The Breakdown - Dollar Dilemmas & Central Banks Gone Wild: The Best Of The Breakdown April/May 2020

Episode Date: May 25, 2020

Highlights from some of the most interesting conversations on The Breakdown from the last two months.  4/1 - Peter Zeihan on why the world we’ve known for 30 years is changing forever 4/6 - Emerson Spartz on a moment of punctuated equilibrium  4/17 - Jared Dillian on the political football of stock buy backs 4/21 - Joe McCann on how financial engineering came to dominate Wall Street 4/22 - Luke Gromen on the genesis of the global monetary order and why the US switched off the gold standard in 1971 5/1 - Danielle DiMartino Booth on how the Federal Reserve moved from incompetent to corrupt  5/9 - Niall Ferguson on a shift back to a multipolar, multi-currency world 5/14 - Jeff Booth on why technology deflation competes with inflationary monetary policy  5/20 - Lyn Alden on the negative impacts of a too-strong dollar 5/22 - Tuomas Malinen on why dismantling the Euro may be the only way to save the European Union 

Welcome back to the breakdown. An everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond, with your host, NLW. The breakdown is distributed by CoinDesk. Welcome back to the breakdown. It is Memorial Day, May 25th Monday. What's up, guys? How are you doing? Hope you're hanging out, having a great weekend, great long weekend if you're in the U.S.

So today I wanted to do something different. Obviously, it's a special day, it's a holiday. And I thought it would be cool because there's so much content that goes through the breakdown, right? We do five shows a week, tons of interviews. I thought that it might be fun to actually look back across the interviews from April and May to pull out some of the highlight clips, the most interesting things, right? The statements that had stuck with me even weeks later. So what I'm going to try is a type of episode. And if you guys like this, I'll do this maybe every month or every couple months, where I'm,

just curating my favorite or some of my favorite clips and conversations from the past month or the past month or two. So I'm going to kick that off right now. I'm just going to go chronologically for lack of having a clear narrative that I'm trying to push. So hope you enjoy it and let me know on Twitter at NLW or at Breakdown NLW. If you like this, definitely hit me up so I know to do more of it. Cheers, guys. We're kicking it off with Peter Zeyan, one of the most interesting thinkers on geopolitics and the changing shape of the global order, basically in the world. We talked about a huge number of topics relating to the acceleration of the withdrawal of the U.S. from the global order that it created in its own image. And we talked about how the coronavirus had accelerated a number of those transitions in a way that was likely to be really painful.

So we've got two overlapping things that have nothing to do with. one another that are kind of crashing together at the same time, just purely coincidentally, that are ending the era of globalization for good. Step one is geopolitical. So at the end of World War II, the Americans were there on the plains of Northern Europe facing down the Soviets and realizing that they had no chance in that fight. We needed allies that would be willing to intersperse themselves between us and the Soviets. And that basically could not be done if you want to occupy them. So what we did is we bribed them. We basically paid everyone to be on our side. We created a global structure that allowed anyone to go out without need of naval cover,

purchase any sort of raw commodity, bring it home, metabolize it into a finished good, sell it within their own market or more likely export it to the United States, and export their way back to being a first world country. It was the first time it had ever been done. In the past, if you were a naval power, you used that to forge your own empire. And for this time, the United States used its naval power to help everybody else recover. It worked great, and eventually it did defeat the Soviet Union. But when we got to 1992 and the Soviet Union had collapsed, we never bothered to kind of reset our foreign policy for the new age. So we kept providing all of these strategic goods for the global commons so that the world could grow, but the U.S. no longer

got any sort of security in response. 30 years later, we've gone through four, presidents, Clinton, W, Obama, and now Trump with decreasing interests in maintaining that system. So it was always going to collapse under whoever we elected three years ago. It's just a question of how organized that collapse was going to be. Okay, so that's piece one. So the U.S. is just done. And without the United States, there is no power, there's no coalition of powers that can hold it together. Piece two is demographics.

People in their 20s act different from people in their 40s act different from people. and their 40s act different from people in their 60s. When you're in the 20s, it's all about consumption. You're raising kids. You're going to college. You're buying homes. When you're in your 40s and 50s, it's all about the savings. The kids have moved out. The house has been paid down. You're saving for retirement. And then when you're in your 60s, it's about whittling away at those savings and basically just kind of idling away and being a net consumer of capital. Well, global birth rates started dropping in the 1960s and really accelerated in, the 70s and 80s. So we are at this weird moment in time, demographically, that's never happened

before where we have very few young workers doing the consumption. We have a lot of mature workers who are doing savings, and we have a rising number of retirees who are consuming. But within the next few years, and it depends on where you are, it's one to six years based on the country, the world jumps from a bunch of mature workers to a bunch of retirees. So at this moment in history, Capital supplies have never been higher. And very soon, the capital will go away, and the retirees will basically consume it all, and we have to move to a completely different economic model that is not based on consumption or trade. So both of these were coming to a head anyway.

