LYN ALDEN: Full Steam Ahead - All Aboard The FISCAL DOMINANCE TRAIN!
This research piece on fiscal dominance in the United States was compiled and written by Sam Callahan, and commissioned and advised by Lyn Alden.
Published: January 2025
Executive Summary
• Structural fiscal deficits have surpassed private sector lending and monetary policy as the primary drivers of economic activity and inflation, marking a fundamental shift in the economy’s liquidity dynamics.
• Debt-to-GDP projections reveal the impact interest rate policy could have on fiscal sustainability. At a fixed 5% rate, debt-to-GDP would steadily increase over the next decade, while a 2% fixed rate would lead to a decline. However, this measure can be misleading, as nominal GDP growth driven by fiscal deficits increases, masking the extent of nominal debt accumulation and inflation in various forms.
• The Department of Government Efficiency is unlikely to make meaningful cuts to federal spending as only 14% of the budget is non-defense discretionary, while 87% of nominal spending growth over the next decade is projected to come from mandatory programs and interest expense.
• Stabilizing factors such as the global demand for U.S. dollars and debt denominated in its own currency suggest an era of fiscal dominance in the U.S. that’s less dramatic than alarmists predict but more persistent and intractable than optimists hope. The deficit problem is unlikely to be resolved this decade, running structurally hot with steady nominal growth and ongoing currency debasement.
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The Fiscal Backdrop Today
In September 2022, the UK gilt market crashed, nearly toppling the country’s pension system. It all began with then-Prime Minister Liz Truss’s controversial “mini-budget,” a fiscal package that consisted of unfunded tax cuts and increased government spending. This came at a time when UK CPI inflation was running above 10% YoY, and its debt-to-GDP was sitting at levels not seen since the 1960s.
The market plummeted on the news. Investors viewed the new budget plan as fiscally reckless, and a massive sell-off in the gilt market ensued. Consequently, pension funds—deeply tied to the gilt market through leveraged strategies—faced a wave of margin calls that threatened their solvency.
CONTINUED…
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