jakiro
The U.S. economy is on the brink of a potential recession.The continued expansion of fiscal deficits, the soaring public debt levels and the intensified economic financialization are intertwined, forming elements of a “perfect storm”.Any economic downturn may no longer be an ordinary cyclical adjustment, but will evolve into a deep crisis caused by debt.The current environment is completely different from history: fiscal policy has pro-cyclical characteristics, abnormal reactions in the bond market, and the uncertainty of the new government policy have jointly exacerbated systemic risks.
Structural fragility of the financial foundation
The deterioration of the US fiscal situation is not a cyclical phenomenon, but a deep-seated structural problem.According to the latest data from the Congressional Budget Office (CBO), the federal budget deficit in fiscal 2025 is expected to reach $1.9 trillion, accounting for 6.2% of GDP, far higher than the average of 3.8% over the past 50 years.What is even more worrying is that this deficit scale occurs during the economic expansion period with an unemployment rate of only 4.3%, which completely violates the traditional wisdom that fiscal policy should accumulate surplus during the prosperity period.
Long-term changes in expenditure structure reveal the nature of the problem.Over the past 70 years, the proportion of federal government spending in GDP has continued to climb from 12% to 23.3%, and is expected to reach 24.4% in 2035.This growth is mainly driven by the “three troikas”: social security, medical insurance and net interest expenses.In contrast, the proportion of federal revenue to GDP has been stagnant from 15% to 17% for a long time.In fiscal 2024, the huge gap between federal revenue of $5.2 trillion and spending $7 trillion directly caused a $1.8 trillion deficit.This structural imbalance means that the start of automatic stabilizers will rapidly expand the deficit in the event of a recession.
The economic “super financialization” further aggravates fiscal vulnerability.Capital gains tax has become an important source of federal revenue, closely linking government fiscal conditions with stock market performance.In the 2008 and 2020 crises, the stock market plunge caused US tax revenue to fall by 18.3% and 15%, respectively.This over-reliance on financial markets, coupled with the ever-expanding current account deficit and the high valuation of the US dollar, creates a very different risk environment than in the past.
Vicious cycle mechanism under recession dynamics
When an economic recession comes, multiple mechanisms will be launched at the same time, forming a vicious cycle of self-reinforcement.
Tax revenue will show an accelerated downward trend.Based on historical data, a moderate recession could lead to a 15% decline in federal revenue, reducing expected revenue in 2025 from $4.92 trillion to $4.2 trillion, a decrease of about $720 billion.This decline not only comes from the contraction of economic activities, but also due to the drastic adjustment of the financial market. The S&P 500 index fell by 38% and 30% in 2008 and 2020, respectively, and the capital gains tax shrank significantly.
At the same time, government spending will automatically expand.Automatic stabilizers such as unemployment insurance and Medicaid will be launched when the economy is down, and with possible fiscal stimulus plans, spending may increase by 29%, from the expected $6.7 trillion in 2025 to $8.7 trillion.With the combined effects of revenue and expenditure, the deficit may surge from US$2 trillion to US$4.5 trillion, equivalent to 15.5% of GDP, far exceeding the peak during the 2020 epidemic.
A double blow to a shrinking GDP and a deteriorating debt ratio.An economic recession usually causes GDP to fall by 4% to 5%, from $30 trillion to around $29 trillion.This not only reduces the tax base, but also reduces the economy’s ability to absorb new debts.The debt/GDP ratio may quickly break through 130% from 100%, far exceeding the historical high of 106% in 1946, sending a red flag to the market.
Deterioration in the labor market will intensify social pressure.In a severe recession, the unemployment rate may rise from 4.3% to 6%, reducing personal income tax revenues, but also increasing social security expenditures.The new government’s large-scale immigration and deportation policy may reduce labor supply, push up wages and prices, while weakening consumption capacity, and creating a risk of stagflation.
The critical point of the debt crisis and the collapse of market confidence
The proportion of U.S. public debt to GDP has soared from 60% in 2007 to 98% in 2024, and the long-term outlook is even more shocking – it is expected to reach 535% by the end of the century.The recession will be a catalyst for accelerating this process.
