Luke Gromen  2:25  

Banks seem like they’re in a bit of a tough spot. The reason I say that is it’s a little bit of it… the banking industry for a long time in this country was heads that went in tails, in a way. They did well and for a long time, I think they’re in a bit of a tough spot. 

The reason I say that is, if the government does enough in terms of stimulus, the banks look like they are being regulated into being basically utilities that buy treasuries at negative real rates. If things go fine, the percentage of their balance sheet that is in treasuries yielding negative real rates, is likely to increase over time. 

If the government doesn’t do enough, then we have a big economic problem and credit problems. It’s sort of the best case for them is to increase their holdings of treasuries at negative real rates. It’s not a terrible deal for them. The funding costs are very low. They changed the SLR rules a year ago or eight months ago, I should say now. 

It’s very little funding cost. It’s a positive carry for them, but they’re likely to be negative real rates over time. 

To me, it’s not to say that banks can’t go up, but I think it is a case where over the course of the next cycle banks as a percent of total, call it S&P market cap, if you will, are likely to shrink relative to other sectors because their balance sheets are growing in terms of treasuries. 

Treasuries are very likely, in my opinion, to be negative real rates over the course of this cycle. They need to be for the US to basically earn its way out of what we’ve just gone through.

Stig Brodersen 4:05

Yeah and whenever we look at the Triple P loans without hearing Q2, that was big for the banks. That’s some of the highest bottom lines. Also, if we look at the top line, let’s just say JP Morgan here for Q2, the top line… In other words, the revenue hit $32.9 billion and that was up from Q1’s $28 billion.

Luke Gromen 4:27

For me, when I look back, we hear a lot that, “Hey, if you look at the Fed’s *inaudible* report for aggregate banking and commercial banking sector lending, it has been declining CNI loans. 

There’s been one line item that’s been growing spectacularly for the past four or five months and those are loans to the government, US Treasury and Agency Holdings, which I think in June were up 48% in July at 37%, August 24%. I think September is the latest date and they were up 17% or 20%. 

However, the portion of their loan book that is represented by treasuries and agencies is growing meaningfully relative to the overall loan book, which I think is now positive. Again, for most of those four months, I think it was negative, but it’s interesting. 

When you look back to the April timeframe, as we were just coming out of the very bottom of the COVID crisis, the Treasury Bond Advisory Committee talked about that the US banking sector looks to be a very good place and a sector that could buy a lot more treasuries as they were looking for areas of potential balance sheet capacity. They could buy treasuries. 

They specifically cited that, “Hey, right now, the banking system in the US in total, about 5% of assets are in treasuries. Last time, the US debt to GDP was as high as it is, was 1946. Back then, you saw the US banking system balance sheet get as high as 50% of the total balance sheet and treasuries.” 

From a macro perspective, I kind of thought about that, the price target for what percentage of the US banking system balance sheet, and it could be taken up with treasuries over the coming years, at the high end is in that 50% range… Just from a very top down level of saying, “Hey, last time, we were in the same type of situation, which is to say very high debt to GDP, very low foreign purchasing of treasuries as a percent of total issuance.” 

You saw the banking system take a lot of that off. You’ve seen the regulations changed between April and now in terms of those SLR regulations, to make it a very attractive positive carry for the banks. 

Therefore, for me, the banks are a little bit of a tough spot. I think there’s the share of their assets that are in treasuries that are likely to be negative real rates over the course of this cycle, probably on the way from 5%, as of earlier this year. 

I don’t know where they are now. They’re probably modestly higher towards something meaningfully north of that. That’s not a bad thing. 

It’s just I think there’s going to be more attractive, higher ROI returns on capital within the economy. That just implies, like I said, a shrinking of the bank share of total equity market cap in the United States, if you will.

Preston Pysh  7:12  

It’s fascinating, while you were talking there, I was pulling up some of the figures for various banks and how I had mentioned earlier, JP Morgan’s went up. Their top line went up in the second quarter of 2020 when COVID hit. 

Wells Fargo went from, in the previous quarter before COVID, it was at $13.7 billion on their top line. COVID hit the second quarter and it was $8.3 billion. Wow, they got hammered. Then it came back in the third quarter to where they were at prior to COVID. 

Now, the Bank of America is completely flat. They basically retained their $22.3 billion. It’s really fascinating to me that you’re seeing these permutations in these banks that are all too big to fail, right? 

Every one of these banks are too big to fail. But yes, you’re seeing a pretty wide divergence in performance through that event. I guess the reason I’m bringing it up is because there are more Triple P loans. These are not going away.

If we think that we understand how that performance played out during those previous events, now, it might not be as well, who knows? It could be exactly like the liquidity crunch we saw during COVID. Do you see that as a barometer for the way that they might perform moving forward? 

Luke Gromen  8:26  

To me that’s the $64,000 question. You got me speechless. As my wife would tell you that that rarely happens. It could be too late, I suppose. For me, it could be too late if you’re a very nimble trader. 

If you’re running a big portfolio that we’ve seen, they’re not going to let you twist in the wind for very long now. That said, it could be painful for a period of time, days, weeks. I don’t think we’re talking about months anymore, even if we were in the fourth quarter of 2018. Let alone quarters like we were in 2011 or 2008. Just given where we are in leverage. 

I think that’s really maybe the biggest legacy of the COVID crisis that we’ve been talking about a lot is that a number of the metrics in 2018, where you’d say, “Okay, the big three: US expenditures, entitlements, defense and interest expense, gross interest expense, we were watching that in early 2016. We were saying all right, it could be over 100% of tax receipts by 2021.”

Lo and behold, 18 months later, because the Fed raised rates and because the economy slowed, those three actually went above 100% of tax receipts by Q3 2018. 

Then, they’ve continued to trend higher. Well, those big three coming out of the COVID crisis as of Q3 2020, were 140% of tax receipts. Entitlements, defense and gross treasury expense, which was primarily a gross interest expense before, but it jumped enormously during the COVID crisis, according to the Treasury TBAC data. 

