PREVIEW： Realpolitik #25 ｜ The Next Financial Crisis with Dan Tubb
Episode Stats
Words per Minute
170.20337
Summary
Firas and Dan discuss whether or not we are facing another financial crisis, and whether it will be worse than 2008, and why China could be a better option than US Treasuries in the short term.
Transcript
00:00:00.000
Hello and welcome to another episode of RealPolitik. I am your host, Firas Modad, and I'm joined
00:00:08.940
here by Dan Tubb. And we are going to talk about whether or not we are facing another
00:00:15.080
massive economic crisis that makes 2008 look like a bit of a picnic. What do you think?
00:00:23.540
Well, I suppose the central throne you're going with here is, you know, is this going
00:00:26.760
to be worse than 1929? Is it going to be worse than 2008? I mean, what I would say is that
00:00:31.820
the central bankers are developing more tools all the time to manage these situations. And
00:00:37.620
it's got a whole bunch more tools than it had in 2008. The issue they got is that the underlying
00:00:43.200
problem is bigger and getting bigger all of the time. So at some point, there does have
00:00:48.320
to be a reset of this system. And when we get to that point, every time they've managed to
00:00:52.540
kick the can down the road for, you know, another couple of years, well, that can gets
00:00:57.140
bigger. You know, it's a pretty bloody colossal can at this point.
00:01:00.440
Yes, yes, yes. And I think what one of the things that sort of expresses this idea is that
00:01:08.060
now we are in a new world where Chinese dollar bonds are yielding the same as American treasuries.
00:01:14.900
And previously in the year, they were yielding less than American treasuries. Help me, help
00:01:22.960
Yeah, so bonds have got this curious relationship where the higher the yield, the more stressed
00:01:31.680
they are, the lower their yield, the more demand there is for them. Yields move inversely
00:01:37.980
So yield is how much you get on placing your money in that asset.
00:01:43.240
So say the bond is $100, and it pays a 5% coupon, or $5 coupon, then that's a 5% yield
00:01:52.200
on it. And, you know, that might be about the level that a lot of these go out. If no one
00:01:58.040
wants to buy the bond, then the price of the bond drops. And so the yield on it you get goes
00:02:03.440
up, because it's essentially saying, well, this is paying more now. So why don't you come
00:02:07.200
and buy it? And eventually, at some point, even though they might think, well, the US
00:02:10.880
has actually no intention of paying back this debt ever. Well, yeah, but I can get 8% on
00:02:16.200
it, so I'm going to buy it. Conversely, if everybody has strong belief in the system, those yields
00:02:22.600
might compress down to, you know, the levels that we've seen, you know, pre 2008, which
00:02:27.600
is, you know, basically nothing, because it's such a sure stock of value that you don't really
00:02:33.720
need to be enticed with a coupon that goes on it.
00:02:36.400
So the markets are saying that they trust China, which has a much less liquid financial
00:02:42.040
system, and which is obviously the United States rival, as much or more than they trust
00:02:53.920
So essentially, what this is, is a battle for the risk free rate, for who has the greatest
00:02:59.800
level of credibility, because of course, elections don't change anything at this point. So the
00:03:03.100
only measure of confidence you can give in a government these days is bond yields, effectively.
00:03:08.380
Now, when I was doing my financial exams, the answer to various questions would be that the
00:03:15.520
US treasuries and UK gilts are the risk free rate.
00:03:20.820
You know, if whatever they're paying, that's the absolute minimum that you should consider
00:03:25.740
for any other investment. You know, if your investment is moderately risky, you should
00:03:30.220
be paying whatever gilts are paying, or whatever US bonds are paying, plus a little bit, or if
00:03:34.680
your thing is a bit more risky, plus a little bit more. And that's how you kind of you measure
00:03:38.960
the value of assets, and then you discount them back.
00:03:41.780
And for years, it has been the dollar and the UK guilt.
00:03:48.660
Although if you're an American financier, you probably would leave out the UK guilt, you
00:03:52.960
just reference the dollar. And it is increasingly clear that Western governments have got themselves
00:04:00.720
in a situation where not only do they have no intention of paying back the debts, but they
00:04:05.700
intend on cheating on the interest side as well.
