The End of Easy Money? Reflections on El-Erian's Warning

Mohamed El-Erian, Practice Professor at the Wharton School, Chief Economic Advisor at Allianz, and Chair of Gramercy Funds Management, recently argued in the Financial Times that the surge in European government bond yields is largely an imported shock from US economic volatility. He warned that European governments cannot simply wait for the US economy to stabilize, as an American slowdown could trigger a broader hard landing with severe consequences for Europe. Crucially, El-Erian emphasized that the era of an “artificially suppressed global rate environment is over.”

That statement underscores, in my view, a profound structural inflection point in global macroeconomics. For nearly fifteen years following the 2008 Great Financial Crisis (GFC), major central banks suppressed policy rates near zero (so-called Zero Interest Rate Policy, or ZIRP) and expanded balance sheets through large-scale asset purchases (Quantitative Easing). ZIRP resulted in anchoring the front end of the yield curve, thus lowering short-term borrowing costs for banks, businesses, and consumers. And by purchasing trillions of dollars of long-duration US Treasury bonds and Mortgage-Backed Securities (MBS), central banks aimed to lower the mid-to-longer end of the yield curve by absorbing duration risk (the price sensitivity of bonds to changes in interest rates) from private markets.

By compressing term premia (i.e., the extra compensation investors demand for bearing duration risk over time, rather than rolling over short-term debt) and flooding markets with liquidity, central banks successfully lowered the cost of capital across the sovereign and corporate yield spectrum.

To illustrate the scale of this liquidity expansion, let’s examine the Federal Reserve’s System Open Market Account (SOMA) holdings:

As can be seen, SOMA holdings stood at approximately $500 billion in 2008, peaked at about $8.5 trillion during the pandemic response, and remained around $6.5 trillion by late October 2026. While this balance sheet expansion anchored ultra-low interest rates throughout most of the 2010s, post-2022 macroeconomic realities – characterized by sticky inflation, elevated public debt issuance, and impediments to international flows due to trade barriers (real or perceived) – have structurally shifted the yield curve upward, as reflected in the behavior of the Federal Funds Effective Rate:

Conclusions:

Central banks no longer possess the unconstrained flexibility to slash rates or deploy massive asset purchases at the first sign of economic friction without risking the amplification of inflationary spirals. If El-Erian is correct, and I think he is, structurally higher baseline rates and elevated term premia are here to stay (until evidence emerges to the contrary). Policymakers everywhere, especially in Europe, must adapt by prioritizing productivity, fiscal discipline, and encouraging private investment rather than relying on central bank accommodation to mask underlying economic vulnerabilities. But, as I have stated in other posts, I remain highly skeptical that government officials will take the proper steps to mitigate this systemic risk. 

Is America Getting Less Growth From More Debt?

When we think about debt in an economy, the central question isn’t just how much debt we have, but rather how productive that debt actually is. To answer this, we looked at the Marginal Productivity of Debt (MPD).

What is MPD?

Marginal Productivity of Debt measures how many dollars of incremental economic growth (i.e., Gross Domestic Product, or GDP) are generated for every new dollar of net credit added to the economy over a given period. Mathematically, MPD is represented as follows:

Change in Nominal GDP ÷ Change in Net Debt

What this measure tells us: If, for example, MPD is +$0.75, it means that for every $1.00 of new borrowing, our annual economic output increased by $0.75. If, let’s say, MPD drops to +$0.35, the economy requires almost $3.00 of new borrowing just to generate that same $1.00 of growth (simply divide 1 over 0.35 to observe the precise value). As we can see, MPD is a direct temperature check, if you will, on the “bang for the buck” of credit expansion.

Data and Methodology

To build a clear, historical picture from 1952 through 2026, we pulled macroeconomic data directly from our favorite tool, the Federal Reserve Economic Data (FRED) database from the St. Louis Fed:

1. Economic Output Data Series (Numerator): “GDP” (Gross Domestic Product, Quarterly, Billions of Dollars)

2. Total Nonfinancial Debt Data Series (Denominator): “TCMDODNS” (Domestic Nonfinancial Sectors; Debt Securities and Loans; Liability, Level, Millions of U.S. Dollars). This captures borrowing by households, nonfinancial businesses, and federal/state governments, while stripping out financial sector intra-bank transactions to avoid double-counting.

