Luke Gromen  2:02  

Is that the one though that they were talking about basically some sort of Jubilee or forgiveness for not something *inaudible*? I just thought it was interesting. I thought there was a bit of a geopolitical contest going on with basically the US and China both trying to apply both honey and vinegar to the rest of the world to basically pick one side or the other. I just thought it was an interesting signpost. I don’t know fully what to make of it, but I’d love to hear your thoughts on it, Grant, because it was interesting to me.

Grant Williams  2:31  

The timing is amazing. I wrote a piece that I published yesterday called The Long Telegram. There was a memorandum published by the US on May 20. It was basically a memorandum from the US. It came out of the National Security Council. It came out under the presidential seal, and it essentially declared war on China. It’s a fascinating piece. I want to read to you the opening couple of paragraphs right. This is from the White House. It says,

“Since the United States and the People’s Republic of China established diplomatic relations in 1979, United States policy toward the PRC was largely premised on a hope that deepening engagement would spur fundamental economic and political opening in the PRC, and lead to its emergence as a constructive and responsible global stakeholder with a more open society.

More than 40 years later, it’s become evident that this approach underestimated the will of the Chinese Communist Party to constrain the scope of economic and political reform in China. Over the past few decades, reforms have slowed, stalled, reversed. They say the CCP has chosen instead to exploit the free-and-open-rules-based order and attempt to reshape the international system in its favor.”

Now, that’s just the first two paragraphs. This thing goes on. It’s an extraordinary document and people should absolutely look this up and read it because, as I said, it’s a de facto declaration of war against China.

When I wrote about this, I went back to the Cold War, to a guy who works in the embassy in the Soviet Union, called George Kennan. He was a lifelong civil servant, and he wrote a telegram back to the State Department in Washington when he was asked for his opinions when the Russians were refusing to endorse the IMF. 

This was in 1946, and the Russians were refusing to endorse the World Bank, and Stalin gets up and makes a speech, which, as I pointed out, was very much within the Soviet doctrine at the time. This shouldn’t have caused anyone to even bat an eyelid, but he basically said: Capitalism and communism cannot coexist peacefully, and we’re here to make sure that communism wins.

They asked Kennan what this meant. His boss at the time, the ambassador, said: Answer as you see fit. This guy wrote a five-and-a-half-thousand-word telegram where he pulled no punches. He basically called out the Soviet and said isten, this is war. We cannot do anything. The best we can do is contain them. It set the policy for the Cold War, essentially.

That’s what we’ve just seen happen. The amazing thing to me is that if you post what people have posted, it’s coming so soon after this. This article was posted May 20th. It was literally within a matter of days that the stuff in Hong Kong happened with Beijing cramming through the security laws in Hong Kong. If you think that’s anything other than a tacit declaration of: This is the way it’s going to be. We’re not going to hold back anymore.

I think this idea of them trying to lead and talk about forgiving emerging market debt is a classic play to get everybody on our side. I just think it’s a really important article, the one you posted, and so was this telegram, and so is this memorandum from the State Department. I think we’re entering a very difficult period that could be fraught with conflict and two big superpowers very much at odds with each other.

Luke Gromen  5:40  

We wrote a report about it. The thing that really grabbed me was on the second page. The US overtly stated that it is a new great power competition. I thought the same thing. I sent it to another good friend of mine in the business, and his reply was, “Gosh! This reads like a war scroll.” 

I think there are some real eyebrows raised in terms of what that said. It marked a real turn in terms of if we’re going to be in a great power competition and a lot of the rules of geopolitics, which reflect this debt forgiveness attempt by China, and your point on Hong Kong, Grant, which I think is very well-taken. 

I think they will start to reshape the rules of finance, in a way, back to Cold War great power competition markets. Quite frankly, in my view, a lot of market participants are using the post-Cold War lens to evaluate what is sort of new or very, very early beginnings of the Cold War markets. I think we have to mention the implications.

Stig Brodersen  6:38  

Also, if you think about the strategic side of Hong Kong itself and the financial data that’s flowing in and out, it’s just a treasure trove of not just data, but also networking effects for them, strategically. You can also add in the social unrest in the US, and some could see that as an opportunity.

Grant Williams  6:55  

That’s exactly right. If you look at some of the propaganda in China about the unrest in the US, you’ll see they’ve gone full force. There’s a caricature of the Statue of Liberty with a utopian chaos, and out of this green shell, there’s a policeman kneeling on someone. They’re not pulling any punches. 

Quotes that have come out from professors at various universities in China, obviously, free speech, but what they’re saying is clearly party-directed, and it’s all about hegemony. It’s all about fugitives trapped being real. It’s all about the US’s “manic behavior” towards the People’s Republic of China. You’ve got both sides kind of coming together. You’ve got harmony in the White House, and amongst the Republican party, pointing the finger at China. You’re going to have the democrats also struggle to be pro-China. 

So, this is all coming together and nobody does a better job than Luke in paying attention to this stuff. His work around this is lightyears ahead of anybody, frankly. What’s happening over in that part of the world, bears a lot of our attention because things could get very shaky very fast over there.

Preston Pysh  8:05  

So, how does oil play into some of this moving forward? Because I don’t think anybody ever expected the negative price dump. That was insane.

Grant Williams  8:16  

It was crazy! At negative price dump or Hertz up 100% after declaring bankruptcy. I don’t know. I thought I’d seen it all until I saw what happened to oil.

Preston Pysh  8:27  

I know. It’s crazy! I think I saw that post today on the Hertz thing. I had to go look. They declared bankruptcy and then the stock prices… It’s just a total meltdown, but in every which direction you wouldn’t expect. You know, as a little kid, when you’re in elementary school, and somebody goes up to you and they say, “Oh, it’s opposite day!” That’s truly what we’re seeing right now.

On a serious note, I forget where I saw the article, but they’re saying the oil monster’s coming back as far as the price drop. What do you guys think? Is this going to bounce? What we have seen just in the last couple weeks, is that was the bottom end? Or are we going to see some more lows?

Luke Gromen  9:14  

This ties back to the point of the rules of geopolitical and economic competition being redefined a more Cold War. I think what’s ultimately going to happen to oil beyond a bounce versus sustained growth is going to depend on two things. 

Number one, beyond going success of China’s ability to price more of their commodity imports, in particular energy, in their own currency. We had heard two different credible sources earlier this year that Saudi had begun selling at least some oil to China in yuan. I think that would be very critical in terms of determining the price of oil.

The CFO of one of the biggest commodity traders in the world told me on a roadshow 15 years ago, back in a former life that in commodity markets, the marginal tonne prices the whole. And so, if the marginal tonne of oil is being priced in yuan, then suddenly you begin to get more of an influence of the yuan dollar cross rate and the price of dollar oil with every marginal barrel that moves to yuan. 

I think a lot of people when they hear me talk about yuan oil, because other people talk about yuan oil in this contract and some of what China has been trying to do, they’ve been under the assumption that it’s not going to matter until half or a third of the world’s oils are in yuan. But that’s not the case because it’s a commodity market and the marginal tonne prices the whole.

The way I think about oil is, okay, now we have this ramped up great power competition. China has been moving pretty rapidly or more rapidly over the last 2-3 years in terms of getting more of their commodity import bill in Yuan as it is. 

You can only assume they’re going to get more aggressive with that and that ties into the point of: How do we get more people to do that? Well, you need to win friends and influence others, maybe start forgiving debt, and things like that. Try to play sort of the long-game on that front. 

