Stig Brodersen 10:11
Luke, you would need major oil countries to be able to secure that physical supply of all that oil. What do you think the outlook for that would be in the future?

Luke Gromen 10:25
In terms of storing the physical oil supply?

Stig Brodersen 10:29
Yeah, before the Chinese can go in and make these contracts with these countries and denominating their own currency, basically move some of the oil supplies away from the oil base dollar standard. You would need support from the Middle East and from other oil providers. What do you think the outlook is there? Typically and historically, the US has been extremely dominant in that region.

Luke Gromen 10:58
Yeah, gotcha. That’s a great point. I think what you would really need to get this system kickstarted is less full support from the Middle East and more full support from one big critical oil supplier. As such, I think that’s where Russia comes in. Obviously, they’re not OPEC.

However, our case has been and if you look at the evidence, there’s a lot to support this is that once China was able to get Russia, Iran, and Venezuela into the fold, you had a quorum of major oil suppliers willing to do this.

Once they begin to be willing to do this, then all of a sudden, that starts to put a lot of pressure on any oil exporter that doesn’t want to do it. What you start to see is a market share move, right? As you look at 2016-2017, China is the world’s biggest oil import market now, Asia broadly…

The head of OPEC, I think, last year said that in the next 25 years, the only market that is going to grow for oil demand is Asia. China, of course, features largely within that.

However, China’s using that dominant position to move market share. Saudi, either two or three years ago was China’s number one position. They fell to number two to Russia. For a period of time last year, they felt a number three behind Russia and Angola, which is incredible when you think about sort of mighty Saudi falling to number three to Angola. They are the most important oil import market in the world.

the question is, why is that happening? Well, in 2015, Angola made the yuan their second reserve currency after the dollar. There’s a lot to suggest they were selling oil in yuan.

To me, China has been patient to gain the clout and to make themselves a big physical market player. They went to Russia and Russia was more than happy to do it. And so now, China’s moving the market share to those willing to price in yuan.

In turn, we’ve been hearing for a while… I was in Londo six months ago and was hearing from people in a position to know that the discussion was happening.

Saudi will probably be forced to go along with yuan. They have to keep their biggest customer happy. Therefore, I think China and Russia have the ability to do what they’re doing. That’s ultimately China and Russia driving this process.

Preston Pysh 13:15
I think anybody who’s hearing this argument can say, “Yeah, I can see that trend playing out.” But then the question really becomes what’s the speed at which that trend is going to play out?

I’m curious to hear your thoughts on whether this is something that takes five years to really kind of reach maturity where you really start seeing a rivalry with the US dollar? Or is this something that’s a 20 year kind of thing? I’m curious to hear the timeline.

Luke Gromen 13:37
There’s a couple ways to look at it. The first is just strictly on the market share side. If you look at what percent of world oil flows could China quickly be denominated in yuan, and I think consensus in the West in particular is you’re going to get three “rogue states”: Russia, Iran, and Venezuela to do it, and nobody else.

The reality is not as clear to me and the reason I say that is where we’ve looked at it is the world’s top 15 oil net exporters. In other words, those nations, you take their production, you subtract their usage domestically and what you have left is their net export number, what they can supply to world markets.

If you look at that number, China has over the last five to six years sign either outright you want oil pricing deals, you want swap deals, significant lending deals, we’re buying a lot of cases, the loans are repaid in actual physical oil, or infrastructure, big major infrastructure deals where China’s either partnering with them in refineries or other domestic infrastructure.

At any rate, these deals that China has signed with oil net exporters are with oil exporters responsible for 96% of global oil net exports, which means, in theory the highways are already there, right? The fibers are already laid. The question is when’s the fiber going to get lit, so to speak.

Given that consensus is that you only got three rogue states pricing on yuan, I would take the over on that, given China’s market clout.

The other way to look at it as a high dose of sort of the physical oil market dynamics we just discussed is sort of the reverberating impacts on the United States fiscal side, which is to say, part of the reason everybody’s had to stockpile dollars for as long as they had… It started off as you had to have dollars to have oil. That was the Petro dollar deal.

The Petro dollar deal led to growth in heavily dollar denominated FX reserves. That’s what the deal started last and it sort of has developed. You started out needing dollars, because if you needed oil. Then it sort of developed into a network effect of you needed dollars, because you needed dollars. Also, everybody had dollars.

