Breaking Down Eurodollars - The Most Important, Least Understood Market in the World

in down Eurodollars the most important least understood market in the world this event is part of our institutional access webinar series I'd like to invite our speakers to unmute their lines and turn on their videos during the webinar please submit your questions through the Q&A section at the bottom of your screen we'll save some time at the end of the discussion to answer these the session will be available on demand all of our districts will receive an email once the recording is live I'd now like to turn the event over to Michael a bolito co-founder of black works group Mike please go ahead doing.and Hey hello everyone thank you so much for joining us today we've got a really special episode of institutional and access I'm very lucky to be joined by Jess Nidoran Brent Johnson will introduce in just a minute but first just a quick 20-second overview on block works group though bwg we are in events in media company that shines a light on some of the most interesting and relevant issues from a macro investing standpoint today in happier non-coated times we host a series of live events and we also produce a series of podcasts and webinars which is what you're watching right now so today's episode of institutional access is all about the euro dollar market or the euro dollar system as our friend Jeff would say so like I said before I'm very lucky to be joined by some of the I say the world's most leading experts on this particular space so without much further ado I'd like to introduce our two guests that Jeff and Brent gentlemen if you wouldn't mind just giving a quick 30 second introduction for yourselves for the audience okay sure I'll start my name is Brent Johnson I have a wealth management firm in San Francisco called Santiago capital and I do a lot of work in the macro space and the the dollar and the euro dollar has been a focus of mine for you know the last two or three years so happy to be here and talk about it I'm Jeff Snyder and with alhambra investments a registered investment advisor in Florida my job my role here is to try to letter inform our portfolio managers of what's going on that's just in a macro context but of the financial monetary context and I've spent a couple of decades now researching following down this rabbit hole of what we call the euro dollar system which is really a monetary black hole or black space that's been unexplored for 40 50 years for reasons I hope we get a chance to get into but essentially it's it's a sense it's a shadow money system that is literally in the shadows excellent thanks Jeff and that black hole day it's it's a black hole so this is actually going to be a 20 hour webinar as we were joking of course I hope everyone's ready for that no it's it's a really interesting topic and we're going to do our best to just condense some of the most relevant points into the one hour that we have today so thanks gentlemen again for being here and without much further ado let's dive in so there's really a lot to cover here in the euro dollar system I'd like to begin with just a basic sort of glossary terms and and one of the contentions that I think both of you has made which is just starting with the US dollar as a reserve currency I think that's kind of the general understanding but as both of you have mentioned before the the US dollar is kind of a reserve currency in name alone and there's actually another system which is the euro dollar system that practically functions as a reserve currency for the rest of the world so there's a lot to break down there and but I'd love to just start with examining that contention that actually the the US dollar is just one part of the central reserve currency system and there's a much more important and larger euro dollar system so whichever one of you starts wants to start to go with that that'd be that'd be great well first of all I mean the term euro dollar itself is somewhat of a misnomer it has a it has a traditional historical use which was you know currency now US dollars that were on deposit outside of the United States and so it represented with Jack what you're talking about which was the US dollar as the reserve currency but this euro dollar system which is a more comprehensive bank centred system that developed over the decades since around 1955 or so that's more encompassing and it's really it's it's the system itself actually undertakes the roles of the reserve currency even though the US is preserved as the overall denomination so we call it the US dollar but this is the actual functions of that reserve currency the monetary functions of that reserve currency are provided by this overall system which is you know far more than u.s. dollars on deposits and banks around the world yeah and I think I would add that in you know the origins of the the euro dollar market are a little bit as you know maybe not quite as murky as the market itself but it's similar you know it's started back in the 50s post-world War two with the you know the Marshall Plan you know the United States financing the rebuilding of Europe and you know getting dollars into Europe and so then you had dollars in Europe and and that's kind of where the name euro dollar came from it continued through the 60s and 70s and you know in the 60s and 70s you know Nixon wanted to finance the Vietnam War but he didn't want to do it through French banks so we started opening up American banks and in Asia to help finance the Vietnam War and so that kind of contributed to it as well and it really you know I think sometimes people here euro dollar and they confuse it with euros which which should not be the case again the thing that makes it such a mess in my opinion and I'm not sure if Jeff agrees with this or not but you know it's it is two systems but they're interwined and there's some fingers that kind of stretch across and in both systems it is US dollars and only there's only one or there's only two entities the the Federal Reserve and the Treasury that can supply dollars but half of this market or more than half of this market or the euro dollar market the euro dollar half of the overall dollar market has no regulation it has no entity out there who you know oversees it so to speak so it's really kind of becomes a spiderweb of dollars around the world some of which are regulated and some of which are not and it's a it becomes incredibly hard to decipher all of it just because there is no regulation anyway all the I'll leave it at that for now well Brad I think that's a really good point especially you know people are taught and we're told to conceive it hey it's the Treasury Department the Federal Reserve that's the only place that US dollars can come from and there we know what are we talking about I used to exactly look you the Fed can print Federal Reserve notes the physical paper that have numbers and all the symbols on and whatever but as a bank and as your if you're a bank and I'm a bank we can create as many IOUs that say that we have dollars as we want and so it's it's a step removed from any actual currency system in many ways it's a quasi currency system of one that's entirely ledger money in fact it's one of the reason we talk about the origin story then one of the reasons the euro dollar market took off and specially the 1960s was because it was freed from the the the need to ship gold bullion around all parts of the world it was then free from the need to ship actual physical currency around it was simply you know with the revolution of technology the immediacy of transactions as long as our my computer screen the numbers on my screen match the numbers on your screen we've got money we've got dollars we've got some something's going on here this monetary in nature and financial in nature so in many ways it basically got added from the physical supply of currency and becomes a David you could argue it was the first digital currency the first global digital currency because it's used all over the world yeah exactly there's nothing new I mean I mean it really was and it still is probably other than