Preston Pysh  1:13  

I really enjoy these chats. I want to open it up with, in my opinion, the big enchilada of what in the world is going on?

It’s this binary situation of deflation versus inflation and kind of what policy is going to pop out of what we’re seeing right now. I’m kind of curious about just your overall thoughts when somebody says deflation versus inflation.

Raoul Pal  1:37  

Deflation always has been, firstly, the trends are in my favor. Secondly, I just think that with an aging population, a debt dynamic like we’ve got, a relatively strong dollar and technology, it’s almost impossible to generate meaningful and ongoing inflation. 

We’ll come into some of the big changes that could come from fiscal and stuff like that, and we’ll talk through that a bit. Though, I think generally, overall, that’s the supertrend you have to fight. 

Now, what do you call inflation? And what do you call deflation? That’s the other thing,  definitional issues. I think that big currencies are deflating versus hard assets. That’s not necessarily price inflation. 

I’m about to write a piece for Global Macro Investor about wage deflation versus actual inflation. Maybe it’s wages, because when you look at most goods versus the price of gold and stuff like that, it hasn’t really changed price. 

It could be that wages are deflating, which is something I want to dig into, because real wages haven’t gone up since 1974. There’s a number of issues here, but I’m very much *inaudible* deflation for now.

Stig Brodersen  2:50  

Michael Saylor, on the other hand, said that inflation is happening in pretty much everything you need. Medical would be an example, real estate would be another. What are your thoughts on that?

Raoul Pal  3:01  

One thing is that millennials themselves are driving it, because they’re trying to get into property at the same time. They can only afford the same kind of price range. Well, guess what? They all push themselves out of it. 

Rich people have obviously had too much money, because they’ve had access to credit unlike average people. That’s pushed up the value of those things. We’ve seen cars, fine art, and wines go to crazy prices because of the same thing: the money of the rich people. 

Then, there’s the stuff around which corporates have power in Washington, and those are pharmaceuticals, health care, and some levels of food and stuff like that. 

Look, it’s a really complicated world. Inflation is not a straightforward CPI thing. However, you do find your fixed cost of living has gone up, while the cost of consumer goods has collapsed. 

Preston Pysh  3:52  

We were interviewing Lyn Alden, who, in my personal opinion, is just unbelievably smart. She was making the case for…because at the end of the day, this is all revolving around CPI and the premium in the fixed income market above CPI. 

She was making the argument… I asked her, “Well, how do you measure ‘inflation’ of the monetary supply of the currency supply?”

She *inaudible* just looking at the printing that’s getting listed on the balance sheets of the central bank. Maybe we can use that as a CPI? What do you think of that idea?

Raoul Pal  4:25  

As I said, there’s different measures of inflation for different things. The other thing I know is my inflation is different from your inflation. I just think that the whole thing is arcane. What are we trying to solve here? What do we care about here? 

We don’t have bond yields that are going to offset anything. That game is gone. We can get into the discussion about Bitcoin, gold, and that kind of stuff to offset the devaluation of currency. I think the real issue is that incomes don’t go up enough. That’s the real issue here. 

In the 1970s, we had inflation because wages went up and pushed up the cost of goods. We don’t have that. We have wages that just do not go up, and that’s the biggest problem here. Therefore, I’m not sure we’re always searching for the wrong enemy. 

I think globalization was one of the enemies. I’m a globalist in many respects, but globalization destroyed wages, because of global wage arbitrage. Then, you throw in technology on top. What chance does anybody have? I mean, there are literally going to be no bus drivers in 10 years time. There’ll be no truck drivers in 15 years time. There will be no cab drivers. All of these jobs will just get all destroyed. 

Marc Andreessen’s software is eating the world. It was probably one of the most profound statements I’ve ever seen. There is this really weird dichotomy, this massive deflation. As you said, there’s the cost of living inflation with health care and housing. Then, there’s the massive deflation in the value of fiat currencies. This is a complicated dynamic.

Preston Pysh  5:53  

I got my roots with this really strong Warren Buffett value investing, calculating the intrinsic value of the company background, when I first was learning about finance. All of that is based on fixed income, risk-free rates of a 10-Year Treasury, and kind of using that as a ruler and a yardstick. 

But now, with everything getting polarized down to zero percent negative yields, how’s a person to do valuations anymore? How are you looking at that?

Raoul Pal  6:25  

Well, the point being is it seems to all be trumped by flows now. Passive investing, again, it’s the millennials who are starting to invest in their passive investment vehicles versus the baby boomers, who are all divesting of active strategies. 

Value is underperforming growth massively because of generational flows. That’s very difficult to change and that’s been Mike Green’s point for a long time. I think that makes it difficult. I think zero interest rates make assets more speculative. Also, if you look at Japan and Europe, they made them tremendously cyclical. 

Japan just went up and down the business cycle. The UK stock market did that for 250 years before the mid 50s, when finally the UK stock market actually broke out of a range, but it just went up and down with the business cycle. That kind of makes sense. PE expansion when people are optimistic and contraction when they’re not. 

However, the flows from baby boomers and millennials have changed all of that. It’s created a crazy world, a world that nobody understands, and models don’t work any longer. I’m not sure if it’ll ever revert. Come elsewhere, I think, but it won’t come back to these markets.

Stig Brodersen  7:33  

You previously mentioned this point about wages not going up since 1974. Is that why you have seen this increased interest in universal basic income from both voters and politicians?

Raoul Pal  7:45  

Let’s strip that down, right? If the problem is wages, that’s not right, that somewhere in this, and I’m still doing the work, and I’m trying to get my head around it. However, let’s say wages are the problem. Well, then UBI solves a lot of that. It basically is giving a premium back to people who got destroyed by globalization. So okay, that’s interesting. 

Now, I know a lot of people don’t like it. But I have a feeling in my work, because what you’re giving people is the ability to pay rent, pay their electricity, and have health care. Now, don’t forget, in other countries, there was more of a welfare state. 

I know Americans find this really difficult to believe and think everyone’s a communist the moment they have a free health care system, but most countries in the world have free healthcare and the welfare state that supports people, should they fall below a certain poverty line. The US doesn’t really have it, so UBI does some of that. 

But I think Europe will have some UBI as well, because so many people have been left behind by globalization. I think that’s what the populist revolt was about globally. It was the fact that people realize that they’ve got poorer, and they don’t know who to blame. They’re blaming everybody. 

