The Derivative - Tis This Inflation Transitory with CME Group Economist Erik Norland

Episode Date: June 24, 2021

There’s a new word in the financial lexicon. Transitory. And it all has to do with whether recent moves higher in prices of everything from lumber to copper to labor are the first signs of 1970s type inflation, or….as the Fed believes, is just “transitory” and will work itself out once the pandemic is over. We’re sitting down with Executive Director and Senior Economist of CME Group, Erik Norland, to discuss just what he sees in the commodity space, including a first for our pod – charts during the video portion! Erik dishes on his background, how he ended up in London, Bayesian models, if you can be an economist without slides, Trillions, the devastation in India, the massive amount of debt in China, inflationary vs deflationary pressures, the craziness that is the hedonic CPI adjustments, infrastructure plans, R&D spending <> materials spending, if Gold is in trouble, why Europe’s lagging, whether there’s enough money to buy meme stocks/crypto AND physical goods to cause inflation, what options prices are saying about agriculture markets, and much more. Join our interesting conversation. Chapters: 00:00-02:40=Intro 02:41-12:00=The CME’s Euro Step 12:01-27:09=Fiscal Stimulus & Inflation during the Pandemic 27:10-48:27=Measuring Inflation & What about Deflation 48:28-55:28=The MMT Theory & China’s Debt 55:29-58:53=How Injured is India? 58:54-01:05:02=Agriculture, Energy & The Importance of Water 01:05:03-01:13:21=Fat Tails in Agriculture 01:13:22-01:16:54=Favorites Read more of Erik’s research on CME Group’s website here: https://www.cmegroup.com/education/featured-reports/bios/erik-norland.html And last but not least, don't forget to subscribe to The Derivative and sign-up for our blog digest. You can follow our host Jeff Malec on Twitter and RCM Alts on Twitter, LinkedIn, Facebook. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. The bond market does, however, seem to do a pretty good job of anticipating rate cuts. But we're a long way from the next rate easing cycle, I think. The bond market, though, it still remains kind of remarkably flat in terms of yield curve. So, you know, I think that all of this kind of has implications

for gold and silver in particular. If Federal Reserve decides it's going to start hiking rates, that's probably pretty bad news for gold in particular, maybe for silver as well. Gold has a pretty consistent negative sensitivity with changes in the sort of forward expectations that are built into the Fed funds futures curve. And also the fact that the U.S. economy is so remarkably strong compared to, say, Europe or Japan might put an upward bias on the U.S. dollar. You know, fiat currencies have kind of been stuck in a range versus each other for a long time, at least among the majors. You know, between the U.S. dollar, the pound, the euro and the yen. But the U.S. is recovering a lot more quickly than these other places are. So it may be necessary for the Fed to act to tighten policy much sooner than the ECB or the

BOJ. And if that's the case, they wind up putting the dollar on a pretty bullish tilt, which could also potentially be really bad news for gold prices. Hello. Welcome back, everybody. We're talking the reflation trade, the inflation trade, and whether this is all transitory today with Executive Director and Senior Economist at the CME Group, Eric Norlin, with a K. Eric has been with the CME for the past six and a half years after spending more than a decade at investment banks and hedge funds. And we're going to do something a little different. He has a commodity-focused deck we're going to go through, and I'll pepper him with questions. And we'll try and figure out if this is real or an illusion. So thanks, Eric. Welcome. Thank you so much for inviting me. I'm looking forward to it.

Yeah. And so give me the background on Eric with a K. Do you have some Scandinavian descent or what's that all about? Yeah. So in the 1880s, my great grandfather arrived from Norway. I believe this family story is, so I believe that he was the third oldest child. And so Norway had, like many European countries, a law of primogeniture, which meant that his eldest brother would inherit everything and he would get nothing. So he and his wife moved to South Dakota and then later on moved to Iowa where they had 10 children, one of whom was my grandfather, Morris Norland. So that's the story. All right. Primogeniture. That didn't survive very well, right? Would lead to a lot of brothers vying to be the top dog.

Yeah, that's right. Well, they didn't want the farmland to get cut up into tinier and tinier parcels. They wanted to keep it at a productive size. So ultimately, it was about economics and it was about economies of scale. Right. But there's not much farmland in Norway, is there? Well, that's the thing. There's not much of it. So you don't want not much farmland in Norway, is there? Well, that's the thing. It's not much of it. So you don't want to divide it up among a big family. Got it. And then so give us a little background. I mentioned you used to work at some hedge funds, some investment banks. What was the background all about there? So I was lucky in 1996, I got a job as a research assistant at Bankers Trust, which at the time was one of the big Manhattan investment banks. So they're not quite as big as Morgan Stanley or Goldman Sachs, but it was one that had a really pioneering reputation in derivatives, which in some ways was good.

But it also caused the bank occasionally to skin its knee, which is how it wound up becoming a part of Deutsche Bank. But anyway, we were running quantitative strategies. So we essentially had a quantitative global macro strategy that used Bayesian models to forecast markets and to optimize portfolios, mainly in stocks, bonds, and currencies. And then later on, our team added commodities to that. And so Bayesian models give us a little, what are you talking about? It would just assign a probability on whether going up today, down today? No, it was actually more complicated than that. So it would actually output a joint probability distribution. It would do a simultaneous forecast of, at the time I joined in 1996, nine different currencies, nine bond markets,

and nine equity markets in countries around the world. So the output of the model was a joint probability distribution for them that had an expected return and a variance-covariance matrix that described how these things were related to one another. And then we would put that into an optimizer and that it would create a long, short portfolio that we would implement through futures and swaps. Got it. Cool. And whatever happened to that, they still run it? It ran for a long time. So basically we went from Bankers Trust. Bankers Trust had had a number of sort of bad publicity with derivatives, you might say. And so our team was hired away. We went to a French

bank in 1997 called La Caisse des Depots et Consignation, which has since privatized part of itself. And that privatized part is now called Netixas. Some of you may know Netixas. So anyway, at CDC, they funded us with $270 million. And so we were able to use that to develop track records and eventually the strategy grew to a maximum of about three billion dollars or so maybe three and a half billion and i would say it ran until probably about 2015 or 2016 and it turned it had really good returns until about 2012 but then finally it fell victim i think to the zero interest rate environment which made it really hard for those models to gain signal, especially in the currency and bond markets. And I think Natixis went on to buy Alpha Simplex, right, and runs a managed futures program.

We've had Catherine Kaminsky, who I'm sure you know, on the pod. I've heard, yeah, I think I've met her before. I think I vaguely know her, yeah. Yeah, she's fun. So then somewhere in there, you said, all right, this is bollocks or whatever, and I'm going to move to the CME, going to get a real job? Well, you know, what I think is so fascinating about working for CME, there's so many things I love about it. But one thing that is so different than working for a hedge fund is working for a hedge fund, you may collaborate with your colleagues. You can work as a team member with colleagues, which is great. But

essentially, it's you versus the market. And so you don't really talk much to your competitors. And you don't really get to talk with the other end users of futures. So working for CME has been a tremendous education for me. It's allowed me to meet farmers, food processors, metal mining companies, energy producers, refiners, as well as people in the trading community who ordinarily wouldn't have talked for me if I was a competitor. But now that I'm working for a neutral counterparty, I can have more interaction with them. So it's just been an extraordinary education in all aspects of the global economy and financial and commodity markets. I bet. And a great place to work from all accounts, right?

