I guess the best way to get a sense of how far detached we are from that very simple idea. If you think back to what’s happened with quantitative easing, and I’ll just pick the Fed, and the Japanese are on QE 19 at this point, and perhaps we can talk about those a little bit later. But the very first, I guess, piece of QE, if you like, was the TARP [Troubled Asset Relief Program] program. If I remember right, when Crux of Lehman’s, they threw $800 billion at the market to buy assets. And that was effectively the first instance of QE at the Fed trial. At that point in time, it’s worth remembering that their balance sheet was somewhere between $700 and $800 billion. They basically doubled their balance sheet overnight. 

And after that, they bought just over a trillion dollars of mortgage backed securities. I think $300 and $350 billion of treasuries and a couple hundred billion dollars of agencies. And that was all by 2010. And generally, we’re buying those from the banks to shore up the bank’s balance sheets. You get to, I guess, June 2010, and the economy was growing again, so that enabled them to say that we’re going to stop this now and start winding back our balance sheet. Well, guess what, two months later, literally, two months later, the economy kind of started showing signs of weakness. So they jumped in with another $30 billion a month of bond purchases, again, to do that same thing. Lower rates, encourage borrowing, [and] stimulate the economy. 

So then you get to I guess, QE 2, which would have been November 2010, that ran through to the middle of 2011. We put about $600 billion more bonds there. Then because people were getting kind of bored with QE, and it was starting to have less effect, they started Operation Twist, which is essentially buying more mortgage backed securities, because those were the problems on the bank’s balance sheet, and extend the duration to let their shorter duration bonds they bought runoff and replace them with longer durations to try and lower borrowing costs further out the curve. And then that didn’t work. And by January 13, we had QE 3, which a lot of people call QE infinity, which essentially we’ll buy $85 billion a month, indefinitely. 

So you can see if you go through that time, and you see how this program escalated, and that’s due to it not really having the effect that they wanted, and not only that, we’re getting in so far that you become a backstop to the market. So as soon as the market falters, everybody’s eyes turn to you to do something, and what you’ve programmed them to expect you to do is buy assets. 

That’s what they’ve done, and the most amazing step I read recently was that now, .2% of the banks control 70% of the assets in the US. So that concentration by trying to bail out the banks has had just, I think, a disastrous effect. And in doing this in following the QE program in trying to create inflation, what they’ve instead done is create asset bubbles and asset bubbles everywhere. So that’s kind of a long answer to your short question, which I apologize for. But that’s just to give people a sense of the progression I think is important to understand.

Preston Pysh  6:43  

No, that’s fabulous. So correct me if I’m wrong, but the way I’m thinking through the mechanics of this is you got all these assets and we’re going back to 2008 to 2009. You got all these assets and the money’s not, you’re not getting any type of velocity with any type of cash flow at this point. Everything’s kind of seizing up. It’s almost like an engine that’s kind of run out of oil and it’s starting to seize up at that point.

And so, the way I understand it is the Fed is basically saying, hey, all these securities, specifically fixed income securities, the bonds on the market, we’re going to take a bunch of cash, and we’re going to buy that from whoever it is out there on the market. So that way, we can swap these bonds with cash, that way, there’s tons of cash in the economy for people to spend. And then, you don’t have this engine seizing up kind of scenario anymore. And like you described on all the different phases of this, they’re pumping cash into the system. Let’s see what happens [once they] double their balance sheet on the first go around, and that wasn’t even close to enough. 

And again, all they’re doing is they’re just buying those securities off the market. The Fed is, they’re buying these bonds off the market. And they’re just doing a cash infusion into the economy, another cash infusion. So all these dollars that can be spent immediately are now being pumped into the economy. 

And now, we’re at the point where the Fed’s saying that they’re going to do that. So now we’re going to have the exact opposite occur, potentially. I mean, they say these things, and then nothing happens for years. 

But effectively, it’d be the exact opposite, right? So we would then be taking the cash that’s currently existing in the system, and we’d be putting these securities back on the market. And now all of a sudden, you don’t have a buyer at any price, like we’ve seen over the last decade.

Grant Williams  8:28  

That’s exactly right. And it’s amazing to me that if you just take a step back, and you look at what QE was designed to do. So first of all, it’s designed to stabilize the economy and fair play the top, I guess, the top will do. The stock market bottomed in March of 2009. It’s been a very weak recovery. It’s certainly not the kind of recovery you would expect to get for $4.5 trillion of stimulus, but the economy’s recovered. But all the way through that, we’ve seen the unintended consequences in Vancouver house prices, Toronto house prices. 

This equity market being at levels and valuations, which we’ve never seen, and companies pouring billions of dollars to buy back stock because it’s cheap to borrow money, but they’re not really feeling like the economy is something they can invest [in and] put capital investment into. So they’d rather buy the shares back and try and produce a return for the shares that way. 

What staggers me is the idea amongst the central bankers that having seen the unintended consequences, but perhaps refusing to acknowledge them. They seem to believe that we can reverse this process and have no unintended consequences the other way. 

Preston Pysh  9:38  

I see it the same way. So they’ve raised the federal funds rate, which is the borrowing cost for tomorrow. It’s not this long term borrowing cost on the 30 year, anything like that. They’ve been just adjusting the federal funds rate on the short end of the bond yield curve.  I was expecting a lot more pullback in the market by them doing that, but you know what, the market has just been screaming since they’ve done a couple rate rises. 

Now, they haven’t raised it a lot, but they’ve raised it a little bit, which is tightening that money supply. It’s not the same as going and reversing QE, which is what they’re talking about by basically selling off their balance sheet. But it is having a contraction or a credit tightening event by them raising that federal funds rate. Do you see when we get into them potentially unwinding the balance sheet that it’s just a completely different ballgame than what they’ve been doing with adjusting the federal funds rate?