Again, once this system starts happening, if you’re China… China announced in late 2013, the PBOC said it’s no longer in our interest to stockpile FX reserves. China has an *inaudible* added a treasury bond. There have been some movements up and down in six or seven years.

When I say there’s this second angle of what it means for US deficits, what China’s doing… The flip side of the coin, what China’s doing for the US, it means over time, the US government gets permanently and structurally defunded at sort of a slow but steady pace, as the world just needs less treasury bonds.

The problem is that everyone doesn’t have to show up and sell their treasuries. They just have to stop buying treasuries with the US fiscal situation doing what it’s doing. It begins to put pressure on the US fiscal side.

The reality is we’re seeing that pressure, we saw that pressure beginning in 3Q 2014, when global FX reserves stopped rising and fell for the first time in 70 years. It wasn’t just happened to bottom that same quarter. *inaudible* has been rising ever since. Now you’re seeing *inaudible* screaming higher like a scalded cat, which tells you there are two reads.

One, there’s obviously $1 shortage offshore. The question is everyone keeps saying, “Well, that’s because there’s all this supply of treasury bonds and it’s soaking up the dollars.”

Exactly. That’s because the US has a funding problem or a fiscal problem that we ultimately think the Fed is going to have to fund.

That’s where I think you get into this two pronged answer. Okay, there’s the physical dynamics that we discussed first, but then there’s also this network effect or sort of slow working balance of payments machinery that is squeezing the US as US funding needs are rising meaningfully higher, given the twin deficit picture in the United States.

Preston Pysh 17:43
You know it’s interesting that you bring up this network effect when you’re talking about currency. I don’t think there’s any way we can answer this, but I wonder if it’s a winner take all kind of scenario that would continue to play out as long as we have a global economy.

If the yuan continues to build steam, is that something that’s going to completely materialize into like this full blown network effect where the dollar would diminish?

We’re obviously talking over a long, extended period of time, but I don’t know, could those currencies coexist together at a 50-50 split as far as the demand? Or does the fiscal situation in the United States make the network effect of the yuan just continue to explode? What do you think through that?

Luke Gromen 18:27
I do think they can and I do think they will coexist regionally. I think the way this movie ends is you end up with regional reserves, where the dollar is the reserve in sort of North America and South America. The euro is the reserve in Western Eurasia, if you will. Then the yuan is the reserve in Eastern Eurasia.

Of course, overlapping around the fringes, each of those currencies.

In terms of this network effect, ultimately, once you begin pricing, oil, commodities, etc, in multiple currencies, you begin driving a multipolar multi-currency world, which is something everybody’s talking about. It’s not just me, it’s the World Bank. It’s the IMF, it’s Russia. Everybody’s talking about this.

However, if you’re going through this multipolar multi-currency world, what starts to happen is that you start moving back towards a currency system that trades off of balance of payments fundamentals. If you look back for 1000s of years, the way currency markets traded and in terms of fundamentals, it was really twofold. It was based on your your trade position, and it was based on how big your reserve pile was.

What’s interesting is Chairman Zhou of the PBOC said exactly this in Shanghai in early 2016, and that was the way the world worked for millennia, up until 1971, in which case the best currency had the lowest pile reserves and the worst trade balance.

If we’re moving back towards this multi-currency system, you have to start looking at the currencies, basically evaluating their fundamentals based less on this dollar centric system and more based on the traditional balance of payments FX reserve pile system.

As we move towards that system, you should see the currency start to move in a manner consistent with that. If you look at the big five, if I have to rank them, yuan is number one. Euro is right up there, number two, running neck and neck. Then you’ve got the yen. Then you’ve got the pound. Then you’ve got bringing up *inaudible*. Then way back is the dollar.

That’s not to say the dollar is bad per se. It’s simply a function of the hangover from the way the old system worked. We had to run those deficits to supply the currency for everybody else.

And so, in terms of how I think it will play out, I think ultimately, as we move towards a multipolar system, the dollar has to weaken dramatically.

To answer your question of will the yuan take over the world or the euro take over the world with network effect? My answer is no, because it has a cell. As we move towards this balance of payments centric system, the dollar has weakened tremendously, but as it does, we compete really well when our currency is relatively fairly valued relative to others.

