Don't Miss The Forest For The Trees
Luke Gromen's Comprehensive Insights on the U.S. Dollar and U.S. Treasury Market Dynamics- Article #27
In this 12 min article, The X Project will answer these questions:
I. Why this article now?
II. Who is Luke Gromen?
III. Where did his perspective come from?
IV. What is the top takeaway from his perspective?
V. What is another top takeaway?
VI. What is a third takeaway?
VII. What is a fourth takeaway?
VIII. What is a fifth takeaway?
IX. What does The X Project Guy have to say?
X. Why should you care?
I. Why this article now?
In an era where economic landscapes are rapidly transforming, Luke Gromen's incisive analysis stands as a beacon for understanding the complex interplay of factors shaping our world. His perspective, culled from multiple interviews, resonates profoundly with the mission of The X Project – to unravel the intricate web of commodities, demographics, economics, energy, geopolitics, government debt & deficits, interest rates, markets, and money. As markets oscillate and governments recalibrate policies, comprehending these insights is crucial for investors, policymakers, and the intellectually curious. His perspectives on sovereign debt, energy economics, the U.S. dollar, fiscal dominance, and recession forecasts offer a prism through which we can view the imminent future.
II. Who is Luke Gromen?
According to his own website, FFTT-LLC.com, which stands for “forest for the trees,”
“Luke Gromen has become one of the most respected names in the global research sector. Having been in the industry for 20+ years and earning a reputation as a client-focused analyst with an unparalleled ability to make broad connections between increasingly siloed industry news and drawing conclusions that help investors understand the bigger picture. Luke offers unique and insightful research derived from a wide variety of sources that provide a clearer picture of global macroeconomic, thematic, and sector trends.
Luke founded FFTT, LLC in early 2014 to address and leverage the opportunity he saw created by applying what clients and former colleagues consistently described as a “unique ability to connect the dots” during a time when he saw an increasing “silo-ing” of perspectives occurring on Wall Street and in corporate America. FFTT caters to institutions and sophisticated individuals by aggregating a wide variety of macroeconomic, thematic and sector trends in an unconventional manner to identify investable developing economic bottlenecks for his clients.
Prior to founding FFTT, Luke was a founding partner of Cleveland Research Company, where he worked from 2006-14. At CRC, Luke worked in sales and edited CRC’s flagship weekly thematic research summary piece (“Straight from the Source”) for the firm’s clients. Prior to that, Luke was a partner at Midwest Research, where he worked in equity research and sales from 1996-2006. While in sales, Luke was a founding editor of Midwest’s widely-read weekly thematic summary (“Heard in the Midwest”) for the firm’s clients, in which he aggregated and combined proprietary research from Midwest with inputs from other sources.
Luke Gromen holds a BBA in Finance and Accounting from the University of Cincinnati and received his MBA from Case Western Reserve University. He earned the CFA designation in 2003.”
III. Where did his perspective come from?
For this article, The X Project analyzed five recent interviews with Luke Gromen that can be found on YouTube:
Luke Gromen: U.S. Treasury Market Continues To Dictate Dollar Liquidity Policies – Jan. 16, 2024 (16,557 views)
Luke Gromen: The Hard Landing Isn't Going To Come In Stocks. It Will Come In Treasuries – Jan. 11, 2024 (45,109 views)
All-Time Top Guests – Luke Gromen (The Forest for the Trees: On Inflation, Retail Investors, Precious Metals, and Bitcoin – Jan. 9, 2024 (2,948 views)
The Debt Bubble with Luke Gromen – Nov. 7 , 2023 (33,875 views)
MacroVoices #396 Luke Gromen: The Dollar Treasury Feedback Loop, Deconstructed – Oct. 5, 2023 (15,630 views)
IV. What is the top takeaway from his perspective?
Global Sovereign Debt Bubble, US Treasury Market, and the Fed’s 3rd Mandate
Here is a quick summary of Gromen’s macro view. In 2000, we had a stock market bubble. It burst, and policymakers dealt with it by shifting the problem to the banking system with the creation of the housing bubble. It burst, and policymakers dealt with it by shifting the problem to global sovereigns as they backstopped the banking system. And now, we have a Western sovereign debt bubble, which is in the process of bursting for the first time in over 100 years.
