We Study Billionaires - The Investor’s Podcast Network - TIP367: The Current Macro Landscape w/ Luke Gromen

Starting point is 00:00:00 You're listening to TIP. On today's episode, I sit down with TIP fan favorite Luke Gromyn. I took the opportunity to dig into Luke's worldview and take on the macro landscape we've been witnessing over the last few months. We discuss what is incentivizing the Fed and policymakers to continue their QE efforts, peak cheap oil and its effects on the burgeoning electric vehicles market and underlying commodities, how gold might actually be positioning itself as the new wealth reserve asset and much, much more. I really enjoyed learning from Luke and he really brings the heat with this one. So without further delay, I hope you enjoy this conversation with Luke Groman. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the

Starting point is 00:00:52 unexpected. Welcome to the Investors podcast. I'm your host, Trey Lockerbie, and today I am so excited to have back on the show, Mr. Luke Groman. Welcome back. Great to be here, Tray. Thanks for having me back on. You don't know this, but before I was the host of this show, I was a longtime listener of this show. And every time they had Luke Gromman on the show, I would fist pump in my car, you know,

Starting point is 00:01:24 ready on my commute going, this is going to be a good one. So I'm super excited to have you on as a guest. And one thing that I've experienced personally, and maybe I think a lot of our listeners can relate to this, is when I got into investing, I was very much. micro-focused. And now I have such an interest in the macro environment, but it's such a beast to wrap your head around. And a lot of times, you're just piecemealing little sound bites from podcasts or articles, and you're getting all these details. And as Elon Musk once put it, knowledge is like a semantic tree where you have to understand the fundamental principles,

Starting point is 00:01:59 you know, the tree, before you get into those details, the branches and the leaves. And I'm finding myself with a lot of these questions about what is the real incentive that is driving the feds behavior, the politicians' behavior, a number of other things that I want to get into here with you. So, with that long-winded introduction, I want to kind of start with a breakdown of what you think is incentivizing the Fed's actions as of late, our politicians' actions as of late, etc. I think there's a couple different big gears that are driving things, if you will. I think the first is what is effectively the first bursting global sovereign debt bubble in 100 years

Starting point is 00:02:42 since the immediate aftermath of World War I. And that's really been driven by a combination of just natural long economic cycles, been driven by being 50 years into a fiat currency system post-U.S. going off the gold standard in 1971. It's being driven by the economic reality that what the U.S. government did in the 1930s under FDR when they set up Social Security, what they did in 1968 under LBJ when they set up Medicare and Medicaid, that the U.S. government and Western social democracies more broadly did right before and in the aftermath of World War II was effectively not that different from what AIG did in the subprime market 15 years ago, which was.

Starting point is 00:03:29 because they wrote a gigantic insurance policy on mortgages across the United States, betting that home prices would never fall nationally. They were in the mortgage insurance business piece of their business. And for a long, long time, it was a great business. It was proverbially picking up nickels in front of a steamroller, but for a long time, they dodged the steamroller. And then when the impossible happened, the quote unquote impossible, because it had happened in the 30s, they just chose to ignore that.

Starting point is 00:03:56 the impossible happened, they were screwed. And they were not setting aside capital, the requisite amount of capital to weather the losses. And so it was going to erode a significant portion or all of AIG's capital base, which was a problem then based on who else they were doing business with around the financial system. And so to bring that back to what's happening now is the U.S. government mortgage insurance on baby boom generation, which when it started this process This didn't even exist, right? The boomers weren't even born. They didn't begin being born until 1946. So Social Security was in place for 10, 12 years before they were even starting to be born. And so we had this 70-year period of time, 80-year period of time now where there was no

Starting point is 00:04:39 political courage to do what everybody knew was coming. Any idiot with a sixth-grade calculator and a sixth-grade math education could tell you that 75 million baby boomers were born. It would stand a reason 75 million baby boomers were going to turn 65 someday. And it was always put off. And so, again, it was like this AIG mortgage insurance. The government was picking up nickels in front of a steamroller. They doubled down in 1968, which again, admirable in terms of its political goals in the 60s being old was synonymous with being poor, by and large. And so again, providing health care for the agent, an admirable political goal. But again, no political courage in the ensuing time, as 75 million baby boomers back then were anywhere

Starting point is 00:05:21 from four to 22 years old, they had 50 years, 50 plus years to fix this problem. There was no political courage. And now the big gear problem number one in the U.S. specifically, because it's the reserve currency issuer, but more broadly in Western social democracies, as the bills do. And just like AIG, the U.S. government has never set aside any capital to pay for this. They've always taken the premiums, if you will, and immediately redeploy them into other things, which when they go to things like the Eisenhower Highway system, that's a good thing. When they go to things like the Internet, that's a good thing. When they go to things like the Iraq War in Afghanistan, that's a catastrophe because it's like pissing money away.

Starting point is 00:06:03 And so the bottom line is that we're now in this situation where we owe a bunch of debt. The bigger deal is we owe a bunch of these off-balance sheet liabilities are coming on balance sheet because the quote-unquote impossible happen again, which is to say 75 million baby boomers, turned 65, surprisingly. And so you've got this same type of problem like we had in the immediate aftermath of World War I, which is everybody owes everybody else and nobody has a capacity to pay in anything resembling real terms. And so it comes down to default or print. And so that, I think, is big gear number one. And we've said it before. We've probably said it on this show, is the Fed, I think, and other central bankers are trying to ride two horses with one ass, which is to say

Starting point is 00:06:48 they're trying to convince global bondholders that they're not going to print while convincing domestic voters that they are going to print. And these horses are increasingly riding in two opposite directions. They're going to have to choose sooner or later. From call it April of last year through April of this year, they did a very good job convincing the world. Central bankers paired with their partners in the fiscal agencies and the governments themselves that they were going to print. And we saw that happen. And since April, there's been this concern. really late April, early May, this concern that, well, maybe they're not going to print. And they've been doing everything they can sort of, well, we're not going to inflate it away