That's right. It's a very collegial environment, very nice place to work. And then, but they sent you, they didn't like you so much, they sent you over to Europe, or is it because they liked you so much? Well, so this is, this is a complicated story. So when I was working for that French bank, they moved me to Paris, eventually to their headquarters where I actually did other things. They worked on the sell side, worked in a bond and fixed income trading room for a while.

Actually, I stayed in France for a total of 10 years. And later on, I worked for a hedge fund there as well. And you parlez-vous français? Oui tout à fait and so not only did I not only do I parlez-vous français if you will excuse my somewhat misuse of French grammar but I lived there for so long I became a naturalized French citizen so then eventually moved back to New York I got a job with another hedge fund actually the the offshoot of the Bayesian hedge fund I'd worked with for many years ago. And so after I joined CME, since I had French nationality, it was very easy at the time to move me to the United Kingdom, which was still part of the European Union.

So I could just kind of show up in the UK, like you could show up in Ohio or Florida or California, just sort of say, in the UK, like you could show up in Ohio or Florida or California, you know, just sort of say, hey, I'm here. And, you know, you didn't need any residence papers or anything. So the idea is that we have another economist in the US, Bluford Putnam. And so, you know, most of CME's growth is abroad. And so it made sense to have somebody living abroad who could be in European and Asian hours and I'm sure you know Asian hours are pretty difficult from Chicago yeah so it was really meant to kind of cover EMEA and APAC yeah we I've been doing we do a weekly call with our partners in

Singapore and at 8 p.m on Wednesdays I'm at my son's baseball games they're like what's going on in the background i'm like don't worry about it just just some baseball um and then with brexit did your french national did that get all messed up or by that time you were a british well so yeah this by this time so basically everybody who was an eu national and had been living in the uk for a certain period of time not very much time i can't remember what the cutoff was. It was less than two years. Got a visa status that the Brits refer to as, what do they call it again? It's this unbelievable expression. I think it's called indefinite leave to remain, which is sort of like having a green card. It basically means you can stay there indefinitely. Good for you. And then you get

back to the States. You're in the States right now, right? That's right. Yeah. I came home to visit my parents for the first time in a year and a half. So I got vaccinated. They're vaccinated. We figured it was finally time for me to come and do a visit. So I got here on Friday, just in time for my mother's birthday on Saturday. So it's been really nice. Perfect. And where are you at? Maryland area, you said? Yeah, in Maryland, right near Washington, DC. Yeah. Perfect. So cool. Let's get into the economics, if you will. And I'm going to help share the screen. For those of you just listening, we're going to have a little, he's going to go through some of his slides. Hard to talk

with an economist without slides, right? That's right. How does that look? Does that look okay on your side? Can you see it? Yep. Okay, great. Well, before we get into it, we do have to go through CME's disclaimers. So this is the short version of the disclaimer. And this is the longer and more involved version of the disclaimer, which essentially say that because CME Group is an exchange operator and not an asset manager or an investment bank or a broker dealer, we cannot offer you any financial advice. No financial advice is given or intended. But that's that.

So the disclaimer is out of the way. So if we just get into it or... Yeah, yeah. Short version is these don't go run out and trade whatever we talk about here. Exactly. Yeah. Think about it.

Think about whether anything's right for your own portfolio. So the global economy has obviously been through this massive, massive shock. It's been an incredibly uneven shock, but things are obviously recovering, but they're recovering at a very uneven pace. So in the US, we'll probably be back above our previous GDP peak this quarter when we get that number in late July, but that's not true for a lot of the rest of the world, which is still a little bit underwater. But what I think is really extraordinary. What do you attribute that to? Tighter lockdown restrictions and whatnot?

Well, some of it may be lockdown restrictions. The U.S. has done relatively well in terms of vaccinations. The U.S., as you know, is losing momentum in terms of vaccination. It's gotten up to a little bit over 50%, but it doesn't seem to be just inching higher now, but it's kind of a snail's pace, but that's still way ahead of Europe. And it's actually way ahead of places like China and Australia and New Zealand. I think now you're seeing this kind of paradox where the countries that wiped out COVID domestically through incredibly strict lockdowns now have very little natural immunity. And because their populations haven't seen a lot of people who've suffered from COVID, they've been very slow on the uptake of vaccines. And you're seeing the problems with that now.

Like China just had to reduce air travel very dramatically because of a small outbreak in Guangzhou province in the south, where the US and the UK are more or less reopened. But there's another reason for it too, is beyond COVID. The US just spent a lot more money than anybody else trying to get out of this. So the US.S. last year spent 17% of GDP on this. So far this year, it's done about another 8.8%. You might even call that 10% when you add in the additional $250 billion that almost nobody paid attention to

that Congress appropriated last week to subsidize the U.S. semiconductor industry. But the U.S. fiscal response has just typically been quite a lot larger than most other countries. Even in percent terms, like obviously in dollar terms, it would likely be the largest, but in percentage terms as well. That's right. Yeah. So, I mean, if you, the U.S. so far has done a total of about 25 and a half percent of GDP in direct government spending.

That's more than twice what Germany's done. Germany's around 11%. France is around 7.7%. Italy's 7%. There are a few countries that come close, like the UK at 16%. The US government has just been extraordinarily generous in terms of providing money. It provided a lot under Trump.

And then it provided even more between the elections during the, if you want to call it a transition. And then it did even more now that Biden is president. And then what do you have on here with these equity loans and guarantees? Well, that's a little bit more amorphous. And see there, you don't really know exactly what the ultimate impact is going to be in terms of deficits. So to give you an example, here in the United States, what we've done is we offered enhanced unemployment benefits and we sent people checks whether they needed them or not. In many other countries, like in the United Kingdom where I live, the government there, and this is also true in Germany and many other countries, the government there, and this is also true in Germany and many other countries, the government

there basically told corporations, okay, well, we will offer you loans. And so long as you use those loans to pay payroll, and you don't actually lay people off, then that loan will be forgiven. And so a lot of companies took the loans, maybe whether they needed them or not. But I don't know what sort of criteria are in place necessarily to make sure that this is really going to payroll. But when you look at Europe's unemployment figures, you see the difference. And U.S. unemployment went up to like 16% briefly. Now it's come back down to 6%. In Europe, the spike in unemployment was really very, very small because everybody sort of remained technically employed, whether they were going to work or not.

