{"id":28766,"date":"2026-08-21T13:13:38","date_gmt":"2026-08-21T17:13:38","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-us\/?p=28766"},"modified":"2026-08-21T13:13:39","modified_gmt":"2026-08-21T17:13:39","slug":"us-fiscal-policy-potholes","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-us\/insights\/us-fiscal-policy-potholes","title":{"rendered":"U.S. fiscal policy potholes"},"content":{"rendered":"\n

\n U.S. fiscal policy is often described as \u201cunsustainable,\u201d a word we\u2019ve\n used ourselves and which we think is entirely appropriate. The critical\n failing, in our view, is the post-COVID \u201cnew normal\u201d of running budget\n deficits of nearly six percent during economic expansions.\n <\/p>\n

\n The result is that U.S. policymakers are operating as one-way Keynsians:\n appropriately ramping up spending during economic shocks such as a global\n pandemic, and then conveniently forgetting to run a budgetary surplus\n during good times.\n <\/p>\n

\n But seeing that the emperor has no clothes is the easy part of U.S.\n budgetary analysis. The hard part is identifying how the situation\n resolves\u2014in other words, what likely happens when the unsustainable can no\n longer be sustained?\n <\/p>\n

\n There is no unique answer, we believe, to that question. It will depend in\n large part on how the global economy performs in the coming years, and in\n part on the \u201canimal spirits\u201d that drive markets. What can be said, we\n believe, is that investors need to be cognizant of what is\u2014and more\n importantly what is not\u2014likely as budgetary constraints eventually bind in\n the United States.\n <\/p>\n

\n We think extreme outcomes are unlikely, and that for most investors the\n best approach to U.S. debt is a return to the basics: global\n diversification, frequent rebalancing, and healthy skepticism. Active\n positioning to exploit a U.S. debt crisis is more likely, we believe, to\n end in tears of sorrow rather than tears of joy.\n <\/p>\n \n

Eventually something\u2019s got to give<\/h3>\n

U.S. federal debt as a percentage of GDP<\/h4>\n\n
\n
\n
\n \"U.S.\n

\n The line chart shows U.S. federal debt as a percentage of GDP from\n 1940 through 2025. Debt in 1940 was roughly 52% of GDP, but surged\n to nearly 119% by 1946. That was the peak level until recently.\n After 1946, it steadily declined to reach a low point of 32% in\n 1981. Thereafter it started to increase, reaching 65% in 1996. it\n dipped shortly thereafter but then began to accelerate substantially\n starting in 2008, and then jumped again in 2020 and 2021. It reached\n an all-time high of roughly 123% in 2021. While it dipped a little\n after that, it began to rise again and reached a new high in 2025.\n <\/p>\n <\/div>\n <\/div>\n <\/div>\n \n

U.S. federal interest payments as a percentage of GDP<\/h4>\n
\n
\n
\n \"U.S.\n\n

\n The line chart shows federal interest payments as a percentage of\n GDP from 1940 through 2025. Interest payments in 1940 were roughly\n 0.9% of GDP and rose to roughly 1.7% in 1946. The percentage eased\n over the next 10 years and reached a low of 1.1% in 1959. It crept\n up slowly until 1978 but then accelerated substantially thereafter,\n reaching a high of roughly 3.2% in 1991. Thereafter it retreated\n sharply through 2004, reaching 1.3%. It remained within a range of\n roughly 1.2% to 1.75% until 2022. Then it once again accelerated\n sharply and reached 3.15% in 2025, nearly matching the previous high\n reached in 1991.\n <\/p>\n <\/div>\n <\/div>\n <\/div>\n

\n Source – RBC Wealth Management, White House Office of Management\n & Budget (OMB), Federal Reserve Bank of St. Louis, FRED\n database, Bloomberg; annual data through 2025\n <\/p>\n \n

The good, the bad, and the ugly<\/h2>\n

Let\u2019s start with what we think is unlikely to happen.<\/p>\n

\n First, there\u2019s the painless path to debt reduction. This often takes the\n form of a deus ex machina assertion about AI productivity gains or revenue\n reduction that unleashes decades of non-inflationary, above-trend growth.\n We think these are largely fairy tales.\n <\/p>\n

\n While AI productivity could reduce the pain of fiscal adjustment, we think\n it\u2019s unlikely to achieve the scale of gains needed to meaningfully reduce\n the deficit and the debt. More importantly, we see any gains likely\n disappearing in a wave of tax cuts, subsidies, and spending.\n <\/p>\n

