next great financial calamity<\/a>.<\/p>\nSovereign debt has spooked investors from the U.K. to\u00a0Japan in recent years, with bond investors suddenly questioning the fiscal plans of governments that have been able to bleed red ink with relative impunity for decades. But the ramifications of a crisis emanating from the engine of the global economy, either directly or through contagion, would be far reaching and devastating, economists say.<\/p>\n
\u201cAll finance theory is built around this idea that the U.S. government debt is the ultimate safe asset. Everything is priced relative to it,\u201d Manger said.<\/p>\n
A sustained breakdown in the U.S. Treasury market could cause a global financial crisis that erodes asset values, destabilizes financial institutions and pushes economies into recession, according to a February analysis by the non-partisan Brookings Institution. Moreover, the assessment suggested, it wouldn\u2019t necessarily take a true default to trigger a crisis, just fears that the deteriorating fiscal situation would make a strategic default plausible.<\/p>\n
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Juan Carlos Hatchondo, an economics professor at Western University who specializes in sovereign debt issues, said the ubiquity of U.S. Treasuries and other government-backed securities, which dominate global debt markets and can be found on the balance sheets of financial players from pension funds to banking giants, would raise the stakes dramatically.<\/p>\n
\u201cA significant decrease in their value (would) trigger a broad financial crisis,\u201d Hatchondo said.<\/p>\n
Even the overnight transactions that allow banks to balance their daily accounts \u2014 known as repurchase or \u201crepo\u201d market operations \u2014 use Treasuries as collateral. A fall in their value would disrupt the circulation of liquidity through the financial system.<\/p>\n
Then there\u2019s the impact on other governments that hold a \u201csignificant\u201d portion of their foreign reserves in U.S. Treasuries.<\/p>\n
\u201cA reduction in their value will weaken the position of governments across the world,\u201d he said<\/p>\n
\u201cIt just takes one trigger for somebody to call ‘time out’ on one of them to cause ripple effects\u201d<\/p>\n
Derek Holt, head of capital markets economics at Bank of Nova Scotia<\/p>\n
The risk of contagion \u2014 in which a crisis spreads from country to country, gathering momentum \u2014 has only been rising.<\/p>\n
\u201cThe bond markets around the world are very tightly integrated now, more so than in past decades,\u201d said Derek Holt, head of capital markets economics at Bank of Nova Scotia. \u201cOne country\u2019s bond yields getting shocked can change the appetite for many other different countries.\u201d<\/p>\n
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Contagion becomes more of a concern as countries around the world face common drivers that are leading to more borrowing, from trade reverberations to budget challenges, Holt added.<\/p>\n
\u201cIt just takes one trigger for somebody to call \u2018time out\u2019 on one of them to cause ripple effects,\u201d he said, noting that there are pockets of unease beyond the U.S. that could trigger bond market shocks, including budget concerns in the U.K. and political upheaval in France.<\/p>\n
The U.K. bond market was spooked in 2022 \u2014 creating a mini-crisis for the country\u2019s pension funds \u2014 when then prime minister Liz Truss announced plans to fund tax cuts with borrowed money. In the summer of 2024, rising yields in Japan prompted a short burst of volatility across markets as so-called \u201ccarry trades\u201d that feed demand for U.S. Treasuries were unwound.<\/p>\n
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The U.K. bond market was spooked in 2022 when then prime minister Liz Truss announced plans to fund tax cuts with borrowed money. Photo by THE CANDIAN PRESS\/AP-Alberto Pezzali<\/p>\n
The spring palpitations in the U.S. bond market came as many countries around the world, including Canada, have been grappling with increasing deficits and substantial debt piles in the wake of the pandemic that leave them more vulnerable to economic shocks.<\/p>\n
On a global scale, public debt is projected to approach 100 per cent of GDP by the end of the decade, surpassing the pandemic peak, according to the International Monetary Fund. More than a third of countries \u2014 which represent 75 per cent of global GDP and including major players such as the U.S., China, France and the U.K. \u2014 are expected to see debt increase further this year amid major policy shifts, escalating trade and geopolitical tensions, volatile markets and deteriorating economic prospects.<\/p>\n
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\u201cMany governments, including some major advanced economies, face growing fiscal strains and have achieved only limited progress in rebuilding fiscal space,\u201d the IMF said in an Oct. 14 report. \u201cWithout immediate action, slower economic growth, higher real interest rates, coupled with elevated debt and new spending needs \u2014 for defence, economic security, climate \u2014 will further tighten the fiscal vise.\u201d<\/p>\n