Starting point is 00:07:25 and sort of try to jump from one horse to the other horse. And so we're in this deflation scare. I don't think it's going to last for very long simply because it really can't. But that's really the one big year, which is this global sovereign debt, global sovereign obligation bubble is bursting. And they're just trying to figure out if they want it to burst in real terms or nominal terms. The other big year is something that was a much bigger theme 10, 15 years ago and is starting to come back up, which is in 2002 Matt Simmons wrote Twilight in the Desert about peak oil,

Starting point is 00:07:57 Saudi reserves, etc. Peak oil, peak cheap oil, which is a metric I prefer, simply because it, I think, more accurate. It describes that the cheap stuff is gone and it's getting more and more expensive to replenish the reserve base. Peak cheap oil was a really big theme for commodities from call it 2002, 2005 through 2011, 2012, maybe even to 2013. And one of the big massive surprises to the positive post-Great financial crisis was the expansion of U.S. shale production. And something that has quietly been happening post-COVID has been, if you look back from 05 to to 2014, 2016, basically the only growth in global oil production, the vast majority of it, has come from U.S. shale.

Starting point is 00:08:46 And post-COVID, the shale guys have high-graded so much of their acreage that they're making noises that's going to be really, really hard to expand production at any price for the foreseeable future. It's not to say they couldn't. There are other resources available. But the punchline is that there is this resource commodity scarcity issue. You've heard people talking about it in copper as well, which is obviously important for the electrification of vehicles. Gas and natural gas as well, there's been some concerns in Europe.

Starting point is 00:09:17 Europe's biggest oil field was supposed to be shut down by 2030. Excuse me, Europe's biggest gas field, Growningan, it was supposed to be wound down by 2030. They're actually going to do it by 2022. So there's this theme of energy commodity scarcity that was a big theme 15, 20 years ago, went away for a period of time during the expansion of U.S. shale. And I think that's starting to come back in. So I think the other big gear that we're watching governments deal with is energy policy, energy scarcity, trying to rework economic systems and address this for their populations. And you can see that in any number of ways. So I think these are these two big gears that we're

Starting point is 00:10:00 really dealing with, which the confluence of both of them, I think are make for a whole lot of volatility. And we're going to dig more into that. I think I'd like to just go back to what you were saying a bit earlier with the debt. We're now at $28.5 trillion of debt, and the debt to GDP is over 143% as of today. But my question, I guess, is going back to World War II, we were in a similar position, right? And we did inflate away the debt. But at this stage, now that there's not a gold standard like there was back in World War II,

Starting point is 00:10:31 is it apples to apples? Does the debt to GDP even matter anymore? It only matters to the extent that resources are available or are not available, shall we say. And so if they want to inflate away the debt, that's fine. That then leads to two problems if you are, right? The MMT crowd would say, well, don't worry, just inflated away. The constraint on the system is simply resources. They're right.

Starting point is 00:11:01 And when they say resources, it's inflation. When does inflating away the debt drive inflation so high that they can't BS the inflation numbers and get away with it? You know, if a real inflation is four and they say it's two or it's five, it's two, okay, great. If inflation's 15 and they're saying it's two, that's hard for them to maintain their credibility. That's an issue. And that then feeds into the second point, which is when debt is this high and critically after World War II, you didn't have free capital flows. You just couldn't move capital all over the world with a couple of keystrokes like you can now. And so it was easy to trap capital in place, a debt capital in particular, while you screwed

Starting point is 00:11:44 the holders of that debt capital on a real basis, which is what they did. And they were very upfront with that in the aftermath of World War II, that this is what we're going to do. If you try to do, remember, our first constraint is inflation. And so if inflation gets too high that you can't even deny any more that, hey, it's actually 10, not 2. Now, at least even if that was the case, and it was the case from 1946 and 1951, U.S. real rates were at their lowest, negative 14%. So bondholders lost in a single year 14% of their money relative to the cost of living in a single year. And that's how they took debt to GDP from 110 to 50% over five years. And it just was what it was. There was the cost of the war. Thank you for your donation bondholders.

Starting point is 00:12:24 However, critically, those bondholders couldn't go anywhere else. There were not free capital flows. If they tried to do that now, bondholders can move their money out of bonds anywhere in the world into something that will betel hedge their inflation. And there's other things that factor into that rule of law, et cetera. So there's a practical matter if they try to do that same thing. What's likely, very, very likely going to happen is you're going to see bondholders say, fine, you take the bonds fed, you take the bonds ECB, you take the bonds bank of Japan. I'll take the equities, the ports, houses, real estate. And so you can sort of see this happening all over. Right. When the headline comes out two weeks ago, three weeks ago, that Blackstone's buying 17,000

Starting point is 00:13:08 houses, that is, we don't want treasuries anymore. They are going to be inflated away. We'd rather own a house. And we can raise rates on that, whereas the coupon on the treasury is fixed. The Chinese have been, by the way, Blackstone doing this now is the same thing the Chinese have been doing for 10 years, which is, you know what, we don't want any more treasuries. We'll take equities, we'll take ports, we'll take gold, we'll take oil fields, copper, anything but fixed rate sovereign debt. And so there's this very different setup this time in terms of the freedom of capital markets that really feeds back into that point before of how they're trying to ride two horses with one ass and why they're eventually going to have to choose, which is to say the horses are riding in

Starting point is 00:13:51 different directions because they need very high rates of inflation to get debt levels down in a relatively compressed period of time. Again, and to go from 110 to 50, over five years took a negative 14% real rate at the lowest last time. Now we're at 130, 140% to try to do it a little bit at a time is going to take too long. You're not going to be able to get out of it, given what's going on on the other side in terms of the off-valent sheet liabilities coming on due to the boomers aging. And so you've got to do it relatively fast. But if you do it too fast, the bond market is going to be the frog in the hot boiling pot of water, they're going to jump out. And what that looks like is, is the Fed's balance she goes 8 trillion, 10 trillion, 20 trillion, 40 trillion, 80 trillion.

