We Study Billionaires - The Investor’s Podcast Network - TIP251: Macro Themes - Summer 2019 w/ Luke Gromen (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, how's everyone doing out there? On today's show, we bring back one of our favorite guests, Mr. Luke Groman. Luke is an expert in discussing currencies, commodities, and global macro themes. Luke has been in finance for 25 years and is the founder of his own macro-thematic research firm, Forrest for the Trees. So without further delay, we bring you a fan favorite, Luke Groman. You are listening to The Investors Podcast, where we study the financial markets and read the books

Starting point is 00:00:31 that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, welcome to the Investors podcast. I'm your host, Prest and Pish, as always, I'm accompanied by my co-host, Stig Broderson. And like we said in the introduction, we got Luke Gromond here. Luke, you've been on the show quite a bit, but it's because you bring so much quality and awesome comments. So I am really pumped to talk to you right now because this market's getting really interesting. So welcome to the show, Luke. Thanks for having me back up and I was excited to talk to you. So let's get to it. This is what I want to say. And I think it's important for people to understand the context of this conversation. This is happening on the 25th of June 2019. So we're kind of at the start of the summer.

Starting point is 00:01:22 Things are looking really squirrely and quite strange in many different markets. But the one that I want to start off the conversation with is currencies. What's your thoughts on the currency markets? I think it's important to take a step back and take a look. at why the dollar's looking vulnerable. I think that is really the big story in currencies, because I think we're at a critical tipping point that is really the culmination of events we've been describing for around five years. So if you go back in time, 3Q14 was the first of these critical moments we thought. That's when global central banks stop growing their holdings of treasury, stop growing FX

Starting point is 00:01:58 reserves. And that led to a series of events where the U.S. took a number of steps. They encouraged the U.S. banking system to buy more treasuries through HQLA, regulations. And that hit a critical tipping point sort of number two in 3Q16, which was when U.S. deficits, the percentage of GDP, began rising for the first time since 2009. At that moment, we said, look, this has happened seven times in the past. Six of those seven times. We've been in a recession to 12 to 18 months later. At that point in time, and basically from now until we get some resolution on global sovereign debt, basically a recession at any point in time is going to drive some really weird outcomes, some really wonky outcome. So our bet was that, you know, you'd see a weaker dollar. because that was sort of the other release valve. 2017, we did get a weaker dollar. It fell 12% in 2017, which is the biggest drop in the dollar in nearly 30 years at that point. Early 2018, we get tax reform, which actually begins restrithening the dollar, sucking

Starting point is 00:02:51 dollar liquidity out of the global system. So you have this period of time in early 2018 where you get sort of the trifectar or the milkshake or whatever you want to call it, a stronger dollar, rising rates, rising equities, and all was sort of copacetic until late 3Q18, early 4Q18, when we hit another critical tipping point, which was actually last time we were on the investor's podcast, we talked about this, which was that in early 4Q18, FX hedge treasury yields had recently gone negative. And that meant that foreign investors that wanted to buy treasuries would either have to accept a negative yield if they wanted to hedge the dollar risk or go unhedge. And at the time,

Starting point is 00:03:25 we said that unless the dollar was weakened pretty notably, that would be a problem for risk markets. And so, you know, of course, shortly thereafter, you know, the Fed paused hikes, then they stopped hikes, then they promise to stop doing QT. Now it looks like the Fed's going to have to assume cut rates and quite possibly be doing QE by the end of the year. And so while we haven't had a weakening in the dollar, we have had increasing promises of dollar liquidity increasing ever since January. And so throughout all this time, what this drove, particularly since 4Q18, was that the burden of funding U.S. deficits fell more and more on the back of the U.S. private sector, the U.S. banking system. And that leads us to the last key moment, if you will, in this

Starting point is 00:04:03 process, which was back in March, late March, Fed funds rates went over the interest on excess reserves rate that the Fed was paying or served Fed funds over IEOER. And that shouldn't happen. And in layman's terms, it meant that basically U.S. deficits were crowding out the U.S. banking system. And the U.S. banking system was running into its own dollar shortage. And so it meant that the Fed was going to have to inject significant dollar liquidity, effectively to fund U.S. government deficits. And importantly, until the dollar falls sharply to drive FX hedge treasury yields back to positive, the amount of dollars the Fed's going to have to inject will have to rise with U.S. deficits, which, you know, as sure as the sun rises in the east,

Starting point is 00:04:39 are going to keep rising. And so they'll have to do that unless they want the dollar to spike and risk assets to really come unhinged, likely driving a U.S. recession. So you've got sort of this reflexivity, this we've come to a key moment, like you said, in markets where it's been five years in the making. There's been sort of a patchwork system that worked for a little bit. Then it began breaking down and breaking down more. And really, this Fed funds over IOUER is, you know, sort of the shrill T-wistle saying, you know, the pressures are too high. The Fed needs to do something. And so tying it back to the currency markets and the dollar specifically, I think the vulnerability of the dollar is really a function of the fact that there's no one more short dollars than the U.S.

