Luke Gromen, founder of FFTT (Forest for the Trees) joins me to talk about his views on Bitcoin. We chat:

• Bitcoin as store of value, medium of exchange bifurcated
• Does Bitcoin recreate the Hunger Games?
• Bitcoin as Smoke Alarm
• US Govt debt
• Why rates can’t rise?

Luke Gromen links:

• Twitter: @LukeGromen
• Site: FFT-LLC.com

Sponsors:

• Swan Bitcoin
• Knox Custody
• Hodl Hodl
• Unchained Capital (code LIVERA)
• CypherSafe (code LIVERA)

Stephan Livera links:

• Show notes and website
• Follow me on twitter @stephanlivera
• Subscribe to the podcast
• Patreon @stephanlivera

Podcast Transcript:

Stephan Livera:

Luke, welcome to the show.

Luke Gromen:

Great to be here. Thanks for having me Stephan.

Stephan Livera:

So, Luke what, you’ve been chatting a bit about Bitcoin recently, and I thought it be great to have a chat with you, but first, could you tell us a little bit about yourself and I guess economically, where would you place yourself?

Luke Gromen:

Sure. So by way of background, I spent almost 20 years on the sell side in investment research, in investment, equity sales at a couple of different regional brokerage firms in the Midwestern United States. We were doing very bottoms up in the weeds type of fundamental research pioneers. At both of those firms I had a role where I was one of the founding editors of a weekly product that we put together that married both our deep fundamental work with macro and thematic work I was doing on my own. Both products ended up being very popular with our client base. And as we went into the 2008 timeframe, and then in the aftermath of it in particular where the world was becoming increasingly macro and central bank driven, I was spending more of my time doing that by 2013. I was looking to do macro full time during a conversation with my partners to talk about me doing that.

Luke Gromen:

And from a marketing standpoint, we just couldn’t quite figure out how to position a macro product in the way I was looking to do it with what we were known for in terms of that deep in the weeds, bottoms up fundamental research. So we decided the best thing to do as part ways amicably. And I hung out my own shingle as FFTT, which stands for forest for the trees. And in early 2014, what we do is aggregate a large amount of publicly available data from a whole disparate array of resources and trying to identify developing economic bottlenecks. And because it’s been my experience throughout my career over the last 25 years now that excess investment returns accrue to those areas set to either benefit from, or be hurt by economic bottlenecks. And so we’re just looking for things that are coming to a head, whether that things like the housing bubble in a way, or whether it is tech bubble or whether it is the benefits were something we’ve discussed a lot last year where the Fed was going to have to step in and increase their balance sheet in a big way.

Luke Gromen:

And that implied positive things for certain asset classes up, those types of things are what we’re looking for. So we’ve been at it for seven years and it’s been a lot of fun.

Stephan Livera:

So you’ve got this idea of, well, as you say, looking at the forest for the trees, so where did Bitcoin come into it for you and how did you come across it? And how did you do your own process of learning about it?

Luke Gromen:

Where Bitcoin came in for me was really, it was a process. It started in 2008 for me when I was very well positioned personally, and our clients were very well positioned for what happened in 2007, 2008. Personally I was in all cash by October 07, because based on a number of things we are seeing in our research at Cleveland research company, it seemed pretty clear to me that there was significant risk of the financial system collapsing. To me, that was apparent by October 07. We remain in cash until 4Q 08 and at that moment you started to see the Fed start to do QE then, but where it really started to hit home for me was in March of 09, when the Fed did the first round of what I call the big QE, where instead of just buying mortgages, they started buying treasuries with printed money.

Luke Gromen:

I think it was a trillion dollars. And that to me was a real game changer because it seemed like the Fed was just effectively financing the US government. So I think I did with a lot of people did then, which was okay, they are printing money and buying sovereign debt. And that’s what the most famous episode of that of something like this happened, which was to say Weimar Germany in the 1920s. And so I went home and got on Amazon and bought some books on Weimar Germany and started researching, okay, what’s going to happen when the results of this? And I went from a view that this is going to be hyperinflationary you quickly realize as you read these books environment, Germany, that there were a number of things that while similar were also very dissimilar, primarily in terms of the domestic political situation in the US relative to that.

Luke Gromen:

Weimar Germany, it was much more cohesive. There was huge political unrest, violence political assassinations regularly in Germany. It just wasn’t the case in the US and then secondly, the fact that the US was the reserve currency issuer and had a much more diversified economy. So I began thinking about it more nuanced terms, but the thing that seemed clear to me is that it would be good for assets. And so I started off by owning gold. I started off by going from being in all cash where I had been since October 07, to going all in on equities and went there. Now, the next step from there to me was okay, historically, the way the system has worked since the 1970s is that part of the reason the US dollar has the reserve status that it does is because oil in particular and commodities more broadly are priced solely in dollars.

Luke Gromen:

And to me, there was just the splinter in my brain that it just didn’t make sense to me that the most important commodity in the world oil could still be priced or maintain sort of the same pricing as it had always had in a currency that was just being printed and then spent the way it was happening. And I began to think that it just didn’t make sense to me that would happen. And so there needed to be some other pricing mechanism and then from there. So I started with gold, at any rate when I started hearing about Bitcoin, which was probably about 2010, 2009. I didn’t know where to buy it. I was intrigued by it just seemed to be blunt just too, too painful, too faddish. I didn’t understand the technology. I think a lot of people like a lot of people at that time, but I was intrigued by the concept that implied in what Bitcoin was doing with the difficulty adjustment and with the basically swapping electricity costs for a hard store of value.