Fitch Ratings, meanwhile, warned in an Oct. 16 report that developed market sovereigns are facing rising exposure to bond market shock, which would lead to increases in already substantial debt and deficit loads.<\/p>\n
\u201cWe see plausible scenarios in which an upward shift in yields increases budget deficits and debt ratios as existing liabilities roll over at higher rates, even without a classic financial bubble,\u201d the ratings agency said.<\/p>\n
The 30-year yields have already risen in most markets, pointing to investor caution over issues including long-term inflation, heavy bond issuance and, in some cases, fiscal sustainability.<\/p>\n
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After \u201cLiberation Day\u201d in April, stocks slid but bond prices also began to fall, pushing yields upward on both 10-year and 30-year securities. Photo by Spencer Platt\/Getty Images\/Postmedia files<\/p>\n
\u201cWeaker demand from central banks enacting quantitative tightening and from long-term investors, such as pension funds and insurers, may also be a factor in some markets, for example, Japan and the U.K.,\u201d Fitch analysts Ed Parker and Nasir Rajah said.<\/p>\n
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Their report said government debt in developed markets is projected to rise by US$6 trillion this year alone to US$71 trillion, representing 105 per cent of GDP. That\u2019s up from just US$28 trillion, or 68 per cent of GDP, in 2007.<\/p>\n
The perils of interconnected markets were put into sharp focus by the 2008 global financial crisis, which tested mechanisms for mitigation, and led to the creation of new ones. The U.S. Federal Reserve and U.S. Treasury were forced to step in to provide liquidity and keep financial markets moving and could intervene again in the event of a debt crisis, potentially in coordination with The IMF, the European Commission and the European Central Bank (ECB).<\/p>\n
But Hatchondo isn\u2019t sure that would be enough.<\/p>\n
\u201cThe U.S. government would be too large to bail out. It is challenging to envision a scenario in which a fiscal crisis in the U.S. is not followed by a global financial crisis, thereby undermining a global coordination effort to bail out the U.S. government,\u201d he said. \u201cThe Fed would have to conduct massive interventions to try to prop up the Treasuries market and assist financial institutions.\u201d<\/p>\n
Predicting the timing of such an event is impossible because there is no red-line number that triggers a debt crisis, said Hatchondo.<\/p>\n
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\u201cWhat is clear is that the U.S. is becoming increasingly more exposed to one,\u201d he said, noting that a substantial portion of U.S. debt will need to be refinanced soon. As of June, more than 31 per cent of the U.S. debt \u2014 more than US$10 trillion \u2014 was set to mature within a year.<\/p>\n
\u201cIf one adds a budget deficit in excess of six per cent of the GDP, the Treasury must issue debt worth approximately 37 per cent of the GDP,\u201d he said.\u00a0\u201cIf the market starts demanding a higher yield to compensate for the risk of holding U.S. bonds, debt growth will accelerate and can easily trigger a crisis.\u201d<\/p>\n
Ray Dalio, the billionaire founder of hedge fund Bridgewater Associates, published a book in June called\u00a0How Countries Go Broke: The Big Cycle,\u00a0which warns that the U.S. government debt situation is nearing the point of no return. In his view, the country is\u00a0headed for\u00a0a classic \u201cdeath spiral\u201d because it will need to keep issuing bonds to pay its debt. The deteriorating fiscal situation will, at some point, cause investors to demand ever higher yields, layering on more debt at higher cost.<\/p>\n
\u201cWith this government \u2026 we don’t know what we’re going to wake up to tomorrow\u201d<\/p>\n
Marc-Andr\u00e9 Pigeon, assistant professor at the University of Saskatchewan\u2019s graduate school of public policy<\/p>\n
But Manger, who has seen what a country\u2019s debt crisis can look like with no obvious solutions, suggested that the United States and other developed countries have options if they choose them: namely austerity and central bank intervention.<\/p>\n
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\u201cThis is not going to turn into a colossal disaster because of the difference between an emerging market and the U.S.,\u201d he said. \u201cArgentina borrows in U.S. dollars, and you cannot print U.S. dollars if you are Argentina. The U.S. can always do this, so it\u2019s ultimately a lot safer, but what they really just need to do is to not lower taxes like crazy and not spend like crazy.\u201d<\/p>\n
He noted that the Bank of England stepped in when markets panicked over Truss\u2019s budget and her tenure as prime minister was short-lived.<\/p>\n
\u201cAnd those taxes were changed, and the U.K.\u2019s fiscal position improved slightly. So that\u2019s the kind of scenario that we could see.\u201d<\/p>\n
