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market:outlook 2024 - 3.1.2024 - Edgar Walk

Risk scenario for 2024: Will sovereign debt become a problem?

Rising trend in government debt

According to the OECD, government debt in the OECD area as a whole is likely to have levelled off at around 113 percent of GDP in 2023, remaining virtually unchanged from the previous year. In 2020, government debt was still around 128 percent of GDP. The high inflation of recent years has thus contributed to a noticeable decline in government debt. This year, however, a return to a rising trend and an increase in public debt to 114.5 percent of GDP is expected. Before the pandemic, public debt was still around 108 percent of GDP.

The question now arises as to whether rising government debt is a relevant factor for the financial markets at all. After all, government debt has been rising continuously since 1974 – when it was still around 36 percent of GDP – without causing any major problems.

Is government debt a relevant factor at all?

The role of government debt in an economy is complex, so it’s necessary to look at the nature of our monetary system.

In its natural state, our monetary system is comparable to the game Monopoly. In Monopoly, the bank is always solvent and never goes bankrupt, only the players do. In Monopoly, taxes and levies have the function of reducing the outstanding money supply so that one of the players goes bankrupt more quickly.

In our monetary system in its natural state, the bank in Monopoly corresponds to the unity of government and the central bank. The central bank prints the money, the government spends it. Taxes then have the function of reducing the money supply created by government spending in order to limit inflation. Government bonds also have this function, as they park the money of the private sector so it doesn’t affect demand. For example, the German Empire first issued money to finance the First World War, and only later did it issue war bonds. When the private sector bought the war bonds it could not spend the money on goods and services. This was intended to prevent high inflation in Germany.

Government debt is therefore only an accounting figure and completely irrelevant. However, the major risk is that a government with access to the printing press could spend far too much money without collecting sufficient taxes. In the past, the result has often been inflation that is way too high.

The solution: a modification of the monetary system

High inflation is generally associated with major macroeconomic damage and a considerable loss of confidence in the political system. Accordingly, the monetary system has been modified to make it more resistant to inflation.


  • Public finances in the USA are in a precarious state
  • There is a threat of high government deficits over a long period of time
  • There is great dependence on foreign investors
  • The USA is vulnerable to a loss of investor confidence
  • The election campaign and the outcome of the 2024 election could be a trigger for this
  • There could be a phase of turbulence in US government bonds and the US dollar exchange rate
  • However, it would be a wake-up call for politicians to significantly reduce deficits again
  • Great Britain could be a blueprint for this
  • Against the backdrop of unsound US fiscal policy, we generally expect the US dollar to trend weaker in 2024 even without turbulence
The solution: Politicians are denied access to the printing press
Indepence of the central bank
EZB Frankfurt
Sources: Metzler, ©
Outsourcing money production to the commercial banks
EZB Frankfurt

The central banks have thus been made politically independent and money production is outsourced to private commercial banks. The printing press has been taken out of the hands of politicians, so to speak.

However, this has also changed the rules of the game. Countries now need the revenue from taxes and government bonds to finance their expenditure. And they can now also suffer a sovereign debt crisis like Greece in 2010 and Cyprus in 2013, when the ECB decided not to buy government bonds from these countries.

At the same time, however, the ECB has specified one condition: only those member states that pursue a fundamentally sound fiscal policy will be rescued. As long as the member states of the European Monetary Union do not have excessive government deficits, the potential purchase of government bonds by the ECB does not pose any inflation risks. There will then only be a reallocation within investors' portfolios – from government bonds to cash. 

Furthermore, there is a fundamental tendency for governments to weaken the modified monetary system in order to regain more influence over money production. The best example of this is Turkey, where the central bank is de facto no longer independent and private commercial banks are under strong state influence. The result is excessive money supply growth and inflation rates of up to 85 percent. However, nobody in Turkey is talking about a debt crisis. Due to high inflation, public debt has recently fallen again to only around 34 percent of GDP.

Of course, there are also grey areas. For example, the ECB's TPI (Transmission Protection Instrument) can be interpreted as a relapse into the old monetary system, as the ECB buys the government bonds of countries affected by the turmoil on the financial markets. The ECB has thus eliminated the risk of a sovereign debt crisis.

