My guest in the latest episode of The Grant Williams Podcast is my good friend, Luke Gromen, publisher of Forest For The Trees.
With events in Ukraine happening at breakneck speed, the moves by Western nations to isolate Russia through a raft of escalating sanctions have revealed a series of weaknesses in the global financial system that bring into sharp focus a set of dominos Luke has been lining up for a number of years.
The dollar’s place at the heart of the financial system is now under serious threat after the sanctions placed on Russia’s central bank have fired a warning shot across the bow of every other central bank in the world.
What does this mean for gold? Oil? Bond markets? Currencies? Luke lays it all out in brilliant fashion as he explains why the moves of the last two weeks have changed the financial world as we know it forever.
Grant Williams:
Before we get going. Here’s the bit where I remind you that nothing we discuss should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets. And now on with the show.
Grant Williams:
Welcome everybody to another episode of the Grant Williams podcast. Now joining me this week is a very special guest and a dear friend, Luke Gromen, the publisher of Forest for the Trees and a man who’s been, I have to say, an extraordinarily valuable resource for me personally, since I found his work quite by chance, about eight years ago.
Grant Williams:
And during that time Luke’s been piecing together an incredible mosaic of articles, actions, and reactions that have laid out a path to a new financial system as the post Breton Woods era reaches the end of its useful life and the United States faces challenges from other countries for its seat at the head of the global financial system. And those challenges have been painted by many as a direct challenge for hegemony. But the truth as Luke has painstakingly chronicled is far more nuanced than that, and is fact rooted in national security issues, not just for countries like China and Russia, but also the US itself.
Grant Williams:
The recent sanctions placed upon Russia in retaliation for its invasion of Ukraine have done several things besides punish the Putin regime for their atrocious, unwarranted actions. Most notably highlighting a broad systemic weakness and the precarious position in which many central banks find themselves at the twilight of the petrodollar system. Now Luke’s work on this subject has been exceptional over the years, so I’m delighted to get the chance to talk to him at what is an absolutely pivotal juncture to see how things might play out from here. So without further ado, here’s my conversation with Luke Gromen.
Grant Williams:
Well, Luke, my friend, welcome. So good to see you and so good to get a chance to talk to you again, it’s been a while.
Luke Gromen:
It has been. Thanks for having me back on Grant. It’s good to catch up.
Grant Williams:
Oh, look, given what’s going on in the world this week. There is nobody I’d rather talk to about this than you and the reasons for that go back some years when I first became aware of your work, which would be maybe seven or eight years ago now. And I’ve talked about that story before, it’s such a remarkable set of coincidences. But the kind of thesis that you laid out then spoke to me in a profound way.
Grant Williams:
And you and I have been in touch since then. And we’ve kind of watched this thing become closer and closer to the headlines, become more and more apparent to anyone that’s kind of willing to see it. And so I think what I’d love to do, because it feels like now is the time when people really need to understand this.
Grant Williams:
So rather than jump straight in and talk about what’s happening now, what I’d love to do is take people back to the very beginning of this picture that you put together so beautifully, and just get you in your own words, to kind of lay out the pathway that it took you on. And also the pictures that you put together, create the picture, the whole mosaic. And then we’ll talk about the moves this week, which I think are pivotal in what you’ve been talking about for so long there. So let me hand that over to you and walk us through it, take all the time you want and let’s do it properly.
Luke Gromen:
So I think probably the best place to start is I think you have to go back… And we’ll do this quickly, because I know it’s a long time back. I don’t want to glaze people’s eyes over. But if you go back-
Grant Williams:
Look, listen, I think it’s important. So don’t shy away from it. People can always fast forward, if they’ve heard it, you and I talking about this before and they get bored, they can just roll their eyes and fast forward. So I think not enough people are aware of this whole set of dominoes. And so I think it’s important that you give them the full Luke Gromen.
Luke Gromen:
Yeah, I think it’s important because once you see the context you said, you really can’t unsee it. You start to really see the world through a new lens or a new, old lens maybe is the best way to describe it. So at the end of World War II, there was a monetary conference to basically set out what was going to be the new monetary system in the aftermath of the war. There were two options. There was the US option and there was the John Maynard Keynes option. And the US option was the dollar is the center of the universe. All other currencies are tied to dollar at various fixed rates or pseudo fixed rates and then very narrow bands. And then the dollar is pegged to gold at $35 per ounce. And Keynes’s proposal was something called the BANCOR, B-A-N-C-O-R.
Luke Gromen:
And it was basically a basket of commodities designed to be a neutral reserve asset. And I think it’s a very important term, we’re going to come back to that later, it was a neutral reserve asset that was designed to settle trade between nations. And so if you were a creditor nation, you sold more than you bought, you ended up with surpluses, you would end up with BANCOR. You would end up with the ability to… You’d have the BANCOR. If you were a deficit nation, you would end up buying more than you sold. To settle that trade you would have to sell your currency and buy BANCOR.
Luke Gromen:
So you’re selling your currency to buy BANCOR. Your currency’s going to weaken against the creditor nations. And so it would become a self-regulating trade system where the BANCOR is a neutral settlement asset that floats in all the currencies. Prevents major imbalances and at any rate, be a much more balanced, less crisis proof… Less crisis prone, excuse me, not crisis proof, but less crisis prone system.
Luke Gromen:
The Americans had all the guns, all the men, all the factories, all the gold, all the oil. And so in short, they went with the American proposal. Fast forward to by the mid to late 50s, the Europeans and the Japanese were getting back on their feet. They were by nature, very productive. They were starting to run surpluses and they were starting to drain America’s gold.
Luke Gromen:
And so at the end of world war II, America had 21,000 tons of gold pegged at $35 an ounce. By 1971, Americans are down to 8,000 tons and draining fast. And in 1971, given the choice per article four, I think it was of the IMF the Americans could have devalued the dollar against gold. They could have said, all right, we’re not going to pay it at 35. And as a practical matter, they did go from 35 to 42 in the intervening time. So there was a modest devaluation.
Luke Gromen:
There were proposals at the time to take the dollar from 35 to 150 against gold, I believe by members of the BIS, but in the end Nixon and the US administration decided to just close the gold window altogether, say the dollar is no longer good for gold. And it threw the system into a period of chaos for a couple years. And then late ‘73, there was, I believe it was the Yom Kippur war, brief war. Three months later, oil was up 400%. There’s a famous story told by Sheik Yamani, the former oil minister of Saudi Arabia, who said that when somebody asked him, he says with 100% that Henry Kissinger wanted the price of oil significantly higher. And told people that. When the Shah of Iran asked Sheik Yamani, why am I raising oil 400%? And Sheik Yamani told the shah of Iran go, “I don’t know, go talk to Henry Kissinger.”
Luke Gromen:
This is all in the public domain. So at any rate, what happened here was one way or another, the oil market was made big enough to serve as a reserve asset, a defacto reserve asset for the dollar and the Petro dollar system was born. Basically the US reached an agreement where Saudi Arabia in particular, biggest marginal swing producer would only take dollars for their oil. As a practical matter that meant all of OPEC would go along.
Luke Gromen:
And so dollar’s only priced in oil. And so if you needed oil, the Europeans, the Japanese in particular were the big creditor regions that were short energy, you had to have dollars. And so you basically ended up with a defacto oil backing of the dollar. Now that doesn’t mean the Americans could simply print willy nilly with this oil backing. What you can see looking back at the relationships of the time is that the US went from being pegged to gold to being pseudo pegged to oil is what I’ve called it.
Luke Gromen:
And it’s a term that Eric Jansen coined at iTulip, which is the dollar went from being as good as gold to being as good as gold for oil. And basically, what that means is if you look back from 1973 through about 2005, there was about a… I guess not ‘73, you did have the run up ‘73. So after the run up right, early ‘74, the punchline is that for almost 30 years, oil traded between roughly $12 to $15 a barrel and about $30 a barrel. And when oil got to $30, the Americans were raising rates and tightening policy. And when oil got down to the low end of that range, the Americans were loosening policy via fed funds.
