Hoping AI will grow the economy out of its debt burden is flawed. The massive investment required to boost GDP growth (G) competes for capital, inadvertently raising interest rates (R). In the short term, this can increase the debt service cost (the R-G spread), potentially worsening the debt spiral before any productivity gains are realized.

While current bond yields resemble pre-2008 historical norms, the fiscal landscape is radically different. Governments now carry much larger debt burdens from the pandemic and other spending. This makes the cost of servicing this debt at historically 'normal' rates a significant and unresolved challenge for the global economy, distinguishing this era from previous ones.

Economic models suggest a quantifiable link between government debt and interest rates. A one percentage point increase in the U.S. debt-to-GDP ratio is estimated to push the real neutral interest rate (R-star) up by a significant 3.5 basis points, signaling future pressure on yields.

Historically, surges in U.S. public debt have consistently led to periods of negative real interest rates. This suggests that the sheer weight of government debt creates a structural constraint, forcing markets to keep real rates capped, irrespective of short-term inflation or central bank policy.

Counterintuitively, the absolute size of the national debt has less impact on interest rates than the pace of its growth. As long as the debt expands at a rate within investor expectations, even a massive increase in the total amount—like the recent $9 trillion addition—may not significantly alter long-term Treasury yields.

While factors like Fed policy play a role, the fundamental cause of rising long-term interest rates is the massive and growing U.S. debt. It's a basic supply-and-demand issue: as more debt is issued, the price of borrowing (interest rates) must increase to attract enough buyers to absorb it.

The last time US debt-to-GDP was over 110% was after WWII, when the debt was halved in five years through real rates that hit -13%. Today's debt levels imply the same outcome is mathematically necessary, requiring years of significant inflation that will destroy the wealth of bondholders.

Among the five factors eroding AI's positive fiscal impact, a projected 35% rise in interest rates is mathematically the most significant. With US debt already at 100% of GDP, even small changes in borrowing costs have an enormous effect on the deficit, overwhelming other factors like defense spending or labor force changes.

Contrary to the popular narrative focusing on debt, the main force pushing interest rates up is robust nominal GDP growth, fueled by aggressive post-pandemic fiscal policy. This era of 'fiscal dominance' changes the fundamental drivers of the bond market.