Both of them are going to crash into the system we understand sometime in this decade. What coronavirus has done is fast forward it, because if we are offline as an economy for the better part of a year, there is not enough time to get through this debt overhang that we're going to have, to set up the supply chains and the way that they used to be in the aftermath. So we have probably just ended the greatest expansion in American history, the greatest expansion in human history. And we're not going to see anything like it again in our lives. On April 6th, I spoke with my friend Emerson Sparts.

Emerson is a really interesting thinker, a really diverse, diverse thinker. He's been spending the last 20 or 30 years really thinking about viral systems and how information is distributed across the internet, starting when he dropped out of middle school to create MuggleNet, which became the world's biggest Harry Potter fan site. We talked about the second order effects of coronavirus and why we were living through a moment of punctuated equilibrium. And yes, we're going through one of those periods right now. And so if you literally just plot out how much area there is under the curve in these periods of punctuated equilibrium, like all the stuff happens in these brief windows. So that means it's very exciting if you're the kind of person

who likes to, you know, if you're looking for leverage, basically. And I think of myself as basically being a hunter for the mother of all leverage points. So I just spend a ton of time researching a wide variety of different subject areas and topics and industries. And I just look for the, you know, the white whale of mispricings, right? And so these are the windows where, you know, you can actually, you know, you could actually beat the market because there is no smartest guys in the room who have everything figured out because too much is happening too quickly. And I see beat the market in a more metaphorical way. But anyway, so there's this window where tons of stuff are happening. Nobody has, basically, the better your mental model stack is, the more clear your picture

of reality is. And I've spent a lot of time basically bulking up like crazy to build out this stack, just like you would if you were a weightlifter, right? Building those muscles to be able to see the world more clearly in situations like this. So just for fun, I and my friend Michael Simmons, we just started writing down tons of second-order effects of coronavirus because I'd spent a bunch of time talking to other entrepreneurs and kicking around ideas and, I mean, the amount of content that's coming online every day right now.

I mean, all of humanity is working on this to some extent. So it's, you know, people, everyone in every industry likes to say that their industry has this, you know, tidal wave of information just flooding in, But those now look like trickles compared to what's happening right now. As humanity has its collective sights set on a single common enemy for the first time in history. On April 17th, I talked with Jared Dillian. Jared has been writing a set of really interesting essays around how people are losing faith in money based on the Fed's rampant actions right now.

And we talked in this context about why corporations shouldn't be buying. buying back their own stock, something that is front and center for a huge number of people as that relates to what the company's obligations should be if they took those government loans. Yeah, it is. I mean, I think a lot of things. First of all, we've known for a long time that buybacks were the source of most of the gains in the market.

Torstensock at Deutsche Bank put out some charts. This was back in like 16 or 17 and showed that pretty much all the gains in the stock market were coming from buybacks. Okay. Now, and a lot of people, I was opposed to buybacks on the grounds that corporations trade their stocks incredibly badly. They buy them back on the highs and then inevitably something bad happens. The stock goes down and they have to issue more stock on the lows.

So they're buying stocks high and they're selling stocks low and they destroy value all the time. And IBM is the perfect example of this. I mean, before the crisis, IBM had 140 billion market cap, and they had spent 160 billion on buybacks more than the entire company was worth. So I think the political blowback here, you know, it was funny, like AOC had a tweet on this and, you know, about the airlines, about the airline buybacks, how they spent 96% of their free cash flow on buybacks and now they were getting a bailout. And I looked at the tweet and I was like, son of a bitch, like I actually agree 100% percent. percent with aOC on this. Like she absolutely nailed it. And, you know, a lot of the buybacks were, you know,

explicitly for the purpose of enriching management, for sure, you know. So I think I think the smart thing to do would be like if we were in a 1980s, Reagan Volker world, we would eliminate taxes on dividends and make dividends and buybacks equal from a tax treatment standpoint. So then companies would pay more dividends. But really where we are right now is where we're moving towards getting rid of buybacks and also discouraging companies from paying dividends, anything that reward shareholders at all.