Starting point is 00:05:17 government. And this strong dollar of the past five years, which on some level has been a function of people ceasing to sterilize U.S. deficits, foreign central bank ceasing to sterilize U.S. deficits, is not putting too much pressure on U.S. government finances, and the fact that the Fed is being called into action is a function of too big a U.S. deficits and too small a foreign demand for those treasuries. So, Luke, if we're looking at billionaire Jeff Gunnallat, he recently said that the fixed income market

Starting point is 00:05:44 is basically controlling the Fed at this point. Could you please elaborate? What does he mean by that? And do you agree with his assessment? I think he's right. I think he's exactly right. And I think some of that ties into Fed funds over IEOER where basically what that's saying is that the Fed is losing control of the price of money

Starting point is 00:06:03 in the United States, right? And that's the Fed's essentially sole reason for existing. And so when you have Fed funds over IEOER, that's telling you there's a, you know, this dollar shortage. And that dollar shortage means that the price of money in the U.S. is going to be set by the market, not the Fed, at an increasing rate or at a greater rate than maybe has persisted in quite some time. I think Goodlock's exactly right that the markets are dictating to the Fed. and the Fed's, I think, going to have to play along. Luke, explain to people the IEOR and how it's basically the lending rate between banks. Yes, so the Fed funds rate is, you know, it's an interbank rate.

Starting point is 00:06:39 I'm not sure it's the most liquid market in the world, but it's a liquid market, of course. And then IEOER was something, interest on excess reserves was something the Fed. It was a policy tool they implemented after QE. They, you know, they bought all these treasuries and mortgages off the banks books. And so you have these what were called excess reserves. that belong to the banks at the Fed. And the IEOR was simply a policy tool to effectively sterilize those reserves. Basically, as long as the banks are getting paid, the interest on excess reserves rate, then those reserves will stay there. That's supposed to have served as basically a ceiling

Starting point is 00:07:15 on Fed funds. And the problem is that Fed funds has risen above IEOER. And really what that's telling you is there's no ER. There's no excess reserves, right? They're telling you that the demand for money is bidding between banks, they're bidding at that rate up through the excess reserve rate. Because in theory, Fed funds over IEOER should set up an arbitrage where you could sell out of your excess reserves pool into the Fed funds market and capture a risk-free rate. The fact that they're not doing that tells you that there is a shortage of excess reserves, that there are no excess reserves. And when you look at how it's broken down, you know, it tends to be amongst, there's one big bank with a whole lot of excess reserves. That's JP Morgan, as it's been described to me. And then there's,

Starting point is 00:07:57 the other primary dealers who are in various states of not having as much or, you know, as much excess reserves as J.P. Morgan or not having excess reserves at all. And so it's really, again, it's a sign that there's this dollar shortage or dollar tightness within the U.S.'s's own banking system that is beginning to take control of Fed funds rate away from the Fed. So if we look at the yield curve here in Europe, it's even worse than it is in the U.S. So from the perspective of an investor, would you say that the U.S. is just the least bad of the major economies? Or rather, is there something that we're missing in a place where you would put your money? It's a great question. I think it's a really important question. I think some statistically

Starting point is 00:08:37 significant part of what we're seeing play out in global fixed income markets, and especially in the sovereign fixed income markets across the world, has relatively little to do with the underlying fundamentals of each sovereign's economy and relatively a lot to do with global collateral needs, whether that is, you know, bank or insurance books that need, you know, sovereign debt as collateral or whether it's insurance and pension liability matching. And also, I think it has a lot to do with FX hedging markets. You know, there's regulatory capital or margin requirements that are mandated by regulations like Dodd-Frank here in the U.S. or Basel III globally. And that requires, you know, banks to hold a certain amount of collateral against certain positions, whatever they are. And by and large,

Starting point is 00:09:17 that collateral can only be satisfied with government bonds or, you're sort of the equivalent. And so, you know, this need for sort of minimum margin pulls down benchmark rates around the world for sovereign debt, and that then allows corporates to issue more cheaply and buyback stock. And so it's sort of, you know, this need for collateral via regulation has driven this virtuous cycle of, you know, rising asset prices, both bonds and stocks. First part of it sort of the regulatory, you know, capital needs are sort of distorting government bond markets around the world. But then secondly, you have balance sheet constraints in FX hedging markets that we've talked about before, negative FX hedged U.S. Treasury yields, the price to hedge dollars is really expensive, is the

Starting point is 00:09:56 reason that's the case. And so, you know, we described that, you know, last time we talked back in late November, you know, as I just mentioned a bit ago, that drove FX hedged yields on treasuries to be negative, it creates other debt distortions in global sovereign debt markets as well. And so, you know, for example, right now, or at least recently, I as a U.S. investor, I can buy a negative yielding German boon and I can sell euro forward in the currency markets. And, you know, to hedge the FX risk, and I can end up earning a higher one-year yield than I could by just going out and buying a 10-year treasury. Even when 10-year treasury was at 2-and-a-quarter, 2-4, or whatever, let alone, 1-99 today where it closed. So, of course, the selling the currencies, I would have to

