When is Government Debt Too Much?

Investment Solutions | Market Insights

After decades of benign borrowing conditions, the sustainability of government debt here in Australia, the United States and in Europe, has returned to the centre of economic debate. A world that grew accustomed to low interest rates and subdued inflation is now confronting a more difficult fiscal* landscape - marked by rising real interest rates, persistent inflation, and mounting structural government spending pressures. The fundamental question looms: when does government debt become too much? Cameron Harrison has undertaken a detailed analysis of sovereign debt sustainability, comparing the outlook for both Australia and the United States. This includes institutional perspectives, economic fundamentals, and stress scenarios, all framed within a shifting macroeconomic environment.

Posted 31 July 2025

A Changed Landscape

The sustainability of public debt rests on four pillars: the primary fiscal balance (revenues minus non-interest spending), the real interest rate, real economic growth, and the level of existing debt. Particularly crucial is the relationship between real growth and real interest rates. When economic growth exceeds interest costs (g > r), governments can maintain deficits without exacerbating debt burdens. But when the equation reverses (r > g), as it has since 2023, debt trajectories become significantly more fragile.

Australia’s gross public sector debt (including state debt) is expected to exceed 83% of GDP in 2025 - up from 41% pre-COVID. In the United States, debt is projected to reach 129% of GDP by 2025, with forecasts indicating 140–150% within a decade without substantial reform.

Leading financial institutions and economists have issued increasingly stark warnings.

Critical Risks and Warning Factors

The Return of the Interest Burden (interest rates > growth)

The Bank for International Settlements (BIS) notes that the era of negative real interest rates has ended. With real interest rates now outpacing economic growth, governments face mounting interest costs. Stabilising debt without generating substantial primary surpluses is now far more challenging.

Fragile Fiscal Foundations and Bank–Sovereign Linkages

Debt sustainability relies on credible fiscal consolidation, robust economic growth, and low interest rates. Countries where financial institutions hold large volumes of sovereign bonds are particularly exposed - rising yields can erode banking capital and amplify systemic risks.

Risk Repricing and Spillover Effects

Fiscal (budget) irresponsibility can prompt sudden market reassessments, which in turn trigger wider financial contagion. Loss of investor confidence in sovereign authority affects the private economy, particularly the banking system, and therefore corporate credit, consumer lending, and overall financial stability.

Interest Rate Term Premium Pressures and Private Sector ‘Crowding-Out’

In the United States, there is growing concern that excessive Treasury issuance could crowd out private investment. Term premia** are rising, which can distort capital allocation (away from the private sector and debt funding as a tool) and tightening financial conditions.

Credibility and Confidence in Fiat systems

Our monetary systems rely on faith and confidence. Being fiat currency, its value is supported by confidence in the monetary, fiscal and legal frameworks that back the promise of future real value. Once credibility falters - due to political dysfunction, poor governance, or unconvincing reform — risk premia increase. The system doesn’t collapse overnight, but markets begin to demand more for lending which in turn undermines credit creation, investment and economic growth.

Structural Deficits and Limits of Monetary Sovereignty

Without reform, the United States could exceed 150% debt-to-GDP within 20 years. Such trajectories risk undermining fiscal space, increasing vulnerability to shocks, and threatening long-term inflation stability. While sovereign currency issuers can technically avoid default by monetising debt, this comes at the cost of currency debasement and inflation. Once inflation expectations become unanchored, restoring stability often requires deep and painful tightening.

Australia vs. United States: A Comparative View

Australia maintains a relatively sound Federal fiscal position (albeit revenue funding being overly reliant on income tax from a diminishing pool of taxpayers), and is supported by strong institutions and credible monetary policy. However, state level debt - particularly in Victoria and New South Wales - continues to rise. Structural spending programs such as the NDIS and ageing-related healthcare costs strain long-term sustainability.

The United States, by contrast, faces deeper challenges. Its debt-to-GDP ratio is far higher, deficits are persistent, and political gridlock impedes reform. While the US benefits from the unique privilege of issuing the world’s reserve currency, this advantage is not limitless.

Australia vs United States: Government Debt Comparison (2025)

Speak to one of our advisers to learn more: paul.ashworth@cameronharrison.com.au

Sourced from:

*Fiscal policy - the government's use of spending and taxation to influence the economy in terms of macroeconomic conditions (inflation, unemployment, economic growth) and in terms of social and community objectives (poverty, national security).

**Term premia – the extra rate of return required to invest in longer dated bonds compared with investing in rolling, shorter-dated bonds or bill notes.

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