Preston Pysh  01:11

This is what I want to say, and I think it’s important for people to understand the context of this conversation. This is happening on the 25th of June 2019. So, we’re kind of at the start of summer. Things are looking really squirrely and quite strange in many different markets. But the one that I want to start off the conversation with is currencies. What are your thoughts on the currency markets?

Luke Gromen  01:34

I think it’s important to take a step back and take a look at why the dollar is looking vulnerable. I think that is really the big story in currencies because I think we’re at a critical tipping point that is really the culmination of events we’ve been describing for around five years. So, if you go back in time, 3Q14 was the first of these critical moments, we thought. That’s when global central banks stopped growing their holdings of treasuries, stop growing FX reserves, and that led to a series of events where the US took a number of steps. They encouraged the US banking system to buy more treasuries through HQ LA regulations, and that had a critical tipping point, number 2 and 3Q16, which was when U.S. deficits percentage GDP began rising for the first time since 09.

02:16

At that moment, we said, “Look, this has happened seven times in the past. Six or seven times we had been in a recession to 12 to 18 months later. At that point in time, and basically from now until we get some resolution on global sovereign debt, you’re basically in a recession.” At any point in time, it’s going to drive some really weird outcomes. Some are some really wonky outcomes. So our bet was that you’d see a weaker dollar because that was the other release valve.

02:39

In 2017, we did get a weaker dollar, it fell 12% in 2017, which is the biggest drop in the dollar in nearly 30 years at that point. Early 2018 we get tax reform, which actually begins strengthening the dollar, sucking dollar liquidity out of the global system. So you have this period of time in early 2018, where you get the trifecta or the milkshake or whatever you want to call it: a stronger dollar, rising rates, rising equities, and all was copacetic until late 3Q18 to early 4Q18.

03:06

We hit another critical tipping point which was, actually last time we were on The Investor’s Podcast, we talked about this. It was that in early 4Q18, FX hedge treasury yields had recently gone negative and that meant that foreign investors that wanted to buy treasuries would either have to accept a negative yield if they wanted to hedge the dollar risk or go on hedge. At that time, we said that unless the dollar was weakened pretty notably, that’d be a problem for risk markets. Of course, shortly thereafter, there was the Fed pause hikes then they stopped hikes, then they promised to stop doing QT. Now it looks like the Fed’s going to have to assume cut rates and quite possibly be doing QE by the end of the year.

03:42

While we haven’t had a weakening in the dollar, we have had increasing promises of dollar liquidity increasing ever since January, and so throughout all this time, what this drove particularly since 4Q18, was the burden of funding U.S. deficits fell more and more on the back of the U.S. private sector and the U.S. banking system. That leads us to the last key moment, if you will, in this process, which was back in late March, Fed fund’s rates went over the interest on excess reserves rate that the Fed was paying or serve Fed Funds over IOER, and that shouldn’t happen.

04:14

In layman’s terms, it meant that basically the U.S. deficits were crowding out the United States’ own banking system and then the U.S. banking system was running into its own dollar shortage. It meant that the Fed was going to have to inject significant dollar liquidity effectively to fund U.S. government deficits, and importantly until the dollar falls sharply to drive FX hedge Treasury yields back to positive, the amount of dollars the Fed is going to have to inject will have to rise with U.S. deficits, which, is sure as the sun rises in the east are going to keep rising. They’ll have to do that unless they want the dollar to spike and risk assets to really come on hinge to likely driving U.S. recession. You’ve got this reflexivity, this we’ve come to a key moment like you said, in markets where it’s been five years in the making, there’s been a patchwork system that worked for a little bit then it began breaking down and breaking down more and more.

05:00

This Fed Funds over IOER is the shrill tea whistle saying the pressures are too high, the Fed needs to do something. Tying it back to the currency markets and the dollar specifically, I think the vulnerability of the dollar is really a function of the fact that there’s no one more short dollars than the U.S. government and this strong dollar of the past five years, which on some level has been a function of people ceasing to sterilize U.S. deficits, foreign central banks ceasing to sterilize U.S. deficits is now putting too much pressure on U.S. government finances and the fact that the Fed is being called into action as a function of too big a U.S. deficits and too small foreign demand for those treasuries.

Stig Brodersen  05:38

So, look, if we’re looking at billionaire Jeffrey Gundlach, he recently said that the fixed income market is basically controlling the Fed at this point. Could you please elaborate? What does he mean by that and do you agree with his assessment?

