Luke Gromen of Forest For The Trees rejoins me on the show to talk about his macro views: 

  • Soft landing vs hard landing
  • Government debt levels
  • US Interest rates and “chicken-pivot”
  • Commodities and dedollarisation
  • Outlook for Bitcoin



Stephan Livera links:

Podcast Transcript:

Over at Mempool Space enterprise and now onto the show. Luke, welcome back to the show.

Luke – 00:02:43:

Great to be here again. Stephan, looking forward to talking with you.

Stephan – 00:02:46:

Yeah, I’ve seen you’ve had some interesting commentary and I thought it’d be great to have a chat a bit about what’s going on around the world. I think an interesting point of discussion we’re seeing now is people are saying, are we in a recession now? Are we heading for a soft landing or a hard landing? I’m curious how you’re seeing that. Maybe if you could start with telling us if you could paint the scenario. What does a soft landing look like and what’s a hard landing look like.

Luke – 00:03:10:

I think that probably depends for depending on who you asked. For me, a soft landing is the FED is able to avoid what will look very much like a balance of payments crisis in the US. And as a result, the world and I would say what we were seeing throughout much of last summer and into the end of September of last year is what that looks like. Right where we get dollar up, risk assets down, treasury yields up, UK gilt market breaking, all of these emerging markets under pressure. That is what a hard landing looks like and that is if the FED over tightens what we will see. And so if you would have asked me, soft landing, I think, isn’t anything short of that. If you would have asked me two weeks ago, maybe three weeks ago, I would have said there’s probably zero chance of the FED being able to orchestrate a soft landing. I have upped those odds in my own mind for the next quarter, maybe two, based on a couple of different factors that I think the FED can maybe keep the balls in the air. But ultimately, in my view, the only way for the FED to engineer a soft landing, in other words, to avoid this balance of payments crisis, us and Global is to resume dollar liquidity injections. And importantly, what the dollar has done since mid October, which is suffer its biggest quarterly decline in decades, very quietly, in fact, has bought time for the FED. And I think there’s some other things that could, some other levers that could be pulled by the US government. And that’s why I think we could see a soft landing type environment for the next quarter or two. And from there it starts to get a little bit trickier. But let’s watch and see.

Stephan – 00:05:12:

Sure. And as you were commenting recently that the FED had done a bit of a chicken pivot recently and you’re forecasting, or at least you’re envisioning this idea that maybe towards the middle half of 2023, that’s when they start to genuinely pivot. Is that what you’re seeing?

Luke – 00:05:30:

Yeah, I would say it was a chicken pivot that was engineered a bit more by treasury than the FED. And the FED I think, had a hand. You saw some sort of obscure liquidity facilities that were drawn on at the end of the year. Not in large amounts, but you saw that in the fourth quarter you saw the reverse repo balances draw down a little. More importantly, you saw the treasury general account not just draw down sharply enough to basically offset all of the QT the FED was doing. But if we go back to October 31, right, so this is pretty late in the year, october 31, US. Treasury comes out and says, we want the TGA, the treasury general account, our checking account at the FED, if you will, our plan is to finish that at $700 billion by the end of the year. And when you looked at where that was, what that implied, the fact that they were upsizing fourth quarter treasury issuance by 37% versus what they thought just three months prior. All of this pointed to a massive tightening of liquidity in the fourth quarter as basically the US government’s borrowings crowded out everybody else with both the borrowing and then the replenishment of the TGA. On top of that, what ended up happening was the TGA finished the year, I believe, $260,000,000,000 short of their target. So instead of 700 billion, the treasury left an extra 260,000,000,000 in basically in dollar liquidity out there. And there’s a couple of possible reasons for that. Reason number one is they’re looking to offset the liquidity draw that would have otherwise happened, or tax receipts are coming in way light and they are therefore not willing to draw that out. Either way. It pointed to this chicken pivot dynamic that I referred to, which effectively you can see it you can see it in the most important metric, which is the dollar. DXY had it from mid October to date. It’s basically a three month period and it had its biggest draw down, like I said, in decades in a single quarter on the heels of its biggest run up in a quarter in decades. So anytime you increase dollar liquidity, dollar liquidity is fungible. And so whether it was the FED growing its balance sheet, whether it was treasury running it down, et cetera, didn’t matter. You get the dollar down, you’re going to buy time for this hard landing. You’re going to push out this hard landing dynamic. And I think that’s what has happened. That’s what has happened in recent months. And that amongst some other things by some time, right?

