Original title: The BBC
Original source: Arthur Hayes
Original translation: Yuliya, PANews
Jerome Powell and Haruhiko Kuroda have developed a strong friendship in the global central bank community. Since Kuroda stepped down as the governor of the Bank of Japan (BOJ) a few years ago, Powell has often sought advice or a chat from him. In early March this year, Powell was troubled by a meeting with the new US Treasury Secretary Scott Bessant. The meeting left a psychological trauma on him, prompting him to seek someone to talk to. Imagine:
During a conversation, Powell confided his troubles to Kuroda. Through the conversation, Kuroda recommended him the Jung Center that specializes in serving central bank governors. This institution originated from the German Imperial Bank period and was founded by the famous psychologist Carl Jung to help top central bankers cope with stress. After World War II, this service expanded to London, Paris, Tokyo and New York.
The next day, Powell went to the office of Justin, a psychologist at 740 Park Avenue. Here, he underwent an in-depth psychological consultation. Justin keenly perceived that Powell was in the dilemma of fiscal domination. During the consultation, Powell revealed the humiliating experience of meeting with Treasury Secretary Bessant, which severely hit his self-esteem as the chairman of the Federal Reserve.
Justin comforted him by saying that this was not the first time this had happened. She suggested that Powell read Arthur Burns’ speech “The Dilemma of Central Banking” to help him understand and accept this situation.
Fed Chairman Powell hinted at the latest meeting in March that quantitative easing (QE) may soon resume, with a focus on the U.S. Treasury market. This statement marks a major shift in the global dollar liquidity landscape. Powell outlined a possible path for this, and this policy shift is expected to begin as early as this summer. At the same time, while the market is still discussing the pros and cons of tariff policies, this may be good news for the cryptocurrency market.
This article will focus on the political, mathematical, and philosophical reasons for Powells concession. It will first discuss President Trumps consistent campaign promise and why this mathematically requires the Federal Reserve and the U.S. commercial banking system to print money to buy Treasury bonds. Then, it will discuss why the Federal Reserve has never had the opportunity to maintain tight enough monetary conditions to reduce inflation.
The promise has been made and will be fulfilled
Recently, macroeconomic analysts have been discussing Trumps policy intentions. Some believe that Trump may adopt radical strategies until his approval rating drops below 30%, while others believe that Trumps goal in his last term is to reshape the world order and rectify the US financial, political and military systems. In short, he is willing to tolerate significant economic pain and a plunge in approval ratings in order to implement policies he believes are beneficial to the United States.
However, the key for investors is to abandon subjective judgments about whether policies are right or wrong and focus on probabilities and mathematical models. The performance of a portfolio depends more on changes in fiat currency liquidity around the world than on the strength of the United States relative to other countries. Therefore, instead of trying to guess Trumps policy inclinations, it is better to focus on relevant data charts and mathematical relationships to better grasp market trends.
Since 2016, Trump has repeatedly stressed that the United States has been treated unfairly by its trading partners over the past few decades. Although there is controversy over the implementation of his policies, his core intentions have remained unchanged. The Democratic Party, although not as strong as Trump in its stance on adjusting the global order, also basically agrees with this direction. Biden continued Trumps policy of restricting Chinas access to semiconductors and other key areas of the US market during his tenure as US President. Vice President Kamala Harris also used tough rhetoric against China in her previous presidential campaign. Although the two parties may disagree on the pace and depth of specific implementation, they are united in their position to promote change.
The blue line represents the US current account balance, which is basically the trade balance. You can see that starting in the mid-1990s, the US imported far more goods than it exported, a trend that accelerated after 2000. What happened during this period? The answer is the rise of China.
In 1994, China significantly devalued its currency and began its journey as a mercantilist export powerhouse. In 2001, U.S. President Bill Clinton allowed China to join the World Trade Organization and significantly reduced tariffs on Chinese exports to the U.S. As a result, the U.S. manufacturing base shifted to China, and history was changed.
Trumps supporters are precisely those who have been negatively affected by the relocation of American manufacturing. These people have no college degrees, live in the interior of the United States, and have almost no financial assets. Hillary Clinton called them deplorables. Vice President JD Vance affectionately called them and himself hillbillies.
