Global Debt Cycle May Be Heading Toward 'Debt Cancellation' Phase

Author: Cailian Press

As global long-term bond yields continue to climb, a warning sign worth heeding is that high debt pressure has already sparked calls in France to cancel part of its public debt... In response, renowned macro strategist and Variant Perception co-founder Simon White warned in his latest report that this mindset is highly contagious. As governments struggle in the debt quagmire and some politicians keep floating increasingly radical policies, similar unorthodox demands are expected to emerge in other countries soon.

However, all these proposals may ultimately lead to the same outcome: higher inflation and depreciation of financial assets!

Burn the Bonds?

White pointed out that the "classic plot" of the global financial crisis is actually replaying itself right now.

The latest example is French left-wing populist politician Jean-Luc Mélenchon, who recently called for canceling 18% of the country's public debt—in his words, "take the bonds and burn them." Such rhetoric is not unfamiliar: it was heard in Europe during the 2009 eurozone debt crisis, and around the same time in the United States as well.

But debt cancellation is essentially disguised "monetary financing," which inevitably triggers severe inflation. White believes this will actually reinforce the logic that "real assets outperform financial assets."

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

Today, the U.S. is only $1.1 trillion away from hitting the debt ceiling again and is accelerating toward it, while the debt-to-GDP ratio is already 25 percentage points higher than 15 years ago. White believes that with interest expenses climbing above $1 trillion, it would not be surprising if someone in the U.S. echoed Mélenchon's call to cancel or reduce part of the national debt.

White pointed out that the current U.S. debt dynamics remain the most worrying 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 Brazil.

For an economy at this stage of the economic cycle, such a massive deficit is clearly unreasonable. Part of the reason is surging interest expenses, but even excluding that factor, the U.S. still has the world's largest deficit in terms of GDP and dollar denomination.

Political Polarization and Tail Risks

White said that given the complete loss of willingness in Western politics to withdraw fiscal stimulus in recent years, with political forces and politicians abandoning the center ground in favor of unconventional policies, it is not unimaginable that avant-garde measures like debt cancellation could be put on the agenda.

Even if these proposals ultimately fail to materialize, low-probability, high-impact "tail events" have already materially changed the risk distribution, because the probability of tail events is much fatter than expected—especially given the obvious anxiety shown by the current Trump administration after the U.S. Treasury announced last week an increase in long-end Treasury buybacks, these possibilities must be taken seriously.

If this anxiety turns into desperation—which is not impossible—we need to be wary of more unorthodox debt prescriptions being implemented by policymakers or pushed to the core of the political agenda by opposition parties.

So, fundamentally, what are the options for reducing government debt? White believes there are only 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 look reveals why there may ultimately be only "one path":

Fiscal consolidation is too risky electorally; economic growth is already hampered by huge government deficits, and inflation has become a problem due to rising interest expenses; financial repression will eventually come, but it will be too late (if the Treasury's enhanced buyback operations are counted, it has already begun); selling government assets (such as gold at Fort Knox) is a one-off measure unlikely to have a substantial impact; and debt restructuring or default would do more harm than good.

White said that understanding these points makes it clear why direct debt cancellation may seem attractive—after all, it is relatively easy to implement.

Methods and Consequences of "Burning Bonds"

But conflating "easy" with "effective" would be a serious mistake. White pointed out that debt cancellation is likely to trigger severe inflation—if France ever goes down this path, it will find this out, because it is just monetary financing in a different package.

As mentioned above, the U.S. has tried this idea before, with its main advocate Ron Paul introducing the Debt Crisis Resolution Act in August 2011. But how would this work in practice?

The U.S. Treasury would simply write down (e.g., by 10%) or completely wipe out the Treasury bonds held by the Federal Reserve. The Fed would then do what only a central bank can do: write down its equity to negative.

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

White said this seems like a permanent solution, but it actually leaves a fatal hidden danger.

The corresponding reserves initially created out of thin air by the Federal Reserve through quantitative easing (QE) were supposed to be naturally extinguished when the Treasury repaid principal and interest at maturity; but once the debt is directly canceled, the extinguishment point for these reserves no longer exists—turning them into explicit and permanent money creation. The key reason QE did not initially cause hyperinflation was that the market expected these reserves to be withdrawn in the future.

Under normal mechanisms, if the private sector anticipates that deficit spending will eventually need to be repaid through delayed taxes (i.e., Ricardian equivalence holds), it will voluntarily reduce consumption. But once monetary financing breaks this balance, the private sector will choose to spend recklessly along with the government.

Even in today's monetary system with highly abundant reserves, making the increase in base money explicitly permanent crosses an irreversible red line and is highly likely to induce severe inflation. Whether it is QE accompanied by fiscal expansion, yield curve control, or direct issuance of an "unlimited credit card" from the central bank to the Treasury, all forms of monetary financing ultimately lead to the same dead end: inflation.

White pointed out that this is exactly the trajectory we are on—as long as the more painful but effective fundamental solutions continue to be shelved, replaced by ineffective speculative measures or even absurd tricks like the "trillion-dollar coin," these tail risks will keep rising.

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