America's Debt: Crisis or Calm?

In the final episode of Season 2, Alex and Tyler take on the growing mountain of federal debt—now equal to 100% of GDP, with interest payments alone rivaling national defense spending. Alex lays out the case for concern: rising obligations, off-balance-sheet liabilities for Social Security and Medicare, and a political system with no appetite for hard choices. Tyler pushes back, arguing that markets remain calm, real borrowing costs are near zero, and America's wealth-to-debt ratio tells a far less alarming story. From the relevance of the R versus G framework to the lessons of Japan's sovereign wealth strategy, they debate whether the real risk is insolvency or illiquidity, and whether solutions will come through growth, inflation, financial repression, or some mix of all three. Along the way, they explore how AI could reshape the fiscal picture—raising welfare more than wealth, extending lifespans while straining budgets, and changing what kinds of income governments can actually tax. 

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ALEX TABARROK: Good morning, Tyler.

TYLER COWEN: Good morning, Alex. We’re here for another round of Marginal Revolution Podcast.

TABARROK: Today, we’re going to be talking about debt, most specifically about federal debt. It is now pretty big. The federal debt held by the public, it’s about $30 trillion. GDP is also about $30 trillion. Another way of saying is that we have a debt-to-GDP ratio of about 100%. That’s $87,000 per person in the United States, $150,000 per adult. 

The interest rate on the federal debt is about 3.4%, as we’re speaking today, and 3.4% of $30 trillion, that’s about $1 trillion. The interest expense on the US debt will be about $1 trillion this year. That’s about the same as we’re spending on national defense or Medicare. Only Social Security is a larger share of the budget. That is just the on-budget amount of our debt. Do you know this James Hamilton paper? Have you seen that some time ago, looking at the off-budget?

COWEN: Sure, of course.

TABARROK: James Hamilton points out that there’s also big off-balance sheet liabilities. The federal government has implicitly or sometimes explicitly promised to pay out big amounts for Social Security, implicit promises for Medicare. If you add all these up and think about the present value of all of the promises which we have promised to pay, the Bureau of Fiscal Services estimates that the present value of federal government liabilities, just for Social Security, is about $34 trillion. Medicare, another $62 trillion. That’s about $100 trillion that we haven’t earmarked the taxes to pay. Putting those together, that doubles the federal debt. You can debate these numbers, but either way, the federal debt is pretty large and growing. How worried should we be?

COWEN: Let’s see if you can dent my relative optimism. My first question for you is, Alex, are you short the 30-year bond? Laughing means no, but continue.

TABARROK: It’s hard for me—I’m not sure if I could—can I short it?

COWEN: Just by puts. 

TABARROK: I’m going to be—

COWEN: On interest rates.

TABARROK: —on the interest rates because the interest rates go up. Maybe after this podcast, I will.

COWEN: Just spend $10K a year doing this every year. If you’re right in being so worried, it’ll be a good investment. Now, it’s striking to me that rates have mostly fallen this year. You said right now the rate was 3.4%. It’s a pretty flat term structure. The rate of inflation is about 3%. It will probably stay somewhat elevated, maybe even more. The real rate of borrowing for our government is well below 1%.

The market is telling us, this is okay. The flat term structure, relatively flat, is also telling us, this is okay. It doesn’t mean we’re spending the money wisely or that it won’t involve too much deadweight loss or crowding out of more valuable goods and services. I’m not saying everything’s fine on those fronts. Just in terms of, will there be a financial crisis, it couldn’t look better.

TABARROK: Now, I worry about this. Usually, you worry, but I worry about this.

COWEN: You started off worried, so I’m going to take the contrary position.

TABARROK: I know. As Rudy Dornbusch once remarked, in economics, things take longer to happen than you think they will, and then they happen faster than you thought was possible. I remember, prior to COVID, as COVID was happening in China, I was very concerned. I was telling people around me, “We need to stock up on masks.” I did stock up on masks. I got my put. Yet, the stock market kept going up and up and up. It kept going up until really pretty late in March, April. Then suddenly, it fell. I worry the same thing could happen with the debt.

