Can the West Avoid Fiscal Armageddon?
The West must confront structural debt, political dysfunction, and economic constraints
This edition is the second instalment in my ongoing exploration of the future of the West. Last week, I focused on the concept of “allied scale”—the capacity of America and Europe to convert their combined mass into coordinated, effective leverage. I wrote about how historical institutions, postwar leadership, and deliberate investment once enabled the West to marshal resources far beyond the sum of its parts. I also noted how that ability has weakened: internal fragmentation, misaligned incentives, and financial extraction have left Europe underutilised, the US distracted, and China in the position to benefit by default. Allied scale, I argued, is the discipline of coordination, long-term planning, and strategic vision—one that transforms size and wealth into power.
This week, I turn to a closely connected challenge: fiscal sustainability and the structural pressures confronting Western economies. Debt is no longer a marginal concern but a central constraint on policy and growth. Europe struggles under eurozone imbalances, idle capacity, and fiscal rigidity. The US faces a debt wall, a dollar-dependent global role, and rising interest obligations that limit monetary freedom. Policy choices—whether austerity, conventional borrowing, or digital finance—carry far-reaching consequences for growth, wealth distribution, and strategic autonomy.
By examining history, contemporary policy, and structural dynamics, this edition shows how fiscal strategy intersects with allied scale. Mobilising idle capacity, coordinating investment, and managing debt wisely are economic imperatives that help preserve the West’s influence, resilience, and cohesion in a rapidly shifting global order. The choices made now will shape whether the West navigates this period safely or faces prolonged stagnation and systemic vulnerability as it confronts China as a challenger.
1/ The state can (and must) borrow in a way no private actor can
Here is the key lesson I once taught my public finance students at Sciences Po: a state holds a kind of credit that no business or household can match. A business can go under. A household can default. Both can vanish from the economy. A state does not do so in normal times. It can fall only if it is invaded or split apart, which is rare.
Lenders assume the state will outlive them and keep the tools it needs to raise tax. This single fact shapes how public debt works. As long as the tax base stays broad, the economy keeps some pace, and leaders avoid gross errors, lenders expect the state to honour its word. This is why the state can issue debt that runs for many decades or more.
It is also vital to see the different roles of interest and principal. The state does not have to pay down the principal on its debt. It can roll it over and replace old debt with new debt. It can do so because lenders trust the state to endure and to keep the power to tax.
What the state must pay is the interest. If it funds interest with new debt year after year, the debt stock climbs at a rising rate. At some point the interest bill grows too large to meet through tax or through new loans on fair terms. This is the point where debt runs out of control. To avoid that case, the state must keep economic growth firm, collect tax in a steady way, and avoid interest rates that sit above the growth of its own income. GDP is a sound guide to the tax base, and when GDP grows faster than the interest rate, the debt load falls over time even if the principal stays the same.
There is another reason why the state must act in a way no business or household can copy. Over the last century we learnt from Keynes and those who used his work that private actors cannot keep the economy stable and growing by themselves. When demand drops, firms cut and households save more. If the state did the same, the slump would deepen. Therefore the state’s function is to act in a countercyclical way: it must spend when demand weakens and invest when private investment is low. Only by doing so, and by funding it with debt, does it support growth and protect its own credit.
2/ Wartime borrowing set the ground for post-war growth and the fall of public debt
The strongest case for the special place of public debt comes from the mid-20th century. The Second World War pushed the fiscal limits of the major Western states. America and Britain, in particular, raised spending to levels once seen as out of reach. Their debt ratios climbed to heights that would alarm most policymakers today. Yet these debts did not lead to default. On the contrary, they became the base for the long boom that followed.
The war forced states to use all idle labour and capital. This ended the long stretch of under-use that marked the interwar years. In the US, the depression held on until military outlays cut joblessness close to zero. In the UK, the scale of wartime production built state capacity and made large post-war budgets possible. When peace came, these states did not return to the small budgets of the pre-war years. They replaced military outlays with welfare systems and with active fiscal policy. This formed the ground for what later became known as Keynesian demand management.
Debt ratios then fell because growth surged. From the late 1940s to the early 1970s, the West saw a long and strong expansion. Productivity and real wages rose at a rate that doubled living standards within a generation. High growth lifted tax income and pushed up nominal GDP. Debt stocks stayed large in cash terms but shrank compared with the size of the economy. From the late 1960s onward, inflation helped as well. It reduced the real value of fixed-rate debt and, when paired with steady growth, cut the real weight of public debt without the need for large primary surpluses.
States also used tight financial rules to keep the process steady. They steered domestic savings into government bonds at low yields, which held down borrowing costs and reduced the risk of capital flight. This mix let states carry high debts while the economy grew faster than the interest rate. By the 1970s, the US and other Western countries had brought their debt ratio down to levels that made wartime borrowing a distant concern.
3/ Currency devaluation doesn’t work every time
Monetary policy is the other main pillar of macroeconomic management and works alongside a sound fiscal stance. In that area, currency devaluation has long helped indebted states regain competitiveness and absorb shocks. A weaker currency makes exports cheaper abroad and gives domestic producers room to grow. It acts as an automatic stabiliser.
It does not always work, however. For devaluation to succeed, trading partners must be expanding, and wage growth must remain contained so the cost advantage is not lost. When these conditions hold, a cheaper currency can help close external deficits, rebuild output, and restore confidence:
Post-war Germany used currency reform to remove old claims, cut purchasing power, and reset relative prices, giving firms space to expand exports when foreign demand was strong.
In the 1980s, small open economies like Canada, Ireland, Denmark, and Australia combined fiscal cuts with large devaluations and wage restraint. These worked because their trading partners were growing, and devaluation allowed exports to rise even as spending tightened.
A key success factor in both periods was steady US growth. America was doing so well both in the immediate post-war period and the 1980s that it could reward its trade partners’ devaluations with strong and steady demand for their products. By contrast, major economies trying deflation alone in the interwar years failed: not all can devalue simultaneously, and attempts to shift adjustment onto others contract the whole system.
That said, modern developed economies face limits that make these tools weaker:
Eurozone members cannot devalue individually because they share the same currency. Therefore the only way for them to regain competitiveness is through internal wage and spending cuts. These depress demand and raise unemployment if exports do not pick up soon. When all governments cut spending at the same time, growth stalls across the bloc.
The US faces a different trap. The dollar’s global role forces large trade deficits. Attempts to curb imports often strengthen the dollar, hurting exporters, while new dollar-based digital instruments increase global demand for outflows.
Both the eurozone and the US could ease their respective constraints, but such strategies require long-term commitment and political agreement. At present, neither shows the capacity to make these choices, and they face unprecedented fiscal stress as a result.
4/ Cutting spending does not reduce debt and can deepen economic problems
Austerity—the deliberate reduction of public spending to restore fiscal balance—is politically appealing but economically flawed. As we saw with the ill-designed, Elon Musk-led DOGE effort earlier this year (make sure to read Michael Cembalest’s takedown on that one), austerity’s appeal is simple: governments signal responsibility, and voters see “less debt” as safer. Therefore elected officials often adopt austerity as a low-cost show of competence, believing cuts will restore confidence and encourage private investment. Yet history shows the logic is mistaken.
