Renowned hedge fund managers Ray Dalio, Stanley Druckemiller and “Bond King” Jeffrey Gundlach along with Wall Street and the financial media have been sounding the alarm bells over the soaring U.S. public debt.

Mr Dalio, for instance, prone to colourful rhetotic issued a dire warning of the “American debt death spiral” while his fellow billionare Mr Druckenmiller warned that the U.S., debt crisis was worse than he imagined. Mr Gundlach is adamant that a “reckoning” for U.S. Treasuries is inevitable.

Looking at the graph below, one can hardly blame them. Measured against Gross Domestic Product (GDP) - i.e. the size of the economy - the public debt skyrocketed from around 41% at the time of the 2007-2008 Great Recession to 122% by 2024. That exceeded the previous record of 106% at the end of World War II.

According to the non-partisan Congressional Budget Office projections, using conservative economic assumptions, the fiscal drain will continue to grow exponentially to 156% of GDP by 2055.

And much of the fiscal irrectitude is funding so-called “entitlements” or government transfer payments to the elderly and the poor as opposed to growth-boosting productive investments in the economy.

As the above infographic demonstrates, 60% of federal government outlays goes to “mandatory” programmes or entitlements and 13.2% to pay the interest on the debt, which represents nearly one-fifth of tax revenues.

No wonder, the federal deficit, shown in the graph below, reached a staggering 6.3% of GDP in 2024 in the midst of an economic boom.

Back to the Future

On the surface, the headline figures suggest that the U.S. will soon face a fiscal retribution of some sort, as Messrs Dalio, Druckenmiller and Grundlach pontificate.

If history is any indication, the chances of a debt crisis occurring in the near future are quite low. Following World War II, the United States faced a heavily indebted economy but succeeded in bringing it under control over the next three decades. Understanding how this was achieved can offer insight into the strategies today's authorities are likely to adopt to prevent fiscal chaos.

Economists Julien Acalin and Laurence M. Ball in 2024 published research to prove that a strict below-inflation interest-rate policy and periodic inflationary surges rather than elevated economic growth contributed the most to reducing debt-to-GDP from 106% in 1946 to 23% in 1974.

They estimated that without financially repressive interest rates and inflation, America’s debt in 1974 would have been 74% of GDP rather than 23%.

Avoiding a debt default remains a reasonable expectation, especially in light of former Fed Chairman Alan Greenspan’s assertion that the government can always “print money” to meet its obligations.

To manage the debt burden, policymakers are likely to rely on a mix of below-inflation interest rates and moderate inflation—carefully calibrated to be acceptable to the general public while steadily reducing the dollar’s purchasing power over time.

Follow the Money

Wall Street and many “experts” peddle the narrative that America’s exploding debt and deficits are spurring the nebulously-defined mysterious “bond vigilantes” to push the 10-Year Treasury bond yield higher and higher:

Their argument is reinforced by a graph comparing the growth of U.S. gross debt with the 10-Year Treasury yield. Since 2020, the data suggests a positive correlation between the two, indicating that rising debt levels may be pushing up bond yields:

However, examining a longer timeframe reveals no clear linear relationship. For instance, between 2009 and 2020, gross debt doubled from $11.9 trillion to $22.7 trillion, while the 10-Year Treasury yield declined from 3.26% to 2.14%.

So, what can better determine the changes in the 10-year Treasury yield? Money supply and inflation:

John Greenwood OBE—former chief economist of INVESCO and architect of the Hong Kong currency board scheme in 1983—created the graph above, which shows M2, a broad money supply measure published by the U.S. Federal Reserve, leading the Consumer Price Index (CPI), which in turn leads the 10-Year Treasury bond yield.

During the 1970s and 1980s, rapid money supply growth coincided with high inflation and low debt levels, resulting in high yields. In contrast, between 1990 and 2019, slower money growth aligned with low inflation and rising public debt, producing low yields.

What happens is that changes in broad money drives changes in nominal GDP growth:

And changes in nominal GDP drives changes in inflation:

This relationship influences the 10-Year Treasury yield, a fact empirically demonstrated by Richard Werner, Professor of Banking and Economics at the University of Winchester:

However, celebrated hedge fund managers, Wall Street and so-called experts often overlook that the alignment between nominal growth, inflation, and long-term bond yields will ultimately occur—albeit with significant short-term volatility, as vividly illustrated by this graph:

Expect volatility to surge beyond previous norms, driven by an unprecedented mix of factors: the Fed’s pandemic-era massive money printing, Covid-induced global economic shutdowns, supply chain disruptions, inflationary spikes, rapid rate hikes from zero percent, quantitative tightening (the Fed shrinking its balance sheet), record fiscal deficits, Trump’s tariffs, and ongoing geopolitical tensions.