The orange dashed line and upper panel in the chart is the U.S. financial account balance. As you can see, it is almost a mirror image of the current account balance. China and other exporting countries can continue to accumulate large trade surpluses because when they earn dollars from selling goods to the United States, they do not reinvest those dollars back home. To do so means that they sell dollars to buy their own currencies, such as the renminbi, causing their own currencies to appreciate, thereby increasing the price of their exports. Instead, they use these dollars to buy U.S. Treasuries and U.S. stocks. This has enabled the United States to maintain large deficits without destroying the Treasury market and to have the best performing stock market in the world over the past few decades.
The yield on the 10-year U.S. Treasury bond (white) has fallen slightly, while the total amount of outstanding debt (yellow) has increased sevenfold over the same period.
Since 2009, the MSCI USA Index (white) has outperformed the MSCI World Index (yellow) by 200%.
Trump believes that by bringing manufacturing jobs back to the United States, he can provide good jobs for the approximately 65% of the population that do not have a college degree, increase military strength (because weapons, etc. will be produced in sufficient quantities to take on peer or near-peer adversaries), and increase economic growth above trend, such as to 3% real GDP growth.
There are some obvious problems with this plan:
First, without dollars from China and other countries to prop up Treasury and stock markets, prices will fall. Treasury Secretary Scott Bessette needs buyers for the massive debt that must be rolled over and for the ongoing federal deficits ahead. His plan is to reduce the deficit from about 7% to 3% by 2028.
The second problem is that capital gains taxes from rising stocks are a marginal revenue driver for the government. When the rich can’t make money playing stocks, the deficit grows. Trump campaigned not on stopping military spending or cutting benefits like health care and social security, but on growth and eliminating fraudulent spending. So he needs capital gains tax revenue, even though it’s the rich who own all the stocks, and they, on average, didn’t vote for him in 2024.
The mathematical dilemma of debt growth and economic growth
Assuming Trump succeeds in reducing the deficit from 7% to 3% by 2028, the government will still be a net borrower year after year, unable to repay any existing stock of debt. Mathematically, this means that interest payments will continue to grow exponentially.
This sounds bad, but the U.S. can mathematically grow its way out of the problem and deleverage its balance sheet. If real GDP growth is 3% and long-term inflation is 2% (although this is unlikely), this means nominal GDP growth is 5%. If the government issues debt at 3% of GDP, but the economy grows nominally at 5%, then mathematically the debt-to-GDP ratio will fall over time. But there is a key factor missing here: At what interest rate can the government finance itself?
In theory, if the U.S. economy grows 5% nominally, Treasury investors should demand at least a 5% return. But that would significantly increase interest costs, since the weighted average rate the Treasury currently pays on its roughly $36 trillion (and growing) of debt is 3.282%.
Unless Bessette can find buyers for Treasuries at unreasonably high prices or low yields, the math doesn’t add up. China and other exporters can’t and won’t buy Treasuries because Trump is busy reshaping the global financial and trade system. Private investors won’t either because yields are too low. Only U.S. commercial banks and the Federal Reserve have the firepower to buy debt at levels the government can afford.
The Fed can print money to buy bonds, which is called quantitative easing (QE). Banks can print money to buy bonds, which is called fractional reserve banking. However, the actual operation is not that simple.
The Fed is ostensibly busy with its unrealistic task of bringing a manipulated and fake inflation measure below their fictitious 2% target. They are removing money/credit from the system by shrinking their balance sheet, which is called quantitative tightening (QT). Because banks performed so badly during the 2008 Global Financial Crisis (GFC), regulators require them to pledge more of their own capital against the treasuries they purchase, called the Supplementary Leverage Ratio (SLR). As a result, banks cannot use unlimited leverage to finance the government.
However, it is quite simple to change this situation and turn the Fed and banks into inelastic buyers of Treasuries. The Fed could decide to end quantitative tightening at least and restart QE at maximum. The Fed could also exempt banks from the SLR, allowing them to buy Treasuries using unlimited leverage.
