Transcripts

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.

Erik: Joining me now is Bianco research founder Jim Bianco. Jim, no shortage of things to talk about this week. Let's discuss the Iran conflict, what it means, what comes next? How are you looking at this.

Jim: Being that we are financially oriented and that's our real interest is we have to look at this from a financial standpoint.

What does that mean for financial markets and potentially the economy, global economy written in general? And obviously the answer is. What does it mean for the price of crude oil? And in the immediate short term, we've got a problem in that the crude oil is not moving. Crude oil is like the circulatory system of the world.

It, it gets pumped, it gets put in the storage, it gets put on the tankers, it gets sent to refineries and the system. Constantly has to be moving. Right now we have a big blockage and that blockage is in the strait of Hormuz. Now, the good news is we have not really done any damage to the system.

Not that I've seen in terms of stories. We haven't blown up a bunch of infrastructure or pipelines or wells or ports or anything that would cause an extended period of time to repair it. We've got a bunch of ships sitting around waiting. For the ability to go through the straight and keep that circulatory system moving.

So the hope is that this is a short term problem. Short term being two to three months, a couple of weeks to get this resolved, and then six weeks to two months to maybe get that circulatory system moving. The concern is the longer this goes. The more we keep lobbing missiles at them and they keep lobbing missiles at us or their neighbors, the higher the probability that they're going to break something that will take a significant period of time to fix.

And that will create a bigger problem for the energy markets. So for right now, the hope in the energy markets, and I share that hope for right now, is. All we're doing is we're waiting for the Strait to get hope in so we could start moving that the moving the crude oil again we haven't sunk any of these ships or anything, but the concern is the longer this goes in the middle of a kinetic war, the longer it goes, the higher the risk is we break something

Erik: Let's talk about what the impacts are. If something does get broken and it delays the ability to deliver crude oil, it seems to me like obviously there's a cost to the economy, which is the most immediate effect of all a sudden energy costs much more, and it's crippling on the productive economy, but I think there's a lot of knock on effects. The first and biggest one in my mind is the inflation wave that creates. Inflation tends to be self-reinforcing, so you get the potential that you've started a fire you can't put out. And then there's probably several other feedback loops.

So when you think about what if they do break something that results in even after the the piece has been made. It's gonna take a long time to fix those broken things before we get the oil delivery system back to normal. What are the knock on effects that you see financially?

Jim: So first of all I'll measure the knock on effects in a very market oriented way.

If you look at the forward curve in the credit oil futures market, it is in record backwardation by Sunday night. On March 8th, it hit minus 25%, meaning that the six month out the September futures for WTI was 25% lower in price than the April futures, which is the current contract. And that is the most extreme that it's ever been right now.

So one way you can look at that is that the market is still pricing and hoping that this is gonna be a short term thing. If we break something of significance, how do we know it? I think you would see that backwardation start to narrow a lot because those deferred contracts would start to rally to meet where the spot contract is.

But you're right, if that were to happen, you're probably going to see. More inflation now. All things being equal, we've been doing a little back of the envelope calculation with the price of gasoline in the United States in the last eight days. The war, the day we're recording March 10th is the 10th day.

So we've got nine days worth of data. Price of gasoline is up 18% or 55 cents. All things being equal, that's probably is gonna give you a March CPI report of around six tenths or seven tenths. That is probably gonna push year over year inflation over 3%. For March. Now, every economist will say, oh, but that's temporary, that's just an inflation thing.

Correct. Unless of course those deferred contracts and rally the backwardation narrows, and then you could start talking about April being elevated. You could start talking about May being elevated. As well. I don't think this is gonna produce big inflation like. Seven, eight, 9% inflation.

But what it can do, at least in the very short term of the next three to six months, if not longer, is keep the inflation rate around 3%, if not above 3% higher if the crude oil situation worsens. I've been arguing that the Fed cannot. Cut rates, if that's the inflation rate. We have gotten used to, and we are still used to that 2010 to 2020 period, where no matter what the Fed did, they couldn't get, or no matter what the economic circumstances were, the inflation rate never got above 2%.

In fact, it averaged around 1.6 during the 2010 to 2020 period. So at any wobble in the economy, print money cut rates to zero, print more money. And that mantra remains to this day that whenever markets or economies wobble print, you can't do that if we've got inflation. Because if you print.

What you're trying to say is the economy's wobbling financial markets are under stress. We need to create easier financial conditions by cutting interest rates or expanding the Fed's balance sheet. But in this environment, if you do that, then you're saying the bond traders. We don't care about your real returns.

You have a fixed income investment and we're willing to risk inflation going up. Even though your investment's fixed income, you should sell bonds right now. And so if they were to try and be easy in this type of environment, you could wind up with higher interest rates and actually making things worse, making it actually tighter.

So one of the things about the higher inflation. Is it takes the fed off the table, even if we get worsening employment numbers, even if markets start to wobble a lot more, because the re the reaction would be, oh, markets are in trouble, or the economies just weakening. We have to cut. Yes. And then if 10 year note traders run away from the 10 year note and those rates start soaring.

You've made things worse. They're gonna want some assurances that they're not gonna lose money because inflation's gonna go up. So that's where I think the the nuance is gonna come in. This is not the 2010 to 2020 period, and if we have enough inflation now because of the rising crude oil that we've seen in the rising gasoline, we've seen now to keep the inflation rate above three.

The fed is just off the table. They just cannot step in and start cutting rates under that environment.

Erik: Jim, at the risk of nitpicking semantics, I wanna come back to your language around saying the Fed cannot cut rates. I think you just made an extremely good argument for why they should not cut rates.

Are you really convinced that they won't?

Jim: Oh, yeah. I guess you're right that in a semantic argument I would argue they should not, because the risk is they make it worse. That's what I meant by cannot, is that. They need to be very careful. Now, obviously, if things were to deteriorate to the point where you would argue that they would overwhelm whatever higher inflation you would get, that the economy would be so weak that even with higher energy prices, it would offset that, that you could then see the fed cutting rates but.

We're talking about like a, almost like a rerun of 2008 or 2020 in that type of scenario. And as we're talking now, the stock market isn't even 5% off of, its all time high. So we're nowhere near that type of scenario. But you're right, I should have said they really should not, because the risk is that in the attempt to try and make easier financial conditions by cutting rates, they spook bond traders.

They're not acting in their best interest. They sell rates go up and you actually wind up making tighter financial conditions and you wind up making it worse.

Erik: Jim, let's take that a little bit further and talk about the next step with Warsh. Taking office as Fed chair, you'll have to refresh our memory on exactly what date that becomes effective.

It seems like we don't have a really clear signal. A lot of people thought he was more hawkish, but then again, it seems like he's extremely loyal to Trump. He's gonna give Trump whatever he needs. I agree with you and what you said about the reasons the Fed should not cut here. I don't think President Trump got the memo on that and if Warsh is gonna do whatever Trump wants. And I'm not sure if that's the case. It seems like there's a potential that the Fed does cut. Am I missing something?

Jim: No, you're not missing anything at all. Just as a quick aside I'll remind everybody that, donald Trump is a real estate guy, and I've yet to meet a real estate guy who has not met an interest rate that he doesn't think should go lower.

