Fiscal Dominance or Fiscal Crisis?  2025 Resembles 2005, Not 1995

Is the US economy on the verge of entering a new phase of "American Exceptionalism," or is it approaching the edge of another financial crisis?These two perspectives represent the extreme ends of potential outcomes. Certainly, the economic outlook for 2025 is not grounded in strong fundamentals, as it was in 1995 when America embarked on a long period of "exceptionalism." However, there are some parallels to 2005 (excessive risk-taking and borrowing) that culminated in a significant financial crisis.

Between 1995 and 1999, over a span of five years, the US experienced an average real GDP growth of 4% per year, a feat unmatched since the 1960s. However, even more remarkable than this growth performance was the fact that America settled its "current bills," concluding that period with a balanced budget, and didn't pass legislation that increased future deficits.

In 2025, the US is experiencing minimal growth and facing a budget deficit projected at $2 trillion, suggesting it is not covering its "current bills." Furthermore, Congress's passage of the "Big Beautiful Bill" (BBB) adds an additional $4 trillion over the upcoming decade, leading to an anticipated cumulative annual deficit nearing $25 trillion for the next ten years, as reported by the Congressional Budget Office. When it comes to federal borrowing, 2025 is fundamentally different from 1995 and the years that followed.

However, 2025 resembles 2005. In 2005, American households borrowed trillions to purchase primary and secondary homes and took out additional home equity loans to fund their spending. Likewise, in 2025, the US government is borrowing unprecedented amounts, not only for the present year but also increasingly for the next decade, to maintain and support the economy's growth trajectory.

As house prices declined, the excessive risk-taking and leverage by households resulted in a series of adverse effects on the financial markets and the economy. While the federal government has more borrowing options and capacity compared to the private sector, it is not limitless.

In 2009, Kevin Hassett, who is the White House Director of the National Economic Council, co-authored an article titled "The Deficit Endgame" for the American Enterprise Institute. In this article, the authors noted "countries most at risk of defaulting on their government debts were those heavily dependent on foreign capital flows to finance their government deficits." The authors also that high levels of domestic debt could and have led to defaults.

The US fits both of these descriptions; it is heavily reliant on foreign capital and operates with a current debt-to-GDP ratio well above the thresholds that have led to previous sovereign defaults in other countries.

Financial markets currently perceive a very small risk of the US entering the "default bucket," unlike with other countries with a similar debt profile. However, the potential for another credit downgrade might change this view or at least raise funding costs. In April, S&P Global Ratings, mentioned that "the outcome of forthcoming fiscal negotiations...will be a key factor in our assessment of the US fiscal profile." The approval of "BBB" by Congress represents "fiscal expansion" as opposed to the "fiscal consolidation" typically preferred by credit ratings, which increases the likelihood of a credit downgrade.

Two decades ago, the notion that home prices might fall was unimaginable for households, as a nationwide decline had never happened, nor did they anticipate challenges in refinancing their debt. Similarly, it's difficult to envision the US government being unable to roll over its debt. However, this scenario can occur at any time, often triggered by factors like the financially reckless 'Big Beautiful Bill'.