Geopolitical Risks May Accelerate A Debt Crisis

Authored by Daniel Lacalle,

Many investors are warning of the risk of a debt crisis, but governments are ignoring all the signals.

In an inflationary crisis, the government should reduce expenditures to help curb price increases while also anticipating a significant increase in borrowing costs. However, in this crisis, the United States administration is ignoring all the warning signs and continuing to borrow at a record pace.

Debt crises always happen when even the most conservative investors refuse to add to a sovereign bond portfolio that is loss-making to begin with. Central banks may decide to purchase those unwanted government bonds, but then the inflation problem worsens and the losses at the central bank accumulate.

The enormous problem created by the monetary and fiscal insanity of 2020 is difficult to solve. Central banks are already publishing losses in their assets, and those negative results must be covered by taxpayers.

Government bonds have been an atrocious investment in 2022 and continue to generate negative results for investors in 2023. Furthermore, sovereign debt is rising at a record pace, ignoring the wall of maturities that the global fixed-income world is facing in 2024 and 2025.

The United States national debt has soared by $550 billion in less than a month. Total debt was $31.4 trillion in July and soared to $33.5 trillion in less than four months. This happened while the 10-year Treasury yield increased from 3.7% to 4.6%. Imagine a government that massively increases debt and does so at a record speed when there is a $500 billion investment-grade maturity wall in 2025 and the government faces $7.6 trillion of maturities of public debt in the next twelve months, according to Goldman Sachs. At the same time, Goldman Sachs also noted that CFTC figures show that U.S. Treasury net long positions in 2-year and 10-year notes have fallen to the lowest level since October 2018. This is truly a dangerous scenario in the middle of geopolitical tensions reaching new highs.

The United States government is counting on rising global demand for US dollars to offset the increased fiscal imbalances and on the Fed to change its monetary policy if needed. This is a dangerous bet when China, Saudi Arabia, and other nations’ Treasury holdings are dropping to multi-year lows. It is also extremely imprudent to believe that the world will absorb the United States’ fiscal imbalances at any cost in the middle of a global geopolitical conflict. Furthermore, it is reckless to believe that the Federal Reserve will buy all the Treasury bonds required when the central bank is already loss-making. Such a level of irresponsibility may put the U.S. dollar in danger in the long term.

The United States’ fiscal imbalances are enormous, but so are the deficit levels of many other developed nations, and the combination of rising rates, losses at the central bank, and impending giant maturity walls happens as well in the euro area.

All of this is evidence of the monetary debasement process that started in 2009 but accelerated in 2020. Governments are destroying the purchasing power of their currencies to disguise their enormous debt and deficit levels, and inflation is eroding citizens’ savings and wages. In this environment, sovereign bonds never protect investors.

Governments do not want to pay for the risk they take and will absorb others’ wealth via negative real rates or price losses in the issued bonds. The inflationary spiral is likely to remain persistent, and the prospect of another round of quantitative easing may not offset the accumulated losses in bond portfolios and certainly will not modify the currency debasement scenario. In a period like this, gold becomes the cheapest asset by far. It is inexpensive relative to its historical purchasing power and monetary qualities, but it is even more attractive relative to the fiat currencies whose monetary value is dissolved by massive printing. The current debt problem and the geopolitical risk tell us that gold is a safe bet in a volatile world.