Warsh Must Choose The Dollar Or The Bond Market — Luke Gromen
Luke Gromen (Forest for the Trees) frames the week ahead of Kevin Warsh's first FOMC meeting as a forced binary the Fed has spent years avoiding: **the dollar or the bond market — they will have to sacrifice one.** His core thesis is unchanged and brutally simple: **"The debt is too high and there isn't enough balance sheet to finance it without the Fed's help."** With debt/GDP at 122% and deficits at 6%, letting the 10-year run from 4.6% toward 5-7% creates near-instant Treasury-market dysfunction, so Warsh will not stand aside — meaning the Fed becomes effectively married to Treasury (he notes Bessant already doubled the pace of Treasury buybacks). Gromen reads Warsh's pre-nomination WSJ op-eds (Dec 2018 begging the Fed to stop hiking; the fall 2025 "job interview" piece) as setting up a "disinflationary growth from AI" narrative he calls "total bs" — pointing out no data centre is cheaper to build today than a year ago. The whole "shrink the balance sheet" plan was, in his read, a cynical package: cut the front end, sell the long end, deregulate banks (suspend SLR-style constraints) so banks backfill the duration the Fed sells — "It's just QE through the banks." **The Iran war detonated that plan:** a CPI headline above 4% and an inflationary energy shock send the front end the wrong way — "like giving yourself a root canal with a shotgun." Gromen's call: **Hormuz stays closed through fall, the physical world starts "kicking the financial world in the head" within one to two months**, oil re-accelerates, deficits blow from 6% toward 8-10%, and foreigners (who hold ~$27T net in dollar assets including ~$9.5T Treasuries) sell Treasuries to raise dollars — a debt spiral. China is the surprise: it cut oil imports 4-5 million bbl/day without collapsing and keeps buying gold, the opposite of consensus. He flags an under-discussed structural shift — UAE leaving OPEC plus a petro-gold/yuan settlement system that removes the need for a supply cartel — and notes China has yuan swap lines with ~185 countries, gutting US swap-line leverage. **Near-term he is very cautious:** his "adjusted Warren Buffett metric" (equity cap minus federal debt, over GDP) is the richest in 65 years, above both 1Q2000 and 4Q21. Gold and bitcoin falling daily are, in his read, "telling us something wicked this way comes" for risk assets unless liquidity is injected fast — which he doesn't expect until real pain forces the "no atheists in foxholes" moment.
Key points
- Gromen's central frame: the Fed faces a forced binary — sacrifice the dollar (via inflation) or the bond market (via higher rates); both can't be defended given 122% debt/GDP and 6% deficits.
- He expects Warsh to revive a "disinflationary growth from AI/technology, like the 1990s" narrative (drawn from Warsh's fall WSJ op-ed) to square the circle — Gromen calls it a "fairy tale" and "total bs," noting no data centre is cheaper to build than a year ago.
- Warsh's Dec 2018 WSJ op-ed begged the Fed to stop hiking with the S&P down 10%; Gromen reads this as evidence Warsh won't actually let the Treasury market break — so the Fed ends up effectively married to Treasury, not independent.
- The 'shrink the balance sheet' plan decoded: cut the front end, sell the long end, deregulate banks so they buy the Treasuries the Fed sells with near-infinite leverage — "It's just QE through the banks," echoing the Q2 2020 SLR suspension during COVID.
- Bessant has doubled the pace of Treasury buybacks versus Yellen — Gromen's evidence the administration is more cornered than its rhetoric admits ("his three arrows has just gotten wadded up and thrown in the trash").
- Macro call: Hormuz stays closed through fall; the physical (energy) world starts hurting the financial world within 1-2 months; oil, fertilizer and crop costs re-accelerate, pushing deficits from 6% toward 8-10%.
- Debt-spiral mechanism: as rates spike on oil, foreigners (long ~$27T net dollar assets, including ~$9.5T Treasuries) sell Treasuries to raise dollars for oil — feeding a spiral.
- China is the contrarian datapoint: cut oil imports 4-5 million bbl/day without economic collapse (EV/grid buildout, ~1.8bn-barrel SPR stockpile) and keeps buying gold as it falls — opposite of the consensus 'China is screwed' view.
- Structural shift: UAE left OPEC and got US swap lines; Gromen argues a petro-gold settlement system priced in yuan removes the need for a supply cartel and changes producer incentives toward max production to accumulate cheap gold.
- Swap-line leverage is gutted: China reportedly has yuan swap lines with ~185 countries (on the PBOC website), so the US is no longer the only buyer — wholesalers like the UAE can play the two against each other.
- Valuation warning: the 'adjusted Warren Buffett metric' (equity market cap minus federal debt, over GDP) is the highest in 65 years — above 1Q2000 and 4Q21; gold and bitcoin selling off daily signal risk-asset trouble absent a fast liquidity injection he doesn't expect yet.
Notable quotes
The debt is too high and there isn't enough balance sheet to finance it without the Fed's help.
If you're going to spend three years, two and a half years shifting issuance to the front end because the back end is blow going out, you can't be stupid and start an inflationary war that sends a front end up.
I think the physical world is going to start kicking the financial world in the head sometime in the next one to two months.
I think gold and bitcoin are telling us something wicked this way comes.
The dollar or the bond market, they're gonna have to sacrifice.
And the problem with rates going up a lot in an economy with 122% debt to GDP and 6% deficits means that you're going to create bond market dysfunction very quickly again.
Yeah, that's like giving yourself a root canal with a shotgun.
But they're long 27 trillion dollars net in dollar or sorry, 13 to 14 trillion dollars in dollar borrowings, but 27 trillion dollars net in dollar assets, including nine and a half trillion dollars in Treasuries.
I find that China has yuan swap lines set up with everyone in the world, basically, except the United States.
The adjusted Warren Buffett metric is now higher than it was in 1Q 2000.
Themes
- fiscal-dominance & Fed independence
- dollar-vs-bond-market policy trap
- energy-shock inflation
- de-dollarization & gold settlement
- equity-valuation extremes
Mentioned
People
Ideas
- dollar vs bond market binary
- disinflationary AI growth narrative
- QE through the banks / SLR deregulation
- Treasury buybacks
- petro-gold yuan settlement system
- yuan swap lines vs dollar swap lines
- adjusted Warren Buffett metric
- debt spiral from foreign Treasury selling
- Hormuz closure / oil supply shock
- capital flight (dollar down, bonds down, stocks down)