So in Europe, the ultimate cost of this in terms of budgets is still very ambiguous. But what I think is clear is that Europe's economy has still been harder hit by COVID overall. It may be that they had less generous fiscal support in Europe. I don't think any country was really sending out gigantic amounts of checks to every citizen below a certain income threshold. It was really more on an as-needed basis. So if you were a restaurant worker, they loaned money to the restaurant. And as long as you got paid by the restaurant, the loan would be forgiven. So the fiscal impact in Europe has just been a lot smaller. And I think that's why you're not seeing a sort of vertical liftoff recovery there that you've seen in the U.S. Do you think it was because of the nature of this crisis

that it became fiscal or was it because we were up against the bounds of monetary policy, right? That makes everywhere we're at zero. So what else are we going to do there? Give the people the money directly. If this had happened in the 80s, would we have done the same thing or would it just been cut rates? Yeah. So I think a lot of this may be born out of regret. And so part of the regret is that when Obama came to office in 2009, there was a sort of fiscal stimulus, but it wasn't really all that big. It was like supposedly 700 billion, but some of that money had already been allocated anyway. So it was probably like maybe 300, 400 billion additional. And then the economy had this very slow, long

recovery that was really held back by terrible state and local finances, by a really bad condition of household and corporate balance sheets, et cetera, as well as by the banking system. And so I think this time there was the idea that we can't allow that to happen again. So this time we have to just put a huge amount of money in the system. And to your point, everybody, I think, recognized that monetary policy was at its limit and that this was not primarily a problem of people paying too much for loans. So the Fed put rates to zero, but they weren't that much above zero to begin with. When the Fed started cutting in earnest, they were like at one and

five-eighths percent. So the sort of monetary bang for the buck was going to be very small in any case. Got it. Sorry. So we buried the lead. Did you ever think you'd become a virologist on top of an economist? Yeah, I never thought so, no. And the truth is, I wasn't a very good virologist. I think like many people, I didn't really take the pandemic that seriously at the beginning. But it took a month or so for it to dawn on me that this was actually going to be a really big deal. But yeah, you also have, of course, the monetary response, which concludes not just cutting rates to zero, but also buying huge, huge quantities of bonds. And I think that's in part why we've seen such a strong response from commodity markets. Although I think the commodity markets response to this is actually kind of three

layered. It's fiscal policy in the US and abroad, monetary policy, and then it's also changing consumer taste and what's happening in China. So I think it's really a sort of a combination of things that you need to look at if you want to sort of gauge where commodities might be going as a result of this. But I think it's worth highlighting, though. You know, we talked about this idea of regret with respect to the global financial crisis. I think it's good to draw a contrast between now and the global financial crisis, because it gives you a

sense of how different things are. You know, back in 2009, the average household had lost 20% of their net worth. This time, since the beginning of the pandemic, the average household net worth is up about 15%. So households are in vastly different shape now than they were back then. Likewise, going into the global financial crisis, we have been through several years in which people were not saving very much money. They were saving maybe 4% of their wealth or income, rather. And so after the global financial crisis, it kind of gradually shifted up to 7% savings rate. So, you know, when consumers go from a low savings rate to a somewhat higher savings rate, that typically implies very soft economic growth. Well this time consumers have gone from a seven percent savings rate to around a twenty percent savings rate.

So what's likely to happen as the pandemic ends is that the savings rate is likely to begin coming down at a time when consumers are feeling extremely wealthy. At least some of them will. I mean, certainly not everybody benefited from the pandemic, but a lot of people have seen their wealth increase. And so one of the stories we hear that I think is kind of relevant to commodities is that, well, part of the reason why commodity prices did so well was that consumers just couldn't spend any money on experiences. They couldn't spend any money on experiences. You know, they couldn't spend any money going to restaurants or traveling, hotels, airline tickets, et cetera. So they had to spend money on manufactured goods if they were going to spend. So we had this almost vertical liftoff in retail sales, as well as in durable goods orders,

especially the sort of core CapEx, the durable goods non-defense X aircraft. We've been growing at a pace that we've simply never seen before, at least not seen in many, many decades. And give us the quick and dirty on retail sales is everything is T-shirts and jewelry and yada yada and durable goods is washing machines and such. Yeah, washing machines, but it can be bigger than that. So durable goods can also include capital investment too for major corporations.

It can be household items, like you said, washing machines, et cetera. But it can also be property plant and equipment and things like that for, especially plant and equipment for corporations as well. So people have just been, there's been a tremendous amount of business investment as well as household investment, you know, in housing, et cetera. So that's why you, in part, why you've seen lumber prices soaring, copper, aluminum, all sorts of prices increasing across the economy. But one of the narratives I hear that I think is kind of interesting is the narrative basically says, OK, well, now that things are reopening, people will be able to spend money on experiences.

And therefore, they may buy less manufactured goods and may invest less in home improvement. OK, that could be true. The thing is, consumers have saved so much money and their wealth has gone up so much that they may not even need to make that choice. They may just be able to spend money on anything reasonably that they want to. It's not just because you go on vacation that you can no longer do home improvement. You might do both at once. In fact, I have some friends here in the U.S. who are going to go on vacation because somebody's redoing their bathroom. So they want to be out of there. So these things actually can

happen at once. And speaking of the two things at once, just going back to that, how do you square these with the narrative that people are taking their stimulus money and they're buying crypto, or they're buying mem stocks and call options on AMC and whatnot, right? Like it seems like if that were the case, it seems both those can't be going up, but maybe they can. Maybe we're saying the same thing of, yeah, you could do many things with this money. Yeah. Well, that's the thing. So, you know, the government, when you add up the various stimulus packages, you're looking at $7 trillion. And then the Federal Reserve initially did a $3 trillion QE, and then since then slowed it to a pace of about $1.5 trillion per year on top of that. So since all this whole thing began, we've done $4.5 trillion of QE, about $7 trillion of fiscal stimulus, which is tremendous. And so you

combine that with the fact that people have not been able to spend money so much on experiences, and it leaves plenty of money left over to simultaneously buy manufactured goods and also cryptocurrencies or equities or gold or silver or anything else that they feel like investing in. So they're really not mutually exclusive. This is sort of the difference between and and or. We're living in an and economy where you can do this and that. You don't even have to choose. And so this is, I think, why you're seeing this simultaneous massive run up in commodities, retail sales, as well as investment products. Which usually with an economist, we want some nice downward sloping chart to offset the upward sloping chart, right? Like here's where it's

coming from. Right. Well, so the downward sloping chart is basically the chart of the value of the U.S. dollar. When I say the value of the U.S. dollar, I don't mean the value of the U.S. dollar versus the euro or versus the yen, but really the value of fiat currency in general versus real assets. So if real asset prices are going up, what's going down is cash. And so cash has been sinking at a pretty fast clip here. We have officially headline inflation now of 5% year-year, which is the fastest since 2008, and core inflation at 3.8%, which is the highest, I think, since about early 1992 or late 1991. It also follows that if copper prices went up 50% or rather went up 100% versus the US dollar, that the US dollar declined by 50% versus copper, for example. So you've seen just a tremendous devaluation of fiat currency. And so I think the really big question for everybody now is, is the inflation going to last or not?

And truthfully, I don't think we know the answer yet. I think the really big question for everybody now is, is the inflation going to last or not? And truthfully, I don't think we know the answer yet. These are measuring CPI, which just interested in your thoughts on how accurate or good of a measure that is of inflation. Right. Everyone's arguing that there's I can't remember some of these tweets right now, but there's a lot of things that people see that are going up massively in price and it's not included. I think it includes like,

I was reading some like racial bias stuff is inside the housing component of CPI. So there's a lot of problems with CPI, right? Yeah, it's always been a very controversial measure. And I would say that the controversy really boils down to two aspects of it in particular. So up until, say, the early 1990s, there was a certain way of calculating the index. And then in the early 1990s, there was this group called the Boskin Commission, which I think had begun under the first President Bush, and it reported its findings under President Bill Clinton. And a lot of his findings were accepted.