Luke Gromen:
And so there was basically, the dollar was kept in a range. Your treasury bonds, if you held treasury bonds as a reserve asset, you were given a degree of comfort over those 30 years, that they would buy you somewhere, a pretty consistent amount of oil for 30 years, which is very different than what we’ve seen in the last 15 years.
Luke Gromen:
So dollar goes from being pegged to gold to being pseudo pegged to oil 2005, we reach a point where between the rise of China and the geological realities that were beginning to hit in global oil fields. In short peak cheap oil, you were starting to see a number of the world’s great oil fields, start to reach peak levels and start to roll over. And Matt Simmons did a lot of great work with that in his book, Twilight in the Desert around that time.
Luke Gromen:
The punchline is oil got to 30 and kept going. It went to 50. So now all of a sudden the dollar is starting to fall out of a 30 year range against oil. And then that happened at a very inopportune time, because right as these external factors, China and geology are forcing the dollar to break down against a 30 year range in terms of oil, all of a sudden the subprime crisis starts breaking out.
Luke Gromen:
And so instead of the Fed tightening into oil prices breaking beyond 30, beyond 40, beyond 50, the Fed was forced to make a choice. either we sacrifice the domestic economy, which is we need to hike rates a lot, get oil back to that range, to keep the dollar as good as gold for oil, or we need to address the domestic economy and lower rates and try to prevent our banks from blowing up with the subprime stuff.
Luke Gromen:
And of course, we all know what the US did. They ultimately tried to save the banks. It’s interesting if you look at, for example, oil is I believe $70, $80 at the end of ‘07, when the sub-prime crisis really started to get intense. And the Feds started cutting rates in October, I think it was October of ‘07. At any rate oil from October of ‘07 to summer of ‘08, went from $70, $80 to $150 in a big hurry.
Luke Gromen:
So the dollar went into absolute free fall against oil. And so our view is that basically you were watching a breakdown of this 30 year, keeping the dollar as good as gold for oil breakdown in the same way that the dollar pegged to gold, excuse me, broke down in the late 60s and early 70s. And so I think this was a surprise to many nations in the world. I think ultimately they had been aggregating FX reserves, dollar reserves, treasuries, having seen 30 years of the US keeping the dollar as good as gold for oil. Including what Volcker did in ‘79, ‘80, where he was willing to take rates to 15% to basically stop an incipient high inflation or hyperinflation of the dollar. Push came to shove and Volcker had faced the same decision that Bernanke later would in ‘08.
Luke Gromen:
And that decision was, do I manage the dollar for the good of the world as a reserve currency? or do I manage the dollar for the good of America, and let it keep inflating. And Volcker managed the dollar for the good of the world. He put the US economy into severe austerity, severe recession. In fact, two severe recessions. Took rates, stumped out inflation. We sort of know how that all that went.
Luke Gromen:
And I think much of the world, particularly China, Russia, Europe, thought that when push came to shove, the Americans would do the same thing again, if another situation like that arose. And instead in 2008, the Americans said, “Forget it. We’re a unipolar power. Doesn’t matter. It’s different this time. However you want to say it, we’re printing the money.” And so in the aftermath of the ‘08, ‘09 crisis, I think in the short run, everybody was just like, “Hey, let’s just get things settled down. The system is frighteningly close to collapse.”
Luke Gromen:
And not very long after the bank, the PBOC People’s Bank of China, the head of it, Zhou wrote a three page white paper at the BIS in March of ‘09, literally I believe six trading days after the US did what I call big QE, which is where they went from just buying mortgage backs to printing a trillion dollars to buy treasury bonds as well.
Luke Gromen:
And it was not very subtly titled. It was the need to reform the international currency system or something like that. And the BIS is essentially the central banker’s central bank. And so there began to be, I think, was sort of the first recognition or the first visible recognition to a non-insider, that there was a high degree of dissatisfaction with how the US had not managed the dollar to be as good as gold for oil anymore.
Luke Gromen:
Now for China, they’re often said, I think there’s a lot of thought that they were just being belligerent, that this is just about China being belligerent. There’s probably some truth to that. But I think it’s not as appreciated that it’s a matter of… This was really a matter of national security for China. China, as I think a lot of people know is short energy. They’re short food. They’re long dollar reserves.
Luke Gromen:
And so if China is long dollar reserves and short energy, and the Americans have just committed showing that they are not going to keep those dollar reserves as good as gold for oil, then China knows they’re going to run out of reserves at some point in the future. And in fact, Kyle Bass talked about this on an interview, I believe on CNBC, if not on several podcasts where he said, listen, Chinese have only so much oil or only so much in dollar reserves, excuse me, they need more and more oil to grow their economy and more and more dollars because the price of oil’s rising and China’s going to run out of dollars.
Luke Gromen:
And when they do, they’re going to have a late 90s currency crisis and Yuan’s going to fall. And that was the case of shorting the Yuan and that a number of people had. And I think the PBOC was well aware of as early as 2009. And that’s why they actually explicitly said, we want to change the system. And not only did they say that, but they said, given how poorly this system has reacted or how many crises this system has had, the Keynes system, the Keynes BANCOR, the PBOC specifically cited it, was cited by the People’s Bank of China as a better system. A system with a neutral reserve asset.
Luke Gromen:
There was that term again. So we saw that we saw rumblings by a very senior reporter, wrote an article, guy named Robert Fisk in the UK Independent saying that there were credible reports that much of Eurasia, the Middle East and Asia were working on trying to move away from strictly dollar settlement of oil, into multicurrency oil pricing with a gold settlement aspect to it.
Luke Gromen:
And again, I think it’s critical to understand if you’re China, you look at this going forward and say, okay, well the Americans just printed $3 trillion to get out of this crisis. We didn’t think they’d print any. And if we look ahead 10 years, not even 10 years, we look ahead five years, we know the American baby boomers are going to start retiring. And we know the Dallas Fed chairman, Richard Fisher said in May of ‘08, that the present value of those obligations were $90 trillion already then.
Luke Gromen:
So the Americans are going to print $90 trillion if they have to. And when they do that, the price of oil is going to go through the roof and we don’t have nearly enough. We’re going to run out of our reserves. And then we’re going to have this currency crisis and social unrest and running out of oil and food is a very big political hot wire in China. They’re not going to let that happen.
Luke Gromen:
So as a matter of national security, they began moving away or moving the system toward a neutral reserve asset. There have been other hints since. You saw the head of the world bank, who’s a former Goldman guy at the time, former treasury official Robert Zoellick in 2010, came out and said, we need to move to a system where the Yuan is more convertible. It’ll also include the dollar, the Yuan, or excuse me, the Yen, the Euro and the pound. And we should probably use gold as a reference point, for both inflation and relative values. It was gold again, as a neutral reserve asset. The IMF talked about it in 2011 saying, well, maybe we should use oil… We should price oil and gold in SDRs. And that would be the same type of thing.
Luke Gromen:
As an SDR, a neutral reserve asset where imbalances would be settled. You move forward to 2014. You start to see China and Russia working together, starting to sign big gas deals, big oil deals in local currency terms. 2014, the Chinese effectively reopened the gold window in Shanghai with this Shanghai gold international board. Where if Russia at that time was then selling a little bit of oil and gas in Yuan, they could take those Yuan, take it to Shanghai, exchange it for physical gold.
Luke Gromen:
So they were making the Yuan fully convertible on a very limited basis through physical gold markets. You continue to see these types of deals in the intervening years. You fast forward to 2018. China opens the Yuan oil contract. And actually, if you look at the flows of that, there too, it makes the Yuan fully convertible through the oil market.
