From calling for interest rate cuts to "fiscal dominance"? Trump's true goal of focusing on the Federal Reserve may be "debt monetization"

As US President Donald Trump seeks to further control the monetary policy of the Federal Reserve, investors have begun to worry that he will use tools of the Fed to solve problems that should not be handled by the Fed, such as the continuously growing debt of the US government. Due to expanding budget deficits and rising interest rates, the total US debt has surged in recent years. On Tuesday, Trump stated that he is prepared to engage in legal battles over his attempt to remove Fed Governor Lael Brainard and looks forward to having a "majority of rate-cut seats" in the Fed Board. This could push Trump to undertake a series of movements aimed at lowering interest rates, claiming that it will save the country "billions of dollars." The soaring costs of US government debt have two main reasons: continuous expanding budget deficits and higher interest rates. In order to bring the bills down, at least one of these must be reversed. However, most economists believe that the solution lies in reducing government borrowing, and achieving a combination of reducing expenditures and increasing taxes - rather than relying on the Fed to continuously lower borrowing costs. For the Fed, the latter path is undoubtedly a very dangerous move, as one of the core goals of the Fed is to control inflation. When politicians continue to inject funds and stimulate the economy, the task of combating inflation becomes even more difficult. If interest rates - the main lever to curb inflationary pressures - become a tool to maintain the government's solvency, then the task of containing inflation may become impossible. Economists use the term "fiscal dominance" to describe this situation. It is often associated with emerging market countries, where monetary policy is more vulnerable to political pressure. As Trump escalates his attacks on the Fed, many analysts believe that the US is moving in a similar direction. University of Virginia economics professor Eric Leeper believes that this has already happened. "Ultimately, if you want to control inflation, fiscal policy needs to be in place in the right way," said Leeper, a former Fed economist. On the contrary, "what we're hearing now is that we need lower interest rates because interest payments are exploding," he said. "This amounts to an acknowledgement that fiscal policy will not self-correct, so they are trying to find other ways. This is fiscal dominance." "This will not end well" Indeed, even investors and economists who are concerned about this risk are not all willing to go so far. There is no indication that interest rate decisions are influenced by the US public financial situation. In order to control the persistent high inflation after the coronavirus epidemic, Fed officials have implemented the most aggressive rate hikes since the 1980s - despite increasing the debt cost to the budget by hundreds of billions of dollars. This year, while the Fed remained cautious about the inflationary backdrop caused by tariffs, Fed Chairman Jerome Powell insisted that the policy is entirely based on economic outlook, as he reiterated at Jackson Hole. Powell has repeatedly stated that US debt is on an unsustainable path. Powell told reporters last month that setting policy based on government fiscal needs "would not be a good thing," adding, "No central bank of a developed economy would do that." Nevertheless, there is a growing concern that the Fed may eventually do exactly that, facing pressure from the Trump administration, Fed Chairman Powell and Fed governors may be forced to compromise, even if the Fed does not concede, it may do so in the future with the next Fed chairman nominated by Trump and more governors nominated by Trump pushing the Fed to compromise is likely. Even if Powell does not compromise, as Trump selects a successor for Powell, the next Fed chair may follow Trump's decision-making direction or influence market expectations through speeches before taking office officially. Powell's term as chair will end in May next year. Trump has nominated his economic advisor Stephen Miranda to fill one of the vacancies on the Board, and if he successfully dismisses Fed Governor Brainard for alleged financial wrongdoing, he will create another vacant seat. His team has hinted at a wider reshuffle of the Fed's FOMC policy committee and ways to exert more influence on the Fed's 12 regional banks. Behind all of this is the constant demand for rate cuts. "The Fed is increasingly facing intensifying fiscal dominance risks," George Saravelos, global director of foreign exchange research at Deutsche Bank, wrote in a report on Tuesday. "Even more surprising is that the market remains largely unconcerned, especially given that equity market pricing has not fully priced in this risk." On Tuesday, as Trump pushed forward his plan to remove Brainard, 30-year US Treasury bonds and the US dollar continued to decline. Earlier this year, driven by concerns about US trade and budget planning, these assets had reached lower levels, but are still far above those lows. Steve Barrow, G-10 strategy director at Standard Chartered, said that concerns about the shift in the Fed's focus on policy could weaken the US dollar and raise bond yields, while increasing interest in alternative assets such as cryptocurrencies and gold. A recent survey by Bank of America showed that more than half of fund managers expect the