The question becomes why would a Jerome Powell-led Fed help Trump achieve his policy goals? The Fed clearly helped Harris’ campaign by cutting interest rates by 0.5% in September 2024, and then acted stubbornly to Trump’s demands to increase the money supply to lower long-term Treasury yields after Trump’s victory. To understand why Powell ultimately did what the government asked him to do, perhaps we can trace back to the historical context of 1979.
The sidelined chairman
Now, Powell is in a very awkward position, watching the dominant forces in fiscal policy undermine the Feds credibility in fighting inflation.
Simply put, when government debt is too large, the Fed is forced to give up its independence and finance the government at low interest rates rather than actually fighting inflation.
This is not a new problem. Former Fed Chairman Burns encountered a similar situation in the 1970s. In his 1979 speech, “The Pain of Central Banking,” he explained why it was difficult for central banks to control inflation:
“Since the 1930s, political and philosophical currents in the United States and elsewhere have transformed economic life in a way that has produced persistent inflationary tendencies.”
Simply put: the politicians made me do it.
Burns points out that the government has become increasingly active in intervening in the economy, not only to relieve suffering, but also to subsidize valuable activities and restrict harmful competition. Despite the growth of national wealth, the 1960s were a time of social unrest in the United States. Minorities, the poor, the elderly, the disabled and other groups felt unfair, and middle-class young people began to reject the existing system and cultural values. Then, as now, prosperity was not evenly distributed, and people demanded that the government solve this problem.
Government actions and public demands interacted and escalated. When the government began to address “unfinished tasks” such as reducing unemployment and eliminating poverty in the mid-1960s, it awakened new expectations and demands.
Now, Powell faces a similar dilemma, wanting to be a hawkish anti-inflation hero like Volcker, but actually being forced to succumb to political pressure like Burns.
Direct government intervention to try to address key constituency groups dates back decades. The actual effectiveness of such interventions often varies from case to case, with mixed results.
Many of the outcomes of active government-citizen engagement have indeed had positive effects. However, the cumulative effect of these actions has injected a strong inflationary bias into the U.S. economy. The proliferation of government programs has led to a gradual increase in the tax burden on individuals and businesses. Even so, the governments willingness to tax is significantly lower than its propensity to spend.
There is a general consensus in society that it is the governments responsibility to solve problems. The main way for the government to solve problems is to increase spending, which deeply embeds inflationary factors into the economic system.
Indeed, the expansion of government spending was driven in large part by a commitment to full employment. Inflation came to be widely viewed as a temporary phenomenon—or, as long as it remained tame, an acceptable state of affairs.
The Fed’s inflation tolerance and policy contradictions
Why does the Fed tolerate 2% inflation every year? Why does the Fed use words like transitory and inflation? 2% inflation compounded over 30 years will cause the price level to rise by 82%. But if the unemployment rate rises by 1%, the sky will fall. These things are worth thinking about.
In theory, the Federal Reserve System could have nipped inflation in the bud, or ended it at any point later. It could have restricted the money supply, created enough tension in financial and industrial markets to quickly end inflation. However, the Fed did not take such action because it itself was influenced by the philosophical and political currents that were changing American life and culture.
The Fed maintains an appearance of independence, but as a government agency philosophically inclined to address broad social problems, it will neither prevent nor be able to prevent inflation that requires intervention. The Fed has effectively become a facilitator, in the process creating the inflation it is supposed to control.
Faced with political realities, the Fed did tighten monetary policy at times—in 1966, 1969, and 1974, for example—but its restrictive stance was not maintained long enough to put an end to inflation. Overall, monetary policy came to be governed by the principle of nurturing the inflationary process at a low level while still accommodating most market pressures.
This is exactly the path that Powell has taken for monetary policy during his tenure as current Fed chairman. This embodies the phenomenon known as fiscal dominance. The Fed will do what is necessary to finance the government. Opinions may differ on the merits of the policy objectives, but Burns message is clear: when one becomes Fed chairman, one implicitly agrees to do whatever is necessary to ensure that the government can finance itself at affordable levels.
