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Tom Bilyeu's Impact Theory
A Great Depression Worse Than 2008 - Survive & Thrive During The New Economic Reset | Arthur Hayes PT 1
01:26:55
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- [00:00]
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- [00:30]
Host
Ray Dalio recently said the next five years will be a period of radical disorder. Money printing, rising inflation, a potential banking crisis and a whole lot of debt threaten to shock the global markets. And many people, including today's guest, believe that something approximating World War three has already begun. But even if that's all true, we can't control it. Whatever hand we're dealt, we have to figure out a way to play it well. So I bring you Arthur Hayes, the controversial macro investor, who's going to provide a masterclass on navigating these difficult times. What are the signs that you see on the horizon that a financial crisis might be headed our way?
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Arthur Hayes
I absolutely agree. There's going to be a major financial crisis, probably, probably as bad or worse than the Great Depression, sometime near the end of the decade. Before we get there, we're going to have, I think, the largest bull market in stocks, real estate, crypto, art, you name it, that we've ever seen since World War II. And the reason I believe that is if we back up to like 1945, essentially Europe blew itself up, China was destroyed by a civil war and Japan, Russia essentially fought the war for everybody else and massive destruction. So if you look across the world, the only country that was left was the US and they had a manufacturing base that was unharmed from the war and they essentially rebuilt the war and reaped enormous benefits. People who are American are still living off of those benefits today. But at the end of the day, everybody's sort of believing this thing called Keynesian economics, which basically is if something gets in trouble, the government should rush in, spend money. If they don't have the money, the central bank should print it, and everybody collectively in the world depending, no matter if you're what sort of ism you believe in, subscribe to this theory. And what that means is we all have collectively agreed that the government is there essentially to attempt to remove the business cycle, should never be bad things that happen to the economy. If there are, we want the government to come in and essentially destroy the free market. So every time We've had a financial crisis over the last 80 years. What happens? Government rushes in and they essentially destroy some part of the free market because they want to save the system. And what does that mean? It's like whack a mole. So every time there's a disturbance, central banks like the Federal reserve in the U.S. they come in, they print money, they enact a bunch of regulations and they basically say, okay, we don't want this sector to fail. We don't want the creative destruction that is so called capitalism. If you actually believe in that, we don't want that. And every five, seven years there's another sector of the economy that's essentially price fixed. And so we've gotten to this point where globally central banks have basically destroyed the free pricing mechanism just about every single sector of the financial economy except for one, which is the government bond markets, because they're so large, so unruly that it's practically impossible to essentially remove the market forces from this part of the market. But the problem is right now we're going to try. We've gone from 100% debt to GDP globally to about 360% as per the World bank. And we are accelerating the amount of debt that we're adding onto the pile. Why? Because in the rich world, including China, Russia and Brazil, we've stopped having enough kids, so the population's actually declining. So if you have all this debt and you don't have more humans being born to essentially do stuff to pay it back, the only way to ensure the system is solvent is for the governments and the central banks to start printing money. And now we've gotten to the situation where we have all this debt that needs to be rolled over. We have a population that has been told that, hey, you're good, anything ever happens, we, the government are going to come in and we're going to make sure that you have enough food to eat, you got health care, we're going to protect you, blah, blah, blah, right? And all that's expensive, especially as you have less humans who are doing productive stuff. And so we're just going to keep adding on debt because that's the only way the government can stay in business. And now we've got this situation where there's so much debt that and it's accelerating in an exponential fashion that in order to save the market this time, right? So I think in the next three to six months there's going to be some sort of major market disturbance and probably in the US treasury or other large global Bond markets. And the solution is going to be let's print the most money that we've ever printed to try to save essentially this fiat financial system that we've created since World War II, which is going to in the first instance, create a massive bull market and anything, you know, like stocks, crypto, real estate, things that have a fixed supply, maybe they're productive, they have some earnings, and then after that we're going to find out actually the government can't save everything. They can't just print as much money as they think to try to save themselves and fix the price of the yield of their bonds. And we're going to get a generational collapse. And hopefully that doesn't coincide with a major global collapse conflict. Usually it does. I hope it doesn't, because I don't really want to live through World War III while I'm alive. But that's sort of my overarching macro cycle thesis. So massive top 20, 26 time frame and then some sort of Great Depression like situation happening towards the end of the decade. If we want to take a look at the progress of human civilization in the past 150, 200 years, it's all predicated on hydrocarbons. The moment we started extracting oil commercially out of the ground and turning it into thousands of different products that we all use every day, that basically powers our modern life development. Supercharged, right? We went from I don't know, how many billions of people in the 1970s to today, population more than doubled.
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Host
Right?
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Arthur Hayes
And that's all because we, we were able to harness this particular type of potential energy of the earth that's underneath us, okay? And we, we've piled on all this debt, we've brought forward all this future growth, and we haven't really innovated on another form of energy that makes us that much more productive. You know, maybe if the world started adopting nuclear today immediately, like small nuclear reactors in our cars, our apartments, powered by nuclear energy, maybe maybe we'd have a chance at growing our way out of this debt. Or if there's some magical alien that comes out and gives us some basic research that allows us to tap a new source of energy and we can commercialize it instantaneously. Yes. Then we could pay back all this money. Or if the population doubled overnight to 16 billion people, then okay, great, we've built all this stuff, there's more people that need to use it. Okay, we can pay back this debt. But barring any of these, you know, you know, I like to say it takes 18 years to make an 18 year old. So it's pretty much impossible to create humans out of thin air, no matter what any politician tells you. And you know, we're not really, you know, what we seem to be doing is, in certain countries is saying, you know, hydrocarbons are worthless. We want to use these other forms of energy that are less dense, less productive, and somehow think that we're going to grow our way out of this debt, which is mathematically impossible. There's just no other way. Other if the government wants to save itself by then printing money. And printing money isn't growth. It's just a piece of paper out of thin air. And once the population thinks, hey, there's more and more of these pieces of paper floating around, there's only so many real goods. There's only, you know, there's only so much oil, there's only so much electricity. Well, I guess I should be consuming everything I can now. That's not actually generating real growth. If we could just print our money and generate real growth, then Rome would have survived. Zimbabwe would be the richest country in the world. Even Argentina, we've had the Weimar Republic in Germany. If this was the answer. There's plenty of other societies that have tried this and the result is always the same. Massive inflation and then social unrest and collapse of the government. So I think we've proven over thousands of years of human history that printing money is not growth. It's a shimmera and at the party lasts for only so long. And then, you know, it's bad news bears.
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Host
This is the thing that really freaks me out about what Ray Dalio is talking about is the predictability of this cycle. And what I want to do. You're really good at explaining this. I want to go through the different things that build up to this moment, this, this inevitable moment. And then one of the things I want to make sure we talk about later is getting the timing right on. This is next to impossible. And so that's going to loom in the background. But first I want to, I just want to go through the things. Now, you said that you hope that this doesn't all happen in a moment of political instability. But I would like to quote Arthur Hayes to Arthur Hayes here real fast. This is from. This is the opening line from one of your recent articles. You said World War three has already begun, whether the mainstream media and political elite wish to acknowledge it or not. So let's talk about the political instability. We're going to get to the debt. We're Going to get to the banking crisis, inflation, all of that, but set the context for us right now. What's happening right now that unnerves you from a political standpoint?
