In the United States, a sense of self-satisfaction about Europe is palpable. But how sustainable is this bravado? Debt underpins America’s dominance, yet even that has its limits. As one economist puts it, “There’s an illusion of invincibility in the United States.”
Just outside Manhattan, two private equity investors and a McKinsey consultant dismiss Europe’s prospects with withering scorn. The young New Yorkers — not yet thirty — claim to have seen it all coming. “You can’t run an economy on tourists and bureaucrats. Why don’t you just become an American?” one quips to this reporter.
Admittedly, Europe is not in peak form. The euro is weakening, stock markets are lagging, and reforms remain elusive. Even European Central Bank President Christine Lagarde conceded in Paris last week that Europe is “falling behind.” Innovation and geopolitical agility, she said, are crucial for maintaining prosperity and the European social model.
The Americans in New York are sceptical. “Europeans are lazy, clueless about money, and barely understand one another,” sneers one private equity man. But while they dismiss Europe as idle and divided, America’s towering debt piles mask vulnerabilities that are just as grave.
Raphaël Gallardo, chief economist at Carmignac, argues that Europe’s weaknesses foster an “illusion of invincibility in the United States.” America, he says, sustains itself on growing debt. If that falters, perceptions could shift dramatically, he told Investment Officer.
Innovation built on borrowing
Just last week, US national debt surpassed 36 trillion dollars. Of every five dollars the government spends, one is used to repay investors for borrowed funds.
The budget deficit is forecast to exceed six percent of GDP annually over the next decade, double its long-term average of under three percent. Among advanced economies tracked by the International Monetary Fund, only Israel is expected to run a higher deficit-to-GDP ratio in 2024.
Scott Bessent, the new Treasury Secretary, faces an unenviable task. His top priorities: addressing the debt ceiling and extending Trump-era tax cuts from 2017. According to the Committee for a Responsible Federal Budget, these measures could add another eight trillion dollars to the national debt.
“The US is in what we call a snowball effect,” warns Gallardo. “Rising interest rates exacerbate the debt spiral. The risk is a sudden shift from a ‘good’ equilibrium to a ‘bad’ one, where investors lose confidence. As Mark Twain said, bankruptcy happens ‘gradually, then suddenly.’”
The age of high rates
Evidence that rates will remain high can be found in Bessent’s proposal to issue ultra-long Treasury bonds with maturities of 50 or even 100 years. “That’s a statement,” says Althea Spinozzi, head of fixed income at Saxo.
“If Bessent believed rates would fall, the logical step would be to stick with short-term debt, refinancing and extending maturities later at cheaper rates. Instead, his focus on ultra-long bonds suggests he believes rates will remain elevated — or even rise further,” Spinozzi told clients.
A looming tipping point
Higher rates make financing investments harder, stifling innovation and economic growth. Technology and real estate — sectors heavily reliant on cheap capital — could be hit hardest. Gallardo sees this as a threat to valuations in private markets, including real estate and tech megacaps.
“If financial markets grow unsettled, the Federal Reserve is likely to step in to limit damage. But a prolonged intervention could compromise the Fed’s independence,” says Mark Sobel, chairman of the US branch of think tank OMFIF and a former senior Treasury official. “Bessent may find himself trapped between a demanding president and a central bank resisting inflationary policies.”
Gallardo adds: “Bond investors will closely monitor the next administration’s fiscal plans, looking for signs that debt can be brought under control in the not-too-distant future.”
Spinozzi warns that foreign investors may start seeking alternatives to US Treasuries if US policy is perceived as favouring negative real interest rates or financial repression. For now, she notes, viable alternatives are scarce.
In the past, doubts over US fiscal sustainability have led to credit downgrades. In 2011, S&P cut America’s rating from AAA to AA+. Fitch followed suit last year. On both occasions, markets shrugged off these formal warnings.
But many asset managers now agree: it is no longer a question of if, but when markets will become as concerned as the US Treasury itself. Washington’s financial reports openly describe the deficit as “unsustainable.”
Humility before the fall
Like Europe, the private equity investors in Manhattan must eventually acknowledge that reforms and innovation are essential for securing future prosperity. After all, hubris often precedes the fall — even in the United States.
This article originally appeared in Dutch on investmentofficer.nl.