Regarding the nomination of Waller, interest rate cuts, balance sheet reduction, and fluctuations in precious metal prices

Introduction

On the evening of January 30, 2026, U.S. President Trump announced that he had nominated Kevin Warsh to be the next Chairman of the Federal Reserve.

Prior to this, precious metal prices had already begun to fluctuate dramatically, with the hallmark event of that period being the probability of Warsh's nomination at 95%.

So, why do some investors associate "Warsh's nomination" with fluctuations in precious metal prices? There are several understandable reasons, including but not limited to:

1. Nominating Warsh can preserve the independence of the Federal Reserve;

2. Warsh has served as a Federal Reserve governor and is a hawk;

3. Nominating Warsh helps boost the U.S. dollar;

In addition, there is a widely circulated but not easily understood reason:

1. Warsh's ascension will lead to interest rate cuts and balance sheet reduction;

Interestingly, many investors scoff at "the story of Kevin Warsh," so they did not want to sell when silver was at 107, expressed confusion when silver broke below 100, and were completely bewildered when silver fell below 80. "What’s the big deal about nominating Kevin Warsh?? Why all the chaos??"

In fact, the reason why nominating Warsh causes such chaos is that this action sends out two signals:

1. The U.S. government is going to implement interest rate cuts and balance sheet reduction;

2. The U.S. is going to raise oil prices;

In the articles "The Deep Relationship Between Gold and Fiat Currency" and "On the Nature of Currency," we discussed that precious metals are the opposite of fiat currency, and oil prices are the foundation of fiat currency, so raising oil prices will strike at the core of precious metals.

As shown in the figure above, in the last two trading days, both the U.S. dollar index and oil prices have been performing relatively strongly.

In fact, for investors who do not seek to understand deeply, they can already close this article at this point. Next, we will discuss some technical issues in monetary banking:

1. What is interest rate cut and balance sheet reduction;

2. Why high oil prices are a prerequisite for interest rate cuts and balance sheet reduction;

Interest Rate Hikes and Balance Sheet Expansion

I have discussed this proposition more than once: investors who adhere to the concept of "interest rate cuts and balance sheet expansion" are completely unprofessional or inexperienced, as they completely ignore the constraints of exchange rates. Ignoring exchange rate constraints means they assume there is a free lunch in the world.

1. Interest Rate Hikes and Balance Sheet Expansion

We will still use the supply and demand curve model of domestic currency debt. As shown in the figure above, for a non-U.S. country, if maintaining the exchange rate E* is a tight constraint, when it wants to expand domestic currency debt, it must raise its domestic policy interest rate r, shifting the demand curve for domestic currency debt from D(R, r1, Y, K) to D(R, r2, Y, K). In this case, the positive effect of the expansion of domestic currency debt demand D on the exchange rate and the negative effect of the expansion of domestic currency debt supply S on the exchange rate offset each other, ultimately keeping the exchange rate E* stable Thus, we have a seesaw. If the private sector wants to expand its debt, then the government sector must bear higher interest rates. "Interest rate hikes and balance sheet expansion" tells this story.

Interest Rate Cuts and Balance Sheet Reduction

1. Interest Rate Cuts and Balance Sheet Reduction

Symmetrically, if a non-U.S. country wants to lower its policy interest rate r to reduce government debt growth, it must consider the negative effects of interest rate cuts, which will cause the demand curve for its currency to shift from D(R, r1, Y, K) to D(R, r2, Y, K). Since maintaining the exchange rate E* is a tight constraint, lowering interest rates comes at a cost— it needs to find a way to shrink private debt, causing the supply curve of domestic currency debt to shift from S(π, e1) to S(π, e2).

Thus, we have another seesaw. If the government sector wants to lower financing costs to reduce debt, it must find a way to tighten private debt. "Interest rate cuts and balance sheet reduction" tells this story.

Swap Points and Private Debt

In the two diagrams above, the supply curve S of domestic currency debt has a swap point e, meaning that when the swap point e increases, private debt contracts; conversely, when the swap point e decreases, private debt expands.

In fact, this is not a new play; it was invented by the Japanese, who created the "lost thirty years" with high swap points.

As shown in the figure above, based on the short-term interest rate parity principle, we estimated the swap point e of the yen against the dollar using the U.S.-Japan short-term bond yield spread. In early 1990, the Japanese stock market peaked, and then Japan's economic problems began to emerge one after another. After that, Japan began "interest rate cuts and balance sheet reduction" and drastic measures. By August 1995, the U.S.-Japan short-term bond yield spread rose to around 5.5%, implying a very high yen swap point e. Thus, the so-called "lost thirty years of Japan" came about.