I think there is gross Treasury expense plus some of the Treasury stimulus stuff or backstopping stuff they were doing as part of COVID. I don’t know if that’s purely apples to apples, but at the same time, we can also say if they took it away, GDP would be shrinking even faster and tax receipts will be shrinking faster. 

The point is those three line items in the TBAC went from, call it 85% of tax receipts in 2016 to 140% of tax receipts in the third quarter of 2020. 

COVID took what was an incipient fiscal problem balance of payments problem, and made it irrecoverable. I mean, they are in the full year of pilot. The Top Gun flat spin, there’s no pulling out of it. There’s some things you can do, but it’s irrecoverable. 

People say, “Well, if there’s a *inaudible* the US is a reserve currency, it can’t have a balance of payments problem.” 

Well, you’re right and that’s what we’ve been seeing for the last 12 to 14 months. I think we’re going to see more of that.

Preston Pysh  11:17  

As a person who likes to just look at patterns, right? I suspect that the more that you step in and start manipulating the market, and there’s a pattern that kind of shows up… 

Everyone who’s watching this is saying, “Oh, well, this is what worked last time when they stepped in and did this. Now, I’m just going to hit the copy paste button here and do this all over again.” 

If there’s one thing we learned from COVID, it’s that tech was a major winner coming out of the debasement of the currency. Let’s just play out the scenario where they wait too long and they don’t provide enough stimulus. They have to step in because there’s just a major liquidity crunch like we saw previously with COVID.  

I would think that a person is looking for some type of technical limitation or they’re looking at how much the government arrives at the table. I suspect they’re going to arrive in a form that triumphs anything that we have seen historically, as far as  debasement goes. I mean, if they did five last time, I guess I’d naturally think they’re going to do double that. Enormous numbers, like numbers you can’t even fathom. 

Do you step into that trade, again, into the tech, Google, Amazon, Apple companies that you know are just going to continue to perform? Do you buy that equity?

Luke Gromen  12:36  

I buy that equity. I buy US industrial equities. I buy gold. I buy bitcoin. I buy all those things. I will step into it again, because the thing that gives me the comfort to do that is the big gears of what we’re talking about, which is debt to GDP is now 135%. You cannot allow GDP to fall for very far and for very long, because you get into a debt spiral.

You have the three big gears of your government: entitlements, defense, and interest expense 140% of tax receipts. Tax receipts are falling sharply as a result of all this. If they don’t do enough and fast enough, your entitlement bill doesn’t go down. It goes up, your defense bill isn’t changing. If anything, it’s going up. Your interest expense isn’t really going anywhere, per se. 

However, as we saw on COVID, if the Treasury does some special stuff, they’re going to do some… When you look at that, you’re 40% short relative to tax receipts on those expenditures, which are non-negotiable. You can’t skip any of those things.

I think that’s a key point that the listeners should really pay attention to because you are talking about these three items. They’re just so important to understand. They’re non-discretionary expenses. Entitlements, defense, and interest expenses have to be paid no matter what. Right now, we had 140% of tax receipts and tax receipts are falling.

Let’s pretend they don’t do enough. How quickly will the Fed step in? Well, you can say okay, 140% of tax receipts. If you did nothing, you’ve got well less than a year before you default on one of them, right? 

You literally don’t have the money if you’re just paying *inaudible*. Then you say, “Okay, well, I’ll just borrow the money.” 

Well, who is fining the treasuries? The US net international investment positions are negative 60% of GDP. The foreigners own a gross $40 trillion in assets, net $12 trillion in assets, dollar assets. 

If you don’t do enough the dollar is going to be going up. The dollar debts they owe are going to be squeezing them. They are going to be liquidating dollar assets for dollars and they’re going to be selling what they can, not what they want to. What they sell that they can is the “deepest most liquid market in the world treasuries.”

So the government now needs to sell treasuries to finance this 140% of tax receipts for big three items. They’re selling treasuries. Foreigners who own $11-12 trillion in US assets are going to be selling treasuries for dollars. 

Mom and Pop are going to be selling treasuries for retirement. Businesses who are holding treasuries are going to be selling treasuries. Banks who own treasuries for high quality, liquid asset purposes, for regulatory reasons so that they have proper liquidity in a crisis are going to be selling treasuries. There’s trillions of treasuries for sale. 

Where’s the bid? Who’s the bidder? The Fed is the bidder. That’s it. That’s why I say I step into that trade is, it’s gonna be uncomfortable as heck possibly. If they don’t do enough, you could absolutely see this sharp sell off and this sharp dollar spike, and it is going to feel terrible, just like it felt in March. 

However, my bet is the US government will not be the first government to allow itself to be shut down for lack of printed fiat currency in history that I’m aware of. 

Preston Pysh  16:03  

Yes, I think that the scar tissue from the early 1930s is so deeply entrenched into policymakers minds, as we’re never going to go down that path again. 

When you look at how that played out initially from 1929, up until they basically relinquished themselves off of this gold standard in 1933, it was a deflationary spiral. 

The reason being policymakers were well if you’re not competent enough to run your business appropriately and have savings for rainy days, then you deserve to fail, right? 

You literally have the exact opposite line of thinking from policymakers today than what you had during that period of time.  

I see folks on Twitter from time to time that are posting these charts that are analogous to the 1929 Great Depression, and it coming down and all that kind of stuff. I’m looking at that and I’m saying, “Yeah, you might see like liquidity shocks that are somewhat mind blowing how quickly they dropped 30% or whatever, but the policy response to that is going to be so drastically different that I just don’t see it playing out as a one to one kind of scenario like what happened back then.”

Luke Gromen  17:22  

I agree, it is different. From 1929 to 1933, the market was falling in dollar terms, but it was really falling against gold because it was a gold-backed dollar. If you look at for example, the equity market since Q3 2018, it is down versus gold. It has fallen versus gold. 

You look at the equity market since 2000. It is down tremendously in gold terms. I think that’s one important thing. 

I think the other thing that is really kind of stuck in my craw chart is that I saw it and it’s a brilliant chart by Dan Oliver at Myrmikan Capital. He gave a presentation on Real Vision back in March. If you haven’t seen it, it’s excellent. I’ve had dinner with him before. He’s brilliant. He’s a gentleman.

