WBD435 Audio Transcription
Bitcoin & the Future of Bonds with Greg Foss
Interview date: Friday 10th December
Note: the following is a transcription of my interview with Greg Foss. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.
In this interview, I talk with Bitcoin Strategist Greg Foss about how government bond markets are being manipulated through quantitative easing and how this will soon have to end. We further discuss what this means for equities and pensions and the potential for investors to seek refuge in bitcoin.
“Bonds have been in a 40 year favourable market to own. That’s now changed. Anybody managing a bond fund now has only experienced the positive about being a bond fund manager. This is a new paradigm for them, and old habits die hard.”
— Greg Foss
Interview Transcription
Peter McCormack: Greg, good to see you again, man.
Greg Foss: Pleasure to be here. Thanks for having me, Peter.
Peter McCormack: Man, I would have you on the show whenever you want to come on the show.
Greg Foss: Okay.
Peter McCormack: It's good to do it in person, we're back out recording. Are you happy you've got your buddy, Peter Schiff, there?
Greg Foss: That is something else, guys. Thank you. Just for full disclosure, I didn't bring the photo of Peter, Peter Schiff we're talking about, but I'm much appreciative of having him at the table there.
Peter McCormack: Are you going to be able to keep your cool?!
Greg Foss: I think we did okay the last time, right?
Peter McCormack: I think so.
Greg Foss: I mean, that was a good experience. The highlight of it for me was basically when he said he didn't care about being a fiduciary responsible risk manager, and that's not what you want to hear if you're one of his unitholders. That having been said, he's a good marketer, let's give him that. And you know what, I did see something afterwards from his son. His son, not blowing him up, but he did text me privately a DM and said, "Do you think I'm being too harsh on my dad?"
Peter McCormack: Wow!
Greg Foss: I basically said, "Look, kid, all I know is your dad and you are special and don't let something like Bitcoin destroy your relationship, that would be dumb".
Peter McCormack: It's so funny watching them go back and forth against each other. I dread the day my son comes on and starts ripping me and everyone's supporting him.
Greg Foss: That is interesting. I wonder if I'd be cheering it, if that's how I wanted to be set up? Let's just say Peter is that smart, which I'm not going to say he's not, imagine this is the plan.
Peter McCormack: Could be.
Greg Foss: If that's the plan, he's doing a magical job of it.
Peter McCormack: Well, shame for his clients, though.
Greg Foss: That has not been a concern of his for the last ten years, clearly. Imagine if he'd put the 1% of the portfolio into Bitcoin when he was first introduced to it? He'd be the best performing gold fund manager, or hard money manager, ever in history, because it's up 10,000 times, which would mean that he'd be up tenfold; 10,000%, so tenfold, on the 1% -- sorry, his whole fund would be up tenfold, just on a 1% allocation.
Peter McCormack: Unreal. That idea of a hard money fund is pretty cool, where it be mixed assets.
Greg Foss: Okay, they're doing it in Canada. So, one of the funds that's going to be marketed in Canada now is exactly that. It's an ETF that holds a portion of Bitcoin and a portion of gold, and probably another sleeve that will allow certain other discretionary hard assets; could even be a real estate portion of the fund.
Peter McCormack: Is it a fund that will rebalance?
Greg Foss: I'm not certain of the technicalities involved, but a lot of these funds can have discretion, and that's how the manager charges a higher fee. If they have discretion, they argue that it's an actively managed fund, and therefore you have to pay a higher management fee. But then it becomes the question whether it's a closed-end fund or an ETF. If it's fixed on the asset base, then the ETF is easy to get.
Peter McCormack: Right. Well, listen, we're here to talk about bonds again. We're always talking about bonds, but we'll talk about some other things. We're going to talk about some mining and some other stuff, but I want to do another 101 on bonds, just because I want to talk about the volcano bond, the El Salvador volcano bond. So, I just want to reintroduce people to what they are, how they work, because the current Treasury bonds, you've been very critical of. You think anyone who's buying that is a moron right now.
Greg Foss: I saw you say that with Lyn, and I do say that within a soundbite. There are people that trade them, and a guy that I met, actually at Mark Moss's event a couple of weeks ago, Steven Van Metre, and he absolutely is a bond bull, but he is a bond bull for a specific event that I believe Bitcoin will far outperform bonds in that event, and Bitcoin wouldn't have the downside if that event doesn't occur.
Let's put it this way. You can trade a bond. He freely admits he will not own a 30-year bond for the next 30 years, and that's what I'm critical of. A pension fund that holds a bond, like a 30-year maturity bond, that will hold that bond for the next 30 years. Then we know for certainty that their return will be what the current yield is right now, call it 2%. Who will own a bond for 30 years and earn an IRR, Internal Rate of Return, of 2% annually? I wouldn't, especially when inflation is 6%.
Peter McCormack: I'm guessing the only people who will are the people who are mandated to, and that's all they can own?
Greg Foss: Correct. There are certain funds that are absolutely bond funds and that's all they can own. A pension fund will be a mixture of bonds and equities, as you know, and those are fixed weightings within the pension allocation, and it takes a long time to change those allocations. So, the traditional 60/40 model, which 60% equities, 40% bonds, to change that to something like 60/20/20, where 20% would be alternative investments and potentially Bitcoin, literally takes years and years.
The trustees of the fund have to be convinced of it, and then the consultants of the fund have to come in and endorse that they're not doing anything reckless with their pensioners' money. It's not an easy process. So absolutely, over time, those antiquated 60/40 allocations will change, but they don't happen quickly.
Peter McCormack: Okay, so let's just go through the basic steps. Remind people what a bond is, who issues them and who buys them?
Greg Foss: Yeah, perfect. A bond is a debt instrument, which means the borrower is signing a contract with a lender that establishes a maturity, or a term to maturity, of the contract and an interest coupon that is traditionally paid semi-annually, twice a year. That interest coupon adjusts the contract essentially for the risk of the borrower.
So, who borrows? Governments. In the case of the US Treasury, the 10-year US Treasury, at around 1.5% right now, is the quintessential risk-free rate for the world. The reason it's risk free for the world is because people will say, "Well, European bonds have a lower yield than US Treasury yields". That's true, but if you translate them back into US dollars, always start in the same currency, you'll see that the US Treasury is the lowest borrower in the world, with the exception of a couple of basis points here and there.