the you know Bitcoin and the digital asset market right now I would argue that the euro dollar market is is was and still is sort of the wild wild west because there's sort of rules around it but there's no agency that can actually enforce it so it's just kind of a a mess lack of a better word yeah and I you know that's that's a great point too because you know we're all taught to believe that the rules are always given top down like central bank regulators central bank's whatever they give the rules to top down and the euro dollar system its exact opposite the rule there are no but they're bottom up it's how banks construct their balance sheets in individual cases that governs what those balance sheets do in the aggregate so it's not a central bank dictating to all the banks it's all the individuals individual the banks within the system operating within the system that use their own set of rules to dictate how they participate in it which makes for as you pointed out a far Messier situation especially when you can't really get a handle on what's going wrong or if something's going wrong what is it you know when you have a bunch of individuals working yeah and I think we're gonna get into this later so I won't go into super detail right now but the reason it's a problem in my opinion is because of the design of the monetary system itself the design of the monetary system is a fractional reserve system which means money gets loaned into existence and that's fine as long as expansion continues and the extension of credit which creates more money continues the problem is that in the fractional reserve system when it starts to go the other way and you get a contraction you have a very high likelihood of contagion and where one loan kind of collapses on to another loan and you go back the other way and in that environment in a fractional reserve system you need a central bank or a lender of last resort to kind of come in and rikka lateral eyes the system but because there is no entity outside the United States that can create dollars for lack of a better word or new collateral there is no regulator or no entity to help stem the problem from a collapse if and when it comes now you there there's been a number of you know little patches here and there but there is no systemic way to actually solve the problem or there's no current way there's no current function there's no current mechanism by which they can solve this problem but this actually happened I mean that you basically I just described 2008 it's exactly what happened in 2000 it's why we had a global financial crisis in the firt and that's why it was a global financial crisis yes because we're talking about a global currency therefore as it is it fell back in on itself you know with no nothing to stop that process from taking place contagion was ever even sprayed all over the world it didn't know parts of the world were unaffected by what happened in 2008 because it's very little to do with subprime mortgages it was about a global shortage in the Eurodollar system which the Federal Reserve the u.s. trade whatever they're just not connected to it and therefore you know even if they wanted to they believe their you know their their mandate ends at the border of the United States and therefore whatever happens in dollar terms outside the United States is somebody else's problem you know but that's the point you know there's this this this unofficial black space where nobody even knows who's responsible for it let alone what goes on in it right yeah where we get too deep into the problems I just want to make sure that everyone's on a level we're talking about here so it seems like what we're describing is two distinct monetary systems right there's the traditional kind of top-down monetary system where the US dollar is the federal reserve currency and it's regulated by central banks right which is the one that we all kind of know and think about existing but it seems like you're both describing is another unregulated almost emergent monetary system right which is this euro dollar system which is actually created by international banks right that are fun accreting funding sources in u.s. dollars just to get on a level to make sure that everyone in the audience is on the same page I'd like to start with the traditional system that people think about existing today right which is top-down and governed by the Fed so could we just start with a brief description of what that monetary system looks like why we have a global reserve currency in the first place and I think by outlining it that then we can get to this euro dollar system and how it's different well I you know I don't think there's actually two different system I think there's an intellectual framework that we're all taught in college and gets reinforced from the media that never actually exists it I think it was a it was oversimplified to begin with you know what we're all taught is you know back before quantitative easing the top-down approach was the Federal Reserve would move the federal funds rate up and down and that would signal to the banking system to either create more credit or to create less credit right if if alan greenspan raised the federal funds rate what that was supposed to mean was that it made it more expensive for maturity transformation which was banks borrowing in the short run lending in the long run so if alan greenspan raised the federal funds rate what that did was that supposedly it constrained banks because it was more expensive for them to borrow i it was ever actually the case I think that's just a myth that was perpetuated to try to explain why and seem like Alan Greenspan had all this power and authority the banking system was far more complicated and as I mentioned before it's it contains its own subset of constraints that often super see whatever the Federal Reserve is doing so you know I hate not to derail the conversation and digress too far but I'm not really sure that you know the the intellectual framework that we've been given for you know for a very long time was ever really appropriate to begin with I certainly think it was oversimplified as a public narrative to try to give a public a sense of what monetary policy was supposed to accomplish but I don't think that was anyway realistic especially when you think about this Eurodollar system didn't show up in 2008 it's been going on since the 1950s and it really took off in the 1960s so while all the stuff was gone you know while Alan Greenspan was playing around with the federal funds rate in the background you had this global monetary systems of global dollar system which had really taken over things long before anybody Rutten long ago long before anybody heard of subprime mortgages yeah and I think the other thing that's important to understand and all this and this probably is that this is more big picture and it brings in the politics side of it a little bit is that you know if we're talking about a global reserve currency we're talking about kind of a a currency that is used worldwide for general trade and it just typically happens that it there is one country whose domestic currency ends up being the global reserve currency and part of the reason that it ends up that way is that it's enforced by that country and it is provided by that country and it just also so happens that it's usually the global superpower that has the the global reserve currency and you know if you look back into the 70s you know part of this whole transformation of the euro dollar market really is when you know Nixon struck the deal with Saudi Arabia to price all the oil in dollars and then you know they would they would sell in dollars and they would use the dollars to buy US Treasury notes and again and then you know with oil being priced in dollars and the whole world needing dollars and in other countries needed dollars to buy oil and so then they would say their reserves in dollars and again this is all kind of you know it wasn't necessarily mandated by the US but it was strongly suggested right and we built army bases all over Saudi Arabia and provided you know defense