WBD449 Audio Transcription
Chaos in the Bond Market with Greg Foss & Lawrence Lepard
Interview date: Thursday 13th January
Note: the following is a transcription of my interview with Greg Foss & Lawrence Lepard. 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 to Bitcoin Strategist Greg Foss and Investment Manager Lawrence Lepard about last week's extraordinary activity in the bond markets. We discuss the convergence of economic constraints boxing in the Fed, the pretence of bond value, contagion risks, and using Bitcoin for capital protection at the individual and national level.
“There comes a point where everybody knows holy cannoli these currencies have no value, none, zero. Get me out of here, get me something else… get me something that doesn’t represent a claim that is run by a government that is completely, utterly, devoid of morals and out of control.”
— Lawrence Lepard
Interview Transcription
Peter McCormack: Let's do what we've got to do and then we can talk football.
Lawrence Lepard: Okay, excellent.
Peter McCormack: There's a lot to do, but how are you, Lawrence? Good to see you again.
Lawrence Lepard: I'm good, thank you. Nice to see you as well. Happy New Year.
Peter McCormack: Yeah, good, Happy New Year, and good to see you, Greg. You know I was trying to get back to doing all these in person, and Danny, my producer, reached out and he's like, "Dude, have you read this thread?" I was like, "No". He sent it to me and he's like, "You've got to do a show about this". I said, "I can't fly out tomorrow". He's like, "Do it remotely". He said, "Get Greg on, get Lawrence on, talk about this". I was like, "Okay", so here we are.
Lawrence Lepard: Yeah, it's epic stuff.
Peter McCormack: Yeah, I mean I don't know how to read it all. Right, thinking of the listeners, we're going to go with the listeners first, and I always get you to do this, Greg, I know it's a bit annoying, but we're going to go through the craziness that happened last week. Can you just do the basics again, can you explain the role of the bond market and how it's changed over this last two years?
Greg Foss: Certainly. Well, thanks for having me, Peter, and Lawrence, or Larry, great to see you again. I'm looking forward to this podcast, I think we're going to have a good one. So here's, gentlemen and ladies, essentially what is a bond. It's a contract that pays a series of coupons over the life of the contract, typically semi-annual coupons, and that contract is set at a price of 100 cents on the dollar, or par, at the outset.
But because of interest rates, which are impacted by things like inflation expectations or credit quality concerns, the price of that bond will change over the life of the contract. It doesn't mean you don't get your $100 back at maturity; what it does mean is that if the coupon is lower than the prevailing yield in the market, the price of the bond falls to compensate for new buyers of the bond that get their return at maturity, which is if you buy something, for example, at 97% of par, at maturity it's worth 100% of par, provided there's no default, and accordingly your yield on that instrument changes so that it's different from the coupon on the contract.
When a bond is issued, that coupon generally reflects the prevailing market yield, and that's why a 1.75% US ten-year will be issued at the current price of par. But let's say the yield in the markets change, so that the ten-year starts to yield 2.75%, the price of your bond will fall by about 8% of its face value, so that the $92 over time makes up for the loss in the coupon, the below-market coupon.
If everything makes sense from that basis, remember this: when interest rates go up, bond prices go down, and the reverse is true when interest rates go down, bond prices go up.
Peter McCormack: But interest rates have been going down and bond prices have been going down?
Greg Foss: Interest rates lately, over 40 years, have been going down from a level of 14%. When I first started trading bonds in the 1980s, the ten-year US Treasury yield was 14% and it went down to as low as under 1%. But now, the ten-year yields 1.75%, which means any bond that was issued with a 1% coupon has incurred a mark-to-market loss, right, because the 1% coupon is too low to compensate those other buyers that could buy bonds at a 1.75% yield.
So, that's how the market continually reprices, Peter, because every single day, the level of interest rates changes, again due to, for example, today, we had an inflation number which was 7% year over year.
Peter McCormack: 40-year high.
Greg Foss: Well, that 7% inflation, if you believe that to be the correct inflation number, and we can get into that argument, that means that if you buy a bond with a 1.75% yield and inflation is 7%, you're actually earning -5.3%, in what's called "real terms". You're losing money because of inflation by owning a bond contract that only pays you 1.75%.
Peter McCormack: Right, okay. One more question, then I've got something for you, Lawrence. What do bond prices tell you about what's going on in the market; what do they tell you about risk?
Greg Foss: Well, let's assume that there was no Fed purchasing of historically $120 billion of bonds a month, open market interest rates, where there's no elephant in the room, is the basis of setting everything from risk/return metrics in the equity market, because the proverbial risk-free rate is defined as the US Treasury yield curve. Now, it's not truly risk free, but if you read your economics textbooks, they always say "the risk-free rate of return".
The US Treasury is a very solid credit. It typically sets the base level of return requirements amongst all other asset classes. So equities, since they are more risky than debt, require higher returns than what you can earn in open market, free treasury markets. I will go on record as saying the current markets are not free. There are manipulated rates, because of the Fed purchasing a bunch of bonds; there are manipulated rates, because of yield curve control in various countries. So, all of this goes into setting the base return that's required on the quintessential risk-free asset, which is typically the central bank obligations of a various country.
You get negative-yielding bonds in Europe, we talked about that on your last show. That makes no sense to me. A bond then, when it has a negative yield, implies that it's not actually an asset or an investment, it's a liability, because you're guaranteed to lose money. I can't explain it, never thought in my lifetime I'd experience negative-yielding bonds, but these are some of the shenanigans that are taking place in the markets today, because of central bank interference.
Peter McCormack: So, Lawrence, what's the role of the Fed in all of this? How much influence do they have over rates, or how much influence do they have over this?