On the other side, what I think matters for oil is what the dollar does because if the yuan dollar cross rate starts to be more important than the price of dollar oil, if you get a weaker dollar, it will likely be seen on the margin. It’s not weakened a ton, but we’ve seen it marginally grow weak over the last 2-3 weeks. It’s a tailwind for oil in that world.

Now, the flip side is if the US can clamp down on the spread of the pricing of oil in yuan. It all goes back to dollars and builds a very big dollar block around the world. It sort of goes back to the Kissenger. I guess if that’s where the dollar’s oil monopoly is at, and that’s all, then you’re back to a world where I think we can see oil really go crazy on the upside. I just don’t think it can for as long as China’s still able to be playing this game where they can start shifting their import bill into their own currency.

Stig Brodersen  11:23  

I think you bring up a really good point, Luke. If I can add to that, given the amount of US dollars that has been printed the last couple of weeks, you might have expected that the dollar would have weakened.

Grant Williams  12:06  

It’s interesting. You would think that given what they’ve done so far –and we know this is the beginning and not the end of this –you would have expected the dollar to be weaker. I think your point is exactly right. It’s surprising to me that we haven’t seen it come off materially harder than this. The Luke Gromen and Brent Johnson show rolls on in Twitter. These various end-dances of bullets being spiked left and right and backwards and forwards are always fun to watch.

The Euro also still has this question mark over the German Constitutional Court hanging over it, so people aren’t 100% sure how that’s going to go. They’re hedging their bets with that given what the Fed had done and what they are committed to do. It’s not often that you get very carefully-planted Fed articles talking about how their balance sheet is unlimited. There’s a reason that we’re seeing those quotes out there, and that’s to tell people exactly what’s going on and the flood of money that’s going to get thrown at this thing as to what is needed. I don’t think they’re going to wipe at all. We’ve seen that. They’ve acted so fast this time around, and what’s happened, ironically, is going to embolden them because they have this snapback bounce, which I don’t think is purely down to Fed liquidity this time. 

But when you’re the guy with a hammer, everything looks like a nail, right? They’ve got the hammer, and they’re going to say, “This looks great. Look what happened when we threw $2 trillion at it. Maybe we have to throw $3 trillion next time and we’ll get a 60% bounce.” It’s craziness to me, but we have to sit and watch this thing play out.

Preston Pysh  13:37  

What’s crazy is when you provide that much liquidity and it doesn’t weaken the dollar at all. It’s almost like giving more meth to a meth addict. That’s where we’re at. You’re supplying all these dollars, and the market soaks them up instantaneously without any drop in the dollar. So, when they have to print again, they’re doubling down, even quadrupling down, on what they did last time just to keep this patient alive. This is insane.

Luke Gromen  14:11  

On the flip side, if we’ve watched what the Treasury General Account has done while the Fed has been pumping money in on one side, Treasury has been sucking it out in the same staggering rate. The biggest TGA balance we’ve ever seen was about $400 billion or $420 billion, and it’s sitting at $1.45 trillion now. Historically, the TGA and the DXY have been very closely correlated as the Treasury’s pulling liquidity out.

It’s been surprising to me on both sides. A, all this liquidity and the interest rate differential collapse and the things that we were just talking about haven’t resulted in a weaker dollar. Then, on the flip side, I’ve been watching this TGA going up and up and up. At some point, that’s going to reverse, and when it reverses, presumably, you’d be increasing the currency in circulation in the US by like a 60% annual rate or something crazy, right?

I wonder if it isn’t just being sterilized for the moment by Treasury and why Treasury would even be doing that? Is it the Trump administration basically trying to hedge themselves against the Fed where they’re saying, “All right. Maybe the Fed will try to make the economy bad and get us out of office, so we’re going to stock up this war chest of a trillion and a half that we can spend in the economy to turbocharge it in the last three months before the election?” 

It’s definitely been interesting that there’s been sterilization, really. There should be dollar weakness on the calm, and that goes the other way because they’re working it. Now, the corollary to that is when the TGA goes up, the dollar goes up, and vice versa. So, I’m with you in that I don’t fully understand exactly what I’m seeing in the dollar markets.

Grant Williams  15:46  

There’s a great shot I saw from Eric Pomboy this week. He had plotted the Treasury net receipts the last 4 months against the Fed’s balance sheet, and, as he said, for the first time ever, the amount printed by the Fed has exceeded the total tax receipts of the Treasury over the 12-month period. 

They took in the $3.26 trillion, and they’ve printed $3.31 trillion. So, that’s it right there. But if guys like us don’t watch this stuff, what a time to be alive, right? If you like charts, you’ll take one look and go, “Wait, what? Hold on a second. This doesn’t make any sense.” I see 15 a day now. It’s extraordinary.

I think what’s amazing is that there are so many of these things that everyone’s just saying, “Okay, I just need to ignore this until we get something I can relate to again. Then, I can take a look at this.” Dave Rosenberg is all over this and he’s putting some fantastic stuff out. Anyone who’s not following Dave on Twitter, they should be. He’s been calling this stuff out.

If you look at these charts, like the unemployment charts that we’ve seen, the initial and continuing claims, they are literally off the charts. I think people just don’t seem to be bothered by it because they can’ t get their head around it.

So, I don’t know how this works itself out or what it takes for people to think this isn’t a V, that this isn’t going to go back to how it was. I just don’t understand how that’s even an option in people’s minds. It’s clear that that’s not going to happen. This is what I’m really struggling with at the moment. 

I’ve put all that Robinhood stuff aside, because that’s just crazy, and if you look at what happened today, unless tomorrow is even crazier, today is going to be one for the record books with some of the stuff that went on here in Chesapeake today, 171% *inaudible chapter 11 after hours. It’s extraordinary what’s happening there, and the bond market is trading for five cents.

This stuff is all happening, and it’s so confusing for everybody right now, and almost more so for the people who spend all day looking at this stuff because you just have no idea where up is anymore. Everything that’s coming at you is completely misrepresentative of everything you’ve learned over your time in the business.

Preston Pysh  18:00  

I had a guy ask me snarkily, “What do you think about this V-shaped recovery?” And I said, “I think it’s an i-shaped recovery. I think you’re seeing a bid up spread here with a gap so high up that it’s going to dot the i.

Luke Gromen  18:16  

Oh, like the “i” in “Ohio”. That’s an honor.

Preston Pysh  18:24  

Yeah, this is crazy! It’s funny because, Luke, you were on our show back in March or something like that, and you said, unflinchingly, “We’re going to have a melt up.” It wasn’t even a question. You said we’re going to see the market melt up, and we had the COVID-19, and it got slammed, but then it just took off. 

All of our momentum indicators on our site, initially, were flashing red. Then there was a bounce and some of them turned green, then all of them turned green. Sure enough, you were exactly right. I think you’re starting to see a melt up here.

Luke Gromen  19:02  

If there’s one thing that I think is really important but really underfollowed thus far, it’s what happened to the Treasury market from March 9 to March 18, during the sell-off. On February 19, equities peaked and began selling off. Between February 19 and March 9, there’s a total of 12 trading days. 

We’ve long been saying that the equity market is so important to the economy, and if it sells off too far, too fast, you’re going to see a problem in the Treasury market. That’s what our research has said, but it never really has been tested.

Then, on March 9, all of a sudden, the Treasury market started crashing right alongside the equity market, and it kept crashing. It fell almost tick for tick. I think this was a really big moment. I said it jokingly, but I think it’s true that the Fed thought it was all fun and games with risk off until the Treasury market lost a lot. As soon as the Treasury market and the Fed held their meeting for March 15, from their minutes, they actually said the Treasury market ceased to function effectively.

