$40 trln US debt: Gray rhino and black swan

The yield on 10-year US Treasury note officially reached 5 percent on Sept 15. By Oct 8, it had risen to 5.22 percent. With total US government debt already exceeding $40 trillion, the consequences of a sustained rise in Treasury yields could be far-reaching, both for the global and the US economy.

US Treasury yields serve as the benchmark for pricing a broad range of financial assets and debt instruments, from mortgages, auto loans and student loans to corporate bonds. They also influence equities, gold and cryptocurrencies. A rapid rise in Treasury yields could therefore trigger volatility across US financial markets and spill over into global markets.

The increase in long-term yields comes amid persistent inflation concerns and expectations of tighter monetary policy. The average rate on 30-year US mortgages has reached around 7 percent, increasing borrowing costs for households. Higher global interest rates could also put pressure on tech stocks and add uncertainty to the global economic recovery.

The International Monetary Fund has warned that higher bond yields in advanced economies could push up global interest rates and financing costs, tightening external financing conditions for developing economies and potentially squeezing funding for infrastructure, healthcare and education.

The 10-year Treasury yield also briefly exceeded 5 percent in October 2023. Separately, US government debt has roughly quadrupled from around $10 trillion during the 2008-09 global financial crisis.

The US gradually emerged from the financial crisis during the 2010s through fiscal stimuli and quantitative easing. The economy returned to positive growth, with average GDP growth of 2.4 percent during the decade. Yet stronger economic growth did not prevent the accumulation of government debt.

By the end of the 2010s, US national debt had approached $20 trillion. Over the following decade, tax reductions, increased government spending and the fiscal response to the COVID-19 pandemic contributed to another sharp expansion in debt. US government debt subsequently surpassed $40 trillion in 2026.

This means that, within roughly a decade, the US added another $20 trillion in debt. The pandemic was the most significant negative economic shock during this period, pushing the annual fiscal deficit above $3 trillion. Even after the pandemic, however, large fiscal deficits continued, keeping government debt on a rapid upward trajectory.

The numbers highlight the scale of the challenge. If government debt doubles over 10 years, nominal GDP would need to grow by roughly 7 percent annually just to prevent the debt-to-GDP ratio from rising further. Whether such a growth rate is achievable for the US economy remains an open question.

The recent rise in Treasury yields, in my view, reflects growing investor concern over the sustainability of US public finances. For decades, US Treasury securities were regarded as the world's premier risk-free asset. Holders of US Treasury securities include the Federal Reserve, sovereign wealth funds, hedge funds and financial institutions around the world.

As the supply of Treasury debt continues to expand, the question is no longer simply who wants to buy US debt, but who can continue buying it and in what quantities. The scale of refinancing is already enormous. About $10 trillion of US government debt is due to mature in 2026, while annual interest payments have also exceeded $1 trillion. Managing debt of such magnitude presents a new challenge not only for the US Treasury, but also for global capital markets.

The deeper problem lies in the government spending side. The traditional emphasis on balanced budgets, particularly cyclical fiscal balance, has weakened. Even in the absence of a major economic shock, government spending and fiscal deficits have remained exceptionally high.

Fiscal expansion has increasingly become a structural rather than temporary feature of the US economy. Once high levels of spending and deficits become entrenched, reducing them can be difficult, as doing so may involve significant economic and social adjustments.

This creates a vicious cycle. Higher deficits require additional borrowing, while a larger debt stock leads to greater interest payments. Rising interest expenses, in turn, put further pressure on the fiscal balance and can increase the need for additional borrowing.

This is the key reason why the growth of US government debt has proven difficult to contain. Fiscal policy is influenced not only by economic cycles, but also by long-term spending commitments, institutional arrangements and changing policy priorities. As a result, fiscal consolidation has become increasingly difficult.

Efforts to improve government efficiency have also struggled to fundamentally change this trajectory. The size of the US government and the complexity of its spending structure make substantial and sustained cuts in expenditure difficult to achieve.

The question of how far US government debt can continue to expand has therefore become increasingly pressing. In recent years, theories based on liquidity management, including modern monetary theory, have argued that a government issuing its own currency can continue to roll over its debt as long as inflation and interest rates remain under control. Under this framework, the absolute size of government debt does not necessarily impose a hard limit.

Financial markets, however, may not fully accept such an assumption. The downgrades of US sovereign debt by major rating agencies reflect concerns about the country's long-term fiscal position and could gradually weaken the special status of US Treasury securities in global markets.

A potential liquidity crisis would be the "black swan", a sudden event that remains difficult to predict and currently appears unlikely. But the rapid expansion of US debt has already become a major systemic threat to global financial markets.

US Treasury debt has become deeply embedded in the global financial system. It is not merely a source of government financing; Treasury securities also serve as collateral, liquidity instruments and foundational assets across global capital markets. Their influence extends into virtually every corner of the world's financial system.

This creates a paradox. The more deeply Treasury securities are integrated into global finance, the greater the potential impact of a disorderly sell-off. If a major holder of US Treasuries were forced to sell bonds to achieve liquidity, stabilize its currency or address fiscal pressures, the resulting market tumult could extend well beyond that individual economy.

Markets may be more concerned about the possibility of a broader US debt crisis and its transmission into the global financial system than about a stand-alone liquidity event.

The expansion of US government debt has occurred alongside the growing role of Treasury securities in global finance. As Treasury instruments have increasingly served not only as a means of financing fiscal deficits, but also as tools for liquidity management and short-term financing, their supply and use have expanded considerably.

Treasury securities are no longer simply instruments used to finance government spending. They have become a foundational component of global bond markets and a key part of the financial infrastructure supporting liquidity and collateral operations.

Yet this growing importance also means that fiscal risks can increasingly be transmitted through financial markets. Persistent deficits and rapidly expanding debt could gradually weaken confidence in the creditworthiness of the US government. Treasury securities could move from being viewed as an unconditional safe asset toward one whose safety increasingly depends on fiscal and market conditions.

The critical risk may therefore emerge during the next major financial crisis. If investors simultaneously sell US Treasury securities in order to raise cash, global markets could experience a synchronized withdrawal of liquidity. Under such circumstances, the US Treasury market could shift from acting as a stabilizer to amplifying market volatility.

The $40 trillion threshold is therefore more than a symbolic milestone. It represents the cumulative result of years of fiscal expansion, persistent deficits and the growing role of US Treasury securities in the global financial system.

The key question is not just how large US government debt can become, but how long global markets can continue to absorb its rapid expansion without a major adjustment. The "gray rhino" is the increasingly visible fiscal sustainability risk; the "black swan" would be a sudden event that causes those accumulated risks to materialize across the global financial system.

For the US and the global economy, the challenge is therefore not only managing the size of government debt, but also preserving confidence in the financial system built around it.

The writer is a professor at the Institute of Economics, Chinese Academy of Social Sciences, and deputy director of the Center for Xi Jinping Economic Thought Studies at the Chinese Academy of Social Sciences.

The views do not necessarily reflect those of China Daily.