Grant Williams  10:31  

Yeah, I think it has to be. Interesting enough, people kind of don’t tie the two together. When they first raised rates back in December of 2015. If you remember the January and February market for a bit, we had the biggest correction we’ve had for several years, and people kind of don’t tend to put the two together. 

But I don’t think it’s any coincidence that the market had two very weak months immediately after that first rate hike. There was a kind of a delay but it was around Christmas, the markets were quiet. When people came back in January, the market spent two months falling, and what the central banks did was they stepped in with all kinds of assurances. They were jawboning themselves crazy. 

And I think that strong reaction from them, that almost desperate reaction to try and stop this is what perhaps has allowed them to gently raise rates subsequently, because the markets now once again thinking, “Okay, well, if the markets fall, they’ve got our backs.” Yeah, I don’t think it’s possible. But they’ve proven it’s impossible to expand the balance sheet by $4 trillion without creating problems to deal with another day. 

So, it stands to reason that by trying to do it the other way, you either unwind the problems you’ve created, which means a massive foreign asset prices, or you create a wholly new set of problems, but there’s no way to do this with no pain and the idea that if you do it slowly, it’ll all be okay, is laughable. I mean, it really is laughable. So, there is going to be some pain that the market is going to try and inflict upon. The only question to me is, how strong is their resolve? And I think Stanley Fischer resigning this week out of the blue is a sign.

Somebody said to me, who shall remain nameless, but they said that the day they heard that Alan Greenspan had stepped down, because if you remember, they kept him on because apparently they couldn’t find his replacement, even though it turns out there’s a guy sitting in a chair next to him. But he stayed on for a little while after his term ended and a friend of mine said, the day I heard that he’d step down, a hundred days shy of becoming the longest ever serving Fed Chair, I put my house on the market because I knew the only reason he would step down that shy was he didn’t want to be there when something he saw bad happened. 

So it’s little signs like this, and I just forget all the finance aspects of it. If you think on a real world basis, what these guys are trying to do, the sheer impossibility of it is almost overwhelming to me.

Preston Pysh  13:03  

I agree. And it’s funny you said the thing about Stanley Fischer because I thought the exact same thing when I saw he was resigning out of nowhere, for personal reasons. They don’t really say anything else, and I wasn’t expecting him stepping down at all. And it’s like, why is he leaving? What’s the real story here? And I mean, he’s the number two guy at the Fed. I hate to imply anything, because we both just don’t know. We have no idea the reason why. But it is, I think, a little strange to see somebody of such prominent position, be stepping down right now, especially as they’re starting to talk about unwinding the balance sheet here in September.

Stig Brodersen  13:40  

Yeah, guys, and really to add something to the discussion here. A lot of people don’t realize what’s happening in Europe. The European Central Bank has been conducting QE on a massive scale for a long time, and they’re still doing it.

Grant Williams  13:53  

Yeah, I mean, significant amounts of quantitative easing and they’ve just kept their purchases steady at $60 billion this month. So, this is interesting, if you take an aggregate graph of the Big Five central banks – the Bank of Japan, Bank of England, the Fed, Bank of China and ECB, you go back to when the Fed stopped QE. The line just keeps going up because some of the baton gets passed to first the Chinese, the Bank of Japan are always in there and latterly, the ECB. There needs to be some form of stimulus being pumped into the markets’ liquidity whatever you want to call it from some angle at every point in time to keep this thing together. 

So we haven’t yet seen what happens when you have opposing forces. We haven’t seen the ECB supplying liquidity and the US draining. We haven’t seen that yet. And I suspect that as powerful as the ECB tailwind has been for markets, the Fed is just a bigger dog in the pound. And I think if the Fed do get serious about reducing their *inaudible*. Personally, I don’t think there’s a chance in hell, I can do it. But if they get serious about trying, then whichever way you look at it, those two counteracting forces are going to produce some turbulence. And that’s never good for markets.

Preston Pysh  15:09  

Based on what I’ve seen from the Fed in the last couple years, it seems like it’s more about the signaling, much more about the signaling, hey, if we talk about this, people are going to start pricing that in, as far as this balance sheet online. But I think that at the end of the day, no one actually believes this. I don’t believe it, I don’t think that they’re going to actually unwind their balance sheet at all.

Grant Williams  15:29  

The market’s performance, which suggests the market certainly doesn’t believe. And here we are, they’re in this crazy situation where they’ve now got to try and convince the market they’re serious because the asset bubbles are getting out of control now, and how do you talk down an asset bubble? It’s the people blowing it, who are absolutely convinced. It’s a very, very difficult maneuver for them to pull off and personally, I just don’t see how they can do it.

Preston Pysh  15:53  

Well, that’s interesting you say that. So if I was sitting on the Fed board, and I would hear what you just said, which is, we’ve got to actually do something. We just can’t talk about it because then no one believes anything. My counter to that knowing how just atomic this thing is that they’ve built up here, and how energized this thing is, I would start to unwind it, but I would do it. 

It’s such an infinitesimal size, that it’s just pretty much meaningless. It’s more a ceremonial kind of thing, that I’m reducing the balance sheet. But in practicality, when you look at the numbers, it’d be so minuscule that it would have no impact. Would you agree with that approach? Is that what we’re going to see out of them? 

Grant Williams  16:32  

I mean, the only problem that I see with that is, it’s just perception. This point where the market starts to extend its forward judgments about what’s going to happen. And so at some point, maybe they get lucky in the markets go okay, this is going to dribble away. They’re going to sell like $28 worth of bonds every week, forever. 

