The Sovereign Debt Bubble with Luke Gromen

Luke good to see you man it's been a while and heck it's been thanks for having me back on Peter I'm looking forward to our conversation yeah listen we'd have you on any time and we'd love to do one in person at some point and really Grill you but there's been so much going on Danny here has been bugging me to get you back on so we we broke our rule we'll do a remote show just because you have so much value to add um Lots happened since we last spoke the whole world has gone completely mad in a nutshell yeah yeah yes exactly but we're both huge fans of yours um we've been following your updates your macro updates and yeah we've got a whole bunch of questions for you um but just to kick off with last time we spoke you said your allocation to bitcoin was about two percent and we're intrigued to see if it's grown uh the short answer is yes quite a bit um so I think the last time we spoke probably would have been what like like 2020 maybe September 2020. yeah so that was you said September 2020 yeah I think we've made 400 episodes since then so September 20 shortly after we spoke uh I ratcheted up my allocation pretty meaningfully actually um when it broke over 20 000 November of 2020 if you remember it was Thanksgiving weekend here and I looked at my wife and I said it went through 20 000 with such Authority uh having been in markets a long time I just said that's that's meaningful so I ratcheted up my uh uh allocation I bet it Peak I was probably in 2021 uh I don't know I was probably 40 at one point of my liquid net worth uh between what I bought in 4q20 and 1q 21 early 1q 21 and then what it ran to uh that summer June of 21 I actually sold most of it um uh to be blunt I paid off my house I just figured you know what worst case I love it I'm gonna get debt free on this you know and again haven't been around markets the pace at which it grow and you were seeing the FED start to talk about talk about tightening so it's just like okay you know what worst case I'm out of debt so I did that still owned right five percent my liquid net worth uh began adding back in at the end of 21 too early of course um but uh it is what it is uh and then have actually um again having been around markets long enough people always say you know you wanna what is it the the famous Roth shell do you know you want to buy when there's blood in the streets even if it's yours um having been around markets enough watching what happened with the exchanges last year in the fall that to me was sort of like a classic okay this is a liquidation and yes some of the blood is mine and so I actually reactionated it back up pretty meaningfully um in really 720 again uh so we're back to full circle so I love it love it you know here here we go so um come full circle but with no mortgage now that's exactly it and yeah my guess is now I'll probably have a little bit more uh more discipline for or more more more holding power because they won't have that Temptation I'm like hey well I could just get completely out of debt because it's you know I'm largely completely out of that already so nice love it so is this just you realizing this as an asset you can trade or if you become more bullish on the asset and it's roll now they have big harm more bullish on the asset and its role as a neutral Reserve asset for the people and maybe at some point down the road uh it can become a reserve asset at The Sovereign level I don't think we're there yet uh I think there's been some interesting work done on that uh in that vein uh most notably by Jason Lowry uh his new book software and it um has his PhD thesis at MIT uh but I have become I had been aware and and and and a key underlying Dynamic to the way my research is suggesting I need to think about the world is that we are in this unique period of time where we have our first bursting Global sovereign debt bubble in a hundred years um and at the same time we've got a peak cheap energy I won't call it a crisis but it's a dynamic it's basically it's not that we're running out of oil and gas and energy it's that the stuff we use most of is getting more and more expensive to replace and so there is sort of this secularly inflationary Dynamic to just replace and keep our energy production flat of fossil fuels broadly speaking which is fine when you have a low debt debt-backed economy but it's not fine when you have a high debt debt-backed economy debt-backed currency uh they're fundamentally incompatible and so when you have a combination of a bursting Global sovereign debt bubble overlaid with a cheap energy Dynamic uh that's an ideal setup for what you want to own what you want to be overweight are neutral Reserve assets with an energy tied to them basically you want to own assets with no counterparty risk that hedge inflation and have an energy tie and historically that was basically gold silver sort of because silver is kind of an industrial metal too and I would also argue that you know if you can't own an oil field which is easier said than done literally on the oil field or the oil assets they are Reserve assets of sorts but there's a whole number of reasons why that's inefficient etc etc but they will do well in that environment that we do that I just talk about cheap energy plus global cyber debt bubble and I think between our conversation and some other conversations I've had with others in in the Bitcoin world that really um you know over the course of 2020 I think went from zero to sixty because I I had owned you know two Bitcoin since 2013 I actually owned 25 Bitcoin back in 2013 and I sold it unfortunately all but two of it to uh help fund fftt so not unfortunately because I started my business it's been a great business and and I'm doing what I love but all else equal I would have sold something else not the 23 Bitcoin I sold sale of eight uh so over the course of 2020 my understanding ramped up to say okay gosh if I look at this objectively this is an energy tied Reserve asset you've got Through My Lens of how I was what what the researchers telling me uh I just began digging into it more talking more and so that I think has really been the key Tipping Point of there are elements where it does a lot of what gold does better than gold does um but it's really about having a neutral Reserve asset with an energy tied to it to me it's that that proof of work Dynamic that energy tide that is so critical because they there's this inflationary impulse to uh peach cheap energy they need energy prices to rise and so you want to maintain your purchasing power and energy terms and there is this Dynamic of first bursting Global sovereign debt level 100 years where they either have to let the debt default which is counterparty risk so you want own an asset neutral Reserve asset no counterparty risk uh or they're more likely that they're going to print the money to keep the debt nominally solvent um but real you know risk on a real basis and we saw that in Spades last year so that's a long-winded answer I think which uh but I but I wanted to give sort of the background of the thought process of how that evolved from there to here no I love it man uh do you have a gold allocation be the ship it's like I do oh you do I do yeah I haven't yet and I've considered it a couple of times but every time I just buy more Bitcoin which hasn't always worked out to be the right decision so this sovereign debt bubble you're talking about and you say it's bursting and then you say they will print to keep it going but I've had a few conversations with Lynn Alden who I know you know well um and I feel like we're yo-yoing towards possibly even much higher inflation what's your read on the sovereign debt Bobble how do you think it's escaped and can it even be escaped uh well it can't be escaped it can only be worked through and there's only two ways to work through it once the debt levels get high enough and that is your default slash restructure or you inflate it away you basically cap yields uh Central Bank buys the debt caps yields lets inflation go and you