Luke Gromen:

It was solving for this splinter in my brain, which was, it made no sense that the US could print dollars and get finite oil for that. And, and so it was always interesting to me. I finally bought some Bitcoin in 2013 when I think it was right around then that Coinbase, maybe a little before came up and I had a friend say, Hey, you can buy it here. I bought Bitcoin for the first time in 2013. I’d love to say that I bought a whole ton of it and went all in, but that is just not the case. Like everybody says that these days but that was really the journey for me was really around what the US was doing as a result of this crisis. And then the energy connection in terms of, it just didn’t make sense to me that the US could just print money out of thin air and still maintain or retain the ability to have oil only priced in dollars. And then the implication that had or how that related back to Bitcoin with the energy connection. As I saw it

Stephan Livera:

In those days in 2013, it was a big thing around this whole idea of merchant adoption. So it was this idea that, Oh, we’re all just going to be using Bitcoin for day-to-day transactions. Now that was one big narrative at the time, but also there were people thinking now. I guess it wasn’t as well advanced and a put out, but this idea of Bitcoin as a long-term savings. So Bitcoin as a store of value was also there. So I presume that was also your thinking about it, that you were thinking more store of value.

Luke Gromen:

I thought I was thinking of it that way, all along. I had done a lot of work and reading around Triffin’s dilemma, which was an economist Robert Triffin laid out that basically, if you had a currency system where the reserve currency was for a single sovereign, and that system required that sovereign to run increasing deficits to supply the world with that currency. Then the dilemma is that sooner or later, the solvency of that issuer is going to be called into question and create a problem for the system. And so my thought was we had reached the Triffin dilemma moment, and it was it’s particularly a problem with the system as it’s been structured since the late seventies due to the treasury bond, being the primary global reserve asset.

Luke Gromen:

And so once you got that to 0% interest rates that bond can’t really appreciate nominally that much more. And so to me, the fix has always been separating. The fixed to the global currency has always been separating the primary global reserve currency from the primary global wealth reserve asset. In other words, basically finding some neutral reserve asset to replace treasuries. And I had always been working under the assumption that it was gold, but when I saw Bitcoin to me, it was something that made sense from a personal standpoint of, Hey, I own gold. I’m going to buy some Bitcoin too, because this could be this, speaks to me as a wealth reserve asset, a neutral wealth reserve asset that floats in price for the individual. But like I said, Hey, and I know now, what I would knew, what a known that, what I know now I would have liked to have been much bigger in it. But that was, I never saw them case for it as an individual currency. I saw it more as a store of value.

Stephan Livera:

So I guess fast forward to today January 2021, are you seeing it more like Bitcoin could be the reserve asset and that we society just broadly speaking would use something else as the day to day transactional currency? Or how are you viewing that?

Luke Gromen:

I still view it that way. I still view it that way, partly because I think that the sovereigns are going to want to retain the ability to respond quickly in crises, whether that is the COVID crisis. For example, they have the ability to quickly marshall resources, because they can print up Fiat currency and spend them as opposed to if it was more Bitcoin based, they wouldn’t be able to print the Bitcoin to do that. It would be a bit more challenging, particularly given the implications, for example of a response of a pandemic crisis where if its true, that as some say that ultimately the productivity of the globe backs Bitcoin, then something like a pandemic. If you were using Bitcoin for both your currency and your store of value, the pandemic would severely impact the productive value or the production of the globe.

Luke Gromen:

And then you would be in this sort of deflationary spiral. So to me, having the Fiat currency separate, which gives the government the flexibility, but then having a neutral reserve asset floating in price to basically it’s the best of both worlds, it gives the sovereign the flexibility to do what it wants to do in terms of its domestic political agenda. But then you also still have a system with a neutral reserve asset that floats in price in all currencies that protects savers from from confiscation by inflation effectively. That’s how I still think about it. I think two, three years ago. Of course, to even have the discussion of, could it be a global wealth reserve asset or sit on sovereign balance sheets? I think probably you would have been laughed out of the room, but I think all of a sudden, as it’s gotten closer to a trillion dollars in market cap, if you will? That’s suddenly a discussion that starts to need to happen. And I think it makes sense that it could, I think it is something that could serve that role very well. It’s ultimately a political question of sorts, but I think you can make the case. There are sovereigns that actually would prefer that to gold and that’s, so it’s going to be an interesting discussion to see going forward.

Stephan Livera:

Right. And I suppose so for me I would say it like, I think, okay, so first of all, I guess separating what I would want to happen and what I think ideologically should happen. Right? I want the government to be smaller or zero if possible, but recognising, as you said, that politically that governments will want some level of control and typically they want to be able to stimulate and they want to be able to say. Look, we did this and we helped fix it, or we helped correct the imbalance. I guess to that extent, they would still want to have some form of Fiat Money and some level of control into how people are transacting and spending and so on. I suppose the question then, Is that really more like a shorter to medium term thing? And as over time, more and more people will literally just be holding Bitcoin and they’ll say the number going up on one side of holding Bitcoin, and then they might eventually try to transition more and more of it over into the Bitcoin economy, even from a transactional point of view, not purely a store of value point of view.