Okay, fine, but that doesn’t really imbue them with much credibility. But if at some point the market says, “You know what? They’re serious about this– that $4.5 trillion is going back to $2 trillion.” Then, the markets have to do what markets do like discount. What does that world look like? And how far away is it? And can we afford to just play along? And the chances are, maybe they can’t afford to play along. 

The one thing that confounds all of this, of course, is if we end up with a recession coming in the middle of this, and if they are going to do this very gently, then there is absolutely zero chance that there won’t be a recession at some point along that path. And so what happens, when the recession comes along, they’re going to have to lower rates, which is at 1%, and with 1% to play with right now. So we know what’s going to happen, they are going to have to step in, once again, and either buy more bonds, or I suspect next time, buy equities, or both. 

The Japanese have shown us the way. The Japanese did QE and bought a significant portion of the bond market over many years. So that’s where we’re heading. Anyone that doesn’t look at Japan, and poorly look at the steps the Bank of Japan has taken, and think, okay, that’s my benchmark of what’s likely to happen, isn’t paying attention. At some point, if we get a recession, I suspect the Fed is going to have to step in and buy equities.

Stig Brodersen  18:12  

Yeah. And I think Warren Buffett and Charlie Munger agree with you, Grant. And it’s really interesting because they always ask these questions about macro. And they always talk about how they refuse to talk about it, how they can’t predict the future, but if you really are reading into the tea leaves here, I think it’s evident that they see the US going down the same path as Japan.

Grant Williams  18:33  

Someone who has done some fantastic work on this is Mark Yusko. Mark has put some great charts out that show all kinds of different metrics, that show that the US is basically 12 years behind Japan. If you overlay the US and Japan with its debt to GDP, whereas a balance sheet, whether it’s equity markets, lag it by 12 years, and you get very, very good matchups. It makes sense. I mean, it really does make sense and that’s kind of worrying.

Preston Pysh  18:59  

Yeah. So we all know how that story ends, which is the market will be down by 75% into the coming decades. I mean, that’s what played out in Japan. Now, I know there’s probably people that are listening to this, that would say, well, that’s never going to happen here in the US. And I would tell you to read up on Japan and try to understand what’s going on, because that might be a real possibility, simply because there’s no juice left for the Fed. 

The Fed’s running out of all their ammunition. They can only buy so much of this before they peg interest rates at 0%, and things then start playing out in a different manner. And that’s really what we’ve got going on. 

The thing that I think a lot of people lose sight of with quantitative easing, is it’s almost like you’ve got this person that will buy at any price. I mean, that’s effectively what it is. It almost be like having, you’ve got your lemonade stand. Mom and dad come by to buy your lemonade because they’re the only people that are going to buy it in the neighborhood, and they’re going to pay any price. 

So as the kid you could say, “Hey, I want $10 for this cup of lemonade.” And mom and dad are saying, “Yeah, sure.” They come back an hour later, you say, “Hey, I want $50 for them.” And they respond, “Sure, here’s $50.” And so, reality is just completely thrown out the window on this stuff, when you have a buyer that will literally buy at any price. And that’s what you see with quantitative easing. The government will buy it at literally any price.

Grant Williams  20:19  

As a father who’s bought his fair share of $10 cups of lemonade is a great analogy. That’s exactly what happened. It’s about conditioning. And if you are conditioned that there is a buyer in a particular market, if you’re on a poker table, and there’s a guy who can just pull his own chips out of thin air, what are you going to do right? The pots are going to get bigger and bigger and bigger, and that’s what happened with the market. There’s a guy at the table who can print poker chips. 

And so, this is what’s happening. They print the cash out of thin air, and there’s no point really to get into semantics if they are genuinely printing money or not. They are creating bank balance sheets out of thin air and swapping out cash for bonds, and they will do that, to your point, at any price, when they commit to saying we are going to spend this much a month. Well, that’s just happy days for the bank. They know it’s $85 billion in the case of the Fed during QE 3, every month a bid. *inaudible* good for $60 billion a month. It’s a great way to make money. It’s a really great way to make money. 

But at the end of the day, bonds are an asset and liability. They’re not just a number that disappears once the trade gets made. All these assets and liabilities are sitting on balance sheets, and they are doing to those balance sheets what you would expect them to do. They are weakening them in many ways.

Preston Pysh  21:33  

I was going to get into this subject a little bit later in the discussion, but I think it’s more appropriate because of the discussion we just had. And, in my mind, I’m trying to understand how this can all end and how this can all play out in a civil manner. That’s maybe it’s the optimist in me trying to understand how this can actually play out in a civil manner. And the only thing that I can wrap my head around is that you have to have some type of global pegged currency. In order for this to all play out in a manner that forces central banks more for the government on the fiscal side, that forces countries to be responsible in the way that they’re printing money. 

Because right now, there’s no incentive for any country to be responsible from a monetary standpoint, it just isn’t. If you devalue the dollar that creates this dynamic where everybody wants to bring their foreign currency into the US. and that applies for if you’re over in Europe, Japan, or wherever, there’s no incentive to be fiscally responsible because of the inflationary impacts that occur whenever you make your currency cheap. 

So that means that somebody has to return to a gold standard, which you know, is not going to happen because there’s no incentive for that to happen. So here comes this idea that in order for there to be some type of global peg, you have to have some type of global currency. And I know Jim Rickards has this SDR, special drawing rights narrative that he talks about, that’s going to be the thing that maybe goes. But I’m much more inclined to think that it’s going to be something to deal with this cryptocurrency cypherpunk movement, where they’re creating a currency, a global currency that’s completely decentralized, that has a fixed amount of coins that could act like a peg. 

