Latest / The National Debt Podcast with Fexingo: Treasury, Borrowing, and Long-Term Fiscal Outlook / How Trade Wars Inflate The National Debt
Transcript
- Lucas: The headline this morning is that the United States has revealed an import ban on a slew of Canadian goods as the trade war escalates, and Canada is hitting back with CA$27.6 billion in retaliatory tariffs. But most people are looking at the political theater instead of the fiscal ledger, which is where the real damage happens. Luna: Right, everyone is focused on the diplomatic spat, but you are talking about how this reshapes the federal budget. How does a border dispute actually show up on the debt chart? Lucas: It shows up in two ways, and neither of them is pretty. First, tariffs are technically taxes paid by the importer, not the exporter, so they raise revenue for the Treasury in the short term. That sounds like a win for reducing the deficit, right? Except it isn't because the second effect is much larger and slower to register. Luna: Which is the inflationary hit. When imports get more expensive, domestic prices rise, and then the government has to spend more on everything indexed to inflation. Lucas: Exactly. You are paying more for lumber, steel, and consumer goods, which pushes up the Consumer Price Index. Higher CPI means higher interest payments on Social Security and veterans benefits, and it also forces the Federal Reserve to keep rates higher for longer to fight that inflation. Both of those things increase the cost of servicing our existing debt. Luna: So we are essentially taxing ourselves to pay higher interest rates on the very debt we are trying to manage. It feels like a circular trap. Lucas: It is a structural trap. Look at the data from early this year. Federal debt total was already sitting at roughly thirty-nine trillion dollars, and the debt to gdp ratio had crept up to twelve point six percent. Now add a trade war that disrupts supply chains and raises input costs for American manufacturers. Luna: And when American manufacturing gets squeezed, they don't just absorb the cost. They pass it on, or they cut back on hiring. Either way, the economic velocity slows down. Lucas: Precisely. Slower growth means lower tax receipts from corporate profits and individual income. So you get a double whammy: revenues stagnate or drop while mandatory spending rises due to inflation indexing. That gap has to be filled by borrowing, which pushes yields higher. Luna: And we are seeing that pressure right now. The ten-year Treasury yield is holding around four point seven eight percent, up slightly over the last few days. Lucas: That is the market pricing in exactly what we are discussing. Investors know that trade friction introduces volatility, and volatility demands a premium. If the U.S. is seen as less predictable because of erratic tariff policies, foreign buyers become cautious. We saw Japan dump eighty billion dollars in reserves last month to intervene in the yen, which signals that global central banks are nervous about currency stability. Luna: So if foreign demand for Treasuries softens because they are worried about U.S. trade policy, the U.S. government has to find someone else to buy that debt. Who is left? Lucas: Domestic investors, mostly. But when domestic capital flows into Treasuries, it competes with private investment. This is the crowding-out effect we have talked about before, but it is accelerated by trade policy. If the government is borrowing more to cover the inflationary drag of tariffs, interest rates stay elevated, making it harder for businesses to expand. Luna: It creates a weird paradox where the policy meant to protect domestic industry ends up choking off the capital needed to modernize it. Lucas: That is the irony. Tariffs are supposed to bring jobs back, but if the cost of production goes up, companies automate or relocate to countries without the trade barriers. The revenue gain from the tariff is tiny compared to the long-term loss in economic output. And that lost output is what drives the debt spiral. Luna: Let's look at the numbers for a second. The federal surplus or deficit for the period ending September twenty-fifth was negative one point seven seven trillion dollars. That is still massive. Lucas: And that number is likely understated regarding the true cost of these new trade measures. When you factor in the administrative costs of enforcing bans, the legal challenges, and the subsidies required to prop up affected industries, the net fiscal impact turns negative faster than anyone predicts. Luna: So the 'victory' on the trade front is actually a liability on the balance sheet. Is there any scenario where this works out positively for the debt? Lucas: Only if the trade partner capitulates immediately and the tariffs are removed quickly. Then you get the revenue bump without the long-term disruption. But that is not happening here. Canada is retaliating, China is missing import estimates, and the European markets are watching closely. This is a multi-front trade stress test. Luna: And the Fed is stuck in