Fiscal Dominance in the US: Trump's Team Holds (Almost) All the Cards

In recent years, the United States has found itself navigating a complex economic landscape, characterized by a significant increase in national debt, an evolving relationship with global markets, and a powerful role in shaping global liquidity.

Central to this story is the concept of fiscal dominance—a situation where government fiscal policy, particularly debt management, plays a dominant role in shaping broader economic conditions, including monetary policy. But how did we get here, and what does it mean for the US’s economic future?

What is Fiscal Dominance?

Fiscal dominance refers to a situation where a government’s fiscal decisions—mainly related to debt issuance and management—become so influential that they shape monetary policy and the overall economic environment.

Essentially, when a country’s debt burden is large enough, and the financial system is heavily dependent on the government’s ability to manage it, fiscal policy takes precedence over other concerns, including controlling inflation through interest rates. The central bank, in this case, may be forced to accommodate the government’s fiscal needs, rather than purely focusing on traditional goals like price stability.

The United States finds itself in a position of fiscal dominance due to decades of rising national debt, driven by substantial government spending, particularly during the 2008 financial crisis and more recently, the COVID-19 pandemic.

As the debt grew, the Federal Reserve and Treasury Department made strategic decisions to keep borrowing costs low, including policies like quantitative easing (QE), which saw the Fed purchasing large amounts of government bonds to keep interest rates low. However, over time, these measures have limited flexibility. With rising inflation concerns and an increasingly burdened debt profile, these "levers" become more difficult to pull or generally less effective.

How We Got Here: The Key Levers of Debt Management

Historically, the US has used various fiscal tools to manage debt, including issuing long-term bonds to spread out repayment periods. However, as national debt grew, particularly in the wake of stimulus programs and economic bailouts, the US government began to focus on issuing shorter-duration debt.

This shift was partly driven by the desire to lock in low interest rates for the short term, which helped keep borrowing costs manageable. However, this decision—particularly under the leadership of Treasury Secretary Janet Yellen—has created a situation where the US is increasingly dependent on the short end of the yield curve.

Yellen’s focus on reducing the maturity of US debt made sense in the context of low interest rates, but it has left the US vulnerable as interest rates begin to rise. Short-term debt is more sensitive to rate hikes, which means that as the Federal Reserve raises interest rates to combat inflation, the cost of servicing that debt will increase significantly. This dynamic gives the US substantial fiscal leverage, but it also sets the stage for economic turbulence in the coming years, especially as the US approaches the need for debt restructuring.

The Role of Janet Yellen and the Federal Reserve

Yellen was appointed at a unique moment in history in January, 2021, as the United States navigated wild macroeconomic disruptions and a global pandemic. During her tenure, Janet Yellen took steps that, while aimed at managing the US’s fiscal obligations, also set the stage for potential challenges down the road. Her strategy of focusing on short-term debt was designed to lower immediate borrowing costs but ignored the long-term consequences of rising interest rates.

Meanwhile, the Federal Reserve was focused on keeping financial conditions loose through QE and low interest rates. However, as inflation rose and the economic landscape shifted, the Fed had to pivot towards quantitative tightening (QT)—unwinding its bond holdings and raising interest rates to curb inflation. These actions, though necessary, have compounded the pressure on the US debt profile.

Now, as the US enters 2025, these decisions are creating a unique confluence of risk. On one hand, the US government has been able to leverage low short-term rates for a prolonged period. On the other, these very policies now leave the US vulnerable to higher debt servicing costs as rates rise, especially when much of the debt is coming due in the next few years.

What is Liquidity and How Does It Relate to Fiscal Dominance?

Central to the world's current focus on debt refinancing is the concept of liquidity. Liquidity refers to the ease with which assets can be bought or sold without significantly affecting their price.

In the context of debt markets, liquidity is critical because it ensures that governments can continue to refinance their debt and access capital markets. A deep and liquid bond market allows governments to issue debt at low costs and roll over maturing bonds without triggering a crisis.

However, liquidity isn’t just a function of domestic conditions. It’s closely tied to global financial conditions, and the US—given its position as the world's largest economy and the issuer of the global reserve currency—plays a central role in global liquidity. US Treasury bonds are considered one of the safest assets globally, and much of the world's wealth is invested in them. But the shift toward short-term debt, combined with the Fed’s tightening policies, has led to a tightening of liquidity conditions both domestically and globally.