If you look at dividend swaps in the United States, we're projecting that dividends are going to be down 40% in a year. So it's actually not just buybacks. It's dividends as well. on April 21st, I talked to Joe McCann, who has had a huge number of different roles across the crypto and tech world. We talked about financial engineering and why financial engineering creates and is creating such huge problems for the real economy. At the same time in the 1980s, we started to see an uptick in the fascination of financial engineering. There's a woman that wrote a book called Makers and Takers, which I recommend to people all the time.

It spells out how the financialization of America has fundamentally changed corporate America and incentives around it. And I kind of dive into a couple of things in the piece that spell out why the dismantling of international trade barriers coupled with this financial. engineering has created what I see as potentially devastating implications for U.S. trade and ultimately supply chain management, manufacturing, creation, and finally, innovation. And what is financial engineering? So I'll give you an example. There are all kinds of unique ways that a CFO and a Fortune 500 company can

calculate their earnings or their revenue or do certain things to tweak, you know, capitalization rates or utilization rates and change the way that the numbers ultimately work out. That's kind of like a tactical way of doing financial engineering. The other ways of doing financial engineering or the incentives around it are anything we can do to grow the stock price. And if you grow the stock price by doing things like, like, off, you know, tens of thousands of workers or shuffling money around as opposed to investing in research and development or capital expenses, you can absolutely, in fact, increase the price of

the stock, but you're not actually doing anything long term to build kind of an innovative or sustainable business. And I use GE and Jack Welch as an example because the Wall Street's sort of media arm, whether it's, you know, Bloomberg, CNBC, Financial Times, Barron, and I'm not calling them out as bad actors, but this is the cohort of folks that dominate financial news. They actually have held Jack Welch in such high esteem as this incredible CEO who created so much value for General Electric. And unfortunately, that's just simply not true. What he did is he created value for the shareholders. He caused GE's market cap to swell to $400 billion.

But the way he did that was not by investing in R&D or CAPX. In fact, he reduced it. He also fired 112,000 employees within his first five years. And the majority of the market cap for GE actually came from its financial services arm, GE Capital, which I believe peaked. in 2000 at making up something along the lines of $96 billion worth of their market cap. So the point that I'm trying to make is that folks like GE are now suffering because instead of focusing on the long term and investing for innovation and new capabilities, they decided

to shuffle money around in this unique sort of financial wizardry, if you will, to prop up the share price. And that, coupled with this kind of this move away from relying on cheap labor and services outside of the United States is one of the reasons why I lead into this thought of, well, this is going to have to change. We're going to actually have to treat not only the impacts of things like share buybacks that artificially inflate the price of a stock, but also things like, hey, if we're reliant on our pharmaceuticals to come out of a place like, I don't know, China, that's probably a national security interest that we should actually look deeper into. On April 22nd, I had a total barn burner of an episode, which was Luke Gromman,

explaining the basic entire system of the global monetary system and how we got to where we are now. In this clip, he talks about how we won the Cold War when we tied the U.S. dollar to oil, and got an unassailable advantage through doing that. We need to go back in time and understand why this system evolves. If we go back to at the end of World War II, at Bretton Woods, there were two options. There was John Maynard Keynes proposed something called the Bank Corps, which was a neutral settlement asset that floated in all currencies and would have basically prevented systemic deficits and surpluses from building up over time

that we have since seen because we didn't go. the Bank Corps. We went with a proposal from the United States as voiced by Harry Dexter White, which was the dollar is the center of the system. The dollars paid the gold at $35 and it everything else is then tied to the dollar. And it provided the U.S. what DeGal called exorbitant privilege. And that system worked at first. It came under stress because of the dollar peg and the U.S. is spending in Vietnam. And the great society. spending by Johnson. By 1971, it was clear to everybody that the valuation, even though the U.S. had written the dollar down against gold from 35 to 42 an ounce in, I want to say 68 or 69,

but at any rate, the system was strained. The peg was the weak length. Everybody knew the U.S. owed way more money than it could satisfy with the gold we had. And so our choices were, number one, devalue the dollar significantly against gold to basically take that gold, backing up to a level requisite to reestablish confidence in the dollar and in the Brettonwood system, or close the gold window, default on the whole system, and move to something else. And we chose the latter. Again, we can discuss, was that the right thing or not, but the key was we we closed the gold window. So now you have a global reserve currency, the dollar, with effectively no backing. And so then we moved to this petro dollar system where what we effectively did was

replace the gold backing of the dollar with oil backing. And to do that, you needed the price of oil to be higher to basically create more dollar liquidity to effectively, increasingly, you know, to make oil big enough to back the dollar effectively. And again, here too, I don't moralize on why this happened or was it a good or bad thing. The reality is, as in 1971, the United States was not exactly winning the Cold War. It was neck and neck. and what this system allowed us to do was print dollars for oil. And while the Soviets had to actually lift oil out of the ground to achieve those same dollars. And so basically, once the system got set up, once the Saudis sort of enforced this by saying they would only price their oil and dollars, we won the Cold War.