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Arthur Hayes
So for whatever reason, and I don't know why Western Europe starting and then America following has it in for Russia. And if you read the, I think it's Mackinder, his global home island theory that he wrote, I want to say in the early 19, early 20th, 19th century, whatever, he was a very famous war strategist and he basically said that the home island is essentially Eurasia, right? So think of China, Russia, Western Europe, right? Whoever controls that portion of the world, controls the world. And so if you think about the naval powers such as Great Britain and the U.S. let's talk about Great Britain first, right. What was the British foreign policy all about in the 19th century and early 20th century? Preventing a strong continent, whether it was France or Germany, they didn't care. They just don't want a unified European. Now as Russia industrialized In the late 19th century, they started to worry about, okay, well what about Russia, right? We can't have an alliance of German strong Germany, after Bismarck, united Germany and Russia because Russia has all these commodities. That would be the worst thing that could ever happen for us. Great Britain and naval power. So what do they do that a series of alliances that precipitated World War I, which was let's make sure that Germany and Russia are not friends. And essentially that was a strategy going into World War I. Obviously that blew up. What was the strategy in World War II? If you take a look at the rise of Hitler and all the different Western powers that were okay with Hitler as long as he was going to turn his army and just fight Russia. Hitler wrote about this. He said, we want to create the space for the, the German people to essentially eradicate the Slavs in Russia and, and go in there. And the Western Europe was perfectly happy about that because again, what do they want? They don't want a united home island. They don't want a united Eurasia because that threatens the hegemon. Great Britain at the time, obviously that didn't work out so well. Hit entered his army on the other half of Europe and then everybody started fighting again. And then we ended that war and then what we were left with, we would have to be the United States versus Russia. Again and again it was all about let's make sure that Russia and China aren't aligned or Russia and the rest of Russia in Europe aren't aligned. That's why US poured however many billions of dollars through the Marshall Plan into rebuilding Western Europe to make sure it was a bulwark against Russia and the virus of communism. And I forgot I was reading a recent book, it's called the wars of Asia 1911-1949. And the author made a very good point about why communism is so hated as a form of government to anything that's not communism. And the reason it is, because, you know, obviously communism has its flaws, but at its the kernel of truth for lots of people is we are going to completely uproot the social system, going to replace the classes that are oppressing us. It's not like, okay, it's one class of elites who was running things. We're going to go over to this other class of elites which is like socialism, fascism, capitalism. It's just one group of elites versus the other. Communism. Let's destroy the whole class of elites and bring the people up to power. Now obviously that never actually happens, but in the beginning it does. And so if you're a bourgeois intellectual and one of these other systems, you're like, I can't have communism take over. I can't have the actual workers rise up, replace me as an entire class and then try to rule. Which is why they hate communism so much. And so, you know, the Russian system and what they're trying to export in terms of ideology is so, so hated in the, you know, they're both democratic or pseudo fascist West. But in any case, the US has now, you know, locked the hedge of Russia to make sure that a divided Eurasia, because a strong Eurasia will control the world because it controls most of the natural resources of the world and most of the population. And that's been the US foreign policy since the end of World War II. Fast forward to the 90s when the Soviet Union collapses. The US response was not let's do another Marshall Plan and rebuild Russia. It was let's incentivize a bunch of former gangsters, now called oligarchs, to come in and take all the natural resources, impoverish their people and move their wealth to London and New York, right? And so that was the policy. Now out of that came, you know, essentially Putin, who was all about let's build a strong, you know, revisionist, the Russian ideal, believe it or not, whether you think that's good or bad, but that's his appeal to the Russian people is, hey, you guys suffered through the end of the Soviet Union. The west was not your friend. You know, they stole your shit. I'm here to rebuild the Russians of the Russian people believe that's his message to his constituents. You can like it or not like it. And so now we're at the situation where Russian invades Ukraine and the west, plus pumping in resources to essentially fight them using the blood and tears of the Ukrainian people. It's not Americans fighting, it's not European, know, NATO Europeans fighting yet. Right. So it's a, it's a proxy war between Russia and the West. Obviously Russia is tacitly supported by, by China and the rest of the world is like, well, we don't want a part of this. We're trying to be not aligned. We don't want to get involved in this thing. So we have this sort of the setup of all over again of what was happening in the late 19th century of the west aligning to create a divided Eurasia. And so, you know, we can call it a conflict or a skirmish or whatever, but you have, I don't know how much, how many billions of dollars have been authorized by US Congress to essentially ship weapons into Ukraine. You have NATO shipping in weapons, different countries providing intelligence so that the Ukrainian forces can attempt to stymie the Russian advance. Now while, yeah, there's not boots on the ground from, from the west and Russia, to our knowledge, maybe there are, I don't know. It's, it's basically a war. And so you can, you could make the argument that World War three has already started. It's just not this hot, super kinetic, you know, I'm going to throw my nukes at you, kind of thing that we had in the last World War.
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Host
Now why do you think this matters? Is this going to play out in energy prices? Is it going to play out as a debt problem? Why does this become part of the backdrop of the context that will lead to this coming financial crisis?
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Arthur Hayes
So at the end of the day, human civilization is a transformation of the potential energy of the sun and the earth into useful economic work. So cheap energy prices equals prosperity. Russia is the largest commodity exporter in the world. They have oil, they have natural gas, they've got metals, they've got food. The Korean embedded bread basket was one of the largest wheat exporters in the world. Sunflower seeds, oils, all this stuff is, is in this, in this region. And now we've, the west has decided that we're no longer going to trade with Russia on paper. Now if you actually look at the details, you know, India, China, some of these other countries are basically buying the Russian stuff, refining it, selling it back to the Europeans and the Americans at a higher price. Right. So the, the, the, the result of this policy of let's ostracize Russia is let's just raise prices on our energy inputs globally. And so the war is causing the inflation that now the central banks have to fight by raising interest rates, which then bankrupts the banking system because they now have all these bonds that are underwater. So this ideology we need to fight Russia to keep the Eurasian island fractured is the proximate cause of the inflation that's causing the financial crisis in the west itself. So it's a dumb policy, but it is the natural result of what happens when you say, I'm not going to trade with the largest commodity exporter in the world.
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Host
I think it's important to break down exactly the cocktail of things that go into making an economy weak. This was something it took me a long time to learn. And for anybody that's been watching the show for a while, they've gotten to go on this journey with, with me of figuring out how all this works. The debt cycle, exactly what happened with the banking crisis, inflation, all of that. How does, how does this begin? Does it all start with the money printing which leads to the inflation which causes the banking crisis? What comes first? How does this ball get rolling?
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Arthur Hayes
So, you know, the situation wouldn't be so bad if there wasn't all the money printing prior. So at the end of the day, and let's take the US for an example, because it's the largest and richest country in the world, my, you know, opinion and thesis is, you know, back in the, you know, 1970s, the US government made a tacit promise to the baby boomers. And they said, hey, go out work, spend your money, don't save. We got you. We're going to make sure that when you get old, you're going to have health care covered by the government. And don't worry, you can be as energy inefficient as you want. Two cars in a garage, driving all, you know, all over the place, not supporting public transportation. We're going to make sure that where there's oil, we're going to get it. So our defense budget is going to be astronomical. And so the baby boomers are great. We're, you know, we're going to go out there and live our lives and consume the most that any generation ever has in human history. US Baby boomers. And what's happened, health costs continue to rise. Now, they didn't rise so much starting until maybe five or ten years ago because they're in the productive years of their life. But now, and I'm sure probably you've had some guests on talking about what they call us sick care, right? The amount of money you spend at the end last 10 years of your life dwarfs all the money you spent proceeding. And the way the incentives work in the US healthcare system, there's no incentive to actually have preventative care. It's when you get sick, let's stick you up in the hospital and just go to town on the insurance company which essentially is a US taxpayer of Medicare and Social Security. Now, no US politician and I don't care if you're Republican or Democrat or third party whatever can stand up there and say I'm going to reform the US healthcare system. And guess what, baby boomers, who are the richest cohort and the most politically active, your health benefits are going to decline. You will not get reelected. And so these two programs are sacr. Sect. You also will not get re elected, say hey we're going to really tackle this runaway US defense budget. We're not going to go around the world bombing everybody to make sure that you have enough oil so that you can have the newest badass pickup truck in your garage guzzling oil. You also will not get reelected. So healthcare and defense, these line items in the government budget cannot be altered under the current political system and what has been promised to the people over the last 50 years, which basically means that as the population gets older and as the world becomes more multipolar, meaning there's other challengers, namely China, who are saying hey, this quote unquote rules based order that's determined by 4% of the population doesn't work for the rest of the 96 of the population that never got a say in what this order was. We want a new order. We want to, we want to have our own commodities, we want to have our own material wealth. We also want to eat a bunch of beef and drive a car. Right? If you think about the per capita energy uses of the world, for it to match the United States on the global level will require an inordinate amount of energy that we just don't have. That just means inflation. So what are countries doing? Is they actually we're going to keep our stuff for ourself. We'll only export finished products which makes things more expensive. And so this is all happening before we even got to what's going on today. And as we've had less and less kids because rich people have less kids. And when women have the choice of contraception they choose not to have as many children. The Federal Reserve is like, well, okay, we don't have any growth of humans. We don't have any, you know, we have an escalating cost of keeping the political promises we made to our people. The only option is to print money to make sure that the government can fund itself at an affordable level. And every time there's a financial crisis, instead of reforming the banking system and allowing some people to fail, they get print money to make sure that the banking system is sound. And the goal of the banking system is to take the people's savings and hand it to the government. That is why the banking system must always be saved from the government perspective, because that's what it's there for. And different countries use their banking systems in different ways to essentially get to the same goal of funding the government at a cheap level. And so that's why whenever the banking system is threatened, the government or the central bank must come in and save it by printing money. So we've gone through this situation, you know, coming up in today, where, you know, the US went from, I don't know, 30% debt to GDP in the 1980s to 130% today, which is, you know, a massive amount. And if you read, I forgot the other author, professor named Roff, wrote a piece about debt. 2011 book came out, I forgot where, when sometime in the last 15, 20 years. And they empirically showed that once a country crosses about 130% debt to GDP, there is always a default. And the default could be massive currency depreciation, it could be massive financial repression, or it could be some sort of default in the government bond market every single time, no exceptions. Right. So they're at this level already. And now the inflation comes, and the inflation is part and partial result of there's less humans doing productive things, the war on climate change and the rebuke of hydrocarbons, and then more players in the world wanting, getting assertive over their natural resources, saying, it shouldn't just all go to the United States and Western Europe. It should come to our people. We should enjoy the same standard of living that we see in the Hollywood movies.