Always look at bonds in the same currency to get a feel for what the coupon needs to be in that currency to reward the lender for the perceived credit quality of the counterparty. So for example, and just to clear this up, let's say Peter McCormack came with a 10-year bond issue in US dollars and the US Treasury was 1.5%, what do you think you would have to pay in an open market transaction to borrow $10 million, Peter? I'm going to guesstimate 6.5%. Why 6.5%? Because Michael Saylor, MicroStrategy, borrowed at 6.125%. So, I'm going to say you're riskier than Michael Saylor, at least 0.875 of a percentage point.
Peter McCormack: I'll give you that.
Greg Foss: Sorry, yeah, we'll give you 7%; we'll say 7% and you would borrow. Then, you look down the line, and there's various credit ratings for the counterparties. These credit ratings are signed by S&P and Moody's as a subjective evaluation of the credit risk. So you'll get different countries will have different ratings, different corporations will have different credit ratings, and I spent my life in the junk bond market, which was credits that are more risky than the typical borrower. They're not as risky as investing in the equities of that company, because bonds have priority of claim; meaning, unless the bonds are worth 100 cents on the dollar, the equity of the same company is worth zero in a restructuring.
So, yes, I was a junk bond trader, but the funny thing I would always tell people is, okay, pejoratives aside, you're a super junk equity investor then, right? If the bonds are junk, the equity is super junk, and lots of people buy the equities of super junk companies. That's okay. Just remember, there's a price for everything, and a junk bond company will have to pay a higher yield on their contract, everything else being equal, because they are a higher risk of default.
Peter McCormack: Right, okay. So, the US is seen as the most trustworthy issuer of bonds?
Greg Foss: Not only trustworthy, they are the biggest, they are the most liquid, they have the world's biggest economy, right, so there's that absolutely, and the world basically functions on a US dollar, so there's always liquidity in US dollars.
Peter McCormack: Right, so the US will issue new bonds, which people may buy?
Greg Foss: They have to buy them, because there's no choice. In a debt spiral, which we are currently experiencing, meaning it's expanding, every single new bond issue is the result of an old bond issue maturing, and the new one has to replace the old one, together with new borrowing that's taking place.
Peter McCormack: Is that to pay the principal?
Greg Foss: Correct, sir. So, let's just say a bond 30 years ago, 30 years ago less 20 days, a 30-year Treasury bond comes due; it's now a 20-day obligation, because it was issued 30 years ago less 20 days. In 20 days, it will have matured. Well, the Treasury needs to pay that off with new borrowing, isn't it funny? So, a bond issue never actually matures, it actually rolls over, and that's the key. So, every single auction that takes place is not really anything but the debt balloon refinancing itself.
The key though, that everyone needs to understand, that debt balloon is growing organically just because of the interest coupon on that debt balloon being bigger than the growth rate of the economy, and that is key.
Peter McCormack: Okay. So, when a bond rolls over, really its term ends, they issue a new bond to pay the principal of the previous bondholder.
Greg Foss: Correct. Add a new coupon.
Peter McCormack: But the coupon will likely change?
Greg Foss: Well, a number of things will change for the calculation of the coupon. The most that everyone's worried about is the inflation expectations. But my argument is that more issues, or more investors will take issue with the credit quality, because no country can fund themselves indefinitely. The US will be the last fiat-issuing country to fail, but it will fail, and that is not something I want to happen. And that is why we need to take precautions, and there are some very smart people out there trying to design a parallel system, where you will have fiat obligations as well as a Bitcoin standard.
Peter McCormack: Okay, so you have the rollover, but is there also the issuance, or the expansion, of the number of bonds?
Greg Foss: The number of bonds potentially, Peter. But what really happens now is they do big benchmark issues, so they try and consolidate borrowing. So, it's not really the number of bonds, it's the cumulative total of the outstanding debt.
Peter McCormack: Yes. And, this is where we get into one of the issues of expansion of the money supply is that, and explain to me if this is correct; every bond has to be bought, but there isn't a buyer for every bond, so the US Government themselves ends up buying their own bonds they've issued, so they would print money to do this. This is the debt cycle, part of it.
Greg Foss: That is largely true, that is correct.
Peter McCormack: Okay. So, interesting, okay. And then, just as a reminder for me to understand; one of the tricky problems with raising the yield is that all bonds are liquid. So, you could buy a bond, but you can trade it at any point, sell it to somebody else, and so that's where you get your yield curve from. So, if they issued a new bond, say a 7% one, to cover for inflation now, that is going to reduce the value of all outstanding bonds with a lower yield?
Greg Foss: Wow, that's an interesting concept. They would never issue a bond with a 7% coupon.
Peter McCormack: Because it would destroy the rest of the bonds?
Greg Foss: Largely yes, but think about it. If the market is charging them 1.5% for a 10-year bond right now and that's a fluid market, they know that the next auction, they only have to pay another 1.5% to issue another 10-year bond, and that yield curve is well defined.
Now, if they came out and said, "We're issuing at 7%", first of all, they're paying way too much. And secondly, the price of that bond would cause all the other bonds to crater, but that bond itself would still trade at probably a 2.5% yield. So, it would be trading at $160, and all the other bonds would be trading at $60. It's just bond maths, I don't want to get too --
Peter McCormack: No, that's fine. But historically, there are bonds that have traded at a very high yield?
Greg Foss: Oh, no question. When I started, bonds were trading -- 10-year US Treasuries were 14%.
Peter McCormack: But it feels, therefore, like the bond market is a race to zero?
Greg Foss: It has been in the past, because inflation expectations have been reduced so much that, why were bonds trading in the late 1980s at a double-digit yield? Because, Volcker hadn't snuffed out, that's Fed Reserve Chairman, Paul Volcker, in the 1980s snuffed out inflation by raising rates to double-digit levels. Since then, due to technology, due to deflationary pressures in the economies, the 10-year rate has gone down from 14% down to less than 1%. Now, it's kicking around at 1.5%, but inflation now is higher than it has been in the last 20 years.