One of his investment letters back in May had this tremendous chart and it showed the price of gold in German Reichsmarks from 1914 to 1923. So at the beginning of World War One, when the Germans went off gold and said, “You know, we’re just going to print the money to pay for the war and we’re going to make the losers pay for it,” which is what everybody said World War One through 1923. 

1914 to 1923 is one of the, particularly 1918 to 1923, 1920 to 1923, one of the great currency hyperinflations of all time, complete currency destroying hyperinflation. *inaudible* shows the price of gold in Weimar German marks go from 14 to 23. Ot does what you think it does. On an annualized basis, it’s a hockey stick up, currency gone. 

However, the fascinating thing that I didn’t know until I saw this chart was I think he has it month over month. What is shown, the month over month returns on gold as the yearly return was the currency was hyperinflation at zero. 

The month over month returns on gold, if you were levered… because you would think, “Okay, well, the currencies are going to hyper inflate. I want to borrow as much as I can and buy as much gold as I can and I will be rich.” 

The reality is if you look at how gold traded in a hyper inflating currency, if you were levered, you lost all your money four or five different times, because there were periods where you just said these air pockets you hit… There’s any number of reasons that that happens. A lot of them in these situations are very political. 

A certain leader gets elected, a certain leader in Germany’s case gets assassinated, whatever the case was. I mean, there were times when the German Reichsmark rose significantly against dollars for a few months. Gold got killed and then sort of a longer.

The point is I think, very supportive of what you just said, which was that you get these counter trend moves, but it just doesn’t when you’re in this purely fiat system, that you’re going to get these… 

When I see the analogs of, “Hey, this is 1929 and we’re going to have this for years down in equity markets,” I just don’t think that’s going to happen because it’s an apples to oranges comparison. It was comparing gold then versus dollars now. 

The equity market effectively is the economy now. We’re highly indebted so it is the economy. It is a circular doom loop they’ve created via policy over the last several decades where they’ve got to have stocks rising to be able to keep the wheels on the cart as it relates to the fiscal situation. 

Preston Pysh  20:38  

I just want to tell the audience so while you were talking there, and your comment about gold, if you price the S&P 500 in gold, it’s down significantly since 2000. I went and I plotted this out. I priced the S&P 500 in gold, it is down 65%, in terms of gold since the year 2000. 

I had no idea it was that much throughout that period of time. If you go to… let’s see here, the 2008 timeframe, the top… Wow, that is just crazy. I had no idea it was that much, Luke. 

Luke Gromen  21:11  

Yeah. 

Preston Pysh  21:12  

From 2008 until now, it’s pretty much flat. The S&P 500 has not even gone up at all

Luke Gromen  21:19  

In nominal terms or dollar terms?

Preston Pysh  21:21  

In gold terms.

Stig Brodersen 21:23  

Luke, you mentioned about pension plans there before. You have the baby boomers who are about to retire. The investment managers have them in a ton of bonds with no yield. How’s this going to be played out? 

Luke Gromen 21:35 

You’ve got a highly indebted government who needs negative real rates and a retirement populace who wants to own these bonds. It’s really these two… The power of the government against the individual pensioner. Like I saw Russell Napier’s quote saying, “It’s robbing old people slowly.” It’s how he phrased it.

As I was reading it, I literally laughed out loud when I saw him say that. 

When you go back to again, the last time the US was in this position, fiscally, which was right after World War Two, debt to GDP is higher this time. Entitlements are higher this time. Medicare and Medicaid didn’t exist, then. 

Foreigners are not buying nearly enough treasuries. US real rates were negative for the majority of the next 35 years. 

When you look at how the USD leveraged from, we were at probably I want to say 125% of GDP or maybe 130% of GDP in 1946. By 1980, we were 30-35% debt to GDP.  That was made up of if you look over those 35 years, US nominal GDP consistently ran at a 500 to 800 basis point premium to the 10-Year Treasury yield. 

The three recessions, real rates would go positive for like a cup of coffee and then they would shoot right back to this. Some of that was tremendous productivity, growth, tremendous demographics, tremendous technological growth, but it was in the end, also massive financial repression. 

If you are a bond holder, and your GDP is nominally growing at 500 to 800 basis points above your coupon, you’re making a donation on a real basis every year in terms of your purchasing power.  

I think that’s where this movie’s going. There are things that are very different this time in terms of the use of treasuries as collateral. Some of this inherent demand for treasuries, regardless of the coupon that it’s not all about mom and pop and pensions drawn a coupon on this. 

I think ultimately the broader lesson holds, which is one way or another, they’re going to get their nominal GDP to make real rates relative to nominal GDP, in particular, significantly negative that de-lever their way out of this.

Preston Pysh  23:56  

Luke, I don’t think of it It helps that when you look at this older population, being in bonds for the last 40 years, especially long duration bonds, has been one heck of a trade. You really could not get a more slam dunk trade. 

I mean, when you look at Bill Gross and the fact that he left during that era that he was doing what he was doing it, there really… I think I could put a mannequin up against him and it probably would have had a similar amount of performance. It would have been a stellar performance.

Luke Gromen  24:33  

I don’t know if I go that far. He was pretty darn good. But you look back at what he did, especially with the size of the fund he was running later in his career, he put up some numbers. I was always on the equity side. That kind was over there but you look at his numbers and the size of his funds, sometimes you go, “Man, put your broader point.” I get it. 

Preston Pysh  24:55  

Ruffle some fixed income investors feathers. Okay, so a couple hours ago I posted that you and I were gonna have a conversation. I think I had 100 comments within a couple hours of people wanting to pick your brain. There was one person who asked about student loan forgiveness. I’m kind of curious to hear your thoughts on this one.

Luke Gromen  25:14  

I think it’s coming. I think it makes sense. I did a tweet thread last week and I said, “If I was tasked with ensuring that the United States stayed in secular stagnation, as Larry Summers called it, we want you to set up economic policies that make sure we continue to underperform as a nation and as a national economy. We continue to remove that dynamism we were once known for, what would you do?