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Host
The idea that 130% debt to GDP has always historically equaled default, I've never heard that before. That's troubling. We'll come back to that. So the idea of money printing, this is what I want to anchor people around. Okay, so you make all these promises to a gigantic generation. That generation does not replenish themselves. So there are not more People to be productive and take care of them. And so your only tool that you have have is to start using debt. The only way to manage the debt is to print money to not default on it. And now walk us through this. Took me a while to really get my head around the idea that money printing is inflation. Inflation is simply saying that the, the, the amount of money is inflating like a balloon compared to the things you can buy with it. So since there are no additional things to buy, then people just start charging more for the things that are on offer because there's more money floating in the system. How accurate is that?
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Arthur Hayes
That's basically it, right? There's the denominator, I. E. The amount of money is just growing infinitely. And then the stuff, the finance stuff, and I think about finance stuff as energy, right? We produce and that is, in my opinion, hydrocarbons, because that is the thing that powers our entire global civilization. I don't care what you believe about the good or evil of oil, but your entire modern life is predicated on oil, whether you believe it or whether you want to believe it or not. And so it's not as if we've gotten that much more productive in pulling oil out the ground or have found or decided to commercialize nuclear energy, which has been around since, I don't know, the 1960s. For whatever reason, we as a civilization globally decided to ignore this amazing energy source and pooh pooh, it's now if we decided back in the day to commercialize nuclear and spend the amount of energy and money that we have spent on wind and solar, on making nuclear the safest possible energy usage in the smallest possible delivery mechanism, we might not be in this situation, but those are political choices we made as a civilization. So the energy and the amount of energy and how much energy we're producing every year is not growing. In actual fact, we hit peak oil a while ago, meaning the entire growth of the oil industry has been predicated on US Shale. And the number of new discoveries and new wells being drilled is declining precipitously because shale depletes itself very quickly. But it's not like we're finding a new Saudi Arabia every 10 years. No, these massive oil discoveries, we're just not making them like we were in the 60s, 70s, 80s, and so more debt. The amount of energy we're producing is flattish. So that's why we're going to have energy inflation. And when you have energy inflation, you have goods inflation because every single good we use is a derivative of energy.
- [28:18]
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- [28:48]
Host
So this is a unique take, at least for me. You're the only person that I've heard anchor everything around energy. I've heard you say and this is really important for people if they want to understand the point of inflation and why it becomes so problematic is that what you're really trying to do across time is preserve your purchasing power as it relates to the amount of energy. So energy is going to determine the cost of a flight. Energy is going to determine the cost of a car. Energy is certainly going to determine the cost of gas, plastics, on and on and on. Like even when it's not plastics can be confused because made of the same substance roughly. But even just to to do the the creation all of that stuff requires energy which right now obviously the main, the main source of that energy is still currently coming from fossil fuels. So understanding that that you're in this race against that. So now you've got two problems. Problem number one is what you just laid out that we're flattish. We're not finding new Saudi Arabia's every 10 years which would be lovely and would certainly help make that easier setting aside any obviously potential global warming issue but just from an an energy cost standpoint. So then problem number two becomes that we're inflating the money supply and so now the cost of that is already going up. So what I want to get into so if we know that we have this magic mark of 130% debt to GDP is going to equal a default. We're already at 130% debt to debt to GDP. But we have two promises healthcare and that to keep the prices where they are from an energy perspective we're going to have to run around the world defense to make sure that we have access to the flows of oil. We're going to be doing more money printing. Now walk me through what are some of the things that are other than that because the crazy thing is is you listed those two. I wasn't even really thinking about those two as being something that's going to cause us to inflate I was thinking about for instance the BTFP bank term funding program, so which is basically stealth money printing, quantitative easing, just under a different name. It's actually bigger than the COVID stimulus which was 4.1 trillion. So walk us through what are some other things that you see on the horizon that are going to lead to more inflation.
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Arthur Hayes
So that's sort of in the past. In the future we have essentially the rest of the world and call it the non aligned countries. They don't subscribe to the west, that is NATO or the China sphere. They just, hey, we're a bunch of countries. We've been impoverished ever since, pretty much forever. We have the natural resources that are needed to power the green revolution. We have hydrocarbons. We have people who will come into the US and be your nurses, will clean your toilets, who will take care of your children, right? This is what we have. We want to keep these resources for ourselves. Now we don't want to choose a side, China or the U.S. we just want to get wealthier ourselves. How do we do that? We trade. What do we trade? We trade higher value goods, right? So an example would be Indonesia, a large producer of nickel, one of the largest in the world. Joko Widodo, the president of the country, has recently banned the export of raw nickel. He said, guys, you want some nickel? Come down to Indonesia, build some sort of manufacturing plant and export the refined product. So I think if I read the statistic recently, they went from about a billion dollars of economy around nickel when they were just exporting the raw stuff to something about $20 billion of value added when they were said, guess what guys, you need to build stuff to employ our people to elevate the standing of our country. So this is just one country. The rest of the world is like, why the fuck are we letting these guys come down here, own our natural resources, not give us jobs and then send back the raw stuff and then we import finished goods, right? That's been the entire structure since, since World War II. And why stuff is very cheap in the US and Western Europe relative to how expensive things are in the rest of the world. And so they're fed up with this and now sort of they've broken the ideological position, you know, conditioning, you know, maybe some of the leaders who were on the take from all these countries over longer in power and they're like, we want to be like the Americans and the Western Europeans. We've seen the movies, we want to be like them. Why can't we be like them? Well, we're going to stop giving you guys all of our stuff essentially almost for free. And so this is just a movement resource nationalism. This is what I called Kirill Sokolov from 13D calls it the allegiance of the aggrieved. The aggrieved being anyone who suffered post colonial issues from essentially being an economic vassal of some European nation or America. And so they are saying they're gaining their voice again. And at a time when the appetite of the western public to go and knock heads against a wall is declining. So you have this situation where the raw stuff that powers the awesome standard of living that's, that's in Western Europe and America is going to get more expensive because it doesn't come from those countries themselves. And in the case of America, America has all the stuff it ever needs. It's just that the companies in charge would rather ship all the stuff out to, you know, third world countries and have a cheaper labor base than employ Americans who are expensive. Right. Europe's not so lucky. But I think that is a source of inflation that's only going to grow as the rest of the world says, I want to live in the Hollywood movie too.