for the the family of Saud from Saudi Arabia and you know again it's not only that but it's part of that because as a global reserve currency you have the power to print money and you have the power to print global money and you can kind of over time you can debase your money you can get away with murder quote-unquote better than a country who doesn't have the global reserve currency because you have so much in demand for your currency and what I mean by that is you think about all the money that has been generated or printed or however you want to define that the whole money printer Gober mean kind of drives me crazy but I guess it's it is accurate you know if you think about all the the new capital has been injected into the system over the last 12 or 13 years and yet the same time or that same time period the dollar has risen versus other fiat currencies it's because there's great demand for the dollar if a if a frontier country printed that much currency you would see dramatic amounts of inflation and in fact you have seen it in places like Venezuela and Argentina because there's not external demand for their currency and so you know it is a great advantage to have the global current reserve currency but you know you can get to a point where it becomes a curse and we may be kind of entering that time period and there's this famous I guess theory for lack of a better word called Triffids dilemma which says you know if you have a country whose domestic currency is used as the global reserve currency you will eventually get to a point where the needs of the domestic economy come into conflict with the needs of the global economy and we are kind of right in the heart of Triffids dilemma right now this is how I see it now again Jeff maybe disagree with this but you know we you know when when Trump came in and you with his make America great policies and he's trying to run a trade surplus rather than a trade deficit that just doesn't really work with a fractional-reserve global reserve currency where the domestic market has to provide plenty of currency for the rest of the world and so we're in this battle of what is good for the US economy versus what is good for the global economy and it's led to a number of problems and I think it's kind of led to the knowledge or at least the awareness of this whole euro dollar system I came or pragmatic view of things especially the development of the euro system which happened long before Nixon went off the gold standard the euro dollar had replaced the the the certainly the British Pound his Co reserve currency as well as took over the monetary functions of the global reserve in the 1950s and 1960s and by the way I mean the US authorities in the Johnson administration we're okay with that because as you pointed out Robert riffin said in 1960 look if you have a national currency become a global reserve currency there's always going to be a natural tension and under the Bretton Woods standard that meant that tension was in terms of cold which was the US only had so much gold but it needed to supply currency to the rest of the world why did it need to supply currency to the rest of the world because that's what a global reserve currency is it's a mitigating factor it's a mediating factor between often very different systems that they can talk to each other and not just trade with each other and merchandise goods but also financial flows if if you're somebody in Sweden you want to invest in Japan it are the Swedish banks have a lot of yen lying around no it's much easier if everybody has a common currency that they can appeal to directly so they can you know a Swedish investor can invest in Japanese firms or whatever you know because Jeff Japan and Sweden both need dollars they have dollars readily available but that's what tripping was saying is that in a national currency to have dollars available all over the world that can create a lot of tensions and I think what happened in the 60s especially was nobody really knew how to go off the gold standard how does how do we keep this globalization effort going but how do we also resolve the problem that this is you know the you there's not enough gold in the United States for all these dollars all over the world dollar liabilities all over the world it's only took the view of what was excuse me what was called benign neglect which was we'll let these banks create all these US euro dollars out there and we won't do anything about it because we don't know what else to do essentially and I'm you know I'm oversimplifying but that's really what happened in the 60s was that okay this there's this this this offshore money market developing and US banks are starting to participate it very heavily and there's all sorts of money creation out there in the in this global marketplace this offshore euro dollar system but it's taking the pressure off of us and our gold reserves therefore we'll take a hands-off approach and we'll just let this thing go and there were a lot of people in this in the 1970s in particularly said wait a minute exactly the stuff you're talking about Brent earlier on you know there's nobody out there's no regulatory agency out there there's no central bank out there what if this thing starts to go right what if there's a bankruptcy god forbid I remember there was a transcript at FOMC transcript from 1969 where Charlie Coons who was the open market desk operator at the time said what happens if a German Bank goes bankrupt in you in the euro dollar market what's gonna happen then well it took you know almost 40 years for us to find out but that we found out that it wasn't out right you know it's it really it's a pragmatic thing because there's really nothing else how do we how do we do how do we how does a global economy actually work it needs money money is a tool for the free all of these systems to work together and really the only way to answer it is this you know this eurodocsis Bank centered system because nothing else has worked so far yeah I kind of want to summarize what both of you're saying that's always locally dangerous when Jeff is on the call here I'm probably going to get corrected but I'll give it my best shot so basically what it seems like is the the reason why we have a global reserve currency used to finance trade right there's sort of a natural monopoly that needs to happen around a currency whereas just for it to function as an effective medium of exchange we want everyone using the same currency there was a bit of a problem when Bretton what the Bretton Woods system was rolled out in that there was a limiting factor which was gold which we essentially got rid of and now we have the Fiat dollar system that exists but even without the limitations of gold it was difficult or not really pragmatic for the United States to print enough dollars to fund the amount of global trade that wanted to have so what we saw is this emergence system which is the Eurodollar system which kind of exists to plug in the holes right and to finance decree financing between countries when there's a shortage of US dollars now I think this is usable deniability right that we can do that's not our fault we're not doing it's the banking systems I'm sorry you're not doing it it's just these dollars are out there in the world it's not ours there's one there's one other little part to that I yeah we don't need to go down this rabbit hole but but you know there is also like the Eastern Bloc nations and the 60 70 s and the height of the Cold War they they had dollars they were afraid that if they kept them in US banks they could be confiscated or you know you know regulations on or whatever and so they wanted to get they wanted to hold dollars because there's a global reserve currency they didn't want to hold them within the United States jurisdiction so I think they moved him to Canada and then they moved into Europe and so anyway I just I always like to just reinforce that while while Jeff is completely correct on all the the economic side of it there there is a political variable in here as well hey there's also the central bank variable too as part of benign neglect