Luke Gromen:
If you can take your dollars, you exchange them for Yuan, you buy oil, you make money, you can take your profits out and you can select the currency in which you take the profits is how it was described to me in the banking documents. So there again, on a limited basis the Yuan is made convertible through oil. But again, it’s a national security issue. China needs to be able to print Yuan for oil. Europeans have the same issue. The Europeans have long had the same issue. They need to print Euro for oil. 2018, Jean Claude-Juncker says, it’s absurd that we pay 2% of our energy bill in Euro and 98% in dollars. It’s 300 billion Euro a year. The Europeans have the same problem.
Luke Gromen:
They need to be able to print Euro for energy. And in fact, I’m going to jump backward a little bit here. It’s not well understood, but if you look at the construction of the Euro in 1999. When they launched the Euro, they put 15% of Eurozone reserves into gold, marked to market on a quarterly basis. And at the time people were scratching their head. This is a huge clue that most people just gloss over, which is if they loved the dollar system so much, why did they put 15% of reserves into gold marked to market quarterly when they could have just put it in treasury bonds? And the answer is they were very likely in my opinion, trying to make the Euro attractive to energy exporters.
Luke Gromen:
Basically by putting gold in their mark to market quarterly what they were saying is the Euro is our currency, but it’s our problem too. As opposed to the dollar where it’s our currency and it’s your problem, which is to say, if the Europeans print a bunch of money for the style of stuff they printed money ever since the price, so gold is going to go up and it will act as ballast to support the Euro. And it will also give comfort to energy creditors that might be holding Euro balances, that the price of gold is going to be allowed to rise and be money good in terms of European goods over time.
Luke Gromen:
Keeping the Eurozone goods as good as gold for… Or keeping gold as good as Euro goods. So you’ve seen across Eurasia, these nods to this neutral reserve asset. Whether it’s Europe at the launch of the Euro, whether it’s China, whether it’s Russia, when you go to 2013, 2014, they start, and 2010, really start buying lots and lots of gold. 2014, 2013, really actually before the sanctions around the first Ukraine episode, they start dumping treasuries by 2018.
Luke Gromen:
The Russians are largely out of treasuries and they diversify their reserves. The Russians, now, if you look at the FX reserves right prior to this crisis, they had 13% in Yuan they had 25%, I think, 6% in Euro. They had a little bit in dollars and they had like 22% in gold. And so you can see the shape of this system moving toward this Keynes BANCOR proposal from 80 years ago that the Chinese advocated for in ‘09, that the Europeans really advocated for as far back as the 70s, settling oil in gold.
Luke Gromen:
Started making a nod to not settling in gold, but having that neutral reserve asset component with the launch of the Euro. And it brings you forward to, I would say pretty much to this present time where over the last eight years, we have seen global central banks buy about $260 billion worth of gold against just roughly $60 billion give or take on a net basis of foreign official buying of US treasury. So foreign central banks, official accounts, I bought 3X more gold in the last eight years than treasury. So there’s been this very slow, but steady and recently accelerating move toward the away from this dollar system that broke in 2005, through 2008 to this system that looks a lot like what was proposed by Keynes 80 years ago.
Grant Williams:
Mate, that’s beautifully done. There were so many points I wanted to kind of jump in, but I didn’t want to break your flow. Because I know how difficult it is when you’re going through all these dates. There’s so much to unpack. Let me jump back to Volcker. You made this point about how Volcker managed the dollar for the world rather than for America.
Grant Williams:
And it’s very interesting that he did that and I don’t think many people think about it that way. People think about what he did as being charged with getting inflation down and being the tough guy and getting inflation down for Americans. We had the whole Whip Inflation Now thing with Carter. And Volcker was the kind of spearhead of that. So when you talk about it in those terms, it really does put a whole new spin on America’s actions back then in the late 70s into the early 1980s. Versus where we are now. So just talk about the dynamics that led Volcker to do that and the pressure that might have been on him, ex-US domestic inflation.
Luke Gromen:
Yeah, I think the easiest way to look at it, or the quickest way is you can go online on the Fed’s archives. And there is a fed white paper called the Reforms of October 1979. And in that white paper, there is a section where there was an IMF meeting in Belgrade Yugoslavia in October of ‘79. Volcker flies there spends less than 24 hours there, meets with key US creditors, primarily European, German, French, a few others. The Fed’s own white paper says that Volcker’s ears were left ringing with the stern words of US creditors include Otmar Emminger, German. And to be blunt, it reads as if the Europeans in particular gave Volcker what we used to call on the sales desk, a “Hey, MFer” conversation. Basically you got to do something about this. We’ve got nowhere else to go.
Luke Gromen:
And he immediately, like I said, spent less than 24 hours in Belgrade, Yugoslavia, flew right back home. And immediately began putting pen to paper in terms of a policy response to stamp out inflation. And so what was really said about what else we’re going to do is never really specified in this paper, but you can get a sense of it if you read the other historical documents from the 70s. There’s a document in the archives where one of the assistant treasuries secretaries, I think Weintraub was telling Volcker and Kissinger that the Europeans were planning on revaluing gold way higher and using market value gold to settle European energy deficits with the Arab oil exporters. And there was actually some support for this in the American administration. This would’ve been like ‘74. But ultimately they went on to say these are counter to our aims for the system.
Luke Gromen:
So our aims for the system, you can even see this back if you go to Yanis Varoufakis gave a speech in 2013, the former Greek finance minister, where he said, look, there’s a document. You can’t find it on the internet. I have a copy. It was given me by someone in the Americas. I’m not going to tell you who. It’s very short, but Kissinger, once the US began running deficits in 1970, Kissinger realized that historically when empires start running deficits, that’s it. And what Varoufakis says is the document specifically lays out that Kissinger tasked Volcker, who was an assistant treasury undersecretary or something at the time with figuring out a way for the US to maintain its hegemonic position. And this was apparently Kissinger’s role, or Kissinger’s words, even though we were turning into a deficit nation. And what Volcker came up with this in this document was we need to go from recycling our surpluses to recycling everybody else’s surpluses.
Luke Gromen:
We need a way to figure out to do that. And that was the energy link. So there’s this path, you can see very clear means, motive, opportunity of uh-oh we’re running deficits. We need to figure out surpluses to recycle. We found oil surpluses. The Europeans are trying to move to gold. That’s against our aims for the system. ‘79, by this point inflation’s running hot. Europeans are now saying, “Hey, MFer. You got to fix inflation.”
Luke Gromen:
Volcker comes back and basically blows up the US economy takes rates to 15% to bring inflation down, to defend the dollar. I mean, what Volcker was doing is no different than what Turkey was doing a few… What Russia did two weeks a ago. Russia took rates to 20%. They’re defending the Ruble. Volcker, took rates to 15%. He was defending the dollar and he did it successfully. And so there was very much an external component to this. Again, it’s never explicitly stated out, but you put the pieces together it’s unmistakable. And it’s a very important side that we very rarely hear here in sort of US finance.
Grant Williams:
You know, it’s interesting because obviously Bill Simon went to Saudi in ‘73 to sign that Petrodollar agreement. So one could argue that at the time this happened ‘78, ‘79, the US actually was in a very strong position. They didn’t have a Euro. You didn’t really have alternatives to the US dollar, nothing.
Grant Williams:
And yet when they were at arguably their strongest, they caved and did what was right for the world and put domestic policy last, which is unusual. Whereas now when they’re arguably at their weakest with all kinds of credible alternatives to the dollar, there’s a degree of hubris in this. That we are at our weakest, but we going to put the US first this time and not the world. Pride comes before a fall and all that. And the more I look at this now, the more I realize just how dangerous a game the United States is playing by continuing to put domestic issues ahead of those of the rest of the world.
