Preston Pysh  1:24  

So we’re talking about a hot topic today. And I mean, you can’t get this word said enough in the news right now. And for people that are listening to this in the future, here we are, the 25th of September in 2019, and the big word that we’re talking about is repo. Everyone is talking about repo. I would argue very few understand what repo is. And so, what we really want to kind of accomplish here is like let’s start off with the basics. Let’s define terminology. Let’s talk about the basic mechanics of the repo market. How would you like to explain this to…if you were going to a high school class and you’re talking to some kids, how would you describe the repo market?

Luke Gromen  2:06  

I would describe it, in brief that it is basically the plumbing that makes the financial system run. The key is that it’s the plumbing to the system. In a repo transaction, [it’s] just a dealer, [who] lends securities, gets back cash at a small haircut, and whether that’s an overnight transaction, it says, and it’s just a means of cheap and safe financing for other positions. And that’s why it’s so important and why it’s such a big [deal]…[and] why it’s the plumbing in essence.

Preston Pysh  2:38  

So let’s just take, for example, let’s say that you’re sitting on a bunch of bonds, and I’m another bank. Say you’re a bank, and I’m a bank. You’re sitting on a bunch of bonds. I have a bunch of cash. I basically take possession of your bonds. I provide you the cash that I was holding. We already have when we do that deal, we have it structured that tomorrow morning, we’re going to then swap back. You’re going to pay me a little bit of interest on that, and the interest should be between the federal funds rate, which right now is 1.75 and 2%. 

And so, we pay a little bit of interest on that exchange, and then I take possession of my cash again, and you take possession of your bonds, and that’s the end of the deal. But that term was that, that one-day term or whether, whether it’s a two-week term is established before that trade between the two of us occurs, am I describing it appropriately there?

Luke Gromen  3:27  

Yeah, that’s, I think, a fair description.

Preston Pysh  3:29  

And so I think it’s important for people to understand that you have basically two different markets here. You have the federal funds. You have the Fed funds, where banks can conduct this exchange with a central bank, and it’s uncollateralized interbank loans. But then, whenever you get into repo where it’s between two banks, that’s when it becomes securitized between the two parties. 

If I’m providing some type of asset to Luke, there’s a redeemability to that. It’s almost like when somebody has a house. The bank can take repossession of the house to make it securitized. So, these repos that are happening between banks are securitized. When they’re happening between a bank and the central bank, that’s whenever [their] obligations between the two of them and the repo market [are] uncollateralized. [That’s] just to kind of get some of that terminology out of the way.

Let’s talk about what in the world’s happening. So here on this, oh, I’m sorry, on the 16th of September, the overnight general collateral repo traded as high as 8%, which is 6% higher than the 1.75, the 2% range. And just to kind of give people an idea of how ludicrous this is, since 2006, this has never happened. In fact, that much of a move beyond what is, what we’ve called normal deviation of how much of a premium people would pay over this federal funds rate, this would be described as I think like a 42 standard deviation event. It’s how far off the variance we are with this. I mean, this is just a total break that happened on the 16th of September. So you were on our show, and when was this Luke? This was probably…

Luke Gromen  5:12  

June 25th. I was looking at the notes. 

Preston Pysh  5:14  

25th of June. And I remember the conversation because you kept bringing this up. And you kept saying, “This is not normal. This is broke[n]. And this is going to be a story.” And sure enough, here we are by September. I mean, you nailed it! You saw this months before this became a thing. So tell people which you were seeing back then, and then describe this interest on excess reserves versus the federal funds rate and how that works.

Luke Gromen  5:44  

If we go back in time to five years ago, foreign central banks stopped growing their holdings of treasury bonds. And that was a big moment number one, and so when that happened, you saw moves in the US and abroad to begin to shift the financing of US government deficits onto the global private sector. 

And so, you saw that begin to crowd out global euro dollar markets. *inaudible* began rising. You saw the US red take regulatory steps such as regulating banks into buying more treasury bonds with HQLA 15, 16. 