That, to me, is a really big missing link to everything we’ve seen since because what we’re really talking about here is that the United States, since the crisis in the 70s, for the first time in our careers and our memories, was seeing its sovereign bonds, which underpin the whole shooting match, were trading like emerging market bonds with a fiscal problem where the economy’s shrinking, the stock market’s selling off, and the bonds’ yields are rising sharply. 

They were rising off of massive lows, granted, but they were rising. There were also big spreads and the deepest most liquid market in the world blew out. Guys that have traded those bonds forever, say that they’ve never seen anything like it. And that, to me, is the real wildcard in terms of answering your question of how long this can go on.

How long will this go on? I think a lot of what we’ve seen the Fed do has been about basically bailing out the Treasury market and fixing the Treasury market. When you read the histories of some of the great hyperinflations, it’s almost always a desire to basically make sovereign debt nominally money good no matter what. In my eyes, that’s what the Fed started having to do in March. They sort of have a gun to their head because who wants to be the guy that picks up the phone and calls the Marines after the US government presumably drafted up this new great power competition document in March? Who would want to call the DOD or the Pentagon and go, “Hey, guys. Your funding costs just went up 200 basis points because the Treasury market stopped functioning because the world’s melting down”? That’s not going to happen.

That then filters back into this view. I really think we are in an almost Venezuelazation of US markets where they have to keep yields at politically-expedient levels. By virtue of our debt levels, that means negative real rates as far as the eye can see if we want to engage in and win a great power competition. 

I think it can go on a lot longer than people think. That’s not to say we can’t have a pullback or anything like that, but I just think that this great power competition means the US government cannot afford positive real rates for a long, long time. I think they’re good. They have the means, motive, and opportunity to keep them at negative real rates for a long, long time, which is ultimately, intellectually, and offensively a good environment for gold, gold miners, and stocks.

Grant Williams  22:39  

It looked like a window, for me, into the real world. I looked at it and said, “That’s what happens when the Fed is not in there.” It kind of caught them off guard, and they said, all right, we need to get on top of this quick. That to me was just confirmation that we’re not going crazy. It’s when the deus ex machina is removed, markets do function the way we think they’re going to function, and the economic reality does weigh on sovereign bonds, including the mighty US Treasury market. 

So, I agree. I think it’s incredibly important and I think they will be paying attention to that. They will do everything they can to stop that from happening because that window, were it to open, leads exactly where you said it would lead.

Stig Brodersen  23:22  

Yes, it was like the curtain just briefly opened up and you could see all these people just piling money into the system like they were shuffling coal into the steam engine of a train. Then it closed again and you’re standing there, thinking, “Holy moly, everything I thought, but didn’t know, is real.”

Luke Gromen  23:40  

That’s right. In my eyes, the Fed confirmed that they were concerned about it not only in the meeting minutes, but also when, if you go back to mid-April, they put out a quickly-released supplementary liquidity ratio metric under either Dodd-Frank or Basel. All these decades-plus of banking regulations to make banks more safe and to make liquidity or banking ratios more tame, and they said, “Look, we’re going to temporarily suspend the SLRs for treasuries so that the banks can basically buy as many treasuries that they want with effectively infinite leverage.” 

It doesn’t ding the liquidity ratios when the banks buy treasuries, so you kind of look at this and read great power competition. They have private treasuries, and they’re going to use the banking system to help soak up this liquidity.

In my eyes, the quid pro quo is, look, I would love to be a bank. I would basically have no capital surcharge to buy a treasury and I’d click the coupon and away I go. That’s not bad. You’re making a positive spread until yields are negative. I don’t think they’ll ever be negative for US Treasury bonds, but as long as yields are nominally positive, it’s almost free money to the banks –free nominal money. It’s not free money on a real basis to these banks.

Preston Pysh  24:57  

Hey, so what’s going on with the repo market because it looks like it’s ramping back up now, in the last couple of weeks?

Grant Williams  25:03  

Yeah. Do you remember back in 2007? There were about eight people in the world that knew what the TED spread was. 

Preston Pysh  25:10  

Now, there’s nine.

Grant Williams  25:12  

Yeah. It was like, “What’s going on with TED spread?” “It’s nothing. There’s nothing to see here.” But we saw those blips in the test, and everyone I knew that was involved in that market was saying, “Dude, this is serious. This doesn’t happen. This shouldn’t happen. This can’t happen.” 

I think the repo is the same thing. We had this crazy period, and the fury, with which everybody in the position to, was saying, “This is nothing to worry about. It’s perfectly normal.” That tells you how big a problem it is. These things do. The *inaudible* quieted down, originally, until it just went off the reservation. I think it’s the same with the repo market.

The stresses are there. What’s happened in the real world away from equity markets, we’re seeing the erosion of trust again that we saw in a way. The counterparties aren’t sure what’s going on, and they want to hold their cash and they want to only do business with people they’re convinced they can do business with, and the only person who’s going to be able to step into this is the Fed, right? 

They will do what we’ve been saying all along in this conversation. They will buy anything, print anything, do anything they have to do because they realize now that the gun is to their head. Every single chicken that they’ve hatched is coming home to roost at the same time. And so, if they don’t step in now, and do “whatever it takes,” this thing falls over in a hurry. To their credit in some way, I think they realized this. I think they understand how bad a situation they’re in, which tells me they will come up with all kinds of crazy. Look, you’ve been talking a lot about yield curve control, which I’m sure has to happen at some point soon.

Luke Gromen  26:50  

I think it’s right. I think later this year, you’ll probably see that vetting gets dependent on recovery. I think it’s dependent on whether there is a second wave or a number of different things.

I agree with your point earlier on just what’s happened in the real economy. I thought that was a really good one. If you go back to the ’07-’08 crisis, there were these esoteric security instruments. We knew what was going on in housing. We could put the number on housing. It was originally $60 billion, and then it was $80 billion, and then, someone got really crazy and made it $120 billion in losses or something, which, by the end of the crisis, was adorable in terms of the number because we didn’t know what was sort of behind the scenes with all this stuff.

Whereas now, when you talk about the counterparty risk and what these banks have to be thinking, you see headlines go by where, like what I saw today, a quarter of commercial landlords got paid in full in the last month and a half for two months. 

By nature, that’s a business that runs at 10 turns a leverage, right? They put down 10% equity, so if you don’t get paid 10% a year, you’re breaking even. If you’re not getting paid 20%, you’re losing money.

So, there’s just this great degree of uncertainty in the real economy right out in the open, which is very easy to see. We’re moving into a quarter and with repo anyway, which has sort of been a hot point each quarter, and banks are window-dressing or chewing up books or however you want to phrase it. You made a really good point in that there’s a real world.

Grant Williams  28:21  

We all look at the stock market, right? The stock market is supposed to reflect economic reality, but what we need to do right now is be out on the streets talking to business owners to get a real sense for how bad this is because we can’t even as they’re all closed. 

You can’t even go into the store and talk to these guys and ask, “How are the things like on the ground?” We’ve got the PPP that will roll-off at some point. I’m sure they’re going to have to re-up with that because of the effect that’s going to have on the unemployment numbers. So, that real economy is totally being masked by the stock market performance. The disparity between the two is so extreme.

Luke Gromen  28:55  

I think COVID-19, basically, got them there. I think the social unrest got them there. I think for a long time in our careers, the central bank policy was seen as a dial that we can dial up a little or dial down. Stocks to the moon? The world’s ending. This was sort of always going to be where it was going. I just think that the degree of just how severe this slowdown was basically probably pulled it forward a couple of years worth.