COWEN: In that case, it going up early; that was, in fact, the correct response because the stock market ended up higher before the pandemic was over. It’s that it ever fell that was wrong.

TABARROK: Well, we don’t know. We ended up in one possible world. There were many possible worlds we could have ended up in.

COWEN: Once the market saw—

TABARROK: It made a lot of sense for the market to fall. A lot of companies had very reduced revenues, the hotels and the airlines, and so forth. They had to collapse in price.

COWEN: It became clear it would be temporary, and the market got cheery again. I agree it’s all strange, but I’m not sure it helps the case for panic to cite a case where things worked out fine. Not fine for the people who died, but in terms of the market reaction, it worked out fine.

TABARROK: I do agree that it is puzzling that the interest rate on bonds is so low. Hanno Lustig and his co-authors have an interesting paper on this. They point out that not only is it the case that we have all of this debt with no plans to pay it, as far as we can tell right now, but the debt is not a very good asset in the sense that when will the debt be paid? If it is going to be paid, it’s going to be paid when the times are good. That means that you’re being paid when GDP is higher and the marginal utility money is low.

When is the debt not paid? When does it get bigger? It means when the economy is doing poorly. The debt as an asset has the opposite kind of structure than you would want. It’s not like gold, which arguably goes down in good times and goes up in bad times. You get some nice covariance to even out your portfolio. The debt as an asset is positively correlated with good times, and that’s bad. You should expect the interest rates to be much, much higher than they actually are.

COWEN: The easy out there is just to say it’s always going to be paid. Let me give you a way of reconceptualizing the problem. The Hanno Lustig paper, which is called “US Public Debt Valuation Puzzle,” like a lot of work on debt, it focuses on flows. There’s the rate of interest, there’s government spending. If you look at stocks, look at the stock of wealth in the United States. A common estimate from the past was wealth is six to eight times higher than GDP. That’s a little misleading. How do you value all the wealth? How liquid is it?

Still, we all know there’s a lot more wealth than GDP. If your economy stays at peace, if anything, that ratio rises. You build things, they’re pretty durable. None of it is destroyed by bombs. We’re just headed to having more and more wealth. If you take, say, 100% debt-to-GDP ratio, and you think wealth is six to eight times higher, what’s our debt-to-wealth ratio? Well, it’s going to depend what kind of wealth, how liquid, blah, blah, blah. Let’s say it’s like 20%. Let’s say you had a debt ratio of 20% to your wealth at some point in the history of your mortgage. I bet you did. You weren’t worried. Why should the US be worried?

TABARROK: The US is a much longer-lived entity, presumably, than I am.

COWEN: That’s right. You could have 200% debt-to-GDP ratio. In terms of your debt-to-wealth ratio, again, it’s somewhat arbitrary, but say it’s 40% to 50% that might be on the high side. It’s not pleasant, but I’ve been in that situation with mortgages.

R vs. G? It's the Political Economy, Stupid

TABARROK: I think a lot depends upon whether the economy and wealth is growing faster than debt. That brings us to the famous discussion of R and G. You remember Piketty when Piketty came out? Piketty’s whole thing was R was bigger than G. Now, he was interested not in debt. He was interested in inequality. His argument, just to remind the reader, it’s a little bit of an aside, but this will get us somewhere.

His argument to remind the followers was if R is bigger than G, if the interest rate, the return on capital is bigger than the growth rate of the economy, then you get growing inequality because people who save, their wealth grows. It grows faster than the economy grows, so you get this tremendous growth in inequality. Now, I wasn’t terribly worried about this myself. Piketty didn’t really take into account a lot of rich people. They do have kids. Like Elon Musk has got, I don’t know, 14 kids now.

COWEN: How many heirs?

TABARROK: We’ll see. 13 heirs, I think, if he distributes his money that way. Bill Gates is giving his money away—Warren Buffett is giving his money away. Buffett’s not even giving it to his kids. Fortunes rise, fortunes fall, the tech fortunes. When people talk about inequality, they’re not really upset about the Rothschilds. Some of them are.

COWEN: Definitely, some of them are. That’s a different podcast.