- [35:00]
Host
Okay. So the, when I think about some of the stealth liabilities that we have, the number starts getting pretty scary. When you think about the, the buildup as we're having this big party, there's all this stimulus coming in one. What do you think is going to trigger that? You said in three to six months you expect some sort of big disturbance. What kind of big disturbance are you looking for? What are things that you know, the government is going to pony up for? Is it just the things you've listed so far, Healthcare, defense and then the banking sector? Or are there other things that people aren't thinking about in terms of liabilities? There's no way they'd let go down.
- [35:43]
Arthur Hayes
Yeah. So at some point I need to write nesting on this. But essentially the, over the last, you know, 40 to 50 years, the financial ecosystem has been predicated on a scenario where there's never been a situation where long end. So let's call it 10 or 30 year bond yields in the US rise. So they go up, but they go up faster than in short term yields.
- [36:10]
Host
It's called that's never happened
- [36:14]
Arthur Hayes
for a sustained period of time. No. Over the last 40, 50 years. It's called a bear steepener. Right. So if I'm a bank, I'm an insurance company, I'm a pension company, and I'm going to model what I think the future is going to look like. I'm going to model the way the futures looked for the past 30, 40 years, which is every time the there's an issue and yields go up, the government comes in and prints money and squashes the bet down. They squash the volatility down in the markets because they want to save the banking system. They don't want anything, anything to blow up. But now, because we're in a situation, at least in the US treasury market, where the US Government is issuing the most amount of debt ever, right? Federal deficits like 7 or 8% of, of GDP. It's, it's as if we're in a war. This is, you know, the largest, longest sustained sort of deficit since World War II. But we're not in a war, you know, at least not an overt one. You have US$7.75 trillion worth of debt must be rolled over by 2026. Massive amount of debt. That's just on the US side. So who's going to buy it? Right? The traditional buyers were one, China, Japan. Right, China. Japan are not buying any more US Treasuries. China because it doesn't want to become more tethered to the dollar from a geopolitical safety issue. Japan because it's also facing an issue in their bond market where their currency is getting trashed because they are also trying to save their bond market. Japan, thankfully to themselves have saved a lot of money over the last 30, 40 years. And so they're now starting to draw down on that money. They're not buying new Treasuries, they're starting to sell Treasuries. China's starting to not buy new, more Treasuries, they're starting to sell Treasuries. And you can look at the official data from the US treasury and you can see the balance of Treasuries owned by China and Japan are declining. On the oil exporter side, talking about opec. Russia is a big member of opec. Russia is obviously not buying any more Treasuries, they just ban them from the Western financial system. Saudi Arabia is not increasing its treasury position, it's also decreasing. So the oil exporting nations who previously would earn dollars internationally and park those dollars in the US Banking system and buy Treasuries. They're no longer buying Treasuries. The US Banking system, the US Banking system is functionally insolvent because the regulators made the rules in such a way that it was profitable from an accounting perspective, not an economic perspective, to essentially take in deposits and buy low yielding Treasuries and they could do it with almost infinite leverage and a few basis points difference in the change in the price and everybody make a lot of money and everybody gets a big bonus, right? So the banks collectively bought all these treasuries in 2021 and obviously the prices went down a lot since then. And that's why we have the regional banking crisis. So at a structural level the US banking system cannot buy more debt because it can't afford to because it's functionally insolvent. And so, and, and you know that leaves the Federal Reserve. But the Federal Reserve has committed to doing quantitative tightening which means it's letting the Treasuries roll off of its balance sheet, it's not accumulating more Treasuries. So the treasury has to issue all this new debt, it has to roll over all this new debt. But the major buyers of this stuff for all their own disparate reasons cannot purchase it. And so what we're seeing in the markets is relationships that held clad are breaking down. If you take a look at the 10 year US treasury versus gold, you would think as yields are rising in the US treasury market that gold would be getting clobbered. That's how it's worked in modern financial history. Because if the interest rate is high, money says I want to own that, I want to own the four and a half percent treasury versus owning gold which pays me nothing. But nowadays gold's holding firm, it's not like rising crazy, crazy fashion but it's not getting clobbered either as US Treasury 10 year yields are at, you know, 400, 434 basis points last time I checked.
- [40:19]
Host
So hold on, that, that makes a prediction at least as my mind grasp it, that people think that the bank is going to default because, sorry, the government's going to default because if you're getting whatever risk free money of it's right now it's like something like 5%. If you can have risk free money at 5% and people are not fleeing gold to get into that risk free money at 5% that says to my limited mind that the market no longer believes that it's risk free. Is that an accurate assumption?
- [40:52]
Arthur Hayes
The market is risk free in the US dollar perspective on a nominal basis,
- [40:57]
Host
why would people stay in gold?
- [41:00]
Arthur Hayes
Because they say I'm not getting paid enough right now I use a term of real yield and if you ask an economist, you'll get a different answer depending on who you ask. My definition of the real yield is I take the government bond yield and I subtract nominal gdp, right? So if I'm lending money to the government, from a philosophical standpoint, I should receive at least the yield of the growth of the economy. So if the economy is growing at 10%, I should get paid 10% too because I'm contributing to that, right? I'm lending to the government, the government's doing its thing, you know, and the economy is growing. I should get paid the same amount. Now from the government's perspective, we're like, hold on, I can make a profit if I can somehow engineer the economy to grow at 10%, but I only pay you 5%, that's a negative yield. I, I, the government am making a profit. Or conversely, if the yield is 10% and the economy is growing at 5%, then me, the bondholder is earning a profit. But right now the economy in the US if you take a look at the latest Atlanta Fed GDP nowcast and they have a real time guesstimate on where they think GDP is running on nominal GDP this quarter is running around 9%. The 10 year yield is about 4.34%. So I, as a bondholder, I'm getting shortchanged. Now people are starting to realize like, hold on, the US economy on paper is growing like gangbusters. I should be getting paid more money. If I'm not going to get paid more money, then I'm not going to own these bonds because I can own something else that's going to give me a better return, whether that's stocks, gold, crypto, whatever. Right?
- [42:46]
Host
Just to take a non controversial one, would gold ever outperform that number in
- [42:53]
Arthur Hayes
terms of the yield?
- [42:55]
Host
Yeah, because the way you're explaining it sounds like people are cutting their nose off despite their face. If you're going to get 5% risk free with a treasury and you're going to get next to nothing with gold, then why on earth would you, even if you could get 10%, even if you have a moral just, you have moral outrage at the government for keeping half of that yield for themselves. Which I admit if you loan the money to the government, it's pretty fishy that they would keep that for themselves. But if you're getting a better yield than you would get from gold, what on earth are people doing? Just saying I'd rather get nothing because I'm angry. I don't understand.
- [43:35]
Arthur Hayes
So most people who own bonds, the bond is a price. So as the yields rise, the bond price goes down. And so as yields go from 5% to, let's say 10%. So the Fed just keeps raising rates. As a holder of the bond, you've lost money because the yields are rising, the bond price goes down. So as yields rise, I lose money because I've locked in the lower rate and it's going higher. The bond price goes down versus gold, which could go up, right. Or just could stay flat at the end of the day and I'm fine. So if you take a look at returns of 10 year bonds starting in 2021 when the Fed started raising rates, you've gotten absolutely killed. It's been the worst bond bear market so in hundreds of years, Right. So owning bonds has been a terrible, terrible investment over the last two years because inflation is going up and the bond market's saying actually I demand more yield. And the just keeps going higher and higher and higher and higher to attract more and more buyers. Now if the US government is perfectly willing to put the 10 year treasury yield up at 10%, they'd have a flood of money into the market. That's awesome. I'm getting paid the same growth as the US economy, but right now I'm not because the government can't afford it. Right now the treasury is already spending something like 34% of the budgets like interest payments on an annual basis.
- [45:01]
Host
34%, yes.