Grant Williams  29:24  

Before this, going back a couple of years, every couple of months, you’d see an article talking about how 50% of Americans didn’t have $500 for a surprise auto bill or so. The fragility in the system of how many people don’t have any savings, how many zombie companies there are in the S&P –and it’s in the hundreds, which is crazy. 

We knew the system was fragile. We all knew that. All the data is out there and has been swirling around for a couple of years. And now, here we are, where all these fragile businesses have lost a quarter of their year’s revenue. People have lost jobs. There was a Deutsche Bank charter that today, they tossed the *inaudible* up. 50% of households have lost employment income in the US.

It doesn’t matter which way you cut it. If you understand the fragility of the balance sheet of corporate America, household America, and governmental America, and the numbers are all there, then what’s happened in the last three months, doesn’t get repaired by what repaired 2008. It doesn’t work. 

So, you just have to kind of sit here and deal with the madness and kind of maintain your focus on the endgame of this thing. You also have to look at what’s out there and not in front of your face because what’s in front of your face is very, very misleading. It’s a head fake that’s going to catch a lot of people, I suspect.

Stig Brodersen  30:45  

Given the ridiculous amount of printing that has happened this year, gold is only up by 11% and the S&P 500 is trading gold, but only at 7%. Taking the circumstances into account, why is gold not taking off in this environment?

Grant Williams  31:02  

The question with gold is always why, right? It’s always why and then when. The two questions that everybody wants to ask about gold are normally: Why has it not done X? And when is it going to do Y? If you look back at mid-to-late February, when the market cracked, you had this period at the beginning where the stocks were tumbling and gold was also falling, and everyone was sitting there, saying, “There’s sorcery going on, so why’s my gold not performing?” 

But there was a 10-day or 2-week period in the first couple of weeks where your one ounce of gold bought you 33% more in terms of units in the S&P. So, it did what it was supposed to do.

I think a lot of people get kind of hornswoggled by fixating on the price of gold. People talk about why the price is not going up. Like you, I would have expected the price to go higher, but when I look at it, I look at all the other stuff that we’ve been talking about, like all the leaders that are being pushed. There are four or five guys pushing on this lever to stop it from springing back and gold always just sits there, right? It doesn’t do anything. It’s just another rock at the center of the financial system and all the chaos goes on around it. It’s never really a case of gold rising. It’s a case of things around it sinking. 

And right now, the stuff around it isn’t sinking and gold is kind of just sitting there. Optically, risk assets are higher. Everybody’s got a bit between the teeth again, and gold really hasn’t done anything.

I suspect that what you’ll see is when the bear market resumes, which is my base case, you will see gold optically start to look better, and you’ll see people coming into gold. We’ve seen it a little bit in the miners already. We’ve seen some people starting to buy the mining shares, and it really gave them a kick because it’s such a small market.

But yeah, normally, why isn’t gold going up? I don’t know, but it’s really not something I spend an awful lot of time thinking about. It may surprise people but I’m not looking at the price of gold. I’m looking at what it buys me relative to other assets. As you said, it buys me 7% more so in pay now than it did a few months ago. 

Even with all this, if you measure the S&P and gold ounces, it’s where it was in 1994, so you could have had your money in gold this whole time, and not missed out on any of this stuff. You could buy the shares today at the same price you could have in 1994. I had no stress. So, none of us really know. It’s kind of a mystery, but then it’ll do what it does in it’s own time to me. I don’t know what you think, Luke.

Luke Gromen  33:24  

I’ve been surprised it hasn’t done better, as well. The Dutch National Bank last fall said good luck. If the system becomes unhinged, we’re going to need gold to rebuild the system. And so to me, I think gold is sort of performing. It’s probably been a little disappointing relative to the chaos, but I think, ultimately, where gold will really shine is if the system really does break down. I think that’s important too.

When you tie back to what we were talking about at the start of the show, in terms of this great power competition, if there’s really a new Cold War between the US and China all of a sudden, it becomes a currency competition as well, which is interesting, right?

I have a chart that looks at the US Treasuries outstanding. The market value of the US is official gold divided by foreign held treasuries outstanding. It’s basically the amount by which the US’s gold collateralized is all the foreign held treasuries outstanding. What’s really interesting about that chart is, prior to 1989, when the Berlin Wall came down and USSR broke up, the US foreign-held treasuries outstanding were never less than 20-40% collateralized by the US gold at market value. 

In 1980, when there was a true dollar crisis, it got as high as 133%. Basically, the US’s official goal was more than 100% collateralizing all the foreign-held treasuries outstanding, which is a true gold bubble, but their number’s 5% today.

For me, where I really expect to see gold perform is one of three things. It may become crystal clear that we’re going to get an asset hyperinflation. The answer to when the Fed is stopping is never. They’re going to bail out the eurodollar market and the balance sheet’s going to $40 trillion over the next three years, and people are going to go, okay. I think gold will perform really well in that scenario. I think another way it performs is if we keep going down either this great geopolitical competition, because the reality is that the US dollar is way too strong for the US to be able to really compete.

Finally, another scenario that I think it will do really well in is if they lose control of this thing and we get a chaotic collapse of the system. Then, I think you’ll see, basically, a write-off of sovereign debts or a big write-down-write-off, and the only thing on central bank balance sheets to collateralize or offset those writedowns is gold. That’s where I think you could see a huge step up. 

But I think it’s a much more systemic thing that we’d have to see or get further along on because I think what we just witnessed was systemic, but I think they nipped it in the butt fast enough is ultimately what gold is telling us at this point.

Grant Williams  36:04  

How do you handicap those, Luke? If you were to put odds on those three outcomes, how do you handicap?

Luke Gromen  36:09  

I think it most likely is a combination of the great power competition and the asset hyperinflation in the US. I think asset hyperinflation in the US is really my base case at this point. Part of that is because the great power competition reinforces that, as you didn’t have a great power competition and have China finance the great power competition against China, that’s going to have to finance it. The US private sector doesn’t have the balance sheet.

Preston Pysh  36:33  

Luke, when you look at the price action that we’ve seen just in the past week and a half, I think it completely confirms what you’re saying. This market’s moving out. There’s nothing in front of it, at least in the indexes that we’re tracking. I mean, they’re just getting bid. They’re not even shaken during the day. It’s just a straight bid at the open and straight to the close for the last 10 days that the market has been running. 

So, if that trend continues, which seems like it will in the coming weeks, the Fed’s going to see what’s happening. They’re going to clearly understand that it’s them that’s causing this. There’s no way they couldn’t. So, then, what’s the tool that they have to slow it down after they pumped all that liquidity into the system? Is there anything?

Luke Gromen  37:19  

I think some of what we’re seeing in the last 10 days you’re referring to is some capitulation, right? You’ve seen legends like Druckenmiller saying, look, I got my *inaudible*, right? I’m not the only guy. I think there are a lot of people that are really negative. I think there’s some element of that that’s driving that. But to your broader question of what are they going to be able to do? You can’t shrink your balance sheet, right? 

During World War II, and that’s where I think we’re ultimately *inaudible*, if we’re in a great power competition where foreigners are not buying nearly enough treasuries, basically, the US domestic private sector and the Fed are going to have to finance everything we want to do in this great power competition. In World War II, the percentage of total US banking system assets that were in the Treasury exceeded 50%. That number is 5% today.

I think the first thing that’s going to happen when the Fed does have some wiggle room is I think they are going to turn the US banking system into Treasury foie gras. They are going to stick a hose down the throat of the banking system and they are just going to pump their belly full of treasuries, and it’s not a terrible deal. 