So I'm not surprised that at every turn he just keeps demanding lower and lower interest rates. 'cause every real estate guy does that. Now, as far as Kevin Warsh goes, you're right, the problem. We face right now is we're all saying he's hawkish, and why do we say he's hawkish? Because we're going back and looking at what he was saying in writing.

Back when he was a Federal Reserve governor during the financial crisis. I hate to date us all, but that was 20 years ago, 19 years ago. At this point, and we don't really know where his thinking is currently, because in the last eight months he's only given two public appearances and he was vague on where he stands on this now, hopefully.

When they do get his confirmation hearing scheduled, he'll have an opportunity to explain his thinking a little bit more fully. And as far as the date goes it's May 15th is the last day. For Jay Powell. So all things being equal, Kevin Warsh would be the chairman at the June meeting. So that would mean the next two meetings, the March 18th meeting and the early May meeting will be Jay Powell will preside over those.

So he's got two meetings left and then we'll have Kevin Warsh, unless there's a snag in his confirmation hearings in any way. The bigger issue I think he's gonna face other than, he will articulate a comment or a view, I assume, that will say that we should be cutting interest rates, is that the Federal Reserve has been changing its stripes.

The individual members of the Fed have been really talking a lot more independent than they've ever been, and they've really been acting more independent. We've seen. Way more dissents in the last three or four meetings than we probably saw in the last five years combined. And I don't think that's a fluke, and I think that's gonna continue so much that I've argued that Fed watching is no longer about parsing the individual words of what the chairman says, but it's really about listening to all the voters and putting them in the cut hold or hike column and asking the question.

Which one has seven votes and whichever one has seven votes, that's what the fed's gonna do. And as of right now, as I look at the Fed's speech broken down, of the 12 voters, fully 10 of them have made hawkish comments. Basically Stephen Marin has made he's still pretty dovish. And you might argue Chris Waller is on the fence, but the rest of them are pretty hawkish. So given all of that, if we had a Kevin Washer Fed chairman right now and he said, look, we have to cut rates. I would just turn around and say, where are the other six votes you're gonna get to approve that rate cut? 'cause if they're gonna vote the way they're talking, and I assume they will.

I don't see where those votes are coming from, so I think that's gonna be the next big thing we're gonna see when we get this new Fed chairman is how much of it is really gonna be about parsing his words and how much of it's gonna be really just about vote tallying and just trying to figure out where all the votes are coming from.

Erik: Let's talk about the broader economy and where the market was headed before this whole oil shock happened. Even before the decision was made to go ahead and have an attack on Iran, it felt like the market was rolling over and, maybe we're heading into a soft patch here. We've just tested the 200 day moving average at least very briefly in the overnight session on the S&P.

Is it over? Is it at all clear or are we really just back to where we were of wondering if it's time for this market to run outta steam?

Jim: I think you, when it comes to the economy, that there's really an issue that is difficult for a lot of economists and a lot of other people to really get their head around.

And that continues to be the story about labor supply. We got the February employment report back, last week, the week before we're recording, and it came in at a stunning number of minus 90,000 jobs. And yet the reaction in the market was very muted. You would've thought, you would've saw interest rates, plunge, and you would've thought, you would've saw maybe the stock market, take it poorly.

And it largely didn't. Now, part of that might be because it was still wrapped up in paying attention to oil, but I do think that it really comes down to the other issue, and that is what is the biggest driver of labor? Because labor is the most important aspect of any economy. How many people have jobs?

How many people are gonna be able to get a job and. The biggest aspect of labor I think comes to population growth. And we have no population growth because of the slow of what's happening at the border. And there's arguments to be made that the number of jobs that the US economy needs to create is somewhere around zero to 50,000.

Probably with an average closer to 15 to 25,000 jobs a month, that's all the US economy needs to create. Right now, it's not 150,000 like it used to be a couple years ago. And again, that's because if you don't have population growth driven by immigration, the number of 15 to 64 year olds, or 16 to 64 year olds, excuse me, that's the working age population isn't growing.

And if that's not growing, you don't need to create a number of jobs. That's why I think we also have this other instance where if you go back to the summer of 2024, the US economy on a 12 month average basis was creating about 150,000 jobs a month in the year ending July, 2024. In the year ending in February of 2026, that fallen from 150 to 9,000, but the unemployment rate hardly moved.

It was a 4.2% in July of 2024. It's 4.4% in February Of 2026 up two 10th while we lost all that job growth. Now why isn't it higher? 'cause we don't need that many jobs, is really where I think it is. And that really gets to the other issue too, is that. If we don't need that many jobs and none other than Jay Powell talked about this at his last press conference, maybe at these very low numbers that we're seeing with employment, we are still in balance and if we are still in balance, the risk you face is that if you overreact to these supposedly weak numbers and cut rates too much, again, that could be perceived as overstimulating when the economy.

Doesn't need it. So I do think that when you look at the market, I don't think it's necessarily looking like it's gonna roll over on the idea that the economy's weakening, because I think that the numbers have so fundamentally changed here right now, and it's a, admittedly, it's a hard thing to get your head around because, when you say that the population growth is down, then people ask, can you be more precise? And the answer is not really, because demographers have never been structured to give us high frequency updates in the population of the United States. 'cause they've never had to. And so what about, labor force participation, those numbers are constantly revised. But we do know that the population growth has come from immigration 'cause of the low fertility rate, and we do know that immigration is most likely negative right now. More people leaving the country than entering the country.

Erik: As we're recording on Tuesday afternoon, we're looking at about 5,200 on the gold price. Something I reported last week on Macro Voices is, feels like there's been a change in the reaction of gold to geopolitics. We had last Monday we had a situation where. Bombs are dropping, oil is going straight up, and gold was down literally $400 over the course of just 10 hours.

We saw the same thing on the Sunday futures open, where it was just a moonshot on on oil prices, in reaction to escalation over the weekend in the straight of Hormuz and so forth. And obviously oil is the direct affected commodity. But you didn't see the expected gold up with oil.

It was actually gold down. Feels like somebody is either selling gold to raise money to cover their losses on something else, or selling into strength or something. It feels like there's been a disturbance in the forest with respect to precious metals. What do you think is going on?

Jim: Sometimes the easiest answer might be the best answer is that first of all, gold and silver, as we know from early February, had that massive reversal and while they haven't followed through on the downside, their up their upward momentum is stalled.

So you've got a lot of people that have a lot of unrealized gains in those. And when you look at markets wobbling and you wonder that if people need to sell something, there's the old adage on Wall Street, you sell what you can. Now what you want and what you can sell is the thing that has big unrealized gains and no momentum.

So whether it's to meet a margin call or a perceived margin call, like Sunday night when futures S&P futures were down two and a half percent at their worst point, or in oil because of the big whipsaws we've seen in it. So somebody's gonna get hit with a margin call. Where are they gonna get the money from?

They've got this other thing here. We assume that they're holding, that they've got a big unrealized gain and they can sell it. So I think that there might be some of that going on with gold because you're right. Normally speaking, all things being equal. If you've got geopolitical stress, the textbooks say gold and silver or precious metals are the place to go.

But they have definitely not been the place to go since February 28th because they have not been responding to this.

Erik: Jim, that, as you said, was the the old school adages precious metals. Of course, the new age version of that would be cryptocurrency. How has that fared since February 28th?

Jim: It's been more of the same.