Lawrence Lepard: Well, a lot, because they set rates and they jawbone and they create expectations. Let me just highlight, Greg did a really excellent summary there of what's going on, and I'd just like to put a couple of exclamation points around it. The last time inflation was where it is today, which was back in 1982, the ten-year yield was 14%. The ten-year yield today is 1.75%, which is up enormously from the 1.5% that it was at at the end of the year, so it's up 17% in a week and a half. And the fact of the matter is, the negative -- I think people listening should just understand how far outside the boundaries of normality, and how outrageous these prices are.
Literally, if you buy a bond today with a negative real yield of -5.3%, as Greg said, and you hold it for ten years, inflation stays the same, and that's of course an assumption that everyone has to make their own determination what they think will happen will inflation; let's stay inflation stays the same, doesn't get worse, doesn't get better, you'll lose half your purchasing power over the ten years, more than half. I mean, it's just outrageous, it's absolutely outrageous.
There's no doubt in my mind that part of the way we got to these low rates is the Fed made it very clear, and they created what I call the "Fed put", what we all call the Fed put, which is to say that they've said that they can't tolerate high interest rates in a weak economy, they want to have continual growth; and therefore they've basically said, "If rates go up, we're going to intervene, we're going to buy, we're going to do quantitative easing", and that has manipulated the price, as Greg pointed out. And that manipulation is part of the reason why people were willing to pay these rates, because they could never go the other way, because they "knew that the Fed had their back".
What's changing right now, that I think is so fascinating to watch, is that it's becoming clear, the market's starting to think, "Hang on a second, maybe they don't have my back, maybe there's an issue here", and I think that's because I think even the Fed has been surprised by just how hot these inflation numbers are. And I personally, I don't know how Greg feels about this, but I personally don't see them getting any better any time soon.
I think they're very behind the curve and I was reading some things this morning talking about how, in fact, Jim Bianco, the tweet we were originally referring to that got this whole conversation started, had an interesting comment on his Twitter feed that said that he was hearing that the Biden Administration was asking the Fed and saying, "Hey, we've got to get this inflation thing under control, or we're going to get creamed in the mid-terms", coming up on 22 November.
So, the Fed has been talking tough and there are a lot of us who think they can't talk tough for long, or they're going to blow things up. Now, they've put in a bunch of swap lines, they've done a bunch of other things to kind of hide it. Fed Guy on Twitter has a good analysis of that. They might actually be able to follow through on some of this tough talk.
Peter McCormack: What's a swap line?
Lawrence Lepard: A swap line?
Peter McCormack: Yeah.
Lawrence Lepard: So, the Fed is controlling the supply of dollars and the supply of bonds and the flows of funds, and this goes to the Dollar Milkshake Theory that Brent of Santiago so eloquently describes. The world is short dollars because of Triffin's dilemma. All debt is dollar-denominated debt, and so everybody, when they want to pay back debt, they need to raise dollars. So, that's why there's naturally a bid for the dollar, even though I chuckled a little bit when Greg said the dollar was a risk-free security, or the US Treasury bond was a risk-free security; because one could argue that ultimately, if you really looked through all the noise, it's not. I mean, look at the condition of the US Federal Government.
But the point is, for the sake of argument, yes, it's risk free, because they can always print more. As Greenspan said, "They will never nominally default, because they can always print more money". So, what happens is, when you have one of these crises, like we had in March of 2020, or like we had in 2008, when things start to go pear-shaped and the markets start to get disrupted, everybody needs dollars. That's why they have to print like crazy, and part of the way they do that is they put in swap lines, because a lot of the people who need dollars are in Europe, or in part of the eurodollar market, and they can't get quick access to dollars.
So, when you're running a big Ponzi scheme that's based on continual dollar creation and you threaten to take away the future creation, somebody looks around the table and goes, "Hang on a second. The music's stopping, I'd like a chair, give me a chair", and that chair means having access to dollars. But again, to have that access, the Fed's got to be willing to print them, and the Fed's saying they're not printing them.
So, all of this goes to the exquisite dilemma that the Fed has that is they're just horribly trapped; they cannot move. To the degree they tighten, it instantly shows up in the bond market, as Greg has just alluded to.
Peter McCormack: Well, I think you're right about the Biden Administration, I think they're going to get creamed anyway.
Lawrence Lepard: Well, that may be so, but that's a different matter. The point is that the bond market is reacting very quickly and aggressively to what the Fed is saying. And of course, that may force a Fed reversal at some point in time. We all know there's a Fed put, and the question then becomes, "What's the strike price? Does the ten-year have to go to 2%?" I mean, it's at 1.7% -- where is it now, Greg, 1.75%, something like that?
Greg Foss: 1.75%, yeah.
Lawrence Lepard: Yeah, I mean does it have to go to 2%, 2.5%, 3%? I mean, that kind of an interest rate environment would be pretty expensive for a lot of people. We used to think the Fed put was tied to the stock market, the stock market needs to have a big correction, and it probably to a degree is. But again, they realise they have a legitimate inflation problem, and so they're trying to address it. The issue is that by addressing the inflation problem, they may be creating another problem, which is a dollar shortage problem, and something else will blow up. So, they push in one area, but another area blows up, is what I'm trying to allude to.
Peter McCormack: Well, it sounds like we're going to have to have some pain somewhere?
Lawrence Lepard: Greg, what do you think?
Greg Foss: In fact, you know what, the reality, yes you should in an efficient market, Peter. But going back to Lawrence's point, the original Greenspan put was when the equity market fell by 20%. The Fed had your back, they would come in and they would ease and rescue equity markets. My personal opinion is that number's probably closer to 10% right now. A 10% fall in the equity markets would cause a return of quantitative easing.