You saw the regulation of money market funds into buying a lot more treasury bonds and keep that one in mind because that’s going to come back to be important in the repo story, and I think going forward as well. This process of basically shifting the financing of the US government from, from global central banks to the global private sector took place from 3–3Q14, and then sort of, I would say came to a head last year in the third quarter of 2018, when due to regulatory changes. 

Banks stopped growing as fast or stopped growing at all, depending on who you talk to. Their FX swapped books, and that’s when FX hedge treasury yields went negative for the first time in I think ever. But the punch line was basically that was a moment, where the foreign private sector began being paid effectively, not to buy treasuries on a hedge basis. 

And so, that began to weaken the marginal foreign private sector bid for treasuries and push more of that onto the domestic sector entirely. And in particular, the US banking sector, and so fourth quarter of 2018, excuse me, you saw US primary dealers buy treasuries at about a $600 billion annual rate in the fourth quarter, which is a lot. And that continued into the first quarter of this year in terms of them buying more, and more, and more of the US government’s deficits being financed by the domestic private sector, and that came to a head in March, where Fed Funds rates went over interest on excess reserves and stayed there. Now, interestingly, back in March, it was said by some people that [are] really deep in these markets. That it was just a technicality. It was a short-term, temporary technical. That there are ways for the Fed to fix this. 

At the time, we said, “Yeah, there are ways for them to fix it, but that’s ignoring the bigger picture.” And so, you fast forward three months, we had two cuts to interest on excess reserves. We’ve had two Fed funds’ rate cuts, and they still narrowly, they still haven’t gotten Fed Funds rates below interest on excess reserves. And our whole case this whole time was that what you’re seeing is the accelerating crowding out of the Fed Funds rates over IOER. 

[It] was a symptom of the acceleration of the crowding out of the US private sector that really began five years ago, and came to really accelerate in 3Q18 with FX hedge treasury yields going negative. And then accelerated further in March and what I think ultimately we’re seeing now with what will happen in repo last week is I think another important acceleration. Or this US fiscal crisis for lack of a better word, incipient fiscal crisis, perhaps more apt is accelerating further. It’s getting more acute.

Preston Pysh  9:07  

Luke, you were talking about the transition there at the end of 2018, where international banks, especially in Europe stopped buying US debt, which meant that the primary buys here in the US were forced by law, due to the changes of basically what happened in the 2008 financial crisis. Is the requirement to purchase really what’s causing the drain in liquidity that’s driving so much of the repo problems?

Luke Gromen  9:32  

That way you described it is fair. That ultimately, that transition and again, foreign private sectors not stopped buying, but they stopped buying enough, and deficits are rising faster than their appetite to grow them because they’re right now…, when I talked to you at the end of June, I want to say the FX hedged yield on a 10-year treasury for a yen investor was like negative 60 basis points, and for a euro investor, negative 85. 

And those numbers are now negative 100 basis points and negative 125, respectively, ballparkish. So, before today [and] before last week or so, it moved, so they’ve gotten more negative. In other words, there’s more incentive to either not buy, not roll treasuries, or take the dollar risk on yourself, which you can do on the margin, but you simply can’t do that for really big books. And so, that by nature forces more of the financing of US deficits on to the US private sector. 

Now, everyone’s been talking about the banks. And there’s been several *inaudible*, really three primary dealers that have bought this is per result and post our *inaudible* work about $200 billion in treasuries over the last 15 months. And that’s a substantial portion of the US’ deficit over that time, but not as many people are talking about just the general absorption of US economic liquidity, when there was an article in the Wall Street Journal in early July, noting that for the first time in a long time, maybe ever, majority of the US has long-term debt was being purchased by US individual retail investors. So, to the extent that I have a finite balance sheet, and I want to own 10-year treasuries, yes, they’re marketable. But once I buy those treasuries, I can buy treasuries, or I can buy a car, or I can buy…I can’t use that treasury as collateral for something else, per se.

And so, I think there’s sort of two portions of this, sucking out of liquidity. It’s what’s happening at the primary dealer level. But then, I also think it’s that there’s a less discussed topic of we’re financing our own deficits for the first time, really, in 70 years. And so, there’s actually sort of classic crowding out taking place.

Preston Pysh  11:50  

So what is driving that shift of why other countries are not buying US debt?

