Trade War Relief, but Debt Cycle Haunts Markets

Bessent’s and Trump’s comments on the trade war with China have caused a reversal in markets, but is it going to last? The US government currently has debt reaching levels that seem unsustainable combined with rising inflation. If the government continues borrowing and spending the way it has, we’ll likely see a future where prices keep rising, interest rates climb, and the value of assets continues to grow. So, what does this all mean for the economy as a whole?

The pattern we’re seeing now isn't new. For decades, the US has followed a predictable path of increasing its debt over about 40 years, only to try to pull back and reduce it in the next phase. Right now, we’re at the tail end of that borrowing cycle, and it’s clear that it’s time for the government to start cutting back. However, with inflation already at higher levels, this “deleveraging” process is likely to be messy. In fact, the road ahead may involve rising inflation and higher interest rates, which we’ve already started to see in recent years.

In the past, the US could easily get away with borrowing more money. Low interest rates meant the government could continue taking on debt without worrying too much about the consequences. This worked well for a long time. Think of it like an individual taking on a mortgage, knowing that interest rates will continue to drop. So, the government kept borrowing more, hoping it could refinance debt at a lower rate down the road.

But that’s no longer the case. Now, the debt-to-GDP ratio in the US has reached over 120%, and inflation is no longer something that can be brushed off. The usual way of refinancing debt at lower rates is no longer an option. Each new dollar borrowed only adds to inflation, and interest rates are rising as lenders demand higher returns due to those inflationary pressures.

After World War II, the US found itself in a similar spot. Back then, the government faced ballooning debt and used a method called “yield curve control” to keep borrowing costs low. But in today’s world, there are no immediate economic growth boosters like there were back then. Without the same productivity boom or global growth we saw post-war, things look a lot different now.

At first, there was hope that the current administration would tackle the issue of runaway spending. Some even hoped the government would reduce spending by trillions of dollars. But that plan has been all but abandoned. Instead of massive cuts, we’re now seeing a modest reduction of about US$150 billion. What’s more, defence spending, which is one of the government’s biggest expenses, is expected to increase by US$1 trillion. This reversal of promises is concerning, especially given the size of the deficits.

The US government’s deficit for 2024 was already at US$2 trillion, and projections for 2025 show it could climb to US$2.6 trillion (about 9% of the country’s GDP). This rising debt means interest rates on US government bonds are climbing as well, putting even more pressure on the economy.

While the tax cuts are a step in the right direction for individual taxpayers, they’re not enough to solve the larger problem of the deficit. Until the government can control its spending, the deficit will keep growing.

As the government tries to deleverage, the likely result will be a continued rise in inflation, higher prices, and climbing interest rates. This could be one major reason gold has been rising so aggressively. Just in the last four months, gold has risen roughly 34%. This could be considered astronomical even in the scope of a year, but it has only happened over several months. 

The US is heading into a period of prolonged debt accumulation and inflationary pressures. The government’s current fiscal path seems unsustainable and unlikely to change dramatically.