Felix Nikolas Prehn on Impact Theory: Debt and Inflation

The bond market has stopped following its usual pattern. Felix Nikolas Prehn noted that investors no longer move into government bonds for safety when economic data weakens. Long-term yields have instead been climbing. He attributed this to bond participants losing confidence in the fiscal trajectory of the United States, where federal debt has reached roughly forty trillion dollars.

Felix Nikolas Prehn described a feedback loop between debt and interest costs. He observed that annual interest payments on federal debt had already reached approximately 1,400 billion dollars. Higher yields raise that bill further, making the debt harder to service. He argued that the deficit, running at about two trillion dollars a year, cannot plausibly be closed through taxation or spending cuts because neither is politically survivable.

The discussion turned to how the Treasury has responded. Felix Nikolas Prehn said the government has been buying its own long-dated debt, funding those purchases by issuing short-term obligations that the Federal Reserve then absorbs. He called this money printing under a different label. He compared it to the quantitative easing deployed during the pandemic, which officials at the time said would not cause inflation but did.

Japan served as a detailed reference case throughout the conversation. Felix Nikolas Prehn noted that Japan has run a similar programme since the early 1990s, accumulating debt exceeding 230 per cent of GDP. Its central bank and domestic institutions now own most of that debt. He said Japan had recently generated enough inflation to begin shrinking its debt relative to the size of its economy. He argued this is the only mechanism any country has used to escape such a burden. The method involves allowing inflation to run above the interest rate so that nominal growth gradually outpaces the outstanding obligations.

Felix Nikolas Prehn suggested that the United States is following the same approach. He pointed to the Genius Act, a stablecoin regulation requiring dollar-backed tokens to be invested in US government debt. He noted that Tether alone had already become the seventeenth-largest owner of Treasury securities. The legislation, in his view, creates compulsory domestic demand for government bonds without drawing attention.

He also discussed the yen carry trade, a strategy in which funds borrow cheaply in one currency and invest the proceeds in higher-yielding assets elsewhere. For roughly two decades, funds have borrowed yen at near-zero rates and invested the proceeds in dollar assets, often with leverage of ten to forty times. A strengthening yen forces those positions to unwind, potentially triggering rapid selling of US stocks and bonds. Felix Nikolas Prehn said Treasury Secretary Bessent's reported willingness to buy yen was less about helping Japan than about preventing a disorderly collapse of that trade.

On inflation measurement, Felix Nikolas Prehn offered an unconventional view. He said he regards official consumer-price indices as understating the true erosion of purchasing power. He proposed using the stock market as a rough proxy. He estimated that perhaps eighty per cent of equity gains over the preceding three years reflected monetary expansion rather than genuine productivity growth. He cited the decline of the 1971 dollar to seven cents of purchasing power as evidence of the cumulative toll.

Felix Nikolas Prehn argued that uninvested cash loses value in an inflationary regime. He said he favours uncorrelated asset classes over concentration in technology shares. He noted that the S&P 500 itself had become roughly half exposed to the artificial-intelligence sector. He mentioned gold as an insurance policy rather than a growth investment. He cited toll-booth businesses such as payment networks as examples of enterprises whose revenues rise mechanically with the money supply.

He said governments will continue to expand the money supply because every alternative is politically unacceptable. Austerity, he said, would tip the economy into recession, while higher taxes would push capital abroad, and an outright default is not something any administration would contemplate. The cost, he argued, falls on wages and on savings, eroding purchasing power without any formal tax announcement.