The Frontier

Luke Groman says Kevin Warsh faces a binary choice: sacrifice the dollar to preserve the bond market, or sacrifice the bond market to preserve the dollar, due to high debt and insufficient private balance sheet.

Groman notes Warsh co-authored a December 2018 op-ed begging the Fed to stop hiking rates when the S&P was down 10%, contradicting his hawkish reputation.

Groman argues Treasury market dysfunction since 2020 stems from one issue: debt is too high, and there isn't enough private balance sheet to finance it without Federal Reserve help.

The US deficit is primarily driven by three politically untouchable items: interest payments, entitlements for 65 million baby boomers, and defense spending.

Groman states US debt-to-GDP is 122%, with a 6% deficit, making significant rate hikes untenable as they would trigger immediate bond market dysfunction.

Groman predicts the physical world, namely an extended closure of the Strait of Hormuz, will start kicking the financial world in the head within one to two months, forcing Warsh's hand.

Foreigners own $9.5 trillion in US Treasuries and have $13-14 trillion in dollar-denominated borrowings against $27 trillion in net dollar assets, creating vulnerability if they sell Treasuries to raise dollars for oil.

China's oil imports have dropped by 4-5 million barrels per day without causing an economic collapse, giving it more flexibility in the Hormuz blockade than consensus believed.

Groman observes Japan and Korea have been trading like emerging markets since late last year, where higher relative yields drive currency weakness, signaling proximity to a debt crisis.

China has swap lines established with 185 countries, reducing the coercive power of US dollar swap lines and giving countries like the UAE leverage to negotiate.

Groman's adjusted Warren Buffett metric, which subtracts federal debt from total equity market cap, is now higher than at any point in the last 65 years, including the peaks of 1Q 2000 and 4Q 2021.

Groman views falling gold and Bitcoin prices as a leading indicator for risk assets, signaling that equities will follow unless the Fed injects massive liquidity soon, which he doubts will happen.