Structurally High Government Debt and Its Consequences
Global debt has risen sharply in recent decades and today amounts to more than 230 percent of global GDP. Government debt is hotly debated because it directly impacts the financial and political room for manoeuvre of countries. High levels of government debt also pose risks for growth, interest rates, and inflation. Key drivers were the financial and euro crises, as well as the massive stimulus measures during the pandemic. Excessive debt raises interest costs and makes economies more vulnerable. It can also destabilise the global financial system. Various ways to reduce debt exist. An increasingly realistic scenario is the combination of fiscal dominance and financial repression. While this stabilises refinancing, it also carries risks such as declining confidence in monetary policy, rising inflation, and greater vulnerability of financial markets. For investors, this means fixed-income investments become less attractive, while real assets such as gold and real estate gain importance. Furthermore, quality stocks with solid profitability and pricing power remain key. The decisive factor is robust diversification through meaningful combination of fixed income, real assets, and equities.
Allocation: Neutral on Equities, Real Estate Fur- ther Overweight
The economic environment remains mixed. Fundamentals are still robust but sentiment has slightly weakened. Moderate US growth and a still solid labour market make an imminent recession less likely. However, persistent political uncertainty — caused by trade conflicts and geopolitical tensions — may increase volatility. Markets are betting on monetary easing. Two more interest rate cuts in the US are likely if the labor market and inflation continue to weaken.
Against this backdrop, we raise our equity allocation from slightly underweight to neutral while maintaining a defensive sector allocation. We take profits after strong performance in consumer staples. At the same time, we upgrade healthcare following a period of weakness. Broad-based earnings development, combined with fiscal stimulus and deregulation in the US, justify this cautious increase.
Conversely, we slightly reduce bonds and short-term investments. We further increase our overweight position in Swiss real estate, bringing stability to the portfolio which should benefit from lower interest rates. We remain strongly overweight in gold since the precious metal continues to be a key component for the strategic hedging of our portfolios.
The core orientation of our investment strategy remains unchanged. We actively manage risks, use opportunities selectively, and focus on quality across all asset classes. Our defensive stance reflects caution, but not pessimism.
Global Debt at a Glance
Debt is an integral part of modern economies enabling investment, crisis management, and growth financing. According to the IMF total global debt amounted to nearly USD 250 trillion in 2023, or 237% of global GDP. Of this, about USD 98 trillion (94% of global GDP) was public debt and more than USD 150 trillion (143% of global GDP) was private debt. Private debt includes the gross liabilities of households as well as non-financial corporations.
Although private debt is higher in absolute terms, public attention is focused mainly on government debt. One reason is that private debt is usually backed by assets, whereas this is only partly the case for governments. Moreover, government debt directly affects the financial and political room for manoeuvre of governments and thus receives more public scrutiny. High public debt limits fiscal flexibility and can influence macroeconomic variables such as interest rates, inflation, and growth.
The Rise in Global Debt
Driven by the 2008 financial crisis, the euro crisis, and massive fiscal stimulus during the pandemic, global government debt has risen sharply in recent decades. While global public debt amounted to around 60 percent of world GDP in 2007, it is expected to reach about 94 percent in 2023. It is noteworthy that not only developed economies, but also many emerging and developing countries, now suffer under heavy debt burdens.
Moderate government debt is economically reasonable and can support long-term growth. Excessive debt, however, has clear negative consequences:
Limited crisis resilience: Highly indebted states can respond less effectively to recessions or geopolitical crises.
Rising interest burdens: Growing interest payments reduce fiscal leeway and increase the risk of a debt spiral.
Crowding out of private investment: High government borrowing can tie up private capital, hampering economic and productivity growth.
Risk of instability: Over-indebted states risk losing market confidence. This may trigger currency crises, capital flight, or even defaults with global consequences.
Intergenerational burdens: Excessive debt today means higher taxes or reduced benefits for future generations.
How Much Debt Is Too Much?
There is no universally valid threshold. However, a debt level of 60 percent of GDP, as stipulated in the EU Maastricht Treaty, is often cited as a benchmark. Risks increase significantly once debt levels approach 100 percent of GDP, especially in times of high interest rates or slowing growth. Both interest rates and growth rates determine a country's debt sustainability — that is, its long-term ability to reliably service interest and repayments.
Why Reduction Is Necessary
Experience in recent decades has shown that persistently high debt levels increase economic vulnerability and can lead to instabilities in the global financial system. Reducing excessive debt is therefore essential to safeguard long-term fiscal capacity, stabilise market confidence, and secure sustainable economic development.
