The Breakdown - What 2020 Taught Us About the ‘Dollar Milkshake Theory,’ feat. Brent Johnson

Episode Date: December 31, 2020

Brent Johnson is an investor at Santiago Capital and the creator of the well-known “Dollar Milkshake Theory.” In this conversation with NLW, he discusses what 2020 taught us about the state of the dollar around the world. Find our guest online: @santiagoaufund Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

When money stops circulating, the money supply shrinks. The reason they do QE and they do fiscal spending is to replace the money that's disappearing. So you got a bucket with water in it, right? And it's got holes in it. And there's water leaking out of the bucket. Well, if you pour money into the top of the bucket, you can keep the bucket from going dry. But unless you pour more in than is being leaked out, the bucket never overflows over the top. QE and these fiscal programs kind of keep the bucket from going dry.

but they don't lead to this runaway hyperinflation that everybody predicts every time the government says we're going to spend a trillion dollars. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com and nexo.io and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, December 30th, and today I'm joined by a Brent Johnson. Brent Johnson of Santiago Capitol is probably best known today for his dollar milkshake theory. His view that the dollar and U.S. markets suck the liquidity from everywhere else. I'm sure we're going to get into that in this conversation on our end-of-year extravaganza.

So without any further ado, let's get to it. All right, Brent, welcome back to the breakdown. It's great to have you here again. Happy to be here. Thanks for having me. So a fun end of the year episode, and I thought of you when I was thinking about some of these questions, I think you'll have really interesting insight into it. So I'm kicking off with a question that I think is sort of the big one, right? Which is what, in your opinion, was the most important economic story of 2020? Well, I mean, the easy answer would be the COVID lockdowns, right? that was obviously, you know, through the whole world for a loop.

And even those of us were expecting high levels of volatility like we were, you know, we had no idea that it would come as a result of a, you know, global pandemic. So I think even the people that were looking for a volatile year and looking for some dislocations were really caught off guard by maybe the, maybe not necessarily severity of it or the magnitude of it, but certainly by the cause of it. It's a good way to put it. Even the people who were braced weren't necessarily braced for this, right?

Right. And, you know, I can tell you that we were very much expecting market action like we got in, you know, January, February, March. And, you know, we did very well through those three months and even into April. But we weren't expecting the trigger to be what it was. So we were, thankfully, we were positioned correctly when that came. The resulting eight months, reaction to the first four months have been dramatically different than what we were expecting. And so,

you know, we not only had volatility to the downside, but, you know, we had great volatility back to the upside. And I'll tell you, I follow a number of different sentiment indicators and oversold indicators, however you want to describe that. And I can tell you the Monday, I think it was what is, what is March 23rd or 21st, everything on my indication was saying they were more oversold than at any other time in the 20 years I've been doing this, and that includes the dot com, that includes, you know, 2008, that includes, you know, 2011 and 12 when we had a, you know, kind of a European sovereign crisis. And so, you know, I had never seen anything as oversold as it was then. So we were actually prepared for a bounce. And we got it. I just didn't expect the bounce to last eight months.

Yeah. I guess this feeds into another question that it's a perfect setup is, you know, what asset or I guess set of assets surprised you most over the past year? Well, I mean, again, the easy answer for me, because I've been so outspoken on dollar strength is the extent to which they've been able to get the dollar under control and get it back down, you know, into the, it's into the very low 90s now kind of sitting just above 90. Again, we were ready for the dollar spike in the first three months. We got it. We were ready for a dollar pullback in Q2. We got it. We were not ready for the continued weakness in the second half of the year.

And in hindsight, what we missed, again, we were ready for the central banks to come out and just, you know, come guns blazing. Everything that the central banks have done was not a surprise to us at all. What was a surprise to us, and in hindsight it probably should not have been. So this is, you know, I guess you could call it one of my maya culpas is that we were ready for them to, quote, unquote, add to supply dollar liquidity. What we missed was their ability to defer dollar demand. And what I mean by that is that we initially thought this COVID shutdown and the global pandemic would be an accelerant to our thesis that we would have this dollar shortage. It turned out to be a deterrent.

And the reason is because they not only added supply, which we knew they would do, but they also were able to institute a number of programs that deferred dollar demand. So what do I mean by that? What I mean is that they said, you know, if you are a renter, you don't have to pay your rent for the next six months. You know, you can defer those rent payments. If you have a mortgage and you're having trouble paying them as a result of COVID, well, you don't have to pay your mortgage. You know, you can, we'll defer those payments. You can either pay those when the pandemic is gone or we'll just add it on to the, you know, to those missed payments on to the principal of the loan.

