Hard Assets, Soft Money: Investing Through Fiscal Dominance

Hard Assets, Soft Money - Investing Through Fiscal Dominance.pdf

Download PDF • 3.78MB

Executive Summary

Global debt markets have swelled to $322.94 trillion (≈250% of world GDP), far outstripping global equities at $126 trillion. Governments now face mounting debt burdens, with servicing costs rising faster than revenues. This environment of fiscal dominance means monetary policy is increasingly dictated by government financing needs, undermining the long-term purchasing power of money.

Key Points

• Debt Dynamics: The United States is projected to run a primary deficit of c.$1 trillion annually over the next decade (excluding interest), with around $12 trillion of new debt required each year to refinance existing obligations and fund deficits. Sustaining this would demand revenue growth outpacing debt costs — a condition unlikely to persist.

• Monetary Policy Regime: We are in MP4 (Fiscal-Dominance Monetary Policy) across the US, UK, EU, and Japan. Here, central banks monetise debt, steepen the yield curve, and erode confidence in long-duration sovereign bonds.

• Investment Implications: Long-duration developed market debt has already suffered severe losses (e.g., US 20-year Treasuries down ~52% since 2020). Shorter-duration positions appear relatively more resilient.

• Hard Assets: Our focus is on assets that either represent hard currency or benefit from currency debasement. Gold and silver remain central, while Bitcoin has grown from <$5bn in 2015 to >$2tn today, becoming a meaningful part of the global hard-money basket.

In a world of fiscal dominance, long-duration bonds are structurally challenged. Short-duration strategies and hard assets provide stronger protection against persistent deficits, inflation, and the erosion of real wealth.

---

This paper provides an overview of how we develop views across asset classes and incorporate data into our investment process. The focus is on US debt, particularly long-duration bonds, and why shorter-duration positions—or select alternative assets—may offer relatively stronger total returns in the years ahead.

While the focus here is on the US debt picture, this is a developed markets issue. Debt burdens are set to rise across the developed world in the coming decades, making it essential to understand these dynamics for investment decisions in the short and long term.

The modern debt markets began to evolve in the 1970s, as investors discovered opportunities to profit by trading bonds in the secondary market. Demand surged—spurred by advances in computing that simplified bond mathematics—and new structures and instruments broadened access for both borrowers and investors. The US has historically offered the deepest bond market, but Europe expanded significantly after the euro’s launch in 1999, while developing economies integrated rapidly in the 2000s as growth accelerated.

Today, sovereign and corporate bonds remain the foundation of global finance, alongside mortgage-backed securities that fund critical sectors such as housing. By the end of 2024, global debt markets had swelled to around $322.94 trillion—about 250% of world GDP—towering over global equities at just $126 trillion.

Source: Institute of International Finance (IIF), IIF Global Debt Monitor, "Sectoral Indebtedness," 3 December 2024

Despite financial innovation, the basic dynamics of debt remain unchanged. Like households or companies, governments must ensure that obligations are supported by sufficient revenue. When debt service outpaces income, the options narrow: allow rates to rise, slowing growth, or turn to central banks to create money, devaluing the currency and fuelling inflation. History shows that major debt crises typically emerge when liabilities expand well beyond the stock of money, goods, services, and assets that can support them.

At its core, debt is a promise to deliver money in the future. When those promises exceed the capacity to pay, the outcome is either default or devaluation—different in form, but similar in effect: the erosion of real wealth.

Human behaviour compounds this imbalance. Borrowers seek immediate gratification by spending (inflationary) to pay it back later (deflationary), lenders chase yield, and policymakers prioritise near-term growth over structural reform. Central banks often respond by monetising debt, perpetuating the cycle. The result is rising leverage that looks sustainable—until growth slows below interest rate, inflation rises, or confidence breaks.

Debt is not inherently bad—insufficient credit can stifle growth, while well-managed borrowing can fund productive investment and remain serviceable. Yet even an AA+-rated bond can lose half its value. Consider long-duration developed market debt: since 2020, monetary policy shifts have materially altered its value.

Can these assets, once viewed as storehold of wealth and ballast in portfolio construction, still act as one in today’s monetary environment?