It's really struggled to do anything right now. Now it's very volatile. You could say it's up five or 6%, but in Bitcoin, five or 6% is an average day. So it hasn't really done anything to establish any kind of an uptrend as well. But I also think that they're also stuck in a.

Different type of cycle as well too. Bitcoin peaked at the end of October, $126,000 at its lows. In February, it was down 50% from that high. So it is definitely broken momentum as well. And I think the narrative. Behind Bitcoin has been changing. Right now. The narrative used to be that institutions, retail investors through wealth managers, and everybody's gonna buy it through these new products like the ETFs and.

They're all gonna say the old gold story. Remember, if all, if only anybody, everybody owned the old, 5% of their portfolio in gold, it would go to the moon. That was the argument that they were using with Bitcoin, was that everybody just bought three or 5% of their portfolio in Bitcoin.

It would go to the moon. I think that narrative is over with right now. Now the potential for a new narrative is out there, and I think the new narrative. If that old narrative was permission that the regulators were giving you permission with it, that Wall Street was creating products to give you permission to own it.

The new narrative for it might be replacement instead of saying, 'cause I've seen on social media a lot of bitcoin enthusiasts saying don't worry. Larry Fink and BlackRock are talking about tokenizing every asset in the world and that'll be bullish for Bitcoin. I was like. Why are you waiting for Larry Fink to do it?

Why doesn't the Bitcoin development community do it instead of him? So maybe the next narrative will be replacement instead of waiting for regulators to approve it, waiting for Wall Street to create products for regular people to trade on it. Why don't you create an alternative system and say, this is better than the old system.

Let's go play on that game and let's play it in this way.

Erik: Jim, you told me off the air that you heard my interview recently with Michael Every about stable coin statecraft. And that comes to mind with what you just said because talk about an asset to tokenize that's already been tokenized. It's the US dollar.

What if Trump and Bessant were to say to the whole world, look don't worry about what your government is telling you. The rules are in your country. Don't worry about what your banking system says in your country. You can skirt the whole system and just buy us. Dollar stable coins on your cell phone regardless of what your country's rules are, and you're backed by the US government that could potentially replace the petrodollar system with the stable coin system and shore up the US treasury market.

Do you think that's a realistic scenario and would it play into what you just said about, the market, creating those tokenized assets without waiting for anybody?

Jim: I think that in that case, that is a realistic scenario. And in fact you could argue that has already started to happen. If you look at countries like Venezuela, Afghanistan, even Iran, and other hotspots around the world. I'll take Venezuela as my example. If you wanted to go and find out what is the black market rate for the Venezuelan Bolivar, their currency, the most credible source that I have found is ance, giving you a tether to Bolivar rate rate. In other words, a stable coin. A stable coin is really where they, where that they operate.

And when you dig deeper into it, you'll find out that in countries like if Afghanistan and Iran to some degree, and Venezuela, definitely those are dollarized economies, they are now trading in commerce in dollars, but it's not. Stacks of a hundred dollars bills. It's on their electronic wallets.

They're owning the dollar stable coin, and they're trading it back and forth. So in the respect that the dollar is going to get a leg up on remaining to be the reserve currency in that, it's going to have a digital version of it in the crypto universe in a stable coin. I think that's already happened now.

It's gonna be a while before we see that. Come to say Europe or the United States because. Our financial system is more stable. We don't go to bed every night worrying that our banks are gonna fail and we don't go to bed every night worrying. I'm talking about Europe, the United States, Japan, that our currencies are gonna get seriously devalued.

At least we don't yet. Or maybe I should say we don't now. But. So we don't really need it, but in a lot of places around the world they do. So I agree that's coming and I agree that to some degree it's already here. Now the second part of that is what Scott Bessent is trying to argue is this will be hugely beneficial for lowering interest rates in the US because as trillions of dollars of stable coins are created.

They're gonna have to be backed by US treasuries, and that's gonna create a demand for them. The problem I have with that argument is. Where is that money coming from right now? That money that would go into a stable, into a dollar based stable coin was probably already into some degree in the financial system to begin with, and it was already backed by a dollar.

So if the argument is we need to pass the Genius Act, and once we get the Genius Act passed, that Americans are gonna start opening up electronic wallets and they're gonna be buying hundreds of billions of dollars worth of stable coins. I understand that argument. I just don't know whether or not a stable coin will be more attractive than a current bank account is, at least not now.

But even if that were to happen and they start buying hundreds of billions of dollars worth of stable coins, where's that? Hundreds of billions of dollars coming from. It's gonna be coming out of the banking system that's already backed by a treasury security. It's gonna go into a new secure, a new instrument, a stable coin that's backed by treasury security.

So it's purely a substitution effect is what you're gonna get. You're not gonna get any really big net buying. Now, you might get net buying out of places like Venezuela, Afghanistan, Iran, because they're not backed by dollars and they put their money into a stable coin. But, They're not gonna be enough to move the needle when you have a $40 trillion deficit.

It's really gonna be the developed world that's gonna be able to move the needle, but I just don't see where you're gonna get that net new money. But let's go back to the first part, the fact that everybody is now using stable coins and they're using them through electronic wallets and they're using them.

In order to affect trade, the dollar is maintaining its dominance as the reserve currency. It's just that if you're looking at the traditional numbers of currency and circulation and how much trade is going on, how much are being held by the banks in reserves you're not gonna see it.

You're gonna start, you're, but you're seeing it at the margins where they need it the most in the countries that are most vulnerable. And that's what people are doing is because remember that in, even in the poorest countries in the world. Cell phone penetration. Smartphone penetration is still 80%. Even in, you could pick the poorest countries in Africa, 80% of the people have a cell phone and they could download an electronic wallet and they can hold a stable coin and add electronic wallet and they could transfer it to another phone, and that's how commerce is being done, and it's all backed by dollars.

Erik: What do you think about the statecraft argument of it where scent and trump intentionally basically tell the rest of the world? Look, the model that we used to have where you guys thought your central bank was in charge of things like managing your own currency, now we're in charge. Now we're going to just tell the entire world that the settlement.

Currency for all international transactions is US dollar stable coins, and we're gonna bypass any monetary policy that other countries try to implement because we're calling the shots. Is that scenario something they would do intentionally?

Jim: I think in a fact that is the scenario that we're having now.

Whether they're trying to intentionally do it, it's very possible. But, the idea is they are giving you a frictionless version of the dollar that everybody can own. And more importantly, unlike the old system that you're, that cannot be regulated by a different country. So if you're in Iran and they wanna say that you can't use dollars because the government will punish you if you use dollars.

In the old system, yes, it was hard to do that you couldn't hold it in a regulated bank account in that country, if you wanted to use dollars, you had to physically carry around money with you, a sack of a hundred dollars bills, and you were subject to crime, somebody trying to steal from you. But now you just walk around with a phone like every other person, and they have no way to know whether or not you own that.

So they are providing. A global standard to the rest of the world, and they're saying to other countries, if you run your financial system poorly. Or you try to devalue your currency a lot. We don't have to say a word. Your population is gonna migrate to our currency, the dollar through a stable coin, and the Federal Reserve will become the World Central Bank by default, whereas your central bank will then start to lose influence.

So I definitely think that's effectively what's happening. I'll assume that's what they. Don't mind happening, but they haven't said it directly, but that's in reality what we're getting.