Listen to Gold

Rising gold prices partly reflect the ballooning U.S. public debt and deficits, but the persistent upward trend signals something deeper and more troubling.

Gold seems to warn that soaring debt is taking a serious toll on the long-term outlook for economic growth and overall well-being—evidenced by the bottoming of the gold-to-S&P 500 price ratio in 2021.

Notably, gold and the S&P 500 serve as indicators: gold often predicts political and economic upheavals, while the S&P 500 acts as a rough proxy for the health of the U.S. economy.

As highlighted in the previous article, “Forget the Analysts: Gold is the Unfiltered Oracle of Global Political and Economic Turmoil”, every time this ratio has hit a low point, significant economic and financial crises have followed.

It is highly likely that the next wave of turmoil will be tied to a prolonged period of U.S. economic stagnation or stagflation—a combination of slow growth and moderately high inflation.

Strong evidence supports the negative impact of high public debt on economic growth, starting with the graph below, which compares public debt-to-GDP ratios against real income per capita:

Plenty of evidence exists to showcase the shackles of high public debt on economic growth, starting with the graph below juxtaposing public debt-to-GDP against real income per capita growth rate:

Numerous studies link high U.S. public debt to slower economic growth by crowding out private investment, diminishing marginal returns on debt, mounting interest costs imposing a “deadweight loss” on the economy and limiting fiscal flexibility.

Carmen M. Reinhart, Vincent R. Reinhart and Kenneth Rogoff found in 2012 that when gross government debt exceeds 90% of GDP for over five years, economies lose about one-third of their growth. U.S. debt passed that level in 2013.

Since 1870, real per capita GDP grew at 2.2% annually; over the past 20 years, it dropped to 1.3%, closely matching their prediction.

Similarly, Andreas Bergh and Magnus Henrekson concluded in 2011 that each 1% rise in government size reduces annual per capita GDP growth by 0.05%–0.1%.

Lacy Hunt, former Dallas Fed senior economist, noted that as the government’s size rose from 25.2% of GDP in 1971 to 34.3% in 2023, growth declined from 2.2% to 1.3%, corresponding with previous estimates.

The Great Stagnation or The Great Stagflation

Surging debt and deficits signal a U.S. economy nearing a “Great Stagnation” of slow growth and low inflation, or more likely, a “Great Stagflation” with sluggish growth and moderately high inflation.

These scenarios, covered in the next article, are worse than a crisis, which can prompt vital reforms. Stagnation or stagflation’s slow incemental decline rarely motivates change. As T.S. Eliot wrote, “The world ends not with a bang, but a whimper”.

Gold’s ongoing bull run, as illustrated by the chart below, is garnering the attention of analysts and investors alike, which is not surprising given their proclivity to focus on ascending asset prices rather than on intrinsically cheap valuations.

For at least decade, the yellow metal has been signalling that radical changes were coming to the world’s post-World War 2 geopolitical and economic architecture well ahead of the foreign policy pundits, economists and investment banks.

Following the collapse of the gold price in 2011, it began a gentle upward, albeit choppy, trend since 2016.

That coincided with the election of Donald Trump as president in November 2016, the application of US tariffs on Chinese merchandise exports due to proliferating US-China hostility and the overwhelming rejection of the 11-nation trade-liberalising Trans-Pacific Partnership agreement by Democrats and Republicans alike.

Central Banks

So, what drove the gold price to start its journey of uplift since 2016? Central bank buying, particularly by The People’s Bank of China at the forefront but joined by the Bank of Russia and other counterparts in Asia.

We can observe in the chart below that gold as a percentage of global international reserves held by central banks has been steadily increasing from 2016 at roughly the same time as the forward march of the gold price.

Why is that an important development? Because central banks, by nature, engage in deep and careful analysis regarding decisions on altering the composition of their reserves. They projected astutely the long term implications of the election of a populist non-establishment figure as US president.

And Trump’s assumption of the presidency, undoubtedly, did herald the US pivot away from free trade and globalisation culminating in the tariff war unleashed in his second term.

His Democratic predecessor Joe Biden pursued the same mercantilist and protectionist path. He implemented restrictions on the sale of high-end semiconductor chips to China while adopting industrial policies with a buy-America bias to boost the domestic production of chips, Electric Vehicles, solar panels and wind turbines.

Gold and US Public Debt

Not only did gold anticipate anti-globalisation sentiments, it also expressed concerns towards the explosion of the US federal debt at least a decade before “experts” raised the red flag on its unsustainable nature.

Juxtaposing the gold price against the US federal budget deficit and debt levels reveals that gold buyers feared, again since 2016, the incessant parabolic direction of America’s insatiable appetite for borrowing and spending.