inflate it away so your debt the GDP is back down to a low enough level um so basically you write that you you bondholders lose money on on a nominal basis or on a real basis basically are the two ways to work through it that's that I guess there's a third way which is energy productivity Miracle right you can get out of it in fact the UK got out of one I want to say it was after the Napoleonic Wars so like 18 50-ish you had a productivity boom you just happened to discover fossil fuels and commercialize them and you had this massive unprecedented historical boom in productivity that actually allowed the UK to get out of to earn its way out of without really having to repress without having to go off the gold standard so it is possible uh but you're talking about sort of because the debt levels as high as they are you know the the commercialization of nuclear fusion on a compressed time scale type of productivity enhancement so if you say we're not going to get this productivity enhancement and who knows maybe AI can help with that too I don't know let's set that aside if you set that aside you either have to restructure default on the debt or you have to print the money to keep the debt nominally but nominally money good but but declining on a real basis to basically inflate it away and is the prince the is the print the most popular option because a traditional default uh is much more damaging to the currency is it that when you print it away and there's a nominal loss to the bondholders is that a more subtle way of hiding it yeah it's a more subtle way of hiding it uh it's it's a more subtle way of hiding it these days when you talk about a lot of this debt being the underlying collateral of a lot of other assets it almost becomes impossible to default on it right is this you hear all the time people say well treasuries are the collateral and they are that basically precludes the let it default option which is actually really helpful from an analytical standpoint right because we know where we are in the debt cycle we know where we are with energy and so then it comes down to these sort of key points when there is tension in the market when there's volatility and treasure okay we've coming to a point they either have to let the debt default or they have to print the chance that they're going to let it default is like zero so then you can sort of scale your positioning um you know into you know bait or and make your decisions based on that and and so I think politically um not just politically it's always been easier but practically speaking from the actual underlying structure of the markets now uh there's just no there's just no chance they can they can let it default really I mean I can't say there's no chance but the chance is so de minimis as to be I think meaningless so do you think we're at risk of going through a decade of inflationary issues it's something Lynn has talked about she said to me the story of the next decade is going to be inflation absolutely it's I I think we are going through and it really the the length the length of time is somewhat dependent on the rate of inflation and the ability to keep the population docile uh uh tricked for lack of a better word about what the actual rate of inflation is uh but ultimately I you know back in 2021 April 2021 I would say we did a report for clients and we looked at the we said okay the last time debt the GDP in America was as high as it is after covid was after World War II and what we did was pretty straightforward we kept yields at two and a half percent the tenure uh the the FED did with yield curve control and they LED inflation they let real rates go to negative I think in the United States I think they went to negative 13 so basically your inflation rate was 13 points over uh the yield on whatever they were using whether it was a front end of the curve or the back and the curve doesn't really matter much uh it's a pretty flat curve uh and the point is from Ford 35 to 51 U.S debt the GDP went from 110 percent down to uh 55 percent and then they did this thing called it treasury fed Accord where basically at that point they said okay now we're going to go back to being separate entities the fed's independent again they're going to set policy based on what's best for the currency now what's best for the government and away we go so we said let's use that analog for now we're at 130 percent death to GDP as of April 2021 we let's our view was that they needed to get that number to 70 to 80 percent debt to GDP because that was sort of in in my view the last time the Fed was able to run a pseudo-normal Fed tightening cycle without really blowing something up remarkably fast and so we said okay we need to take debt the GDP down by 50 to 60 percentage points and let's say they do it over five years like they did after World War II what would that entail holding everything else constant in this relatively simple model and what we found was that you needed five years four to five years of call it twelve to eighteen percent annual inflation uh just to get it there so that implies two things number one that level of money printing number two that level of uh keeping the population uh yeah keeping the bond market still right basically you're you're holding the bond market down and and and uh using that unitizing you know uh you're putting the bond market to sleep you're killing the bond market in real terms and there's a number of reasons why uh from a capital control is a perspective in particular that was much easier to do from 45 to 51 than it would be to do now and so when you lay it out that way it gives you two conclusions number one inflation's the way out and that gives you a sense of scale of the amount of inflation for the period of time that would be needed uh but then number two it highlights the difficulty of actually doing that an extremity of the policies that would have to be put in place to make that happen and so where you go with that is some people say well we can just do five you five percent negative real rates for five years no no you can't do it five years like negative five needs to be like 20 years uh 15 years and you say okay well can we do it faster that's probably what this conclusion tells you right is is it's gonna be a surprise it's going it's not going to be 12th of 18 inflation for five years it's going to be it's gonna be the Israeli situation in the early 80s which is 100 to 300 percent inflation for two to three years and voila you're done and I think increasingly think that's where this is all heading toward where they're just gonna have to compress it they're going to have to do sort of a real short term basically reset um you know jack up the monetary bases hold the you know let inflation absolutely rip for a bit because otherwise you can't without Capital controls You Can't Screw the bond market in real terms for very long before you lose control of it and so you kind of get to the same spot either way right like you can't sit there and go we're going to take 10 of your money Mr Bond Market for five years it doesn't work that way they'll they'll you know they will instantly make that adjustment if they get the sense that's how it's going to go so that it it becomes self-referential so hold on so you're saying perhaps in the US even in UK and Europe we could see 100 to 300 inflation uh please don't make that the title of this one no I won't I won't but Luke Roman says right exactly yeah are you saying that's the risk that's that's a potential absolutely yeah it's absolutely a risk um and it's one of these things where you people say oh if we had that kind of inflation you know there's be zombies oh you're gonna need shotguns and spam and you know it's it's an apocalypse you kind of go Israel did it for three years and you know you can call off a guy named Stan Fisher who is a former fed Vice chair he wrote one of the authority of papers on how to manage the process and he was he was a Fed Vice chairs recently as 2017 2018. he wrote a BlackRock white paper in 2019 about how to