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US Faces Default in 20 Years Without Debt Reduction, Warns Penn Wharton Budget Model

A recent analysis by the Penn Wharton Budget Model (PWBM) has raised concerns about the trajectory of the United States’ debt, warning that the nation could face default within approximately 20 years if corrective actions are not taken.

Scope of The Study

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The study assesses the US’s current debt level, excluding intra-governmental holdings, and emphasizes the urgency of addressing this issue to prevent a significant default event that could have far-reaching consequences.

Debt at Critical Levels

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PWBM’s analysis focuses on the $26.3 trillion of US debt held by the public, excluding intra-governmental debt, which brings the total outstanding debt to approximately $33 trillion.

20 Year Window

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The report underscores that under the current trajectory, the US has a limited window of about 20 years to take corrective measures; otherwise, default becomes increasingly inevitable.

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Default Risk Beyond Technical Defaults-

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The report clarifies that the default risk in question goes beyond technical defaults, where payments are temporarily delayed. Instead, it pertains to a much larger default event that would have profound repercussions on both the US and global economies. This default could take the form of either explicit or implicit defaults, such as debt monetization leading to significant inflation.

Optimistic 20-Year Timeline

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The 20-year timeline provided by PWBM is somewhat optimistic as it factors in a future fiscal policy that would stabilize the debt. Key to avoiding the worst-case scenario is ensuring that US debt does not exceed 200% of the Gross Domestic Product (GDP).

Debt To GDP Ratio

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Currently, it stands at approximately 98% of GDP. However, a more realistic threshold is around 175%, assuming necessary fiscal policy corrections will be implemented.

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Market Unraveling at Smaller Ratios

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PWBM’s report raises a critical point that once financial markets lose confidence in the government’s ability to manage its debt, market turmoil can occur at debt-GDP ratios lower than the 175% threshold. This underscores the urgency of addressing the issue promptly.

Continuous Rise in Bond Yields

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The analysts stress that to attract buyers for government debt, bond yields must continually rise. The recent spike in long-dated yields, breaching the 5% threshold, reflects concerns about insufficient Treasury buyers, potentially leading to a market collapse. The Treasury Department itself has acknowledged these demand challenges.

Debt Pile Expansion and Higher Interest Rates

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As borrowing costs increase due to rising yields, the overall debt burden expands, creating a self-perpetuating cycle. Eventually, interest rates could reach levels that trigger a crisis.

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Timeline Might Be Pushed Even Nearer

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Recognizing this risk, borrowers may demand higher interest rates earlier, precipitating a crisis sooner than the 20-year timeline envisioned by PWBM.

Preventive Measures: Tax Hikes and Spending Cuts

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Addressing the debt issue requires proactive measures such as tax hikes and federal spending reductions. However, these actions must be taken ahead of time to be effective in averting a default crisis.

Growing Concerns

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Despite recent declines in bond yields, US debt remains a growing concern for policymakers and investors. Net interest payments are projected to exceed defense spending soon and are expected to become the largest single federal expenditure by 2051. PWBM underscores that debt projections have been consistently underestimated, reflecting the increasing urgency of addressing this challenge.

Rising Entitlement Spending

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The report notes that faster-than-expected increases in entitlement spending, including Social Security and Medicare, have outpaced previous estimates. Additionally, US debt has become less responsive to policy changes, emphasizing the need for immediate corrective action.

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