I am very worried about this. The big problem with being worried about it is being worried way ahead of everyone else. When you worry about this issue too early, you make misguided decisions, because if you're worried and nobody else is worried, things just keep going.
Today, we are at a global debt level in developed countries comparable to the end of World War II. It has never reached these levels. During World War II, the currencies that held up, like the United States and Great Britain, managed to survive and adjusted their debt over the following 15 years, largely through financial repression and negative real interest rates. Meanwhile, the countries that lost the war saw their currencies turn to dust—money in Germany, in Japan; wealth was destroyed, it went to zero.
Then we entered a dynamic, for some time now, of negative primary balances at alarming levels, especially in the United States. In Europe, the debt is larger, especially in France, Italy, and the United Kingdom, but the nominal deficit is around 3% to 4% of GDP. In the United States, the debt is still a bit lower, but the deficit is around 8%.
I think this issue will only get worse, because to balance the actuarial math, you would need more pension reforms, and that's in nobody's pipeline. People are living much longer, and this continues to be rampant. Pension expenses will rise, defense spending will rise, and the Western world continues to hold elections where populism reigns—in Brazil, the United States, and Europe. Whoever promises fiscal consolidation does not win elections.
Curiously, the dynamic in the United States today is quite similar to Brazil: a nominal deficit of 8% to 9%, with debt rising three to four percentage points of GDP per year. So you ask: US debt-to-GDP hit 100%, matching World War II levels, and keeps climbing. Neither Democrats, nor Republicans, nor the American public are minimally concerned with addressing this issue. We will just keep going until the day this becomes a real problem.
Since this is a widespread problem, sometimes when we ask American investors investing in Brazil, saying 'our fiscal situation is very bad,' they reply: 'it's better here.' It's very difficult to imagine what will make this turn into a real concern, or if it will just stay like this: debt rises three or four percentage points of GDP, life goes on, and nothing happens.
Thinking of this as an illness with symptoms: where is the symptom? What is the crack that will appear and give us advance warning? It's the long end of the curve; it's market liquidity in general. Part of the symptom already exists, which is very long-term rates in the United States: today the 30-Year Treasury is practically at an all-time high. There was a time it pulled back a bit, but it shouldn't be here, because you don't have high inflation. That in itself is concerning. But because it's only the 30-year—even the 10-year is relatively well-behaved—and very long debt is a small part of total US debt composition, it doesn't cause too much worry, and the government reduces long-end issuance.
That is clearly a symptom, albeit still small. I think this problem will materialize when it becomes difficult to fund the 10-year, because today the 10-year relative to the 5y5y forward—when that reaches one, alarm bells ring. The day that happens, governments can act by buying back long debt and selling short debt—central banks have tools we don't have. So Fed or Treasury intervention could postpone that.
What intrigues me most about the US 30-year curve is that it's the exact opposite of what happens in Brazil. Here—and in other emerging markets, though Brazil has a very good interest rate pricing market that others lack—breakeven inflation rises significantly. For example, 10-to-15-year BEI in Brazil, even with a 3% inflation target, is relatively well-behaved around 4.5%, and indicators are even improving at the margin. In the United States, you can buy 30-year inflation at 2.2%.
If you imagine how the debt problem gets resolved—through financial repression, like after World War II, or the Japanese style: the only debt falling in the world is Japan's, due to completely misguided monetary policy with deeply negative real interest rates for 4 to 5 years—Japanese debt dropped 20 percentage points of GDP, while everyone else's rose 20 points. They have the advantage that, being very deflationary Asian economies, inflation didn't explode despite ultra-misguided monetary policy.
This intrigues me because, if the debt problem is resolved with inflation—short-term interest rates well below nominal GDP growth—inflation should rise. If I buy a 30-year TIPS and pay the swap, I'm long US 30-year inflation at 1.5%—I'd say below 2%—because of the swap spread. Breakeven inflation is 2.3%, but the swap spread is near an all-time high, around 80 bps a year.
Wouldn't it be a great hedge to buy US inflation at 1.40% in a long position? But that risk premium, when you look at inflation, isn't there—it's not reflected in high implied inflation, which is the exact opposite of Brazil. That leaves me very intrigued. You ask: why don't you do it? Because buying inflation is scary. First, because if breakeven widens, you lose—and you lose leveraged, over 30 years. That forward could go to 0.80, 1.20, and you'd end up buying that 30-year inflation far too expensively. It's a trade that, while very attractive, is very dangerous—and then you have this deflationary world of AI.
So, even though I look at this trade every day—because, deep down, what everyone wants is to hedge against inflation—I think: I can buy very long-term inflation in a country where I know US debt will cause problems. I just don't know when.