I’m curious to hear your opinion on this because I know Raoul [Pal]’s opinion, and I think he was all on board with a lot of the Bitcoin stuff and cryptocurrency, but I know that he has taken a completely different approach and he doesn’t think that it has the legs to survive. I’m curious what your opinion is because I’m a big fan of this stuff. And I know there’s a lot of people out there that will probably hear that and think I’m nuts. But when I’m thinking about the solution to how all this can be solved from the burning until buying at any price, that has to end somehow. I think we’ve got some really, really smart people in the world, specifically out in Silicon Valley that are trying to solve this problem. And they have huge network effects built around cryptocurrencies. I’m really curious to hear your opinion on how that weighs into all this.

Grant Williams  24:01  

Yeah, I’ve done a lot of reading about this. I would never in a million years claim to be any kind of expert on it. I’m fascinated by it as you are, as I think anybody who’s paying attention. I always start by just separating the currencies from the blockchain. I think the blockchain is here to stay. The blockchain is revolutionary. Best way I’ve had it put to me was it’s triple entry bookkeeping, and you don’t go back once you’ve created triple entry bookkeeping, the same way we didn’t go back when de Medici invented double entry bookkeeping. 

So, blockchain is here to stay. And it’s potentially the most revolutionary technology we’ve seen in our lifetime. So I’m a huge fan of blockchain. Now, when you dip into the cryptocurrencies, it gets a bit murkier. When you can on a day that we had earlier this week, [and] when you have Paris Hilton, Floyd crypto Mayweather, and the rapper, The Game, each issue their own coins, you realize that this is a tulip bubble of sorts. 

Now, when you say that the Bitcoin is jumping up and down I mean, I’m not saying Bitcoin is a bubble. I’m saying the phenomenon of ICOs [initial coin offering] and coins linked to really nothing will end in horrendous tears for a lot. But once all that happens, and you know the petals fall off the ugliest tulips, you’re going to have stuff still standing, that’s going to be very, very important going forward. 

My fear for one of us slightly less emotive words is that this libertarian movement, wherein the whole blockchain started with noble ideals and a great way to decentralize and take control away from government is slowly building the walls of its own prison. And by that, what I worry about is, let’s picture a world 25 years hence, where the US dollar is now cryptocurrency, and the US government has its own blockchain, and you and I are forced to transact in crypto dollars. 

And by doing that, there’s a couple of things here that can be taken. If trading cryptocurrencies is made illegal, 97% of the people that use them will stop because they’re law abiding citizens. And if they’re told it’s illegal, they will stop. So the volumes will collapse. If then, people are told, okay, the new currency is the crypto dollar, you’re going to get paid in crypto dollars, your money’s going to get transferred from your employer to your bank account. That’s the gates going on the prison cell because you can’t get your money out of that system. It’s great for the government, they can tax you at source. You can’t hide any transactions, real estate taxes, no money laundering, a cryptocurrency blockchain answers a lot of questions from a government perspective.

Preston Pysh  26:42  

So I completely agree with you for countries that are living in a fiscally responsible way, that they could implement a blockchain backed currency. But whenever I look at countries like the US over in Europe, Japan, they’re not in a situation where whenever you look at the snowball of debt that’s compounding, if they would move to something that was crypto backed, it’d be impossible. I don’t think that it’s possible for the US to move to a crypto backed currency because that’d be the same as saying we’re going back to a gold standard, at a fractional reserve of whatever. You give us this many dollars, we’ll give you this much gold. They can’t move to that model because it’s physically impossible by the amount of debt that’s accumulating. It would never last. They’d have to break it. They have to break their peg. 

So, I think for some countries, you’re going to see that roll out. I think if you go to a country that’s fiscally responsible, you’re going to see them able to roll out some type of blockchain technology that backs up the currency. But in the US, I don’t see that happen. I think that’s impossible. So if that’s a true statement, in your argument about the legalization part, I think it is a very valid concern. 

But I think whenever I look at the US, let’s just say Bitcoin. If the US would make Bitcoin illegal, I think they’d be doing a huge disservice to the long term viability of the country because the more people that are holding Bitcoin in the US, the better that is with the US economy to be able to kind of shake out of this because it acts like gold. It serves the same exact function, and what country doesn’t want to hoard as much gold as possible, and I think you’d see the same dynamic kind of play out with bitcoins. The country would be very dumb to ban it.

Grant Williams  28:25  

Well, yeah, I don’t disagree with a lot of that. The one thing I would say is, what we haven’t seen in Bitcoin yet, is how it performs in a panic. We haven’t seen what happens in 2008. In a world where people have Bitcoin, particularly where they’ve made huge gains on Bitcoin. You know how gold performs in those panics because we’ve had immeasurable numbers of them over thousands of years, so I’m interested to see how Bitcoin performs. 

And I think to your point, the politicians will need to come up with some new construct or acting out of necessity. Jeff Gundlach a year ago, he said, greatest powerful fears even more powerful, but there’s one thing that’s even more powerful, both of *inaudible*. If you need something, you don’t have a choice. And that’s where these governments are, you know, they need a solution to this intractable problem of having $100 trillion of entitlements that they promised to people, and no money to pay it back. And that creates a problem where elegant solutions, if they can’t be found while we wait, they’ll come up with inelegant solutions. And who knows what that could be.

Preston Pysh  29:28  

It’s quite incredible to think through how this is all going to play out. The more I read on it, the more I think about how does this all end, especially when you talk about the quantitative easing aspect. I mean, eventually, there’s going to be a downturn in the market, right? It has to happen, whether it’s next year or five years or seven years. I personally think that we’re in for probably one of the longest credit cycles that we’re ever going to see with the one that we’re in right now. Simply because of the idea that I think all these central bankers absolutely understand what’s happening. And I think every one of them don’t want to be at the helm whenever this thing comes crashing down because they’ve just pumped so much energy into it. 