inflate your way out of the next Crisis you cap elt let inflation rip uh with the head of the Swiss National Bank and a and a former head of the Swiss National Bank and a and a Bank of Canada Governor so point is is that it happened in Israel Israel is not the United States um obviously for a number of different reasons from a size and from a complete economic complexity uh uh Dynamic but from a standpoint of a first world nation where they did it for two three years and like a pretty nice place to go visit it's a nice place to you know it's it's like the world didn't end yeah bondholders got screwed for three years and then you move on and we are getting to that point of the movie where bondholders get screwed on a real braces in a short period of time and we move on and that to me yeah I think it's I think it's possible and I think it's important to say that the longer they delay getting to the inflating It Away part the more likely that becomes so in other words if we go back to 2021 I wrote that piece I said they look like they were doing what they said they were going to do in 2019 which is you know cap yields let the debt go or let the inflation go get that the GDP back down uh it looked like they were doing what they did post World War II and then all of a sudden 2022 here in the states in particular it became a political problem it was an election year oh inflation no one cared about covet anymore it's all about inflation and so suddenly uh it started to become problematic and they started fighting it which is on one hand fine but you you once the debt is there once the deficits are there you don't have the option of like well I'm gonna fight inflation now no no your options are inflated away or default and the more you try to fight the inflation the inflation was the only thing keeping the government solve it it's only keeping tax receipts above where they needed to be to prevent really a debt death spiral in the western world and so when you fight the inflation what you're really doing is increasing the strains so that the only outcome then becomes the only possible way to get out of it at some point becomes 100 inflation for two years for three years that the more you right it's it's like you know the more you delay you know you know you're sick you delay you delayed you delay you get to a certain point and it's like okay well if you have gangrene in your toes and you you know you traded early great but if you wait too long at some point the only thing to do is chop off your leg and they keep delaying because of politics so I'm curious um when that happened in Israel what happened to the markets because I would assume that a lot of the money kind of fled the country but if that happened in somewhere like the US where that money can't flee the country like what happens in the markets in that situation if you look at the Israeli stock market it was like really you know it looked like it looked like the Venezuelan Argentinian stock market you know which is up in local terms I don't know if they had Capital controls on at that time um I should be more well well versed in that uh we if we look at it today through this lens then all of a sudden when you start hearing things like operation choke point 2.0 um that starts to look you know to me operation show Point 2.0 there's a political angle which I'm not in favor of them doing that just but I don't want to talk politics but from as I just put on my you know objective historical hat it starts to look like I mean look if I was in charge of the U.S economic policy and they came and they said Luke we're gonna have to inflate 100 a year for two years where we try you know we try to inflate a little inflation got bit of political problem that we went the other way now we're having these treasury market problems we're going to have to inflate it but what what you know we can't allow we can't put in capital controls but we also want to control things in a way so that we don't look too bad right we want we don't want things going up that make us look bad you know so the stock market goes up a ton there's not going to be any Americans going oh you guys are terrible the stock market's up 100 a year for three years like though the people love that they won't ask a lot of questions if Bitcoin goes up 500 a year for three years or if gold goes up 200 percent a year for three years there starts to be more questions so when I look when I think about where they are when I think about this framework of they need to inflate away and by delaying the inflating away as much as they already have they're increasing the odds they need to do a really compressed period and then I look at operation show Point 2.0 of gosh it sure looks like they're trying to chain the theater doors before they light the joint on fire uh to me I think there might be some informational value about where they are starting to see the inevitability of where policy is going to have to go which is a compressed period of high rates of inflation and I don't know if that's 100 or if that's 20 or you know again for me a hundred a year is still a tail risk but that tail has gotten meaningfully fatter over the last two three years um you know for me choke point 2.0 within this starts to look like a capital control of an asset class that you would not want certain elements of the government would not want going up as a result of what they're doing or what they're going to do yeah because I considered uh operation choke point 2.0 more of a control but I didn't think it's so much in terms of a capital control that's fascinating um okay so so we've experienced quoted inflation in the UK it's about up to about 10 11 I think the US reached close to 10 didn't I think it got into a digital double digits we all know realistically it's been higher um certain things have been I mean energy in the UK has been well I mean up up to 100 200 energy price inflation now we've seen people have their energy prices double or triple so we we've seen masses we've seen High inflation here we've seen it in the US we know it is much higher so I is it what you're saying is that this kind of like 10 to 20 could continue for a few years but there's a chance they might squeeze in some high double digit potentially triple digit and and what you're saying could that happen in the next two three years or do you think it's a bit further down the line I I think my base case is that they are going to try to keep it in the double digit range without letting it get away from them but I think that is an increasing risk I think it's going to be over the next two three years really and we may get this sort of deflationary whoosh in the very short term I think you're seeing symptoms of it um you know from a credits and lending standpoint if you read the history books on a lot of the great inflations they almost all there's a quote I wish I know who said it to me it's not one of these famous ones um that you can sort of Google and find who said it but I've had it said to me a couple different times but it's deflation is the Midwife of hyperinflation and that's not to say I think we're going to hyperinflate but the these great inflations are ultimately driven by Sovereign in solvency and deflation and Sovereign insolvency are fundamentally incompatible and so they want to get inflation down but they're not gonna be able to get it down enough um if they get it down too far then they can't pay their interest their entitlements and their defense bill out of tax receipts and then given the choice between defaulting on Target treasuries in the case of the U.S slashing defense spending in the U.S or slashing entitlements in the U.S which right now are already at the three of them are like 110 percent of receipts and and Rising uh then they have to print the difference uh and they can try to crowd out the banking system right they can regulate the banks into buying treasuries which they did and until that blows up oops that's already blown up they can regulate the domestic sector into doing it but here too that simply increases the