Stephan – 00:08:20:

And I think the other big and you’ve commented on this also is just the level of government debt out there is just incredible, like just breathtaking the level of government debt that’s out there so what kind of constraints are you seeing that placing on what governments around the world can do?

Luke – 00:08:39:

That is the hard landing dynamic and that’s that balance of payments issue that we talked about just a couple of minutes ago us issues the global reserve currency and that’s why I spend most of my time on the US government’s debt levels because if we’ve got a problem, everybody’s got a problem. And so I’ve looked at it a couple of different ways. When you look at the absolute debt levels, where it starts to filter into, in my view, is through for me, it’s less the absolute debt level and more the annual expenditure of floating that debt, right? So obviously we’ve had a big increase in interest rates. You’ve got an economy that is highly interest rate sensitive. And so the metric I have spent a lot of time looking at is your true interest expense, which for the United States is not just what are we paying, what’s treasury paying to float the debt? And all in treasury spending last year was, I think a trillion two. When you look at the treasury or the TBAC Treasury Borrowing Advisory Committee report So Treasury spending all ends a trillion two. And most people look at that number and say, oh, rate hikes, no problem. Well, in my view, the right way to look at that is to then say, well, that’s just for the on balance sheet portion. That’s just to float the on balance sheet portion of the US debt. That $31 trillion number plus some stimulus. The true interest expense that I think is more relevant for these purposes is to add in the entitlement pay goes, which are what you’re spending annually in entitlements and which most people don’t know what that number is. But that number according to the TBAC is $2.9 trillion last year, which is about two thirds of record tax receipts, record tax receipts inflated by a bubble. Tax receipts that are now rolling over with the slowdown in the economy and the increase in interest rates. So when you add the 2.9 plus the 1.2, you get the $4.1 trillion in effective annual interest expense against tax receipts that are, I think, at record last year hit 4.6 trillion maybe. I mean, and this is with sort of, you know, the, the gasoline on the economy pressed through the floor. This is you’re, you’re going, if you have a recession, you’re going to see tax receipts in a modest recession down ten to 20%. If you have a crisis, they’ll be down 30 or 40. And now all of a sudden you’re back into the situation that we saw for a brief moment in time in the COVID crisis where your effective interest expense is more than your tax receipts. And so that’s where to me, the debt filters in because already you’re talking about effective interest expense. That is what, 4.1 trillion on 4.6, I guess it’s what, 90%, 88%, and that’s down from about 100, 510 at the peak in the COVID crisis. You have a recession, it’s going back over 100%. And then it’s a pretty basic decision tree, which is either the FED prints the difference or the FED doesn’t. And if the FED doesn’t print the difference, as we saw in 2022 where we weren’t even at 100%. You get what we had then, which was dollar up, treasury yields up, bond yields up around the world, risk assets down around the world until either the system collapses or the FED pivots. One way or another, more dollar liquidity is injected one way or another. Another way I’ve looked at this same dynamic in terms of the importance of the debt and the size of the debt is to look at the annual federal US deficit as a percent of projected global GDP growth all in dollar terms. And we did a chart for our clients about a month and a half ago and showed it a couple of times since. But what it shows is if you go back to 1995 so going back 27 years, anytime the US federal deficit and again, it’s relevant because we are the global reserve currency issuer. We got to get funded first. Anytime the US federal deficit is more than 20% of global GDP growth, the FED has been in supplementing helping finance that via QE, and that held 100% of the time until 2022. 2022 was the first time that US deficit was more than 20% of global GDP growth. And it was 32% of global GDP growth based on the IMF preliminary GDP growth numbers. And you saw what we got, which is worst combined stock and bond market since 71. And that’s in the US dollar up, bonds down, stocks down, real estate down, bitcoin down, everything down. I bring this up because that was 32%. It was U. S. Federal deficits at 32% of global GDP growth. 2023. We are looking at if you project the deficit of the US for four Q and one Q as an annualized number, which I think is reasonable, it might even be low, but let’s just go with it. And then you assume the IMF’s GDP growth estimate for 2023 of 2.7%, which I think might be high, but we’ll see china might be changing that, but let’s just go with it. You end up with a US federal deficit at 72% of global GDP. If you didn’t like what happened in 2022 at 32%, we’re really not going to like what happens at 72%. So the point here is the debt is a problem. It’s a problem now, today. Last year was an indication or a warm up of what it looks like. If enough dollar liquidity has not been injected, we have gotten a respite via the biggest decline in a quarter in the dollar in decades. And here we are. And to me it really comes down to then, okay, what’s the FED do, depending on the FED, is what’s inflation do. And the comps get easier. It should come down. Will it come down fast enough? I think investors are underweighting the reality that the US government calculates inflation and the US government desperately needs lower inflation prints. For the next to me, investors are putting too much faith that they’re actually going to calculate the numbers in an honest and objective way. And this is not listen, I love America. We convinced our country to go to war for weapons of mass destruction that didn’t exist. Right? We said two weeks to flatten the curve. You really think that a government that needs lower inflation, desperately needs lower inflation, wouldn’t be tempted to sort of force the FED’s hand? I think they would. It’s exactly what I would do if I’m sitting in the Bureau of Labor Statistics and listen, we need lower inflation. You really want to be that guy? No, I want to be honest about them, maybe. But the bottom line to it, you don’t want to sound too much like a crazy tinfoil hack guy, so let’s set that aside. The bottom line to it is these inflation numbers over the next three months are really, really critical because if they come in hot, that’s going to spur the FED to go back to not financing enough deficits to sort of turn this. Ultimately, I think we’re in a very secularly inflationary environment. But I think these next my personal view is we will get softer than expected inflation over the next, even softer than expectations that are on the street because the comps get a lot easier, or a little harder, I should say, right. The base effect, I think they’re going to come in below that and I think markets are going to like that and I think that buys time in the soft landing.