Starting point is 00:14:31 That's really my base case of some version of that. I don't know if 80 trillion or 40 trillion even is the right number. But basically, they are trying to play this game back and forth, particularly post-COVID of, hey, we're going to inflate this thing away, it's growth. And then in April, I think they got there and they're watching Bitcoin. It's 60,000. They're watching lumber go vertical. They're watching used cars go vertical. They're watching houses go vertical.

Starting point is 00:14:52 Equities go vertical. And I think they all said, like, this isn't good. Okay, guys, let's pretend and scare them that we're not going to inflate away the debt for, you know, is it two months? It's not two months. It's not three months. I would have thought it was sooner quicker. You know, I would have thought probably a month or two.

Starting point is 00:15:07 They've done it for, I guess we're going on month three now. And it's work. Lumber's come down, used car prices are peaking, whole house demand is slowing. We've had a few scares in the equity. market, ultimately, I think it's a very temporary thing, but it's, they can't have too many days in the Dow like yesterday and the markets like yesterday before they're going to have to go, hey, hey, we were just kidding, just kidding. We're back to inflating again. And that's sort of this world we're in right now. So it's a tricky operating environment for them. It's something

Starting point is 00:15:34 that has been seen many times before in the last 40 years in emerging markets. It's not been seen in developed markets since after World War I. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days of 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. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the

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Starting point is 00:19:44 That's Shopify. dot com slash WSB. All right. Back to the show. Okay, so I was recently interviewing economist Richard Duncan and asking him some similar questions. And his base case was essentially that credit drives economic growth. And his opinion, credit has peaked because we've kind of pulled forward a lot of demand

Starting point is 00:20:08 on the credit side because of COVID, and we don't really see needing more stimulus of that magnitude anytime soon. Now, things could change. But at the moment, that's how it's looking. And even the infrastructure bill will be, you know, chopped up over a number of years. So in his base case, credits peaked. So therefore, inflation has peaked. And we're talking to the CPI, right?

Starting point is 00:20:27 And so as you kind of mentioned, there's some manipulation potentially there. Home prices used to be in the CPI in the 1980s, for example, they're not anymore. But it begs the question, can we even get to, like you said, 15% on something like the CPI this day and age when we have globalization that's continuously deflationary on, I would say, the metrics making up the CPI, as well as deflationary technology. All of those forces are combating the CPI. And given that things like bonds, a number of equities, even, they're priced on CPI. So I guess what I'm wondering is does the Fed, you know, is it that they're just negligent or is it that they understand that deflationary forces in play and that they're going to have a very, it's going to take a lot to get the CPI up to where it used to be, so they're just taking

Starting point is 00:21:20 full advantage of that? The short answer is I think they can generate as much inflation as they want. And the reason I say that is we can make it real simple. We can just say, okay, the U.S. Treasury decides it wants to issue $1 million directly into the bank account of every American, women, children, men, everybody, and the Fed's going to buy all of it. The Fed's going to buy every bond. So it's basically just a helicopter drop of money, a million dollars per person. There's going to be inflation, right? So if we say, if we say extremes inform the means, then we say, okay, they can absolutely generate inflation. Now, there's a couple of key

Starting point is 00:21:54 caveats that we can sort of derive from that that we would need to see to get there. Number one is it has to really be a pairing between the fiscal authority, the U.S. government, and the monetary authority of the Fed. And we saw that marriage between those two after COVID in a way we did not see it after 08. And lo and behold, we got some really nice inflation reading, some really nice GDP reading. From that point, it gets to be a political question, really on two fronts. Number one, can Congress and the fiscal authority ever agree on anything, which, to the deflationist's point has been and likely remains a very big impediment until those people's 401ks get threatened, right? So, you know, as soon as Nancy Pelosi goes from being worth 115 million bucks to

Starting point is 00:22:37 threaten to be worth 80 million bucks or vice versa on the other side of the aisle, it's amazing how quickly they'll get to work together to find something to get their, you know, their net worth statements back to all-time lives. And that's fine. It is what it is. It's the political reality I'm not opining on whether it's right or wrong. It just is what it is. The other question then is also political, and it comes down to, to be blunt, it's a question of what is more important to you politically, America or the bond market, and in particular, the 99% or the 90% of America or the bond market. And what I mean by that is that from, call it, 1982, until last year, I would argue, last April, the U.S. policy was basically subjugate the American middle and

Starting point is 00:23:24 working class to support the bond market. The bond market always had to be taken care of, and if that meant austerity, if that meant offshoring jobs, if that meant whatever, bailing out banks, that was what was done. And there's very much a group of policymakers, economists, politicians that support this, have supported this. If you go back to 1998 or 1999, you see the Committee to Save the World on the cover of Time magazine. Those are like the crown prince. of the bond market over the 90% of America. It's Larry Summers and it's Robert Rubin and it's Alan Greenspan at the behest of the Clinton administration and the Bush administration, etc. There was a 40-year policy subjugate the 90% of America to support the bond market and to support

Starting point is 00:24:11 the dollar. The dollar system has structured post-71. Post-COVID, what we saw for a period of 12 months from April last year up until I would argue late April, early May of this year, there was a coordinated effort for the first time in 40 years to subjugate the dollar, to subjugate the bond market in the interest of the 90% of America, the U.S. middle and working classes. They were printing up money, handing it out, backstopping Main Street, backstopping small business, the bond market be damned. And inflation reading showed that. And that was a 12-month period of time that was very different than what we saw the prior 40 years. And since then, since late April, early May, we've seen a bit of a change on that front. So to me, it really comes down to, you know,