I said, “Well, one of the things I would do is I would load up our most productive generation with as much college debt as possible. Then I would make it non-dischargeable in bankruptcy. Then I would have as much of the wealth as possible with the older class of citizens who have an extraordinarily low marginal propensity to consume.” 

I’ve got my high marginal or marginal propensity consumer, high MPC generation loaded with debt, so they can’t afford to buy anything like houses, cars, get married, have kids, etc. I would have my low MPC generation with all the money and benefiting from all the monetary stimulus, etc. They are just getting richer and richer. 

To me, when you hear these policymakers, whether it’s Powell and other central bankers saying we need more fiscal. Then you hear other pundits and policymakers saying, “We need a policy that gets money into the hands of people that will spend it.”

Then you hear other people say, “Well, it was a divided Congress, how are we ever going to do that?” All of these are valid points. To me, when you do a Venn diagram of all this stuff, the thing that’s right in the middle are student loans. 

You’ve got $1.6 or $1.5 trillion in student loans. I don’t know the exact number, but the vast majority are owned by the government. It’s literally a balance sheet entry. You cross it out. You tell them to stop paying. They don’t have to pay anymore and you immediately have put hundreds, if not thousands of dollars per month, every month, into a generation of people with a very high marginal propensity to consume. 

They’re going to get married. They’re going to buy cars. They’re going to buy houses. They’re going to have kids. They’re going to reinvest in the economy. GDP is going to grow velocity. Money is going to grow. There’s a whole bunch of positive things. 

The negatives are some dogmatic view of, “Okay, well, that’s socialism. I paid my loans and they didn’t have to and they should have.”To be fair, that’s a real discussion. My views need to be weighed off against, “Well, is that worse than continuing the secular stagnation where we’re starting to have riots in the streets and people burning stuff down?” In my view, that’s a lesser evil of the two at this point. 

Beyond that, it stinks if you’re a bond holder. It stinks if you’re long dollars. 

Stig Brodersen  28:07  

That was where I was going to go. Really the way you are paying for that would be something along the lines of a 5% debasement of the currency for debt forgiveness?

Luke Gromen  28:16  

*inaudible* because you assume I’m only multiplier on that monthly. No, it could be big.

Preston Pysh  28:22  

I think that that’s a really important point. Let’s transition into this term “inflation” because you bring up the multiplier on top of the base money, because I’m talking base money inflation of 5%. Though, when you account for the multiplier on top of that, are we still talking about 5% more currency or spendability into the system? Or are we talking more than that?

Luke Gromen  28:46  

Well, it could be more than that. They can really be more than when you start talking about a vaccine, right? Think about how they’ve created all this base money and how often have you heard…I’ve heard it a lot this year. All this M2 money supply has been created. It’s okay, because they’re just filling in a hole. It’s not inflationary because they are filling in a hole created by COVID. That’s 100% correct, in my view.

Then the next line is, well, as long as velocity doesn’t pick up on that M2, it won’t be a problem. It won’t create inflation. Well, what do you think is going to happen when they get a vaccine? The last season is going to take off so now you’re looking at a situation where you could have velocity picking up from when you’ve had Warren Schumer saying they can get student loan forgiveness. They’re encouraging the presumed President Biden to do it via executive order in his first hundred days. 

To me, you’re looking at some things that could be extraordinarily stimulative-slash-inflationary. I think it will be really good for GDP growth when you’re talking about an economy that desperately needs nominal GDP growth and inflation to start trying to earn or de-lever this record debt to GDP. 

By the way, you still have high unemployment. You still have record social tensions. This checks a lot of boxes. It’s going to be really hard to sit there with whatever unemployment, [which is] still at 6-7% with the tension we have between young and old, and we have to consider the wealth inequality to not sign off on this. It’s easy to do. 

Yes, I think it would be… It’s interesting because I do think it could be very inflationary and it introduces a new… When you push one thing and it’s like the balloon pops out on the other side. 

Then all of a sudden, you’re going to get the yield curve back up further, and as we know… I don’t know what the number is but there’s a level in my view on the bond market, where the Fed is going to come in and basically say, “That’s it, the yield is not going any higher than this. No matter what.”

Student debt forgiveness is enough to take the yield over that number? We won’t know until it happens, but that then would turn around. Now you’ve taken one inflationary thing and you’ve turbocharged it because now the Fed’s balance sheet is just going to grow. Real yields will be significantly negative.

Stig Brodersen  30:54  

For the person listening to this, we’re seeing the same problems as you are, Luke. How should they position themselves first of all, to protect their portfolio, but also to compound the wealth?

Luke Gromen  31:05  

I think it’s super important for anybody listening to this to understand, I think, a couple really big pieces of context. The big piece of context number one is we are, I think, without a doubt, in the first bursting global sovereign debt bubble in 100 years. Nobody alive that is trading today has ever lived through one of these things to trade it. 

With that said, the last time one burst, the real value of the sovereign debt, relative to gold of the six biggest industrial powers in the world: the US, the UK, Germany, France, Japan, and Russia. 

From 1918 to 1933, the sovereign debt relative to gold fell anywhere from 50 to 100%.  Germany and Russia went to zero against gold. They hyperinflated. The Japanese, I want to say were 75%. The US was 75%. France, I think was 75% or 80%. The UK was, I think, only 40% or 50%, as the reserve currency of the world. 

The point is when you get here to this point, it becomes the sovereigns, they are going to do whatever they can to keep themselves in business, so to speak. The release valve is the currency. 

I think it’s super important to understand that within these trading moves, this, I think, is the big year and you don’t want to get crushed up by this big year. When you talk about these types of things, you need to be overrepresented in your portfolio to things like gold, like Bitcoin. I think like high quality equities. Things that will preserve your purchasing power, if currencies do what they did the last time a global sovereign debt bubble burst. 

This isn’t about this quarter’s performance or this month’s performance. This is about two years, five years, ten years from now, currency debasement of those periods of time. 

I think that’s the first big one. This is the first burst in global sovereign debt over 100 years. 