Luke Gromen  05:52

I think he’s right. I think he’s exactly right. I think some of that ties into Fed Funds over IOER, where basically was that is saying is that the Fed is losing control the price of money in the United States, right? That’s the Fed’s essentially sole reason for existing. So when you have Fed Funds over IOER, that’s telling you there’s this dollar shortage and that dollar shortage means that the price of money in the U.S. is going to be set by the market and not the Fed at an increasing rate or at a greater rate than maybe has persisted in quite some time. I think Gundlach is exactly right, that the markets are dictating the Fed and the Fed’s going to have to play along.

Preston Pysh  06:30

Luke, explain to people the IOER and how it’s basically the lending rate between banks.

Luke Gromen  06:35

So the Fed funds rate is, it’s an interbank rate. And I’m not sure it’s the most liquid market in the world, but it’s a liquid market of course, and then IO er was something interest on excess reserves was something the Fed was a policy tool they implemented after a QE they they bought all these treasuries and mortgages off the bank’s books. And so you have these what were called excess reserves that belong to the banks at the Fed and the IOU R was simply a policy tool to effectively sterilize those reserves.

07:04

Basically, as long as the banks are getting paid the interest on excess reserves rate, then those reserves will stay there. That’s supposed to have served as basically a ceiling on Fed funds. The problem is that Fed funds has risen above IOER, and really what that’s telling you is there’s no ER, there’s no excess reserves, right? They’re telling you that the demand for money is bidding between banks, they’re bidding at that rate up through the excess reserve rate, because in theory, Fed funds over IOER should set up an arbitrage where you could sell out of your excess reserves pool into the Fed funds market and capture a risk free rate.

07:41

The fact that they’re not doing that tells you that there is a shortage of excess reserves, that there are no excess reserves. When you look at how it’s broken down it tends to be amongst them, there’s one big bank with a whole lot of excess reserves as JP Morgan as it’s been described to me. Then there’s the other primary dealers who are in various states of not having as much excess reserves as JP Morgan or not having excess reserves at all. Again, it’s a sign that there’s this dollar shortage or dollar tightness within the U.S. banking system that is beginning to take control of Fed funds rate away from the Fed.

08:16

If you look at the yield curve here in Europe, it’s even worse than it is in the U.S. So, from the perspective of an investor, would you say that the U.S. is just the least bad of the major economies? Or rather, is there something that we’re missing, and a place where you would put your money?

08:33

That’s a great question. I think it’s a really important question. I think some statistically significant part of what we’re seeing play out in the global fixed income markets, and especially in the sovereign fixed income markets across the world has relatively little to do with the underlying fundamentals of each sovereign’s economy, and relatively a lot to do with global collateral needs; whether that is a bank or insurance books that need sovereign debt as collateral or whether it’s an insurance and pension liability matching.

09:02

Also, I think it has a lot to do with FX hedging markets. There’s regulatory capital or margin requirements that are mandated by regulations like Dodd-Frank here in the U.S. or Basel III globally. That requires banks to hold a certain amount of collateral against certain positions, whatever they are, and by and large, that collateral can only be satisfied with government bonds or the equivalent. So no, this need for minimum margin pulls down benchmark rates around the world for sovereign debt. That then allows corporates to issue more cheaply and buy back stock. It’s this need for collateral via regulation and has driven this virtuous cycle of new rising asset prices, both bonds and stocks.

09:39

First part is the regulatory capital needs are distorting government bond markets around the world. Then secondly, you have balance sheet constraints in FX hedging markets that we’ve talked about before, and negative FX hedged U.S. Treasury yields, price to hedge dollars is really expensive, it’s the reason that’s the case. We described that last time we talked back in late November, as I just mentioned a bit ago that that drove FX hedged yields on treasuries to be negative, it creates other distortions in global sovereign debt markets as well.

10:09

For example, right now, or at least recently, I, as a U.S. investor, I can buy a negative yielding German boons and I can sell euro forward in the currency markets to hedge the FX risk, and I can end up earning a higher one year yield than I could by just going out and buying a 10-year treasury even when 10-year treasury was at two and a quarter to four, whatever native let alone 199 today we’re close.

10:33

Of course, selling the currencies, I would have to roll that right. So, I’m taking that risk on the out years. So it’s not a perfect offset, but these FX hedging dynamics are creating all kinds of distortions like this as well. Sending capital to places that it might not otherwise go if you simply looked at it based on nominal yields alone. A perfect example, someone sent me a month or two ago that Japan had bought a record amount of French government bonds.