TABARROK: That’s a different podcast. They’re worried about the Bezos and the Elon Musks of the world. That’s all new wealth. That’s not generated at all because R is bigger than G. That’s generated by tech, which is a good thing. 

Now, why do we care that there’s R bigger than G? Well, Blanchard argues that R is less than G. Now, to be fair, Piketty is talking about the return on capital. That’s his R, G being the growth rate of the economy.

Blanchard is talking about R being the return on safe bonds. If R, now the return on safe bonds, is lower than G, then GDP is growing over time faster than the debt, which means that we will eventually pay it off. It’ll eventually become much, much cheaper. If R is less than G, we don’t have to worry about the debt. Is R less than G?

COWEN: In previous decades, and decades is the right word here, I used to be very fond of the R versus G framework, but I’ve moved away from it more and more.

TABARROK: So have I.

COWEN: The more you think about wealth, you’re director of the Public Choice Center, it’s just all a public choice question. Let’s take Greece, which had a true inability to pay debt, and default, and everything exploded. It was terrible. Greece could have paid off the debt just by confiscating wealth. Now, I’m not saying they should have, but not Burkina Faso, not Chad, but the normal wealthy countries we’re talking about, they can always pay off the debt, certainly the US.

The real question is the political economy one. Will your citizens let you tax them more and or spend less? That’s up for grabs. The markets are judging that the United States is very willing to make any necessary changes. That actually fits with my picture of this country. In the years of the Trump second term, there’s a lot of policy I don’t like. One thing they show, in a bad way largely, but we are willing to turn on a dime and go from being like the free trade nation to the protectionist nation or whatever else. The parties can flip positions.

That, in some ways, makes the market, I think, more optimistic on our ability to do what is needed. You look at World War II, America rises to the occasion. You look at the war on terror, it had many mistakes. To just say, well, the US was willing to do some pretty radical things quite differently all of a sudden. You look at COVID, you see the same. We spent all these trillions after what was supposedly this era of austerity. There’s a long historical record of the US turning on a dime, for better or worse.

Then I think you can just say, “We have so much wealth.” The G, R, it determines how painful the adjustment will be. Obviously, you want a higher growth rate. It’s not really the thing in the model that matters. It’s just the political economy. What are people willing to put up with? Same with Japan. It is believed, correctly or not, the Japanese citizenry is willing to do its duty and put up with, be it tax hikes or changes in policy, if need be. The rate on Japanese debt, while higher than it used to be, in real terms, it’s still quite low. I think that’s a much better framework.

TABARROK: Yes, I agree with you. I enjoy the R less than G, R bigger than G debates as an intellectual exercise, what happens in the long run. I think the issue with debt is not about insolvency, it’s about illiquidity. You can still go bankrupt when you’re illiquid, even if you’re not insolvent. R bigger or less than G is a bit of a sideshow. I agree with you on the political economy. I do think that it’s odd, though, to say that the fact that Trump can make all these big changes, that this reassures the markets. After all, one of the big changes which he is doing is not raising taxes.

COWEN: Oh, but the tariffs are a huge tax hike.

TABARROK: The tariffs are, yes, we’ll see whether that, compared to we have cut income taxes more than we have plausibly raised consumption taxes through the tariffs. I think the big lesson of Trump is there’s an unwillingness to raise taxes. It does seem a little bit odd to say that this should reassure that eventually we will tax wealth. There doesn’t seem to be any desire or political economy to tax US wealth to pay off the debt.

COWEN: There is a referendum coming in California to tax what, like the 15 or so richest billionaires in the state. I haven’t been tracking it, but I would think there’s a decent chance it passes.

TABARROK: We’re going to have to tax a lot more than billionaires if we’re talking about taxes.

COWEN: I understand, but I’m just saying things that felt unthinkable a short while ago, again, often in bad ways, they now seem thinkable. That’s the lesson of Trump. Trump being president seemed unthinkable before he was president, and now we’re into term two. I wouldn’t say it makes the markets more optimistic about everything, but just this old-school notion of the Republicans will never support any tax increase. Grover Norquist is in there fighting the good fight. That seems so obsolete to me.

