Transcripts

Erik: Joining me now is Forest for the Trees founder, Luke Gromen. Luke we're recording this on Monday afternoon. That's only three days before our listeners will hear it, there could have been two or three wars between now and then at the rate things are going. Why don't we start with a recap of your understanding and.

Perception of the current situation with the Iran conflict and what it means to markets. And listeners, obviously please understand that we have to record in advance of airing this. The news flow is coming pretty fast, so it may have changed by the time you hear this.

Luke: Fast and furious indeed. Now, thanks for having me on again, Eric. I appreciate it. For me, I think this is simultaneously. At the moment, both the easiest and the hardest macro event to trade in quite some time. And the reason I say that is it's the easiest because it's a one factor market, in my opinion. Is Hormuz Open or is Hormuz closed?

And as long as it's still closed, we are accelerating nonlinearly toward a really bad outcome. And if it reopens, then we can start looking at secondary and tertiary explanations, outcomes Etc As things stand now. You know Hormuz when this war started, it was started, it was supposed to be a weekend and then maybe a week, and then maybe a couple weeks, and then a month, and it was supposed to be open quickly and when it started, my worst case scenario was that this could end up being a US Suez 1956 moment and now seven weeks in hor moves is still closed. Supply chain issues are just now really starting to stack up. Whether you look at social unrest over fuel in Ireland, you look at, I thought interesting data point today. Toto, the Japanese toiletry maker or toilet maker had to new orders for raw material.

The stock down percent today. So I think the base case now for me is that this is a US Suez 1956 moment where, until Hormuz reopens I think supply chains are gonna keep getting worse exponentially from here. I think we still have at some point that's gonna matter even more to sovereign bond markets, particularly in the West.

You're already seeing Japanese bond yields. The US has had, I think two or three different Trump tacos once the tenure has hit 4.4%. A couple weeks ago, we had three straight really sloppy auctions. So there's some noise in there that is being managed as well. And at the same time as all this is going on I'm just astonished still how complacent that consensus appears to be about these supply chains and bonds.

Number one, but then number two, how complacent consensus is about the fact that this is not just existential for Iran and for Israel and for the US but it's ex existential for China and Russia too. And so every analysis I see practically it seems that sooner or later we're just gonna beat up and we're down the Iranians.

And maybe that's true. It's probably true. None of these analyses I see are factoring in that this is existential for China and it's existential for Russia. And what does that mean? And people say they can't do anything. China supplies our military China's factories back the S&P500, essentially.

There's a lot they can do. I think where this is all headed is forcing the US into a choice. So what does Suez 1956 mean For us, I think it means we're forced to pull back. Or we're forced to print money into an oil spike to contain the bond market. Or we let rates rise in a recession, in an oil spike and let the economy take the hit, which is not really an option, but it's for very long.

At least it's an option in the very short run, conceivably. But, so I guess just overall. I've been doing this 30 years in investment research and I've only seen two other times like this that I can recall, and the first is in 4Q07, where I was in a former seat and I was seeing, we were doing bottoms up fundamental equity research at Cleveland Research and I was seeing the US economy and financial system collapse in real time.

And yet the equity markets hit an all time record on the S&P in the fourth quarter of oh seven. And it also reminds me of 1Q20 when, obviously with COVID. And quite honestly I didn't think COVID was a big a deal initially, and I was wrong about that. But the same way markets were just blissfully.

Complacent. And then Tom Hanks said he had COVID and then they shut things down and the markets absolutely, had a fit. The view I'm I've had, and the view I'm sticking with Hormuz is all that matters and every day that it stays closed is it brings us closer to a nonlinear break in supply chains.

And my view has been that's not gonna be good for markets if slash when that happens. And I just, that's why I highlighted that Japanese toilet maker today, down 7% on the day like. If they had gone up 7% or up 10% on announcing that they couldn't make anything anymore, 'cause the supply chains, I'd probably would've have to say, all right maybe I'm just not getting this, but the fact that individual names are getting crushed on supply chain problems I think means that if this continues, the market's gonna get crushed probably sooner rather than later.

It just feels like a Wiley Coyote moment.

Erik: Let's go a little deeper on that issue of consensus, complacency. I have a theory I'd like to run past you, which is I think it's as simple as the people in finance who are not physical crude oil market traders just don't understand the logistics lag effect, and trust me, the among professional physical market.

Crude to oil traders. There's no complacency crisis there. They're scared shitless. And I think what people don't understand is the last tanker to transit successfully on February 28th before all of this stuff started. That hor is oil will arrive at its destination next week. That's how long it takes for oil that's flowing through the Strait of Hormuz to get to where it's going.

So there hasn't been any supply. There's been speculation, obviously about this is a big deal and what could be coming, but the actual disruption of supply hasn't even started yet. It seems to me like it sets the stage if we saw some kind of resolution in the next week or so. Fingers crossed.

It really sets the stage for the market to breathe this huge sigh of relief where all the people who don't understand the physical logistics say, okay, that's over. Wow, glad we got through that. And they don't realize that there's like this six week complete stoppage of flow of crude oil. Into the whole rest of the world.

That's going to happen no matter what. And you don't just take the, let's say we resolve this and we open the strait completely and totally next week. You don't just call up the captains of those vccs and say, Hey, engage your warp drive and, get to Asia in a week instead of a month and a half.

It still takes more than a month to get there. It seems to me like that's a setup, if I'm right about that for the market to really have kind of a final blow off of complacency and then a, oh shit, this is reality. What do you think?

Luke: I think that makes perfect sense. I've seen that in conference calls where, someone asked me on a conference call, and this was probably six days into this, and they said, okay, what do you think?

And this should be over another week. I said, another week. Are you kidding me? Based on what I was hearing was, what I said is, I said, my base case is we're gonna be, we're gonna get to at least mid April. I said, and that, that kind of stuned them, I said but. I would actually be risking, your portfolio for Hormuz is still closed on the 4th of July or for mid-May, late, or mid-May to mid-June.

And it looked like their face, looked like I jumped through the screen, kicked their coffee into their lap, and then, just shock them. And their response was you understand, you're saying if that happens, like hundreds of millions of people could starve to death, right? I said, I know exactly what I'm saying.

This is why I'm so worked up. that people in finance are just hey, just, hit, control P and. We'll print oil or, we'll, the oil will be where it needs to be and the sulfur will be where it needs to be and the fertilizer will be where it needs to be.

'cause oh, by the way, on fertilizer as I'm sure Eric, we're on the clock for a growing season. Like you're not gonna be throwing fertilizer down in June or July. It's too late at that point in, in the Northern Hemisphere for a lot of places. So I think it's that. And then I also think too, there is.

We are in, generously, we're in fog of war, not generously. We are being subjected to very good propaganda and control of the message, which is to say from day one, I was getting very credible rumblings that this war was a going to last longer than we thought, and b, it was not going as well as we were advertised as we were being told.

And. When I started hearing that, it was probably 3, 4, 5 weeks ago, and last week and a half, we've had in the Wall Street Journal the news come out that the US Embassy at Riyadh not only was hit way harder than we had admitted, but that the Iranians were so accurate that they didn't just hit the embassy.

They picked out the very part of the embassy where the CIA office was and destroyed it. They were so accurate. I hear credible rumblings that much of the CIA evacuated much the Middle East, early in this war, not a peep from. And so I had heard that relatively early on. Then you hear things like fifth Fleet at Bahrain again.

Heard that it got hit very hard relatively early on, that our air defense stuff wasn't as good as we were being told our air defense missiles and the Iranians were far more accurate than we expected and that the Russians were helping target and the Russians helping Target came out relatively early on.

And then again, last week we had an article saying that 1500 people at the head, the home of the US. Fifth fleet in Bahrain were evacuated so quickly. They couldn't, at first, they weren't even gonna let them take pets and they finally let 'em take pets. But it's basically grab your pet, grab a bag, grab your toothbrush, and go.

And they evacuated them back to the US. I'd heard about that three, four weeks ago. And so it's publicly reported now. And my point here is that. Between the physical constraints and the lagged effect of that, that people in that world are seeing. And then just this, you would never gather, hey, the Iranians, and to be clear, I'm not hearing the Iranians are winning. That's not my point I'm hearing they're getting beaten up tactically very badly. And I'm also hearing that they are doing some very damaging things to our infrastructure and bases in a way that absolutely point to this being a much longer than we thought, which I was hearing three, four weeks ago, five weeks ago, and b.

Like the whole dynamic of weed are just, there've been all kinds of reasons why Hormuz isn't closed. Like when you tell people on the ground in the Middle East MOUs isn't closed because they don't want to, and it's ship insurance and all this stuff. Like they laugh at you and they're like, that's stupid.

The reason it's closed it's cause no wants to get blown up. And, We've seen sort of the proof in that of, hey, not only did they get by our air defenses, but they hit, they hit our embassy and they hit the part of the embassy where the CIA a was not where the families were. They hit the fifth fleet base at Bahrain is very beat up.

I hear. If they're getting through those things, which presumably had pretty good air defense, like by all accounts, sailing a ship through the strait of Hormuz is like. Shooting fish in a barrel for that kind of stuff. When you pair that with what what you're hearing in the physical world, what the physical world's okay.

The war we have not even seen the shortfall yet. And then the guys in the defense world are going, this is gonna last longer than we think, and it's gonna, if we really do this the wrong way, it's gonna be bloodier than we think. Then you start saying, okay. I'm not, still not optimistic.

It's gonna be open in a week, in two weeks, in a month. I like, to me, I think it's very possible this thing's still closed on the 4th of July. And if that, like nobody's position for that at all. So I think between your point of, Hey, we've not even seen the lag effects and look, I don't, it's, is it my base case?

It's still closed on 4th of July. No, but is it, my base case is still closed in a month. Yes. And you and I both know what that implies for the second half of the year for supply chains. It's a disaster.

Erik: Let's talk about some of those knock on effects now and how they're going to affect the economy and what it's gonna mean in terms of trades and markets.

Let's suppose you're right that the fertilizer shortage that's already occurring is gonna mean that farmers don't. Plant 'cause it's planting season now or it's coming up on planting season. Depending on, on, what latitude you're at. If they're not able to use as much fertilizer as they would like to, or they can't get the fertilizer they need or whatever it means, crop yields this year are not going to be as strong as they've been in past years.

We won't see those effects hit the real economy until after the harvest season, but it means six to 12 months down the road there's a very significant food inflation effect there potentially, if you're right, that it's at least another month. That's going to cause the backwardation to steepen even further.

And we're going to get to where, the people who need the diesel fuel most urgently, especially in Asia, Australia, the hardest geographies. We're gonna be looking at double, triple prices that creates. An inflation shock wave that potentially becomes self-reinforcing and changes behaviors because as we know as our listeners know the study of inflation says that once it gets going, consumer behavior changes.

As people know that things, the prices are going up, they start hoarding and, that just exacerbates the problem. Are we headed into some of those feedback loops that are, are they avoidable at this point? And if they're not avoidable, where's that gonna leave us a year from now in terms of inflation bond yields and so forth?

Luke: I think you absolutely nailed it. I'll simplify I'll use a stark, but I think straightforward. Simplification of it, which is, our world and data put out a chart data is 2015, but it shows world population of seven and a half billion. And then it shows world population supported without synthetic fertilizers.

So to be clear, this is what population would go to if we didn't have synthetic nitrogen fertilizers via the the Haber Bosch process and. World population in 2015 with fertilizers, seven and a half billion world population without synthetic nitrogen fertilizers in 2015, 3.9 billion. That's the dynamic we're talking about.

And so it, there's a, obviously it isn't a, we've not been completely cut off, but it is a margin. Everything happens on the margin and on the margin. Yields are gonna fall, supplies are gonna fall. Supplies down demand for food is constant. And if anything, it's probably up here. You saw the Trump administration take the E 15 limits off of ethanol.

So I don't know if anyone's blending higher levels, but conceivably they could, which will chew up more of the corn crop here in the US and further reduce any sort of you know Tighten global corn, markets. Yeah, you're looking at a situation where later this year you're gonna be looking at starvation across, in parts of the, in the poorest parts of the global south, possibly quite bad a humanitarian crisis.

You're gonna see food inflation that is pretty pronounced across. The richer countries and that then gets into important implications for obviously for politics. You can if food inflation and gas inflation is short soaring, you can certainly short the it's probably a good idea to short the incumbent.

So you'd be talking about a blue wave probably in midterms this year. But from a market's perspective. Mar that's, we're gonna be talking about a spike in inflation bond yields already at problematic levels and not able to go much higher without creating market feedback issues.

I had thought that number was 4.6% of 4.8% on the US 10Y treasury yield. Last three weeks, four weeks have shown me at least that. Bessent and Trump seemed to think that number's 4.4% because every time it breaks 4.4%, like the war goes away for a couple days and some sort of positive announcement.

Or the last week or a week and a half ago, Bessent did the single biggest treasury buyback in a single day in history at $15 billion. So clearly four point percent, 4.5% in a tenure is a bogey they're watching for. And we're at what, 4.32 today? You get more food inflation, it's gonna wanna go through that 4.4% on the upside, like a hot knife through butter, which if it did, would then create, okay, this decision point again, do we let.

Stocks really tank and the dollar really rip, which is gonna create a dollar debt spiral of, higher yields, higher dollar, lower stocks, lower receipts, higher deficits higher issuance, higher yields, higher dollar lower stocks until we crash into the ground at, 500 miles an hour.

Or do they come in into a food spike and an oil spike and print money to cap yields, which I think is what they would do, which will only make the problem worse. Yeah, it is a, it's a huge issue. And again, if they fixed it today, it's gonna be a huge issue. And I don't think they're gonna fix it today.

And I don't think they're gonna fix it for another month at least. And that makes it a huge issue. And if it goes the 4th of July, which I think is, 10, 20% chance. Holy cow. Like you we really are talking about looking at the possibility, one of the worst humanitarian crises in my lifetime.

And then you get into, from the financial standpoint of, all right, you're gonna have food riots all over the global south. You're going to have political instability, you're going to have bond problems. And that's, it's just, it's not a good environment for risk taking, for investing. It's a good environment to, own cash.

Own gold and go to the beach and have a, ha, have a drink because it's gonna be, it's gonna be a tough environment.

Erik: Based on the things that you're saying and that we both agree on, governments would need to get very heavily involved in coming to the rescue. If you have a humanitarian crisis where people are literally starving to death, obviously governments have to step in and do something to help.

California's already announced an intention to suspend its gasoline tax in order to help people through this crisis. Okay I support all those things, but wait a minute. If all of the governments around the world. World have to subsidize a whole bunch of things. Doesn't that dramatically exacerbate a government debt crisis that you and I both agree is already, you've famously made the comment that government deficits and excessive debt don't matter.

Until they do, then they matter a lot. I thought we were getting close to that matter a lot moment already before this all hit the stage. Now we're talking about events that it seems to me are necessarily going to force governments to step in and subsidize a whole bunch of things with a whole bunch of money that they don't have

Luke: a hundred percent.

That's that really awkward. Moment of you gonna print money into a food and oil spike, are you gonna, how are you gonna, and some governments have other options, right? Depending on the government. For example, Chi Japan's probably one of the first that is already right there, teetering on the edge of a bond market problem.

If, you know something we've been repeatedly highlighting declines is if you look at, for the past six to nine months, if you look at. The 10 year US treasury yield minus the 10 year JGB Japanese government bond yield. And then you compare that to the the yen against the dollar. You can see that those two have been very tightly correlated up until about six or eight months ago.

They've diverged massively with and so what that's telling you is the Japanese government bond yield is getting higher and higher relative to the treasury bond. But Instead of that strengthening the Yen, it's weakening the Yen against the dollar. And that's emerging market price action. Like people are watching that with great curiosity in the developed markets going we've never seen this before.

And everybody in the emerging markets is doing like the Leonardo DiCaprio meme, right? Where you agree with the beer in their hand on the sofa pointing at the tv. I recognize that's I know what that is and that's the market saying. Higher yields are not gonna strengthen your currency, Japan, they're gonna weaken it because we know you can't afford a higher yield and you're gonna have to print it.

So you know, Japan's already dancing along the edge. But Japan has some has an option that say the US doesn't have and that Britain doesn't have and Europe has less of, which is, Japanese have this massively positive net international investment position, which is just.

Japan's piggy bank, all of the years that Japan's been running massive trade and current account surpluses, they've invested a lot of 'em into dollar assets and they've got trillions of dollars in dollar assets. And if this hits Japan, something Japan can do something Korea can do, something Germany can do to a lesser extent.

And parts of Europe is, do we print the money or do we not print the money and we just sell treasury bonds and sell us dollar assets that we've saved up for a rainy day. They're gonna sell the bonds, they're gonna sell the stocks. And that's where, people say there's this view that.

The plan of what Trump is doing is he's an agent of chaos and he is just gonna create chaos, and that's gonna be an opportunity. And it's not it's going to blow up his own bond market because people aren't gonna hold treasury bonds and certainly not gonna buy more of them. They don't have enough food if they don't have enough energy.

Treasury bonds and stocks are below food and energy on Maslow's hierarchy of needs. And you know the countries that have been running surpluses for a long time, they have some leeway to sell dollar assets, and the world in total owns $70 trillion in dollar assets. Gross $27 trillion in dollar assets net, and they'll sell every one of 'em to get food.

Get food and energy in the same way that you or I would sell everything we own to feed our children or feed our loved ones. The world will break down, now the poorer countries that are barely have not really run current account surpluses like. They're gonna have to print money, and it's only gonna make it worse.

The Americans are only are gonna have to print money. The Brits are gonna have to print money because us is a Twin Deficit Nation. Brits are a twin deficit nation. Turkey is a twin deficit nation. These places are gonna have to print money to buy food and it, it will be orders of difference, right?

Rather be in the US than in Turkey, rather be in the US than Britain. But it's all gonna be highly inflationary. Yeah I agree. It is very problematic.

Erik: You mentioned gold a minute ago. Let's come back to that. 'cause this has been really fascinating. At the beginning of this crisis in February, gold was acting in its traditional role as a geopolitical risk hitch.

The bombs drop gold goes up along with oil. Then on March 2nd, everything changed and we got this inverse relationship where its bombs drop, oil goes up, gold goes down, presumably because the market was sensing that oil driven inflation signal was going to tie the fed's hands and pretty much rule out any possibility of a rate cut.

It started to look like gold was maybe starting to go back to its its historic behavior over the last week or two. But then Monday we saw, eh, muted recovery on gold. But as, and just think about this, Monday was a day, first. Over the weekend there was supposed to be this big peace talk and everything would be worked out that failed.

We didn't get to a peaceful resolution to the the crisis in Iran. And The S&P breaks out to the upside through. Its a hundred day moving average in reaction to that news, but gold, which had been suppressed because of the, the Iran crisis and the perception that it was gonna create this inflation signal.

It's not breaking out to new highs. It's struggling. What gives here,

Luke: I think your explanation for why Gold got hit initially was exactly right.

And, there were a lot of tourists in gold at those prior price levels and so there was some fuel for it to head lower when there were concerns about higher rates. And people were complacent initially about stocks, and then people were like, oh my gosh, this actually is a big deal.

And they hit stocks. And so people have been out of off sides for, for a lot of these moves. So a lot of people who got, for the first week, oil didn't really move that much and then it moved a lot and then, then it came back. So it, a lot of people have been offsides both ways on oil, and a lot of people have been offsides both ways on gold.

A lot of people had been, hey, I'm, okay, markets don't care about, the stock market doesn't care about this. And then the next week you cared about it a lot. And so people had to position by the time everyone repositioned and then it started going the other way. And so I feel like there's a lot of that still going on.

In the context of the broader context of investors, have had 30 plus years going back to 1990, 35 years. So everybody in a senior seat today has gotten paid for buying. When the bonds start falling and, once the bonds drop, you buy stocks and you sell oil, and you sell gold.

You don't need, and they've not revisited their priors. This thing was supposed to be over three, four weeks ago. It ain't, and it's not it's not getting better. Now, I also I'll that's my Occam's razor explanation. I think there is, look in, there's in, there's a, an old saw, there's no atheists and foxholes and in wartime there's no such thing as free markets.

And so these markets make no mistake, are being managed. And I'm not gonna say that they managed gold. I think look, gold was due for a selloff. And I think that's the reason gold sold off. Now you had three really ugly auctions, including in a two year treasury auction. You should never have a bad two year treasury auction ever.

And it was a really ugly one. I think it was three weeks ago, followed by an ugly five, and I think an ugly seven or ugly 10, I can't remember what, but they were all ugly. And then literally five days later, we get, this huge treasury buyback program. And again, is it new liquidity? Not technically, but if you're putting in bills and taking out notes or duration, like it's, it's a management it's a manipulation.

