How Do Governments Escape the Global Debt Trap?

The world has not merely accumulated a large amount of debt. It has constructed an economic system that depends upon debt continuing to grow.

According to the International Monetary Fund (IMF), global debt stood at approximately $251 trillion in 2024—more than 235 per cent of global GDP. Of that, $99.2 trillion was public debt and $151.8 trillion was owed by households and businesses. Global public debt continued rising in 2025 and is now forecast by the IMF to reach 100 per cent of global GDP before the end of this decade.^[1][2]

These numbers are so large that they become almost meaningless. The more useful question is what happens when governments can no longer borrow cheaply enough to disguise the underlying problem.

Governments do not normally repay their national debts in the way that a household repays a mortgage. They refinance maturing bonds, issue new ones and hope that economic growth allows the debt to become smaller relative to the economy supporting it.

That model works while investors remain willing to lend, interest costs remain manageable and the economy grows sufficiently quickly. It becomes considerably more difficult when old debt issued at one or two per cent has to be replaced with new debt costing four, five or six per cent.

This refinancing process is now underway.

In 2025, governments in the Organisation for Economic Co-operation and Development (OECD) faced sovereign refinancing requirements of approximately $13.5 trillion. Nearly 80 per cent of their gross borrowing was required simply to refinance existing debt. This was not new investment in power stations, transport, technology or defence. Much of it represented governments replacing one liability with another.^[4]

The uncomfortable truth is that there are only a limited number of ways out of a debt trap. Governments can grow, tax, cut spending, inflate, repress savers or default. Most will use a combination of all six while avoiding those descriptions wherever possible.

Debt Is Not Necessarily the Problem

Debt can be extremely productive.

Borrowing to construct electricity grids, nuclear power stations, ports, roads, data centres or other productive infrastructure can make a country richer. If the investment increases national income by more than the cost of financing it, the additional debt may improve rather than weaken the national balance sheet.

Borrowing to finance a war, rescue a banking system or support an economy during a pandemic may also be unavoidable. The benefit is not necessarily financial, but the alternative could be considerably worse.

The problem arises when borrowing is used to finance permanent expenditure without creating the productive capacity required to service it. Governments then become dependent upon continuing deficits merely to maintain existing promises.

There is also an important distinction between debt issued in a country's own currency and debt issued in somebody else's.

The United States, Britain and Japan can create the currency in which most of their government debt is denominated. This makes a conventional inability to pay less likely. It does not make the debt costless. The danger is transferred from outright default to inflation, currency depreciation and the gradual loss of purchasing power.

A developing country that has borrowed in dollars has far less room for manoeuvre. It cannot manufacture the dollars required to repay its creditors. If its domestic currency falls, the real burden of its foreign debt rises. What is a difficult refinancing exercise for Britain or America can become a solvency crisis for an emerging economy.

The Refinancing Trap

Higher interest rates do not affect every government bond immediately. Most government debt carries a fixed interest rate until it matures. The damage therefore arrives gradually as cheaper bonds are refinanced at higher rates.

The OECD estimated that approximately $9 trillion of fixed-rate government debt maturing between 2025 and 2027 had largely been issued before the recent interest-rate cycle. Its average yield was below two per cent. Replacement borrowing was likely to cost close to twice as much.^[3]

Britain, France, Spain and the United States were identified as particularly exposed. In each case, debt maturing by 2027 exceeded 15 per cent of GDP while the cost of issuing replacement debt was substantially higher than the cost of the bonds being redeemed.

Britain provides a particularly clear illustration. The cost of servicing the national debt rose from £39 billion in 2019–20 to £106 billion in 2024–25. The Office for Budget Responsibility (OBR) expects it to rise from approximately £110 billion in 2025–26 to £137 billion by 2030–31.^[5]

That is money that cannot simultaneously be spent on defence, healthcare, education, policing or energy infrastructure. The debt does not need to cause a formal crisis to reduce a government's freedom of action. The interest bill does that quietly.

The United States has more room because the dollar remains the principal reserve currency and US Treasury securities remain central to the global financial system. Nevertheless, the Congressional Budget Office (CBO) projects a federal deficit of $1.9 trillion in 2026 and debt held by the public rising from approximately 101 per cent of GDP in 2026 to 120 per cent in 2036. Rising interest expenditure is an important cause of that deterioration.^[6]

Growth: The Most Attractive Escape

Economic growth is the least painful and most politically attractive solution.

A government does not necessarily need to reduce the cash value of its debt. If nominal GDP grows faster than the debt, the debt-to-GDP ratio falls. This is how a liability can become more manageable without ever being repaid.