It just hadn't been marked to market yet because we were printing money for oil and the Soviets had to dig it out or pump it out of the ground. On May 1st, I talked to Danielle DiMartino Booth, a former Fed insider who has become one of the most thoughtful critics of the Federal Reserve and the Federal Reserve System as a whole. The Federal Reserve Act, I'm going to get a little, I'm going to get a little bit in the weeds here, but it's necessary. Love it. Love it. The Federal Reserve Act explicitly precludes the Fed from taking on individual company risk and any kind of corporate risk. And it takes on, and it's not allowed to extend credit in any way to insolvent firms. So in turn, I don't know if anybody can remember the Enron saga, but Enron WorldCom, a lot of companies had off-balance sheet vehicles that allowed them to really monkey with their accounting. And that is what the Fed has done.

There are special purpose vehicles that have been set up at the Treasury Department, and it is through those vehicles that the Fed is able to provide financing and funding to the corporate bond market, to the high-yield bond market, potentially to the municipal bond market. There's been yet another facility set up to reach out to municipalities that are in need of a lifeline. And these are, again, an express violation of the Federal Reserve Act, but by the virtue of setting up entities at, the Treasury Department, it's now an arm's length transaction, if you will. By the same token, the Treasury Department has control, if you will, if you take it to the extreme over what the Federal Reserve funds going forward. So we have, and by extension, the Treasury Department is answerable, that they answer to the administration. And the Federal Reserve is supposed to be by its very

by the law, an independent and apolitical institution. And that violates this. The fact that the Fed is getting off on a technicality because it's not technically holding, let's say, a corporate bond on its balance sheet, but rather offloading it onto the Treasury's balance sheet where any first losses are going to be absorbed by taxpayers is extremely problematic.

And when you consider that the administration could potentially be charge of allocating financing and funding to companies, you know, it's enough to make, at least in my case, it's enough to make my hair get set on fire. Support for this podcast and this message come from Eris X. With ArisX, you can trade spot and regulated futures on cryptocurrencies through a licensed U.S.-based exchange. ErisX believes in fair access for all. Sign up today to take advantage of zero fees and learn more at ArisX.com slash consensus.

This episode is also sponsored by the Stellar Foundation. The Stellar Network connects your business to the global financial infrastructure, whether you're looking to power of payments application, or issue digital assets like stable coins or digital dollars. Stellar is easy to learn and fast implement. Start your journey today at stellar.org slash coin desk. Over the course of the last month, we've been doing a special documentary style series called Money Reimagined that is all about the future, the battle for the future of money.

Episode one was all about the dollar and its role in the world. Episode two was all about the contenders, whether the euro, a Chinese digital yuan, or the Libra, might actually have a chance of competing with the dollar on the global stage. In this clip, Neil Ferguson, one of our featured guests, talked about why we might be moving, in fact, back to a multipolar, multi-currency world. Some of the greatest theorists about money,

Hayek, for example, Friedman, thought it better for the to be multiple competing currencies rather than a single global standard. And there were plenty of periods in history when that was the case. There were multiple currencies in, for example, 17th century Europe. And there were, in fact, many different forms of payment across the United States and the 19th century. Standardization of money came relatively late to the world. It began with the British gold standard, which by around 1900, was a global standard pegging currencies to a specific quantity of gold. I think one of the lessons of history is that with globalization comes a tendency for a particular currency to become the number one dominant currency for transactions, for trade.

for international reserves. In the 19th century, it was the British pound, in the 20th century, it became the US dollar. And a great question to ask is globalization enters this phase of crisis. Will there be some other transition from the dollar to another currency? Or could we see a reversion to a multipolar, multi-currency world of the sort that we've seen in previous eras. Support for this podcast and this message come from Grayscale Digital Large Cap Fund. In times like these, diversification is key. Consider Grayscale Digital Large Cap Fund, ticker symbol GDLC. It's the only publicly traded investment product that offers diversified exposure to large-cap digital currencies, all from your brokerage account. For more information,

visit grayscale.co slash coin desk. That's g r a y scale.cow slash coin desk. Jeff Booth has a fascinating thesis. In his estimation, the economy is being shaped by two competing forces. On the one hand, the force of technology rot deflation, making things cheaper. On the other, inflationary economic policy that is keeping and is designed to keep things more expensive, particularly assets more expensive. In this clip from May 14th, Jeff talks about how Keynes thought 70 years ago, 80 years ago, that because of technology, we'd only have to work 15 hours a week at this point. Okay, I'll tie this back to John Maynard Keynes.