And it like that is what it is. Because the reality is if, the reality is the, is bestin and Trump are not going to let the bond market. And the stock market beat them. And so the release valve is gonna have to be something else. They're not gonna let the price of oil beat them. The former commander in chief of the Iranian the IRGC came out like a week and a half in and said, listen, our plan is simple.

They were planning on a very short stay. We can see that from their logistics. All we're gonna do is we're gonna hang in here and we are going to create a financial crisis like Hormuz stays closed, the world economy is gonna collapse. That is not a guess. That is a mathematical, physical certainty. We can debate how long it'll take Hormuz to stay closed for it collapse, but it stays closed long enough.

The world economy will absolutely 100% collapse. That's their plan is, Hey, let's keep Hormuz closed. And we'll collapse the global economy and we'll see if Trump wants to continue to be a warmonger. His word's not mine we'll drive oil up a whole bunch. So I, I think part of what's going on here is you're getting the military guys like, hey, some of what they're doing over there with these airstrikes are shaping operations.

I think Besson and his team are doing shaping operations in the market, which is. If people want to take yields to a bad level, they shape those people wanna run away with oil. They shape those, they, they there's I think it's a very challenging environment as a result of that because again, that there is zero chance, in my opinion, that Trump and Bessent are going to allow the US to lose because of free markets.

They have absolutely have the firepower, the means mode of an opportunity to do these things. And I would just, people don't wanna make, might think I'm crazy, but I would just point you to the blatant front running in the oil markets, which I'm sure you saw, right? Somebody, on the 24th of March, somebody front ran on $500 million in notional on shorting oil ahead of Trump's tweet.

And then last week somebody front ran the ceasefire $950 million in notional, that's. Big boy positions who's getting the heads up, right? Why is these are not clean markets. These are not exactly the these are not your, these are not our fathers or our grandfather's markets of, Hey, this is just supply demand and there's no political impetus here.

There's a huge political impetus in these markets.

Erik: Let's talk about how this inflation signal plays out, because at first glance it seems just overwhelmingly clear that if you have an oil crisis, the oil prices have to go dramatically up. That's a huge driver of inflation. Food prices. If you have crop yields diminished as a result of a lack of fertilizer, that is.

A huge driver of inflation. But wait a minute, Luke, you said just a minute ago that it is an absolute certainty that the entire global economy crashes and stops if this thing goes too far. Wait a minute. That's deflationary, right? At what point does the inflation signal go the other way?

Luke: Yeah, it's a great question because it isn't a very short run. You're exactly right, which is to say that once these oil prices get too high as a deflationary impulse. Now if you have right now, the new fiscal numbers just came out for the us It's through it's halfway through the year, right?

So we're six months in through March. I ran the math on Friday. If you look at US true interest expense, which is entitlements plus gross interest, or actually in this case, net interest. Plus Veterans Affairs through March, which is six months of the fiscal year, we're at 102% of receipts. In other words, the interest and interest like obligations of the federal government are 102% of the receipts.

And it's, it is this tricky dynamic where there is a pass through inflationary impulse of commodities. On the one hand, which all else equal raises inflation expectations, there is a deflationary impulse from the recessionary aspect of higher of an oil price spike and commodity price spike, which takes away slows growth, takes away discretionary spending, Etc.

And then there's this, you know that it tho both of those two factors get layered onto the dynamic, which is if you have a recessionary deflationary impulse, you're going to send your receipts well below your interest and your entitlements. And then you're in real sim. Another very simple decision market, which is the US government going to print money to pay for interest and entitlements?

Or is the United States government going to default and miss a payment on entitlements and interest? And I think there is zero chance. They do the latter. I think they're gonna print the money now, to be clear. Until they do. That's gonna be a market we can get dollar up rates up everything else down. And we've seen a number of those markets since 2019.

And so there's this very. Sensitive. Okay. Inflationary impulse of higher commodities, higher oil, deflationary, impulse of those things, and then a deflationary impulse of those things. Hitting receipts, which are going to create dollar up rates up, slow things down. But then it also is going to raise the question of.

Are they gonna print money? Are they gonna default on treasury bonds and entitlements? And of course, they're never gonna do those things. And there's, there is nothing that is more inflationary in the long run than a government who needs to print the money just to pay the interest on their existing debt and obligations.

So that's the sort of when I let off by saying it's both the easiest market and the hardest market at the same time, it's the easiest. It's is hor moves closed? Yes or no? Okay. That's pretty easy. The hard part. Okay, when is it inflationary? When is it not inflationary? Are they, how long are they gonna let people twist in the wind until they print the interest and the entitlements?

How much is the US and other governments involved in markets, whether that be subsidizing food or, if you're long oil, what, if Trump comes out, you're long oil, you're feeling good, bombs are dropping. Trump comes out and goes, Hey, I'm thinking about doing export controls on oil. Ah, now oil's gonna go limit down.

What? Like it's. It is very simple and very complex. I personally, for me, I put it in what, my friend Lynn our friend Lynn Alden calls it the too hard camp, right? Just too hard. So for me, it's too hard to try to trade the very short run. I feel very confident that an oil spike and a food spike will drive a slowdown, if not a recession.

Particularly when married with higher rates and the disruption from supply chains, and I'm not trying to bet on, on exactly when they're gonna pivot. I feel very strongly it's gonna create an air pocket and I feel very strongly that Air Pocket will send receipts below their interest and their entitlements.

And I feel very strongly that we ultimately, due to them having to print money probably into a commodity spike,

That's the sequencing. I see. And in the short run, I'm just sitting in cash and bullying mostly because. It's just too hard to try to, it's too hard to try to nimbly work my way through that. I'd rather just wait, maybe give up some upside and wait for the, okay. They're having to do QE and they're they'll do it, whatever, they won't call it QE. Probably they'll call it reserve management purchases or, food purchases to help the poor or some BS.

It'll, with the masses. So at any rate, that's, I'm rambling now, but that's you're right that it's this yin and yang to inflation, deflation in the context of the fiscal situation.

Erik: Let's come back to my favorite Luke Roman quote, which you've been saying for more than a decade now, which is government deficits don't matter until they do, and then they matter a whole lot.

It seems to me like when you talk about market complacency, the complacency we have in the United States is everybody is just always assumed. Look the US dollar is the world's global reserve currency. There's always gonna be a market for us treasuries. Always there. There's a special privilege, the exorbitant privilege that the US government has.

They're always able to print the money. They're always able to go into further debt. They're not going to have a fiscal crisis or runaway interest rates because they got. too indebted because they're immune to it, thanks to being the world's reserve currency. Hang on a second. Didn't we just see most of Europe completely unwilling to support the US in this Iran debacle?

Aren't we seeing changes where around the world? A lot of central banks are a lot less inclined to really focus on US treasuries as their primary reserve asset. Are we headed toward a US fiscal crisis that, everybody was too complacent to see coming

Luke: in a word? Yes. And you can see it, it's been slow motion.

People say, look, foreign demand for treasuries at all time highs, which is true. When you break that down, what that actually looks is well. Foreign central banks who once upon a time were the one of, if not the biggest holder. They haven't bought any new treasury since 2014 on net.

They're actually down slightly. Japan's bought a little bit more. The UK's bought a bunch more, which is primarily investors and hedge funds. And then, you look at where the biggest marginal buyer is in foreign, fed did a white paper in October of 25 that pointed out that 37% of the net issuance of US treasury notes and bonds.

Belly the curve and duration 37% in net issuance over the last four years has been the Cayman Islands. Which is heavily US hedge funds. It's this treasury basis trade and where you're buying cash bonds and you're shortened futures on insane amounts of leverage.

And yes, nominally foreign demand is absolutely at highs. That's correct. The makeup of it has been, we've gone from financing with very patient foreign insurers and pensions and central banks to. Highly levered hedge funds who sell treasuries when risk goes off, which is why treasuries, when you look at the correlations, have become risk off at risk, off risk on assets.

They've stopped acting. Even in this crisis, the weekend we, the bomb started flying around. I was having a discussion with someone on X. They're like, oh, 10 year yields are going way lower. I'm like, sold to you. They aren't going lower. They're going way higher.

Sure enough, right? We're up 50 basis points, give or take from, in seven weeks from where they started this war at, I don't know that they ever traded down at all from 3.94 on the tenure. So we have the foreign demand is nominally better, but it is lower quality, low, less patient creditors.

And in the meantime, the biggest marginal buyers have been, besides. Hedge funds in the Caymans have been us the Fed itself and US banks as well. And so people say when's it gonna start? And you go, when's it gonna start? Since Central Banks stopped buying treasuries and started buying gold.

Long-term treasury bond futures priced in gold are down 90% since 2014. And it's like the dream trade for a macro, the sharp ratio on it's beautiful. It's like up and to the right at a 45 degree angle if you look at it as gold over treasuries. But it is a one-way trade long gold short treasuries has just been an absolute beautiful, very minimal drawdowns, very minimal volatility.

So I think we're already there, but in terms of it going critical. That's the part to me that I just think the administration and a lot of investors were just super complacent on, or just out to lunch on, which is there's this view that the Chinese have no move, and I think that's totally wrong.

I think they just need to squeeze supply chains a little, get inflation going. And

The bond market will do the rest, and if the bond market doesn't wanna do the rest. Point being that if. They don't let inflation print the real number or they cap yields or whatever they do, then, real inflation's gonna show up politically no matter what. Because Trump and vesting can say, Hey, inflation's only three and a half, and if it's actually seven or eight, they're gonna be, they're gonna be spending the next two years of their lives dealing with impeachment hearings for Trump for the last two years because he'll lose the House and the Senate.

One way or another. China has a way to force this dynamic in terms of cost on the bond market. And so yeah, I think it is, that's where I think it is going to further accelerate. There's nothing more inflationary than war. So if you already had a very delicately balanced situation and here too, I would just point back to what we talked about earlier, which is this net international investment position dynamic.

Look, Japan needs oil, they need food other places that own a lot of dollar assets, including treasuries. They need food, they need energy. They're gonna sell those things. And so your net supplies of treasuries. May potentially rise dramatically, US deficits, especially if we have a recession, foreigners selling.

Your biggest marginal buyers have been levered hedge funds and, when volatility goes up in equities or anywhere else, they're gonna sell treasuries, not buy them. Yeah it is a, it is an accelerant without a doubt to the stresses we've been talking about for some time in the sovereign bond marketS&Particularly western sovereign bond markets.

Erik: Let's talk about where the trades are. I appreciate you said this is, too hard to trade in the very short term. As we start to get through this and see a light at the end of the tunnel, where are the trades gonna be? It seems to me that the food, if you look for things that have not been priced yet, that are certain to be coming.

Food inflation seems to me like a certainty. So how do you play that? Is there a curve steeper here in the bond market? That makes sense. What else? Where might the trades be when it is time to start trading this?

Luke: I think there's a lot here in, in secular, food inflation. There's even things like, grocery store comps will accelerate, it's nominal, but there's leverage there.

'cause it's a high fixed cost model, right? So grocery stores should do well in a higher. Food inflation environment. I would think for me, the cleanest fundamental plays are things around energy and uranium and domestic electrical infrastructure and the industrial selling into that. You've got bottlenecks there already.

You've got an impetus to reshore. So I think every, and anything in electrical infrastructure and nuclear and even oil, ENP, those things all seem very well positioned. I think I still really like gold. I think gold as well. I think there's gonna be a time for Bitcoin, coming up here probably next.

I dunno, a few months later this year I still, I'm watching Bitcoin as a trades still with IGV, the software ETF, and, there's maybe a sign of a divergence in the last week we'll see IG v's broken down again, but then Bitcoin didn't. But I think Bitcoin's gonna follow it lower again if I'm correct about the, the supply chain whoosh down.

So I think all of these things, when you get to the other side of. What I think is this supply chain problem that is going to get very acute and a moment of brief, moment of panic in the grand scheme of things. On the other side of that, I think these types of names will do quite well.

Erik: Luke, I can't thank you enough for a terrific interview. Before I let you go, your firm Forest for the Trees, which is fftt-llc.com has really become one of the most respected boutique investment research firms really in existence. Tell us a little bit more about what you do and what people can expect to find when they go to fftt-llc.com.

Luke: Thank you for that, Eric. I appreciate you. You've played a big role in that and I've always been very appreciative of all the support you've given us over the years. What we do is we aggregate a large amount of publicly available data points in a unique manner, trying to identify developing economic bottlenecks for our clients and and identifying different sectors to that are more attractive and less attractive for investment.

Really appreciate that.

Erik: Folks, be sure to stay tuned as Rory Johnston, founder of commoditycontext.com will be joining us next for an update on the Iran crisis and the logistics of oil in and out of the straight of Hormuz.

Erik: Joining me now is Goehring and Rozencwajg, co-founder Adam  Rozencwajg, . Adam, great to get you back on. Needless to say we live in interesting times. And for our listeners, Adam and I recorded this interview on Tuesday afternoon about five hours before President Trump's 8:00 PM deadline. So needless to say there will be some news flow that has occurred after this interview was recorded before this, goes to air.

Adam, we don't know what will happen in the next few days, but why don't we start with the situation at hand. Almost every physical market expert that I've spoken to agrees that this is the biggest physical market logistics dislocation in the history of the modern oil market, but it's definitely not the biggest price dislocation.

Why is that?

Adam: so first of all, wonderful to speak with you again. It's nice to be back and lots to talk about. As you very well mentioned, it's entirely likely that by tomorrow all the facts will be completely different and, , this might have a short shelf life. But what I'm gonna try to do is talk about some of the fundamentals in the details that we see in the oil market today and the commodity markets in general that are a little bit longer term in nature that are a little bit, stickier. And obviously we might have to adjust everyone's sentiment or everyone's outlook depending on what happens in the next 24 hours or 72 or who knows how long. But I think a lot of what I'm gonna say will be true today. It'll be true tomorrow. It'll be true months from now. So first of all, you're absolutely right that.

From a physical dislocation perspective, what we're seeing right now, is pretty clearly the largest disruption in the global energy markets that we've ever seen. But we're not necessarily feeling or experiencing all of that dislocation just yet. So what is it that we're experiencing today?

What are we seeing in real time and why maybe have we not felt some of the larger impacts of that as everyone. Now knows about 20% of the world's crude market passes through the strait of Hormuz and about 20% of the LNG trade as well. I think some people are beginning to learn that quite a bit of aluminum passes through that Very sensitive choke point, quite a bit of fertilizer as well. So it's not just limited to oil and gas, but certainly oil and gas are incredibly impacted. And since the offensive from the United States and Israel five weeks ago now the Iranians and the IRGC have taken effective control of the, strait of Hormuz and they've been certainly impacting.

Vessel's ability to transit. Some vessels are getting through many are not. And some oil is getting through on what they're calling these bypass pipelines, let's say the East west pipeline in Saudi Arabia being the most notable, which was built over the last, 15 or 20 years or so. Basically for exactly just this contingency to provide another form of ress for Saudi crude.

And basically what that does is it trends, cuts across Saudi Arabia on an East west basis, as the name would imply and allows for Port loadings in the Red Sea. Now that port is not immune from attacks either, and it's also not able to handle enough oil to totally offset what the Saudis relied on the Strait of Hormuz.

four. So it's a partial offset but certainly not certainly not a total fix. By most estimates you're talking about somewhere between at the absolute low end, 10 million at the absolute high end, 15, split the difference, call it 12 million barrels a day of impacted oil. That's essentially not making it to market, which is huge.

We haven't really seen anything quite like that before. Now. One thing that I'd like to point out and particularly for those that have followed us, we really like to focus on long-term supply and demand fundamentals. We like to focus on depletion and geology. We like to focus on capital cycles, and if you read our stuff, we don't too often talk about.

What I would call these logistical issues or these kind of headline grabbing events. Sometimes you get them. For instance, back in 2019 when the Houthis bombed the Abqaiq and Khurais oil processing facilities in Saudi Arabia there was a little bit of a panic there. It didn't last very long.

Only a few days before people realized that the impacts wouldn't. Could be repaired in a matter of a week or two. Similarly, in 2022 when Russia invaded Ukraine, it really dislocated energy markets and you got a spike there and it came off again. We're not the type of analyst firm that focuses too much on those near term dislocations.

It's not that they're not important, but they don't last. They're resolved. In this case, I think it's a little bit different though, and I think it's different. For two reasons. First of all, it's different because the magnitude of this dislocation is just much bigger than anything we've seen before.

So you'll have, I think in the near term, call it weeks, and potentially in the medium term, call it months. I do think you'll see some fairly pronounced disruptions to the global supply chain for energy. I think you're starting to see them already in places like Asia that were more dependent. On Middle Eastern imports, you're starting to see it now in parts of Europe as well.

You're not seeing it so much in North America, mostly because we've been able to produce a lot through the shales over the last 20 years, we've been able to reduce our reliance on, middle Eastern imports. You all remember when the US went to war in Iraq and after 9/11 there was a huge amount of consternation over how reliant we were on Middle Eastern oil.

That's just not the case anymore because entirely of the shales, which have grown, to 13 million barrels of crude and even more when you include the NGLs. We're not seeing the physical crunch here, but that doesn't mean we're not gonna see the economic impact because as we all know, oil is largely a global commodity and prices, arbitrage fairly quickly.

So we are seeing prices move here. We're not seeing, let's say the gas shortages or the gas lines in this country that we saw. Let's say back in the 1970s with the dual oil crisis in 73, 74, and again in 79. That's not to say that might not happen doubt in the future, but this is a really big volume of oil that's being disrupted.

So that in and of itself makes it a bit of a unique event as far as dislocations go. But the second thing that I think is gonna be really much more. Lasting and apparent is the fact that everyone has gotten the oil market wrong. We went into 2026 with oil being, I don't think this is an exaggeration, the most hated asset class in the whole world.

The weighting in the S&P of oil stocks was pushing back down to the COVID lows is a little bit above that, but not by much. And following investors. Positioning was extremely bearish and pessimistic. And in fact, even with. All of that US Naval asset sailing East towards Iran and the Gulf.

People went into the Friday before the attacks were launched with near record. Gross short positions on the speculative contracts at the nymex and on a net long basis. 'cause there's some logs there too. A net long basis. Basically the lowest net length we've seen in almost decades. So people were super, super bearish.

Prices started this year at 50 bucks, and that's too low. The oil market doesn't work at 50. And why was that? The reason everyone was so pessimistic on the oil markets right up until this conflict started was that. People like the IEA and others but most notably the International Energy Agency or the IEA were saying that the global crude market was in the biggest surplus in oil market history.

It had never been in a bigger surplus. And in fact, they were saying that supply was running about two and a half to 3 million barrels ahead of demand. Now, if that were the case that would be really bearish. Situation Indeed. And that would justify a $50 price or maybe even a bit lower than that.

There's only one problem. We weren't seeing any evidence of that surplus. Notably, if in fact supply was running so much ahead of demand, inventories around the world should be surging, right? They think that last year, call it 2 million barrels, conservatively in surplus 365 days In the year that should be about 720, 720 million barrels of accumulated oil that was produced but not needed over the year.

That should have wound up in storage tanks around the world, and instead we saw storage barely budge. Now, I wanna put that into perspective because here we are today on April 7th, I'm six weeks into this conflict. With the Strait of Horror, moving somewhere between 10 and 15 million barrels a day being impacted and lost.

And if in fact we had built inventories 700 odd million barrels more than they were a year prior in 2025, we should be absorbing this fairly easily. We should only be taken down. That excess inventory that we built last year by some, I don't know what, 30 or 40% of that, we should still be in a better position, a looser position, a better supplied position today, right?

Than we were in even April or May of last year, if you believe those numbers. And yet we're finding out that the whole transmission system of the global energy market, is massively desperately searching for crude oil. I am gonna tell you, and this is what our research has said, and we've been saying this long before the situation in Iran.

That the market was not in the big surplus. Everyone thought it was. The market was balanced. That's why inventories didn't grow, and it was balanced. Despite the fact that OPEC surged production by 2 million barrels last year. They brought everything they had back online and they did it, I think in a gesture to help Trump keep the oil price low.

When he announced his tariffs the day that. Trump announced the tariffs last April was the day that OPEC said, we're just gonna flood the world with oil. They did. They brought everything they had to bear. They brought two, two and a half million barrels a day online. And it was absorbed. It was absorbed by really strong demand.

And so today we find ourselves now in a situation where. We should have been able to absorb this. In theory, we don't seem able to, and I think what it, the longer lasting effects of this conflict is that it's gonna cause everybody to take a very close look at the oil market. And in many cases, that's for the first time in a decade there, there's many investment firms in the world that have just written off and gas for 10 years.

And I don't think That that cuts it anymore. I think you need to have a more nuanced view, and as people begin to come back to the sector, they're gonna say, oh my God, we haven't invested in any of this stuff in over a decade. And we're starting to see how fragile the supply chain really is.

