Whack-A-Mole

For the first time in 13 years, the Bank of Korea bought gold as part of its reserves. This could just be another central bank joining the crowd, but interconnected events this past week signal an increasingly unstable monetary system.

First, the WSJ reported that President Trump has been calling newly appointed Fed Chairman Kevin Warsh in multiple bursts followed by quiet stretches since Warsh took office three months ago. Trump has reportedly asked him only about the Iran War’s economic impacts and AI’s impact on the economy and not rates and Warsh has expressed a positive view in these calls. Usually, such calls go through the Treasury Secretary. In last week’s Fed meeting and press conference, the market assessed Warsh as less likely to raise rates in the evidence of high inflation. Trump also has restarted a campaign to remove Fed governor Lisa Cook. All these are signs of a Fed that is becoming less independent, and a lesser steward of money.

This comes in the face of Treasury Secretary Scott Bessent’s mysterious moves to coordinate the yen. Japan does not hold a cross-section of the Treasury market. Its holdings are disproportionately weighted towards longer-duration bonds such as the 10-year and the 30-year. When Japan sells Treasuries, it sells the long end of the curve where the U.S. is most fiscally sensitive. Social security liabilities and mortgage costs all price off of longer duration benchmarks. This past week mortgage rates hit almost 7%, making homes even less affordable. The Treasury is also forced into shorter duration issuance making monthly debt issuance larger. Japan’s behaviour could also trigger other U.S. Treasury holders into selling their long duration assets before Japan does, further exacerbating rates. The sharp steepening of the curve post Warsh’s press conference indicate the market is pricing in the need for the U.S. to have to issue paper at very high interest rates in the long-term.

Bessent has asked the Fed to allow Japan to use its FIMA (Foreign and International Monetary Authority) repo facility. Instead of selling Treasury bonds to raise dollars and defend the yen, Japan would pledge Treasuries as collateral and borrow from the Fed through the repo facility. The idea is that if Prime Minister Takaichi’s policies work and the yen naturally strengthens, then Japan will gradually pay down the repo facility and keep the Treasury bonds. However, if the bet doesn’t work then the Fed would own the Treasury bonds, which blurs the line between the Treasury and central bank independence, as it is potentially monetizing the debt.

Compounding the situation is the Iran War, where a deal always seems to be around the corner but never comes. It is clear now that Iran wants to control the Hormuz, much to the chagrin of the Trump administration. It also wants its dollar reserves back and has other asks that Trump is loath to give. With defensive munitions low, American allies would likely suffer from an Iranian missile onslaught if Trump took further escalatory actions. A ground war is now the only feasible way to control the Hormuz. And wars cost a lot of money. Trump has become a bit like King George III, where Parliament was reluctant to fund a war to keep America. The American Revolution was as much about Britain’s poor fiscal condition as it was about military victories.

On top of that is the large amount of debt betting on AI. This could lead to high returns and payoffs in the future, but in the short-term it’s fuelling inflation and is a serious risk to the private credit market if it doesn’t work out. Markets expect the Fed and the U.S. government to help bail them out if the bets go awry, but that safety net may come at the expense of the dollar.

The FT also reported that Bessent did not inform Christine Lagarde at the ECB that Washington would be selling euros to boost the yen. Typically, the U.S. would use dollars in such an operation. Senior ECB officials think the U.S. decision to use euros is an unprecedented breach of longstanding conventions on cooperation between western monetary authorities. One official was sad. “This has never happened before.” Europe not only should have concerns on the military safety net, but the monetary one as well. The Fed played an important role in stabilizing European banks during the Global Financial Crisis and played an active advisory role during the Greek sovereign crisis.

Another development last week is that China’s Zhu Hexin, PBOC Deputy Governor and SAFE administrator, met with Stephanie Eckermann, Chairwoman of Clearstream, which is one of two central securities depositories (the other being Euroclear). Clearstream handles trillions of dollars in settlement and custody. Hexin is in charge monetary policy and foreign exchange reserves management for China. The meeting almost certainly involved a discussion of yuan-denominated assets as eligible collateral in European settlement systems. Once a security is eligible in Clearstream's system, it becomes usable as collateral in triparty repo, securities lending, and margin arrangements across Clearstream's entire counterparty network, the same plumbing that lets a Bund or a US Treasury get pledged, re-hypothecated, and moved between institutions without the underlying asset changing hands. That's the thing USD and EUR assets have that RMB assets mostly don't yet, fungibility as collateral in the Western financial system, independent of whether anyone wants to hold them as an investment. A European bank that holds a yuan asset needs Clearstream (or Euroclear) if it wants to post that bond as margin in a repo with a counterparty that has never touched China's domestic settlement system. China’s SAFE put out a short statement on the meeting, which said nothing, but they usually only put out such releases when the meeting has significance.