Incidentally, in Europe, last month's inflation was higher than it's ever been, ever, and Europe still has negative yielding bonds. Something doesn't smell right, okay.
Peter McCormack: So, are essentially all bonds junk bonds?
Greg Foss: In my opinion, it's all about price, and if you're not buying a bond at the right price, you're getting stiffed. And if you're making a foolish investment, you could call that a junk investment, meaning that it will be a poor risk/return investment. So, yes. The old adage is, "There's a price for everything". Well, I don't believe the right price for US 10-year Treasuries right now is 1.5%. Therefore, firstly, why would that not be the case? Well, when inflation's running at 6%, you know the maths, you're earning a negative 4.5% real return.
The other thing is, everyone assumes the credit quality with the USA is still gilt-edged; it's not. The credit default swap markets are telling you that there's a higher and higher chance that the US Treasury will not make full on their obligations. It's a real market out there, it's a credit default swap market, so it's not impacted by the Treasury. They're not in the CDS market, Credit Default Swap market, they're not in there, and that's a market that's calculated on a daily basis between buyers and sellers of risk.
Peter McCormack: So, credit default swaps are essentially an insurance on paper?
Greg Foss: Bingo, exactly. And they were the instruments that foresaw the default of Lehman Brothers and Bear Stearns and the like.
Peter McCormack: So, how does the bond market get fixed, because to me it sounds like it's a broken market right now? I mean, it still works how it's meant to work, but in terms of earning a return if all bonds are essentially negative yielding --
Greg Foss: On a real basis, negative, yes.
Peter McCormack: On a real basis, and we know that some people have to buy them, because they're mandated to, but essentially it is a broken system; it's a fiat system that doesn't make logical sense.
Greg Foss: Peter, I don't know how it gets fixed, if they do not let yields go to their natural level. Now, that natural level is open for debate, but Stanley Druckenmiller feels that the natural level for US 10-year Treasuries would be 4.5%. Again, it's trading at 1.5% right now. There are other people that argue that the Fed is not impacting the shape of the yield curve, and I just say, "Come on, guys. There's an elephant in the room that was purchasing $120 billion of bonds a month. Tell me that's not impacting the yield curve?" And if someone say it isn't, I think you've never traded markets before.
There are bond bulls out there that will swear it hasn't impacted the yield curve and I just go, "Guys, take your heads out of the sand, because supply and demand is what it is, and that's what sets the price of bonds".
Peter McCormack: Okay. Sorry, what's stopping bonds reaching their natural rate of 4.5% yield?
Greg Foss: Again, the Fed in the market buying $120 billion of it per month. That's just the biggest buyer out there by far, it's in the market, and when you're a buyer, you're soaking up sellers. The way a yield rises, Peter, is the price goes down. And when the price of the bond goes down to reach an equilibrium level, the yield on the bond gets adjusted accordingly. So, as the price goes down, the yield goes up, and we'll do a quick bond maths here.
If a 10-year bond were to move from 1.5% to 4.5%, where Stanley Druckenmiller thinks it should trade, the price or principal trading value of the bond would drop by over 25% in one day. Now, it's not going to move there in one day, but it could move there in one year. You could lose 25% of the principal value of your bond when it's earning 1.5% annually. God, that's unbelievable, isn't it? It would take you your entire maturity of the bond just to make the coupon payments back for the loss in principal value; isn't it crazy?
Peter McCormack: Yeah.
Greg Foss: So, this is bond maths, and this is what people don't appreciate. So then, you can even extend it to a 30-year bond, where the impact of what's called "duration" is more than twice as severe. 30-year bonds would drop by over 50% in value. You've lost half of the value of your bond portfolio, "Oh, but it's a risk-free value"; oh, it is, is it? And I could lose 50% of my trading value, just because the market interest rate adjusts in an open market way? I don't want any of that. It's picking up nickels in front of a steamroller.
Peter McCormack: Hold on, let me understand.
Greg Foss: Okay.
Peter McCormack: So, if the US Government wasn't buying up the bonds themselves -- is it the Fed that buys them, you say?
Greg Foss: Correct.
Peter McCormack: If the Fed wasn't buying them, therefore there wouldn't be enough demand, so the rates would have to go up to fill that demand?
Greg Foss: You've got it.
Peter McCormack: Yeah. It's funny, because the thing with bonds is everything feels inverse.
Greg Foss: That's what it is, because if the price goes down, the yield goes up. And that's like a toboggan -- not a toboggan, a teetertotter, okay, and it's basically when yields go up or they're allowed to rise to their natural level of supply and demand, the price of the bonds goes down; because again, the bond is a contract with a fixed amount of coupons over its term. The only way the yield can adjust is that the principal value of that bond falls in price, so that you buy something at 60 cents on the dollar that matures at 100 cents on the dollar, but that adjusts for the lower coupons than the open-market rate. So again, it's a teetertotter.
You've got your coupons, you've got your principal, and it's bond maths and it can really confuse a lot of people. Don't overthink it. I'll just tell you, when I started trading in 1988, 10-year yields were 14%. Man, that's easy to make your bogie when you have a 10-year yield of 14%. Is it possible to get an 8% return in a pension fund when bonds are yielding 14%? Well, it's pretty darn easy, isn't it? You've got the risk-free asset in the world yielding 14%. You've got to be pretty good at losing 6% everywhere else in your portfolio just to come up with the 8% number.
Now, though, CalPERS has the same assumed return of 8%, even though interest rates are 1.5%, which means they think equities will make up the balance, which means equities have to have double-digit returns for ever and ever. Guess what, people, your pension funds are underfunded, okay; don't listen to what the government are saying. They're underfunded because the equity portion cannot make up for the lack of yield in the bond portion.
Peter McCormack: So, it is the pensioners who are going to be paying for this?
Greg Foss: They will not get their anticipated returns in their pension funds, correct.
Peter McCormack: So, the pension funds are growing, but losing purchasing power?
Greg Foss: The actuarial accountants are doing headstands to try and pretend the funds are what's called "funded". I've talked to a few of these actuaries, and they are embarrassed and realise that it's almost impossible for the pension funds to be fully funded when 10-year rates are 1.5%.
Peter McCormack: How much are bonds and bond rates an indicator of the health of the economy?