And so you’re going to see the exact amount of energy kind of pull out of it whenever it does have the downturn. And I think that they don’t really have too much ammo left in their storage bay here in order keep this thing afloat. And so I think, personally, that they are going to continue to dance around this. 

I think they’re going to talk about doing things that mean that we’re going to tighten the money supply, but they’re really not going to do anything that’s very meaningful. And they’re just going to let this thing come to its own structural demise. And it’s going to take some time for that to play out. Would you agree with that narrative? I’m kind of curious what you think about them.

Grant Williams  30:42  

100%. Nobody empties their trash can, when it’s just about full right? You keep jamming stuff in and jamming stuff in until it just can’t take anymore. And that’s what these guys are doing. I think you’re absolutely right. This is taking a life of its own now. And so if you think about when was the last proactive move the central bank made, I can’t think of one. But what I do remember from my career in the city, so it’s not that long ago is central banks getting punched in the face. And that was when the UK had to take the pound out of the ERM [European Exchange Rate Mechanism] back in 1992. 

They said the day before, there was no way we were leaving ERM, and they woke up the next morning, and they backed out because the market had basically seen their weakness and pounced. Yesterday, the famous day, Monday, George Soros made a billion dollars. That happens from time to time and the central bankers have had the upper hand for 9 to 10 rounds since 2008. But they’re tiring, and when you get to the end of the rounds, one punch can cause a lot of damage. I don’t know what that punch is going to be, but I know that volatility will not stay at all time lows forever. I know that volatility in a world which is inherently volatile will pick up. And once that starts to happen again, it just makes the number of valves and leavers that they have to try and keep together to keep a lid on this whole thing, too many for them to reach. 

So it’s just a matter of time. But that’s always the problem, right? We all can see kind of what’s going to happen as to when. And frankly, I’m amazed it’s gone on this long. And maybe they could drag this thing out for another year or two, who knows. But the more extended we get, the more dangerous it gets to believe that and invest solely in belief.

Preston Pysh  32:26  

So you brought up an interesting point when you were talking about wondering how crypto, specifically Bitcoin would perform whenever we get into a market crash condition. And, there’s some people that might argue that when we had the meltdown of the government there in Cyprus, and also in Greece. During both of those scenarios, we saw a massive surge with Bitcoin in both of those scenarios. 

Now, I think that if you’d see something play out in a more developed economy, a much bigger economy would probably be a better way to phrase it. I don’t think that that’s been proven, that you’re going to see a flight to that cryptocurrency in that scenario. But I think that seeing that what happened in Cyprus and Greece is quite an interesting thing. And you also saw some stuff down in Chile, with the inflation happening down there. And a lot of the citizens inside of Chile running to Bitcoin specifically. It’s an interesting conversation. 

Now, something, Grant, I want to ask you because I’ve noticed, I went out to this New York event, and we talked to various really amazing investors. And it’s almost like a taboo thing to talk about in public. And I’m asking you this specifically because you and I have a lot of similarities in that. 

We interview and we talk to various people that have managed billion-dollar portfolios or whatever, but as soon as we’re done recording, it’s almost like that is exactly what they want to talk about is cryptocurrencies and Bitcoin, specifically. Have you kind of seen a similar thing, whenever you’re not recording and the conversation kind of goes to the bar? Is that what people are wanting to talk about? I’m curious.

Grant Williams  34:02  

Undoubtedly. And I think a lot of that is due to the fact that it’s so new, it’s so noisy, and so few people really understand it. So everyone’s trying to soak up as much knowledge as they can. And you know what I found? The smarter the guys, the more they want to talk about it.

Preston Pysh  34:20  

I say the same thing.

Grant Williams  34:21  

Yeah, but it pretty makes sense, right? Because the smart guys understand that I need to understand this. This is not going away. This is technology that’s gonna be with us for a long time. And I need to understand. I interviewed Kyle Bass a short time ago, and he said, I have a confession to make. I blew off Bitcoin. I blew off blockchain. I didn’t listen. I didn’t pay attention to it. But it’s got his attention now. 

He said, “I was late, but now I’m soaking up everything I can about understanding how it works, and understanding the role it has to play in the future, because it’s clear it has a very important role to play.” So I’m seeing exactly the same thing as you. Everybody wants to talk about cryptocurrencies, and I completely understand that because I want to learn more about them too.

Preston Pysh  35:01  

So this is an interesting thing. And I really didn’t intend on talking about crypto hardly at all. But it’s kind of interesting how this is developing here. So Howard Marks comes out with his Oaktree memos that he puts out, and they’re always so awesome. I’m a really big fan of Howard Marks. He’s a billionaire that we study. And in his last memo that came out, he just crushes crypto. 

I think he said four or five times in there. It’s not real. It’s not real. And he gives really superficial reasons for what he had. I read through this, and after I was done reading it, I just came to the quick conclusion, Howard Marks does not understand this, like he hasn’t done a lot of research on it. It was really obvious based on the arguments that he was making against it. 

And so, lo and behold, literally last night, I got an email. Howard Marks has a new memo that came out and so I immediately click on it, and I start reading through it. And it was, I guess, he got more feedback from his last memo that came out, the one that I was originally referencing about where he bashes crypto. And so, he has a response. 

So I read through this thing last night. I mean, it was a doozy of a response. They’re talking to Marc Andreessen. He’s talking to all these [people]…referencing all these people. And he’s talking about his…basically, [he’s] going back on a lot of the stuff that he was saying about cryptocurrency and basically said, “This might be something,” and I think it was the most delicate way that he could say, “Hey, I might have been wrong about what I was writing, and there might be a lot of merit to some of this stuff. I’m still learning.” That was basically what he was saying, but there was a huge write up on this. I’ll have it in the show notes for people if they want to read it.

