(Originally published in The Dispatch)
Recently, the U.S. government tried to borrow money by selling 30-year bonds and found investors reluctant to lend. That reluctance forced the Treasury to offer a 5.2 percent interest rate to sell its bonds, the highest auction rate in two decades. Washington responded not by curbing its insatiable appetite for borrowing but by announcing a few billion dollars in bond buybacks to calm investors. It did not work.
This weak auction may be a temporary blip, but the financial markets seem to be suggesting otherwise. Rising government debt pushes up interest rates, which in turn drive up interest costs and debt still further, until the two spiral together beyond anyone’s control. Washington keeps meeting rising rates with half-hearted gestures that ignore the underlying problem. To see why that is a mistake, start with what is actually driving rates higher.
What is happening with the Treasury and interest rates?
The interest rate on the 30-year Treasury bond, the government’s longest-term IOU and a benchmark that feeds into mortgage and business-loan rates, has climbed all year. In mid-August, a routine sale of these bonds drew unusually weak demand and cleared at 5.2 percent, the highest in roughly two decades. The same week, 10-year Treasury notes cleared near 4.7 percent, continuing their own upward march.
The reason is not mysterious. At a time when demand for AI investment and global instability are already pushing interest rates up, the U.S. government must borrow enormous sums to finance its escalating budget deficits. To attract ever more investors, it has to entice them with higher interest rates, especially on notes and bonds that will not mature for 10 to 30 years. A great deal can go wrong over such a long horizon, from inflation that erodes the value of a bond to the risk of default if the debt grows too large, and lenders demand compensation for bearing those risks.
This alarmed the Trump administration enough that, on August 19, Treasury Secretary Scott Bessent announced a plan. Beginning on September 9, the Treasury would borrow a few billion dollars at lower short-term interest rates and use the proceeds to buy back some of its longer-term bonds. That swap of a few billion dollars is a drop in the ocean of a $30 trillion market for U.S. debt. Its purpose was more psychological than mechanical—to assure investors that they can safely buy long-term bonds at modest interest rates because the Treasury stands ready to intervene on behalf of their confidence.
The trouble is that reassurance works only if investors believe there is force behind it. Because the swap was so small, the 30-year rate dipped to about 5.19 percent on the day of the announcement and climbed back to 5.27 percent within two days. If anything, the move backfired by signaling that the Treasury was alarmed about long-term rates yet too feckless to address them. The swap also left the Treasury marginally more reliant on short-term debt, which must be refinanced regularly—and potentially at higher rates.
The lesson is not that Treasury buybacks are a bad idea. They can help maintain liquidity in the bond market. The lesson is that rising interest rates are not a technical problem to be solved with creative financial engineering. They are a structural challenge, driven by the fundamentals of escalating government borrowing, incompetent lawmakers, and economic uncertainty.
But do not take my word for it. While the Fitch ratings agency recently affirmed the U.S. government’s AA+ credit rating on a AAA to D scale, it flagged two developments that could trigger a future downgrade: 1) a “marked deterioration in the [general government] debt/GDP level and/or debt service costs,” and 2) “an erosion in the coherence and credibility of policymaking.” The latter is Fitch’s diplomatic way of questioning whether current U.S. leadership is even capable of managing economic and fiscal policy.
Interest rates can bury the federal budget.
The Treasury’s concern was not misplaced. Elevated interest rates make it costlier for businesses to borrow, expand, innovate, and hire. They make it harder for families to buy a home or a car, or to move out of a house they had financed at a lower rate. All of this saps the investment and innovation that power economic growth, create jobs, and raise wages.
Rising interest rates also pose a dire threat to governments with escalating debt. With the federal government now $32 trillion in debt (or $40 trillion including intragovernmental debt that has not yet been borrowed from credit markets), interest costs in 2026 will reach $1 trillion. That is already the largest share of both GDP (3.3 percent) and federal tax revenue (19 percent) in U.S. history. Moreover, swelling federal debt is projected to drive interest costs to nearly one-third of tax revenue within a decade and more than half within three decades.
Congress’ solution has been simple: Keep expanding spending and cutting taxes on the naïve assumption that interest rates on the resulting debt will stay low forever. The Congressional Budget Office’s own long-term baseline assumes that, even as America undertakes an unprecedented long-term borrowing binge, the average interest rate on government debt will not surpass 4.2 percent for at least 30 years.
The CBO in February also projected that the rate on 10-year Treasury notes would not exceed 4.4 percent for the next 30 years. Merely six months later, that rate is 4.7 percent and rising.
The budgetary cost of rising interest rates is brutal. If interest rates simply exceed the CBO’s projection by a single percentage point, they would push annual budget deficits to nearly $5 trillion within a decade (up from an estimated $2.1 trillion in 2026), and to nearly 20 percent of GDP within three decades. By 2056, interest costs would consume 83 percent of federal taxes, or everything Americans pay into the federal government between New Year’s Day and Halloween.
Anatomy of a debt and interest-rate spiral.
Congress has bet the country’s economic future on the hope that interest rates will stay low forever. Yet standard economic analysis suggests the rising debt will itself push rates up. As the government absorbs a growing share of the economy’s annual savings, businesses, homebuyers, and other borrowers must compete for the shrinking remainder, and that added demand for savings drives the interest rate higher. The consensus estimate is that each 1 percentage point rise in the debt as a share of GDP raises interest rates by roughly 3 basis points. Applied to the roughly 140-percentage-point rise in debt projected over the next three decades (from about 100 percent of GDP today to 240 percent under current policies), that relationship would, all else equal, push interest rates up by about 4.2 percentage points.
This rule of thumb may overstate the increase, since other forces, such as Federal Reserve policy or slower economic growth, can pull rates back down. Yet even a 1-percentage-point rise would drive federal debt to unsustainable levels, and a self-reinforcing spiral could push rates higher still.
A debt-and-interest-rate spiral follows a familiar path. Structural deficits and elevated rates keep federal debt climbing. Financing that debt requires the government to borrow heavily every year, which pushes rates up further. Higher interest costs swell the debt, forcing still more borrowing and still higher interest rates. Eventually financial markets recognize that a spiral is underway and, fearing default or monetization, demand even higher rates to compensate for the risk. At that point the government is borrowing destabilizing sums at punishing rates simply to cover the interest on its earlier borrowing.
Such spirals have happened elsewhere, from Greece’s cascade of bailouts to Argentina’s serial defaults to Sri Lanka’s 2022 collapse. Sure, the United States is not Greece and is unlikely to experience these scenarios in full. Yet even the tools meant to avert them inflict real economic damage. The rosiest outcome is that, as rates climb and deficits approach 10 percent of GDP, lawmakers finally heed the bond market and enact fiscal reforms to slow borrowing. Those tax increases and spending cuts would be painful, but far less painful than a spiral. A short-term “mini-panic” in financial markets can even be useful, provided the president and Congress treat it as the warning it is.
A more dangerous outcome is that debt, interest costs, and rates all worsen gradually, never hitting a trigger dramatic enough to rouse lawmakers. The economy muddles along, offering a false sense of calm even as the waves build beneath the surface. The public says it worries about deficits and interest rates, but not enough to accept new taxes or spending cuts, or to break past the stale ritual of partisan finger-pointing. Policymakers meet those worries with gimmicks such as pressuring the Federal Reserve to cut rates, chasing creative financial fixes, or simply downplaying the debt. In other words, precisely what is happening now.
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