But here's the real thing, and Lawrence alluded to this. When the US dollar strengthens, because of things like increased interest rates in the United States, which make the United States a more attractive place to invest than, let's say, Europe, that strengthening of the US dollar causes emerging markets to get creamed. And eventually, the creaming in the emerging markets finds its way back to the S&P, because ultimately the contagion permeates and circulates around the globe until everybody says, "You know what, the S&P has to come down as well, because hedge funds out there, they're getting destroyed", and South America, for example, might turn around and say, "I'm starting to short US equities".
So, this is how everything's interconnected, but it starts with a strong dollar. It's my personal opinion that the Fed is painted into a box, that any talk of meaningful tightening is nothing more than virtue signalling, if you will. There is no way, and let's go back to this, Lawrence pointed out the last time posted inflation was this high, using the original CPI formula in 1980, US ten-year treasuries were double-digit yield, which means bond prices at the current levels, if we were to reach double-digit yields, ten-year US bonds would fall by over 40%. Can you imagine losing 40% of a risk-free asset called the US Treasury? Oh my God, no. And that's only because of inflation.
What happens, Lawrence, I postulate, when people understand that the USA really can default on their debt and all of a sudden start adding in a premium for credit concerns? This could turn into an absolute collapse. Now, the Fed doesn't want that to happen, I don't want it to happen. I will give advice that anybody owning fixed-income securities right now is likely picking up nickels in front of a steamroller. They should not be invested in this risk-free asset, because there is tremendous risk in these assets, as Jim Bianco pointed out.
Last week, the long bond, which is the 30-year Treasury bond, which yields 2%, lost 10% of its value. In other words, it lost five years' worth of coupon return in one week. That's not very safe. I don't know who you have to be to call that safe, but in my life, I don't call that a safe investment or a safe asset.
Lawrence Lepard: And actually referring to that exact tweet, when you take both the interest rate and the principal, it lost 9% of its value. And that was the worst one-week return in the 49-year recorded history of that bond. So, whenever I see a financial event that hasn't happened in 49 years, I immediately say to myself, "That's meaningful, something's going on here".
Greg Foss: It all happens, Lawrence, because it happens when interest rates have come from 14% down to close to 0% in the USA, under 1%, and a bond is a contract, ladies and gentlemen, as I've said. And this contract, there's no subjectivity to it. Once you sign that contract, it is fixed. That is why they call it "fixed income". And once that coupon is fixed, if that coupon is not in the realm of what markets should be yielding, the price of the bond has to go down, because the discretionary buyer has the option of buying any bond in a slew of Treasury securities that will reflect open market yields, and not the coupon on the bond.
So, it is the world's biggest market, and I'm talking about debt; total global debt is the world's biggest financial asset, but it's really misunderstood by so many people. And why is that? Because literally, we have lived in a bond bull market for the last 40 years, because in 1980, Paul Volcker, who was at the time Head of the Fed, was fighting inflation and he raised short-term interest rates to 18% to fight inflation. The current Fed is not going to do that, they can't possibly, it would cause the debt balloon to explode, so they're going to try and massage things, or whatever, right, Lawrence? They'll talk a good game, let's see what they can actually do.
Lawrence Lepard: I think the important thing to understand here is the Fed thinks they're dealing with a thermostat that they can just turn up and turn down and everything's going to be fine. There's no possibility of a big event occurring. What I would submit is that actually, they're dealing with an on/off switch of a nuclear reactor, and if they get it wrong, the damn thing's going to blow up.
That's why you've absolutely got to have a CDS on these sovereign bonds and sovereign currencies, because at some point -- it's horrifying to me to watch what these people are doing, it's absolutely horrifying. I really think they're in deeply, deeply over their head, and they can keep pulling it back from the brink, but at some point, this thing could break; and if it does break and it breaks hard enough, they're going to have to print until their eyes bleed and everyone's going to see it.
I mean, we just saw the Fed balance sheet go from $3.7 trillion to $8.8 trillion, or whatever it is. I mean, what's the next one going to be; we're going to go from $8 trillion to $24 trillion? Then we're going to go from $24 trillion to $100 trillion? I mean, at what point do people go, "Jesus, they can't stop, they just literally can't stop"? You can't taper a Ponzi, you have to print and you have to print in increasing quantities. And because you have to print in increasing quantities, I mean we all know Gresham's Law, we all know what happened in Weimar.
There comes a point where everybody knows, "Holy cannoli, these currencies have no value, none, zero, get me out of here, give me something else, give me a house, give me a car, give me some food, give me some guns, give me some Bitcoin, give me some gold, give me some silver, whatever. Give me something that's not this promise. Give me some liquor".
Peter McCormack: Give me some Eagle Rare Kentucky Bourbon. This is what I'm having.
Lawrence Lepard: That looks pretty good.
Peter McCormack: I can get through it now! You've got to be drinking, Lawrence.
Lawrence Lepard: But give me something that doesn't represent a claim that's run by a government that's completely and utterly devoid of morals and out of control, and has got idiots sitting at the top of the Federal Reserve, I mean these people are really stupid.
Peter McCormack: What actually happened last week, Greg, because Danny forwarded me Bianco Research thread.
Greg Foss: James Bianco, yeah.
Peter McCormack: Just so people who are listening, what actually happened; explain to them what happened?
Greg Foss: Basically, the start of the year is always when you re-evaluate, so it didn't hurt that it was the beginning of the first quarter, and people have to set out an investment strategy for the year likely. But what happens is, people realise, much like Lawrence is saying, does it make sense that I own this fixed-income instrument that yields 1.75% when inflation is running as hot as it has in the last 25 years? People will intrinsically look at themselves, and they'd better say, "Why am I signed up for a contract, or invested in a contract, where I am guaranteed to lose money on a real basis?" which means after subtracting out inflation.