Well, I think we are probably trying to fix the wrong problem, and that is the issue. I mean, demographic shows all of this. It shows where CPI is going, and it’s been forecasting it for years. It’s all driven by demographics. 

Now, why did we get a debt bubble? People don’t ask these questions. They just say, “Oh, yeah! Well, the central bank has created it.” 

Well, they didn’t. It actually came from the 80s. So where did that debt bubble come from? Well, if you start to think of the world in the way that wages didn’t go up and up, what do we do? We borrow money. 

Preston Pysh  9:23  

I guess my big narrative for how we got there in the 80s was that we kept adjusting the money multiplier. We had a gold standard, but if you go in, and you adjust the money multiplier… I had this really cool chart, I need to send you this chart. It shows how the money multiplier was adjusted from Bretton Woods up into when we came off the gold standard in 1971. They just kept adjusting it more and more and more. 

When you’re doing that, you’re just expanding the money supply until you get to a point where you can’t make good on the gold that’s sitting in the vaults. Why did we see all that wage growth through that period of time? 

Well, I would adjust because the central banks were manipulating the markets even back then.

Raoul Pal  10:02  

Look, governments and central banks have always manipulated the markets. However, I think there’s a confluence of events here, some big events that all happened, and who knows? 

One was the biggest generation of people in recorded history all coming into the workforce at the same time, right? Then, there’s the fact that their wages didn’t go up, because there are so many of them. 

You had globalization by 1996 in the World Trade Organization. Afterwards, you’ve had the massive rise of technology. Then, you’ve had the massive rise of debt, whether it’s been driven by the central banks, driven by people trying to cover their wage gap, or a combination of everything, probably. You’ve got this massive confluence of events that have created this huge mess. 

The other thing was the rise of the pension system from the 80s, too. Then, there was the rise of passive funds, index funds that started in the late 90s. You can see the trajectory in the S&P, [which] just completely took off from 1996 onwards. It’s like a weird break in the chart. That was the launch of all of these index funds. 

All of these things have come together, and they’ve all compounded themselves. To pick them apart is almost impossible now, but to predict where they go is more reasonable.

Stig Brodersen  11:07  

All the decisions that have been made are reflective of the decisions made before. Fiscal monetary policies by nature of controlling something that, by default, would move in another direction, if allowed.

Raoul Pal  11:19  

Yeah and don’t forget, throw on top of that the fact that all the central banks use economic models which don’t work, right? They use linear extractions of GDP, [which] even a child knows it goes up and down. It’s cyclical. Not one of them has cyclicality in their models, so [there’s] this error on top of error. They’re also trying to solve the wrong problem. It’s all become the law of unintended consequences. 

Nobody thought that index funds cheapening the ability for people to invest was going to create this ridiculous bubble where the entire stock market is trading on PEs of 30, 40, or 50, or choose the number. Nobody thought that was going to happen. 

I know there are people who say, “Just raise rates and get to the normal level.” I think rates are at their normal level, because of the debt bubble, because of the demographics, because of all of the other things. I don’t know what you can do about it, but we’ll start again.

Preston Pysh  12:14  

No, it’s a fascinating point. When you start to hear MMT and talking about taking rates negative, at the end of the day, I guess, I might be just a really hardcore free-market type person, where if your business sucks, and it’s not making some money, you shouldn’t be bailed out. You should fail, because if we don’t let that naturally happen, then we’re just going to compound that problem. 

Raoul Pal  12:38  

That was the law of unintended consequences, probably from 1997, maybe even 1987. The stock market crashed, when they cut rates. When Greenspan cut rates then, they needed to support markets and that created unintended consequences all the way through. 

It’s now, as you suggest, yes in the free market. Things should go bust. However, now, it’s such a big debt bubble, that you destroy everything. The only answer is to create a parallel system and try and jump, because you can’t do it by letting the whole thing go. Nobody’s going to let it go, because the devastation is too big. 

I honestly believe that interest rates are trading at free market levels, because even if you go to get a private sector loan, the rate is maybe 10%. But it’s not wildly different. We’ve seen this in Japan for a long time as well. 

I don’t know, but yes, if the central banks hadn’t made so much capital available, rates would have been higher. Though, the whole thing now is looking back is almost pointless because it’s such a big mess.

Preston Pysh  13:41  

A year ago, when you and I were talking, I was just looking at the bond market, and it’s in these very low yields. I was saying, “Hey, this is a mess. I’m not going anywhere near this.”

Then, you said, “No, my friend. This is going to be a big buy in the coming year.” 

You were dead right.

I guess my question for you, and I wasn’t going to be surprised if you were right, it’s just for me, it was a personal choice of risk that I just don’t know when this is eventually going to blow up or when the market is going to lose trust and all these other things. 

As we’re looking at it now, it wouldn’t surprise me in the least bit if we go into the summer and interest rates on all these bond instruments are getting pushed even lower.

Raoul Pal  14:24  

Or will go negative. Let’s face it, the UK went negative for the first time in 400 years of the history of the UK credit markets. That happened last month. The Bank of England will follow suit. All of Europe is negative, i.e. in the EU. Denmark is negative. Sweden is negative. New Zealand is negative. Basically, it’s everywhere, right? It’s systemic in every single place. 

If the US thinks they’re going to avoid this, they’re smoking crack. It is coming. 

The charter said it, and I call it the “charter of truth.” It is going negative, because there is nothing they can do to stop it, and the market will walk them there first. Nobody believes it. 

Nobody believes that US rates can go negative, but they will. They’ll need to, if you’ve been following what’s been happening in the German bond market, where yields have been collapsing because Europe had to go back into deep recession because of the virus. 

What’s going on there? The US is following suit. So, yes, it’s going more negatively. I’m long bonds right now, and I think it’s a good trade.

Stig Brodersen  15:27  

Raoul, I can’t help but ask, what would need to happen for you to change position in long bonds?

Raoul Pal  15:33  

Well, we will at some point finish this recession. I think it goes on longer than people imagine, but at the end, you then get cyclical inflation. Are you going to create structural inflation? Are you going to create structural dislocation in the bond market? 

Zero chance, 0.0, because the central bank will own it all. It tipped into the currency market, not the bond market.