10:56

My guess is it had little to do with how they felt about France, or whether they thought the riots on the ground increased geopolitical risk, and probably had a lot to do with if you looked at the euro-yen FX cross rate relative to the yen-dollar FX cross rate right now. The Japanese investors have to hedge out the dollar risk. They’ll have to collect a negative 65 basis point coupon on a 10-year yield. It’s not they don’t get 1.99 if they want to hedge out the dollar risk, and they all need to hedge out the dollar risk.

Preston Pysh  11:23

That is absolutely fascinating. I’ve never had somebody explain that to me the way that you just described that and it makes total sense why you’re seeing people participating in these markets that have negative yielding debt. They’re basically looking at the spreads between the durations. That is crazy. Absolutely crazy. You just got it.

Luke Gromen  11:43

It’s really something right. I mean, if I could make someone explain it to me about a month ago, you saw euro for today and collect a 3% coupon on a negative 25 basis point 10-year German yield. Like if I could do that, sure. Then I’ll borrow in dollars and I’ll do that for the year. Come a year you’re going to have something else to figure out but it’s important to factor in the FX hedge components to it because that’s how the whales in the market are going to look at it. These multibillion, even trillion-dollar German and Japanese pension funds and insurance funds etc.

Stig Brodersen  12:13

It hardly seems sustainable to do this for the long run call it 10, 20, 30 years. So one thing is how long can we have negative rates? But the other question is given that it’s not sustainable, how does it resolve itself?

Luke Gromen  12:26

It’s difficult to say. I agree it’s not going to continue forever. You have to start looking into these FX hedging markets as an example for how it breaks down. So, when you just look nominally, it seems like a layup that the U.S. should be seeing all these capital flows because the transatlantic spreads as wide as it’s been in 35 or 40 years or whatever. Yet it’s not really working that way because basically, when I say FX hedge treasury yields went negative last fall, what I’m really saying is that hedges on the dollar went no offer last fall.

12:57

It’s interesting because last time we saw hedges on risk prior on an asset class go no offer. No real notable way it was summer of 07 and CDS on subprime mortgages went no offer. The next couple years weren’t really good for subprime mortgages as an asset class, right? So, it was a regulatory decision somewhere. The regulators tap banks on the shoulders and said, stop writing this insurance on the dollar, and they stopped, and then you started having these markets respond, you saw the pricing of dollar hedges go through the roof, which made it very expensive to hedge dollar risk.

13:29

I think you’re going to need some policy or regulatory moves that will disincentive behavior that you’re seeing whether that’s balance sheet constraints on FX hedging, whether that is collateral needs or requirements. If you came out and if a regulator came out and said we don’t need any more, you could do all this stuff. There’s no minimum margin requirement. Go crazy, then you would see a different price response or different market movement response.

13:55

I do think you’re seeing moves to escape this because it’s one thing for a German insure, they can call up Neil Goldman and say, “Yes, I want to hedge out the FX risk on a pool of Japanese government bonds,” and boom, the deal is done. You and I, we’re not going to call Goldman and ask for a quote on one year euro forwards, but you and I probably buy gold, we probably will buy bitcoin and other assets that are basically competing zero percent yielding, infinite duration, finite issuance bond equivalents.

14:28

I think you’re seeing that and not just, obviously Bitcoin haven’t done whether it’s done over the last two years, but it’s done year to date. I think you’re seeing gold breakout, which is interesting when I think you’re seeing something we’ve talked about a lot has been in the last six years. Global central banks have bought almost $200 billion worth of gold and they’ve sold about $10 billion in treasuries. So I think that process is ongoing, but as far as the one catalyst to point to that say, hey, this will happen and that’ll be the tipping point. I think it’s much more likely to be one of these esoteric regulator decisions, or something where it becomes very obvious after the fact. Now, they’re very hard to pinpoint ahead of time.

Preston Pysh  15:04

I find it interesting the way that you described that before where you’re talking about back in 2007, how you saw this play out before, but it was based on subprime mortgages. This time around, we’re seeing a very similar dynamic, but it seems like it’s a concern with currency opposed to a specific asset class. That is, in my opinion, kind of mind blowing when you take a step back and you think of the implications of that, if that’s truly what we’re seeing. Then I think what else is fascinating is in that same timeframe, you saw the bond yield curve invert, you saw the Fed start to ease before we got into a recession back in the 2007 – 2008 timeframe.