Luke Gromen:
I think that’s right. And yeah, when you get to 2008, there was this choice again, and hubris, dogma. I mean, the fact that the end of history happened in 1990. So we don’t need to make… Deficits don’t matter. Reagan proved deficits don’t matter. I mean, that’s something that Cheney allegedly said just four years before. Listen, Reagan proved deficits don’t matter. So the debt doesn’t matter. And at that point in 2001, the US government ran a surplus. So by 2008, we were still as weak as we were in that moment. When you look at the balance sheet of the United States, both the on balance sheet, the debt, I think that the GDP was 60%. Very robust economy, good demographics. The boomers really hadn’t started retiring yet.
Luke Gromen:
So the off balance sheet stuff was still cash flow positive in terms of entitlements, we were in pretty good shape. And you had a group of leaders that had been taught by the Mexican crisis, Long Term Capital crisis, Asian crisis, Dot Com crisis, 9/11 crisis, 2003 Iraq invasion. There’s no cost to this stuff, just print the money, man, just print the money.
Luke Gromen:
And so they did. And so you can understand why they did it. Now, critically Hank Paulson later on said that the Russians approached the Chinese in summer of ‘08 and said, “Hey, we’ve got them, let’s start dumping Fannie, Freddie bonds, let’s start dumping agencies.” And really force them to bail it out, really force this bailout, force them to print money, force them to devalue the dollar. And so I think that’s an important foreshadowing for what I think we’re going to talk about a little bit here for sort of a grand strategy of what might be at work today.
Grant Williams:
Yeah. And we’ll definitely come onto it. But I just want to run a parallel path from 2000 onwards when China entered the WTO and became a rapidly rising power and really demanding a much louder voice in all these negotiations. So let’s just talk about what’s been happening with alternatives being put in place over time. And you’ve done such a fantastic job with this. For anyone that doesn’t read your work at Forest For The Trees, you have been picking stuff out that as we’ve gone through that opening kind of 20 minute monologue, which you did so beautifully. You’ve been so good at picking out these seemingly idiosyncratic news story headlines, articles here and there, that if you read them in isolation really seem insignificant. But when you put them in a picture from the other side.
Grant Williams:
We’ll put the US aside. Now let’s look at the other side of this coin. And at the other countries who are beholden to the mighty US dollar and the moves they’ve been trying to put in place to try and give themselves an escape route. Now, you talked about Russia who have very visibly swapped treasuries for gold. They’ve been doing that very, very clearly for a number of years now and are effectively, completely out of US treasuries now.
Grant Williams:
I’ve seen that being referenced as they were doing that ahead of this Ukraine move. I think it’s probably been going on longer than that, and their motives are separate, but it certainly hasn’t hurt them. But let’s talk about China. Let’s talk about Russia. Let’s talk about those local currency deals that you talked about and bring in the Saudis, the Iranians, the Turks, and the other countries that really are clearly looking a part of this alliance.
Luke Gromen:
Yeah. I think it really comes down to enlightened or self-interest. Maybe not enlightened, just self-interest, raw self-interest. Whether it’s enlightened or not is really irrelevant for purposes of this discussion. If you’re Russia and you’re only pricing your oil in dollars, you have no sovereignty. You are a subsidiary of the US Fed. The US Fed decides… Your job in Russia is to try to manage the oil price. You maximize oil price, but you’re getting dollars.
Luke Gromen:
And so what you’re getting is based on US economy, US financial policy, fiscal policy, you’re effectively a vasal of the US, and that’s never rubbed the Russians the right way, particularly after the late 90s. If you are Europe, Japan, China, India, I will group all of them together because they are very alike in one critical way for purposes of this to discussion, which is to say they are essentially, the Indians, a little tricky, because they import so much gold they run deficits sometimes.
Luke Gromen:
But they’re essentially creditor nations. They run trade surpluses or current account surpluses, but they are net short energy. They are energy importers. So they are running deficits with the oil exporters. And so it’s this dollar link. So the Russians have no say over their sovereignty, the value of their oil. And the creditor nations that are oil importers are kind constantly at risk of running into a currency crisis.
Luke Gromen:
If the Europeans need oil and run out of dollars, they’re going to run out of oil, and you run out of oil or you run out of dollars and either the Euro’s going to crash against the dollar like we saw in Southeast Asia in ‘97, or the economy’s going to crash as you run out of oil or both. Same thing with China, Japan, India. For the Russians it’s the opposite side of the same coin, which is particularly once you get into the geological issues we talked about before, if you remember, I said, you started to see the as good as gold for oil deal breakdown in ‘05, where oil starts rising because of China because of emerging market demand.
Luke Gromen:
By 2013, emerging markets were the majority of global GDP and oil consumption for the first time in 300 years in the case of GDP. So suddenly this system, it just structurally doesn’t work, but the geological side in particular is really important. Because if you’re Russia peak cheap oil means that you’re going to sell oil today and in a year is going to go up 10% and it’s going to go up 10% a year smoothing out the economic cycles forever.
Luke Gromen:
And so you’re trading Fiat dollars, putting them in treasuries. You’re basically selling your oil at significantly negative real interest rates. So what’s going to happen is you’re going to wake up in 10 years, 15 years, and you’re going to have a pile of treasuries that used to buy you 1,000 barrels of oil. And they’re going to end up buying you 10 barrels of oil and your people are going to starve, and you’re going to be in trouble as a leader.
Luke Gromen:
The flip side of that, of the peak cheap energy issue holds true for that group of creditor nations that import energy. Which is the value, the real value, in oil terms of their dollar reserves are going to melt away like an ice cube by 10% per year. So either they have to depreciate their currencies, or they have to shrink their economies. Neither of these things are politically popular. And so it becomes a matter of national security from a strategic standpoint, for the entirety of Eurasia to move to a system where they can buy oil in something else.
Luke Gromen:
Now, ultimately I think Putin would tell you, “Hey, I love the dollar. The dollar’s a great system.” The Chinese would tell you, “I love the dollar. There’s nothing better than the dollar.” So what’s the better system and the better system, the only thing better for these countries than the dollar to buy oil in is their own currency. One they can print.
Luke Gromen:
And so the Europeans want to print Euro for oil, China want to print Yuan, so on and so forth. The issue with this is the American version of this deal that we’re printing dollars for oil as we have since ‘73 is, and this is the downside of the deal, is you got to run the deficits to supply the dollars to the world. Which means you got to offshore all the manufacturing. You got to offshore all the manufacturing jobs. You got to run a bunch of deficits at the government level. You got to do all these things that are really, really good for GDP growth and the economy in the short and medium term. And in the long run, they bankrupt you. This is just an expression of Triffin’s dilemma. So the issue is the Germans have no interest in offshoring all of the manufacturing, the Chinese have no interest in doing the same. The Japanese have no interest in doing the same.
Luke Gromen:
So they’re not going to run the deficits to supply the currency, to be able to print their own currency in. So what’s the next best option, especially when nobody trusts each other. It’s gold. It’s already sitting on the central bank balance sheets. It’s right back to where we were for Keynes. It’s right back to where we were for the Europeans in the 70s. And you suddenly see the central banks from 2008 on buying gold, repatriating gold, getting gold back into their own borders. I mean, it’s been this fascinating thing to me that ever since 2014, some people will say Russia is a threat to invade Europe. Well, since 2013, the Europeans have been repatriating gold back like their life depends on it. Gold that they had kept in America for safety from the Russians.
Luke Gromen:
So how big a threat do the Europeans really see the Russians as if they’re repatriating gold they kept away from Europe for safety from the Russian. So there’s, I think something bigger going on here that you can kind of again, see that on the surface, they’re repatriating gold. So what? But in the context of all of this other stuff, it starts to take on you said, much, much greater meaning. And so I think that’s really… It’s a matter of national security from a strategic standpoint, because otherwise you’re going to end up with your currency collapsing, your economy collapsing as you run out of dollars to buy oil, due to the geology of peak cheap oil. And due to the Americans who expressed very clearly in a way, “Listen, when the boomers retire, we’re just going to print the money guys. And it’s a lot of money.”