3. Data Transformations Applied:

• Evaluated the 1-year trailing change (“change from Year Ago”) for both GDP and Debt to capture the rolling 12-month net expansion.
• Harmonized units by scaling debt from millions into billions using the formula: (∆GDP x 1000) ÷ ∆TCMDODNS 

Key Observations from 70+ Years of Data (1952-2026)

Let’s examine what the graph we generated shows (red circle and lines on the graph are my markings):

The 70-year shift in U.S. debt efficiency is stark, and the core takeaways from this analysis are as follows:

1950s – 1970s: High Efficiency Era (range from ~+$0.60 to ~+$0.85 per $1.00 of debt):

• Debt directly funded industrial capex, factory equipment, and physical infrastructure.

1980s – 2026: Financialization & Diminishing Returns Era (range from ~+$0.25 to ~+$0.40 per $1.00 of debt):

• Shift toward asset refinancing, real estate turnover, and servicing legacy debt overhang. 

1. The Structural Decline in Debt Efficiency is Real

Prior to the early 1980s, the U.S. economy routinely generated ~+$0.60 to ~+$0.85 in annual GDP for every $1.00 of net new debt issued outside of recessions. Starting in the early 1980s, this baseline experienced a persistent structural downward shift. For the past two decades (2000s through 2026), the baseline has hovered between ~+$0.25 to ~+$0.40. It now takes significantly more credit to generate the same unit of economic expansion.

2. Diminishing Marginal Returns to Credit

Why did this happen? Here we draw from our experience and understanding to come up with the likely culprits.

From Productive Capex to Asset Refinancing: In the post-war era, debt primarily funded tangible, capacity-expanding capital investments (e.g., manufacturing plants, highways, utility grids). Over the last four decades, an increasing share of borrowing shifted into real estate asset turnover, corporate financial engineering (e.g., share buybacks and M&A), and government deficit spending.

The Drag of Debt Overhang: As total accumulated debt expanded relative to GDP, a growing share of every newly borrowed dollar had to be spent simply servicing, rolling over, and refinancing existing debt rather than building new productive capacity.

3. Debt Does Not Prevent Recessions (Credit Cycle Vulnerabilities)

I like to think of this part as a double-edge sword, because debt is a powerful tool to amplify returns both on the way up and on the way down. You will see in a moment what I mean. Indeed, while credit is a powerful tool at pulling future demand into the present during expansionary periods, it does not immunize the economy from downturns:

• In every major recession – 1954, 1958, 1974, 1982, 1990, 2001, 2008, and 2020 – the MPD dropped sharply, dipping deep into negative territory (reaching ~-$0.40 during the Great Financial Crisis).
• Because debt creates fixed payment obligations while economic income fluctuates, high leverage actually amplifies downturns. When income contracts, borrowers are forced to slash spending, payroll, and investment to service their debt, turning mild slowdowns into sharper contractions. On this point, I think the so-called Austrian School of Economics has it mostly right in their view of the economic cycle, but that is a story for another day.

Conclusion:

Debt is a critical tool for economic growth, but it has its limits. The historical data from 1952 to 2026 shows that the U.S. economy is getting diminishing marginal output from each new dollar of credit, and accumulating more debt cannot eliminate the cyclical reality of recessions. Unless something structural occurs in the economy that improves the marginal output from each new dollar of credit, the U.S. will at some point find itself facing serious economic issues. We cannot indefinitely borrow ourselves to prosperity.

Global Public Debt: Why Governments Have Less Room for Error

Earlier this month (October 2026), the International Monetary Fund (IMF) published its yearly report, World Economic Outlook. It included a very interesting set of graphs relating to government finances:

Across the world, governments are facing a challenging fiscal environment. Global public debt remains near historic highs following major economic disruptions such as the COVID-19 pandemic. At the same time, higher interest rates, ongoing budget deficits, and a heavy reliance on short-term borrowing are making it substantially more expensive for nations to manage their debt.

The takeaway from recent IMF data is clear: While strong economic growth can help stabilize debt burdens over time, the combination of elevated debt levels and higher refinancing costs leaves governments with less room for error than in the previous decade.

Key Takeaways Explained Simply: Four Pressures

1. Debt Remains Near Record Highs

Historically, global public debt has surged after major crises and has tended to subside following periods of economic stabilization. Today, global public debt as a share of GDP sits around 100%, far higher than before the COVID pandemic.

2. Annual Deficits Are Still Wide

A government runs a “primary deficit” when its regular spending (excluding interest payments) exceeds its revenue from taxes. In most major economies, including the U.S., China, France, and the U.K., primary deficits from 2020 through 2025 have stayed wider than their pre-pendemic averages. Current government plans do not appear sufficient to reduce spending or increase revenues enough to prevent debt ratios from rising further.