In fact, when you break it down, it’s quite simple. To save the Japanese economy, the Japanese government must first be saved, so Japan's policy interest rate was directly brought down to 0. Conversely, the cost was transferred to the private sector, which needed to drastically reduce debt. Therefore, Japan's zero interest rates and the "lost thirty years" are intertwined, as Japan was engaged in "interest rate cuts and balance sheet reduction," prioritizing the repair of the government's balance sheet. The subsequent story is well known; although the Japanese government's balance sheet cannot be described as very healthy, it can still extract some money to make things happen.

Interestingly, Kevin Walsh has been labeled with "interest rate cuts and balance sheet reduction," and this label has been amplified by financial media, claiming that Walsh's monetary policy is strange. In fact, Walsh's proposals are not strange at all, and these proposals have been practiced by others for decades. What is truly strange is that the vast majority of people inexplicably cling to the dogma of "interest rate hikes and balance sheet expansion," completely ignoring the developments in macroeconomics over the past few decades

In general, the essence of Walsh's "interest rate cuts and balance sheet reduction" is to compress private sector balance sheets and repair government balance sheets.

Dollar Swaps - Oil Prices

At this point, we encounter a bug: for central banks in non-US countries, the dollar is a natural swap object, so non-US countries have the swap point e as a tool. However, who should the dollar pair with?

In fact, this bug is prompting us to step outside the concept of "swaps" and look at the problem from a higher dimension, thus understanding "why high swap point e suppresses private debt."

As shown in the figure above, when the domestic banking system cuts interest rates, capital flows out, leading domestic banks to shrink their balance sheets while foreign banks expand theirs. However, government bonds are the core of the entire system, so we need to find ways to protect them and ensure their rigidity.

Thus, we have the topological structure shown above. The government has many ways to protect the government bond system, and in fact, the Japanese government has tried:

1. At a basic level, providing a high swap point e;

2. At a more advanced level, the central bank directly buys government bonds;

The final result is that significant interest rate cuts lead to a contraction of the domestic balance sheet, and the excessive contraction of private debt replaces the contraction of government debt.

Once we understand the principle of "the rigid core subset of the balance sheet," we can comprehend that the petrodollar agreement actually constitutes a variant of the dollar swap. The higher the price of oil, the more money oil-producing countries have to purchase US Treasury bonds. Therefore, the petrodollar agreement forms a funding pool that can maintain the rigidity of US Treasuries. When oil prices are sufficiently high, this funding pool will increase rapidly, which can lower US Treasury bond yields and attract more funds to buy US Treasuries.

Thus, we find a homomorphism: the principle of high oil prices damaging private debt is consistent with the principle of high swap points damaging private debt.

American-style Interest Rate Cuts and Balance Sheet Reduction

1. American-style interest rate cuts and balance sheet reduction

Thus, we can derive the supply and demand curve for US domestic currency debt, where oil price O replaces swap point e. Here, we need to make a careful distinction:

1. If oil is controlled by large multinational companies, high oil prices do not increase the US trade surplus, then O should appear on the supply side of domestic currency debt, as a parameter of S;

2. If oil is controlled by domestic US companies, high oil prices increase the US trade surplus, then O should appear on the demand side of domestic currency debt, belonging to the key monopoly factor K, for example, China's PPI is a parameter of D; To make the analysis more realistic, we let O appear on the supply side of local currency debt, serving the same function as the swap point e.

In the new framework, the discussion is quite simple. A reduction in the federal funds rate R by the Federal Reserve will cause the local currency debt demand curve to shift from D(R1, r, Y) to D(R2, r, Y). Symmetrically, they also need to raise oil prices O to curb the expansion of private debt. Ultimately, we will see a scenario similar to Japan: 1. low interest rates; 2. severe contraction of domestic balance sheets; 3. relative stability of the dollar.

The only difference is oil. In fact, this article clarifies why crude oil is an extremely special commodity: 1. the dollar has no object to peg to; 2. crude oil prices fill the role of dollar swaps.

In fact, this mechanism has been functioning normally for many years, and the muscle memory formed by most people is: fearing rising oil prices because of inflation. In reality, it is not at all; rising oil prices are aimed directly at private debt, so how can the U.S. stock market do well with a contraction in private debt??

Conclusion

1. Waller nominated

1. Dollar strengthens

1. Oil prices strengthen

1. Gold weakens

Finally, through the reasoning of the entire model, we find that Waller's interest rate cuts and balance sheet reductions are aimed at inducing stagflation in the U.S., where stagnation comes from the balance sheet reduction and inflation comes from high oil prices. Thus, the villain becomes an external variable—high oil prices force the Federal Reserve to "maintain" low interest rates to support the economy, and the government is "forced" to manage debt to curb inflation, making everyone a hero in eliminating the "external enemy."

So, this is the art of politics; stagflation is the option that best fits the current political logic of the United States.

Inflation is a choice of the Federal Reserve.

ps: Data from Wind, images from the internet

Risk warning and disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at your own risk.