Lesson 4
Fiscal vs Monetary Dominance
In fiscal dominance, the Fed is less independent. Policy rates may stay lower than inflation would warrant. This is structurally bullish for hard assets (gold, Bitcoin (BTCUSD)) and real assets, but requires new frameworks for valuation.
The relationship between fiscal policy (government spending/taxing) and monetary policy (central bank) determines the regime.
Monetary Dominance (Pre-2020):
- Central bank independent
- Fed sets rates to control inflation
- Government must fund itself in markets
- If deficit too high, bond market punishes via higher yields
- Central bank won't monetize debt
Fiscal Dominance (Emerging):
- Government spending determines conditions
- Central bank accommodates fiscal needs
- If rates are raised too much, fiscal math breaks
- Central bank 'forced' to buy government debt
- Inflation becomes acceptable vs. fiscal crisis
Signs of Fiscal Dominance:
- Interest expense growing as % of budget
- Deficits continuing regardless of rates
- Central bank buying most new issuance
- 'Yield curve control' discussions
- Political pressure on central bank
The Transition:
We're transitioning from monetary to fiscal dominance:
- US interest expense is >$1 trillion/year and growing
- Deficits are 6%+ of GDP in 'good times'
- Fed will find it increasingly hard to raise rates
- The bond vigilantes may eventually lose
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What happens to central bank independence in fiscal dominance?