Luke Gromen:

I think that’s a very, I think it’s a possibility when you start thinking about it. And I think it was a conversation that you and I had on Twitter where I had, when we started that conversation, I felt much more strongly about that separation of medium of exchange and store of value was the solution. But the more you and I interacted on it on Twitter, the more I could see clear to what I think is a point you’re making. Which is there’s, the more the government spends, the more there’s going to be, the more deficits they run, the more there is an incentive, the more the price of Bitcoin is going to rise. And the more incentive there is, like you said, to basically to save in Bitcoin and not to save in not to store any wealth in government Fiat or the paper associated with it.

Luke Gromen:

And that feeds on itself. And that’s, I hadn’t really thought of how that feeds on itself, but it does. I mean, it’s almost a little bit like Bitcoin in that case is almost like the punctures in the hall of the Titanic, right? In the movie 25 years ago, God I’m dating myself now. But in that movie, if you remember the iceberg just punched like little more scold holes in the hall, and it just filled up a little bit of the front and then it went in and because none of the airtight parts in the hold were kept it just float over the first wall and then into the second, and then over the second end of the third, and it went faster and faster and faster, and the same kind of thing would happen there unless the government basically reigned in their deficit spending.

Luke Gromen:

And so to your point, having the separation of the two medium of exchange and government Fiat and Bitcoin as as a floating store of value would still ultimately enforce discipline on the government because what would happen if they refuse to bring their spending under control would be a run into Bitcoin. And the more that ran into Bitcoin, the more the central bank would have to print to fund the government, which more run into Bitcoin. And it would as numerous times is these things don’t go linearly. They’ll go very non-linearly. So that is something I think as a result no small part of our interaction a month or so ago. I’ve thought a lot about, and I’ve wrestled with, and I don’t know the right answer other than Bitcoin really is. It ends up serving as the smoke alarm that they can’t disable they being policymakers can’t disable as they have with others. Because to the way for them to disable it is pretty simple mechanically. It’s don’t run really big deficits and raise interest rates enough so that I’m more interested in holding their government debt than I am in Bitcoin.

Luke Gromen:

The challenges is given the promises that they’ve made, et cetera, et cetera resolve that, what they would have to cut and how much they’d have to raise rates and what that would do to the economy. Isn’t it politically unpalatable at the very least and impossible, more likely.

Stephan Livera:

Very interesting! and so you have this interesting characterisation of Bitcoin as smoke alarm. I like that idea. And so I guess your earlier characterisation where you were saying, okay, it could potentially be like Bitcoin is recreating The Hunger Games. Do you still see that idea or you maybe one way to think of that ID might be, if a transition happens too quickly, that maybe that could be bad for society. What’s your view on that whole idea?

Luke Gromen:

Yeah, when we were talking about that, we were talking about using Bitcoin as both medium of exchange and store of value. and I think if it happened too fast what I said was it would lead to a global, basically a global hunger games where either you add enough value to earn it, or you starved and given if it happened over to compressed a timeframe, the political ramifications of that would be extraordinarily, they’d be very painful. It would be basically hyperinflation of sorts with no government help coming. Right. So in terms of food assistance, in terms of et cetera. So that’s when I said that’s the thought I had in terms of, if again the government does not have the flexibility to act, it has to come up with the Bitcoin.

Luke Gromen:

Now, I suppose you could tax, they could tax the Bitcoin, et cetera, but that gets into you. You would have to be uniform across nations, et cetera. And so to me, it’s more a, if you had emerging of Bitcoin as Fiat currency and store of value and medium of exchange and store value, I shouldn’t say (inaudible) but if Bitcoin served as both medium of exchange and store of value and have it happen too fast, then I think you would really get into this. It would really reduce the flexibility of governments to, in the short run address some of the more vulnerable portions of society. And that would be very politically, it would have some pretty severe political ramifications. Now I just, from earlier, I think it’s unlikely that we’ll get, I still think it’s the most likely scenario is a store of medium exchange remains Fiat currency, and Bitcoin continues gaining share as a store of value, but to your point there is a scenario where organically that can happen pretty fast.

Stephan Livera:

Right? And I think the way most people are thinking about it, I mean, once they’ve kind of been in the Bitcoin space along enough they treat it like I want to hold onto the Bitcoin. And if I get Fiat money, I will preferentially spend that fiat. And so I guess what happens over time? And this is, we don’t know when, but this is kind of the whole cyclical nature of Bitcoin as well. And some of this comes into the whole four year cycles idea. And maybe that kind of really extreme transition is really only going to happen at the quote unquote Final Cycle, like a discussion I had with Preston a little while ago. So I guess one way to think about it is how should we anticipate a quote unquote, deflationary spiral to look like, because I think one way to appraise that and assess that is to think that, well, hold on the productive materials of society still exists right, like the office buildings and the computers and the printers and the factories and the tractors. And so on these things still exist. It’s just a question of who owns what, and then repurposing those things into being productive machinery and things that are used to produce food and et cetera. So I guess that to me is how I’m thinking about the so-called deflationary spiral, but what’s your view on what that might look like if it were to happen kind of in a quick? I guess quick way.

Luke Gromen:

I would think you’d have to be an externality, like the COVID crisis if you’re talking about just in a Bitcoin world where Bitcoin is medium of exchange and store of value, is that what you mean?