Erik: Adam, I agree with you that what's going to happen next is everybody is gonna take a closer look at energy.

Something I've been thinking about though is probably, depending on each investor's own political orientation, some of them are gonna look at this as you were just diluting and say, boy, time to reinvest an oil and gas. Others are gonna say, we gotta do something about the oil and gas problem. We gotta invest more heavily in renewables, while others, myself included, will say no.

We gotta invest more heavily in building out the nuclear renaissance. Do you think that those other themes are going to be big and how do you think the market decides which ones get the most money and what happens next?

Adam: Eric, that's a really interesting question. Obviously, we've spoken quite a bit in the past on our view of renewables and whether we think that renewables are a particularly suitable form of energy.

And to save your listeners going back, the answer is no, we don't. They're not a very efficient form of energy conversion. You take energy from sunlight and you can create energy from electricity from it however. It requires an unbelievable amount of material, of raw material in the form of steel cement polysilicon in the case of in the case of solar, obviously huge amounts of steel and copper and in, in the case of windmills.

And then the fact that the sun doesn't shine at the middle of the night and the wind doesn't blow all the time, and so you need battery backups to do all that. All of these things consume energy and so what you're left with is a really poor converter. Of energy with renewables. And that's why, quite frankly, countries like Germany and England and, all the all the countries that have really decided to push hard for renewables are feeling this energy crisis the most acutely, right?

Whereas the countries that have doubled down on their oil and gas infrastructure, like particularly the United States helped along by the shales, they're riding out the storm in a much better position. So will people argue that? The takeaway from the Iran conflict is to double down on renewable energy.

I have absolutely no doubt that they will, do people in their hearts really think that's the solution. I think the cat's a little bit out of the bag there, and I think people are now beginning to realize some of the challenges, could nuclear help. Absolutely. And I think that will help push along the adoption of small modular reactors, but realistically, that's not gonna be here before the early 2030s.

And even then, it's gonna take quite a bit of time to roll out and scale. So I can only hope that the big takeaway from all this is a big push into nuclear, not just for our portfolio, but more importantly for the energy abundance of the whole world. But that's gonna take some time. I think in the near term though the one thing that.

Maybe people don't have on their radar is. Potentially a return to coal and particularly in what they're now calling the global south or the global third world, or developing markets or what have you, countries India being one of them, let's say that had made real commitments to pursuing LNG imports and have now had to face both.

Russia, Ukraine, and now Iran disrupting natural gas flows over the last 10 years. So if you wanna talk about something that's really sensitive to disruption, I would say that's gas. International gas, and perhaps we'll see this as a catalyst to say, maybe we shouldn't retire all those coal fired power plants.

Maybe we should double down on some of them.

Erik: Adam, let's talk more about what happens next. In oil and gas were, let's assume that one way or another, this war. Eventually ends for better or for worse, and we have to go to the recovery. So now we're dealing with a great big backlog, a logistics nightmare, probably.

What happens next in terms of the market? Do oil prices come right back down or do we see oil prices continue to increase? Is the the recovery from this situation maybe drags on? And where are the investments? What would you be actually moving on next as an asset manager?

Adam: I think the best investments right now remain in the oil equities, believe it or not, because many of them have moved, but they've moved like 30 or 40%.

They haven't had the kind of two to three x move that the spot price of oil has had from 50 up to 120, or I guess dated Brent today, hit 148 or something like that. The stocks are up 30 to 50. Percent. So what gives and why haven't they moved more and why might they move in the future?

The reason they haven't moved more is because outside of the spot price, the price for oil delivery imminently the forward curve hasn't moved all that much at all. It's moved from about 50 bucks to 70 bucks. And so the stocks have moved up in, in concert with that. So it's up, it's up this year.

Doesn't think that I. It doesn't think that things have gotten looser. Certainly, but nowhere near what you've seen in the spot price action. And the reason for that, I think, is that oil traders right now acknowledge that it's awfully difficult and getting a lot harder. Mind you to find physical barrels today.

But that, as you put it a second ago, this will resolve itself for better or for worse in a relatively timely fashion. And from then on, the market will get back to where it was before. Maybe a little bit scarier of a world because of the geopolitical risk, but by and large, back to where it was before that 50 to 70 dollar range.

And I think that's what is going to, people are gonna wake up to because that's not going to happen. And the reason I say that. Imagine, we're losing, call it 10 million barrels a day on the most conservative estimates. So that's 70 million barrels a week, and 70 million barrels a week times 6, 7, 8 weeks.

Pick your length you're going to take the global inventory level down dramatically by somewhere between three to 400 million barrels now. Global OECD countries have announced that they're intending to release 400 million barrels from their strategic petroleum reserves, but that will take their strategic petroleum reserves down to quite low levels.

Because remember, in the US we've already hald ours. And so now that would take it down by another. Material percent to what I would call dangerously low strategic levels. And I suspect most countries around the world, certainly China and I think certainly the United States, if there's a lesson to be learned here, it's that you better, have a good strategic petroleum reserve in place.

So I don't think any country is going to Bach at trying to rebuild those. And so the total global inventory situation is going to be a lot lower than it was in January. And once the dust begins to settle literally and proverbially, I think analysts are going to stop saying, how much is being impacted in the strait today?

How dislocated can this market get? And they're going to start to say. Let's work on rebuilding these inventories, and that's when people will begin to realize the market's quite tight. Because again, remember if you took everyone at headline value and you think we're two to 3 million barrels a day in surplus, which I don't think we are, you could rebuild that inventory in a hundred days.

And so it's no wonder ISI guess, that people in the forward curve are saying, yeah, by the third and fourth quarter, everything will be just like it was in January. I think what will change people's attitude is once the proximal crisis is over, people will begin to realize that inventories just aren't rebuilding the way they thought they were.

And that's when people will say, wait a second, this is a tight market and it's gonna be. Awfully difficult to make things feel comfortable again, that's when the longer end of the curve begins to rise, and that's when the stocks, I think, will begin to respond. Because what they like to do, obviously is they like to price in the cash flows.

And what cash flows do you use? You're pricing it off of the forward curve, which tells you, yeah, there might be a good bumper quarter here, but that within three, six months you're basically back to where you were in January. I don't think that's the case and that's the next shoe to drop from an investing standpoint.

Erik: The inflection point right now on the WTI forward curve is right around the December 26 contract. And it's amazing to me as we're speaking, it's upwards of $114 to buy the front month, WTI future, but you can buy the December contract for 75 bucks. It seems to me like I wouldn't even describe that as a long dated future.

That's a medium dated future. What about just buying December 26? Futures for 75 bucks on the logic that, yeah, everybody's gonna need to re replenish their SPR and they're going to, it's gonna take months to work through this surplus. It seems to me like that's a pretty good bit. What do you think?

Adam: Listen, I'm not a futures trader and so I won't offer any recommendations on how to put out a futures strategy. In principle. I don't disagree with you. However, I think you can make it even easier on yourself. I think you can buy oil stocks and you can get that same exposure, essentially the same, type of exposure as trying to play for a move higher in the $75 december dated, contract. If December contract goes from 75 up to a hundred, a basket of oil stocks, certainly offshore drilling stocks will do very well. And I suspect, depending, obviously there's an element of leverage in the futures contract, but I think you could earn just as good a return in the equities, if not better than you could just trying to play that move in the future.

Erik: Adam, I wanna move on to the knock on effects of this that we've talked to some previous guests about, because I know at Goehring and Rozencwajg, you guys focus a lot, not just in the context of this crisis, but bigger picture on food. Let's talk about what's happening, not just to oil through the strait of Hormuz, but also fertilizer, which has a much longer lag effect.

It's, the crop cycle where it's, if there's not enough fertilizer, it's going to be next year's crop that ends up not being as big as this year's crop. What is this gonna mean for food prices and how does that affect inflation more generally as we look out for the next few years?

Adam: I think that everything that's been happening in the last six weeks can have an impact on inflation.

And if you want to talk about things that are not priced, I think that's exactly one of them. If you look at the fed futures, if you look at inflation tips and things like that, I think again, these are woefully behind and investors should begin. Thinking now about protecting if not a base case, at least protecting the tail risk, that you're gonna have some pretty nasty and difficult inflationary prints.

Ironically, the only. Area of the market and it's a commodity that, that is signaling that maybe things are not gonna follow the playbook that we thought they would six or eight weeks ago is gold. And people have said, why isn't gold doing better through this crisis? And I think one of the reasons is that some gold investors are now beginning.

To price in what could happen if you actually get a rate hike this year, which was unheard of in January and February. The only thing was how do dovish will the new Fed chairman be? I think now there's, at least on the margin, some people saying, look, maybe there is some big disruptions. Another big area like you just said is going to be in agriculture, and that is because a lot of fertilizer does pass through the strait of Hormuz.

It's very clear now that's being disrupted. I don't have the number off the top of my head in terms of how much of the world's fertilizer production passes through, but it's fairly dramatic. And what's, I think really important when you talk about the grain market is let's take a step back.

So for the last 10 years or so, maybe even 15. We've had this very unique, interesting dynamic in global agricultural markets. Demand has been off the charts and the reason it's been off the charts has been rising incomes in developing markets. People like to talk about energy demand. Certainly we spend a lot of time talking about energy demand and in emerging markets, but the first thing you do when you have a couple bucks in your pocket is eat protein and.

If you think about eating protein, and you think about it from an energetic perspective or from an energy systems perspective, what you're do, what you're doing is you're taking the sun's energy, you're growing grain, you're feeding the grain to an animal, which is then growing the animal, and then you're eating.

Animal. And so you're eating a lot of energy, caloric energy that's come through the sun, into the agriculture, into the animal, and then into you. That's obviously a lot less efficient than you just eating the grain yourself because it's not a perfect, the animal's not a perfect converter of caloric energy from the plant into its own into its own meat, right?

So if you were to subsist on just a grain-based diet, and then you move to just a meat-based diet. Just to survive, you would require seven times as much grain as if you just ate the grains in the first place, right? So I'm not a vegetarian, I'm not a vegan. But when people do talk about the environmental impacts of eating meat, one of the things, a lot of attention's focused on bovine flatulence and things like that.

But really what it is it's just a much bigger energy system, right? Because you now need to convert from gr from sunlight to grain to animal to food. And grain demand because of rising incomes in the third world. And because of increased protein consumption, grain demand has just gone off the charts.

Off the charts. And anybody looking at that would've said in the last 15 years, this is a huge bull market for AG. But it hasn't been. And the reason it hasn't been is that our yields have gone off the charts. We've had some of the. Best record yields year after year for the last 15 years. Part of that is better fertilizer.

Part of that is better seeds and better GMOs and things like that. And part of it, which no one wants to talk about is that for the time being rising temperatures across the. The globe have resulted in a longer growing season and better yields. I'm not saying that one day we're not gonna have crop failures.

That's a discussion for another day, for today and for the last decade. The growing season has gotten longer and there has been more ability to get higher yields out of those plants because of that. And so our yields have just been off the charts, and so we approach every year, every growing season, almost like we're going down this razor's edge.

On the one hand, demand is off the charts. On the other hand, yields are off the charts. And we said to ourselves every year, if anything happens to disrupt that growing season, if anything happens to impact the yields, this market will be very tight in a hurry. And I think that this fertilizer issue could be that, right?

You've needed perfection in your crop, year in and year out to meet demand. And I'm worried that finally with this, I. Impact on fertilizer supply we're not going to be able to get another record yield. And if you don't do that, the market tightens way faster. So when you think about it from an investment perspective, it's a classic asymmetry, right?

It's not a normal distribution here. If something happens, the market tightens really quickly and you have this asymmetric move. And I think that's what a lot of people that convexity, that asymmetry is what a lot of investors look for. And I think Grain could potentially give it to you this year.

Erik: Adam, I definitely want to come back to gold later in this interview, but let's start with another metal you and I are both fond of, which is uranium, and even before that, why don't we talk about where nuclear energy is headed?

Seems to me like the outcome of this crisis is gonna be a lot more attention on energy security generally. We already have a formative nuclear renaissance globally. Seems to me like this has to be super bullish for nuclear energy generally. Unless we were to get one of two escalations that I'm crossing my fingers are off the table.

But if we actually saw a nuclear weapon used in this conflict, I think that would probably resensitize people to, nuclear is bad and they. The public can't seem to sort out the difference between nuclear weapons and nuclear energy. So I'm afraid that the use of a nuclear weapon would resensitize the public to fear nuclear energy.

And I'm also concerned about the possibility of military strikes on an operating reactor, which is a violation of international law. But so are several other things that are being discussed in this conflict if that were to happen and you had a worse than Chernobyl radiological disaster because somebody.

Hit an operating nuclear power reactor with a missile that could derail everything. I don't know how to think about those risks. Do you worry about that stuff? And how do you see the outlook for nuclear energy and then of course for uranium,

Adam: Back in 2022 the uranium bull market had started already and we had big sizable positions. And Lee and I discussed just that what happens if something happened to one of the Ukrainian nuclear reactors, which so far has remained intact and or what happened if a tactical nuke was released. And I think. That would not be good certainly for humanity, and I don't think that would be good if I'm being really callous pragmatic.

I don't think that would probably be great for a uranium portfolio. But taking sort of the biggest black swan events off the table I, I think that the future for nuclear energy remains. Very bright. I think we're starting to see some very real advancements in permitting in the United States, notably towards small modular reactors.

And we've argued for some time now that the biggest hurdle to the SMR adoption will be the Nuclear Regulatory Commission. And I remember sitting with someone who was very senior at, in Washington. And we talked a little bit about, what the US could do to really improve its energy security long term.

And I said quite clearly, gut the NRC and put in place people that are actually willing to regulate the nuclear industry and not people who are just hell bent on closing down every nuclear reactor in the country. Which is really what the NRC became following Fukushima, I think after Fukushima.

The regulatory agency was desperate to make sure nobody could argue that they were in bed with the industry that they were regulating, right? I think that was their number one concern. And so they became incredibly hostile towards nuclear energy to the point of making it almost impossible to build a new third generation reactor in the us And certainly the idea of.

A small modular reactor passing permitting, and it's a two-phase permitting process, seemed almost impossible. That has largely been changed. The Trump administration. Has really changed a lot of of things in the NRC and they've moved some of the responsibility to the Army Corps of Engineers. And they've really tasked the NRC with making timely decisions.

It doesn't have to be approvals, but timely decisions on new reactor design. So we've seen, for instance, Terra power get major permit and I think that's wonderful. Team at Terra Power over the years. And I think that their technology probably the best in the industry. And so I do think that we're gonna see a big improvement in nuclear reactor design in the next five or six years.

I don't think you need any of that incidentally, to invest in uranium today because the story between now and 2030 is really a story of not producing enough out of minds to meet the current reactor fleet. And. This is where I think a lot of investors get it wrong. People ask me all the time, when does this really become a problem?

How many years out until you really hit a severe deficit in the world's uranium market? And I tell people it's here already. It has been largely obfuscated by these massive Japanese stockpiles that were accumulated post Fukushima. Those are now gone. Those are all into the market, and so the market is trading pretty much heads up, supply and demand.

That's why prices just keep creeping higher and higher. This is like a really simple, boring story, wrapped in a huge amount of emotion and a huge amount of speculative energy where the hedge funds come in and play it massively on the long side and drive the price up and then become super short and they get it on the short side and drive the price back down.

The longer term true. Signal here, the true trend is very easy to understand, is that we're not producing enough from today's mine supply to meet today's reactor demand, and we don't have much in the way of new mines coming online for the next three, four years. So I think between now and 2030, it's a really boring story and a bullish one.

After that, it's gonna be a question of. How many new mines come on versus how many SMRs come on, do we get the nuclear renaissance that we hope we do? It's all very exciting and full of promise, but between now and 2030, it's just a simple story of supply and demand.

Erik: Do you have a price target for Uranium in 2030?

Adam: That's what's so interesting is that if you look at the total cost of fuel in a nuclear reactor. It's minuscule. Everything is all about the initial CapEx build. So once you have built, for instance, an operating nuclear power plant, what would a fuel buyer at an operating nuclear power plant pay? When would they stop buying uranium?

When would they say, you know what, we're gonna step outta this market and not buy, or just shut the plant down. It's almost never could you get $500 and make your budgets work. Absolutely. It made even more interesting by the fact that most of them are regulated and would just pass that on. To the consumer, and nuclear power is still quite cheap compared to other forms of power.

So even at $500 uranium, you're not gonna squeeze out demand. So I think for the next five years, again, until we inflect and it becomes a story of new mine supply relative to SMR demand, which is a 2030 story. But for now, what's super interesting about the uranium market is that it's. Difficult to find that price that squeezes out the next unit of demand.

So what is a good long-term price? I think 150 bucks is a good long-term price. I'm talking per pound U 3 0 8 because that's really the price that you would need to make. Several good. Uranium deposits begin to make sense. The best ones in the world are Next Gen and Denison. Those need about a hundred bucks, and then there's not much till you get to about 150.

And so I think to truly balance the market, you probably need 150. Could you spike it up and above that? Absolutely, because again, there's no demand destruction.

Erik: Let's move on to gold, which you mentioned earlier, as you said, the fear here, and it's fascinating when you really think through the macro dynamics.

The reason there's a bearish case for gold is because as yields move higher. Gold competes with treasuries, and if gold's not producing any return, and treasuries are producing a return, the competitor's producing a greater return. Wait a minute, Adam. What that means is if people were completely abandoning US treasuries because of some geopolitical loss of faith in the United States and the treasury market was outright crashing, crashing treasury market means much higher yields.

So that means you don't buy gold in that circumstance. At what point does this argument break down?

Adam: Oh, I think you're exactly right. Listen, I think that there's a very big difference between a real rate hike cycle, which historically has not been good for gold and actually was not good for gold in 2022, either despite the fact that inflation inflation was high money was abundant.

We had just printed all these stimulus checks during COVID You had a big market dislocation, you would think that gold did really well. But it wasn't until 23 and 24 that it started to do well. And the reason was that in 22 you had a rate height cycle that was beginning.

I think you need to make a little bit of a of a delineation between. A Fed chairman that surprises everyone with raising rates a couple times, which is more what I'm saying could happen versus a collapse of the treasury markets in which yields go up. This, the net result could be the same, yields rise, but very different beneath the surface of the water.

So I think one is a loss of confidence in the United States, which would probably be quite good for gold. And one is just a more typical rate hike cycle to try to get inflation under control, which historically might. Cause gold to sell off, particularly at the levels that we're at today. So one of the things that concerns me a little bit about gold today is that.

This was not true the last time we spoke. Not so much in the stocks, but in the actual holdings of the GLD for instance. There's quite a bit of speculative money that's come into that that has also chased a bunch of central bank buying of gold. Of the two, I find that the central bank buying of gold is going to be.

Quote unquote, better buying of gold. Not that their timing is better. Obviously, their timing in the nineties was terrible and they sold all their gold. However, their price agnostic. All they know is they will move a certain amount of their treasury holdings into gold. So that's always nice. And second of all, they're not really like hot money.

They're not gonna change on a dime their policies, whereas the speculative money that goes into the GLD that's a bit more trend following. And in fact, as a really good example of that, when did that. Volumes start to accumulate in the GLD. When did Western speculators start to buy gold? It wasn't at the beginning of 25.

It wasn't in 24. They didn't catch the bottom. They put really the majority of their investment into gold in the fourth quarter of 25, in the first quarter of 26. So they were a momentum buyer and now there's a lot of gold that's being held by them. So if that reverses and they start to come out, I think that gold could sell off a little bit.

I think ultimately gold goes higher this cycle. I don't think it's done at 5,000. But I think it's entirely possible in the midst of a commodity bull market, which I think we're in now for precious metals to seed leadership to other areas, notably energy in the middle part of the cycle. We saw that in the seventies.

We saw it frankly from 29 to 40, and we saw it in the early two thousands, and that would not be atypical. And nor do I think that means it's the end of the run for gold this cycle. I think gold could probably double from here, but I think from January of this year. And obviously, here we are in April oil's doubled since then, so it's, but go back and we were saying this in January this year, from January of this year, oil will be the better performer for a couple years I think.

That's for sure. Does gold go down? I think it could. I think you could also just trade sideways and be less good than other areas of the commodity market. But gold is gonna have another run here at some point. It's not done just yet. And what's going to cause that next run? I think it's exactly what you said.

It's a bit of a crisis of confidence in. Whether it's the United States in particular or Western economies in general remains to be seen, right? But we've had so far what has been called the Debasement trade. I think the next shoe to drop, which to be clear, I don't think is gonna happen for a year or two or three will be the insolvency trade.