Stephan – 00:16:22:

Okay, so if I’m understanding you, like, we’re in this overall scenario where government debt is just absolutely massive. And as you were saying, when the US government debt is too high as a percentage of global GDP growth, that is where we see not fun times for most investors. And because as a result of that, you’re saying basically the US. Government really wants CPI inflation to go down. They want that CPI number to be low so that they can have this credible story of why it’s okay for them to not keep the rates this high. Because as the rates keep going higher and higher, this government debt problem just becomes harder and harder and harder for them to deal with in an honest way. And so now they’re sort of trying to maneuver things into a scenario where it looks okay for them to not have rates this high. And I guess in a similar sense, obviously we’ve been talking about the government debt and of course there is the 31 trillion and the off balance sheet stuff, but there’s also the factor of how everyday people are living, right? Because what we’re seeing is like a person may have entered a mortgage a few years ago with the payment at a certain level, and now that payment level is so much higher because their mortgage payments are so much higher. But it’s not like their earnings have gone up a lot. So I’m sure there’s also going to be that stress factor on households and families, right?

Luke – 00:17:43:

I think in places like Australia, UK, where these reset, these mortgages reset more quickly, I think Canada might be in that group too, but here in America, most people have a 30 year fixed, so there’s no reset. And quite frankly, it’s a way that the US can engineer a debt jubilee for the masses, right? If you own a house and have a fixed mortgage on it, and inflation runs ten and your wages run eight and your mortgage is three, and who holds them? Who’s a sucker at the table holding the mortgage? Well, it’s the FED. Then what you’re seeing is effectively a debt jubilee for the home owning class. So that’s your middle and working class in America, which is it’s not a terrible outcome on net, right, you’re basically getting your house from the government for free for a discounted rate over time. Now, the problem, of course, is that this dynamic has been in play one way or another for 15 years now. So home prices here, there, everywhere have exploded higher. And so the more you run this game, the more inflation you need to keep this game going. And that’s the tricky part. And last year, we saw what happens when you try to stop the game for a second. The longer you go, the more painful and binary the choices get with each increase in debt. And once debt hits certain and that’s really where when you talk about the absolute debt levels, why they’re so big is high level of debt, reduce your optionality, you get levels high enough and it’s collapse or hyperinflate. That’s it. And that’s I don’t know that we’re quite there yet, but I think we’re at the point where the options are sort of, you know, big, big economic crisis or sustained double digit inflation for five years, three years. Those are our choices now.

Stephan – 00:19:47:

And that’s not going to be fun as well, especially for those people who are trying to get into the housing market and it’s been bid to this incredible level. Although I’m curious where you balance that out with the demographics aspect, as, let’s say baby boomers are retiring, or maybe the older boomers are dying and passing it on to the lower generations, to the younger generations, rather. How do you sort of balance that out? What does that look like for housing affordability? And this idea of everyone using their houses, their savings account instead of savings.