The second big thing is that we are in a currency, the first major currency system changeover in 50 years, really, since the petrodollar system. You’re seeing these tensions between the US and China and between the US and Europe. 

Nobody knows how it’s all going to work out other than to say it’s changing.  You know what the winners and losers were in the old system so you can sort of infer that.  

I said only two big things, but I think there’s probably a third that’s worth noting is we’ve never had a demographic situation like this at a time when social democracies… You’re basically having sort of this social democracy promise bubble bursting as well. 

You’re in rundown mode on these entitlements and what have you. That too, I think is important. Really I am supportive of the first point, in terms of the bursting global sovereign debt bubble. 

I think these things are the big gears that are really driving things and they’re driving both the domestic economics. They’re driving international geopolitics. To protect yourself, I think you need to be conservative and your leverage. I think you need to be conservative in your finances. 

I think you do want to have some leverage, but I think it needs to be smart leverage and by smart leverage, I mean, not overly levered, ideally in productive assets or in a house where loans can’t get called. They can’t get repriced. You can be locked in for long periods of time. 

Then being whatever the model says you should be in bonds, I would take the under on that. Just pretty systemically over the next 2, 5, 10 years. Again, this is not this month or this quarter. Though I think these are the big ears that are really turning faster and faster.

Preston Pysh  34:52  

How do you see residential real estate playing out through this? I’m going to use this term because somebody had a question about this, but you kind of addressed the question, which was a World Economic Forum using the term “the great reset”, what does that mean to you? 

I think you’ve just described perfectly what that means to you. 

Back to my original question, which is the residential real estate, the homes that people are living in, what does this mean for property value, if you go through a “great reset”?

Luke Gromen  35:21  

I think it depends where you are. I have a very dear friend who is down in Hilton Head, South Carolina, who owns one of the bigger architecture firms down there. They have been jammed all year. I mean, the real estate number even in the depths of the COVID crisis in the region, he would send me the MLS listings, sales and dollars numbers, year over year… They were beating the numbers by 40-50%, as the world was coming unhinged. 

Then I said, “What is going on man?” He said, “Ah, so I had another one last week, someone from New York. They just came, and they have a house down here, or they were they they’ve rented down here. They came down.They bought a house. They called back to Connecticut. They called the agents to sell it all. Pack up the furniture, send it down. We are never coming back.” 

He said this has happened every week. Real estate has always been a local game, but I think unless some really big things change relatively soon, I think this migration out of cities into more rural or semi rural areas, and probably in the south… 

I mean, there was an article this week in the Wall Street Journal, an op-ed, I don’t remember the man’s name, but he runs a big VC fund in San Francisco.

The op-ed was titled “California: love it and leave it.” He just said, “My wife doesn’t feel safe walking in San Francisco anymore. Sometimes the power outages are like a third world country so I’m packing up my family. I’m packing up my firm and we’re going to Austin.”

These two stories, I think, are just anecdotally, but I think it’s going to depend where you are. I think what we are seeing this year could very well be an early stage of a reprioritizing of what people really value, particularly if these big trends of sovereign municipal…

What I’m implying is, if you keep the promises to all of your pensioners in Chicago, you might not be able to pay new *inaudible* as well, or you may not be able to hire as many or you may disenfranchise them. I’m picking on Chicago. I shouldn’t have. It could be Cleveland as well where I live.

However, the point is, there are trade offs that have to happen. As those trade offs start to happen, you get sort of this entropy throughout the system. Suddenly, the things that people say like, “I love being in a city,” they go, “Maybe I don’t like being in a city as much. Maybe I want to go live on outside of Hilton Head. Maybe I want to go live down in South Carolina. Maybe I want to go live in Texas.” 

You’re seeing these movement patterns. You can see them in the U-haul rates and in the destinations, etc. So [it’s a] long winded way of saying it. Think some of it. I don’t want to get carried away with it, because some of it could be COVID… I think this trend is real because of these big gears. I think it may have gotten turbocharged to a certain extent or maybe overshooting the trend, if you will, because of COVID this year. 

However, current course in track, I think these big gears are likely to drive sort of a reprioritizing of what people where they want to live. I think it’s just going to depend on where you are in terms of real estate.

Preston Pysh  38:37  

I agree with you on this trend, I think that this trend is going to continue to persist now whether it stays as aggressive as it has over the last six months. This is the rationale that I think you’re seeing, is local governments, state governments can’t print, right?

The policies of some of these various locations, these local governments have policies of spending as if they can print. As far as tax implications go, it’s getting obscene and absurd to continue to pay such a ridiculously high tax rate for local municipalities or states that you’re in. 

I think that trend is absolutely going to keep getting worse. If true, these migration patterns that we’ve seen of people moving to areas that have more favorable, local and state tax considerations are going to continue to trend in the direction that they’ve been trending. 

I’m going to throw this out to the audience because I know we have people that are real estate investors. If you have a really good chart that shows which regions have gone up and which regions have gone down in the past six months, please… I beg you to share this with Luke, myself and Stig on Twitter. I will retweet it out to everybody to see because I think that you were really onto something here, Luke.

I think it’s part of the tax consideration. I’m curious, do you agree with that? Do you think that that is what’s driving it?

Luke Gromen  40:11  

Yeah, I think it is. I think it’s primarily a tax thing. I think that’s Bennett. I think this year has been the first time where there has been a little bit of safety, which is unfortunate, but I think it’s primarily Jack’s. I think that’s right.

Preston Pysh  40:25  

Yeah, I agree with you. I think that the fact that you’ve seen some social unrest on top of the issue that the person probably already had with living in the area was simply the icing on the cake. They just think, “I’m out of here. I’m not dealing with this anymore.”

Hey, so online, a lot of people are wanting to know your thoughts on the Judy Shelton fall out. First, explain who she is for people who aren’t familiar with who she is.

Luke Gromen  40:51  

Judy Shelton was a Fed nominee from Trump. She’s most well known for her considered unconventional or controversial views regarding gold, the gold standard. 

In particular, she’s written at least one or maybe two op-eds about having a neutral reference point or gold-backed bonds to settle trade. It would go a long way in increasing actually the dynamism of the US economy and sort of undoing some of these imbalances that have accrued and that have caused some of the problems we’re seeing in terms of wealth inequality and deindustrialization of the US. 