American shale is a very good example of that. You take the dollar to 70, you take the dollar to 65 or 60 on the index, we’re going to be competing really, really well. To me, it’s less a winner take all and more having this multi polar currency system, driving more appropriate relative currency valuations based on the fundamentals of trade and the fundamentals of FX reserve positions. You’ll get to that sort of regional reserve system, in my opinion.

Preston Pysh 21:50
Are we there with the dollar like we’ve seen the dollar devalue in the last, when it really started to devalue probably six months ago, really started to take off and we’re seeing this trend. It’s looking like there’s a lot of momentum getting behind this. Is this just an interim kind of thing or do you think that this is the start of something much bigger?

Luke Gromen 22:08
I think it’s the start of something bigger. I mean, it’s not to say we couldn’t get a sort of near term countermove. In fact, I think some of the Feds increased hawkishness of late. It has been more about supporting the dollar and supporting the long into the Treasury curve than it is about the need to become more hawkish.

However, ultimately, as long as China, Russia and OPEC, as long as sort of this big trend of multi currency, settlement of oil and commodities, trade more broadly keeps happening, it’s going to keep forcing the world towards this multipolar system.

As it does that, boy, the dollar still not trading in the right zip code, yet. It’s got to go way lower in order to kind of get that system to balance.

The governor on that ultimately, in my opinion, will be the US deficits. If this multipolar system just keeps developing, it means people don’t have to sell treasury. They just don’t have to buy, or they don’t have to buy as much as we’re generating.

Compounding math will do a compounding mass going to do and the dollar will weaken from there..

Preston Pysh 23:17
Especially if our debt keeps going up and we just have to keep issuing more and more? It only compounds the issue.

Luke Gromen 23:22
Yeah, that’s exactly right. When you look at the demographics and some of the structural deficits, we’re getting to a very dangerous place. You look at what the United States spends its money on and it’s 90% of what we spend our tax receipt on.

90% of tax receipts are spent on entitlements, defense and interest expense. It’s politically impossible to cut any of those.

Preston Pysh 23:47
When a person would compare the US to Japan and say, “Well, why isn’t it happening over there?” Would your response be because of the FX reserves? What’s your response for that?

Luke Gromen 23:56
Why hasn’t this happened to Japan is really multipronged. Number one, Japan’s a big surplus nation. Number two, Japan does not have the global reserve currency. Number three, the United States has effectively provided Japan’s defense for the last 40 or 50 years and so, Japan has not had to spend their money on that, like the United States.

Not only we have to spend on our own defense, but de facto sort of defend global trade lanes.

Japan is very different, demographically speaking. Japan has largely funded its debt internally, which means when you have deflation, it’s not a problem, as opposed to the US who is funded externally.

There’s a lot of really important reasons why Japan is different than the US in terms of how this situation is likely to resolve, given what would seem to be a similar problem, given debt loads on the surface.

Stig Brodersen 24:56
Like, I would like to talk about the other element here in this equation because we keep talking about oil primarily. Then we also talk about gold from time to time, then sometimes that will also be denominated. We just briefly touched upon it before.

I think one thing we need to outline for the audience here and also to talk about the dramatic changes we have seen in recent years in the gold market, especially from China and Russia. So could you tell us about what has happened to the gold market? Then talk about how does that in turn, change perhaps the relationship dynamics between the US, Russia, and China?

Luke Gromen 25:40
Absolutely. Gold markets are a really interesting market. Most people want to look at it and think about it as a market. The price on the screen is a price they see. The reality is it’s a political metal. Additionally, it is a market where you have a very big cash settled derivative market attached to it, which also complicates things.

There’s always been this discussion of is it manipulated? Is it not manipulated? That’s conspiracy theorists. No, just look at the Fed. As I look at what’s happening with gold, with what China and Russia appear to be doing, the calculus seems very simple. China and Russia seem to be saying, “Okay, you’re right. It’s not manipulated, give us the physical.”

The problem, of course, is regardless of whether it’s manipulated or not, the physical oil market alone is an annual production term basis, 10 to 15 times the physical gold market.

As soon as you see Russia do what they started doing in 2013, which was their pile of Treasury stopped growing, actually fell a bit. It fell quite a bit at first. Since then it’s sort of just been marching time.

Their pile of gold at the FX reserve level is rising steadily. That’s effectively what you’re seeing happen. I’m saying, okay, it’s not manipulated, great. Give us the physical.