Luke – 00:20:18:

Accounts, that gets into an interesting dynamic, right? Because if the housing market, when you look at house prices and asset wealth overall, you end up with this air pocket between offer prices and bid prices in terms of the ability to pay these prices. And in the case of generational change, right, wealthy boomer, generation dies, generation below them, less capacity to float those assets, right, from the tax standpoint, et cetera. This is where I wonder ultimately, I think it’s really good for growth because you end up with sort of a windfall, right, unencumbered assets flowing to an indebted generation. They pay off their debt. They are much more the propensity to consume is much higher than, in theory, a 70 year old. Although, as I’ve talked in the past, I’m not convinced that those theories about the boomers marginal propensity to consume at age 70 is I don’t think that model holding up well in the last couple of years especially. But it also has implications for, I think, individual assets within that, right. At times, right? Where look, if your parents die and you don’t need the house, you don’t want to rent the house, you’re going to sell the house, and your interest in sort of maximizing every last penny out of that, it’s like okay, if there is any bid, ask spread at that point whether that’s generated by supply because a lot of boomers are dying or whether that’s generated by a change in interest rate. So the price that it was carried at is now, you know, the average that the person, the marginal buyer for that house can’t afford that monthly payment. Do you really want to sit there, right, if it’s my parents house and they have it has a monthly tax bill on it, $800 a month on a $300,000 house, then do I want to pay that $800 or do I just want to friggin market down 20%, move it, and so you end up with these. I think there might be shifts within asset markets around that where, hey, maybe housing maybe housing comes in, but other assets go up, but other consumer assets go up because you’re ultimately having sort of this generational wealth transfer. I don’t know that it’s a plain black and white dynamic. It depends on how you go. So I don’t have a sort of concrete answer to that. I think it would depend how it would develop, I guess.

Stephan – 00:22:42:

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Luke – 00:24:21:

Yeah, I think if you do get the FED to pivot then into the software inning, I think it’s really good for all of the above, right? And I think that’s also kind of where it ties into. It’d be really convenient for the government now for the FED later for the government to understate inflation. Right. And I bring this up because we have two or three different CPI methodology changes here in the United States that go live in February. I forgot to mention that before. So it’s not just me saying, oh, what if they change us? They are changing it. And so my guess is if they’re changing the methodology anyway, they’re probably going to change it on that. There’s a lot of incentive for the government to get it lower, put it that way. If they can do that, then that frees up. We’ve heard this phrase the FED is a one mandate central bank. They have to get inflation down. Well, they get inflation down, reported inflation. However they do it, if they do it in sort of a genuine way and it actually comes down. And to be clear, inflation is softening, meaningfully, sequentially and if they stay too tight, it will fall very sharply for at least a bit. But ultimately it ties back. When we talk about a FED pivot, to me one of the biggest factors that is not getting nearly enough attention is this reality that the debt and the deficit position of the United States of the west more broadly require inflation. We will have if you get inflation down too much, let alone deflation, we will have that hard landing we talked about before as tax receipts go below just your effective interest expense, let alone the 900 billion in defense and education and labor. And so that to me is really critical. When you think about a FED pivot. This isn’t just about oh, we want to guess stocks and bonds. Stocks and bonds are probably benefit too but bitcoin, gold, real estate it’s not about bailing out the investor class it’s about bailing out the government, it’s about bailing out Social Security, it’s about bailing out defense, it’s about all of this. We are just at the period of the long cycle dictated by our bad choices in the past. And compounding interest, the FED’s job is to keep treasury solvent at the end of the day, that’s their job. And if they are too good at getting inflation down. They are going to have to be very explicit about bailing out treasury again. And that is a bad look. So they are really trying to thread a needle here I think yeah end of a couple of quarters they are going to have to pivot, I think more explicitly and yeah, I think it’s really good for assets broadly I think it’s great for Bitcoin and it’s great for gold. I think it’s great for commodities I think it’s great for stocks it’s probably good for bonds although that’s a suboptimal way to play the trade because your bonds are going to be falling against sort of all those other assets that I think is to tie the loop to get the FED from here to there. It’s really nice to have lower reported inflation that helps facilitate that that helps prevent them from making this mistake of inflation stays high as inflation oh God inflation is too low. We know what happens when they go too far? Because we were starting to see that in July, August, September of last year.

Stephan – 00:27:49:

I see. And so do you believe then that I guess let me put it this way. This is actually an interesting area. So you’ve been chatting about this idea of dedollarisation around the world in different countries. And I guess you could argue that maybe certain individuals or businesses have been dollar rising. But maybe you could also present the case that some of the countries and the commodity trades are de dollarizing. So could you explain a little bit of that dynamic for us how we can see this weird almost dichotomy there?