That deindustrialization is now a bit of a problem as it relates to US and China relations. At any rate, Trump nominated her. They brought it up, tabled it. Today, they tried to get it through, and it didn’t go through.

My understanding is there still a chance that it could happen in the next few days, maybe depending on who’s there. However, to me, it was somewhat disappointing only because of my long standing view, our research suggests that really, if you don’t change the currency system in a way, so that you’re settling trade in a neutral reserve asset, so whether that’s gold-backed bonds that are gold at a floating rate. Some sort of neutral reserve asset.

The US’s role in the world increasingly gets relegated to us supplying the dollars to China, for China to buy up finite assets, and grow their own military and global economic influence, and reduce our role in the world. 

I was a bit disappointed, because I thought it was an interesting potential new voice that maybe she could communicate and do some cross pollination of some ideas with the people at the Fed currently, “Here’s what, this system has rot,” but it’s not meant to be apparent at this point. 

There’s this great article from the FT early 2019, called “How to diagnose your own Dutch disease?” The United States has Dutch disease. It has dollar Dutch disease. Dutch diseases came up when the Netherlands found oil or gas, I forget what it was. 

The gist of it was when you have this resource endowment, if managed improperly, and leads the rest of your economy to atrophy, because you become… It’s so easy to get rich using that and exporting tha. That’s what you do and everything else goes away. 

This article makes the point. The US is the Saudi Arabia of money. We can produce dollars with a couple keystrokes. Why would we produce anything else? Let’s just produce dollars and have the rest of the world make stuff for us. 

At first, it’s the greatest deal in the world. It helped us win the Cold War and helped us drive and get very powerful. 

However, the point is that the US military, then in late 2018, said, “Look, our industrial supply chain is falling apart because for 40 years, we don’t mess up articles today. We built this new crane in Florida for container ships built in China.” They built a giant container ship crane in China and sent it here presumably because we don’t do that anymore.

On one level, it’s like, “Okay, I guess that sort of makes sense.” But then you go to the guys in the military… The politician will say, “Well, we need to really crack down on China.” Then the guys in the military are going, “Will we send them dollars to make our stuff for us?”

[With the COVID crisis, it became], “Hey, China, send us some PPE, please. Pretty please.” That’s happening across Taiwan. We’ve outsourced all this stuff to Taiwan, which all made a whole bunch of sense until the Chinese had the ability to easily take it over. Then we couldn’t do anything about it, which is the case right now in all likelihood.

Preston Pysh  44:28  

One of the things that you and I talk about a lot online is gold and Bitcoin. I mean, the price in Bitcoin has just been explosive in 2020. When you look at gold, it was explosive as well, but then it has fizzled out here in the third going into the fourth quarter, when Bitcoin has really started to perform. It’s been the strongest part of the move in 2020. 

When you and I have some engagements online, you talk about gold having this levered derivative kind of explosive piece to it potentially, if it gets to a certain point. Explain this to the listener and I’m more interested in just kind of hearing your general thoughts about both of these two forms of holding value.

Luke Gromen  45:16  

I like them both a lot.The gold market was allowed to expand in a lot of different ways. Cash settled. Futures are a small part of the problem. When you have a cash settled futures contract, that means you don’t have to have the gold. You can settle in cash, most of them are settled in cash. 

However, once you’re settling something out with a high stock to flow ratio like gold, in cash, the high stock to flow ratio means you can separate physical fundamental supply-demand fundamentals from the price for a very long period of time, which means the cash settlement aspect of it turns it into a balance sheet contest.

I think gold supplies are being bought, and they’re getting very tight. I’m going to own some gold futures and that might very well be right.

However, if JP Morgan’s trading desk comes in with $2 billion notional for sale, or whoever that is that comes into the middle of the night, it doesn’t matter. Your stops get run. You create this waterfall effect, right? 

That’s a short term type of aspect in terms of futures.

The bigger deal, in my view, and I had it explained to me is the unallocated gold market out of London or the credit gold market out of London, where it’s, “Hey, I want to own $100 million worth of gold.” Done. 

It’s not like they found the gold and produced the gold *inaudible*. So contrast that with what Michael Saylor has on the tape saying what he had to do to buy his $400 million in Bitcoin. It was like a Navy SEAL raid in terms of trading to make sure he didn’t squeeze the price up. 

The difference in that amount of liquidity is this credit gold market. When I say ultimately, the credit gold market can go on and on, as long as there are no leverage restrictions. 

There’s always been sort of this mythical or conceptual, maybe the better way to put it, or something could break that market or force an unwind in that market. They would have to be big. They would have to probably have nukes because they are. 

Gold is not a free market. It has never been a free market. It is a political mettle and that is I don’t think fully appreciated by everybody.

However, in theory, if that happened, then the deleveraging of that system would have to be settled via price. The COMEX Guys, when they said, “Hey, we’ve got 1% or 3% of the vault.”  Kyle Bass talked about it maybe 3 or 7 years ago when he owned some gold for the Texas University System, etc. He went on the vault tour of COMEX. He said, “What happens if you guys are 3% reserve? What would happen if someone came in and said, ‘I want it all’?”

COMEX said, “Oh, no! That never happens, Kyle.” Yeah, but what would happen? Price would settle everything. That’s the point. 

Again, it’s a political mettle. The Hunt Brothers tried to do that and they just shut down the exchange when sales only and squeezed him out. They lost big. 

Any average size hedge fund could go into the COMEX and clean it out today. There’s a reason why they don’t. I don’t fully know why they don’t but I’ve got my suspicions. It’s a political mettle. It’s not a pure market.

Stig Brodersen 48:25

Some are saying that if you really wanted to take it home, it might be an issue. Even if it was a fractional situation of how to beat the price. However, in that situation, the prices globally play into a factor of what’s happening locally.