Starting point is 00:10:35 roll that, right? So I'm taking that risk on the out-years. So it's not a perfect offset, but these FX hedging dynamics are creating, I think, all kinds of distortions like this as well, sending capital to places that, you know, it might not otherwise go if you simply looked at it based on nominal yields alone. Now, you know, perfect example. Someone sent me a month or two ago that Japan had bought a record amount of French government bonds. And my guess is it had little to do with how they felt about France or whether they thought the riots on the ground increased geopolitical risk and probably had a lot to do with if you looked at the Euro-Yen FX cross rate relative to the, you know, the yen dollar FX cross rate. Right now, Japanese investor, to hedge out the dollar risk, they'll have to collect a negative $6,000. basis point coupon on a 10-year yield. It's not, they don't get 1.99 if they want to hedge out the dollar risk and they all need

Starting point is 00:11:21 to hedge out the dollar risk. That is absolutely fascinating. I've never had somebody explain that to me the way that you just described that. And it makes total sense why you're seeing people participating in these markets that have negative yielding debt. They're basically looking at the spreads between the durations. That is crazy. Absolutely crazy.

Starting point is 00:11:43 You just get it. It's really something, right? Yeah. I mean, if I can make, someone explained it to me about a month ago, Luke, you could sell Euro forward today and, you know, collect a 3% coupon on a negative 25 basis point 10 year German yield. Like, well, if I could do that, yeah, sure, then I'll borrow in dollars and I'll, I'll do that for the year. And, you know, come a year, you're going to have something else to figure out. But it's important to factor in the FX hedged components to it because

Starting point is 00:12:05 that's how the, you know, the whales in the market are going to look at it, right? These, these multi-billion and, you know, trillion dollar, you know, German and Japanese pension funds and insurance funds, et cetera. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:16:16 That's Shopify.com slash WSB. All right, back to the show. It hardly seems sustainable to do this for the long run, called it 10, 20, 30 years. So one thing is how long can we have negative rates? But your other question is, given that it's not sustainable, how does it resolve itself? It's difficult to say. I agree it's not going to continue forever. You know, you have to start looking into these FX hedging markets as an example for how it sort of breaks down, right? So when you just look nominally, it seems like a layup that the U.S.

Starting point is 00:16:49 should see, be seeing all these capital flows because the transatlantic spreads as wide as it's been in 35 or 40 years or whatever. Yet it's not really working that way because basically, you know, when I say FX hedge treasury yields went negative last fall, what I'm really saying is, is hedges on the dollar went no offer last fall. It's interesting, right, because last time we saw hedges on a risk pro on an asset class go no offer in a real notable way, it was summer of 07, and CDS on subprime mortgages went no offer. And, you know, the next couple years weren't really good for subprime mortgages as an asset class, right? And so it was a regulatory decision somewhere, the regulators tap banks on the shoulders and said, stop writing this insurance on the dollar.

Starting point is 00:17:31 And they stopped. And then you started having these market. respond. You saw the pricing of dollar hedges go through the roof, which made it very expensive to hedge dollar risk. And so I think you're going to need some sort of policy or regulatory moves that will disincent the behavior that you're seeing, whether that's, you know, balance sheet constraints on fx hedging, whether that is collateral needs or requirements, right? I mean, if you came out and if a regulator came out and said, we don't need any more, you can do all this stuff and there's no minimum margin requirement, go crazy. Then, you know, you would see a different price. response or different market movement response. But I do think you're seeing moves to escape this,

Starting point is 00:18:08 right? Because it's one thing for a German insurer, they can call up, you know, Goldman and say, yeah, I want to, you know, I want to hedge out the FX risk on a pool of Japanese, you know, government bonds and boom, the deal's done. And you and I, we're not going to call Goldman and ask, you know, for a quote on one year euro forwards, right? But you and I would probably buy gold. and we probably buy Bitcoin and other assets that are, you know, basically, you know, competing, zero percent yielding, you know, infinite duration, finite issuance, bond equivalence. And I think you're seeing that. I think you're seeing that not just, you know, obviously Bitcoin having done what it's done

Starting point is 00:18:43 over the last two years, what it's done year to date. I think you're seeing gold break out, which is interesting. And I think you're seeing, you know, something we've talked about a lot has been, you know, in the last six years, global central banks have bought almost $200 billion worth of gold, and they've sold about $10 billion in Treasury. So I think that process is ongoing, but as far as sort of the one catalyst to point to that say, hey, this will happen and that'll be the tipping point, I think it's much more likely to be one of these sort of esoteric regulator decisions or something where it becomes