The critical relationship is between the rate of economic growth and the effective interest rate paid on government debt. If the economy grows more quickly than the cost of servicing the debt, the burden can decline—provided the government is not continually adding large primary deficits before interest costs.

This is why the quality of government spending matters. Debt used to increase energy supply, productivity, housing, transport capacity and technological development can support the growth required to service it. Debt used solely to sustain current consumption produces no equivalent future income.

The artificial intelligence (AI) capital-expenditure cycle offers an opportunity, particularly for the United States. Investment in semiconductors, data centres, power generation, networks and software could raise productivity and create new sources of taxable income.

However, AI investment cannot provide an escape if electricity is unavailable, infrastructure cannot be built, planning takes a decade and fiscal policy diverts capital towards politically convenient consumption. Britain's energy costs and planning system make this distinction particularly important.

Growth is the best solution, but governments cannot simply insert an optimistic growth assumption into a spreadsheet and declare the problem solved. Productive investment has to take place first.

Spending Restraint and Taxation

The conventional answer to excessive government debt is to reduce deficits through spending restraint, higher taxation or both.

In principle, this is straightforward. A government runs a primary surplus—raising more in revenue than it spends before interest—and uses that surplus to stabilise or reduce the debt burden.

In practice, it is extraordinarily difficult. Government expenditure is dominated by politically protected commitments: pensions, healthcare, welfare, defence and interest on the debt itself. Ageing populations make several of these commitments more expensive each year. Tax increases can raise revenue, but excessive taxation may discourage the investment and enterprise required to generate growth.

There is also a timing problem. Cutting public investment may improve the deficit today while weakening the economy tomorrow. A government that cancels power stations, roads and technology projects to meet a short-term fiscal rule may reduce borrowing but leave the debt less sustainable.

Fiscal restraint is unavoidable in many countries, but intelligent restraint must distinguish consumption from investment. Not every reduction in spending represents sound economics, just as not every increase represents productive investment.

Inflation: The Politically Convenient Default

Inflation reduces the real value of fixed-rate debt.

If a government borrows £100 and repays £100 after prices and wages have doubled, the lender receives the correct number of pounds but considerably less purchasing power. The debt has been honoured contractually while being partially defaulted upon economically. This is one reason governments have historically tolerated inflation after periods of exceptional borrowing. Inflation increases nominal GDP and tax revenues while reducing the real burden of older fixed-rate liabilities.

But inflation is neither painless nor easily controlled. Bond investors eventually demand higher yields as compensation. Workers demand higher wages. The currency may weaken. Confidence in government institutions deteriorates. If inflation becomes embedded, the cost of refinancing the debt rises and the apparent solution begins creating a new version of the original problem.

Britain is also less able to benefit from inflation than countries whose debt is almost entirely fixed in nominal terms. A significant portion of British government debt is index-linked, meaning that inflation directly increases the amount paid to bondholders. Quantitative easing (QE) created another sensitivity. The Bank of England bought mainly long-dated government bonds and paid for them by creating electronic reserves—deposits held by commercial banks at the Bank of England. The Bank of England pays Bank Rate on those reserves. In effect, QE exchanged a large amount of longer-term, fixed-rate government debt for a liability whose interest cost resets immediately whenever Bank Rate changes. When Bank Rate was close to zero, that refinancing appeared cheap. When Bank Rate rose, the cost to the consolidated public sector rose with it.^[10]

Inflation can still reduce parts of the debt burden, but Britain pays an unusually immediate price for employing it.

Financial Repression

Financial repression is the solution governments are least likely to describe honestly.

It involves arranging the financial system so that domestic savings are directed towards government debt at interest rates below inflation or below those that would prevail in a genuinely free market.

Banks can be required to hold more government bonds as liquid assets. Pension funds and insurance companies can be encouraged—or compelled—to maintain larger holdings. Regulators can make sovereign debt appear particularly attractive by assigning it preferential capital treatment. Central banks can suppress bond yields through asset purchases or yield-curve control. Capital controls can make it more difficult for savers to escape.

The policy is normally presented as prudence, stability, liquidity management or protection of the financial system. The effect is to create a captive audience for government borrowing.

Carmen Reinhart and M. Belen Sbrancia documented how financial repression, combined with inflation, helped reduce the enormous public debts accumulated during the Second World War. Interest-rate ceilings, capital restrictions and regulated financial institutions produced negative real returns for savers and transferred wealth to governments over an extended period.^[7]

It worked. But it was not free. The debt was effectively paid through lower returns on bank deposits, pensions and government bonds. The transfer was less visible than a tax increase and less dramatic than a default, which is precisely why it was politically useful.

Governments facing enormous refinancing requirements will find the pools of capital controlled by banks, pension funds and insurance companies increasingly difficult to ignore.