Luke – 00:28:22:

Yeah for me dollarization, is driven by multiple factors but the most important of them is peak cheap energy and what we’re seeing is a world where according to Envirus 90% of the growth of global oil supply over the last ten years has come from US shale. US. Shale is peaking. You can see it in the data you can see it and at the very least when I say it’s peaking they could produce more but producing more is going to require sustainably much higher oil prices. So peak cheap energy peak cheap oil is a critical dynamic because and this is why I think this I focus de dollarizations about commodities is as long as oil is only priced in dollars then peak cheap energy will mathematically collapse the post $71 system without fail it is it is guaranteed I should be careful that word. Is going to get me in trouble. But it’s a mathematical certainty, right? Because basically global emerging markets need oil. They need more oil since they’re growing. And so they need to import more oil, which means they need to have spend more dollars. So peak cheap energy means not only do they use more oil, but the price of the oil in dollars goes up. So they need to export more dollars, but they don’t print the dollars. They have dollar reserves. So as soon as their dollar reserves get too low because the price of more oil is going up, not only are their imports going up, but the price is going up. As soon as their dollar reserves get too low, you start to have currency crises, people start dumping their currency. And so now the price of oil in dollars one goes up even faster. So their oil consumption drops. So their oil consumption drops, their economy drops. Standing, delivering drops, their economy collapses. And this will just happen over and over and over and over and it will happen to China, it will happen everywhere. And in the meantime, the people that are benefiting from this, the oil producers, are going to have a bunch of dollars, but they’re not going to be willing to lend it to these countries because there’s no hope of repayment. They can’t be repaid because their economy has collapsed. And that’s why I say it is a guarantee peak cheap energy will drive the collapse of the system. And so there’s sort of a couple of ways out of this. Like you said, you could burn the short term fixes, burn your reserves of oil or burn your reserves of dollars down. That’s a very dangerous short term fix. The other fix is you can find more oil, you can produce more oil. And China has certainly been doing that. They’ve been swapping dollars for oil all over the world, other resources all over the world for 15 years, making dollar loans in return for commodities back. The final way you do this is you de dollarize, your oil flows, your commodity imports, which is to say you pay in your own currency and you offer settlement in goods you produce and or gold that floats in neutral terms. And could this be bitcoin someday? Absolutely it could be, but that’s what we’re seeing de facto. For example, Ghana right now it’s gold. Russia effectively it has been gold. China effectively. In some ways it has been gold. So the dellerization is really sort of paradoxical, because what deceleration is ultimately about. Yes, there is an aspect that is geopolitical in certain countries, cases systemically. It is absolutely critical to do this because otherwise the system is going peak cheap energy means its system is going to collapse. And this would have started ten years ago. But again us. Shale biggest marginal Producer 90% of growth kept the lid. But now shale is done keeping a lid on oil and so I don’t get the sense that this dynamic is that well understood that this decolarization dynamic is being driven by a desire to sort of keep this to avoid catastrophe. So that’s the first paradoxical aspect. The second paradoxical aspect to it is initially as you dollarization your commodity imports, you’re emitting more of your local currency and there’s less dollars. While there’s offshore, there’s a big dollar demand and no demand for your local currency. So in the very short run, it actually strengthens the dollar against these other currencies paradoxically for a bit and then eventually it should weaken it because you’re basically freeing up dollar liquidity via your commodity bill. Right. You can see it. Ghana talked about this last week. We import $3 billion a year of oil. We also owe all this other dollars for debt, et cetera. We are now going to use gold for oil and that’s going to free up $3 billion for us to address our other dollar needs. Right. So you’re loosening dollar liquidity via the commodity market, which over time makes the situation more sustainable. And ultimately once you hit some sort of tipping point and I don’t know where that is or what percent of the market that is, then it becomes negative for the dollar on the flip side of that, which is sort of this other paradox. But to me, like, I mean, it’s interesting. Do I think individuals are still demanding dollars and EMS? Yeah, of course I would suspect they would. I would do the same thing. But that’s a little bit like, hey, my local coin shop is out of gold coins or silver coins. Okay, it’s interesting, but wake me up when the LBMA declares force majeure. Right. The difference between individuals dollarizing and the global commodity markets decolarizing. It’s akin to like, hey, my local coin shop is out of silver versus hey, the LBMA just declared force majeure on silver. That’s the order of magnitude difference. And just because one is true doesn’t mean the other isn’t.