So that dollar payment was deferred. You know, if you were some kind of a manufacturer or you were importing inventory from China and their ships weren't sailing and the planes weren't flying, so they weren't shipping you the inventory. Well, then you didn't have to pay for it either, right? They said, you know, you don't have to wait six months, wait seven months. You don't have to finance that or you don't have to pay that right now. We'll offer financing alternatives.

So that they were able to defer that dollar demand. And, you know, a number of countries around the world. emerging market countries, some of these smaller emerging countries that the IMF had given loan dollar loans to. The IMF said, you know what, you can defer those payments. So they were able to kick the can down the road. They were able to get the dollar spike under control. And as a result, we've had not just a U.S. rebound, but a global rebound. And in my opinion, it's got ahead of itself, not just on the equity side, but you look at a number of commodities, a number of inflation statistics. We've seen this happen several times.

the last 10 years. Every time, this time is different, and every time, you know, it ends up rolling over, and I believe that those inflation statistics will roll over again. But in the meantime, these rally, these inflationary rallies are powerful, and there's a lot of people that want to believe it. What you want to happen is a powerful force, you know, and narratives are very powerful. And the narrative is that the central banks have it under control. We're going to get some inflation this time. You know, this time is different and get on board. When that takes hold, It's powerful. And then that's kind of where we're at right now.

We're kind of right in the middle of that. So I think it makes tons of sense. I think it's actually super interesting just to kind of put the pin on that, the demand side of the equation as well, right? Everyone has been talking throughout the year. I mean, the biggest meme of the year was about the increase in the supply of money, right? Money printer go burr.

But that demand deferral is a really interesting point. I guess just to kind of finish the thought maybe into next year as you guys reevaluate your kind of core thesis, does anything change or is this really a time scale issue? And I mean, you use the phrase kicking the can down the road. So I guess maybe that, is that a good descriptor of how you see it playing out from where you're sitting? Yeah, I would say that my thesis has not changed. If you want me to admit that I got it wrong this year, that's easy for me to do.

All you have to do is look at the screen and you know, I got it wrong this year. A lot of people have a hard time saying they get something wrong. You know, I mean, to me, like it's silly to pretend you're not wrong if you're wrong. And so that's one of the things I love about having you on the show is you've got conviction and you got clarity and you figure out, you know, what new pieces of information you didn't have. The interesting thing was is, and I have said this from the beginning and that in my opinion, this is going to take three or four years to play out. This may not play out until, completely play out until, you know, 2022 to 2024. I think it's going to take longer than most people think it's going to take, you know, maybe it's all done in the next year or two years, but I think it could easily last three or four. I think central bankers are fantastic at prolonging the game longer than anybody thinks it can go on.

So, you know, like I said, our biggest mistake this year was viewing the pandemic as an accelerant to our three to four year time horizon rather than as a deterrent to our three to four year time horizon, right? Obviously, hindsight's 20-20. In hindsight, we should have booked all the profits that we had in the first three quarters and just kind of sat back the last three and, you know, waited to redeploy. But here's what I would say. And a lot of people say, you know, at what price do you reevaluate your thesis? Well, I reevaluate my thesis all the time. The question is, do I stop trying to profit from an eventual change in trend? And my answer is that if you sized your position appropriately to begin with,

we've consistently said that people should allocate something like 5% of their portfolio to our idea here to play these asymmetric bets. And if you've sized your position appropriately, you never like anything going against you. You never like to be wrong. but, you know, it doesn't kill you. So from that perspective, we still think because all the things have been deferred and because in that time of deferment, nothing has been done to address the underlying problem. In other words, they provided swap lines.

Well, all swap lines do is make the dollar loans bigger. You know, over the last seven months, the issuance of dollar debt by the international entities has been through the roof. So they're ultimately making the problem bigger. But in general, the world has not used the last six or six. seven months to get out of their dollar loans. What they've done is they've added to their dollar loans. The problem has only gotten bigger. And once you understand how the monetary system is designed, and you understand, you know, how the flow of capital is so important to keep the monetary

system operating, until they address the underlying structural design of the system, our thesis is always valid. Now, the question is, when will it hit? And, you know, I don't know if it will hit again in first quarter of 2021 or if it'll be first quarter of 2022 or, you know, or when it is. But I'm still convinced that this is the biggest problem out there. I don't think that the, you know, central bankers are magicians who have suddenly fixed the problem. And so the question is whether we are still in a position to profit when it comes up again. This episode is brought to you by crypto.com, the crypto super app that lets you buy, earn, and spend crypto all in one place and earn up to