- [45:04]
Arthur Hayes
So it's like $1 trillion annualized right now is the interest expense as of second quarter, the last time the treasury published a statistic. So they're issuing more debt and they're paying more money on the debt. And that number is just going like that in terms of the interest expense handed out the people who own bonds. But on the long end, and this is how bonds work, the longer the maturity, the more sensitive you are to interest rates, especially if the yield starts at a low level. Going from 1% to 5% on a 10 year treasury absolutely destroys you as a long bondholder. Which is why a lot of these bond funds have done terribly well to have done terribly over the last few years because of how bond math works. And it's, it's a nonlinear change when you raise interest rates and how the bond price performs. Gold is pretty much held constant over that time. You haven't made money out and lost money. But if you were holding a long bond at 1, 2% and now it's at 5, you've got crushed. And that's exactly what happened with the banking system. You know, svb, First Republic, Silvergate, Signature, you know, this year they've gotten crushed on long, long bond trading.
- [46:18]
Host
Okay, I want to Walk people through that. So I, when it comes to math, I have a very simple mind. You're going to correct me where I go wrong. But I think people at home, some of them are going to benefit from what I have struggled over the last year or so to put together in my mind. Again, you're going to, when I go wrong, you need to jump in and let people know. But here is how I understand bonds. If you hold a bond to maturity, you're not going to lose your principal. So what you're losing is potential earnings. So you would not be able to sell that bond. So for those keeping score, it goes like this. You buy a bond, that bond has a interest payment. And that interest payment, let's say is 2%. And if you buy that bond for 10 years to get the 2% and a year later a new bond comes out for 10 years that pays 5%. Now if you try to sell that bond in the secondary market, people are going to go why on earth would I buy that when I can, for the same price, I can get a better yield. And so you have sort of lost money in that. You can't sell it before the mature date. You are now going to have to hold it all 10 years in order to get all of your money back. But if you hold it for all 10 years, you will get your 2% and you will get your money back. Assuming that this is a government bond and they don't default. So that I, I want to make sure people understand the difference between you're losing potential revenue. Because if you didn't have your money tied up in a 10 year bond and you could now put it into that other 10 year bond that's earning 5%, obviously you'd be better off, but you don't lose your money unless you need to sell. Now that brings us, and you will notice he has not interrupted me. So I'll assume that's all correct so far.
- [47:54]
Arthur Hayes
I'll give it even more, even closer to home example, people who have a mortgage on a house, right? I think this is even more understandable. Like everybody rushed to bought houses in 20, 20, 2021 and the old mortgage, three year mortgage rates in the US are around three, three and a half percent. And now there's another job in another location. Or maybe you're living in a high tax state, you want to move to a low tax state, right? And you need to buy another house. Same value of the house, the price of the house is the same, but you need to get a new mortgage now the mortgage rates are 7, 8%. And you're like, holy shit, I can't afford this house anymore because this bond that I have at 3% is more valuable than the bond of the mortgage at 7, 8%. Therefore I can't find another loan that I can service with my income because of the change in interest rates. And so that's, I think even more hits home. Example, the majority of the public who own the house or apartment or whatever, it's oh, I had a mortgage at 3%, I can't. In the same value of the house. I cannot afford that house in another location because I'd have to get a new mortgage at 7, 8%. That is bond math. That's the exact. And you can put the same thing for, you know, Treasuries. Mortgage is a bit more complicated but at a high level. That, that's, that's exactly the phenomenon you describe it.
- [49:13]
Host
Now the mortgage though would be completely inverse, right? So on a mortgage I want my rate going down. On a bond I want my going up. Yeah, makes sense. Okay, so now let's take that. So we understand that I buy a long term bond and back in 21, when all the banks gobbled up all this US debt, they had to go long to get a return, which a bank is incentivized to do. So they're going to take the deposits that they're getting. Everybody's getting stimulus checks, everybody's depositing into a bank. The bank's like, amazing, I'm going to invest. The first of all, the Fed is like, we're not going to raise rates. Oh my God. It's going to be like this basically forever. And so they buy all these long term bonds on the word of the Fed that they're not going to be raising rates. So they think, okay, well if rates aren't going to go up, then I don't have to worry about the value of this going down. This will get me a higher yield by me taking a longer term, which we need to get back to because you were talking about how it's very atypical for short term to raise faster than long term. So that's a sign that something weird is happening. But in 21 that hadn't happened yet. So a long term was the way to get the extra interest payment. So the banks gobble up these long term Treasuries, so they're buying debt.
- [50:26]
Arthur Hayes
I'll add one little caveat here is you can actually hedge this stuff. So it's not as if there is an instruments to say like, okay, I bought a bond at 2, 3%. I'm worried about a future where the Fed raises rates. Let me go out in the market and hedge that. The banking system could have easily hedged a lot of this risk because some banks did, a lot of banks didn't. But that comes at a cost. So I can either have a higher bonus or a lower bonus. The Fed says, don't worry, I got this. Inflation is transitory, never raising rates, we're never going above 2% inflation, blah blah blah. Why would I go out and hedge the long end rates? Why would I go out and hedge rates going up and reduce my bonus? So I'll stop there.
- [51:09]
Host
Dude, that's horrifying if that. And look, I'm sure it did. I don't want to play naive, but that's horrible. Okay, so if that's right, then to get their bigger bonus, they buy these longer term Treasuries, they lock themselves in. Now the Fed does raise the interest rate. Now that bond, they can't sell it early and therefore they're losing that potential income. Wouldn't necessarily be a problem except for the fact that people begin to realize, hold on a second now, the risk free rate of a U.S. treasury that I can get myself is 5%. So I don't want to leave it in the bank where they're paying me next to nothing. I want to go get my 5% risk free with the government. So hey SVB, I will take my money, thank you very much. And now SVB has to cover that so that they can give you the money back. And now they're forced to sell these long bonds at a loss and all hell breaks loose.
- [52:10]
Arthur Hayes
Yep, that's exactly it. The US government bankrupted the banking system essentially.
- [52:17]
Host
That, that is brutal when said that plainly. Okay, so now my question is they create the, I just had it, the BTFP bank term funding program which basically says, hey everybody, don't worry, your deposits are safe. But the problem is that puts them on the hook for up to $4.4 trillion that they would have to print their way out of. So do we still have a banking crisis or do we only have a looming potential inflation crisis?
- [52:51]
Arthur Hayes
There is a political choice either, as people say. Again, I haven't looked at the deposit rates yet, but if you are a non too big digital bank, there's eight of them, it's very hard to attract deposits and it's very hard for you to raise your deposit rate because again, you have this portfolio of stuff and your deposits are not guaranteed. So If I'm a J.P. morgan, a Citibank, a Wells Fargo, I forgot the other ones, the big banks, they have an unlimited deposit guarantee. Now, they have to pay a bunch of other charges for that. But if I'm a deposit in those banks, I know there is no question, the politicians have told me I will get 100 of my money back, no limit. If I'm not in one of those banks, I have to think to myself, okay, is this bank going to get saved? Is this going to be the Lehman Brothers or is this going to be the Goldman Sachs? Which one's going to. Which one is going to be? Right? They let Lehman fail. They didn't let Goldman fail, right? And so it's the thought. And so you're like, well, why even take the risk? Get me the fuck out of here. I'm giving my money to Jamie Dimon, right? And so that's the issue. People are fleeing because, number one, the political choice has been we are not going to extend a blanket guarantee to all these other smaller banks because of moral hazard and all these different things. We're only going to give it to these banks over here. So then the rational response of the public is, well, I don't want to be in that bank. I don't want to have to take the risk that they decide that this is the bank they're going to believe in capitalism on. I'm going to go on over here, let me go to socialism, I get my money back. And so I think that's driving part of it. And then the other thing is the rates are still going up, right? Five and a half percent. Maybe the Fed raises a couple more times, maybe it'll be 6%. I can literally, two clicks, go online, go to my money market account, deposit money with the government essentially, and get more money than my bank can mathematically pay me. So, yes, there's a banking crisis. It was smoothed out a bit with the bank term funding program. But it's not as if people have stopped noticing that in less than five minutes they can, you know, go from 0% to 6% interest income. That didn't stop. So the banking crisis is still there. The acute political choice that the regulators and the government is going to have to make is still there. It's still looming. Who is going to pay for these losses on the bond portfolios of all these banks? I don't know what they're going to decide, but I think they're going to decide to print the money and make sure that the electric gets their deposit back in nominal dollar terms. So that's just my opinion.
- [55:32]
Host
So the bank term funding program does not cover regional banks? I thought it did.