\n Next up, we have the idea of political leaders showing genuine leadership.\n This, we think, is even less likely. The simple reality, in our opinion,\n is that fixing the deficit will almost certainly be a contractionary\n influence on the U.S. economy and will likely lead to higher unemployment\n and lower stock prices. In short, it is a great way to lose an election.\n <\/p>\n

\n As a result, single-party control is never going to address the issue, in\n our view. Talk about it, sure. Blame the other side, absolutely. But do\n something about it? Maybe next time. Divided government is unlikely to be\n better, given the high degree of partisan divide. The type of compromise\n and negotiation required to address the deficit is simply beyond the\n realities of today\u2019s political conditions, in our opinion.\n <\/p>\n

Safe to say, we are not optimistic of an easy budget path ahead.<\/p>\n

\n But we believe the negative extreme is even less likely. We often read of\n analogies to the Weimar Republic and wheelbarrows of dollars to buy a loaf\n of bread. Both intellectual honesty and U.S. securities law compel us to\n recognize that this is a possible outcome, but we would emphasize that we\n see it as a remote outcome, to say the least.\n <\/p>\n

\n Post-WWI German debt was crushing, and came with devastated infrastructure\n and massive human carnage. The U.S. just has a bit too much debt and needs\n to make some fiscal adjustments. There\u2019s a point at which differences of\n scale are differences of kind, and the comparison between the U.S. and\n hyperinflation regimes is firmly in that camp, we believe.\n <\/p>\n \n

A fistful of dollars<\/h2>\n

\n If the two extremes are unlikely, we\u2019re left where we usually are in\n economics\u2014the uncertain middle. Even with the lack of clarity, we think\n there are a few likely hallmarks of the debt adjustment process:\n <\/p>\n

    \n
  • \n Higher inflation:<\/strong> The U.S. has to pay back dollars. The\n less those dollars are worth, the less painful the repayment. The Fed may\n talk tough, but tolerating a bit of extra inflation helps the budget,\n helps home prices, and makes friends in Washington, D.C.\n <\/li>\n
  • \n Long bond pain: <\/strong>As we\u2019ve said, we believe a real solution\n will require compromise between politicians via some good old-fashioned\n backroom deal making. Political realities make it impossible for\n politicians to kick off the process, in our opinion, but the bond market\n is not squeamish about making itself heard. Expect periodic flare-ups of\n higher yields to exert pressure on policymakers to act.\n <\/li>\n
  • \n Unnecessary economic contraction: <\/strong>Adding debt is\n borrowing future growth, and reducing it is paying back the extra fillip.\n By its nature, deficit and debt reductions are not going to be fun, but\n the costs can be minimized by timing and sequencing. We think the current\n environment\u2014with solid, broad-based growth\u2014would be perfect to start the\n process. In a similar vein, a well-considered plan, agreed to and\n implemented over decades, could be a real boon for the United States.\n Unfortunately, that\u2019s unlikely, in our view. Instead, we think we\u2019ll get\n an ad hoc series of measures, kicked off when the bond market forces it,\n with the usual stop-start approach to savings. In short, effective, but\n not efficient.\n <\/li>\n <\/ul>\n \n

    Investment implications<\/h2>\n

    \n Despite our skepticism that debt reduction will be well-handled, we would\n be very cautious investing on that view.\n <\/p>\n

    \n One problem is timing. The budget can stay irrational much longer than any\n investor can stay solvent. Forecasters have been calling out U.S. debt\n dynamics since the Reagan administration in the 1980s. Imagine missing all\n those investment gains waiting for a collapse.\n <\/p>\n

    \n Another is policy response. We are very cautious on U.S. Treasury 30-year\n debt, for instance. But in the context of a large debt selloff, it would\n not be strange if the Fed stepped in to buy debt and put a ceiling on\n yields. While that may ultimately prove self-defeating, it would be cold\n comfort to investors who lost money.\n <\/p>\n

    \n The better approach, we believe, is sticking to the basics and making\n small adjustments. These include diversifying internationally, rebalancing\n between asset classes, and considering shorter Treasury maturities.\n <\/p>\n","protected":false},"excerpt":{"rendered":"

    Identifying imperfections in U.S. fiscal policy is an easy task, but it\u2019s less clear what the potential adjustment process will look like. We discuss the potential path ahead for the bloated federal deficit and debt, and what it could mean for investors.<\/p>\n","protected":false},"author":15,"featured_media":28764,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"rbcwm_post_date":"2026-08-20T11:37:47","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[71],"tags":[],"rbcwm_content_owner":[609],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[468],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-28766","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"Identifying imperfections in U.S. fiscal policy is an easy task, but it\u2019s less clear what the potential adjustment process will look like. 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