Won’t Get Fooled Again
One of the laws of the Universe is that one who travels east with family to visit more family must eventually travel back west with family to return home. For this author and his family, the return trip has been a very rocky one, so HAI apologizes for the late Monday release. This week will be quick, so let’s get right to it.
Last week, HAI asserted that the United States has firmly reached a state of “fiscal dominance.” In other words, the government’s massive debt and budget deficits are forcing the central bank and Treasury Department (regardless of whether they want to admit it or not) to prioritize government financing needs over controlling inflation.
If true, that’s a supremely important crossing of the Rubicon for gold. In the previous secular regime (when the system was deemed healthy), rising inflation was seen as bearish for precious metals because inflation meant the Fed would hike rates, and yields on U.S. debt would rise. By extension, the opportunity cost of holding gold vs. Treasuries would become increasingly unattractive. As a result, rising inflation and rate hikes tended to be bearish for gold.
But what happens when inflation is an issue, and because we have too much debt and the system is no longer healthy the Fed can’t fight that inflation with rising rates? In that environment, when the Fed can’t adequately react to rising inflation, gold’s reaction to inflation is very different—it screams higher. In HAI‘s view, that’s the powerful gold bull market we’re quickly moving toward—a secular fundamental regime change toward gold, suddenly widely recognized.
Since late July, the fundamental case supporting the idea of a U.S. government caught in fiscal dominance (and all that comes with it) has been growing by the week. First, with inflation in its 65th consecutive month above target, we had the obvious contradiction at the July FOMC where Fed Chair Warsh continued to talk tough on inflation but opted not to fight it by raising rates. Then we had Treasury Secretary Scott Bessent intervene to strengthen the yen (weaken the dollar) for the first time in 28 years to keep the Japanese from having to sell U.S. Treasuries to defend their own currency—Treasury sales that would have added upward pressure to already surging long-term U.S. yields.
Now, most recently (Wednesday), Bessent announced his latest Treasury market intervention—that the U.S. Treasury Department will be “increasing, by at least double, the size of liquidity support buyback operations for longer-dated nominal coupon securities.” The official reason for the added support? The increase in buyback operation sizes “reflects Treasury’s desire to provide greater liquidity support in longer-dated nominal sectors…”
Bessent and Co. can leave it at “liquidity support,” but reality sings a far more interesting tune. HAI has long been predicting that yield curve control would be utilized in some form (at some point) as a means to slow building U.S. debt spiral dynamics.
In HAI‘s view, everything that’s happened since late July (very much including last week’s Treasury buyback news), strongly supports the notion that “some form of yield curve control” policy has already started, has left the station, and is likely to gain much more steam over time.
Functionally we are now effectively seeing a pattern of soft yield curve control—as policy—implemented by multiple Treasury Secretaries, over several years, by various means. In short, every time 10-year U.S. Treasury yields have reached about 4.7% over the last several years, the U.S. Treasury (or the Fed, or some Trump administration jawboning) has taken actions that effectively punched yields lower for a short time. That is “some form” of soft yield curve control (YCC) policy.
Importantly, however, that policy of soft YCC just became far more obvious for all to see. Furthermore, this week’s actions prompt market participants to ask the question, “what’s the problem, and what comes next?”
In HAI‘s view, the problem is that U.S. true interest expense (a combination of gross interest expense, entitlement spending, and veterans benefits spending) alone represents 106% of tax receipts, and that combined core expense is growing at 7.5% annually while tax receipts are only growing at 4% annually.
That’s “Houston, we have a problem” territory, especially when considering that that math is still the math even while the U.S. is not currently in recession, while it’s benefiting from the greatest cap-ex boom in history (AI related), and while major U.S. stock indexes are near all-time highs—meaning, the math doesn’t math even at record (exceptionally boosted) tax receipts.
Furthermore, it seems that over the last several weeks a realization has been dawning on markets that the new Bessent/Warsh dream team can’t normalize the combined inflation, debt, and deficit problem that likewise seemed to confound predecessors Yellen and Powell.
In short, market participants are now beginning to echo rock band The Who in their 1971 song “Won’t Get Fooled Again.” As the song put it, “Meet the new boss, same as the old boss.”
In other words, it seems as if markets—suddenly attuned to what policymakers do over what they say—are quickly beginning to see that we are likely only at the start of a secular “run it hot and cap yields” (fiscal dominance) policy with secular dollar weakness necessarily written all over it.
That means, the “debasement trade” is suddenly back, and is the belle of the ball all over again—especially now that Bessent/Warsh have now scorned many of their most dedicated believers.
As Robin Brooks, Senior Fellow at the Brookings Institute and former Chief FX Strategist at Goldman Sachs, put it according to Bloomberg last week, “Markets are primed for dollar debasement to resume and—as Japan shows—it can be next to impossible to stabilize a currency once it enters a devaluation spiral… The US is playing with fire with this buyback.”
In HAI‘s view, the big news wasn’t the amount of the upsizing, but the upsizing announcement itself. This upsizing of the U.S. Treasury buyback program is, in HAI‘s view, ultimately likely to be just the tip of the iceberg of what will eventually have to be a much bigger program.
So, in short, this was a very eventful week, but one that just confirmed HAI‘s closing remarks from a week ago: 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.
We appear to be rapidly approaching the point where market participants won’t get fooled again because they increasingly see that (given the brutal combination of inflation plus broken fiscal math), despite what they say, policy reality is meet the new boss, same as the old boss—meaning there is no consequence-free righting of the ship. There is only the purposeful leaning into the debasement of the dollar and, by extension, the value of outstanding debt obligations.
Policymakers will do what they have to do to inflate away the debt, keep yields capped, and keep the government nominally funded. Gold will do what it has to do to preserve purchasing power—it will go much higher.
As for the implications of recent Treasury actions on the larger issue of U.S. Treasuries as the global reserve asset in the post-1971 U.S. dollar-centric system, HAI will defer to financial commentator Michelle Makori, who posted on Twitter/X this week. She raised an important fundamental question, “If a country cannot sell its U.S. Treasury reserves during a crisis without making that crisis worse, are those Treasuries still fit for purpose as foreign exchange reserves? If U.S. Treasuries are considered the world’s safest and most liquid asset, but policymakers are trying to avoid a situation where a major holder has to sell them, what does that tell us about their true safety and liquidity when it matters most?”
In HAI‘s view, Michelle’s is a very good question. When foreigners can’t be allowed to sell, while the issuing central bank prints money to buy and stabilize, you’re dealing with a deeply troubled asset/system—full stop. Years of record global central bank gold buying also compellingly testifies to that verdict.
In short, the new boss is the same as the old boss. In HAI‘s view, we’ve been given a heads-up over the last few weeks as to what’s likely coming, so don’t get fooled again.
Weekly performance: The S&P 500 was off 1.46%. Gold was up 5.23%, silver gained 6.64%, platinum was up 7.62%, and palladium was up 2.17%. The HUI gold miners index surged 12.56%. The IFRA iShares US Infrastructure ETF was down 3.44%. Energy commodities were volatile and up on the week. WTI crude oil was up 5.14%, while natural gas was up 0.72%. The CRB Commodity Index was up 3.79%. Copper was off 0.40%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 0.78%. The Vanguard Utilities ETF was off 3.49%. The dollar index was down 0.80% to close the week at 98.84. The yield on the 10-yr U.S. Treasury was up 4 bps on the week, closing at 4.73%.
Have a wonderful weekend!
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