Starting point is 00:19:11 very obvious after the fact, you know, they're very hard to pinpoint ahead of time. So I find it interesting the way that you described that before where you were talking about back in 2007, how you saw this play out before, but it was based on subprime mortgages. This time around, we're seeing a very similar dynamic, but it seems like it's a concern with currency opposed to a specific asset class. And that's, in my opinion, kind of mind-blowing when you take a step back and you think of the implications of that, if that's truly what we're seeing. And then I think what else is fascinating is in that same time frame, you saw the bond yield curve invert. You saw the Fed start to ease before we got into a recession back in the 2007-2008 time frame. And it

Starting point is 00:19:57 almost seems like you're seeing a very similar timeline of events playing out right now. Obviously, we haven't had a recession or anything close to recession at this point, but you're seeing the bond yield curve invert. And now you're seeing the Fed talking about lowering interest rates. So what does that mean. As I'm playing that out in my head, it does not sound like it's very, like it's going to be a good thing, especially when we think about the fact that the fiscal side of the U.S. debt, and I'm just talking to the U.S. specifically, is exploding to the upside, which is not what was playing out back then. So if this is truly a currency issue, I think that it's only more dramatic when you think about the fiscal implications of how we're responding right now. So what's your opinion moving forward

Starting point is 00:20:38 here? I think it is concerning. And I think, you know, I think if you, if you take a step back, you know, 2000, we had the stock bubble and it burst. And the solution to that was sort of kicked the problem upstairs to the banking system. So we needed a housing bubble to drive growth, as, you know, Kroogman famously said. We did that. And so then we had a banking system bubble. And that burst. And we kicked the problems upstairs to the sovereign level. You know, it was just inconceivable that the problems would be allowed to sort of metastasize to where they are now. And once you've kicked it up to the sovereign level, you know, sovereigns can't go bankrupt. They can print their own currencies and pay the debt. But what that tells you is that the release valve in the next crisis and the next recession is going to have to be the currency.

Starting point is 00:21:21 That then when you take a step back and say, all right, well, everyone's borrowed and so much in dollars as a funding currency by virtue of this euro dollar system. And really, you know, the euro dollar system going back 40, 50 years, the more. you look into it, the scarier it gets. And the reason I say that is you say, okay, well, in the last crisis, the problem was with the big brokers that were, you know, allowed to be, you know, levered up 30 to 60x. And so they had a small move against them, and it blew up the system. The challenge is that if we've kicked it all upstairs to the sovereign level, and it's, you know, the euro dollar system where everyone's borrowing dollars, the euro dollars, there's no reserves in the euro dollar system. It's infinitely leveraged. So the only people that can create the dollars are the

Starting point is 00:22:03 Fed. And so we're moving to this point where it's sort of put up or shut up time. And so what's really interesting, sort of the tail wagging the dog, and this kind of ties into the, you know, Gunlach's point that you raised earlier, which is that the euro dollar market is supposed to be separate from the sort of, you know, the onshore dollar market, if you will, that the Fed controls, but that the offshore euro dollar market has been allowed to become so big and has no reserves against it. You know, we loved that because that helped enforce dollar hegemony, it lowered our borrowing costs, it gave us a great deal of political control all over the world. There's lots of really, really neat things that we liked in terms of the benefits on the upside. But now it's gotten so big,

Starting point is 00:22:44 it's put the Fed in a bind where basically the Fed is either going to have to create enormous amounts of base money to basically bail out the world or one of two other things will happen in my view. Number one, the world will basically implode, right? The dollar will skyrocket. You'll have risk off, you know, treasury yields will go probably to zero or lower. Equities would crash, home prices crash, global economies crash, you know, global trade collapses, sort of all the worst parts of the depression until the Fed prints, you know, enough base money to fix the problem. Or this is something that I think is very underappreciated by as an option, a political option, is there's a real chance of the reason the world and global credit or central banks in

Starting point is 00:23:25 particular have been buying and repatriating gold at the fastest pace in 50 to 60 years. has been to give themselves optionality, right? Because now, you know, this Eurodollar system is clearly under stress. We're seeing that in bond yield. You're seeing it in the plumbing of the money market system we were talking about before. If these foreign central banks didn't have gold, they're sort of stuck. They're at the Fed's win. But now they can get in the room with the Fed and say, look, you've got to create all these dollars,

Starting point is 00:23:49 you know, to relinquify the system. And if the Fed says, no, we're going to let you, you know, twist in the wind. Then, you know, they have the option to say, well, that's fine. Well, we're going to remonetize the gold at a much bigger number. And that will be the end of the dollars reserve status as currently. structured and it's going to go back to a pre-Bretton Woods with gold at five or ten or $20,000 an ounce or whatever is needed to relinquify the system and lubricate trade and devalue the real value of debt. And those are sort of, I think, our paths from here, right,