Stephan Livera:

Yes.

Luke Gromen:

I would think it would have to be in a scenario where a pandemic, war, something like that, and war, it gets very expensive with, if you have to pay for it and Bitcoin. Right. but I would think the biggest one would be some sort of pandemic and I wouldn’t have even thought of it until a year ago. But I had a conversation actually with Preston and Lyn, not that long ago. And it was when you talk about it, cause you’re right. The productive capacity is there. It’s just a question of who owns it. The risk is then is the productive capacity gets haircut by 50% because everyone has to stay home indefinitely.

Luke Gromen:

And now all of a sudden you’re into sort of this deflationary spiral where we can take a real life example. We start doing shutdowns, we leave the markets open and we could see what happened. Right? Bitcoin went to 3400 stocks, went down and gold went down, everything went down except the dollar. And what we were telling clients at the time is look the financial system with the leverage involved with everything involved is uniquely unsuited to to a pandemic, which is to say, we said, you can’t shut down economies and keep markets open because the world runs short dollars naturally, and it will sell everything to accomplish that. And so to the extent that you had this drawdown of materials if you substitute Bitcoin for dollars in that scenario, if everything was running on an equity-based system where everyone had Bitcoin, then everybody needs, you see a deflation in Bitcoin terms, as you see a breakdown in global supply chains.

Luke Gromen:

And that would be at deflationary in Bitcoin terms scenario, if Bitcoin was both medium exchange and store value. Now these pandemics only come around. Not that often. Thank goodness. It’s maybe a one off tail risk thing. So I don’t know how much time we need to devote to it, but that would, that’s the type of, it would have to be in a physical world interruption. Something like that or something like some sort of giant, one of heck the rays from the from the sun that periodically can come and in theory, wiped out big parts of the electrical grid, something like that, where it’s a physical interruption would be deflationary instead of some sort of market event, if that makes sense. Right.

Stephan Livera:

I see. I get you. Yeah. So I guess it’s also about how does society adjust to that. And look, I think, no matter what monetary standard this society is living under that those kinds of things can cause a shock and it can cause an issue to the market, whether we’re using US dollars or we’re on the Bitcoin standard. So I think that’s one point there. I’m also curious so my friend Saifedean Ammous, you might’ve read The Bitcoin Standard. One view that I’ve seen him share is this idea that if we consider the world as it is today with the fractional reserve banking system, as new loans are created, that’s the creation of new money. So Saifedean’s view is actually one view I’ve seen input is this idea that because Bitcoin is more like an equity based system, more people might just not, they might just save into Bitcoin and it might become more of an equity based system. And in some way it might slow the creation of new loans, which in turn slows the creation of new money. So I’m wondering whether that might actually create less demand for holding dollars because there’s less demand for borrowing dollars. What’s your reaction on that idea?

Luke Gromen:

I think I would think there’d be less demand for dollars as Bitcoin gets bigger ultimately is such a hard currency. It resembles a gold standard in a way where historically the governing mechanism of the gold standard, right, was when the sovereign is being irresponsible in terms of deficits you show up and you demand gold. And the way the sovereign gets the gold back and for many decades, centuries, excuse me, that was the Bank of England would raise rates. So if the UK went to have had a big, expensive war, and there were concerns about the pound, so people would go to banks, take gold out that gold would flow away from London. And then in order to control that he bank of England would have to tighten policy, raise rates and make Sterling more attractive than gold relative to whatever what was happening in the world.

Luke Gromen:

And basically call that golden by raising rates, by strangling the economy, by putting things into a deflation. And it’s kind of similar here where you’re seeing the run into Bitcoin happen in real time. I don’t think anyone can argue that isn’t happening. And the reason that’s happening is the fiscal situation of the reserve currency issuer, the US and Western sovereigns more broadly is a mess. And they’re paying I mean I’ve looked at it as it’s last 12 years. The growth of us federal debt has risen by between nine and 10% CAGR maybe it’s eight to 10% CAGR and the coupon on that, that’s never been more than 3% at the longest. And so you’re the money supply, if you will, that the supply of debt out there is growing anywhere from 500 to 800 basis points faster than the coupon on that is.

Luke Gromen:

So you’re in, on one measure, it’s a significantly negative, real rate relative to the issuance of that. And so the fact that there is a release valve, that Bitcoin is a release valve that can’t be manipulated, I think is doing exactly what was Saifedean said, which is it’s like a gold standard, right? The way that this has been, why gold hasn’t worked is the gold has been managed by allowing unallocated paper derivatives to expand as fast or faster than the debt and the money supplies. So if you have paper claims rise on gold, and because gold is centralised and most people don’t take physical delivery. You can control the price of gold. So the smoke detector of gold has been managed by policymakers in this way, and that’s allowed them to expand the money supply more than they otherwise would have.

Luke Gromen:

If these paper derivatives didn’t exist in gold. If the unallocated paper claims didn’t exist and weren’t able to expand as rapidly as they’ve been allowed to expand. Bitcoin, doesn’t have that. And so what Bitcoin’s price is doing is it’s just telling us what’s happening. And there’s, I think, a catch-up aspect to it. And I think there’s momentum chasing aspect to it and all that. But the underlying fundamentals, I think, are this escape out of Fiat currency whose supply is growing well in excess of the interest rate that people are being paid to hold it. And the governmental officials can stop that anytime they want, all they have to do is really ratchet back spending and, or really ratchet up rates, right? So it’s basically running the old bank what the bank of England used to do to bring the gold back is really all policymakers.