Starting point is 00:24:55 when you say, can they get inflation? It's a political question on a couple of different fronts, the first metric. And then the second metric, which is, is it in the interest of the United States to support the 90% of America or the bond market, the 10%. It's probably more like the 5% of the 1% of America. And in the last three, four months, you've seen, you know, guess who's been out writing an article a week on Bloomberg talking about inflation? Larry Summers, our friend from the late 90s. Bill Dudley, oh, watch out, inflation's picking up. And again, that's fine. The offshoot to that then ties into some of the geopolitical points we made earlier, which is, if we're going to subjugate America to the bond market, then the offshoot to that is,

Starting point is 00:25:35 we're going to offshore our manufacturing, our production base, et cetera, to China. And we've seen how that's gone. And so there were the early days of that process, hey, this is great. The Chinese, they make stuff cheap, and they help us contain unions, and they by our treasuries and isn't this thing great. And in the aftermath of COVID, we've come full cycle to like, oh my God, we can't make anything without the Chinese, including weapons, including pharmaceuticals, et cetera. And so there's been a bit of a swing away from the Larry Summers and the Robert Rubens on these policymakers that are, you know, the dollar system as structured post 71 and the bond market over everything else simply because the national security establishment is in their ear

Starting point is 00:26:15 and in other policymakers here going, look, guys, it is not in our interest to be so beholden to China economically that we can't make anything ourselves. And so, again, that hasn't matter. It looked like it was starting to matter from April of 20 to April of 21. In the last two, three months, it looks like it's kind of gone back to, hey, we need to take care of the bond market for a little bit. My base case is that we have made a major shift post-COVID toward reshoring, taking care of the 90% to the detriment of the dollar, to the detriment of the bond market, but it's not going to be a straight line. So I think to summarize, we can generate the inflation. I think we will ultimately generate the inflation. It's a political question. The government can

Starting point is 00:26:58 create the money, hand it out, and either have the Fed print it up or have it change the Fed's charter and have it hand it out directly from the Fed, however you want to structure it. But it's a political question. And right now, you know, the politics are in favor of not doing it. So you write a fantastic newsletter. And in the most recent one, it appears that you've got a couple of drivers in your opinion that could be inflationary, one being the repo market activity, the other being the cheap peak oil, as you mentioned. But on the flip side, some deflationary pressures might be coming from China and it's

Starting point is 00:27:31 slowdown in credit growth. So I kind of want to dive into each of those. And let's start with the repo market. This seems like the canary and the coal mine of sorts right before COVID hit. There was a lot of flurry there happening before the rest of the market seemed to dive. So has this become a key indicator to you and if so, in what way? And possibly dig in a little bit on what the repo market is. As far as what is how?

Starting point is 00:27:58 I understand it's the plumbing. It's the transactions between banks. But what is driving all of this mania happening there? There's any number of people that are better to talk to than me on the actual. mechanics of how the plumbing works. I think I have a decent feel for how the big pieces fit together with the macro and what it's telling us from a big picture perspective. The repo market is just an overnight, there's very short-term lending market where basically assets of all stripes are financed across the system. I think what the trouble we've been seeing in repo

Starting point is 00:28:32 markets have been, there's two sort of schools of thought. There is the, oh, it's just regulatory. It was regulatory in September 19 when we had repo rates spiked 8 to 10%. The repo, reverse repo, it's just regulatory and sort of different opposite regulatory problems. I take a bit of a different tack. I think it was regulatory, but I think those people, to turn a phrase, are missing the forest for the trees and have continued to miss the forest for the trees, which is that if we look at the regulatory regime of which is Basel 3. So in September 2019, Basel 3, the constraint was that the banks did not have enough reserves

Starting point is 00:29:14 relative to the amount of U.S. Treasury issuance because they didn't want to go any higher under Basel 3. And as a result, you created the supply demand mismatch and rates spiked. And so the Fed then stepped in with not 2E to basically buy the short end, basically what the banks couldn't or wouldn't buy for regulatory reasons under Basel 3, the Fed did. So it's a lot of the Fed, you It is nominally correct to say it was regulatory. With that said, the elephant in the room is the Fed or the U.S. Treasury was issuing so much at the short end, despite rates being very, very low, in part because there's no demand. There's not nearly enough demand to issue that much paper at the long end without sending rates to prohibitive levels or forcing the Fed into

Starting point is 00:29:56 QE at longer durations, which they were at that point still tapering. They were trying to do the opposite. The repo rate spike back in September 19 was really a, it was regulatory, but it was a symptom of too much treasury issuance to the short end because there wasn't enough demand at the long end from the historical creditors of the U.S. that were very, very favorable central foreign central banks, foreign pension funds buying at the long end. If we go forward in time to now this reverse repo spike, they have sort of the opposite problem, which is the Fed's been buying so many treasuries. The U.S. government's been issuing so many. The Fed's been issuing. or the Fed's been buying so many, the accounting key account of the Fed buying the Treasury is

Starting point is 00:30:37 they buy the Treasury and they credit reserves, the bank's reserves. So basically, the government's spending the money, they issue a treasury, the bank, it buys the Treasury. The bank then turns and sells the Treasury to the Fed. When the Fed does that, they credit a reserve balance for the banks and the Fed puts the treasury on their balance sheet. Now, this is sort of the opposite problem, which is under, again, it's regulatory. nominally, this is regulatory. There are also rules under Basel 3 as it relates to the amount