My second derivative to that is, the $100 you lend the Treasury today for a period of ten years, they may well, not certain, but highly probable pay you back that $100 in ten years, but what is the value of that $100 in ten years, right Lawrence? It is substantially lower than it is today, at time zero. So, a bond contract is a bunch of buyers and sellers, the buyers being the lenders to the US Treasury, or any other corporation, they look at themselves and say, "Does this contract make sense in the context of inflation and credit concerns?"
Lawrence mentioned credit default swaps. Without getting too granular, the probably of default by the US Treasury is low, but it is not zero. And you can just get an approximation of the implied probability of default by looking at something called "the credit default swap market". Very simply, people are waking up to the fact that bonds may be far more risky than they've been led to believe over the last 40 years.
Peter McCormack: Sounds like a shitcoin!
Greg Foss: The US dollar shitcoin, right! But if you have sellers that outpace buyers, the price goes down. And when the price goes down, I mentioned, yields go up. So, while it wasn't a large move up in yields, the fact that a 30-year bond has something called "a very long duration", it's a mathematical calculation, it's actually the first derivative of price. That first derivative of price on a 30-year bond is approximately 20 years, which means that for every 1% increase in yields in the 30-year, the bond will lose $20 in price. Holy moly, it's only $100 to start with.
So, last week, it lost 10%. The price was $9.83, as Lawrence pointed out. Let's use $10. That means very simply that long yields only increased by 50 basis points, or 0.5%, and yet the price of the bond fell by $10. It's only bond maths, don't get too confused. Bond maths is very simple stuff, if you've done it for history, it's a pricing mechanism. The longer the duration, or the longer the maturity of the bond, the bigger the price changes for a given change in interest rates.
So, the long bond got smoked by 10%, but short bonds, one- to three-year bonds may have lost 25 cents to as much as 55 cents, sort of thing; really not material in the short-end of the curve, but in a yield curve that stretches out to 30 years, that's where they get crushed in the long end.
Lawrence Lepard: And, Peter, to further answer your question, what made it happen now also is that the fact that the Fed minutes came out, and the minutes were more bearish, hawkish I think than people expected. It was growing awareness that the Fed is going to, for a while, talk tough, and perhaps even act tough, in spite of the risks of blowing up the market; they need to, because they really need to try to put some cap on the inflation problem, and they know they've got a real problem.
Peter McCormack: So, Lawrence, you say these people are crooks and idiots and I agree with you and I feel assured that you're right, but what could they do? I mean, is the big issue that we're not allowing a correction to happen; do we just need a market correction?
Lawrence Lepard: Well, yeah, we don't really have markets, so it's hard to say you need a correction on something you don't really have. But I think Stein's Law applies, "If something can't go on forever, it's going to end". I mean, you cannot continue to -- you can't taper this Ponzi. It's either got to continue growing until it becomes hyperinflation, or it's going to collapse, because it's way out over its skis and there's just not going to be enough money feeding the system.
They're obviously going to try and walk some path between those two, and here's the best-case scenario for them, and I'm guessing what they're trying to aim for. They're trying to aim for medium to high inflation, not over 10%, but greater than 5%, and they're praying that the bond market hangs together. And they'll push rates up to 1% or 2% or 3%. So, what they'll then have is they'll have a nice negative real rate of 3% or 4%. If they can let that go on for five, six, seven, maybe ten years, and GDP doesn't fall apart, then the debt-to-GDP ratio will get somewhat normal and our system won't blow up. That's what they're aiming for.
Whether they're able to achieve that or not, I'd give it low odds that they can pull that off, just because of all the derivatives out there, all the leverage in the system, and the awareness. One thing that's going on here, and Greg pointed it out, we have had 40 years of deflation. I mean, look, think about it logically. Everyone can look at the inflation rate today and say it's 7%. Everyone can look at the bonds and say, "I'm getting 1.5%. Okay, I'm losing 5.5%". That's a shitty deal, everyone knows that. Why is anyone willing to hold that bond? Because they think inflation's going to come back down.
The consensus today amongst a lot of people on Wall Street and in the investment management business, wrongly so, is that the inflation is somewhat transitory and will eventually come down when COVID subsides and the supply chain problems subside, that's the consensus. And they're wrong, in my opinion. And the reason that is the consensus is they're doing what all investors have done since the beginning of time, which is you invest looking in the rear-view mirror.
We've had 40 years of deflation, and there are a lot of deflationary forces. Technology is deflationary, the China price was deflationary, demographics are deflationary; hell, even death's deflationary. So, there's a lot of reasons why we could have deflation. I mean, Lacy Hunt's not an idiot, but one would also see that we've kind of turned the corner on that trend, in my opinion, and we've let the inflation out of the bag; and once you do that, it's hard to put it back. It's extremely hard to put it back, and that's the lesson of the 1970s.
So, even though there were increasing rates during the 1970s, inflation was roaring, and I think it's going to roar here again. So, I think the people who are in a worse position today in the investment universe own bonds, and then ultimately I don't think equities will do well either. But at least equities represent a claim on a business that may be able to pass along price increases. I mean, Greg rants about this all the time and I totally agree with him; how anybody in any investment management professional could own a bond is just beyond me. You know, what's going on in the world, it's so far out there, it's absurd.
Peter McCormack: I think I asked Greg this question last time I was here, but are US bonds now essentially junk bonds?
Greg Foss: Not yet, but here's the truth. Firstly, if we measured true inflation using the original formula for CPI --
Peter McCormack: Where are we at, 15%?