Luke Gromen:

And in particular, the US have to do to bring Bitcoin back in the challenge is that the political implications of slashing spending the market implications of raising rates enough to do that. I think are at a point where they couldn’t do that without forcing the US to default on its own debt, which means they can’t do that without, and they’re not going to default nominally, but what I’m saying is that basically they wouldn’t be able to pay the interest or pay the entitlements on a pay as you go basis without help from the Fed, which then gets us right back to the point that they can’t, they can’t do it. So I think the way you described you and the way he’s describing that, basically Bitcoin is serving as a very hard gold standard. And I think up for most of its life to date, it’s been primarily sort of Cypherpunks and a few gold bugs and people like myself who owned a little bit, and I think it’s really changed the tenor of what Bitcoin is doing has really changed in the last nine months, I think in no small part to how the crisis evolved with the US back in and globally with COVID and the implications it has for the us fiscal situation since March.

Luke Gromen:

So I think it’s really, when now you’re seeing corporations looking at it for treasury, you’re seeing institutional interest. It’s become much more a mainstream asset, which is I think the reason for that is exactly for what are the reasons you described.

Stephan Livera:

Really great explanations there. And I think we could summarise in terms of the US government situation there, it’s kind of like either the Fed has to keep printing or the world defaults, right?

Luke Gromen:

That’s basically it. Yeah. Like if you said, Luke, I want you to stop Bitcoin. If I was Luke, I want you to stop this. How would you do it? And the first way I would do it would be to attempt to roll out a cash settled futures exchange on Bitcoin. And obviously they tried to do that, and there was, the futures exists, but it just is a it is not the same as a cash settled futures on Bitcoin. And that’s part of it. Then you would also need an unallocated Bitcoin market where, and that’s the real issue for gold, which is you can go to London, say, I want to buy a hundred million dollars in gold. They say done, and now you don’t own a hundred million dollars in gold. You own a hundred million dollars in gold credit.

Luke Gromen:

And as long as you don’t try to get that gold that’s fine. I was told recently that there are a major investors looking to buy a hundred million dollars in physical gold, and it’s taken two months to source at least. So physical gold supplies are extremely tight. It’s still hard to source physical gold. It’s very easy to source paper gold, but that’s partly this, what speaks to the centralisation weak point of gold relative to Bitcoin that a number of the Bitcoin proponents have talked about. Which is because gold’s centralised, they, this, this can be done, Bitcoin, not centralised. And so you, and because of that it’s easier to buy quote unquote, physical Bitcoin, right? I can buy, I can buy Bitcoin on my phone, much easier than I can buy physical gold. Any time I want to do that.

Luke Gromen:

And more importantly, it’s much easier for me to buy physical Bitcoin if you will, than it is to buy Bitcoin futures. And so, because of that, this cash settled futures and the unallocated gold expansion, it doesn’t work. So step one would be to try to try to recreate the paper, the unallocated paper markets that exist around gold that help control Gold’s price. And thus far because of the decentralisation of Bitcoin has been very difficult to do it. Hasn’t worked. So step two for me, if I was tasked with controlling Bitcoin would be, I would revalue gold enormously that sits on government balance sheets take gold to $50,000 an ounce in the US. The proceeds we are doing that in the United States would deposit by virtue of the calculation. It would deposit about $12 trillion into the general account of the US treasury.

Luke Gromen:

And they could then spend that money. However they saw fit whether they wanted to just go out and buy back $12 trillion of debt outright, they could do that. They could turn around and spend it into the economy, get some sort of multiplier effect on infrastructure. The point is that they could use it to massively deliver the government’s balance sheet. Because remember what I said before, the reason the government can’t raise rates and sort of call the Bitcoin back in if you will. Is because calling it, they can’t raise rates without bankrupting the government. The US government would not have the tax revenues to pay the interest on the debt without the Fed’s help. So, in theory, if you delevered the government’s balance sheet enough, by revaluing the gold, then the Fed could raise rates enough to bring the Bitcoin back in without bankrupting the government.

Luke Gromen:

Now, the devaluation of the dollar against gold would likely be massively bullish for Bitcoin at the same time. And so there’d be sort of Bitcoin up huge gold up huge, but then the government would be able to take rates up to seven or 10 or 12% or whatever they needed to do to sort of bring the Bitcoin back in. And that at that point, Bitcoiners gold holders, et cetera, would have to decide. Do I want to continue to hold my Bitcoin and my gold, or do I want to own the sovereign debt of the United States of America who has zero debt effectively, or much lower debt effectively? And it’s going to pay me 10 or 12% per year, and that’s a different discussion. Then I’ve got the discussion today regarding our fiscal situation, the 0% yielding debt, negative real rates relative to gold Bitcoin. So that’s, I think sort of the discussion when you sort of think about, okay, Hey, what would you do to bring it back in? But until you do one of those two things. They’re in a tough spot where they can’t, they being the United States government can’t make whole they can’t make their obligations nominally money good without help from the Fed base if they raised rates.