Grant Williams:
Yeah. It’s a mountain of money. Great, so we’ve got those two parallel tracks there, and that I guess, brings us up to where we are today. And the reason why what’s been happening in the last couple of weeks with regards the economic sanctions and the kind of moves that have been made to ostracize Russia and put pressure on them.
Grant Williams:
As I’ve watched all these things unfold, I just see this game changing dramatically. And with it, people’s attitudes, I suspect in months to come. Now, what’s been interesting all the way through this, what you’ve talked about, and as you’ve outlined that, it’s amazing how many people you reflexively go back to the price of gold.
Grant Williams:
Well the price of gold hasn’t gone crazy. So you must be wrong. Because gold isn’t $3,500 an ounce, how could any of this make any sense. And what we’ve been waiting for really is a catalyst, when this becomes not just something you kind of quietly chip away at setting up in the background, but the actual matter of national security now becomes a race to put in place what you’ve been talking about. So let’s talk about the sanctions that have been placed on Russia. And why that accelerates what you’ve been talking about.
Luke Gromen:
Sure. I think before we get there, we need to spend 30 seconds highlighting when you said in ‘08, I said, the US actually was still in really good shape. We had a good balance sheet, all these things. Well in the intervening time based on policy choices, based on crises in the intervening time and then based on COVID, the US balance sheet went from 60% debt to GDP to 130% debt to GDP. Deficits went from sort of run rate of 2% to 3% of GDP. They’re running at 10% now.
Luke Gromen:
And foreign central banks stopped financing U.S. Deficits to a large extent in 2014 because, in part, because they didn’t have the deficits to… Or the surplus is to recycle. And in part, because they were buying gold instead of treasuries. And so all of that by way of saying, we came into this crisis with this situation, and I think this was ultimately what Russia understood.
Luke Gromen:
And I think what China understood was because, I don’t think Russia does this without, China’s explicit backing. And there’s been hints to suggest that’s actually been the case in the last week or so. But I think Russia saw two things, which is unlike 2008, when they tried to force a run on the dollar via dumping mortgage-backed and treasuries in the heat of that crisis. I think Putin saw two things.
Luke Gromen:
I think he saw number one, the peak cheap energy. And the fact that US shale is peaking, which the Wall Street Journal’s been harping on for a year. We’ve been talking about peak cheap energy. The biggest marginal oil supplier to neutralize him over the last 10 years has been shale. And shale can’t really grow production much anymore for a number of different geological reasons. So I think Putin knew number one, that if you take his energy out of the mix, the global economy cannot survive without him.
Luke Gromen:
It will go into a very severe recession. Which then takes into account the second part, which is the US government’s balance sheet isn’t where it was in ‘08, it’s sure as heck not where it was in 2000, ‘95, ‘90, ‘85, ‘80. It is now a dumpster fire. And what I mean by that is when you look at… For example, one metric I’ve used it. True interest expense is US treasury spending plus the pay as you go portion of entitlements. That’s 100% of US tax receipts. With tax receipts at all time highs and 12% nominal GDP last year.
Luke Gromen:
So the point is that the US fiscal situation is exceedingly weak. So weak that if the US has just a modest recession, the Fed is going to have come in, mathematically. They’re either going to have to stand aside as the US misses payments on entitlements or treasuries or both, or the Fed’s going to have to come in and cover the difference. Or else the system’s going to come unhinged.
Luke Gromen:
And so I think Putin understood that if he takes his energy away, the ensuing recession will trigger a financial crisis that will force the Fed to respond with money printing. And so I think there was a very calculated move within the move, the sort of the game we’re all seeing of, he wants his territory back and all those things.
Luke Gromen:
I’m sure that’s the case, but I think in terms of the response, he had to have known that we were going to do these things. And that then brings to the point of some of the things we’ve done in the last week. Which have been nothing short of astounding to me. I mean, just absolutely astonishing where I think he expected that we would sanction, maybe throw him out of SWIFT do what we did to the Iranians. The huge thing that just happened that I think virtually, nobody understands the implications of in response to this is the US and the EU sanctioning Russia’s central bank reserves.
Luke Gromen:
They basically said your FX reserves, Russia are no longer money good. And that to me was… I think this is, we will look back in a few years time and realize that was every bit as big as Nixon closing the gold window in August of ‘71. Because if you’re a central bank, you can’t store… Basically that was the US saying take your money elsewhere. Take your money elsewhere. And people say, “Well, it’s just for bad actors.”
Luke Gromen:
But if you look at the last 80 years, the list of nations that the US has not considered a bad actor at some point is exceedingly short. The French were bad actors when they were raiding our gold in the 60s. The Israelis were bad actors when they… It’s so fickle. And so, I mean, it was literally one of these moments where you say the US just told the world to buy gold.
Luke Gromen:
They just told the world’s central banks to do that system, to do the BANCOR system that Eurasia has been looking for a long time. And I think it’s important because sort of all along in this process, I’ve thought some sort of systemic change like this would need two requirements.
Luke Gromen:
It would need to be able to be an easily crafted narrative. So the average guy on wall street could say, when his client says, “Hey, why is gold $3000 and the world isn’t ending?” And it he’s like, “Oh, well we sanctioned Russian reserves. And now central banks are all buying gold and there’s 12 trillion in reserves, and there’s only 12 trillion in gold ever mined. And the price is going to go to $5,000 because of that. And it’s just supply demand.” And that’s pretty easy.
Luke Gromen:
And anybody can tell that story. And so it’s the first time we’ve really had that. And then I think the second thing is maybe even more important, which is this was the American system. And as much as the US position is as weak as it’s been in 40 years, we’re still very, very powerful.
Luke Gromen:
And so I think if the system was going to make the final changeover, it was going to have to be the Americans to make the choice to basically do it. And ideally, if you were the American administration you know this needs to happen. If you want to re-shore you need this to happen. The DOD has been in favor of this type of thing. You’ve got to re-shore the industrial base for national security reasons. But if you’re going to do this, you got to do it in a way so that it looks like we’re doing it from a position of strength, not from a position of weakness.
Luke Gromen:
If it looks like the Russians and the Chinese have forced us into a corner, and now we’re doing the… We’re changing the dollar system, it makes us look weak. But this makes us look strong. Listen to how Wall Street, listen to how everybody is saying, “We showed those Russians. Froze those reserves. That’ll teach them.” And it’s like, it’s perfect. It’s a perfect narrative. It checks all the boxes and it checks the boxes for America in the long run. Like I said, the DOD has been… In the same way that moving away from system is a matter of national security for China, Russia, Eurasia, Japan. It’s been a matter of national security for the US defense department. They have been talking about this and talking about this for 10 years. They say we’re borrowing money from China to build weapons, to face down China.
Luke Gromen:
Our supply… We can’t fight a war without supply chains from China, which is a problem, because you guys are telling us our big adversary is China. We need to change the dollar system. When you read the defense documents on it they talk about how excess buying of treasuries keeps the Chinese Yuan undervalued relative to the dollar.
Luke Gromen:
Defense understands that if you want to be able to, as a matter of national security, bring manufacturing back, dollar system has to change. And so here we are. Now who loses? Who loses? Who is counseling, Washington, DC, not to sanction Russia out of SWIFT? Citi Group, JP Morgan, Jamie Dimon. There was articles on it in Bloomberg two weeks ago.
Luke Gromen:
So Wall Street, Fed, treasury. Treasury will like this eventually because tax receipts eventually going to go much higher with inflation, but in the short run, sort of this financial establishment of the last 40 years that has loved this Volcker era, they don’t like this. They’re not going to like this. Defense likes this. This is really good for America, but it’s sort of, once you sort of… It’s like the keystone, it’s the keystone, capstone piece of this whole thing’s been building, building, building. And this was the capstone piece put in place last Saturday night or two Saturday nights ago where they said, “Listen, your dollars aren’t good in FX reserves. Take them into gold and put them in your own country. We’re done here.”