Current policy shift
Powell showed signs of the Fed continuing to succumb to political pressure at his recent Fed press conference. He had to explain why the pace of quantitative tightening (QT) was slowing down when US economic indicators were strong and monetary conditions were loose. The current low unemployment rate, historically high stock markets, and inflation still above the 2% target should have supported tighter monetary policy.
Reuters reported: “The Federal Reserve said on Wednesday it will slow the pace of shrinking its balance sheet starting next month as questions about the government’s borrowing limits remain unresolved, a shift that could last for the rest of the process.”
According to the Federal Reserves historical archives, although former Federal Reserve Chairman Paul Volcker was known for his strict monetary policy, he chose to relax policy in the summer of 1982 in the face of economic recession and political pressure. At that time, James C. Wright Jr., the majority leader of the U.S. House of Representatives, met with Volcker several times to try to make him understand the impact of high interest rates on the economy, but to no avail. However, by July 1982, data showed that the recession had bottomed out. Volcker then told members of Congress that he would abandon his previously set tight monetary policy goals and predicted that economic recovery in the second half of the year was highly likely. This decision also echoed the Reagan administrations long-standing recovery expectations. It is worth noting that although Volcker was regarded as one of the most respected Federal Reserve chairmen, he was not able to completely withstand political pressure. At that time, the U.S. governments debt situation was much better than it is now, with debt accounting for only 30% of GDP, while it is now as high as 130%.
Evidence of fiscal dominance
Powell demonstrated last week that fiscal dominance is still here. Therefore, in the short to medium term, QT for Treasuries will cease. Going further, Powell said that while the Fed may maintain a natural reduction in mortgage-backed securities, it will be a net purchase of Treasuries. Mathematically, this keeps the Feds balance sheet constant; however, it is actually QE for Treasuries. Once it is officially announced, the price of Bitcoin will rise sharply.
In addition, the Fed will provide banks with an SLR exemption, another form of Treasury QE, due to requests from banks and the Treasury. The ultimate reason is that the above math doesn’t work otherwise, and Powell can’t sit back and let the US government get stuck, even if he loathes Trump.
Powell mentioned the balance sheet adjustment plan at the FOMC press conference on March 19. He said that the Fed will stop reducing its net assets at some point, but no decision has been made yet. At the same time, he emphasized that he hopes to gradually withdraw MBS (mortgage-backed securities) from the Feds balance sheet in the future. However, he also mentioned that the Fed may allow MBS to mature naturally while keeping the overall balance sheet size unchanged. The specific time and method of these adjustments have not yet been determined.
Speaking about the Supplementary Leverage Ratio (SLR) in a recent podcast, Finance Minister Bessant noted that if the SLR were removed, it could become a constraint for banks and could cause Treasury yields to fall by 30 to 70 basis points. He noted that each basis point change would equate to an economic impact of about $1 billion per year.
In addition, Federal Reserve Chairman Powell said at a press conference after the Federal Open Market Committee (FOMC) meeting in March that he believed that the inflationary effect of the tariff policy proposed by the Trump administration might be temporary. He believes that although tariffs may trigger inflation, the effect is not expected to last long. This judgment of transient inflation gives the Federal Reserve room to continue to adopt an accommodative policy in the face of inflation caused by tariff increases. Powell pointed out that the current baseline view is that the impact of tariffs on prices will not last long, but he also emphasized that there is still uncertainty about the future situation. Analysts believe that this statement means that the impact of tariffs on asset prices may be weakening, especially those assets that rely solely on legal liquidity.
Fed Chairman Powell said at the March FOMC meeting that the inflationary effects of tariffs could be transient. He believes that this transient inflation expectation allows the Fed to continue to implement loose policies even if inflation rises sharply due to tariffs.
At the post-meeting press conference, Powell emphasized that the current basic expectation is that price increases caused by tariffs will be temporary, but he also added that we cannot be sure of the specific situation in the future. Market analysts pointed out that for assets that rely on fiat currency liquidity, the impact of tariffs may have gradually weakened.
In addition, Trumps planned Liberation Day announcement on April 2 and potential tariff increases did not seem to have a significant impact on market expectations.
USD liquidity calculation
What matters is the change in forward-looking dollar liquidity relative to previous expectations.