Stephan – 00:34:18:

I see. Yeah. And so I guess the other question people might be thinking is what about just the aspect of what countries or governments in this case are holding as their savings? Right. So it may well be that they’re de dollarizing in the commodities aspect, but if a lot of other contracts are still priced in dollars and a lot of other, then maybe it forces them to keep some of their reserves or Treasuries in this case in dollar denominated assets or things. I’m curious how you weigh that up as well.

Luke – 00:34:45:

Yeah, so you can see the data. Right. So going back to 2014 when global FX reserves basically peaked, since then global central banks have bought about $400 billion of gold and they’ve sold about $300 billion of Treasuries. So that in and of itself sort of shows you directionally where the shift is happening on the margin as far as holding other things. That’s where it gets geopolitical. Because ultimately it’s not our choice. We can have that power taken away from us if a big nuclear armed oil exporter starts changing the ratios in which it will transact. In other words, if Russia comes out and says zoltan Pose, I wrote about this, instead of one barrel per gram of gold, we’ll do two. We will sell you two barrels of Russian oil per gram of gold. Now Russia is in control of that gold to oil ratio which I would argue is one of the most important ratios economically in the world because that is most important commodity energy commodity the de facto backing of the dollar for 50 years in oil over the competing reserve asset to Treasuries and the reserve asset that back the dollar for the 40 years or whatever before that. 30 years before. If that happens, that changes behavior entirely through the oil market because people may want dollars, may not want dollars. Debt can move around. They need oil. And if they have dollars and need oil, we saw last year outgo the dollars, outgo the dollar assets. That is, we know that for a fact. And we saw that. We know that for a fact because we saw that last year. So that’s why I say it. Ultimately Russia has a choice in that. Saudi has a choice in that. After that Iran. They’re not nuclear arms. So that changes as well. Really? It’s Russia. And so if Russia says, look, a gram of gold is worth two barrels, not one like it is in the paper markets in London and in New York, then that changes everything, right? Because think about the arbitrage that sets up. People say, well, so what? So what? Well, I can then as a country short oil in New York take the dollars, I short a barrel of law and I’ll just keep it at the base level. You short one barrel of oil in New York, you take the barrel those dollars, you buy 1 gram of gold in New York, you take physical delivery. You take that gram of gold to Russia, you give them the gram of gold, they give you two barrels. You take one barrel, put it in your stockpile, you take the other barrel, cover your short in New York, go buy another. Go do it again. Go do it again. Go do it again. Go do it again. And it basically turns the whole thing into a contest of what will run out first, gold stocks in London and New York or Russian oil. And I guarantee you gold stocks in New York and London will run out way faster because it’ll happen instantly. Because it’s a free arbitrage. The entire market will instantly reprice at two barrels an ounce because the market loves free money. So that’s why I say the reserve asset is not entirely our choice. Now, this all goes back to that point before about peak cheap energy, where russia is partly doing now, there’s been some let me back up one more. Zoltan proposed this. This proposal was also quoted two weeks ago in the Russian language media, not reported anywhere in the US by Sergey Glazyev, who has been a close economic adviser to Putin for going on ten years. So this is being discussed. Will it happen? Who knows? But this is not in markets at all, especially now that you’re seeing Ghana do a version of this as we speak. The first oil tanker showed up in Ghana two weeks ago. Three weeks ago. Guess where it was from? Russia. So, you know, let’s or the excuse me, it had stopped its prior last stop had been in Russia at the end of December. It showed up last week in Ghana full of oil. So my point here is that Russia is doing this partly to tweak us in theory, but partly they need to they have to again, peak cheap energy is catastrophic for the debt backed system as it’s been structured. That system cannot work in peak cheap energy. You have to change the reserve asset to something that is not negotiable. The geopolitics of it, as we are seeing, are trickier.

Stephan – 00:39:23:

Also curious on your thoughts around payment systems. Right. But we are starting to see other countries try to create or promote alternative payment systems. So does that play into any of this analysis? Does it change any of the analysis?