Luke Gromen 48:41

Well, it would have to be some sort of structural event, right? It would have to be.. the one I’ve used a lot, because I think that’s maybe the cleanest way you could see it happen. So things get shipped with the US, Russia and China. Russia and China get together with Saudi and say, “We are only accepting physical gold for our oil at a value of 1000 barrels of oil per ounce.” 

Immediately everyone in America and paper markets go, “Oh my God, what a great arbitrage opportunity. I’m going to go buy an ounce of paper gold, and I’m going to turn around and get 1000 barrels of oil. I’ll turn around and sell the thousand barrels of oil, and it’ll be worth $40,000.” 

Everyone will show up at the paper markets, which will promptly close… you’ll be cash settled with the prior day’s close. It’ll be physical only. So your paper… You’ll get paid in your paper but unless you own the physical, that’s how you get a break. That’s the type of thing that it would have to happen.

Preston Pysh  49:37  

Let’s say we fast forward into August of 2021. Let’s just say for critical thinking drills here, the price of Bitcoin is punching through $100,000 in August 2021. Does this narrative start to run on Wall Street and cause concern as to the utility of gold being a store of value? Is this something that the people that own gold start trying to actually sell it in order to start buying Bitcoin? Or do you see that these are just two totally different worlds?

Luke Gromen  50:13  

I think it depends on the level you are. I think, if you’re the average millionaire, you’re the average ten millionaire, you will probably sell some gold. Maybe you get real aggressive, sell all your gold. The market is telling me this. If you are a giant, if you are Russia, if you’re Saudi… The Russians are not going to dump their gold to buy Bitcoin.

Stig Brodersen 50:40

Yeah, I completely agree with you. I don’t think that would ever happen if they wanted to buy Bitcoin, but they didn’t just print more money?

Luke Gromen  50:46

They could conceivably. As it is, I think they banned it. I think it’s illegal. Not that that’s worked per se for them or their currency. But I think I saw they were looking at making it illegal. Not that that is, I think, the right thing to do.

The point is, I think, the supergiants in the system, and I tweeted about this today… At some point as Bitcoin us punching through these bigger and bigger levels, you’re starting to talk about this sort of institutional threat. We’re disintermediating the banking system. What do you need a central bank for?

Bitcoin is a million dollars a coin. A billion dollars a coin, who needs a central bank? That’s where I think the higher it goes, at some point, I think there starts to be some institutional pressure for these guys to defend their franchise. 

“All right, what do we have on our balance sheet that can compete with Bitcoin? Well, look around guys, we’ve got mortgages for mom and pop in Poughkeepsie and gold. Okay, let’s raise the price of that.” There’s things they can do there. 

To be clear, this is speculative on my part, it’s based on a view that if Bitcoin does what I think it could do as to what you’re hypothesizing you could do, which I think is entirely possible with the stock to flow charts that what have you, that are out there suggest it could do, to me the wildcards in it are, that don’t get as much airplay that I’m trying to raise is, what do the supergiants, so to speak, and that’s a term from FOA…

What do the supergiants in the system and the status quo, do they just sit there and watch all that whole central banking fee, senior age franchise, just get taken away? Like what Amazon did to Walmart and Kmart. Maybe a bad example. The entire brick and mortar stores.

Or do they say, what are we going to use to defend our franchise? What are we going to do? There’s only one thing on their books they can use to defend that franchise that has unlimited upside in price. That’s gold. They have a printing press. 

In theory, they could come out and say, “Oh, Bitcoin is a million. Okay. Gold is $100,000. We will make a market right there.” 

I don’t think that’s going to happen but I’m just saying conceptually, it could. I’m just thinking in terms of the institutional motivations, as Bitcoin continues to be more and more successful, and really sort of stick their nose in it, right?  

I had a drink with one of the biggest physical gold traders in the world three years ago, so it would have been like August 2017. We were in New York City. Bitcoin was doing sort of its first day. It wasn’t really getting to the heights of that year yet, but it was starting to really ramp up and [get] unsolicited. We’re talking. He goes, “Bitcoin is doing what gold would be doing if it didn’t have all this giant paper market attached to it.” That was exactly what I thought of it. 

I do agree the stock to flow dynamics in terms of the happenings and the supply, their superior Bitcoin versus gold. They are because you do have the mind supply increases. I disagree with Saylor’s 2% number. I don’t think that’s the right number. Gold supplies haven’t risen for a couple years actually. At current prices, I think its supply numbers are overstated.

To his point, they are generally positive over time. Unlike Bitcoin, they’re price sensitive, right? So we woke up to *inaudible* 5000, those supply numbers are going to adjust accordingly, etc. 

I think he makes a very valid point but I think the price response could be very nonlinear in gold. I think I said that to you today where I think there are periods of time where gold could outperform. Those periods of time are probably going to be very compressed, and probably around political events, or just the system being your bidding Bitcoin doing so well that it starts to sort of threaten these guys and their franchise. 

Preston Pysh  54:44  

Alright, well, Luke, I know I’ve learned a ton from you through the years. One of the things that I think I’ve learned the most from you is the books that you’ve written. These two books that you’ve written, they go by the title “The Mr. X Interviews,” if people want to look it up on Amazon. We’ll have links in the show notes. 

Your books are fantastic. They’re so easy to understand. I know one of the first times I talked to you, I said, “Wow, this guy has a lot more behind the discussion points and a depth of knowledge that’s there that I wish I could tap into.”

I’m telling you, folks, if you do want to tap into that, read his two books. Luke, if people want to learn more about you give them a hand off where they can learn more about you. 

Luke Gromen  55:30  

Sure, thank you for those kind words. I appreciate it. If you want to learn more about what we’re up to, you can check us out at fftt-llc.com. I’ve got a fairly active twitter feed at @LukeGromen.

Preston Pysh  55:47  

Luke, thanks so much for your time.

Luke Gromen  55:49  

Absolutely. Thanks for having me on. It’s always great catching up.

Stig Brodersen 55:49 

All right, guys. We’re letting Luke Gromen [go]. Now, we’re going to play a question from the audience. This question comes from Jeff.

