Top Three Videos – July 14 2023

Quick Summary Bullets:

Concerns about Fiscal Dominance and Inflation

• “The more the FED raises rates, the more inflation is actually going to go up because the more deficits are going to go up.” – Luke Gromen suggests that rising rates may actually lead to increased inflation, challenging the traditional belief that rising rates are bad for gold.
• “If the world returned to two percent inflation rates, the U.S would be facing an immediate fiscal dominance problem.”
• “The sooner we get the real rates and if we get to positive two we’re going to be in it which is this Paradox right because you hear most of the discussion in macros well. The FED has to fight inflation so they’ve got to get the positive real rates again and what this white paper says is. They get the positive real rights.” – The paradox of needing positive real rates to fight inflation while also impacting bank profitability.
• Many countries are realizing that achieving a 2% inflation target is unrealistic if they want to avoid a financial crisis.
• The math is now so obvious that accepting higher inflation is necessary for systemic stability, even if it goes against political considerations.
• “Why can Japan have deflation yet the U.S not be able to withstand anything but inflation?” – Gromen raises the question of the differences between the debt systems and balance sheets of Japan and the U.S., challenging the conventional understanding of inflation and deflation dynamics.
• The current situation of high debt-to-GDP ratios and large deficits in the United States raises concerns about the ability of the government to handle higher rates on treasury issues and the potential for fiscal dominance, where the Federal Reserve loses control of inflation.
• Historically, the dollar preserves its dominance by forcing nations to collapse before the U.S. banking system does, making it a relative game of who hits the wall first.
• Rising inflation and energy prices will have significant impacts on financial markets due to high debt and deficits.
• “When there’s that much leverage in the system, things are going to break super fast and when there’s that much leverage in the system, when one thing breaks fast, everything breaks fast.” – Luke Gromen on the nature of leverage and its impact on the financial system.

Impact of Rising Rates on Gold

• Rising rates are no longer negative for gold because it introduces increased solvency risk to Western sovereigns and increases fiscal dominance risk, which is positive for gold.
• Rising rates are no longer bad for gold.

Challenges to Traditional Beliefs

• “We live in a fantasy world. Now reality has been destroyed. This is the time that you really need to pay attention.”
• “Rising rates are no longer bad for gold” – Luke Gromen suggests that gold can still perform well despite increasing interest rates, challenging the traditional belief.

Transcript Summary:

• 00:00 Gold is expected to increase in value due to factors such as increased Central Bank gold buying, the need for energy prices to rise, and the high debt levels of Western sovereigns, making rising rates no longer negative for gold, and while trading during this unprecedented time may be difficult, the end game is clear and the speaker advises staying unlevered and waiting for increased liquidity from the Fed.
  • Gold is expected to increase in value due to the current economic environment.
  • Gold has started to separate from its correlation with real rates and is likely to continue to do so throughout the decade due to factors such as increased Central Bank gold buying, the need for energy prices to rise, and the high debt levels of Western sovereigns, making rising rates no longer negative for gold.
  • Rising rates are no longer bad for gold as seen in past instances in Latin America, Russia, and Southeast Asia, and the Western banking system will prioritize supporting the banking system over fighting inflation.
  • The US may face a capital crunch as it needs to refinance a significant amount of debt, and if the Federal Reserve does not provide enough liquidity, there could be a spike in the dollar, an increase in rates, and a decline in risk assets and the economy, or if the Fed does provide enough liquidity, there could be a re-acceleration in inflation.
  • Rising rates are no longer bad for gold, bonds, risk, inflation, commodities, Bitcoin, and stocks, and while trading during this unprecedented time may be difficult, the end game is clear and the speaker advises staying unlevered and waiting for increased liquidity from the Fed.
  • Gromen believes that the Federal Reserve will have to provide more liquidity due to high inflation and fiscal deficits, but acknowledges the possibility of high volatility in the short run and the political challenges the Fed faces in making tough decisions, especially with an upcoming election.
• 12:30 Rising rates are no longer bad for gold due to fiscal dominance and increasing inflation, making short-term treasuries a better investment option than long-term ones.
  • Shorting long-term US, UK, and Western sovereign debt is currently the clearest trade due to negative term premiums and lack of demand, unless there is an imminent crisis.
  • Rising rates are no longer bad for gold due to fiscal dominance and increasing inflation, making short-term treasuries a better investment option than long-term ones.
  • Owning 10-year U.S. treasuries during a severe recession doesn’t make sense because the U.S. government cannot cover its interest obligations with tax receipts, let alone other expenses.
  • Rising rates are no longer bad for gold because the Treasury market will break and the Fed will implement massive quantitative easing in a severe recession.
  • The US government will print money to avoid defaulting on treasuries, leading to a fiscal dominance problem if inflation rates return to two percent.
  • The high debt and deficits have forced the Fed to print money to finance the government, leading to fiscal dominance and a loss of control over inflation.
• 20:02 The need for high inflation to finance deficits and stabilize the banking system is leading to a shift in policy, making long-term US, UK, and EU debt a favorable trade.
  • CPI needs to be high to finance deficits and the Fed may cut interest rates on reserves to encourage lending.
  • The reserve ratio and lack of interest payments on reserves are negatively impacting bank profitability and financing the US government, leading to the need for positive real rates to combat inflation.
  • Inflation is expected to rise and countries are acknowledging that achieving a 2% inflation target is unrealistic if they want to avoid a financial crisis.
  • The choice between depression or inflation is inevitable due to high deficits, and senior policymakers are now openly admitting that accepting higher inflation is necessary to avoid a banking stability problem.
  • Higher inflation is necessary for systemic stability, making long-term US, UK, and EU debt a clear trade, as policymakers are puzzled by the persistence of high inflation despite rate hikes.
  • The speaker suggests that the Federal Reserve is starting to realize that they are trapped, as evidenced by Chairman Powell’s response to a question about fiscal dominance.
• 26:35 Rising rates are no longer bad for gold as evidence suggests central banks have been buying gold since 2014, foreign creditors require a positive real rate of return, and the US government may face fiscal dominance and inflation issues with rising interest rates.
  • The evidence suggests that the banking system’s collapse and the failure of China and Russia to break before the US has led to a realization that the previous understanding of the world is incorrect, and central banks have stopped buying treasuries and instead have been buying gold since 2014, with a significant increase in 2022, and there have been small steps towards implementing yield curve control in the US through programs like btfp and the treasury buyback program.
  • Gromen believes that the Federal Reserve will avoid yield curve control as it would trap them, and instead, they will use other liquidity measures to supplement buying treasuries, with the process leading to yield curve control being paved with more liquidity crises.
  • Foreign creditors financing the US twin deficits require a positive real rate of return, making rising rates no longer bad for gold.
  • Gromen explains that trying to replicate Japan’s economic policies will lead to a similar outcome as Argentina, and highlights the importance of understanding Japan’s relationship with the United States in analyzing its economic situation.
  • Rising interest rates will lead to a significant increase in interest expense for the US government, which highlights the fiscal dominance issue and the potential for inflation, while the commercial real estate sector may face challenges due to both rate changes and changes in work patterns.
  • A substantial percentage of the younger generation is permanently working from home due to tight labor markets and it being a condition of employment.
• 40:24 Rising rates are no longer bad for gold as the US faces high inflation, debt, and deficits, potentially leading to fiscal dominance and loss of control of inflation by the Federal Reserve, while the dollar’s hegemony is gradually eroding and developing countries are seeking alternative payment methods.
  • Commercial real estate, particularly office space, will need to be worked out over a long period of time through extending and pretending, but the challenge lies in the high levels of inflation, U.S. debt, and deficits, which may push the U.S. government into fiscal dominance and cause the Federal Reserve to lose control of inflation.
  • Gromen believes that the banking problems are symptoms of a fiscal crisis in the US and the West, and that the choice is between inflating or letting the banking system collapse, with the former leading to more inflation and higher rates, but ultimately the steps taken by the authorities suggest they will not let it get too bad.
  • Banks face a greater risk from fiscal dominance and financial repression by the government rather than another 2008 crisis, with inflation control being crucial, while the impact of the BRICS on the dollar is also discussed.
  • Nations trading oil for yuan and the decreasing percentage of the dollar in FX reserves suggest a gradual erosion of the dollar’s hegemony, but it will still be used in financial transactions and trade.
  • The strength of the dollar is causing developing countries to move away from it, resulting in dollar outflows and a need for alternative payment methods, which is a sign of the dollar’s dominance being undermined.
  • Issuance has not hit the race, as the US banking system and UK guilt market blew up first, while China, India, and Brazil were not affected, indicating that the increasing dollarization of commodity markets buys time for countries like Argentina to trade with China and strategically shift away from the US dollar.
• 51:24 Rising energy prices, particularly oil, may disrupt the market equilibrium, leading to higher inflation and potential control of the oil, inflation, and bond markets by OPEC and Russia.
  • Gromen discusses the concept of assuming a can opener and how it relates to economists.
  • The IMF accepting the Yuan as a payment from Argentina could potentially undermine the US dollar’s hegemony and reinforce the belief in the global South that the IMF is an arm of US hegemony and dollar support.
  • The current low prices of oil and lack of investment in the industry may lead to a major supply crisis in the future, as highlighted by the Saudi oil minister and the decline in global oil production growth from US shale basins.
  • Inflation is expected to rise due to increasing oil prices, which will have significant impacts on financial markets, and the shale industry is responding to investor demands for cash flow rather than investing in new production.
  • Rising energy prices, particularly oil, will disrupt the fragile equilibrium of the market, leading to higher inflation and potential control of the oil market, inflation, and bond market by OPEC and Russia.
  • Gromen suggests that the release of the Strategic Petroleum Reserve was used to protect the treasury market and lower inflation, but now that those measures have been exhausted, there are limited options left.
• 01:02:38 The Biden Administration’s decision to buy oil at a higher price has implications for the global economy, shale production, inflation, and geopolitics, while OPEC’s control over oil production and the bond market is crucial in preventing economic crises and maintaining political stability.
  • The Biden Administration’s decision to buy oil at $68 to $70 per barrel is wise because it has implications for the global economy, U.S. shale production, oil prices, the dollar, inflation, the bond market, and geopolitics.
  • OPEC is cutting oil production to support the market and act as the adults in the room, while Western markets are controlled by short-term thinking traders.
  • If oil prices drop to $40-$45, shale production will decrease, causing the US to be unable to address a subsequent increase in oil prices, leading to OPEC and Russia controlling the market and the bond market collapsing, which would be detrimental to the economy and geopolitics.
  • Rising oil prices due to a potential oil shortage in 2027 would negatively impact political stability, bond markets, and sustained demand for oil, making it unfavorable for Saudi Arabia.
  • Central banks are cutting rates to prevent a potential economic crisis in 2027, as the consequences of higher or lower oil prices have far-reaching effects on geopolitics, bond markets, and the overall solvency of Western governments.
  • In a highly leveraged system, when one thing breaks, everything breaks fast, and there is a lack of appreciation for the second derivative impacts of oil supply and price issues.
• 01:11:17 Rising rates can potentially be a catalyst for gold.