00:04:08.120
They're just going to financialize the markets. They're just going to force people to buy
00:04:12.720
these bonds through financial oppression, which I'm sure we can talk about when we get
00:04:15.620
into this. And it's starting to look like China could potentially be a more viable, a
00:04:22.180
more credible government in terms of retaining your value over long periods of time, which
00:04:27.680
these bonds are supposed to do. Often, you know, 10 year periods are supposed to do.
00:04:31.380
And I think what we're talking about here is Chinese issuing dollar denominated
00:04:36.420
bonds. So the dons are priced in dollars. They pay coupons in dollars, but they're backed
00:04:43.500
by the Chinese instead and their ability to command dollars. Now, that's, you know, perhaps
00:04:49.540
not wildly surprising because the Europeans have been doing a similar thing for a long
00:04:53.460
time. But they are, you know, London, for example, is deep within the US dollar system.
00:04:59.540
It has certain privileges in order to operate this global dollar system, which is one of the
00:05:04.260
reasons why if it came to, if Labour had a proper collapse at some point, the one
00:05:11.380
advantage we've got is we are so deep within the dollar system that the US would have an
00:05:14.900
incentive to make sure that it doesn't end too messily for us.
00:05:19.140
They would want to involve. China doesn't quite have that.
00:05:23.640
No, it's quite, quite. But they're at the point where they can realistically operate within
00:05:32.060
this dollar market with such depth and liquidity that their dollar denominated bonds attract
00:05:37.580
more credibility. And you can see that with the rates that display on them.
00:05:44.000
I mean, there was another thing that I could, I don't know if you've got gold coming up on
00:05:50.760
We're seeing what the gold price is doing. Yes, it's going through the roof.
00:05:55.220
I mean, the reason I mentioned that is because, you know, as a, you know, some of my sort of
00:06:01.340
outlook on markets, my sort of Austrian outlook, I went through, of course, the whole gold bug
00:06:07.680
Where you buy gold. And I met with a fund manager who was running a gold fund. And he told me
00:06:15.320
something, something extremely interesting. And this was maybe 15 years ago.
00:06:21.480
He was telling me that, you know, he said, you know, who do you think the biggest producers
00:06:26.800
of gold are? Now, if you're a gold bug and you're going out and you're buying one ounce
00:06:31.000
gold coins, you're used to seeing, well, British sovereigns, used to seeing South African
00:06:38.360
crew guns. What else? South Africa, oh, Canadian, used to seeing Canadian. Some
00:06:44.440
US gold, one ounce coins. I'd never actually seen a Chinese one. And he told me, no, actually,
00:06:52.740
the Chinese are the world's biggest miners and producers of gold.
00:06:56.980
Well, that's interesting because I've never seen one. I used to buy one ounce coins all
00:07:01.260
the time. And he says, no, the reason you haven't is because the Chinese, they go to
00:07:07.460
these mines and they buy every single ounce that is produced. Every single ounce they go
00:07:15.440
Whatever the global spot price of gold is, they pay that.
00:07:18.440
They buy every single ounce. And there is this persistent rumour that the Chinese have significantly
00:07:25.600
more gold reserves than they have publicly so far announced.
00:07:32.160
So it's supposed to be that the US has something like 8,000 tonnes. Quite a lot of gold. It's
00:07:38.680
supposed to be in Fort Knox. And as I'm sure you've heard from time to time, there's these
00:07:42.260
efforts to say, OK, well, let's audit it. Let's go and see what's in there. And you hear
00:07:48.340
these persistent rumours from people who have, because it is a military base as well, Fort Knox.
00:07:52.760
You hear these sort of persistent rumours from people who, squaddies, well, whatever the US
00:07:57.300
calls their squaddies. But, you know, the grunts that work there who say, oh, no, yeah, the
00:08:02.640
gold was gone long ago. You know, and where is this gold? But anyway, the US is supposed
00:08:11.400
Some people have been suggesting that the China is probably not on 2,000 tonnes. It's probably
00:08:21.000
I mean, I've seen the Turks buying a lot of gold. I've seen the Iranians, obviously,
00:08:28.680
for sanctions evasion. If you go to Dubai and try to buy gold, you can only buy it in cash,
00:08:34.220
meaning that it is untraceable. And that's on purpose. I've seen the Russians building up
00:08:41.080
gold reserves. And yes, the Chinese. And as you say,
00:08:46.880
Yep. With the exception of, say, for example, the UK.