15:46

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

Luke Gromen  16:28

I think it is concerning and I think if you take a step back in 2000, we had the stock bubble. It burst and the solution to that was kick the problem upstairs to the banking system. We needed a housing bubble to drive growth, as improvement famously said. We did that and so then we had a banking system bubble and that burst and we kicked the problems upstairs to the sovereign level. It was just inconceivable that the problems would be allowed to metastasize to where they are now.

16:58

Once you’ve kicked it up to the sovereign level, sovereigns can’t go bankrupt. They can print their own currencies and pay the debt, but what that tells you is that the release valve in the next crisis in the next recession is going to have to be the currency. That then when you take a step back and say, “Well, everyone’s borrowing so much in dollars as a funding currency by virtue of this euro-dollar system, and really, the euro-dollar system going back 40 – 50 years, the more you look into it, the scarier it gets. The reason I say that is because in the last crisis, the problem was with the big brokers that were allowed to be levered up 30 to 60x.  They had a small move against them, and it blew up the system.

17:37

The challenge is that we’ve kicked it all upstairs to the sovereign level. The euro-dollar system where everyone’s borrowing dollars. There are no reserves in the euro-dollar system. It’s infinitely leveraged so the only people who can create the dollars are the Fed. So, we’re moving to this point where it’s put up or shut up time, and what’s really interesting is it’s sort of like a tail wagging dog. This kind of ties into that no good luck point that you raised earlier, which is that the euro-dollar market was supposed to be separate from the onshore dollar market, if you will, that the Fed controls but that the offshore euro-dollar market has been allowed to become so big and has no reserves against it.

18:18

We loved that because that helped enforce dollar hegemony, it lowered our borrowing costs, gave us a great deal of political control all over the world. Lots of really, really neat things that we liked in terms of the benefits on the upside, but now it’s gotten so big. It has put the Fed in a bind, where basically, the Fed is either going to have to create enormous amounts of base money to basically bail out the world or what about two other things will happen. In my view, number one, the world will basically implode; the dollar will skyrocket, you’ll have risk off, Treasury yields will go probably to zero or lower, equities would crash, home prices would crash, global economies would crash, global trade will collapse.

19:00

The worst parts of the depression will happen until the Fed prints enough base money to fix the problem, or this is something that I think is very underappreciated; as an option, a political option is there’s a real chance the reason the world and global credit or central banks, in particular, have been buying and repatriating gold in the fastest pace in 50 to 60 years has been to give themselves optionality. Because now, this euro-dollar system is clearly under stress.

19:26

We’re seeing that in bond yields, you’re seeing it in the plumbing of the money market system we were talking about before, if these foreign central banks didn’t have gold, they’re stuck there at the Fed’s whim, but now they can get in the room with the Fed and say, “Look, you’ve got to create all these dollars to reliqufy the system,” and if the Fed says no, we’re going to let you twist in the wind, then they have the option to say, “Well, that’s fine. We’re going to remonetize the gold at a much bigger number and that will be the end of the dollars reserve status as currently structured and it’s going to go back to pre-Bretton Woods with gold at $5, $10 or $20,000 an ounce or whatever is needed to reliquefy the system and lubricate trade, devalue the real value of debt.

20:03

I think our paths from here is either number one, the Fed basically creates a large amount of base money to reliquefy the euro-dollar system. It’s a huge number because it’s basically infinitely leveraged, or you get a period of time where the Fed lets everybody twist in the wind and the system. That’ll be a very scary world, you’ll want to own dollars, you’ll want to own gold, you’ll want short dated treasuries. But that’s not a world that’s going to be allowed to persist for very long because trade lines will break down. You’ll see shortages in parts of the world, etc. Or you get these forces, a move to a new reserve, a primary reserve asset where either gold gets remonetized or you’re not seeing any SDR bonds. So I don’t think that can be it. I bet if you watch what everyone’s doing, it has to be gold.

Stig Brodersen  20:48

Silicon Valley is plowing money into crypto and Bitcoin, in particular. Is that a system that could work if you compare it to the monetary system we have now or even the gold-based system that you briefly mentioned here at the end.