one of the reasons the euro dollar system flourished was the all these overseas central banks especially the 1960s were the biggest participants in it you know for example the Bank of Switzerland which would get you know because they had a peg that they had to manage their currency pegged to gold whenever they had too many dollars flowing into Switzerland they were obliged to convert them into u.s. gold what they realized in conjunction with US authorities was they could circumvent the Bretton Woods system by swapping swapping those dollars into the euro dollar market thereby allowing the Americans to keep their gold letting those dollars go into the euro dollar market not as physical currency but as a liability to the central bank and the whole thing just worked when everybody just kind of turned a blind eye to it in a lot of ways they didn't understand what they were doing but really it was you know really benign neglect we don't really care what's going on because it seems to be working and so long as it seems to be working we'll just kind of take a very hands-off approach to it well it's a very good point because it happens on a smaller level in every everyday lives like as long as people are making money little problems oh don't it's not worry about it right you know making money solves a lot of problems like it's like when you're on a sports team when you're winning everybody's happy but when you start to lose or when things start to go wrong then every little thing starts to become a problem but when you're winning it's all good and so I think that translates you know to Jeff's point as long as things were working credit was being expanded you know economies were growing you know turn the blind eye or the plausible deniability and you know let's just let this thing let this thing rise yeah you know one of the things I think you talked a lot about Brent is emerging markets you know why would a merging markets especially China go along with this system well it's just what you said right I mean that you the Eurodollar system and the globalization wave that started after World War two turned all of these emerging market economies upside down they were agrarian very primitive very simple all of a sudden they're modern super power type economies so now why wouldn't they go along with it because it was making them wealthy and rich and so long as that was going on you know they might have seen it may have been aware of some of the downside some of the imbalances you know the bubble tendencies why are so many foreign banks interested in my economy that kind of stuff they didn't care about that because at the time it was working really really well and so it was hard to say we have you know we object to this kind of a system because you know we see that there's problems with it it's always down the road well we'll deal with it at some point down the road and then once you get down the road it's too late yeah taking the cab so to speak policy decision so I really want to put as much as possible almost a ring fence around this definition of what the Eurodollar system is so if you look it up on a simplistic definition which is just you know if I might take $100 you know hundred dollar US dollar bill go over to France and deposit it in a bank there then that will become a euro dollar I think that's a very narrow definition of what we're talking about and I think what we're talking about is a system that is much more large and more impactful so I know it's a tall task but I put the question to either of you could you define what we are talking about when we're talking about the euro dollar system well it's what happens when that dollar goes what happens to it from there so you've deposited a dollar in France what is the bank was that Bank in France do with it well usually nothing it sits in a vault but then it can create all sorts of liabilities predicated on that dollar because it says I have a dollar so in a fractional reserve system is Milton Friedman showed in 1969 there's a reserve there's a multiplier effect for all of these foreign dollars and they don't even have to be physical dollars they could just be any kind of US dollar liability or asset in the case of the bank that that holds it so it's what happens once those dollars are offshore what happened a long time ago when those are all shorts that we can't they began to expand so you have all sorts of liabilities piled on top of what used to be your single dollar bill that is on the in in the vault for this bank in France and that it doesn't stay in just one place it B gets multiplied through all these ledger transactions between banks that are operating all over the world so your one dollar that goes to France could end up as multiple dollars in Asia South America Africa any all the way all the way around the world so that's what I was taught I'll give you a really simple analogy so I grew up in a little town in western Nebraska about an hour from the Colorado border and when I was in junior high in high school the laws around alkyl buying alcohol were different in Colorado than they were in Nebraska so you could imagine people that were eighteen and Nebraska couldn't buy beer but if you went to Colorado you could so you would get in your car you drive an hour to Colorado and all of a sudden you're still the same person so it's like you're still the dollar but now you're in a land that has different rules and then you buy your beer and now you've got a young irresponsible person who's drunk now that's the Eurodollar you know you're still a dollar you just don't have the rules are different there's nobody trying to catch you and you're irresponsible and so you know that'd be my way to explain the Eurodollar system the drunk dollars algae we can all relate to it's just the same thing with different rules it's the same commodity with different rules and when and when when rules are relaxed people will take them you know as far as they can absolutely so what are the implications of this system existing you know I think in in other and also if you could try to you know order I know it's difficult to measure what the size of this market is but both of you have indicated that the size of the Eurodollar market is actually much larger than the size of the market for just US dollars so what are the implications on a system a large and very impactful system like this existing outside of the reach or the direct reach of US regulators well again that's a very good point because we actually have no idea how big the system is I mean we don't really have any good idea I mean there there have been a few efforts especially in the wake of 2008 to try to figure out what's out there but you know we have a bunch of probably have we have blends we have blending of dirt of geography in jurisdictions we have blending between what's credit what's money and so you really have to go into what are you know Bank footnotes to try to figure out what are all these banks doing in each other and then there's double-counting there's also a mean because this euro dollar system grew up under benign neglect the plausible deniability all of these things nobody has ever undertaken a real determined effort to study what goes on out there that includes not just quality or quantitative measures but also qualitative measures what actually is a euro dollar in terms of money what kind of transactions would qualify you know Alan Greenspan said in 2000 that the proliferation of financial products made it impossible to even define money in the modern sense so we're already starting from you know again literal shadow money we don't even know how to define it we can't quantify it and so we're kind of trying to study and to understand a system that is not easily understandable that is not you can't observe it you can't feel you can't touch it so you know to understand the implications to get a sense of it it's it's really a very difficult and esoteric process yeah I think what I would say is I you know I'm not gonna sit here and pretend that I know exactly how it big it is because there's people you know like Jeff and maybe there's another 50 