Last week, the total debt of the United States Government passed $40 Trillion in face value. This is a milestone impressive for its size and distressing in its implications. It took only five months to go from $39 to $40 Trillion. The total was $38 Trillion five months before that. In fact, as recently as 2018 the total debt stood at $20 Trillion. Covid played a part in this. The problem is that post covid, the trend is accelerating. At the end of July, the government deficit stood at $1.8 Trillion for the fiscal year ending September 30, 2026. This is in a way understated, as billions of dollars will be needed to resupply the munitions spent in the Iran War since it was launched in February. The cost of missiles and shells had been booked in prior years when they were made.
Interest in the government debt is now $600 billion. It is the third largest budget item after Social Security and Medicare. Interest rates are rising across the board, with the longest dated bonds now demanding yields of 5.3%. There has been a program announced by the Treasury to buy back the longer dated bonds in an effort to flatten the yield curve.
This is not the same thing as coming up with a way to reduce the deficit. Scott Bessent, who is credited with coming up with the idea of long-bond purchases, has been likened to the Dutch boy who tried to stop the collapse of a dike by putting his finger in a hole to keep the water from flowing in. Implicitly, issuance of debt of shorter maturities has increased in response to the long-bond purchases. If interest rates do keep going up, the government will feel the higher cost more quickly as short-maturity debt is being rolled over more quickly than longer-dated bonds.
There are four ways a government can address this situation. To the uninitiated, the favorite political chestnut about “eliminating waste, fraud and abuse” has been substantially discredited as not material. Besides, if eliminating criminal behavior were a goal, then why were thirteen Inspectors generals, whose jobs it was to do this very thing, let go and not replaced among the first acts of this administration?
The second way is to return taxes to their pre-2017 levels. The third is to reduce spending. The fourth is to encourage inflation. Under inflation bonds, most of which are denominated in nominal (not inflation-adjusted) terms, are repaid with inflated dollars, which buy less than they did when the bond was issued.
If of any comfort, rising government interest rates seem to be a world-wide problem among most of the wealthier countries. Other governments are grappling with similar issues of record government bond issuances and deficits. These issues are often brought on by demographic trends. Then there is the matter of the AI infrastructure buildout, which is competing with the government for borrowers. However, in terms of size and scale, the US debt stands alone. Japan also has high amounts of government debt, but most is absorbed by the country’s savers.
Until last year, the US could rely on foreign governments to buy US debt, using the dollars accumulated in trade with the US. Unlike investors, governments by and large did not demand competitive interest rates on their bond investments. Once the US started its trade wars with the world, foreign governments through their treasuries let their US bonds mature and did not purchase new bonds. This has been one of the sources of upwards pressure on interest rates. The situation where we imported other countries’ goods and exported our inflation is no longer in effect. This has put the US Treasury in the unenviable position of not only needing to sell ever larger amounts of debt but have a shrinking market to sell to.
The best way to increase the size of the debt market is to increase the amount of interest paid per bond. This is anathema to the idea of decreasing the size of the budget deficit. If bond yields were increased to a level to attract domestic demand, the loss of economic activity would surely generate a recession of some magnitude.
If something is not done, we could go the way of Argentina or other Latin American countries that restructured their debt and have budget restrictions placed on the country by the International Monetary Fund (IMF). Such a move would be both an irony and an embarrassment. The United States set up the IMF after World War II to reform the economies of countries in need of the same. It was never envisioned that they would need such reform themselves.
The Economy
Economic activity drifts along, pushed by the AI buildout and deficit spending, and held back by rising interest rates which have hurt housing and, less obviously, business spending.
AI is continuing to be built out, although there is much political incentive to slow down its growth. People do not understand the benefits to them. Server farms hire relatively few people compared to the dollars invested, electricity and water used, etc. There is some concern about what is gained besides property taxes when such a project is built in a given community. Fears of higher electric rates, water shortages, etc. are issues that need to be addressed.
As interest rates rise, the increase in mortgage rates approaching seven percent has caused several people to not pursue house hunting. At the same time, older homeowners do not want to give up equity by lowering the price. In a similar vein, companies are weighing the cost of capital expansion and even whether the market will be there given interest rates and tariffs making forecasting difficult.
Inflation
Inflation has been in part hostage to the Iran War, as oil prices drive the cost of transportation higher and a lack of refining capacity higher still. Interest rates also play a part. Less obvious is the loss of 2.6 million people who have self-deported and no longer offer their labor locally.
As always, the government data focuses on goods which can be easily counted, as opposed to services that cannot be used. Some noise coming from the healthcare industry predicts that health insurance premiums will be up close to 10 percent in 2027. Not a good sign for next year.
Interest Rates
Interest rates are due to rise so long as the government does not address the size and growth of the nation’s spending in excess of its income.
Resolution of the Iran War would help, as it would eventually put the refineries in the middle east back online. The Russia-Ukraine War is another source of cost, both human and economic. How it will be resolved is anyone’s guess at this point.
The Stock Market
Stocks seem to be a bit adrift. Those who hold big profits on AI issues want to party on. Whether that can be done is a bit problematic, especially given the signals being given off by the bond market that interest rates will rise, and economic activity will be reduced.
The current yield on the Standard and Poors 500 Index is 1.07 percent and has fallen from last year. The ten-year Treasury bond is 4.7 percent and rising from a year ago. At some point these two trends will confront each other. A doubt about earnings forecast will probably be the key.
Warren M. Barnett, CFA
August 26, 2026