Normally, for the banks, like we said before, there’s basically no cost to carry, there’s no cost of capital against those treasuries. But the government cannot win the great power competition unless real rates are negative, so they’re going to be losing money over time on a real basis, but making money nominally in the near term. So, if they have some wiggle room, the Fed could maneuver there. 

However, ultimately, they can’t let rates rise. If they implement yield curve control, then you have to pick your rates  pretty carefully, right? Because if you pick too low a level, you’re going to have to buy a lot more to hold those levels versus if you pick them high, then you’ll need less, and then you can buy less. But if you pick them too high, then it becomes hard to finance the great power competition given *inaudible* so that they’re painted into a corner.

Preston Pysh  39:07  

That’s a really interesting idea. You’re saying that they’re going to pump the banks full of treasuries. The other big challenge that they’ve got is to keep the slope of the yield curve positive because if it starts inverting these banks, they’ll go boom. 

So, if they’re controlling the amount of treasuries that are sitting on their balance sheets, they then can also control the shape of that curve a whole lot better. But are they going to be able to soak up that liquidity in a manner by doing that? I’m trying to wrap my head around that.

Grant Williams  39:39  

Preston, let me ask you a question. We’re talking about what do they do if this thing runs away? But we might be at the point now where we should think: Why would they think like that? Why would they try and stop this thing running away?

 

Because, at the end of the day they realize that if it stops going up and starts coming down, they’re on the hook. Right? They’re going to have to spend an unlimited amount of money, which we’ve said they’re willing to do. 

I can’t believe they want to do it because they realize that they’re going to need all these bullets at some point. So, maybe this is like, okay, we’ve already shown that we don’t take the punch bowl away. Why don’t we go and put another fifth of Jack Daniels into this thing? Right? What possible reason do they have to try and stop this running away now?

Preston Pysh  40:24  

What’s fascinating when you look at the stock market in Venezuela, Argentina in nominal terms, it’s fascinating that the shape that it has at a very similar point where we’re at here in the US. It gets really violent. I would argue that we’ve seen two violent moves so far. 

The first one wasn’t nearly as violent as the one that we just saw. My expectation moving forward is that we’re going to continue to see these violent waves. They definitely don’t go anywhere in real terms, but as far as nominal terms, they kind of go up, but they’re really violent. 

So, I guess my expectation is that we’re going to see a new all-time high, then, that’s where the Fed is going to say, “Oh my god, we’re putting too much in the system. Let’s just ease off this a little bit.” Then, you’re going to get the cataclysmic whipsaw to the downside, only for them to add the next unprecedented amount of liquidity into the system.

Luke Gromen  41:19  

That’s a really great point, Preston. I think it was Chris Cole, whom I’ve read recently, who used the easiest example. If you look at the Weimar Republic, what happened to stocks in nominal terms, the average person, myself included, said, oh, easy trades. You’d borrow a bunch of marks, buy stocks, own a bit of Germany for free. 

But he said that you have to really look at these violent reversals that you talked about. The reality was the only way to get from point A to point B and gain wealth was to be unlevered, actually. Because if you were levered either way, those swings clean you out in between. It’s a really interesting point. 

Again, I don’t think the US is going to be like Weimar, to be clear, but when you look at the fiscal side, the wealth inequality side, the social unrest side, and at what happened with the Treasury market in March, I think we’re moving towards sort of a Venezuelazation of the US market.

Preston Pysh  42:18  

You say we’re not in a Weimar situation? I guess I do think we’re in that situation. Maybe to tinfoil hat here, why do you think that we’re not?

Luke Gromen  42:33  

There are certainly some things that are very similar. The biggest may be that we have war reparations due that are inflation-adjusting and impossibly large as a percent of GDP in the form of our entitlements. The US government can print dollars, but they can’t print healthcare services, which is what they owe the baby boomers.

However, there are two things in particular that I think are different. The first is the political situation, which, while it has continued to get worse, when you read the history books, it’s not as bad. If we start having open gunfights between Antifa and the southern boys or whatever they are in major cities around the country with the cops standing aside and the local guys running Beer Hall Putsch– basically LA seceding– that would almost be more parallel to what Germany was suffering at that time. So, it’s not that bad yet.

The other thing that is I think critical is that the US still has the ability to produce virtually everything it needs at the right price. A perfect example would be shale. The dollar collapsed 90% against oil going from $12 to $120 or $150 over many years, and what we got out of that was an incremental 8 or 10 million barrels a day of oil. 

There’s a lot else that the US could do, and, ultimately, that’s what would stop the hyperinflation from being completely currency-destroying, unlike a Weimar, in my view. It’s not to say it couldn’t get very inflationary, but I just don’t think it can destroy the world. currency in the same manner.

Stig Brodersen  44:02  

Interesting arguments. Grant?

Grant Williams  44:05  

For me, the outcome is uncertain. But what I’m just listening to are two very smart, very knowledgeable guys discussing whether the US is Venezuela or Weimar, Germany, right? But that’s the important thing for me because you’re both saying it with a straight face, and they’re both possible outcomes. That’s a really, really important thing for people to understand. 10-15 years ago, A, we wouldn’t have been having this conversation; and B, if you had it done, it wasn’t a possible outcome. It would have been some fantasy or game, just for fun, right?

However, when guys like you are armwrestling over those two outcomes, it tells you that we’re on a path that potentially leads to one of those things. How far down that path we are is to be decided, but with what’s going on, like when you talked about what was going on in Germany back during the Weimar Republic, we’ve seen flashes of that in the last few days. We’ve seen social media posts from people outside their window in New York. 

I was talking to someone just today, saying that it’s like I’m looking at a scene from a Batman movie, The Dark Knight or something, right? It’s just chaos in the streets of New York just after lawlessness. There were so many of those kinds of posts that, when you look around, you think, “How did we get here?” 

So, we can go from thinking, “Bah, things are kind of screwed up right now” to “How do we get here in a matter of three or four days?” That’s what people have to understand. Outcomes like Venezuela and outcomes like the Weimar Republic are crazy until you’re three days away from them.

Luke Gromen  45:48  

It’s all fun and games until you go to the store and there’s nothing there. That’s the moment you go, “My money’s not good for…”

Grant Williams  45:54  

Pippa Malmgren made a great point *inaudible* as I spoke to her a couple of weeks ago. She’s talking about people’s willingness to bear inflation now having been locked down. Everybody has a recent memory of going to the grocery store and not being able to buy what they want, so they go back in a few weeks and a loaf of bread’s $5 instead of $2.50. 

People are probably going to go, “Yeah, well, it’s better than having no bread like we had a month ago. So yeah, I’ll pay the $5 for the bread.” It’s that willingness to accept the higher prices that is turning the key to this thing. We haven’t talked about it yet, but if we get inflation on top of all this stuff, …

Luke Gromen  46:32  

I was going to say, when you pointed out two serious people talking about these outcomes, another piece of evidence of that is we’re talking about empty food shelves in America. I went to the grocery store with my wife a few weeks ago and, on one level, I understand this situation. 

But on another level, once you understand that, as Nicolas Nassim Taleb talks about, the system was not anti-fragile. We went from, in the name of efficiency, having 30-60 processing plants around the country to just like 5 plants that make the process all the protein. 

If any one of those go down, you are by definition going to have shortages in parts of the country. It was very, very weird to be in America and to go to the grocery store and to see empty shelves. I’ve never seen it in my life. I didn’t want to put too much into it, but there it was.

Stig Brodersen  47:24  

Let’s continue talking about some of those prices that we are seeing in grocery stores. We see the price of meat and so many other products go up dramatically. What is driving those price trends right now? Do you guys expect that to accelerate?