Greg Foss: Correct. So, 7% is horrendous, but 15%, which may be closer to the truth, makes things even more ridiculous. What it requires, first of all there are investment policy guidelines that are set so that many professional investors and institutions have to own bonds, because that's what their investment policy mix is. But as people over time realise this might get foolish, surely they're going to think outside the box and say, "I'm going to adjust my investment policy guidelines so that I don't have to own 40% of my assets, for example, in bonds". I use 40% from the 60/40 traditional asset mix, with 60% equities, 40% bonds. But that takes time, Peter.
Over time though, there will be net sellers of bonds, I'm highly convinced of it, and a net selling of bonds means, if the Fed doesn't step in and buy them, interest rates go up and cause havoc in the market, disrupt mortgage rates for example, disrupt high-yield bond rates. But as junk goes, the USA is the best crack-house on a crack street. Other countries are in very, very bad shape before the USA.
So, my home country of Canada is in big trouble. We are not a high-yield borrower yet, but I promise you that Canada will fail ten years before the United States fails, and it will be the first G7 --
Peter McCormack: Just let me jump in there quickly. Are other country's bonds struggling independently because of their own --
Greg Foss: Credit quality?
Peter McCormack: No, I mean their own factors that are happening within that country?
Greg Foss: Oh, absolutely.
Peter McCormack: But is there a contagion effect from the US bonds struggling --
Greg Foss: Has to be.
Peter McCormack: But is there a contagion as well?
Greg Foss: There will, there has to be. So, look, they have the countries called the "Fragile Five", countries like South Africa, countries like Russia. These are fragile countries that can collapse because of their own economic scenarios that are less rosy than the United States, things that cause people to charge a premium on those bonds to reward them for the risk.
Look, in my career, Argentina, which is a G20 nation, has defaulted on their debt four times, four! Think about this. And now, the good thing is, Jack Mallers is doing everything he can to bring Bitcoin to Argentina.
Peter McCormack: Big up, Jack.
Greg Foss: But think about it for one second. Who, in their right mind, buys a 30-year bond of Argentina when, in my life, no 30-year bond has ever been issued and matured in Argentina? Well, there are lots of other countries that are in way worse shape than Argentina. Argentina's a G20, Canada's a G7, but we're hanging on there by a thread.
Listen, if it wasn't for the European Central Bank, Italy, France, Portugal, all the former PIIGS, so Portugal, Italy, Greece and Spain, they'd all be up there defaulting before Canada, but they have European Central Bank backstop support. It is ugly in bond land, in terms of earning return for the risk, and we joked about this the last time I was on your show. As much as Peter Schiff and I don't get along, I do agree with him on one thing. He called bonds "return-free risk", not risk-free return, but return-free risk. So, shoutout to Mr Schiff, yes, bonds are return-free risk, I'm giving him that one, yeah, great call.
Peter McCormack: Who's getting screwed here; is it the pensioners?
Greg Foss: Absolutely. You think about the guys, Blue Collar Bitcoin boys in Chicago, they're a bunch of first responders, firefighters and policemen and women, who are pushing their investment policy committee to remove bonds, or lighten the weighting of their bond allocation and incorporate Bitcoin. It takes time, Peter, but when it happens, and it can change, and then once a big fund, like CalPERS, changes their allocation, so do a whole bunch of other funds, like the Indiana State Pension Fund and the Firefighters of Houston, etc. So, everything trickles down.
The biggest problem here is, anybody who has a bond allocation is penalising their pension and their future returns, because those bonds are not paying you for the risk that your pension fund manager is taking. That's not good, I hope that it changes, because it's not fair for the pensioners; but at the end of the day, it takes time to change.
Peter McCormack: Lawrence, who else is at risk here? I mean, we've talked about the pensioners there. Who else is at risk here? What kind of assets are risky assets to be holding right now?
Lawrence Lepard: Well, any bondholders. I mean, I've talked to people who go to traditional financial planners. I mean, the model used to be, take 100 minus your age and that's your equity allocation and you have the balance in bonds. And I know wealthy people who have a lot of money in bonds, and their wealth is just going to melt away, it really is. So, it tends to be older people, because older people own more bonds than equities, but yeah, I think the pensioners are a big place that's going to get hurt.
It's funny though, I mean to some extent, even all these parties are getting crowded out, because the Fed is one of the biggest holders of the bonds. I mean, we're buying our own paper. And by the way, that's the beginning of the end, right, when you can't even sell your debt and you basically have to sell it to yourself. That's the definition of a Ponzi, and you print money to sell it, or you print money to buy it. Well, gosh, where's the real value.
Once again, these bonds will not default because they have a printing press. They can print as much money as is necessary to make sure you get paid the money in nominal terms. The question is, what will the money buy you? That's the question and that's the issue, and it's the Hemingway quote, slowly then all at once. These bonds are losing value, and as people come to see that they're losing value…
I mean, I've often said that yield curve control could lead to the entire bond market saying, "Sold to you, Fed". Think about it. I just don't get, why would you buy a ten-year obligation at 1.5% when inflation's running at 7%? I mean, it's so crazy upside-down as to be almost insane. So, I think that there's going to come a time when people do it out of tradition, and they do it because they're looking backwards, and they do it because they have mandates that they have to do it, and there are a lot of reasons why people do it. But slowly but surely, they're going to do it less, especially if the 7% persists or grows.
As that occurs, the Fed's going to be faced with a choice: either let interest rates go up and then croak the stock market and the economy, and they might do that; or, intervene and buy more bonds. With what? Certainly not with savings. They're already running at 40% deficit on tax revenues. I mean, it's amazing. Basically we spend $6 billion and we only collect $3.5 billion, or something. They're going to do it with printed money.