Erik: There's another topic where it feels to me like the winds are changing, Jim, and that's artificial intelligence.

I don't mean recent developments in ai, although there have certainly been some of those. What I'm talking about is the public sentiment and reaction to it until very recently was, oh boy, this is just the coolest thing ever. It's gonna, enable so many things, it's gonna be great. I'm hearing a lot more of the fears of, it's taking our jobs, it's putting us out of business.

We're going to end up losing a lot of industries, losing tens of thousands of jobs, and it's going to make our electric bills triple because we're competing with AI data centers for electricity and there's not a lot electricity to go around. So you've got the public sentiment seems to be changing. And meanwhile, the military sentiment toward the AI developers, if you look at the pissing contest that Anthropic just had with or is still having with the US State Department.

It seems like we're getting to a showdown where the US government is saying, no, look, we're gonna tell you what to do. You don't get to decide what your technology gets used for or what you wanna sell it for. You're gonna sell it to us on our terms, whether you like it or not. It seems like things are heating up on, on both fronts.

Where do you see this going?

Jim: Yeah, you're right. There was a recent poll done that was put out in the last week or so asking people their favorability, unfavorability of of certain topics and. AI scored near the bottom of the list. The very bottom of the list, by the way, was people's opinion about Iran.

So at least people like AI more than Iran, that's all they've got really going for them at this point, but not much more. And of course, as you pointed out, the real reason that AI is look down so much is we've been told by the media it's a threat. It's either a threat for our job. Or it's a threat for our electric bill that we're, that our our local utility is going to be, we're gonna be competing with the data center in order to pay for, putting the lights on in our house.

Right now. And bear in mind that in some places, and I'll give you the state of Wisconsin for, as a matter of fact, state of Wisconsin has a lot of data centers in it. Very popular place to put those. The electrical consumption of data centers in the state of Wisconsin is larger than the 6 million people.

Residents of Wisconsin. Now, to keep this number in perspective, about 60 or 70% of all electrical usage in the United States is commercial and industrial and data centers are part of commercial and industrial, but they're larger than residential UDI usage right now. So that's part of the thing that gives people a lot of pause about AI Now.

I have a little bit different view on it. And, just by background I've said this before. I subscribe to the pro version of every data, of every AI right now. I use all of them and I'm learning that they're not all the same. It's not like switching from Coke to Pepsi. If you go from open AI to Claude with this Anthropic they all have their strengths and they all have their weaknesses depending on which one you wanna use.

But what has changed in the last 90 days that has really brought this on forward is what's called agentic AI. In other words, we're all familiar with when Chat GPT, went to its free service in late 2022, it's called generative AI. That's prompt and response. Ask it a question, get an answer. It's Google search on steroids.

But what Agentic AI or AI agents is. Give the AI control of your computer. Tell it. It has the ability to read your files, change your files. Execute commands without you doing it. So don't tell me how to do it. Just go do it. And that has been the thing that has really opened up people's eyes why the software stocks have been tr struggling because the most o obvious application is as in coding and in development right now, that people have been using AI to basically.

As an assistant as opposed to just something you ask questions for, and I do think that is going to be transformational. Now, as far as jobs go, I have a different view on it, not necessarily a unique view but what is a job? A job is a series of tasks. You do a number of things and put 'em together, and that's your job. Now...

Some of those tasks tend to be boring and tend to be repetitive, and you don't wanna do them. They're usually around compliance, accounting, answering emails, putting together slide decks, updating Excel spreadsheets. I'm speaking from a financial point of view filling out expense reports and all that.

AI can be very helpful in all of that stuff, in streamlining or automating a lot of those processes in order so that you don't have to do 'em. Now, that's gonna free me up or anybody else up that uses AI to do more of the higher end stuff. Collaboration, creativity communication. These are things that humans are clearly better at than AI.

If your argument is. Oh, if AI's gonna do all this other stuff, answer some of my emails, help me, take the one hour process of putting together my slide deck and make it five minutes, filling out my expense reports automatically. I could go home every day at one o'clock 'cause I don't have to spend the other three hours at work doing that other stuff.

Then your job's in trouble. But if you say, no, I have three more hours to do more higher end stuff at my job, then your job necessarily won't be as much in trouble. But, so I'm not of the opinion that it's necessarily something we should be afraid of, but I understand why everybody is because they're only told you're gonna lose your job and you're gonna pay more in your electric bill.

And most people haven't yet fully recognized that this Agentic AI is here. And they're saying, for what? For a Google search, why am I gonna lose my job over a Google search? Why am I gonna have to pay more in electrical bills over a Google search? And so I do think that this industry is moving so fast.

I'll give you one fun anecdote and somebody told me to do this with Claude. On on Claude. If you asked AI. Right now, how do I use you? How do I use AI? It'll give you instructions on how to use it, which are three months old, which is not even the latest version, so it's moving so fast, it can't keep up with itself right now.

Erik: I couldn't agree more with that. I use Claude and chat, GPT both extensively. I agree with you that they're completely different in their, I hate to say the word personality, but I don't know how else to describe it. They're completely different tools with different characteristics.

There's something that nobody's talking about though, which I think they should be, which is, we've heard one side of this argument, which you just articulated perfectly, and that is. The argument in favor of AI is that it enables humans to do much more than they ever could have done before. It means our economy could be much more productive because you can literally write and publish a book in a week or two using Claude that just.

Wasn't possible previously. You can do a lot of things. The thing is the energy consumption side of it, and it seems to me that the solution to this is if you change the rules and you told the tech companies, look, you guys are really good at innovating and doing things more quickly than a lot of other industries are.

The new rules are we're gonna open a whole bunch of doors for you. We're gonna take a lot of barriers outta your way, so you can have the growth in everything you want, but it's a two for one. Not only do you have to build your own energy to support your data center, but you have to build double the amount of energy that your data center needs and sell it back to the grid so that.

In the course of getting your AI running and doing everything you're doing, you're supplying more energy to the rest of society, not consuming net energy that we can't afford to spare if we un. Regulated a bunch of things so that Google was allowed to build power plants all over the countryside and could do things like work with, acquiring an advanced nuclear company, investing.

We just talked to AALO last week about mass produced entire nuclear power plants. If the hyperscalers. Could buy into something like that and start building nuclear faster than electric utilities can do it because frankly the tech companies are pretty good at innovating technology and deploying it quickly.

I think you could see the AI industry supplying net energy to the rest of the world. Problem is, there's protections in place that only utilities are allowed to build power plants and so forth. I think we should re-architect this and open the door for high tech to build more than enough energy to, than it consumes.

What do you think of that idea?

Jim: I think not only do I agree with it, I think that most of the high tech is on board with that idea full scale, that they would be more than happy to

They're trying to do

Jim: it right,

but the rules don't really

Jim: allow it. And the biggest problem with the rules is that you now run into the environmental lobby and the environmental lobby is full sail against a lot of these rules.

Because one of the things, as you mentioned. They're saying, yes, I'm ready to do that. Yes. We actually will build up energy sources to not only power our data centers, but overpower our data centers so we can sell back to the grid and they'll go You one step further. The energy sources that we have don't produce any pollution.

