The Fiscal Perils of a US Recession
How even a mild downturn could trigger a debt crisis
1. Introduction
The United States is already running a fiscal deficit of 7% of GDP in peacetime. Even a mild recession could tip this fragile position into crisis. Historically, debt and interest payments have outpaced economic growth for decades. This post lays out the fiscal mechanics behind why the US can no longer afford even a “garden variety” recession - and how the outcome could be a full-blown debt spiral.
2. Government Expenditures and Revenues
Expenditures:
Federal spending has grown in a near-parabolic fashion since the postwar era, and most dramatically during the 2000 dot-com crash, the 2008 financial crisis, and the 2020 pandemic. In each recession, spending jumped by 9–13%. This is due to automatic stabilisers like unemployment insurance and stimulus programmes.
Revenues:
Revenues fall sharply in recessions. Tax receipts dropped 24% in the 2001 recession and 32% in 2008. Capital gains taxes - tied to stock market performance - form a significant chunk of US federal income, which links government income directly to the boom-bust cycle of financial markets.
3. Debt Dynamics
Since the 1971 end of the gold standard, US federal debt has grown by 8,500%. By contrast, GDP has increased by only 2,300%. The cost of servicing this debt (interest expense) has grown by 5,500%.
Debt is growing far faster than the income needed to service it. This trend is long-standing and non-partisan, having accelerated under both Democrat and Republican administrations. The productivity of new debt is declining - each additional dollar of debt now generates less and less economic output.
4. Fiscal Deficit and Debt-to-GDP Risk
The deficit is currently $2 trillion, or 7% of GDP. If GDP falls 7% in a recession, government revenues will drop (by around 28% on average), while spending increases (by around 11%). This would push the deficit to $4 trillion—about 18% of a shrunken GDP.
Such a figure is extreme. Outside of World War II or the COVID shock, the US has never seen deficits of this size. Yet it is now within reach due to structural imbalances baked into the system.
5. The Debt Spiral and Bond Market Repricing
A deficit of 18–20% of GDP would require massive new borrowing. But during a recession, demand for US Treasury bonds would likely fall, not rise, because investors would fear runaway money printing. ( This is not what the dollar milkshake theory says, but we'll leave that for another time...)
The bond market is already repricing. Real yields on US Treasuries are rising. As more bonds are issued into a shrinking economy, interest rates must rise to attract buyers. This raises the government’s interest expense, which must then be covered with even more debt... fuel for a classic debt spiral.
6. Inflation: The Endgame
To finance such deficits, the government would likely resort to "financial repression". This uses interest rates, QE Infinity and yield curve control, to create negative real interest rates ie., yields are kept below inflation, guaranteeing a loss in real (inflation-adjusted) terms to investors, but burning off the debt for the government. (And yes, investors are ready to accept a loss of a couple of percentage points because the alternative might be twenty percent in the markets.)
Money printing under tight yield control (= loads of cheap money) would allow the Treasury to control interest payments, but would also drive inflation far beyond current levels. The last inflation wave (2021–23) could pale in comparison. Double-digit inflation, sustained over time, would erode savings, wages, and destroy the purchasing power of the US dollar in what's called currency destruction.
7. Conclusion
The United States is already at the edge of a fiscal cliff. The maths is: revenues fall, expenditures rise, debt grows, interest compounds, and GDP stagnates. In such a system, even a modest recession becomes a trigger event, exposing the fragile architecture of a government addicted to deficit spending.
Unless policymakers radically change course, the next downturn will not be a cyclical adjustment, with a reversion to the norm, but will be a sovereign debt crisis with a structural change in the world economic system.
It is to avoid this, many believe trump will have to call a Mar-a-Lago Accord.
8. Looking Forward
Without a coordinated accord i.e. something in the spirit of Plaza or what we’ve called here the Mar-a-Lago Accord, the trajectory looks dire.
Debt-fuelled deficits will overwhelm markets. Inflation will rage. Currencies will unravel. Safe-haven panic will set in and gold will go to the moon.
But if, somehow, agreement is forged - if the major players can be persuaded by stick and carrot to recalibrate the terms of trade, the value of money, and the path of debt - then the storm might just pass.
Markets would stabilise. Currencies could hold. And gold, no longer needed as a last refuge, would fall back toward its long-term mean. The whole system would breathe again... not saved, but given a stay of execution....
Glossary of Technical Terms
Deficit (Fiscal Deficit)
The shortfall between what a government spends and what it earns in a given year.
Debt
The cumulative amount of money the government owes from past deficits.
GDP (Gross Domestic Product)
The total value of all goods and services produced in a country. It is calculated as:
GDP = Consumption + Investment + Government Spending + Exports – Imports
Debt-to-GDP Ratio
This is a key measure of a country's fiscal health. It compares the total public debt of a government to its gross domestic product (GDP).
It shows how much a country owes relative to what it produces. A higher ratio - say, over 100% - implies greater difficulty in repaying debts without incurring more debt. Maastricht 1992 recommended a tops 60% debt-to-GDP and a tops 3% fiscal deficit, as fiscal convergence criteria, for countries wanting to adopt the Euro. (That was indeed a long time ago, wasn't it.)
Debt monetisation
When a Treasury repays debt not from reserves, but by borrowing more - aka a Ponzi scheme. Monetisation is an alternative to restructuring or defaulting on the debt.
Automatic Stabilisers
Government policies like unemployment insurance that increase spending automatically during downturns.
Interest Expense
The cost of servicing debt - i.e., paying interest on the government’s borrowing.
Bond Yields
The return investors demand to lend money to the government. Higher yields mean higher borrowing costs.
US Treasury Ten Year Yield
It’s not just another number. The 10-year US Treasury yield is the world’s benchmark interest rate. It sets the tone for mortgages, business loans, and even DCF stock valuations. When it rises, borrowing gets more expensive; when it falls, it often signals fear of recession.
Investors watch it because it reflects inflation expectations, growth prospects, and global confidence in the US economy.
Financial Repression
Economic actions like interest rates below inflation ie negative real returns, are used to reduce the real burden of government debt.
Quantitative Easing (QE)
Central bank policy of buying government bonds to inject money into the economy. With more liquidity available to buy assets, this will increase demand, raise asset prices and push down yields. Great for those who have money ...
Yield Curve Control
The yield curve is the graph of yields, according to the date of maturity.
Normally, you would expect longer term maturities, with increased risk and opportunity costs, to return greater yields. Yield curve control is a policy in which a central bank targets specific interest rates across different bond maturities to control their yield.
Central banks use YCC to control borrowing costs, stimulate the economy, and manage debt, especially when other tools have run their course. It’s powerful, though not without danger as the bank's credibility is on the line.
Inflation
The general rise in prices, reducing the purchasing power of money.
A Mar-a-Lago Accord
Is a proposed economic plan aimed at addressing the U.S. trade deficit by weakening a dollar severely overvalued by hyper-financialisation, through tariffs and incentives for foreign countries coupled with the threat of withdrawing security (military) arrangements.
It seeks to restructure the global trading system to benefit U.S. manufacturing and reduce fiscal deficits, without raising taxes or cutting spending.