Preston Pysh  15:55  

I’ve had this opinion that the more that they start exercising the UBI lever, the more that we have the potential for the CPI gauge to start demonstrating some form of inflation. Do you buy that?

Raoul Pal  16:10  

No, because it’s a one off annual rate of change. What drives inflation is when wages keep going up. That is what demand inflation is. That’s the real, toxic, nasty inflation. Once you give people $20,000 a year, you get one year. And we’ve seen this in Japan, when they’ve tried various measures like this. What you get is a massive rise in inflation. 

Next year, it comes out, and then inflation is gone because there’s no increasing wage. Without increasing wages, you don’t get structural inflation. You simply can’t do it.

Preston Pysh  16:43  

When you’re measuring in nominal fiat dollars?

Raoul Pal  16:47  

Yes, and again, when you’re not measuring it in other things, where there’s massive demand from millennials, which will drive it up. All of those things. When you’re looking at it in fiat dollars, yes, UBI will lower the price of a fiat system. Again, it’s complicated.

Preston Pysh  17:06  

Let’s talk about the big topic here. The first thing that I want to cover is just if Bitcoin wasn’t out there, this is a story about gold. This is a major story about gold, but now you have this technology that is offering a counter to even that, that brings a whole lot of other qualities that gold is deficient in as far as spendability, visibility, all of those things.

Raoul Pal  17:35  

Sorry, I’m just going to go back a sec. Actually, about three things. Gold would have been and the other one, maybe even more importantly, and you’re seeing it, is cash flow. So the SAS business model is all powerful, because you’re generating something of real value. Though, it’s overvalued right now, it throws off cash, right? 

When you’ve got businesses that are throwing off 70-80% margins, whoever wants to own a bond? Why do you even want to own gold? You’re just compounding capital at such an incredible rate. That’s the other thing: gold, cash flows.

Stig Brodersen  18:13  

That’s a great point. Just look at here in 2020. Look at NASDAQ, the margins of the FAANG stocks, the stock is just really drying the index. They just have the fattest margins.

Raoul Pal  18:24  

We’ve never seen margins like this before. General Electric and Ford never had margins like this. We’ve never seen this before. 

I understand it’s difficult for the market to figure out how to price this stuff, because we just don’t know. I mean, we’ve never seen businesses that generate hundreds of billions of dollars in revenues and have 70% margins. That’s astonishing, so it’s difficult to value. I get it. 

Preston Pysh  18:48  

Before we start going down this path, I want to talk to you about something that is kind of in a similar light. Right now, you’re seeing a political movement to break up some of these companies. Many of these companies are being driven by artificial intelligence, deep learning. 

Then, you look at the competitors over in China, where the centralization of their competitors over in that geographical region, are encouraged for consolidation and encouraged to be integrated with the government, so that all that data can be harvested, manipulated, and used to benefit the regime. 

Is the West in a vulnerable position because of the cries for monopolies and for governments to step in and start breaking some of these apart? I mean, how are we going to remain competitive against the East, when they’re embracing it? 

Raoul Pal  19:37  

We’re going to wall ourselves off or wall them off, whichever way you want to look at it. It’s the only way. The only way is to break into two internets, essentially, because you can’t compete with state actors, because it’s too dangerous. They’re too powerful. 

Meanwhile, I also don’t agree with the fact that Google has more data on more people than any other entity in the world, far more than the Chinese government has. Those guys have everything. I’ve never even seen anybody else question how secure that data is. 

Nobody even talks about the security of Google data, but this is a sovereign risk of the highest order, probably the most important database in the world. Can Google on their own manage it and how? 

We have to be very careful with granting these people the powers, including the private sector, because the ability of either abuse or of a nefarious act of stealing it, I think, is too important to ignore.

Preston Pysh  20:40  

Let’s talk about Bitcoin versus gold versus cash flow. What are your overarching opinions on this?

Raoul Pal  20:48  

My opinions in life [are to] have cash flow, and then own Bitcoin as your hard asset, because if you’re operating cash flow, you’re generating cash, which devalues over time. I don’t believe necessarily that Michael Saylor’s point is applicable to everybody, because nobody’s thinking about hundreds of time horizons of the capital.

However, overall look, we’re in a risky world out there. We’re trying to make growth in our capital for the future. First thing is to invest in yourself, so whether you create a business, and you’ve done that, right? You create a business, and it’s a high margin business. It generates an income. It affords you the opportunities to make investments and have a lifestyle. That’s all that matters. 

For me, everything is all about the lifestyle token. That’s what you live for is your life. I don’t live for my Bitcoin. The Bitcoin case, my life, for example. That’s how I think of it first. First is cash flow. Cash flow security gives the ability to then accumulate assets that have future value.

Stig Brodersen  21:46  

As you’re talking about your retained earnings, you say that some of that is in Bitcoin? Do you also own *inaudible* knowledge stocks?

Raoul Pal  21:53  

I have none and the reason being is I fear about regulatory risk. I also think they’re expensive. I don’t know how to value them any longer. I kind of think I know how to value Bitcoin, which is it’s a reserve asset with a call attached.

On the future financial system, we talked about opting into a parallel system well once it is being built. So what value is that worth? Well, that’s worth a lot. 

I think I can get a macro valuation. I can’t for Apple. I can’t get a trillion dollar company and figure out, “Is it worth $3 trillion?” I just can’t do that and that’s just probably because I’m stupid, but I just don’t know how to do it. I just stay away from it. 

I put out a tweet thread today that now I can’t even use my Twitter. I [am] kind of overwhelmed with this thread showing Bitcoin versus every other major asset, including Amazon and Apple. They are all breaking down versus Bitcoin.

Look, I’ve been in this game a long time. I’ve also studied history. I have never, ever seen an entire asset consume every single other asset in the world. I mean, it’s extraordinary. I think this is just the start.

Preston Pysh  22:59  

Talk about the charts that you’re describing, because I’ve seen them on Twitter. Tell the audience who may not have seen your tweet.

Raoul Pal  23:04  

The charts I started with are okay, what does gold look like versus Bitcoin? Well, gold is breaking down versus Bitcoin. Then, what does the NASDAQ look like because surely the NASDAQ must be outperforming? No, it’s breaking down. What about the banks? Well, the banks, we’ve always talked about Bitcoins destroying the banks. Well, the banks are all time lows in Bitcoin price, using Bitcoin as the denominator. What about commodities? Well, if you use Bitcoin as the denominator, commodities are [at] all time lows. 