Grant Williams  47:51  

I’m just going to say something about the inflation thing. It’s all about people’s expectations. If expectations rise, then that’s really often all it takes and we’re seeing that. People’s expectations, based on what’s happened, are increasing and that’s a very dangerous place to be. 

The bond market is screaming deflation and the price action would suggest that even if we do inflation, we’re going to have to go through another deflationary shock of some sort before we get there. 

But the people’s willingness to bear higher costs and people’s expectations and people’s feelings– You have a more intense fear of inflation when you lose your job because, suddenly, everything seems more expensive to you, right? Because you don’t have any income. This mindset that people are in believing that price is going to go up. That’s what it takes for people to start going out and trying and getting in front of that.

The data that we’re seeing suggests that we’re not quite there, but we’re approaching a tipping point where people do start to worry about jobs and start hoarding and seeing the price of meat go up, and say, “I’m going to fill the freezer. I bought a new freezer because of COVID. So, I might as well fill it with meat now.” We’re close to that. 

Again, it’s like a lot of these things we keep coming back to this in this conversation. We’re close to all these crazy outcomes. For 40 odd years, inflation has been a crazy outcome, right? It’s just another example of our having a generation of people who for whom has not been an issue or a problem or a likely outcome. It’s been just discounted upon the shelf as something for the history books.

Ronnie Stifler put out a fantastic chart of inflationary surprises. In 1915, inflation, this is US CPI, was 1%. In 1917, two years later, it was 20%. In 1945, it was 1%. Two years later, it was 19%. In 1972, it was 3%. Two years later, it was 12%. That’s how quickly these things happen when they happen. 

We’ve built up a hell of a lot of complacency in all component parts of this financial system that we operate in. Inflation is a big part of that. The complacency around inflation is saying it’s just not something you have to worry about. It’s just another dangerous thing to take for granted, I think.

Luke Gromen  50:08  

I think that’s right. I think, too, when you look at it structurally, even away from food, when we go back to this new great power competition, boy, globalization has been remarkably disinflationary for labor, for stuff, for consumer goods.

Another way we can read that great power competition document is globalization’s dead and now we’re going to go back to re-localization. That, by definition, is going to bring back inflation. It’s going to be more expensive to make elsewhere because 7 of the 10 biggest container ports in the world are in China. Even if you start moving this stuff elsewhere, it’s going to take a lot of costs jammed very quickly to get it done.

A lot of people are paying attention to the US-China tensions and the deglobalization, but, to me, the bond market is extraordinarily complacent about the real implications of this. We’re hearing the policy guys all saying we’re divorcing China much faster, and we’re going to reshore much faster, but the bond market’s going “Ehhh.” 

It sets up for exactly what you just described, Grant, where you go from 1% to 20% in just a couple of years. It’s interesting because each of those times when that happened, ’15 to ’17, it was wartime. 

There was a new supply change, and you’re building stuff up. Then ’72, end of a war, end of a currency system. These types of things just happen, and this is the end of a 30-50 year period of globalization. This sort of sequence of the US moving its supply chain from one nation to another nation to another nation, and each cheaper each time leads to: Where are we going to put this stuff? It sounds like someone’s going to come back in more expensive areas.

Preston Pysh  51:52  

Ray Dalio talks about inserting liquidity when you’re in these types of environments. He talks about the use of quantitative easing where, when you’re buying a bond, you’re basically inserting it into the top of the economy. Then, you have to balance that with liquidity insertions into the masses through universal basic income. 

It’s kind of surprising that we’ve been exercising that insertion point of quantitative easing straight into the top of the economy for more than 10 years straight without hesitation, without implementing it to the masses through universal basic income because, politically, it’s been really unpopular. Now, all of a sudden, the first payment has gone out.

We were talking about this being like a drug earlier. I think, politically, after they do this and they see the feedback that they’re receiving, like, “Hey, that was awesome. Give us another shot of that,” my impression moving forward is that we haven’t even hit the tip of the iceberg with universal basic income. I’m curious to hear your thoughts.

Luke Gromen  53:02  

I agree. I think it’s crossing the Rubicon, right? Lacy Hunt was talking about, “Hey, the Fed can lend but it can’t spend.” And I understand what he’s saying, but I think it’s semantics, say, once you get to a UBI. If the government spends, and then, Grant, to your point, the Fed is buying up the bonds in a greater amount than the entire tax receipts, they’re two sides of the same coin. I agree that once you cross that Rubicon, particularly in this social unrest environment, and particularly in a setup where, as we discussed before, where monetary policy has gone from a dial to on-off, I think it’s going to be really hard to turn off.

Grant Williams  53:42  

They say there’s nothing more permanent than temporary government programs, like one that gives money to people. Once you give people money, try taking it away from them, right? Particularly, as Luke pointed out, in an environment like this where people come home and, by the front door, have got their protest outfits. 

They put on their black mask and ninja suit, and pick up a banner for the day. People are in that mood. They’re getting checks from the government, but they’re also reading all kinds of articles about the fat cats who are becoming even richer and wealthier than them. $1200 is great when it comes to the door, but you realize it doesn’t really make the difference you need it to make, so you want more. 

There are plenty of things they can hang their hat on, saying how Wall Street got bailed out and Starbucks took 10 million PPP loans and all these chipotle, so we’re going to boycott them, going to do this, etc.

Once this thing begins, there’s no way the guys who are going to write these checks and sign them don’t understand this. Once this begins, as I said, you’re not going to be able to take this money away from people. A, because they’re going to need it; and B, because if you try, they’re going to get pissed. We’re also in an election year. What you don’t want is to piss people.

So, we’ve crossed the Rubicon. We didn’t wade through it. We just leapt to the other bank, and we’re running. I dread to think what this will turn into, this experiment and UBI, because the hands are out, and what you said, Preston, is absolutely right. Wall Street has been bailed out to an unconscionable degree and Main Street deserves their bailout. There’s no two ways about it, right? 

But it’s tough to see how they bail out Main Street and keep the system together, whatever that means, because they either bail both out, or they choose the politically expedient route, which is bailing out Main Street and let the system go to hell, which they can’t do. 

So, bailing out just Wall Street is no longer an option because the people are wise to that now. I just think that takes us full circle to where we started this, with this unlimited amount of printing that’s going to have to happen because now you’ve got to bail everybody out. You don’t have a choice.

Stig Brodersen  55:53  

A thing to also consider is how they’ve been able to do QE for so long benefited the haves, and not to UBI, benefiting the have nots. In order to do QE, the process is simply much easier. You don’t have to run by Congress, for instance. Moreover, something as politically charged as UBI would be almost impossible to get through Congress, under most circumstances. However, because of COVID-19, and to Grant’s point about it being an election year, now, the standards for prudent fiscal policy have just changed. So, perhaps you are right when you said that nothing is more permanent than a temporary government program.

Grant Williams  56:34  

I think the beauty, if you like, of QE was that it was just arcane enough for people to not really understand it. Everybody that you trust, from a political standpoint, like Paulson and Bernanke, all these trustworthy guys are standing up and saying, “We’re going to save you. This is what we’re going to do.”

It’s basically a variation on the theme of the old joke about what’s the difference between a recession and depression. Recession is when your neighbor loses his job, and depression is when you lose yours. That’s kind of where we’re at now, in that, before we had this sharp spike in ’08, a lot of people’s lives got turned upside down. 

Now, it’s a third of the working population, so suddenly, this problem is everybody’s problem. As was tossed on the chart today, 50% of households have lost employment income. That’s 50% of everybody that everybody knows has lost a job, which is why we’re seeing the consumer spending numbers fall off a cliff and savings rates [are] going through the roof. This is where we’re at, so now, you don’t have an option to bail out the banks because of how many millions of people need that extra unemployment check.