Grant Williams:
Yeah, this is I think such a crucial thing for people to understand. When you replay the narrative, that’s been put around this kind of alternate system that’s been built quietly in plain sight by the Chinese, the Russians and everybody else. It’s always been framed as a way to attack the US, as a way to attack the dollar. And the reality of it has been, it was in their own national security interest. Now we’re talking about this as a national security interest.
Grant Williams:
And as you laid out so perfectly, this was always a national security risk for China, for Russia, for the Saudis, for all these guys. Now we reached this kind of bizarre point where, as you’ve just explained, the dollar system is potentially a national security risk for the US. And so we finally have a bizarre situation where for the first time it’s in almost everybody’s interest to find a way to end the dollar system and to transition to a new system that works better for everybody.
Grant Williams:
However, it seems like the only way to do that is through conflict, because it’s the only way to, as you say, to disguise, what’s really going on here and to be able to come up with a reason that plays well politically. Other than saying the system’s broken and the net effect of that is your standard of living is going to go down dramatically. And the price of your assets is going to get cut in half potentially. So what better way to do that than to create something out of this, which is a conflict between a group of nations who are all really trying to secure their own futures out of the same system. It’s bizarre.
Luke Gromen:
Yeah, absolutely. I mean, it’s one of these things where I tweeted this the other day where if you are frustrated with the US’s seeming inability to do anything to Putin without also sort of blowing off our own arm or leg or worse, but you also think that the dollar system is still a net benefit to the US. Those two things are contradictory, mutually exclusive positions.
Luke Gromen:
I mean the reason at its core that once China sides with Russia, there’s not a lot we can do is because we have so much of our own production sitting in China. We can’t cut off China. We’ll hyper inflate our own economy like we just trying to hyper inflate the Russians almost instantly. The reason why you’re seeing things like the Saudis say to us as they have last week, we’re going with the Russians, which means we’re going with the Chinese is because the Chinese are their biggest client.
Luke Gromen:
They sell way more oil to the Chinese. They can’t make the Chinese unhappy. They have to keep their biggest client happy. When you see absurdities like the US administration flying to Venezuela, and to Iran over the weekend. And effectively panhandling for oil. I mean, they’ve literally been trying to tip these regimes over for 20 to 40 years. And I would’ve loved to have been a fly on the wall of those conversations.
Luke Gromen:
But the fact that we had to do that, all of these things are mere symptoms of a dollar system that became a victim of its own success. Where literally, we got dollar Dutch disease. We’re the Saudi Arabia of dollars. We’ll provide dollars for everybody and you guys make all the stuff and we’ll give you the dollars. And like the other side of that deal is you got to keep dollars as good as gold for oil. And if you don’t, they’ve got to go away. And if they go away, well, they got all your factories. Well, you got no options. And so then it just becomes a matter of, again, you just said, managing the optics of the transition. And I think that’s what we’re watching. And it’s very interesting.
Grant Williams:
Yeah. I mean, I guess systems can’t end quietly, optically. Because that just doesn’t work. But let’s put ourselves in the position of the Russian central bank right now. Because they are about to provide a lesson, or they’re in the process of providing a lesson to every other central bank in the world.
Grant Williams:
As you said, that big move to sanction the Russian central bank was key. So what the Russians have now is a whole bunch of gold reserves. Most of which are sitting in Russia. They have no treasuries, they have their biggest customer, potentially, the Chinese who could one would imagine simply take all or a huge part of the oil that currently flows through Nord Stream into Europe. But they have other problems. They have this problem of being shut out the SWIFT system. Now CHPS, the system between the Russians and the Chinese, the kind of alternative to SWIFT isn’t ready yet it seems. So what does the Russian central bank do at this point, Luke? What are the likely ramifications as other central banks around the world watch the situation Russia is in and they try to mitigate being put in the same situation.
Luke Gromen:
And I think the Chinese, having their back helps keep them alive. But it there’s logistical issues in terms of the oil and how much can flow and the gas, et cetera. But if I’m the Russian central bank, and I wrote about this last week, I used the metaphor of one of my favorite movies, Field of Dreams. So there’s a great scene and field of dreams where Kevin Costner goes to James Earl Jones’ character. He’s trying to get it with him to come to Fenway park, to see a game. And James Earl Jones won’t go. So Kevin Costner puts his hand in his pocket and makes a shape like a gun and says, “All right, I’m going to kidnap you then.” And James Earl Jones sort of casually walks by and grabs a crowbar and starts chasing him down.
Luke Gromen:
And Kevin Costner goes, “Wait, wait, you can’t do that. You can’t do that.” And James Earl Jones says, “Oh, there’s rules here. There’s no rules here.” So it’s a little bit of the same thing where we have a little bit more than a gun in our pocket, but going back to my prior point, I think what Russia and China did was very, very calculated. The world can’t survive without Russia’s oil. It can’t, you just look at, you run through. It can’t. The system will collapse. Now, if we had no debt, we’d probably be okay. We’d have a nasty recession, but we can manage it. But it’s the debt and the sovereign debt, if it was just private debt companies going bankrupt, who cares? The sovereign debt market itself will collapse if they take away Russian energy and that’s critical.
Luke Gromen:
Oh, there’s rules here. What’s the crowbar, the Russian central bank grab for the gun in the pocket. And there’s a number of different things. You saw a hint of it last weekend. Look, if I’m Putin, I mean, you already saw him say, “Listen, we’re going to replace dollars with rubles in contracts.” So next step I would do is replace dollars with rubles for oil.
Luke Gromen:
Now, all of a sudden you’re going to have the Europeans and the Americans having to sell dollars and euros to buy rubles, to buy… You’re going to start supporting the ruble for him. Next up is you can use that oil to… You could, if you really, and I think this is the nuclear weapon is ultimately, we’re only accepting gold and we’ve revalued.
Luke Gromen:
We’ve revalued the right… We value gold at 500 barrels an ounce, 200 barrels an ounce. It doesn’t even have to be that high. I’ve used the number 1,000 before, that’s hyperbolic. It’s easy math. Rather than going to 150 barrels. But you go to 150 barrels an ounce. All of a sudden the Americans face a choice, that throws it back in their lap. As long as you have not shut all of Russia’s oil out of the global market, then it’s going to be fungible. You’re not going to be able to maintain a value of gold that is 150 barrels or 1,000 barrels of oil over here. And 20 on the COMEX NYMEX gold to oil ratio. And what that ultimately does then is when you talk about a move to the transition to this new system, where gold is the neutral reserve asset out of necessity, national security necessity.
Luke Gromen:
Remember what I said about the Yom Kippur war, and what happened to oil. Oil was made big enough to back the dollar. Oil went up 400%. All of a sudden the oil market’s big enough to serve as effectively a trade settlement, neutral settlement asset. Same thing here, if the Russians at any point in time, tomorrow, the next day, never, have the ability to make gold big enough to sort of apply the coup de gras to this ongoing transition.
Luke Gromen:
We’re already seeing of the primary global reserve asset being treasuries to the primary global reserve asset, being gold, simply by weaponizing their oil. Because at the end of the day, the ruble is functionally Russia’s, or nominally Russia’s currency. But their currency is really oil. And every currency is in the world has collapsed against oil over the last two weeks. So they have many more options than is appreciated. Once you start thinking, in terms of the systemic change that has been clearly underway for 50 years.
Grant Williams:
So let’s talk about options available to other central banks. Because like I said, they’re all watching this. And to your point, America’s basically said, potentially, if we don’t like something you do, then we are just going to freeze your reserves. We’re going to make them worthless.