deflation because I can buy a car or I can buy a treasury bond portfolio I can't buy both um and so if I buy those from the government I start detracting from consumption I detract from consumption I detract from tax receipts that means the amount the government needs to either borrow from me or print over Rises not Falls and so they're into this Loop uh and and in this conversation of inflation deflation deflation's been the only thing or to me inflation has been the only thing keeping receipts high enough so that they don't have to print and now with inflation coming down I you can see it in the numbers and the receipts the receipts are falling below these things these uncuttable things and that's why I say deflation is the Midwife of I won't say hyper a little bit of high rates of inflation is now they face a choice you want to call up zielinski and say hey sorry our tax receipts stink we're we're pulling out have fun with the Russians and oh by the way Taiwan or we're gonna pull back there too because we can't afford it or is the Fed gonna print the money but it's going to print the money ultimately uh right now we're in this sort of you know stage of hey you know the American people and the American Banks well we're starting to realize the American Banks aren't going to finance the government anymore that was sort of 2013 to to about two months ago uh that suddenly they the Folly of that is suddenly um beginning to be realized that that was not a permanent solution so now it is American people or the FED financing us U.S deficits so this depletionary impulse just accelerates this whole gig so do you think do you think they're going to end the hikes and do you think we're going back into QE then uh yes uh I think ultimately the U.S fiscal situation is going to force them to end hikes first and in some way shape or form you can already see you know the btfp program that is essentially a yield curve control light for banks right so the banks had these treasuries they were trading at 70 80 cents on the dollar and the FED came in and said no that's not the price the price is par and we'll lend you the money to it to at five percent and we'll value that collateral at par that is essentially you know bringing down you know Bringing Down the effective yield on those bonds that's a yield curve control soft for the banks uh treasury has quieted the U.S treasury has quietly been spending a lot of time looking at a treasury buyback program uh and so it was really interesting I I pay very close attention to every quarterly release of the treasury borrowing advisory committee report so there's a tbac treasury buying advisory committee report a group of Market participants meets quarterly and they make recommendations about all kinds of things to treasury you know issuance you know how to the tenor long baited short dated expenditures what the Market's thinking Etc it's a very useful document gives you tax receipts it gives you what they're spending it on Etc how auctions have gone and so the One calendar one two tbac report kind of standard thing and there was nothing at the back but recently there was an update someone pointed out to me I didn't see it on January 31st because it wasn't there they amended it after the fact there's a 38-page addendum that they amended after the fact of the 1q tbac looking at what they call it was a clear and regular treasury buyback program benefits or something like that right so it was and it basically here too is we're not doing this to fund the treasury we're doing this to maintain high functioning treasury markets and what we'll do is we'll we'll issue new treasuries that are more liquid we'll buy back off the Run treasury is a little more illiquid and that'll bring the yield down a little bit and from like that's the dog whistle I mean it's it's they can say whatever they want to say it's a soft form of yield curve control it is a soft form of kiwi it's a soft man because basically there's plenty of demand for the very front end stuff because that stuff's being used as collateral by the markets which you know as you add leverage to markets there's more demand for collateral et cetera et cetera so they've got no problem with that where they have a problem is sort of everything Beyond seven years where which is where they should have been terming it out a couple years ago but that's because they probably couldn't there wasn't the demand and the size they needed my point in highlighting this the btfp and the the the treasury buyback is I think they're moving towards they they know they have a problem they're not spending 38 pages and sticking it in after the fact for shits and giggles right this is not some academic exercise these are not academics these are people at BlackRock and Goldman and and like these are Market participants and so they know they have a financing prop this is a balance of payments problem in in the United States in the reserve currency issue of the world and they're trying to address this while not going straight to QE right it's the old what I've called trying to ride two horses with one ass which is they want to maintain their credibility as inflation Fighters but they also need to finance the government and those two things with debt and deficit levels here are fundamentally incompatible the only thing keeping the government financed is the inflation they claim they need to fight so they're I do think they will stop raising raids maybe they do one more and then they stop regardless of where inflation is and then I don't know that they go straight to QE but I think we I do think we will get increasing liquidity injections in the manner we've seen which is it's not it's not QE it's btfp it's not QE air they are regular treasury BuyBacks that are smooth the functioning of the treasury market or something like that uh they're liquidity injections right it's a I'm reminded of the movie The Fugitive right where it's you know uh Paris and forces I didn't kill my wife and Tommy Lee Jones says I don't care you know it's a big I see all these these economists saying this isn't QE it's if I say I don't care it's it's inflationary they're injecting liquidity trying to preserve the functioning of the treasury market so just thinking back to what happened with Israel because we often think of a high inflation as being catastrophic to uh catastrophic that people living there I mean I've spoken to people live in Lebanon I've been I've been to Venezuela yeah I've seen the impact uh on people uh it's catastrophic but as you said with Israel you know it's a great country to visit it's got a successful economy you know it seems a fairly wealthy nation is there a way of running High inflation uh but consumer prices and wages are able to keep up with inflation and therefore you know most people you know outside of people hold large savings most people are able to kind of ride through it and it really is just the bond holders that get screwed or did anyone else get screwed in Israel because it doesn't seem to have been a catastrophic for Israel as I've heard it is in other countries say for example Argentina their inflation levels have been catastrophic to people it was sort of the day new mall and again I'm not as well versed in it as I should be uh there was a long period of time leading up to this compressed period of very high rates of inflation where very consistently you had deficit spending you had uh unions with a lot of power public unions a lot of power so you had sort of this inflation wage spiral Dynamic um and I think this was finally just sort of the ultimate denuma to that sort of span of 20 years not that different than what we went through in the U.S right just less extreme right where we sort of went through 60s 70s and then there was sort of the spasm of last little inflation finally bulkers like enough right I'm taking it to 15. percent and and we're gonna stop it out and that's what they did there too uh in terms of the social impacts I would have to say it's probably it would probably be much more akin to the Argentinian