Forget fiscal sanity. Stock markets are in a mood to party. They’re surging—and surging not despite U.S. President Donald Trump’s One Big Beautiful Bill Act, but because of it.
Investors should view this euphoria with at least a hint of caution. Sure, the spendthrift OBBBA could goose economic activity in the short run. In the long term, though, it launches the world’s most important economy on an unsustainable fiscal trajectory.
Digging a deeper hole
The bill takes the gaping budget hole that has built up over the past couple of decades under both U.S. political parties and enshrines it as a permanent feature of the economy. According to projections from the non-partisan Congressional Budget Office, the OBBBA will help push the amount of government debt held by the public to a record high by 2029 relative to the size of the underlying economy.
This is a truly remarkable feat. It means the U.S. will soon be carrying a heavier debt burden in peacetime than it did at the end of the Second World War, when it had just finished bankrolling a global battle to defeat fascism.
And the great U.S. borrowing binge shows no signs of slowing down. The CBO estimates that the U.S. federal government will continue to run massive annual deficits, equal to five to six per cent of the nation’s economic output, as far as the eye can see. Within a decade, interest payments could be gobbling up one of every five dollars of federal revenue.
So why aren’t markets having conniptions? Their calm has a lot to do with two letters: R and G.
Taking stock of R and G
In economists’ jargon, R is the return that investors demand on their capital. G is the growth rate of the economy.
When G is greater than R—that is, when the economy is expanding faster than the interest rate on government debt—a country’s debt load is sustainable. Even if its debt load is heavy, it can grow its way out of problems because the burden of carrying existing debt is shrinking in comparison to the size of the expanding economy.
Watch out, though, when R surpasses G. At that point, the interest costs on accumulated debt surpass the growth rate of the underlying economy. Without drastic action, the ratio of debt to gross domestic product begins to rise. The burden of carrying the nation’s debt grows heavier and heavier with each passing year.
For now, markets seem to be living in a pleasant fantasy where G will always remain higher than R for U.S. government debt. They’re not worried because they think the U.S. can grow its way out of problems.
Really? Economic forecasters suggest the U.S. economy is likely to grow by about 4.6 per cent in nominal terms in 2025. (This is composed of roughly 1.7 per cent in real growth plus about 2.9 per cent in inflation.) Meanwhile, benchmark 10-year U.S. Treasuries are yielding around 4.4 per cent. So, yes, G is still higher than R, but the two are awfully close.
If growth stumbles, or if bond yields tick higher because investors balk at buying so much U.S. government debt, then R could move decisively past G—and unpleasantness could ensue.
This should be a matter of deep concern for the stock market. Yet somehow it keeps climbing higher.
At that point, Washington would presumably have to slash spending or hike taxes to restore fiscal sanity. Things could get messy because any combination of lower spending and higher taxes would probably make things worse in the short term by slowing growth even more and widening the gap between R and G. One likely casualty of this slowdown would be the stock market, which is counting on booming profits to justify its record high share prices.
To be sure, this is a scenario, not destiny. Some optimists argue there is nothing to worry about because artificial intelligence is poised to boost the economy’s growth rate. Others point out that Japan seems to shoulder huge amounts of public debt without problems. And still others argue that R rose above G in the U.S. during the 1980s without triggering a crisis.
Unfortunately, none of these objections constitute a get-out-of-jail-free card for Washington budget makers.
For starters, it’s impossible to say what AI’s impact on economic growth will be. Perhaps we should wait and see before banking on big productivity gains.
As for Japan, it is in a fundamentally different position than the U.S. because it typically runs trade surpluses instead of deficits and, until recently, it has been more concerned with deflation than inflation. All of this means it doesn’t have to worry about maintaining the confidence of foreign debt buyers in the same way the U.S. does.
So how about that 1980s precedent for R surpassing G? It is encouraging, but those were different times. When R moved above G during the Reagan years, the amount of federal debt held by the public was less than 40 per cent of gross domestic product. Now it’s verging on 100 per cent.
The U.S. economy also faces much worse demographics than in the 1980s. An aging population means slower labour force growth and higher healthcare costs, both of which pressure the G-R equation from opposite directions.
Spend now, pay later
This should be a matter of deep concern for the stock market. Yet somehow it keeps climbing higher. A cynic might wonder if its insouciance owes something to the time-delayed nature of the OBBBA.
According to the Penn Wharton Budget Model at the University of Pennsylvania, the tax cuts and spending included in the legislation will inject an impressive US$3.2 trillion into the U.S. economy over the next decade, with a significant portion of that being paid out in the first three years.
To put that another way, the OBBBA seems designed to boost the economy for the extent of Mr. Trump’s second term, then leave his successor to deal with the mountain of debt left behind. This strategy probably shouldn’t come as a huge surprise, but it does underline the growing risks in a U.S. economy that seems intent on living for today and ignoring tomorrow.
Ian McGugan writes about markets and economics. His work has appeared in the Globe and Mail, the New York Times and Bloomberg/BusinessWeek. He was founding editor of MoneySense magazine.
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