Stephan Livera:

Yeah. So, interesting thoughts there. I guess my first reaction with the idea of the gold revaluation is that it’s effectively like trying to play an accounting trick to try, like, because it’s not that the US magically would have more productive resources. All of a sudden it’s just kind of revaluing and saying, Oh, well, actually all this gold we have, we’re just going to treat it as though it’s worth more than what it was before. And so I guess that’s probably, I don’t know how easily that would fly amongst the international community. I mean, potentially I guess if there’s enough kind of, sense of power for coming, being projected by the US government. And I guess the other point I would just, I guess I’m curious what your thoughts are on this idea of trying to raise the interest rates to, I guess, give people more incentive to hold US government debt.

Stephan Livera:

The problem I could see, or one problem I could see is that Bitcoin returns have, I mean, if you look at over the last 10 years or so, it’s something like 200 return per year annualised. So it’s almost like they would have to bring the interest rates so high that it would just be crazy. So I guess, but I guess the point you were saying is that they would have already gone up a lot as a result of this. And so maybe at that point, they could try to encourage people to hold US government debt. Is that how you’re thinking about it? Or how are you thinking of about that?

Luke Gromen:

No, I can’t remember. It was a Saifedean’s book that, that made that point, that when you look at the return the amount of the interest rate that would have to be paid on sovereign debt to make that competitive. I don’t know if it has to go to par, but the point stands, right. I don’t know if it’s 200% or if it’s a hundred it’s 20%. I don’t know what that number is, but it’s very high. It’s not three, it’s not 5%. All right. Exactly. Some of that would depend on the fiscal situation. Some of that would depend on again, is it gimmicky and wonkish in terms of that bolder evaluation. Absolutely. That said it’s no less gimmicky than what we did to the world in 1971 when we said, yeah, we’re going to back it and gold at 35.

Luke Gromen:

And then one day president Nixon got on TV and said, kidding, it’s your problem now? Right. I mean and it’s no different than what FDR did in 1933. Right. Which was, Hey it was 20, yesterday, 35 today have a good day. Right. So it’s, we’ve done these things before, and it’s just been a long time. And so people think we won’t do it again. I mean we did it in 2002, Hey, Iraq has weapons of mass destruction and you’re all either with us or against us. And so it is gimmicky. It is wonkish. It would work to devalue the balance sheet. And then if you delever the balance sheet, you’re also by the way, going to be having an economy that is absolutely soaring in dollar terms, right. Because of the inflationary the dollar will be falling sharply, you’ll have inflation.

Luke Gromen:

Economic growth would absolutely rip. So it would be it would effectively amount to a reset and you’d basically have to raise rates to a really significant level. And so the question would be what would I, as a Bitcoin holder say that would take Bitcoin to 35,000 today, after they take gold to 50,000, let’s say Bitcoin goes to 500,000 and $500,000 with a US government balance sheet largely delevered. Would I want to have my Bitcoin holdings making 12% in the US government maybe, is it 15%? Is it 8%? It’s probably not below it. That’s a question that’s sort of the calculus. And I don’t know what the right rate would be, but that’s really the calculus that basically of what Bitcoin is global gold standard would require is basically sort of that.

Luke Gromen:

And particularly, Oh, by the way, if the US is no longer running deficits in any real way, right. If this, in the aftermath of all of this, the answer is, yeah, the US is running a balanced budget. Its debt to GDP is 20% and we’re paying 12% interest right now. What do you want to do, boy, that’s a really productive economy making 12% now I’d be tempted. Right. So that’s the calculus and I don’t know what the right number is. Because again I agree with your point that when you look at the 200% per year, would I sell all of it for government bonds. No, but would I sell, some of it probably.

Stephan Livera:

Maybe maybe enough to sustain the government debt market. I mean, look at where we’re talking. Like obviously Bitcoin today is very small. It is what $600 billion as a total market where other markets are just dwarfing that. So I guess I know you’ll have some interesting things to say on this is that the, with the US fiscal situation and the way the government bond markets are. It really does boggle the mind why people are holding these things. Now the explanations I’ve heard probably three main ones. One of them is greater fool theory, right? So this idea that I’m just going to buy it and sell it onto somebody else. And that’s it secondly there’s this idea of the collateral and the safety implications of holding US treasuries or other near money rather than cash in the banks itself because of the safety perspective. And then I guess thirdly, you could also say maybe there’s a regulatory reason. It might be Basel standards that mandate holding some level of government bonds. And that’s why these big investing entities are holding government bonds from your perspective, how would you explain that? Why do people hold these bonds that are literally paying out negative?

Luke Gromen:

I think it’s a combination of the regulatory side where your incentive to hold them or mandated to hold them. I think there is the the derivative and collateral side where they can be levered up or hold them as collateral and they can effectively be levered up to by other things they need to be held for derivative positions as collateral. So I think that sort of falls back into the regulatory side. I think another big part of it is really portion of the industry are holdings that are duration matching. Which is to the extent you have liabilities, you don’t care what you are earning nominally. You are just trying to match as close as possible your cash flows with those liabilities. And so when you’re talking about insurance companies and certain fixed fixed pensions, et cetera it’s all about matching liabilities.

Luke Gromen:

And so I think it’s a combination of those things. It is central banks, I think it’s policy at which people tend to leave out. Because I think it’s all those prior are very important, regulatory and collateral and liability matching. But you look, the Fed’s grow in their balance sheet by $3.7 trillion in the last 18 months, last 15 months, what would the yield be if they didn’t step in? We saw a brief glimpse of what the yield, what could happen to the yield in September, 2019 when repo rates spike to eight to 10%. And the Fed jumped on that immediately within 48 hours began growing their balance sheet again, to bring those back under control. And so I think some portion of the answer is rates are where they are, because that’s where governments can afford to keep the wheels on the car.