· Previous pace of quantitative tightening (QT) of Treasury bonds: $25 billion per month
· QT pace of national debt after April 1: $5 billion per month reduction
Net effect: positive change in US dollar liquidity of US$240 billion per year
· Effect of QT reversal: Reduce MBS by up to $35 billion per month
If the Fed balance sheet remains unchanged, it can purchase: Up to $35 billion in Treasuries per month or $420 billion per year
Starting on April 1, an additional $240 billion of relative dollar liquidity will be created. In the near future, by the third quarter of this year at the latest, this $240 billion will rise to an annualized $420 billion. Once quantitative easing begins, it will not stop for a long time; it will increase as the economy needs more money printing to maintain the status quo.
How the Treasury manages its general account (TGA) is also an important factor affecting dollar liquidity. TGA is currently about $360 billion, down from about $750 billion at the beginning of the year. TGA is used to maintain government spending due to debt ceiling constraints.
Traditionally, the TGA is refilled once the debt ceiling is raised, which has a negative impact on US dollar liquidity. However, maintaining excessive cash balances is not always economically justified; during the tenure of former Treasury Secretary Yellen, the target TGA balance was set at $850 billion.
Considering that the Federal Reserve can provide liquidity support as needed, the Treasury Department may adopt a more flexible TGA management strategy. Analysts expect that in the quarterly refunding announcement (QRA) in early May, the Treasury Department may not significantly increase the TGA target relative to the current level. This will mitigate the negative dollar liquidity shock that may occur after the debt ceiling is raised and provide a more stable environment for the market.
2008 Financial Crisis Case Study
During the 2008 Global Financial Crisis (GFC), gold and the SP 500 showed different responses to increased fiat liquidity. Gold, as an anti-establishment commodity financial asset, reacts faster to liquidity injections, while the SP 500 relies on the legal backing of the national system and may be slower to react when the solvency of the economic system is questioned. Data shows that gold outperformed the SP 500 during the worst phase of the crisis and the subsequent recovery. This case study shows that even with the current significant increase in US dollar liquidity, negative economic conditions may still have an adverse impact on the price trend of Bitcoin and cryptocurrencies.
On October 3, 2008, the US government announced the launch of the Troubled Asset Relief Program (TARP) to deal with the market turmoil caused by the bankruptcy of Lehman Brothers. However, the plan failed to prevent the continued decline of the financial market, and both gold and US stocks fell. Subsequently, Federal Reserve Chairman Ben Bernanke announced the launch of a large-scale asset purchase program (later known as quantitative easing policy QE 1) in early December 2008. Affected by this, gold began to rebound, while US stocks continued to fall until the Fed officially launched the money printing operation in March 2009. As of early 2010, the price of gold rose 30% from the time of Lehman Brothers bankruptcy, while US stocks only rose 1% during the same period.
Bitcoin Value Equation
Bitcoin did not exist during the 2008 financial crisis, but now it has become an important financial asset. The value of Bitcoin can be simplified to:
Bitcoin Value = Technology + Fiat Currency Liquidity
Bitcoin’s technology works well and there are no major changes in the near term, good or bad. Therefore, Bitcoin trades purely based on market expectations of future fiat money supply. If the analysis of the major shift by the Federal Reserve from quantitative tightening to quantitative easing of Treasury bonds is correct, then Bitcoin, which hit a local low of $76,500 last month, will begin its climb toward its target of $250,000 by the end of the year.
While this prediction is not an exact science, based on golds performance pattern in similar environments, Bitcoin is more likely to hit $110,000 than $76,500 again. Even if the U.S. stock market continues to fall due to tariffs, collapsing corporate earnings expectations, or weakening foreign demand, Bitcoin is likely to continue to rise. Investors should deploy funds carefully, without leverage, and purchase small positions relative to the total size of their portfolio.
However, Bitcoin is still likely to reach $250,000 by the end of the year, based on a number of factors, including the Federal Reserves potential release of liquidity to boost the market, and the Chinese central banks potential easing of monetary policy to maintain the stability of the RMB against the US dollar. In addition, European countries increased military spending due to security concerns may be achieved through the printing of euros, which may also indirectly stimulate market liquidity.