Okay, what about Apple? Amazon? The G4 central bank balance sheets that’s been the most powerful asset in the world? No. Bitcoin is eating them all.

Bitcoin then is becoming the world’s strongest narrative. It’s only just started. The chart patterns alone all look like they’re breaking. This is very interesting. I’ve never seen this before in my life.

Preston Pysh  23:56  

Just to put a little context on what Raoul was talking about, so from the start of 2020, you have the…let’s see what this is…. Gold is up 24% since the start of the year, the NASDAQ is up 30%, Apple is up 55%, and Bitcoin is up 97%. It’s crazy.

Raoul Pal  24:18  

It is crazy and then the banks are down. What 40 or 30? 

Preston Pysh  24:23  

Yeah, they’re negative. 

Raoul Pal  24:25  

Bitcoin is up 97% and the banks are down 30%. That’s 120% outperformance. This is incredible. 

Preston Pysh  24:36  

Yeah, it’s mind blowing. So talk to us about banking. Your opinion is that Bitcoin is going to continue to run probably more aggressively than what the hundred percent we’ve seen year-to-date. What does this do to the banking sector, moving forward?

Raoul Pal  24:51  

The banking sector is reflecting something else, and it’s that theory [that] everyone’s got bored of me talking about, [it’s] the insolvencies. We have this bifurcated world where NASDAQ stocks were going up, but really, everything, from oil markets to banking stocks, was doing the opposite. 

The old economy names and the triple B credit companies, they’re the most indebted large companies in the world. They all look the same. They basically bounced a bit from the low and then flatlined, and then started rolling over, which is actually exactly the same as the real time economic data. 

The European economic data is rolling over and tipping down. Guess what? The European banks are tipping down, so they’re reflecting the economy. The bond market looks the same, too. 

As we said, that cash flow *inaudible* business model of SAS businesses kind of decoupled. Everything else is the same.

But banks? If insolvency really is the problem and how insolvency is a problem, [then] if I’m right and GDP growth stays negative for the next 12 months, there’s not enough cash flow to pay for the debt. Simple as that, whether it’s at household level, foreign corporation level, or US corporate level, smaller, medium-sized enterprise level. That creates more insolvencies as companies go insolvent. 

What the banks are telling you is there’s a problem here. That’s what the bond market is telling you. That’s what General Electric’s telling you. That’s what AT&T is telling you. They are all saying there’s a debt problem here.

Stig Brodersen  26:16  

Let’s say that you’re right that Bitcoin is going to take off in 2021. I’m not saying that I agree or disagree with that statement, but let’s say that is true. What does that do for the opportunity cost perspective of fixed income investors, and what if it’s not true?

Raoul Pal  26:31  

There’s a reflective loop that’s going to happen. It’s so obvious. The US has approved custody of Bitcoin for certain banks, which is a code word for prime broking for hedge funds, which means the hedge funds will see this. 

Most of them haven’t got custody yet, but soon they will. That means that they will come into this space because they can trade multi-asset classes. That sucks them in. I’ve talked about this. 

The next is the ETF will get launched at some point. Somebody will get it off the ground, and then all the IRAs buy it for their customers, because it’s outperforming everything, and they love to be cheap and chase the trade. 

This is going to be the strongest trade now. So, you got the hedge funds and the IRAs. We know the family office space is already interested, and they get sucked in the more the price goes up, the narrative goes up, and more people talk about it. Family offices tend to do that. 

Endowment level [is] next, because they can hold it because of the long-term asset. Endowments can justify it earlier than pension funds can. Pension funds can’t do this yet. It’s quite difficult for them. 

We’ve got this wall of money that I keep talking about and that’s coming. If you throw in the public, the NASDAQ traders, the speculators and the Robin Hooders, and everybody else, you’ve got a perfect storm. You also got the corporate treasures.

Preston Pysh  27:46  

I think that last one’s huge. I mean, Michael Saylor, no offense to Michael and his company, but I know him dropping $425 million into this. That’s a small company in the grand scheme of things, globally, right? It’s not a big company.

Raoul Pal  28:01  

Yeah, unfortunately, I’ve talked about this a few times recently. The crypto space is not very good at speaking the language of others. We tend to impose our own language, so the corporate treasurers will not buy Michael Saylor’s language, because it’s not the language that they speak. They don’t think in those terms. You have a corporate treasurer, who may step into Microsoft for 10 years and then leave. He doesn’t think in the sense. It wasn’t his company and built it. 

We need to talk about how it works as a diversified asset, how it works in a corporate treasury portfolio of fixed income, commercial paper, currency baskets, all of the things that they do. We need to talk in that language and show them. 

Once you do that, Microsoft, Apple and all these other massive cash businesses will loan it. Of course they will, because it’s a great asset for diversification, and they don’t need to buy too much of it. 

The pension system, okay, that’s another beast. Again, everyone keeps saying they should do this. Well, until you can show it to them in bearer model. Bearer is the model by which most of the pension industry builds their portfolio and risk management tools. 

However, we’re not talking that language. So it’s like you are shouting at me in French, and I’m just shouting back in English saying, “I can’t understand you.” That’s what’s going on because they can’t do anything with this. They’ve got a bearer asset. They don’t know how to custody, but we’re not telling them how it works from a portfolio diversification or risk metric standpoint. 

We’ll get there, and I’ve already been starting to beg people who understand the bearer world to say, “Listen.” 

Who owns that pension fund asset allocation world? It is consultants like Mercer. We need to get them across the line. You need to teach them about it first, then they go to the pension fund trustees, and then the pension fund trustees approve it for the asset allocators. That’s a big process.

Preston Pysh  29:44  

I think the key distinction between what you’re talking about across all these different mechanisms of how they could come into the market versus Michael Saylor is it’s a story about voting rights. It’s a story about control inside the company. He has complete control that just goes out and makes a bold call of taking his entire treasury and dropping it into bitcoin like he did.

Raoul Pal  30:07  

The brave go first. Good on him, right? Because he was in a position that he could, and he got it. There’s a few other people around that have got it, but that will spread slowly. Though, it will come because…and I know everybody’s going to hate this, but the investment banks will get into this space, and they know how to translate. They know how to speak to these other people. That’s a net beneficiary to the space, even though all of us want to protect it from the investment banks.  