Greg Foss: Good question. A lot of things go into the calculation of the 10-year rate. If we think of governments outside of a normal corporation, let's think of what a normal corporation is. A normal corporation has cash flows, assumed cash flows, that will grow with the success of the company, the products of the company. That rate goes up and down independent of what the government rate is. So, you can have a US 10-year at 1.5% and the high-yield market itself is yielding around 4%. So, the spread is about 250 basis points between the two. But that high-yield market, the spread will go up and down according to the health of that company.
Flip that on its ear and say, "Is the government the same way?" Strangely, when the government can print money and the economy is slowing, yields are going to come down because a slow economy means non-inflation, all the things that would cause yields to fall. The reality is though, at some point, I think international bond investors are going to look at governments more like a corporation. What are the cash flows of the government that can satisfy the obligations in terms of interest expense, as well as repayment of principal? Guess what the answer is? It's impossible, it's over, you cannot possibly outgrow the debt spiral, it's mathematically impossible.
This is why I say, fiat currencies will always have to debase, because they have to print the money to solve the debt balloon. When your economy's not growing fast enough to meet your interest obligations and your principal repayments on your bonds, you've got to print the money; it's got to appear from somewhere. If it's not appearing from your tax base, you've got to print it.
Peter McCormack: Well, if they were companies, they would be essentially bankrupt.
Greg Foss: Listen, I won't criticise the USA, because I'm in the great state of Florida right now. But if Canada, my home country, was rated as a corporation, it would be a solid junk bond borrower. Canada would be a junk bond borrower if it was rated on the same scales that corporations are rated on.
Peter McCormack: Well, listen, I run a company, I've run companies, if I had a magic money printer in my back office, then I would never risk going bankrupt. Same at home.
Greg Foss: There you go, thank you.
Peter McCormack: I would always be able to pay my mortgage and buy my shopping, if I had a money printer. But I don't have one.
Greg Foss: So, all I would say is this. People have not yet done the maths, and they are still assuming that governments have the luxury of going to an auction and that auction being fully subscribed. There's something called "a bid-to-cover ratio" in the auctions, which indicate how much demand there was for the auction versus how much was issued. A bid-to-cover ratio of two times means there was twice as much demand as was issued.
What happens if that bid-to-cover ratio starts falling and it gets closer to one times, which means there was only as much demand as the auction? Then the next people are going to say, "Gosh, we're getting awfully close to the demand not being there. Maybe I'd better sell some bonds and lighten up on my own bond portfolio, in anticipation of worse auction results". It starts its own spiral, or contagion.
I've lived these markets, it's not fun when confidence is lost in the issuer of a bond. I've spent my life trading corporate bonds, but trust me, there's no difference when a government is involved.
Peter McCormack: Yeah. I mean, if I go back to thinking about Ray Dalio's video, I've been watching on YouTube for the first time, is it How the Industrial Machine Works? But he talks about debt and credit, there's always a balance. Wherever there's credit, there's debt; and wherever there's credit. At some point, they always have to balance.
Greg Foss: Correct.
Peter McCormack: But when the government is issuing debt, they don't have the credit to cover.
Greg Foss: Scary.
Peter McCormack: Yeah.
Greg Foss: Look, risk happens fast, okay, you need to live with that understanding. You think it's all going to be fine until it isn't. And as soon as it isn't, it unravels really quickly.
Peter McCormack: And we saw 6.2% inflation quoted. I think everybody is in agreement, it is way higher than that. The US is currently double-digit inflation.
Greg Foss: Well, if you use the same formula that they used in 1980 to calculate the original consumer price index, it would be over 14%, apples to apples.
Peter McCormack: I think we all know.
Greg Foss: You can feel it, yeah.
Peter McCormack: Whether it's you filling up your car with, we say petrol, you say gas, whether you're going to Starbuck's, whether you're going to dinner, everything is starting to feel really expensive.
Greg Foss: It's the reality that this is the first time in my lifetime that I've experienced inflation like this, that's true.
Peter McCormack: It feels like we're in a very unhealthy place and it feels like we're talking about it, because I have a show and feel part of a community and everybody is in it. But I feel there's a lot of people sleepwalking through this.
Greg Foss: People honestly, Peter, do not understand, including a lot of bond fund managers. The lack of understanding of bond mathematics is atrocious. Bonds have been in a 40-year favourable market to own bonds. That's now changed. Anybody managing a bond fund now has only experienced the positive about being a bond fund manager. This is a new paradigm for them, and old habits die hard, including the likes of Steven Van Meter, the Bond King, and everything; and he's going to outtrade this market, and I hope he does.
But I just would not risk my hard-earned capital to pick up nickels in front of a steamroller. I don't want to risk earning $5 to lose $45; I'm just not going to do it.
Peter McCormack: It seems to me this is why recessions are important, and trying to avoid recessionary periods, which while they are politically favourable, ultimately somebody's going to be in power, somebody's going to be leading the country when the collapse happens. A collapse appears to be inevitable now.
Greg Foss: They are cyclical. Ray Dalio is very good at laying out the debt cycles. There's long-term debt cycles and there's short-term debt cycles.
Peter McCormack: Could we argue we're in a super long-term debt cycle --
Greg Foss: No question.
Peter McCormack: -- because we've avoided the long-term debt cycle, or is that what we are in?
Greg Foss: In my opinion, you started again with rates being at 14% and they came down to under 1%. In the case of the European Union, they're negative, so they actually went below zero. If you can explain to me the logic of lending someone $100 to get $99 back, please do it, but I'm afraid I can't explain that. And yet, there's trillions of dollars of European debt that is trading at a negative yield.
Peter McCormack: Well, is it because, what are their other options?
Greg Foss: How about being smart? I mean, it's true, some people are paying for the security of holding your asset in safe-keeping, and paying for that safe-keeping; that is correct.
Peter McCormack: But is it also, if inflation was 6%, if you leave the money -- if you don't do anything with the money, you're losing 6% in purchasing power. But at least if you've got it in a negative yielding bond… Oh, hold on?
Greg Foss: You're losing more than 6%, yes, sir.
Peter McCormack: You're losing more? Hold on, that doesn't make any fucking sense.
Greg Foss: Yes, okay, thank you, you're right, it does not make any F'ing sense.