You go okay, what is that energy source, small nuclear reactors? And that's when the, the environmental groups then throw up the wall and go, hold on a minute, hold on a minute. We're not building more nuclear reactors. And they're like, oh, yes, that is the answer. These small nuclear reactors, they're the size of a two car garage and they will produce tremendous amounts of energy and they exist.

Their safety record is very good. They'll try and demagogue them by that. This is the environmental groups and saying that they're dangerous and that we shouldn't be using them, but they, but there's no reason to think that they are dangerous right now. It would just be demagoguery that we would say it, but, so that's really where the blockage blockages.

Now maybe there is a sign that this is coming because in the last week. The Trump administration has given at least Department of Energy approval, if I've got it right for a new nuclear power plant to be built in the United States. The first one in 50 years that's gotten approval doesn't mean it's gonna, it's not done with all the approvals, but we are moving in that direction.

So I do think you're right. If you allow the tech companies to, build your power, build your data center, bring your all, and then construct the power to build it, they're all for it. You've gotta let them do it. And you can't say we're gonna do it, but then we're gonna go through the same rigamarole that we have right now.

You wanna build some power plant to, to palm fund it first we have to have 10 years worth of studies done. Then we have to have five years worth of public hearings, and then maybe we could build it, if you're still interested in doing it at that point, cannot have that game being played anymore with this.

So that's really where the fight is gonna be is really with whether or not the environmental lobby will allow this to happen.

Erik: Yeah, that announcement that you're talking about was terror power and their sodium cooled nuclear reactor. It's the first time in the 52 year history of the Nuclear regulatory Commission that they have ever approved a civilian power reactor that was cooled by something other than water.

They're finally moving off of 1952 technology to something more modern, and the NRC is not in the way as they've been in the past. So I think that's a breakthrough, and I hope that we see more of it.

Jim: I agree, and I really do hope so too because we need it for a lot of other reasons too. Because as AI comes not only.

There's a thing called Jevons Paradox, that when the cost of something goes down, you get a lot more of it. So if the cost of creating software and the cost of using a computer becomes easier, and I'm talking about a. My personal cost. Your personal cost that we're just at the point where you just talk to your computer and it does things for you, or it runs things for you automatically.

You're gonna have more of these and you're gonna demand more of it. And we're gonna have more power demands for us, not just for data centers, but even for our personal use too. So as you make the cost of things go down, you get more of it. And we're gonna need more power in order to meet those demands.

Erik: Jim, it seems like you and I agree on a lot of the Jevons paradox example, as well as just the big picture of AI as a good thing, not a bad thing, but I think there is an angle we haven't acknowledged yet, and that is we already see a lot of divisiveness in the US and in the western world in general.

Let's talk about what AI really does. It enables smart people to be a hell of a lot more productive, but it also does, I think, legitimately eliminate a lot of jobs for dumb people. The office worker that had to do the grunt work, the. Because the smart executive, needs that assistance.

Yeah. Smart executive can pretty much be self-sufficient with AI and doesn't need the grunt workers anymore. Does this create a further worsening of the K shaped economy where the people who are well educated, intelligent enough to know how to leverage AI and use it to their benefit, start to really do well?

The guy who's not smart enough to figure out what it is really in trouble.

Jim: Oh yeah. You can even think about I read this a couple years ago, and I assume it's still true, that the IRS puts out these lists of whenever you fill out your tax returns, they ask you what your occupation is and you write it down.

And they did a study of that. And the biggest occupation listed in the United States is the word has the word driver in it. Taxi driver, truck driver, forklift driver, bus driver, fill in, whatever. But the word driver, like millions and millions of jobs all autonomous driving is coming and AI is gonna power that.

AI is going to power 50% of all. Of minimum wage jobs have the word cashier in them. That's gonna be done by AI as well. So you're gonna see a lot of these lower end jobs that can be automated away. Now the funny thing about AI is the more science fiction side, you could argue that AI can help scientists cure cancer.

But if you asked AI to power a robot to fold laundry, it's still struggling to do that part of it as well. So there's gonna be other roles that are gonna be, that it can't really do right now, but the concern that I have with it is, and we saw this during the Industrial Revolution, that as we first get this new technology, industrial Revolution, AI, it automated away a lot of jobs.

200 years ago it was, farming jobs and the like, and all you saw was job loss first. And then the job creation came second because keep in mind what we're talking about. If you automate, I'll use my example of driver. If you automate driver and all, and the world is reduced to 50 million or 75 million autonomous taxis that run 24 7, 365 in autonomous delivery trucks.

The price of transportation is going to plummet and it's gonna cost you practically nothing to ship either yourself to the airport or a product somewhere else. That is going to make business models that are not economic now. And we don't even think about 'em 'cause they aren't. Will be economic in the future if you want a near term example of that.

The Apple I store opened up business models such as Uber, Airbnb to be able to compete with taxi drivers and hotels. Because they had this new technology that you could now put an app out and people could use the app to book book somebody's room in their house or book a private car to take you from A to B.

And so it created a lot more jobs. So I do think that. What technology has always done, and I do believe is a net creator of jobs. So ultimately, yes, we might lose that driver job. We might lose that cashier job, but we're gonna create whole new industries and we're gonna need those people in other industries, the concern is the jobs get lost first.

The new jobs get created later, and in that gap. People get angry. All they wind up seeing is job loss. All they wind up seeing is what they perceive. Is it making things worse? and in The 18th century when we had the industrial revolution, we got a pushback. The pushback was Frederick Engles and Karl Marx writing the Communist Manifesto and pushing back against the capitalist system.

We might get a pushback against this now. It won't be communism. That was a pushback to a different era, but it'll be some kind of collective socialistic type of argument to put up a barrier from putting this together. So I hope that the AI industry, and I hope that the AI proponents understand that if all we're going to do is say, great, we can automate this and fire all these people and everything is better, it won't be better in the long run.

It might be better for the very short term, but if it's gonna be, we're gonna create new opportunities at the same time. You lose your job here, but there's gonna be this new industry here begging for people to help doing whole new things that we haven't figured out yet because of that new technology. I think that transition will be much softer, but that is a real risk right now.

Erik: Jim, I can't thank you enough for a terrific interview. As always, before I let you go tell our listeners who are not familiar with what you do at Bianco research a little bit more about what you're up to. You've got WisdomTree now following your work with an ETF that basically follows a fixed income index that you created.

Tell us more about that, how people can invest in it, as well as your Twitter handle and all that stuff to follow your work.

Jim: We put out Bianco Research, which is an institutional research product at biancoresearch.com.

If you're interested, you can sign up for a free trial there. Otherwise, I'm very active on social media, under my bussiness name Bianco research on Twitter X, on YouTube, on LinkedIn. And also we started a couple of years ago an in fixed income total return index, which has its own website, Bianco advisors.

It's a Managed index to try and beat the benchmarks in the bond market. And we have an ETF with our partners as WisdomTree as you mentioned, WTBN, WisdomTree Bianco, Nancy as its ticker symbol that tracks our index as well too. So you can find out more about it by looking up more about WTBN or looking at biancoadvisors.com.

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

Erik: Joining me now is Matt Loszak, founder and CEO of Aalo Atomics, a company that proposes to mass produce not just modular nuclear reactors, but entire modular nuclear power plants in a gigafactory for the express goal of rapid deployment at scale. Aalos initial market focus will be on data centers where rapidly deployable power solutions are most critically needed.

