The Podcast of the Lotus Eaters

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

00:01:21.960 me understand this a little bit.

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

00:01:36.140 to the price level.

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

00:02:50.780 the United States to pay back what it owes.

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.

00:03:07.600 Right.

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.

00:03:19.760 Yes.

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.

00:03:41.680 Right.

00:03:41.780 And for years, it has been the dollar and the UK guilt.

00:03:47.520 Right.

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 0.95

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.

00:05:18.440 Right.

00:05:19.140 They would want to involve. China doesn't quite have that.

00:05:23.100 Quite the opposite.

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

00:05:48.440 this list.

00:05:49.640 Go 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

00:06:06.640 phase.

00:06:07.480 Yep.

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.

00:06:21.000 Right.

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 0.66

00:06:38.360 crew guns. What else? South Africa, oh, Canadian, used to seeing Canadian. Some 0.94

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.

00:06:56.640 Yep.

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 1.00

00:07:07.460 these mines and they buy every single ounce that is produced. Every single ounce they go

00:07:12.860 and buy. They pay full market rate for it.

00:07:14.800 Right.

00:07:15.440 Whatever the global spot price of gold is, they pay that.

00:07:18.180 Yep.

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.

00:07:31.840 Right.

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

00:08:08.240 to have about 8,000 ounces of gold.

00:08:10.660 Right.

00:08:11.400 Some people have been suggesting that the China is probably not on 2,000 tonnes. It's probably

00:08:18.820 more like 20,000 at this point.

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 1.00

00:08:41.080 gold reserves. And yes, the Chinese. And as you say,

00:08:45.280 almost every central bank is doing it.

00:08:46.880 Yep. With the exception of, say, for example, the UK.

00:08:50.480 Yep.

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 0.80

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 1.00

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.

00:13:48.420 You need to export banknotes, essentially.

00:13:51.060 Yeah. Yeah. And have a big current account deficit.

00:13:54.420 Yes. Which the Chinese don't want to have. 1.00

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.

00:14:20.180 They might be preparing for a regional world.

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.

00:14:48.180 And support, investments, all kinds of.

00:14:52.340 You can imagine it comes with a whole package of different things and currency being one of them.

00:14:57.460 Yes.

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.

00:17:24.360 Yes.

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.

00:17:33.100 Yes.

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?

00:17:41.400 Yes.

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.

00:17:58.140 Yes.

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.

00:18:17.120 Yep.

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.

00:18:52.180 Yep.

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.

00:19:04.800 Yes.

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.

00:19:18.200 Yes.

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?

00:19:53.700 Yep.

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.

00:20:10.180 It's basically 100% of GDP.

00:20:12.120 Yep.

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.

00:20:32.780 Yep.

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.

00:20:37.680 Yeah.

00:20:37.900 And basically the coupon rate is higher than the growth rate.

00:20:41.520 Right.

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.

00:21:02.720 Not pay off the debt, pay the rollover.

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.

00:21:32.200 So the growth in GDP isn't happening.

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.

00:21:47.000 And so you have...

00:21:48.200 And I'm guessing that's including private debt as well to be up at that level.

00:21:53.260 Yeah, maybe.

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.

00:22:13.000 But it's a bit of a disaster.

00:22:15.660 So he's moving his money or he's moving a lot of his cash into Japanese yen.

00:22:22.280 But the Japanese are just a stuck. 1.00

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.

00:22:47.160 Yep, their debt is a lot higher.

00:22:49.460 I mean, at this point, we should probably talk about what's actually causing this underlying debt position.

00:22:54.280 Okay.

00:22:54.660 How do we get here?

00:22:56.740 And I tell you what, it links into...

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.

00:23:06.680 Yes.

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.

00:23:19.580 Yes.

00:23:19.880 The largest generation, the largest number of them in work.

00:23:24.140 That's essentially what it was.

00:23:25.820 Right.

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.

00:23:36.120 Yes.

00:23:36.340 The pensions were being paid to the greatest generation and a handful of the oldest silent generation at that point.

00:23:46.280 And so the money going out wasn't much.

00:23:49.020 The money coming in was strong.

00:23:53.180 And effectively, as...

00:23:54.340 Well, I mean, the shorter version of this is the booms didn't have enough kids.

00:23:58.420 Yep.

00:23:59.080 They should have had more kids if they wanted a Ponzi scheme like this to continue to function. 0.62

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PREVIEW： Realpolitik #25 ｜ The Next Financial Crisis with Dan Tubb

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