Starting point is 00:24:15 is either, you know, number one, the Fed basically creates a large amount of base money to reliquify the Eurodollar system. And it's a huge number because it's basically infinitely leveraged. Or, you know, you get a period of time where the Fed lets everybody twist in the wind and the system, that'll be a very scary world. want to own dollars, you'll want to own gold, you'll want to own old and short-doted, dated treasuries. But that's not a world that's going to be allowed to persist for very long, because trade lines are break. Your trade lanes will break down. You know, you'll see, you know, sort of shortages and parts of the world, et cetera. Or you get, you know, this forces a move to a new

Starting point is 00:24:48 reserve, a primary reserve asset where either gold gets remonitized or you're not seeing any SDR bonds. So I don't think that can be it. I bet you really, you watch what everyone's doing. It has to be gold. Silicon Valley is plowing money into crypto and Bitcoin in particular. Is that a system that could work if you compare it to the monetary system we have now or even a goal-based system that you briefly mentioned here at the end? I think it could work. I had an interesting conversation with a hedge fund manager.

Starting point is 00:25:18 I was out at a conference south on the West Coast about a year and a half ago. They made an interesting comment to me over cocktails. They said that all his friends in tech, they almost have sort of like a perverse. Herbial trophy wall, right, where they have the scalps of all the industries that tech has sort of disintermediated. And that's sort of the big white whale that they want to disintermediate, that they haven't been able to get. It's the banking system. And when you look at crypto through that lens, that would absolutely accomplish that. And I think it would be a very free market capitalist method of doing that. I mean, you see what Bitcoin has done. Bitcoin has done what gold

Starting point is 00:25:56 should have been doing all along, except gold had a, you know, 100x or more levered paper market attached to it that basically diluted what should have been happening to gold's price. And it's been happening to Bitcoin's price. So they've tried to put some futures contracts attached to it to sort of dilute what's happened. But what's happening is in Bitcoin terms, the dollar's hyperinflating. That's basically, you know, you go from 100 to 11,000. That's hyperinflation in the span of three years. I think what they are all doing could absolutely make moves in that direction that basically render the central bank sort of powerless. Now, the challenge in it, I think, is less from a mechanical solution. I think the challenge in it is political,

Starting point is 00:26:33 because now you're talking about, you know, who gets to dictate money. And that has always been the role of the state. They have always used the threat of or actual violence to enforce that right. You know, you saw there were comments from, I forget which representative or senator about a month or so ago, but basically calling for the outlaw of Bitcoin because it takes away. the sovereign's right to issue the currency and manage that for their own purposes. So Bitcoin on some level would, you know, sort of defund the government or move in that direction, right? It would force, not defund, that's too, that's not the right word, but it would enforce a discipline on the government, on the U.S. government in particular, that hasn't existed in, you know, since Bretton Woods,

Starting point is 00:27:10 really. In that way, if tech were to get Bitcoin into that as sort of that neutral bankor role, you know, as Keynes envisioned it at Bretton Woods, rather than gold, you know, to me it's sort of six of one, you know, half dozen of the other. You're sort of getting to the same place. You know, back in the bull market in 2017, when Bitcoin was shooting up, and I think it hit around $20,000, you actually saw some discussion actually hitting the press room at the White House in reference to the meteoric rise of Bitcoin, right? And so then Bitcoin has a meltdown for the next year, year and a half. And it's almost like everyone in Paul, politics kind of stopped talking about it, like, oh, that's just going to go away. But during that

Starting point is 00:27:55 period of time and that law, it seems like everyone in their kid's sister on Wall Street and Silicon Valley just further became entrenched into Bitcoin and other crypto coins. And it became just a way of doing business and finance. And it's completely accepted. You can't talk to anybody that hasn't heard of Bitcoin. Every single person's heard of Bitcoin. Sure. And as especially anybody in finance has heard of Bitcoin. So I guess my question is this, has that law and the entrenchment around Bitcoin where now you can go onto all these different platforms? I mean, it's hard to name a finance platform where you can't go on there and buy Bitcoin in some shape or fashion or have access to some type of vehicle that trades off of the price

Starting point is 00:28:45 action of Bitcoin. There's just total entrenchment at this point. There's derivatives around it. I mean, there's all sorts of things around it. So can the government at this point do something about it? Or are we so far down that path and so many people invested that this is now a thing? And this is a thing that's not going away. I think it's a thing. It's not going away. I mean, I asked at that same conference, I forget the monetary guy, but I say, could the government

Starting point is 00:29:09 just ban Bitcoin? And his reply was, no, not if we want to have an open capital account. If the United States wants to have an open capital account, you can't impose capital controls in any way. Now, there are things you can do to control Bitcoin, and I think, you know, one of the things I would have done is, is launch a futures contract, a cash settled futures contract and hope it gains a lot of traction because that's how you've been able to control gold, right? Once you have a cash settled futures contract on a monetary asset, and by monetary asset, I mean a very high stock to flow ratio, you know, you can have futures contracts on oil, but ultimately the stock to flow ratio on oil is, you know, 1.2. So you can't separate the paper market from the physical market for very long. You can do for short periods, but not for very long. Ultimately, the physical market will rule out. Now, in gold, you have a 65x stock to flow ratio. Bitcoin might be even higher. So if I was the U.S. government and wanted to control Bitcoin, I would do what I did with gold, which is I get a really robust, large cash-settled futures market. Because when you cash-settle a monetary instrument or monetary asset with a high stock-to-flow ratio, you basically shift price discovery from supply demand. end to whoever has the biggest balance sheet, right? You basically turn the market into a high

