The United States is approaching a milestone that feels like a breaking point. The national debt has passed $39 trillion, and as it approaches the big 40, the math is becoming impossible to ignore.

Billionaire investor Jeffrey Gundlach—often dubbed "The Bond King"—believes the real issue isn't just how much debt exists, but when the system stops functioning.

In a recent interview with Julia La Roche, Gundlach made it clear that the old playbook is no longer in play.

"We are no longer in a secular declining interest rate environment," he said, signaling the end of a 40-year tailwind that made debt manageable.

At the same time, the U.S. is running roughly $2 trillion annual deficits, while interest costs have exploded from $300 billion to $1.4 trillion per year. That combination, Gundlach bluntly states, is "untenable." The implication is that something has to give.

Inflation As a Tool

One path forward is as old as the postwar era—currency debasement. This strategy aims to repay debt in cheaper dollars through inflation.

After World War II, the U.S. used this exact approach, holding interest rates artificially low while inflation ran higher. The result was deeply negative real interest rates, which quietly eroded the real value of debt over decades.

A modern version of this approach would likely involve similar "financial repression"—keeping borrowing costs contained while allowing inflation to do the heavy lifting.

Yet, the consequences would be significant. Gundlach warns that such a path would likely usher in a long-term bear market in bonds and structurally higher nominal yields. Investors, he argues, should already be adapting.

"American investors… should be 100% non-US stocks," he said, pointing to the need to hedge against potential dollar weakness.

A Soft Landing Default

The alternative is far more radical. A "soft default." Rather than missing payments outright, the government could change the rules.

Gundlach's idea is that policymakers might "extend the maturity and reduce the coupon" on Treasury bonds, effectively restructuring the debt. He even suggested a scenario where the average coupon, currently around 3.8%, could be slashed to 1%, cutting interest expenses by roughly 75%.

"We're going to just cut the coupon on the treasuries so that we can reduce our interest expense," he said. The logic is simple, if unsettling. If interest costs approach $2 trillion annually, "that's really going to be untenable."

There are other variations of this idea, including the possibility of imposing taxes on Treasury interest payments, particularly for foreign investors. While politically explosive, such measures would function similarly by reducing the government's net payout.

But the cost would be immense. Markets would likely view it as a default in all but name, shattering trust in U.S. credit for generations. Still, Gundlach is clear that investors underestimate how far policymakers might go.

"Rules can be changed," he noted, pointing to past moments when supposedly fixed constraints were quickly rewritten under pressure. From mortgage modifications after 2008 to emergency bond-buying programs, nothing is truly off-limits in a crisis.

For that reason, Gundlach is playing defense. He has reduced risk across portfolios and even shifted Treasury holdings toward the lowest coupons to minimize exposure to potential restructuring.

"Don't take any risks if you're not getting paid," he said, reiterating a principle that feels increasingly relevant in today's environment.

Price Watch: iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) is down 0.28% year-to-date.