00:08:50.860
Because we are so deep within that dollar global system that we're just like, no, no,
00:08:55.320
dollars are fine. Dollars are fine. We'll be right. Pieces of paper. You know, how could
00:09:00.340
they possibly not have value? The reason I mentioned the Chinese thing is because it's
00:09:04.900
like, well, OK, let's say they are. And there's a lot of evidence to point to this, not just
00:09:09.340
the fact that they buy every ounce that is produced in China. But also they appear to be buying
00:09:14.740
a considerable amount through Shanghai, which is supposed to be their sort of access port
00:09:19.200
to the rest of the financial system. And a lot of gold is getting traded through there.
00:09:23.940
A lot of gold is getting traded through Hong Kong. And it's like, is it really Chinese private
00:09:30.000
citizens who are buying all this gold? Or is it the government that's building up a colossal
00:09:33.640
stock of gold? Why might they be doing that? It's because potentially what they are doing
00:09:40.260
is waiting until the US has its next predictable financial crisis. Maybe they even considered
00:09:47.220
doing this in 2008. When everybody looks at the dollar and thinks, oh, that is definitely iffy.
00:09:54.700
And then they come out and announce, by the way, we've got vast reserves of gold. Significantly
00:10:02.160
more than three times, four times what the US has. Maybe they say the yuan is partially backed
00:10:10.620
by gold. Now, I don't know if they would go quite that far, because then you have to be willing to get
00:10:15.900
into exchange. You should be then turn up at a Chinese bank with a yuan note and say, well, OK,
00:10:22.060
give me the gold then. But it might be as just a strong credibility signal. And it might be they've
00:10:28.240
spent decades. And because it's a Chinese, I can kind of believe that they would have spent
00:10:33.760
decades planning for something. They're waiting for their moment to come along and say, no, actually,
00:10:39.800
we are the most credible global currency. And that, you know, global trade and store value should be held
00:10:48.580
with the Chinese. And if you take this two steps further.
00:10:55.460
Well, one key point as to when you would do this would be when the United States is having an
00:11:01.200
economic crisis. You pick your moment. Yeah. And the other point you would you would do this at is
00:11:07.160
when China invades Taiwan. I hadn't considered which could trigger an economic crisis because of
00:11:15.380
the sanctions that would inevitably follow. And you are hit with this wall of sanctions,
00:11:22.820
which the Americans would probably feel compelled to do. And you hit them back by saying, well,
00:11:29.460
actually, I want to be the reserve currency. And here are the new terms that I will impose.
00:11:36.700
That is very I had. And here is my new Bretton Woods arrangement. Bretton Woods being the arrangement
00:11:42.160
that happened after the Second World War that built the architecture of the financial system
00:11:47.180
that we live in today until Nixon broke it by abandoning the gold standard.
00:11:52.540
Yeah, I mean, that is worth talking about, actually. I mean, as way of bit of background
00:11:56.840
for the audience, there was a big war in the sort of late 30s and 40s. Some of the audience may have
00:12:04.500
heard of it. And the end result was that all the gold ended up in the US. Yes, for a number of
00:12:10.260
reasons. I mean, it's partly because they were producing stuff. And so therefore, they were
00:12:15.860
getting paid a lot. But also it's because, you know, if you're if you're France, you might think
00:12:20.180
that holding on to large amounts of gold when you could see this thing coming at you was probably a
00:12:24.020
bad idea. Maybe we need a better place to put it. So anyway, they ended up with all the gold after
00:12:28.440
the war. And somebody, I would suggest probably American, thought to himself, well, why don't we
00:12:34.780
just keep it? And the arrangement was is, okay, well, we're going to have the dollar backed by gold.
00:12:41.320
And so it used to be the case that you could walk into a bank with a dollar and get it exchanged for
00:12:46.500
a little lump of gold. It was convertible. And what the arrangement was, which I know Trump has
00:12:54.900
clearly forgotten at this point, is that the US would basically become the world policeman,
00:12:59.860
they were secure. I mean, the way it was framed is that they will protect global shipping routes.
00:13:06.020
And also on those shipping routes, when you're trading, you then trade in dollars.
