In a recent Bloomberg interview, former Treasury Secretary Hank Paulson issued what he himself described as a “break the glass” warning about the U.S. fiscal situation. On episode 134 of the InFi podcast, I played clips from that interview and filled in the supporting data. In this post, I’ll lay out the argument in print and give you links to the underlying sources so you can verify everything for yourself.
First, a word on why Paulson’s appearance matters. He was a towering figure during the Global Financial Crisis, a former CEO of Goldman Sachs who served as Treasury Secretary under President Bush from 2006 to 2009. For those of us who were of the hard-money, anti-bailout persuasion, he was not exactly a hero; he was the architect of TARP (the Troubled Asset Relief Program) and, as the story goes, essentially marched the CEOs of the nine largest U.S. banks into a room, slid a folder in front of each of them listing the capital infusion Treasury was going to pour into their institutions, and made clear that declining was not really an option. Finally, Paulson isn’t a regular on the financial media circuit, which makes his re-emergence now, with language this dire, all the more notable.
The Fiscal Headroom Problem
In the (full) Bloomberg interview, the host asked Paulson to compare today’s situation to the environment he faced in 2008. The key observation Paulson echoed — and one that I think is underappreciated — is that back in 2008, major governments still had enormous fiscal headroom. When the financial system began to seize up, the United States (and other large economies) could respond with massive deficit spending precisely because debt levels were relatively modest. Today, that buffer is largely gone.
(To avoid confusion: As an Austrian School economist, I disagree that government “stimulus” spending is actually helpful, but I’m aware that policymakers and the economics establishment will disagree when the next crisis hits.)
The numbers tell the story clearly. In Q2 2008, when the crisis was gathering force, U.S. federal debt held by the public stood at roughly 36 percent of GDP. That figure then rose sharply as stimulus spending kicked in, spiked again during COVID, and is now just breaking 100 percent of GDP. In other words, the federal government currently owes outside creditors — including the Federal Reserve — an amount equal to everything the entire U.S. economy produces in a full year.
A quick note on the debt measure: there are two commonly cited figures. The “gross public debt” (the number the debt ceiling refers to) is larger, because it includes debt held internally by government agencies, most notably the Social Security Trust Fund. “Debt held by the public” strips out that intragovernmental portion, and is the figure most economists prefer when comparing debt burdens across countries. Even this more conservative measure is just now breaking 100 percent of GDP.
And if you’re tempted to think of this the way you’d think of a household or a business, it’s actually worse than a 100% debt-to-GDP ratio implies. Federal tax receipts are nowhere near 100% of GDP; they’re more like one-third of that. So if you want to think of tax revenue as the government’s “income,” the debt-to-income ratio is closer to 300%.
The Entitlement Clock Is Running Out
I’ve been following fiscal policy debates since I was quite young, and for as long as I can remember, entitlement reform has been the perennial “long-term problem” that politicians of both parties have kicked down the road. Well, the road is ending.
Here are three milestones worth marking. First, in 2010, Social Security became cash-flow negative for the first time (at least since the early 1980s when it was reformed), which meant that the payroll taxes (FICA contributions) coming in from workers were no longer enough to cover the benefit checks going out to retirees and other beneficiaries. However, this didn’t immediately create a crisis, because the Social Security Administration had spent decades accumulating a large stockpile of Treasury securities in its Trust Fund — the product of a major reform in the 1980s that ran the system at a surplus. The interest income from those holdings still kept the overall balance positive.
That changed around 2021, when the interest income was no longer enough to cover the gap. From that point forward, the Social Security Administration began drawing down the principal of the Trust Fund, selling off Treasury securities to make up the shortfall. The Trust Fund is now shrinking every year. According to the latest projections, it will be fully exhausted around 2034 or 2035. At that point, under current law, benefits would be cut by roughly 20 percent across the board, because incoming payroll taxes would be the only funding source.
This isn’t a theoretical future scenario. It’s less than a decade away. And the structural forces driving it — an aging population, more retirees per worker than in the 1970s or 1980s, decades of accumulated promises — aren’t going to reverse themselves.
Why This Time Is Different From World War II
A common retort to fiscal warnings such as the above, is to note that U.S. debt-to-GDP hit even higher levels during World War II, and yet the country grew out of it just fine. That’s true, but the analogy doesn’t hold. The WWII debt spike was a one-off emergency. Once the war ended, the country returned to peacetime budgets; the government actually ran outright surpluses for a year or two, and then the economy simply grew faster than the nominal debt. The debt-to-GDP ratio fell through the 1950s and 1960s not because Washington was especially fiscally virtuous, but because the denominator (GDP) was expanding rapidly.