If you and I will try to do that, that’s what the Hunt brothers did in the silver market, they just changed the rules and closed it out.

I mean, but when you’re a nuclear armed power, it puts you in a difficult position. It turns into a geopolitical statement or a geopolitical issue.

I think what Russia and China are doing with this, which is, if you look at what China has set up their system of, as we said before, it looks like China has reopened the Bretton Woods gold window, through yuan at a floating gold price, when you look at what they’ve done at the SGEI, in Shanghai, Hong Kong and Dubai.

However, to our eyes, it looks like China has learned the lessons from the mistakes the United States made and is trying to operate a gold window.

Number one, they’re not fixing the price, because you can’t maintain a peg. Every peg in history has broken a currency peg and history is broken. Then number two, and this is very elegant, in my opinion, that any gold that is in mainland China is not allowed to leave Mainland China.

When you look at this system, China and Russia previously said, “Okay, great. It’s not being manipulated. Give us the physical. We’re going to start trading in it and settling some imbalances in it on the margin.”

By the way, this pile that sits in China is not allowed to leave. We’ve been buying it and we keep buying it. We’re just tightening global supplies. However, once it’s in Mainland China, it can’t leave. This little pile over here in Shanghai can leave and if you have some in Hong Kong or Dubai, it can move however you want.

When you think about the implications of that, then you go, “Okay, well, where does the gold that gets offshore in yuan that was to get settled in physical goal? If it can’t come from Mainland China, where does it come from?”

Well, there’s really only two or three places, right? It’s US, UK or India.

The Indians aren’t selling. They’re buying. They’re always buying. So okay, it’s really US and UK.

To anybody familiar with or having read the history of the London gold pool in the late 60s, this starts to look really familiar because now you can just see it’s basically like a boa constrictor slowly tightening.

What China and Russia are saying, “Hey, all right. Gold’s not manipulated. Give us a physical.” You end up with a situation in Shanghai, Hong Kong, Dubai, where they’re saying, “Okay, we need a physical that can only come from the US or UK.”

Now, the US or UK say one of three things: 1. “Yes, you can have your gold and we’re going to let the price rise which will devalue the dollar as gold rises.” 2. “Yes, you can have your gold, but we’re not going to let the price of gold rise. We’re going to allow the leverage in the gold system to rise as the physical leaves and move east.”

As a practical matter, I think that’s what’s been happening since 2013.

Option 3. “You can’t have the gold.”

For that to ever come when London or New York says no to Shanghai, Hong Kong, and Dubai, that’ll be a really interesting day. However, I don’t think the dollar is going to open up the day the CME says, “Sorry, COMEX is going cash settled on everything.”

That’s what I think China and Russia are doing is effectively. They’re saying they don’t care if it is manipulated or not. Give us the physical. You say that’s the right price. Okay, give us the physical.

The reality is if you look at gold relative to any number of monetary aggregates, US foreign debt outstanding, etc, gold trading at a fraction of where it should be, relative to any number of those sort of gold PE ratios, if you will.

Stig Brodersen 30:47
How much do you think that they will accumulate? If you look at how much gold that they have, if you look at the US, call it, 8000 times, or whatnot… If you look at that comparison to GDP, we approximate the same rate with Russia, though they are still accumulating.

I don’t think that anyone except for the Chinese knows how much gold that they have. It’s a very difficult number to find. I think if you can find any number, it’s probably not the right one.

However, it seems like they’re buying up like everything in productions and everything that’s on and off the market.

How much do you think that will end up accumulating? Do you think that will find new thresholds compared to the GDP? Or do they just look at this in a much longer time horizon?

Luke Gromen 31:39
I think they’re looking at this and a much longer time horizon. I had a customer who said to me, “Luke, have you ever heard what Mao said about the point he was asked about the French Revolution. His answer was, ‘It’s too soon to tell.’ You know, 170 years later.

Whether the story is apocryphal or not, to me, I think that it speaks to the cultural willingness and ability to be patient to achieve a longer term outcome. If I’m them, I want to acquire as much as possible.

I think what they’re doing broadly, and then this relates to gold, this relates to oil, etc. Remember, we talked before about how the dollar system has been supported by the expansion of paper derivatives that promise gold, oil, and real wealth. There are assets that provide real wealth in this world.

As those derivatives have expanded, you end up with these highly levered paper derivative systems that require nobody to ever exchange the derivatives for the actual underlying.