The fact that a lot of these governments are in really tough shape. That hasn't happened yet. We've had a debasement trade. I think the next step is the insolvency trade, and that'll be good for gold.

Erik: Adam, I can't thank you enough, as always for a terrific interview. Before I let you go, let's talk a little bit about what you do at Goehring and Rozencwajg.

A lot of people perceive you guys to be a commodity research firm because you publish some of the best work in the industry, but that's actually not your real day job. What's the story there?

Adam: Thank you for saying that, Eric. That's very kind of you. We're very proud of our research, but our research underpins an investment process.

We're money managers and we have a fund in the US as well as a fund internationally. And I should point out that this is what we've al what we've always done. My partner, Elise, started managing this strategy back in 1991 and the research and the letters is really just, I think a way to show people and our partners and clients what it is that's driving our investment decision. So we spend maybe a little bit more time polishing it than some other buy-side folks might. But we are investment people first and foremost. And it makes me think a couple years ago somebody asked me how I enjoyed making the transition from newsletter writer to portfolio manager.

And I said no, I think you have that backwards. We made the transition from, portfolio managers to being on podcasts and stuff like that, but we're money managers first and foremost.

Erik: Patrick Ceresna and I will be back as Macro Voices continues right here at macrovoices.com.

Erik: Joining me now is freelancer.com founder Matt Barrie. As usual, Matt has written an excellent paper about AI. This one is called Pay to Pray. That's pay to PRAI. You can find that linked in your research roundup email. If you don't have a research roundup email, it means you're not yet This email address is being protected from spambots. You need JavaScript enabled to view it..

Just go to our homepage, macro voices.com. Look for the red button above Matt's picture on the homepage that says, looking for the downloads, Matt, before we even. Get into all of what's going on in AI. We've got some news just as we're recording this on Tuesday evening US time. There's some recent news just in the last day or so, which is, a lot of companies before they, IPO, they'll do a little bridge round, eh, 10, 20 million bucks.

Cover some expenses until they get to their actual IPO. OpenAI is planning an IPO. They did a little bridge round, 122 billion with a B dollars all time record for a private fundraising round. And what is that? Something like a hundred times bigger than any private fundraising round has ever occurred like before 2025.

Why did they need 122 billion just to bridge them from now to their IPO, which is expected in less than a year. 

Matt: Thanks for having me. It's truly is stupendous. But before 2025 the largest sort of, private venture rounds were in the single digit billions

The headline number is 122 billion raised on a 730 billion pre-money valuation. When you get down to the actual segmentation of kind of what's going on, it's it seems that it's only about $25 billion worth of cash.

It's, and it seems to be more of a vendor financing than an actual straight cash injection. You've got Amazon, Nvidia and, SoftBank primarily putting the money in or the in kind in Amazon's putting in 50 billion but that's contingent on OpenAI spending a hundred billion I think over the next eight years on their compute, which I'm sure what Microsoft happy.

And it seems like a good deal, at least on on paper for Amazon. So there's 15 billion going in upfront and 35 Billion Is further more contingent on the company, either going public by 2028 or achieving artificial general intelligence. I'm not sure how they're going to really define that. I think the underlying definition is a panel of experts will make a decision, yes or no which is a bit strange for a financial decision.

There's 15 billion down upfront, 35 billion contingent on going public or AGI for a hundred billion commitment the other way round. So it's a bit like a procurement round. SoftBank loves doing the sort of, I like to call them sort of Russian stents where they lead rounds and mark up valuations to the moon.

We saw it with WeWork. We're seeing it again with Enron, OpenAI. And they've already putting about 40 billion, they're putting another 30 billion in, but to raise that money. They don't actually have the cash on the balance sheet. So they've taken a 12 month bridge loan for 40 billion.

And they're trenching in 10 billion at a time over the course of the, over the year for a total 30 billion. And obviously that's just getting them through. So to the IPOs, they've got liquidity event. And then Nvidia is putting it in kind as they as. Tend to be doing in all these sort of, circular economy, deals in the AI space where, GPUs and infrastructure will be provided to the tune of 30 billion into the round.

So it's about it's actually a $25 billion round of cash upfront. And which is 10 from 10 from SoftBank, 15 from from Amazon. We'll see if the rest of the money comes in, but the rest is in kind. So it seems from looking at this. If you look at the compute numbers, they truly are astronomical that are being contributed in the form of either Nvidia credits, I think it's three gigawatts of inference and two gigawatts of training capacity as part of the, a part of this investment.

That's the power that gets drawn by a small country. So it seems to be what they're trying to do is Scale up the the spend on compute so much that they can find, a way to bring the unit economics down. Because that's really the key problem in the space. Nobody, in the AI compute space is making any money other than really Nvidia. Who does about 160 billion of, of revenue and a hundred billion of earnings.

And then TSMC provides the chips to Nvidia. But the rest of the space is actually negative on using the products in terms of the unit economics. So the more you use the product, the more you lose the money. So I think they're trying to make it up on volume. 

Erik: Matt, I can't imagine any responsible business executive signing off on $122 billion deal unless the underlying business model was rock solid.

It didn't have any major risks in it just happens that you wrote dismissive over the last couple of weeks called Pay to Pray. I don't think that's actually the conclusion that you reached. Tell us about the economics of the, I'll call it the consumer AI business model, offering AI through chat to people like me who sign up for a max subscription on Claude, or a pro subscription on OpenAI.

How much money are they making or losing on that? 

Matt: The AI industry is consuming an absolute bonfire of money. It's about $600 billion a year that's being spent by the hyperscalers on CapEx. It's it's reaching a kind of a point now, which is incredible. Where, the CapEx is higher than the kind of internal free cash flow.

The fundamental business model that's being pushed in the consumer market and the software development market. Up until now has really been a venture capital style subsidized model where you pay, you either use the free product and then hopefully upgrade to the 20 a month product, or you use the 20 a month product if you're a consumer or a 200$ a month product, if you're a power user or if you're starting to do programming.

But the problem with with these models are that they take an incredible amount of money to train. And I think we talked about that in a previous episode. Where you got training running North of a hundred million dollars a run, approaching half a billion dollars a training run that requires a huge amount of data center build out a whole incredible stupendous amount of data needs to go into these models.

And because the cheap data that's scraped off the internet for free is basically drilled out to an extent. They have to do licensing deals to get access to that data. Sometimes they do dodgy things like anthropics, scraped a whole bunch of books and scan them in.

And they got caught and they had to pay the biggest fine. I think in copyright history, I think it's about 1.5$ billion for the illegal scanning of all that data, et cetera. So it's incredibly expensive to train. But the fundamental problem is that when you actually use the inference, you basically put queries into GPT or queries into Claude and you run them.

Those queries are loss making. You can't make it up on volume under the current models. While we do see, the underlying hardware is on a Moore's law sort of trend and Moore's Law, for those of you that dunno what it's is, every 18 months to two years or so effectively the technology that goes into chips allows semiconductors to be used with finer and finer featured sizes, which effectively allows the compute capability in terms of processing power to, to effectively double the cost to have every 18 months while. you are waiting on that silicone Moores law trend because the the models. Are in such a brutally competitive environment where there's literally zero lock in. There's very, almost zero switching costs. So I can, if one day Chat GPT 5 comes out, I'll switch to that, but then Claude 4.6 Opus comes out and that's better.

I'll switch to that. And, so there's nothing stopping me overnight really just changing the models because of, because of the competitive environment. And, and so forth. What the situation basically is that each generation of model is being rushed out to get the top of the scoreboard.

So that all the customers, flock to that. And as a result of that, the actual amount of inference or tokens burned, if you will per useful query with each generation of model. While the Underlying compute is getting cheaper and cheaper in terms of what you can get done on the chips.

The amount of inference you have to burn for a useful query is actually going up quite dramatically. And so you're actually not seeing a reduction in the cost of inference. You're se you're seeing an increase, and that's before you consider the issue with energy and, constrained your build capacity for building data centers and power gear and all the other things.

And a few people have done various models of how much it costs for GPT to deliver their 20$ Plans. And even if you ask Claude itself, you just type a query into Claude saying, how much is the underlying compute costs for you on a 20 plan? With Claude, it'll tell you 15 to $20, maybe 80, 18 maybe a bit more.

So effectively there's no money being made on these $20 plans. And when you're a power user you can burn up to several hundred dollars on the, on the 20$ plan and it gets even worse on these 200$ plans. Which is used by programmers now because, the nature of programing you are a stream of tokens almost forever and the average user on. On a 200$ plan can burn, many thousands of dollars of underlying compute. And in fact, there's a leaderboard called vibe rank, which where people compete to see how much money how much underlying compute they can burn on a 200 plan. The leading guy on the on the leaderboard has burn 51,000 US dollars in a single month on a 200 plan.

So the issue is that as these models get more and more competitive and new versions come out, you're getting an exponential increase in the amount of inference you've gotta burn. And that is, is meaning that these models are not getting cheaper and you're not making up on unit economics.

And so it feels like this funding round is, especially with the amount of vendor financing that's packed into it, it feels like this is an attempt to really try and scale up. The underlying infrastructure and GPU capabilities so that potentially some sort of threshold can be crossed in the underlying economics.

So inference can be profitable, but there's one big problem with all of that which is the demand there and and that's where we are. 

Erik: Matt, you said it's $122 billion capital raise on a pre-money of 730. So I get 852 billion is the current enterprise value, assuming an up round, which is what everybody assumes, eh, we're gonna go just, let's call it an even trillion for the IPO 'cause hey, what's, a hundred billion here, a hundred billion there. Eventually you're talking about real money, but holy cow. If, let's say that, that OpenAI. Goes ahead and IPOs sometime this year for $1 trillion. Are you going to be long, short, or flat? And why? 

Matt: It really does feel in the space that we're. Really in the moment where a supernova is starting to explode, and we're probably gonna end up with a giant black hole like we did in the dotcom boom the first time around.

That's a trillion dollar valuation at IPO is absolutely gigantic. They've raised 122 billion here in this round. They were mooting that the IPO earlier in the year was gonna be a 60 billion raise in about a trillion. You could probably imagine that number is possibly up a little bit, or they wanna keep it tight, obviously, because once it gets the public markets, you don't have too much stock unload onto the market, but.

A, a bigger problem for them is the fact that you've got Elon Musk in the wings who's not just suing OpenAI because it turns out you can't IPO a charity. And they've converted OpenAI to a for profit model and there's a lot of complications around that. But he's also IPOing his SpaceX for, I think it's 1.75 trillion valuation.

So there's a big possibility that a lot of the heat's gonna be taken out the market when he does his 70 billion, 1.75 trillion raise, and it looks like he's gonna beat OpenAI To, to, to going public because you, if you look at the news and you know what's all happening with the ETFs and the allocations and so forth he's a lot further along.

I, I dunno in the olden days, if you would invest in Amazon when it went public, or Microsoft when it went public, you had the ability to make a lot of money. I, how much is left on the table for the general public when the company is being valued at a Trillion dollars when it goes public, know, whatcha gonna do get to 2 trillion, 10 trillion, I think Nvidia is what?

Four? 4 trillion. Valuation and they're the only ones making money in the space. 

Erik: Matt, the parallels between this and the late 1990's Dotcom boom before the 2000's dotcom bust are just striking to me and it occurs to me before I go on that we probably have listeners that weren't even born when that happened.

So for anyone who's not familiar with what happened there. Wall Street became absolutely obsessed with the idea that the internet is going to be a really big deal. And the thing to I, it's really important to understand about this, is they got that call exactly right. The internet. The public internet was going to change the world we lived in ways beyond what anyone could even conceive.

And they got the call right, that it was a really big deal, and I think they're getting the call right. Again, that AI is a really big deal, maybe as big or bigger than the public internet. But the thing is, even though they got the call right. They started throwing money at dumb ideas without thinking, and it just turned into a complete frenzy.

It seems like that's happening again here. But in the late nineties, it was every tiny little company that had.com in its name, and it didn't really matter whether they had a business model. It's. Different here. It's the big players, which frankly have a business model.

But as you very eloquently explain in this excellent piece, I recommend everyone read called Pay to Pray that business model isn't viable for the reasons that you just described, or it's not profitable or not likely to be sustainable. How should we think about this? I, is it inevitable that a.com bust like we had in 2000 is coming for AI and does it have the same dimensions as the one in 2000?

Does? Is it bigger, smaller, worse, better? What do you think? 

Matt: So if you think about the.com boom, and I was there actually in Silicon Valley in 97,98,99 2000. I saw it all. The, there's a, the hypothesis, the internet was gonna be a big thing and it turned out to be a enormous thing in terms of the benefits to humanity and society.

And we'll continue to grow in terms of it as its applications. And AI is the same thing. A AI is gonna be absolutely transformative for humanity in terms of in terms of what can do, at that time, a company that whose valuation went through the roof was Cisco. And their tagline was, we Network networks.

We talked about, I think at Last macro Voices, every time you plugged in a, a bit of the internet, you needed to have a a router to connect up the network. And Cisco equipment was gonna be everywhere. And why wouldn't it be the most stable company in the world? The same as with OpenAI to an extent, you think, okay, they've got the best AI models, AI's gonna be everywhere.

Why wouldn't AI OpenAI be the most valuable company in the world? But then at the same time, you also had At&t. And up until about 1996 AT&T had a 60% market share it. It basically built. The network, using Cisco equipment to connect up the world. You had three players in the market and I think it was mentioned at the time by an analyst that they had margins that would make drug dealers blush.

But the problem was that in 1996, the telecommunications, act, regulation Act came in and deregulated the market. And then you started having fourth entrance and fifth entrance and so forth and people buying, companies buying, selling capacity to each other, et cetera. And when you started having the fourth entrant come in and competing on cost, the unit economics fell apart.

And if you think about the AI compute space. Amazon had a pretty good up until the AI boom. It's, I think it's its CapEx as a percentage of earnings was down to about 6% at one point. Now, these hyperscalers are spending, the cloud computing companies are spending, 60% of earnings on CapEx, over a hundred percent of earnings on CapEx.

They're sending $600 billion a year. At the moment in terms of a run rate in CapEx, and it's hypothesized that by 2030 it's gonna be 5.2 trillion of CapEx. Now when you just had Amazon, really dominating in terms of a cloud. It was sitting pretty and I think I had about, about a 60% market share.

Now you've got Microsoft who's taken over and they their market leader and and and so forth. And now you've got entrant such as Oracle that's competing on price, and you've got core weave in the neo clouds and the unit economics are starting to look a little bit shaky. and then you had a big bust in the bust where, all these companies have money being thrown at 'em, and you're seeing that right now. Any company that kind of has AI in its, business plan is getting these stupid seed rounds in the hundreds of millions of dollars. I remember when seed rounds were hundreds of thousands of dollars now, hundreds of millions of dollars.

And you had the, through the early two thousands, you had a real trough in the technology space where everything blew up and somewhat uninvestible for a period of time, but. Through that period of time, you had companies like Google and Amazon continue to grow and double down and Microsoft and so forth.

And ultimately today became very big companies. I think we're seeing this on steroids right now with the with AI CapEx and compute and the OpenAI funding rounds and so forth. And it's unquestionable AI is gonna be completely end during, and just absolutely game changing for society.

But I think the kind of circle jerk of money that's sloshing around between a very small number of companies that's stupidly high valuations and it's scale that. It's just stupendous is gonna potentially end up in a big bust. 

Erik: Now I want to focus on that because a lot of people are going to mishear what you just said, and they're gonna say, Matt Barrie said imminently tomorrow, there's about to be a great big bust in all of the AI stocks.

That's not what you said. And it really rings home for me because the reason that my partners and I sold our software company. In the summer of 1998 is because we knew it was a bubble, and my plan at the time was to take all of the proceeds and short the nasdaq because I knew it was a bubble.

Fortunately, I got talked out of that, but if I hadn't, I would've lost everything because even though we were right, it basically, the NASDAQ doubled between 98 and 2000 before it crashed exactly like I predicted it was going to crash. What do we do here? It's do you go long? Do you go short?

And I'll say I'll ask the question this way. Open. AI and anthropic are both expected to IPO probably in 2026. When they do, is it time to go long or is it time to go short because I could make either argument. It seems to me eventually you wanna be short, but how do you time that?

Matt: That's the trillion dollar question, right? You've got SpaceX going public, which obviously has GR and XX AI within it. You've got anthropic going public and you've got OpenAI going public. That's why I think it feels like a bit like a supernova. So we'll end up with a big bang in one way, one way or another.

I think the issue's gonna be, some of these valuations, like the OpenAI valuation is predicated on the fact that it's gonna capture. An enormous amount of value out of the world in order to justify these valuations. These funding rounds are so large and the valuations are so high that you need to pitch a revenue line that that, that matches them.

And, at the moment, open is doing about 2 billion a month in revenue. I think it's about a run rate of about 25 billion. I wish they do stop using the word run rate because I think you've actually gotta recur once before you can call something annual recurring revenue. So it's doing about 2 billion a month of revenue losing 14 billion this year.

I think the burn rate that came out today was about, is expected to lose $70 million a day this year, scaling to 56 million a day, lost. Next year. But in order to to, cross the value of death and get to the promised land, they've gotta, they've gotta show a business model. Makes sense. And I think what their business model is gonna is twofold.

One is that they're going to take. A substantial amount of white collar jobs away from humans. And some substantial percentage of jobs in the world are gonna go to ai and that's the top line revenue number. And then the, in terms of generating earnings out the other side the justification is that the infrastructure that's being contributed as part of this 22 billion round is at such a scale.

That only OpenAI will have the unit economics that will make the inference profitable. So in a, in combination with taking everyone's job and having the only infrastructure that can run this sort of stuff profitably, I think that's the argument for justifying these sort of trillion dollar valuations now.

 I don't think OpenAI is gonna capture, for example, hypothetically the value in the AI powered drug discovery market any more than At&t captured the value of the iPhone. The underlying technology is phenomenal. But as Ilya Sutskever said himself he was one of the founders of OpenAI that you can just read 40 academic papers.

95% of what's out there in AI is published in, in, in the public domain. That's why. Every couple of weeks there, there's a kind of a new foundational model that's top of the leaderboard. And every once in a while there's a team of people that you have never heard of 160 engineers in the room, on Guangzhou like, like deepseek, that comes out nowhere and suddenly, leads in the leaderboard because it turns out that, there's no sustainable competitive advantage in the underlying foundational models.

And what you do need though, is you need access to data. But a lot, a lot of that, those data sets are are now out there and public, or in the case of the Chinese, they probably don't care too much about copyright. So we always have a sustainable competitive advantage and I think there's incredible and tremendous opportunity in AI, but it's probably not gonna be in the, in these models that, that haven't really figured out what the business model is.

Erik: Matt, I think there is a very distinct difference between this scenario and the late nineties to two thousand.com story, and that is this let's say, we don't know whether it's 97, 98 or 99 right now, but we know that March of 2000 is coming. At some point, there's gonna be a washout in this commercial AI space where they just realized that.

The business model wasn't sustainable and it all starts to fall apart. What happened in the.com bust is we went really a good solid couple of years of kind of a technology recession where there wasn't a whole lot of progress on the public internet because we had to basically shake that mal investment out of the system, get back to efficient capital allocation.

And then, after 2002, 2003, things started to really take off again. Okay. What if. The US government steps in and says, no, wait a minute. The military applications of AI create an existential threat to the country. If we don't stay ahead of this, we can't tolerate a 2000 to 2003 pause. You must continue.

You must do it under US government funding, but we're not gonna fund the giving away stuff for free too. Max subscribers on Claude, we're gonna take it over. And, it's just for the military now. We're not gonna have consumer AI anymore. Is that a realistic scenario or do we need consumer AI in order to train the models in order for the military to get the benefit?

What would happen in that scenario where the military says, no we can't allow a stock market crash to slow down progress on the military applications of ai. 

Matt: I don't think it's realistic that we're not gonna have consumer ai. The Chinese are open sourcing their models and in fact they've got their strategy to open source both the software and the hardware.

And there's been previous leaks Meta's Llama and, so forth so I think, it's here to stay. I think the interesting thing here is that it won't be the government stepping in. I think that there's one big company that's been sitting in the wings that has God awful ai AI product and it's everyone's pockets.

And that's, apple on the iPhone. I think in, in, in our last chat we talked about how God damn awful Siri is for supposedly being your kind of your original chat bot, AI assistant. And we hypothesized it'll continue to be awful in the next year. And here we're and it continues to be.

Pretty bad, but bad. They've avoided this whole getting sucked into this whole CapEx bonfire. And they've really got two levers they can pull. One is, one is they're sitting on this cash and they've they can sit back and watch. And as with the dotcom bust, there was a lot of infrastructure that went through to the second and third owners where, maybe the first owner that builds out the optical fiber.