The Risk of Liquidity Reduction and Debt Restructuring in 2025

Liquidity experts are raising alarms about a potential liquidity crisis later in 2025. As the US looks to restructure its debt—likely to address the overwhelming burden of rising debt servicing costs—it could face a reduction in liquidity. The risk comes from the need to roll over large amounts of maturing debt, which could become more difficult as global investors demand higher yields for taking on US debt. Such a scenario would create higher borrowing costs for the US and possibly trigger a global liquidity crunch.

Debt restructuring could involve extending the maturity of US debt, altering interest rates, or even more drastic measures. If markets view the restructuring as a sign of fiscal instability, such actions may undermine investor confidence in US Treasuries. This, in turn, could lead to a liquidity reduction, both within the US and globally. Central banks around the world may be forced to intervene to stabilize the system, but their ability to do so could be limited by the Fed's own actions and the ongoing risk of inflation.

The US Dollar’s Strength: Bargaining Chips for US Policymakers

Now, we arrive at one of the most important aspects of this economic dynamic: the strength of the US dollar. Currently, the dollar is in a strong upward trajectory, benefiting from global demand for US assets and Trump's new tariffs. Investors continue to flock to the US due to its perceived stability, even amid rising interest rates. This dollar strength gives US policymakers substantial leverage in international negotiations.

The strength of the dollar can exacerbate liquidity issues for other nations, particularly those that maintain currency pegs or heavily rely on the US dollar for trade and reserves. These countries face increasing pressure to support their own currencies as the dollar strengthens, and their economies are squeezed by the rising cost of dollar-denominated debt.

In such a scenario, the US has powerful bargaining chips to extract concessions from these nations, such as trade agreements, military alliances, or even participation in broader global policy initiatives.

How Does This Position the US for Negotiations?

Given the current strength of the dollar, the US is in a position to demand favorable terms from other nations, especially if it offers to help stabilize the global economy through more dovish policies. Other nations, struggling with rising debt burdens and weakened currencies, may be more willing to make concessions in exchange for US intervention, whether through monetary easing or liquidity support.

This gives the Trump administration, as it takes control of the Treasury, substantial negotiating power. The US can leverage its fiscal policy decisions, backed by the strength of the dollar, to reshape global economic and trade dynamics to its advantage. The debt burden may be an ongoing concern domestically, but on the global stage, the US holds most of the cards.

It's interesting to note that the US must play its cards wisely, however, considering their competition. China and the BRICS nations stand to gain with any heightened geopolitical tensions or breaking points, so the US must ensure that it achieves diplomatic victories without strengthening its rivals.

The Path Forward: Key Takeaways

• Fiscal Dominance: The US has the unique ability to influence global markets and financial systems through its fiscal policies, but the rising debt burden and reliance on short-term debt create risks that need careful management.

  
  

• Liquidity Challenges: With the risk of a global liquidity crunch in 2025, central banks worldwide may have to take coordinated action, but the US could be the key player in shaping that response.

  
  

• Dollar Strength as Leverage: The strength of the US dollar gives policymakers leverage in international negotiations, and the US is well-positioned to extract favorable terms from other countries facing liquidity pressures. Last week, Trump told world leaders he is pushing for lower interest rates, but it's unlikely that that will happen until they are confident that inflation is "in check."

  
  

• Debt Restructuring and Global Impact: The need to restructure US debt in the coming months and years may create volatility in markets, but it could also provide an opportunity for the US to reshape its fiscal and diplomatic strategies.

  
  

• Stablecoin Adoption: At this unique point in history and technological development, stablecoins and the tokenization of real-world assets like stocks and treasuries may soften today's liquidity and borrowing risks. The growing importance of stablecoins and crypto regulations in the US adds another layer of strength to the dollar’s dominance, potentially lowering borrowing costs, increasing global liquidity, and reinforcing the US’s position as a global economic leader.

While the US faces significant challenges in the coming years, its fiscal dominance, coupled with strategic leverage in global negotiations, places it in a powerful position. The decisions made today will set the stage for how the US navigates its fiscal future and its role in the global economy. The road ahead is uncertain, but one thing is clear: the US will continue to shape the global financial landscape for the foreseeable future.