So, QE was great when they did it first because no one really understood what was going on. Now, people still don’t understand it, but they feel bilked because there’s been enough ink spilled with the talk about how Wall Street was bailed out and not Main Street. 

Even if they don’t know what that means, they can grab onto that. It’s a cause to rally behind to demand to be made whole by the government. I don’t see anyone out there that’s going to be able to say no to this.

Preston Pysh  58:16  

How much longer until we see municipalities start failing and needing bailouts along with everybody else?

Luke Gromen  58:25  

Is it tomorrow yet?

Grant Williams  58:26  

Oh, yeah. I was wrestling for my watch.

Luke Gromen  58:28  

We know that Illinois is looking to tap the Fed already. They were in a tough spot before this unrest, and now, it might be much more structural. There are probably a lot of conversations going on at a lot of the very expensive houses in very nice cities in America on: “Do we really want to be here? Where is this going to go? If they ban the police, do I want to live in a major metro area?”

I saw Bernard Kerik on Twitter today. There are 600 New York cops that he knows are going to resign. How are these cities going to start to look? The New York we’ve all come to know and love in the last 30 years is great. I understand it wasn’t that nice a place in the 70s in terms of the crime levels and the finances, etc.

The COVID thing was one thing. However, I think the social unrest and change in perception of the potential relative safety of American cities going forward, combined with the work from home shift where you make a case that commercial real estate has a structural problem, and Amazon and what it’s done to storefronts, now even hitting the fifth avenues of the world. I think there are a lot of cities in a lot of trouble. 

That then comes down to the question of we’re about to see how different the US is versus Europe with Greece. Are they going to put these cities through the wringer? Or are we going to default on cops pensions and teachers pensions after we bailed out Wall Street 12-15 years ago? Maybe we will, but again, there’s going to be a political cost to that on the other side that I think will be further supportive of things like UBI, and larger and larger amounts of whatever.

Grant Williams  1:00:09  

We’ve seen the trial balloon, right? We’ve already seen that trial of a very prominent republican politician. I can’t remember which one it was now, but a couple of weeks ago, he talked about how he thought that he and his party should be allowed to declare bankruptcy. Immediately, everybody jumped all over it. It became a big thing for a couple of days. They hashed it out pretty quick, but that felt like a trial balloon to me.

During the Great Depression, people forget that Arkansas went bust. There is precedent for this stuff. Again, we’re in a modern world where this stuff hasn’t happened, and it’s not entertaining, but at this point, everything is on the table. 

Anybody who’s trying to structure a portfolio or trying to manage a portfolio who isn’t entertaining the most extreme outcomes in terms of protecting themselves from possible tail risks is missing a trick. 

They should be listening to guys like you talking about these outcomes because you have to have a plan for a wilder outcome. You have to have a plan for if municipalities declare bankruptcy. You have to have a plan for these things now because they’re all in play, every single one of them.

Preston Pysh  1:00:32  

Yeah, they’re high-probability events as opposed to being one-off or 1-in-100.

Okay, last question. All right, as you guys know, I’m a Bitcoin bull. I think that it’s going to have a major role playing forward. I get the impression that you guys are less bullish or somewhat skeptical of that, so I’m kind of curious to hear your skepticism.

Grant Williams  1:01:48  

I’m going to give you my very succinct Bitcoin answer because I love having Bitcoin a lot. I don’t try and avoid the answer, but my answer is always the same, and I’m bullish on Bitcoin. I think everybody should own some bitcoin because it’s a great option in an uncertain future. It could potentially be a game changer for a lot of people.

However, my understanding of it, and the depth of my knowledge on it, is so far below the people that immersed themselves in this thing. I don’t see how my opinion is of any constructive use to that whatsoever because the people who understand Bitcoin understand it way better than I do. 

And the gulf is, in my experience, when you don’t immerse yourself in Bitcoin, it’s such a fast changing technology. It’s such a fast changing world that I think you’d have to make a commitment to be deep deep deep into blockchain and really understand it, which means you have to give up a lot of time trying to understand a lot of other things. 

If not that, you have to find a lot of smart friends that really understand it, ask them questions about it, and get the dummies guide, which is the route I’ve chosen to go. So yeah, my opinion is everyone should own some, but if people ask me for my opinion on Bitcoin, there are way better people than me to ask you be one of the

Preston Pysh  1:03:01  

You know, I taught my girls that the hallmark of somebody who is very intelligent is somebody who says, “I don’t know,” or “Why don’t you tell me what you think?” or those kinds of things. I just love that response.

Grant Williams  1:03:17  

Billy Connolly said, “The definition of an intelligent person is someone who can listen to the William Tell Overture and not think of the Lone Ranger.” I think that’s a way better *inaudible*.

Preston Pysh  1:03:30  

Luke, let’s hear it man.

Luke Gromen  1:03:32  

I echo a lot of Grant’s sentiments. I own Bitcoin. It’s a tail position for me. I’ve always looked at it. I’m in sort of the same boat as him as there are a lot of people who understand it a lot better than I do that I would defer to. I think of it in a very simplistic way, being almost as a neutral reserve asset with no counterparty risk for the millennial group, if you will, and it’s easier. It’s sort of a digital gold.

My one hang-up on it relative to gold, at least, is that, ultimately, it’s not on central bank balance sheets. In a world where central banks continue to exist, I think Bitcoin will do really well, but I think gold will also do really well and I feel like I understand gold better. 

Moreover, if central banks are going to have to basically run a global sovereign debt bubble, an outcome of that is that global sovereign debt is going to have to be written down significantly, possibly up to 100%, if it was like certain nations, and in the 20s, against the only other asset on central bank balance sheets that’s able to do that, which is gold. And so, I think gold’s going to  really outperform sovereign debt, and I think Bitcoin will do well alongside that. That has always been my thought on it.

Preston Pysh  1:04:43  

I want to play a hypothetical situation here for you. Because I think the speed at which something progresses in value could have an important impact on how things transpire here moving forward. I’m of the opinion that in the coming six months to a year we’re about to see some aggressive price movement on Bitcoin due to various things that have been happening with the protocol. 

Today, the price of bitcoin is close to $10,000, and we’re recording this in June of 2020. Let’s say the price of bitcoin runs too aggressively to $20,000 by Christmas or January timeframe of 2021, where it’s literally doubled, and in the backdrop, we have all of this chaos that we’ve just described.

It seems like it’s pretty much the very high probability of an outcome playing out. Does that create a situation that just becomes a self-fulfilling prophecy just because of the sheer fact that it starts to look like a gold chart in 1920 Germany?

Grant Williams  1:05:49  

It’s possible. For me, what I’ve wanted to see from Bitcoin is how it performs in a crisis. We nearly got a look at that a couple of months ago, and it didn’t do great, which is understandable as all risk assets got sold off. I definitely want to see what it does in a crisis. We’ve kind of seen it go to $20,000 before. 

We saw that back in end of 2017, where it ran up to $19,000. I think that will give people confidence again, but I think to get the juices flowing, like we’re seeing in some of these Robinhood stocks at the moment, it’s going to have to do something really crazy. 

It could conceivably do that, but, as Luke said, I’ll remain in a tail position until I see an event and if people run to it or away from it. At an event people will run towards gold because they always have done. Yeah, you may get the initial margin call selling but people will want to own gold. Do they want to own Bitcoin? Or do they want to cash out their Bitcoin because they’re not sure? I don’t know the answer, and I’m fascinated to watch it.