Network goes bust and the second owner comes in and tries, maybe makes it to be break even after, after, pur purchasing it at a cheaper price and washing out the, washing out the underlying sunk costs. And then the third owner comes in and makes some money out of it.

And I think you might have that situation in the ai compute space where if there is a problem with some of these large foundational model companies. There might be a second or third owner and Apple would be ideal for that. At the same time, what they've been doing.

They've been putting in some AI silicon into their products. And a lot of this compute that's currently being done in data centers by OpenAI, by Anthropic et cetera, is gonna go to the edge, and it's gonna go to the edge for a variety of different reasons. One is that you don't want Sam Altman training on your data.

And I, we've talked about before, that I think an emperor has no clothes as was heading into Saas. Where I think large enterprises are start thinking to themselves, you know what? I don't want my data in Google Drive and Gmail, it might get trained on. And you're certainly seeing all the major SaaS companies quietly flicking on a switch in the settings without telling you where they're saying by default.

Now we can train on your data potentially, and then you flick it off, but by then it's too late. Your data's been sucked down. A lot of that compute is gonna go to the edge, it's gonna go to cer, to OnPrem in, in the enterprise on compute devices. So it doesn't go into the cloud.

It's gonna be on your phone, it's gonna be on your MacBook, it's gonna be on your Mac studio or whatever it may be. For privacy, for confidentiality, for latency reasons. And the fact that there's some models now that can, that actually can fit on that silicon. And, while it might be one or two generations away, at some point, I think real soon.

A lot of that load and a lot of that compute that's going to AWS data centers and Azure data centers to run Anthropic and then turn around , to run OpenAI is gonna go to the edge. It's gonna be on Apple's devices, it's gonna be on Apple's, laptops it's gonna be OnPrem. And at the same time, Apple's cached up and might end up being the second or third owner of some of these companies.

Erik: Matt, the title of your missive that you just written, pay to Pray or Pay to Pray. PRAI is actually a reference to the inevitability in your prediction of something called paper token monetization. What does that mean? What, how does that relevant explain what that's about? 

Matt: The fundamental business model of Silicon Valley venture capitalists is to try and win markets by financing companies with astronomical amounts of money such that that money gets spent on marketing and a subsidization of the product to such a scale that nobody could compete with these Silicon Valley investing companies or unicorns.

And so total nuclear war is launched on a market. So you can think maybe Uber and free rides in China or whatever it may be, or DoorDash delivering, noodles to people in Indonesia or grab or whatever it may be. So what we have here in the AI space is the subsidization model is that you have a freemium, you have a free product, being GPT or what have you, and then you've got a 20$ a month product. Which I said earlier probably cost 20$ to serve and a 200$ product that probably cost 2000$ a month to serve

If you were you to, this can't continue forever. It's, so the question is gonna be at, can we get the unit economics down to do inference to such a point that these models are profitable before they run out of funding. These companies running outta funding. Now the problem is that as you have as as we've moved into, for example, software development, which consumes a never ending amount of tokens to write code because every company in the world powered by software now, there's this huge token burn that's happening in these $200 plans. And if you were to try and make some sort of reasonable software, like margin, like 80% et cetera, you would've to price these plans, not hundred a month, but maybe thousand or thousand a month, higher.

And the, so at some point. The money is gonna run out and I think they had a near death experience in the last couple of weeks. Anyone who, and I know you're constantly using GPT and Claude, et cetera, and you probably noticed the same thing, in the last couple of weeks, there seems to have been a bit of a panic from these companies where, you log into your $200 plan, you type a couple of queries and then you run outta credit.

And you've always known that these companies aren't making money on the inference because instead of saying put your credit card in and top, top up your credit, it puts you in the naughty corner for seven hours or longer. And so at some point where we the inevitable destination.

For these subscription models which are basically massively subsidized Silicon Valley financed and increasingly debt financed business models is that they're gonna have to move to a per token pricing now, and that is gonna cost a lot of money. I think there was some comments in the last couple of weeks on Reddit where someone who's on a two do $200 plan ran out of credit pretty quickly.

You had to get it done. It had to get something done pretty that night. And so we moved to the API pricing, which is using the programming interface and that was costing 200 an hour instead of hundred a month. And he thought, gee, I've used a couple hours used, 500$, 600$

The problem with that sort of pricing is has several dimensions. The first is that already at 20 a month for a plan, which is 240$ a year, that already prices the product out from Over half world population. The median global income in the world is about two a year. So at two 40 a year, you're already 10% of the pretax income for half the people on the planet, right?

So you, you're already quite expensive. The second point problem here is that, you know these programming models which, realistically to make any sort of margin, need to be priced in the thousands of dollars a month or maybe. Ten Thousand dollars a month. You're gonna, you have a bit of a problem in the fact that these models do hallucinate.

And they, their error when they do hallucinate and throw errors. They're very different from humans. When you use a hire, a freelancer, for example, on my website, you put in some money, okay, I'm gonna pay you to build a website for me. You don't release that milestone until the job is done and.

If the human can't figure out a problem, they'll ask their friends, they'll try and find a more senior engineer for advice. They'll get on our forums and ask other people how to solve problems. They'll browse the internet, they'll he'll clum their way out of solving problems and look, they may take they may ultimately not get there, and you might get frustrated with them and wanna find another developer to do the job.

But ultimately they, their failure modes are very different from AI with ai. Sometimes when it hallucinates, it can do wildly crazy things. About three weeks ago I had a problem with my VPN on my computer. I was using Claude to help me through figuring out how to get it fixed.

I'm a software developer by background. I've engineer degree from Stanford. I do know how to program quite well. But I veered into PowerShell commands in Windows 11, which I dunno very well, and I was blindly pasting in Claude and made me delete my entire network in stack And, you know, so you have these very crazy failure modes with ai where you either go in loops or it goes away in thinking and it goes and burns, 10 x the inference, try, these reasoning chains, trying to figure out what's going on.

Or it just has these crazy suggestions. And it will look at you in the eye with the, the eyes of a sociopath on a first date in some regards. Trying to, gaslight you into thinking that its answer is is true when it's clearly not the case. It's just hallucinated something rather.

And the issue here is that in a paper token pricing model, it really turns software development into a slot machine. In that, if the if ultimately, you're riding your app and you need to get called to do something, rather you're really pulling the slot machine handle, you dunno how much gonna cost, how much it's gonna cost you by the time the tokens are all burned.

And you dunno if you're actually gonna get a solution at the end of the day. And I guess only in Silicon Valley because they turn software development into, to generate gambling because that's where you end up. And the frustrating thing that I think will happen is when you're on the 200$ plan.

You've got a certain amount of capacity and maybe it tells you to time out or what have you. You kind of know, you are capped at 200$ right? It's frustrating. Runs outta credit, you are going to find alternative ways of doing things. You kind of know what you are up for? When pulling the handle onto the paper token model, it could be, $50 per spin. You may go a circle, you circle 10 times.

There's examples of people over of radical crazy things that claude does to your codebase. And I think people are going to get very very frustrated

If they have to put a coin in the machine, pull a handle every time, and they get a non-deterministic outcome of whether, of whether they're moving forward in a hill climbing sense to this, to their final solution and their final app or the final bit of software being developed or whether they're going in circles, round and round again.

And I think people are gonna get frustrated. They're gonna go try and find open source models. They're gonna try and find alternative ways to get things done. And I think it that's really the problem. While the hallucinations are getting are reducing. As part of, each new generation in terms of the engineering of the infrastructure around the foundational models to reduce those hallucinations.

What is actually happening is the token spend is going up exponentially because you're doing more and more complex things. So you have a much bigger surface area in which you could generate an, so what I mean by that is, while the probability of a failure pulling. Pulling the handle on the slot machine is getting reduced with the, the engineering from each, subsequent generation of model.

The number of handle pools you need to make is going up exponentially. And so you've got a multiplicative effect in terms of in terms of potentially the impact of errors. I just think it's going to the question that basically needs to be solved now with this $122 billion fundraise is can you get the cost to compute way down to get this whole model profitable and will the market tolerate.

Software development is a slot machine. 

Erik: A lot has been said already by lots of people about the incredible rate of progress and how quickly AI itself is getting smarter. What I don't think has been discussed enough, and I'd like to get your comment on, is the rate to which. Professionals are becoming dependent on it.

I think more than you know this, it's more addictive than cocaine. I remember our first interview on AI when chat GPT had just come out, and I remember thinking to myself, boy, Matt's really into this stuff. To me it's a novelty, but I don't think I'd ever actually pay 20 bucks a month for it.

It's just. It passed a touring test. Big deal. But I I don't think I'd ever buy a subscription. I'll tell you, Matt, in the last several weeks, there's been a lot of stress in my life because of this war and family that are affected by the war. And waking up double digits down on a percentage basis, on my net worth because of something that happened in the market overnight.

Okay, look, I'm a big boy. I've been through that stuff before. I've been through the 2008 crisis. It's not that big of a deal, but Claude 4.6 was going offline and the server wasn't available, and I was freaking the F out. I couldn't handle it. I was losing, and don't you dare insult me by suggesting that I go back to Chat GPT 5.4. I don't drink Pap blue ribbon and I don't do chat GPT. Okay. I've gotten to the point where I can't live without Claude. This is, this seems like a risk. 

Matt: When Claude went down, it's quite interesting actually because, the first time it had a bit of an outage was when the data centers got blown up in, in Dubai and you have to wonder yourself what potentially was being run in those data centers in the Middle East that caused the outage of Claude.

And I do think those companies did have a bit of a near death experience in the last couple of weeks. In that all of a sudden you had Sam Altman kill SORA, which was this hyped up video modality model where you could generate clips or, the whole point was you're supposed to be able to type in a prompt and get a movie out the other side.

In fact, Disney paid a billion dollars to OpenAI for use of the technology, and I only found out half an hour before a meeting that the whole thing was gonna be canceled. At the same time, Sam Aman killed instant checkout and he killed the he was working on some sort of erotic model as well, which is a bit strange, but I think it's probably one of the big markets is his pornography.

And he thought maybe he could make some money there. He killed that as well. And the same time Claude had this big changes in terms of how they did the plans and they were giving out, extra tokens in off peak, but in peak they're you back, et cetera. And ultimately it seems that they've cut back a token budget models.

On the path to this sort of pay per, pray Pay per token business model. So I do think they all had a bit of a near death experience and that near death experience obviously is what I was feeling. What you've been feeling when you see these models, you start using 'em going, gee, is my access to gonna start getting restricted?

We'll have to pay a lot more money. We'll have to add a zero to, to, to my monthly subscription. What? I'm have to pay per query. What's going on? And then of course you've got this financing round which is less cash and more infrastructure.

And perhaps it's a way to help the company towards IPO. So there's liquidity event. So the, the original investors can make a bit of a return. It turns out that, this whole it's pretty funny that this whole AI compute space is predicated on $600 billion a year of CapEx which is incredibly energy intensive.

When at the same time your bombing the, you know an area Where 48% of the world's energy is. And and you're relying on energy being cheap in order to have this AI boom work. 

Erik: Let's move on to private credit. There's a lot that's been said as a lot of private credit funds are gating investors that this is AI driven or it's related to Claude Codes, specifically creating fears that software companies would no longer be profitable.

And I have a hard time with this one because this sounds like the claim I remember hearing in the 1970s when supposedly the introduction of the, hewlett Packard Digital Computer, or edit, please. The introduction of the Hewlett Packard electronic calculator was supposedly gonna put every accountant out of business and create vast unemployment of bookkeepers and so on and so forth, and it was the exact opposite.

It created more productivity. It seems to me that Claude Code just gave the software industry the biggest productivity boosting tool that they've ever had, and that's the reason that private credit is blowing up. Is that really right? Am I missing something? 

Matt: There's a few things going on.

First of all, the, these funding rounds are getting too big for equity. As we saw with the hundred 22 billion in all the infrastructure, you the vendor financing in there, and so you've increasingly, these companies are turning to debt. Even Meta had to go and get 30 billion from Blue au not so long ago in order to fund data centers because they can't do it off the balance sheet anymore.

And the numbers are starting to get too big for equity raising. So they're borrowing the money and not just are we seeing record equity rounds. We're seeing record debt rounds that blew our financing of meta was the biggest private credit round ever. the problem is that, private credit in these portfolios has got SaaS businesses, and one of the big pictures that these our compute companies has is that SaaS is dead. Which is ironic when, chat chip on a 20 a month subscription is a SaaS business. So it's funny that they're saying SAS is dead when they actually are SA business themselves but.

There's been some warnings that have come out around these private credit portfolios that pack in the AI debt as well as the SaaS debt because AI is actively pitching. The, it says the future of these SaaS companies will be eroded by the fact that AI is coming, so it's causing some instability in the private debt markets.

And of course, what else is causing instability is rising interest rates in an uncertain world and a war in Iran amongst other things. 

Erik: Matt, speaking of data centers blowing up, let's talk about the Iran conflict, its connection to ai, and particularly in your latest missive. You expressed some concerns that there's a risk that potentially this Iran conflict kind of pulls the rug on the whole AI business model.

What do you mean what's going on? 

Matt: This is where the fifth Industrial Revolution meets the Islamic Revolution, right? A lot of the financing for AI has come from the Middle East. And you can imagine now if you're Saudi Arabia or you are the UAE and you have a fiduciary duty to protect your nation and your citizens and your economy, are you gonna be putting it into a hyper rounds of Sam Altman's?

Highly invited, highly inflated highly inflated valuations or will you spend on defense energy rebuilding, rebuilding your civilian and industrial infrastructure and potentially gonna war to to fund an army, right? It's quite problematic when, you know you've got a country that sits right in the middle of, 48% of the world's energy infrastructure controls a strai where 21 million barrels of oil goes through every day that can fire, $20,000 drones at scale into anything within a 2000 kilometers range and

Migrate not just your data centers in the region, but potentially your energy infrastructure into the cloud literally in a puff of smoke. 

Erik: Matt, another theme that you have in the latest missive is that you've gotta be pretty smart to really get the most out of ai. What do you mean by that and what are the consequences?

Matt: When I look at deep down at what, what's happening in the space? Despite, you've got a conflation, a few things happening right now. You've got the AI companies trying to justify these huge valuation rounds, and they're doing that by saying they're gonna take away a lot of the world's work.

Then at the same time you've got mass layoffs happening in the market. With Block today with Oracle, I dunno if you saw overnight, but Oracle has announced 18% of their workforce has been cut, Etc And so you would not be surprised that the general market has conflated these things and thinking that AI is taking people's jobs away.

Now. I see AI instead as a tool. It's a very powerful tool. It's yeah, but it's a productivity tool. Much like the world was, when you went to work and there was no computer on your desk and then you went to work and there was a computer at your desk, or you didn't have mobile phones and you have mobile phones, or you didn't have the internet and then you have the internet.

Yes, there is. Incredibly disruptive and transformative time and some jobs are lost, but, just like pretty much all forms of technology, more jobs are created over time. And what I mean essentially by you could be smart to use AI is AI is a power tool and, so as a chainsaw, right? You give a chainsaw to a carpenter and they can do a skilled carpenter, and they do amazing things. You give a chainsaw to a novice and you can cause all sorts of problems, right? And so what I'm observing both across my platform as well as within my my engineering team is the.

The people who are benefiting most from AI are the ones that are highly skilled and intelligent and know how to use the ai, and they're seeing productivity gains, which are astronomical. They're seeing, double to triple their productivity. And you can measure that in different ways in, in terms of what, what they're achieving.

The and then as you go down the skill level you do, it is a rising tide lifts or boats. So if you are an average copywriter, you can now be a good copywriter. If you're an average illustrator, you can be a good illustrator using these various tools. If you, I make a joke, if you're an average programmer, you certainly are a confident programmer now using these tools.

But to really get the best out of them. The people who are highly skilled are the ones that are really driving the outcomes. And I see that, for example with your work and what you do writing these missives and books and so forth. And so I think just just like technology has over time, created a bifurcation in society where you have the people who are skilled and can create technology and that's where all the wealth flows. And that's why you see these companies, huge valuations and and the ultra, high net worth in the technology industry.

And then you see a general deterioration at the low end of society. I think this is going to drive it even further in extent. The people who really know to use AI are gonna capture incredible opportunities in all sorts of different market segments where they can control that customer interface. 

Erik: I definitely agree with you.

I just finished a writing project, or I should say Claude, and I just finished a writing project that was considerably bigger than writing my book beyond blockchain. It required a lot more research 'cause beyond blockchain was just my own opinions. It was a lot to it and. Beyond blockchain took me more than three months.

This project took me less than two weeks, and it's just amazing how much you can accomplish, although you definitely, as you say, it takes some skill to learn how to manage context, window exhaustion and recognize symptoms of it occurring and so forth. So I couldn't agree with you more. It scares me though, Matt, because I think.

One of the biggest problems that society faces in the mid 2020s is the K-Shaped economy. The tendency that the rich get richer and the poor get poorer. It sounds to me like AI really is going to exacerbate that in the sense that the smartest people are going to really benefit in productivity from ai.

They're going to be a whole lot smarter and more capable than they used to be. One guy will be able to do the job of 10 or 12 guys, but. The 10 or 12 guys that weren't that bright and really didn't figure out how to recognize the symptoms of context window exhaustion and their LLM I think it really does take their jobs and it seems to me like this could become the basis for deeper division in society.

So Matt, I want to ask you this because as the CEO of freelancer.com, and for any listeners who aren't familiar with Freelancer, it's basically a marketplace where people can hire independent workers, whether they be high-end expert consultants in their field, who are the leaders of their field, or if it's just a guy who will design a logo for you for five bucks, you can hire all those different people on freelancer.

Matt has a very unique perspective on AI because first of all. He's running a company that uses ai. So he leads an engineering team that's building AI based solutions. But some of the people that his customers are hiring are AI experts that are helping companies to implement AI at a corporate level.

And then some of the more mass freelancer, larger group of graphic designers and people that are making logos and so forth are users of AI that are. Leveraging their logo, design contests and all that. So Matt sees all of these different dimensions of different people using AI in different ways, corporations and organizations adopting it.

Versus an individual guy in Indonesia who's just trying to make a buck as a graphic designer suddenly becoming much more productive and being able to work in different. L languages that he doesn't even speak. So Matt sees all of these different dimensions. Matt, from that vantage point that you have, what would you say are the top three things that you've become aware of that the average person who can't see all that stuff probably wouldn't think of.

Matt: The amazing thing is we're gonna see the ability for you to get things done that you could never possibly think of before, right? Rather than just getting a website built, you get a whole business built. The ability for, I think we're gonna enter a whole new world of explosive entrepreneurship where now, you really just need to have an idea to start a company and the ability for you to execute on that using both AI and also accessing humans powered by AI will be unprecedented. You'll be able to do it at cost that's cheaper than ever before. So we're gonna, I think, enter an explosion period of hyper hyper competition. And, thanks to the internet and the ability to distribute products or services, though the internet at scale so quickly, if you've got a great idea, that great idea can take off and you can make a billion dollars faster than any time ever in the history before.

So I think it, it is an incredible time. I certainly haven't seen as yet the complete replacement of someone in a job. I dunno, if you ask around, does anyone know any graphic designers that completely lost their job? Where the dislocation will occur is where you've got highly paralyzable workflows where you've got thousands of people or hundreds of people doing the same job.

So maybe in a call center where there might be 10,000 people or a thousand people in a call center doing the same workflow, which is, customer support, answering our phones, et cetera. With ai, you'll be able to take it from a thousand people down to maybe a hundred people. If you've got 30 junior lawyers drafting legal agreements in a room, maybe you'll be able to take it down to 13 people in a room.

But I don't see because of the way AI works and goes in circles and the failure mode and the fact that as you burn more tokens, you've got more chance, even though the unit rate of errors goes down, the fact you're burning all these. Extra tokens means that ultimately an error becomes more catastrophic and in a way that a human never would make an error.

What that means is that I think the ultimate combination is humans and ai. I think it's probably one of the productivity to tools known to man, and I think it's gonna open up a whole amazing golden age of building and creating businesses and hyper competition. 

Erik: Matt, I can't thank you enough for a terrific interview.

Before I let you go, you run freelancer.com, a public company that trades under ticker symbol FLN on the Australian Stock Exchange. Tell people who are not familiar with it, what Freelancer does, and how to follow your work. Your latest piece, again, it's linked in the research roundup email. It's published on Medium.

It's called Pay to Pray. You write quite a bit of interesting stuff for people who wanna follow your work. And learn more about freelancer.com. Tell us about it. 

Matt: We run the world's largest cloud workforce, so there's about 87 million people in that marketplace. We can do any job you can possibly think of from $10 jobs to $10 million jobs.