These interconnected events are one of the reasons for gold’s recent upsurge. Korea restarted its gold purchase program after many years although for the moment it’s only buying domestically produced gold. Poland’s central bank has bought 80 tons of gold this year. China bought 20 tons of gold this past month.

How all this interconnection plays out is hard to predict. It depends on political decisions, inherently unpredictable. If the AI bet does not work out, there really are two directions of travel: (1) massive tax increases in the U.S. to help pay down the national debt and austerity; or (2) monetary debasement and the U.S. gives up reserve status. The weight of the evidence points toward debasement over austerity. Each incremental blurring of Fed independence lowers the bar for the next one, and central banks are pricing that erosion into gold. The tail risk to my thesis is that Warsh's institutional instincts do the disciplining work Trump's fiscal appetite won't.

The Singularity Goes Off-Balance Sheet. Barron’s said total off-balance sheet commitments to AI are now $2.7tn. This is the most recent consolidated estimate of the AI financing liability. AI companies are now talking about reaching the singularity with Elon Musk, Sam Altman and others all hitting the podcast circuit this week on recursive AI. This is essentially AI building itself and evolving on its own to solve great problems, or to cyber-hack your Bitcoin. Only the AI will know. Labs are racing each other and the technology’s own timeline, so they are not pacing out the investment. Their thought seems to be that if the singularity is coming or is here, they can’t afford to be behind. Hock Tan in a recent podcast logically noted that if the supply chain were given more time, there wouldn’t be such a logjam and prices would be much lower for semiconductors. Instead, the $2.7tn is funding 86% gross margins for memory makers. If the ROI on AI comes 10 years from now, Scott Bessent is going to be very upset.

DeepSeek Raises Prices. Just as markets were selling off on news that Chinese models would soon commoditize the AI space, DeepSeek announced that it would be raising prices substantially. DeepSeek's own compute bill probably explains the move. It is mid-raise on an $8 billion round to help fund a roughly $50 billion data centre build in Inner Mongolia, and sub-cost token pricing doesn't fund gigawatt-scale infrastructure. If the cheapest model in the market can't sustain its prices, that's a more useful data point for AI capex bulls than the singularity podcast circuit. DeepSeek hasn’t announced where its pricing will be, and Meta announced its own competitive pricing (although one can argue that its models are not competitive). Whatever the case, this is good for the AI space and potential returns on the massive capex investments.

No More Wind. President Trump doesn’t agree with The London Brief’s view that severing dependence on fossil fuels would enhance national security. Instead, the U.S. will pay $4 billion to companies to terminate their offshore wind farm projects. In exchange, these companies said they will invest in U.S. fossil fuels. To build a domestic solar supply chain, Trump is also imposing a 15% tariff and setting price floors on imported polysilicon (which will primarily impact China). Roth Capital projects the price floor will add $0.10 per watt to imported solar cells, translating to $600 to $800 in additional cost per typical residential installation. This seems likely to undermine the returns on solar project investments in the U.S. and make America more dependent on fossil fuels.

End Note

The hamburger was invented in America, but its name comes from Hamburg. German immigrants brought with them Hamburg steak, seasoned minced beef patties, a Hamburg specialty. America innovated by putting the beef into a soft bun allowing for portability and ease of eating, important at county fairs. However, I was introduced to ttaekgalbi, a grilled mince-meat patty, whose origins go back centuries well before Hamburg steak was developed. There’s no evidence Germany got the idea of minced-meat patties from Korea, and it seems like a completely independent event. Ttaekgalbi was mostly consumed by the royal court. If Korean historians can prove they put the meat in some sort of bread, there might be some intellectual property claim.

Omar Sayed