Washington Has More Than One Spare Key?

Last week, I wrote about Washington apparently knowing where the spare key is (link to previous post).

The Fed can keep rates high (maybe even push higher?), but the Treasury has other doors it can open: bigger long-end buybacks, changes in issuance, financial plumbing - the boring stuff that suddenly becomes LESS boring when the 30-year is north of 5%.

Well, apparently Scotty-B has another key on that glorious ring of his.

The U.S. dollar.

On Monday, Treasury Secretary Scott Bessent announced Operation Economic Outcast, which sounds less like a sanctions package and more like a spinoff of Mean Girls.

So, what's the focus? Total economic isolation of Iran...and anyone that is trying to help Iran.

The Treasury says it has mapped the networks Iran uses to sell oil and evade sanctions, expanded secondary sanctions across shipping, aviation, gold, technology and digital assets, and sanctioned more than 60 entities, individuals and vessels (who pooped in his coffee?).

But this was the line that almost made me choke on my lunch:

“Any entity that facilitates money laundering on behalf of Iran will be removed from the U.S. dollar system.”

He literally said "the clock is ticking"...after a reference about D-Day during WWII.

If you needed a refresher about what America's financial superpower actually is - well there you go. We print the thing everybody wants.

A bank, company, or country can decide to stick it to the man (the U.S.) and keep doing business with Iran. Washington's response is essentially: Sure. How attached are you to dollars?

Now, figuring out who actually gets hurt most by that threat is a whole other can-o-worms. I don't have the time, and frankly I don't trust the foreign-reserve data enough to pretend I have the answer.

But I can tie it to what I wrote about last. Remember our oil problem?

Last week, the first problem with Washington's spare key was oil.

Hormuz traffic remains severely disrupted, global inventories are under pressure, and any further escalation threatens another inflationary impulse.

We have been cushioning this impulse by using our Strategic Petroleum Reserve - and guess who is slurping that puppy dry...

So imagine Operation Economic Outcast works.

Iran loses revenue. Its trading partners get squeezed. Tehran feels increasingly cornered - that's the goal.

The unintended effect could be that Iran decides it has fewer reasons to play nice around the world's most important oil chokepoint.

And suddenly we're back to:

Iran -> Hormuz -> oil -> inflation -> Fed -> yields.

Not ideal when the long end was already giving Scotty-B attitude last week.

Then there's the dollar.

Here's the fun paradox - Operation Economic Outcast works because the dollar is dominant. If losing access to dollars didn't hurt, threatening to kick someone out of the dollar system wouldn't be much of a threat.

But every time America weaponizes that access, we're also giving other countries another reason to ask: Do we really want to be this dependent on the dollar?

Remember the sanctions we put on Russia in 2022? Russia has since been building legal rails for settling some foreign transactions using digital assets. Does that mean sanctions “caused” Russia to abandon the dollar? No. Does getting kicked in the crotch by the dollar system give you a pretty strong incentive to find alternatives to the dollar system? Pfft...yeah.

That doesn't mean everyone will dump Treasuries tomorrow or next year and start settling trade in gold, Bitcoin, or any other decentralized asset. The alternatives still have problems on the global scale. Lots of them.

But incentives matter.

If foreign governments gradually diversify reserves, settle more trade outside dollars, or simply become less enthusiastic buyers of U.S. debt, that matters for a country with $40+ trillion of federal debt (Lord help us).

It doesn't mean the dollar collapses. It means one of the structural sources of demand America has enjoyed for decades gets a little less structural. And when you're financing that much debt, “a little less structural” isn't exactly comforting to the broader market.

Less demand can mean higher yields. A structurally weaker dollar can mean pricier imports. Both have a funny way of eventually finding their way back to the Fed.

So now our tug-of-war from last week gets another participant.

Treasury: We would like lower long-term financing costs please.

Fed: Inflation is still a problem.

Iran: How about $100+ oil?

Bond market: Mom I think I threw up.

Also Treasury: Anyone doing business with Iran may lose access to dollars.

America's financial system gives Washington extraordinary leverage - when used correctly. But leverage isn't free.

Last week, Bessent was trying to make the Treasury market easier to finance. This week, he's using the dollar system to wage economic war.

Those two policies don't necessarily conflict today. Over a long enough timeline, maybe?

Washington might want to be careful with that spare key. It only works while everyone still wants into the house.