Debt dynamics in an international context

However, the role of public debt must be considered not only in a national context, but in our globalized world, especially in an international context. Foreign investors can play a decisive role in the financing of states. There are basically three scenarios:


  1. If foreign exporters do not accept the domestic currency, a country must take out foreign currency loans if there is an import surplus


  1. Government deficits can be fully financed by domestic savings in domestic currency


  1. Government deficits can be financed in domestic currency but only with the help of foreign investors


Argentina is a prime example of the first scenario. When domestic savings were not sufficient to finance government deficits. Argentina was forced to take out foreign currency loans, as foreign exporters did not accept payments in Argentine pesos.

As a rule, foreign investors financed Argentina for several years until the flow of capital from abroad came to a standstill – for various reasons, such as interest rate 

hikes by the US Federal Reserve. The result was a sovereign debt crisis with a debt haircut. Despite numerous debt crises, it was worthwhile overall for foreign investors to invest in Argentina1. The big loser was the general Argentinian population.

Against this backdrop, it is completely irrelevant whether the new Argentinian President Javier Milei intends to “dollarize” the economy or not. The decisive factor for the success of his policy is to end the long phase of government deficits, especially since Argentina lacks the US dollars for dollarization anyway.

In principle, therefore, countries that finance their government deficits entirely with foreign currency loans are at great risk for a debt crisis. In a certain sense, they face the modified monetary system in its pure form, as they have no influence on money production and are completely dependent on foreign investors. Of course, there are many shades of grey here too – and Argentina is an extreme case.  

Argentina: To finance government borrowing by foreign currency debt is highly risky
Borrowing abroad and by the state as % of GDP

Sources: Refinitiv Datastream, Metzler; as of September 30, 2023

Japan is a prime example of the second scenario. The private sector in Japan is so willing to save that it can finance a national debt of around 250 percent of GDP and even build up additional assets abroad at the same time. Japan is therefore not dependent on foreign investors and is free to decide whether it wants to follow the old or new monetary system. Japan is also characterized by weak consumption and structurally low inflation. The risk of a debt crisis is therefore very low. Should the Japanese people suddenly become more willing to consume, the government can still achieve budget surpluses again and reduce debt by increasing taxes.

China also fits into this category. Despite a total debt of over 300 percent of GDP, China has been able to increase its foreign assets every year. China is also characterized by weak domestic consumption and low inflation – partly due to the property crisis. The savings rate in China is therefore extremely high.

The Chinese government controls the central bank and the financial system and could therefore stimulate the economy at any time by producing money – i.e. returning to the old monetary system – without generating excessive inflation.

Obviously, there are reservations within the government about going down this path. However, the Chinese government always has complete freedom of action and will ensure that the crisis on the property market does not turn into a financial market crisis. Against this backdrop, we believe the Chinese economy will face a phase of stagnation lasting several years until the oversized property market has returned to normal. 

Japan: high internal savings by households and companies can finance high government debt in local currency and foreign assets
Public debt and foreign assets as % of GDP

Sources: Refinitiv Datastream, Metzler; as of September 30, 2023

The USA is a prime example of the third scenario, which is actually a combination of the first two. The USA can borrow entirely in its own currency, as the whole world wants US dollars. There is thus no threat of a debt crisis at any time. However, the USA is characterized by strong domestic demand and a low propensity to save and therefore has to finance around half of its national deficits through foreign investors. According to the official US Congressional Budget Office (CBO), the national debt has already reached a level last seen after the Second World War – and could even double again by 2050. If foreign investors decide they are no longer prepared to finance US deficits, either the government would have to start saving more (recession) or the central bank would have to buy bonds (inflation).

USA: Although the USA borrows in its own currency, it is dependent on foreigners to finance the national deficit
US Government debt as % of GDP

Sources: CBO, Metzler; as at October 31, 2023

The reason for the high debt dynamics in the USA

Two factors have a significant influence on the trend in government debt: 1) the difference between interest rates and economic growth and 2) the government deficit excluding interest payments. The CBO estimates that the average interest rate on outstanding government bonds will be lower than economic growth in 2024. As a result, government debt should actually decrease. However, the government deficit is estimated to be unusually high at 3.0 percent of GDP, meaning that overall, government debt is expected to increase by around 2.0 percentage points of GDP.  

