Author: Zhou Ziheng

1. Current U.S. Debt Situation and Macroeconomic Background

As of April 2026, the scale of U.S. federal debt is approaching a historical high. According to the latest forecast from the Congressional Budget Office (CBO), the debt-to-GDP ratio is expected to be around 101% in fiscal year 2026 (publicly held portion), but when considering total debt, it had reached 122.57% by the end of 2025, and is projected to further rise to about 125.8% in 2026, with some estimates even approaching 137%. The total national debt is approximately $39 trillion, while GDP is around $28.5 trillion, indicating that the debt significantly exceeds the economic capacity that can sustain it. The federal deficit is expected to reach $1.9 trillion in fiscal year 2026, accounting for about 5.8% of GDP, which is substantially higher than the historical average.

The federal expenditure has long maintained a high proportion of 22%-23% of GDP. The net expenditure ratio is about 22.8% in 2025 and is expected to be 23.3% in 2026, far above the 50-year average of 21.2%. Among these, mandatory spending (Social Security, Medicare, Medicaid) has been continuously rising, becoming a major driver of deficit expansion. Net interest expenditure is also growing rapidly due to the expansion of debt stock and changes in the interest rate environment, with CBO projecting that by 2036, it will reach 24.4% of GDP. Meanwhile, M2 money supply, after a significant expansion in 2020-2021 and a brief contraction, has been gradually rebounding since 2025, reaching $22.667 trillion in February 2026, with an annual growth rate of about 4.88%. These data indicate that the U.S. is facing the most severe debt pressure since World War II, with structural deficits and long-term liabilities mutually reinforcing, creating a vicious cycle.

2. Traditional Paths to Resolve Debt Crisis and Their Realistic Limitations

The main options for the government to respond to the extremely high debt-to-GDP ratio include fiscal tightening, debt default, monetary financing, and debt burden dilution through growth. Tightening policy entails drastically cutting expenditures, but it is difficult to implement in the current political environment. Entitlement programs like Social Security and Medicare have not seen declines but have instead accelerated growth due to an aging population, making it challenging for federal spending to drop below the pre-war level of 10%. While default can relieve burdens in the short term, it would destroy credit and lead to soaring borrowing costs and restricted market access, thus it is also unfeasible.

Monetary printing has become a mainstream choice, but money is not simply "printed" but created through loans. For every new dollar of currency, the future demand for dollars increases. The total debt must grow faster than the money supply; otherwise, the system becomes unbalanced. If the new currency fails to convert into real production and economic growth, it will only amplify future repayment pressures without corresponding output support, ultimately triggering inflation or stagflation risk. This encapsulates the core dilemma of the current debt crisis: the government needs to borrow new to pay old to maintain operation but finds it difficult to cover all liabilities through taxation.

3. Micro-Transmission Mechanism of Monetary Supply Expansion and the Cantillon Effect

The impact of monetary expansion depends on the path through which it enters the economy, rather than just the total amount. If all dollar stocks doubled evenly, with prices adjusting simultaneously, the real purchasing power would remain unchanged, akin to a stock split, without any real wealth transfer. If new currency is completely isolated (e.g., sent to outer space), it would have zero impact on the economy. However, in reality, money is injected through specific channels: the first recipients purchase goods and services at old prices and obtain real resources; as the currency spreads, prices rise, and later recipients face higher costs. This illustrates the classic Cantillon effect—wealth is transferred from later recipients to earlier ones.

The monetary expansion in 2020-2021 exemplifies this. M2 surged at the beginning of the pandemic, followed by a brief contraction by the Federal Reserve to control inflation, yet it re-initiated expansion to avoid a deflationary spiral. Most of the newly created money did not stimulate direct checks but flowed through government borrowing to contractors, PPP loans, and politically connected parties. Asset prices and commodity prices rose first, while ordinary citizens endured rising living costs before wage adjustments, leading to a widening wealth gap. The centrally planned distribution mechanism replaced market prices and voluntary exchanges, resulting in resource misallocation rather than production growth.

4. Historical Comparison: Debt Resolution Post-World War II and Contemporary Structural Differences

During World War II, the U.S. debt-to-GDP peak exceeded 120%, but successfully resolved it through monetary financing post-war. Measures such as financial repression, capital controls, and yield curve control were employed, allowing the government to issue debt supported indirectly by the Federal Reserve. Meanwhile, wartime spending sharply declined from 40% of GDP, factories transitioned from military to civilian production, and labor returned from battlefields to economic construction, leading to rapid accumulation of real wealth, which diluted the debt through economic growth.