In the interest of full disclosure, I am personally a private equity investor in Matt's company, Aalo Atomics. Matt, it's great to have you on the show. Thanks for joining us today. 

Matt: Thanks so much for having me. Great to be here. 

Erik: I wanna start by playing devil's advocate and describing the most commonly held view in the conventional nuclear power industry, despite the fact that I personally disagree pretty strongly with that view.

The common wisdom says that the pressurized water reactor originally designed for the Nautilus submarine back in the early 1950s has evolved to become the gold standard of nuclear power alongside its close cousin, the boiling water reactor, most seasoned. Nuclear industry professionals share the view that the operational experience that we've gained from running these lightwater reactors as they're called for several decades now, is the most important safety consideration that we should think about.

And so they question why anybody in their right mind would even consider deviating from what's already been proven to work for nearly six decades. Thousands of reactor years of commercial service. For those reasons, they strongly advocate focusing the formative nuclear renaissance on building more of them, more lightwater reactors like the Westinghouse model, AP 1000.

And a lot of these people think that experimenting with different reactor designs, involving coolants other than water, is just asking for trouble both economically and from a supply chain perspective. Matt, you and I disagree with the consensus view. What's wrong with the narrative shared by. So many of your peers in the nuclear industry that we should just stick with what we already know, which is lightwater reactors that have been proven to work for decades.

Matt: If we had to boil it down, I'd say it's that essentially the current solution is a local maxima, but not a global maxima. So if we think about some of the problems that have happened in the past 20 years of nuclear deployment, we saw Vogel go 10 years over schedule, $15 billion over budget. And essentially the problem is that you have a industry where every reactor that's been built in the past.

75 years is bespoke. They've been one-off projects. And in that world, the best way to try to lower cost is just make the reactors bigger and bigger, and stick with the same design you've been doing before. but as we know, there's two ways to optimize economics. One is make things bigger, and two is make a lot more of that.

The interesting thing is the idea of making a lot more of nuclear reactors has really not been attempted properly. In other words, there's no single large factory we can point to globally that is mass producing along the lines of Henry Ford's cars nuclear reactors. The reason to switch off of water is essentially this emergent realization when you start to explore and ask yourself.

What is the best design to mass manufacture? And if you're no longer just going bigger and bigger and you wanna get a better design that can be maybe transportable on everyday roads, then you start to look at these other coolants things like liquid metal, sodium molten salt, or even gas. And especially sodium and molten salt.

Allow you to make the the vessel of the reactor much smaller. So in other words if the vessel was the same size for all these coolants with sodium and molten salt, you'd get around anywhere from two to 10 times more energy out of it. So you can imagine that's much better from a mass manufacturing perspective.

And so you also get other advantages, things like, more Inherent safety. And something I think we might talk a bit more about later around when you can achieve higher temperatures, you can service things like industrial process, heat and so on. But those are some of the core reasons for exploring other technologies beyond just water-based gigawatt scale reactors that we have today.

Erik: Certainly the high tech boys have recognized this case, and I know that's where you're focusing a lot of your business. Help our audience understand what this advanced nuclear industry really is all about. One of the most commonly held views among institutional investors is, look, we don't wanna invest in science projects.

We don't wanna mess with unproven technologies. So even if you're onto some great idea, that's gonna completely change the course of human history. Eh, it probably belongs in a research lab at MIT. Not in a startup company like Oklo or Aalo that proposes to actually be selling nuclear reactors to data centers in the next few years.

So we really only wanna invest in stuff that's already been proven to work and proven to be deployable in a commercial context. How much do we really know about all this advanced nuclear technology and to what extent is it proven to be viable and how much technology risk is involved in deviating from that accepted norm of, essentially lightwater reactors forever, which is what a lot of the industry wants to focus on.

Matt: I think a lot of people don't realize that advanced reactors actually do have quite a bit of operational history. So water cooled reactors definitely have the most to the tune of thousands of cumulative years of operational history. But sodium still has around 400 operational years. Gas has maybe a hundred and molten salt has on the order of just a few years, it's the least one on molten salt. But the, these have been built before. And the interesting debate in nuclear is why these technology branches on the tech tree weren't fully explored. And, our argument essentially, my belief is that it was largely for political reasons.

If you look at the history that these reactors did not get further explored. And one interesting anecdote is EBR2 which is one of the reactors that we take the most inspiration from operated from essentially for 30 years at 20 megawatts of power. And it was a real success. When they decommissioned it, the sodium had bit, the look of metal had been so compatible with the stainless steel that the welder's etchings were still visible inside the pipes.

And it operated with a very high capacity factor for that time as well. And interestingly, they did a test where they basically tried to make the reactor melt down by removing all the backup power and leaving the control rods, the brakes on the reactor fully open and or the operational open level and what they found.

Is that the reactor was able to safely shut itself off inherently 'cause of the physics of the system without depending on human control. So it demonstrated good capacity factor, good safety, but you'll never guess what happened 12 days after that test occurred. Chernobyl. It's some of these different sodium reactors had different political challenges that caused them to slow down development.

But I think that, taking a step back, the thing to realize is these advanced Fision reactors are not really for example, fusion, where there's Nobel Prize winning discoveries that have to be made, or new science has to be unearthed in order to make it feasible they've already been deployed. And the kind of best analogy in my mind is.

Some of these advanced coolants, like sodium are like SpaceX with landing a rocket. Is it easy compared to water? No. There's a bit of extra engineering challenge, but if you can do it, it unlocks a holy grail of economics. And if you get a smart team together with a bunch of capital and the right environment with the right customer, in this case, AI data centers we think you can really make this work.

And so I think that's what's most exciting about this technology. 

Erik: Matt, you mentioned a holy grail of economics, and that's what I wanna focus on next. Not so much what's possible in the next few years, but let's zoom out and talk about the future of nuclear energy and what it's going to take to truly change the course of human history and deliver a new source of energy that will eventually be able to replace fossil fuels and give us a cleaner, greener, better future.

The more I've learned about all this nuclear energy technology. And more that I've come to realize two things. Number one, we're never gonna really and truly change the world and be able to scale nuclear up enough to replace fossil fuels until we get to something called a breeder reactor economy.

The second thing though is that breeder reactors at least. As they've been developed and deployed to date, have generally not proven themselves to be economically viable for commercial deployment. So that's a real conundrum. Let's start with what is a breeder reactor in the first place? Why is that important?

Why do we need breeder reactors to eventually change the world completely with nuclear energy? And then what are your thoughts on how we overcome the fact that. Frankly, breeder reactors haven't proven themselves. Economic, at least not yet. And how do we get to that eventual infrastructure that we need?

How does the evolution occur and why is that important? 

Matt: Currently the nuclear fuel supply chain is primarily based on uranium 2 35. And if we were to burn all of the known resources on U235, it would probably have a similar life span to oil and gas and lasting us another 200 years maybe. But if you can do a breeder, it unlocks different fuels still in a nuclear reactor like thorium.

And uranium 238, which are both much more abundant than U235. So essentially that enables you to expand the usable fuel lifespan of known reserves on Earth to 4 billion years. That's what's really exciting is when you think about scaling up in the future of energy production on earth really it almost seems inevitable.