And basically, the Boskin Commission argued that CPI at the time was overstating inflation because it was not taking into account hedonic and substitution adjustments accurately enough. So since then, the government has made more and more aggressive use of hedonic and substitution adjustments. So hedonic basically relates to hedonism, the Greek word for pleasure. So the idea is that, say, your smartphone last year cost $1,000, but then the smartphone company, who shall remain nameless, but we all know who they are, comes out with a new smartphone the next year that still costs $1,000, but it has better features and a bigger processor that's maybe, say, 40% more powerful. So then they say, well, okay, so it's actually 40% better. So it's a $1,000 smartphone, but we're going to divide it by 1.4. So the real value of that cell phone actually fell by 27%.

So we're going to put negative 27% as the actual inflation in cell phone prices. So the cell phone price didn't really change. It's a different product. And it is with automobiles too. Like, you know, maybe that like an automobile a long time ago, didn't have a navigation computer as part of its standard feature. Now it's part of the standard feature. The auto price stays the same, but now it has better features. So the car price really dropped, at least according to the CPI measure. Then you have substitution adjustments work a little differently. It's kind of like say the price of chicken doubles, but the price of pork stays unchanged. Then they reweight it. They assume, okay, well, people, because higher chicken prices

will eat less chicken. So we'll reduce the weight of chicken in the CPI and we'll expand the weight of pork. And it seems as an outsider, it seems they're just gaming it to make sure it doesn't move too high or too low. Right. Well, there's a there's a Web site that argues this. And so the Web site is very interesting. It's run by an economist. He's either at the University of Michigan or retired from the University of Michigan. But anyway, it's called shadow government statistics dot com. And so what this Web site purports to do and website purports to do, and I've never gone into the details, so I can't really tell you how accurate it is, but their viewpoint is they try to calculate CPI in a pre-Boston commission manner without such aggressive hedonic and

substitution adjustments. And it consistently shows that inflation is maybe two to 4% higher than what the official CPI says, not just this year, but kind of in general. And, you know, that may be the experience of many Americans. Yeah, exactly. I was going to say that, me personally, that's what I feel that, right, of living in Chicago and taxes and tuition and things that aren't part of the CPI whatsoever. Yeah. I mean, I feel it too. I mean, look, when I moved to New York in 1996, and I know New York's sort of a strange example, but at that time, a one bedroom apartment was going for $1,200 a month. When I moved back in 2011, a one bedroom apartment was going for $3,500 a month. So the CPI didn't triple in the meantime. But yeah, it seems like a lot of prices are higher.

Yeah, our college tuition is easily tripled, right? Yeah, exactly. But I think what I would say is this, is that essentially you can look at three different aspects of inflation. So there's a sort of commodity aspect of inflation, which you might broadly include real estate, as well as things that we call commodities, these trade-on exchanges. Those prices have gone up a lot over the last three decades or so.

They've gone up hundreds of percent. Secondly, there's the cost of human labor. So if I'm going to employ you or you're going to employ me, that actually hasn't really changed all that much because our labor costs haven't changed. But then third, there is a cost of computing power. We can do things with our smartphones that would have been unimaginable, not even conceivably possible. So in some ways, we actually are made vastly more wealthy in a sense by these devices. So there is an argument to be made for what the government is doing. But it's not the commodity value indicator.

It's the commodity price indicator. Like that's the weird part to me. They're trying to like, what's its value instead of just, it is what it is. It's a price indicator. Yeah, although the problem is that these numbers, well, not the CPI, but the FEDS preferred measure, the core PC deflator is what's used to measure gross domestic product. And so what they're trying to do is they are trying to measure value when they are trying to do GDP. But in any case, yeah, I get your point. of and even if we're talking about there's this this massive stimulus is still coming biden has the infrastructure plant right and the narrative is that's going to all fuel commodity boom but

a lot of that is r&d a lot of its research a lot of it's in the new tech right and so almost like beyond semiconductors maybe copper and battery components go up but maybe grown in the ground commodities don't care. Maybe it's not reaching all the way to traditional commodities. So it seems in the modern world, there's a bit of a bifurcation there between what we actually need to drive software and computing power and what we need to feed people and build roads and whatnot. Yeah, I mean, that's probably true. I think a lot of the infrastructure money, if it gets passed through Congress, which is still a question mark, even if it goes to fund sort of non-traditional infrastructure, including things like R&D, for example, for new technologies, that's still paying people, will still wind up in people's pockets. So it may still come back in the form of consumer spending at some point, just by virtue of employing people to do something, even if it's not necessarily pouring concrete and building things, which you might think of as traditional infrastructure. But yeah,

it still could have an influence on commodity prices, especially if it's deficit financed, it could further degrade the value of fiat currency. But yeah, I think the point here to take away is if the inflation numbers are biased, they're consistently biased over time. So in any respect, we've gone from a period of somewhat lower inflation to potentially a period of higher inflation. So the question is, is this higher inflation period compared to what we've been through, is this going to be permanent or temporary? And I think we just don't know. But what I would say is this, is that the market is fully on board with the Federal Reserve's

assertion that it's going to be transitory. If you look at the pricing and the bond market, the bond market absolutely does not accept the idea that we're going to be in for a lot of inflation. The Fed funds future basically says that there's no chance that the Fed is going to raise rates in the next 12 months. That's the view of the futures market right now. Then it says in the subsequent 12 months, maybe they'll hike one time. If you look at long-term bond yields, they're kind of where they were at the end of 2019. If you look at breakeven inflation spreads, those haven't really moved very much either. Breakeven inflation spreads were seeing 2.5% inflation or less from here to the end of time, which translates to around 0.2% per month. So what I can tell you there is we'd better see 0.2% per month inflation

over the course of the summer, because if it turns out to be a lot higher than that, the bond market is going to have to reevaluate that position. And the Federal Reserve will eventually have to start thinking about hiking rates. Yeah, I guess that last part is the red, some would argue like, well, maybe we in a new new normal where we can have some inflation and the fed doesn't have to raise rates right yeah that's right they won't raise rates which is what we're seeing right now um yeah but that that's the million dollar question or billion or trillion dollar question of how does that end if they don't raise rates and they can't get a a handle on it if they can't control it. And then, sorry, second comment is on that

bond chart. Like you've seen those charts go around of the economists, not to throw you under the bus, but those economists, you know, they always think rates are going to be different than they are. They're continuously wrong on the rate predictions. Yeah. And so, you know, there's a case to be made on both sides. So I'm actually not really making any, any predictions myself, but what's interesting though, is that the Fed funds future actually has a really bad track record of forecasting what's going to happen with rate hikes. You know, it spent most of the last several decades expecting rate hikes. It never happened. Yeah. That's the chart I'm talking about. It's like a spider chart. It has these little squiggles that never come into existence. Yeah, exactly. So back in 2015, the market was

saying, or at the end of 2014, the market was saying by the end of 2016, the Fed was going to have rates at a percent and a half, and the Fed wound up having rates at about 1% lower than that. The bond market does, however, seem to do a pretty good job of anticipating rate cuts. But we're a long way from the next rate easing cycle, I think. So the bond market, though, it still remains kind of remarkably flat in terms of yield curve. So I think that all of this kind of has implications for gold and silver in particular. If the Federal Reserve decides it's going to start hiking rates, that's probably pretty bad news for gold in particular, maybe for silver as well. Gold has a pretty consistent negative sensitivity with changes in the sort of forward expectations that are built into the Fed funds futures curve. And also, the fact that the U.S. economy is so remarkably strong compared to, say, Europe or