Peter McCormack: I don't understand.
Greg Foss: Peter, I know, and I could not explain this. If you told me when I started trading bonds over 30 years ago, there would be a time where a bond was negative yielding, I would have laughed you off the trading floor, but it's happened.
Peter McCormack: But is there no reason you can attribute to this?
Greg Foss: Yes, manipulation by European Bank.
Peter McCormack: Okay. Because?
Greg Foss: They just want to try and enhance the economy by having yields that are so low that people will borrow money to spend for capital expenditures.
Peter McCormack: There are multiple cans being kicked down the road here.
Greg Foss: Buddy, I've never been so bearish on bonds in 30 years. And I'm okay if I'm wrong, I just know I won't be, because it's only mathematics, that's what a bond is. That's why it's so beautiful, it's only mathematics. There is no subjectivity to a bond, except for the fact that the borrower may not repay you. Other than that, it's 100% contractual mathematics.
Peter McCormack: Okay, so central banks can issue bonds.
Greg Foss: Well essentially, the central banks and the treasuries, they work hand-in-hand.
Peter McCormack: Yeah. Companies can also issue bonds.
Greg Foss: Companies issue bonds all the time, correct.
Peter McCormack: Is that a similar-sized market, or is it a lot smaller?
Greg Foss: Oh, way, way smaller. So, total global debt is about $400 trillion.
Peter McCormack: Holy shit!
Greg Foss: Holy shit is right; of which governments account for at least almost three-eights of that. The others are banks and high-rated corporations, and then there are lesser-rated corporations, called junk bonds, which are very much smaller. But total global debt, $400 trillion. What's total global GDP?
Peter McCormack: Do you know what, I just don't know.
Greg Foss: About $100 trillion. So, total global debt is about four times as large as the global economy. Think about that for a second.
Peter McCormack: Right, yeah.
Greg Foss: Essentially, it would be the same as you borrowing four times your annual salary, not collateralised by a house or anything. Does the bank lend you four times your annual salary not collateralised by a house? Not on your life.
Peter McCormack: No, only with a house if it is collateralised, and usually with a decent deposit.
Greg Foss: Correct, yeah, 20% down. So, this is why credit markets are very interesting. They're no different from an equity market, except there's a lot less subjectivity to it. I always say equity guys are so bullish, right, and bond guys are so pessimistic. Equity guys are, "This tree will grow to the moon", and bond guys are, "Look, trees don't grow to the moon and stop telling me that equities are -- I'm going to dictate what's happening in the world, because total global debt at four times total global GDP is far larger than the equity markets".
Everyone always looks to the equity markets to get an indication of how things are going. Stop it, guys. The equity markets are a subordinate claim to the debt markets, and the debt markets are far bigger than the equity markets. Always look at the credit markets to judge the health of an economy.
Peter McCormack: Okay, so let's talk about this volcano bond Bukele announced on stage in El Salvador, Samson was there.
Greg Foss: Were you down there?
Peter McCormack: No, I wasn't, I couldn't make that one, I'd been away for too long. To me, it seems kind of interesting, but I want your perspective on it. I know that El Salvador bonds have a 13.5% coupon; this one is 6.5%. The idea is they raise on the first bond $1 billion, dollar denominated, and they're going to put $0.5 billion into buying Bitcoin, $0.5 billion into mining infrastructure, as I understand, and then they'll pay the 6.5% coupon. I think there's a lock-up, I'd have to confirm that.
Greg Foss: It's five years.
Peter McCormack: Five years. My assumption is their assumption is Bitcoin will do their thing and that $500 million will increase in value, and then after the five years, they will be selling off the Bitcoin?
Greg Foss: They could be. There is a participation, in terms of the performance of the Bitcoin price over that time, in which the bondholders will participate in the performance of the Bitcoin price to the upside, and they won't be penalised to the downside, but I'll promise you that the price of the bond will go lower if Bitcoin doesn't do its thing. So, the price, it won't be a contractual participation in the price in terms of the Bitcoin price, but the price of the bond will reflect the Bitcoin price.
Peter McCormack: So, the bond will be a derivative of Bitcoin?
Greg Foss: There's two components of the bond. One is a Bitcoin option, correct; and the other one is a pure cashflow consideration on the creditworthiness of El Salvador, or Bitcoin City. The question is, are they ringfencing Bitcoin City from the El Salvador counterparty risk? That's where some of the technicalities of the issue can come into play. If they're able to ringfence the Bitcoin City component, in theory Bitcoin City could have a far higher credit quality than El Salvador as a whole.
These are some of the issues that I'm not aware if they've been ironed out or not, but there's certainly an argument that Bitcoin City and the thesis behind Bitcoin City could be a pretty attractive investment opportunity, right, not even considering the performance of the Bitcoin price. Hey, you're going to build a mining infrastructure that's going to mine Bitcoin, and Bitcoin mining, there's a component of it that's sensitive to Bitcoin price; but in theory, the difficulty adjustment, as you know very well, should allow miners to make money, regardless of what the Bitcoin price is.
Someone may look at that and say, "Bitcoin City, mining infrastructure, passports, new people coming in to be citizens of El Salvador? Hey, I sort of like that". And, the 6.5% rate there, is that attractive for all of that optionality? There's certain lenders out there in the world that I think will say, "Give me some of that".
Peter McCormack: So, if the bond is fully subscribed, and during the period of the lock-up, the Bitcoin just does a 5X, 10X, an amazing thing, and ends up being $300,000, $400,000 a Bitcoin, those bonds are going to trade on the open market at a much higher rate than 6.5%?
Greg Foss: Correct, sir. So that means the price will -- they'll trade at a lower yield at a higher price, because the 6.5% will be extremely attractive, so people will bid up the price of those bonds. And the yield conversely will decline in yield, and maybe that yield becomes 2%.
Peter McCormack: So, what do you think of this bond then?
Greg Foss: I think it's an awesome experiment in, I won't use the word "circumventing", but in terms of putting more funding options on the table for a country that's so far been hostage to IMF, how do we say this politically correct? Hostage to IMF posturing. They're trying to increase their own funding flexibility outside of the "IMF safeguards", I say that with quotes. There are other ways I could describe the IMF.