Starting point is 00:30:21 stakes poker and high stakes, no limit poker game, you know, between me and a billionaire. And I might have a royal flush, but he will show up and go, $100 million, he's going to win because I don't have the $100 million dollars. And you've seen that in the gold market. They push the gold market around that forever, right, where I did get the critical tipping points and someone comes in with $6 billion for sale at 2 in the morning in New York. And boom, you can sort of push the market around or push the pot around to continue the metaphor. So I don't think the government can control it. I I think it's an entrenched thing. And I think it looks like they've tried to do some of the futures contracts.

Starting point is 00:30:50 To me is really interesting. There were two futures contracts. There was a CBOE. And then there was, I think, the CME. And they shut down the CBOE, the smaller of the two contracts for lack of interest back in March. And it was at Bitcoin was at like $3,800. And as soon as they shut down that contract, you know, maybe it's just coincidence.

Starting point is 00:31:06 But it went to, you know, it's tripled since then, you know, in three months. So it's been interesting to see that. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform.

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Starting point is 00:34:24 be found in the income fund fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right, back to the show. So as we continue down this path of crypto and privatized money, or should I say money that is not dictated by a single government, Facebook had a huge announcement this past week talking about coming out with their own coin. And one of the ideas that I heard a long time ago, probably two years ago, is this idea of privatizing decentralized applications. So if we come up with a decentralized application, adapt for short, think about

Starting point is 00:35:01 replicating Facebook. If somebody goes out there and creates a protocol that replicates Facebook, and now all of a sudden that there's coins based into that protocol, those coins can now be used as the currency between the people that are running advertising and then the people that are using the platform. So it's almost a peer-to-peer kind of transaction. If you're on this decentralized application, call it Facebook with crypto coins attached to it. Now all of a sudden, the advertiser can come direct to the people that are using the platform and you actually get money for using the platform. I'm sure that's not Facebook's intention here, but maybe Facebook could give a small, minuscule cut of the funding off of this coin to the users of the community that are using

Starting point is 00:35:45 their platform. And that small amount that would be paid to the users, the advertisers have to use that currency inside of the application. Now all of a sudden you've got everybody using that currency because they've got millions and millions of users and all of a sudden that has a whole lot of value because of the utility that's applied to the platform. So that's the idea. That's the thesis of whether something like that can happen. So what are your thoughts on if one company can do this or one group of programmers can establish a protocol with crypto coins attached to it to pull off this model? Why can't there be others? And it just further becomes smushier as to what currency becomes in the future because you have decentralized applications that might be

Starting point is 00:36:26 replacing government money. I'm sorry, I talked so much there. I guess I'm just trying to explain what it is that I understand this to potentially be. Is that something that you've heard, or have you heard anything that's different as far as money becoming privatized? Yeah, I read an article on FDN, FT about Libra. It was arguably, if I would have just changed Libra to Fed, it would have been the single best, most succinct anti-fed diatribe I'd ever read in my life. It's a really interesting when you spin it that way. To me, it speaks to your point that clearly there is a, it is part of a threat to just sort of what is money, what is currency, how does government control that? How is government able to use that to tax, et cetera? It's very interesting,

Starting point is 00:37:14 right? Because ultimately, you know, the MMT and the monetary purists will tell you what's long as you, you can only pay your U.S. taxes in dollars, then that's that. Now, you get in, you know, Ohio, state of Ohio, where I live now, I can pay my taxes in Bitcoin. So, you know, my tax bill has evaporated this year. You know, I own some Bitcoin. Whatever taxes I own to Ohio, I probably earned 10 years worth of taxes in the last two months, right? Like, it's this weird, I think it's just this weird sort of like Twilight or sort of like Nowhereville of in between sort of the system that it existed for a long, long time and sort of this new system. What I don't know is when you have a bunch of people issuing a bunch of currencies, do you get into like what you had before you had a national bank in the U.S.,

Starting point is 00:37:54 right, where everyone's sort of issuing local currencies and bonds and you don't know who to trust. Now, the technology sort of, the verification measures go a long way and preventing that problem. I think the bigger thing is just, you know, taking the power of monetary issuance away from the government. And ultimately, the reason the government wants to hold that is because they touch the money first. They can spend it first. They can inflate and it doesn't hurt them as much as it hurts others. You know, all of the sort of benefits of particularly holding the reserve currency, but issuing any currency.