and Venezuelan experience in America and a lot of the in a lot of Europe then in Israel where I think there's a number of real Israel is a smaller economy uh it is it is uh uh um it is more um what's the word I'm looking for uh yeah but it's it's more monocultural than the United States or then the UK or then Western Europe uh I think there is a greater sense of togetherness in in you know everyone has to serve in the military in in Israel right so there is a sense of uh togetherness and commitment to their in a smaller country uh that is more sort of uh um uh monocultural than I think we would see in Western Europe and in in the U.S so I'm not sure I'm not sure we could do it without some Fallout politically uh yep from a domestic standpoint um like like you get the sense happened there yeah so it's really interesting time because what it is is based on the things you're saying I'm able to start connecting some Dots here you know uh anecdotally um I just bought a bar right and I've gone in and given all the staff a 20 pay rise I think they're underpaid and I would I'm able to do that and that I'm also able then to raise the price of the drinks which pays for it and also raise the price of the drinks to cover our new energy costs so we are able to swallow our increase in prices and we're also able to cover that by raising our prices and it all just kind of like it just all kind of works out but I also know that it becomes a lot more difficult say for the government when they're getting wage demands from certain unions so we're seeing a lot of strikes now from the ambulance workers uh we're seeing it with UK doctors we've seen it with people who work on the trains and these are brutal to go associations with massive sites so the kind of strikes we've not seen before UK Junior doctors at the moment have demanded a 30 increase in their wages that's a massive increase but In fairness to them they've probably experienced close to that level of inflation over the last two years and I don't know where their increase will come out I think the nurses just got was it about 11 and got some back dated pay but we're starting to see massive pay rises from people who work within the government sector we're also seeing a massive increase in prices so that was why I was kind of asking the question because we're starting to see that now it will never be an even pattern looped through everything you know certain companies can raise their prices certain companies can't certain people can have an increase in their uh pay but I I wonder how it Nets out my suspicion is is that it will all eventually net out but those who hold assets will benefit more and we will see an increase in the wealth divide um and that will put a lot of pressure on families but that will also put a lot of pressure on the government to support those at the lower end probably means more printing it you know and there's two things I would say so here most of our mortgages are fixed rate right so it's an interesting Dynamic of a debt Jubilee right so if we see if doctors go go up 15 here uh costs you know get a 15 wage like their mortgage doesn't move right so they're still paying three percent mortgages so they've literally just gotten a huge debt Jubilee on their biggest expense uh throughout most of this country and their 30-year fix in America most mortgages are 30 are fixed and my understanding is that's not the case in the UK where there's five year fixed and then things can reset even though it looks like I'm on a two-year fixed on a two-year yeah so that makes it trickier and that ties into the second point which is we frequently hear um this case will America can't have a way an inflation spiral or a period of really high inflation because he owes it owes its debt in its own currency and it can always print that and for the death portion that's absolutely true but Social Security we're paying a 10 cost of living adjustment I want to say it's 9.7 percent for 2022. uh that is so there's that has a cost of living side to it right but even then we can understate that the Medicare Medicaid side of the US entitlements those are not owed in dollars so those are owed in health care goods and services that is no different than a foreign currency effectively right so you know you don't oh the US government does not owe I want to say then so between Social Security and Medicare and medic all entitlements Social Security Medicare Medicaid some of the other stuff uh this year will be three trillion dollars or about 65 percent of tax receipts wow so yeah huge number and the health care side of it is not owed in dollars it's owed in doctor's time and to your point you start getting doctor's time the dollar is collapsing against doctors tot the doc the dollar has fallen sharply against hips and knees and you know uh medical centers Etc uh in the west and so that's where you can when I say whatever this hundred percent odds were you know this this this this um odds of really high inflation for a compressed period of time whatever they were two years ago they've gone up you know there's a very far out tail rest that tail risk is getting fatter because you can see clearly how this could happen right where you get another eight percent cost of living increase boom and oh by the way the government's interest expense is going up because the fed paradoxically by raising rates is actually there's no functional difference between the US government printing of 500 billion in stimulus and handing it out to the people and the FED raising the US government's interest expense by 500 billion and paying that out the only difference is who it goes to the 500 billion goes to everybody and the 500 billion uh 500 billion stemi goes to everybody the 500 billion interest goes to the wealthy and so it's very um uh um non-progressive right it's very uh uh very uh a wealth wealth the increases the wealth divide so but you can see how this can happen is it is very much and I say this with a big asterisk because I don't this is not my base case but it's people say well yeah the Weimar Republic in Germany hyperfully because they had these War reparations and the war reparations were were not in reich's marks they were in they were tied to goal and so the more rights marks they printed the more the Reich Mark Fell against gold the more they went up and and and washer and repeat until it became obvious they could never pay it and then we're in sort of that same position where we don't oh dollars we owe Health Care goods and services and the more inflation goes up to address the debt the part that we will print because we want to avoid defaulting on it that leads to higher inflation but that then leads to higher cost of living adjustments and these things that are not denominated in dollars they're denied they're either cost of living adjusted or they're denominated in health care goods and services and that gets into this very uh for lack of a better word dangerous dynamic because in this case the doctors have a lot of Leverage that's just say fine you know screw it I'll go work at Peter's bar you know I'll make the here in the U.S after the last 30 years what's happened to Health Care you know we've got you know plumbers making 350 000 and I have a friend of mine who's you know uh uh oncologist and hematologist with 25 years of experience and he's probably not making that much money and that's not to say I devalue plumbers relative to oncologists and hematologists all I'm saying is is that uh there's a lot of Runway there's been a misallocation of capital for so long into different uh trades labor markets Etc uh across the government spending now you're sort of stuck you need to reallocate stuff and there's there's no easy answers so I'm now starting to think any cash I'm holding in Savings in the bank I need to find another use for that money because that's going to inflate away but I think holding having a house or maybe if I could afford a second house that might be a good theme because with inflation the value of the house will rise but then I'm also like what