Gromen has opined for well over a year now that the Federal Reserve has a third “shadow” mandate: to keep the U.S. Treasury (UST) market functioning. And so, in order to fight inflation, the Fed can only tighten so much and for so long as the UST market continues to function. As soon as the UST market becomes dysfunctional, the Fed (and/or U.S. Treasury and/or U.S. policymakers) injects more liquidity into the system.
What does a dysfunctional UST market look like? The X Project looked at that in article #17, “Everyone is Missing the Point about the Fed's Rate Cuts in 2024.” You should read that article if you haven’t already. The punchline is that we’ve had five episodes of UST market stress and/or dysfunctionality in September 2019, March 2020, October 2022, March 2023, and most recently, October 2023. In each case, U.S. policymakers (the Fed and/or U.S. Treasury) figured out a way to inject more liquidity into the system, resulting in a weaker U.S. dollar.
What if the Fed and/or U.S. Treasury did not supply the needed liquidity in those situations? Demand for the U.S. Dollar would cause it to continue to spike higher. Those who need U.S. dollars would be forced to sell assets (USTs and U.S. equities) to get those U.S. dollars. The added selling of USTs on top of the U.S. Treasury’s massive issuance of USTs (and the Fed’s ongoing quantitative tightening or QT to reduce its balance sheet) would add to the overwhelming supply of USTs for which there is not enough demand and/or balance sheet capacity to absorb. The interest rates on USTs would, therefore, spike higher as the prices of USTs would crash lower. Because USTs are the primary collateral underpinning our hyper-financialized system, the reduced value of USTs would, therefore, create more demand for U.S. dollars, which would force more selling of USTs, which would lower the value of those USTs further, and round and round we go, spiraling out of control until it breaks big.
This is why there is a third “shadow” mandate of the Fed to ensure the UST market functioning - which means ensuring the U.S. government is able to finance its ever-growing debt and deficits. Given that we have already seen five episodes of things starting to break, we are approaching or already at the limits of the global financial system’s ability to continue absorbing U.S. debt. Be prepared for more frequent bouts of the UST market becoming dysfunctional, for U.S. policymakers to address it when it does happen, and for U.S. policymakers to do everything possible to avoid that from happening.
V. What is another top takeaway?
Energy Economics and Peak Cheap Oil
The concept of 'Peak Cheap Oil', central to Gromen's discourse, is a crucial pivot in understanding current energy economics. He argues that the age of easily accessible and inexpensive oil has passed, leading to rising costs and reshaping global energy dynamics. This shift is not just an energy sector issue; it's a fundamental financial system issue. The implications are vast, from inflationary pressures to geopolitical realignments.
The key takeaway here is that oil prices feed into the dynamic discussed in the section above. Despite efforts by the BRIC nations, the overwhelming majority of international oil is still traded in U.S. dollars. Therefore, the oil trade is a major source of demand for U.S. dollars. Oil-importing nations or regions (the European Union, China, India, Japan, South Korea, etc.) need U.S. dollars to buy oil. As their demand for oil grows, so does their demand for U.S. dollars. As the price of oil increases, so does their demand for U.S. dollars. This means that as they spend more U.S. dollars to buy oil, fewer U.S. dollars are available to buy USTs. Or worse, in some cases, this means that they have to sell USTs (adding to the dynamic described above) in order to buy oil.
This is why Gromen has long said that the only thing that can stop the bursting of the U.S. sovereign debt bubble is an energy productivity miracle, which is not imminent or even on the horizon in the timeframe necessary to stop this dynamic.
VI. What is a third takeaway?
U.S. Dollar
In Gromen's view, the U.S. dollar stands at a crossroads, and The X Project will explain which way it will go in section IX below. Gromen explains the paradoxical nature of the dollar’s current strength, suggesting it is a symptom of systemic issues rather than a sign of economic vigor, as explained in section IV above. According to him, the dynamics of dollarization and de-dollarization in global markets are critical factors shaping the future of international finance.
The X Project will write a future article about money and the U.S. dollar, but for today’s purpose, it is critical to know and understand that money is created in two ways: first, by the Federal Reserve, and second, by banks when they make a loan. And within that second reason lies the second irony, which is that efforts to de-dollarize actually strengthen the dollar in the short term because de-dollarization reduces (the growth rate of) the supply of new dollars.