Grant Williams  36:35  

Yeah, it’s funny if you think about cryptos, which I think makes it difficult for a lot of people to get their heads around is because it’s completely ethereal. So people are talking about these coins as if they have a value. And value, generally tends to be physical. There are things that have sentimental value, whatever. But when we talk about value particularly in investing, it’s a physical, tangible asset, it’s a stock, bond, it’s a house, it’s a commodity, whatever it is.

So I think the fact that these cryptocurrencies are just code throws a lot of people off. And a lot of people just equate bits and bytes with nothing tangible, therefore, it can’t really have any value. So I kind of understand that. What’s amazing is how fast if you start to read and you start to really try and seek out people, understand this, and get them to explain it to you. You very quickly understand, I think, as from what you’re saying Howard has, actually, there’s something here I need to do more of that. 

I think everybody has to get to that point. There are two schools there. There are the schools that see it as a get-rich-quick scheme. A lot of the sort of hardened super crypto fans don’t have a clue how it works. They just see the price going up. And if you’re not on the train, you’re an idiot. We saw that in 1999 to 2000 with tech stocks. Exactly the same. And then, you’ve got the guys who are building incredible companies, developing incredible technology on the blockchain. And when you talk to those two groups, you have two completely different conversations. 

You have a group of people, as I said, it’s all about the price. And if you don’t buy a bitcoin, you’re a loser. And they have these guys that will sit down with you, and they want you to understand it. They won’t explain it to you. They really want your knowledge to go up because they feel it’s important, and they feel it is the future. The more people they can educate about it, the better, and there are a lot of people like that out there. 

If you seek them out, you’d be amazed how much time they will be willing to sit down because it’s a passion of theirs. They’re passionate about blockchain. They’re passionate about the technology, and they’re passionate about transmitting that and finding more people to try to come into that world and accept it. 

So I think it’s here to stay. There’s no two ways about it. I think we’re going to have a period where a lot of these coins go away, and there’ll be all kinds of bad press, and there’ll be all kinds of malfeasance. I think that’s inevitable. But once we get through that. I think Kyle said this to me. So there’s going to be one big step change in the Bitcoin community and then it’ll find some kind of stability. I think he’s right. But that stability will come with a massive contraction in the number of coins. Well, certainly high priced coins and people can have their own little blockchains with their own little coins, but they’re not going to be able to raise $75 million for.

Preston Pysh  39:13  

Yeah, I think most of the concern when you’re talking about the bubble in this stuff, really kind of comes out of the Ethereum side with the initial coin offerings that you’re referencing there, which is completely detached from Bitcoin itself. And this is something that if you don’t know anything that we’re talking about right now, I’d tell you to go out and read a book. One of the books that I really liked was called, “The Age of Cryptocurrency.” [It’s a] fantastic book that really kind of gives you a base, a fundamental understanding of what we’re talking about.

Stig Brodersen  39:42  

Alright, guys, so let’s shift gears here a bit. And Grant, I watched your interview with Richard Koo the other day. Richard Koo was a super smart economist, and he’s been doing a ton of study into what we’re talking about today, about quantitative easing, what’s happened in Japan, what might happen to the US. 

Preston and I have been a big fan of his work for quite some time. Actually it was back in episode 32, we had an episode about balance sheet recession, which is what he’s known for. And also, the quantitative easing trap that we already back then talked about, would have a huge impact on the financial markets. So Grant, could you tell us about the main thesis he had and what we and the audience can learn from that discussion?

Grant Williams  40:26  

Yeah, he’s a brilliant man. And super nice too. He was just so gracious with his time. Yeah, Richard is famous for this concept of the balance sheet recession. And if you think about it, it actually makes perfect sense. He’s talking about you’ve had a massive buildup of debt, you’ve got a massive inflation of asset prices, and then you get the bust. And what happens is investors, entrepreneurs, consumers, they hunker down and they don’t want to invest it. They traumatized it effectively. [That’s] what happened. 

So they may still have decent cash flow, but they’re going to take that cash flow and use it to pay down debt instead of investing and still spending in the economy. So you get into this stuck situation where the money won’t go back out into the economy. I think we’ve seen this so clearly. Where Richard and I diverged slightly is his solution, as a lot of people’s solution is, the government steps in and takes the place of that spending by consumers and businesses, until such time as the economy is back on its feet, and people have forgotten the trauma, and they’re happy to come out of their shelters and start spending their money again. That’s in a nutshell, what it’s all about. And his book is brilliant. 

The evidence he puts, all is absolutely brilliant. Top was a perfect example of that. The government needs to step in and do this, but if you look at what’s happened in Japan, where they’re 20 years into this, and you could argue that maybe in 2005 to 2006, we’ve started to see that the effects that they were looking for happen. The economy started to grow, and that got crushed by 2007 to 2008. But that was still 15 years after they began this thing. 

So, it’s yet to be proven if this works or not, but it’s yet to be proven that it doesn’t work. So we’re kind of in that twilight zone. I think from a human perspective, from a psychological perspective, it makes all the sense of the world to me. I think the way of thinking that he’s identified is exactly right. I think the behavioral side of it is exactly right, and the initial solution also is arguably exactly right. 

And again, we go back to Japan. The Bank of Japan, had been doing this for 15 years longer than the US, no sign of them being able to unwind their balance sheet yet, in fact, quite the reverse. So the US is kind of next cab-off-the rank. Are they going to be able to do this? As I said, I don’t give them accounting hell’s chance, but we’re all guessing about the future.