A lot of people talk about negatively now and everything else. But I think his policies are being manipulated right now. And so he was, government should step in in soft times and then repay in good times. And he also believed, he wrote a article, I wrote a paper in 1930 saying the economic, the economic possibilities of our grandchildren. And in it, he forecasted, I think it was a 13-hour work week today, where we are today. looking at what was happening in the kind of eightfold or more that you'd have have with technology from that time and saying what would that look like and for a long time

we were actually tracking towards that and we were tracking ironically until 1971 we had a 38 hour work week and then after the US went off the gold reserve it started to change now you needed two incomes to support the same thing, and you started to, and it started to get more and more further and further away from that ideal. So a very small percentage of people live, they don't have to work. Their assets are so high, their revenue is so high from rent seeking on those assets, and they don't have to. So a small portion of the population has had that because we've manipulated currency so that some people are enjoying the games and most people are not. So that's really what's happened.

And it's gotten worse every year since. So when you started it, it was a tiny little bit nobody would notice. Now where we are, it's a lot. And so in the last 20 years, $185 trillion of stimulation to produce $46 trillion of economic growth. And so you can see it really clearly. By the way, that's pre-COVID. Imagine what it looks like now. Right. But it looks like, so now, if you just follow the technology doubling, and effectively the productivity gains doubling, that means you have to double the debt to remain even. And now you're getting to a debt level that is unsustainable.

It's impossible to pay back. And it's not necessarily the debt. It's debt that you can't pay back. you have to do artificial bailouts and everything else of that. So you create a perverse incentive structure that creates the debt in the first place. On May 20th, I was joined by Lynn Alden, who really understands and can speak to the dollar in a way that very few people can. We talked a huge amount about why the dollar might no longer be serving either the U.S. or the world as the world's reserve currency. Yeah, so the current monetary systems have been in place since 1971, which is that, you know, none of the currencies are pegged to anything other than, you know, essentially that the dollars kind of pegged to oil in a way indirectly. But since over those 50 years, roughly, there have been three super cycles of dollar strength and weakness. So the first one, it peaked in the mid-1980s, and then it had a long decline. The second one peaked in 2002. And then it had a

had a long decline. And then this current one has been in a peak for several years now, starting in 2015. So that's kind of the overall long-term cycle. And of course, there's different fluctuations each year. But those are the three very large changes in the dollar. And every time the dollar has one of those massive spikes, something breaks because the whole system is levered to the dollar. And the dollar dictates all the liquidity in the world. as far as trade and currencies go. So in the 1980s, it broke some of the South American economies. In the late 90s, it broke some of the Asian emerging markets.

And then recently, it's impacted Turkey. It's impacted Argentina. And it's slow growth worldwide. And then in many ways, it also negatively impacts the United States. So, for example, if you chart corporate profits in the United States, and you overlay the dollar with it. Whenever the dollar is in one of those giant peaks, you generally see a long, flat, kind of sideways growth in corporate profits

because they have trouble growing in dollar terms when the dollar is that strong. Finally, in this best of episode, I talked to Thomas Malinen on May 21st. He is an economist out of Helsinki, the head of a macro research firm, as well as a professor at the University of Helsinki, and we talked about why it might take dismantling the euro to preserve the European Union. Well, of course, depend a lot, but there was actually a proposition from a German economist

just published yesterday or today morning about that. Let's just let Italy leave, and Germany pays them for leaving, gives a grant, just, you know, that they can manage. And there are several scenarios how this could play out in each country, but there's all, there's, there has to be some defaults, basically, on the, on the most indebted countries. And well, going country by country is not possible in this interview,

but they, and we don't, I have an analysis. it in the in the in the but but the it would go fine if we would just you know support each other and and the and we will we will most likely have a banking crisis we just have to go through it so it it will not be easy it will be economically very difficult but it would give us the possibility of a very fast recovery after the crisis that's what we are aiming here and when countries, economies recover, cooperation also recovers. So it would be very important looking to look in the future that we get rid of the euro because it would most likely revive the economies of, well, all the suffering nations.

Only loser would be probably Germany, but she would be, she will be justified. So that's it, guys. let me know what you thought of this best of episode and be on the lookout for a ton of other great guests to come. I appreciate you. I appreciate you listening. So until we speak again, be safe and take care of each other. Peace.