Global Debt Markets: The Real Crisis Behind the Headlines

Recent shifts in debt yields have surprised many market participants, prompting questions not only about tariffs but also the broader health of the global economy. While supply chain commentary will be covered in the upcoming SKILLSOOP Monthly Report (June edition), this update will focus on the deeper systemic issue at hand—one that tariffs merely distract from: the escalating risks in the global debt and banking systems.

The long end of the yield curve is under significant pressure. In the United States, the 30-year Treasury yield is nearing 5%, while the 10-year is approaching 4.5%. Across the Atlantic, the UK 10-year yield sits close to 4.7%, with the 30-year touching 5.42%. These elevated levels are not isolated phenomena—they reflect widespread stress in sovereign debt markets.

One of the most alarming signals comes from Japan. With a staggering debt-to-GDP ratio of 260%, a shrinking population, and ongoing currency challenges, Japan’s 10-year yield has crept up to nearly 1.5%, with the 30-year nearing 3%. This is particularly significant given Japan’s pivotal role in global finance through the yen carry trade. The Bank of Japan (BOJ) is now caught in an impossible position: defend the economy or defend the currency—each choice comes with deep global repercussions.

In the U.S., former President Trump has pushed aggressively for lower rates, clashing with Fed Chair Jerome Powell, who has resisted calls to cut. Cutting rates would imply an increase in bond prices—something the current market dynamics don’t support. The Fed has quietly re-entered the bond market through quantitative easing (QE), trying to suppress yields, but the effort appears increasingly ineffective.

Japan, for its part, has publicly acknowledged that its debt situation may now be worse than the crisis that engulfed Greece a decade ago. With such levels of fiscal vulnerability, any shift in bond market confidence could trigger cascading effects throughout the global financial system.

Much of the media attention has focused on tariffs, but they are only one piece of a larger inflation management puzzle. Energy prices—central to all inflation metrics—have become a focal point of U.S. foreign policy. Trump’s visit to the Middle East is as much about securing energy flows as it is about diplomatic negotiations.

Meanwhile, Saudi Arabia is increasing oil supply while tariffs restrict supply chains, dampening demand. The aim is to lower the Consumer Price Index (CPI) and justify interest rate cuts. However, these interventions are not succeeding in capping long-term yields, as SKILLSOOP has long forecasted.

Rising long-term yields spell trouble for consumers and asset markets. Leverage becomes more expensive, impacting sectors like housing and auto loans. More critically, equities markets—which rely heavily on low borrowing costs—face devaluation risks.

In a low-interest-rate environment, companies have used cheap debt to finance dividends, share buybacks, and expansion. But as borrowing costs rise and central banks lose control of long-end yields, equities will lose their appeal. This directly erodes consumer wealth and disposable income.

In Australia, the government’s move to tax unrealised capital gains on superannuation funds exceeding $3 million could have significant knock-on effects. While aimed at increasing revenue, this policy risks backfiring:

• Investors may shift funds from equities into property or offshore vehicles, draining capital from domestic businesses.
• Higher property investment could inflate housing prices further, worsening affordability.
• Lower private sector investment will likely impact employment and tax revenues, compounding the budgetary shortfall.

This highlights a classic case of excess burden—where the cost of taxation outweighs the revenue it generates due to changes in economic behaviour. Efficient taxation relies on targeting less elastic sources of revenue—those that don’t prompt significant behavioural shifts. The current approach risks triggering the opposite effect.

While tariffs and CPI figures dominate the headlines, the real structural risk lies in the global debt markets and central banks’ waning control over long-term yields. Investors, policymakers, and consumers should prepare for a prolonged period of volatility. The yield curve is not just reacting to inflation—it’s flashing warning signs about the very foundation of the global financial system.

So How Do Banks Really Work?

The mainstream understanding of how banks operate is deeply flawed—and according to economist Richard Werner, it’s not by accident. As the author of Princes of the Yen and the originator of quantitative easing (QE), Werner has extensively challenged conventional economic thinking, and the dominant role central banks play in shaping monetary policy. His work offers a critical perspective on the inner workings of the global banking system and its influence on economic outcomes.

The Great Misunderstanding: What Most People Get Wrong

Surveys and research indicate that around 85% of people do not understand how banks actually work. The common belief is that banks function by taking in customer deposits, keeping them safe, and lending them out at a profit. This model suggests a simple intermediation function between savers and borrowers.