Preston Pysh  42:44  

Over in Japan, they’re getting to the point where they’re running out of securities to buy, correct?

Grant Williams  42:48  

Yeah, that’s exactly right. The Bank of Japan owns, I think, 35% or 40% of the JGB (Japanese Government Bond) market now, and these are just above half or just below half of the ETF [exchange-traded fund]. That’s a very dangerous place to be [in], for it was the third largest economy in the world. It’s an incredibly dangerous place to be [in]. I mean, picture the Federal Reserve owning 50% of the US ETF market. What would have to happen for us to get there is truly terrifying to me.

Preston Pysh  43:15  

I mean, in effect, what you’re really doing is you’re nationalizing all assets in the country. 

Grant Williams  43:19  

Exactly.

Preston Pysh  43:20  

It’s almost like you’re in this autocratic form of government, where now the government owns every single business, but it was done in this manner where cash or liquidity was swapped for all the assets, and then all of a sudden it’s sitting on the government’s balance sheet.

Grant Williams  43:37  

One thing I would say, Preston is sort of a plea to the listeners is, all these things we’re talking about, whether it’s Bitcoin, whether it’s the Trump presidency, whether it’s North Korea, all these things, it’s such a shame that the ability to have civil disagreement has just vanished recently. You see in cryptocurrencies, people are just so fixed on either side and unwilling to stand in the middle and talk about this stuff. Some of the stuff we’re talking about here, I’m sure there will be people sitting there, saying, I’m the greatest idiot the world’s ever seen. 

It’s important to just seek out people that are willing to have these discussions and talk to them and get the other side. There’s no right, there’s no wrong, we’re all trying to figure this out. I find it’s such a shame, how quickly your comments, threads and the like just devolve into name-calling and ad hominem attacks when there’s a whole world of people like you, [who] put this fantastic podcast out that reaches so many people. 

And in those communities, disability to have civilized disagreement has never been more important than it is right now. It’s never been more lacking than it is right now. And I think it’s such a shame. 

I would plead to all the people listening to this to don’t write this off, but debate it, talk about it, get other opinions, and just try to understand that none of us have an answer. However, there’s an answer out there, and they’re just all these different pieces that you can put together. 

Howard [Marks], go back in his Bitcoin, is a great example. You can. It’s okay to be wrong. It’s okay to change your mind. You don’t have to be dogmatic about everything. So I’ll get off my soapbox now. But I just think it’s so important that people try and regain that lost art.

Preston Pysh  45:16  

You’re so right about Howard Marks really setting the example of a guy [with a] huge public platform. [He] goes out there and says some stuff and is willing to listen to other people and change his opinion within a month. Change his opinion on things. I’m going to mess up the quote, but Munger has this quote, “If you can’t argue the other side of the opinion as well as the side that you have, you should probably just shut your mouth.” 

I love that idea because how many people are out there talking and just voicing their opinion and really kind of digging in and becoming dogmatic about their opinion, when they can’t even start the argument from the other side. That’s Munger’s way of saying, “Hey, if you can’t argue both sides of this and really understand the vantage points that every person could see it from, you don’t even understand the issue. So shut up and start listening.”

Grant Williams  46:04  

It’s so true.

Preston Pysh  46:06  

Well Grant, it’s such a pleasure to talk to you. I really look forward to these interviews every time we get a chance to sit down and chat. It’s fun for me to talk to you because you’re doing it seven times a week, where we’re doing once a week. So, you’re putting in a lot more hours than I have ever put in on this stuff. But it’s fun for me to sit down and talk to you and kind of compare notes with some of the people you’ve talked to, compared to the ones that we’ve talked to. And I really enjoy these exchanges. So thanks so much for coming on the show.

Grant Williams  46:31  

Oh Preston, you guys do an absolutely phenomenal job. So I’m flattered to be invited on such an illustrious cast of characters. So thank you for having me.

Preston Pysh  46:39  

Well Grant, thank you so much for coming on the show. What I really want our audience to know is Grant also has his own podcast with Real Vision. It’s called, “Adventures in Finance.” This podcast is phenomenal. You can see how intelligent Grant is. So, if you’re listening to this, I’m telling you go on to your app or whatever you guys are using, and go ahead and subscribe to their Real Vision adventures and finance podcast. Grant, is there anything else that you want to add to what you guys are doing with the podcast?

Grant Williams  47:07  

Well, we just got started with season two. We were just blown away. We had a million downloads in season one, which was phenomenal. We’re going to switch things up a little bit in season two. We’re kicking things off. I’ve got a few financial legends who are going to co-host with me. We actually launched our first one last night with Kyle Bass, who sat in with me for the hour. 

Next week, I’ve got Hugh Hendry joining me. He and I got a bit of unfinished business we need to thrash out, which is going to be fun. We got Jim Rogers lined up, and many more including yourself. You’ve agreed to come on so we’re going to make sure you you stand by that.

I just want to get the thing that you do, a sense of what makes these guys tick. We’re going to get people to talk about a pivotal moment in their lives, some of the investing mistakes they’ve made, which has been an incredibly popular feature and get some questions. 

So, the best thing that listeners can do is sign up to the podcast, [and] send questions in on what you want to ask these guys. The podcast goes out every Thursday night. It’s called “Adventures in Finance”, and it goes out on a Thursday night. I think at 9pm, Eastern time.

Stig Brodersen  48:02  

Thanks, Grant. I download your podcast every Thursday, and I highly recommend anyone in the audience do the same thing. And thank you, Grant for coming on the show. Preston and I really hope we can invite you once again.

Grant Williams  48:14  

Thank you for having me so much.