Debt dynamics will show a nonlinear deterioration.The combination of deficit expansion, shrinking GDP and surge in new bond issuance will create a typical “debt vicious cycle”: the expansion of the deficit pushes up the scale of debt, the increase of debt raises interest rate levels, and the rise of interest rates increases interest expenses, thereby further expanding the deficit.According to research, every $1 new debt has brought only $0.34 GDP growth since 2007, and this rate of return will continue to decline at high debt levels.
The Fed’s policy space has narrowed significantly.Over the past two decades, the Federal Reserve has played the role of “the last buyer” through quantitative easing, with its government debt holdings rising from 4% to 5% of GDP to 15%.However, under the current inflation environment (the core PCE inflation rate is expected to be 3.6% in 2025), continuing to expand the balance sheet may intensify inflationary pressure and push up long-term interest rates, which will increase the debt burden.More fundamentally, this operation may weaken the dollar’s reserve currency status.
The abnormal reaction in the bond market indicates a deep crisis.The interest rate cut cycle that began in September 2024 saw a rare “bear market steepening” phenomenon – long-term interest rates rose instead of falling, and the 30-year Treasury bond yield rose from 3.96% to 4.96%.This is in stark contrast to the “steepening of the bull market” in the recessions in 2008 and 2020, indicating that the market is questioning debt sustainability.If the medium- and long-term interest rates rise further to 5.5%, the annual additional interest expenses may exceed US$300 billion, making the deficit situation worse.
Policy Choice and Structural Challenges
The White House policy portfolio may alleviate certain problems in the short term, but will intensify structural risks in the long term.
In terms of trade policy, tariffs have pushed up the prices of imported goods and increased inflationary pressure.Analysis predicts that the core PCE inflation rate may reach 3.1% in 2026, forcing the Federal Reserve to maintain a high interest rate level.What’s more serious is that trading partners’ retaliation measures may reduce U.S. exports and curb economic growth.
Adjustments to immigration policies will affect labor supply.Programs that deport about 600,000 illegal immigrants each year may reduce labor reserves, drive up wage costs, and weaken consumer demand.The CBO estimates that this policy may reduce GDP growth rate by 0.2 percentage points in 2026.
Fiscal policy continues the dilemma of increasing revenue and reducing expenditure.The extension of the 2017 tax cut bill is expected to increase the deficit from 2025 to 2035 by US$1.2 trillion. Although reducing social welfare projects can reduce expenditures, it will weaken the consumption capacity of low-income groups and affect the resilience of economic recovery.The analysis predicts that the average economic growth rate of the United States may drop to 1.7% from 2025 to 2028, and the unemployment rate will reach 4.7% in 2027.
Faced with this complex challenge, multi-level and systematic response strategies are required.At the individual level, it is crucial to establish 6 to 12 months of emergency reserves, reduce high-interest debt, and achieve investment diversification.Focus on anti-cyclical assets such as gold and high-rated bonds to improve financial resilience.Enterprises need to optimize cost structure, diversify revenue sources, and strengthen supply chain resilience to cope with changes in the trade environment.Investing in digital transformation and emerging market exploration will become a key strategy.
For policy makers, there is a need to balance short-term stimulus with long-term sustainability.In terms of monetary policy, the Fed needs to be cautious in balancing inflation with employment goals to avoid excessive easing causing inflation to get out of control.Fiscal policy should prioritize investment in high-return areas such as green energy and digital infrastructure rather than simply expanding spending.
The most fundamental thing is to promote fiscal reform.The U.S. fiscal gap in 2024 is equivalent to 4.3% of GDP. If it is postponed to 2035 or 2045, the required primary surplus will increase to 5.1% and 6.3% respectively.Reforms should optimize the efficiency of social security and medical expenditures, while taking into account tax structure reform.International cooperation is also crucial to ease the impact of tariff wars by strengthening trade coordination and maintaining global economic stability.