people in the world who understand it as well as Jeff and you know they probably all disagree right and I don't think they have an idea of how big the market is this is what I know for sure what I know for sure is that is a huge market very few people understand it there's no regulators and that the people who do sort of have quasi regulation over it our PhDs who have never acted in the real world and so it's it's you know Jeff I got a plug Jeff here for a second I don't always agree with everything Jeff said but he put out a report a week or so ago and it was titled these idiots and I just I just started like I just saw that headlight and I started laughing because it's true you've got these you've got these PhDs who are very smart people but I just think they're completely misguided they're completely their hubris is off the charts they think that they can control this massive monster that's been created that nobody understands and so my point with all of this is we have a system that is inherently unstable fractional reserve banking is a system through which it has to continue to grow or else it crashes and if it doesn't continue to grow then you have bad things and the fact that we have a huge system that nobody understands that nobody regulates and that nobody has their arms around or even the mechanism by which to solve it if they did understand it I think really bad thing is going to happen and so I'm prove I'm preparing for that really bad thing to happen now and the people who tell me that the central banks have this all under control I just I fundamentally disagree well you know again what Michael was saying about the implications of the system even though we can't observe we have no idea how big it is we know it's substantial we know it's significant because of how it impacts everything I usually use the analogy of corks you know corks every physicist in the world every physicist around the world will agree that corks exist or a fundamental property of nature yet nobody's ever observed it they know it's there because of how it interacts with others things around it so that's what we're really doing we're studying the Eurodollar system we can't observe the Eurodollar system directly but we understand that it disturbs markets it disturbs economies it disturbs all in any number of things that we can see and so we're seeing the implications of monetary dysfunction especially santino as we've talked about before what was 2008 it was a very big disturbance in the shadow money system that you know as Brent you pointed out the phd's at the Fed had no idea was there they had no idea they should be paying attention to and of course they didn't actually solve the problem they just hoped that it would go away and that they could then take credit for that going away saying oh we saved a bunch of jobs it didn't get worse so you know the implications are for the global economy for the global marketplace and therefore we have to pay attention to the I first of all understand that we can't really observe and we're behind the we're behind the eight ball because we don't have any good data we don't have any good direct observations of the system but we know it sets the agenda it sets the direction for the entire global marketplace the global economy financial systems everything I just want to point out for everyone who missed we've got two analogies here so far Brian was talking about drinking when he was a kid and Geoff just brought up means oh not me people I knew people you never started sorry people you me okay great so we've got about 10 more minutes here before audience questions and and I really want to dig a little bit more into these implications and I want to look into the past and an example which both of you just referenced so far but the great financial crisis and oh seven and oh eight and I want to look to the implications for understanding the current situation that we're in because I know one distinction that is important to both of you is when that money printer Goldberg you know Brent that you were referring to before they're not actually creating new there's a difference between creating money and just creating new money so I want to start with oh seven and oh eight because it's a pretty big contention when people think about the GFC they think about the subprime mortgage crisis but I think both of you would say that was actually part of a larger story which is tension in in this euro dollar system so do you want to describe how this this emergent large system is actually a large cause of the the GFC put it simply the global financial crisis in 2007-2008 was a global dollar shortage that's really all it was and so it manifested in very different ways which ended up being in terms of liquidations across markets which is what people pay attention to when the stock market crash that was really tied to these liquidations so it's a global dollar shortage but I think the larger issue here especially moving forward under quantitative easing in these types of regimes is the issue of bank reserve and and really people see that you know the Fed creates these bank reserves we're told that's base money it goes into the base M 1 M 0 statistics and therefore it looks like oh my god this has to be inflationary because look at all this money printing the Federal Reserve is doing and that's understandable because you look at the Fed's balance sheet was this and now it's this x 2 so it looks like the Fed is engaged in money printing you know and by the way the Fed wants you to believe that because they want you to think inflationary and therefore act inflationary but in reality that's not the entire story in fact I would argue it's not even the most interesting part of the story what happens we talk about a global dollar shortage what we really mean is monetary destruction taking place in these places you can't see so in the sea offshore euro dollar system however much money there was you know out there that we can't really define but however much money there was come 2007 it started to go it started to go the wrong direction it started to shrink so what the Fed was trying to do was to create an asset that could be used in place of all that money we never saw disappear and so we have to at least start with the concept of net liquidity and net money and when the Fed by the time the Fed actually acted in any significant way in October 2008 obviously it was already too late because the amount of monetary destruction that we never saw was enormous and so the Fed was already starting from way way behind even if you assume that bank reserves are base money which I don't agree that they are I think there's something else but you know that's a separate conversation but you know the point is that you know people see the Fed's balance sheet go way up and they think that has to be money but that's adding new money to the system that's adding a you know trillions of new money to the system what they don't see in what they don't appreciate is the money that's been destroyed in the shadow system so I'm really glad you brought this up Jeff because I this is a point that I've been trying to make all year is that the first thing you know you again you've got to look at this from the central bank's point of view and from you know then on our side of it so there's two different sides the the central bank side of it to Jeff's point as they are printing reserves they're telling you it's money in the hopes that you will believe them and then go out and extend more credit because in the monetary system most of the credit most of the money is actually created by commercial banks extending loans or shadow banks extending loans the central bank's print the reserves they forward guide that we're going to do more of it in the hopes that it will change behavior but if the central bank but if the commercial banks don't lend and if the extension of credit is not continued it doesn't work and so they can print all the reserves they want if it doesn't get into the real economy it doesn't really matter so that's the first thing the second thing is that central banks are reactionary agencies