00:13:10.020
And the whole thing sort of ties together, which is clearly lost on the current US administration,
00:13:15.860
because when they say things like, oh, the rest of the world is is is freeloading onto American
00:13:20.980
security. Well, yeah, but you kind of engineered that situation after the war, you kind of put
00:13:25.620
yourself in that situation where you explicitly became the world policeman in exchange for the
00:13:30.500
global dollar system. But but that aspect of it has been forgotten. And yeah, I don't think the
00:13:38.420
the Chinese necessarily want to become the world's reserve global currency, because there were all sorts
00:13:44.100
of drawbacks with that, you basically need to pump an awful lot of your currency into the world.
00:13:51.060
Yeah. Yeah. And have a big current account deficit.
00:13:57.780
They would probably not be sensible to do that, because it's been so ruinous to the US. And we
00:14:01.460
can come on to talk about why it's been so ruinous for the US. But what they might want,
00:14:07.460
and actually, this ties in now, I think about it very closely to points you've been making on real
00:14:11.460
politics and on a show we did very recently, that podcast where you talked about this element.
00:14:22.420
Yes. And actually, that quite quite nicely to the thought that you that I hadn't considered there
00:14:28.340
about Taiwan, which is, you know, what if they invade Taiwan? And then that is that is the launch
00:14:36.020
of their whole play for regional dominance. And it comes with a currency package, a military package,
00:14:42.900
presumably some sort of security considerations for the region and stuff like that.
00:14:52.340
You can imagine it comes with a whole package of different things and currency being one of them.
00:14:58.020
You know, convertible, use our currency, use it for trade in the region.
00:15:02.820
And you could quite possibly end up in a period where we then have multiple regions, you know,
00:15:08.740
perhaps a dollar-based region, perhaps a yuan-based region, and maybe even a euro-based region attempt.
00:15:17.220
Yes. I mean, speaking of the euro, there is this graphic here from Daniel LaSalle.
00:15:24.740
And what it's saying is the following, that central banks are trying to cut interest rates,
00:15:31.620
but the yield on debt is going up, as in the markets don't trust these governments
00:15:37.860
and don't accept the rates that they're trying to set. Now, this is a problem because pretty much
00:15:43.620
all of these countries need to refinance massive amounts of debt. France, 115, 120 percent of GDP.
00:15:52.660
United Kingdom, 100, 105 percent of GDP. US, 130, something like that.
00:15:58.420
Italy and Spain and Portugal in very difficult positions when it comes to their debts.
00:16:05.460
So what's happening here is that the governments want to pay less interest on their debt, but the
00:16:13.140
market won't accept it. And they are going to get to a point where they have to refinance their debts.
00:16:23.060
And this is the amount that the Americans need to refinance just next year in 2026.
00:16:32.580
And this will have to be done at a higher interest rate than what the Fed is willing to promise.
00:16:38.100
And this is a bit of a problem because, well, the markets simply won't swallow the treasuries that you're trying to force down their throats.
00:16:51.700
Yeah. So, I mean, the broader trend is over the period of, well, maybe the last 30 years minus the, you know, maybe the last five is the price of money effectively has just been going low.
00:17:08.980
If you're looking on a chart, it's, you know, it's straight across and down to the right.
00:17:14.580
So money is being made cheaper. And during that sort of 30 year period, the level of debt in the system has sort of consistently risen.
00:17:25.300
Lots of things to say about that. I mean, one of the things I'd add is effectively when you're lowering the price of money, you're lowering the price of time.
00:17:33.640
That's effectively what you're doing because you're saying that, you know, how much are you willing to defer consumption today for tomorrow?
00:17:41.940
And time is being devalued consistently. It's all being pushed out into the future over this mechanism.
00:17:49.680
And a lot of this debt was accumulated. It's got maturities of, you know, on average sort of four, five, six years.
00:17:55.560
It's something around that. I'd have to look it up to see exactly what it was.
00:17:58.320
Yes. And what they got into after 2008, when these, when these, the price of money kept on coming down, is after 2008, they were having to refinance at much higher.
00:18:11.600
Sorry, after 2008, it had been pushing down and then it basically just hit zero.
00:18:17.440
To try and recover from that. So then you've got that period from 2008 to pre-COVID, where governments could effectively just borrow for absolutely nothing.
00:18:26.000
Yep. An extraordinary period. And actually, one of the things, to give him great credit, is that Trump was saying in his first term, why don't we issue, if we could borrow money for nothing, why don't we issue 50-year bonds?
00:18:37.700
And the establishment, the US establishment, was so resistant to him in every way that they blocked that.