Luke Gromen:

They can afford all of their fiscal obligations without interest expense, spiraling up to an ever growing portion of ever declining tax revenues as rates rise. The release valve can always be either rates rising or central bank balance sheets rising, and the answer cannot be rates rising. And so it’s been foreign central bank ownership of government, and increasingly in less over years, corporate debt markets, mortgage markets. And I think that’s ultimately really when you talk about what the marginal bid is doing every time they’ve needed a marginal bid. This the central banks have been there and that ultimately ties back to. I think why Bitcoin has done what it’s done is I think it is becoming. I think 2020 in particular made it very obvious that when the treasury markets sold off sharply in March. It started crashing alongside the stock market. I think was a very big eye opening moment when a lot of investors around the world where they suddenly realise that, Oh my gosh, in the next deflationary crisis in this deflationary crisis that the safe Haven is crashing alongside stock, okay.

Luke Gromen:

They are not going to let that happen. That means the central bank balance sheets are going to have to arise a lot more than we think. I need something that hedges that basically does well when central bank balance sheets are rising and that’s Bitcoin that’s gold. So I think that’s really the dynamic driving.

Stephan Livera:

So I guess we could say then as more and more people wake up to this dynamic, there’ll just be more and more people running for the heading for the Hills and buying gold and Bitcoin.

Luke Gromen:

I think it is. I really do. I think it was very eye opening to people in terms of just what happened with in particular, the US treasury market back in March.

Stephan Livera:

Very interesting. I also wanted to get your thoughts around state control of money. So AML regulation and so on. I know you were just recently commenting about Lloyd Blankfein. So he was the former CEO of Goldman Sachs. What was your view on what he was saying about government control of money?

Luke Gromen:

I just thought it was really interesting how in over the last, since Nixon closed the gold winner, we’ve moved to this period over the last 50 years where, because it’s happened little by little, we’ve all sort of been the frogs that have gotten boiled about the the normalisation of complete state and government control over sort of every aspect of financial privacy. I understand the need for KYC AML, these kinds of things. It just was fascinating to the degree to which they are painting Bitcoin with that brush, because the reality is I mean, at least for me, my Coinbase account in 25 years in investment research and sales, I had all the compliance, KYC AML stuff ramped up and compliance after 2001, of course, and to open Coinbase and participate in Bitcoin markets in the United States, there’s very rigorous KYC and AML compliance measures in place.

Luke Gromen:

And so for me, what Blankfein was talking about today on CNBC. It was really two fold number one, the focus on Bitcoin as it relates to KYC, AML, when those measures are already in place to me smacks, It seems a bit disingenuous. It feels like they don’t like the message of what Bitcoin’s price is telling them. And so they’re trying to beat it over the head with the KYC AML club and then from a bigger picture perspective, it’s just interesting to me to see the CEO of a broker and a former CEO of arguably one of, if not the most important systemic brokerage firm out there effectively sounding like a CCP apparatchik right. In terms of just, Hey, we need to make sure the state has control over the money and over the so we know where all the money’s flowing and all this stuff. I mean, it’s the very antithesis of sort of where we started this process 50 or 60 years ago, where there was it was much more capitalism from the ground up as opposed to from the state down. So it just, struck me just hearing him say that more than anything else.

Stephan Livera:

Yeah. We’ve just seen this continual erosion of any possibility of having financial privacy. And it seems to me that people have just overwhelmingly accepted Oh this massive amount of control, this massive amount of intrusion and asking about all, Hey, where did you get this money? What is the ultimate beneficiary or this et cetera, stuff that they’ll ask you, but it just seems like everything is becoming KYC, bureaucracy papers, please.

Luke Gromen:

Yeah, for me it’s a little, and to be clear, I’m not against KYC or AML, but I look at a system where, when I, it always left me scratching my head, right. So if you go back and you can find the story online from 2011, 2012, there was a US bank that was reported to US authorities for years by an internal whistleblower authorities didn’t do anything it was with. At any rate they had laundered like $360 billion with a B for a number of different elements. It took like six or seven years to get anything done. And around the same time, they were able to basically politically discredit one of our politicians Elliot Spitzer New York politician, by finding that he had passed a $3,000 check to a prostitute. And I just always wondered how they couldn’t find $360 billion in laundered money.

Luke Gromen:

But they were able to find $3,000 check from a politician to a prostitute as quickly as they were. And what it speaks to me is that it runs the risk of being unevenly or politically applied which is not the spirit of the constitution, et cetera. I’m all for KYC, AML. But I also, as a sovereign person with a finite lifespan on this earth, I want to have the ability to protect my savings from what I have earned throughout my life, to this point from confiscation, by inflation or currency collapse, as a result of bad decisions that I really didn’t have a vote on. And those decisions range from entitlement programs approved before I was born to Wars fought before I was born to Wars fought when I was born in which I thought probably didn’t make sense and have clearly in hindsight, have not made sense.