Grant Williams:
So every central bank in the world is now looking at this thinking, okay, we need to not be in a position where that can happen to us. Because who knows what might happen in the future and what might get us deemed a bad actor. So presumably they are going to be looking to accumulate a lot more gold. Because it is, as you said, and as Keynes said a neutral reserve asset. It’s nobody’s liability. But I think in addition to that, they’re also not going to want to hold it at the Bank of England. They’re not going to want to at the New York Fed. There is going to be one would imagine if common sense, if nothing else prevails, there is going to be a lot more central banks buying gold and a lot more central banks wanting to repatriate it and hold it within their own borders.
Luke Gromen:
Agreed.
Grant Williams:
So what do those two things, what effect do they have on just the global gold market, but this kind of strange relationship between physical gold and paper gold?
Luke Gromen:
The fact that the… Not just the US effectively said, treasuries are no longer good FX reserves two weeks ago, or the US said, the White House said. But also the fact that they said, you have US senators saying, we’re going to seize your gold. You had a small group of US senators. [crosstalk 01:00:33].
Grant Williams:
Even though that’s held in Russia.
Luke Gromen:
Right. Good luck with that. I don’t think they were senior senators. So you get some of these crazy sort of fringe bills laid out there to sort of pander to their audiences. But if we take them at face value, what they were really saying is, “Hey, there’s almost 6,000 tons of foreign gold at the New York Fed. You should probably get it before we confiscate it.” But within all of this, I think, is it relates to your question of the paper gold market versus the physical gold market. Is this is a physical aspect. This is all physical. And so I think it’s interesting as all of this has happened, something that I can’t get out of my head is this incredible timing coincidence of the net stable funding ratio changes for the gold market per Basel III, that had been laid out for years that went into effect January 1st, 2022 in the UK. The very center of the unallocated gold market that drives this management of the gold price via the expansion of unallocated gold derivatives, really for the last 30 years.
Luke Gromen:
And I remember reading at the time, this net stable funding ratio language. And I couldn’t figure it out because you have the BIS putting this out. Basel’s putting this out and you go, this sounds like they want to wind down the paper gold market. This sounds like they’re telling London banks, “Hey, the price of Gold’s going to go up, get on side. Don’t be short paper gold, wind down your unallocated business, your short business, and get ready for the price of gold to go up.”
Luke Gromen:
And at the time you kind of go, okay. And now to be clear, it got watered down to a certain degree in July. But the gold guys that really know the market that I’ve talked to say it got watered down, but the spirit of it in terms of making the pricing of gold to be more physically driven seems to still be there. And so it’s really interesting. I think we’re about to see… Long winded way of saying, I think we’re about to see, I think the pieces are in place for the physical market dog to start actually wagging the tail of that market. Again, because it’s finally in everybody’s interest.
Grant Williams:
Yeah. I mean, look, perhaps just take a couple of minutes, just to explain the NSF for people that aren’t actually completely familiar what it is.
Luke Gromen:
Yeah. The net stable funding ratio and this is going to be the very simplified version. Alasdair Macleod did a great piece on it in great depth. I want to say in May or June of last year with Goldmoney. And I point you to that. And he did a follow-up in July when they watered it down. The gist of it is that there are two different capital charges for paper gold versus physical gold. And it’s much more… It’s, I won’t say prohibitively expensive, but it’s notably more expensive, basically paper versus physical. So it’s going to effectively… It effectively incented banks to wind down unallocated paper gold, basically to get out of that business was the gist of it. And so Basel for the audience they’re making the banking rules for everybody. They say it, you got to do it.
Luke Gromen:
It’s this sort of not something you can’t go along with. So it was this very odd thing to me. Because that’s sort of been the center of how you managed to keep the price of gold from rising as much as it should have. It should have been doing what Bitcoin’s been doing all along, which is if there’s more demand for gold, the price of gold can rise or the amount of paper claims on gold can rise. And it’s always been, the price of gold has risen sort of in line with debt outstanding, et cetera. But it’s not been allowed to rise as much as it might have otherwise done given events, et cetera.
Grant Williams:
Now, when you describe this… We had this famous thing about Nixon closing the gold window, and you kind of coined this phrase about the US closing the FX reserves window. And there were a couple of charts in the piece you put out today, which I thought spoke volumes. The first one was the comparison of the size of annual oil production versus annual gold production.
Grant Williams:
Because if we are talking about what we’re talking about here, where the gold market might need to be made bigger in order to accommodate this change. So perhaps you could talk about that for a second. And then the other one, which I think is probably the most important one for people to understand is just the debt as a percentage of GDP. And where we are in that chart. And also the CBO, I’m pretty sure it was the CBO projections that you were talking. But the CBO projections to where that’s going to go. And so when you tie those two charts together, the picture that paints is pretty stark.
Luke Gromen:
Yeah. So I think when you say, let’s… Our view is that the US closed the gold window in ‘71, that’s everybody’s view. Our view is that the US closed the FX reserves window on February 26th, 2022. When they said we can seize these for political reasons. I think you’re going to see a structural, secular… I don’t think it’s going to be all at once, but I think you’re going to see this relentless structural bid, FX reserves bid, for gold, for physical gold. It’ll be physical because it’ll be warehoused in those countries, because otherwise it could get grabbed.
Luke Gromen:
The FX reserves total are about 12 trillion. All the gold ever mined about 12 trillion. So that’s going to be very supportive of gold’s price over time if this is correct. Then, remember all of this goes back.. This is all… In the end it’s not about gold, it’s about oil, and about the ability to print your own currency for oil as a matter of national security to prevent your economy from blowing up when the Americans print all the money they need to, for the entitlements.
Luke Gromen:
If you look at just the oil market in annual dollar terms, it’s roughly almost 20 times the size of the global gold market, in terms of annual production. So new production of gold over new production… excuse me, new production of oil over new production of gold is nearly 20X bigger. That doesn’t include gas. Doesn’t include copper, iron ore, corn, et cetera. Oil’s the biggie, to be clear. It’s by far the biggest commodity.
Luke Gromen:
So the point is that you’re already talking about an epic short squeeze driven by FX reserves moving into gold. It would be even more epic, it’s piled onto by the commodity markets doing much the same thing. And where this all goes is and where it affects the dollar where it interplays with the debt is if you look back historically from two…
Luke Gromen:
So starting in ‘71 FX reserve balances began rising inexorably, but where they really rose were from call it 2000 to 2014, 2016, right before and then after China got into the WTO. So FX reserve balances globally, I think they went from 2 trillion to 12 trillion in the span of 12 years. So by far and away, the US’s biggest export were treasury bonds, it wasn’t even close. US Treasury bonds were two or three X the size of the US’s next biggest export. But the point here is that from 2002 to 2014, 53% of the treasuries the US issued in aggregate of the amount of debt that US increased in that time. So in aggregate 53% of the US debt was sterilized by global central banks. In other words, 53 cents of every dollar in debt the US took on from 2002 to 2014, ended up as FX reserves.
Luke Gromen:
So this did two things, very cheap financing for the US government. And two, it overvalued the dollar and undervalued Yuan and others who were buying these as currency management. So it’s basically turbocharging the deindustrialization of the US in favor of China. When you look from 2014 forward to 2020, what you see is that basically global central banks stopped growing their holdings of FX reserves. They stopped growing their holdings of treasuries.
Luke Gromen:
And in that time you saw two things happen. A period of time where the US regulated US banks into buying more treasuries. Then they regulated US money market funds into buying more treasuries. And then before the dollar rose as the US government crowded out global dollar markets. And ultimately this manifested in a repo rate spike at the short end of the curve was ultimately a short term treasury supply demand problem complicated or made worse by regulatory issues.
Luke Gromen:
But it was ultimately a supply demand problem. Fed begins growing their balance sheet. So what you’re talking about here is if gold becomes the primary reserve asset displacing treasuries, the US has to either slash spending to reduce treasury issuance, force the banking system to buy a lot more treasuries. And there’s some regulatory things they can do SLR exemptions that they did after COVID et cetera that basically is more QE through the banking system.