they're not proactive agencies if the central bank people always tell me the Fed is going to print 20 trillion dollars and it's going to be massively inflationary and I always say if the Fed is printing 20 trillion dollars it's because the global markets are melting down and they're trying to fill a bucket that's leaking yeah they are not filling a bucket that's already they're not pouring water into a bucket that's full and has no holes they're pouring water into a bucket that is leaking like crazy and they're trying to keep a level and they're trying to convince everybody to go extend more credit and it's just you know and it will it works I mean look at the last two or three months they have they have they have printed a lot of reserves and people have believed them and look what the markets have done now can that go on for a while yeah I mean that many people thought in 2008 the whole thing was coming down here we are 12 years later and the same you know kind of stuff is still you know on there's also two different market views right we're talking about stocks versus bonds oh yes not you're right the stock market has bought a hook line & sinker that there's right there money a good point where the bond market is saying we've seen or we know this game there's no money here and we look at inflation expectation inflation expectations are absolute low levels so yeah I think but it gets back to the point you and I were making at the beginning which is it's not a top-down system it's a bottom-up system so the Fed is trying to force these bank reserves onto the banking system and the individual banks are saying we've got our own problems man we can't do it even if we wanted to and I you know we talked about it before you know the negative interest rates in Europe and Japan why they don't work now negative interest rates are essentially a punished trying to punish banks into doing it like hey you're gonna create money or I'm gonna penalize the hell out of you that's what a NERP is and what banks have done in Europe is you're paying to say well you're just gonna hurt us because we're not going to do we're not gonna lend we're not gonna create new money because they don't we have our own problems we have our own balance sheet problems that override any inputs that you try to put on top of us you know negative interest rates quantitative easing bank reserves whatever it is we're just not going to lend because we have these constraints in our system which are tied to this euro dollar liquidity the stuff that we've been talking about so yeah it just goes it just goes back to the Fed and their models and what works on a model doesn't necessarily work in the real world it's just you know again so that there's there's two different systems right there a system the world it's the system that works in the central bank's minds and the system that works in reality and they're not the same historical component to that too because you know alan greenspan in the 1990s used to lament all the time that they could no longer define money and he worried that that might be a problem in fact his most famous speech the 1996 irrational exuberance speech everybody thought that was about the stock market it wasn't what he was actually saying is because we can't define money anymore how would we even know if the stock market's behaving rationally or irrationally that's what he was really saying now put that into a monetary policy context when you're confronted with something like 2007-2008 you can no longer define money you haven't really tried in in 30 years what do you do then you know it becomes a you know not to not to not to portray central bankers is sympathetic but really they had took they've taken their eyes off the monetary ball for so long when they were confronted with a monetary event they really had no idea what to do so you're right you know Bradley these PhDs are incredibly intelligent they can create the most elegant breathtaking mathematical models but they aren't worth a nickel in the real world because they don't take into account anything that you know they're not realistic and take into account what actually has happened in them especially the monetary system well and again in in many ways they come up with a hundred different ways to do the same trick and the trick is the extension of credit or continuing the flow or the extension of the dollar of the Eurodollar system hey guys I almost hate to cut you off here but what we're coming towards the end of our interview portion we have a ton of audience questions that I want to get to as many as possible but I would just end with this and this actually is a question that we got from the audience how do you see this all playing out right we're talking about a system that seems very large and impactful and it's not regulated it seems like there are some some downsides I mean how do you see the interaction how do you see this all playing a hard question here I'm putting you on this yeah yeah I mean how do you see this all playing out is this sustainable long term so I'll take it first I mean a long story short is the long story I know I will all be fairly brief the long story short it is not a sustainable system and I've said this a hundred times but a fractional reserve system is a system that must grow and if it doesn't grow it crashes and so maybe it will continue ad or I don't know how long it will continue to grow but I know it's an inherently unstable system and I'm convinced it will crash and when it crashes because we are now on a dollar standard and not a gold standard I feel like the underlying collateral which is the dollar is going to have a super spike and that is going to just kind of wreck the global economy so that that's my base that's my base case yeah I think that that puts it pretty good I mean look the system you're right absolutely right it has to grow or it doesn't it doesn't work right I mean that's that's really the issue and in fact is it stopped growing in August of 2007 so we're now in year 13 going approaching year 14 of a system that's not really working and so you know how does it play out well it's it's impossible to predict except that we know that something is going to happen we don't know when I you know I agree with it on that on that account Brent that we have no idea when it stops working but it has at least kept things reasonably working for the last 13 years you know as I say it keeps the lights on at the very bare minimum but we haven't had any extras of actual economic growth in the United States or anywhere else for that matter and we're dealing with the consequences beyond economies and markets in terms of social consequences political consequences divisions d globalization so we're already into the phase where we're dealing with you know beyond the monetary system the financial system and even the economy so how much longer can it go before something happens and I actually look you know it could go one of two ways they could go like Brent says that we're I think you know the the fiery end of the euro dollar system is not where the dollar plunges to zero value I think it goes the other way he goes up to infinity it becomes solar it's such short supply that it's essentially you know it's it's a it's value is impossible to calculate now that's the worst-case scenario and I hope to god we avoid that kind of a scenario and I have to believe in faith in some faith in humanity but before we get to that that far we might have a situation where god forbid maybe a central bank here somewhere you know the B is something somebody stops and says hey there's a problem here that we need to fix before we go too far maybe that leads to a Bretton Woods part too maybe we have some smart people get together and design a system that's actually works maybe even replicate some of the best features of the gold standard some limiting factors some rules some transparency behind this the system and that that is the you know that would be a hugely positive result where I think if that that scenario plays out the implications are massive economic growth worldwide and and all the good things