Starting point is 00:31:06 of bank reserves that begin to elicit a capital charge for banks. So banks don't want to have too many treasuries, which was the problem relative to reserves in September 19. And they don't want to have too many reserves relative to everything else, which is the problem as we moved into April of 2021. And so when you look at it, this, so what's interesting is from March 31st of 2021, there was something called this supplementary leverage ratio, which is one of the regulatory constraints on bank balance sheets that was causing this. And basically, the Fed said they exempted treasuries from that for the banks. So it basically meant the Fed, the banks could buy as many treasuries as they wanted without sort of bumping up here and

Starting point is 00:31:47 these regulatory constraints. It was basically helping the Fed do QE without calling it QE. March 31st, those expired for domestic political reasons, including people like Elizabeth Warren, et cetera, thinking it was a handout to the banks. not really realizing it was really a handout to her own government, ironically, but basically the Fed decided or got political pressure that it was a bad look, that it was still a handout to the bank. So they get rid of the SLR exemptions for Treasuries for Banks on March 31st. And on April 1st, lo and behold, the reverse repo facility for the Fed begins going up and up and up and goes from basically zero to a trillion dollars by quarter rent in just three months. And so it was a lot

Starting point is 00:32:25 to talk about whether the reverse repo facility was tightening, whether it was a sign of a crisis, and most of what I saw on it, nominally, again, it was too many reserves that the Fed is sterilizing there's reserves. So basically, Treasury issues a bond, bank buys the bond, bank sells the bond to the Fed, Fed credits reserves. Fed then has the bond, and then Fed reverse repos, the bond back to the bank repeatedly to basically sterilize reserves. to keep the reserve balance below regulatory limits. It's an accounting creation. So there was a lot of talk that, hey, it's just a symptom of too many reserves

Starting point is 00:33:03 that just sterilizing the reserves, which again, nominally is true. But again, I think it misses the force for the trees, which is, I have it on very good record that they're a very good account, that the RRP, the reverse repo, is not on balance sheet. It's basically an off balance sheet special purpose vehicle for the banks. And if we look at it that way, the reverse repo balance rising the way it did and staying, as it has effectively means is it's almost like an Enron like SPV to help the U.S. government finance itself, where if you go back in time, you know, this great Enron was

Starting point is 00:33:37 repowing barges at the end of every quarter to one of their broker partners to get them off balance sheet for when they did quarter-end books and then they bring them back on balance sheet and whatever. It's sort of the same thing, which is the government issues the bond, bank buys the bond, bank sells the bond of the Fed, bank credits, bank reserves, bank reserves, and then Fed takes bond and repos it back to the bank to sterilize the reserve pile. And the reverse repo balance just goes up and up and up as the pile of reserves sterilize goes up. You're basically helping the banks.

Starting point is 00:34:08 The banks are helping the Fed finance the government while the Fed at the same time are helping the banks circumvent the Basel 3 regulations as it relates to both the lower constraint to how many treasuries they can own and the upper constraint, how many reserves they can have. And so to me, what this reverse repo, and when I put it together, especially with the other one, it's a different side of the same coin. But I think, again, you don't want to miss the forest for the trees. The fundamental issue, the big gear is that the U.S. debt is high and rising, and they don't have sufficient global private sector buyers. And so they are getting increasingly creative with finding ways to have the Fed finance it held, the banking system finance it.

Starting point is 00:34:50 And then once they started bumping up against Basel 3 restrictions on how much the banks could help the government, help the Fed finance the government, the Fed started helping the banks circumvent the Basel 3 regulations. And so I think ultimately what we conclude is that the reverse repo balances, having done what they did in the second quarter, suggests that sort of this inflationary trade remains risk on, that it's nothing's really changed. It's just that they're using some creative, basically an SPV, moving. stuff off balance sheet to keep financing the government and keeping it on the, keeping it

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Starting point is 00:38:59 way, or should we be watching it more closely? You know, it's one of those things where to me it depends on the other things that are moving around at the same time. If the Fed is still sort of continuing steady as she goes with QE, both on the Treasury and the mortgage backside, then, you know, I'm not sure that it matters a whole lot. If other things start moving around and it starts moving around, that might otherwise change that. So you really have to, it really depends on the context in my view. So let's go into peak cheap oil and why you think that is where it is, but also an inflationary measure. A couple of things happened. You can see it in the oil numbers, the production numbers.

Starting point is 00:39:41 You can see how much shale, A, caught people by surprise, myself included at the time, I was not doing FFTT, but it was very surprising to see that. In the early days of FFTT, we wrote a number of reports talking about the problem with shale is the depletion rate is so high. In other words, right now, the depletion rate of the four big basins, which are Bakken, Nyabrara, Permian, and Eagleford. The depletion rate's running at about 5.4, 5.5% per month. So in those four basins, they've got to grow production about 60% per year just to stay flat. And that number changes over time, depending on how much they've produced or grown production by in the preceding 12, 24, 36 months, the further way they get from that that the completion rate slows, the more

Starting point is 00:40:25 they produce, the more it increases in the near term and then slows. But the punchline is, is this is once the installed base of shale gets high enough, it gets harder and harder. It's the Red Queen problem, as some have said it. You've got to run harder and harder just to stay in the same place. And so that's always sort of been known. What changed in the after after the COVID, and there were a couple different, Go Rosen did a great piece on this. And there was a good article on Bloomberg at the end of last year as well, where it just, there's something called high grading your reserve base in commodity production. And I'm no expert on this other than just sort of the topical of what it means, which is when you high grade your reserve base, when the business slows down, you pull back to your highest grade or basis. And you produce there because that maximizes your cash flow. And that helps you get back to the other side of the trough. And in 2014, when oil prices rolled over, that's exactly what the shale producers did. They high graded their production. They cut rig count enormously. But the productivity of the remaining rig count soared as basically they pulled back to their highest production,

