Of debt and deficits and the dollar system

The chiming of the debt clock at $40 trillion – just as Voyager 1 reached one light-day's distance from

Earth and for similar reasons – has provoked a flood of comment. Milestones are milestones: they

measure, and they help pass the time. Otherwise, they have no intrinsic importance.

By force of pre-set agendas, conservatives and liberals react to debt headlines like Pavlov's dogs. For

one side, it's about Social Security and Medicare. For the other, it's about making the wealthy pay.

There is surely good reason to control health care costs. And we do need progressive taxation, to

restore the democratic middle-class society we once enjoyed. Neither has to do with the so-called

problem of the federal debt.

Is the federal debt “sustainable”? The simplest answer is: “obviously.” US debts are due in US dollars

produced by the US itself. All debts of that type are sustainable: they can always be paid, exactly as

promised, “debt limit” or no.

Fans of complexity have cooked up a criterion: a stable or declining ratio of government debt to Gross

Domestic Product. This metric compares growth of debt to growth of GDP. Here the key determinant

is the interest rate on the existing debt. So long as that rate (averaged over all the maturities) is below

the nominal (meaning real growth plus inflation) GDP growth rate, the debt/GDP ratio will eventually

shrink. When Secretary Bessent says that we can “grow out of the debt”, this is the common-sense

meaning of that short-hand.

Guess what? Today's federal debt interest rates are well below today's growth of GDP. We are already

“growing” out of the so-called problem. You have to add in the current deficit, but over time it's the

interest rate and the growth rate that decide which way the ratio goes.

True, interest rates have gone up, and may rise further. But it takes time for that to work through the

federal debt stock. And the macro effect of interest rates – the double-whammy of higher interest and

lower GDP, both driving up the debt/GDP ratio – isn't what it used to be.

Back when the federal debt was much smaller, higher interest rates mainly hit the private sector:

business investment, housing, consumer credit. In 1981, Volcker could (and did) raise rates to twenty

percent and take the economy down. Today, with a federal debt greater than GDP, higher interest

payments flood debt-holders with cash, which they tend to put into stocks and other assets. That is why

the Fed under Powell couldn't slow the economy after 2021. The distributive effect, more money to the

rich, is bad. But these days the macro effects are at worst a wash.

What then is going on with “long” bonds? Again it's simple enough: existing long bonds have a low

coupon. So when short rates rise, their price falls and the yield goes up. This inflicts a capital loss on

bond funds. It has nothing to do with risk, confidence, or the $40 trillion milestone. Bessent tried to

buck up the long bond market by buying some back. It didn't work: the interest rate is powerful and the

purchases were small. The buy-backs also replaced low-rate long bonds with high-rate short-term debt,

increasing Treasury's interest payout. Why, pray, would a public servant, supposedly not working for

the bondholders, want to do that?

What about that bail-out of Japan? Japan faces two very big problems: a steep oil bill (thanks to Mr.

Trump's Iran war) and a “carry trade” that takes advantage of the low interest rates Japan has

maintained for decades. Traders borrow in yen, invest in (say) pesos, and pocket the spread. This means

constant selling of yen, and that places unremitting pressure on the yen's value.

To offset that, and to pay for oil, Japan might have to sell US bonds, causing more grief for the bond

funds. So Bessent recently swapped euros for yen. When this stopgap expires (I predict, in November)

Japan will have to raise its own interest rates (destroying much local business), or let the yen fall

(bringing on inflation), or liquidate those US bonds, or impose capital controls (decapitating the carry

trade). It should have imposed controls long ago.

Japan's dilemma exposes contradictions within the dollar system. The Fed's move toward higher rates

and Treasury's desire to keep the dollar down, relative to the yen and any other country in similar

trouble, are in conflict. Japan's domestic economic objectives, locked into low interest rates, conflict

with stable exchange rates in open capital markets. But capital controls, should Japan finally go that

route, do not spell the end for the dollar. China amassed trillions in US bonds while maintaining capital

controls – before selling many of them off to build stockpiles of oil and other key resources.

Many US adversaries, and not a few Americans – including Vice President Vance, to his credit – have

reservations about the dollar-reserve system. Some would like to get rid of it. But it's not so easy; there

is no other place in the world system to place all the existing reserves. China is the obvious successor

state – a large, stable country with great industry and technical talent. But China isn't run by bankers.

The Chinese can see very well what being run by bankers has done to us.

The system may fall apart some day. Maybe the Iran war will bring it down. Maybe it won't. For now,

though, the dollar is like the dictionary: you can move around in it, from one asset to another, but you

can't easily jump to the outside. To put it all in two words: Hotel California.

**

James K. Galbraith is the author of The Power to Destroy: How Bad Economics Drove America's

Decline, published September 6, 2026 by the University of Chicago Press. He teaches at The

University of Texas at Austin.