Again, a crack-up boom, a failure of a currency, hyperinflation, it all occurs when enough people become aware that the policy is, and has to be, to debase the currency to get out of this problem. I mean, there's no going back, we can't have a Paul Volcker, we can't go to 20%. If we went to 20% interest rates, the entire world would go bankrupt overnight. If we went to 5% interest rates, probably the entire world would go bankrupt overnight, so that's not going to happen.
So, there's no going back through establishing credibility. We're way beyond the point where we can save the system. Now it's just a matter of, are we going to die with fire, which is hyperinflation, or are we going to die with ice, which is a debt collapse and deflation? That's the only remaining question in my mind. Then the other remaining question is, on what timescale? I thought it was happening in 2008, obviously I was wrong. 12 years is a long time. But they're coming more rapidly now, in my opinion, and we're in a fourth turning. And my sense is, by the end of this decade, it will be all over, and probably within the next two to five years it will be pretty seriously over.
Frankly, I think this year is going to be one hell of a year. I mean, it's really, really clear that the Fed is the naked emperor and there are a lot of little boys now pointing at him. So, that knowledge is going to spread and the next time gold goes through $2,000 or Bitcoin takes out $68,000, $69,000, they're going to both move and they're the fire alarms that say monetary debasement, front and centre.
The other thing that's going to happen, I think gasoline is going to be a big thing. Everyone knows what the price of gasoline does. I filled up my car last night, it was $4.20. I have a nice car so it's premium gas, but the point is, when we start seeing $5 and $6 gas prints, you're going to hear some people howl, and that's common, because oil's at $82 right now and it's marching. The oil chart looks fabulous, it's just marching relentlessly higher.
So, my opinion is inflation is going to cook these guys and I don't know what the hell they're going to do. I don't know why J Powell wanted to be reappointed. I mean, he has to be one of the dumbest men in the world. I mean, if I were in that job, I would have gotten out of there so damn fast, your head would have spun. I would have said, "Thank you very much, I'll hit the lecture circuit, I'll write a book, I'll call myself a hero. Bernanke, I mean all those guys, when you're in that seat, he's going to be the guy frankly who takes the blame when this whole thing comes undone.
Greg Foss: Now, the interesting thing with everything Larry said, I think to a man, as a person on this podcast, none of us want this to happen though, right, gentlemen; we do not want this system to unravel; you cannot possibly want that? So, there is a solution, and we've talked about what that solution is. That solution is a Bitcoin standard, or a parallel network that operates as your savings account, and the fiat currency is your chequing account. And you use the fiat currency for things like international trade and avoiding barter. But you don't store your value in your chequing account, you store your value in your savings account.
If the United States adopts the Bitcoin standard, which I think they should do and I think they will do, then you can ensure that this network transfer rescues this horrible outcome, and you can continue having a fiat global reserve currency, and the global reserve asset will be Bitcoin, not US Treasuries anymore, but Bitcoin.
Lawrence Lepard: I completely agree.
Peter McCormack: Isn't there a risk though, Greg, that if the equity markets drop, that Bitcoin still correlates with the equity markets, and Bitcoin itself could drop? You don't think so?
Greg Foss: No question it could drop, but here's the reality, and I've tried to explain this. The best thing I can describe Bitcoin as, is it is credit protection on a basket of sovereigns; Lawrence brought that up. If you think of what credit protection is, it is a short credit position, meaning you are long volatility. Right now, Bitcoin trades as a short-volatility asset, it trades in line with equities. Equities are a short-volatility asset.
But people haven't done their homework to understand what the beauty is of this instrument. It's only 13 years old. Most people don't understand what credit protection is to begin with, let alone what a long-volatility asset is. But the smart guys out there, the Ray Dalios of the world, I promise you, understand what a long-volatility asset is. So, it's a question of education. More importantly, it's a question of the big money understanding this most beautiful instrument which will hedge all their other short-volatility positions. In reality, you should own Bitcoin against the price of equities falling, like everyone trades them.
Now, here's an interesting thing and Lawrence may opine on this. Open interest in Bitcoin futures just reached all-time highs. Okay, are there equity players out there that are short Bitcoin to hedge their long equity positions? I guarantee you there are.
Lawrence Lepard: Oh, absolutely.
Greg Foss: That's what's called "hedged and wedged". You are in an inverted trade and you're going to get your face ripped off when the world understands that Bitcoin is actually insurance, and everyone who's short insurance now needs to not only cover their short, but actually go out there and buy insurance as well. It will create what I called in a Bitcoin Magazine article that I wrote with Seb Bunney, "the gamma squeeze on the Fed put".
Bitcoin is a put on the Fed put. It's the most beautiful option instrument ever designed. It has no fadeout, which means no time expiry. It is actually a long-volatility asset, and the gamma squeeze on the Fed put means the Fed central bank is also going to have to be a buyer of Bitcoin. It will be a face-ripping rally that will make your eyes bleed, and it's coming as open interest.
Lawrence Lepard: Yeah. Anyone who's short Bitcoin is going to get rekt. I mean, they're just going to get absolutely, totally and utterly rekt. I mean, imagine a situation where Bitcoin goes to $1 million a coin in the space of three or four months? I mean, people will just get destroyed. I mean, Caitlin thinks a GCIP will go down as a result of it, because people who are on the short side of the Bitcoin trade don't understand what they're doing, and if they're putting on the trade that Greg just talked about, they're insane, they're absolutely insane, because there's a limited supply of this stuff and it could go discontinuous up, almost to the point where there's no offer.
It will probably croak the financial system at some point, and so to be short is, I mean, I can't imagine anything more stupid, I really can't.
Peter McCormack: Oh, man. Well, listen, cheers! I'm enjoying my whiskey here!
Lawrence Lepard: I mean, look, it's going to be a rocky thing, it's going to be hard for us. I mean, how would we all react if Bitcoin were at $0.5 million a coin? Quickly.