The mainstream jobs are things like, build me a website or build me a, an app, or it basically help me start a company. Or grow my company. The biggest things we run. We've got a Moonshot Innovation Challenge program at the high end where we help all sorts of US government departments and enterprises around the world solve scientific and technical challenges.

Give us your hardest scientific technical challenge and we'll solve it. Or you don't have, pay the prize out. So the biggest thing we've got running right now is a $10 million. It's a seven half million US dollar gene editing challenge. For in the central n system of humans, which we're doing for the National Institute of Health and and also working with nasa.

Actually, ironically, the when art goes up, in the next 24 hours into space we worked with NASA to crowdsource the mascot from kids all around the world. That's going up with the astronauts to basically inspire kids about about space and so forth. If you wanna get anything done, you come to our site, we can get it done.

And no job is too small, too big, or too complex, and it ranges, through to mechanical engineering or electronic design or whatever you need. And if you wanna follow my writing on ai there's a series of, obviously a podcast that we've done together on Macro voices on ai. I think this may be the fifth or the sixth.

And if you've got a medium or substack, you better find me and see my essays. 

Erik: And if you just put Matt's name in Matt Barry at the search box at macrovoices.com, you'll see a list of all of the previous AI interviews that we've done Right here on Macro Voices, Patrick Ceresna and I will Be Back as Macro Voices continues right here at macrovoices.com.

Erik: Joining me now is Lyn Alden, founder of Lyn Alden Investment Strategy. Lyn, it's great to get you back on the show. Obviously we've gotta start with Iran, which has been the all consuming news. What's your high level take on what's going on and how does this play into some of the writings that you've done in the past about the transition into a multipolar world that we're moving into?

Lyn: First of all, thanks for having me on. And this, it's certainly one of those occasions where we all have to be experts on the current thing. Usually that tendency's overblown, but not really in this case. We all have to be on top of it because it's the all consuming news item that affects, let alone human lives.

But of course, all the investment topics we would potentially talk about on a program like this. And, one of the, the frameworks I've had for a while, and I'm of course not the only one that's had it, is that the world is exiting a peak period of like a unipolar power or, very like a hyperscale, a hyper power in the world.

And for, obviously after World War II and then especially after the fall of the Soviet Union the United States basically became the really the core center of kind of global economy, global military projection power and all that. And that, that's a historically unusual situation for one country to have such a large, relative portion of the rest of the world. Even for example, during the height of the Roman Empire the Han Dynasty in China and other empires of the world were still pretty significant. And so you still, that was a world where they didn't, obviously in long distances they wouldn't connect that much.

But in this kind of post telecom world, this post industrial world where we, we can get around the world very quickly, both digitally and, with. Military projection capability. We, we've been in this kind of hyper power world. And then also of course, that's financial power.

That's the global reserve currency which unlike prior Global Reserve currencies is, it's different because it's not, it's not based on gold, which was the actual reserve currency back for those prior periods. It's all tied to the dollar and the treasury. And so we reach unusual levels of global centralization of multiple types of power really peaking in the late nineties by many metrics. And ever since then there's been a gradual, very gradual shift toward a little bit more of a multipolar world. We obviously saw the rise of China as a massive economic power and then, around the margins.

Obviously financial power, a military power. Especially that, that economic and manufacturing power we saw, to a lesser extent the rise of India. And, other economies. And so the share of us influence across multiple domains is on the decline still, of course, very high.

Ray Dalio and others have mapped this. I might have different views on him about the relative forward outcomes of the US and China. But he's published research that kind of maps out the different metrics that you might analyze an empire by and by, and they tend to roll over at different paces.

For example, education quality tends to be a leading indicator on the way up, and it also tends to fall early. Whereas something like global reserve currency, because it has network effects that tends to be a later rise. But also one of the last things to decline over time but all this is to say is that we are falling back toward a world that historically is more usual, which is that you have multiple poles of power that are in competition with each other rather than one central world power. And so of course the two biggest polls would be the US and China. The Europe's decisions have reduced their the size of their pole going forward, I think as far as many analysts can tell.

And then there's other large polls of power in India and to some extent Brazil and others. And this kind of battle over the Middle East is I think both a symptom of that which is that empires rarely give up their kind of projection capabilities easily, even when it would potentially be the right thing to do from a strategic standpoint would be the kind of right size from a position of strength rather than kind of fight to always maintain whatever capability you have. But that's where we and so I think this is, this is a milestone to watch for sure. Both in terms of current market impacts, current humanitarian impacts but then also just the. Relative projection might of different entities around the world.

Erik: Lyn, something that surprised a lot of people was that precious metals, which we're used to thinking of as a geopolitical risk hedge, it's usually bombs. Drop oil goes up, dollar goes up, and gold goes up. All of a sudden it's bombs drop, oil goes up, dollar goes up, gold goes down. What happened?

What's causing that? How long does it last?

Lyn: Based on what I can estimate, I think there are multiple factors. One is we can't ignore, of course, the price action that occurred in precious metals before all this happened. We had an unusually strong rise in gold, silver and platinum prices in the year leading up to this event.

And some people have used the word bubble to describe it. And while I think that might be valid on the shorter term, like it's a sentiment bubble around those, this sheer, the sheer magnitude and speed of those moves is concerning. I don't really view them as fundamentally overvalued. But certainly when something trades that volatile to the upside there's a risk that it just goes volatile to the downside.

So as a long-term, nearly decade long, precious metals bull they hit the price targets that I had years ago. And so my position in my research for months now was. I'm not turning into a bear on precious metals per se. I'm not calling them a bubble, but they no longer have that asymmetry that was available, at 20 something silver and at, 2000 something gold or, before that even lower for the book of those metals.

And that now they were in a more kind of balanced range, which is, I wouldn't be surprised by a big sell off, nor would I be surprised by a, a continued march higher because they have been pretty resilient. And. One is just that price action becomes unreliable when you have such a massive move.

And to, sentiment that's almost unbeatable compared to where it was. So that just opens the door toward more unusual situations because as you point out, blank sheet of paper if you ask people, what would you think precious metals would do during a war of this magnitude?

You'd think they'd be flat to up at least. And they haven't been. The other factor I think and I'm not the first to bring this up is that, in times of crisis sometimes entities have to sell what they can, not what they wanna and gold is a source of liquidity for many market participants, including potentially sovereign participants.

In this crisis. And the other side of the coin is that, molt, usually when we have a crisis occur we usually see Bitcoin not do great. We see, we usually see do gold do pretty well. The other side of the coin is that Bitcoin is held up oddly well in this environment. There are some that are arguing that it's like showing signs of, risk off finally.

I wouldn't go nearly that far because, bitcoin had the opposite price action of gold going into this. So Bitcoin had a particularly rough several months leading into this. So it was already largely de levered. It already sentiment was already very washed out. A lot of the fast money was out and a lot of the coins were held by pretty strong hands.

And so we, I think we've seen a sentiment shift. And then if you wanna add a fundamental component, if people find themselves wanting to move. Portable scarce money. It has, some certain advantages compared to, more eternal scarce money that is maybe harder to move across borders or jurisdictions.

So I think that there's a fundamental component there, potentially, but I wouldn't, I personally don't read too much into this kind of multi-week action of gold doing poorly, silver, doing poorly, Bitcoin doing well just because the price action for both of them was so significant in the months leading up to it.

Erik: Lyn, let's move on to the effect of this war and higher oil prices on the economy. Obviously, the experts have told us that, there's really no limit to how high oil prices could go if the strait of Hormuz stayed closed indefinitely, well over $200. I would think cripple the global economy question is, okay, how do you put a number on that?

If it, if let's say, a thousand dollars oil would clearly cause a massive global crisis is $150 oil, something we can tolerate without the economy collapsing. What's the number, what's the threshold? Any thoughts?

Lyn: Yeah, it's a good question. I think there's a couple ways to look at it.

One it's, you can inflation adjust it and say, okay, what prior oil price levels damage the economy? And of course, we can't just take those nominal figures because, it, depending on how far back you go, money supply has doubled over more. And just the, the size of the stock market's bigger.

The average income's bigger, the average house price is bigger. Just the amount of money going around is bigger. So Just because you get back up to hundred 50 oil which historically has, been awful, that kind of, anything well over a hundred has historically been awful for the global economy.

I do think that the economy is resilient enough to handle those types of similar nominal numbers of the past. I think where it runs into danger is when you get into these kind of unprecedented levels, like something approaching new inflation adjusted highs. As you mentioned is you know, potentially that 200 plus barrel range, which according to the oil experts that I follow.

If the straight stays closed long enough and or if these shut-ins. And, the worst case scenario is these severely damaged energy production, infrastructure if a multiple of those things together gives us, a another month or more. A nearly closed strait.

Then those, the analysts I'm following are saying that those 200 plus numbers are quite possible, if not probable. And that does start, I think, become crippling for the economy. Now there's kind of two. Threshold to consider. The first one is, what is painful for the economy and painful for say, lower income consumers or even middle income consumers?

We've already touched that. This, let's focus on the American consumer for a second. We're already in what other analysts are calling a k-shape economy or a two speed economy. And all the data I look at that at, fully confirms that. So if you're on the right side of AI CapEx or you're on the right side of fiscal deficit spending, the healthcare, the social security the defense sector those areas are receiving the, the majority of the deficits. And they're on average doing pretty well. So on average, older, wealthier Americans are generally doing fine and people that work in certain industries are doing fine.

If you're a new college graduate looking for a white collar job in a world of stalling total payrolls and AI optimization to cut costs on the backend for companies all across the country, and of course in other economies as well. It's rough. Same thing as if someone is looking for a home.

Especially, if they're on the low to medium income side they're gonna finance it. They're not gonna buy it in cash. The combination of somewhat high mortgage rates and still high average price levels puts that out of reach for a lot of people. And we had insurance prices going up higher.

Were already rough for a lot of consumers. And gasoline even before it gets to all time high, just the fact that it's gone up considerably in a matter of weeks already puts pressure at a time when the shields are down when you have flat. Non-farm payrolls for the better part of a year.

Even though you don't have high initial claims yet even though you don't have any sort of acute signs of issues, you just have a stall speed type of economy outside of those really hot spending areas. So it's already that's already a painful element to the US economy, let alone.

Obviously in develop countries it's often even worse in Egypt, for example, where I actually plan to be in a number of because I there year. They've already announced that, because their natural gas import bill effectively tripled from somewhere in the ballpark of 500 million a month to 1.5 billion a month.

They've already, effectively had to have rolling power issues kind of curfews on certain types of businesses that, close cafes, other things like that at 9:00 PM at night to try to conserve electricity because a lot of that is, is derived from natural gas.

And that's just one example. Obviously in, countries in the world where. They can't quite bid as much as the wealthy nations for energy. These pain points are already there, especially when they happen so quickly. But I think that there are, because of spending of large fiscal deficits as well as high income spending we've generally seen that the US economy in particular, but also to some extent the global economy is more resilient than many bears think. Which is why I think that just because you have $150 oil doesn't mean the economy can't function. It just generally means that changes have to occur when we're back in a high energy environment. So I think that after a period of friction, the global economy could function on 150 oil because that's not the same thing as inflation adjusted.

It's not all time high oil. I think that can be sustained. You just have to adjust to it. But yeah, once you get a, once you get into 200 plus oil, a lot of things start breaking down.

Erik: Oil is an input cost to the price of everything, and therefore a very important inflation driver. At what point let's say we get a really big inflationary pulse out of this war, and then the war gets wrapped up in a couple of months, does that inflation pulse come back out of the system or has it already started a self-reinforcing process that can't be unwound at that point?

Lyn: From data we have available, the most persistent type of inflationary pressures, when you have a growth in the money supply, usually, they create more money. There's various mechanisms. They get that money broadly out into the public, which is why, for example, 2020 was very different than 2008.

We didn't just recapitalize banks. If look at broad money supply during 2008, 2009, it just stayed on its normal trend. Whereas you look at the money supply in 2020 and 2021, it spiked because not only did the fed print money, but that, that funded direct fiscal injections out to the broad public.

And and then it took years for that increased money supply to trickle out into various types of prices, which is why we have, five plus years of inflation from what was effectively. A hyper for two years. And but when you have a something that's caused by a supply disruption.

That part shouldn't be as persistent. Like how the energy price spike we had in 2022, while very damaging for that it, it gave us less persistent effects on inflation. I would argue all those quote unquote transitory types of inflation that. Policymakers kept saying things would be the transitory things did go away, or at least diminish in time.

It was the persistent increase in the money supply that really solidified the higher price that we see across the board. We saw massive increases in, home insurance and health insurance and all sorts of things that have nothing to do with supply chain issues or very little to do with supply chain issues.

And so at the moment. Let you know, let's call it the next couple months, there's no particular sign that we're gonna get a massive increase in money supply in the US or certain other major economies. And so because of that, should this be resolved starting with some sort of peace talks in the coming days and weeks, and then it still takes time unfortunately, for all that shut and energy to come back.

We have to see what, what's gonna happen with the insurance markets for these ships. We have to see how quickly, the straight will fully open just because it's, partially open. So even in the best of scenarios this seems to, looks like it's gonna be quite a while. But if there's no kind of massive increase in the money supply we should over time expect this to mostly go back to baseline.

Now, it doesn't change the fact that a consumer would've spent more on gasoline. During a number of weeks or months that they're never gonna get back. It doesn't change the fact that farmers because of, sharp changes in fertilizer prices and things like that they're not necessarily gonna get a season of profits back.

So it's not that those things don't have permanent issues on certain parts of the economy. I wouldn't expect a broad and permanent increase in prices just because you have a multi-month spike in energy. Unless we, we get some sort of stimulus to help people pay for that energy, that's where you start to get that broad money supply growth.

And that of course is all. All what I'm saying there is compared to the fact that we already have inflation, we already have money supply growth occurring we already have price, aggregate price levels going up. We're still getting permanent inflation. But then I'm taking your question to mean will this energy price spike give us a, like a permanent sharp increase inflation above that baseline?

A answer would be that, generally speaking, only if we get that money supply growth accompanying it, that's above the current baseline.

Erik: While we're on the subject of monetary policy, let's talk about Kevin Warsh, and I guess he hasn't actually been confirmed yet. That's on hold.

Pending criminal investigation of Jay Powell. What a crazy world that we live in. Do you think there is a question as to whether or not Walsh will be confirmed? And is there a question? I think Powell's term is set to expire on May 15th. Does worst definitely take over at that point? We're only a little more than a month away.

Lyn: Yeah Powell's term as chairman expires he still has the option to remain on the board, which ironically, he might increases the odds that he might stay on it based on recent comments he's made because of some of these investigations I've been operating with the assumption that the new Fed chair can be in place by mid-May.

But I'm not a, I'm not, deep in the weeds in Washington politics to that could, give you a precise answer on that. But I, he's certainly a candidate that in isolation should be, is likely to be confirmed by the Senate. He's not an outlandish candidate or anything like that.

And then this criminal investigation adds a new element to it that I'm not really in a position to, to judge. But yeah, my, I've been operating with the assumption that mid-May or, maybe with some delay we would have the new chairman in place. But obviously we live in very unusual times, so I wouldn't be high conviction on almost anything, but I think my main focus would be that I don't really perceive a giant difference.

As we get the new chairman because, as listeners know you know that the FOMC at any given time has 12 voting members in it. And some, they rotate over time. And so while the chairman is a significant force on setting fed policy and kind of controlling the microphone, the biggest microphone in the central Bank it's by no means a dictatorship.

In addition, mean, you know, I, I've come to analyzed his comments around balance sheet reduction while there are certain levers that he and other can pull

that potentially give commercial banks the ability to provide a little bit more liquidity which would, reduce the need, the Fed to provide a little bit of liquidity. A lot of these things are, at the end of the day, liquidity neutral and not that big overall. So I generally fate his comments on balance sheet reduction.

Other than maybe around the margins. And then, I do expect all being equal, he would be more dovish on interest rates than Powell would be. But, to a moderate extent. And what I don't think changes either way is that anytime you have a acute liquidity stress, either in the treasury market.

Or in inter, interbank overnight lending market. The fed's gonna step in when needed either, starting with their standing facilities but then also including purchases if needed. I, while leadership changes do affect the Fed, I think majority of it is locked in.

I do expect the fed rotation to, to happen, at least roughly on schedule. It's not really like a thing that any of my investment decisions are gonna massively hinge on per se.

Erik: There's one aspect of that I'm a little curious about, which is my thinking on this was pretty much consistent with yours, except that I thought that Jay Powell was really not wanting to give President Trump the rate cuts the policy rate cuts that he wants, and it seemed like warsh was lined up very loyal to the president and likely to champion those cuts. It seems to me like it's impossible for any fed share to champion rate cuts with what's happened with the Iran conflict, unless there's a complete reversal of the inflation signal that's coming from elevated oil prices. Would you agree with that or do you think that it's still, Warsh comes in and starts cutting rates?

Lyn: I would roughly agree with that. So if you asked me a month ago, I would say that all is being equal. War should be slightly less growth oriented on the balance sheet and slightly more dovish on interest rates would be my kind of base case. And, but now that we have this war and we have higher energy prices and inflationary pressures in multiple dimensions here.

I wouldn't say it's impossible for him to cut. It'd be historically very unusual and he would, again he'd have to convince other voting members to decide with such unusual policy. So I wouldn't quite say impossible, especially because we're in this age of like impossible headlines being true.

Oftentimes, I do think that, the war actually does narrow the choices they have. And narrows the difference between Powell and Warsh which I already don't think was huge to begin with. And I think that, to your point, further narrows it because it it ties the Fed's hands a little bit.

At least until they see more employment damage. As long as overall employment levels unemployment levels are still on, on the lower side. Even when they have softening and total payroll numbers and some of that's. Net migration, some of that's demographics. They're not they're really looking at the unemployment rate more and those numbers are still fine.

Jobless claims are still fine. And so if they do have this kind of inflationary pressure from energy I think it puts them in somewhat of a holding pattern almost regardless of who's in charge, as long as someone who's semi credible I is in charge. And I certain, I certainly think he, he's a credible candidate.

Erik: Lin, let's continue on that multipolar theme and talk about some of the other polls. As this war continues, it seems like one of the effects that it's going to have is that it's probably worsening the the conflict between the United States and Russia, which is an ally of Iran. What does that mean in terms of the resolution of the Ukraine conflict and what does it mean with respect to energy and energy policy for Russia's sale of oil, both internationally and particularly with China?

Lyn: All us being equal, this has been a positive development for Russia. Their energy prices are higher. The sanction pressures less on them. And it's also, they're also a major fertilizer producer. So they're potentially gonna get benefits in that department as well. And as listeners know, the vast majority of the energy that comes out of the Persian Gulf heads east toward China and the rest of Asia. And, because these markets have varying degrees of fungibility to them the economies that we're not getting that particular energy source are, especially the we, the wealthier ones, the bigger ones are gonna be bidding pretty aggressively for any other sources they can get.

And while not all oil is the same there's many spots that get similar types of oil. Natural gas is, one of the least fungible of the energy markets because LNG is so limited and the transportation costs are higher compared to the pricing which is why we see bigger and more persistent.

Pricing spreads between, say, North American Gas and say European gas back when that war broke out between Russia and Ukraine. So all has been equal. This has been positive for Russia. It's I would generally consider it. Negative for China. They generally benefit from stability.

They benefit from having fairly cheap energy as an energy importer. But, I much like the US economy is often more resilient than bears think. It's also true that China's economy is often more resilient than bears. Think they're very flexible in terms of how they are able to keep functioning on average Chinese citizenry, they're this, their experience over the past decades has given them higher economic pain tolerance than Americans because they have a more of that uni uniparty system. Political polarization is less of an issue over there.

That obviously comes with massive downsides of freedom of speech and stuff, but it's just that, it's a reality to, to take into account when we see how these things respond. And so I, I do think that China's gonna be quite resilient. as these other, inputs get scarce, there they are one of the powers that is capable of bidding pretty aggressively to get much of what they need.

And so what, this is a conflict that is, is. Good for very few entities and bad for most entities around the world. On average it does, I think it's significantly bad for Europe. It is bad for China, but like I said, China's quite resilient. I would argue more resilient than Europe on average economically.

And Russia has been one of the outlier beneficiaries now from. Military experts that I'm somewhat familiar with. I think one of the negative showings was that some of the military equipment that Iran had from Russia and China has not necessarily operated as well as they would've hoped.

So if there's a downside to Russia, that might be that. But that's, that's outside of the scope that I'm able to comment on in any sort of I, like I certainly don't have an edge on that topic.

Erik: You mentioned fertilizer in passing there. Let's come back to that because one of the things that several experts have predicted is maybe the oil price inflation shock that we're feeling right now is the first wave, but the bigger and.