While the rising debt levels and slowing growth make it inviting to suggest the U.S. debt party is in its final innings, judging the likelihood of a default based on established metrics such as the level of debt to gross domestic product can be a dangerous game, said Marc-Andr\u00e9 Pigeon, an assistant professor at the University of Saskatchewan\u2019s graduate school of public policy, pointing to the experience of Japan.<\/p>\n
With public debt at around twice the country\u2019s GDP for more than a decade, Japan was downgraded by Moody\u2019s Investors Service as far back as 2014, but the country hasn\u2019t defaulted, making naysayers look foolish.<\/p>\n
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\u201cIf you bought into the \u2018ability to pay\u2019 story, you\u2019ve been wrong for years on Japan,\u201d Pigeon said. \u201cGo ahead, bet against the yen. Bet against the Japanese debt market. See how long you last.\u201d<\/p>\n
More concerning to him than rising U.S. deficits and debt is the unpredictability of the current administration and Trump\u2019s willingness to defy convention. It\u2019s not whether there is capacity to pay, but whether they might simply choose a path that leads to a crisis.<\/p>\n
\u201cWith this government \u2026 we don\u2019t know what we\u2019re going to wake up to tomorrow,\u201d he said. \u201cThe institutional supports for the U.S. government debt are thick and rich and not going anywhere, unless there\u2019s bad policy decisions: rule of law, arbitrarily changing norms and rules, those are the things I worry about, not the ability to pay.\u201d<\/p>\n
Fitch, which became the second of three large bond-rating agencies to knock U.S. sovereign debt from its triple-A rating, in 2023, said in an Oct. 1 report that its analysis now considers factors such as a \u201cpossible erosion of checks and balances\u201d in U.S. policy making, in addition to longstanding \u201cintractable disputes\u201d over public finances stemming from an aging population and entitlement spending.<\/p>\n
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Among the concerns is the administration\u2019s frequent criticism of Federal Reserve Chairman Jerome Powell, Trump\u2019s efforts to fire Fed governor Lisa Cook, the dismissal of Bureau of Labor Statistics head Erika McEntarfer, as well as how the administration appropriates congressionally approved budgetary allocations.<\/p>\n
However, Fitch did not downgrade U.S. sovereign debt further, concluding that \u201cself-correcting mechanisms,\u201d including the country\u2019s reserve currency status, will continue to support the debt for now.<\/p>\n
\u201cDespite increased uncertainty around U.S. policy and the possible erosion of institutional checks and balances, we expect the U.S. dollar\u2019s predominant reserve currency status \u2014 a material sovereign rating strength \u2014 to continue for the foreseeable future,\u201d the ratings agency concluded.<\/p>\n
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Federal Reserve Chairman Jerome Powell seen during a news conference this year in Washington. The Fed would likely intervene in the event of a debt crisis. Photo by Manuel Balce Ceneta\/AP Photo\/Postmedia files<\/p>\n
Part of Trump\u2019s months-long pressure campaign on the U.S. Federal Reserve to lower interest rates is being waged as debt servicing costs balloon. Net interest on the public debt tracked by the Congressional Budget Office in its monthly budget review released Oct. 8 topped $1 trillion for the first time.<\/p>\n
What\u2019s more, interest payments are on track to be the fastest-growing portion of the federal budget in the coming years. The CBO projects net interest payments will total $13.8 trillion over the next decade, rising from an annual cost of $1 trillion in 2026 to $1.8 trillion in 2035.<\/p>\n
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There are expected offsets, though. It\u2019s estimated that the increased tariff haul will bring in around US$300 billion a year, up from just US$77 billion in 2024, which should narrow the deficit to 6.8 per cent of GDP from 7.7\u00a0per cent, according to the Fitch Ratings report. Some $195 billion was already collected from April through the end of the fiscal year in September.<\/p>\n
However, once legislated tax cuts kick in, the deficit to GDP ratio will rise again to 7.4 per cent of GDP in both 2026 and 2027. The U.S. general government debt-to-GDP ratio will rise to 122 per cent by the end of 2027, Fitch said, more than double the median for its \u2018AA\u2019 rated sovereigns at the end of fiscal 2024. The IMF, meanwhile, has projected U.S. debt-to-GDP ratio will continue to rise to 143.4 per cent by the end of the decade, surpassing the ratios of long-time European laggards Greece and Italy, which will see their positions improve.<\/p>\n
The United States is arguably the most likely source of global contagion, but Japan and France are also in the mix, said Ross Schaap, head of research at GeoQuant,\u00a0a division of Fitch that produces and analyzes data to assess country risk.<\/p>\n