the middle. They can't cut rates because of inflation, but they can't hike them further because growth is slowing. It is a classic stagflationary setup. Lucas: Stagflation is the worst-case scenario for debt management. High interest payments plus low growth equals a widening deficit. We are currently looking at a Fed Funds effective rate of three point six three percent, flat for a while, but the market expects changes based on what happens next week with the FOMC. Luna: If they hold rates steady, it might signal confidence. If they move, it could be a reaction to the trade data. Either way, the bond market is jittery. Lucas: The VIX is usually a good proxy for that anxiety, and while we don't have the live ticker, the movement in the ten-year and thirty-year yields suggests risk aversion is rising. The thirty-year yield dropped slightly to five point two four percent, which is odd, but it might reflect a flight to quality rather than optimism. Luna: Flight to quality makes sense. If equities are volatile due to trade wars, money moves to bonds. But bonds are becoming less attractive because of the inflation risk we just discussed. Lucas: Right. So you have a tug of war between fear of stocks and fear of inflation. That tension keeps the yield curve twisted, and a twisted curve is bad for long-term planning. Banks lend based on the short end, but governments borrow on the long end. If those disconnect too much, liquidity dries up. Luna: This feels like a lesson in unintended consequences. We treat tariffs as a simple lever—pull it, get revenue—but it pulls a lot of other levers we didn't account for. Lucas: Exactly. Fiscal policy and trade policy are inseparable. You cannot do one without affecting the other. The national debt is not just about Washington spending; it is about how the world trades with us. When we build walls, the cost of maintaining those walls gets added to the tab. Luna: It reminds me of the old saying that the best tax is no tax, but the worst subsidy is a forced one. Tariffs are basically forced subsidies to inefficient domestic producers, paid for by consumers and funded by debt. Lucas: A perfect summary. And until the administration realizes that the debt service cost is rising faster than the tariff revenue, we are going to see more of this volatility. The thirty-nine trillion dollar elephant in the room doesn't care about the political headlines. Luna: It just cares about the interest rate. And right now, that rate is climbing because we are making the economy less efficient. Lucas: Before we go further, I want to pause for a moment. Walking through the complexities of trade policy and its hidden toll on the national debt can feel overwhelming, especially when the headlines are screaming about tariffs and retaliation. Luna: Yeah, it is easy to get lost in the noise of geopolitical spats and miss the quiet mechanics of how our money actually works behind the scenes. Lucas: Exactly. That is why listener support matters so much. It allows us to keep digging into these structural issues without relying on ads that interrupt the flow of information. If you value deep, ad-free analysis, you can support us at buy me a coffee dot com slash fexingo. Luna: Even a small contribution helps keep the lights on and the research sharp, so we can keep bringing you these conversations every single day. Lucas: Thanks for considering it. Now, let's get back to the data, because there is another layer to this trade-debt link that most people ignore. Luna: Which is the impact on state and local budgets. When federal trade policy disrupts industries, states lose tax revenue from their own citizens and businesses. Lucas: Spot on. State governments often have balanced budget requirements. If their revenue drops because of a federal trade shock, they either have to cut services or borrow locally. Local borrowing rates are usually higher than Treasury rates, so the cost of debt spirals even faster at the municipal level. Luna: So the federal action ripples down to the city level, forcing municipalities to issue more expensive debt to cover basic services. Lucas: It is a cascade effect. One decision in Washington about Canadian lumber becomes a budget crisis for a school district in Michigan or a transit authority in Ohio. The national debt is national, but the pain is distributed unevenly. Luna: It highlights how fragile the fiscal ecosystem really is. We tend to think of debt as a abstract number on a screen, but it is connected to every school bus and police patrol car in the country. Lucas: And that connection is why we need to pay attention to the details. Not just the politics, but the plumbing. The plumbing is leaking, and we are all standing in the water. Luna: So the question for next quarter is whether the Fed can stabilize rates before the trade war causes enough revenue loss to force a major shift in fiscal policy. Lucas: I doubt it. The momentum is too strong, and the markets are too sensitive. We will likely see more turbulence ahead as the full costs of these tariffs start to appear in the quarterly reports.