Starting point is 00:41:31 their most productive reserve base. What changed in the aftermath of COVID was once again, prices tanked. Obviously, oil prices actually went negative for a brief period of time. Rig count collapsed, just like it did in 14, 15, and instead, productivity fell as well. And the implication that Go Rosen pointed out, and we've highlighted the article for our clients, is that they'd already produced most of, or they produced a substantial amount out of their highest resource, most productive resources. And from there on, you were going to have these sort of lower grade resource bases, which means that it's going to be really, really hard at current prices, anywhere near current prices or for the foreseeable future to kind of exceed prior peaks at a time when there were global

Starting point is 00:42:15 economy still growing. And as I noted earlier, that the shale was one of the biggest sources of petroleum supply going forward, or excuse me, from 2005 to 2014. And so sort of with that as context, there were a couple of things in the last two months that really sort of hit me like a bit of a gut punch. The first was Audi coming out and saying, we're going to get rid of all internal combustion engines by 2026. And that to me was a real stunner because from when I've been told, it's a very different production process to go from internal combustion engine to electric. It's a very different supply base. It's a very different supply chain. And for them to do it in five years is extraordinary. And obviously, the Germans have a very longstanding tradition of

Starting point is 00:42:59 very good engineering, almost to a fault at times, cold, calculating rationality of of what needs to happen. And so I went back and I remember it. It was one of those pieces of, you know, one of those splinters that stuck in my brain for a long time. If you go back to September 2010, there was a leaked German military report that came out and said that the German military thought peak oil would hit peak oil would hit by about 2013, excuse me, around 2010. And that the real economic impacts wouldn't be seen for 15 to 30 years later. And so I said, all right, well, so 2010, maybe 2011, 15 years is 2026. And now we got Audi, who is a subsidiary of Volkswagen, which happens to be the single largest corporation in Germany

Starting point is 00:43:45 and the single largest employer in Germany, if my date is correct, making what seems to be and otherwise irrational decision to completely get out of internal combustion engines in five years, which is extraordinarily fast period of time to execute on the supply chain restructuring that that would imply. And so for me, it implies one of two things. Either Audi and the Germans have lost their minds and then they are taking, they're basically betting a subsidiary of one of Germany's biggest corporations and employers on a green energy gambit, which I suppose is possible.

Starting point is 00:44:23 Or Germany's biggest corporation is very politically tied in. And they've been given a tap on the shoulder, say, listen, here's what's happening to the underlying resource base for the fuels for internal combustion engines. And if we are going to be in a proper position to compete Mr. and Mrs. biggest corporation in Germany, if we're going to be a position to compete in 2030 and 2040, this has to happen now. If I had to wait which of those is more likely, and some of that, given my German background, of just being very pragmatic, and again, sometimes to a fault sort of coldly objective, I think it's more likely that it's the latter than the former. The Germans aren't just taking a flyer on, hey, let's just bet our biggest

Starting point is 00:45:10 corporation employer on some green energy thing. Maybe it'll work, maybe it won't. I think what's happening is there is underlying depletion, not just of what's happening in shale, but if you look back in reference Matt Simmons work, a staggering percentage of the world's biggest, of the world's oil production comes from a handful of the biggest fields. And the youngest of those fields are now 50, 60 years old. The oldest are nearly 100 years old. And the depletion, they all follow some bell curve of depletion rates. And so I think we have gotten away from Shale sort of pushed to the back of everyone's mind, this underlying Pareto principle that exists in global oil production that was always there, was always going to be there. And I think when we start looking at what Audi did,

Starting point is 00:45:59 when we look at what GM came out and did earlier this year, which is they ran their first national ad campaign in 10 years on the Super Bowl, bragging about how they're going to roll out 30 new electric cars in five years, bragging about their battery, getting Will Ferrell on to talk about it was the Sweden commercial. You know, we hate the Swedes because they're, they're ahead of us in electric adoption. Again, GM makes all their money in huge trucks. In heavy, you know, it's sort of the prototypical American. My wife's got one of them, the giant truck and is a gas guzzler and GM makes all their money there. And so for GM to say, we're going to have 30 new models and we're to do this national ad campaign in the Super Bowl. Again, it's, are they just going, you know,

Starting point is 00:46:36 spending a bunch of money and restructuring supply chains on some virtue signaling, you know, Gambit, or is there something else happening here that they see the need to reposition, to begin to significantly accelerate the repositioning of their supply chains towards more electric vehicles over the next five years? And again, I just think the latter is more likely. I don't know if that's a 6040 more likely or 9010 more likely, but I think it's more likely that what was once a big catalyst for fossil fuels prices, for commodity prices more broadly, and went away from 2008 through 2014 because of U.S. shale, I think we're going to start seeing it

Starting point is 00:47:15 come back on the scene in a much bigger way in coming years, notwithstanding the current sort of deflationary scare pullback. So what I'm taking away from that is essentially a lot of these forces are going to drive the price of shale and therefore oil much higher to a place where it's untenable for someone like Audi to continue to compete. I do think gasoline will get much more expensive, but I do think that, there's a sense of urgency where, yeah, if you start to have supply issues, I mean, if you start with the fundamental, let's just say, let's assume a first principle that there's an oil supply

Starting point is 00:47:49 problem in 2030, 2035. And we want to push that time out. And you came to me and you said, Luke, what would you do to reduce that, you know, to push that number out further? And I would say, oh, that's easy. Number one thing is you got to get global passenger car down as big as you can, as fast as you can. And if getting global passenger car, down, there's a couple different ways you can do that. It's easier in certain places that have a much more rail-centric culture. You've seen what the Chinese are doing in high-speed rail, obviously. In America, we've been stubborn and we've gone the other way with rail. And so high-speed rail, rail is still an on-starter here, so politically. And so the only thing we can do is, okay,