Luke – 00:39:39:

Yes, it plays into it enormously. It might be changing. The short version is and there are a lot of other guys that are better to talk to on the plumbing pipes than me. Their dollar pipes is the short version of it. And so as long as they are dollar pipes, they can do this around de dollarization, et cetera, around the fringes. They can affect some change in balance of payments on the margin. They can manage relative currency, cross rates on the margin. But it gets difficult to do wholesale changes through dollar pipes unless it’s dollar approved, system approved. And there are some signs that some dollar people want approve of this. That’s a separate discussion. The key then is how do you change the pipes? And that’s where I think it’s getting very interesting. Again, something I was unaware of. A month, month and a half ago, Pozar wrote about this Mcbdc, this Mbridge project at the BIS, and it’s centered on the Hong Kong Monetary Authority, china, UAE. I think India is in there too, but I could be misquoting it. But the point here is you have a global central bankers, central bank, the BIS, facilitating non dollar pipes. This is up and running. It’s being tested in the hundreds of millions of dollars. It’s still a rounding error. But that’s the thing about technology. Once you get it going, it’s not constrained. It’s very un-capacity constrained. And that’s why I think it is so interesting, because I think if you look at sort of traditional dollar pipes. You’re years, decades away. Even if there weren’t geopolitical and political frictions trying to stop that. Now we all know the speed at which tech moves, right? I mean you could be BlockFi Video and laughing at Netflix, sending DVDs in the mail and refusing to buy Netflix because why would you do that? We have 5000 stores and like two years later you’re, you’re done. Because the technology moves that fast. To me, and that’s all credit to that metaphor goes to Jeff Booth. Obviously listeners will know exactly what I’m referring to, his brilliant book and Price It tomorrow. So I think there’s a metaphor in terms of the price it tomorrow potentially to this Bis Mbridge Cbdc project where if you have monetary authorities facilitating the extra dollar outside the dollar pipe settlement of trade, then things can start to move really, really fast and you can get Netflixed or BlockFi really fast. You can see those types of changes again. And I don’t think there’s an appreciation of how fast that could happen. Now what’s the US going to do? Are we going to go bomb the BIS in Basel, Switzerland? Probably not, right? That’s probably not what we’re going to do. So there’s some things obviously we could do sanction this or that. But again, you’re going to sanction the BIS because, oh by the way, once these pipes are open, the more you sanction, the more it’s going to get adopted. At that point it becomes all you can do is accelerate the use. So I think the plumbing is extremely important. I don’t think the plumbing is there to make massive wholesale changes yet, but I think markets are possibly underestimating the speed at which the pipes could be there. Because we as humans, we always underestimate the exponential function. We’ve done it with technology. We’ve seen it with technology for our entire careers.

Stephan – 00:43:24:

Coming back to the question around governments wanting that CPI number to come down, I’m curious your thought on if they are not able to do this right, like what happens in that other scenario where let’s say they can’t really get that number down or do you just kind of write it? Like basically they’re going to get the CPI number down?

Luke – 00:43:45:

I think they’re just going to get the CPI number down and I think that buys us time as a soft landing for a quarter or two and then let’s see what happens if they don’t, right, is where I was, I would say two weeks ago. It’s a relatively recent change in terms of my viewpoint, which is the balance sheet and the debt is such there is not enough balance sheet. Either more dollar liquidity is supplied or we have a balance of payments crisis globally which looks like 2022 on steroids. Those are our choices. Now the dollar liquidity has been supplied with the FED still tightening by virtue of what the dollar has done since October, which again it’s hard to measure, but when you have the dollar fall that much that quickly, it supplies a lot of dollar liquidity globally. It just frees up breathing room. We’ve seen that over and over over the last couple of decades. Those were my two options as of two, three weeks ago. Now there’s a third option, which is just change of math, just change the rules, right? And what I’ve highlighted for my clients is when I heard about these CPI rule changes that start in February, I had been unaware of these. And so I started sending feelers out to friends, clients, etc. Saying, hey, did you know about this? And everybody goes, no, it’s first I’ve heard of it. So I was like, okay, that’s kind of interesting. So that’s not to say nobody knew, but if you’re not a CPI junkie, you didn’t know. Okay, so that’s number one. So number two, I think it’s underappreciated how desperate the situation is getting Visa vis the effective interest relative to tax receipts, right? We’re seeing tax receipts roll over the fiscal situation is what it is. It’s getting desperate. When I heard of the CPI rule changes, my mind went back to two discrete moments in time in my career that I don’t think people are there yet, which is number 1, April 2009, Wall Street Journal FASB Financial Accounting Standards Board suspends Mark to market. And at the time it’s like, what does that mean? And the wrong thing to do at that moment was say, oh, well, what does that mean for bank earnings and what is their charge offs and how many more loans are they going to make and what does that mean? But that was the wrong thing to do. The right thing to do was like, holy crap, the US. Government just said they’re changing the rules. Extend and pretend as official government policy buy everything. That was the right reaction. Similarly, we go to January 2016. There was a headline on over a weekend on Zero Hedge, dallas FED Quietly suspends mark to Market for Shale on Contagion Fears. Even setting aside the source, even setting aside the official denials that occurred at the time, but then later on were shown to be directionally accurate. The wrong thing to do was, okay, what is the earnings impact for oil and for these energy related banks and for the stock market? And then the right thing to do was like, holy crap, extend and pretend is official policy again. Buy everything. And so these are the two point where you come out and you say, because importantly, these CPI rule changes, they were noticed in August 2021. So in August 2021, let’s go back there. Inflation is transitory, blah, blah, blah. Well, we’ve noticed because of COVID there’s these inaccuracies. Now we’re going to go with the other way still. Now you fast forward to September 2022, hey, we’re changing the method. Really? And by the way, they announced it in may of 2022, two weeks after Biden gave a speech in which he said his number one, his number one fight is inflation. Okay, so now the BLS in May of 2022 says, hey guys, the, the method that we noticed, we’re creating some inaccuracies a year ago when all the, you know, the very serious people said inflation was transitory, well, now our boss says it’s his number one thing, so we’re going to change the method. True. So how are they going to change that? I don’t know. But my brain didn’t go to like, okay, what’s the earnings impact and what’s it going to be? My brain went to okay, they’re goal seeking inflation.

