This is the most likely outcome in my opinion.
Inflation makes debts smaller so long as those debts are denominated in domestic currency. What you say about third world countries is only true because their debt is denominated in foreign currencies. So when all those US dollars are repatriated, we should see huge inflation which will wreck the economy but existing debt will be a lot easier to pay. Nobody will lend us more money though.
Again, what you're not getting is that China, Japan, Hong Kong, Taiwan...etc, have NO CHOICE but to lend us more money. Their entire economy is based on exporting to us and them running a current account surplus as a result. The natural outcome of this is that we run a current account deficit. The natural outcome of that is that they accumulate dollars, but also have to issue their own currency in the correct proportion to maintain the FX rate they want.
Numerically speaking, here is how it works.
US Consumer buys $100 worth of goods, Chinese manufactuer sells 800 Yuan worth of goods. Chinese manufacturer (government) gets $100 and turns around and buys $25 worth of US goods (200 Yuan). They are left with $75 USD (600 Yuan). What do they do with this money?
Since there's more dollars than created from the trade, the natural effect would be for the USD to depreciate vs Yuan and the Yuan to raise. This would be what would happen once the Chinese sell the USD into the market to buy other goods with their surplus. However, doing so would further depreciate the USD. The only choice they have is to keep the $75 and invest it in USD assets. If they don't then their goods become unattractive to US consumers (b/c currency appreciates) and they lose the export business.
They can do this in 2 main ways, acquire financial assets (treasuries or other debt) or acquire hard assets. Unfortunately, Japan learned the hard asset lesson, so China buys debt. All other countries that have a trade surplus with the US have the same issue.
The second issue is how to keep the correct proportion of Yuan/USD in place? Since they "import" USD, the FX rate internally must stay the same, otherwise they'll have tons of dollars and fewer Yuan (relatively speaking). Thus, they must print Yuan to keep the correct ratio in place. So, for every USD they acquire they must print 8 Yuan. This is the main reason why Chinese inflation is far higher than US inflation.
So you have two issues here. The world is piggybacking their economies on the US (Because we like to play "fair") and, as a result, the world HAS to acquire USD assets. They wont acquire USD hard assets, otherwise once the US economy takes off from raising asset prices (from the acquisition), they'll get screwed. So they HAVE to keep buying debt.
If they don't, then their entire economies fall apart. We can, effectively, keep this up in perpetuity as long as they want to keep their economies afloat. We can rack up $200TR in debt and pay interest with debt and it still won't matter. They *HAVE* to keep it up, otherwise they crash.
People say the US is manipulating the world's financial markets. However, it is the world that is manipulating the US' economy and debt volume. The Fed is fighting back against that.
Now, imagine if we had no central bank. Gold backed currency couldn't deal with people manipulating the currency outside of a "free market". Our economy would be toast.
The "free market" only works as long as *EVERY* country has a free market and nobody games the system. Unfortunately, this isn't Star Trek or utopia.