Peter McCormack: If the IMF lends money to a country, is it just a loan?
Greg Foss: It's not just a loan, because there are contingencies that require certain benchmarks to be met and, in bond terminology, covenants that need to be met. And I'm not aware, I've never lent money to El Salvador so I've never gone through any of their covenants, but trust me, one of the things that's very restrictive about lending to a risky counterparty is, the lender makes sure that the borrower is somewhat constrained as to what they can do with the money, do you have what's called "cash flow sweeps", where you get the money back before they're able to spend excess cash flows on other projects, all these things are covenants that exist in certain bond structures.
I'm not aware of what the ones are for El Salvador, but I anticipate that the IMF has some pretty strict covenants in their bond package.
Peter McCormack: Okay. I mean, the talk is of El Salvador doing up to ten of these bonds.
Greg Foss: They have to do one first. And I would definitely say, if one goes off, don't flood the market, but if one goes off and the price performance of the bonds in the aftermarkets reflects good demand, then I would do another one, 100%.
Peter McCormack: What do you think the risk is with these bonds, because one of the things I like about it is at least half of it is backed by Bitcoin?
Greg Foss: Honestly, Peter, I need to be very careful here. This bond, in my opinion, is attractive for investors who do not have the opportunity to own Bitcoin outright. You are different, okay, and so am I. And then there's some whales out there that have so much Bitcoin at risk that they may actually want to go the other direction, and they might want to take some pure Bitcoin off the table and earn a yield to a counterparty, like El Salvador, that they want to succeed.
If this goes well, this is going to be good for the Bitcoin ecosystem. I'm not going to call them philanthropists, but there are certainly some well-wishing whales out there that might fund this project just to prove that this is possible.
Peter McCormack: And stick a middle finger up to the IMF!
Greg Foss: But nothing comes for free. I mean, we are not a philanthropic organisation. When I say "we", I mean the Bitcoin community as a whole. You could not rely on that to continue indefinitely. So, this is a bit of a litmus test, there's no question. Will you buy this bond? I'm not saying whether you will or you won't, but certainly there's some people in the position who've been involved in Bitcoin as long as you have that would look at it and say, "The greater good is that this succeeds for El Salvador, so therefore I am going to help fund this project to ensure its initial success". I think there's quite a bit of that that might come to the table.
Peter McCormack: I agree.
Greg Foss: Not being the underwriter, meaning the Blockstream and Samson Mows of the world and everything, I don't know. I haven't canvassed the buyer base, but I sure hope that they have done some pre-work on this to give them a level of comfort that this would be the case.
Peter McCormack: Yeah, my assumption is they would have -- I mean, I personally won't be buying it, because I'm not wealthy enough, but I do support the idea. I hope it's successful, but I hope it's successful for a different reason, not just for El Salvador. I actually hope it's successful, because if this works, this will highlight to other countries around the world there's another alternative way.
Greg Foss: Oh, 100%, yeah. And don't forget, then you've got to be careful that you don't get everyone jumping into the same pool all at the same time, because then it will ensure that there's oversupply versus demand, meaning every single country wants to do this. All of a sudden, you have $100 billion of desired supply; well, that's a lot. The market's not big enough to hold -- the whole Bitcoin market's only $1 trillion. You're talking $1 billion, well that's one-one-thousandth. But all of a sudden, if it's $100 billion, you're talking one-tenth of the market wants to get absorbed into Bitcoin bonds. Then you're talking a big dilution. So, you can't do too much, it's a process.
Peter McCormack: But it's a useful test.
Greg Foss: Honest to gosh, I really want this to succeed and I really hope that the underwriters have done their best Wall Street imitation, where they would have gone around and canvassed a number of very key buyers and said, "On the QT, we're looking at bringing this to market. Can we put you in the book, an initial order book, that would justify --" I'm going to throw a number out; wouldn't it be amazing if they had $600 million worth of demand prior to even announcing the issue?
Peter McCormack: Because closing the gap then would be fairly --
Greg Foss: And you want it to be oversubscribed, meaning you want it to appear that there was more demand than the issue size. And we can get into some of the technicalities as to whether there's a syndicate short on these bonds and all this good stuff.
Peter McCormack: What's a syndicate short?
Greg Foss: It's when, if you bring a $1 billion bond issue and the syndicate sells more than $1 billion, essentially settles the issue short, meaning they have to go back into the market and repurchase some of the bonds to satisfy that short, it ensures that there's a bid under the market and that the price of the bond, if it's issued at 100 cents on the dollar, may trade up to 102 or 104 cents on the dollar.
Believe it or not, in bond land, that's huge. That 4% is a 4% return at time zero. Well, when 10-year rates are 1.5% and you can make 4%, just because the price of the bond issue went up 4% from 100 to 104, that's a good day's work in the bond market. So, these are all things that Wall Street will do. They'll have a syndicate short, they'll have their pocket buyers. The pocket buyer will be, "Okay, I'll put $200 million in the book, and I'm good for another $200 million in secondary market trading".
Guess how coddled that buyer gets? How many baseball games does that buyer get to go to a year on behalf of the Wall Street syndicates? Come on, that's how it works though. And these are huge funds. These are funds that have trillions of dollars to invest in bonds.
Peter McCormack: So, do you think some of the Wall Street bond traders might take a look at this?
Greg Foss: I can't comment on that. Certainly, if I was in my old chair, would I take a look at it? 100%; in my old chair, I would have taken a look at it. Would I have bought it? I'll tell you what I would have done. I would have broken it down into its components, its pure cashflow characteristics, its Bitcoin optionality, and I might have gotten too smart by half and sold out call options on Bitcoin and covered some of this and done all that stuff that a hedge fund pretends they do, and then I could have been in the game.
That being said, at my old seat, I would have been hopefully allowed to buy Bitcoin as well. So, you have to be careful. Is it a fund that's allowed to buy Bitcoin, or a fund that isn't allowed to buy Bitcoin, but wants to get Bitcoin optionality exposure?
Peter McCormack: Why are these funds still not able to buy Bitcoin?
Greg Foss: Again, the investment policy guidelines. We talked about that at the beginning. These things are set by old men, like Warren Buffet and Charlie Munger. Time will take care of their old age; but for now, they are the people setting investment policy guidelines for pension funds.
