#425 Axel Merk: I Sat Down With Kevin Warsh — What the Fed Is Really Up To and Where Gold Goes Next

Axel Merk · Merk Investments

Fed's MBS buying and credit micromanagement eroded independence; Warsh's reforms would stop that slide.

Merk argues monetary policy should only set the amount of credit and interest rates, not allocate credit to sectors, which is fiscal policy. Buying mortgage-backed securities was an initial sin because it favored the housing sector, and it drew politicians into Fed decisions. He criticizes Bernanke, Yellen and Powell for going down this slippery slope and for micromanaging the economy, which increased political engagement. He says Warsh wants much less of that and that stopping this slide is a success even if little else is achieved. He cites Bernanke's own book as evidence that he envisioned ever more micromanagement.

“I think one of the initial sins was for the Federal Reserve to buy mortgage backed securities. When you buy mortgage backed securities, you are allocating credit to the mortgage sector.”at 18:05

Axel Merk · Merk Investments

Forward guidance makes markets mirror the Fed and strips the FOMC of market feedback; Fed should be referee.

Merk says that when the Fed gives forward guidance, the market becomes a reflection of what the Fed says, which removes the market indicators the FOMC relies on. The FOMC then ends up reading tea leaves. The more the Fed can get feedback from a market that is not dominated by its guidance, the better its decisions. He praises Warsh for saying the Fed should be the referee, not the player, and for striking the right balance in September. He notes Fed officials still give forward guidance, and that a reaction function is impossible without the full FOMC on board.

“one of the things that happens when you give forward guidance is that the market will just be a reflection of what the Fed says. And in the PowerFed, we saw that what happens then is that the FOMC is just reading tea leaves.”at 19:22

Axel Merk · Merk Investments

Fed should return to the pre-2008 scarce reserve system; current interest on reserves is politically costly.

Merk believes the Fed needs to go back to the scarce reserve system that existed before 2008. Under the current system the Fed pays billions in interest on reserves to banks, which is politically problematic and also covers up problems in the financial system. In the old system the New York markets desk intervened to set interest rates, a process the desk disliked because it was labor-intensive. Institutional pushback will be tremendous if Warsh pursues this, and he may not succeed. He says the balance sheet is still large and this is probably the hardest issue Warsh faces.

“I happen to believe we need to go back to the scarce reserve system that existed before 2008. For those that don't know, nowadays there's interest paid on reserves terribly politically because you pay billions to banks explicitly.”at 31:47

Axel Merk · Merk Investments

Fed is leaning toward tightening; an October hike was always very unlikely given the pre-election timing.

Merk reads Powell's successor Warsh's removal of a dose of accommodation as a tightening bias. Markets priced a near-zero chance of a hike this week, but he was surprised that any October hike was priced in after the September press conference. He says the tightening bias matters because the Fed won't hike and then immediately signal easing. He believes nobody at the Fed wants to hike directly before an election and would rather postpone, though they would hike if deemed necessary. He says Fed officials care more about the medium-term trajectory of rates and inflation than 25 basis point moves.

“the market is pricing in a near zero chance of a hike this week. I was surprised that after his September press conference, there was a high priced in at all for October. I always thought there was a remote possibility.”at 34:23

Axel Merk · Merk Investments

An AI bust would likely push the Fed toward lower rates, which would help gold miners.

Merk says AI investment is heavily debt-driven, so a bust would likely warrant a lower interest-rate environment. He says Kevin Warsh, though he praised him, will react to markets. In that scenario the classic dynamics of lower rates would follow and the miners would do quite well.

“If or when we have a bust in AI, because it is so heavily influenced by debt or much of it is debt driven, I would think that would warrant a lower interest rate environment, and then you'll have the more classic dynamics work out and have the miners do quite well.”at 41:44

Axel Merk · Merk Investments

Gold is hostage to the Iran supply shock; expects it to decouple as bonds and metals focus on risk-off.

Gold and bonds have been trading on the Iran supply shock rather than on broader risk sentiment. Last week gold fell, but Merk reads that as a positive sign because both bonds and gold focused more on the risk-off environment and less on Iran. He has been waiting for this decoupling and has seen several attempts in recent months. He says the market is forward-looking and should focus on the next development, so decoupling is positive even on down days. He notes gold's correlation with equities is roughly zero in the long run but unstable in the short run.

“what I've been waiting for is that the bond market more broadly, but then precious metals markets more specifically, are less hostage of that. And we've seen several attempts in recent months for this decoupling.”at 5:02

Axel Merk · Merk Investments

Central bank, diversification and purchasing-power demand should support gold over the long term.

Merk splits precious-metals buyers into groups. Central banks are incentivized to diversify out of the dollar, especially those hostile to the US. They will not move all reserves into gold, but gold benefits on the margin. Diversification investors are embracing precious metals as an asset uncorrelated with traditional assets. Purchasing-power investors are alive and well because US deficits are huge with no credible path to sustainability. He also notes the speculator returned to metals in spring 2025 and is now on the sidelines. He runs a firm that manages a lot of precious metals and says he personally holds more gold and gold miners than most investors.

“Central banks have been quote unquote incentivized to diversify out of the dollar, notably central banks that are hostile to The US. That doesn't mean they'll reallocate all the reserves out of the dollar into gold, but on the margin, gold has been a beneficiary.”at 11:54

Axel Merk · Merk Investments

Gold miners look cheap, and high precious-metals prices give them very high profit margins.

