The Federal Reserve (3)

The US government debt now is huge. It is not sustainable. Moreover, it might threaten not only the economy but also the nation and the world (because the US plays a key role in the world order). For example, Niall Ferguson presented a lecture on November 11, 2024: Is Democracy Doomed? [1]. In history, an empire would be doomed if the interest service of its debt is greater than its defence spending. (A more formal paper is [2].) Soon afterward, several well known figures also voiced concern of the government debt. To be sure, government debt problems are not unique to the US; many other governments in the world also have debt problems. However, because the US dollar is the reserve currency, the US debt might cause severe troubles worldwide.  

Perhaps the best analysis about the US debt problem was Mohamed El-Erian and two Stanford economists in September last year [3]. A few scenarios were considered. The best one is to grow the US economy so that the debt as a percentage of the GDP might be capped, if not lowered. 

One approach is to reduce government expenses, such as DOGE [4]. Initially, Elon Musk led DOGE. Recall after Elon Musk bought Twitter (now X), he fired 85% of its employees while keeping Twitter running. However, the government is completely different from the private sector. There are legal requirements, contracts to honor, unions to negotiate. DOGE is unlikely to solve the debt problem. 

When the so-called Big, Beautiful Bill was passed and signed, Donald Trump and many Republicans hailed its success. However, careful examination shows that it might in fact increase the debt rather than reducing it. True, there are different ways to forecast the budget. But in any event it is unlikely to reduce deficit and debt significantly. The above implies why Federal Reserve is important. 

Recall that by changing the interest rate, the Federal Reserve can increase or reduce economic expansion. If done carefully, the US economy can grow out of the debt problem. Indeed this is the goal of Treasury Secretary Scott Bessent. (BTW, Scott Bessent is very, very good.) But wait a minute, is this possible? Wouldn’t this cause inflation? The key is if AI indeed causes productivity to increase, this is possible. When productivity increases, products and services increase and more money (if it matches the increased GDP) will not cause inflation. 

The problem is that the current Federal Reserve, led by Powell, is too backward looking. They do not know how to take the AI revolution into account. Trump was frustrated with the Fed. So we shall see. … 

References: 

1. Is Democracy Doomed? | Robert Menzies Institute Oration 2024 (11-2024) 

2. Ferguson’s Law: Debt Service, Military Spending,and the Fiscal Limits of Power (2-2025)

3. Ep47 “Is the U.S. National Debt Sustainable?” with Mohamed El-Erian (9-2024) 

4. What DOGE Is Trying To Fix And Why It Matters | Niall Ferguson (ARC 2025)  

More References: 

Trump begins audacious plan to reshape this 'powerful' institution (8-9) 

Kudlow: China has to play ball or face consequences (7-30)  (Ted Cruz on Fed Reserve)