Japan might put an upward bias on the U.S. dollar. Fiat currencies have kind of been stuck in a range versus each other for a long time, at least among the majors, between the US dollar, the pound, the euro, and the yen. But the US is recovering a lot more quickly than these other places are. So it may be necessary for the Fed to act to tighten policy much sooner than the ECB or the BOJ. And if that's the case, it wind up putting the dollar in a pretty bullish chilt, which could also potentially be really bad news for gold prices. How do you weigh that against somewhere saying, no, the dollar selling off is good, the debt service is going to be less, right? Like all of those arguments for kind of deflation on the dollar is going to be good

for all the debt we've taken on, all the deficits. So they don't necessarily want the dollar to strengthen. Well, they may not want it to strengthen, but the problem is that they may strengthen anyway. I don't think the central banks have that much control over the currency markets. They can control interest rates, but they can't really control the currencies. I think the reason why currencies haven't moved isn't because the central banks don't want them to move. It's been mainly just because everybody's been doing the same thing i mean how do you value the euro versus the dollar when they're all printing money and deficit spending right and it's like we all need sorry i had a police siren going by there right it's like we all want to uh deflate and get

the the debt service under control but at the same time can that all but at the same time, can that all happen at the same time? There's got to be a relative winner versus loser, it would seem, right? Yeah, it just looks like the U.S. is emerging much, much faster economically than most of the rest of the world is. At least compared to Europe or Japan, it's emerging much, much more quickly from its economic function. It's really the economy where it looks like demand is really vastly outstripping supply, at least for the moment. It's starting to create a lot of potential inflation. And so if it turns out that's not transitory, the Fed's going to have to do something. I'm going to push on that.

Why do they have to do something? Well, if they don't do something, then it could wind up getting embedded in inflation expectations. And the danger of that is that when you have people who have saved a tremendous amount of money and they're sitting on a lot of wealth and a lot of cash, and they also have access in many households to a lot of credit, and they suddenly start seeing inflation going up, they have a lot of money sitting in the bank that's losing its value, then there could be a real incentive to go and put that money into something hard and real. You need to go out and

start buying goods of one sort or another, to spend it before it loses its value. And if they do that, then it could create a spiral where other people start doing that, and then money starts losing its value, and you wind up with higher inflation expectations. So people start demanding higher wages, et cetera. And so this could be, it could potentially turn into an inflationary spiral like we had in the 1960s or 70s. And that partly resulted from the combined spending of great Society plus the Vietnam War, which overheated the economy and set off basically about a 15-year-long inflation cycle or series of inflation cycles that really caught the central banks very much off guard. Hasn't, Ryan, that comes back to, what is it, the Phillips curve, the employment inflation inflation link but hasn't that been

rather debunked or you know that it hasn't held over 20 plus years yeah so i would yeah so i would argue that it's not so much that it's been debunked but the nature of it has changed uh so the phillips curve used to be fairly steep uh maybe back in the 50s and 60s. So when you lowered unemployment, you tended to get higher inflation, etc. I would argue that since about 1994, the Phillips curve has turned into a Phillips pancake. There is basically no relation in the last 26 years or so between the level of unemployment and the level of inflation. But the problem is that that curve could potentially re-steepen again and so if people successfully demand higher wages and those wages are growing more quickly than productivity you could wind up in a situation where and the only way to sort of kill inflation is to raise unemployment which is how Paul Volcker did it in 1979 and 1980, really all the way until 1982

when he drove unemployment from five and a half percent to 11 percent almost in order to kill inflation. And then I'm also like you're, you know, you're kind of outlining hyperinflation and people are grabbing stuff as fast as they can. But it seems we're halfway there, at least right of home prices and mem stocks and crypto and all that stuff of people just, can, but it seems we're halfway there at least, right, of home prices and mem stocks and crypto and all that stuff of people just, hey, I got to get this before it doubles and triples in price. Yeah, that's right. And I think that that speaks to a really profound change in the economy that we've seen. It explains sort of why inflation has been so low for the last quarter century and also explains the flattening of the Phillips curve.

During the 1960s and 70s, when we had high consumer price inflation, during that time, we didn't have a lot of asset price inflation outside of gold and silver. Stocks were not a thing in the 1970s, for example. And real estate wasn't particularly great in the 70s either. I mean, it actually fell in value after inflation. But the difference is this. So in the 1960s and 70s, we had a highly unionized economy with a lot of collective bargaining power for wages. International trade was a very small portion of GDP. Imports and exports were roughly 5% of GDP compared to about 15 or 20% today. And also at that time, labor cost differentials between countries were not as great as they are

today because Mao Zedong had cut China off from the rest of the world. The Soviet bloc had cut a whole bunch of other countries off from the rest of the world. And Nehru's India was also somewhat separated from the rest of the world. And Nehru's India was also somewhat separated from the rest of the world. They were kind of following a policy of autarky where they weren't doing a lot of trade either. So essentially half the world's population was taken off the market. So the only low wage countries Americans had to compete with were places like Africa countries or Latin American countries. Aside from that, they were competing mainly with Japan and with Europe, all of which were either rich or becoming rich again. So now you have tremendous labor cost differentials, very little unionization,

much greater levels of inequality. So now when central banks create too much money, it immediately results in inflation, but it tends to result in asset price inflation rather than consumer price inflation. And so central banks for the moment anyway, they only target consumer price inflation. So just as long as consumer price inflation doesn't change too much, they don't care if the stock market goes to infinity. They don't care if Bitcoin goes up like 10,000% in one year. They don't care if the price of silver and copper doubles, as long as it doesn't impact its consumer prices. But I think the question now is, is this beginning to change?

Since the global financial crisis, we've seen a lot of anger among the public about rising inequality. And so essentially you have two responses. You have this sort of right-wing nationalist response, which is to point the finger externally and blame foreign trade and immigrants. Then you have the more left wing response, which is to point the finger upward. Basically, we have to redistribute wealth downward.