And this feeds into the strong dollar/weak UST dynamic described in section IV above. Gromen’s examination of the dollar's role in the global economy is a masterclass in understanding how currency power plays in the modern world. Have you figured out yet which way the dollar will go, according to Gromen?
VII. What is a fourth takeaway?
Fiscal Dominance
As Gromen describes, fiscal dominance is the growing supremacy of fiscal policy over monetary policy in shaping economic outcomes. He implies that government spending and deficits are more significant in economic steering than traditional monetary tools like interest rates. This change, Gromen suggests, redefines the relationship between government action and market responses. It’s a shift that potentially rewrites the rules of economic engagement, and Gromen’s insights here are particularly prescient.
The X Project first introduced “Fiscal Dominance” in article #6. Then, it expanded on the concept in article #9, “An Introduction to Inflation: What is its relationship to interest rates, government debt/deficits, and fiscal dominance?” You should also read these two articles, along with article #17, which I mentioned above if you have not already done so. The punchline of the last article is:
“The US fiscal position is forcing the Fed to stop hiking and will be forcing the Fed to cut rates before inflation is back down to its targets. I wrote an earlier article introducing the concept, but this is what FISCAL DOMINANCE is.”
VIII. What is a fifth takeaway?
No Recession in 2024
Contrary to widespread pessimism among many well-respected and experienced economists and macro strategists, Gromen offers a contrarian view on the prospects of a 2024 recession. He bases his optimism - if you can call it that - on the fact that deficits greatly expand during recessions, which the U.S. can no longer afford, given everything discussed thus far. He argues that U.S. policymakers will do everything possible to avoid a recession; in fact, we have been witnessing that.
IX. What does The X Project Guy have to say?
Do not underestimate U.S. policymakers’ creativity in expanding the system’s ability to absorb the debt in an attempt to keep kicking the can down the dead-end road ever closer to the brick wall at the end.
What is an example of what they could do? An interesting and realistic idea Gromen offered in his latest Tree Ring report is releasing Fannie Mae and Freddie Mac from conservatorship. Freddie Mac and Fannie Mae are two government-sponsored enterprises (GSEs) that help the U.S. housing market by providing liquidity, stability, and affordability to the mortgage market. They buy mortgages from lenders and either hold them in their own portfolios or package them into mortgage-backed securities (MBS) that they sell to investors. This way, they help lenders to create more cash flow and lower interest rates for borrowers, and they also help investors to diversify their portfolios and earn income from the mortgages. Both GSEs went into conservatorship during the financial crisis of 2008 when the U.S. government bailed them out. Gromen’s idea is that if released from conservatorship, the GSEs could raise $25-$50 billion in capital to add to their retained earnings of ~$100 billion, giving them $125-$150 billion in capital. Given the FHFA-mandated capital ratio of 3%, their equity capital could be levered up to 33x, creating balance sheet capacity of $4-5 trillion to buy mortgage-backed securities (MBS), which the Fed thinks are effectively fungible with USTs in terms of the liquidity impact of the Fed buying them.
The other thing likely to see is more “alphabet soup” coming from the Fed in terms of various funding programs and mechanisms that will attempt to use all the letters in the alphabet except “Q” and “E” despite those forthcoming programs essentially being “QE.”
And, in or at the end, understand that this third mandate of the Fed to ensure the U.S. Treasury market functions (or, said, another way, to keep the government debt machine running in high gear) trumps the Fed’s mandate to fight inflation. This means that given a choice between saving the UST market or saving the U.S. dollar, they will choose - and actually have already chosen - to save the UST market at the sacrifice of the U.S. dollar. Of course, this should be no surprise to anyone who read This Time is Different: Eight Centuries of Financial Folly or The X Project’s summary of the book in article #5, as this is how all fiat currencies ultimately die.
In the final section, I will reveal other reasons why you should care about this dynamic and, more importantly, what you could do about it. However, The X Project now requires you to be a paid subscriber to view the final section. In a few articles, the paywall will move up within the article so that only paid subscribers will see the last two sections, or rather, free subscribers will only see the first eight sections. I will be moving the paywall up every few weeks, so ultimately, free subscribers will only see the first four or five sections of each article. Please consider a paid subscription.
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