Peter McCormack: I'd be blowing it on another car.
Lawrence Lepard: Well, right. I mean, it's messy.
Greg Foss: But that car may not be safe in your driveway, okay. So, you might buy it Peter, but it might not ever live a day to drive around the block, okay?
Peter McCormack: That's true.
Lawrence Lepard: We all might have other problems. I mean, the sad, sad thing, nobody wishes for the system to blow up. None of us created this system and none of us voted for this system, but the system is what it is; and I think it's important to understand that the Bitcoin Network is just a mathematical network, it doesn't give a shit. And there is no higher authority that can bail it out. And if there's more demand than supply, the price is going to reflect that. And if people have written derivatives around it, and anyone is short it, they're going to get rekt, period.
Peter McCormack: Are there any historical precedents to what we're going through right now, where you can look back and say, okay, there was a similar time here and therefore we can kind of predict what's going to happen?
Greg Foss: The difference now, Peter, is that the debt burden has never been this high, and we have never been dealing with a debt burden, not just government debt, but total global corporate and federal, provincial, every debt included has never been this high relative to global GDP. So, it is certain that currencies will debase in the absence of a crisis. But if another crisis happens, they'll just accelerate their debasement. So, we want to create a parallel network.
I want to give Larry a shoutout, because gold bugs have known this for a long time, and this is the difference between our friend, Peter Schiff, and Lawrence Lepard, who basically Larry saw a better horse at the horse track and adjusted his portfolio allocation accordingly, and that's the mark of a great risk manager. When the information changes, that risk manager adjusts his or her portfolio position. So, a shoutout to Larry for at least doing what he can to protect and fulfil his fiduciary responsibility to his unitholders.
On the flip side, Peter, who admits he doesn't care, on our debate, "I don't care about my fiduciary responsibility", I don't think I'd put a whole lot of money with Mr Schiff. But at the end of the day, there are smart asset managers out there that are making the right portfolio changes that will reward the unitholders. And we can get to a point again where you have a network transfer. And in a network transfer, you don't just flip a switch and forget the old network and hope that the new network survives. Our network is only 13 years old, and I don't want the USA to fail, because that means Canada will have failed 10 years prior to that. And I don't want that, because I have three kids who live in Canada.
So, when is it going to happen? This can go for a while as long as things are put in place as protection mechanisms. Every single fiat will fail, the USA will be the last, and Canada will be substantially prior to the USA failing.
Lawrence Lepard: Your comments are great, but let's go back through history, because there are some similarities. There's nothing perfectly comparable with this, because no Bitcoin existed pre this, but they almost lost it in the 1970s. The 1970s culminated with the Hunt Brothers trying to squeeze the silver market, and they had it. There was more paper silver out there than there was real silver, and they might have put a lot of people out of business and they might have won, but the powers that be changed the rules. They basically went to the CME and said, "We're going to change the rules. This is liquidation only, you cannot buy any more", and that was the end of it.
But how are you going to change the rules of Bitcoin? You can't do that, you just can't do it. If everyone wants Bitcoin, the network's there. But here's a risk. They kind of did it in 1933. Gold was doing it, gold was the winning trade, and the government said, "All right, we've got to severely devalue the dollar, because we've got a debt crisis going on here. All right, it's illegal to own gold. Oh, and by the way, turn all yours in. And by the way, we're going to write it down 70%". So, there've been other countries that have failed.
Credit cycle leading to enormous leverage leading to currency failure, this is not a new thing. Dan Oliver at Myrmikan is in the process of writing a brilliant book about this, and I've read drafts of it. This has been going on for hundreds of years, thousands of years. I mean, John Law ran something similar to this; the French assignats were similar to this; Zimbabwe did something similar; Venezuela did something similar to this.
Printing money is an age-old political game that has been played that always ends in tears. I mean, Voltaire said it so well, "Fiat currencies always return to their intrinsic value: zero". The problem is that in the interim, they happen to be what you need to use to pay for gasoline. So, it is getting the timing right, and Keynes said it right too, "The market can be irrational longer than you can stay solvent". So, you've got to time it right.
But to be living in today's world and to not have some monetary insurance, I mean we all have to admit, this is the craziest monetary situation we've seen in our lifetimes, at least I know it is in my lifetime. And, given that, how can you live without having monetary insurance? To me, there are three really obvious and clear forms of monetary insurance: gold, silver, Bitcoin. They each have different characteristics, different positives and negatives. Bitcoin's the fastest horse, don't dispute that, but gold and silver aren't going to zero. Silver has a lot of uses and gold's been money for 5,000 years. So, they are all monetary insurance, they all beat fiat and they all beat bonds denominated in fiat, and that's the key takeaway from my point of view.
Peter McCormack: And, Lawrence, are you changing your allocation to any of these markets, based on what's happening, or any of these commodities?
Lawrence Lepard: Well, yeah. I've said this in the past, I'll just be upfront, everybody knows: my PA is about 60% Bitcoin, 40% gold and gold stocks. The fund I manage, everyone who invests in my fund, they bought a gold-stock fund, meant to hedge against monetary debasement. Against some protest of some of my investors, I convinced them that they should have an allocation to Bitcoin in the fund. They said, "Fine, just don't make it too big". Okay, I took it up to about 5%, and then Bitcoin did a five-bagger.
So, now it's about 25% of the fund and if it continues to grow as a percentage, that would be great. I'm not selling any of the Bitcoin, but I haven't exited the gold business, because the people who invested with me, they bought a gold-stock picker fund. And I can create alpha there. The gold market does what it does, and gold stocks do what they do, but I'm also a stock picker. I had a stock recently we sold and in a market that was down 16%, we created a 100% rate of return, so that's a lot of alpha; or, I'm sorry, the market was up 16% from when we did the deal to when we sold the company, and we made 100% return on the investment and the market was up 16%, so it was 85 points of alpha. So, I'm paid to do that in my fund.