Potentially more crippling. Second wave comes from food inflation, and a lot of people don't understand that the straight of ous is not just an oil passing lane. A lot of the fertilizer in the world goes through the straight of ous if that stays closed. We get to a situation where farmers can't grow their crops, food becomes more expensive, and that doesn't go away the day that the bomb stop dropping.

It continues for a full crop cycle. Would you agree with that outlook, first of all? And if so, what are the implications of that food? Price inflation. How does it affect different economies?

Lyn: So I agree, of course a lot of raw inputs to, to make fertilizer come from the hydrocarbon industry. And then even other things, even like helium and other components that are used for chip making and stuff there's a whole assortment of things that are now at risk of price spikes and or outright shortages rather than just oil, gas and, other liquids.

And while price of the pump is the first sign we see and, potential shortages of LNG shipments coming in as expected in certain economies that that's all hits first. But I do agree that food inflation is a significant risk. Should this be prolonged.

My understanding at the current time is, as we see already fertilizer prices go up, farmers are squeezed because they haven't really seen the sharp of a move up in, their. Cash crops yet. So they have higher expenses, but not necessarily much higher revenue. But that obviously that situation only lasts so long.

And un until you, either, until the situation resolves itself and those expenses come back down or they, the prices for their crops starts to increase. And food inflation's one of the, obviously one of the most damaging types of inflation you can get. In a developing country.

The two things policymakers have to try to not mess up are food inflation and energy inflation or shortages. That's how you get revolutions. It's, when people just can't put food on the table or they, they can't get to work or they just can't function or they can't keep their lights on, that's when they go out in the streets.

And in the developed country. Food inflation, there's less of an acute risk of shortages and people literally unable to eat just because the overall environment's wealthier. But it does squeeze people especially on the lower half of the income spectrum. So you do get more anger, more, we're already in the US nearly record low consumer sentiment.

We're, we're off, like the absolute lows we were on, but it's still very low and a prolonged, gas, gasoline spike combined with over time, potentially just higher food prices is damaging. And so I, I do think that's a significant risk and it's gonna, if it's prolonged, it's gonna show up in, in energy food, as well as things that

People are not looking for supply chain for making things often requires gases or other feedstocks that come out of the Persian Gulf.

Erik: What are the implications for emerging market countries that don't have access to a lot of alternatives? It seems to me that there, there are some countries, I know you, you spend some time every year in Egypt.

There are places around the world where the entire economy depends on certain kinds of imports, and if they get cut off. There's really no backup plan in a lot of cases. What are the potential risks? And I hate to take a humanitarian crisis and turn it into a trading opportunity, but where are the trades there in the sense of emerging markets?

Should we be, worried about emerging market economies taking this harder than the rest of the world? Is, are they a short, what? What's the outlook?

Lyn: I would argue that a decent chunk of it has been priced in, but that, of course, it depends how bearish an investor is on this outlook. The longer and more severe they expect this to go on, the more that shorts become reasonable for.

The more vulnerable spots of the world from a purely financial perspective. I got questions from family in Egypt asking why did the Egyptian pound suddenly jump from, 47 to the dollar to 52 to the dollar? In kind of the. Weak leading up to the war, and then especially after the war.

And it's in large part, I think because, FX traders are looking at this saying Egypt is more vulnerable than, the US and other safe haven currencies. Like I mentioned before they, I mean they, long time ago they were an energy exporter, but now they are an importer.

They're not a wealthy nation on a per capita basis. And, they're out there bidding with everyone else. Like when we saw, for example the natural gas price spikes in Europe back in 2022. And it really, they started in 2021. Europe suffered, but we also saw developing countries like Pakistan were, would often suffer even more because they would get outbid by, comparatively wealthier European buyers that can scramble to get the energy that they need more easily than a poorer country.

And I don't treat emerging markets as the, as just one big group. China's still classified as emerging market. Even that has many characteristics that wouldn't put it in that category anymore. There are also emerging markets that, of course are, energy sufficient or exporters or fertilizer exporters.

But for those that are more tech-based and more tourism based where they, they have to import their energy people fly in on very energy consuming jets and things like that their economies are at risk the longer this goes on. That can impact their currencies, that can impact, like I said, in Egypt.

They're already planning for that rationing stage, not just, higher prices at the pump and pain there. It's just outright, just portions of the city shutting down hours earlier. So that impacts everyone. And I you'll see that in, in multiple countries the longer this goes on.

And you asked before about the topic of kind of permanent inflation, like if spikes for a Number of months and is not going back down, the countries at risk of kind of permanent inflation are the weaker ones because when you have an already vulnerable country have that kind of energy price spike and it's got its debts denominated in a currency it can't print.

And other issues like that, they're more likely to have a big kind of money supply spike. after this happens. So they're more likely to actually lock in a lot of that inflation because they're more likely to get a persistent and like a higher plateau of money supply resulting from this not necessarily after these weeks, but after some months.

Erik: Lyn, I wanna change the topic now to something that we haven't really covered a lot on macro voices I've been looking forward to asking you about, which is the private credit crisis that is also breaking out. It's not in the headlines as much because of the war, but it's a big deal as I understand it.

Basically, there's a whole lot of private credit was loan to software companies. Then Claude Dot code came along and made it. Very easy to to write software almost automatically, and it creates a threat. So this is the first time we've really seen AI pose a threat to jobs and to businesses, but not quite in the way a lot of people expected it.

Is that what's driving this private credit dislocation or is it something else? And what do you make of the situation?

Lyn: So I think that's part of it. That is a topic I've been focused heavily on since last year. Especially my research service. I've generally been in the camp that is not too alarmist on private credit at least in terms of its contagion effects.

So I, I think it's, without question that is obviously a lot of issues in private credit. For all the reasons you've said. I think even before the AI and software issue just if you just look at the total credit creation that was happening in that sector it was very rapid.

And whenever you have a, a very quickly moving quickly growing part of the financial economy the odds are that's where the next issue's going to be. Just because that's where the most exposure is. That's where, generally speaking, you're gonna get looser lending standards just because there's so much money sloshing around.

It's not a tight area. Banks on average have been pretty tight. But non deposit financial institutions, a, AKA private credit and other types of equity or credit based lenders they've been, looser regulations to take more risks. And so I do think that. For private credit investors it's likely gonna be a rough while I think that's true for private equity as well.

Basically you have a lot of illiquid investments on the private equity side. Then you have just the risk of bad loans in the private credit side. But one thing I noticed is we already see search activity like Google trends and stuff for private credit. Is like roughly as, as high as subprime mortgage crisis was, during the peak of 2008.

So it's already getting a lot of attention. And of course, what investors are really asking outside of investors that are directly invested in private credit funds, what broadly speaking investors are asking is what are the contagion risks from this, should we have. Multi hundred billion dollar losses in private credit, what does that do to the banking system and what does that do to the broader economy?

That's, so after all that kind of bearish talk, the part that I'm not quite as bearish on. Is the ability for losses in private credit to severely hurt the aggregate US banking system? When we put some numbers into it, perspective, banks have collectively lent something like 1.9 trillion to non deposit financial institutions of which a subset.

Is private credit. And that sounds like a giant number. And it is because we all macro stuff's in the trillions these days. But that's in, in relation to about 25 trillion of total bank assets which gives you seven to 8% of total bank assets are held in the form of loans to non deposit financial institutions.

And then from there, a typical private credit fund. Would have to have rather massive losses for its investors before it would come back and hit the bank, that lent some money to it. So it's not as though, as soon as private credit has losses it's the bank having losses.

This is the mechanism where banks have exposure to the space, but they have this risk reduced exposure to the space compared to the investors that are on the front line investing in those private funds. And let's say, you, let's say you have multi a hundred billion losses you'd have a much smaller percentage of that hit the banking system.

And they've, they've got 25 trillion assets and then even their capital buffer. While, a small proportion of that is large enough to absorb, just by any kind of reasonable default scenario for private credit now there's always a case that you have indi individual banks that are like oddly exposed to a given sector.

So you can see individual bank failures but across the board of the bigger banks they seem to have their exposure. Protected. So I, I'm in the camp that while private credit is a problem especially for investors in that space I am less worried about contagion risks. Now, of course, when you have multiple crises together, the issue is that one can feed into another.

So for example, I was on Fox Business with Charles Payne, and he you put a list of crises on the board and said, okay, which ones are the worst ones? And I said the one I'm most concerned by far about is what's happening in the strait of Hormuz because, energy shortages, raw component shortages.

If they persist are like one of the worst risks in the world. And I, I say compared to that, I'm not worried about private credit contagion into the banking system nearly as much. With a caveat that, one of the catalysts that can damage private credit is interest rates going up because of these stagflationary issues.

So these pockets are not in isolation, like how. High energy prices, in a way led to the subprime mortgage crisis. Now it wouldn't, the high energy prices wouldn't have been nearly as bad. It like that recession wouldn't have been like so severe if the banking system was not so highly levered back then.

But basically that was the that more inflationary environment, the higher interest rates that followed that's what kind of popped that particular financial bubble. And so there are risks, of course, that high energy prices will pop any number of other bubbles. But I don't view the banking system as being in the US nearly as vulnerable at the current time as it was back in 2007, 2008.

Erik: Lyn, I can't thank you enough for a terrific interview, but I've got one last question I cannot resist asking because I think the best advice I've ever heard on Macro Voices came from you when you said, do not write a book unless you can't help yourself. Now, in fairness, that was advice on business books.

Tell me about The Stolguard Incident. What happened? You couldn't have, couldn't help yourself.

Lyn: Yeah, I've cutting out myself. That's my new sci-fi book that's out. We all have to have hobbies. And although I, I analyze markets and financial systems for a living. My initial background was engineering.

And like many people, I'm a big fan of fiction. And I've had this story in my head for a while and I decided to write a kind, a sci-fi thriller, The Stolguard Incident. In a world of bad news I figured. It's a good time for it to come out so people can buy it on Amazon or elsewhere.

And it's a dark story it projects some of the technological trends explores some more farfetched areas because that's what sci-fi is good for. But yeah, people can check it out if they wanna. And I think in general, I would say that. In certainly don't write a book for money.

Like I said it's like you only do it if you can't help yourself, and that was certainly my case here. But from a perspective of reading books, I think that especially in times like these were of course glued to the news headlines. Many of us are, our jobs make us have to be and then even other people just trying to figure how to protect themselves.

But over time, of course, on average, we are more glued to the current thing and headlines and social media. Reading is one of those things that's slowly on the decline. And I do think that there's still much to be gained from reading fiction of multiple genres in addition to the nonfiction reading that people do.

While I've benefited a lot from reading, nonfiction books, business books and history books and, technology books and all that. I've certainly also benefited over the years from reading fiction. And I think it's it's important.

Erik: I'm hearing fantastic things about the book, so congratulations on that.

Let's get back to our usual format closing question, which is tell us about the services on offer at Lyn Alden Investment strategy, what you do there and how people can follow your work.

Lyn: Sure. So that's at Lynalden.com. I provide public articles and newsletters so people can sign up to the free newsletter.

Where I provide research every six to eight weeks on the broad macro picture. And then I have a low cost research service for individual investors as well as institutions. That comes out every two weeks and provides a little bit more granular detail on what's happening, both macro a as well as specific investment ideas.

And of course people can also check out my nonfiction book, Broken Money which is about the intersection of money and technology. Thank you,

Erik: Patrick Ceresna and I will be back as Macro Voices continues right here macrovoices.com.

Erik: Joining me now is Bloomberg macro strategist Simon White. Simon prepared a slide deck to accompany this week's interview, registered users will find the download link in your research roundup email. If you don't have a research roundup email, it means you haven't yet registered macrovoices.com. Just go to our homepage, macrovoices.com.

Look for the red button above Simon's picture that says, looking for the downloads. Simon, it's great to get you back on the show. It's been too long. I want to dive right into your slide deck 'cause there's so much to cover today. Let's start on page two. You say Infl. Is a three act play that we really need to be thinking about a return to secular inflation.

And a lot of people said there was no catalyst. I think we got our catalyst, didn't we?

Simon: Yeah, in, that's I think that's that's absolutely right. Eric, I think this is playing out in a way that's very analogous to the seventies, which is why a there and I think most mispriced at the moment, I think mispriced before this war with Iran started, and I think it's even more mispriced now.

It certainly seems that transitory is back and forth. If you look at the CPI swaps, for instance, they show a quite sharp rise in inflation over the next few months, expected maybe peak out 3%, then very quickly goes straight back down, and 12 months. I think we're looking at 0.8% and spot C, which is basis points higher.

Term break have to five, maybe 20 basis points. The started, but the has five to basis points and I think the memory is kicking back in. Inflation will always go back to target. I think that's I think that's quite complacent and that's why it's helpful to look.

Is perfect. But, the seventies does have an uncanny amount of common commonalities with them today. And also the one thing that doesn't change is human nature. Human nature is immutable and inflation is as much of a psychological thing as it is an actual, financial phenomenon or an economic phenomenon.

So the chart on the left was something I first used 22, so almost four years ago. And it was uncanny because I updated it. And so the blue line shows the CPI in like level, not the growth from the late sixties into the late seventies, early eighties. And the white line is today. And so I updated it on today at the end of Act two.

So the way I thought about it's act one was when inflation first hits new highs. So this time round, that was the pandemic. First climb round in the seventies. It was on the back of we had a lot of fiscal because of the Vietnam War. We had LBJs, great Society, Medicare. We already had quite loose fiscal policy.

Inflation started to creep up much higher than expected. And then we went into act two, which was like the premature all clear.

Inflation, a temporary phenomenon wasn't gonna be much of a problem. Gonna back in fairly quickly, and that feels like where we've been over the last couple of years. But you, inflation not back to target, stayed Target. So remains elevated. And if you look actually where act two ends, match October. The beginning of the yo Kippur war.

And that in itself is a comparison work looking at, there's a lot of differences with that war, but there's actually a lot of commonalities that definitely makes it looking compared to, what we're seeing today. So back then it was a surprise attack. It was the Arab states led by Syria and Egypt on Israel and attacked.

It was a very short war. It was only three weeks, so this war is not yet three weeks. Initially, it was expected to be short, but that's looking less likely now. I think as an end of April ceasefire now down to 40% probability from something like 65% not that long ago. And you had obviously a major oil shop in response to this this war because what happened after the war, after the three week war was that the US state aid to Israel and the Arab states decided to have an embargo on oil.

And that created this huge oil shop. So oil prices managed to quadruple in a matter of months. That's quite a significant oil shop. That led to the Act three, which the comeback, this massive in inflation the end of the decade. And it really didn't end until you got in this exceptionally high interest rate heights, the Saturday night special that really managed to break back inflation.

Look the further commonalities,

the Middle East

also. Next slide. You look at the then, so market, back then, this was the time of the nifty 50. So this was a set of stocks that everybody thought they had to own. They had great earnings, they were great businesses, and pretty much everyone owned them excuse me. And similar to today.

So we had very narrow leadership. In fact, it wasn't until the tiny, the banks and the magnificent seven that we had such narrow leadership again, as what we had back in, in the early seventies. Extremely narrow leadership as well. Before, just after it started, stocks had already sell off maybe 10% the months before the following year, they sold off another 45% and that the largest sell off we've seen since the since the great, so we saw significant stock sell.

Now, that's not to say, that we're gonna get the same thing playing out here. There's a lot of differences obviously today. The US is a major oil producer. This is not the same, exactly the same states that are involved. The choke point here is not an embargo, it's the of hor. And there is still nonetheless, choke point in the supply states.

But I think it's worth bearing in mind that, as a non, just given, we're in a sort of not similar situation and kind of nail the coffin, if you like in some ways for why be. To the, is that even though this massive in market in

and also households compared to financial assets, which much lower back then it's much, much higher back to date. So really it's the number of reasons why. You could see things, we're not see a more deterioration obviously, or to get anything like that, but given some of the commonalities, I think it's worth in, especially when you look at the market today, it just does seem, again, there is some complacency in stock market been to believe.

I think that there is some sort of tackle on the way and therefore, it's not really worth market trading down too much. Even if you look at the food spread. So the V went up initially a lot of that was, first of all it was driven by cold spreads falling, and then it's driven by food spread rising.

So people were putting on insurance, but then they quickly monetized. I think those monetize those edges and that spread start to come off. And so the V has started to come off. So really I think the markets getting to the point where it feels like, you know what, this isn't gonna be a major issue.

We don't have too much to worry about here. Not ready to obviously rally and making your highs again. So get overly knickers. I'd argue along with inflation, that's something that is beginning to look a little bit complacent.

Erik: Simon, let's go a little bit deeper on some of the both differences and similarities between the Yom Kippur war and the present conflict.

The Yom Kippur War was really a war of solidarity. As you said, the US had sided with Israel. Basically all of the Arab states together went in on the Arab oil embargo. You have a very different situation today where the US has once again sided with Israel in a conflict with Iran, but now Iran. Does not have solidarity of the other Gulf States.

In fact, it's attacking the other Gulf states that are allied with the United States. It seems to me there are still similarities, but there are some almost diametric opposites in some aspects of this. How do we sort that out and make sense of, what extent the economic outcome might be the same or different?

Simon: Yeah, I think as hundred percent, I alluded to that there is a number of differences. And so that puts you in a point where, no analog is gonna be perfect. But I think when you combine it, as I say with the overall inflationary backdrop, where we're in terms of this free in the seventies, you could argue that what happened in the seventies were a series of kind of quote unquote bad luck that inflation rising.

Inflation, as I mentioned, we had already the war, we had the fiscal expansion on the back of the society. And then you had, 1971 was Nixon closing the gold window. Then you had the Arab oil embargo, the war. You had the end of the decade, you had the Iranian revolution. You could argue all these things were bad luck, but they're also hitting a situation where inflation was already in a different regime.

So I think that's the thing to, to note the differences of when you're an inflationary regime, lots of things can happen, right? Things will always happen. But if they hit when you're already an inflationary regime, they're much more likely to have bigger inflationary impact. You know that's where we are today.

It's very uncanny if we happen to look, compare the two analogies that almost to the month when you get this sort of premature all clear ending. When the yo war started as when the attacks on Iran started. Yeah I wouldn't wanna over the point in terms of the analysis, the there's so many precedent that makes it worthwhile looking a little bit deeper into, for instance, another one that's very interesting is an underappreciated fact that in the seventies the food shop was actually much bigger than the energy shop.

Effect on C. So if you look at the weighted contribution from food and from energy in the 1970s, it much bigger for than it was for energy. In fact, food inflation was already rising before energy. This time around we have the disruption to the straight of our moves. That obviously doesn't just affect energy prices, it affects energy products.

Lot stuff that goes re produced in that region or has travel through that region. So Iran itself produces a lot of, there's a huge amount of sulfur flows through the, all these things go into and in fact further into presentation, if we go to lemme just find this slide. If we go to slide eight.

We can, there actually, you can see the two shots. So the Blue line chose the good shot after OPEC one the shot. And you can see again after OPEC two, the Iranian revolution, both times the, and today already we have, if you look at the contribution to CPI, the US CPI, that is from food. It's it's higher than ER energy already.

So if you have this effect getting into, fertilizer prices, and that's what I to show on the chart on the right, on slide eight, you can see this fertilizer include some of these I mentioned along with things like bot, when that starts to, it's a very reliable by the six months that CPI will start to rise.

So I don't think that. And especially I think if you take account have very unlikely you're not gonna get some second. Feed into core inflation. And you get the sticky inflation that we saw in the 1970s, and that's a lot more troublesome for the Fed. In one sense, it should make it easier because the Fed can then go, if we see inflation, that's something we think we can do something about. We'll high, but with the. Mute, muted. Sorry. Next, Kevin coming in, whether he's gonna lean towards the do the spectrum I certainly think he's more likely to be more like an Arthur Burns who was in the, in seventies times.

He's likely be

I 19. So I think that further complicates the matter in terms of what the best reaction functions gonna be.

Erik: It seems like the analogy that's most relevant is the Yom Kippur War only lasted a few days, but the Arab oil embargo lasted quite a lot longer than that. So the question is, once the direct kinetic conflict is over, how long can Iran continue to disrupt the flow of traffic through the straight of four?

Is that the right thing to focus on? And if so, what's the answer?

Simon: Yeah.

Key message, I think from that period was the war itself was very short. Say it was about a few weeks, but the impact was felt way through all through the decade. And I had a number of consequences. So again, no analog perfect, but the human side of things, it doesn't change how humans respond. Human nature responds.

It doesn't really, in fact, I can see that this two nature of the two different shops, if we go to slide then six. So we've got two more charts there. And this brings me to another point, which I think needs to be made is that I don't think the yield curve is pricing in what's looking to be much larger inflationary shop than for instance has been picked up in the breakeven market.