- [55:37]
Arthur Hayes
No, no, it covers, it covers banks that have eligible securities. So that essentially means U.S. treasury bonds and mortgage backed securities. Now the big thing that a lot of people are now focusing on is the commercial real estate, right? That's not included. So it's not as if I lent money to some real estate developer in some market who's going to build office buildings. I can't take that loan right now and give it to the Fed and get back 100% of my money back in dollars. Right. I can take a Treasury, I can take a mortgage backed security, I can swap that for dollars. I can't swap commercial real estate, which is a problem because small regional banks were the engine of commercial real estate lending boom over the last decades, whatever you want to call it. So now as we are changing the way we work and you know, two to three days work from home for a lot of folks, these office buildings are becoming kind of irrelevant and the market has frozen. So now it's a question of okay, what deals get done, how big is the price decline going to be? And then are banks going to have to write down this, this section of their balance sheet and oh shit, they're insolvent again. Or at least we know they're insolvent again. Or what's the Fed going to do? Are they going to expand the BTFP to include commercial real estate? Lots of. Because this is, you know, this is the thing that's going down in price. Or they can expand it to auto loans or they can expand it to, you know, personal loans. Like all these things that the banks have been lending out where the ability to pay or the asset value is declining that aren't U.S. treasury bonds and mortgage backed securities. Is the BCP going to be expanded to cover those? Because if those go down in price, the banking system still install them. Right? And so yes, they've solved one portion of the market, the one they really, really care about, which is mortgage backed securities. They want Americans own a House and U.S. treasuries, they want Americans to invest in the government. Now it's all this other stuff they would rather not have to bail it out. But again the banking system is choking on all this stuff and they're going to have to make the political choice at some point. Either they're going to let the non cubic defilled banks actually fail and a lot of, you know, Americans with small deposits not get their money back or they're going to come in and save the day and bail everybody out and print more dollars.
- [57:54]
Host
Okay, I think this is the part in our program where we point out exactly what inflation is. When it was first described to me as an invisible tax, I was like, it didn't make sense to me. And now understanding it better, I realize that what you're doing is you're saying, okay, um, we're going to make everybody's money worth a little bit less. So by making more of it, then the value of any $1 just reduces a little bit. And so it becomes a way to spread the taxation across everybody. So the real question the government is asking is, okay, this bank, whatever they did something that isn't well, so we already know that mortgage backed securities and Treasuries, those are going to be one for one. But if they have something other than that, they're asking the question, do we want everybody to have to cover this thing that didn't end up working out, this investment that didn't work out, or are we just going to let them roll over and die? As you look at that and when you think about this three to six month big disturbance, is that the thing that you think happens, that we get something triggers a run on these small banks? Could be commercial real estate starts, something kicks off and it starts going down. Or are there other things on your bingo card other than the regional bank failures?
- [59:17]
Arthur Hayes
I mean usually it's the problems are known. It's a question of whether or not we're focusing on and we being the market. Right. So the market knows that commercial real estate's a problem, but we haven't really seen a big price markdown because no one wants to trade. The sellers don't want to realize a loss and then have to mark the rest of their portfolio down and thus be insolvent. And the buyers don't want to buy at this price. They know it's too high. So nobody's trading. Right. So it's that calm situation where okay, well the price is still where it was, you know, 12 months ago. But there's no transactions. Right. So once there's a few transactions when people have to sell for whatever reason, we don't know what that's going to be, then we're going to go. Then it's the fiduciary responsibility is okay, well there are these transactions in the market and I now need to mark down my portfolio report to my regulators. Oh, my capital buffer is declined, therefore I'm insolvent And what usually happens is, you know, because of the politics, they'll let somebody fail. Someone's going to, there's going to be at least one failure and then the market's going to throw a fit, shit's going to be trading all sorts of up ways and then, you know, on one weekend they're like, okay, we can't let the next one fail. Right? They let Silvergate fail in March of this year, but they didn't let svb. And by fail I mean Silvergate went bankrupt. And the depositors are not guaranteed to get their money back by the Federal Deposit Insurance Company, the fdic. Whereas with SCB and Signature and First Republic, they were bailed out. They being the depositors were bailed out. Now obviously the bank management was replaced and equity holders lost money, but the depositors were bailed, failed out. So usually one person fails. There was a Lehman, there was a Bear, before there was Goldman, Morgan Stanley, everybody else sitting around. So they'll probably let somebody fail first because the politics demand it. Once the fear of looming collapse is instilled in the regulators, they're then going to say we have to print the money because the system is going to fail. What that's going to be, I don't know. I guess see that for whatever reason, financial crises happen in the fall and in, you know, the winter in the Northern Hemisphere perspective. And so we haven't solved any of these problems. They're only getting worse. They're getting exponentially worse. And the countries that would usually bail out the American financial system by buying assets for their own reasons can't do so. And so as we progress further into this season where traditionally crisis happens, there's going to be something. I don't know what it's going to be. That's just my, my, my base case. And I want to prepare myself and make sure that I'm able to make money in a situation where shit gets all up.
- [62:07]
Host
Yeah, okay. I didn't know that. There's a preponderance of problems in the fall and winter. Is that the obvious guess for somebody that's never heard that before would be it has something to do with energy prices as people have to crank up their usually.
- [62:20]
Arthur Hayes
So in the past it was agricultural issues, right. So the farmers, the credit tightens in certain parts of the year depending on when the farmers need credit to, you know, buy more equipment to do the winter planting. Right. They receive a bunch of money. Now they need to, to draw down on credit. And so that's why you get the spikes in, in. In credit as we move through the agricultural cycle. And that's part of the reason why you have different Federal Reserve banks in different districts is to try to smooth out that the demand and supply of credit between the banks in the east and the agricultural regions and sort of the center of the country and every other country is kind of the same. Farmers are always in debt and they're always borrowing money and then receiving lots of money depending on how the harvest goes. And I think that's part of the reason why we usually experience crises in harvest season and then winter planting.
- [63:20]
Host
Now, you said the problem is usually known, but it's a question of whether the market's paying attention to it or not. What are some of the problems that you're already aware of, whether the market's focused on them or not? That could be those early dominoes that fall.
- [63:35]
Arthur Hayes
So we already know that the US Banking system is insolvent from a year's perspective. We already know that the major buyers of U.S. treasury debt are not buying and the treasury needs to issue a lot of it. That's known. We already know that commercial real estate in the US Is a problem. It's just that nobody's trading right now because of what I just described. Globally, we already know that China has this massive real estate issue and is deleveraging, which means that China cannot contribute to global growth in the ways that it used to, meaning doing massive government stimulus and essentially buying stuff from the rest of the world to build up their country. Right. China's been the economic powerhouse of global growth, which bleeds into the US and European economies since the early 90s. They have lost their capacity to stimulate in the ways that they're used to. Japan is a problem. Either they're going to save their government bond market or they're going to save their currency. Japan holds is one of the richest countries from an asset perspective on their balance sheet. Are they going to sell down their Treasuries, their fancy US Real estate, their equity positions to essentially help fund the ability for their central bank to manage the depreciation of a currency? So these are all known things. There's nothing hiding which one is the one that causes the spark for everyone to start focusing on freaking out? I don't know.
- [65:11]
Host
So then as we start putting all of these pieces together, what becomes the. The next step is there. The crisis kicks off, the money printing continues. And I assume when you think about money printing and analogy to use would be a rubber band that's being pulled farther and farther back and every failure releases tension because we, those people, they lose and we don't have to make them whole. And there's no more printing and there's, it's not inflationary and every time we print more, there's more tension, more attention, more tension. Is that how you look at that? You're waiting for the domino, the housing mar, or sorry the regional banking goes the, the Fed decides they're going to bail them out, we pour a ton of money into the system and you're just waiting for that moment where there's too much tension. Like is do you see a,
- [66:07]
Arthur Hayes
when
- [66:08]
Host
you say a big disturbance happens, do we just load up more attention on the rubber band? But we're still, who knows, 10, 20 years away from a real crisis or do you think it has to break? And that's why we go into the Great Depression style problem.