That this will become the main source of energy that replaces oil and gas on earth. And certainly inevitably within a 200 year timeframe, but we think much sooner because of the demand from AI data centers and nuclear being the best fit for powering them. That's the kind of bottom line now. So if that's the case, why are we not doing breeding right now?

The answer is it's a bit more expensive right now, and there's gonna be a crossover point in the supply chain of U235 and U238 when it makes sense to actually do the extra step of recycling and reprocessing the fuel to access the resources within spent fuel and to switch the mining supply chain to beef for thorium and U238.

So there gonna be an economic crossover point when that occurs. For the time being, the cheaper, faster, short term path is to use standard low enrichment. 5% uranium dioxide which is what we're doing at our company. But yeah, that's essentially how we see it is it's an inevitable move that'll happen in the coming probably couple decades.

But for now, the cheaper, faster approach for the customer of the day data centers is to use the existing supply chain and the existing reactor technology. 

Erik: I think there's a point here that a lot of people don't fully appreciate, which is they've heard about these breeder reactors being able to use this fuel.

The, only less than 1% of uranium that's mined out of the ground is U235. The kind of fuel that's actually used today, the other 99.3%. U238, and when people think about it, they hear, okay we're wasting all of that U238. We're not putting it to use, but hey, the cost of the uranium's not really that big of a deal to run a nuclear power plant.

Let's not worry about it. What I don't think people really understand is we're not just wasting it in the sense of not putting it to good use. We're literally creating so-called nuclear waste spent. Fuel waste is mostly all of that. U238 that. People think is just this horrible, awful, toxic stuff that stays around forever really.

It's perfectly good nuclear fuel that we could have used to make energy. We just didn't do that because we didn't build the style of reactor that we've known about. Since before I was born that can use that U238 fuel. So I want to talk about this nuclear waste. Now a lot of experts say, don't worry so much about it.

It's a public perception problem, but technologically speaking they shouldn't worry 'cause it's not as big of a deal as they think it is. And I think that those technical experts are missing the point because the public perception that this nuclear waste is horribly dangerous is really I think the biggest thing that's holding back the growth of nuclear energy.

So talk to us a little bit about, and we've been hearing these stories that some companies are coming up with technology. They can actually take the stuff we call nuclear waste that's been sitting around for decades, burn it up and use it as fuel in order to make more energy, which covers.

Two, kills two birds with one stone. One is we're making energy that we don't have to mine new uranium for. But the other thing is we're getting rid of all that nuclear waste that everybody's so concerned about. Are we back to science projects here? Is this brand new unproven technology or is there really a way that's available today that we could get rid of those 250,000 metric tons of spent nuclear fuel waste that's sitting around in dry cask storage all around the world and get rid of it by actually making power from it.

Matt: So there, there definitely is a way. And again, coming back to EBR two, the reactor we spoke about earlier that was actually the first time we demonstrated what's called closing the fuel cycle. Essentially the way to think of this is as follows. First of all, nuclear waste. The fears of nuclear waste were somewhat propaganda driven by, in large part the oil and gas lobbyists in the seventies and eighties.

That created fear around something that really hasn't ever harmed anyone. Is pretty easy to store and there's tiny amounts of it. I have to be empathetic to. Fears of nuclear meltdowns and radiation, causing relocations. And that's something we also can avoid through technology.

But the nuclear waste issue, I think is almost entirely propaganda and not really at all technological, technologically, it's a solved issue from a safety perspective. But to your point, it's not just about keeping it stored safely.

It's also about the fact that when you have nuclear waste, it's actually a very useful substance. There's still 95% of the energy still in there what's happening around the world today is France is currently recycling most of their fuel and they're extracting. So once fuel is burned, some of the, what's called Fisile isotopes, like U235 and plutonium are still in there.

You can make what's called mixed oxide fuels by recycling the fuel and just extracting those leftover facile isotopes. But, With the approach of using breeder reactors, we can then tap into the other 95% of the energy that's still in there, which is the U238. And in doing so, you can really get a lot more energy out of the fuel and also reduce the volume of waste that you have to even store to begin with.

So to give you an anecdote the entire history of nuclear power production in America. So 70 years for 20% of on average, 300 million people has produced only a football field of waste stacked around 10 yards tall. And if you were to do waste burning and use the useful stuff in that leftover fuel, then.

The height of the true waste would only be six inches on that whole football field. It goes to show you, a waste is not really this existential problem for nuclear. It's actually one of the main selling points because everything produces waste. Oil and gas puts waste into the air we breathe.

Solar panels have an end of life and must be, put under the earth or expensively, recycled. Same with wind turbine blades. So everything produces waste when it reaches end of life. But nuclear's, main selling point, or one of them is that there's such a small amount of waste and it's so easy to maintain.

And what we conceive of as waste today is actually, like you said, a very useful substance. It's a very valuable substance that we actually want to to use in future reactive. 

Erik: Matt, you and I share a vision that the way we get from where we are today to the point where nuclear energy finally becomes cost competitive with energy from oil and gas, is that we need to mass produce.

Not just components to build modular reactors, but we need to do factory assembly line mass production of entire nuclear power plants in Gigafactories, so the whole power plant just gets set up and configured on site like IKEA furniture as opposed to having to be custom built on site the way we've built all of the nuclear plants that exist today.

I'll save my own reasons for thinking that's important for another podcast. What are yours? 

Matt: At a high level what we're trying to do. I think what the ideal solution here is to turn nuclear from being a project into a product. And I'll give you a few examples of that. But the key advantage, if we're asking why does it make sense to do this for the current customer of the day data centers, it's all about speed.

And if you can mass produce your nuclear power plant, again, not just the reactor, but the whole plant in the factory, you can do a lot mo more in parallel and essentially deploy hundreds of megawatts in under a year. Whereas normally it would take five or 10 years eventually. The goal is to be deploying 10, 20, 30 gigawatts per year by doing a lot of sites, a lot of reactors, a lot of nuclear product in parallel.

But that's essentially what's the key unlock for AI data centers who will pay a real premium in return for speed. Clean is nice and base load is important, but speed is really one of the most important things there. In our view, the key to achieving this is extreme vertical integration.

And maybe we can talk a bit more about this later, but that's a really key part to achieving that scale and speed and essentially cost reduction will follow from that scale and speed. And nuclear, a big part of the cost today is actually interest. 'cause it takes so long to build all this major hardware.

So if you can build it much faster in a more predictable, repeatable way, costs come down. And then that unlocks a whole bunch of other markets for whom a gigawatt scale nuclear plant would've been just too big and too expensive and too slow. But when you get faster and below a certain cost threshold, let's call it seven to 10 cents a kilowatt hour, then it opens up all these other markets like large industrial onsite loads.

For example, desalination, industrial process, heat, small utility, even large utility, and then microgrids for powering EVs hydrogen production, ammonia, et cetera. So those are some of the biggest reasons to mass produce a slightly smaller nuclear product that. C major cost reduction and then unlock entirely new markets that were not previously available to nuclear.

Erik: I wanna stay on this topic of scale 'cause I think it's the single most important thing we have to think about. It's been a lot of hype in the industry about, Hey, we're gonna triple nuclear by 2050. Sounds great. A lot of people are skeptical that's even possible because that's a lot of old school nuclear power plants to build.