Merk says he believes the miners have some of the cheapest valuations in the market. Current precious-metals pricing gives miners very high profit margins, even though mining needs substantial investment. He argues this levels the playing field against capital-heavy sectors such as AI, where margins are uncertain. He says he holds a bigger miners allocation than most people and can afford the swings, so he is invested on this view.

“you also have very high profit margins in current pricing environment for precious metals. So you suddenly have a much more level playing field across many sectors.”at 41:06

Axel Merk · Merk Investments

US deficits have no credible path to sustainability; bond markets will eventually force fiscal reform.

Merk says US deficits are incredible and no path in sight shows they will come down in earnest and become sustainable. He expects a bond market reaction at some point that tells the fiscal side to get its act together, citing France and Brazil as examples of markets reacting to fiscal concerns. Monetary policy cannot fix bad fiscal policy, and the Fed should not egg on Congress to issue more debt. He expects more volatility as a result but says no politician wants to discuss deficits beyond lip service.

“The deficits that are just incredible and there's no path in sight that shows that our deficits will come down in earnest and will become sustainable is there.”at 12:32

Axel Merk · Merk Investments

The US fiscal situation is quite dire, in Merk's view.

Merk says the fiscal situation is quite dire in his view and layers this on top of his expectation that an AI bust would push rates lower and help miners. He gives no specific figures or mechanism beyond that.

“the fiscal situation is quite dire in my view”at 42:00

Axel Merk · Merk Investments

Rising long-term real rates reflect Iran seen as a shock, and signal market confidence in the Fed.

Gold fell in spring because the Iran supply shock pushed long-term real interest rates higher. Real rates rose because the market treats Iran as a temporary shock rather than a structural change, which raises short-term costs of doing business. He says long-term real rates and inflation expectations are confidence indicators on whether the Fed will contain inflation. Market orderliness shows confidence in central banks, and if there were no confidence, markets would be far more disorderly. He cites the Brazilian election reaction as an example of markets punishing policies they dislike.

“the market has and continues to price what's happening in Iran as a shock rather than a structural change. And in the short term, the cost of doing business, so to speak, is going higher.”at 8:11

Axel Merk · Merk Investments

Iran war is a supply shock; oil likely falls under either a Hormuz toll or regime collapse.

Merk calls the Iran war a severe supply shock with crosscurrents. He argues the Iran war will eventually resolve. In one extreme, Trump walks away and Iran controls the Strait of Hormuz, which would be geopolitically bad, but even with a high toll oil prices would likely come down. In the other extreme, the US prevails and the Iranian regime collapses, which also leads to a resolution. Even in the current stalemate oil is flowing, though fertilizer may not be. He expects the market to adapt and move on to other themes over the medium term.

“even if they exert a high toll, odds are that oil prices would come down. At the other extreme, if The US prevails, Iran's regime collapses, there would also be a resolution going forward.”at 10:22

Axel Merk · Merk Investments

Active short sellers last week set up more volatility; volatility can surge at any time.

Last week short sellers were very active across the broader market. Merk says this sets up more volatility because they can create violent moves. He is mostly long-term oriented but believes short-term positioning matters. For precious metals, volatility has been elevated and tends to surge periodically even when the long-term picture is intact. He says investors should be aware volatility can always surge and that it is part of how metals behave.

“last week from what we saw in the broader market, short sellers were very, very active. And what that means, if nothing else, is that we are setting ourselves up for more volatility because they can create some violin moves.”at 13:37

Axel Merk · Merk Investments

Warsh backs an AI productivity boom that could let the economy outgrow its debt.

Merk believes Warsh got the job because he believes in an AI-driven productivity boom. The world has too much debt, which can either be paid down, a path he calls a depression, or outgrown. Investments taking place now give a chance to let this boom happen and grow out of the debt. Merk frames this as the central reason Warsh was appointed, while noting Warsh is at heart a hawk who will tolerate no prolonged elevated inflation.

“I believe that Wash got the job because he believes in an AI driven productivity boom. But if you think about the world we live in, there's way too much debt out there.”at 20:53

Axel Merk · Merk Investments

AI-heavy markets risk a rude awakening with spillovers; the timing of any peak is unknowable.

Merk says the market is very tech heavy with AI trades dominating many portfolios, including those in the S&P 500. Even investors who avoid it are exposed to the sector's dominance. If or when the sector has a rude awakening, it will have spillover effects, and the question will be whether there are bailouts. He compares it to the late 1990s, when Greenspan warned of irrational exuberance in 1997 but the bubble did not burst until 2000. He says he has no idea whether we are in 1998, 1999 or 2000 and that the outcome could go either way.

“We are very, very tech heavy with the AI trades dominating many, many portfolios. If you invest in the S and P 500 and the like. And even if you're not, because of the dead binge in that sector, if or when there is going to be a rude awakening in that sector, it's going to have spillover effects.”at 38:04

Axel Merk · Merk Investments

AI investment needs huge capital spending with uncertain margins, unlike software's high-margin past.

Merk compares the 2011 software boom, which had a low barrier to entry and huge profit margins, with today's AI investment. He says AI requires huge capital investment and has uncertain margins. He uses this contrast to argue that capital-heavy sectors, including mining, now compete on more level terms.

“Software had a low barrier to entry, huge profit margins. If you think about the hot topic of today, it's AI investment, huge capital investment, and uncertain margins.”at 40:45