- [66:24]
Arthur Hayes
So I think we've moved the crisis upstairs to the, the sovereign debt markets. And so this crisis will be the buyers refuse to buy long end bonds of a particular government because we're all, every government's in the same sort of position. Different things can set it off. But again, Global debt to GDP is 360%. Why on earth would I as an investor own a long end bond when I know that there's nobody getting born and there's not going to be an energy productivity miracle. There's just no way for me to get paid back in a real dollar, real yen, a real renminbi, at a rate that's affordable for the government, for me to make money over time. So then why own these bonds? I'm perfectly happy to sit in like overnight, you know, Fed deposits or short end bonds of a particular company because I know I can just sell those pretty quickly and not suffer any sort of capital loss. But if I'm forced to sell a 10 year treasury or a 10 year Chinese bond or Japanese government bond, 10, 20 years because REITs have gone up, I'm going to suffer a massive capital loss. So then why even own that stuff? And if nobody wants to own the long end of the government bond market, the rates will go up a lot. And then the response is some form of either closing down the banking system, so making sure that depositors cannot flee to other asset classes and then forcing deposits to buy government bonds. This is called fiscal dominance, this is a theory. Or the next thing is called yield curve control where the central bank says okay, we know you all want to leave this market, so we're going to fix the price at a particular level, whatever is politically expedient, whatever is affordable for the government. We're going to telegraph this and we're going to expand our balance sheet infinitely to make sure that the rates sit at that level. So in Japan, the Bank of Japan is doing this, been doing this for almost a decade, where they say they determine a band of the yield and they say if the yield gets to a certain level, we will go into the market and buy bonds by printing money to make sure the yields don't go up. The United States did this back in the late 40s and early 50s to pay back the debt from World War II by capping long end treasury rates, 10 year rates at 2.5%. The Fed was expanding its balance sheet to make sure the rate is at level. So if we get a revolt from large asset holders who say I don't want to own these long bonds because I know mathematically there's no way for me to make money in a real basis, I would rather own stocks, I would rather own crypto, I'd rather own oil field, I'd rather own gold, whatever it is, then the only response is to move to the end game, which is, okay, we fix the yield and we just print money until as long as it's required to keep the yield at that level. And once you've gone to yield curve control or something similar in the US it's already in Japan, something might happen similarly in China and other places, then the question is, okay, can the authorities keep the money inside their banking systems or are there ways for us, the people, to get our money outside of the system so that on a real basis we're able to maintain our energy purchasing power? And that becomes the real fulcrum of the crisis. Because if all the money is sitting in the banking system and it can't leave, which it's been able to do prior to Bitcoin and some of these other blockchain based cryptocurrencies, Then they just tax us all. And over time the government basically earns itself out of the situation. Yes, there's high inflation depending on how your company, your country is structured. Maybe it's hyperinflation, maybe it's just high inflation and some governments fall, some governments stay the same, but at the end of the day, the government can survive. But if we the people can get our money into a type of money or a type of asset that's outside of the government control, outside of the banking system, then the system collapses.
- [70:27]
Host
Well, that is, that is a very unnerving thing said very calmly Mr. Hayes. So, okay, how. Give me, give me like the odds here. So if, if Japan has been doing yield curve control for a while, for a decade, you said. I've been to Japan. It's amazing. So is there really a problem? Because it sounds bad, but having experience, if, if my time in Tokyo is what yield curve control looks like, it's not so bad. So what am I missing? Why is that something to be very wary of?
- [71:07]
Arthur Hayes
So I think people have mistaken the fact that you've been able to print so much money and not have an adverse effect. They're not looking at why. What has changed in the global economy over the past, let's call it 20 years? And what has changed is China. China joined the WTO in 2000 and essentially became the workshop of the world. And so you've lowered the cost of goods across every single sector because of China. And they're willing to, number one, degrade their environment to capture market share and a lot of the dirty processing, so rare earths, different types of commodity refining that the west and Japan are not willing to do. They have had a growth of young people willing to go into factory work and do these things at a very cheap wage. And that is it. We don't have China anymore. China, number one, is dying just like everybody else. The population is like forecast to be half of what it is by the, you know, by the end of the century. China, the population of China has also decided that they do not want to live in a small field factory. And they have told their government to prioritize protecting the environment, which basically means that China does no longer want to essentially pollute itself so that America, Western Europe and, you know, and Japan, Korea don't have to. Right. So we're going to make these things more expensive. And so there is no more big country that's going to join and essentially degrade themselves so that the rest of the world, the rest of the very developed and rich world can enjoy a higher standard of living if all the while they're printing a bunch of money. So there is no more. That's just not going to happen again. And so I think that's what people miss about why we were able to print all this money over the last 20 years and not really have any sort of adverse effects. That's just not going to happen anymore.
- [73:03]
Host
Well, so I'll ask maybe the uncouth question, but the obvious question, so India is still growing, is there? Because the, the thing that I'm dancing around is being right about the concepts, but getting the Timing wrong is the same as being wrong. And so what I don't want to do is get myself all worked up that, you know, the sky's falling, this is all going to be bad. I need to get my money out of the banking system. I don't want the government to close the exits. I don't want them to force me to buy things. I want to maintain my financial autonomy. I want to maintain my freedom. I want to come and go where I want. And certainly there are many, many, many horror stories throughout time of governments doing that. And if there is a way to keep this party going again, I'll just use Japan as an example. You know, my whole life I've heard Japan is in stagflation. But again, being in Japan, it's beautiful and lovely and there are wonderful restaurants and exceptional people. And for me as a storyteller, some of my favorite storytelling comes out of Japan. Like, there just doesn't seem to be. And look, I've never lived there, but there doesn't seem to be downsides. It's not like I'm like, oh my God, I would never want to be in Japan. I'm like, this fucking place is amazing. So I hear your point about China and China, the just booming growth and the amount of things that we were all able to reap the benefits of is as the developed world a little bit ahead of them, we were able to reap the benefits of their transition period, which is just astonishing. To have been cognizant while it was happening was really something magnificent. And look, I was far removed, but still had a sense of how extraordinary their growth was. Are we not poised to see the same thing in India?