I think that’s what China sees, and I’ve been told a number of stories suggesting that is exactly what China sees. Then if you understand that, then the way we’ve looked at it is I don’t know if you guys have seen the movie or read the book “Moneyball” byMichael Lewis.

They’re effectively playing a sort of monetary Moneyball, which is to say, the gist of that book was that walk in a single in baseball are functionally the same thing. However, the guys who hit a lot of singles get paid and a big multiple guys walk a lot. And so, they can build a very competitive team on the cheap by hiring the guys or by signing the guys that walked a lot as opposed to the guys that hit a lot.

At any rate, in much the same way, Westerners in particular, Western banks have been told by regulatory authorities, which are controlled by the American government that a treasury bond is every bit as good as gold and treasury bonds are worth this much oil, etc.

China’s looking around and going, “Well, gosh, there’s all that debt out there. There’s not that much gold out there. There’s not that much oil out there.”

The mismatch between American dollar derivatives and American dollar debt relative to the physical underlying, has been allowed to get way out of whack over the last 25 or 30 years.

China is just walking and going, “Okay, you take the treasuries and the dollars, we will take the fill in the blank, physical underlying.” That’s really the game I think they’re playing.

To directly answer your question, how much do they have? How much is enough? If I’m in China, I’ve probably been looking around going, I can’t believe they just let me keep exchanging dollars for this. What are they doing? I can’t believe they’re being this dogmatic about the Treasury system, the dollar system, but we have.

Now maybe that’s changing on the margin. People are certainly squawking about it here in terms of some of the domestic implications but that’s what I think the game is: “Okay, you take the dollars, we’ll take the stuff.”

Preston Pysh 34:51
I’m curious, Luke, a lot of the ideas that you’re talking about kind of resemble some of the stuff that Jim Rickards has been talking about for the last couple years. One of the narratives that Jim usually brings up is this idea of the SDR is becoming a global currency and things like that.

I’m kind of curious how you view the SDR. Do you see it in a similar light and playing a similar role?

Luke Gromen 35:11
Ah, yeah, I could see it. I would definitely defer to him and his understanding of that relative of mine, just given some of his relationships and how long he’s been involved at those levels in that game.

That said, in terms of my interpretation, yes, I think you saw China come out in 2009 and explicitly say, “We want to move to some sort of neutral reserve asset.”

I think it gets into a political discussion between the varying parties of do we include some gold and how do we manage that? I mean, there was a white paper put out by the IMF in 2011. Under Dominique Strauss-Kahn, when he was the chair. It looked at pricing commodities.

The quote is: “Look at pricing commodities, such as oil and gold in SDRs.”

So that would kind of tie back to the point I made earlier, where if you reestablish a ratio, right? So if we come out and say, “The IMF is going to bid for gold at 5000 SDR and maintain a ratio of gold to oil at 400 to one. There’s 400 barrels per ounce. So now you got SDR 5000 gold. You’ve got 120 SDR oil, and then you’ve got the five basket currencies underneath that have different implications for.”

Mechanically, there’s no reason why something like that wouldn’t work. It would work beautifully. The system would be balanced almost instantly. There would certainly be major vicious sector rotations, etc, but that would allow you to very quickly sort of move along that transition, from this dollar centric system to that balance of payments currency system that we were discussing earlier.

It really would actually be a huge boon to global trade. A lot of times people have golds at 5000 or 5000 SDR, the world will be ending… No. You’re going to reset. You’re going to basically have written down the real value of sovereign debt globally. You’re going to rebalance trade. You’re going to incentive trade, the global economy, growth, wealth, prosperity. It will all explode higher with one caveat.

If you have all your wealth in sovereign debt globally, you’re not going to be happy on a real basis. You will get paid every dime nominally, but you’re going to lose money on a real basis.

However, I think that’s the direct answer to your question. Does the SDR ever own quite possibly? Yes. Could it be done? It’s easy to do in the way I described. It’s not simple.

Preston Pysh 37:51
I love your point there, because you just identified the bill payer for all this. That’s if you’re holding this super low yielding debt, you’re going to be the bill payer.

Luke Gromen 38:02
To me this is like the most crystal clear thing. I’ve been doing this for 23 or 24 years now. It’s interesting when you look at who has the biggest bought marginal buyers of US Treasury bonds over the last three, four or five years, it has been US Commercial Banks, US public pension funds, US retail investors through investment funds. This is based on US Treasury data.