3. Borrowing Costs Have Risen

During the 2010s, record-low interest rates made it cheap for governments to borrow. Over the past three years, real (inflation-adjusted) interest rates have risen substantially in the US, the UK, Europe, and Japan. This directly increases the interest expense taxpayers and governments must cover.

4. The Rollover Risk: Short-Term Debt Meets Higher Rates

A substantial portion of government debt has relatively short maturities. When these obligations mature, governments often refinance them by issuing new debt rather than repaying them outright. We call this process refinancing risk (also known as a rollover risk). Because these new bonds carry higher interest rates, debt servicing costs will continue to rise over the coming years. 

Why This Matters

When a government spends an increasing share of its budget on interest payments, it creates two major challenges:

• Crowding Out Priorities: Fewer resources remain available for public investments, healthcare, infrastructure, education, and national defence.
• Eroded Buffers (“Fiscal Space”): In a healthy economy, governments keep debt manageable so they can step in with support during emergencies (e.g., recessions, health crises, or geopolitical events). With debt already stretched thin, the room to maneuver during the next downturn is significantly constrained.

Conclusion

The IMF data highlights a fragile equilibrium. Managing elevated debt levels while refinancing obligations at higher rates will require careful fiscal discipline. I remain highly skeptical that government officials will succeed. While it is impossible to predict the catalyst of the next financial crisis, elevated sovereign debt levels and shrinking fiscal space appear to be important vulnerabilities that deserve close attention. I may be overly concerned, but the data certainly reinforces that view.      

AI's Next Big Question: Will Future Cash Flows Justify Today's Investment Boom?

According to the Financial Times reporting,

"More than $9bn worth of CDS linked to bonds issued by Oracle, SpaceX, Alpha­bet, Amazon, Meta, Broad­com and Nvidia was traded on average each week in September, up from less than $2bn in July, accord­ing to Morgan Stanley Research. US cor­por­ate CDS index trading volumes this year have overtaken last year’s total, according to Bloomberg.

AI-linked debt issuance has rocketed with companies raising an estimated $466bn so far this year, up from $101bn in the same period in 2025, according to Morgan Stanley, to fund infrastructure such as data centres and chips.

Five-year Meta CDS has this month climbed to 108 basis points, meaning it costs $108,000 a year to insure $10mn of debt against default, while derivatives tied to Nvidia have climbed to 101bp. Protection against Alphabet and Amazon default is also at record highs.

Oracle’s CDS is now 322bp, up from 144bp at the start of the year. The five-year CDS tied to CoreWeave debt is trading at about 1,090bp, with demand so high that a buyer of $10mn of pro­tection would need to pay $1.82mn upfront."

My Take:

This is an interesting piece of information because it suggests that the broader market is becoming more aware of potential credit risks associated with the massive AI investment cycle. While increased CDS activity does not necessarily imply that defaults are imminent, it is an important data point because many financial crises have historically begun with credit events that later cascaded through the broader financial system.

Make no mistake, AI is here to stay. That is not the question. The FT article signals to me that investors are beginning to ask a question that has surfaced during many investment booms: Will the future cash flows generated by these enormous investments ultimately justify the amount of debt and capital being committed today?

Demystifying GDP: What 10 Years of Data Reveal About Spending, Investment, and Global Capital Flows

When news outlets report on economic health, GDP is almost always the start of the show. We often hear that it grew by 2% (we are richer) or that it shrank by 1% (we are poorer), treating it like a single national scorecard. Yet, beneath that single headline number lies a simple but helpful formula that helps explain how an economy functions, who is investing, and how a nation interacts with the rest of the world.

By looking at the GDP equation alongside a decade of data from the FRED database from 2016 to 2026, we can uncover an interesting story about modern economic life, including why a “negative” trade balance isn’t simply a loss, but a reflection of global capital flowing across borders.

The Anatomy of an Economy: The GDP Equation

At its core, GDP measures the total market value of all finished goods and services produced within a country over a specified time period. Economists commonly track GDP using the so-called expenditure approach, which breaks economic activity into four distinct buckets:

GDP = C + I + G + (X – M) 

Here is what each component represents:

• Consumer Spending (C): Everything households purchase.
• Business Investment (I): Capital to build future productive capacity.
• Government Spending (G): Spending by local, state, and federal government (excludes social service spending).
• Net Exports (X – M): What we sell to other nations minus what we purchase from abroad.