TABARROK: If you look at taxes as a share of GDP, it has been between 17% and 20% for 50 years.

COWEN: Now it’s like 23%, isn’t it? 24%. It’s gone up permanently, yes.

TABARROK: I don’t think it’s that—not taxes. Spending has. Spending has. Actual taxes have not gone up as a share of GDP. You’re right that ultimately, spending is a tax increase. Where that money is going to come from, I don’t think there’s any political consensus on that whatsoever.

COWEN: I have a prediction where it will come from. We will keep the capital gains rate nonindexed as it is now, so higher inflation plus a capital gains tax is partly a wealth tax, and we’ll boost wealth taxes by having somewhat higher inflation. You could call it financial repression. We’ll pay off some but not all of the debt that way, and you and I will hate it, but the US is not going to default. 

It doesn’t require a tax hike of the kind you normally think about being contentious. We’ve already had 9% inflation during the pandemic. Now the rate ongoing seems to be 3%. That’s already a tax hike. People don’t like it, but it’s accepted, and we’ll just keep on going, and maybe we’ll get a bunch of years where it’s 7%, 8%, and we’ll converge toward something a little more sustainable.

The Five Ways Out 

TABARROK: Okay. Let’s put this in a little bit of a framework so we can discuss it. There’s five ways to stop increasing debt. One is growth. We’ll come to this.

COWEN: Yes, and AI may help there. That’ll kick in at some point.

TABARROK: Two is default. Three is inflation. Four is spending cuts. Five is tax increases. You’ve been talking about tax increases, and particularly a tax increase on wealth. I don’t see the political consensus for that, though you’re right. Things could change.

COWEN: Just through the capital gains rate. Again, we’ve already hiked that rate in real terms. No one talks about it. You’re paying taxes on nominal gains more than you used to.

TABARROK: That’s partly true. There’s a difficulty with the higher inflation. I think higher inflation, which reduces the real value of the debt, it’s kind of a quasi default, but higher inflation works when your debt is really high and your deficit is zero or low because then it’s just on the stock. When you have higher inflation with a deficit, that is, you’re continuing to spend more than you tax, you have to fund that through bonds, and the inflation means that the interest rate on that debt goes up, Fisher effect.

COWEN: We’ll make finance buy more T-bills than the market would have brought about on its own. That’s the financial repression. I agree with your point, and we’ll do that too, and it’s bad, right?

TABARROK: Yes, but I’m pointing out that inflation as a solution to the debt problem has become much more difficult because, unlike, say, after World War II, when we had a lot of debt but we had very low deficits, right now we’ve got debt and deficits as far as the eye can see. Inflation, what we gain on the stock, we lose on the flow, and it’s no longer an easy way out.

COWEN: That’s a good argument, but we all know real rates now are below 0.5%, and the term structure of the debt got a lot shorter over the years. That was a mistake, but so far it’s a mistake we’ve gotten away with, which I find hard to believe, but you can see it in the market prices.

TABARROK: Yes, again, I see us, it’s like the Wile E. Coyote moment. You go off the cliff, and you seem to be hanging there in midair for longer than you think possible.

COWEN: The bowdlerized version of what Alex used to say is, “Betting is a tax on BS,” right? This is a G-rated podcast. So I’m waiting for you to short the 30-year bond. There’s other things you could do, but that’s the simple, direct way. There’s options on interest rate futures, whether that’s the best way, but again, that’d be a simple way. Don’t use any leverage. You don’t need to be in debt.

TABARROK: I do think that, as Keynes said, I hate to be quoting Keynes, “The market can stay irrational longer than you can stay liquid.”

COWEN: That’s not true. Just spend $10K a year doing this. You’re not going to run out of money. You probably should spend more than $10K. For sure, you can manage $10K a year. Just flush it down the toilet. I’ll be giggling. You may someday be a very wealthy man, and then you’ll be giggling, but nothing’s stopping you.

TABARROK: I worry, though, that even if I did that, then according to you, they’re just going to tax my wealth.

COWEN: They’ll tax it anyway. You might as well have them tax higher wealth than lower wealth. Do I hear $100K a year? I got you up to $10K, at least rhetorically.