They can’t *inaudible* really, because it’s distributed. It’s not owned by them. [There’s] nothing they can do with it. They can help create a derivative market around it, but that’s coming anyway. There’s nothing we can do to stop it, because humans want leverage for some reason.

Stig Brodersen  30:46  

Back in 2017, when this thing was really running, the big issue discussed was, “Will the governments shut it down?” You almost do not hear that argument anymore. What are your thoughts on that subject?

Raoul Pal  30:59  

I’ve read the IMF papers, the BIS papers, the ECB, the Bank of England, the Fed and the Department of Justice, all their papers. Not one of them is saying that we need to stop this. They’re all saying, “Let’s make sure it’s regulated. Make sure the MCs are regulated. By the way, let’s build digital currency systems, because that’s where we have to get to.”

They kind of acknowledge Bitcoin. It’s like, “Yes, look. This was the great invention, and we understand that.” They’ve got no reason to stop it, because the bloody foreign exchange markets trade $4 trillion a day. They don’t care about Bitcoin. 

What was really interesting to them and taught them, “Okay, we need to move into a digital future.” Good on them. They’re doing it now. How they use it in the end, who knows? But I don’t think Bitcoin is a problem. Talk to me when it’s $10 trillion and maybe they try. 

However, in a globalized world, with something that moves around on the internet, it’s almost possible to stop, because somebody will allow it.

Preston Pysh  31:59  

However, Raoul when it’s $10 trillion, you have so much entrenchment on corporate balance sheets all over the globe. How in the world are they possibly going to shut it down potentially?

Raoul Pal  32:11  

That’s not going to go well with voters so they’re not. It’s the fear. They once tried it with gold. Well, last time I checked, gold has been around for about 10,000 years and still works as a system of value and money, regardless that the Fed once banned it. 

Yeah, Turks banned it recently that it stopped Turkey. It’s not a narrative that’s provable in the outside world.

Preston Pysh  32:34  

One of the unique things that pops out of this, if we start going down this path, if you want to take out a loan right now, and you want a $100,000 loan, you have to pretty much cough up $200,000 worth of Bitcoin and put it into somebody else’s Escrow account. That’s not how loans work today. 

It’s very different from that type of system. So when you think about this world we live in today that is so credit based, and if everything starts moving in this direction, where everything is equity-based, what does this do to the landscape of everything?

Raoul Pal  33:10  

I don’t know the answer to that, because I think this is going to be a phased affair. It looks like this now, but in the end, Bitcoin won’t look like this. Its volatility will come down to 5%, but at what price is that? What market cap? $10 trillion? $100 trillion? I don’t know. 

Then, it’s like money, and then it stabilizes massively. I don’t really know how this is all going to work, but it will take time for that to play out.

Stig Brodersen  33:38  

All right, Raoul, to shift gears here. You recently had a post about the IMF and the new Bretton Woods system. Could you please talk to us about that?

Raoul Pal  33:48  

Yeah, I’ve been flagging this for a while. The central banks… I think the BIS went first and then Mark Carney at the Bank of England shocked everybody at Jackson Hole last year by talking about central bank digital currencies. Well, the main media missed it. 

I said, “What? This is the Bank of England, the second oldest central bank in the world, talking about central bank digital currency and how disruptive Facebook Libra was as an idea. They’re not sure that they should let Facebook do this, but they should.” 

I thought, “Okay, he gets it.” 

Well, then the ECB, *inaudible*, the BIS, the IMF, and the Fed all started talking about it. Then last week, there’s the IMF on video for everybody to watch, talking about the new Bretton Woods, and they all know that the dollar standard is a problem because the US is 25% of the global economy and 79.5% of all payments.

There’s then a massive mismatch, and the Fed had basically filled the gap, but now, the mechanisms between onshore dollars and offshore dollars don’t flow either. 

Now, the whole thing’s a mess and [countries] like China, who are larger don’t want to be held to ransom by the swift payment system and a bunch of these things. The Europeans too, really, because they want to trade with Iran. They want the US to *inaudible* the contract with Iran.

Anyway, it’s in everybody’s interest to walk off the dollar standard and create something new. The central bank digital currencies are that. They’re talking about it in terms of Bretton Woods, of having a new agreement on a currency. 

Now, I don’t think there’s going to be a single world currency, but I think you can construct baskets. There’s no reason that South Africa should get penalized, because it has a weak currency and has to deal with everything in US dollars. It’s destructive. 

Imagine if all commodities were traded on a commodity currency to better reflect the fundamentals of those countries, it will be so much better than having to reflect it in the dollar, which is not fair on those countries, because they’re cyclical. I think we’re going to see regional baskets, different types of trade baskets, anything we can create from this. We’ve only just started.

Then, we have the ability of central banks to use this to completely change what monetary and fiscal policy even is and what economics is. I mean, we are walking away from the standard Keynesian model and everything else. 

We’re going to go into the world of behavioral economics, big data and incentive pay systems, where you get a different interest rate to me. They can make direct payments. Then, before you know it, your incentive systems where they can change your behavior. 

For example, your car monitor caught you speeding, and therefore you’re going to pay a higher tax rate this month. I don’t know if it’s worse or better. Look, everybody says, “Oh, my God! It’s a police state and everything else.” 

Well, guess what? Surveillance state has been there forever, and if you don’t think Google, Facebook, and everybody else owns you, even here we are on Skype. Who’s got this data? Microsoft, right? Forget about the fact that we can get out of anonymity. 

Yeah, I’m on an island of 140 people. I don’t use the internet, so I’m pretty anonymous here. However, most of us don’t get that. I think it’s a really exciting time, because they’re going to screw this up. They’re going to make some amazing changes, some great things, some terrible things, and as investors, those are opportunities to me.

Preston Pysh  37:04  

When you look at the news and you see Paul Tudor Jones coming out and talking about “I bought Bitcoin a few months ago. I even like it more now.” I mean, he’s really kind of coming on strong. 

How do the rest of the people with Goldman Sachs and everybody on Wall Street? How are they viewing that CNBC clip? Are people rolling their eyes? Are they taking it very seriously?

Raoul Pal  37:27  

They never take people like Paul seriously. They take his wealth seriously, but he’s a trader, and they don’t get it. Paul changed his mind a lot, but big hedge fund managers who can afford to take the risk… I mean, many of them just left the business and went to crypto. 