A Decade in Numbers: What the Data Shows (2016 – 2026)

Let’s examine the historical time series of the U.S. Real GDP (adjusted for inflation, measured in chained 2027 dollars) between 2016 and 2026:

Here is another view of the data:

Key Observations:

• The Consumer Remains the Engine: Consumer spending consistently makes up about 70% of total GDP.
• Investment and Government Share the Remaining Domestic Slice: These categories together account for approximately 35% of GDP.
• Net Exports Have Consistently Run Negatives: The Net Exports category has remained below zero across the entire 10-year span. The trade deficit expanded from approximately 3% of GDP in 2016 to 5% in 2026.

Demystifying the Minus Sign: Are Imports a “Drag” on GDP?

A persistent misconception in popular commentary is that because imports are subtracted from the Net Exports formula (X = M), running a trade deficit reduces or destroys economic growth. Let me give a simple example to show why that is not the case.

When an individual buys a $1,500 imported television, the full $1,500 is immediately added to Consumer Spending (‘C’). However, that television was produced abroad, not domestically. Because GDP only measures domestic production, the accounting system subtracts $1,500 under Imports (‘M’). Therefore, the calculation balances out: +$1,500 in C + -$1,500 in M = 0 (net change to GDP).

Subtracting imports is simply an arithmetic correction to ensure foreign-made goods counted in side C, I, and G are not falsely credited to domestic factories.

The Real Meaning of Negative Net Exports: Borrowing from the World

When an entire country buys more goods and services that it produces, it must finance the difference through capital inflows from abroad. This brings us to one of the most fundamental relationships in macroeconomics: the Saving-Investment Identity:

National Saving – Domestic Investment = Net Exports

When Net Exports are negative (a trade deficit), it directly implies that Domestic Investment > National Savings. This means that the country does not have enough domestic savings to fund all private investment and government borrowing; as a result, it must obtain capital from abroad. Foreign exporters who earn dollars selling goods do not simply stash those dollars away. Instead, they reinvest them back into the domestic economy (e.g. purchasing government and corporate debt, or acquiring productive assets).

Viewing trade through the lens of capital flows gives us a far more balanced perspective. Accessing global capital flows allows the U.S. to invest in capital at higher levels than domestic savings alone would support. However, persistent capital inflows (trade deficits) increase foreign claims on future domestic income, whether through interest payments on debt or dividends and asset returns sent to foreign owners.

Having said that, it is worth pointing out that whether a trade deficit is beneficial or harmful depends largely on how the associated foreign capital is used. Capital that finances productive investment can enhance future growth, while capital that primarily supports consumption or persistent fiscal deficits may create long-term vulnerabilities.

Furthermore, while the saving-investment identity shows that trade deficits are associated with domestic investment exceeding national saving, economists debate the direction of causation. Some emphasize insufficient savings, others point to attractive investment opportunities that draw foreign capital, and others focus on monetary conditions that encourage borrowing and spending.

Conclusion:

The GDP formula is more than an abstract equation; it is a live mirror of national economic choices. The past decade of data illustrates an economy anchored by high consumer spending and supported by investment levels that exceed domestic savings, something which has been made possible by a global financial system that continues to supply the necessary capital. A key systemic risk is the disorderly reduction in capital inflows without a concomitant increase in savings, which could lead to a severe economic contraction. This is no speculation. It is a possibility and something we should be mindful of.

Upstream Pressure, Downstream Reality: What the CPI vs. PPI Gap Means for Corporate Profits and the Economy

This past week we read about the headline Consumer Price Index (CPI) and how it compares to the Median CPI (read my post here). Here in this note, I will explain what the CPI says with respect to the Producers Price Index (PPI). The PPI tracks the wholesale selling prices received by domestic businesses.

Comparing the CPI and PPI provides a view into corporate profit margins, business pricing power, and the inflation pipeline. The latest economic data reveals a significant divergence: wholesale costs are rising much faster than retail prices (PPI at 6.3% vs. CPI at 3.7%). This gap points to an upstream supply shock that is currently squeezing corporate profit margins rather than fueling an economy-wide boom.

The Mechanics: What the CPI vs. PPI Relationship Tells Us

To understand how inflation moves through the economy, economists monitor the “spread” between what consumers pay and what producers receive as a rough proxy for the pressure on corporate margins:

Profit Margin Proxy Spread = CPI – PPI

When the CPI is greater than the PPI (Positive Spread):

• Consumer prices rise faster than wholesale input costs.
• Businesses have high pricing power and can easily pass on costs.
• Result: Corporate profit margins expand.

When the PPI is greater than the CPI (Negative Spread):

• Wholesale input costs rise faster than consumer prices.
• Businesses face resistance when attempting to pass higher costs on to consumers.
• Result: Corporate profit margins are squeezed.

