On January 13, 2025, the financial landscape underwent a seismic shift when the US dollar index surged, exceeding the 110 mark for the first time in over two yearsThis pronounced strengthening of the dollar precipitated a sharp decline in numerous currencies, including the euro, yen, pound, won, and rupee, which all plummeted to historical lowsSuch fluctuations highlight the interconnected nature of global finance and the challenges modern economies face in maintaining currency stability.

In the wake of this turmoil, central banks around the world are grappling with the daunting task of stabilizing their currenciesOne of the few remaining tools at their disposal is interest rate adjustmentRaising interest rates is often viewed as a lifeline to support a faltering currency and stave off a potential currency crisisHowever, this tactic can lead to a surge in government bond yields, risking the likelihood of a national debt crisis and potentially plunging the economy into paralysis.

Take Japan as a case study: the country’s national debt has ballooned to an astounding 2.5 times its gross domestic product (GDP). Over the last three decades, Japan's GDP has grown at an annual rate of less than 1%. This troubling statistic implies that a mere increase of 4 percentage points in bond yields could obliterate the gains made by Japan's economy in one year, as interest payments on the debt would devour the entire economic output increase.

Furthermore, Japanese fiscal revenue accounts for about 20% of its GDP, which means that a rise of just 1% in bond interest rates would require the government to allocate 12.5% of its revenue just to cover interest payments

This is problematic since the same revenue base must also support public sector salaries, defense spending, social welfare programs, infrastructure investments, and myriad other obligationsIf the entirety of Japan's fiscal revenue were diverted solely to servicing its national debt, the government's functionality would come into question.

In 2022, prior to the Federal Reserve's interest rate hikes, over twenty nations had experimented with negative interest rate policiesHowever, post-rate hikes, countries scrambled to raise their own rates to stabilize their currenciesThis sequence of events left Japan as the last major economy maintaining a negative interest rateFor the Bank of Japan, the decision not to raise rates meant risking currency depreciationA significant drop in currency value could, theoretically, be offset using foreign exchange reservesBut if Japan chose to increase rates, interest obligations would quickly escalate, risking a debt crisis similar to what was witnessed in earlier years, which could have catastrophic consequences.

Europe finds itself in a parallel situation

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On the surface, the plummeting value of the euro appears to stem from the Federal Reserve's aggressive interest rate hikesHowever, a deeper examination uncovers a common undercurrent: the risk of a debt crisisThe European debt crisis, which erupted in 2010, continues to linger, unresolved and festering beneath the surfaceThis ongoing crisis largely originates from fiscal irresponsibility among several nations including Greece, Italy, Portugal, and Spain—countries whose financial systems have been propped up by government bonds due to chronic deficits.

To address the European debt crisis, the most apparent remedy is to impose stricter fiscal discipline among EU member states, reduce budget deficits, and lower excessively high debt levelsYet, this is easier said than doneEuropean governments face fierce backlash from voters when they attempt to cut deficits or reduce welfare spending

From 2010 to 2012, vocal opposition to austerity measures grew, exacerbating the crisis rather than alleviating it.

In 2012, at the most critical juncture of the European debt crisis, Mario Draghi, then-President of the European Central Bank (ECB), infamously declared that he would do “whatever it takes” to preserve the euroThis pledge was followed by expansive monetary policies, including large-scale purchases of government bonds from distressed nations like Greece and Italy, often with maturities of less than three yearsBy 2014, due to rising concerns over high debt levels and difficulties even servicing interest payments, the ECB introduced negative interest rates to navigate through turbulent watersWhile this measure effectively alleviated immediate pressures during the crisis, it served only as a temporary fix, essentially masking the underlying issues without addressing the burgeoning debt burdens of member states.

Fast forward to today, and many countries in the eurozone, including Greece and Italy, find themselves in a worse-off situation than they were at the onset of the 2010 crisis, with soaring government debt ratios

The successive interest rate increases by the Federal Reserve have triggered another slump in the euro's value, complicating the ECB's capacity to maintain negative ratesThis predicament poses a dilemma reminiscent of Japan’s: continue to suppress rates and risk currency collapse or raise them and provoke a debt crisis.

Meanwhile, the United Kingdom's economy has faced its own trialsThe British pound recently teetered on the brink of parity against the dollar, a reflection of underlying debt issuesOn September 23, 2022, the UK’s Chancellor announced a sweeping tax cut and energy subsidy plan amounting to £220 billionWhile aimed at providing relief to businesses and consumers alike, this announcement triggered widespread market panic because the UK government is already financially stretched thin.

Since the pandemic, the debt-to-GDP ratio in the UK has skyrocketed from 84% to 100%. The announcement of such substantial financial measures incited alarming sell-offs in UK government bonds, marking the most extensive wave of selling in nearly four decades, leading to drastic declines in bond prices

The fallout from this situation was catastrophic for pension funds, which suffered considerable lossesThe Bank of England found itself forced to step in, purchasing government bonds to prevent a broader contagion effectWhile the Federal Reserve is tightening monetary policy through rate hikes, the Bank of England is counteracting with expansionary measuresThis has created a perfect storm where the UK faces a simultaneous downturn in equity, debt, and currency markets, a confluence of misfortune aptly termed the “triple kill” in British financial discourse.

The unfolding circumstances in Japan, the eurozone, and the UK showcase that the central issue at play is not merely currency fluctuations but a profound debt crisisTo navigate vast sums of national debt requires an accommodating zero interest rate policyHowever, if countries opt to prioritize currency stability over maintaining zero rates, they risk overpowering interest burdens that can thoroughly cripple national finances.

This brings us to an intriguing question: why have so many developed nations, including Japan, Europe, the UK, and the US, simultaneously spiraled into such dire debt crises? Renowned investor Ray Dalio, in his recent book “Principles: Life and Work,” suggests we are nearing the end of a long-term debt cycle lasting 50 to 70 years

During this phase, debt levels surged dramaticallyThe remedy to mounting debts has often involved central banks flooding economies with liquidity while keeping interest rates at rock bottom to facilitate continual borrowingAt this point, it can be argued that many government debts resemble a Ponzi scheme—mounting unsustainable debt levels will inevitably lead to a debt crisis surging forth until it becomes unavoidable.

Ultimately, the crises we are witnessing this year can be traced back to the fact that the long-term debt cycle is approaching its terminal phaseThe massive liquidity injection and zero interest policies that have dominated for years are beginning to unravelWhile central banks might have initially fostered economic booms and market exuberance, tightening monetary policies signal impending hardship, manifesting not just as economic recession but also igniting social unrest and potentially triggering extreme geopolitical events.

To illustrate a typical long-term debt cycle, consider a scenario early in a nation’s development where opportunities abound, and a variety of sectors achieve high profits

If a business demonstrates a 15% profit margin while banks charge 10% interest for loans, the logical step for the business would be to borrow for investment—an ideal circumstance fostering economic health characterized by a healthy debt leverage.

As time progresses, the economy matures and competition heightens, gradually diminishing profit margins across various industriesAs soon as profit margins drop to 10%, effectively equal to bank loan rates, businesses lose their incentive to expand through borrowingAt this juncture, breakthroughs in technology or successful international expansion could elevate marginal profits, potentially leading the economy into another growth periodHowever, such technological advancements are not guaranteed, nor is the expansion into foreign markets without its limits.

In summary, this progression reveals a disturbing trend: with an influx of new competitors saturating the market, the lucrative opportunities dwindle, leading profit margins to persistently decline until they fall below bank loan rates