Yield-Curve Control and Central-Bank Independence

Yield-curve control (YCC) is an explicit form of financial repression. A central bank announces that government bond yields will not be allowed to rise above a particular level and creates money to buy whatever quantity of bonds is necessary to enforce that ceiling.

Japan has already conducted a prolonged experiment with this approach. It can prevent an immediate debt crisis and keep government financing costs below the rate the market might otherwise demand. But it risks weakening the currency, encouraging inflation and blurring the distinction between monetary policy and government financing.

The appointment of Kevin Warsh as Chair of the Federal Reserve in May 2026 makes the relationship between monetary and fiscal policy particularly important.^[8] Treasury Secretary Scott Bessent previously served as Chief Investment Officer of Soros Fund Management, while Warsh later worked at Stanley Druckenmiller's Duquesne Family Office. They did not work together at Soros in the manner sometimes suggested, although both are closely connected to Druckenmiller's investment world.^[9]

Their challenge is formidable. The Treasury needs an enormous and dependable market for government debt. The Federal Reserve is supposed to control inflation and maintain monetary credibility. Those objectives can conflict when higher interest rates threaten the government's finances.

Central-bank independence matters most when it becomes inconvenient.

Default and Restructuring

Countries that borrow in foreign currencies or lose access to capital markets may have no choice but to restructure.

This can involve extending maturities, reducing interest payments or imposing an outright reduction in the value of the debt. Creditors lose money immediately rather than gradually through inflation.

Default is traumatic, but sometimes it recognises a reality that repeated rescue packages merely postpone. Unsustainable debt cannot be made sustainable through optimistic forecasts and creative accounting.

For heavily indebted developing economies, restructuring may need to involve private creditors, multilateral institutions and sovereign lenders such as China. Coordinating those parties is difficult because each wants somebody else to absorb the loss.

Developed countries issuing debt in their own currencies are more likely to choose inflation and repression than formal default. The economic distinction may be smaller than the legal terminology suggests.

Who Will Continue Buying the Debt?

Every government liability is somebody else's asset.

Government bonds are owned by pension funds, insurance companies, banks, investment funds, central banks, households and foreign reserve managers. They are used as collateral throughout the financial system and are treated as the foundation upon which many other assets are priced.

This creates both strength and vulnerability. There is a structural demand for safe, liquid government debt. But there is no guarantee that investors will absorb an unlimited supply at the yield governments would prefer to pay.

The combined sovereign and corporate bond market reached approximately $109 trillion in 2025. Outstanding sovereign bond debt alone stood at a record $61 trillion. Governments and corporations are expected to borrow approximately $29 trillion from markets in 2026.^[3]

At the same time, central banks are no longer the indiscriminate buyers they were during quantitative easing. More of the debt must therefore be absorbed by investors who care about price, inflation, currency risk and fiscal credibility.

Governments may discover that there is always a buyer—but not necessarily at an affordable interest rate.

There Is No Single Global Solution

Japan can rely heavily upon domestic institutions and its own central bank, although this risks further currency weakness.

The United States benefits from the dollar and the unrivalled depth of its Treasury market, but persistent deficits may eventually test the privilege it has been granted.

Britain has control of its currency but suffers from weak productivity growth, substantial index-linked debt and unusually high sensitivity to interest rates and inflation.

The eurozone has the European Central Bank, but no single national treasury standing behind every member state. Common EU debt instruments have created new shared assets, but have not eliminated the fiscal differences between Germany, France, Italy and the rest of the union.

China has substantial control over its banks, capital account and domestic savings. This gives Beijing more capacity to direct credit and restructure liabilities behind closed doors, but it also makes the true allocation of losses more difficult to observe.

Emerging economies with dollar liabilities have the least flexibility of all.

There will therefore be no coordinated moment when the world 'solves' its debt problem. Each country will select a different mixture of growth, taxation, restraint, inflation, repression and restructuring.

What Happens Next?

The easy-money era encouraged governments to believe that debt was almost free. Interest rates were close to zero, central banks bought government bonds and every crisis produced another round of quantitative easing.

That period has stalled.

The world now requires enormous investment in energy, defence, AI infrastructure and ageing populations at precisely the moment when the cost of capital has risen and the existing debt stock must be refinanced.

This does not mean that an immediate global debt crisis is inevitable. Debt crises often develop slowly. They appear first through higher taxes, weaker currencies, reduced public services, disappointing investment returns and regulations directing private savings towards public borrowing.

Governments will escape the debt trap only if they restore growth and distinguish productive investment from political consumption. Where they fail, they will resort to inflation and financial repression while insisting that both are necessary to protect economic stability.

The debt will ultimately be paid.

The unresolved question is who will pay it—and whether they will be told that they are doing so.