TABARROK: It seems like that strategy pays off only in the state of the world in which you don’t get to keep the money. You don’t get to keep the returns because they come after your wealth. 

COWEN: Progressive taxation discourages any good investment, but still, you try to make better investments. You might put less time into it, but now you know exactly what to do.

TABARROK: We have some argument for tax increases. You think that’s a plausible political outcome moving forward, particularly tax increases on wealth, some inflation. What about default now? You said the United States is not going to default. Pretty amazing that the Moody’s downgraded our debt from AAA.

COWEN: No one cares. That’s just so they can avoid blame if something weird happens.

TABARROK: It still seems pretty remarkable. Microsoft bonds now are paying less than Treasuries.

COWEN: That should make you more optimistic. We have this incredible company, so rich with revenue. It’s a sign AI is going to work, cloud computing is going to pay off. That should make you more optimistic if Microsoft is doing well.

TABARROK: It is doing well in the sense that, yes, people expect Microsoft to pay its debts more than they expect the US government to pay its debts. There is a puzzle, however, in that. 

AI's Fiscal Paradox

TABARROK: Let’s turn to growth as a way of paying off the debt. Microsoft’s doing well, and AI’s doing well. Now, that should be raising real interest rates.

COWEN: Correct. It’s not.

TABARROK: It’s not.

COWEN: It depends. Getting back to your earlier point, do we mean the rate of return on equity or the borrowing rate for the government? There’s a big difference there. Still, you don’t see evidence that it’s mattered yet.

TABARROK: Right. People do say, “Yes, AI could increase GDP, increase wealth so much that we’ll be able to pay our debt without any problems.” You and I, while we’re optimistic on AI, neither of us think that we’re going to get into the boom scenario of ending scarcity.

COWEN: 20% growth a year. No, not going to happen.

TABARROK: I would be very happy if we increase the rate of productivity growth by 0.5%.

COWEN: Right. That’s been my prediction as a default. If that would not solve the problem, that would make it sustainable. That’s right on the knife-edge number. That would make it all work. If that’s your modal forecast, don’t buy those puts. Now, we’d agree there’s a lot of variance on any AI forecast, right? It could even be regulated. Even if you’re sure on the tech side, a lot is going to happen. Say it’s 0.2% productivity growth in the growth rate, that’s a huge help. It gets you almost half the way there to a coherent adjustment. That’s, again, reason to not be too pessimistic.

TABARROK: To be clear, a 0.5% increase in the rate of productivity growth, that doesn’t seem like a lot, but that would be historically a bigger increase than we got from anything. A bigger increase than the internet. Sure, yes.

COWEN: It is the internet in a way, but yes.

TABARROK: It was founded on the internet, yes. The internet was the agar culture for the growth of the AI.

COWEN: That’s why the internet’s important. We’re just beginning to realize this, right?

TABARROK: Exactly, yes.

COWEN: It’s why a lot of people can’t admit AI might be a good thing, because then they’d have to admit the internet was a good thing. They’re so committed to never saying that.

TABARROK: Is that why?

COWEN: That’s why, yes. Believe me. That’s why.

TABARROK: It is funny that I think historically, when we look back, I think you’re right, we’ll think about what was the internet. The growth culture was putting everything online, was for the AI. It wasn’t for us.

COWEN: That’s right.

TABARROK: Yes. That’s surprising. I don’t think anyone thought about that.

COWEN: I do have a worry with AI. It’s not a worry from a human welfare point of view, but from a fiscal point of view. The incidence of AI, it’s quite uncertain; it’s fair to say. Let’s say one big positive effect is it cures a lot of diseases. Many people now who die at 70 live to 96. To me, that’s pretty plausible over some timeframe. That could make the budget worse. It’s great for people, but you’ve got to spend a lot more on healthcare. We’re not sure how productive they’ll be in those extra 26 years.

To say it boosts growth by some amount, the distribution of that boost is really going to matter. It could also be some of the gains of AI go to land. Land in San Francisco is worth much more. Loudoun County, the data centers, that’s worth more. Now, the federal government is not very good at taxing land, or they don’t do it in a very effective way on purpose.