Today’s situation is structurally different. Yes, there have been specific crises — the 2008 recession and COVID, to be specific — that caused debt to spike. But we can’t just return to “normal” once those crises pass, because the long-term entitlement math has finally caught up with us. The spending pressures are built in. And on top of that, the interest cost on servicing the existing debt has itself become enormous: as of last year, the federal government’s annual interest payments exceeded its entire defense budget. That’s not a one-off — it’s now the baseline.
Paulson’s “Break the Glass” Warning
The second clip I played from the Bloomberg interview — the one that generated headlines — had Paulson warning that the U.S. could face a crisis of confidence in Treasuries. This is the scenario that has long seemed unthinkable to many serious, sophisticated observers: a world in which global investors no longer treat U.S. government debt as the ultimate risk-free asset.
I’ve been making versions of this argument for years, including at conferences where I laid out the case that the dollar’s status as the global reserve currency was not guaranteed forever. Afterward, people would come up to me and say something like: “Yeah, Bob, I can’t point to anything you said that was wrong, but come on. Where else are people going to go?”
The honest answer is: you can’t time when a crisis of confidence will hit. A Chicago School economist can correctly point out that if it were common knowledge that Treasury yields would spike in, say, August 2026, investors would try to get out in July — and if it were common knowledge they’d try to get out in July, the exodus would start in June, and so on. Crises of this type can’t be publicly pre-scheduled. Instead, what can happen is that the underlying fundamentals deteriorate over time, more and more observers start to recognize the danger, and then some spark — unpredictable in advance — triggers a run. Afterward, in hindsight, people slap their heads and say, “How did we not see that coming?” The answer is that many of them did see it coming; they just couldn’t coordinate on when.
Warning Signs Already Visible
A few specific data points suggest the erosion is already underway. As I discussed on the podcast, the Federal Reserve itself is currently insolvent in a meaningful sense: if you mark its fixed-income assets to market, its liabilities exceed its assets. Beyond that, last October it was reported that, for the first time since 1996, global central banks held more in gold reserves than in U.S. Treasury reserves. Gold isn’t a currency (in today’s financial system), so one might argue that this fact alone doesn’t mean the dollar has ceased to be the reserve currency, but at the very least it means that one key metric of reserve-asset status has already shifted.
Meanwhile, more recently, the UAE approached the U.S. Treasury seeking a special dollar swap line, with the implication that without it, they might move toward pricing oil in yuan. A few years ago, the suggestion that a Gulf state would openly float such a possibility would have seemed far-fetched. Today it’s in the news. Similarly, during the disruptions around the Strait of Hormuz, reports emerged that Iran was accepting payment — for passage tolls — in both Tether and yuan. The dollar’s grip on global energy trade, which has been one of the bedrock supports of its reserve-currency status since the 1970s, is showing visible cracks.
What a Treasury Crisis Would Actually Look Like
To make this concrete: imagine a scenario in which Treasury yields spike sharply — perhaps because a meaningful number of global investors decide to reduce their holdings. The interest cost on servicing the existing debt, already large, would become crushing. The Fed’s normal response would be to step in and purchase Treasuries to cap yields (essentially monetizing the debt). But what if this scenario unfolds at the same moment that consumer price inflation is already running hot, perhaps because the Middle East conflict has pushed gasoline to $6 a gallon? The Fed would be caught between its two mandates, forced to choose between letting Treasury yields rip or flooding the system with new money into an already-inflationary environment. That’s the type of scenario I had in mind when I periodically warned after the Fed began rounds of QE (while the Obama Administration ran trillion-dollar-plus deficits) that it was painting itself into a corner.
For decades, the Federal Reserve has enjoyed the benefit of the doubt: investors around the world assumed that the grown-ups were in charge and that the Fed would never let things truly spiral. That credibility is a real and valuable asset. But it is not infinite, and it is not self-replenishing. If investors begin to conclude — individually, not as a coordinated group — that the U.S. authorities have lost control of the situation, the process that follows would not look orderly.
Conclusion
I want to be clear about what I am and am not arguing. I am not predicting that a Treasury market crisis is imminent, or that it will happen on any particular timeline. What I am saying is that the structural preconditions for such a crisis are more firmly in place today than at any point in modern American history, and that a person of Hank Paulson’s stature and experience is now saying so publicly. When the Hindenburg caught fire, I imagine some people who had nervously watched hydrogen-filled dirigibles for years felt a grim sense of vindication. The appropriate response isn’t “I told you so” — it’s to make sure you’re not standing underneath the thing when the spark hits. I’ll leave the specific investment implications to individual readers and their advisors. But ignoring the warning entirely, on the grounds that people have been warning about it for years and nothing has happened yet, would be a mistake.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together the dependability of Whole Life insurance policies with the benefits of blockchain-based finance.
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