Luke Gromen  21:03

I think it could work. I had an interesting conversation with a hedge fund manager. I was out at a conference on the West Coast about a year and a half ago.  He made an interesting comment to me over cocktails. He said that all his friends in tech, they almost have a proverbial trophy wall where they have the scalps of all the industries that tech has disintermediated and there’s that the big white whale that they want to disintermediate. They haven’t been able to get the banking system, and when you look at crypto through that lens, that would absolutely accomplish that.  I think it would be a very free market capitalist method of doing that.

21:42

I mean, you see what Bitcoin has done, Bitcoin has done what gold should have been doing all along, except gold had a hundred times or more levered paper market attached to it that basically diluted what should have been happening to gold’s price. It’s been happening to bitcoin’s price, so they tried to put some futures contracts attached to it to dilute what’s happened. But what’s happening is in Bitcoin terms, the dollar is hyper inflating. That’s basically you go from 100 to 11,000, that’s hyperinflation in the span of three years.

22:09

I think what they’re all doing could absolutely make moves in that direction that basically render the central bank powerless. Now, the challenge in it, I think, is less from a mechanical solution. I think the challenge in it is political, because now you’re talking about who gets to dictate money. That has always been the role of the state. They have always used the threat of or actual violence to enforce that right. You saw there were comments from I forget which representative or senator about a month or so ago, but basically, he’s calling for the outlaw of Bitcoin because it takes away the sovereigns right to issue the currency and manage that for their own purposes.

Luke Gromen  22:46

So Bitcoin on some level would defund the government now or move in that direction. It would force not the fund, that’s not the right word, but he would enforce a discipline on the U.S. government, in particular, that hasn’t existed since Bretton Woods, really. In that way, if tech were to get Bitcoin into that as a neutral bank core role, as Keynes envisioned it at Bretton Woods rather than gold, to me it’s six to one,  half dozen to the other, you’re getting to the same place.

Preston Pysh  23:15

Back in the bull market in 2017, when Bitcoin was shooting up, and I think it hit around $20,000. You actually saw some discussion actually hitting the press room at the White House in reference to the meteoric rise of Bitcoin. So then Bitcoin has a meltdown for the next year, year and a half. It’s almost like everyone in politics kind of stopped talking about it, like all that’s just going to go away. But during that period of time and that lull, it seems like everyone in their kid sister on Wall Street, in Silicon Valley just further became entrenched into bitcoin and other crypto coins.

23:58

It became just a way of doing business in finance, and it’s completely accepted. You can’t talk to anybody that hasn’t heard of Bitcoin. Every single person has heard of Bitcoin. Especially anybody in finance has heard of Bitcoin. So I guess my question is this, has that lull and the entrenchment around Bitcoin, where now you can go on to all these different platforms. I mean, it’s hard to name a finance platform where you can’t go on there and buy bitcoin in some shape or fashion or have access to some type of vehicle that trades off of the price action of Bitcoin.

24:36

There’s just total entrenchment at this point, there’s derivatives around it. I mean, there’s all sorts of things around it. So can the government at this point, do something about it? Or are we so far down that path and so many people invested that this is now a thing, and this is a thing that’s not going away?

Luke Gromen  24:52

I think it’s a thing. It’s not going away. I mean, I asked at that same conference, I forget the monetary guy, but I said could the government just ban Bitcoin and his reply was, “No, not if we want to have an open capital account if the United States wants to have an open capital account, you can’t impose capital controls in any way.” Now, there are things you can do to control Bitcoin and I think one of the things I would have done is launch a futures contract, a cash settled futures contract and hopefully it gains a lot of traction because that’s how you’ve been able to control gold.

25:22

Once you have a cash settled futures contract on a monetary asset and by monetary asset, I mean a very high stock to flow ratio. You can have futures contracts on oil, but ultimately the stock to flow ratio on oil is  1.2 So, you can’t separate the paper market from the physical market for very long. You can do for short periods, but not for very long, ultimately the physical market will rule out. In gold, you have a 65x stock to flow ratio, Bitcoin might be even higher, so if I was the U.S. government wanting to control Bitcoin, I would do what I did with gold, which is I would get a really robust large cash settled futures market because when you cash settle a monetary instrument or monetary asset with a high stock to flow ratio, you basically shift price discovery from supply demand to whoever has the biggest balance sheet.

26:08

You basically turn the market into a high stakes poker and high stakes no limit poker game, between me and a billionaire. I might have a royal flush, but he will show up and go hundred million dollars. He’s just going to wait; I don’t have the hundred million dollars.  You’ve seen that in the gold market. They push the gold market around that forever, where they get the critical tipping points and someone comes in with 6 billion for sale at two in the morning in New York and boom, you can push the market around, push the pot around to continue the metaphor.

