Back through political history to the age of Ronald Reagan, Republicans have repeatedly promised the US public that tax cuts would pay for themselves, firing up economic growth and filling the government’s coffers. The promise never really panned out. From the Gipper’s day on, the Republicans’ tax cuts inevitably increased the budget deficit.
Despite its failure, though, the promise is back, coated in a fine new layer of artificial intelligence pixie dust. The treasury secretary, Scott Bessent, is relying on an AI-laced economy when he promises to deliver annual economic growth of 3% – a rate that, except for the rebound from the Covid pandemic, has been achieved only twice this century. Dreams of AI inflect Donald Trump’s fantasy that “we’re growing at a faster rate than we’ve ever grown before,” which will allow the government to “take care of the 40 trillion” in federal debt “over a period of time”.
Financial markets, however, are not buying. Last week, the yield on the 10-year treasury bond surged to its highest in almost a quarter century, more than a full percentage point higher than when Trump launched his misbegotten war against Iran. The war’s inflationary impact is the most immediate cause of rising bond yields.
It already persuaded the Fed to raise short-term interest rates. But the treasury market is also being walloped by the US’s unbalanced finances. There is no realistic path for economic growth to generate the tax revenues needed to fix the US’s enormous and growing budget deficit.
Investors are demanding more to cover the growing funding gap. Borrowing is likely to become more expensive still. Foreign central banks, which once reliably bought treasuries to build up foreign reserves and manage their exchange rates, have cut back on their exposure to US government debt.
The treasury now relies largely on private investors seeking to turn a profit. It finds itself competing for their money with the very AI superscalers on which it is pinning its future hopes, which are borrowing hand over fist to fund the buildout of datacenters to train their agents. Indeed, the US’s finances find themselves in a bit of a negative spiral, as rising bond yields put additional pressure on the budget.
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