For the euro zone, on the other hand, the EU Commission estimates a decline in government debt of -0.7 percentage points of GDP, as the aggregate government deficit of all euro zone member states is low at around 1.0 percent of GDP. The euro zone is therefore in a much better fiscal position than the USA.

In the USA, baby boomers are retiring at an increasing rate and are increasingly utilizing state-funded pensions (Social Security) and healthcare (Medicare). The government deficit is therefore of a structural nature, making it all the more problematic. According to the fiscal theory of the price level, the expectation of future deficits is a decisive factor for the inflation outlook.

Fiscal theory Fiscal theory of the price level<br/>
Source: Book Presentation with John Cochrane: "The Fiscal Theory of the Price Level" in Frankfurt in 2023; ©©RTimages

If the government deficit is currently high but financial market participants expect budget surpluses to be achieved again in the future and government debt to fall, there will be no impact on the price level. Countries have often had high deficits during wars and temporarily decoupled themselves from the gold standard. After the war, they have returned to the gold standard and reduced their national debt as a result of budget surpluses. Although the price level fluctuated time and again, it remained stable overall.

If the government deficit is currently high and there is an expectation of persistently high government deficits, there is a risk that confidence in monetary stability will be lost. Persistently high deficits are only possible if the central bank finances them, at least in part. However, a loss of confidence means that investors are quick to invest their money in tangible assets or taking it abroad to safety. Inflation can then occur immediately in the event of a loss of confidence.

USA: Although the USA borrows in its own currency, it is dependent on foreigners to finance the national deficit
US Government debt as % of GDP

Sources: CBO, Metzler; as at October 31, 2023

According to projections of the official US budget authority, the USA is facing considerable deficits in the coming years, which could even tend to increase. The yield on US government bonds has recently fallen noticeably and the US dollar is still strong, so investors are apparently still expecting politicians to be able to significantly reduce deficits again in the future.

The big risk, however, is that new promises to cut taxes or increase government spending will be made during the presidential election campaign. This could trigger a loss of confidence in the sustainability of US public finances, as the US is heavily reliant on foreign investors who generally react more quickly and sensitively to negative news.

Great Britain as an example of loss of trust

A good example of how a loss of confidence can play out took place in the UK in autumn of 2022, when the then newly elected Prime Minister Liz Truss announced the biggest tax cuts ever in the UK and an increase in government spending. The UK is in a similar position to the US – debt in domestic currency but reliance on foreign investors. This announcement caused a loss of confidence among foreign investors who stopped investing in British government bonds. The result was a marked increase in government bond yields and a noticeable weakening of the British pound.

USA: The Congressional Budget Office projects high and increasing government deficits
Overall deficit, primary deficit and net interest expenditure, in % of GDP

Sources: Refinitiv Datastream, Metzler; as of September 30, 2023

Although the Bank of England intervened to stabilize the situation and bought government bonds, the financial markets only calmed down after the government made a U-turn and suddenly discussed austerity measures. If the Bank of England had intervened but the government had stuck to its plans, the British currency would probably have crashed.

1 According to a study, it was worthwhile for foreign investors to invest in Argentinian bonds despite the ongoing debt crises. From 1802 to 2016, Argentinian US dollar government bonds generated an excess return of almost 6.0 percent per year compared to US government bonds. Josefin Meyer, Carmen Reinhart and Christoph Trebesch (2021): "Sovereign Bonds since Waterloo." Kiel Working Paper

Edgar Walk
Edgar Walk

Chief Economist , Metzler Asset Management

Edgar Walk joined Metzler in 2000. As Chief Economist in the asset management division, he is responsible for formulating our global economic outlook. Due to his close cooperation with the portfolio management, he focuses on capital market themes as well as on global economic analyses. Mr. Walk holds a master’s degree in economics from the University of Tübingen in Germany and spent a semester at the University of Doshisha in Kyoto, Japan. In addition, he completed the program “Advanced Studies in International Economic Policy Research“ at the Institute of World Economy in Kiel, Germany.

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