what happened with interest rates in Israel during that period do we know I don't know I'm assuming they were capped in some way shape or form but I don't know yeah because otherwise people wouldn't be able to pay their mortgages um but I am starting to think about like how I'm partially protected against inflation I consider because I have a significant holding a Bitcoin but I'm not protected against inflation with savings and I mean I'm asking this about me but I'm really saying Luke with your experience that somebody understands markets what you do for work how do you how are you preparing yourself for a potential world of High double digit inflation for a couple of years how are you protecting what you have so when I first started thinking about some of these types of issues I mean gosh you know probably a decade or so ago with you know with with the first rounds of QE Etc you you see the famous you know you go right to the most famous example of Weimar Germany currency goes to zero and you start reading about it and you quickly realize it's not apples it's not exactly the same there's political differences and there's there's the diversity economy you know the America in particular can produce pretty much everything we need at the right price right so oil prices in America went up 10x from 19 2000 to 2008 and voila we're the biggest oil producer in the world a few years later like that you know it's the dollar collapsed against oil and then we produced a lot more the dollar collapses against something in America we're probably going to produce a lot more of it by virtue of our Diversified economy our land mass natural resource endowments Etc so that's something you know in the UK to think about is is okay you don't have the land mass you don't have the natural endowments there is more of a risk where the inflation wall spur production it will simply spur an inflation spiral and there's a lot of other countries that you'd expect that to happen versus in the UK before but it's really a statement of Diversified economy versus not Diversified um the the other sort of thing that I've learned more recently as it relates to this in particular context of bursting Global sovereign debt bubble and then they overlay the speed cheap energy Dynamic is you frequently see these great inflations you know and I mean again I'm going to use the Weimar Germany one because it's well known and it's so extreme and it wasn't a developed economy and and you see the turn it's like okay in 1918 the reichs Mark was at 100 you know 100 you know 100 uh race marks uh per ounce of gold and by 1923 it was at a trillion like the currency just went away and you say oh well that's easy right I want to borrow a bunch of money and I want to buy a bunch of gold and then you know in 1923 I want to make sure that you know when gold you know when a city block in Berlin is going for one ounce of gold I just start swapping gold for you know I pay off my debt and then I start swapping gold for velocity blocks in Berlin and and voila I win and the reality is is not that easy um what really happens is face peeling volatility and so there's this great chart I've shown in our research before uh it's been on Twitter before uh it's by Dan Oliver at murmican Capital and it shows sort of that classic hey here's gold in German Reich marks and it's this beautiful uh hyperbolic asymptotic line to a trillion in five years and then he overlays the month-over-month price of gold in German Reich marks from 1918 1923 and that is an absolute bloodbath where literally it's like up 50 down 50 up 50 and you if you borrowed a bunch of money and bought gold and hoping the gold was get rid of your debt the reality was you lost all of your money probably four or five times you got margin called out gone all your capital is gone uh before you got to that end game payoff and why did that happen when you read the history books of it it's such a political process of okay they owe this money okay there's a negotiation the Allies are going to write it down oh yay buy the rights Mark okay or list of the the German Central you know the the bundus bike is going to the rights bank is going to uh raise rates and defend the the right smart Okay I want to sell gold and buy reich's marks and like so I bring this up by way of saying I think it's really important that this volatility we've been seeing in things we're not used to seeing it in in the developed markets FX rates right I mean last summer we saw the British pound trade like a Latin American currency uh we saw the Euro true to the same we saw the Yen do the same um and then there was the dollars turn in the fourth quarter falling 11 a quarter um we're gonna see this type of FX volatility we obviously saw it in Bitcoin and you know um that type of volatility uh and then in rates as well I think you're going to see that and so the point here is is that I think it's critical to understand it's going to be face peeling volatility and so you need to be Diversified understanding that there is a path and the path doesn't look like this the path looks like this to this High rates of inflation and number two you want to be under levered because you don't want to be wrong for the right reason right you do you don't want to get carried out on your Shield because you borrowed too much money what we're looking to you know you know pigs gift bad Hogs get slaughtered is something my dad always tells me yeah pigs about like so for me the way I'm playing it I actually have 20 we came in and came to the air told clients we have 25 to 30 percent of our net liquid worth Nick my liquid net worth in US dollar cash and short-term treasury bonds uh I had probably I think I was said uh 30 to 45 percent in a combination of uh gold Bitcoin and some gold miners uh we own industrial equities uh we own some energy related Commodities um we own some real estate again here in the U.S it's residential you know I bought a vacation place uh after I paid off my house and you know that is a a low levered you know basically I mean not basically thanks to what the FED did with mortgages I've got a 2.9 mortgage on it I can make five right now on money market funds right so I'm a bank I'm making positive carry uh on on a on a on a on a second home so uh conservative leverage Diversified cash Bitcoin slash gold neutral Reserve asset energy industrial equities when you have a peak cheap energy Dynamic you're going to move away from discretionaries towards needed needed things right so it's you know in the companies you own it's gonna be you you know things you need over things that are discretionary and then good balance sheets over bad balance sheets I think is the way to get through this and to be clear like when the liquidity is there it good balance sheets are going to underperform bad balance sheets and vice versa but with the volatility what you what you're trying to do is avoid getting carried out right the bad balance sheets might not survive we've now seen that right like svb and Signature Bank they got carried out and like sorry you got zeroed out have a good day um Danny who is the guy we had in came in from San Diego into New York so he said he said I think it's a bit similar to you yeah but I think his was like a third cash a third equities and a third oh what was it was it even property possible I don't know yeah he said the same he said he just does I can't remember who it was but he remember the New York one we did not their last one the previous one um we even I I can't even remember no not Peter Doyle I can't remember his name you might find him but um yeah he he said the best way is not to try and trade through these times is to is to just have a diversified portfolio and just make sure that if a market Moves In One Way or you've got a bit of that you know if if you know if cash increases you've got a bit of that it's not something I've done I'm like I'm like Luke I'm balls deep in Bitcoin fingers crossed but but it is something I'm starting to think a lot more now you know it's just starting to protect myself into