Stig Brodersen  1:06:54  

Luke, could you talk more about the difference between the Bitcoin market and the gold market? I also know you have some thoughts on the role of the Bitcoin exchanges.

Luke Gromen  1:07:04  

I do think Bitcoin is still a purer market than gold is. By that, I mean there are fewer paper derivatives attached. For me, I would get really excited. Last year, technically, Bitcoin was moving up. I forget what the key technical level it was. 4000 or 5000 when it broke about, but it was interesting that in April or May last year, one of the Bitcoin futures exchanges shut down. 

It was interesting to watch how Bitcoin reacted as soon as that happened. It took off, and so, for me, following gold as long as I have and in the way that I have, one of those bullish things for me for Bitcoin would be to see that futures exchange shut down and have it be a true market again.

If you find my tweets from it at the time, in late ’17, one of my big regrets of ’17-’18 was not selling the Bitcoin ahead, but not maybe even trying to sell some Futures. The marginal costs are just crazy high. But anyway, the point was that as those futures are being rolled out, a lot from the Bitcoin community said that this is a sign of acceptance, while I was saying, “This is going to be a freakin disaster for Bitcoin because this is how they control gold.”

Just thinking of the financialization of the futures market, when you have a cash-settled futures market on a monetary asset like gold or like bitcoin, it begins to shift price discovery from the physical supply-demand fundamentals to whoever has the biggest balance sheet, right? 

It’s almost like going to a casino and playing No Limit Poker with Warren Buffett where you might have a royal flush, but he’s got $100 billion, and he’ll take your house and everything else so you have to fold. That’s sort of what’s happening with the futures markets as they develop around these monetary assets. 

By monetary asset, I define that as something with a very high stock-to-flow ratio. It’s basically money. It’s not used for anything else. It’s not a commodity. So, I would love to see the futures market go away or be severely impaired for Bitcoins. I think you’ve seen Bitcoin take off again.

Preston Pysh  1:08:59  

When you say that, I think a big component of that, especially in the gold market, is to physically settle. There are expenses, friction, to do that easily. In Bitcoin, there are physically-settled Bitcoin markets where you can take possession of the coins literally at the snap of a finger, so all of that frictional administrative piece of providing physical delivery is gone. As long as you have some market that you can go to, that conducts that physical exchange, maybe that makes that argument mute.

I participate in a derivatives market with Bitcoin, where I can buy long-dated call options. Just recently, I purchased one for December of 2021, and guess what? In order for the person to write the other side of that contract, they have to cough up one full Bitcoin, 100% equity, into escrow in order to write that contract. 

I guess I’m looking at it from the other perspective, which is that now that these derivative markets, particularly in Bitcoin, are requiring 100% upfront escrow of the underlying, that bitcoin’s locked up. It can’t be traded. It can’t be sold anymore. I think that’s really bullish for the market, long term, that you’re seeing this lock-up of 100% equity. I think it’s a little crazy.

Guys, I don’t want to take any more of your time. This was amazing. I really, really want to do this again, if you guys are up for it.

Luke Gromen  1:10:24  

Anytime!

Grant Williams  1:10:25  

I can’t go. You’re not allowed to go outside the house, so I’m just glad of the company. *laughter*

Preston Pysh  1:10:30  

Thank you both. Give people a handoff to your handles, where they can learn more about you and follow you.

Luke Gromen  1:10:37  

@LukeGromen on Twitter, and fftt-llc.com for more information about our research products.

Grant Williams  1:10:44  

I am @ttmygh, and that’s the acronym for Things that make you go Hmmm. The website’s the same, ttmygh.com.

Preston Pysh  1:10:53  

Gentlemen, thank you for your time.

Luke Gromen  1:10:55  

Great seeing you too, guys.

Stig Brodersen  1:10:58  

At this point in time, the show will play a question from the audience. This question comes from AJ. Here we go.

AJ  1:11:05  

Hi, Preston and Stig. Investing has a simple rule of buying low and selling high. Responsible allocators will often buy back their own shares of companies when they think their stock price is low, or undervalued. 

On the other hand, why don’t companies issue new shares when the market is hitting all-time highs where they feel their stock is overvalued? While I don’t think companies should day trade their own stock, wouldn’t this be a good strategy for companies to buy back when share prices are low and reissue them at higher prices?

Stig Brodersen  1:11:39  

Fantastic question, and a very insightful question that really shows that you truly think as a capital allocator. Now, one reason that comes to mind is the book, The Outsiders. You might remember that we covered that here on the podcast. We’ll make sure to link to that in the show notes. It was Episode 180. It’s a book that is both endorsed by Warren Buffett and Charlie Munger.

What really stands out in that book is that the best CEOs are also the best capital allocators, and they’re doing exactly what you’re saying. They’re using their own stock as currency and they have the deepest respect for the valuation. They sell it whenever the stock is very expensive, and they buy back whenever it’s out of favorite in the market.

So, you might be thinking, “If it’s that simple, CEOs across corporate America must be the best capital allocators.” But that is actually not the case. CEOs being great counsel educators are very often the exception to the rule. It’s not that they’re not skilled, but where they often excel is at being salespeople or politicians, which is why they became CEOs in the first place.

Really few people in corporate America rose to the top because they made better decisions of when to issue and buy back stocks at the right time. Even if they did, which, unfortunately, they don’t, It’s also very tricky to have good timing. Even the best counsel educators might think a stock is trading at a very high level and issue stock, or they might be one to buy back shares when everything looks cheap. 

But if the market that has a vastly different opinion, it might, in hindsight, look like the CEO doesn’t know the value of his or her own company, while the real reason is that the market just acted very irrational.

A final reason why the timing is off is actually that the CEO might be acting irrational. What I mean by that is that whenever a stock is trading an all-time high, very often, it’s because the company is also spinning off a lot of cash. 

So, even if what looks to be an attractive stock price to issue shares, there’s really no reason to dilute the stocks since you have enough cash to pursue your best projects. Furthermore, the extra cash you generate from issuing stocks, you could only invest them in the second-best projects, which by definition would give you a worse return.

Preston Pysh  1:13:52  

AJ, I don’t have really anything else to add other than what Stig had covered. I would tell you to go back, listen to our episode of when we covered the book, The Outsiders. I would tell you to read the book. This book is by William Thorndike and it covers eight unconventional CEOs. What all eight of them are doing is exactly what you’re describing. They’re just incredible capital allocators. 

They’re not only great at running the operational side of the business, but they’re also really good at allocating all their retained earnings and investing them into businesses, non-operational subsidiaries that then give them a higher return as a company, because they’re able to employ those retained earnings in a manner that many CEOs are not able to do. So, I would tell you to check out that book.

So, AJ, for asking such a great question, we’re going to give you a one-year subscription to our TIP Finance Tool. This helps you do the things that the folks in the book, The Outsiders, are doing, what we were talking about here, which is allocating capital by finding undervalued companies using all those metrics to read through the financial statements. We have it all on our website in a very easy to understand way, so that you can conduct intrinsic value calculations on the fly. Quick, easy, and simple.

For anybody else out there, if you want to get your question played on the show, go to asktheinvestors.com and just record it. If your question gets played on the show like AJ’s, you’ll get a free 1-year subscription to our TIP Finance Tool.

 If people want to check out TIP Finance, just go onto Google, and type in “TIP Finance” or go to our website, theinvestorspodcast.com, and just click on the Finance tab. You can find it all there.

So AJ, thanks for asking such a great question.

Stig Brodersen  1:15:36  

All right, guys. Preston, I really hope you enjoyed this episode of The Investor’s Podcast. We will see each other again next week.

Outro  1:15:44  

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