So in a sense, the pandemic response has been a downward, not exactly redistribution of wealth, but has been a sort of creation of new money that has been distributed to the middle and lower classes, if you will, or middle and lower income groups of people. But to the upper incomes, great benefit, right? So it seems like maybe everyone's just like, hey, we figured it out. We've unlocked the code. Yeah, well, if you're upper income and you've been invested in Bitcoin or if you've been invested in a stock market, you've done very, very well. That's true. So that has been your inflation hedge so far. But it's not really a hedge against consumer prices. It's more of just a ride that they have been on with respect to asset prices. Right, but it tells me like maybe we have, right? I feel like you could get the upper class would vote for basic income or be like, hey, if we're gonna get this constant demand

that makes all of our investments kind of infinitely go up, let's do it, let's pay for it. Yeah, and I think that the problem is eventually the bill comes due. And so the bill could come due in terms of higher consumer price inflation, which will hit mainly the lower and middle classes. It could come due in the form of higher taxes or less government spending, higher interest rates. And higher interest rates are really the major threat to anybody who owns a lot of assets. There's a strong inverse correlation between the

multiples at which equities trade and the level of interest rates or the level of long-term bond yields. And so I think part of the reason why the equity market has gone up to such extreme valuations by historical standards is because long-term interest rates are low. And if long-term interest rates stay low, the equity market might be fine with those valuations. Maybe we'll even go to higher valuations. But I think now the central bank is kind of in this dilemma where they've kind of maybe overheated the economy.

Maybe they have to think about pulling back on monetary stimulus. But if they do that, long-term interest rates could go up and the equity market might have a very significant, potentially very brutal correction, in which case the central bank might then feel obliged to do more quantitative easing to offset situation of their own creation, may not be their fault, but partially of their own creation, where they're sort of trapped in what could become a cycle of market volatility, whatever, the bill's never going to come due, just print those money, put those zeros in the digital bank accounts? Well, MMT is really fascinating. I actually think it's a pretty legitimate theory and approach, but I think it's really best applied when you're in a really severe economic depression.

It would have been great in the 1930s. Roosevelt never called it MMT. The word didn't exist back then, but Roosevelt sort of did an MMT in a sense. He devalued the dollar versus gold. He ran huge deficits and he created all sorts of new social programs, including a few of which are still around today, like Social Security. And, you know, all of this lifted a tremendous number of people out of poverty. And then during World War II, all that New Deal program was kind of put on steroids. And the sort of exit strategy or the United States also said that MMT would have been a pretty good response in 2009 or 2010. But the problem is it's now being

applied to a very different situation. The COVID crisis is not an endogenous problem in the banking system like we had in the 30s or in 2008. This is an exogenous shock to the economy, kind of with the main reason for rising unemployment was sort of artificial government mandated shutdowns of the economy, which may have been necessary to protect public health and hospital systems, but were not really done mainly for an economic purpose. So now we're doing MMT in that context. And the MMT theory basically says, OK, well, deficit spending is fine so long as it's being productively invested in, so long as you don't wind up running into high inflation, by which I think they mean consumer price inflation. I don't think they care about asset prices either, just like the Fed doesn't. But the problem is we're already seeing the consumer price inflation. And the question is, is it sticky? Does it stay or does it go away?

I mean, if it goes away, it doesn't matter. But the thing is that what really frightens me is we should be looking. Part of the reason why we've seen the year on year inflation go up is just that we rolled off some negative numbers from last year. That doesn't explain all of it. In the last couple of months, we've seen positive 0.9, positive 0.5 print on core CPI. That's like 1.4% inflation in two months. It's like almost as you would expect in a whole year if we were running our inflation target.

That's why there's month on month numbers. To your point before, that's on the skewed, biased, smoothed number even, right? Yeah, that's right. Yeah. Yeah. Yeah. But, you know, I don't think you can have a real discussion on, you know, commodities without also addressing what's going on in China. But yes, when it comes to China, China is also sort of an interesting case too. And in China, there's one particular measure of their economic growth that I really love, I think is relevant to

quite a wide range of commodities, basically everything except maybe gold. It has this thing called the Li Ka-Shing Index, which is a super simple measure of economic activity. It only has three components, bank loans, electrical production, and rail freight volumes. Unlike the official GDP, it's not sort of suspiciously stable, like GDP was prior to the pandemic. It shows much more variation, but it also shows an incredibly strong correlation to commodity price levels one year in the future. And not just in China, we're talking global commodities. Global commodity prices denominated in U.S. dollars, like not even in Renminbi.

So it just shows this really strong correlation so china's economy you know has been growing probably at about eight and a half percent per year in the manufacturing sector over the last two years and so that's also um yeah part of the reason why we saw the dip in commodities last year when china shut down that obviously hit all the industrial commodities, and China reopened, then their prices started soaring again. So I think the other question for anybody who thinks there's going to be a commodity super cycle is, how durable is this Chinese economic growth?

But China also has another sort of darker side of its economic growth, which is debt. When we had the global financial crisis in the West, China's economy, I think, did slow more than the government let on. But at the time, they had a really low level of debt. So at the time, the combined public and private sector debt in China was about 140 percent of GDP compared to around 250% at the time in the Western countries. Since then, Chinese debt levels have come to actually be higher than they are in the euro area or in the UK, and about the same as they are in the US as a percentage of GDP.

So China's huge spike in growth didn't occur only because of reopening from COVID. It also occurred because of a massive program of mainly getting their private sector corporations, but also households and government to borrow more money. And so China's now also being saddled with really high levels of debt. And so, you know, as you look ahead, one thing, one word I hear mentioned a lot, commodities is the word super cycle, which I think maybe, you know, needs to be defined. But I hear a lot of journalists saying, well, we're in a commodities super cycle because prices have doubled. Okay, maybe if that's how you define super cycle, I don't know. When I define super cycle, I tend to think of it as being something that happens over the course of maybe 10 years or

so. It doesn't merely involve a doubling of commodity prices, but maybe increases of three, four, 500% rather than just 100% over the course of a decade. And to me, it looks really improbable that we're going to see that kind of an increase. It's not impossible, but at least any industrial commodities. And bear in mind, this doesn't really apply so much to gold and silver, but it applies more to things like copper and aluminum and even oil prices, because China has so much debt. They went to a three-child policy. It's also a sign of their demographic issues. Chinese currency is also strengthened, which has probably been good for commodities in the short term because that enables them to buy more of them.

But Chinese currency has become very expensive, which is going to really start taxing their exports. So they have a lot of debt probably slowing our more expensive, less competitive exports. So I think China probably can't support a huge commodity price boom. And I just don't see any emerging market out there, you know, like not India, not Brazil, not Russia, who's going to sort of pick up the baton from them in the relay race. That's why I'm a little skeptical of this idea of a commodity super cycle. Who owns, this is a question here in the chat, who owns most of the Chinese debt? Are there statistics on that? Yes, I think Elusive is just owned by the Chinese themselves. I don't think much of it's held abroad. Within China, I don't know who the holders are exactly. I'm not sure.