Luke Gromen  11:54  

I think it’s a couple things. I think mechanically for the private sector, I think they are political and just…profit motivated, and so it’s that FX hedge treasury yields going negative begins to change their economics. And, and the way you fix that is either a much weaker dollar to normal, to normalize FX hedge yields, you need a much weaker dollar, or you need much higher rates. But I think away from that, which we already touched on. 

I think it’s two things. I think it’s number one, when you hear slowing trade. When you hear China’s current account surplus is vanishing for secular reasons as they become more consumer and less export driven. We hear about that a lot as it’s negative for China, or as it’s a change for China, and we never hear about, “Is that the flip side of that coin?” [This is because] they don’t have the dollars to reinvest back into treasuries. 

Similarly, what we’ve seen in oil. Where we hear in the US, it’s becoming self-sufficient in oil. Shale has kept oil prices. Shale is taking power from OPEC. All true, but we rarely hear the flip side of that, which is at $55 a barrel. OPEC doesn’t have a lot of dollar surpluses to reinvest into treasuries like they used to, so some of it is secular, current account surplus deterioration. Call it amongst the big creditor nations in the world, which are really China, Germany, South Korea, and then, it falls off pretty sharply there. 

It depends where you are in the oil cycle if it’s OPEC. And then, I think there’s geopolitical reasons as well. Of course, you’ve seen [this] with Russia, China, [and] others as well. But to the extent that we are spending an inordinate amount of time trying to sanction. A lot of people will say, “I think that doesn’t help make the case for redeploying any surpluses that they do have, and which are shrinking into, into treasuries.

Preston Pysh  13:49  

I’m sure the typical listener hearing this conversation is just saying, “Well, how in the world are interest rates over in Europe all negative? No matter where you go, they’re negative. Here in the US, the 10-year treasuries are still a positive by quite a bit. And when I say quite a bit, I mean, higher than 1.5% on the 10-year, which is, I guess, laughable. 

But in comparison that doesn’t add up. So they’re saying, “Well, you would think that the capital over in Europe, for example, would absolutely be buying up US debt if they’ve got a positive yield.” So explain to the audience why that’s happening.

Luke Gromen  14:27  

Yeah, I think a lot of it has to do with what after FX hedging costs yields are doing, and what that means is you can buy treasury bonds, and the 10-year…say, whatever 1.8% today. 1.75% today. You can buy those, and there seems to be an easy pickup in yield, but you’re absorbing the risk of the dollar falling against the euro. 

If you look back to 2017, the dollar or the DXY fell about 12% in 12 months, and so, the risk of the dollar may not seem like much, but if you’re running a 50 or hundred billion dollar portfolio, and you’re unhedged, and the dollar falls 12% in 12 months again, or there’s a plaza accord like we had in 85, where it falls 25 or 30%, you’re going to be out of a job best case. 

And so, you need to hedge those, the FX risk, and once you go to do that, then historically for a long period of time that has been positive, which suffice it to say, it was positive up until the third quarter of ‘18. Borrow money in euro. Put money into treasuries. Hedge the dollar risk. Still pay the insurance that’s basically an insurance premium [to] the FX hedge, and still earn a positive carry [and] still earn a positive yield after that cost. 

After three QA teams, the cost of ensuring a fall in the dollar got so expensive that you could no longer afford to borrow money in euros, buy US Treasuries, hedge out the dollar risk, and earn a positive yield. And so, the opposite is also true. And so, as US dollar investors, you and I could in theory, buy euro debt, and sell euro forward, and the hedging cost picked up to us and American investors. We could earn more doing that trade than we could just buying a 10-year treasury at 1.75% today.

Stig Brodersen  16:22  

So considering the drop off of buying happening in Q4 2018, we do hear arguments for some of their players that if you’re European banker, the dollar needs to devalue against other currencies, including the euro. That is why it’s happening.

Luke Gromen  16:37  

The way the markets are pricing, that’s a fair statement, but I don’t know that that’s what they are saying per se. Because really, what drove it was a balance sheet constraint. What was happening is largely US banks were growing their swap books infinitely and basically taking on the risk of a falling dollar. And by that happening, that was allowing the global private sector to buy treasuries hedged and still make a positive carry, so basically the US banking system through the swap books were absorbing the risk of a fall in the dollar. And starting last fall, basically for regulatory reasons, and I still don’t know which regulator. I don’t know [if] it was Basel, or if it was Dodd–Frank, [for] whatever reason. 