I don’t want to come off as sounding flip or glib, but the reality is, as I look across my career, almost a quarter century now, the biggest bag holder in every macro blow up I’ve had in my career have been US Commercial banks and US retail investors.

Preston Pysh 38:45
Why are they the Patsy at the table? Are they the Patsy at the table because they have a relationship with the Fed and they’re forced into it?

Luke Gromen 38:53
Yeah, the banks certainly have been regulatorily forced into it over the last four years, in particular, right? You look at 3Q 2014, you had new HQLA or high quality liquid asset regulations that mandated that the banks up their capital levels.

The capital they held was risk weighted. By the way, treasury bonds are zero risk weighted. Go buy a bunch and they did.

Money market funds, we are going to reform the money market fund industry, but those reforms are much less draconian if you buy treasuries than if you buy private sector paper.

I think some of the public pension stuff, I don’t think there’s anything necessarily regulatory driven there other than I think that in a low interest rate environment, they’re just trying to match liability. They’re just getting squeezed. They sort of are natural buyers.

US investment funds some of that is demographic…

Preston Pysh 39:49
They can get away with it because of the governance and the way that it’s been. The ownership is so distributed. The underlying owner doesn’t even understand what the heck’s happening.

Luke Gromen 39:58
That’s exactly right. When you really look at it, remember, I’ve made my point before, what are the two biggest line items that we need to spend all this treasuries for are entitlements. To the extent that public pensions and individuals are responsible for this stuff, and are the “bag holders”, they’re really paying for their own care. It’s a novel concept, right?

Preston Pysh 40:20
If we now have established where the downside is, and where we think in the coming 10 years, where people are going to be the bill payers for the future growth, where is that growth going to happen moving forward? Where are you excited moving forward into the next 10 years?

Luke Gromen 40:35
I’m really excited… if you look at from the big context of what we’re discussing, if the dollar centric system and if the beneficiaries of that in the United States were people in the dollar export business, and the losers in that were people in the manufacturing or in export business, I think that’s going to reverse.

I think the balancing of the dollar through some of the methods potentially that we talked about, the dollar export business loses, relatively speaking and the stuff export business wins, relatively speaking in the United States. Structurally, infrastructure, commodities, industrials, tech…

Preston Pysh 41:23
Intangible products?

Luke Gromen 41:24
Tangible and intangible. The IP is every bit as valuable as a steel mill. Maybe more so, in today’s economy. Definitely more so in today’s economy.

The flip side of that coin, of course, you look over to Asia or these other export driven economies, right? It has been the loser. Their game has been we’re going to defer consumption in order to build capital and export to the Americans.

I think you’re going to see a reversal of that as well away from sort of mercantile, I know that can be a loaded word, but sort of export-driven production growth and producing more for our own consumption. I think, former, in particular, in Asia, former export driven economies will see outperformance on a relative basis by consumption and services and vice versa in the US. The stuff that outperformed before, while relatively underperformed, will be more stuff export driven.

Preston Pysh 42:26
I know that this industry has just been bludgeoned over the last two or three months. That’s the crypto industry since December.

However, as a guy who understands why a peg is so important, and this whole movement of global currency and the mixing in the dollar kind of devaluing, this whole narrative we’re talking about, I’m really curious to hear your thoughts on the idea of crypto becoming this global peg and kind of your thoughts on what you think the likelihood of something like that is. Just your general thoughts on it.

Luke Gromen 43:03
Crypto, to me, the thing that has gotten my attention most are two things.

Number one, in the short term, it was interesting. I was looking at what Bitcoin was doing last year and I was thinking to myself that Bitcoin is doing what gold would be doing if it didn’t have this gigantic paper derivative market attached to it.

I was introduced via a mutual friend to one of the one of the bigger physical gold traders in the world late last year. Unsolicited, this person says to me, “Bitcoin is doing what gold would be doing if it didn’t have this gigantic derivative market attached to it.” I just remember my jaw dropping.

Watching what Bitcoin did was very interesting, just in sort of a near term perspective.

From a broader structural perspective of crypto, to me, the thing that gets me most interested most excited ties back to the point I made earlier that I think it’s underappreciated, particularly in the West. The degree to which the dollar centric system has been supported by rapid growth of paper derivatives… They control the pricing of underlying real wealth, whether you’re talking about gold, silver, commodities, etc.