You just mentioned India, you don't see stepping up to the plate. What are your thoughts on how injured their economy is going to be coming out of their mess with COVID? Yeah, India's economy has been doing somewhat poorly for a long time. I think Modi has been kind of a disappointment to a lot of people who are hoping to see faster economic growth. I mean, his main reforms may bear fruit in the long term. So he kind of pre-COVID, his main reform was to essentially confiscate a lot of high denomination bills to force people into the financial system to make it less of an informal economy and much more of a sort of banked economy. But India's economic growth was very disappointing even before the pandemic, and it's been hit very, very hard by the pandemic. And they have not really responded with tremendous fiscal measures. So there's just a lot of

suffering in India right now. I don't really know how things in India will turn out over a longer period of time. But I think that the Modi reforms have not really addressed some key issues like land reform, for example. One reason why China is an industrial powerhouse is because if the government decides there needs to be a roadway or a railway, we'll just clear anything in its way out of it and build it. You know, in the U.S., that can happen. You happen. We have this concept of eminent domain, so the government can take property with just compensation, hopefully, to build necessary infrastructure. But in India, though, the concept of land rights is even stronger than in the US, and it's really, really hard to take people's property to create infrastructure. They have a real hard time

competing with China in a sense of industrial development. So they're much more of a service economy. 10 years ago, right, it was a who's going to be the winner. Maybe it's more like 20, but there was a real discussion back then of is it going to be India or China? I think clearly it's been China. Yeah, so far. I mean, I guess maybe you could argue that India's economy might in the end prove to be more flexible and, you know, in the sort of analogy that a tree in a storm that bends survives, whereas the rigid tree does not. But look, we don't know how it's going to turn out. But so far, China's been winning the race. That's clear. And then what are your thoughts on China's, right? They, if they like the price of soybeans or whatnot, they'll go buy tons of soybeans and

store them. Right. What are your thoughts on actual demand for, you know, the manufacturing they're doing, which is driven off the demand from non-Chinese versus just stockpiling for their population and for future, future price sensitivity. Yeah, so I think that when it comes to industrial metals like copper, it's definitely a real, the price increases really do reflect actual demand coming from China.

But oil prices are probably also influenced by China. But when it comes to agricultural goods prices, I think it's a little bit of a different story. Those have been driven higher, I think, by drought as well as by Chinese demand. And you're just seeing tremendous increases in the price of corn, wheat, and soy, probably in part because of Chinese stockpiling

at a time when supply is being stressed by droughts in the Black Sea region in parts of the U.S. and in Brazil. And so you just pulled up this interesting chart of ag correlating with oil. What's that all about? So, you know, I think people sometimes don't realize the extent to which ags move with energy prices. There's a variety of reasons for this. Some of it may have to do with biofuels. There are about 60 countries around the world that mandate some

sort of biofuel, including China, Brazil, countries of the European Union and the U.S. And so X price is going to be very sensitive to sort of incipient shortages or surpluses in the crude oil market. In addition to that, though, people sometimes forget, I think, what an energy intensive industry agriculture is, um, if every one calorie of food, um, that you eat roughly 10 calories of fossil fuel energy went into creating it. Um, yeah, that's a little bit less for the crops. Uh, so for crops like corn, wheat, and soy, it may be like four calories of fossil fuel for one calorie of actual food energy, but it's much higher for meats like pork and beef and maybe more like, you know, 10 or maybe more like 20 or 30. So it's just a very energy intensive industry, you know, from the planting to the harvesting. Also the fertilizers are made in part using natural gas and the pesticides also involve a great deal of petrol as well. And then plus on

top of that, you have to transport the food to market and package it. And almost all the packaging is made out of some sort of plastic, which of course comes from petrol. So it's just a very energy intensive business. And what are your thoughts in general on, do we stop caring about energy, about petrol, as you call it, or oil, right? As we get more about energy about petrol as you call it or oil right as we get more cars with batteries as we get um you know as we more move more into a green energy when do we kind of cross the cross the chasm where we don't care as much about oil anymore well so i i think it's still a ways off i mean i think that think that oil prices are still, we still have a sort of combustion engine dominated economy. Now things are starting to move very quickly towards electric vehicles, our hybrid vehicles. So it not quite there. So I think it's going to be decades before we completely switch off of the sort of traditional purely combustion engine. But when that happens, I think it has a lot of really interesting consequences that people have

not thought through at all. For example, now the price of plastic, of course, is not free, but it's very close to being free because it's just a by-product of a transportation fuel. So imagine that we could snap our fingers and get rid of all the combustion engines tomorrow, just replace everything with electric, and we could get rid of all the coal and natural gas and have everything powered by solar and wind, et cetera. I'm not saying that could actually happen in real life, but just imagine we could. So you get rid of all the transportation fuel. You don't need natural gas anymore. So how do you make fertilizer? How do you make pesticides? Something like 99% of pharmaceutical goods involves some sort of petrol. When I just look around the room, like my computer here is made in a plastic case. I'm sitting on a chair that's made from polymers.

They're so ubiquitous when you look around you. And so what happens to those prices when petrol is no longer being produced? And if it's being produced from vegetable oils, You can also make plastic from vegetable oils. Then does that cause the price of agricultural goods to start soaring? Because farmland is being used to produce not just food, but also all sorts of other products. So there's a lot of sort of secondary effects that I think almost nobody thinks through. And they're going to be of enormous consequence. Interesting. And then what I think you guys, CME launched a water futures contract a while back,

right? Yeah, that's right. What are your thoughts on just where you mentioned there's drought here, there's drought there. It seems increasing amount of drought. Water is going to play a bigger and bigger role in all that. Yeah, water is extremely important. It's a commodity whose pricing is often very opaque or people assume that it's free or don't really have to pay very much for it. But yeah, I think that water demand is a very, very interesting one

because agriculture is also, of course, extremely water intensive in addition to being energy intensive. People don't think about it for every almond grown in California, for example, that involves one gallon of water per almond, which is crazy when you think about it. It's so dry. I love almonds, you have a competition over water between agricultural interests, industrial interests, and households and other businesses who need to use water. So it's important that the pricing is done correctly and done transparently in a way that people can understand. So creating a water market, I think, may be a first step towards that. But, you know, ultimately, we may have to find ways to desalinize water. The Israelis and the Saudis have moved really very far out on this one.

It's very energy intensive, but, you know, you can also desalinize water. That could be interesting, too. I don't know. I think the future, and you can also invest a lot of money in water systems. A lot of, in a lot of the world, a lot of the water leaks out of pipes before it gets to its end destination. So there's a tremendous amount of infrastructure investments simply to use the water that we have more efficiently and less wastefully.

Here in Chicago, we're going to have like parapets on the around Lake Michigan and guarding the largest freshwater source, right? Yeah. Don't let them pump that to phoenix that's great yeah exactly stay away from our lake um so i think yeah just one last thing we haven't talked fully i think about the acts um yeah you know so the acts are interesting you know the thing is i i i tend to you I think, like a lot of people to be a little lazy when I look at markets. So the first thing I look at is the forward curve just to see, well, where do people think prices are going?

