Public debt: a risk for the markets?

The US government is struggling to find a way out of the debt ceiling. As a result, markets are holding their breath and fearing default. We discussed in our previous article the role of long cycles in monetary policy. In this context, the French debt is also subject to concerns. The stability plan presented already seems optimistic. It is obvious that difficulties in the management of public debts would have dramatic consequences for the markets and the world economy. Decryption.

The United States facing the risk of default

In the first quarter of 2023, the public debt of the United States amounts to nearly 31,419 billion dollars. In addition, this public debt record is also accompanied by a break with the traditional economic balance of the United States. The United States has accentuated a policy of public sector expansion in recent years, and this is not without risks.

But the debt ceiling is $31.4 trillion. This ceiling has therefore been exceeded since January, but it was also accompanied by “exceptional measures”. Treasury Secretary Janet Yellen has warned that in the absence of an agreement, a default will have to be considered by June 1, 2023. It must be said that the exponential increase in the American debt does not bode well long-term fiscal stability. Public debt amounts to more than 123% of GDP at the end of 2022. This ratio was only 30% of GDP in 1981, and 55% of GDP in 2001.

Annual change in US public debt. Source | Federal Debt: Total Public Debt (GFDEBTN) | FRED | St. Louis Fed (

The cost of insuring US debt, known in the jargon as CDS, has also skyrocketed. Joe Biden refuses the budget cuts of the Republicans when the latter consequently refuse the raising of the ceiling. This ceiling, raised almost 80 times over the last 40 years, is obviously exceeded by events when the debt increases at an exponential rate.

Potentially dramatic consequences

There is nothing more sensitive in finance than the instability of public debts. Indeed, Citigroup or even JP Morgan have already scheduled meetings in anticipation of a possible default. As a result, significant volatility on bond prices would lead to great uncertainty on many transactions and derivative products, which are largely insured by bonds.

In addition, the White House wants to be very cautious and affirmsand one “actual violation of the US debt ceiling would likely cause serious damage to the US economy”. In the case of a “prolonged default”, the recession could result in a considerable contraction of -6.1% of GDP. This would result in the loss of more than 8 million jobs and a rise in unemployment of 5 points. This amounts to the deepest recession since the Great Depression of 2008.

Projections of the effects of a possible default on the US economy. Source | The Potential Economic Impacts of Various Debt Ceiling Scenarios | ECA | The White House

Moreover, the global consequences would also be dramatic. Moody’s analysts predict in the event of a “prolonged default” a fall in the financial markets of 20%. GDP would contract by almost 4%. Which is considerable. It should be noted that more than 500 billion dollars of American debt are exchanged every day on the markets.

France: one “stability program” too optimistic?

The situation on the other side of the Atlantic, which runs (even without default) a risk of downgrading the rating, is not without echo with the French situation.

The trajectory of French public finances

The Ministry of Public Finance has revealed its “stability program” for 2027. Considered too optimistic by many economists, it aims to reduce the deficit below 3% of GDP and stabilize the level of debt. Despite everything, the debt burden is expected to be 70 billion euros in 2027. This is quite simply the State’s first expenditure… What will be the impact of the rise in interest rates on the trajectory of public finances? What will be the consequences for financial stability in France?

The French signature depends closely on the government’s ability to reassure investors. Moreover, the agency Fitch (which is however not representative of investors), downgraded the rating of the Franc to “AA-“. Thus, it is quite usual to set trajectories which are only very rarely reached. The ministry also reveals a very gradual reduction in the public deficit. The deficit is projected at 2.7% in 2027.

Debt is also projected to increase slightly, when growth should stabilize around +1.4%. But this program seems quite optimistic in a context of uncertainty and spending (war, low growth rate, massive investments planned in many areas, etc.).

Presentation of the 2021-2027 stability program |

The problem of long-term public debt

It is very rare in history that an excessive public debt does not end in an inflation crisis, a war or a default. And it is quite natural that such amounts, manipulated by a minority of politicians, present significant economic risks. The problem of long-term public debt must be analyzed under two aspects: that of financing, and that of growth.

  • The main problem arises when the financial markets, as well as the central bank due to inflation, are no longer able to directly or indirectly finance the budget.
  • The other problem is given by the inability of the State to manage political crises, social disorganization, but also by its inability to raise taxes. The famous adage “too much tax kills tax” refers in economics to the Laffer Curve. If the State becomes too “heavy” in the economy, any new tax will reduce activity, which will reduce revenue, and the quality of public services. This threshold can be estimated at around 55% of GDP levies for France. But it is clear that the ability of the state to raise taxes is gradually weaker as the state expands its economic power.

What if inflation saved the state?

The only way to smoothly reduce public debt is to have historically (1) a growth rate higher than the increase in indebtedness and/or the short-term interest rate, and (2) a rate of sufficiently high interest rate (zero or positive real rate) to encourage the State to balance its long-term budget. This last condition may seem contradictory, yet the reduction in the debt ratio has been accompanied in recent centuries by the rise in the interest rate.

States only react to coercion. Because even if inflation can reduce indebtedness in the medium term, it always ends up having a long-term neutral effect. The rise in the interest rate with stable inflation causes a deterioration of the State budget in the long term, which cancels out the effects of the reduction in short-term debt. It is therefore obvious that only real incentives (the effective rise in the real rate) must be present for the reduction in debt to be not mechanical but political.

What are the consequences for gold and cryptocurrencies?

We have seen that public debt was one of the major explanations for the financialization of economies. There is a close, and statistically very strong, link between public debt, money supply, and financial markets. A risk of default, or an amplified volatility of the rating of the public signature, could cause a significant fall in the financial markets. The impact would first be the most significant on the banking system, but it would also affect the financing capacities of most companies. The resulting fall in the financial markets would therefore not be negligible.

In view of sensitivity of bitcoin (BTC) to cash, it is possible to imagine a significant downside risk on the course of the cryptocurrency. Nevertheless, we have seen in recent weeks that banking crises have favored bitcoin. If a short-term bearish effect would be possible, it is also likely that it would strengthen the legitimacy of the market in the long term. It is also useless to specify that an increase in volatility on the signature across the Atlantic would lead to a fall in the dollar. This increase in volatility would therefore benefit the price of bitcoin.

For its part, gold would certainly benefit from a recession. But the long-term impact would be more indeterminate. Only the entry into a lasting deflation could constitute a bearish factor for the yellow metal. But this scenario is de facto ruled out in a context of funding tensions.

In conclusion

In short, the US government could go into default within weeks. This default would not be due to an inability to finance but to a political blockage. Raising the debt ceiling becomes a subject of tension as the increase in debt becomes structural and unprecedented. This may only be the beginning of a long period of tensions over public debt.

With or without default, the government’s solvency could suffer. Furthermore, the impact of a default, as discussed so far, would be rather moderate on the economy. But the risk of runaway is great. Several analysts, and even the White House, anticipate a very strong recession in the event of a “prolonged default”. The consequences on the world economy and the financial system would be very serious. It is in this context that this structural risk leads us to wonder about the weaknesses of the economy.

France is also showing structural difficulties which, in the long term, could increase. Inflation can benefit States in the short term to deleverage, but its positive effects are already diminishing as interest rates rise. On the contrary, we could witness an inability of States to control the management of their signature. Some safe-haven assets could benefit from this.

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