Starting point is 00:38:21 So, Luke, I come to think of a question. Now that you mentioned that you can pay your taxes in Bitcoin in Ohio State, you have other states, California, for example, having so much debt that we don't know if they ever get out of it. And they don't print their own currency. They use dollars. Could these states turn to currencies as a way to protect themselves? And if so, if they have a strategy for it? It's a really interesting question.

Starting point is 00:38:48 I hadn't really thought of it until then because you're right. I'd love to think my home state is really thinking about this. those terms, but I would say it's, you know, slim and none that they've actually thought about it. Then again, I put it, Texas, just opened up their own statewide gold vault. They went to Manhattan and said, we don't want our gold Manhattan anymore. We want it in the state of Texas and we want it in our vault. And, you know, the state senator who did this was a really champion that was, you know, arguably either, you know, very right wing or libertarian leanings. And not that there's anything wrong with that, but just in terms of, I think his motivations were probably not, hey,

Starting point is 00:39:23 you know, we've got a pension problem. And the way we can fix this pension problem is, is we, you know, we bring back a reserve asset of some sort and, you know, we inflate the crap out of it. Or we go to our public union and say, listen, you know, we will give you a stake in, you know, Bitcoin or gold in the state vault, a discount today. And you can write checks out of it today, or you can just hold onto it. And, you know, as the money is printed to fulfill all these obligations, we can sort of work our way out of these things. It's sort of the same thing that global central banks are doing or appear to be preparing for, just, you know, sort of writ small. But it's something that would work, but I think I'm giving them too much credit at this point.

Starting point is 00:40:03 It is a possible solution. So what do you think is the most important thing happening in financial markets today? Oh, by far and away, it's the persistence of Fed funds over IEOER in my. opinion, you know, signaling this dollar shortage in the U.S.'s own banking system. And the root cause of the dollar shortage in the banking system is the combination of falling foreign U.S. Treasury demand because of falling surpluses overseas and rising dollar hedging costs and then rising U.S. Treasury supplies. So, you have falling demand, rising supply because of rising deficits. And so, you know, we've long been saying that we're structurally bearish on the dollar

Starting point is 00:40:36 because there's no one more short dollars in the U.S. government. And when push comes to shove, you know, the Fed's going to be forced to effectively fund the U.S. government. And Fed funds over IEOER is the warning gauge that pushes coming to shove. And what we've been watching the Fed do year to date, culminating in last week's meeting, is start to set the narrative for what will effectively be the Fed financing U.S. government deficits likely for the foreseeable future. You know, there's been this discussion around what the Fed's doing. It's all been centered by and large based on what everyone has known over the last 20, 30, 40 years of their career. Well, inflation's not that high or it's too low or what's unemployment doing or what's GDP growth

Starting point is 00:41:14 doing. And that's the narrative and that's the discussion. And the reality is that the reason the Fed is doing what they're doing has very little to do with any of those things that we've spent all our time worrying about. And very much, if not all, to do with this dollar supply issue, this dollar shortage issue in the U.S.'s own banking system that is ultimately being driven by a U.S. fiscal problem that is a function of too much supply and not enough demand. And so to me, you know, this Fed funds over IOUER is just sort of the shrill warning whistle, like it's the starting gun. So I think we're going to get our Fed rate cuts and then we're going to get our QE and people are going to be surprised at the whole thing. But I think as sort of the quorum of investing public is not aware of this, they're going to catch up quickly.

Starting point is 00:41:54 People are smart. And I think as they start to realize that what the Fed's doing doesn't have anything to do inflation or unemployment or GDP growth and has everything to do with effectively funding the U.S. government who has a fiscal problem. You know, ironically, when you have fiscal crises in any other country, it's very bearish for assets. It's bearish for the currency. You know, it drives higher yields. For the U.S., I think it'll be very, very good for risk assets. I think it'll be bad for the currency, but I think it'd be good for yields. Yield to go wherever the Fed says the yield should be. They have the ability to shape the yield curve and do whatever they want. They just have to let go of control the quantity of money to control the price of money. So I think far in a way, that's the most

Starting point is 00:42:31 important thing. So knowing that, and I'm just really going to put you on the spot here, if you could buy just one thing and not touch it for at least a few years, what would you buy? I'll do two things. It'd probably be 50-50 gold and Bitcoin. If I could do some other things, it would be emerging market assets, which haven't moved in 10 years. It would be commodities that are at 100-year lows relative to financial assets, value stocks in the U.S. relative to growth. I think if you, you know, bought a basket of gold and Bitcoin and emerging market stocks and U.S. value stocks and commodities and, you know, didn't put it on margin and fell asleep for two years, I think you'd be really, really happy.

Starting point is 00:43:11 I'm kind of curious if there's any billionaires out there that you pay particular attention to. I know we were talking about Jeff Gunlock earlier, but is there any that you pay particular attention to? And is there anything that any of those people have said that have kind of made you go, hmm, that's kind of interesting. You know, I'm always watching as much as I can. And what I'm looking for is sort of the old game, you know, the Sesame Street game, like which of these things is not like the other, right?