Famous people like John Burbank just left, Dan Morehead, Dan *inaudible*. You name it. They’re all novo. It’s the supermassive black hole sucking them into saying, “Well, all the opportunity sets and all the other asset prices are less than this one.” 

Hedge fund managers that I speak to, some of the most famous in the world, have held crypto investing units for their own personal wealth. They get it. And the Wall Street guys, they get it too. 

Don’t forget, there’s been a massive deflation in Wall Street salaries over the last decade. A salesman used to earn $2 million bucks a year. Now, he earns $500,000. That’s a 75% haircut. These guys now realize that banking is not the rich job that you then get out of and you can retire. It doesn’t happen. 

These guys are having to get the new religion as well. There’s a lot of people involved in this now. It will permeate into the actual investment banks themselves as they set up trading desks and all of that. I mean, it’s all coming because the customers are demanding it.

Stig Brodersen  38:47  

Raoul, you speak to the smartest guys in finance and still with your experience, I know you always strive to make yourself smarter every single day. What is something you heard here recently [that] has really changed your mind about a financial topic?

Raoul Pal  39:01  

The last interesting conversation I had that made me really stop and think was with Jeff Booth. That made me start thinking about wage deflation. I’m only just starting that thought process. You’re the first person to really hear it. I’m going to be writing something up. 

That’s made me think something differently. I don’t know where that work is going to lead to and what it’s going to tell me. But I just know, it’s interesting, because it’s the opposite of what everybody else is saying. 

When you look at everything in the world, what I’m going to do is look at all asset prices in the denominator of wages. Then, let’s see what things look like. 

Also the other guy that really opened my mind to stuff, a discovery I made on Twitter, Santiago Velez, who now does [interviews] for us in Real Vision. He has this incredible understanding of the kind of internet of value and the whole broader landscape. So, that was super interesting to me as well, because he’s really in the weeds of interoperability, how we connect all of these systems together that is not only winner takes all. 

He also said a really interesting thing because you see tribalism, the Bitcoin maximalist versus blah, blah, blah. 

He said, “Good. At first, I thought it was a bug. Now, I realize it’s the feature. Everybody’s fighting for their own piece of turf.” 

What it’s doing and Michael Saylor talks about this, really, what he’s doing is creating the super vibrant, rich, deep communities that ensure the survival of their asset. Only the strongest will survive, because it has to be invested in by the community. It doesn’t survive in its own way. It has to create a network effect. It’s really clever when you realize that this is a network effect. This is Metcalfe’s law happening in front of our eyes.

Preston Pysh  40:41  

What do you think about the whole Defi movement where you have these decentralized exchanges? I know that Uniswap was the big one that everyone’s talking about on top of the theory. I’m curious how you’re using some of this stuff.

Raoul Pal  40:54  

These are the baby steps into solving what needs to happen, which is a yield curve. Once Bitcoin and the crypto markets solve the yield curve and have its own yield curve, then we’re free of the old system. It’s as simple as that. Time value of money has to exist. It doesn’t yet. 

So Defi, whether you hate it or not, like the tokens, it’s irrelevant. It is the market struggling to price *inaudible* in the crypto world. I love that. It will get solved, and it will because if Bitcoin is to be this pristine asset and a pristine collateral that I’ve talked about, it has to have time value, because I’m not going to lock it up without time value. 

If I’m going to give it to you as collateral, I want to get something in exchange, which is interest in whatever format that is. It doesn’t have to be money. It can be an extra Bitcoin or whatever it is, or other tokens or anything in this world. 

I just think this is really interesting. People don’t really get it yet, because they’re still fighting over coins. They think coins and cryptocurrency, that’s the future versus…it’s not Bitcoin.

Everyone’s missing what is going on, which is the largest single financial revolution that we’ve seen, it is the internet of value. I mean, this whole tokenization thing hasn’t even started, and it won’t be this wave. But the next wave behind this is you and I are going to be talking about tokens in all sorts of things. 

When we talk about value investing, we’ll be talking about what tokens people don’t understand, because people don’t know how to price the smart contract embedded in this token versus this one. 

People like Arca, who have the kind of long short token funds are up 130 odd percent this year, last time I checked, because there’s alpha in that space. 

There’s going to be alpha in money markets, in the crypto markets. There is alpha in tokens. This is truly exciting because we’re so bored of financial markets that we can’t even price [them] any longer.

Preston Pysh  42:47  

You think value investing comes back once we get the yield curve back? 

Raoul Pal  42:49  

Yes, because you’ve got assets that are not now driven by the demographic issues of the baby boomers selling all the active funds and the millennials buying the passive. Now we’re going to create millions of new securities, literally millions. What a beast of an opportunity. 

This is like going back into the hedge fund business in the 70s, when Star Wars started, and there’s no competition. There’s not enough capital in the space and there would literally be millions of tokens. What a great thing.

To figure out how to create pricing models around smart contracts, I can’t get my head around it yet, but we’re going to have to.

Preston Pysh  43:23  

Last question for you. Who’s the Patsy at the table in all of this?

Raoul Pal  43:28  

What is really nice is that the person who is not the Patsy is the little guy for once. The little guy is the winner. They are going to take their share and that is amazing, because for so long, they are the Patsy. This time, probably Wall Street, because I think their business model is going to change dramatically because of FinTech. 

FinTech or central bank digital currencies, plus crypto currencies, [are] a big problem for the banks. That will change. They have been abusive of their monopolistic powers for a long time. 

Sure, they don’t make as much money as they used to, but they’re going to make a lot less like the oil companies make less and less now. They will do so in the future, because they now have competition. 

I think the balance of power shifts, because don’t forget, at one point, the financials were 70% of the entire US stock market. Over-financialization of the world has been the key feature of our lifetimes. 

Our lifetimes, we’ve seen this enormous debt bubble, and if you are the dealer at the table of a debt bubble, which is a bank, you make all the money. Well, this is the opposite. It’s the inverse. That’s really, really unique.

Preston Pysh  44:46  

Raoul, what a pleasure to always have you on. I’m a huge fan of Real Vision. I’m pretty sure most of the people listening to this are also huge fans, but give people a hand off. Maybe highlight something that you want people to hear.

