Europe Must Hedge Against US-China Debt Risks

In their bilateral summit, Donald Trump and Xi Jinping addressed many issues concerning the relationship between the two global powers, but not the most important one: the unsustainability of their growth models, both based on public debt, and the consequences of that unsustainability for their own economies and for the international financial system. 

In the United States, public debt has doubled over the past 20 years, reaching 124 per cent of gross domestic product, as a result of highly expansionary fiscal policies, with an average deficit of 6 per cent of GDP a year. According to the International Monetary Fund, US debt will continue to rise in the coming years, exceeding 140 per cent by the end of the decade. Interest payments on the debt exceed 4 per cent of GDP, more than military spending. According to Niall Ferguson, a historian at the Hoover Institution, this trend is a source of vulnerability for a military power. 

China’s situation is no better. Public debt has doubled in less than 10 years, rising to 100 per cent of GDP in 2025. By the end of this decade, it is projected to exceed 123 per cent, as a result of public deficits of more than 8 per cent a year. 

Interest payments on Chinese debt are lower than in the United States, because the debt is held mainly by the banking system. This, however, creates other distortions in the economy. 

In short, in both countries public debt is on an unsustainable trajectory. The budgetary correction is postponed year after year, but it is unavoidable if a financial crisis is to be avoided. 

The difficulty of such an adjustment is mainly political, because it calls into question the development model of recent years. 

In the United States, stabilising the debt would require, even with growth above 3 per cent a year, driven by investment in artificial intelligence, achieving a primary budget balance — that is, a balance excluding interest payments on government bonds. 

On current projections, this means reducing the deficit by more than 3 per cent of GDP. 

It is hard to imagine this being achieved solely through cuts in public spending, which is already below the average for advanced economies. An increase in revenues therefore seems inevitable. Yet it is politically difficult to raise taxes on the middle class, which represent the main electoral constituency. That leaves taxation of the profits of the most profitable companies, particularly technology groups. 

Such a measure would amount to a drastic reversal of the stimulus policies pursued in recent years, which have underpinned the extraordinary stock market performance of the large US technology companies. 

In other words, raising taxes would call into question America’s competitive strategy. 

In China, too, fiscal consolidation can hardly come from the spending side, since public expenditure amounts to little more than 30 per cent of GDP. On the other hand, an increase in revenues could not fall on consumption, which is already low, nor on household incomes. 

It would instead have to aim at reducing the public subsidies provided by the state, which have supported the development of companies in the sectors identified in successive five-year plans: technology, defence and the energy transition. 

These subsidies, provided mainly by local authorities competing with one another to attract investment, have generated excess production capacity and pushed companies to cut costs, and therefore wages, in order to export to third markets, mainly Europe and the United States. 

A reduction in subsidies would lead many companies to go bankrupt, with a severe impact not only on employment but also on banks’ balance sheets, which are heavily exposed to loans granted above all to large state-owned enterprises. 

Banks would then have less room to refinance public debt, which would have to be sold on the market at higher interest rates. 

In short, competition between the United States and China, in technology and military spending, is pushing the leaderships of both countries to defer the repair of their public finances. Public debt therefore continues to rise, reaching unprecedented levels. 

This increases the risk of financial instability, with potential repercussions for the rest of the world. This is especially true for Europe, whose savings — largely managed by US financial institutions, thanks to the short-sightedness of European governments — are heavily exposed to US public debt. 

Perhaps the time has come for Europe to do something concrete to protect itself from these risks. 

A previous version of this article was published in the Italian daily Il Foglio