Global Debt Cycle May Enter 'Debt Cancellation' Phase

Author: Caixin News

As global long-term bond yields continue to rise, a concerning sign is emerging: high debt pressure has sparked calls in France for the cancellation of some public debt. In response, renowned macro strategist and co-founder of Variant Perception, Simon White, has issued a warning in his latest report, stating that this mindset is highly contagious. As governments struggle in the quagmire of debt, coupled with some politicians proposing increasingly radical policies, it is expected that similar unorthodox demands will soon arise in other countries.

However, all these proposals may ultimately point to the same outcome: intensified inflation and devaluation of financial assets!

Will a Fire Burn the Bonds?

White points out that the "classic scenario" of the global financial crisis is actually being replayed today.

A recent example is the French left-wing populist politician Jean-Luc Mélenchon, who recently called for the cancellation of 18% of the country's public debt—"Take the bonds and burn them directly," as Mélenchon put it. This kind of rhetoric is not unfamiliar: similar sentiments were heard during the Eurozone debt crisis in 2009, and around the same time in the United States as well.

However, debt cancellation is essentially a disguised form of "monetary financing," which will inevitably trigger severe inflation. White believes this will reinforce the logic that "real assets are superior to financial assets."

White notes that many may remember the serious proposal from 2011—that was later officially denied—where the U.S. Treasury would mint a platinum coin worth $1 trillion. The Federal Reserve would exchange this coin for $1 trillion in government bonds, which the Treasury would then cancel. This plan aimed to circumvent the debt ceiling that the U.S. was rapidly approaching after the Lehman crisis.

Today, the U.S. is only $1.1 trillion away from triggering the debt ceiling and is accelerating towards it, with the debt-to-GDP ratio already 25 percentage points higher than it was 15 years ago. White believes that as interest payments rise to over $1 trillion, it would not be surprising if someone in the U.S. echoed Mélenchon's call for the cancellation or reduction of some national debt.

White points out that the current debt dynamics in the U.S. remain the most concerning globally. In terms of GDP share, the U.S. "twin deficits" (current account deficit plus budget deficit) exceed those of all major emerging markets and developed economies, except for Brazil.

For economies at this stage of the economic cycle, such a massive deficit is clearly unreasonable. Part of the reason is the surge in interest payments, but even excluding this factor, the U.S. still holds the largest deficit globally in terms of GDP and dollar valuation.

Concerns of Political Polarization and Extreme Risks

White states that given the complete loss of willingness to withdraw fiscal stimulus in recent years in Western politics, political forces and politicians have increasingly deviated from the middle ground towards non-traditional policies. The idea of cancelling debt has been brought to the forefront, which is not unimaginable.

Even if these proposals ultimately do not materialize, low-probability, high-impact "tail events" have already substantially changed the risk distribution, as the probability of tail events occurring is much thicker than anticipated. Given the evident anxiety expressed by the current Trump administration after the U.S. Treasury announced an increase in long-term government bond repurchases last week, it is clear that these possibilities must be taken seriously.

If this anxiety evolves into despair—which is not impossible—more unorthodox debt prescriptions may be implemented by decision-makers or pushed to the core of the political agenda by opposition parties.

So, fundamentally, what options are currently available to reduce government debt? White believes there are essentially six: fiscal consolidation, economic growth/inflation, financial repression, selling government assets, debt default or restructuring, and debt cancellation, or other forms of monetary financing.

A closer examination reveals why there may ultimately be only one "road to take":

Fiscal consolidation carries too much risk in elections; economic growth has been hindered by massive government deficits, and inflation has become a problem due to rising interest payments; financial repression will eventually come, but it will be too late (if the Treasury's enhanced repurchase operations are included, it has actually already begun); selling government assets (like gold from Fort Knox) is merely a one-time measure and unlikely to have a substantial impact; while debt restructuring or default is more harmful than beneficial.

White states that understanding these factors clarifies why direct debt cancellation may seem quite attractive—after all, it is relatively easy to implement.

The Methods and Consequences of "Destroying Bonds"

However, confusing "ease" with "effectiveness" would be a serious mistake. White points out that debt cancellation is likely to trigger severe inflation—if France ever goes down this path, it will discover this, as it is merely a different form of monetary financing.

As mentioned earlier, the U.S. had previously attempted this idea, primarily advocated by Ron Paul, who proposed the "Debt Crisis Resolution Act" in August 2011. But how would this work in practice?

The U.S. Treasury would simply need to write down the government bonds held by the Federal Reserve (for example, reducing them by 10%) or directly erase them. Subsequently, the Federal Reserve would take measures that only a central bank can take: writing down its equity to negative values.

Of course, there are other variants—such as minting platinum coins or opening central bank overdraft limits—but the essence is the same.

White states that this may seem like a permanent solution, but it actually leaves behind fatal hidden dangers.

The reserves that the Federal Reserve initially created through quantitative easing (QE) were supposed to be naturally canceled when the Treasury repaid principal and interest at maturity; however, once the debt is directly canceled, the cancellation point of these reserves no longer exists—turning into a clear and permanent monetary injection. The reason QE did not initially trigger hyperinflation is that the market expected these reserves would eventually be withdrawn.

Under normal mechanisms, if the private sector anticipates that deficit spending will ultimately need to be repaid through delayed taxation (i.e., the Ricardian equivalence theorem applies), it will actively reduce consumption. However, once monetary financing breaks this balance, the private sector will choose to indulge in extravagance alongside the government.

Even in today's monetary system, where reserves are highly abundant, explicitly setting the increase in base money as permanent still crosses an irreversible red line and is highly likely to trigger severe inflation. Whether through QE accompanied by fiscal expansion, yield curve control, or directly granting the Treasury an "unlimited credit card" by the central bank, all forms of monetary financing will ultimately lead to the irreversible path of inflation.

White points out that this is precisely the trajectory we are currently on—as long as those painful yet effective fundamental solutions continue to be shelved in favor of ineffective speculative measures or even absurd tactics like the "trillion-dollar coin," the aforementioned tail risks will continue to rise.

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