While the CPI-PPI spread can provide insight into pricing power and margin pressure, it should not be viewed as a direct measure of corporate profitability. Labor costs, financing costs, productivity trends, and industry-specific factors also influence profit margins.

In addition to serving as a profit margin proxy, the PPI acts as an early-stage inflation pipeline: changes in wholesale costs often influence consumer prices with a lag, although the timing and magnitude vary considerably (some believe it often takes 3 to 6 months for them to filter into consumer prices). Although the CPI and PPI do not measure the same basket of products, the important observation is that they are directionally related.

What the Latest BLS PPI Report Shows

The latest release from the U.S. Bureau of Labor Statistics highlights a dramatic surge in upstream costs:

• Annual Surge: Over the last 12 months, the PPI for final demand jumped 6.3%, the fastest 12-month advance since December 2022.
• Monthly Acceleration: In September alone, the final demand prices increased 1.3%, the fastest 12-month advance since March 2022.
• The Energy Driver: Over 80% of the goods increase was driven by energy costs, which jumped 10.8% in a single month (led by a 20.3% spike in gasoline).
• Underlying Core Wholesale: Even after stripping out food, energy, and trade, core PPI rose 5% over the last year, indicating that wholesale cost pressures are broad across the industrial supply chain.

Interpreting the CPI vs. PPI Spread Chart

Courtesy of ZeroHedge, we obtained the following graph:

Let’s analyze the big picture of where we are in the economic cycle. When the CPI is greater than the PPI, you see a positive spread (green bars). When the PPI is greater than the CPI, you see a negative spread (red bars).

• 2015 – 2016: Strong corporate profit margin expansion (green bars, CPI > PPI)
• 2021 – 2022: Massive supply shock / corporate profit margin squeeze (deep red bars, CPI < PPI)
• 2023 – 2024: Corporate profit margin recovery (green bars, CPI > PPI)
• 2025 – Present: Sharp negative plunge to -2.6% (red bars, CPI < PPI)

Key Takeaway: The current deep red bars demonstrate that this is a classic supply/cost shock. Businesses are currently absorbing a substantial portion of higher wholesale energy and logistics costs rather than passing 100% of them immediately onto consumer price tags.

Conclusion

Federal Reserve monetary policy has a delicate balancing act to perform, because it cannot pump more oil or clear transport bottlenecks. Aggressive interest rate hikes to curb inflation could have the knock-on effect of choking off business investment and hiring, which will heighten recession risks. The risk is a type of self-fulfilling prophecy: in attempting to prevent inflation from becoming entrenched, the Federal Reserve may tighten financial conditions enough to contribute to the very recession it hopes to avoid. My view is that the Federal Reserve is likely to continue following its stated guidance and respond to persistent inflation pressures with additional gradual interest rate hikes.

If wholesale costs remain near 6.3% for multiple quarters, businesses will be tempted to eventually pass these higher costs through to consumers to protect corporate profit margins, which could push the CPI higher in 2027. 

Why an October Rate Hike Appears Increasingly Unlikely

According to the Financial Times reporting,

“Federal Reserve chair Kevin Warsh has signalled that hotter-than-anticipated inflation has not swayed his views on the US economy, prompting traders to further scale back bets on a rate rise this month…Bets on a rate increase climbed to as high as 55 per cent following stronger than expected US inflation figures on Wednesday before edging back. They fell further after Warsh’s comments, declining from around 27 per cent to around 15 per cent on Friday [October 16], according to Fed funds futures.”

In other words, it is highly unlikely that the Federal Reserve is going to hike rates at their next meeting on October 28. Although we are told that the Federal Reserve is independent, the fact is that, like all human beings, members of the Federal Reserve committee responsible for monetary policy are subject to influence. Barring a major economic surprise, I suspect that the proximity of the U.S. Congressional elections on November 4 reduces the likelihood of a rate increase at the October meeting. The last thing the Federal Reserve likely wants to do is draw attention to itself just days before an election, as its actions could be interpreted by some as favoring one group over another.

Having said that, I fully agree with Goldman Sachs’ economists that:

“’[a]longside other recent comments from FOMC participants, Warsh’s comments indicate that the FOMC is set to pause in October,’ economists at Goldman Sachs noted, adding they expect officials to raise rates at the Fed’s final meeting of the year in early December.”

In my view, the question is not whether rates will rise, but whether the Federal Reserve chooses to wait until after the election before taking further action. I think they will wait.