that go along with it and not just massive economic growth over the short run but sustainable stuff like we saw in the in the 1950s so I think you know there's two ways that we can this thing can go and you know I have to hope that I have to really hope that that we get it fixed before it gets to its limitation because I agree with Brent this this thing is it's on a ticking clock and we don't know when that clock reaches zero yeah I'd say I agree with Jeff I you know that would be a nice scenario would I think what Jeff just described I think a good way to describe what Jeff just described is would be to say it's a pleasant fiction it's no fiction at this point really thank you so much for that that was a really enlightening talking and for those of you who might have had to leave early we will have this on-demand for anyone who wants to we've got about 35 audience questions and we've got 13 minutes so Brent I would ask you to yes Jeff will be happy to answer all of them we'll do a rapid fire here so just starting with disappeared I'd love to hear Brent and Jess thoughts on the dollar presently it seems everyone is forecasting an inflation and falling dollar yet it sounds like they're saying the system is at risk and there's a dollar shortage thoughts I think between now and the election all bets are off if you could go ten percent either way wouldn't shock me at all there's a huge treasury balance at the Fed I mean at the the Treasury has a huge balance in their checking account at the Fed I'm not exactly sure what they're going to do with that that is the wild card for me but as we get further you know a year two years from now I expect the dollar to be dramatically higher than it is today yeah we've heard about the dollar destruction and inflation for the last 13 years and it never happens because nobody ever factors the euro dollar system into their analysis they're just looking at the Fed's balance sheet and extrapolating from there without thinking about net in terms of net liquidity or even what bank reserves actually are so you know the idea that this is gonna be inflationary again look at the bond market the bond market is already telling you it's not so no I don't think I think the issue with the dollar is it doesn't go up in a straight line it's very lumpy ego it goes through bursts where extremes higher like we saw in March like I expect that would happen as the dollar shortage becomes acute again probably over the interval you know the next less the last half of this year maybe the next year I would expect that there would be another dollar episode where it jumps next question here what's the word what's the risk that with feds or foreign central banks won't sell their Treasuries for gold displacing the US dollar as a reserve currency and collapsing euro dollar markets and foreign shadow banking systems close to zero what foreign central banks are already selling the Treasuries and they have done they've been doing that heavily since 2014 and the reason they're doing it is because they're confronted with this dollar short selling Treasuries is a BEC is a byproduct or a bypass of the dollar system it's way of trying to fulfill that dollar demand by mobilizing what are essentially reserves so when you see foreign central banks and foreign governments selling Treasuries that's not because they hate the dollar or they think it's inflationary they're selling them because they're telling you their their experience their local banking system is experiencing the dollar shortage so if you see foreign sales of some of the US Treasuries in particular or any US dollar assets that's a dead-on accurate signal of this shadow dysfunction this shortage it's an indication of demand not an indication of anything else exactly okay guys this is kind of a combination of several different questions but you both talked about the rules for US dollars in Euro dollars being different what are some of the most key are the most important differences in between these two forms of dollars well one is regulated and one is not one is measurable and one is not one has a solution to fix it and one doesn't that's my opinion yeah I think he just comes back to what we said before the the regulated domestic system is a top-down system where there's all sorts of regulation that sometimes owners regulations there's a central bank that sort of a central bank standing behind it the euro dollar system is a bottom-up system often ad hoc networks appear disappear it it's it you know I I think Brent you said we call it the Wild West that's probably a really good analogy because it's it's really it's an individualistic system where it's defined by these bottom-up characteristics rather than the attempt what we all understand it's a top-down approach here's another question why does the Fed not care about the euro dollar shortage it causes US stock market crashes which the Fed can't afford to let happen for many reasons tax pension Treasury credibility etc so and I guess I would just add on to that are they truly aware of what's going on in the euro dollar market and what if anything are they doing they're aware that there is a dollar market but it's outside of their jurisdiction number one in fact you go back to 2007 when the first dollars foreign showed up they had lots of different discussions about what they what should they do about it a lot of them were centered around should they do anything about it because a lot of the euro dollar problem in the early global financial crisis in 2007 centred on banks in London and so their discussions were revolved around is that a Bank of England's problem even though they were true these banks in London were trading in US dollars they were banks in London and so the Fed was taking the approach of you know maybe this isn't our issue it's it's it's it's an English issue it's a British issue it's not it's not a Federal Reserve issue so that's number one the feds mandate ends at the US border but however they were forced to realize that the implications of allowing the system to go as it as it may including is in terms of you know how it was in reverse and crashing in 2007-2008 causes backlash inside the US to that's where dollar swaps came from that's where all of these foreign facing US dollar activities from the Federal Reserve showed up from it's the idea that okay there's this dollar system beyond our control but we got to do something so we'll swap dollars with foreign central banks and allow those foreign central banks to take care of their own dollar problems so you just I mean there's there's more to it than that but just intellectually and ideologically the Federal Reserve takes a hands-off of a hands-off approach to the euro dollar system because statutorily their authority ends at the u.s. boundary yeah I'll just go with that answer well I mean there's more to it than that I mean intellectually different you know to talk about the monetary framework to but you know the easiest answer is to say the Fed says there's a you there's a foreign dollar system out there but it's for and it's not our problem all right this is a great question because it's actually something that we didn't get to but we talked about before this this webinar and this crisis how effective are the feds the new dollar swap lines in vivo facility with global central banks and addressing issues with the euro dollar system in the global dollar shortage so let me just address it from the very big picture and then I will let Jeff go into some details if he has any interest in doing that but in the very short term it can provide some help and I think you just looked at the last couple months and it has helped provide liquidity to the markets but what it doesn't do is it does not solve anything the only thing is it does is it makes the problem bigger by perpetuating the current system it's just a further extension of credit it's it's a way to get some quick collateral dollar collateral into the euro dollar market which can then hopefully spur further dollar kuroh dollar credit extension but further dollar credit extension actually increases the demand for dollars so it