26:33

I don’t think the government can control it. I think it’s an entrenched thing and it looks like they’ve tried to do some of the futures contracts. To me it’s really interesting. There are two futures contracts. It was a CBOE and then there was I think the CME, and they shut down the CBOE, the smaller of the two contracts for lack of interest back in March and Bitcoin was at like $3,800. As soon as they shut down that contract, maybe it’s just coincidence, but it’s tripled since then, in three months. It’s been interesting to see that.

Preston Pysh  27:01

As we continue down this path of crypto and privatized money, or should I say money that is not dictated by a single government, Facebook had a huge announcement this past week talking about coming out with their own coin. One of the ideas that I heard, a long time ago, probably two years ago, is this idea of privatizing decentralized applications. So, if we come up with a decentralized application, adapt for short, think about replicating Facebook, if somebody goes out there and creates a protocol that replicates Facebook, and now all of a sudden there are coins based into that protocol, those coins can now be used as the currency between the people that are running advertising and then the people that are using the platform.

27:43

So it’s almost a peer to peer kind of transaction, if you’re on this decentralized application, call it Facebook with crypto coins attached to it. Now all of a sudden, the advertiser can come direct to the people that are using the platform and you actually get money for using the platform. I’m sure that’s not Facebook’s intention here, but maybe Facebook could give a small miniscule cut of the funding off of this coin to the users of the community that are using their platform. Then that small amount that would be paid to the users, the advertisers have to use that currency inside of the application.

28:21

Now all of a sudden, you got everybody using that currency, because they’ve got millions and millions of users and all of a sudden that has a whole lot of value because of the utility that’s applied to the platform. So that’s the idea. That’s the thesis of whether something like that can happen. So, what are your thoughts on if one company can do this, or one group of programmers can establish a protocol with crypto coins attached to it to pull off this model? Why can’t there be others and it just further becomes smooshier as to what currency becomes in the future because you have decentralized applications that might be replacing government money. I’m sorry, I talked so much there. I guess I’m just trying to explain what it is that I understand this to potentially be. Is that something that you’ve heard? Or have you heard anything that’s different as far as money becoming privatized?

Luke Gromen  29:07

Yes, I read an article on *inaudible* about Libra. It was arguably, if I would have just changed Libra to Fed, it would have been the single best most succinct anti-Fed diatribe I’d ever read in my life. It was really interesting when you spin it that way. To me, it speaks to your point that clearly it is part of a threat to what is money? What is currency? How does government control that? How is government able to use that to tax etc.

29:40

It’s very interesting because ultimately, the MMT and the monetary purists will tell you that you can only pay your U.S. taxes in dollars then that’s that. Now you get in Ohio State of Ohio where I live now I can pay my taxes in Bitcoin, so my tax bill has evaporated this year.  I own some Bitcoin, whatever taxes I own Ohio, I probably earned 10 years’ worth of taxes in the last two months, right? I think it’s just this weird Twilight or Nowhere Ville in between the system. That it existed for a long, long time in this new system.

30:14

What I don’t know is when you have a bunch of people issuing a bunch of currencies, do you get into like what you had before you had a national bank in the U.S. where everyone’s issue in local currencies and bonds, and you don’t know who to trust? Now, the technology, the verification measures go a long way in preventing that problem. I think the bigger thing is just taking the power of monetary issuance away from the government, and ultimately, the reason the government wants to hold that is because they touch the money first, they can spend it first, they can inflate, and it doesn’t hurt them as much as it hurts others. All of these benefits of particularly holding the reserve currency but issuing any currency.

Stig Brodersen  30:49

Luke, I come to think of a question now that you mentioned that you can pay your taxes in Bitcoin in Ohio State. You have other states, California, for example, having so much debt that we don’t know If they ever get out of it, and they don’t print their own currency. They use dollars. Could these states turn to currencies as a way to protect themselves? And if so, do they have a strategy for it?

Luke Gromen  31:13

It’s a really interesting question. I hadn’t really thought of it because you’re right, like I’d love to think my home state is really thinking about this in those terms, but I would say it’s slim and none that they’ve actually thought about it. Then again, Texas just opened up their own statewide gold vault. They went to Manhattan and said we don’t want our gold in Manhattan anymore. We want it in the state of Texas, and we want it in our vault, and the state senator who did this was a really champion. That was arguably either very right wing or libertarian leanings. Not that there’s anything wrong with that.

