Time to get real

Financial markets’ growing concerns about debt sustainability, mainly but not solely in the United States, are taking us into an era of fiscal dominance. This is essentially political pressure to keep interest rates down as a way to cope with ballooning government borrowing. As recently as 2014, central bankers were dubbed “Alchemists”ⁱ and hailed as the most powerful people on the planet, whose monetary remedies brought the world back from the brink during the Great Financial Crisis (GFC). Now, they are bullied and fighting to control their policy compass. They are at the sharp end of fiscal dominance.

Since the GFC, the US has departed further from its traditional pattern of expanding deficits at times of war, and reducing them during times of peace. The incumbent US administration is accelerating this trend, and pushing the reliance on debt towards a tipping point. This is shown by the One Big Beautiful Bill Act (OBBBA), which extends expiring tax cuts and creates new ones, and which the Congressional Budget Office estimates will add over USD 3 trillion to the national debt by 2034.

Going hand in hand with fiscal largesse is the US administration’s interference with institutions, like the Federal Reserve. The administration is not only leaning on Fed policymakers to cut interest rates, it is pressing for some of them to quit. This is with a view to appointing its favoured picks and thereby effectively controlling the Fed.

The undermining of the institutional status quo extends to other US public institutions, as shown by the firing of the chief of the Bureau of Labor Statistics (BLS). Staff cuts at the BLS have reduced its capacity tocollect actual price data — developments that are calling into question the credibility of US data. Such a fraying of confidence in these leading US institutions is problematic for a fiat currency — one that derives value from faith in its issuer, rather than being pegged to the price of a commodity such as gold.

The upshot of the new US policy agenda is an erosion of the value of money, and the depreciation of the dollar. Dollar debasement is negative for holders of US cash and fixed income assets — as the market has little control over the policies that underpin, or undermine, trust in the US dollar.

Investors are piling into equities and other “real assets” — like gold, private assets, real estate and Bitcoin — as the debasement of money pushes them away from cash and government bonds. As a result, equities have just enjoyed their best 5-year period of outperformance versus bonds in over 40 years despite all the uncertainty and political moves that would have rocked markets in the past. Gold hitting record highs is acting as a warning sign about the future of the fiat monetary system.

Furthermore, in the corporate world, an uptrend in profit margins is being driven by a sustained shift towards knowledge-based industries, reduced corporate taxes, efficiency gains, and improving productivity. This may help explain why markets seem to be so resilient to the increasingly unorthodox policies being pursued by the US administration, such as ramping up trade tariffs and politicising public institutions. Moreover, the OBBBA can be expected to stimulate the US economy and support growth from next year.

For investors, the key here is to keep an open mind. The equity bull run could continue, or it could break. In this context, it is essential to keep an open mind while maintaining sensible risk-reward parameters. In these abnormal times, markets may exhibit strange behaviour and equity valuations may appear to diverge from fundamentals. However, the rise of fiscal dominance and the associated debasement of money serve to highlight the case for real assets. For some investors that means gold, for others equities, and for some crypto currencies as an alternative store of value. In other words, keep it real.