Luke Gromen:
Or the Fed has to basically re-up QE into an inflation spike to continue to finance these things that defense, entitlements, treasury, interest and treasury spending, these aren’t cuttable. So ultimately remember that defense report that we talked about where they talked about the excess Chinese buying of treasuries undervalued the Yuan, overvalued the dollar, deindustrialized, the US made the US defense industrial base weaker vis a vis China. And we need to stop this, this reverses that. All of a sudden closing the FX reserves window, no one’s going to buy FX reserves anymore.
Luke Gromen:
Even if they just buy less, forget about not buy them anymore, they buy less. That means the Fed’s got to buy more, which means the Fed’s going to have to do more deficit financing via the printing press. And we know what that did to the dollar, what that did to inflation, because we saw it from 2020 through 2021 and even forward. So the bad news is if you hold a lot of bonds, it’s a sea change. It’s the end of a 40 year bond bull market on a real basis.
Luke Gromen:
If you own industrials, it’s really good because all of a sudden this structural dollar system component that was preventing the re-shoring of American manufacturer, it prevented the US from having enough masks in COVID. It’s preventing us from being able to be industrially as sufficient enough to really stick it to China for siding with Russia, that will change over time. And you’ve seen hints of it already.
Luke Gromen:
When you see Ohio getting an Intel fab and the CEO of Intel saying, “We’re going to make Ohio one of the biggest Intel manufacturing regions in the world.” What? Ohio was ground zero of the people who took it in the shorts from 1973 to present under this deal. Another semi fab in Arizona, another semi fab in Texas. I think you’re going to see… I think we’re just like, it’s not even the first inning in this reindustrialization of America, but reindustrialization was never going to happen until you changed this dollar system and removed treasuries as the primary reserve asset, replaced it with a neutral one. And here we are. We’re two weeks into it. It’s incredibly exciting.
Grant Williams:
Yeah. You made an almost throwaway comment there that I think is a really important one for people to pick up on. And that is this idea that we’re just talking about oil. But just about every commodity is priced in dollars. And oil is the most important. It’s the lifeblood of the economy, but we’re not talking about natural gas and copper and zinc. Look at what’s happened to all those commodity prices. They’re all showing the effects of the same stresses on the same system effectively that we’re talking about with gold here.
Luke Gromen:
That’s right. And another way to think about the FX reserves build, that’s gone from 2 trillion to 12 trillion. When I say sterilize, sterilize is the right word, what it sterilized was the inflation we otherwise would’ve seen. They were sterilizing inflation. And so what the US did two weeks ago was basically turn the fire hose on. All of that stuff that was stored up in the attic, that $12 trillion of liquidity that was sterilized and prevented from causing inflation. It’s going to come rushing down into the bedrooms, into the living rooms.
Luke Gromen:
And ultimately this is what we need. We need to rebalance the economy. We can’t have an economy that can provide for its own self defense against the Russians and the Chinese, if we’re all bankers, if we’re all laundering money for the Russians and the Chinese. Hey, we’re going to seize your yachts is not a great… What else you got?
Luke Gromen:
You’ve got to be able to make something. And the defense department’s been warning about this for a while. This facilitates it. And again, it’s for me, it’s not, is it good? Is it bad? It’s what’s normal for the spider is chaos for the fly. And the bond market is the fly. And the industrials and commodities and gold and the US middle and working classes are the spider in this case. And those roles have been reversed for the last 40 years. It sucked to be a gold investor. It sucked to be in the middle class. It sucked to be a working class guy. It sucked to be a steel worker in America. And it’s actually going to change.
Grant Williams:
This isn’t the end of something. This is a reversal of something.
Luke Gromen:
That’s right.
Grant Williams:
We’re not in a system that’s kind of reached the end of its useful life. We’re going back the other way. And in many ways for investors, although it’s going to be an incredibly choppy period. The fact that we’re going to reverse everything actually gives you a pretty decent framework for what’s likely going to happen here. It’s not a time to be owning bonds. You’ve had a great time owning bonds for the last 40 years. You’ve been able to own them with your eyes shut and just kind of grit your teeth when you’ve had a few periods of bumpiness, that’s not going to be the same. It’s going to be a terrible time to own bonds.
Grant Williams:
It’s been an awful time… Well, not an awful time, but it’s been a poor time to own commodities. It’s not been a great time to own gold given what’s happened, but those trends are likely to reverse. Asset prices, which have been inflated on the back of QE are going to have to fall. All these things that have happened have been the bedrock of the kind of veneer of prosperity that’s been laid across this system are going to reverse, not just end, but reverse.
Luke Gromen:
I think that’s right. And you might actually see US indices rise. But underneath that, I think it’s going to be this vicious sector rotation of industrial, commodities, infrastructure. And I think there’ll be roles for even some of the growth tech names or the sort of the Microsofts and the Googles of the world that are sort of tech infrastructure. So I think on net, you probably end up with indices up, but underneath that, it’s going to be this vicious sector rotation.
Grant Williams:
From the fly to the spider. You’re right.
Luke Gromen:
Yeah.
Grant Williams:
Yeah, exactly right. Well, listen, look, this has been such a fantastic conversation as they always are whenever I talk to you. And look for people out there that’s listening, who are familiar with you and have been kind of sitting around on the fence, wondering about whether they should subscribe to your work and stuff. I can’t stress strongly enough that now is the time in my book.
Grant Williams:
If you want to understand what’s going on. And if you want to understand what we’re about to go into. I think Luke, your work is just about finest of its type that’s out there and has been following this dynamic for such a long time now. And I would encourage everybody to at least give it a try. To contact you and find out more about your work and maybe get some samples to really understand what it is you’re talking about.
Grant Williams:
Because to me, it’s been invaluable in building my own framework over the last nearly a decade. And I just feel like it, you are about to come into your own in regards what’s going forward. So let people out there, give them a really comprehensive way of how they can get in touch with you and kind of sample some of your work and find out what you can do.
Luke Gromen:
Absolutely. The easiest ways to get in touch with us, you can check us out at our website FFTT-llc.com. That includes what we’re up to as well as different product offerings, both institutional and mass market. You can also check us out on Twitter. I’ve got a very active Twitter feed @LukeGromen, L-U-K-E-G-R-O-M-E-N. And you reach out there and it’s fun. I don’t work a day of my life, because this is just, it’s fun. It’s a passion. It’s interesting. It’s stimulating. And I get to talk to you and talk about this interesting stuff for an hour and a half on a Wednesday. I love it.
Grant Williams:
Well, mate, listen again. Thank you for making the time to do this at short notice. I really appreciate it. I’ve messed you around a bit this week, scheduling wise, but I’m so glad we found time to do this, Luke. Thanks so much. Say hi to Tracy and the boys for me, and hopefully I’ll see you in person soon.
Luke Gromen:
Absolutely. Thanks again for having me out. It was great catching up.
Grant Williams:
Take care, mate. There’s really not much for me to add all that except to echo what I just said. For any of you, who’ve been circling Luke’s work now I’ve got to say would be an exceptionally smart time to at the very least sample his writing and get a deeper understanding of the picture he’s painted so brilliantly over this last decade. I say that with zero skin in the game myself, should you choose to do so.
Grant Williams:
Visit Luke’s website at FFTT-llc.com and inquire about his work. I’ve long considered it essential reading, as I’ve said, and I strongly suspect it’s about to come into its own with what happens next. You can also, as Luke pointed out, follow him on Twitter, you’ll find him @LukeGromen. That’s one M and that’s something everybody can and absolutely should do.
Grant Williams:
That’s it for me, I’ll be back again very soon with another great returning guest who finds himself also squarely in the spotlight once more. Until then, my thanks to you for listening.
Grant Williams:
Nothing we discussed should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets.
