A couple of relevant concepts affecting todays market are joined at the hip. Why has the U.S. experienced a sustained GDP growth despite having a hawkish stance by the Fed? Why the U.S. exceptionalism? And why does it appear that we’re seeing a pickup in inflation? Perhaps all of this has to do with what’s called fiscal dominance. As you can see in the chart below, the U.S. has been running large (in fact the largest) budget deficits at least for the last 7 years, above Developed and Emerging Markets. Growth has been financed by debt in a meaningful percentage, and that may have diluted the Fed actions, both when they have tightened rates, as well as when they have lowered rates. Government spending is inflationary, in fact as Milton Friedman used to say, it’s the only true source of inflation. And after being economically depressed for some time (ZIRP), but sustained by fiscal dominance and QE, we’re now experiencing the aftermath of excess spending, which manifests through inflation.
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