For the first time since the Second World War, excluding the COVID-19 pandemic, public debt in the United States has surpassed the entire economy’s GDP. As of late March, debt held by the public reached US$31.27 trillion, just ahead of the GDP of US$31.22 trillion.

This threshold is often treated as a long-term fiscal issue, but the economic costs of this debt are now moving to the forefront. The most immediate pressure comes from the possibility that major foreign holders of American assets begin pulling capital out of U.S. markets.

Gulf states — whose confidence in U.S. fiscal and military protection has been shaken by the U.S.-Israel attacks on Iran — collectively hold roughly US$2 trillion in U.S. assets through their sovereign wealth funds.

Officials across the Gulf are already reassessing their positions. In March, one Gulf official said three of the four largest economies in the Gulf Cooperation Council were reviewing their sovereign wealth fund positions to offset the impact of the Iran war.

Why the U.S. cannot simply block a selloff

The U.S. has limited options to prevent foreign investors from selling. The freedom to enter and exit what the Federal Reserve Bank calls “the deepest and most liquid fixed-income market in the world” is exactly what makes U.S. assets attractive. That same openness creates a structural vulnerability.

The U.S. economy relies heavily on stretched asset valuations — elevated prices in stocks, bonds and real estate — where market values far exceed their underlying fundamentals.

When holders........

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