That may change. I know federal, state, local, it’s ultimately some consolidated entity. It could be a lot of the gains will go to places we’re not very good at taxing or not very interested in taxing. Again, the fiscal upside could be less than it looks from the excitement about all the wonderful things that we’ll do.

TABARROK: AI could raise welfare more than wealth.

COWEN: Exactly. It will be wealth in forms that don’t translate into paying off T-bills very early.

TABARROK: Exactly.

COWEN: A lot of it could be abroad in very poor countries. That’s wonderful, but very hard to forecast. That makes me somewhat more pessimistic on the fiscal side.

TABARROK: Yes. Increase in life expectancy is a very big deal. After all, when you’re rich, as people in the United States already are, more goods, you’re just pushing them down the marginal utility curve. If you’re already rich, an increase in life expectancy means that you could enjoy years where you’re rich. It’s especially valuable the richer you are.

COWEN: There’ll be all these new treatments that voters demand. Again, that’s a great thing. Someone has to pay for them, and probably a lot of that would be our government.

TABARROK: AI seems like exactly the type of thing which could increase life expectancy. I mean, biology is such a complex system. It’s precisely the kind of system that AI ought to be very good at understanding and improving.

COWEN: There’s going to be, in my view, high returns to labor, but those could be welfare rather than wealth. The fact that you, even now, can get free legal advice of very high quality, I get there are longer-run wealth effects, easier to start a new business. A lot of the gains are just you feel less stressed. You save time.

You have much more leisure time. We see that already. So many of the AI gains so far are just a task that took you three hours, now takes you five minutes. I’m all for that, but it may be welfare rather than wealth. More leisure time, it’s not the same as living longer, but it’s more time for you. If that’s the biggest effect, again, fiscally, it’s not as good as it might have sounded at first.

TABARROK: Yes, leisure don’t pay the bills.

COWEN: That’s right. 

TABARROK: I guess the bottom line is that AI is a source of growth. The growth that we get might not be the kind of growth that helps us to pay off the bills, in which case, again, we still are left with default, inflation, spending cuts. We haven’t talked much about spending cuts.

COWEN: Let me just say, the kind of growth you want to pay the bills, it’s worth thinking about what that will look like. I’m not sure we know, but my superficial intuition is to think, if you have a lot of lawyers earning $600K a year, living in New York and California, just paying income tax at a high rate, of course, they’ll end up owning capital, but the core income is just taxed at the income tax rates. They don’t have that many shelters. They’re not wealthy enough to do super tricky things through Dubai. Those seem exactly the jobs at risk because of AI. They’re the jobs that are, on net, putting a lot of money into the pot. That’s another way to think about the possible tension here between welfare and the fiscal side.

TABARROK: Yes. If we think about lawyers, doctors, accountants, they’re all doing pretty well, but very subject to AI.

COWEN: The AI will help some of those people create these billion-dollar companies, which will do a better job, but that’s taxed at the capital rate, and we get back to higher taxes on capital gains and or wealth, which merges into each other to some extent. That to me is what the future looks like. I don’t like it, but I’ll take the wealth if that’s the price of the wealth. It’s probably a good tradeoff. 

TABARROK: UBI, pro or against?

COWEN: No, we’re not going to see it. The notion that one person works and the neighbor doesn’t work and gets money, it’s proven so politically unpopular. I just don’t think it’s that relevant. I also don’t think it’s in the randomized control trials, which I think Sam Altman helped to fund. It didn’t make people better off. It’s not a good idea. People need to work; COVID showed that. Politically, it’s a loser. It’s like a carbon tax. You can think of good arguments for it, but it’s just not what the future is, even with very powerful AI.

The Hidden Sovereign Wealth Fund

TABARROK: We have all of this debt. Right now, we are still accumulating even more debt. We got ourselves into trouble with, first, the financial crisis, and then with COVID. How high is it going to go?

COWEN: I don’t know. To hit 200% of GDP seems obviously to be expected. If there’s a major war, then all bets are off. That could happen. I don’t see the political forces that keep us away from 200%. Now, it seems we can manage that. It may not be what you want in terms of resource allocation, but we’ll hit it, and people won’t care is my best guess.