Preston Pysh  48:16  

All right. So at this point in the show, we’re going to go ahead and play a question from the audience. And this question comes from Cory.

Cory 48:23  

Thank you, Preston and Stig for taking the time to listen and respond to my question. I need to start off by acknowledging the incredible amount of time and effort you guys are putting into The Investor’s Podcast and the tremendous amount of value it has been to me, and obviously to so many others. Thank you so much for your continued dedication to this world and the quality and volume of information that you so willingly share. 

With that said, I have a question about interest rates and how they influence individual company valuation. Stig put out a great recap based on Mr. Buffett’s book, “Tap Dancing to Work” regarding how interest rates affect the stock market. This was really interesting to see so clearly put, but I’m really curious to know how you two factor in the current interest rate when you run a discount cash flow analysis on an individual company, or when you’re thinking about the future earnings and growth prospects of a company as it relates to evaluation metric.

Preston Pysh  49:20  

So, Cory, I love this question, and you’re gonna see why. So, when you’re talking about interest rates, I think so many people get caught up in this idea that because interest rates are super low right now, I have to settle for a much lower return. And that might be true if you’re buying publicly traded companies, or you’re buying stocks on the stock market. That is a true statement. 

But what I would challenge people to do, and this is how I personally think about it. I know this is how Stig thinks about it, too, is think operationally first. How can I create a product? How can I create a service? How can I start a business around an idea that’s going to give me a much higher return than 2%, which is where the 10-year Treasury in the United States is, and you’re probably getting a 3% by being in the stock market. 

I think that those returns totally stink. And I think that they are a very low return for the amount of risk you assume because of the credit that’s in the US economy. That’s my personal opinion. So as a result, I’m not settling for a 2% or 3% return. And I’m looking at investing more operationally in my own business and reading assets or services or whatever. I think that’s how people need to think. 

If you don’t have that as an option, or you’re not comfortable running your own business, or any of that stuff and you want to invest in public markets. What I would tell you is, you have to really do a lot of research and you have to settle for lower returns because of how polarized interest rates have become, which has been induced by central banking policy. 

So, that’s how I see this. And you can see this playing out with Warren Buffett. When we were at the Berkshire meeting back in May, somebody asked a question about his recent purchase of Precision Castparts Corp. And the business, I think he paid a P/E of around 30 on the business, which gives you about a 3.3% return, assuming that all the net income is free cash flow and whatnot. 

But that’s a really important thing. And when the person asked Buffett, he said, is this something that is a new norm that we’re getting a lower return? We’re paying higher premiums on businesses and Buffett and Munger basically said, yes, that’s a new norm ,and we’re going to have to pay higher premiums to own these businesses, and we’re going to get lower returns. So, [those are] my thoughts on interest rates. I’m really curious to hear what Stig has to say on this one.

Stig Brodersen  51:37  

I’m really happy you brought this up, Cory. Because a lot of investors really don’t think too much about the interest rate, especially now that it’s so low. So it’s almost like, let’s just forget it. So they’ll just act if we invest in like, there’s no interest at all. It’s more or less free money. But what you refer to is really crucial. 

What Warren Buffett talks about is this so-called 17-year cycles. And the first one that I would like to mention is the one from the mid ’60s to the early ’90s. And specifically, 1981. You saw the interest rates go up from around 4% to 4.5% percent and up to 15%. And this is on the 10-year Treasury. You just saw like interest rates in height again and again, and what happened to the stock market, it was more or less flat, even though the P rose and corporations were making more and more money. 

The stock market barely moved. And then from 1981, and then to the next 17 year cycle, then to the late ’90s as some of you might remember we’re approaching the .com bubble here, you saw the exact opposite. 

So, the interest rate was just slammed. It went down to around 4% to 4.5% again, and you saw the stock market, perform 11x. 11x in almost 17 years. I mean, it’s almost impossible to find them. They can go so fast. A huge part of that, at least according to Warren Buffett, was because of the interest rate. 

Cory, regardless of what the interest rate is going to do, we don’t know. I think there’s a lot of opinions whether or not it will stay down or go up, or whatever will happen in the current environment. What it means today is that you have the discount rate, when you’re talking about the interest rate, and you also have growth. And when you don’t have the availability, for instance, as you saw from the early ’80s, to the late ’90s to lower interest rates, you simply need to expect another type of growth. 

So to expect, call it, 10% or whatnot if you’re looking at something for a long period of time, it’s just going to be really, really hard. Because the central bank can’t go in and support the economy the way that they’ve been used to. They simply used the remedy too many times now. So I think, in new valuations, you should probably just be more modest in your growth expectations in the future.

Preston Pysh  53:52  

All right, Cory, really appreciate the question. I know Stig and I have a tendency to go long winded on some of our responses, but we really do appreciate you calling in. Hopefully it was a value add for you to hear our response. For calling in, we want to give you the brand new Intrinsic Value course that Stig and I just completed. We got a bunch of hours of content created there. We’ve got our intrinsic value calculator built into Excel, we have videos teaching people how to use this stuff. 

We even have an options portion on how to mix value investing with options based on some of the stuff that Joel Greenblatt’s written, all wrapped into this course. So we’re really excited to give this to you completely for free. If anybody else out there listening this wants to check out the course it’s on our TIP Academy on our website. 

Alright, so if you want to get your question played, like our guest here, just go to asktheinvestors.com, and if you go to asktheinvestors.com, you will see there’s a little recorder there. You just hit record and you can ask your question, and then it goes right into our queue, and if we select it and play it on the show, you get access to one of our courses.

Stig Brodersen  54:53  

Alright guys, that was all Preston and I have for this week’s episode of The Investor’s Podcast. We’ll see you again next week.

Outro  55:00  

Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.