Debt servicing costs rise for developed economies
Data from the Federal Reserve Economic Data shows developed economies allocating larger portions of tax collections to debt servicing. The era when debt could rise indefinitely while interest costs remained low appears to be ending.
Over the last fifty years, debt-to-GDP has risen relentlessly while real interest rates have generally moved in the opposite direction. That relationship is unlikely to be accidental.
The Arithmetic of Debt
Governments have only a handful of ways to deal with rising debt burdens: lower the real cost of borrowing, increase economic growth, raise taxes, or implement spending restraint.
The first three options are becoming increasingly difficult. Ageing populations constrain growth. Tax burdens are already raised across much of Europe. Spending restraint is politically unpopular almost everywhere.
This leaves a fourth option: ensuring borrowing costs remain below nominal economic growth for long enough that debt becomes manageable. This is financial repression.
Financial Repression
Historically, financial repression has involved a combination of moderate inflation and interest rates that are held below where free markets might otherwise set them, resulting in a gradual transfer of wealth from creditors to debtors.
Governments are the world’s largest debtors. The post-pandemic period has delivered exactly the combination policymakers should fear: record debt levels alongside the highest real yields in more than a decade. The consequence is visible in the increasing proportion of government revenues consumed by interest expenses.
A Global Problem
Much of Europe is highly indebted, and the incentives are remarkably similar across the developed world. Which raises an interesting possibility. Rather than one country pursuing financial repression in isolation, the more likely outcome may be that everyone moves in the same direction at roughly the same time. Not through formal coordination, but through shared necessity.
If this happens, the adjustment mechanism changes. Instead of one currency weakening dramatically against another, all currencies gradually lose purchasing power together. The devaluation does not occur in foreign exchange markets. It occurs relative to real assets. Gold, Commodities, Energy, Infrastructure are all moving higher yet Inflation-linked bonds are trading at the lows in price.
In this scenario, policymakers can tolerate a degree of inflation because no single currency is experiencing a disorderly collapse. Instead, the purchasing power of money slowly erodes across the developed world.
Taken together, the charts pose an obvious question: can the developed world comfortably sustain today’s level of real interest rates with debt burdens exceeding 100% of GDP? Perhaps it can. But if not, policymakers will eventually be forced to choose between fiscal austerity, higher taxation, or some form of financial repression that pushes real borrowing costs lower.
If governments are unwilling to pursue austerity and voters are unwilling to accept materially higher taxes, then financial repression increasingly looks less like a policy choice and more like a fiscal necessity. For investors, that points towards assets that benefit from declining real yields and the erosion of fiat purchasing power. Gold and Commodities have already moved higher, yet TIPS are trading at the most attractive level in many years.