TABARROK: Yes. Okay. You think that a combination of tax increases? Oh, yes. We didn’t talk much about spending cuts. You think anything?

COWEN:  No, not going to happen.

TABARROK: Yes, not going to happen.

COWEN: I would love it. Look, healthcare is the sink you can pour more and more money into. It’s politically popular. I just don’t see us stopping.

TABARROK: Okay.

COWEN: Here’s another perspective I’ve been toying with lately. This focuses on Japan, but it relates to the US. It turns out there’s this recent paper in Journal of Economic Perspectives. Hanno Lustig is co-author on it. He’s a great economist with YiLi Chien and Wenxin Du, forgive my pronunciations, on how Japan has kept its debt sustainable. It turns out Japan is running a sovereign wealth fund, in essence, through its public pension scheme. That sovereign wealth fund, which is what I’ll call it, it’s not called that formally, but it’s done very well. They’ve made good picks. Japan is a lot more leveraged than it seems.

If US equities really went south, that’s where a lot of their good picks have come from; Japan would truly be in fiscal trouble. Their situation is riskier than it looks. Their current net liability is way lower than it looks because on the equity side, they’ve earned so much. If you think US is facing systematic risk, US and Japan are much more correlated than it looked to begin with, and they already seem to be pretty highly correlated.

This idea I’ve been thinking about lately, is the world becoming more correlated or less correlated across countries, asset classes. With Japan, that’s been moving in the wrong direction. The US, to some extent, through public sector unions—like you ever give a talk at a financial institution or even a crypto VC fund, and so many of the people you speak to, they work for a public sector employees’ union because they’re investing the fund in that.

That’s our sovereign wealth fund. Smaller than Japan’s, it turns out. We’re making these leveraged bets on equities. As you know, equities have done well since the early 1980s. My goodness, a lot is riding on that, and now it’s riding on AI. The AI thing, it’s more knife-edge than people even think, and they already think it’s pretty knife-edge. That stuff had better work.

TABARROK: The equities, yes, equities have gone up, but I think a lot of that is just due to falling interest rates. It’s not that the future flows have gotten bigger; it’s that we are discounting the future flows at a lower rate, which means the present value goes up, but we’re not richer over time.

COWEN: There’s a funny circularity. Maybe the interest rates have stayed low because equities have gone up, and Japan is not going to default or have to raise taxes a lot. Then it’s like, well, elephants all the way down, but what’s beneath the elephants? Low interest rates, high equity prices all the way down. I feel okay about that. Maybe the world is always built on this circularity of asset value. Certainly, the value of money is circular in a sense and always has been, but you just wake up and you realize, this mechanism operates a little more than you’d like to feel comfortable with. 

The Bottom Line

TABARROK: Okay. Have we reached any conclusions about debt and deficits, Tyler?

COWEN: Well, I want to hear your pending portfolio decisions once you decide to make them. I’m still at a point of relative calm. My modal scenario is pretty positive, but I am realizing you see this in crypto prices as well. The original story was they’re hedge against the dollar. They’re not a hedge against anything. They’re very correlated. That’s okay, but when you see more and more things being correlated together, and maybe this operates through mechanisms of good governance, bad governance, you ought to get more nervous. I’m super nervous on the things seem to be more correlated front. Still not that nervous on the modal scenarios front. I hope to live long enough to see, and maybe AI can enable that too.

TABARROK: Just to conclude, I do think it is ironic that crypto found product market fit in putting the dollar on stablecoins. Satoshi Nakamoto would be quite upset, I think, to find out that—

COWEN: Would be. I would say is.

TABARROK: No. He’s long gone. He’s long gone. All right. A more correlated world is a more dangerous world, but still, you’re not worried about the debt, per se.

COWEN: It’s a world with more upside. I am worried about the debt, but I’m worried about it in extreme cases. In the middle of the distribution, I think we’re doing better than most people believe.

TABARROK: Okay. Very good. Thank you, Tyler.

COWEN: Thank you, Alex.