A balance sheet constraint hit, where they basically discouraged the infinite growth of those FX swap books at that point, and once that happened, then you began to see market forces were suddenly…if you can’t hedge, and the price of the hedge has [increased], or you can’t grow the hedge book, the price of the hedge goes up, and once the price of the hedge goes up, so basically, once the price of that hedge begins to go up without the growth of that balance sheet. 

To be clear, I don’t know that the bankers over there are saying, “Okay, we think the dollar [is] screwed, so this is something that is we want to make.” I think it’s the way the balance sheet regulations are playing through or effectively you can infer that from, from those movements.

Preston Pysh  18:05  

So let’s talk a little bit more about this 8% blow out that happened here in September 16. So if you’ve got the central bank willing to provide liquidity at this 2% rate, right? And all of a sudden you have people saying, “Hey, I’ll pay 4%. I’ll pay 5%, just give me some cash. I’ll pay 6%. I’ll pay 8%.” Right? And this is overnight, it’s based on an annual rate, but for something that was normally 2% that could blow out clear up to 8%. 

Also, historically, I think the deviation was like point .02 or something like that. That’s totally crazy. That tells you that there was no cash to provide this person, who’s wanting to take on the position. So I mean, that’s kind of crazy, and you weren’t seeing this in the international market. You were just seeing this in the US. Talk to us about that specific event.

Luke Gromen  19:03  

Look, I think there are near term technical factors [and] short-term factors at play. And then, I think there’s the overriding theme, right? So within that you had, when I say the short-term technical factors, I think the people that have been talking about those things I think are absolutely right. By that I mean, you’re coming up on quarter end. 

And so, there’s liquidity requirements…window dressing, the banks want to do. That happens every quarter. You had corporate tax payments done, so that’s also draining cash out of the system. That was known ahead of time. It still happens. I think those two factors should come and go. You had the Saudi attack on that Saturday, and there were credible rumblings that the Saudis and the aftermath of that were in the markets on Monday and Tuesday, draining cash to make payments to fund whatever they need to do, obviously. 

They have dollar needs to fund the kingdom. And if half the oil is down or half the oil production capabilities are down, you’d expect their cash burn rate to possibly be fairly substantial. And so, you would expect to see them draining that. So I think you had a number of or a  confluence of, of short-term factors. Some expected, some unexpected, but all short-term technical drivers. Also, I think a lot of the narrative around what happened last Monday and Tuesday have been focused on these things. And that’s not to say they aren’t correct. 

Some of the things we were talking about in June would have happened regardless, but I think some of these short term technical factors probably brought it to a head sooner, and maybe more explosively like is it the short-term is where we’re seeing the narrative really focused on, and there just is not a lot of discussion going on around. 

This is the first time we’re having to finance our own deficits in 70 years. And between the liquidity coverage ratios, the requirements of primary dealers to bid at auctions and, and deficits, which are simply not slowing down. And that’s assuming we don’t go into a recession. There’s not a lot of discussion still around that portion of what drove last week.

Stig Brodersen  21:17  

So Luke, in Europe, they’re working with a model where more money is going out than is going in. And you have people here in the US, we’re seeing the effects of those policies. And they’re saying that they don’t want to go there. How do you see the policies here in the US being influenced by European central banking?

Luke Gromen  21:37  

I think the repo programs they put in place buy them time. Look, if I was them, I think they’ve handled this as best, as best they could, really. They’re in a very, they’re in an unwinnable situation ’cause the reality is the political side has been irresponsible to varying degrees or wanting to kick the can for that irresponsibility for 80 years. And so, nobody wanted to basically. It’s falling onto the Fed’s lap. It’s accelerated under Trump. 