Possible Ways Out of the Debt Trap
There are several options for reducing government debt: fiscal consolidation, debt restructuring, economic growth, and a combination of fiscal dominance and financial repression.
Fiscal Consolidation
This involves spending cuts and/or tax hikes to achieve surpluses and reduce debt. This can be effective in smaller economies, as seen in Portugal and Greece during the euro crisis under external pressure. In large democracies, however, strict austerity is politically difficult to enforce as spending cuts and tax hikes are unpopular and reduce reelection chances.
Debt Restructuring
This involves renegotiating or partially forgiving liabilities. Debt restructuring is mainly used by emerging and developing countries, such as Argentina, which has restructured several times since the 1980s. For systemically relevant economies such as the US or the Eurozone, however, this option is hardly realistic, as it would jeopardise global financial stability.
Debt Reduction Through Growth
Economic growth can reduce the relative debt burden. Debtto-GDP ratios decline if nominal GDP growth exceeds financing costs. A historical example is the post-WWII era: in the US and many Western European countries debt reached record highs but fell sharply in the 1950s and 1960s thanks to strong growth and low interest rates, without major austerity programs.
Fiscal Dominance and Financial Repression
Given current developments in the US, the combination of fiscal dominance and financial repression is gaining attention. Fiscal dominance means monetary policy becomes subordinate to fiscal policy needs. In this environment central banks support government financing by purchasing large amounts of government bonds or by keeping interest rates low through caps and yield curve control. A prominent example is Japan, where fiscal and monetary policies have been closely aligned since the early 1990s. Financial repression complements this: banks, pension funds, and insurers are legally or regulatorily obliged to hold a large share of their assets in government bonds.
For the US, such a combination may be one of the few realistic options to stabilise its high debt load over the long term. While it lowers refinancing costs, it also entails risks: declining confidence in monetary policy, rising inflation, and increased financial market vulnerability. In a globally dominant economy like the US, this approach is particularly delicate, as it directly impacts not only domestic financial stability but also international capital markets.
Investment Policy in Times of High Public Debt
The high levels of global debt and the realistic prospect of fiscal dominance combined with financial repression have far-reaching consequences for investors. In an environment of higher inflation and artificially low interest rates, fixed-income investments become significantly less attractive. Returns on cash and bonds may fall below inflation, resulting in real losses of purchasing power.
Real Assets as Winners
Real assets gain in importance as alternatives. In times of monetary and fiscal uncertainty, gold has proven to be a reliable store of value. It preserves purchasing power even in inflationary environments as supply is limited. It is also independent of monetary and fiscal interventions and of the solvency of individual states. These properties make gold particularly attractive in uncertain market conditions.
Real estate is another category of real assets. Swiss residential property has historically generated stable returns thanks to steady demand, limited supply, and strong property rights. Furthermore, Swiss investors face no currency risk. However, government interventions such as rent controls or stricter equity requirements can negatively affect returns.
Focus on Quality Stocks
Equities also belong to the category of real assets. Careful stock selection is crucial. Companies with clear competitive advantages, pricing power, high margins, and stable earnings can maintain profitability even in inflationary environments. Quality companies also tend to be more resilient to economic fluctuations.
The Importance of Currency
Currencies are particularly important for Swiss investors. A strong Swiss Franc reduces returns on foreign bonds, as interest payments are made in foreign currency. We therefore recommend holding bonds in the investor's domestic currency. Currency risk is less significant for equities, since many companies are geographically diversified and often hedge currency effects internally.
Strategic Implications
Even the world's largest economies, such as the US, cannot increase debt indefinitely without risks to economic stability. This underscores the need for investors to actively and proactively shape their investment strategy. Robust diversification through a combination of fixed income, real assets like gold and real estate, and carefully selected quality stocks offers the best foundation for sustainably protecting purchasing power in this environment.
Authors:
Tobias Wagner
Timo R. A. Mayr, CFA
Disclaimer
The prices used in our analysis are end-of-period prices. The figures used for our valuation model are estimates referring to dates and therefore carry a risk. These are liable to change without notice. The usage of valuation models does not rule out the risk that fair valuations over a specific investment period cannot be attained. A complex multitude of factors influences price developments. Unforeseeable changes could, for instance, arise from technological innovations, general economic activities, exchange-rate fluctuations or changes in social values. This discussion of valuation methods makes no claim to be complete. Dreyfus Sons & Co Ltd publishes Compass four times a year since June 2008. The publication is aimed at clients of the bank and interested parties. It describes some of the instruments and methods the bank uses to monitor everything to do with the financial markets. A description of the investment process can be obtained from your client advisers or our website. Compass provides guidance but cannot take the circumstances of an individual portfolio into account. It is for information and marketing purposes.