31:46

I think his motivations were probably not, “Hey, we’ve got a pension problem and the way we can fix this pension problem is bring back a reserve asset of some sort and, we inflate the crap out of it.” Or we go to our public unions and say, “Listen, we will give you a stake in Bitcoin or gold in the state vault at discount today, and you can write checks out of it today, or you can just hold on to it. As the money is printed to fulfill all these obligations, we can work our way out of these things.” It’s the same thing that global central banks are doing or appear to be preparing for just, writ small, but it’s something that would work, but I think I’m giving them too much credit at this point. It is a possible solution.

Preston Pysh  32:31

So what do you think is the most important thing happening in financial markets today?

Luke Gromen  32:37

Oh, by far and away, it’s the persistence of Fed funds over IOER, in my opinion. You’re signaling this dollar shortage in the U.S. banking system and the root cause of the dollar shortage in the banking system is the combination of falling foreign U.S. Treasury demand because of falling surpluses overseas and rising dollar hedging costs and then rising U.S. Treasury supplies. You have falling demand and rising supply because of rising deficits. We’ve long been saying that we’re structurally bearish on the dollar because there’s no one more short dollars in the U.S. government and when push comes to shove,  the Fed’s going to be forced to effectively fund the U.S. government and Fed funds over IOER is the warning gauge that pushes coming to shove.

33:14

What we’ve been watching the Fed do year to date culminating in last week’s meeting, start to set the narrative for what will effectively be the Fed financing U.S. government deficits likely for the foreseeable future. There’s been this discussion around what the Fed’s doing. It’s all been centered by and large, based on what everyone has known over the last 20, 30, 40 years of their career. Well, inflation is not that high, or it’s too low, or what’s unemployment doing, or what’s GDP growth doing? That’s the narrative and that’s the discussion and the reality is that the reason the Fed is doing what they’re doing has very little to do with any of those things. So that we spent all our time worrying about and very much if not all to do with this dollar supply issue.

33:55

This dollar shortage issue in the U.S. banking system that is ultimately being driven by a U.S. fiscal problem that is a function of too much supply and not enough demand. So to me, the Fed funds over IOER is just the shrill warning whistle like it’s the starting gun. I think we’re going to get our Fed rate cuts, and then we’re going to get our QE and people are going to be surprised at the whole thing. But I think the quorum of investing public is not aware of this, they’re going to catch up quickly. People are smart. I think as they start to realize that what the Fed’s doing doesn’t have anything to do with inflation, unemployment, or GDP growth, and has everything to do with effectively funding the U.S. government who has a fiscal problem.

34:32

Ironically, when you have fiscal crises in any other country, it’s very bearish for assets. It’s bearish for the currency, drives higher yields. For the U.S., I think it’ll be very, very good for risk assets. I think it’ll be bad for the currency, but I think it’d be good for yields. Yields to go where the Fed says the yield should be and they have the ability to shape the yield curve and do whatever they want. They just have to let go of control the quantity of money to control the price of money. So, I think far and away, that’s the most important thing.

Stig Brodersen  35:00

Knowing that, I’m just really going to put you on the spot here. If you could buy just one thing and not touch it for at least a few years, what would you buy?

Luke Gromen  35:11

I’ll do two things and probably 50:50, gold and Bitcoin. We’re going to do some other things. It would be,  emerging market assets, which haven’t moved in 10 years, it would be commodities that are at 100 year lows relative to financial assets, value stocks in the U.S. relative to growth. I think if you bought a basket of gold and Bitcoin in emerging market stocks, and U.S. value stocks and commodities, and didn’t put it on margin and fell asleep for two years, I think you’d be really, really happy.

Preston Pysh  35:38

I’m kind of curious if there are any billionaires out there that you pay particular attention to. I know we were talking about Jeff Gundlach earlier, but is there any that you pay particular attention to? And is there anything that any of those people have said that have kind of made you go, “Hmm, that’s kind of interesting.”

Luke Gromen  35:54

I’m always watching as much as I can and I’m what I’m looking for is the old game the Sesame Street. Like which of these things is not like the other, right? Where’s the change in behavior? So, the first one that really grabbed my attention earlier this year was Sam Zell. Back in January, Sam Zell said that he was buying gold for the first time in his entire career. Zell is 75 years old. He said it was due to it being a good hedge and because the supply demand picture is incredibly attractive, and basically, we’re at peak gold. So, Zell is a guy who’s not that vocal, but he has consistently gotten the very big things very right.