00:18:44.380
And it's a damn shame that they didn't, because if he'd locked in most of the debt at 50 years at 0%, they wouldn't be having a lot of the problem that they're having now.
00:18:53.080
But then after COVID, and so much money was printed and thrown into the system to protect the economy from the impact of, and when I say protect the economy, I mean protect asset prices.
00:19:05.200
To protect asset prices from the fact that everything had been shut down.
00:19:08.040
When you're, when you do that, the amount of inflation that you kick up on the other side through the debasement of money becomes very much a problem for people.
00:19:18.400
So then rates have to go up, and now they're having to refinance this constant flow of debt, this refinancing cycle.
00:19:25.660
They're going to have to do it at a considerably higher rate than the near nothing that it was brought on.
00:19:31.420
So debt doesn't kill you when you issue it. Debt kills you when it comes up for refinancing.
00:19:36.140
Yes. Because the idea of just actually paying your debts and making it and being done with it is inconceivable.
00:19:44.340
We are nowhere near paying off the debt. The only question is how low can we refinance it time after time?
00:19:54.040
But all the time while adding more debt to the system that also then needs to be refinanced.
00:19:59.540
Yep. And the issue that they've got is that the debt piles have now grown so large, as you mentioned there in, you know, for US, UK and a whole bunch of European countries as well.
00:20:12.300
That the coupon that you have to pay on this kind of dictates how fast it's going to grow.
00:20:19.900
So picture this. You've got GDP at this level and you've got debt at this level.
00:20:24.280
So they're both about 100% of each other, okay?
00:20:27.040
Okay. How fast is the debt growing? Well, the debt's growing by the coupon rate.
00:20:33.120
The amount that it has to pay on it. How fast is GDP growing? Well, it's growing by the growth rate.
00:20:37.900
And basically the coupon rate is higher than the growth rate.
00:20:41.800
And people have looked at this and sort of worked out, such as Global Macro Investor, which is a hedge fund newsletter.
00:20:49.080
It's very expensive, but some of the stuff trickles out of it.
00:20:51.980
They worked out that basically all of the growth that exists in Western economies is being used to pay the rollover of debt.
00:21:04.940
And this graph sort of shows precisely the point that you're making.
00:21:10.000
And what it shows is the level of U.S. debt versus the level of U.S. GDP.
00:21:16.140
And the picture is quite horrible, I would say, with the debt growing considerably faster.
00:21:23.840
There was a period where it wasn't, but this is long behind us.
00:21:28.820
And the size of the debt relative to the size of the economy is huge.
00:21:36.060
What the money is going to is to sort of pay down debts that you've already taken.
00:21:42.040
And when you're trapped in the cycle, all you get is inflation.
00:21:48.200
And I'm guessing that's including private debt as well to be up at that level.
00:21:54.960
I think that's government debt and private debt.
00:21:57.140
But what you have here is basically Warren Buffett saying that the government is just going to keep on debasing the currency,
00:22:07.660
trying to get out of the cycle by reducing the value of the debt.
00:22:15.660
So he's moving his money or he's moving a lot of his cash into Japanese yen.
00:22:25.460
They are funding more stimulus and they're borrowing a lot more money.
00:22:30.640
But they are having to pay higher rates and to raise the interest on that debt.
00:22:39.280
And they are trapping themselves in this cycle.
00:22:42.480
I mean, Japan has 214 debt to GDP ratio, the highest in the world.
00:22:49.460
I mean, at this point, we should probably talk about what's actually causing this underlying debt position.
00:22:59.020
I don't even remember, but under Bill Clinton, he's often hailed as being this financial genius because he ran a budget surplus.
00:23:07.000
Which is effectively the last time that the US ran a surplus.
00:23:10.760
What really was going on there is that under Bill Clinton, it was peak boomer workforce participation.
00:23:19.880
The largest generation, the largest number of them in work.
00:23:26.440
And so the ratio of workers to dependents, I mean, the US did not have quite such pronounced benefits, welfare culture.
00:23:36.340
The pensions were being paid to the greatest generation and a handful of the oldest silent generation at that point.
00:23:54.340
Well, I mean, the shorter version of this is the booms didn't have enough kids.
00:23:59.080
They should have had more kids if they wanted a Ponzi scheme like this to continue to function.
00:24:03.640
If you enjoyed this piece of premium content from the Lotus Eaters, head to our website where you can find more.