Two new National Bureau of Economic Research working papers reframe the debate over America's $40 trillion in federal debt. Rather than asking whether the debt is sustainable, MIT economist Ricardo Caballero asks whether a large stock of even safe, solvent debt can itself start dragging on the economy — and finds the U.S. is edging closer to that tipping point. A separate paper shows nonaligned central banks have already shifted nearly a third of their reserve portfolios away from foreign-currency assets.
A different question than default
Washington's standard debate over gross federal debt, which crossed $40 trillion, centers on sustainability and the risk of default. Caballero, who once chaired MIT's economics department, poses a different question in his new NBER paper: even if the sovereign stays solvent, can a larger stock of safe public debt still drag on demand? According to MarketWatch, he writes: "Suppose the sovereign remains solvent and its debt remains safe."
The absorption premium is rising
Caballero's model centers on what he calls the absorption premium — the financing cost of warehousing one dollar of debt, driven by the balance-sheet space, market making, and rollover capacity that intermediaries must supply as debt grows. On his numbers, the marginal Treasury absorption cost has more than doubled, rising from about 80 basis points in the first quarter of 2015 to 187 basis points in the first quarter of 2026. He estimates the wealth benefit to households from that safe income stream at 330 basis points, so debt issuance is still net positive for the economy — but by a shrinking margin, and the tipping point is getting closer.
Using the Congressional Budget Office's projected 2026 borrowing pace, Caballero finds one year of debt issuance erodes an additional 18 basis points of the remaining margin. Because absorption costs are convex, he warns the depletion will accelerate if debt keeps outpacing financial capacity.
Central banks are already hedging
A second paper, from a team of European Central Bank and Banque de France economists, quantifies a related shift already under way abroad. Since Russian assets were frozen after the 2022 invasion of Ukraine, nonaligned countries have moved nearly one-third of their total reserve portfolios away from foreign-currency claims, increasingly favoring gold instead of the dollar as a reserve currency. Together, the two papers point to pressure on Treasury demand building both at home and overseas.
Source: MarketWatch
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