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your choice. Get started at nexo.io. So let me ask you a question, kind of a variant of the first one. What do you think is the most important economic story that people didn't pay enough attention to? That's a good one. You know, I would, again, I think I'd probably go back to the deferment of dollar. Well, no, I shouldn't say it. The reality is, I think a lot of people weren't ready for the first three months, right? Like our year has been kind of the opposite of everybody else. We did really well through the first four months and have struggled the last, you know, seven to eight,

whereas everybody else struggled, you know, the first four months. And, you know, they held on to their positions and they've come. roaring back. I would say that, you know, what everybody missed early on was the dollar shortage that we had been talking about. And I think what they're missing now is that they think the problems have been solved when in reality the problems have only been magnified. That's my perception. Now, whether somebody agrees with that or not, you know, I can't say there's, like I said, there's always exceptions to everything. But I think people are in general too willing to just accept the current narrative. And, you know, again, the current narrative is that inflation,

here. Central Bank have everything to control. Janet Yellen's going to Treasury, money printer go bhaer, and all you got to do is buy risk assets and it all work out. And, you know, I just think that that's wrong. Yeah. Interesting. I think it's, by the way, completely legitimate to say that when you're taking kind of a contrarian position that, that position is the thing that people maybe not were paying attention enough attention to. I guess the inverse of that question for me is, was there an economic story or maybe you can take it in the narrative direction that people paid more attention to than they should have. Yeah. Okay. So that's a very good question. I would say it sort of goes along with my comment that the people have been very willing to accept the narrative. And,

you know, a large part of the dollar's weakness in the second half of the year has been the euro. If you just look at the dollar index, right, it's like 57 or 58 percent of it is is the euro. And, you know, earlier this year, as a result of the pandemic, you know, Europe got together and they announced this new, you know, loan program where everybody's going to issue these pandemic bonds or whatever, and it's going to go to finance green projects, and it's going to pull, you know, Europe out of its deflationary, recessionary, you know, environment and everything's going to be good. Well, it's going to bring Europe closer together than it ever has been before as opposed to, you know, breaking up into a number of countries rather than one economic union. I think everybody's just bought that hook line and sinker. I just don't think it's true. I think that when you get right down to it,

I think those countries are in a lot of trouble. A lot of the funds from these bonds won't even be available for another six to nine, ten months. I think, you know, we get into early next year. I think a lot of these countries are already going to need the liquidity. I don't think behind the scenes that the social factors and a lot of the economic factors will allow them to integrate into one union the way many people have just accepted that they will. And the other thing is that you've got to realize that, the dollar falls, the pair trades against other currencies, other currencies have risen a lot. Well,

those other currencies are exporting countries. Forget the pandemic, right? Forget COVID. It's not like we were in a fantastic economic environment prior to COVID. There was some growth problems and stuff prior to COVID. And the idea now that the rest of the world, Sands the U.S., is now in this growth mode, they can sustain, you know, their currency is rising 5, 10, 15 percent when they're exporting countries and it's not going to have some kind of a deflationary event on their on their growth again i just think it's wrong and i think you're going to start seeing those stuff start to show up now again whether it shows up in you know q1 q2 or or 2022 i don't know but this is a problem that is looming out there i think global growth is slowing i don't think global growth is

accelerating and you know i can send you a chart for the last you know 20 30 years every time global growth slows the dollar rises now whether the dollar rises as a result of global growth slowing or whether the dollar rising causes global growth to slow, well, people can make up their own mind on that, but the correlation is there. And again, if you think that, if you think the global economy is growing and we're in this new paradigm and that everything is well, then, you know, you got nothing to worry about. If you're a little skeptical of that, I think you need to be careful because I think we could very easily have another Q1 of 2020. How much are you paying attention to signals around changing monetary policy or fiscal policy as it relates to all of this?

Well, I mean, a lot. It's key to all of it. And I think, you know, one of the big debates that's kind of come up this year is, are these QE policies, are these fiscal policies? Are they inflationary or are they deflationary? You know, I come down on the fact that as you increase the amount of debt in the world, that is deflationary. Because if more of your money has to go towards a source, servicing debt and paying off debt, it's taking away from that money being put to something more useful and productive. And so whenever you get these big fiscal plans, whenever you get this QE announcements, you do get a pop in, you know, prices or inflationary expectations. And sometimes it lasts six months, sometimes it lasts a year, 18 months. You know, we've seen this several times for the last 12 years and it always rolls over. And I think it's kind of that same thing again. And part of the reason is because these QE policies, QE basically just gives money to the banks, keeps them alive, but the money gets trapped in the banking system. It doesn't actually go into the real economy.