But I can see Bitcoin, it's a faster horse, it's got a lot of beautiful characteristics. It may ultimately become -- I mean, the gold thing may fade away. But that's not what my investors bought and my first obligation is to give my investors good risk management, as Greg has said. Personally, I've got more Bitcoin than I've got gold.
Peter McCormack: What about you, Foss, what are you doing?
Greg Foss: If you include the company that I'm working with as a Bitcoin derivative, which I do, I'm higher than Lawrence, but again that's assuming that my private equity investment is truly a Bitcoin derivative. There's arguments out there that we have some Bitcoin maxis that say, "You have to be all in", and they actually question me. They say, "Foss, if you're such a Bitcoin bull, how come you're not all in?" and I answer very succinctly. If Bitcoin goes to the price I think it's going to go to, I'm going to do just fine and I don't have to put all my eggs in one basket, because I'm highly confident, but I'm not certain, and that's how I've always managed risk.
This is the greatest asymmetric return opportunity I have ever seen, I'll be very clear about that, but I still don't have a 100% allocation to Bitcoin. It's not the way I've managed risk, and by the way, I don't need to have that allocation in order to gain the upside asymmetry of the trade opportunity or the investment opportunity.
Lawrence Lepard: Exactly. I think an interesting way, and I've been saying this recently, "Gold is a CDS on Bitcoin failure", and I don't think Bitcoin's going to fail. But if heaven forbid, Bitcoin were to fail, the next best choice would be gold. So, when I'm talking to maxis who have 100% of their money in Bitcoin and maybe they're not comfortable with the volatility, I'm like, "You know what, you wouldn't be crazy to take 10% and buy some gold, you wouldn't be crazy. The 90% will get you to where you want to be, and the 10% will help you sleep at night, and it's not going down".
Peter McCormack: Do you know what, I've been thinking about that a lot, because I am pretty much 100%, maybe 105% Bitcoin! I've been thinking about that 10% allocation to gold. I've also been thinking about putting a little bit more in property.
Lawrence Lepard: That too, yeah, property's good. The only issue there is they can tax that shit. I mean, the property taxes -- and as we all know, these governments are going to get more and more aggressive.
Peter McCormack: Yeah, property tax is different in the UK than the US and Canada, but yeah, I understand what you're saying. Well, listen, I'm glad I had a bottle of whiskey to go through this, because I'm smiling away, but I'm smiling away at some pretty apocalyptic potential outcomes. But it will be what it will be. I'm with you, Foss man, I think more people need to realise Bitcoin is the escape valve for a lot of these people. But listen, appreciate you both coming on. We've got to try and get the three of us together in person.
Greg Foss: I look forward to that.
Lawrence Lepard: Yeah, any time.
Peter McCormack: We'll make that happen.
Greg Foss: Lawrence and I have a standing date in Boston. I actually have to pay a bet I made with a mutual friend of Larry's and mine that, as a bit of a quirk, I bet on the price of Bitcoin at a closing level. He's a gold bug, a very intelligent gold bug, I may add, not knowing him as well as Lawrence knows him, but here's the cool thing. It's not about Bitcoin versus gold. First of all, gold is still arguably $10 trillion. It's pretty small in the global pie of financial assets, which is US$900 trillion. Of that $900 trillion, debt is $400 trillion.
Get me 10% of the debt market going into Bitcoin. 10% of the debt market is $40 trillion. $40 trillion divided by 21 million, oh my goodness, there's your $2 million price target of Bitcoin. We don't have to argue with the gold bugs, we don't have to argue with the equity guys, the debt guys are the idiots in the room. If you are lending money, you are a clown. You failed mathematics. Understand that Bitcoin is your appropriate new asset class. If you're going to allocate to Bitcoin, you have zero Bitcoin, you need to get some, take it out of your bond portfolio, take it out of your bond basket and move it into Bitcoin.
Get off zero, right, Peter? There's too many people in the world that still have zero allocation to Bitcoin, and that is too dangerous.
Lawrence Lepard: It's not all apocalyptic. This thing will get sorted out, it really will. I mean unfortunately, there will be some people who were naïve who will get hurt, but a lot of people won't and the issues here will get sorted out. We will return to sound money and I'm very much in the Jeff Booth school of the world being a really great place when we get to the other side of this transition. It's just going to bumpy, that's all, it's going to be really bumpy, but people get a couple of chances at it.
I mean, look, there are people at 69 thinking, "Hey, this shit's getting away from me", and now they've got a chance. They had a chance recently to buy it at $41,000 and this is the case for dollar cost averaging. Just save in Bitcoin terms. In ten years, you'll be really glad you did.
Peter McCormack: Well listen, Foss, you let me know when this dinner date is in Boston, I'll fly out. Wherever I am, I'm going to come out. I need to be sat at that table.
Greg Foss: Yeah, and we'll get together with Jason Lowery too, right, we'll do that again with Jason Lowery.
Peter McCormack: Spooks are us, we'll do that.
Greg Foss: Spooks are us, yeah! Listen, guys, thank you so much.
Lawrence Lepard: Yeah, thanks, guys, I really enjoyed it.
Greg Foss: I love what you both are doing for the community and I'm so proud to be part of this community. So, yeah, we'll get together in person, and I'll see you in Miami, if not before, okay. I'm looking forward to that.
Peter McCormack: Let's do that.
Greg Foss: Okay, boys, thank you again, goodnight.
Lawrence Lepard: Take care.
