The Tip of the Spear
Last week, HAI argued that new Fed Chairman Kevin Warsh and the FOMC are firmly caught between a rock and a hard place. In short, that’s because, in HAI’s view, the United States has firmly reached a state of “fiscal dominance,” an economic condition where the government’s massive debt and budget deficits force the central bank (regardless of whether they want to admit it or not) to prioritize government financing needs over controlling inflation.
This week, the latest Treasury Borrowing Advisory Committee (TBAC) report re-confirmed the increasingly precarious nature of the U.S. fiscal position, and, by extension, strongly argued that the U.S. is indeed in the iron grip of fiscal dominance.
According to the TBAC, the U.S. Government officially posted its largest July budget deficit in history (negative $432 billion), while interest expense on the U.S. debt was up $26 billion from last July’s levels to an alarming $118 billion for the month.
Not only does the U.S. government now spend more money on interest than it does on Medicare spending for seniors or even to fund the entire U.S. Military, but currently the combination of Gross Interest, Entitlements, and Veterans Benefits alone are 106% of U.S. tax receipts through the fiscal third quarter of 2026. What’s worse, this accelerating shortfall comes amid history’s greatest capital expenditure boom (AI related) outside of recession, and while the major U.S. stock indexes are at/near all-time highs.
In other words, if Kevin Warsh (amid fiscal dominance) is going to raise rates to squash inflation back down to the Fed’s two percent target, he’ll have to sacrifice the bond market, the stock market, the economy, and the government fiscal position to do it.
By contrast, for a government in fiscal dominance, what’s really required is higher inflation (which keeps tax receipts up and inflates away the value of obligations) along with some form of yield curve control (repressing the bond market) to create deeply negative real yields.
This is why the last several weeks have been so fundamentally important for the “debasement trade” and establishing a potential bottom to gold’s recent correction. As Warsh talks tough but doesn’t actually raise rates to fight inflation, Bessent moves closer towards some form of yield curve control.
In other words, if market participants are starting to pay attention to what policymakers do over what they say, then over the last several weeks those market participants are watching fiscal dominance policy reality emerge from the fanciful rhetorical narrative.
Indeed, if this week’s Bloomberg article titled “Wall Street sees sign of bond market angst behind Bessent moves” is any indication, it does appear market participants are beginning to pay attention.
According to Bloomberg:
Wall Street traders and strategists say US Treasury Secretary Scott Bessent is sending fresh signals that he’s eager to keep bond yields from spiking higher. First, he staged the US’s first currency intervention to prop up the yen since 1998, mitigating the risk that Japan would dump US government bonds to raise the dollars needed to buy the currency on its own. And he pointed to a Federal Reserve facility that Tokyo could tap in the future. Then at last week’s quarterly bond sales announcement, a subtle and unexpected change to his department’s guidance was seen as opening the door to potential cuts in long-bond sales. “The Fed and the Treasury have to be getting concerned about the level of long-end rates,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “The intervention with Japan, support for Warsh and a possible reduction in long-end supply can be attempts for Treasury to signal that they are aware of the rate-market move and do not hesitate to use the different tools at their disposal.”
In a Financial Times Op-Ed titled, “The real message in the JPY intervention,” famed UC Berkley economics professor Barry Eichengreen also offered his interpretation of what policymakers are doing. As Eichengreen put it:
The bottom line is that Washington, fearing the consequences for US financial markets, is reluctant to see foreign central banks use their dollar reserves. This is telling us that the dollar is not the attractive reserve currency it once was. When this message sinks in, other countries will redouble their search for more attractive, readily usable alternatives. Reserve diversification is apt to gather steam.
Then this week the Telegraph published an article titled, “The ingredients are coming together for a US financial crisis.” According to the article, “A dangerous view is creeping into the markets that the US has already gone so far down the path of a debt compound trap that it dare not raise interest rates to control inflation.” As a consequence, the article warns that we could be approaching “a disaster as markets lose faith in Washington’s economic management.”
As fiscal dominance policy reality (let inflation run hot and cap yields) begins to overshadow the comforting but fanciful rhetorical Fed narrative (Warsh will deliver price stability above all other considerations), an increasing number of market participants seem to be catching on.
In short, in HAI’s view, as fiscal dominance asserts itself as the new policy reality, the debasement trade will similarly assert itself as the trade of the decade. And as market participants increasingly react to the fact that debasement is the path out of fiscal dominance, gold will reassert itself as the tip of the debasement trade spear.
Weekly performance: The S&P 500 was up 0.36%. Gold was up 0.73%, silver gained 1.79%, platinum was off 0.13%, and palladium was down 4.50%. The HUI gold miners index gained 1.91%. The IFRA iShares US Infrastructure ETF was up 1.16%. Energy commodities were volatile and up on the week. WTI crude oil was up 5.35%, while natural gas was up 2.01%. The CRB Commodity Index was up 2.78%. Copper was up 0.37%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 0.81%. The Vanguard Utilities ETF was up 1.52%. The dollar index was nearly flat, up 0.03% to close the week at 99.64. The yield on the 10-yr U.S. Treasury was up 4 bps on the week, closing at 4.69%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