Raoul Pal  45:00  

If you haven’t seen it already, I did a piece about the new Bretton Woods, because I think it’s really important. That’s why you said, “Hey, listen! We’ve got to talk about it.”

It’s on YouTube, just go to Real Vision on YouTube for free. Go and have a look or listen to the Real Vision podcast. So, they’re all free. You don’t have to pay for anything. Just go and check out some of that content. This three or four piece of me, [there’s] one where I lay out my unfolding thesis that’s on there from a couple of weeks ago. There’s this one. 

Then, there’s some of these really smart people that you’ll find interesting, because if you like this podcast, you’ll like Real Vision, because we’ve always known each other. We always realized we’re in the same space. It’s very accretive to all of us to create these kinds of conversations and broaden everybody’s mind, so we’re all in the same game. 

The other thing is really exciting news. We’re about to do something massive in crypto, as you can tell, I’m probably marginally positive on the cryptocurrency space. Look, we wanted to create what we did in Real Vision and Macro for the whole crypto space. We’re launching Real Vision Crypto. It has been launched internally for the Real Vision subscribers, but it’s going to be free to the world with some really big sponsors.  

Everybody’s going to be able to have access to the quality of information that Real Vision does in the rest of the investing space, especially in crypto. That’s covering every part of digital assets from the Bitcoin maximalist to the weird, funky tokens that none of us understand. It’s all coming. 

Just look out for me on Twitter as well, and you’ll see notifications of it. You can sign up for that for free.

Preston Pysh  46:31  

Raoul, thank you so much for coming on The Investor’s Podcast.

Raoul Pal  46:35  

It’s always a pleasure. Thank you, my friend.

Stig Brodersen  46:38  

All right. At this point in time, as we’re letting Raoul go, we have a question from the audience. This question comes from Josephine.

Josephine  46:45  

Hello, Preston and Stig. First, I want to thank you and say that I greatly appreciate listening to your weekly podcast. You’re both an inspiration to me. My request today is in relation to the modern monetary theory or MMT, which seems to be a top issue at the moment. 

As far as I understand, the simplest form of MMT proposes that governments borrowing in their own currency should not worry about deficits as they can always print more money to finance the debt. 

However, countries under the eurozone are dependent on the European Central Bank to manage the monetary policy for the member countries. My question to you is: How MMT would relate to the eurozone countries that are not able to independently manage their monetary policies? Also, I would love to hear your general thoughts on MMT.

Stig Brodersen  47:32  

Josephine, I absolutely love this question. It’s a very insightful question you’re asking. Unfortunately, I don’t know you personally, but I can see that you’re writing from an email account that belongs to a business school. I wanted to highlight that because macroeconomics is being taught in a weird way in business schools today and that includes modern monetary theory or MMT as it’s often referred to.

I just wanted to shout out to you and other students who listen to this podcast about how much I admire that you’re thinking so critical about what is being taught to you right now, because we should all be able to think independently. Of course, both students going to school and those of us, who are students of life as well. 

Let me address your question first about MMT in general, and then specifically talk about the eurozone afterwards. The idea behind MMT, as you mentioned, in its most simple form is that a country can print its own money, and can thereby run the continuous budget deficit since it can’t be insolvent. Well, it sounds good, right? 

But if something’s too good to be true, it typically is. The same goes for MMT. So let’s first talk about the scenario of a non-global currency country, and that includes most countries. Often, they can issue some debt in their local currency, but they are at the end of the day, depending on the major currencies, whenever they issue debt. Most noticeable is the US dollar.

Turning continuous deficits quickly erodes the faith in that country and the state obligations, leading to a debasement of the currency. 

One of the most famous examples of that would be the Weimar Republic in the 1920s, who experienced this hyperinflation because they had to repay its debt mainly in US dollars and the sterling. 

A more recent example is that we’ve seen how reliant the world still is on the US dollar. We’ve seen that just this year, when we saw $1 shortage during the pandemic and the dollar soared. That happened because none reserve currencies had to service the debt in US dollars. That was non-reserve currency. 

Let’s talk about MMT in the global reserve currency. As I mentioned, the most important currency we have is the US dollar, and so, not surprisingly, you could say MMT also originated in the US. 

It was first proposed by a gentleman named Warren Mosler, but it was also validated by former Fed Chairman Alan Greenspan, who said that “There is nothing to prevent the federal government from creating as much money and paying it to somebody.” He actually said that.

The US is in a slightly different situation, because they are the main global reserve currency. However, the conclusion is really the same. Whenever the music stops, you are in the world of pain. 

Now, the US in that previous position that they were in can play the music for longer due to its size and the currency dominance, but the music still stops. The longer the music plays, the more it’s going to hurt. So you might be asking, “How’s it going to hurt and why?” 

Well, the most obvious way this is going to hurt the US is through inflation. The US can continue to issue bonds to finance the debt, but only as long as the world keeps trusting the value of the US dollar as a store of value. 

When that stops, you will see rapid inflation and the worst case hyperinflation that could destroy the economy and lead to social unrest. Now, proponents of MMT acknowledge the risk of inflation, but bring the argument that it can be countered by increasing taxes. 

To me, that is just an argument that makes little sense because inflation is a tax on everyone. It hurts the have-nots the most. Whenever you try to make tax reforms in the country with rapid inflation, the idea of just raising taxes is really just going to be a disaster. 

So you might be thinking, “Why is MMT so popular, even among politicians, when it’s obviously wrong?” 

Well, think about it, if you are petitioned and want to get elected, do you get more votes, if you spend more or less money? Obviously, it’s easier if you pledge to give money to more voter groups, rather than few, because it’s a pain to stay within your budget. 

If you can argue that you can print as much money as you want, and you don’t have to care about the budget deficit at all, well, a lot of politicians like that idea. Voters are used to seeing actual cash.

On cash, what do you see? Well, you see, it’s being printed by the central bank. So the idea of just printing more money resonates with a lot of people, but that doesn’t make it true. 

Then, specifically to your question about MMT in Europe, and sorry, for the long way around going to that question. It’s a basic assumption. You know how economists like to make assumptions that in a sovereign country, you need to be able to control your own money supply. As you say, that’s not the case in Europe. 

MMT is not applicable to Europe. Also, given that you don’t have the same crossover between fiscal and monetary policies, as you do in the United States. It’s sort of being tested here in 2020. I want to give you that with the corona bonds and raising money for fiscal spending. So far, I’m not impressed. 