Jeff  55:59  

Hi, my name is Jeff. I’m from Toronto. I have a question, I guess, which would be appropriate for Preston. You’ve made a compelling case for investing in Bitcoin, but having never done it before, I’m just wondering if you could explain to listeners in some detail how we go about safely buying Bitcoin. Equally importantly, how do we store it securely, so that we don’t become another one of these high profile hacks that takes place? Thanks very much and great podcast, guys.

Preston Pysh  56:37  

Jeff, great question. This is something that I get asked a lot on Twitter. It’s something that I normally don’t respond to, because it really comes down to the person and their technical expertise as to how they want to take possession of Bitcoin. 

I would put this into two different categories. You can take physical possession of the Bitcoins yourself or you can outsource it and you can have somebody else take possession of the Bitcoins.

Early on, there was a hack. There was a really famous hack of an exchange. Not Bitcoin, but of an exchange. This was Mt. Gox hack. I think this happened back in 2013. 

Ever since that event, there’s been a lot of folks, especially folks on Twitter that have been in the space for a very long time, that strongly suggest that everyone should take physical possession of their Bitcoins and not outsource it to some other entity to manage their private keys for them. 

There’s a rift between those two communities. I’m one of the people that would encourage you to take physical possession of your Bitcoins, if you’re technically capable of doing it. If you’re not good with computers, and you’re somebody who would lose your private key and are just not comfortable with those kinds of things well, then maybe having somebody else manage that for you that has a reputable source. It might be a better solution. I can’t answer that for you, you got to answer that one for yourself. 

If you’re going to take physical possession of your Bitcoins, there’s a couple hardware wallets that I would recommend. The first one would be Ledger, another one would be Coldcard. The third one would be Trezor. Those are very reputable hardware wallets. 

All of that hardware wallets are really holding your private key. It’s holding the 24 word mnemonic. That makes up your private key. If that sounds like a bunch of technical gobbledygook for a person listening to this, think of it like this. 

Think of your Bitcoin as really just being a key to an address. You’ve got your house and you’ve got a key to get into your house. Everybody knows your address to your house, your mailing address, but they don’t know what the key looks like in order to get into your front door. 

I would explain Bitcoin in a very similar way where everyone has a public address. Like if I want to send somebody some Bitcoin, I just have to know what their public address is.

In order for me to send it, I have to have that key to unlock the Bitcoins to leave my address to go to their address. That hardware wallet that we’re talking about is the thing that manages or has that private key inside of it, which is the 24 word mnemonic. 

If you’ve got that, and you know what the public address is that’s associated with it, well, that’s how you store your Bitcoins. 

There’s one more hardware wallet that I want to mention and it’s actually on your smartphone. It’s by a company called BlockStream. The name of the app is the Green App. Because it’s connected to the internet at all times and people might want to try to take a picture of their private keys because it’s on their smartphone, they might do it like a screen shot with their smartphone, I would highly encourage you to not do that. 

You don’t want any type of digital records of your private keys if you’re taking physical possession of them. 

One final note that I would tell you, if you’re taking physical possession of your Bitcoins is think about getting what’s called a metal seed storage. This is just a piece of metal, in which you would engrave your 24 word mnemonic onto. 

In the event that you would have a house fire, or you would lose your smartphone or you’d lose your Trezor or whatever it might be, that 24 word mnemonic will always be able to restore your account, if you have it saved on a piece of metal. There’s probably nothing better than that. 

Alright, so for people who don’t want to go through all of that, and they don’t want to take possession of their private keys, which is my recommendation, if you have the technical skills to do it. There’s a lot of other options. You can own a thing called GBTC. This is just a stock ticker. You go into whatever trading account you’ve got. Type in GBTC, it will come up just like you would an apple stock. 

This is a trust where somebody else is buying physical Bitcoins. They’re storing them for you. It’s a company called Greyscale. I think they have $10 billion worth of Bitcoin under management. You’ll get total access to the price action, but you will not have physical possession of the Bitcoins. I think that’s a really important point. 

I can’t make that decision for you. It’s a personal decision. PayPal recently announced that they’re doing something similar where you can gain access to Bitcoin, but they’re going to continue to hold the private keys at PayPal.

Cash App, this is Jack Dorsey’s company. They’re doing it. Robin Hood, you can do it on Robin Hood. I recently saw that JP Morgan was doing something with the Winklevosses’ exchange. There’s all sorts of businesses. Fidelity, I’m sure is going to have access to this shortly.

If people want to buy but they don’t want to manage their private keys, because they don’t feel like they have the technical prowess to do it, these are other options for you to gain access to Bitcoin. 

Here’s what Stig and I have decided to do. We’re going to release a show every Wednesday that talks specifically about Bitcoin. This way, we’re able to keep the stock investing conversations on Saturday. We can talk about this new and emerging technology that so many people have an interest in on Wednesdays.

If this is something that does not interest you, I highly encourage you to not listen to the Wednesday show. Just skip over it. Then on Saturday, the normal show the normal stuff that we cover is going to come out then

If it is something you want to learn more about, please download the show on Wednesdays. We’re going to bring in some of the most impressive technically skilled guests that can talk this stuff in so much detail, way more than Stig and I can do but we’re going to be the ones asking the questions. Hopefully pulling this information and just the best resources for you to learn right along with us as to what in the world this is all about. 

Our first show is actually going to come out this Wednesday, right before Thanksgiving. It’s already recorded and it is one heck of a conversation. My mind was blown at the end of this conversation, and I would highly encourage you to check it out, if you do have an interest in this stuff. If you don’t, no big deal. We’ll see you guys again on the following Saturday. 

So Jeff, really appreciate you asking this awesome question. For asking this, we’re gonna give you free access to our TIP Finance tool. It’s got all sorts of things on there, like being able to do intrinsic value assessments and momentum tools, portfolio tools to help manage your correlation between your various picks. We’re really excited to be able to give that to you. Thanks for asking a great question. 

If anybody else wants to get a question played on the show, go to asktheinvestors.com and record your question there. If it gets played, you get free access to our TIP Finance tool. 

All right, that’s all we have for this week’s show. Be sure to check out the new release on Wednesdays and we look forward to bringing that content to you. Thanks for joining us.

Outro  1:04:03  

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