You know, when you do fiscal spending, well, you know, governments have been spending trillions of dollars a years for decades. You know, fiscal spending is nothing new. If they spend more, it's really just redistributing money that already exists. It's not like they're adding to money. You got to understand, like when money stops circulating, the money supply shrinks. The reason they do QE and they do fiscal spending is to replace the money that's disappearing. So you've got a bucket with water in it, right? And it's got holes in it.

And there's water leaking out of the bucket. Well, if you pour money into the top of the bucket, you can keep the bucket from going dry. But unless you pour more than in than is being leaked out, the bucket never overflows over the top. And that's kind of how I view it. you know, QE and, you know, these fiscal programs, they do kind of keep the bucket from going dry, but they don't lead to this runaway hyperinflation that everybody predicts every time the government says we're going to spend a trillion dollars. To your point, do I pay attention to monetary and fiscal?

I absolutely do because it's very key. And depending on what they do, it can have different effects on the inflationary level. And for the last 12 years, in general, the money that has been provided through fiscal and, you know, monetary programs, has for the most part, gotten stuck in the banking system as opposed to getting pushed into the real economy. If they can figure out a way to get the banks to lend, and that's the other thing. Right now, banks are not lending. The only loans that banks have given are the ones that were guaranteed by the government, and the only reason they gave those loans is because the government guaranteed them. So you had a big spike in lending in April and May,

and then nothing since then, contraction since then. Lending standards right now are tighter now than at any time since 2008. the banks are not lending. And so new money is not being created. In other words, more money is not being created by the banks through the lending process. And until they do that, I don't think we're going to get this runaway inflation that everybody's talking about. So if, you know, going back to your question on paying attention to monetary and fiscal policy, if they can do something to get the banks to actually lend, or maybe they skip the banks and go right to the real economy, then that's something that I would pay very much attention to. It's fascinating stuff. This year,

has also reinforced just how blunt the instrument of monetary policy is when it comes to stated objectives, I think, as you're just kind of making that point. I could ask you a million more questions, but I guess to kind of wrap this up, one that I think is a little funny asking you, because you kind of are so public with at least one version of this, but what's one prediction that only you have? Oh, well, I wouldn't say. only I have. Yeah, sure. It's purposefully overstated. The view that I have that I think is in the minority is that the U.S. is on the decline and that the rest of the world is on the rise. And I don't agree with that. You go back to the end of World War II and we were seeing as kind

of the global hero. You got into the 60s and 70s and maybe some of the shine of that started to come off a little bit with the Korean War and the Vietnam War. And then you get into the 90s and the 2000s. And now even Americans are saying, you know, maybe we're not quite this, you know, shining city on the hill that Ronald Reagan said that we were. The cycle has gone from us being the hero to some of the shine coming off from the outside world. And now even internally we're saying, you know, gosh, maybe we're just not all that we thought we were. And as a result, that we are Rome and that means that we're going to collapse and that the rest of the world is going to rise and we're just going to be in ashes. And I just think that that's wrong.

I think even if you ascribe the definition of an empire to us, and perhaps you even want to classify us as an evil empire. I think even if you do that, you've got to realize that evil empires just don't typically collapse overnight. They do a lot of damage and they last longer than you think that they should. And I think that before all this said and done, the U.S. is going to stay stronger, longer than people think that it is. Now, that doesn't mean that we don't have problems. It doesn't mean that, you know, we're not eventually going to have a really big kind of come to Jesus and have to pay the Piper. I think that we will. I just happen to think that based on the design of the monetary,

system based on many of the advantages that we have. Our advantages go from economic to demographic to demographic to military. We have some advantages that are going to allow us to stay higher longer than many people think that we will. Here, here. We'll have to have you back to go into that deeply. Maybe we'll bring Peter Zeon and a couple others too to have that conversation because I think it's a fascinating one. I think it's very important. It's very easy to get trapped in narratives around these sort of secular decline issues. But Brent, always awesome to have you on the show. Really, really fun to get your take on things and your kind of reflections on the year. And happy New Year and looking forward to connecting again in 2021.

Absolutely. Thanks for having me and I wish you and your family the best.