So now, I think given all of that, I think they’ve done not that bad. I think they’ve done what they could, which is to say, if I’m them, I put this repo program into place. I say it’s temporary. I extend it out around quarter end, and this buys me three or four weeks. And now I can start to change the messaging. And because realistically, you can’t go from we’re going to do three or four more cuts to we’re going to do a 100 billion a month in QE until further notice, right? Because that could create more problems than it solves. 

You’ve got to allow the levered play in the markets to begin to sort of go the other [way]. We got $16 trillion and negative interest rate debt that’s on the wrong side of the boat in my opinion because they’re going to go to QE. I mean, it’s…and maybe you’re starting to see it today with the long end of the curve backing up pretty pronounced. Real rates turning higher. 

Yeah, their next step, I think, is they’re going to have to do QE because, again, people said, “Well, this is just temporary.” I said, “It’s just temporary.” Fine, step away from the money markets. Let them go back to 8 because the deficits aren’t going away. And negative hundred basis points, the Europeans aren’t going to be buying private sectors might be buying enough treasuries. So step away, and let’s see what happens for a month at 8% repo.

Preston Pysh  23:20  

Talk to the audience about what a standing repo facility is, and what kind of function that could play in all of this.

Luke Gromen  23:27  

It would do a lot toward liquidity as I understand. I mean, it’s effectively a wand you could wave and magically turn treasuries on bank balance sheets into cash, whenever you need it, which is very powerful [and] very liquefying. It effectively amounts to, again, financing the fiscal authority through the banking system via the monetary authority.

Preston Pysh  23:52  

So let’s transition back to the discussion about Europe. Because regardless of what is happening in the US, Europe has these banks that are just too big to fail. So if the policy is to do more QE and drive down interest rates even more, how can that persist?

Luke Gromen  24:10  

Yeah, there’s some interesting things going on with Europe. There’s, I would say three things. So there’s this tiered structure that they just laid out, which I’m trying to read as much as I can. There is, call it, the “implications for the dollar and for the treasury.” [The] treasury market is on a rise in long-term rates in Europe, and in particular, the bund as a potential carry trade is unwound. 

And then, there’s what they’ve been doing in energy, which is interesting as well and could buy them room. So I’ll touch on each quickly. So the tiered system that they began discussing or rolling out what Draghi proposed within last week or 10 days ago. People that are really deep in the weeds on this think it’s a really big deal in terms of just the amount of liquidity it could drive. It could be a real game-changer in terms of asking that question: How much more QE can they do that doesn’t hurt the banks? 

My understanding is they’re basically paying the banks to make loans effectively. So, to your point, the question at this point is, is political. It seems like more, there seems to be some, some pushback on that, as well as on the fiscal side, which ties into the second point, which is you’ve actually started to hear even some of the Germans say, “We need to do more fiscal stimulus and take advantage of…basically hit this bit in the bond market, and do some fiscal stimulus.” 

We’ll see politically, and to me, the question, too, is if you have a backup in bund rates, does that lead to an unwind you’ve seen. Has there been a carry trade of some description put on where your short bunds, long dollars, [and] long treasuries? What does that do to the global financial system setting aside any of the FX hedging stuff we talked about before. And then, the last part, I think too within Europe has been what we’ve seen since late June, regarding energy, where the Europeans have been for lack of a better word, they’ve shown surprising backbone vis-a-vis the United States over the last three months in regards to Iran, to setting up this SPV, a special purpose vehicle to buy oil from Iran in euros. 

And last fall, three of the world’s biggest energy importers, they spent $300 billion or €300 billion a year with 85% of that being spent in dollars, which makes no sense to them. And so, if they were able to convert that entire bill into euro, it’s basically a $250 billion increase to their current account surplus instantly, which you can then redeploy. It buys them time, at the very least, and you can talk about how you can spend it. 

Can they get out of their own way politically in terms of deciding what to do with it? But the bottom line is their current account surplus would rise by $250 billion right off the bat, which then would allow them to say, “Hey, China. We’ll…” or “Hey, US. We’ll weaken or, excuse me, we’ll strengthen the euro X because we know we have the breathing room with this $250 billion we’re picking up over here.” So, those are the three things I’m looking at with Europe.