Starting point is 00:43:35 Where's the change in behavior? And so the first one that really grabbed my attention earlier this year was Sam Zell. So back in January, Sam Zell said that he was buying gold for the first time in his entire career. Zell is 75. He said it was due to it being a good hedge and because the supply demand picture is incredibly attractive. He said basically we're at peak gold. So Zell is a guy. who's not that vocal, but he has consistently gotten the very big things, very right. You know, perfect example was back in 07 when he sold equity office product or equity office properties to Blackstone at basically the top. So that was interesting enough for Zell. But then a couple months later, Zell at a conference comes out and says, Trump's right, the economy would do better

Starting point is 00:44:17 if the Fed cut rates by 100 basis points, but that it could put the dollars reserve status at risk, which Zell thought was the biggest risk to the U.S. economy right now. So you've got to a guy like Sam Zell, not only, you know, when Sam Zell buys gold, he's not going to come out and say, hey, I'm buying gold because I think the dollars reserve status is at risk. And I think, you know, you don't get invited back to the cocktail parties, right? They sort of look at you funny. They think you're, you know, an alt-right guy or something. And so you say, hey, I think supply demands are attractive. And I think we're at Pete Gold, which is still true. Like, that's a totally valid reason. But he did not mention the fact that he'd been buying gold when he came

Starting point is 00:44:51 out and said, look, the dollars reserve status, I think, is a big risk. And so when you put those two together, those appearances, two, three months apart, I thought that was really interesting. And then the other one that got my attention recently was Warren Buffett. He put in $10 billion into Anadarko Petroleum. Again, he flat out said, it's a long-term bet on oil prices. As far as I know, the last time Buffett made a big bet on oil production was in 03 when he put a bunch of money into China oil or CNNOC. Of course, you know, O3 to 08, oil had a pretty good little run there. So nobody's more tied in with the U.S. government than Buffett. He's been around, you know, Solomon needed a backer, it was Buffett.

Starting point is 00:45:28 You know, long-term capital, he got showed that book. He was involved with Goldman and Bank of America and the crisis. He is extremely politically tied in with the U.S. government. So when he's putting $10 billion into Anadarko at a tie in, in an industry, he doesn't particularly like, you know, hasn't done a lot in, but has done in the past in a big way and done it well. That caught my attention for sure. So when we're talking about Bitcoin, should we talk about it in the same breath as gold? Are they taking Magia away from each other, other serving different purposes? How do you think about all this, Luke?

Starting point is 00:45:59 I think they should be discussed together. I mean, I think to oversimplify probably, but I think both are being used as neutral reserve assets by people around the world. And, you know, I think Bitcoin is doing what gold would be doing if it didn't have a gigantic paper market attached to it. And I actually think blockchain plus gold is a killer act. Some of the Bitcoin purists say, hey, gold is dead. It's never going to come back at that asset.

Starting point is 00:46:20 But if blockchain is merrier, married to gold. And I think it's just a matter of time until it is. If that's going to force the de-leveraging of paper market, paper gold markets that are levered by some estimates, 100x or more. So basically, you know, it's interesting. I think there's a lot of reasons to own both gold moving back into the system. I think Bitcoin's serving as sort of a neutral reserve asset for the people. But the interesting thing is if you put blockchain and gold together, you're going to take the opacity out of a market that's levered as much as 100 times paper to physical. And suddenly, what you conclude is that if blockchain's married to gold, it could drive gold to

Starting point is 00:46:54 Bitcoin like returns over time if that were to happen. And so there's a lot of different people trying to do that. And so to me, I just, you know, I don't both. I just think you buy them both and you put them away. And I think you're going to be pretty happy. So I like thinking about them both. All right, Luke, we can't thank you enough for coming on the show. We really look forward to each one of these discussions. And you've got a new book out there. It's called Mr. X interviews. We'll have a link to it in our show notes. But if people want to learn more about you, give them a handoff where they can learn more about your, Luke.

Starting point is 00:47:24 Sure things. We've got an active Twitter feed at Luke Gromman. You can check out our firm's website, FFTT-LC, Frank Frank TomTom, dash LLC. Got updates on what we're up to, what we're doing. And our latest product we rolled out, which was tree rings. It's a 10 most interesting things. Synopsies of what we're seeing in any given week. And it's been a really popular product,

Starting point is 00:47:48 but you've been reading rave reviews about it. So you can find more about that on our website. And other than that, thank you very much for having me on. Love having you. And we'll have links to what he just described in our show notes. So make sure you guys take the opportunity to check that stuff out. So Luke, thank you so much for coming on the show. Thanks for having me on.

Starting point is 00:48:03 It's been a blast. All right, guys. That was all the Preston and I had for this week's episode of the Ammasters podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only.

Starting point is 00:48:31 Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or rebroadcasting. Do you know.

We Study Billionaires - The Investor’s Podcast Network - TIP251: Macro Themes - Summer 2019 w/ Luke Gromen (Business Podcast)

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