When I start to look around and see a lot of different uses of crypto in these systems, like putting gold on the blockchain, putting oil and copper and all these different real assets on the blockchain. You start thinking about…

If you think about those things in the context of understanding how big the dollar derivative markets were allowed to get relative to the physical underlying of not just gold, but of lots of different real wealth assets, and start thinking about the implications of that. To me, crypto could be absolutely groundbreaking in terms of its ability to relatively quickly you know, sort of disintermediate or re-intermediate, this paper derivative market.

I’ll pick on gold specifically because it’s easy to illuminate. If you’ve got gold, which has, say there’s 100 paper ounces out forever real ounce, and you start putting a gold on the blockchain where all of a sudden it’s one to one, you’re effectively creating a parallel market in gold in much the same way that China and Russia are trying to do.

In other words, if I’m a gold miner, and you get gold blockchain to take off in any real way, say there does get to be a shortage historically, when you’ve got a giant derivative market, and there’s a shortage and physical gold, the price of gold crashes, actually, because it’s just a run on the bank, the liability collapses. However, the premium should be rising.

All of a sudden, you would have to ration where gold miners could go start selling into this sort of this, this real physical bid in blockchain, suppliers could go to that market and you’d be circumventing the gold derivative market.

That could take place in any market where there is a physical asset market where there is a paper market attached that has historically set a price. And so, I look at crypto as potentially very revolutionary means of disintermediating the dollar based commodity derivative system which has massive implications. Given the speed at which the guys in Silicon Valley and in tech historically move, I don’t know if we’re talking about decades.

Preston Pysh 46:36
We’re with you.

Stig Brodersen 46:39
It’s so interesting talking about currencies. We talked about the dollar and now we are talking about cryptocurrencies, gold for that matter. I’m curious to hear your thought process of how to value the prospects for a currency.

It could basically be any currency, it’s more like how you think of it? It might be easier to say, “Well, it’s demand supply.” Then someone will come in with three arguments that you will appreciate. Another guy can say, “Well, I have another three arguments.” It’s a push. What do you consider the magnitude and significance in different events and different demand supply factors?

Preston Pysh 47:21
Can I piggyback on what Stig just said? If you were going to describe how currencies work or how their value is to high school students, how would you describe that?

Luke Gromen 47:35
I think you have to start all the way back and understand that they’re lent into existence, right? The way our system works starts when they’re lent into existence, okay?

If they’re lent into existence, then you start getting into some… Next branch down is okay. Historically, the way this has worked is the guy with the best trade position and with the biggest pile reserves, the best currency and vice versa, the worst, and then we change the system. That’s a bit for the last 40 to 50 years. Now we’re starting to move back.

Then I think you go down to another level where you have to understand that it’s not purely based on supply demand of trade, but then there’s also debt levels, right? Certainly, once, if you’ve had sort of this mono currency driven system like we’ve had, which has been basically everyone borrows in dollars, there is this incipient dollar demand that is always there. If you understand that, then you can understand what’s happening offshore in terms of liquidity based on what the dollar is doing based on what *inaudible* is doing.

I think within all that, another overlay you have to look at is you get into geopolitics. You get into creditor and debtor relationships. Something that one of the big things I think the world is missing, and particularly Westerners, are missing is that the United States especially post 2008 everyone says, “Well, we need to run the debts. Everyone loans us the money. We are everybody’s consumer.”

What’s going to happen if we’re not here to consume everybody’s production and it’s still always been the case but particularly post 2008 has been the case that’s a little bit like being on the aisle. It’s also being on a deserted island with Mr. Yuan, Mr. Yen, Mr. Euro, Mr. Pound and Mr. Dollar. We’re all sitting around a table and Mr. Yuan catches all the fish and Mr. Euro cooks all the fish. Mr. Yen upkeeps the boats too and makes the boat that go catch the fish. Mr. Pound has nets to catch the fish and Mr. Dollar is sent into the table going, “Well, you guys can’t vote me off the island because if I’m not here to eat all your fish, you guys are screwed.”

Historically that was sort of true, but actually, once upon a time kept again. We keep in the dollar as good as gold for *inaudible.* There was a responsibility that the US had or managed.