Preston Pysh  27:23  

So let’s quickly talk about how do you position yourself through all this because this is, this is some crazy stuff. The last time we talked to you. You brought up gold. You’ve brought up Bitcoin. What are…where do people position themselves, particularly if you’re a baby boomer, and you’re in a position, where you just can’t have an appetite for a lot of volatility? What in the world do you do?

Luke Gromen  27:45  

Yeah, it’s hard. To me, the one thing that is crystal clear is that we are moving towards QE or MMT or capping of yields at the long-term or all of the above. The bottom line is that it is a matter of national security for the US and other western social democracies, if you will, for their bonds to be certificates of confiscation on a real basis. 

And so, if I’m a baby boomer, or somebody who’s retiring or retired, the way I’m thinking about it in terms of my long-term assets. That’s sort of like the wheels to not completely come off the cart, and free of need…spam, and gold, and guns, and K-rations, sovereign bonds have to yield negative on a real basis for an extended period of time. 

It’s just where we are with that level. That’s how it’s worked out, so understanding that. To me, I think everybody needs to have an allocation of physical gold, 5-10% more if you really understand gold markets, and, and really feel like you understand what’s happening here. I still like equities relative to debt. But I ultimately think, again, tying back to this the real basis. The debt has to lose on a real basis for sort of everything to kind of hold together.

Stig Brodersen  29:10  

So let’s imagine that the Fed comes out, and to say that we need to do QE, our past experience has resulted in assets going up in price in a major way. But given that we talked about, do you think a melt up or meltdown is most likely to occur?

Luke Gromen  29:25  

I feel like a melt up is a much more likely scenario than a meltdown. A positioning, right? You’ve got 16 trillion and negative interest rate debt. And it’s been interesting. I think if I was sitting in negative interest rate debt, seeing what the Fed did would scare me to death because to me the message of last Monday and Tuesday, if you look at overriding the dollar, shortage came home. 

The US money markets broke before China did. And when push came to shove, right? When we talked in June, I said our bet consensus [is] that the Fed will stand aside for a while. Let people twist in the wind on risk. And we saw a Fed vault, where we sell repo go to 8. 

The Fed didn’t let anybody twist in the wind. How long did it take them? It didn’t take them 24 hours. [It] took them 12 hours to respond. And now we’ve seen two or three upsizings to that. The addition of a two-week term repo and a doubling of that. I don’t know if you saw that today, but they took the term repo from $30 billion to $60 billion to $75 billion overnight to $100 billion. 

I was asked earlier this year if [I] was wrong, or “What were the signs you’ll be looking for if you’re wrong, [and] that the melt up isn’t the right scenario?” And one of the things I said was, “Look, when push comes to shove, and will–if the Fed stands aside, and lets people twist in the wind, that I’ll have to completely revisit this.” And Monday, Tuesday, boom! Fed was there. Fed’s got your back. There’s $16 trillion and negative interest rate debt going. Push came to shove, and the Fed was there in 12 hours to fix the problem.

Preston Pysh  30:57  

You got billionaire Ray Dalio, basically, wrote his big piece probably like a month and a half ago. And at the end of it, he was basically saying, “Hey, gold is the place to be!” But if you go through a scenario, and I’m really just trying to play devil’s advocate here, let’s say that we go through a massive QE. We have a melt up. Would high quality businesses outperform gold at that point, and does it make more sense to be positioned that way?

Luke Gromen  31:27  

I think it could if you look at how gold and the correlation between gold and negative interest rate debt totals that we’ve seen. I’m sure you’ve seen those charts. I think gold right now is very popular, and I think it’s very popular as both a safety trade, and it’s popular as a long duration in a negative interest rate environment trade, right? 

And there’s a fair number of tourists there. And so, if I’m right that we get an equity melt up, and that basically we temporarily open market operations, [which turn] into permanent open market operations or “permanent temporary [operations].” However, they structured it, and you start to see the long end of the curve back up. I think you could see gold sell off for a bit. I think that will–that could continue for a time until there is sort of, and that might even be good for the dollar. So you look at what happened today. The market’s up. Risk or equities [are] up. You had the dollar up. You had yields up, pretty sharply. Yeah, gold’s down a bunch. I could see that for a bit as that sort of $16 trillion. Oh God, the world’s ending. Trade goes the other way. 

