If the U.S. hits deflation with GDP shrinking at -5% due to high tariffs and a trade war, a 7% interest rate on Treasury bonds would create a brutal economic scenario. Hereâs how it could play out:
Debt Servicing Nightmare
With the national debt over $34 trillion, a 7% average interest rate means annual interest payments of $2.38 trillion. Federal revenue in 2023 was $4.9 trillion, but with GDP contracting 5%, tax revenue would likely dropâletâs estimate 5-10% lower, say $4.4-$4.6 trillion. T
hat pushes interest payments to 50-54% of revenue, an unsustainable level. The government would have to borrow more just to cover interest, ballooning the debt further, or slash spending drastically, which could deepen the downturn.
Deflation vs. High Rates
Deflation (falling prices) typically lowers interest rates as demand for safe assets like Treasuries rises, pushing yields down. A 7% rate in this context suggests markets have lost faith in U.S. stabilityâperhaps due to the trade war tanking exports, tariffs spiking import costs, or deflation signaling a depression-like collapse. High rates amid deflation would crush borrowers (businesses, households) as the real value of debt rises, amplifying defaults and bankruptcies. Think 1930s Great Depression vibes, but with a modern debt load.
GDP Growth at -5%
Negative 5% growth is a severe recessionâworse than 2008 (-4.3% peak decline). Combined with 7% rates, the debt-to-GDP ratio would skyrocket. If GDP drops from $28 trillion (2024 estimate) to $26.6 trillion, and debt stays at $34 trillion, thatâs a 128% ratio jumping to 135% in a yearâand climbing as borrowing continues. Real (inflation-adjusted) rates would be even higher with deflation (say, -2% prices), making 7% nominal feel like 9% real, choking investment and consumption.
Trade War and Tariffs
High tariffs sparking this mess would likely tank global trade, hitting U.S. exporters (e.g., agriculture, tech) and raising costs for consumers despite deflation in other sectors. Deflation might come from a demand collapseâpeople stop buying, inventories pile up, prices fall. A 7% rate suggests bond markets are pricing in a risk premium, not expecting deflation to last, or betting on a chaotic policy response (e.g., printing money to offset tariffs, then overshooting).
Likely Effects
- Fiscal Crisis: Half the budget going to interest leaves little for stimulus or safety nets, forcing austerity or money printing. Austerity deepens the GDP drop; printing risks flipping deflation to hyperinflation if confidence collapses.
- Dollar Pressure: Deflation might initially boost the dollar as a safe haven, but 7% rates with negative growth could signal distress, weakening its reserve status if foreigners dump Treasuries.
- Market Meltdown: Stocks and housing would tankâhigh rates kill valuations, and deflation erodes corporate profits. Unemployment could soar past 10%.
- Breaking Point: The U.S. wouldnât "go bankrupt" instantlyâit could print dollars to pay bondholdersâbut the economy could stagflate (stagnation + inflation) if the Fed overreacts, or spiral into a depression if it doesnât.
Could It Hold?
The U.S. might limp through a year or two at 7% rates and -5% growth, leaning on its reserve currency privilege. But the debt-to-GDP ratio could hit 150% fast, and interest costs nearing 60% of revenue would test even that resilience. Without massive growth (unlikely in deflation) or a sharp rate drop (hard with trade war chaos), youâre looking at a slow bleed toward default-like conditionsâthink Argentina 2001, but with more global fallout. The Fed would likely slash rates or buy bonds aggressively before it gets that far, unless political gridlock or market panic ties its hands.