Some commodities like oil and agriculture have really interesting forward curves. So the forward curves on corn, soy and wheat are all pointing downward, especially for corn and soy. People think that prices are most likely to drop over the next few years. But the problem with this analysis, though, is that it ignores that the forward curve is kind of like the center of a very wide probability distribution. So when you look at the, at the probability distribution in greater detail, and you look at the options markets, both at the, at the money volatility,

as well as the, the smile for the out of the money options, what you find is that a, that the options costs are extremely high, like corn options are trading. I can't remember, last I saw it, like 42% implied vols, really tremendously high volatility by historical standards. And then secondly, the out-of-the-money calls cost a lot more than the out-of-the-money puts, which, by the way, is typical in ag markets. That's pretty normal. It may have to do with some structural bias in ag markets. That's pretty normal. It may have to do with some structural bias in ags. Maybe the

food buyers tend to be fewer in number and therefore employ more sophisticated trading than the sellers of agricultural goods who tend to be thousands of different farmers, or maybe actually millions of different farmers around the world who maybe don't have the same level of knowledge of options or inclination to trade them. I have a simpler explanation. We talk with a lot of farmers here at RCM and they're always bullish, right? So they have the crop in the ground, then they're also buying call options and they're also buying their way, you know, more than you would expect as an economist or a rational market participant.

They're kind of on double bullish instead of protecting themselves on the downside. Yeah. This to me is a really interesting opportunity for a commodities manager. Because if you look over the last 60 years, you kind of do a decade by decade, there's actually no evidence that I've been able to find no statistical evidence looking at daily price series, that corn, wheat or soy are more prone to extreme upside moves than extreme downside moves. The actual distribution of returns, it's not exactly a normal distribution, of course, it's like somewhat fat tails, but it's not fatter

on one side than the other. And so at the same time, there is a structural bias where the call options out of the money calls are consistently more expensive than out of the money puts. So there may be a really interesting opportunity there for somebody to take advantage of. But in any case, long story short, the options markets are showing just incredibly wide set of possibilities. So the forward curve for corn, for example, says that corn prices are going to come down to like maybe 425 cents per bushel by some time in late 2022.

But the options market says there's a 95% chance that the price will be somewhere between maybe 180 cents per bushel and 1,350 cents per bushel. So that's how wide the expectations are. And so that's a reflection of the high cost of options prices, tremendous uncertainty. And you can have a scenario that justifies any of this. The drought goes away, we have bumper harvest, China stops buying. Of course, ag prices crash to levels we haven't seen in decades. Or by contrast, the drought worsens. We have crop failures. And the Chinese and others decide to buy even more food so they can make sure their supplies are robust enough.

And you wind up seeing crop prices go much, much higher. What I can tell you is the spike in prices, we have not seen the consequences of this yet. The last time we had a similar spike was in 2010 and 2011, and that was one of the sort of sparks that set the fire of the Arab Spring. So for wealthy countries, if corn prices double, it honestly makes very little difference to people's budgets. But in places like Egypt or Jordan, the less well-off countries, it's going to be a big deal for a lot of people. And it's going to be very hard for governments to keep their populations happy if they're not able to provide that food. And what, do you have any thoughts on, I'm always saying like, especially in the ag space, right? You got satellite imagery and drone weed detection and all of those sophisticated hedging techniques you're talking about. So there's a million ways to

make it better. And it seems like no matter how much extra demand there is, we've always come in with more supply, right? it sounds like the technology is outpacing the the growth and demand that's right yeah and the other thing is we've also seen a lot of years too especially in the last say five or six years in which the harvest starts starts out looking like it's going to be really bad so you see a spike in corn prices it takes place in may and june and then by july and and August and September, people realize that actually everything's turning out fine. And then the prices come way back down. And so some of that may also be technological as well. It may be crops that are more resistant, better farming

techniques. May also have been luck too. It may have been that we got lucky with the weather later in the growing season. But even in oil right now, we can go down 3,000 feet and over 2,000 feet to get out of pocket oil we couldn't have get to before. Yeah, that's right. And that, you know, I heard somebody do a presentation the other day saying that, well, U.S. oil production is doomed because oil rig counts haven't recovered. But, you know, I think that he misses the point though, that productivity per rig has just, you know, I think that he misses the point, though, that productivity per rig has just, you know, continuously gone higher for precisely the reason that you say. So we're having huge technological advances. You know, we went from having phones that were only used to call to now having smartphones.

We're going to in the direction of smart farming. You know, we have detectors all over the place that, the place that manage different aspects of the farm that maximize productivity. So things are really moving quickly in terms of ag productivity. That's for sure. That story's not over. And the old adage, right? The cure for high prices is high prices. More technology will flow into it, the higher the price. Yes, exactly. flow into it the higher the price yes exactly uh great any last thoughts so it seems like you're on the yes this is transitory in that camp well i would say i would say i'm more in the i don't know camp and i would say yeah i would say i'm really the thing that worries me is that the

bond market um which of course is connected to all the other markets. The bond market is very closely connected to stocks and to gold in particular. The bond market is basically fully on board with the Fed. And my position is I'm not sure, I don't really know. Maybe the Fed scenario turns out to be the right one, but these recent consumer price numbers have been very, very high, and I don't know what's gonna mitigate them in the next few months.

I think the real test is going to come in September when those enhanced unemployment benefits expire nationwide. And hopefully a larger portion of the population is vaccinated or has some other form of immunity because maybe they had COVID already. And so I think the real test is going to be this fall. Do people return to work in droves? Does that kind of, you know, drive away the supply chain blockages and supply chain disruptions? And do we get prices under control or do they keep rising? And my point is that the jury is still out um i want people not to necessarily go back to work but go back to taking public transportation because chicago roads have been terrible lately i think people are going back out but they're still hesitant to get on a bus or on a on the

l train so traffic's been pretty bad great well thanks so much eric we're gonna finish uh ask all our guests some rapid fire favorite questions so you ready favorite favorite economist oh that's a good one um oh that's a good one i I would say Ray Dalio. Ray Dalio. All right. Is he an economist? Close enough. He probably would be insulted if you call him an economist. Exactly. But he's in the business of allocating scarce assets. And I think he's made some important contributions, the understanding of debt, debt cycles. Great. And I forgot to mention, I wanted to say, like the bond market may be not what you mentioned, but the Fed is controlling the bond,

right? They're doing purchases in there. So there's a little weirdness there. But we'll leave that for another time. Favorite. So you've lived in US, UK, France, favorite country to live in. You're allowed to go back to the others but well I like living here in the United States a lot so all right um favorite London restaurant favorite London restaurant that's a tough one I'm a fan of Indian food and there's one called Tamarand of Mayfair it's my favorite all right I think I was in uh last time we were there we went to a nice Indian restaurant. It was like over near Kensington a little bit.

I don't know if that's the same area. Yeah, it could be. They have a sister restaurant in Kensington. Might be the same one. Favorite go-to stat or chart? Oh. You got two minutes. Which chart are you showing me?

Which chart am I showing you? That's a good question. My favorite go-to chart. Yeah, I have a really weird, well, yeah, well, here, let me think about that. I don't know. I have so many different charts I like. It's hard to go to just one. Yeah. All right. We'll let you mull on that one. Then we ask all our guests' favorite Star Wars character. You can look at my... Favorite Star Wars character. Yeah, I've always been very partial to Darth Vader.

All right. We've had two Darth Vaders in a row on here. Yeah. Because you're evil or what? Or because you turn out good in the end? Well, I think he turns out good in the end. Yeah. He does. I love it. Yeah. Well, thanks so much, Eric. This has been fun. All right. Thank you. We'll put this out and we'll talk to you soon.

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