The Debt Trap Democracy Cannot Escape

Good Morning Ladies and Gentlemen

“Those betting against ‚the house‘ keep winning.”

Jeffrey Gundlach

I recently came across an interesting perspective that I would like to share. Over the past several years, China and the Western economies have faced markedly different macroeconomic environments, resulting in a pronounced divergence in monetary-policy trajectories. In the United States and much of Europe, central banks were compelled to raise interest rates in response to a broad-based inflationary surge fuelled by expansive fiscal policies, tight labour markets, pandemic-induced supply-chain disruptions, and rising energy prices. Higher policy rates were therefore required to contain aggregate demand and preserve inflation expectations. China, by contrast, has been grappling with the characteristics of a balance-sheet recession, reflected in a persistent property-market downturn, elevated precautionary savings, weak consumer sentiment, excess industrial capacity, and subdued credit creation. In such an environment, lower interest rates have served not to stimulate speculative borrowing, but rather to mitigate debt-deflation dynamics and support economic activity. Geopolitical tensions, including conflicts in the Middle East, have further complicated the global landscape by contributing to energy-price volatility and inflationary pressures in Western economies. At the same time, ongoing efforts by a number of emerging economies to reduce their dependence on the US$ have strengthened China’s ambition to internationalise the renminbi. While the dollar remains the dominant global reserve currency, the gradual emergence of a more multipolar monetary order may enhance China’s strategic flexibility, enabling it to maintain comparatively accommodative monetary conditions without facing the same external constraints that have historically shaped policy choices across emerging markets. However, global PMI numbers are improving.

PMI

Global growth prospects, according to the Purchasing Managers Index (PMI), have improved noticeably in recent months, with the United States emerging as the principal driver of economic expansion. The underlying objective of policymakers is straightforward, at least in theory. To ensure that nominal economic growth exceeds the pace of debt accumulation, thereby reducing the public debt burden relative to GDP despite a continued increase in the absolute level of indebtedness. In practice, however, this objective faces formidable political constraints. Democratic systems are inherently shaped by short-term incentives, as voters tend to focus primarily on their immediate economic circumstances rather than on long-term fiscal sustainability. Consequently, meaningful debt reduction remains politically elusive. Governments are under constant pressure to accommodate competing demands for public spending, transfers, and support measures, even as the fiscal resources needed to meet them are often unavailable. The result is a persistent reliance on additional borrowing to finance present consumption and postpone adjustment. This dynamic has produced a paradoxical situation in which debt levels continue to rise to ever more extraordinary heights, while the political and social willingness to confront the underlying imbalances remains conspicuously absent. If you ask me, such a trajectory raises increasingly important questions about the long-term sustainability of the prevailing economic and political model.

Government Debt

This is a fascinating development that merits closer attention. Let us take Germany and France as an example. With public debt equivalent to approximately 63.5% of GDP, Germany remains comparatively conservatively financed by advanced-economy standards and stands in stark contrast to France, where public indebtedness is estimated at around 119% of GDP. This divergence is increasingly reflected in sovereign bond markets. German Bunds continue to function as the euro area’s benchmark safe-haven asset, supported by stronger investor confidence, lower perceived fiscal risk, and a longstanding reputation for fiscal prudence. By contrast, the widening yield differential between French and German government bonds suggests growing market concern regarding France’s medium-term fiscal trajectory and its ability to stabilise debt dynamics without a combination of fiscal consolidation, structural reform, and stronger economic growth. Discussions surrounding unconventional approaches to debt management, including various proposals related to central bank-held government debt, have further fuelled uncertainty. Ultimately, debt sustainability is largely a function of nominal GDP growth, which can reduce debt ratios even in the absence of substantial debt repayment. While the United States has recently benefited from robust nominal growth that has helped stabilise its debt burden, the weaker growth outlooks across much of Europe limit this adjustment mechanism. Against this backdrop, investors are closely monitoring both fiscal developments and the European Central Bank’s role in ensuring orderly sovereign bond markets. Over the longer term, however, stronger productivity growth, credible fiscal discipline, and a gradual reduction in debt burdens remain the most sustainable foundations for preserving fiscal stability and maintaining market confidence.

Contagion Risk

This leads me to another important and dangerous issue. Financial markets have become increasingly attentive to the risk of contagion within European sovereign bond markets following a recent selloff that revived memories of the euro-area debt crisis of the early 2010s. For much of the year, government bond yields across the monetary union had moved broadly in tandem, reflecting a common response to persistent inflationary pressures, the energy-price shock, and the European Central Bank’s tightening cycle. France, however, emerged as a notable exception. Ongoing fiscal disputes, political fragmentation, and uncertainty surrounding medium-term budget consolidation have contributed to a deterioration in investor sentiment, causing French government bonds to underperform their European counterparts. At the core of investor concerns lies the combination of a large fiscal deficit, a public debt burden approaching 120% of GDP, and limited political consensus regarding the reforms necessary to stabilise public finances. As higher interest rates gradually raise government financing costs, markets have become increasingly focused on the sustainability of France’s fiscal path and its ability to reconcile social spending commitments with fiscal discipline. Concurrently, global bond markets remained under pressure, with the yield on 30-year U.S. Treasury securities rising to its highest level since 2002, underscoring broader concerns regarding sovereign indebtedness and long-term inflation risks. Within Europe, particular attention has focused on the widening spread between French and German government bond yields, a development that suggests investors are increasingly differentiating between sovereign credit profiles within the euro area. These concerns were reinforced by recent remarks from the Governor of the Banque de France, who characterised the country as operating within a fiscal „risk zone“ and emphasised the need for a credible budgetary framework by 2027. Absent a combination of stronger trend growth, productivity-enhancing reforms, and meaningful fiscal consolidation, France faces the prospect of persistently higher risk premia, which could further complicate debt-management efforts and place additional pressure on public finances. Viewed through this lens, the widening Franco-German yield spread is not merely a market phenomenon but a reflection of growing doubts regarding the long-term sustainability of France’s fiscal model.

Conclusion

While global growth indicators have strengthened markedly in recent months, a significant portion of the observed expansion is attributable to higher prices rather than to a meaningful increase in real economic output. With global inflation still hovering near 4%, it is conceivable that roughly half of current nominal growth reflects inflationary effects rather than genuine gains in productive capacity. This observation is particularly important in the context of rising public indebtedness, as inflation and nominal growth continue to play a central role in stabilising debt ratios across many advanced economies. Against this backdrop, recent developments present a somewhat paradoxical picture. On the one hand, improving PMI data, resilient US economic activity, and the stabilising effects of accommodative monetary policy in China have reduced the immediate risk of a global downturn. On the other hand, the structural vulnerabilities that have accumulated over the past decade remain largely unresolved. Public and private debt levels continue to rise, while political incentives frequently favour short-term economic support over long-term fiscal consolidation. The widening spread between French and German government bond yields serves as a timely reminder that sovereign risk has not disappeared from developed markets but is increasingly being repriced by investors. Viewed through this lens, Ladies and Gentlemen, the current economic expansion appears less robust than headline growth figures may suggest. Sustainable prosperity cannot be built on debt accumulation and inflation alone. Without stronger productivity growth, credible fiscal discipline, and a renewed commitment to long-term economic reform, today’s encouraging cyclical momentum may ultimately prove insufficient to address the deeper structural challenges confronting the global economy.

Ladies and Gentlemen

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I wish you an excellent start to the day and weekend!

Yours truly,

Stefan M. Kremeth
CEO & Head of Wealth Management
Incrementum AG – we love managing assets

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