Starting point is 00:48:31 we're going to go full-speed electric, and then that will buy us time. So I think that's more what we're seeing. I don't think it's an issue of, hey, we're going to have shortages of oil or oil is going to be 20 bucks a gallon in America in five years. I think oil could be four or five bucks a gallon in four or five years. And certainly that'll change behavior. But I just think the proactive nature of these major politically tied in corporations and the implied inconvenience and expense to them of restructuring massively embedded supply chains in such a compressed period of time suggests that either they've been fully drinking the Kool-Aid on sort of and basically betting their corporation on a virtue signaling dynamic, or they've sort of been tapped on the

Starting point is 00:49:18 shoulder and said, listen, here's sort of a series of potential pass of what the supply chains look like for oil and you need to start thinking about restructuring your internal combustion engine supply chains sooner rather than later. I think when we go back to pre-shale, that to me doesn't sound crazy at all. I think that there's probably a lot to that. All right, shifting gears, let's talk a little bit about the gold NSFR rule changes and how that might impact gold and gold miners in the future. We had written a lot about this. There was a big net stable funding ratio rule change under, again, under Basel 3 banking rules. And the gist of it was historically been a huge unallocated gold market in London. And so effectively,

Starting point is 00:50:06 London has set gold prices. If someone wanted to buy more gold, one or two things can happen. You can buy gold. And if there's more demand for gold, broadly speaking, one or two things can happen. You can either have the price of gold go up to address that increased demand, or you can keep the price of gold relatively constrained and allow the number of claims on that same ounce of gold to rise instead of the price of gold. And since 1980, 1985-ish, what has happened is in London in particular, the number of unallocated claims has been allowed to expand more than the price of gold. This NSFR rule, to my reading, made it seem as if Basel 3 was moving toward making it much more expensive to continue floating these unallocated claims on gold. It was basically a capital charge being brought to bear in London that hadn't, they had to be

Starting point is 00:50:58 existed prior. And it was going to go live in Europe in the U.S. at the end of June this year and in the U.K.K. in January 1 of next year. As far as I know, it did go live in Europe and the U.S., but ultimately the big cahuna there in terms of the gold market is London. So January 1st of 2022, so six, less than six months from now. Last week or a week and a half ago at the last minute, the PRA, the Prudential Regulatory Authority, I think it stands for in the UK, basically gave the London Bullion Market Association, the LBMA, a sort of last minute reprieve where, and I'm going to probably misquote this, it still applies for loans and leases, but not for unallocated amounts, not for clearing, excuse me, not for the clearing side of their business. And so I'm still trying

Starting point is 00:51:45 to make heads or tails of what that means. I do think a couple different resources that I've read, Bob Coleman, as well as Alastair McLeod, I've written really good pieces on it. And I agree with basically their conclusion of it, which is it probably takes away some of the urgency that existed in terms of the removal of that unallocated gold market, which would have probably put upward pressure on gold's price and make it a more physically driven market. So maybe not necessarily upward in price, but basically going forward, if people wanted gold, gold's price would respond rather than gold leverage, we're not responding higher. The rules that as they exist in their view still continue a shift toward moving it toward a more physical market, but just maybe at a slower pace.

Starting point is 00:52:29 So we'll see what that ultimately means. My bigger picture on that is I just, I think it's part and parcel to sort of a bigger shift of moving gold back into the system as a neutral reserve asset, where central banks begin reserving more gold as their reserve asset at a floating price rather than reserving treasury bonds, the U.S. treasury bonds as their reserve asset. For a number of the reasons we just highlighted it, right? If the U.S. ultimately has to inflate away their debt, the other side of that same coin is the U.S. ultimately has to inflate away the real value of other central bank's treasury holdings. And they need something to offset that. Otherwise, the wealth of their nation evaporates, the reserves backing their currency evaporates on a real

Starting point is 00:53:10 basis. And that's no good. So I think there is still this movement afoot, but I would say it's probably been delayed a bit or maybe slowed down a bit by this change or this loophole, this carveout that was given by the PRA for the LBMA. Now, I noticed that you mentioned gold and not Bitcoin and that becoming of a new neutral reserve asset. Have you seen a change in Bitcoin? The price has been down for a number of months now for seemingly a lot of reasons. Pretty much everything is down.

Starting point is 00:53:39 I think a lot of that has to do with the Delta variant, some concerns there. I just find it curious that you're leaning more towards gold in that fixed reserve asset. Is that something you think other countries are more prone to adopt in the near future? It's a great question. As I look at what they're doing, it appears to me that when you look at what China's doing, where it seems like it's been more pro-gold, less pro-bitcoin in the last two, three months, certainly. Russia, I think, has been more pro-gold, less pro-bitcoin.

Starting point is 00:54:10 The Europeans, to me, it seems as if there is more of an establishment proclivity toward gold as a neutral settlement asset if the system's going to move in that direction. That's not to say Bitcoin couldn't continue to do it. And I'm on record. I continue to think this is the case that there's probably a lot that would recommend the U.S. choosing Bitcoin over gold as a reserve asset, just given relative gold reserve bases, given potential that others have more. than we do, et cetera. But for the time being, ultimately it appears that, yes, there seems to be more of a movement afoot, particularly by the creditors in the system in Eurasia, broadly speaking, they're reserving gold, they're buying more gold, they're repatriating gold, they're not doing so with Bitcoin. You know, we'll see that could change. Ultimately, Bitcoin, I think, can still

Starting point is 00:55:02 serve as a sort of neutral reserve asset for the people, if you will. I continue to use it alongside gold myself in that manner. So let's kind of wrap up here and talk a little bit about how you're positioning yourselves to benefit, to take advantage of some of these macro environments playing out. What's your goal position look like versus other commodities? You mentioned the electric vehicle, bullishness, so underlying metals, perhaps that tie into that. Walk us through your framework about your own portfolio, kind of how you're approaching this. I don't really trade it a whole lot day to day.