History shows that when hard currencies cannot service debts, governments often abandon them, shifting to fiat systems—the last major instance being 1971. In fiat regimes, central banks rely on interest rates, debt monetisation, and liquidity management to sustain lending.

Our assessment of this asset class focuses on three key factors: 1) the current monetary policy regime of the central bank, 2) government debt service relative to revenues and the balance of debt supply and demand, and 3) the relationship between revenue growth and debt interest rates.

Understanding the current monetary policy framework is therefore crucial. The following categorisation, drawn from Ray Dalio’s work on types of monetary policies1, helps navigate where we stand today.

Governments tend to take the politically expedient path, avoiding hard choices that threaten their standing, while central banks almost invariably resort to monetisation. In a deleveraging phase, options include cutting expenses through austerity, raising taxes—both deeply unpopular—or lowering interest rates to reduce debt-servicing costs. Yet in practice, governments favour fiscal expansion and central banks expand credit: a combination that inevitably devalues debt instruments by eroding the future purchasing power of money. Japan serves as a classic example of excessive credit, followed by deflationary bust and then monetary easing again. More recently, there was an attempt to cut expenses under President Trump, which was soon abandoned in favour of the “Big Beautiful Bill.”.

Japan’s case is an interesting one. The country’s economic woes trace back to the 1960s–80s, when credit-fuelled land and equity booms created a powerful wealth effect. By 1989, Japanese equities made up 42% of global market capitalisation. The subsequent collapse left banks weighed down by non-performing “zombie” loans, firms drowning in leverage, and consumers hoarding cash—over 60% of household assets sat idle at near-zero returns, while property values tumbled. For 35 years, the country struggled to repair the imbalance.

Since 2013, Prime Minister Shinzo Abe’s “three arrows” programme and the Bank (BoJ)’s ultra-low rates and aggressive debt monetisation further eroded the yen. Bondholders lost around 60% versus gold, 45% versus US Treasuries, and 6% in domestic purchasing power. Today, Japan faces a trilemma: CPI above 3%, 30-year JGB yields at 3.235%, and debt-to-GDP near 264%. But it has a healthy savings account due to Abenomics that has kept Japan from debt death spiral. The BoJ has so far stayed profitable, but, even modest rate rises could turn its balance sheet sharply negative. Japan remains a cautionary tale of credit excess, prolonged deleveraging, and monetary trilemma risks.

Today, we are in MP4—fiscal-dominance monetary policy—in the US and broadly across developed markets such as the EU, UK, and Japan. In this regime, fiscal priorities dictate monetary action rather than the reverse.

Several indicators support this view:

Central banks are effectively supporting government debt monetisation, devaluing local currency against hard assets like gold, and simultaneously boosting asset prices. The Fed has halted QT (Quantitative Tightening) and reinvests maturing securities into Treasuries, creating local demand when foreign demand has slowed. Despite minimal long-duration issuance, the long end of the yield curve remains highly sensitive to Treasury supply, reflecting an implicit yield curve control via issuance. Changes to the Supplementary Leverage Ratio allow banks to hold more Treasuries, increasing private demand. Traditionally reliable foreign buyers, including China and Japan, are reducing US Treasury holdings due to long-duration treasury bond losses, geopolitical factors, and more attractive domestic alternatives. Political interventions add further uncertainty, including Trump’s calls to limit debt maturities and push for lower rates. Another red flag is President Trump’s recent move to reshape the Federal Reserve Board by seeking the dismissal of Fed Governor Lisa Cook.

The effects, as discussed are that the long end of the curve has continued to steepen over the last year despite minimal coupon issuance, signalling loss of confidence over longer-dated debt not directly controlled by the Fed.

Source: Bloomberg, "US Treasury Actives Curve", 4 September 2025

Impact on US 20-year Treasury ETF total returns (-52% from its peak in 2020):

Source: Bloomberg, "TLT US Equity", 22 August 2025

Given the current debt cost and maturity profile, debt servicing as a share of revenue is particularly relevant. Excluding interest payments, the US is projected to run a primary deficit of around $1 trillion annually over the next decade—roughly 12% of revenue. This does not include interest expenses or the $10 trillion typically needed each year to roll over existing debt.