Investors are fretting that the deteriorating US fiscal picture will compel the authorities to print it away via higher inflation, otherwise known as the “inflation tax”. In a scenario where the purchasing power of the mighty Dollar tumbles, gold’s role as a hedge and protector of wealth shines brighter than ever.

Weaponisation of the US Dollar

A third factor motivating the gold price is the incessant imposition of US economic and financial sanctions against countries, entities and individuals deemed inimical to its foreign and security interests. These actions, undoubtedly, encourage diversification into gold as a consequence of its historical reputation as a monetary metal and free of counterparty risk.

Revealingly, the tempo of sanctioning accelerated somewhat from 2016 and then decisively in 2021 onwards roughly in line with gold price movements during the last decade.

What Is Gold Telling Us Now?

Gold is informing us quite loudly and forcefully that some seismic geopolitical, financial and economic developments will be unfolding in the short-to-medium term with durable and long-lasting implications.

Viewing the chart below comparing the gold price relative to the value of the the S&P 500 U.S. stock index, one can immediately observe a rare pattern predictive of transformational changes being afoot.

In 1929, 1967 and 2000, the ratio of gold to the S&P 500 bottomed prior to earth-shattering events of the time:

• 1929: the US Great Depression and the tariff-raising Smoot Hawley Act of 1930 unleashing a destructive international trade war;

• 1967: the loosening of the gold standard until its abolition by US President Richard Nixon in 1971, the introduction of fiat currencies and elevated inflation during the decade of the 1970s; and

• 2000: China’s admission into the World Trade Organisation and the Dotcom bust in 2001 and the collapse of the subprime mortgage shambles, both in the United States, leading to the 2007-2008 Global Financial Crisis.

Now we see this ratio bottoming in 2021 hinting that something majorly in terms of geopolitics and economics will happen. What could that be is the intriguing question, which I will explore in the next two articles.

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What is the Quantity Theory of Money?

Milton Friedman, the modern founder of the Quantity Theory of Money (QTM), best described it:

Inflation is and always a monetary phenomenon, resulting from and accompanied by a rise in the quantity of money relative to output.

Inflation, or the general increase in the price of goods and services, is caused when the money supply increases faster than the output of such goods and services in the economy.

Put differently, the over-printing of money compared to the amount of goods and services produces inflation that diminishes the value of money over time.

What is money?

One might think the answer is obvious, but actually it’s not in a well-developed economy like that of China, Eurozone, Japan, United Kingdom (UK) and the United States (US).

QTM works optimally with broad definitions of money.

Broad money encompasses liquid forms of money, like cash and current/checking accounts, and less liquid forms such as savings accounts, timed deposits and certain investment instruments.

Cash is normally disregarded since only 3% of transactions are done in notes and coins.

What are the primary sources of money?

Central banks historically issued 5% of the money supply but that percentage skyrocketed to around 20% or higher once they financed government debt through a process known as “quantitative easing” or “QE” after the 2008 Great Financial Crisis.

Commercial bank lending is the primary engine of money creation, which is probably a surprise to most readers.

In an excellent 2014 publication, the Bank of England challenged popular misconceptions that banks acted as intermediaries lending out customer deposits or that they “multiply up” their funds - known as reserves - held up at the central bank to establish loans or deposits.

Richard Werner, a banking and economics professor at the University of Winchester and father of QE, published the first empirical proof that banks generate money when they grant loans.

What is the link between money supply and inflation?

Milton Friedman derived a simple formula to explicate the link between money supply and inflation:

MV = PY

Where:

M = Money Supply

V = Velocity (i.e. the rate at which each unit of money circulates in the economy)

P = Price level or Inflation

Y = Real Output or Real Gross Domestic Product (i.e. value of all goods and services in an economy adjusted for inflation)

So, as the formula demonstrates, any sustained money supply changes spills over into the nominal economy (i.e. the real economy plus the inflation rate) and then inflation.

This spillover does not happen instantaneously. There are always long and variable lags of 1-3 years between a change in the money supply and inflation.

What factor drove inflation way up in 2021 - 2023 and then quickly down in 2024 - 2025 in the US, Eurozone and UK?

Money supply changes.

Between 2020-2021 at the pandemic’s height, the US Federal Reserve (Fed), the European Central Bank and the Bank of England argued for “transitory inflation” meaning that it would be short-term and self-correcting.

In reality, they primed monetary growth by monetising the government debt using aggressive QE (i.e. purchasing government debt). Like clockwork, the inflation shot up in all three at nearly the same time period.

Subsequently, the Fed and its counterparts contracted their money supply in 2021 until 2024 largely through “Quantitative Tightening” or reverse QE (i.e. by selling or letting government bonds mature).