And now, ultimately, I think there is a holy cow moment coming where it is, “Oh, my God! The monetary authorities financing the fiscal authority, and it’s never going to stop until the dollar falls 10% or 15% or 20%, relative to these other currencies, and that means *inaudible*. So when I look out, it comes down, I think you could see gold underperform high quality equities for a bit. I ultimately think gold trades with a different numeral in the front of it, and a couple three years out, I think yields can back up for a bit. 

But to me the way I’m looking at the world, I think you can see a two stage rocket for the melt up, right? So I think stage one for an equity market melt up is, “Oh, gosh! This isn’t temporary. This is permanent. OMO, and they’re financing the deficits effectively.” Boom! “Okay, I’m on the wrong side of the boat.” $16 trillion. Some portion of $16 trillion has to move into equities. That’s point one. 

And as that happens, you start to see it back up in yields. If that back up in yields gets disorderly, we know what the Fed’s gonna do. They just did it to repo. Repo got disorderly. It was eight. The market said, “The repo was 8,” and the Fed said, “No, no, no, it’s 2.” And it’s, well, here’s $50 billion. Here’s $75 billion. Here’s $100 [billion] of them. And I think that’s exact stage two of the equity melt up rocket. I think yeah, you get the long end. Selling off on this first day. This realization of, “Oh, God! They’re financing, and they’re financing the deficits. And it’s not going to stop.” 

The equity yields back up, and Lael Brainard talked about this earlier this year. Claridon talked about this earlier this year. Push comes to shove, will cap long-term yields like we did during World War II. I think that’s stage two, where you go from, “Oh, God! I’ve got to get out of 16 trillion into equities and yields back up a bit.” 

And if yields get sloppy, then the Fed says, “Well, in addition to the front end of the curve, repo, we’re also going to cap the long end of the curve at whatever politically tenable rate or politically expedient rate we’re required to do that at.” And that’s, I think, stage two of an equity melt up, and I just don’t think–it’s fascinating. I don’t think people think it’s possible, and I think it’s highly likely. It’s where we are. There’s nowhere else to finance these deficits. They are what they are, and it’s interesting. 

Someone said to me before that we’re in this deflationary stage in terms of where pressures are, and I said, “Well, you have to understand we, we had an equity bubble. We kicked it up to the banking system in the housing market, and then we had that bubble. We kicked it upstairs, the sovereign. It’s been 100 years since you’ve had a bubble burst at the sovereign level. And the road map for sovereign bubble bursts is very, very different. 

Now, you want to know what it looks like, you’ll look at Latin America, other emerging markets in the 80s and 90s, which are in hard currency. Everything falls. Well, the only hard currency relative to the dollar is gold. And in local currency, risk assets. I mean, look at Venezuela. On a percentage basis, Venezuela has killed every market in the world for, 5, 6, 7 years in a row. Now, it hasn’t gotten anything on a real basis. 

And so…back to your original question of where do you put your money? I think you have to have some money in the hardest currency, which is gold. And then, I think after that, it’s basically a hierarchy of when you do monetary financing of the fiscal authority. Okay, stocks do better than bonds. Bonds turn into certificates of confiscation. [If] I have to own bonds, I’d rather own Apple bonds than I would US treasuries.

Preston Pysh  36:05  

Fascinating stuff. Luke, tell our audience where they can find you. I’m sure they’re going to be looking you up after this discussion. So I’m just so thrilled to have you on. I really enjoy these conversations. I always learned so much, so thanks for coming on the show, and telling people where they can learn more about you.

Luke Gromen  36:22  

Absolutely. No, it’s a…probably the easiest place to find us at our website. FFTT, Frank, Frank, Tom, Tom dash LLC.com. Always, updates there on what we’re up to, and find out some more about our different research product offerings there. I’ve also got a very active twitter feed at @LukeGromen, L-U-K-E-G-R-O-M-E-N.

Stig Brodersen  36:43  

Luke, thank you so much for coming on the show. What a pleasure!

Luke Gromen  36:47  

Thanks for having me on! It’s always great. I really enjoyed talking.

Stig Brodersen  36:50  

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

Outro 36:58  

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