Source: Congressional Budget Office, The Budget and Economic Outlook: 2025 to 2035 (Washington, DC: Congressional Budget Office, 2025).

This dynamic creates government’s need to issue new debt of roughly $12 trillion (principal, interest and primary deficit) a year that the buyers must absorb. We believe the market’s (especially private holder) appetite for long-duration bonds appears constrained, as debt issuance increasingly serves to service existing obligations without a corresponding rise in revenue.

In other words, for debt to remain sustainable, revenue growth must outpace interest costs—a condition that may not hold over the medium to long term.

Source: Ray Dalio, How Countries Go Broke: The Big Cycle (New York: Avid Reader Press, 2025), pg 199.

This funding requirement would necessitate increased issuance, and under current Treasury policy, we expect a shortening of the debt’s weighted average maturity. In our view, this would compel the Fed to further cut rates to keep interest costs below revenue growth (President Trump has indicated this a few times), while expanding credit and purchasing Treasuries to monetise the deficit. However, for long-duration bonds, this is unfavourable: market participants would demand higher premiums to hold debt losing value through currency debasement.

Currency debasement and an expanding money supply inevitably drive inflation—more dollars chasing the same assets—as demonstrated in 2022. This underscores the importance of inflation, a core Fed mandate that has been previously mismanaged, and its implications for long-duration bonds.

The next chart shows the 10-year Treasury yield alongside a 3-year moving average of inflation. This relationship matters because high interest rates relative to inflation reward saving, while low rates incentivise borrowing and holding assets that benefit from inflation. Ultimately, while nominal rates are important, real rates are more telling as they reflect the true attractiveness of Treasuries as a store of wealth.

Source: TradingView, "US Government Bonds 10 YR Yield - 6M - TVC", August 2025

Current real yields are +1.55%, with 5-year, 5-year forward inflation expectations at 2.34% and the Fed projecting around 3.1% for this year. If deficit monetisation and currency debasement persist, inflation is likely to rise and real yields compress, making debt less attractive to investors. In this scenario, we expect the yield curve to continue steepening, as it has done to date (see Treasury yield chart).

In summary, short-term risks remain contained, supported by moderate inflation expectations, steady growth, and relatively healthy private finances, though debt supply-and-demand pressures persist. Long-term risks are far greater: US, G7, and Chinese debt levels are approaching thresholds that could prompt restructuring or monetisation. Accordingly, we favour short-duration positions relative to long duration debt positions.

Our focus is on assets that either represent hard currency or benefit from currency debasement. Gold has long held this role; today, Bitcoin—a scarce, decentralised asset—is emerging as a credible complement. Our hard-asset basket now includes gold, silver, and Bitcoin. Our Portfolios already carry commodities, gold, and silver equity exposures, and we are modelling to introduce Bitcoin from Q4, subject to FCA guidance on crypto Exchange-Traded Notes (cETNs).

Bitcoin has evolved rapidly. In 2015, its market capitalisation was under $5 billion, negligible in a $6.8 trillion global hard-money basket. Today, it exceeds $2 trillion, forming a meaningful portion of a basket now worth over $25 trillion. Institutional infrastructure—custodians, prime brokers, and regulated vehicles—has helped increase adoption and credibility.

Ownership remains concentrated—roughly 70% in retail hands, governments below 3%—and would need to broaden for Bitcoin to function as a true reserve asset. Yet its liquidity, cleaner price structure, and performance versus global M2 signal an asset maturing into the mainstream.

Source: bitcoincounterflow.com, "M2 Global Supply Growth YoY and YoY Growth Rate," 4 September 2025

As adoption broadens and volatility moderates, Bitcoin may settle into a conventional asset role with muted volatility compared to the last 5 years. For now, it occupies a unique space—structurally independent of macro-economic signals, and offering asymmetric upside provided our thesis of money stock expansion remains in force.

From an allocation perspective, the questions are clear: how stable is the price structure, how manageable is volatility, and how does it integrate with existing exposures?

We also consider whether, and to what extent, monetary policy would transmit in a Bitcoin-inclusive financial system.

Discussion of complementary strategies that may shape our asset allocation evolution will follow in a future note.

Authored by Asim Javed, CFA.