So the left chart we can see there is whats did. OPEC two. Both cases they ended up, did rise quite considerably, but they long after, if you liked CPI, already started rising kind late. But both times they did rise. And if you look at the chart on the right there, you can see the two, the nature, the different nature of the two shocks.

So OPEC one was definitely more of a permanent shock to oil prices. So really oil prices never really revisited. Pre OPEC one or pre-war, pre war levels, again they just kept rallying through until OPEC two hit the Iranian revolution in 1979, they sharp again, but nowhere near as much in percentage terms as they did O one, and then they gradually start to fairly soon after.

OPEC two was more transient, the more transient, but in both cases, if you look at the bottom, you can see core and in the interim, OPEC both made a higher. Early eighties, and again, it wasn't until Paul Volker got his hands on monetary policy that he was really able to put an end to this this huge inflation that it had through that decades.

Erik: One of the theories of secular inflation is that it's a self-reinforcing vicious cycles. So as you begin to see inflation, it changes consumer behavior. People start stocking up on things because they wanna buy it while the price is still cheap before the price goes up more, that causes more consumption than.

Is inflationary and it all feeds on itself. And you, it's like a fire that once you've started it, you can't put it out. Are we already at that point in terms of this coming inflation cycle where the fire has been started and can't be put out? Or are we still in the need to look at this and see what happens?

Stage

Simon: We're in, we're already in that my quite clear that what began in 2020 with the pandemic large spike in inflation was the beginning. That, that cycle starting and really what's happening underneath is that why 2% inflation for whatever reason, an but 2%, around 2% inflation overall, like over the whole economy tends to be fairly stable.

And I think that's because all the different actors that are taking price signaled off one another when inflation is not moving around that much. They tend not to go out sync. Once the cat outta the bag, like once you have this large rise in inflation, which we saw in the early 2020s, they get all, it'll sink and it takes a huge amount for them to get back.

And and you end up with inflation remaining elevated. So you can split CPI up, for instance, into, components. So you can look at essentially non components and what you noticed in 2020 is structural start to fall, but the structural one remained more by the time the structural fall, because you can tell by his name cyclical has started to rise again and start to reinforce.

Structural inflation was already elevated and we're right in that period again, now where structural had stopped to fall at a higher low, but the cyclical part of it is already rising again, and this war is just gonna make it worse because obviously the immediate effect is on headline inflation.

And so straight away you're gonna see that feed through into the cyclical side of things. Once again what was 0.4% we're now C 3% and pce, they're gonna look like again, equivalent to what we saw in the mid seventies after the, this is the point where we start to see a rise again. I know how far it goes.

Again, the U US is much more insulated and than it was back then. But I think you do see a re-acceleration. And the real kind of, if you like, the real kind of tinder in this is that as I say, going back to Kevin War, you've got someone that's coming in that nobody's really sure is gonna be an inflation fighter.

In fact, quite the opposite, quite possibly. Which is actually a bit odd, just the slight deviation. But connected is, it's strained. If you look at real yields have been rising. So real yields have been rising since the war, and that's been driven by higher rate expectations.

So that's part of the rise in nominal yield. So evens have moved a bit, as I mentioned, but really the bulk of the, so far have been real. And that's on the back of as say, expectations are gonna higher seems a little bit, given, and the conditions that, not conditions, but the circumstances under his nomination.

And a president who still makes no bonds about being absolutely determined to get lower rates immediately. He was saying so only a couple of days ago yesterday. So I feel that is also adding to the structural kind of impediment for inflation to, to keep rising. Go back to the yield point I was mentioned.

So I think yields as say, are not priced for an shock. And I think one, one thing we'll see, the yield curve will steepen. So if we go to slide seven on the look, basically how grays and real yields behaved in the seventies. Now, there was no real yields in the seventies because didn't start trading until 1997.

But you can synthesize real. So you basically look at how reals have traded laterally versus a whole bunch of different economic market indicators. And then you can back it out and look at how and build basically a series of in the seventies. So far there we can see again the dip, OPEC and OPEC two and how the yields behave.

So in both cases breakevens rose. Pec what happened is that you put shock to greats, but then we had equal opposite shock to, that's textbook sta what happened in pec pec two even buts stayed largely static. And I think that was basically for two main reasons. One, the US response to OPEC one.

So the US became less energy intensive and more energy efficient. And a lot of non OPEC production came on street completed, like Alaska and the North Sea. And on top of that, you had, or very soon after the Iranian revolution, you had Paul Volker at the Fed and that kind of cushion under how far uhs could fall.

So in OPEC one, the maybe didn't amount.

Steep. And he as mentioned earlier for not believing that central bank much, let shock inflation was of the view that by and large most inflation shock couldn't be solved by a central buyer. And in fact, he was the guy when he was at the bed he got staffers working on some of the first measures of core inflation.

And then to the decades he kept on taking out more and more core inflation and a frantic hope that something would be going down which he discovered wasn't the case. We, we have this very banker who doesn't really believe central banker, who doesn't really believe that inflation is something he can do much about.

So short yields fell. So steepened, OPEC one and OPEC two. Little bit, but had Paul Volker who massively curve flat. But this time I think in some ways be

rise. So I think that move, thus that we see this muted move, I don't think that'll last. And that this should rise more from, the relative status.

You're gonna see lower weight. So I think I would lean curve seating.

OPEC one is as similar to what's happening today. There are, as we covered to some similarities, but there's a lot of differences as well.

Erik: If this was 1973 all over again, and clearly you've said that it's not exactly a perfect analogy, but to the extent that there's a lot of overlaps, 1973 was not a good time to have a long-term bullish outlook on buying and holding stocks for the long haul.

What does this mean for equity markets for the rest of the decade?

Simon: I it's interesting now. It depends who you speak to. So I've got a lot of stuff, some friends and people I know that speak to commodity people. And they're overall a lot more bearish than rates.

People you seem to be overall less pessimistic. I think, again, going back to what I said earlier, I think that there's still this sort of belief that there's some sort of an attack on. Even more than that. I think the big difference is that ultimately there's atop and if things get really bad the Fed can step in.

I'm not saying that's what's gonna happen right now, but you're always gonna have that tail covered. So the commodity markets can really price in extremely kind of negative outcomes. They don't have a less lender of last resort, right? So there's nowhere to go. If your commodity market sees for whatever reason, there's nothing really can be done.

There's no backstop in the way that you have for financial assets. And so I think that sort of explains why we have that today. And, 1973, I don't think we, we had that to the same extent. It wasn't this belief that the Fed was always gonna protect efficacy returns. So that's why you probably had that situation where you had this huge shock, much bigger than the energy shock we've got today.

Combined with a that was yes, it was overall more dubbish, but this is the decade monetary policy where, policy came back, then you tightened it, and then you're like, oh, listen policy again. Back and forth, back and forward. There's huge amount of volatility underlying there obviously.

Makes it more likely or yeah. Increases the chance that you can have deeper falls in the market. And so you don't really have some of that today. But it does seem, as I earlier, that feels the market overall being more complacent. Even with that in mind, that there is a backstop, that there is still a potential for some sort of still seems to be some sort of complacency.

What especially.

Initially there was the response to let's hedge some downside, but very quickly that reversed. It was almost as if like the market went, oh, maybe I don't need such outta money here. Maybe the market's not gonna sell off that. In which case I don't need this insurance right now. So again, that, that sort of me, just because distribution are still very right there still a lot of moving parts.

Most unpredictable. Back in the seventies we had a lot of volatility, political volatility. Again, I don't think he had anyone quite as volatile and he was able to obviously voice his volatility in such a realtime manner than we've gotta, that puts a lot of people in a sort of frozen moment, like move money.

They're fearful that they can't really put much risk on because so much could change.

Erik: Simon, on page 11, you say gold is a hedge against both tails. Elaborate on that please. But also I think it's relevant to point out if we're looking at the analog as being the 1970s. Private ownership of gold wasn't re legalized until 1974.

So there was a very big transition catalyst there where it became legal once again to own gold bullion, which probably disrupts the data. How should we think about this in the 2020s?

Simon: Yeah, that, that's a good point. I think. I think there's also another disruption at the yellow side as well because the data on this chart goes back to the late twenties.

Thirties was essentially the USSC gold ownerships gold, I think 20 so quite possibly could up in that period. I think. I think that's why gold misunderstood though, was that it's to some extent an inflation hedge. It's not a perfect inflation hedge. It's not dependent. Inflation goes very high. You're in that sort of environment. It does a good job because you've got the things and the general kind insurance against system.

It's appreciated that it's also a downside tail as well. And I think what has been driving a lot of the rally recently in is this is the lack of alternatives. If start thinking about, I dunno what's gonna happen, I, whether we're gonna basement world where there's a lot inflation, I dunno whether there's gonna be a massive credit event.

And that's gonna be deflation rate. These are potential threats to the financial system. What can I own? You record of protecting a portfolio in such an environment and there's really not much else other than gold. I think people ran through all the options. They're like that would work.

That work Bitcoin that hasn't been tested and they landed upon gold. And a lot of people that. Generally openly admitted. They've never, ever really tapered gold. They've never been a fan of gold. They never understood it, are never nevertheless starting to add or have started to add some exposure to their portfolio.

So I think as an uni of collateral really is what's driving it. And although struggled a little bit over the last few weeks. I think it's premature to say that's the end of the primary trend because a lot of the main reasons that driving it are still valid today. There's still a need for diversification from the system.

I still think there's obviously geopolitical volatility. Hasn't. Central banks I don't think are suddenly like market central banks. They were the ones that initially kicked off the rally a few years ago. I don't think they're gonna turn and start selling in any great size. They, they bought some and they may stop buying it, but I don't see why they were suddenly turned tail start selling on mass.

And there was a story that Poland was mooting selling. Some of its foldings. There were, the reason why they were thinking of selling them was for defense. And that doesn't really strike me as a great sort of a gold bearish kind of reason for selling gold overall. So I think, yeah, the general environment still very conducive to gold still generally keeping to its primary.

And it's struggling right now, perhaps because we've seen some marking up of short-term rates and the dollars had a little bit of a rally, things like that. Overall I don't see why, it would take a big seller to come around to really force into a massive bear market. I just don't see where that's gonna come from.

Erik: As you said, unfortunately, what has not gone away is geopolitical excitement, for lack of a better word. The thing that's I've noticed just in the last few weeks is there was a very strong, positive correlation. The next time a bomb drops gold spikes upward. And what we've seen just in the last few weeks is a breakdown where, when oil is up hard because of geopolitical, bombs are dropping, gold's actually moving down.

What's going on there?

Simon: Yeah, I say I think potentially it's because of, the real has risen. That could be partly the little bit of the rally in the, it should also be in times of if there's any capital repatriation going on, maybe in the Middle East. I know for sure, but, gold can often get hit in the shorter term people need to liquidate.

That's unfortunately. Asset. Asset is it's

narrative.

Anything more than just, obviously we've gotta remember the market has rallied extraordinarily much in recent months. So there's partly respectable for it to have. The kind of pause that it's having right now, like it can't continue in that sort of trend indefinitely, but I don't think that means that the trend is over.

Yeah, I mean I think silver is a far more obviously volatile, but a far more questionable kind of response to that kind of overall idea on trade. But gold to me seems certainly more, more secure just because, as I say, the reasons underpinning it rally all seem to be mostly intact still.

Now,

Erik: Simon, we've been jumping around in the slide deck. Let's go back to page four because you've basically said you're rewriting the Risk Off Playbook. It seems like an important book to read. Tell us more about it.

Simon: I'm certainly not gonna rewrite it myself, but my point here is really know.

We analog guide, I think you have to keep in mind as rules change. So I think standard, playbook, can the dollar rally and risk assets sell off? And that might not be the case to the same extent as, so for instance, take so quintessential. Risk really was the gsc. And then the gsc, the dollar rally.

So I think that's a lot of people's you know what, that the one therefore safe. But really if you look at what drove that and then necessarily say in position to rally quite as hard as it did back then. So the chart on left there, you can see that the glue line shows the bond flows inflows from foreigners.

They slowed. Equities were tiny back then. Equities much today as far are concerned. What actually drove the dollar, the rally repatriation. So the US basically funds and banks had led to various European entities. And it was these guys repatriating that led to the dollar rallies. It wasn't the case of foreigners channeling money in or meeting dollars to cover like structural shocks.

It was really just US entities repatriating, and that led to the dollar rally. Now this time around the cash flows are the structure of this is different. And so bons are much smaller now because we've had, because the US has now not seen, ies not seeing as much a safe haven and equity falls are massive and the US Outfalls are not as large as they were back in net impact.

Exposed to equity. So in a sort of risk off environment that we're in right now, it's conceivable that more capital repa and some of that is equities in the tend be is a dollar negative, and you don't have the same cushion of dollar repatriation. Yeah you wouldn't expect to see the dollar necessarily rallying as much, and that could be seen even more if you look at the chart on the right.

So after the Marla Accord all the talk of the dollar disruption, the tariff, that didn't lead to sell America trade, but I certainly think it made people think twice about their exposure to, and that can be seen. Say this chart, just the bark. So the white line shows the dollar reverse.

And what you tend to see is the blue line, which is a reserve in denominating dollars. So when the dollar weakens, IE see the white lines rise. Manager

and time

yet in attitude to global demand for dollars. So I don't necessarily see, and I think it's all a rally will be as big as time and thus far, the DXYI think is up about one half, 2% since the war started. Slide at say commodities. So as asset of seen as well recession, general interpretation that isn't always the case either if you have a commodity in recession and if we gonna get recession chance that at the next few months.

But that could change if the war continues. And the negative effects spiral. Happens then is that commodities start to sell off before the slump and growth. But the, that, that sort of sell up and commodity prices eases the growth. And actually that allows commodities to rally through the rest of the recession.

So that might, may well happen again. We get a commodity induced recession, say later, this is your next year. That's not a prediction. But if we were to get one. I wouldn't automatically assume that commodities are gonna sell off through that.

Erik: Simon, let's move on to page nine. The title of that slide is it takes a war to bring down an economy This Strong, let's start with how strong the economy is.

But then later you say it would take a protracted war. So I guess the question is, how protracted does it need to be in order to take down the strength of economy that we already have and where is this thing headed?

Simon: Economy is actually remarkably strong. Given I think the length of time of the and that really surprised me when I was looking at this.

And it's also a little bit ironic I guess that, coming into this war, the US was fing in all cylinders. And as mentioned, I mentioned war is perhaps just take to derail it. You have number cycles for the US economy that everyone knows about the business cycle.

There's also the liquidity cycle. There's the housing cycle, there's the inventory cycle, and all of them are actually in pretty good shape. And so the business cycle, if you look at leading indicators, has been turning up the liquidity cycle. So that's the chart on the left there. And I look at excess liquidity, which is between real money growth and economic growth.

This liquidity gonna have on markets. So the bigger gap between liquidity and economic growth means the economy needs less, but that more to go into risk assets that has been vacillating around, as you can see the chart, but turned back up again. And even taking into account, we've seen some tightening in financial conditions since the war, but overall they've not been massive.

As I di alluded earlier that the dollars rally hasn't been huge either. Thus, so the s in pretty good shape and the, the general business cycle is in pretty good shape. Even taking into account the job market slow down, it's possible to have a job as, and some of the things that I would look at to see if it was a slow down in growth coming, such that temporary help is actually rising, not falling.

Hours worked kind static. You would expect to see that fall as people cut, start people. I think it's, you've remember that we have companies still very strong. The balance are generally in good shape and you've got this massive amount of government money still filtering through the system.

And so there's maybe not the same acute needs in the shorter term, at least. Lay and that global, the global economy is also in good shape. As that's the chart on the right there, you can see that we're in the midst. Global cyclical upswing. If leading indicators around world almost all are turning up on six basis.

And then if look at inventory, that looks to be turning up as well. Leading indicators are putting in it to continue to rise. Sales inventory ratios have started to rise. Housing cycle is not as in good shape, it's okay. Okay. Housing growth sales growth has slowed down and things like that, but one of the best indicators for housing is building permits.

Building permits are doing okay. And they're actually led by mortgage spreads. We'll see quite significant compression in mortgage press spreads for bears, such as falling bond volatility, and so you can't see that the housing cycle in particularly bad shape. We have credit, we go to slide 10 the listed credit market.

From a fundamental perspective, my leading indicator there on the chart on the shows that on fundamental are to tighter spread. So things like lending conditions are particularly tightening in a particularly rapid way right now. Personal savings is still quite low, which means there's more money to be spent, which goes into back to corporates their, to their profits.

So you've got this general kind of listed credit markets. The weakest though is private credit. And private credit I think is the one you do probably have to be most aware of. Obviously it's very ap, unlike the listed markets. I've seen a number of cockroaches. To be popping up with a little bit more frequency that probably most people would like.

We had redemptions redemptions in waters funds JP Morgan loans, and was limiting the amount of lending it was doing to, to private and really what kind of triggered this latest little bout or weakness. Concentration of software companies that private credit companies probably have exposure to.

And that was on the back of this massive kind of like content leap in the performance of AI coding agents, which leads lot software companies, business models maybe of them are, it's not existential for a lot of them, but it certainly means that they may not be able to charge as high or get as high margins on their businesses.

Then they have before. So we're seeing this mark down valuations in their stocks, and obviously that's reflected in the loans as well. And we're getting this visible. We can't see the loans themselves obviously, because they're okay. That's a selling point, the USP of the market, but we can see the shares of BDCs.

Business develop companies and they've obviously been B because the market is obviously what they have underneath loans they have aren't good shape. And because used to be, I remember something bad happens that be contained, these guys are kind, insulate the rest of the financial system. That's case. If you look at the banks have been lending to private funds and if you look at lending to non financial institutions that has mushroom in over the last couple years, you're really number of loans been know, extended from banking, a lot of private credit.

So there's your kind of vector of risk right there. And if there is something well happens in private credit, it. The credit markets, and then it's feasible, of course that, that's bad for the rest of the economy. We've obviously been here before, credit markets are big enough that they can do a lot of damage and if they turn down very rapidly.

So that's where we are in terms of the overall economy is strong. Credit market, again, fundamentals look okay, but the weakest link is private credit. And that's obviously the one to watch or watch as much as you can because of its opacity. It's typical, other than just watching red banner headlines coming up telling you which fund is doing what with redemptions.

Otherwise, it's very difficult to really get a proper handle unless you're in that particular space yourself of really what's going on. But certain that's. As the US economy's in a pretty good spot. And the one thing I think that could really derail it would be a protracted war. You asked how long it's protracted.

I, I dunno. But the longer that we have straight or moves blocked, the more the longer it takes to switch things back on. So the longer things are all streamed, the longer it takes to switch back on. So whether that's, if you power down refineries or refineries of damage. M them off six months to bring them back on.

And so there's many of these effects that will start to kick in. I think that's also one of the reasons why a lot of people in space are more bearish because they're kind seeing this and they, they can't see any upside. They're looking at disruptions going way out, probably well into next year and that's when the basis of, even if the war stopped in quite short term.

So I think that does up to color your view and a protracted war would definitely.

Erik: Simon, as you talked about, private credit, it was concerning to me because frankly it, it echoes in my mind to about 19 years ago, the summer of 2007, when we were also talking about an opaque, not well understood in the broader finance community.

Small little piece of the credit market that couldn't possibly disturb anything else. And the reassurance at the time was. Don't worry, it's contained to subprime. There's nothing to worry about. Is this another setup like that?

Simon: It looks very much like it. I think that was Bernan himself who said contained.

Look, I go back to my axiom that the one thing that doesn't change is human nature. I think we're seeing that even within the private credit space in terms of when people have opportunities to make money. Off grid. They're away from regulation. The standard kind of emotions of greed and fear will kick in greed initially.

And people will start to take inflated risks to essentially earn money. Now, what are risks later? Hopefully they can not be around when the proverbial hits the fan. So I don't see why it wouldn't be any different. There was even a story today. One of the credit funds, if you look in the private credit fund is yet, it's a black box, but within it, there's even more black boxes.

That straight away reminded me of CDO Square. So here we had CDOs, which are already niche deriv products, but people started making up these CDOs or CDOs themselves. And I'm sure a lot of people at cyber are thinking this probably can't end well. And, here we're again, there's nothing new in finance.

Erik: Simon, I can't thank you enough for a terrific interview. Before I let you go, I'm sure a lot of listeners are gonna want to follow your work. You have to be somebody special and have a Bloomberg terminal in order to access most of it. Tell 'em for those who are lucky enough to have that access where they can find your writings.

Simon: Sure. And thanks again for having me on the show, Eric. So on the terminals, I have a column called Microscope. Tuesday and Thursday. I also write for the blog, which is four hour, five days. Follow all the latest market developments.

Erik: Patrick and I will be back as Macro Voices continues right here macrovoices.com.