve currency share, but it's been declining in recent years, and the status depends on continued confidence in the dollar and treasuries as safe havens, or places to part capital when times get tough. When you talk to clients abroad, how often do they bring up the U.S. deficit? Very interesting question, and I travel a lot. When I go to Asia, was there late last year, it's by far the single biggest question that I get.

21:51Probably in nearly every meeting, it's top of the board in terms of questions. They are confused as to why the U.S. economy can be so strong. And despite significant economic strength, we can still be running deficits in that 6 % to 7 % range. Our answer is usually that, hey, yes, it's a concern, but we likely have some time on our hands. But it's a reminder that these are global markets. And if we don't show signals that we're addressing the fiscal situation over time, those investors that are asking the questions may look for answers that involve a little bit less investing in U.S. government securities.

22:29And of course, that will have fallout, as we talked about in other areas of the capital markets. Is there almost a moral hazard, though, given that, you know, because the U.S. is the reserve currency. They won't default necessarily on their obligations. They'll just print more money. I mean, does that create kind of a unique dynamic? And what does that mean for someone who is a tremendous investor in U.S. treasuries? It's either moral hazard or some form of complacency because we do have the significant advantage of being the global reserve currency. And sure, you've seen some diversification over the last several years away from U.S.

23:11dollar denominated investments, particularly foreign central banks, at least have slowed the pace of acquisition of U.S. treasuries. But there's still tremendous confidence in the United States in this idea of U.S. exceptionalism. And perhaps because of that, you haven't had the same type of political catalyst to address the deficits. But up until now, and we still think, although there's an increased focus on deficits, it's probably not sufficient. And we probably need to see a little bit more volatility or some other type of catalyst to get us to seriously think about the debt picture. Economists try to estimate how much investors want to be compensated for longer-term risks, such as the federal budget and inflation.

23:55It's called the term premium. If the term premium is rising, It may mean that investors are experiencing more uncertainty about macro conditions, whereas if it's declining, there's likely more stability. It's not a perfect statistic and models tend to vary. But in January, the term premium hit its highest level since the post-financial crisis era. It's pulled back a bit since then, but remains elevated. J.P. Morgan chairman and CEO Jamie Dimon recently offered a warning. You are going to see a crack in the bond market, okay? It is going to happen. I just don't know if it's going to be a crisis in six months or six years.

24:33And unfortunately, it may be that we need that to wake us up. It's an unfortunate thing. Moody is lowering its credit rating on the United States debt one notch to AA from AAA due to increasing government debt and interest payments. In May, Moody's became the third major ratings agency to downgrade the U.S. from top-tier status. Americans often see immediate benefits from policies that widen the deficit, things like tax cuts and spending increases, making them politically popular. So then, why should everyday Americans be concerned about the deficit? This is the question I asked former Treasury Secretary Robert Rubin.

25:12I think that's a very difficult issue because it's not obvious to people. how it affects their standards of living, how it affects the economy, how it affects jobs, how it affects wages. But it does. It can profoundly affect all of this because it can affect our economy, the health of our economy, and the growth of our economy. Let's dig into exactly how the deficit impacts the U.S. economy. We will be in very shortly into the highest debt-to-GDP ratio, ratio of our debt to our economy that we've been in our history. And it is decreasing very rapidly. If you go from 100 % 130 to 135 percent over 10 years.

25:51That's an immense increase. And we've never been in that territory before. Yeah, I think it has multiple risks. What do you think those risks are? One is that it affects interest rates. And I think that's probably a little bit now, but maybe not. But I certainly think that's a material risk as you go out in time. It can affect business confidence. I don't think it is now. But once again, we saw that once before, and I think you certainly have a material risk as we go out in time. Our resilience, our ability to deal with emergencies, geopolitical or economic, it can affect those. And it can affect what is called crowding out.

26:29That is to say, the more capital the federal government is, or the larger claim on our savings that the federal government is making because of our deficits, the less capital is there available. But the private sector now manifests itself in higher interest rates. And finally, and ultimately, if we don't deal with this, we run the risk of a fiscal crisis. What does that look like? Well, nobody knows what it looks like. We haven't had one of those. But I think what it looks like is rapidly escalating interest rates, a deep concern about our economy and our markets and interest rates around the world.

27:08instead of global capital coming into the country, which it has now for such a long, long period of time, global capital moving out of the country. And then a very serious, at least potentially, a very serious adverse effect because of all of that on our economy, on growth, on weight, on standards of living, and the economic well-being of average Americans. Why is the debt-to-GDP ratio skyrocketing? Well, demographic shifts and pricier health care have caused Social Security and Medicare costs to soar. These are mandatory outlays, federal spending required by law, deepening the hole. How much the government is paying to service the debt?