You can see in the way we manage the dollar, you have two currencies, right? You have dollar external and dollar internal. We in particular in the early 80s… Paul Volcker, late 70s or early 80s, you can read the Fed transcripts, they have a great archive called the “Reform of 1979.”

The dollar was in a very bad place. Paul Volcker went to Belgrade, Yugoslavia, and was effectively told by the chairmans, “Listen, take care of the dollar.” He spent 24 hours there and flew back to Washington.

Basically, you put the United States into a very bad recession, effectively to show the world that we would be willing to take the pain to manage the dollar for everybody else. That bought us 30-35 years.

Today, I find it’s not, particularly in the last 10-20 years, you can see how Washington has dealt with it. It’s basically been this, “It’s our currency and it’s your problem.” And so, there’s sort of this, this mutual balance has been lost or was lost. It’s being restored now.

When you think about what currencies are, what they mean, when you think about creditors and debtors, there’s a responsibility of both. You can’t just be the debtor because at some point, post 2008, we get into a situation where you still need us to consume. If things change too rapidly, it creates a problem. People understood that.

You get 5, 8, 10 years on. Look, America still needs the world to lend to us at negative real rates to be able to consume and to basically keep the wheels on the car.

The problem with that is over time, if you lend to somebody at negative real rates, you’re going to go broke yourself on a real basis. I am happy to borrow all the money in the world at negative 2%, real rates for 30 years. I’ll take it right now. Give me a call. But of course, anyone who lends that to me, I’m going to have all the wealth in 30 years.

It’s a very complex topic, with a number of different ways. But I think if you start understanding the structure of the system, if you understand motivations and partners under that system, and how the motivations of those partners change over time… As you know, Charlie Munger says, “You show me an incentive, I’ll show you an outcome.”

The outcome we have right now, is the most predictable thing in the world. The only the only thing left to know is sort of what the data *inaudible*. I don’t know what that is, but getting to where we are, if you understand where we started from, and how things developed since, it makes sense.

Preston Pysh 52:51
I’ll tell you what, Luke, I’m just so impressed with your depth of knowledge. It is mind blowing. If somebody listened to this, I’m sure people out there listening would love to learn more about what Luke knows here.

What book would you recommend for currency and understanding the depth of the stuff that we were talking about today? What are some books or a video or whatever, we can link to it in the show notes, if you found something that was really influential that helped you understand the things that you know?

Luke Gromen 53:23
“Lords of Finance” by Liaquat Ahamed. It’s a biopic of the Big Four central bankers right after World War One. That was really the last time we had a global sovereign debt bubble like we have now.

I first read that book and it was published in 2010. I think I read it in 2011. It’s a veritable roadmap to what we’re going through. I would highlight that.

There’s also a book called “A Century of War” by F. William Engdahl. He can be a bit conspiratorial at times, in my opinion. There are certain things in the book that can be considered a bit conspiratorial. That said, it is well researched. It provides some really good narrative background of kind of understanding how some of the world’s geopolitics currency overlaps have developed over time.

Preston Pysh 54:25
Luke, I know you’re on Twitter, and we’ll have a link to your Twitter feed in our show notes. For anybody else that wants to follow you and talk with you on Twitter. But anything else that you want to tell our audience a little bit about your company, your background, just tell everyone what you do.

Luke Gromen 54:41
I am the Founder and President of Forest for the Trees. As I said before in the interview, I spent nearly 25 years on Wall Street as an analyst and sales executive at a couple different regional investment research firms. In early 2014, I hung on my own shingle.

At FFTT, what we’ve really tried to do is aggregate a large amount of publicly available data in a unique manner and try to identify developing economic bottlenecks in different sectors. It’s a macro theme for our customers. Our customers are institutions, family offices, and sophisticated individual investors.

We publish an eight to 10 page report every Thursday. We do a brief pre-recorded webinar with a brief transcript every other Tuesday. For people who are looking for more information about that and some samples of our work, it’s available online at fftt-llc.com.

Preston Pysh 55:44
Awesome. We’ll have a link in the show notes for people to check that out. Luke, thank you. Seriously, incredible discussion with you and we really appreciate your time.

Luke Gromen 55:53
Absolutely. Thanks for having me out. It was thoroughly enjoyable. I really appreciate you guys having me on the show.

Stig Brodersen 55:58
Alright guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast.

Outro 56:05
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