In any case, it won’t change the fundamental flaw of the theory. We had multiple monetary regimes throughout the last few centuries. It’s always tempting to conclude that as long as you don’t see a complete failure in a few currencies like hyperinflation, it validates monetary policy. I don’t agree with that. 

I also just want to clarify, I don’t see hyperinflation at all in the US or Europe in the near future. That’s not what I’m saying and that’s not the point, but I am certain that if we continue to run these crazy deficits and just print and print and print, it doesn’t matter, MMT or whatever kind of theory you’re going to relate to. It won’t save us. 

So, to your question about MMT in Europe, not only in reality is MMT not applicable in the eurozone, even in theory, it’s hard to make the argument, even though I’m sure you’ll find some economists [who] will give it a fair try.

Preston Pysh  53:41  

All right, so Josephine, fantastic question. I think a lot of what we talked about with Raoul really kind of gets at the heart of what’s going on and why MMT is going to be, in my personal opinion, a disaster. 

Why are they doing this? Why haven’t they ever proposed something like this in the past? Well, why they’re proposing this is because when you look at the velocity of money, how often money is being exchanged amongst all the participants in the economy, it’s slowing down, year after year. It has been for decades. Now, it’s at a snail’s pace between participants inside the economy. 

What’s blowing the minds of so many economists is they’re saying, “Well, we’re printing faster and harder than we ever have historically. How come that’s not driving the velocity of money up?”

Well, you have to look at how it’s been inserted to date, and how it’s going to be inserted into the future. If they continue to just insert it into the bond market and straight into the hands of people who are holding all these assets, and then those people take that cash flow that’s just been recently printed… What are they going to do with it? 

Well, they’re going to go and buy other assets, because they’re already fairly wealthy or they’re extremely wealthy in most cases. They don’t need to go out and buy more things. They just need to go out and buy more equity, or they need to go out and buy more fixed income investments with that money that has just been stuffed into their hands. 

The way that they’re supplying that liquidity into the system, it’s just nesting itself straight into assets, as opposed to into the hands of people to conduct transactions, which is where they really want it to go. 

The problem with this long term, in my humble opinion, is you’re creating an incentive structure that is broken. If you want to understand the incentive structure of printing and the inflation of monetary units, as they’re adding more and more units, then the credit is just being stacked on top of that, which also spends like money credit spends exactly like money. 

When you look at that, what that incentive structure is doing is it’s forcing the speed of technology and the speed of investment into new technology to accelerate. 

Jeff Booth has one of the best books on how this investment and this incentive structure compounds on itself, similar to what we’re seeing with Moore’s law. That’s why you see technology just eating the world right now. 

As they continue to double down, triple down, quadruple down on this idea of MMT, starting to take interest rates negative, it’s only going to compound this technology software eating the world type event that we are currently experiencing. It’s starting to feel like it’s getting out of control, like beyond society’s ability to actually handle it.

Just look at how the media is being spread and social media, all those aspects that are just devouring our social norms. I would suggest that a lot of these are due to these policies and they’re due to this incentive structure that is a result of these policies. I’m very concerned about it. 

One of the reasons, and I know we just talked about Bitcoin on this show for a lot of time, one of the reasons I like Bitcoin is because it could potentially slow some of this down. In my personal opinion, some people will argue different sides of this, but in my opinion, if an inflationary monetary policy, and I’m talking about adding more units, whenever I say inflationary monetary policy…if you’re adding more units, and it creates this incentive structure, if you have something that’s pegged, it might slow it down. That’s not a reason why Bitcoin will be successful. 

The reason I’m bringing it up is because it might be a counter to all this software eating the world that we’re seeing. It could slow some of that incentive structure for capital investment into more and more technology. It might slow it down a little bit. 

Another thing that I think is huge about this is when you’re talking about modern monetary policy, what it’s really doing is it’s keeping these zombie companies alive. So many of these companies do not have free cash flows. 

Whenever they just hand out triple P loans to companies that otherwise would fail, you’re just keeping them alive. You’re not allowing creative destruction in a free and open market to occur. I think that that’s my biggest issue with MMT, is you’re not really allowing free and open markets to really exist. I just think that that’s crazy.

So those are some of my thoughts, those are some of my concerns. I get very frustrated when I see academia not kind of laying some of these counter arguments out like Stig and I have just done. It seems like academia is just going along for it. They’re recommending it. They’re suggesting that this is the best route to go. I would suggest the exact opposite. 

Now, let’s just say that I know a lot of people don’t buy into the Bitcoin argument and that’s fine. I would just say that if that starts to become a reality, and it would start to take hold, and I suspect that’s what is going to happen, you’re going to need some type of policy like MMT in order to grease the skids for that transition to actually occur. 

If central bankers just step back and didn’t print anything, that transition period over to something that would be a hard equity based monetary policy that’s being delivered completely decentralized would be an extremely painful event for the world. 

Although, I like to bash MMT in a weird way. If we are going to this Bitcoin world, we really do need some type of MMT policy where a lot of liquidity is being provided into the system in order to make that transition a whole lot smoother and not as abrupt. 

I know that’s kind of counterintuitive to some of the stuff I was saying before, but in a weird way, MMT policy is somewhat needed for a more graceful transition, if this Bitcoin world that we were talking about actually transpires.

Josephine, fantastic question. This stuff is not easy. We definitely don’t have all the answers. We’re just looking at this from so many different angles. We’re trying to talk to as many people as we can, but what a great question.

For asking such a great question, we’re going to give you access to our TIP Finance tool. This allows you to go in there and filter all the stocks on the stock market for value, so you can find really good companies that are kicking off good free cash flows and that are undervalued relative to every other stock in the market right now. 

It also has a momentum tool, which has been extremely useful here in 2020 with the volatility that we’ve seen. Our momentum tool has been extremely accurate at keeping people in the market at the right time. 

For anybody else out there, if you want to get your question played on the show like Josephine, just go to asktheinvestors.com to record your question there. If it gets played on the show, you get free access to our TIP Finance tool.

Stig Brodersen  1:01:25  

Alright guys, Preston and I really hope you enjoyed this episode of The Investor’s Podcast. We will see each other again next week.

Outro  1:01:32  

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