Warsh Must Choose The Dollar Or The Bond Market | Luke Gromen
Luke Gromen, founder of Forest for the Trees, argues that incoming Fed Chair Kevin Warsh faces an impossible binary choice between defending the dollar or the bond market, complicated by the ongoing Iran war driving inflation. He believes the US fiscal situation is fundamentally unsustainable without Fed monetization, and that near-term risk assets face significant downside despite longer-term inflationary tailwinds.
Summary
The conversation centers on the macroeconomic challenges facing newly appointed Fed Chair Kevin Warsh heading into his first meeting. Gromen argues that despite Warsh's reputation as a hawk, he will ultimately be forced to support the bond market through unconventional means, as the US debt-to-GDP ratio of 122% and 6% deficits make the treasury market structurally dependent on Fed support. Gromen dismisses Warsh's publicly stated thesis of 'disinflationary AI-driven growth' as a 'fairy tale' designed to avoid making the explicit choice between sacrificing the dollar or the bond market.
Gromen outlines what he believes was Warsh's original plan: cut the front end of the yield curve, shrink the Fed balance sheet to steepen the curve, and use bank deregulation to allow commercial banks to absorb treasury supply through leveraged trades — effectively QE conducted through banks rather than the Fed directly. This package, overlaid with AI productivity narratives, was intended to be politically sellable. However, Gromen argues the Iran war has completely disrupted this plan by sending the front end of the yield curve higher at exactly the wrong time, creating what he calls a 'root canal with a shotgun.'
On the geopolitical dimension, Gromen argues the Iran conflict is being prolonged strategically by China, which has reduced oil imports by 4-5 million barrels per day without economic collapse due to EV adoption, grid infrastructure, and large strategic petroleum reserves. He views China as content to let the conflict drag on, watching US, UK, and EU bond markets destabilize. He cites the lack of any positive outcome from the Trump-Xi summit as confirming China is not interested in helping resolve the situation.
Gromen discusses financial warfare dimensions including China's yuan swap lines with 185 countries, which he argues have dramatically reduced the leverage of US dollar swap lines as a diplomatic tool. The UAE's demand for US swap lines — with an implicit threat to price oil in yuan — exemplifies this shift in bargaining power. He interprets the UAE leaving OPEC as part of a deal to ramp up oil production to help Bessent manage energy prices.
On markets, Gromen is bearish near-term across essentially all asset classes. He notes that gold and Bitcoin falling alongside risk assets is a warning signal, not a buying opportunity — they are pricing in the pain coming to equities before liquidity injections resume. He uses an 'adjusted Warren Buffett metric' (market cap minus federal debt, divided by GDP) which he says is at its highest level in 65 years, exceeding even the 2000 and 2021 peaks. He expects a 'no atheists in foxholes' moment where market pain forces policy capitulation before the monetization cycle resumes.
Key Insights
- Gromen argues the US treasury market is structurally dependent on Fed support because debt-to-GDP at 122% and 6% deficits mean there is not enough private balance sheet to absorb treasury issuance without the Fed's intervention — making true Fed independence functionally impossible.
- Gromen contends that Warsh's bank deregulation plan is effectively covert QE: steepen the yield curve, remove leverage constraints, and let banks buy the treasuries the Fed is selling — the same outcome as Fed bond purchases but laundered through commercial banks.
- Gromen argues China deliberately allows the Iran conflict to persist because closing the Strait of Hormuz destabilizes Western bond markets (US, UK, EU) while China has insulated itself through EV adoption, stockpiling, and reduced oil import dependency — making the conflict strategically advantageous for Beijing.
- Gromen claims China has established yuan swap lines with approximately 185 countries, which has fundamentally eroded US leverage from dollar swap lines — meaning countries like the UAE can now credibly threaten to switch to yuan arrangements, forcing the US into concessions.
- Gromen interprets the complete absence of positive announcements following the Trump-Xi summit as strong evidence the meeting failed from the US perspective, consistent with his view that China has no incentive to help end the Hormuz closure.
- Gromen's 'adjusted Warren Buffett metric' — total equity market cap minus US federal debt, divided by GDP — is currently at its highest level in 65 years, exceeding both the Q1 2000 and Q4 2021 peaks, which he views as a historically extreme valuation warning for US equities.
- Gromen argues that gold and Bitcoin declining alongside equities is a leading warning signal for risk assets rather than a buying opportunity, suggesting these assets are pricing in coming pain before liquidity injections resume rather than reflecting current monetary conditions.
- Gromen interprets the UAE leaving OPEC not just tactically as a deal with Bessent for increased oil production, but strategically as consistent with a shift toward petro-gold pricing — arguing that under a gold-settled oil system, producers' incentives reverse from restricting supply (OPEC logic) to maximizing production to accumulate gold at currently cheap prices.
Topics
Full transcript available for MurmurCast members
Sign Up to Access