But Werner’s research reveals something entirely different.

Retail banks don’t lend out deposits—they create money by issuing credit.

According to English law, a deposit at a bank is not held in custody but rather becomes a liability on the bank’s balance sheet—a record of what the bank owes you. When banks issue loans, they simultaneously create deposits, effectively generating money “out of thin air.” In Werner’s view, credit creation is the single most powerful force in the economy, yet it’s often overlooked in macroeconomic models.

Who Actually Creates Money?

• Central banks account for only about 5% of the total money supply.
• Retail banks create the remaining 95% through the process of credit creation.
• Governments, contrary to popular belief, create virtually zero money directly.

This means that when politicians talk about new spending or investment programs, they are relying on either debt or taxation, not newly created money. These decisions can have profound implications for economic behaviour and capital allocation.

Why Credit Allocation Matters

Werner argues that how and where banks allocate credit is more important than headline monetary or fiscal policy. For example:

• When banks direct credit towards productive investment (e.g., small businesses, infrastructure, innovation), economies experience real growth.
• When banks channel credit into financial assets (e.g., property, stocks, hedge funds), it fuels asset bubbles and ultimately leads to economic busts.

In the UK, five large banks dominate about 80% of all deposits. Their lending tends to favour institutions and asset speculation, not small businesses. Werner promotes the decentralisation of banking, arguing that small, community-based banks are far more effective at funding real economic activity.

Decentralised credit creation = sustainable, inclusive growth.

The Truth About QE and Inflation

Werner also explains why quantitative easing (QE) often has unpredictable effects on inflation and growth. His distinction between two types of QE is crucial:

• QE1: Central banks purchase non-performing assets from banks to clean up their balance sheets. This is largely non-inflationary as it is an interbank transaction and does not inject money into the real economy.
• QE2: Central banks purchase assets from non-banks (open market operations), which does create credit in the real economy and can be inflationary.

In 2008, QE1 helped stabilise U.S. banks after the financial crisis. However, in 2020, the Federal Reserve moved directly to QE2—buying assets via BlackRock from non-banks at a time when demand was already high and supply chains were broken. This approach, Werner argues, artificially fuelled inflation during a time of global fragility.

Rethinking Interest Rates and Growth

Mainstream economics teaches that lower interest rates stimulate growth, and higher rates dampen it. Werner contests this idea:

• He claims no empirical studies support the inverse relationship between interest rates and GDP growth.
• Instead, he asserts that interest rates follow growth—not the other way around.
• In periods of high growth, interest rates rise as a response.
• In periods of low growth, rates fall—but they do not cause the recovery.

Thus, interest rates are lagging indicators, not effective tools for managing real-time economic dynamics.

The Problem with GDP and Centralised Power

Werner also challenges the usefulness of GDP as an economic measure, calling it “economic waffle”—a concept created to justify interest rate mechanisms. He views it as disconnected from real economic activity and overly influenced by banking interests.

Moreover, central banks and large financial institutions have, in Werner’s view, orchestrated a long-term strategy to consolidate power, crush small banks, and centralise money creation. This is seen in the economic contraction of countries like Germany, now in its third consecutive year of decline, and the financial devastation experienced by Greece, Spain, and Portugal after policy missteps from 2004 to 2009 under ECB influence.

Why This Matters for Today’s Economy

Understanding the real mechanics of banking matters because credit creation—and who controls it—shapes every facet of economic life: investment, employment, housing, inflation, and even political stability.

Werner warns that without a paradigm shift in economic thinking—one that puts banking at the centre of macroeconomic models—governments and central banks will continue to misdiagnose crises, apply ineffective solutions, and fuel a cycle of bubbles, busts, and inequality.

Key Takeaways

• Retail banks create most of the money supply through credit.
• Deposits are liabilities, not funds waiting to be lent.
• Productive credit allocation supports sustainable growth; speculative lending inflates bubbles.
• QE has two forms, only one of which impacts inflation directly.
• Interest rates are lagging, not leading, indicators of growth.
• A return to decentralised banking—thousands of small local banks—can drive equitable economic expansion.
• The current system increasingly centralises power, risks systemic collapse, and stifles long-term growth.

This understanding redefines the way we should view banks—not as neutral intermediaries, but as powerful engines of monetary creation whose decisions shape the very fabric of modern economies.