Starting point is 00:55:36 I'm not a trader. to me, I am positioned for really two things, which is I have pretty high conviction that ultimately we're going to do what every other sovereign has done in this position with a fiat currency, which is inflated away, and that this sovereign debt bubble, global sovereign debt bubble, will resolve itself like the last one did. And the way the last one resolved itself was that the six industrial powers of the time, US, UK, Germany, France, Japan, and Russia saw the real value of their sovereign debt relative to gold fall anywhere from 75 to 100%. The Russians and the Germans saw their sovereign debt hyperinflate to zero against gold within 10 years after World War I.

Starting point is 00:56:19 Germans, it only took three or four years. Everybody else, massive devaluations of the currency. And so I think that is the end game this time around as well. And that's how I'm ultimately positioned. Now, with that said, historically, it would lead you to a conclusion of, okay, I want to borrow as much as I can and own these assets. And there was a chart I've cited numerous times. All credit for it goes to Dan Oliver at Mermican Capital, but it shows the month over month price movements in gold in German Reichs marks as the German Reichs marks was hyperinflating to infinity. And what's fascinating is if you were levered long gold, which nominally is absolutely the right trade, you would have lost all of your money four or five times in the three years that the

Starting point is 00:57:03 German Mark was disappearing as you were right ultimately. And so to me, the way I'm positioning my own assets, what we've been advising for clients is we're overweight gold, we're overweight energy and metals commodities. We are overweight industrial equities and foreign equities, simply from the standpoint of I think the dollar has to get weaker because the Fed has to do more than every other central bank by virtue of the existence of the euro dollar system. Ultimately, the dollar is our problem. It's the Fed's problem. And we also like big tech, because ultimately, big tech does well when real rates get very negative. And as we mentioned before, in World War II, which is the last time we were in a sort of a similar position. I would argue we're in far

Starting point is 00:57:48 worse a position now. U.S. real rates went to negative 14%. And so I think it's good for big tech, industrials, energy and metals commodities, some foreign equities, gold, Bitcoin, silver. This trade has been going against us for the last two, three months. And this, I think, speaks to the last point. And that point I made about the Dan Oliver chart is that we've been saying for the last couple, probably last 12 to 18 months that we're talking about the bursting of a global sovereign debt bubble. We're talking about what is in my view, the first change of a global currency system in at least 50 years. I think the volatility is going to be higher and continue to be high. And so you need to get from point A to point B. So I think it's important, you know,

Starting point is 00:58:27 to remember hogs get fat, you know, pigs get fat, hogs, it gets slug. I think maybe a little leverage is okay, but I think being minimally levered is really important for exactly what we've just lived through for the last two, three months, which is, you know, Bitcoin has gotten slaughtered from the highs. Gold is down from, it's actually held in okay, right? If you know, 1,800, whatever, oil's done okay, it's backed off now, et cetera. So how much of this trade going against you do you attribute to what you're highlighting in your newsletter about China's credit impulse declining?

Starting point is 00:58:59 How much do you think that's playing in all this? I think it's a big part of it. I think it's a pretty substantial part. And I think in the last week, we've had this Delta variant fears get layered on to it. But if I was the perfect analyst, you always want to look and see what did you miss? What would have you done differently? And that's, I think I would have waited that much more from a trading perspective just to say, hey, this thing's really, this China credit impulse is really rolling over.

Starting point is 00:59:23 And this is going to be a headwind for the next X months for these inflationary trades. So you always want to check back and cross-reference yourself in terms of what you could have done better. And certainly, I think that's something in my case that if I could do it again, it's a right. This is going to be a weight. You know, these under these big gears are still absolutely turning. They're absolutely turning faster. But between sort of the rebound in the U.S. economy, the China credit impulse rolling, I think part of it too, like the U.S. economy rebounding, there's this belief that this is just like all these other cycles.

Starting point is 00:59:52 Oh, we're going to rebound. And it could not be more different. We haven't seen a cycle like this in 80 to 100 years. So it's a little bit of the narrative that, oh, it'll be just like 08, it'll be just like a 1, it'll be just like 91. It's not going to be. In all likelihood, it's not going to be. But I think the biggest thing has been this China credit impulse.

Starting point is 01:00:10 Fantastic. Well, with that said, before we let you go, Luke, this conversation didn't disappoint, just like I expected. And I'm so happy you came back on the show to share these insights. Before I let you go, I just want to make sure everyone knows about your newsletter. So give me a hand off there. You also wrote some books. So inform our audience here where they can follow along and learn more about you.

Starting point is 01:00:29 Absolutely. So the easiest place to find out what we're doing, what we're up to is FFTT-LC.com. So Frank Frank TomTom.com. Find a lot more about our different research product offerings there. I've also written a couple books, Mr. X interviews, volume one and two. I'm working on volume three. It's been a little slower than expected this summer. But those are mock interviews with a fictional sovereign creditor of the United States conducted

Starting point is 01:00:52 in the Socratic Method. And so it's really gotten great feedback on it in terms of just how it kind of talks through the thought process and gives me a lot of freedom for laying out various paths along the decision tree, which is a lot of fun for me to just sort of explore. It helps my thought process. And I think it helps reader as well. So you can find those both on Amazon.com if you're interested in ordering those. Fantastic. Always a pleasure. Can't wait to have you on again soon. Absolutely.

Starting point is 01:01:20 Thanks for having me on, Trey. It's great being here. All right, everybody. that's all we had for you today. If you're loving the show, go on your favorite podcast app and follow us. Please, if you can, leave us a review. We'd love to know what you think of the show. It really helps. And with the market being down like it has been lately, it's the perfect time to go on our TIP finance tool and check out the filter where we list out what we believe are the most undervalued stocks at the moment. And with that, we'll see you again next time.

Starting point is 01:01:44 Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP367: The Current Macro Landscape w/ Luke Gromen

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