The contemporary context is vastly different. Federal spending has not experienced a post-war-style collapse; it has maintained a high level over the long term, still exceeding 23% in 2026. The proportion of entitlements in spending continues to rise, and demographic changes impose rigid growth on Social Security and Medicare expenditures. Production resources have not been "destroyed and rebuilt" by wartime efforts but continue to be used for consumption and transfer payments. The CBO's long-term outlook indicates that by 2036, the debt-to-GDP ratio will rise to 120%, reaching as high as 175% by 2056, with interest payments potentially exceeding economic growth, and the R>G phenomenon may emerge by 2031, creating debt spiral risks. Historical experience shows that monetary financing must accompany real production expansion to be successful; otherwise, it only postpones the crisis.

5. Proposed Policy Tools: Regulatory Adjustments to the Supplementary Leverage Ratio (SLR)

To stimulate growth without triggering high inflation during monetary expansion, the government is advocating for deregulation in the banking sector. A key measure is the adjustment of the Supplementary Leverage Ratio (SLR). In November-December 2025, the Federal Reserve, OCC, and FDIC finalized modifications to the enhanced SLR (eSLR) rules, which will take effect on April 1, 2026, and can be voluntarily adopted as early as January 1, 2026. The new regulation lowers the leverage penalty for GSIBs and their subsidiaries on low-risk assets (such as U.S. Treasury Bonds), allowing banks to hold unlimited amounts of Treasury securities while freeing up risk capacity for private sector lending.

This move is akin to "quasi-QE," but executed by commercial banks instead of the Federal Reserve directly. Banks, driven by profit motives, are more inclined to allocate funds to high-return productive projects rather than merely government financing or speculation. The temporary suspension of the SLR in 2020 led to a surge in bank lending, spurring economic activity, but combined with the Federal Reserve’s QE resulted in out-of-control inflation. This adjustment aims to replicate the lending effect while reducing direct intervention from the central bank and decreasing moral hazard.

6. Economic Consequences and Risk Assessment Under Two Potential Scenarios

Scenario 1: Banks fully utilize the new capacity, significantly purchasing Treasury securities to lower Treasury yields and relieve government interest burdens while providing cheap credit to enterprises. Business investments and hiring expand, leading to real GDP growth. Monetary expansion coupled with supply increases could partially or fully offset inflationary pressures. The overall economic pie grows, and the debt-to-GDP ratio remains relatively stable. In this scenario, productive lending predominates, enhancing resource allocation efficiency, resembling a market-led growth path.

Scenario 2: Banks prefer only to purchase Treasury securities or direct funds to financial markets (hedge funds, private equity, leveraged buyouts). Government financing costs decline, but private entities receive no substantive support, leading to asset price bubbles. Prices of goods and services rise, concentrating wealth further among those who first received the money, while later recipients bear higher costs. The wealth gap widens, and the real economy falters, resembling certain effects seen in 2020-2021.

Both scenarios benefit asset prices: in a sovereign debt crisis environment, the government tends to avoid tightening or default, generally benefiting asset holders. However, if the situation merely stays at asset inflation without real growth, long-term sustainability becomes concerning. Political connections and central planning may still distort resource allocation, and while bank profit motivations are superior to direct government spending, systemic risks (like shadow banking and excessive leverage) cannot be overlooked.

7. Comprehensive Policy Assessment and Long-term Economic Outlook

The adjustment of bank SLR reflects the difficult balance between the Federal Reserve and fiscal departments regarding debt sustainability, growth, and inflation. It attempts to achieve a "money printing + growth" combination through market-oriented channels, avoiding the inefficiencies and inequities of pure fiscal stimulus. However, the fundamental problems remain unresolved: rigid growth in entitlements, mismatch of tax revenues to expenditures, and ongoing challenges related to demographics and productivity. The CBO warns that if R continues to exceed G, debt will rise indefinitely, and the risk of a fiscal crisis will increase.

From a broader perspective, this policy highlights the tension between modern monetary theory and traditional fiscal discipline. It may stabilize the market and boost assets in the short term but relies on sustained growth in the long term. If the global interest rate environment tightens or geopolitical black swan events (like war or supply chain shocks) occur, the probabilities of runaway inflation or a debt spiral may increase. Historical lessons indicate that successfully resolving debt requires real production expansion rather than merely financial engineering. Policymakers must be vigilant about moral hazards and resource misallocation, avoiding a repeat of the high inflation experienced in 2021.

Overall, the U.S. is attempting to "thread the needle" during the debt crisis: leveraging bank deregulation to achieve supply-side responses under monetary expansion. This path is more targeted than pure money printing, but its effectiveness depends on actual bank lending behavior and the macro environment. Market participants should focus on credit data, GDP growth rates, and inflation indicators following the SLR adjustment to assess the trajectory of scenarios. The debt issue is fundamentally a fiscal sustainability issue; any monetary-financial tools serve only as temporary buffers, with structural reforms being the long-term solution.

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