Japan\u2019s rising interest rates after years of low and even negative rates have already caused market tremors as investors moved to unwind leveraged trades aimed at taking advantage of low borrowing costs to buy higher-return bonds elsewhere. But while markets stabilized quickly in August of 2024, Trump had not yet been elected to his second term.<\/p>\n
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\u201cMarkets could still trust that backstop currency swap agreements meant there was no real chance of a contagion-level blow up, just volatile adjustments in the short-term,\u201d Schaap said. \u201cHow might Trump use such leverage?\u201d<\/p>\n
\u201c(Institutional investors) might look at Germany, and say, \u2018Well, I’m not going to offer this much, I’m going to price this a little lower, because the U.S. is also now priced lower\u201d<\/p>\n
Ross Schaap, head of research at GeoQuant<\/p>\n
For France, the contagion-triggering concerns lie in political gridlock and a large budget deficit, with a unique reliance on borrowed foreign-currency funds.<\/p>\n
\u201cParis borrows in a currency it cannot print \u2026 unlike the U.S. or Japan, which can inflate their way out of dire straits,\u201d he said.<\/p>\n
\u201cAnd while Germany and other EU members with stronger balance sheets look to invest in domestic and security capacities, eurozone sovereign rates are likely to remain elevated relative to what would happen if France had an independent currency.\u201d<\/p>\n
Manger, who has advised governments in Canada and Japan, said global investor sentiment plays a large role in whether a small crisis in one country\u2019s bond market sparks upheaval in others, even when conditions vary from country to country.<\/p>\n
\u201c(Institutional investors) might look at Germany, and say, \u2018Well, I\u2019m not going to offer this much, I\u2019m going to price this a little lower, because the U.S. is also now priced lower,\u2019\u201d he said.<\/p>\n
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Canada is arguably in a better fiscal state than many countries around the world, including the debt-burdened United States, but it, too, could be vulnerable to a broader market shakeup driven by a sudden distaste for sovereign bonds, particularly as a relatively small economy on the world stage.<\/p>\n
Trump\u2019s trade war and other protectionist polices have put Canada among the countries increasing deficits, contrary to the reversals pledged by the previous Liberal government under Justin Trudeau. Prime Minister Mark Carney will unveil the latest projections in his first budget Nov. 4.<\/p>\n
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![\"President](\"https:\/\/www.newsbeep.com\/ca\/wp-content\/uploads\/2025\/10\/1028-mg-carney-trump.jpg\")
President Donald Trump talks with Canada\u2019s Prime Minister Mark Carney during a summit in Sharm El Sheikh, Egypt. Trump\u2019s trade war has put Canada among the countries increasing deficits. Photo by Evan Vucci\/AP Photo\/Postmedia files<\/p>\n
A report from Canada\u2019s Parliamentary Budget Office in September said the deficit is expected to grow to\u00a0$68.5 billion this year but Holt, the Scotia economist, pegs the figure somewhere between $75 billion and $100 billion, with the top end more than twice the amount forecast by Ottawa just last December.<\/p>\n
He said he can envision a scenario in which Canada\u2019s debt-to-GDP ratio doubles or even triples in the next few years and warned that the country \u201cshould not take our Triple-A status for granted\u201d as the government rolls out expensive infrastructure projects aimed at lessening trade dependence on the United States.<\/p>\n
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\u201cWe\u2019ve been in an environment of these rolling sovereign debt shocks, and I think we need to be very careful about being the next one, especially as the global economic outlook is looking pretty frail in the context of the U.S.-motivated trade wars,\u201d Holt said.<\/p>\n
\u201cCanada (represents) two per cent or less of everything in the world markets and global market participants aren\u2019t going to spend the same amount of time thinking about sovereign credit risks facing a country like Canada. \u201cWhen you go down a path of raising the risks around your deficits and debt, they\u2019ll just get out.\u2019\u201d<\/p>\n
\u2022 Email: bshecter@postmedia.com<\/a><\/p>\nArticle content<\/p>\n
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Shredded currency surrounds U.S. dollar bills in Washington. Photo by Andrew Harrer\/Bloomberg\/Postmedia filesArticle content<\/p>\n![\"Financial](\"https:\/\/dcs-static.gprod.postmedia.digital\/19.8.1\/websites\/images\/identity\/logo-identity-fp.svg\"){kind=logo}
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U.S. President Donald Trump signs an executive order for reciprocal tariffs on \u201cLiberation Day,\u201d April 2, 2025. Photo by SAUL LOEB\/AFP via Getty Images\/Postmedia files<\/p>\n