does not solve the problem it makes it bigger and while it can kick it down the road we will eventually come up on it again yeah the only thing I'll say about is it I don't think it I don't even think it's that good I think it's it's more window dressing designed along with quantitative easing to make people think that it's effective as long as you don't ask any questions about what really happens with these dollar swaps which is really all these policies are designed to to essentially fool people into believing these something substantial is taking place but if you actually the dollar swaps in particular if you actually look at the data especially the the tick data treasure international capital what you find is as these dollar swaps the Fed swaps tiles with foreign central banks then banks in those those overseas jurisdictions transact with the central bank's but who are the banks that are actually transacting with these foreign central banks well it turns out it's US banks it's their foreign subsidiaries are borrowing dollars from foreign central banks that are swapped to them to the Fed and then those foreign subsidiaries of US banks transfer those dollars back onshore so these are overseas Tolliver's swaps they go over to a foreign central bank our bid by a foreign subsidiary of a US bank and then transferred back into the United States so how does that help a global talk like Jordans it doesn't it's just it's all window-dressing it's all of it's all a shell game designed to make you think something positive has happened it's really ridiculous all right I've got another hard one for you here so you're given carte blanche to fix the euro dollar system how do you go about doing it blows I think I would agree on that I want to you grant but I think we agree on the the system doesn't work we need to start over I know you know start over is probably too much I mean there are some good elements to the euro dollars it's a modern system it's a virtual currency system there there are positive aspects of it and I think what needs to it needs to be reformed substantially that there's some structure to it and more than anything there has to be some transparency to it we have to know what goes on everybody who operates in it has to know what everybody else is doing in what terms and so that you know that was what the beauty of the gold standard was the under the gold stone knew what the rules were it was you had gold in your pocket we knew what it was and so there was no there was no need for you know an entire cottage industry surrounding you know lobbying and laws and rules and regulations and how do banks operate and what levels of compliance interval you know all of these all these things that served to push the system further and further away from the public and so you know maybe there are some elements of the Eurodollar system that are worth preserving you know I don't know but we need to it needs to be substantially reformed so that the product on the other side of it probably doesn't look too much like it does now yeah I mean I think I think one thing to keep in mind with all of this is this is the thing I always come back to is I can wish for something all I want you know and there's certain things that I would like the monetary system to be but you know the reality is is that the politicians and the monetary authorities don't want it the way I want it to be and they have a lot more power than I do so it's it's important to kind of figure out what you know it's fine to understand what you would like to see happen but I think it's more important to understand what's actually going to happen and you know I don't think that we're going to go back to a gold standard anytime soon I don't think the monetary authorities are going to go for that now if they did I would that's fine with me I think that would be a fantastic system but I don't think it's going to happen I think what's going to happen is that the monetary authorities will continue to try to build you know on top of this Frankenstein that they've already built and it eventually it will have such a climactic disaster that they will have to start over yeah I think that's really the issue really the point is at what point do we do we do we force their hand into acting and I would hope that it's before stiff there's a really bad ending that they can you know we can get them to wake up before then so that they can act in just in time to save the system and a real sigh that's probably to pollyannish but that's a fiction of something extra for right I mean otherwise we were really talking about some bad stuff yeah great sorry one last question just to end on maybe a pragmatic notes I think we've discussed a lot of great information here some of our investors in the audience are wondering how some of this information can be translated into actionable advice so anything that you're comfortable sharing just in terms of an asset that you like or trade that you think would be particularly interesting we've got two minutes left here you know I'll just reiterate what I've been saying for a couple years I think this is going to end in a fantastic spike in the dollar the asymmetry lies with the dollar getting stronger not getting weaker easily you look at prices around the world you look at posit rate positioning you look at you know forecasts by global financial institutions everybody thinks the dollar is going down over the next two or three years all the positioning says the dollar is going down over the next two or three years but the position 'try lies and they say that because it just the dollar has to go down for the system to work and so that's why it's all forecast that way but the asymmetry lies with it not working out the way everybody says it needs to work out and so I can't give advice on individuals of how they should trade this but I'm telling you the asymmetry lies to the upside on the dollar yeah I would just add the same thing it's deflationary just what however you want to invest how are you going to structure investments just understand what these market signals are telling you what the system is telling you is that India's Brett said the risks are asymmetric toward deflationary circumstances which is dollar positive so you have a rising dollar deflation not inflation excellent all right gentlemen well thank you both so much for your time here this has been a bit of a just such an interesting conversation and we really appreciate it and if if anyone would like to find you where where can the people on the webinar find you they'd like to just learn more well I you can go to my website it's just ww santiago capital comm you can email me Brent at santiago capital com you know I'm very active on Twitter I do a number of interviews here and there so I'm happy to you know I always say this that you can feel free to send me a message I'll do my best to get back to you I get a lot of them but I do like interacting with people so feel free to reach out thanks a lot yeah I met hambert partners calm I published a lot of articles blog post research reports and on the Eurodollar system implications of it I'm also working on a website of a related website called Eurodollar University where myself along with a couple other people are looking to really get people's attention and then try to explain some of these things that go on in the system so that they can interpret the world around them because economics and in traditional education has done such a poor job of really explaining how things actually work that it's fallen to somebody like me to try to bridge that divide to fill in the shadows so to speak you know to to shine a light on what's really going on so look for that - alhambra partners calm and then Eurodollar university calm excellent thanks very much Jeff and Bren for those of you who enjoyed this webinar standby for incoming information about future episodes that we've got planned but for now gentlemen thanks very much again and to the audience thank you for joining us today

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Length: 60min 59sec (3659 seconds)

Published: Tue Sep 01 2020