Stephan – 00:47:39:

All right?

Luke – 00:47:40:

If I’m them, how am I going to go seek inflation? It ain’t either. They’re going to goal seek it, they’re going to go seek it lower. So that’s why I think it’s intellectually offensive. It’s conspiracy theory. Some will say, maybe I say it’s how the way the world’s worked. It’s how I’ve been, you know, I’ve been doing this for 27 years. I’ve seen it twice and I’ve seen the exact wrong thing to do is to, you know, as I joke with my boys to grow a brain and try to calculate and I tried to grow a brain and calculate and I mucked it up twice. To be clear, it was a disaster. If you want to really see how easy it is to game the numbers, spend an hour in going down the rabbit hole, how CPI is calculated and it’s like, holy cow, there’s so many ways they can just move. I think the numbers are going to come in low. And if I’m right, then you get sort of this goldilocks off landing. Oh, by the way, it puts pressure on the FED to stop tightening because they’re a one mandate central bank fighting inflation. So let’s see. But that’s the sort of the thought process and how that evolved and why I think that that’s going to happen.

Stephan – 00:48:42:

I’m with you there on that. They have this incentive to have CPI low, right? The incentive from their point of view is have actually, like monetary inflation is high, but CPI low. They want CPI low because that’s what they want. So it’s not that crazy to think that that’s what they’re going to try to get. I think one other interesting comment you had was on our friend Jamie Dimon talking about fossil fuels. So you were saying Dimon’s comments about fossil fuels, quote, unquote, going to need them for the next 50 years. We’re not investing in oil and gas to keep it low. And bitcoin, it’s going to low, it’s going to zero are fundamentally incongruent. So I think maybe you were alluding to some of this in our earlier commentary, but do you mind just elaborating on that comment?

Luke – 00:49:25:

Yeah, look, unless Jamie Diamond knows a way of mining bitcoin with nuclear fusion so the energy cost is zero, then I don’t see how he gets there. There’s an energy cost attached to mining and running the network and if he thinks energy costs are going higher, I don’t see how he gets to bitcoin going to zero. I mean, maybe he knows something regulatorily that I don’t. Again, if the Chinese can’t ban Bitcoin, good luck to Jamie Dimon and the American government. I don’t think they’re going to be able to do that, but who knows? Maybe they know something I don’t. But on the face of it, that’s why I say those are fundamentally incongruent positions. There is an energy cost to mining and maintaining the network. Unless energy goes to zero, I don’t get what his point.

Stephan – 00:50:12:

Well, I think that’s probably a good spot to finish up there, then. Luke, where can people find you online?

Luke – 00:50:17:

Absolutely. So I am our website, You can also find me at Luke Gromen L-U-K-E-G-R-O-M-E-N on Twitter. And those are the two best places to find me.

Stephan – 00:50:33:

Fantastic. Well, Luke, thank you for sharing your insights with us today. So, thank you for joining me.

Luke – 00:50:37:

Thanks for having me on. It’s great being here.

Stephan – 00:50:39: Show notes are available over at four, five, three thanks for listening and I’ll see you in the Citadel’s

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