Peter McCormack: Right, okay. Sorry, help me understand that. So, it's not the fund itself; these are policies that are created outside.
Greg Foss: Right, by committees, pension trustees, that set these policy guidelines, that is correct. So, don't forget, let's say you're the Chicago Firefighters' Pension Plan. You have, on behalf of your pensioners, the obligation to try and fund your pension plan. You will farm out an asset mix to specialty managers across the board, based on an asset allocation plan defined by your trustees.
So, the trustees could say, "Well, the Chicago pensioned firefighters, they're really risk averse, so we're going to be 90% in bonds". Well, that stinks, doesn't it, but there are funds like that. And then, there are other people that are, "Look, I'm very proactive, I want to take risk on behalf of my pensioners", and these guys might be, instead of the Chicago Firefighters, let's say they're the circus act, the Chicago Circus guys, the trapeze artists; they take risks their whole life. Well, they might be 90% equities and 10% Bitcoin, they live with risks like that.
So, it's a balancing act across different pension guidelines, and some of it is regulated by the state as well, because there are pension plan guarantees by various states in the USA, where if the pension plan isn't fully funded, it will be subsidised by various government entities. So, there's a pension plan, what is it? It's the Pension Plan Guarantee Board, something like that.
Peter McCormack: A bit like the FDIC?
Greg Foss: Correct, except for pension plans.
Peter McCormack: It's no wonder the government's got no fucking money.
Greg Foss: Peter, there's just so many different moving parts in all of these policy decisions, and this is what a lot of bitcoiners don't understand. I love the Bitcoin community, they just don't understand how big money works. "Why aren't they 100% in?" well, because it doesn't work that way. It takes a long time to change these policy guidelines. A lot of the people who make these decisions, again are people that have been managing money for 40 years. They don't understand how an iPhone works, let alone how the blockchain works, okay, and these are the people who are making the decisions.
Peter McCormack: It does seem to me, though, that pension funds are almost the perfect vehicle for investing in Bitcoin, because they have that long time preference.
Greg Foss: Bingo. The question is how much, and that's what we have to come down to. The wrong answer is zero. How much Bitcoin should they own? The wrong answer is zero, what is the right answer?
Peter McCormack: Start at 1%.
Greg Foss: Well, you've got to get off zero. And borrowing from Pomp, "Get off of zero". The right answer, in my opinion, somewhere between 10% and 20%.
Peter McCormack: Okay, that's big.
Greg Foss: If it goes 10% to 20% of all pensions are allocated to Bitcoin --
Peter McCormack: We'd probably hit our +$1 million.
Greg Foss: Easy. Well, just do the maths, and you'll see the demand side of the equation. I've run through this maths with you before, but if total financial assets in the world are $900 trillion, that's what they are. All bonds or all debt, all equities, all real estate, all gold, commodities, fine art, store of value, total of $900 trillion. I think Bitcoin easily captures 5% of that market. What's 5% of $900 trillion? It's $45 trillion. What's $45 trillion divided by 21 million? It's over $2 million a Bitcoin, in today's dollars.
Peter McCormack: But that's not even counting for price slippage when a lot of people want to buy.
Greg Foss: How about this, brother? It has to go through my price before it gets to $8 million. So, let's start with $2 million, and the point is, the way it gets there is when pension funds say, "I've got to get my 5%", because 5% is a minimum. And what if they say 10%? Well then, it's $90 trillion divided by 21 million, and all of a sudden it's $4.5 million a Bitcoin.
Peter McCormack: You see, they are the perfect vehicle for Bitcoin. They have long time preference.
Greg Foss: And, by the way, what are their alternatives? They're pretty stinky right now. 10-year bonds? And gold is way better than owning a bond, and congrats to our friend, Peter Schiff. Look, here's the picture, I'm going to put Schiff-ty on his head. Schiff-ty's on his head, because he actually stood on his head for once. Schiff-ty, you're standing on your head, okay! He stood on his head because, why? He actually appropriate called bonds, "Return-free risk". That's a great expression, "Bonds are return-free risk".
Gold is better than bonds, so we're putting Schiff-ty on his side now, okay, because he correctly said that gold is better than bonds. But gold is nowhere as good as Bitcoin. So anyway, thank you, Peter. I love you, man, I love your son, I love everything that you try and do; but at the end of the day, you've been so wrong on your risk allocation, because he was 99 yards -- he was running for a try and he was inside the 22-metre line, and he's running down and he fumbled, not the ball, but the rugger --
Peter McCormack: Yeah, we call it a ball.
Greg Foss: He fumbled it. What a loser.
Peter McCormack: He knocked it on.
Greg Foss: He knocked it on! Beautiful, exactly. Okay, unfortunate, but he has a great kid that's going to make up for it!
Peter McCormack: Oh, man. I was with Saylor a couple of days ago. We got into an issue you love. Bitcoin is digital energy.
Greg Foss: Well, he's the man.
Peter McCormack: So, I struggled with that as a concept for quite a long time. I was like, "What do you mean, 'Bitcoin is digital energy'? You're mining the Bitcoin and selling it, how is that storing energy? It's not, it's storing wealth". I still struggle. I understand why people want to sell it as that, but I don't 100% understand why it's digital energy.
Greg Foss: I guess it's easier for me, as an engineer, to appreciate that, because I grew up with the law of conservation of energy, that's imbedded in my brain. Energy can't be created or destroyed. It is the law of conservation of energy, and Bitcoin proof of work is storing the value of somebody's time and energy to be consumed at some point in the future, in a conservation of energy principle. And, I hope I didn't use this on one of your podcasts, and forgive me if I did, but I'll go back to when I was 20 years old.
So, over 35 years ago, I was working. One of my summer jobs was working as an asphalt shingle installer. I might have made $40 that day, pounding shingles in a hot summer, 8 hours, $5 an hour, I made $40, 35 years ago. What do you think that $40 is worth to me today, after I stored it for over 35 years?
Peter McCormack: A couple of bucks?
