The US Debt Gray Rhino Continued: Thinking the (Apparently Not-So) Unthinkable
Are Markets Taking Default Risk Seriously Enough?
On the eve of yet another government shutdown, Washington appears to be no closer to even a short-term (don’t even think about medium to long-term) solution to the ongoing and wholly unnecessary federal debt and budget deficit drama.
Even if a highly unlikely Hail Mary deal materializes before midnight, or a stop-gap measure is reached in coming days or weeks, that’s not going stop the running shutdown showdown cycle that happens every time the federal government needs authorization to borrow and/or spend more money to keep the lights on and meet its obligations.
It pains me to think of how long this obvious, visible, high-impact problem has been looming over the United States, getting bigger all the time. One day –likely sooner rather than later—it is going to trample us.
There are feasible answers to the question, “What can U.S policy makers do to fix the budget deficit gray rhino?” These sensible responses are a long way from the dismal results of the question, “What ARE they doing?”
In this short series on the US debt gray rhino, we’ve gone through potential ways to fix the federal budget deficit and rising debt burden. First, we looked at how to raise tax revenue by growing our way out of debt. Second, we looked at how to raise income via various tax increase options. Third, we played with various options for balancing the budget via spending cuts. There are many viable combinations of these three approaches.
Today let’s look at the fourth, previously all but unthinkable option: that the US government might default on US Treasury securities.
An Unpalatable Menu
The federal government has shut down 21 times over the past five decades when it could no longer borrow or spend –three of those times, including the longest one (35 days) and the shortest (several hours) under a Trump administration. Lest you think I am picking on him: A shutdown under the Obama administration lasted 17 days and another under Clinton, 21 days.
Looking past the immediate crisis, without a credible fix we will just find ourselves in the same place again sooner rather than later.
A default on obligations to creditors in the form of holders of US Treasury bonds could come in various forms, some of which might allow the White House to claim it was not *actually* defaulting.
1) The easiest and most likely: inflation, which would allow the Treasury to repay the debt in devalued dollars. While not technically a default, inflation de facto reduces the real value of what is owed.
2) Financial repression: Requiring banks to buy certain amounts of government debt and cap the interest rates paid, or forcing them to roll over maturing Treasury bonds.
3) The nuclear option: “Making a deal” forcing some sort of restructuring or otherwise reducting liabilities.
With the clock ticking, the White House on September 24 issued a memo to federal agencies to prepare plans for mass firings should a shutdown happen.
A shutdown and delay in payments to employees and to the citizens the government is supposed to serve is one kind of default on obligations. Over recent months, the executive branch also has failed to honor its duty to disburse funds as the legislative branch had directed. It has breached contracts with universities and researchers who are essential to ongoing innovation and this country’s reputation for academic excellence.
No Longer Unthinkable or even Unspeakable
If the government cannot resume borrowing, at some point it would no longer be able to keep current on payments to creditors.
Recall that in late March, the Government Accountability Office and the private Bipartisan Policy Center warned that the US Treasury could be forced to default on its debt obligations by late summer. That did not come to pass. The fact that the previously unthinkable is being discussed openly means that nobody can plausibly call such an event an “unimaginable” black swan.
People ARE thinking it. People ARE talking about it.
Let’s not forget that Donald Trump himself has suggested that the United States could “make a deal” –for example, in a May 2016 campaign speech that rattled the markets, for good reason. (At the time the national debt was a paltry $14 trillion.) To be sure, he also said that he specifically did not mean renegotiating the terms of outstanding Treasury bonds, but rather perhaps buying back debt “at a discount” or printing money. He claimed again in January 2025 that he did not want to see a default.
But Trump has repeatedly downplayed the potential consequences if the US government failed to pay its bills, most recently during the debt ceiling standoff in December 2024. In a May 2023 town hall, he called for a default if President Biden and Democrats did not agree to massive budget cuts, and played down the consequences of a potential default. “It could be really bad. It could be maybe nothing. Maybe it’s a bad week, or a bad day—who knows?”
What Comes Next?
For argument’s sake, let’s say we get another stopgap, bubble-gum-and-shoe-string fix. For now.
The tax cuts for billionaires will show up bigly in 2026 after tax day (though no doubt some are already showing up in estimated payments).
The spending cuts in the July package won’t bite until after the 2026 mid-term elections. So look for the deficit to increase more sooner rather than later.
More inflation definitely is part of Washington’s response to the growing debt.
That is part of why President Trump keeps pushing for the Federal Reserve to cut rates sooner and faster. He has said that rates are at least 3 percent too high.) It’s also why he has been threatening the independence of the central bank – which is a red line in the sand for bondholders.
What might “making a deal” look like? To be sure, Trump has repeatedly denied that he intends to outright default. For argument’s sake, let’s risk taking him at his word -- not least of all because a full-on default would likely lose him the support of some of his biggest backers.
Printing money (ie more money created and pumped into the economy by the Federal Reserve) and/or some kind of debt buyback or swap is more likely.
Trump no doubt understands that the higher interest rates go, the lower bond prices go. So perhaps his logic is that the Treasury (or Fed) could buy the debt back at less than their face value. That technically would lower the federal debt –though we’re talking about buying back a lot of bonds.
But the government would have to pay higher interest rates to borrow to buy back that debt. Unless it forced banks to buy at a lower rate. Or perhaps enticed them with goodies like, for example, changing bank reserve requirements (as happened temporarily around the 2023 bank crisis).
That could destabilize the banking system, already burdened by commercial real estate losses and rising auto, credit card, and mortgage troubles.
See No, Hear No, Speak No Default
So far, financial markets continue to shrug off the political drama and its implications.
They shouldn’t. Remember last spring, when Trumps’s tariffs sent markets into a tailspin? The precipitous drop in prices of stocks, bonds, and dollars helped pressure the White House to delay imposing tariffs and eventually to soften its position. That led to the current —rapidly aging— market rally.
The financial markets could speak again.
That might lead to faster rate cuts, which would slow the rise in the interest cost to the government (at the cost of higher inflation). A serious slowdown could also hold inflation down. But it also would hurt the economy, job market, eventually the stock market, and above all the administration’s public approval –which already is underwater.
A sensible solution to turn the debt situation around is the only thing that could get the United States off this crazy carousel.
Next Up: The Wink-Wink, Non-Nod of Sovereign Credit Pricing