next Fed chair to resort to quantitative easing or "yield curve control" - policies involving the purchase of government bonds to limit the upward cost of borrowing to relieve the US debt burden. "It's getting closer" While Trump and his allies are pressuring the Fed, they have also put forward other ways to lower government debt costs. A proposed tweak to bank capital rules could boost demand for US government debt, thereby lowering its yields. A new law regulating stablecoins could have a similar positive effect, requiring issuers to be backed by safe assets such as government debt. US government officials have also mentioned saving some costs by issuing more short-term government debt. Republican Senator Ted Cruz has drafted legislation to prohibit the Fed from paying interest on reserves, claiming that this would bring fiscal gains. According to David Beckworth, a senior researcher at the Mercatus Center at George Mason University, all of these are signs that budget pressures are increasingly shaping policy. "We're not yet in the textbook sense of fiscal dominance, but we're getting closer and closer," he emphasized. "I would say we're on that spectrum." As for the budget itself, Trump pushed through a tax cut and spending bill this summer, known as the "big and beautiful" bill in Congress, which is expected to increase the deficit by $3.4 trillion over ten years. He has also opened up new sources of fiscal revenue by imposing hefty tariffs on imported goods. According to recent analysis by S&P Global Ratings, the two sides basically offset each other. "Although the final budget deficit outcome will not show meaningful improvement, we also do not expect it to continue to deteriorate," the rating agency wrote. S&P predicts that the budget deficit will remain at about 6% of GDP during the remainder of Trump's term, roughly in line with other forecasting institutions. This is smaller than most periods after the pandemic, but still larger than historical standards -- and double the 3% target set by Treasury Secretary Scott Bennett. This means that the total US debt will reach a historical record of over 100% of GDP during peacetime. This increasingly massive budget expenditure has been accumulated under both Republican and Democratic governments, involving rescues during the global financial crisis and the pandemic, as well as indecision on key budget items such as raising taxes or cutting social welfare and defense. When the government runs a deficit, it usually finances the additional expenditure by issuing more bonds. At this point, the central bank comes into play: during times of crisis, they can enter the market and buy these debts directly. Even in normal times, central banks set short-term interest rates, which can potentially affect the cost of long-term sovereign debt. However, the two do not always move in the same direction. "Regardless of what any government wishes, in the end, interest rates are determined by the market," said Fabio Natalucci, director of the Anderson Institute for Economic Finance. "This is especially true for the long end of the US Treasury yield curve." A recent example: When the Fed loosened its monetary policy at the end of last year, the yields on 10-year and 30-year US Treasury bonds actually rose - in part because investors were concerned that after the November election, the Trump administration's larger budget deficits and much greater tariff pressures could reignite inflation. This situation reminds us that the Fed cannot automatically bring down the government's borrowing costs -- and it also reminds us that rising public debt will create huge challenges for central banks, and central banks would rather bond markets remain sensitive to their actions. Atlanta Fed President Rafael Bostic pointed out in July that if investors are concerned about fiscal risks, the effectiveness of monetary policy may decrease. "You may see long-term bond yields fluctuate somewhat independently of our actions," he said. "That will be a problem that needs to be seriously considered." "This chicken game, who will blink first?" Opposing directions in fiscal and monetary policy are not uncommon. The danger lies when both sides continue to pressure each other and are unwilling to compromise. "I see this as a 'chicken game'," said George Hall, a professor at the Brandeis University and a former economist at the Chicago Fed. "Who will blink first? Will it be the Fed, or Congress, or will it be US President Trump?" For the Fed, the central bank must win in this game in order to maintain its credibility as an inflation fighter, even if it means keeping interest rates at historically high levels that exacerbate budget pressures. Fiscal dominance is when the central bank fails in this kind of game - monetary policy becomes a tool for debt management, and inflation targets are diluted or even abandoned. These scenarios do not currently apply to the United States. There is no sign of an economic emergency that would lead some countries into fiscal dominance. On the contrary, the concern is political - London TS Lombard economist Dario Perkins emphasized that the questioning sentiment towards the Fed and Trump's intervention pressure on the Fed is opening the door to that kind of regime. "Trump has made it clear almost every week that the high interest rates long maintained by the Fed have cost the government," he emphasized. "In looking at it, it clearly relates to the over-expansion of the debt problem, rather than a simple US inflation issue."