Greg Foss: How horrendous is that? I can't even buy a beer for eight hours of work, because again, the purchasing power has gone down to $6 in 80 cents-ish, do you know what I mean? And at the end of the day, that's what fiat does, it robs you of energy, and this is key. If you understand that my time and energy was worth something in that hot sun, I improved the value of that house, my work energy went into that house improving the value of that house. Then, I was rewarded for that work energy and I stored it in an inferior asset that lost its purchasing power over time.
Peter McCormack: So, is all money energy, but some is better energy than another?
Greg Foss: Interesting. It should be, but it's not. Fiat is certainly not energy. Fiat, there's no conservation of energy principle with fiat, they can just make it out of thin air. You can't make energy out of thin air. Energy exists, and conservation of energy is the first law of thermodynamics.
Saylor says it, because he's a rocket scientist, and I appreciate it, because I'm a mechanical engineer. And I know people that are as smart as Saylor. The difference with Saylor is, he's a walking mainframe who can actually communicate with the common man. Most rocket scientists are gibberish people. They speak in maths and they make funny jokes that no one understands, because it's like, "The square root of 3, ha-ha, that kills me!" Fuck off, I have no idea what you're talking about!
So, Saylor gets it, he's a walking mainframe that basically understands the common man. Now, that being said, you'll say, "Okay, I still don't quite get the conservation of energy". Hopefully, thinking about working 30 years in sweat, hot sun, you come to use that money 30 years later and it's worth nowhere near what it would have been when it was worth $40, 35 years ago.
Peter McCormack: So is gold metallic energy?
Greg Foss: Yes, sir, absolutely. How is it formed?
Peter McCormack: It's mined.
Greg Foss: No, how does it get formed in the universe?
Peter McCormack: Oh, sorry, supernova.
Greg Foss: There's lots of ways, but those things are high-intensity energy things.
Peter McCormack: Okay.
Greg Foss: There's scarcity value to gold. I mean, the beautiful thing about gold is, you don't produce it, it's not like producing concrete. You don't put half a mixture of stones and concrete and sand and water to produce cement; your cement, sand, stones and water equal concrete. You can't produce gold that way. You can get gold out of seawater. You know there's more gold in seawater than is on land? The problem is, getting it out of seawater is very polluting, arsenic, and all those things. But yeah, that energy could extract gold out of seawater.
That's a big thing, right? Everyone says, "We're going to mine an asteroid". What the fuck are you talking about, mine an asteroid? Just go to your backyard and suck in enough seawater and get the gold out of the seawater, it's true.
Peter McCormack: Yeah, you can see it on one of the documentary channels.
Greg Foss: Anyway, look, this is all good. I still am not dissing gold, like Saylor really does. There's a friend of mine, Lawrence Leppard.
Peter McCormack: Yeah, we interviewed him.
Greg Foss: He's brilliant.
Peter McCormack: Such a great guy.
Greg Foss: I love Lawrence, and I love how he manages risk, and there's just a different risk tolerance between Lawrence's clients and Michael Saylor's unitholders.
Peter McCormack: In our show that came out today with Saylor, he calls gold, "The enemy of Bitcoin".
Greg Foss: Oh, darn. I respectfully disagree with Mr Saylor, because most gold bugs, and I'm going to specifically call out a couple of them, Lawrence Leppard, Santiago Gold Fund's Brent Johnson, these guys get it, they've done the homework. They understand that fiat is the enemy. Now, they've chosen a store of value that's $10 trillion. There's no doubt in my mind that Bitcoin will be far more valuable than gold. But if you ask me who's the real enemy, bondholders or gold holders? I'm like, come on, don't even start.
Firstly, bonds are 40 times the size of gold, and they're 40 times as stupid as the gold holders, because they really don't know mathematics as far as depreciation or debasing of the currency goes.
Peter McCormack: Fair, man, fair. Well, listen, it's always a pleasure to have you on here.
Greg Foss: It's great to be here, guys. I mean, I want to thank your team and everything. It's nice to be face-to-face in beautiful Hollywood Beach, Florida. I love this state.
Peter McCormack: I do. It's got some really cool bits and some really weird bits, and that's what I like about it.
Greg Foss: It's eclectic. I drove from Canada down to Miami.
Peter McCormack: What? How long did that take?
Greg Foss: A couple of days, three days.
Peter McCormack: That must have been fun.
Greg Foss: I stopped in some great stops, including Gainesville, Florida, where the University of Florida is. Man, that is a sweet town, and I really look forward to going to a couple of football games there. I'm not going to live down here full time, but I'm proud to say that I'm a property owner in the state of Florida now. And listen, Canada's a great country, but we've got a lot of wood to chop up there.
Peter McCormack: Oh, are you kind of planning your exit, because it's all a bit weird?
Greg Foss: No.
Peter McCormack: Optionality?
Greg Foss: Yeah, optionality, correct. And here's the thing. I have a great wife that, she likes Bitcoin, but she doesn't love it, and if I put everything in Bitcoin, I may not have a wife. So she said, "Okay, put it in another hard asset" and I said, "Look, real estate in Florida, on a dollars-to-dollars basis, real estate in Florida's quite attractive, relative to real estate in Canada".
Peter McCormack: Well, keep that wife, man.
Greg Foss: Yeah, they keep the world going, man, they do. So, yeah, thanks again for having me and I'll say one more thing. We talked a lot about bonds here. Bonds are the most important financial contract in the world, they're the biggest, they run all markets. This is what people don't understand. When the credit markets get sick, all other markets absolutely get disastrously ill. Why? Because credit runs the world in a capitalist system.
I really want the El Salvador bond experience to be positive, I hope it is, but regardless; that's $1 billion in the context of $400 trillion, 4,000 times as big. I guess it's more than 4,000. Anyway, it could be 40,000 times as big.
Peter McCormack: It's a big fucking number.
Greg Foss: It's a big fucking number, and that's the real elephant in the room. Please, please do your homework. If you own bonds and you own no Bitcoin, that's the people I feel sorry for. The gold holders, they'll be okay.
Peter McCormack: They'll be okay. Get some Bitcoin.
Greg Foss: Yes, sir.
Peter McCormack: Greg, love you, man, good to see you.
Greg Foss: So great, guys, thank you very much, and look forward to having another chance to meet up in Miami on different occasions.
Peter McCormack: We'll make it happen, dude.
Greg Foss: All right, thank you, guys.