No surprise, the Eurozone, UK and US witnessed a disinflationary trend since 2023.

Is there any evidence on the veracity of the Quantity Theory of Money?

Yes, there is.

In 2001, the Federal Reserve of Minneapolis published a study evidencing a high “correlation” (i.e. relationship) between growth rates of money supply and the general price level in 110 countries over a 30 year period.

Steven Hanke, Professor of Applied Economics at Johns Hopkins University, published an updated study confirming the strong link between the money supply and inflation in 147 countries between 1990-2021.

Thirdly, the post-pandemic inflation rates in China, India, Japan and Switzerland remained low or muted given that they did not spike their money supply in 2020-2021.

Do you need to be an expert to apply the Quantity Theory of Money to anticipate inflationary trends?

Definitely not.

Steve Hanke calculated utilising the QTM formula that the year-on-year money supply rate for the Eurozone, Japan, UK and US has to be around 6% to achieve a 2% inflation target.

By contrast, China’s annual money supply growth consistent with its 3% inflation target is 11-13%.

One can predict the pathway of inflation by monitoring the appropriate monetary aggregate of a particular country.

For instance, the Fed releases each month its measure of broad money supply called “M2” money supply, which at 4.12 % year-on-year increase as of March 2025, is below the 6% benchmark consistent with a 2% inflation target. That indicates a US inflation rate of 2% or below in 2025 and 2026.

But, one should pay close attention to the ongoing pattern of M2, as shown in the graph below:

Considering the gentle upward trend, this begs the question: will M2 settle at a level close to or at 6% or will it exceed it in the short-to-medium term? This will inform the astute observer about US inflation in the months and years ahead.

“Cost of living crisis” invaded the UK lexicon ever since inflation, or the general increase of goods’ and services’ prices, dominated the economy following the global COVID pandemic in 2021/2022.

Skyrocketing from 0.7% in March 2021 to 11.1% in October 2022, it declined precipitously to 2.5% by December last year, as can be seen in the graph below:

Going forward, the Bank of England predicts that:

inflation is on a bumpy path and we expect it to rise to 3.7% towards the middle of 2025. This is because of increases in global energy costs and some regulated prices, such as water bills. But it will be only temporary and inflation should fall back to 2% after that.

It is very difficult to predict how the economy will evolve. Another global shock could significantly change the situation. For example, global trade tariffs and developments in the Middle East may impact some prices.

Revealingly, the Bank cites external factors, principally global energy costs, water bills and uncertainties over global trade tariffs and Middle Eastern “developments” as the source of inflation. Nowhere, does it accept any responsibility for influencing its primary mandate of price stability.

In spite of the Bank’s research department populated by high-flying Phd economists from elite universities, its track record on inflation leaves much to be desired. It failed to anticipate the upward momentum between 2021-2022 and the subsequent disinflationary episode unfolding today.

By focusing on “exogenous” or external factors for explaining inflationary changes, the Bank’s predictions on price dynamics are wide off the mark.

Unsurprisingly, the average investor, business owner and household, who fail to anticipate inflation accurately, end up making wrong decisions on borrowings, corporate investments and financial planning.

A Better Way to Forecast Inflation

Bank of England economists declared that recent:

high inflation in the UK was driven primarily by higher costs [i.e. “cost-push” inflation]… Covid-induced supply shortages, the invasion of Ukraine and lack of workers post pandemic all led to ‘cost-push’ inflation.

Simultaneously, they belittled “demand-pull” inflation defined as:

when there is an increase in the demand for something compared to its supply. For example, too much money in the economy can lead to higher demand for goods and services than there are available, which raises prices and inflation.

In effect, the quote above in bold-type demonstrates that the Bank is pouring cold water on the one metric that it controls in the economy as the primer of inflation: money supply.

That is a shocking contention to make in light of its quadrupling the year-on-year growth of broad money during the pandemic, as shown in the graph below:

Similarly, the rapid disinflation that commenced in end-2022 is accounted for by the steep decline in money supply from early 2021 onwards.

Magic Target

To achieve the Bank of England inflation target of 2%, the annual increase of UK’s broad money metric called “M4ex” has to be around 6%, as calculated by Steve Hanke, an eminent economist at Johns Hopkins University:

Unsurprisingly, the inflation rate jumped with a lag, which can oscillate between 1 - 3 years, when the money supply growth crossed the 6% benchmark and then quickly fell - again with a long lag - following its contraction.

Given the current M4ex growth rate of 3.3% is still below the 6% threshhold, inflation will continue to descend to 2% by year-end and remain at or close to that level for much of 2026.

In the next article, the Quantity Theory of Money will be outlined to illustrate the link between money supply and inflation.

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