Congress just pushed the U.S. toward a debt crisis. The Fed can’t save us. (WaPo)

Intro LO:

The biggest problem of a debt crisis is the increasing interest burden in annual government budgets. This explains why Trump wants to replace the chairman of the Federal Reserve, who resists lowering interest rates. Lower interest rates would – normally – help in containing the annual interest burden.

Wikipedia: “A debt crisis is a situation in which a government (nation, state/province, county, or city etc.) loses the ability of paying back its governmental debt. When the expenditures of a government are more than its tax revenues for a prolonged period, the government may enter into a debt crisis.”

In my view, items #1 and #2 would – usually – be combined. Apparently, the US president prefers lowering both interest rates and the US$. Not combining both might even result in hyperinflation (eg, Turkey 2018-onwards).

Lowering interest rates by the Central Bank (eg, the Fed) would – normally – cause a difference between nominal (eg, FED) and market interest rates.

Market interest levels have already been increasing since its “record low” in 2020.

Hence, Trump‘s idea of lowering Central Bank interest rates is wishful thinking, in my view.

Clearly, the market decides on actual interest rates.

In my view, item #3 – mandatory investments in national US debt (eg, by banks, citizens, insurance companies, pension funds) – will have to be considered in 2025 or in 2026.

Considering item #4 would be a blessing for China and Russia, such an event is (very) unlikely.

Note LO: technically speaking, the Washington Post article below is an opinion by its Editorial Board.

Congress just pushed the U.S. toward a debt crisis. The Fed can’t save us. (Washington Post)

Subtitle: The One Big Beautiful Bill might add $3.3 trillion to the national debt. The odds of calamity just rose.

By: the Washington Post Editorial Board
Date: 3 July 2025

“The odds of a federal debt crisis just got more daunting.

On Thursday, Congress passed the One Big Beautiful Bill, a sweeping piece of legislation that threatens to leave the government with one big not-so-beautiful pile of debt.

Even before the bill, several warning signs pointed to trouble. Since January, the value of the dollar has dropped, suggesting that fewer foreign investors want to hold U.S. assets. Separately, unpredictable movements in U.S. Treasury markets indicate that investors are concerned about America’s long-term fiscal stability.

Now, Republicans have passed a bill that would add $3.3 trillion to the national debt over the next 10 years, according to the Congressional Budget Office.

The best-case scenario is that economic conditions suddenly and sharply improve, ameliorating the effects of even Republicans’ monumental degree of irresponsibility. If, say, artificial intelligence drives an efficiency boom that raises incomes and tax receipts without boosting federal spending — growth and federal outlays often rise in tandem — America’s fiscal picture would look better. Markets, though, don’t appear to be counting on this.

In the worst case, rising debt could trigger a downward spiral. As investors grow nervous about the United States’ ability to cover its obligations, they demand higher interest rates when lending to the government to offset that extra risk. But those higher rates in turn increase interest payments, which make the debt even harder to service, deepening anxiety and driving rates higher still.

When interest payments consume a larger share of the federal budget, there’s less room for everything else — from Social Security to defense to infrastructure. Higher Treasury rates mean household borrowing becomes costlier, too. Mortgage rates climb, and businesses have a tougher time securing bank loans.

For now, America benefits from the dollar’s status as the world’s reserve currency, which means global central banks and investors continue to demand dollars to conduct trade and, as such, hold reserves. That privilege gives the U.S. more leeway to borrow than other countries.

If neither the best nor the worst case occurs, more debt would still make government borrowing costlier, which would add stress to an already vulnerable Treasury market. The next time there’s a shock to the economy, jittery investors could sell Treasurys faster than the market could absorb, forcing the Federal Reserve to step in and buy them up.

That’s what happened in March 2020. When the coronavirus pandemic hit, foreign central banks, hedge funds and other large investors rushed to sell Treasurys to raise cash, overwhelming the dealer banks, such as Goldman Sachs and Morgan Stanley, that would typically absorb those sales. The Fed, attempting to contain the damage, ended up purchasing billions of dollars in Treasurys to restore market functioning. If the Fed hadn’t done this, the Treasury market could have frozen entirely, cutting off the flow of credit across the economy and potentially triggering mass foreclosures, defaults and bank failures.

The Fed appears worried that this scenario could repeat itself. Last week, it unveiled a proposal that would relax the “supplementary leverage ratio,” which dictates how much of a cash buffer banks must hold. By easing the capital rule, the Fed hopes to encourage dealer banks to hold more Treasurys on their balance sheets — so that if investors rush to sell again, the market has more capacity to handle the shock without immediate intervention from the Fed.

The Fed is right to be worried about Congress’s fiscal irresponsibility. If the Treasury market goes haywire again, the Fed will have a tougher time stepping in than it did in 2020. Then, the emergency bond purchases also happened to align with monetary policy goals: The economy was in free fall, so, in addition to stabilizing markets, buying bonds helped lower interest rates and stimulate demand.

Today, inflation risks are much higher than they were, so buying large amounts of government debt, pushing out cash, risks overheating the economy. Separately, emergency bond purchases — particularly after the bill’s passage — could give the impression that the Fed is stepping in to help finance the government’s spending. That could kick-start a full-blown crisis if investors fear the government is deliberately encouraging inflation to reduce the real value of the debt, eroding the value of the dollar and wiping out household savings and retirement accounts.

The Fed can do some other things to keep the financial system resilient when stress hits. For one, strengthening Treasury market infrastructure — by quickly setting up a central clearinghouse, for example — would make it easier to match buyers and sellers during moments of panic. In addition, regulators should ensure that large banks hold ample capital in normal times, so they have more capacity when markets go bad.

But Congress is at fault for pushing America’s long-term financial health to the edge. The Fed can’t fix that.

Keep an eye on the bond market. The fuse has been lit. The Fed can’t stop an explosion, even if it might soften the potential blast.”

Sources:

• Washington Post, 3 July 2025: Congress just pushed the U.S. toward a debt crisis. The Fed can’t save us.
• Axios Markets, 10 July 2025: 1 big thing: Trump’s mega-rate cut dreams could backfire
• Axios Markets, 10 July 2025: 2. The long bond keeps the score