36:28

Perfect example is back in ’07 when he sold equity office products or equity office properties to Blackstone at basically the top. So that was interesting enough for Zell, but then a couple months later, Zell at conference comes out and says Trump’s right; the economy would do better if the Fed cut rates by 100 basis points, but that it could put the dollars reserve status at risk, which Zell thought was the biggest risk to the U.S. economy right now.

36:53

So you’ve got a guy like Sam Zell, he buys gold, he’s not going to come out and say, “Hey, I’m buying gold because I think the dollars reserve status is at risk.” I think you don’t get invited back to the cocktail parties, right? They look at you funny. They think you’re an alright guy or something. So you say, “Hey, I think supply demand’s attractive and I think we’re at peak gold,” which is still true like that’s a totally valid reason, but he did not mention the fact that you’ve been buying gold when he came out and said, “Look, the dollars reserve status, I think is a big risk.”

37:20

So, when you put those two together, those appearances two, three months apart, I thought that was really interesting. Then the other one that got my attention recently was Warren Buffett. He put in $10 billion into Anadarko Petroleum. Again, he flat out said it’s a long-term bet on oil prices. As far as I know the last time Buffett made a big bet on oil production was in ’03 when he put a bunch of money into China oil.

37:45

Of course, ’03 to ’08, oil had a pretty good little run there so nobody’s more tied in with the U.S. government than Buffett. He’s been around. Solomon needed a backer, it was Buffett. Long term capital he got showed that book. He was involved with Goldman and Bank of America and the crisis. He is extremely politically tied in with the U.S. government. So, when he’s putting 10 billion into Anadarko, in an industry he doesn’t particularly like, it hasn’t done a lot in but has done in the past in a big way and done it well, that caught my attention for sure.

Stig Brodersen  38:14

So, when we’re talking about Bitcoin should we talk about in the same breath as gold? Are they taking market share away from each other? Are they serving different purposes? How do you think about all these, Luke?

Luke Gromen  38:25

I think they should be discussed together. I think to oversimplify probably, but I think both are being used as neutral reserve assets by people around the world. I think Bitcoin as I noted earlier, it’s doing what gold would be doing if it didn’t have a gigantic paper market attached to it. I actually think blockchain plus gold is a killer app. Some of the Bitcoin purists say, “Hey, gold is dead. It’s never going to come back at that asset,” but blockchain is married to gold, and I think it’s just a matter of time until it is. If that’s going to force the deleveraging of paper markets, paper gold markets that are levered by some estimates 100 extra more.

38:57

So basically, it’s interesting. I think there’s a lot of reasons to own both, gold moving back into the system, I think Bitcoin’s serving as a neutral reserve asset for the people. But the interesting thing is, if you put blockchain and gold together, you’re going to take the opacity out of a market that’s levered as much as 100 times paper to physical. Suddenly, what you conclude is that blockchain’s married to gold. It could drive gold to Bitcoin, like returns over time if that were to happen. There’s a lot of different people trying to do that. So to me, buy in both, put them away, and I think you’re going to be pretty happy. So I like thinking about them both.

Preston Pysh  39:35

Alright, Luke, we can’t thank you enough for coming on the show. We really look forward to each one of these discussions and you’ve got a new book out there. It’s called Mr. X Interviews. We’ll have a link to it in our show notes, but if people want to learn more about you, give them a hand off where they can learn more about you, Luke?

Luke Gromen  39:50

Sure, thanks. So we’ve got an active Twitter feed @LukeGromen. You can check out our firm’s website FFTT-LLC.com, that’s Frank, Frank, Tom, Tom dash LLC. Get updates on what we’re up to, what we’re doing, and our latest product we rolled out which was Tree Rings as a 10 most interesting things. Synopsis of what we’re seeing in any given week, and it’s actually been a really popular product. We’ve been getting rave reviews about it, you can find out more about that on our website. Other than that, thank you very much for having me on.

Preston Pysh  40:20

We love having you, and we’ll have links to what he just described in our show notes. So, make sure you guys take the opportunity to check that stuff out. Luke, thank you so much for coming on the show.

Luke Gromen  40:29

Thanks for having me on. It’s been a blast.

Stig Brodersen  40:31

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

Outro 40:38

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.