Luke Gromen:

Ultimately that’s where I really get caught up, which is, listen, I’m happy to tell you where I got the money from, because it’s not coming from an illegal place, and I understand your need to protect your citizens. And that’s a role of government. However, I don’t want those protections to morph into an excuse for not giving me the avenue to protect my the efforts that I’ve put in my life today for my family, for my kids for productive investment for this country. And in terms of a bottoms up capitalism, like we were talking about before, as opposed to state down directed investment. So that’s how I come at it is less a full on, I’m not a full-on libertarian. Hey, don’t, I don’t want any, I understand they need to protect citizens and they need to do some of the KYC AML, but I just don’t want that to be used against that lens to use, or that hat to be used to try to stop me from protecting the real value of the work and the time on the percentage of my life that I’ve expended so far.

Stephan Livera:

And I think I can appreciate that view. I would say even considering just the AML regulation, I think there was actually a recent study showing that very few actual cases of AML get discovered because of all the AML compliance. So the net result is just that all the banks and financial institutions and all of us who have to deal with the compliance burden basically end up we are just paying this huge cost. And all of this reporting goes into the government in the US it’s FinCEN in Australia, it’s AUSTRAC, and so on basically the AML regulator, all this reporting goes into them and even sanctions as well. So now we’re talking OFAC, all this reporting just kind of goes into them. And at the end of the day criminals still end up using the system and manage to slip through the cracks anyway, because they find other things, they find other ways to do it. So it’s just seems like a very ineffective system, even taking them on their own terms at solving their own stated purpose. So it just seems a very odd and unusual system in that regard to me.

Luke Gromen:

Yeah, it’s a fair point. I mean, given the amounts, you’ve got to be able to see given the sensitivity of the system, in terms of the ability to track flows, where you can see they were able to track this flow or that flow. It just raises questions about some of the flows that are missed, I guess.

Stephan Livera:

Exactly. so look, I think we’re sort of coming to the end of time, but I guess if you’ve got any thoughts for listeners in terms of outlook over the next year or so in terms of Bitcoin, or even just kind of macro in general, if you’ve got any thoughts to leave for the listeners.

Luke Gromen:

Yeah. I really come at Bitcoin more from the macro side than the technologist side. And for me, it really comes down to what’s the next marginal step for the United States because the United States is a reserve currency issuer. And so we saw this the US fiscal position as a result of the COVID crisis really became, what I would call irrecoverable, which is to say the way we’ve defined it. If you look at the US’ big three expenditures, it’s defense entitlements and interest expense treasury spending. And those big three are 140% of tax receipts as of the third quarter of 2020 as a result of the COVID crisis. And so you really, it’s very difficult for the US to raise rates. Basically operate without ongoing Fed support. And so to me, it really comes down to what is the marginal level of Fed support going forward relative to the amount of stimulus out there going forward relative to the amount of treasury issuance going forward, because if treasury issuance ramps, but the Fed’s balance sheet does not, the fed doesn’t effectively monetize it dollar for dollar or more than dollar for dollar like they did in 2020.

Luke Gromen:

Then you’re talking about the United States beginning to effectively suck dollar liquidity out of the world. And that’s going to be a tough macro environment. That’s not going to be a great macro environment. I think you’ll start to see the dollar rise. I think you’ll start to see cracks emerging in the weakest emerging markets. So I’d start with the Argentinas and the Turkeys of the world. And before long, I think you would start to see it show up in the price of gold and Bitcoin, and eventually in more broad risk assets. And eventually the Fed is going to have to come back and do a lot more in our view. But that to me is the one thing I’m really paying most attention to on the macro side is basically is the Fed going to effectively monetize enough of what the US spends and issues in terms of treasuries?

Luke Gromen:

Because if they don’t, it’s going to be a little like the first half of 2018, where you saw this dollar strength, you saw a Bitcoin weakness, you saw assets flow to the United States. The US stock market did well for a while. Dollar did well gold sort of floundered. And then fourth quarter of 18, of course the wheels came off the cart and the Fed had to reverse course, and that took us into 2019 and sort of the re expansion of the Fed’s balance sheet. And I think that whole playbook, if the Fed doesn’t do enough would happen much faster this time around. So then it took call it from the time the US started sort of tightening a little bit. The it would take a it took four to five, maybe six months for basically US markets to blow up and force the Fed to reverse course.

Luke Gromen:

I think it would happen a lot faster this time, but I think that’s sort of the one big macro question at this point that is still unclear. Because there’s a number of different moving parts. There’s US as a big treasury general account it can spend policies of the Biden administration are still pretty unclear. Janet Yellen seems to be talking out of both sides of her mouth as it relates to what treasury is going to do. Powell kind of a little bit of the same in terms of what that will do. So we’re in a little bit of a holding pattern. You can kind of see that reflected in markets, but that’s the thing I’m really watching for most closely.

Stephan Livera:

Excellent. And Luke, before we let you go make sure you tell the listeners where they can find you online.

Luke Gromen:

Absolutely. So if you’re interested in learning a little bit more about our research product, we have product for both institutional and individual investors. It’s @FFT-LLC.com that’s Frank, Frank, Tom, Tom, dash, llc.com. If you’re in following what we’re doing and talking about, et cetera, I’ve got a pretty active Twitter feed @lukegromen.

Stephan Livera:

Awesome. Well, I really enjoyed chatting with you, Luke. Thank you for joining me.

Luke Gromen:

Thanks for me Stephan. It was a great conversation. I really appreciate it.