- [74:54]
Arthur Hayes
So on the Japan thing, because this is called the widowmaker trait, the oh my God, Japan's dying. Oh my God, debt to gdp. This only goes in one direction. Oh, my God, the BOJ's balance sheet is going through the roof. So Japan is essentially just like China. Japan is a more successful version of China. They both have run the exact same industrial playbook. Japan had two nuclear bombs dropped on it by the United States
- [75:20]
Host
and the
- [75:21]
Arthur Hayes
US Essentially made it a colony for a bit. And so what did Japan do? They reoriented, reoriented themselves to making shit for America. And essentially the Japanese government and the large companies made essentially a pact that said, okay, we're going to give all the people jobs for life. You work really hard for the nation of Japan to make things grow, the prosperity of the country, but you're not going to keep all of the Productivity gains, Right. That difference is going to go essentially to these large companies and they're going to reinvest that profit back into the United States and Western Europe, essentially. So if you look at Japan as a country, they're one of the richest countries in the world on a net investment portfolio perspective. They've got one or two trillion dollars worth of assets. What are those assets? Those are, that's essentially the productivity gains of their people over, you know, since World War II. So Japan has this buffer of money that can cushion themselves. They owe the money to themselves. It's not as if the, the money is owed to, you know, the, the foreigners out there. You really can't buy Japanese debt in large quantities. So, yes, Japan is a unique situation where, number one, they, they have a lot of assets. Number two, their banking system is relatively close. Right. It's not as if Saudi Arabia can go in there and buy a billion, you know, a trillion dollars of Japanese bonds. They just won't let them do it. Right. Because they don't want the, the, the situation that the United States is in where essentially capital holders determine the, the policy of, of the nation. And number three, Japan has been, you know, very fortunate to use the labor of China and Southeast Asia to reduce the cost of labor. If you look at the major Japanese trading houses and manufacturers, and if you go around Southeast Asia, you see there's a lot of Japanese companies who have factories in all these countries employing all this labor that's very cheap versus the very expensive labor in Japan. Japan's a very special case. But again, all that's running out because the countries that did not benefit from the last 80 years, they're like, well, why am I the, the donkey for Japan to make a lot of money or the United States, Western Europe? I want high wages, I want to live in the Hollywood movie, I want more energy consumption. I'm not going to sell my resources to these other countries cheaply anymore. And so inflation in Japan is actually for the first time rising. It's at 4 or 5% highs in 40 years. The Asahi, for the first time in 30 years, raised beer prices, right? So the problem is when inflation shows up, and so when you exhaust a cheap labor, when you exhaust a cheap energy, when you sell down all of your trillions of dollars of assets and inflation remains in a world where the United States is not able to dictate the flows of energy unilaterally, then your special circumstance, you know, since the collapse of your equity market and property market since the late 80s, is no longer valid. And so I think people are making a mistake by not understanding why Japan is successful to say, oh, if Japan did it, they can be successful. Let's take a look at the United States. The United States owes the world something around 1 to 2 trillion dollars. The United States runs a current account deficit and a budget deficit. So it's a completely different financial situation in Japan. The United States foreigners own a lot of the debt. The United States relies on the foreigners to buy the debt to fund itself at affordable levels. It's a completely opposite situation of Japan. So saying that Japan did it and it's okay, it can work in the United States misses the differences fundamentally between the two. The two situations now on to like, you know, don't freak out and go, you know, move all your money into gold or whatever or something and you know, suffer some capital losses. My, you know, how I structure my portfolio is to benefit from both situations. I have high nominal rates right now, right. I know on a real basis I'm losing money but thankfully as a percentage of my, my net worth, the amount of money I consume on food and energy is very low. So even if I have a 5% rate and it's still a negative real gate on the amount of capital that I have, I'm still making more than I need to sustain myself. So keep some money in cash, put it in a money market fund, you're making 5, 6% and take whatever you can afford, a small amount and put it in something that's going to benefit if money printing resumes. That could be Nvidia stock, it could be bitcoin, it could be productive farmland, whatever. You want to have a barbell. You want to make sure that in the event that the money starts getting printed, I can easily move out of my short term money market fund government bonds into the risky stuff for the fixed supply and zoom up that way or if nothing happens, I'm still earning money. I'm starting earning yield over here on my, my, my treasuries or whatever short term government bonds. I can fund some of my expenses and I run a positive carry trade meaning I've structured my portfolio such that if shit really fucks up, I'm going to make so much money on the, on in that situation. But as long as nothing is very calm, I'm still covering day to day expenses. And so you want to have an optionality portfolio that costs you little to nothing if not makes you money over time if you're able to construct that. Then again timing doesn't matter because you're not paying for time if you're selling a bunch of stuff and you've got everything in the risky bucket. Yes, I would agree with you. Then you're like, well when is it going to happen? It didn't happen last month and I'm down, I'm down such percent or I needed to buy, you know, go to the hospital because I had an emergency injury and I had to sell down some of my this portfolio that I'm like betting on this collapse. And that was financially ruinous. Right. So it's all about trying to construct this portfolio where the cost of waiting is zero to making money versus you know, it's costing me money the longer this takes to happen.
- [81:40]
Host
Okay, so I want to go a little bit deeper into exactly how you structure your portfolio from. So I heard the we're going to do a barbell strategy. We want to make sure that we can move one way or the other depending on what's going on as something starts to pop off. But you said risky stuff with a fixed supply. So hiding in that are, are what I'll call two philosophical principles. Risky stuff. I'm guessing you mean high volatility. And so explaining to people why volatility is a feature and not a bug, I think may be surprising to somebody. And then why a fixed supply?
- [82:16]
Arthur Hayes
So again we want to make the, we want to basically participate in the upside to the maximum we can, right. So we want the high volatile stuff, we want the crypto, we want the, the tech stocks, right. But when stuff doesn't happen then we want our brakes. So like a car, right, you want to go as fast as you can on the straightaway when you are racing and you want the best brakes possible so they can take those corners and not get wrecked, right? So the breaks are cash, short term cash instruments that are earning yield, that's, that's paying you your grocery bill, you're, you're filling up your car tank, whatever it is that you need to do. You want to be making sure you can cover those expenses with some cash in the bank or in a money market fund or something like that. And higher yielding instrument so you can pay some of those expenses so that when shit's ready to go, oh, I'm over here, I'm ready to make as much money as possible. When they're printing money, I'm not in this safe, boring thing because this situation doesn't happen. There's not very many straightaways, right. I need to make as much money as I can. When the making Money is good and then put the brakes back on. Right. As if you were a race car driver. That's kind of how I want to think about it.
- [83:31]
Host
Okay. So knowing that these trades are excruciatingly difficult to pull off. So for people that don't know you, you manage your own money. You've often said you find it intellectually stimulating. It's fun. I will ask the question that better be on everybody's mind. So lifetime, are you up or down?
- [83:51]
Arthur Hayes
Up.
- [83:52]
Host
Okay, good. So we know at least your strategy has worked once. That's very valuable. So how do we make the volatility work for us? Because the obviously the best advice and people laugh at this, but I think they laugh at this at their own peril because they don't understand why it's become the phrase buy low, sell high. Now it got repeated so many times that it became funny because people think it's so self evident. But in reality it's the thing people never do. They almost always buy high and sell low. They buy high because it's hype, it's moving. They finally pay attention, they ape in and then it starts trending down, they panic and they sell as it's lower than when they bought it. So let's assume that they're going to be emotionally cognizant, they're going to stay calm. They're not going to make that mistake. But how do they know which of the risky assets to do? How do they know how to do volatility?
- [84:51]
Arthur Hayes
Well, I. Personal preference, right? Like obviously I'm in the crypto sphere. I love crypto. I understand it. The volatility doesn't scare me. For some people they might, you know, that's, that's, that's too much for me maybe. I'm going to stick with NASDAQ tech stocks. I understand that. I get, you know, I understand why this particular company could do well, you know, I'm going to jump on the AI tech. It doesn't really matter what it is, right? But looking at whatever it is that you think is going to be your upside winner look at.
- [85:24]
Host
So hold on, it, it not only does it matter what it is, it's the only thing that matters. Because if they bet wrong, they either make no money or God forbid, they lose a lot of money.
- [85:36]
Arthur Hayes
So important thing is not the upside, it's the break. The break is I own right now. The break is I own cash and a five and a half, 6% yielding money, my friend, or wherever you are in the world, whatever that is, like the short term government, that's the break. That's paying your bills, that's, you know, paying your rent, that's earning you a little bit of income. Right? Because at the end of the day, you want this portfolio to make you money while you wait.
- [86:01]
Host
So if, okay, so to turn that into, to turn it into a principle, you're saying basically you're going to move into high volatility, something that you have some reason to believe is going to do well, but you should not be putting more into the high volatility than you can see. Go to absolutely zero. You should have enough in the break category that even if all of that goes to zero, that you're still going to be able to eat and fill your tank up.
- [86:26]
Arthur Hayes
Exactly. Because you're going to know when to move into ivolf. Market panics, everything's getting dumped. Fed comes in overnight, says, we are backstopping the financial system and we've created some Alphabet letters that essentially mean print money. Right? And it could be, you know, pick your different central bank and wherever you're from, then, you know, okay, cash is trash. I was earning 6% overnight, now it's zero. I'm out of this. And guess what? You're not going to suffer any capital loss versus if I were in some other type of instrument, you need to liquid or whatever, right? So I can get out of this thing very easily. Boom. I, maybe I had some already in my high volatility bucket, but now I'm, I'm fully in that high volatility bucket because I no longer am earning anything on the cash. So there's no. Why would I have anything in the other bucket? I wouldn't, because I'm getting zero. I'm getting nothing. So I have to go into that because I have to find something that's going to maintain its purchasing power. What's the. When the denominator of fiat money expands infinitely, so you'll know, it'll be. It's not as if, like the S and P went up three times the instant that Ben Bernanke unveiled quantitative easing in March 2009. It took many, many, many years. It's not like it's. You have time. This isn't like, oh, shit, I gotta go, you know, sell this, buy this, and I miss it by a day and therefore goes my return for the next year. No, you're going to have time. It'll be very clearly communicated. It's just. Are you listening to what they're saying?
- [87:56]
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