you know far riskier times so it's definitely something I'm gonna need to think about but I'll probably have a bit of US dollar cash a bit of British pound thrown in there a bit of Bitcoin I think it's time to get some gold Danny yeah and I've never bought equities in my life and it's possibly a time to get some equities yeah and I think it's you know there's a um one of the wealthiest men in history by percent of the economy at the time was a man named Jacob fuger f-u-g-g-e-r I think he was he was Dutch at anyway the point is is that he had a allocation where it was 25 cash 25 gold 25 stocks 25 real estate and then just reallocate and it you know through tumultuous times you know you short upper cover right you you every everything everything is covered because really you're just trying No One Alive has ever seen what we're going through uh the combination of what we're going through plus the scale of what we're going through um you know energy availability has historically for the last 150 years been a story of more at a cheaper price and now we're getting more at a more expensive price and that is that changes everything that is Nature's discount rate uh as effectively right so that's that that's your true cost of capital they can tell you rates are what they are but the real cost of capital is what's your energy cost and you know you're seeing that there in the UK right where you know if your energy bill doubles that changes behaviors that discounts other other economic activities in a way that have nothing to do with the bank of England so um it I think it's really important to have that balance um and just you know balance some leverage but not not a lot and fixed rate because um it can act as an inflation hedge particularly in areas like here where we can figure you know if I you know to me term it out a mortgage 30 years at 2.9 percent like that's a layup especially if they're going to pay me five on my cash now which is you know it's great for me and it wasn't great for for Silicon Valley Bank or Signature Bank but it's great for me it was Cullen Roche ah okay I think he was on the 20th I think it was like 20 I think it was exactly what you just said there what 25 real estate 25 cash 25 equities and what was the last one Commodities I said 25 gold and I would when I say gold I would you know because personal preference call Bitcoin but there's yeah there's you know some sort of blend in there yeah well I'm not gonna reallocate while bitcoin's on the rise right now but maybe uh maybe I'll call the top like you did and sell a bit off okay so thinking about this this kind of catastrophic well the situation that potentially become catastrophic do you is this related I know you're you've followed geopolitics um is this related to the kind of d-dollarization this move away from the dollar the global Reserve currency that we're seeing from the likes of China and Russia and I know there's some Ukraine war stuff that can probably be thrown into that as well anyway but is this just basically smarter people in the room who need to understand this at The Sovereign level within these nations who've realized what's happening and that's why they're exiting the dollar yeah for for the detailerization of Commodities is largely defensive in nature it is an existential threat to them to get away from the dollar Monopoly in Commodities and the reason we say that is can be laid out most easily Kyle bass gave an interview um I don't know about four years ago which he said listen the Chinese they're buying more and more oil uh they're importing more and more oil they're consuming more and more oil every year and that oil is only priced in dollars and so as oil gets more expensive and they consume more of it they're going to need to have more dollars every year just to keep their economy going or else all the debt they have their economy will implode the debt will implode you'll have a huge crisis and Kyle went on to say but they only have a finite number of dollar reserves and so as oil Rises and their consumption Rises and at some point they're gonna run out of dollar reserves and then they're going to have a 1997 southeast Asia crisis where they run out of reserves to buy oil and either they have to shrink their economy and they own economic crisis or they devalue D1 or whatever you know then you have inflation it's crisis so ultimately for China in particular on on one side of it and and some others it is a manner of national security for them to gain the ability to import their energy at least partially in their own currency and they have done that uh they've done that with Russia they've done it with Venezuela they've done it with a number of other nations that if you look at this was back in 2018 data and it's uh the iif uh iif data if China had bought all of their Commodities in Yuan then 2018 their their Trade Surplus in dollars would have risen by 800 billion dollars right so they picked 800 billion dollars they wouldn't have had to have put out in Commodities uh because they were printing up Yuan now you know there's a recycling issue we've highlighted a number of times that we think the recycling it into gold uh and a goods and goal uh but the point here is is that that 800 billion is probably a trillion or a trillion and a half now given more volumes thereby importing in Commodities and higher prices so China cannot have the dollar crisis that a lot of Yuan bears are saying if they just start moving some of their oil import Builder commodity import bill into Yuan every you know if it's a trillion trillion and a half in aggregate every 10 percent though they shift their commodity bill out of dollars into Yuan increases their annual dollar liquidity every year permanently be by 100 to 150 billion dollars they're not going to run out of dollars and so if they're not going to run out of dollars that means they're not going to have those crises and the flip side of that is means they don't need to buy as many treasuries it means they're the intensity of their FX reserves per dollars goes down so in 2013 China's FX reserves is a percent of China's GDP was 46 percent by 2018 that number was 26 percent that number is now 18 and it's going lower because again they can buy marginal tonnage of Commodities in Yuan not dollars that turns around and puts pressure on the U.S in terms of just the treasury market of foreigners don't need to buy as much on the flip side of that same coin Russia you know Putin said this in June of last year in a speech that was of course ignored across most of the U.S uh he highlighted that the U.S is the real rate on on Treasury death negative eight percent and where do you get that number if you look back from 2008 to present U.S treasury issuance has Rose by eight percent per year has risen eight percent kager the yield on the 10-year treasury has barely ever been above three so basically like I would love that deal like if you guys want to give me that deal let me know I will issue you eight percent more ious every year and I'll pay you three percent and I'll use part of the eight percent more that I borrow every single year from you to pay you back yours and then this it's Ponzi scheme and he has finite like he has finite oil production we don't know where that number is but it's finite we heard that when people said well if he doesn't reinvest oil production is going to fall exactly he has finite oil production at some level he cannot afford to stockpile his wealth in a reserve asset like treasuries where the supply Rises eight and the coupons three he would have to be an idiot and he's a lot of things but an idiot isn't one of them so he he started buying gold it has his primary Reserve asset ten years ago 15 years ago uh some of that was in response post 13 in response to the original sanctions Etc but the point stands which is both of this the this D dollarization Dynamic from both sides of this coin are really The Sovereign version of what we let off talking about which is peat cheap loyal cheap energy and Global sovereign debt crisis uh they they are