This government faced a budget mess, and with it a difficult road ahead. Our debt/GDP is close to 120%, the level of an emerging market in crisis, held together by the US dollar which remains a major reserve and trading currency, and by the importance and relative stability of our economy and financial markets.
Our government is still running massive deficits – the kind of deficits you might encounter during a recession or war, not during a time of GDP growth. And we are now at a point where the interest costs on our national debt exceed our defense spending. As historian Niall Ferguson’s eponymous Ferguson’s Law says: “Any great power that spends more on debt servicing than on defense risks ceasing to be a great power.”
Given that higher interest rates mean higher debt service costs, and that we need to finance more and more debt, refinancing trillions of dollars of debt this year, President Donald Trump is right to be concerned about interest rates.
But there is no free lunch.
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Kevin Warsh, former Governor of the U.S. Federal Reserve, during the Spring Meetings of the International Monetary Fund and the World Bank at IMF Headquarters in Washington, DC on Friday, April 25, 2025. (Tierney L. Cross/Bloomberg via Getty Images)
Although the Fed has lowered its target interest rates, this is more directly related to interest rates at the short end of the yield curve (i.e. short-term Treasury bonds). The market controls the long end of the curve (i.e. government bonds with longer maturities, such as the 10, 20 and 30 year maturities). And we have seen that those returns remain stubbornly high.
Ultimately, some form of yield curve control (measures that lower and maintain yields on longer-term bonds) will likely be needed. If we continue to see our interest costs rise, it will lead to a larger deficit. That means more debt financing, which will drive up interest rates, make interest rates more expensive again and create a debt spiral until the US and global bond markets are thrown into turmoil.
But as we have seen with Fed interference and government overspending, there are costs associated with Fed interventions. The price paid will likely continue to inflate the asset (on a nominal basis). While we need this because the value of stocks and homes declining over time would likely directly and indirectly lead to a decline in government revenues (also called tax revenues), it has the same effect of widening deficits and exploding the cost of debt. This again means that action will be taken.
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This is also why Fed Chairman Kevin Warsh’s positioning as a hawk (someone who favors tighter Fed policy) versus a dove (someone who favors looser monetary policy) doesn’t really matter. Our budget situation and basic calculations will force him and the Fed to somehow intervene in the markets and cut rates.
The price paid for keeping our fiscal house together will likely be inflation. This will continue to erode the purchasing power of the US dollar and drive a bigger wedge between the wealthy and the middle class in America.
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But intervention is only a temporary solution. It takes time, but it doesn’t solve the problem.
Unless government spending is reduced, not just by cutting interest costs, but across all categories, or growth is so high that the deficit is eliminated in both scenarios, the core problem will not go away. It is only held back for a short time and then we find ourselves in the same situation again.
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Our government is still running massive deficits – the kind of deficits you might encounter during a recession or war, not during a time of GDP growth.
And if you’re familiar with Congress, there doesn’t seem to be any political will in any of the major political parties to spend money within an actual budget.
So yes, interest rates are a problem, as is government spending. Warsh will be forced to help whether he likes it or not, and we will all pay a price.
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