addressing this by by shifting to multi-currency energy pricing settling in goods and then settling net deficits and physical gold whose price floats in all currency now could Bitcoin be that Reserve asset at some point on the road yes it could is it there yet in my opinion no because you've got the status quo system and if there's going to be a transition in the system it's probably going to go through gold first which requires a much higher price of gold uh that's a separate discussion but yeah this whole detailerization thing is ultimately all about sovereign's making an Enlighten a decision in their own enlightened self-interest it's basically a matter of acute National Security that they get away from pricing their Commodities because otherwise their commodity bills go up 100 200 percent and you know they have they have the same problem except in those places people don't sort of yeah the political outcomes are more extreme shall we say and so obviously this movement away from the dollar being a global Reserve currency is is going to exacerbate issues for the US for their own currency but is there an argument that this is net good for the world because it takes the pressure of other nations with a rising value of the dollar makes All Imports a lot more expensive especially for smaller countries and we've made shows discussing this you know when um when the US for example during covid printed stimulus checks none of those Reach people in El Salvador who are a dollarized nation but yeah you don't even have to be a dollarized nation with everything priced in dollars now it makes it difficult for other countries so can you make an argument that a de-dollarization yes bad for the us but good for the world I would even go up further it's good for the world right when we talk about all the debt is owed in dollars if you want to stimulate growth the easiest way to do it is reduce the debt burden right give the world a death break how do you give the world a debt break you reduce the value of the dollar right so the dollar Falls the debt burden of the world Falls I would go on further and say it's good for the U.S if you look at the it's just not good for the part of the U.S that has won the last 20 years the last 30 years who's won the last 20 30 years in the US it hasn't been the U.S it's been China it's been Wall Street and it's been Washington DC certain interests in Washington DC those have been the winners in the US everyone else is lost on the net basically we're all just you know it's Washington's world you know so in this seven of the 10 wealthiest counties in America around Washington DC what is Washington DC export to make all that money simple treasuries export dollars they don't make anything uh so if you look at the winners in the U.S over the last 20 25 years in particular you can make the case even stretch out the last 35 40 years the weaker dollar and and and and the loss of treasures I think the dollar is going to stay the reserve currency but I think we are we are 10 years into the treasury by losing its status as the primary Reserve asset to Gold de facto we can see it in the data central banks have bought 300 billion in Gold they've sold 400 billion in treasuries in the last eight years uh that switch is already well underway it accelerated meaningfully last year uh that is a world where if gold at a floating rate is the neutral Reserve asset again then suddenly currencies will trade on a balance of payments basis around gold right basically you if you if if you are settling net settling in Gold then you're going to run deficits like the US and the US and UK are on the biggest deficits U.S first UK second uh your currencies are going to fall sharply against gold and at the same time China who has been sort of manipulating this dollar system an emergency away they're running this big Surplus their currency is going to uh uh strike them meaningfully through the gold link right so the price of gold will fall in China because Gold's gonna flow in that direction gold Falls in China Yuan Rises against the dollar China suddenly has to consume more of their own production they've been talking about becoming more consumption oriented forever well to become more consumptionary you have to be able to print your currency per energy check and then you just need your currency to strengthen relative to your Imports check same same side here is if we need a rebalancing in America what does it take set up a neutral Reserve asset the dollar needs to fall dramatically that's going to increase uh inflation in the U.S dramatically but it's going to increase production at the expense of consumption and it's going to rebalance the economy away from Washington and Wall Street towards more productive Enterprises and at the same time that falling dollar remember it like we just said it reduces the debt burden globally so there's going to be more Global demand as the global debt dollar debt burden Falls so like literally the falling dollar is great for everybody except for Washington interests certain Wall Street interests uh and certain Chinese interests uh so I I think we're moving in that direction because people say well we couldn't afford the wars we couldn't afford the military well yeah not at 850 billion a year but like if you talk to most U.S military officers on down they for 10 years they've been telling you this is unsustainable we need to get out of this you know what we need to we need to reinvest into more productive Enterprises such as infrastructure education um you know Etc so I would argue a much weaker dollar and and the process that is already underway by vert deal much weaker Dollar by moving from treasuries being our primary Reserve asset to gold at a floating rate in all currencies being our Reserve asset really good for the USA it's just not really good for you know the USA that are Whispering into the anchors years at CNN and you know MSNBC and and fox and what have you yeah I mean it is it's a really we it's it's a Monumental time and there's a lot of different ways this can play out this can end really really happily this can end really really painfully um and there's it can end sort of a whole range of outcomes in between those two extremes which unfortunately both have fat tails based on that geopolitics Etc so no I feel like we've had a pretty pretty wide ranging conversation across uh to highlight that yeah it's absolutely fascinating looking really really glad we did this so good man Danny um I still want to interview one day in person we will find a time somehow we'll come to you uh yeah yeah that's you know once my last kids out of school I used to get over the UK twice a year so um you know pre-covered so and we do my wife and I do absolutely love London and you know outside of London so and we we've never made it up North so we want to we want to get over expensive time so we will be over there at some point we're only we're only 40 minutes north of London so it's not too far beautiful and uh we got a football team you can come and watch over here so oh we we would love that it's uh uh they do serve pints there right in the stadium I mean the stadium is a stretch I mean we're a non-league team but yeah we uh no we sold yeah we won the league yesterday so we sold a lot of bits oh congratulations that's terrific yeah so we sold a lot of beer me and Danny our heads were a bit sore this morning but most of the day was sold to me yeah we'll get them up all right Luke where do you want to send me where can we help you uh you know you can find us at uh fftt llc.com or our website on information about Mass market and institutional product offerings and people can always find me on Twitter I'm at Luke groman l-u-k-e-g-r-o-m-e-n uh pretty pretty active feed as as you guys both know yeah definitely follow really appreciate your time thank you so much Luke well thanks for me out again I really enjoyed our conversation foreign

Channel: What Bitcoin Did

Views: 52,523

Keywords: Bitcoin

Id: k1TUNrwMUFQ

Length: 70min 6sec (4206 seconds)

Published: Mon Apr 17 2023