If you build them the old way, the thing is what you'd need to replace fossil fuels is not tripling nuclear. It's literally 25 times the amount of nuclear that we have in operation today. So my view is the most important thing is get the cost down to the cost of energy from coal and gas. Because when you do that, it unlocks what I call the nuclear Henry Ford moment.

And you alluded to Henry Ford and his automobiles a little bit earlier. I think this is really what the game is all about because there's 10. Terawatts of nuclear generation capacity 25 more than we have today that could be deployed if we could somehow get the cost down to where nuclear costs the same as coal and gas.

I, I don't think it's at all an exaggeration to say we could change the the course of human history in a way that it is more impactful than the industrial revolution. If we could figure out how to get the cost down and really scale this up so that we could actually build 25 times more nuclear than we have today.

But we're struggling right now just to get back in the business of, building nuclear power plants. So I wanna talk about the future. Do you think that vision can ever be realized? And is it mass production that gets us from there, from here to there? And if not, what else do we need to worry about in order to achieve that vision?

Matt: It's gonna be really hard. But I think it's possible. If you think about the pathway in going from 10 reactors per year to a hundred to a thousand to 10,000 and in doing so, you go from, at our reactor output, a hundred megawatts per year to a hundred gigawatts per year. You can imagine a lot of different things in the supply chain will break along the way.

And I think this is all very doable, but it requires a very ambitious effort from a company really thinking about the future and how to break down those barriers in the supply chain at every step along the way. So if you think about what it takes to deploy 10,000 reactors a year, for example. In the short term, you can deploy a bunch of reactors let's call it 10 per year with the existing fuel supply chain, pump, supply chain, turbine, supply chain, heat exchanger, supply chain.

But different parts of that supply chain will break as we go in that journey. For example, in a hundred reactors per year. Vertical integration on the heat exchangers becomes important. At a thousand, the company will have to make its own turbines and at 10,000 a company using sodium might have to create its own sort of industrial conglomerate that does things like sets up a reactor at Salt Lake City to separate sodium from chlorine and the salt that's there and manufacture its own sodium at scale.

So none of this is really impossible from a first principles perspective, it's all very doable. It just takes the right team, the right effort.

What this unlocks, if you look at some of the technical economic models, is you can very rapidly get below 10 cents per kilowatt hour. Let's call it n equals 20 reactors. By then, you could probably get below 10. And then to get to, for example, maybe 3 cents one day, which would really unlock a whole bunch of new markets and really beat oil and gas across the board.

Call it two to 3 cents, might require a different kind of learning. For example, to get down below 10 might involve just construction learnings turning it more into a product versus a project. Building most of the modules in the factory and keeping onset construction to basically a very simple concrete slab with no excavation and really productizing nuclear.

But then to get it down to 3 cents might require, much more of a, I just referenced with the extreme vertical integration in the supply chain to achieve way faster greater scale, faster deployment, lower costs. But I think that is the core way to. Allow nuclear to really do stand a chance of replacing oil and gas almost wholesale in the next century or so.

Erik: Back in Henry Ford's day, automobiles were like, private jets are today. Everybody knew what it was. Everybody wanted one, but nobody except the super rich could afford to actually have one. And I've contended that the same thing is true of nuclear energy. It's the safest, cleanest, greenest form of energy that's known to man, but it frankly just costs too darned much.

It seems to me, if you think about Henry Ford's challenge, he wanted to bring the cost way down, but he needed at least a small number of rich guys that could afford the bespoke automobiles in order to get his business going before he could really build his assembly line and bring the cost down to the point that the common man could afford one.

It seems to me, if we take this analogy forward to the 21st century, the hyperscalers. And their AI data centers are the rich kids who can afford to buy private jets. They're the guys who could afford. If you said, look, we can deliver your data center energy from an auto atomics nuclear plant that we can roll out in a period of months rather than years, they can afford to pay extra for that, is that the strategy is to use the budget of the data centers to get this started and then eventually scale it up to mass, really big mass production from there.

Matt: Our kind of top secret master plan is to start by servicing data centers because they have a high willingness to pay with a lot of urgency. So they'll pay a premium for speed. And as we come down the cost curve, we can go after all these other markets that we talked about. Industrial process, heat desalination, large utility, small utility.

For whom, if you go and talk to them today. They would say, come back and talk to us when you're below 10 cents per kilowatt hour. But once you get down below 10 cents, it really opens up this whole other set of markets. And like we were referencing earlier, eventually you can imagine going after the developing world with around 3 cent per kilowatt hour electricity to bring the world out of energy poverty.

So in the long term, that would be our goal. I think that's a good goal. But, I think it's important to realize, like we talked about earlier, there are two main ways to make nuclear cheap. You go bigger or you go more numerous, and the beautiful thing is the hyperscalers have a huge amount of demand.

We're talking a hundred gigawatts in the next five years. In the US alone for a it's a huge amount of demand for a very consistent product, and they want a reactor that's a bit smaller because then you can deploy a fleet of smaller reactors and have a higher availability. Meaning if you have a single gigawatt scale reactor, it has to go offline for refueling for a month, every two years.

So you lose the whole gigawatt, which puts a big strain on the grid. And then you see data centers being bad Samaritans with their local communities, putting a strain on the grid. So if you have a fleet of these smaller reactors, you can refuel one by one and essentially always have power available at a high availability.

So it's cool how these customers, they want exactly this product, which almost is inventing this new nuclear product that can then, once it comes down the cost curve, go after all those other markets we talked about. Essentially allows you to go from large bespoke reactors to small, repeatable mass manufacturable ones.

And the fact that it's clean is essentially a nice to have right now, but frankly will benefit everyone in the long term. That's the last kind of, benefit of doing this approach. But yes, I think the hyperscalers are arguably the core unlock to this new model in nuclear that we haven't really seen done before.

Erik: Now I want to touch on what has to be the hottest marketing trend in the nuclear power industry. Something called SMRs, small modular reactors. I have to confess my naivety, when I first heard that phrase, I assumed that they were talking about nuclear reactors that would be both small and modular. Given the name Small Modular Reactor frankly, I don't think either of those things are true for products like the Westinghouse AP 300 or the ge Hitachi BWRX 300, which seem to have taken over that marketing phrase of small modular reactor.

So let's just talk for a minute about why would small be better than large? In the first place. 'cause as you said the whole trend of the 1960s and seventies was to go to much larger reactors for the sake of economy of scale.

So why do you want to go from large to small in the first place? And how small does it have to be in order for that benefit to actually be realized? And do these SMRs, like the AP 300, achieve that goal? 

Matt: In terms of achieving the Henry Ford vision for nuclear, there is a sweet spot in terms of size and that size of all the modules for the reactor and the whole plant.

But if you think about it, a reactor that's too small will have very bad economics for physics reasons, it has a very poor neutron economy, and if you go too large, you can't ship it on normal roads. So if you're trying to build one reactor a year. Then, yeah, I'd say build a bigger reactor. But if you're trying to.

Ship 10,000 reactors per year. You've gotta have something that's the right size to ship normally on everyday roads and the rest of the global transportation network. So that's the thinking between that's the thinking behind what is the optimal size for mass production and for rapidly achieving the scale that data centers are desiring.

But the other kind of thing to highlight, so the SMR term you correctly highlighted that. They're not small nor modular, but in my view one of the other major disconnects and maybe the biggest flaw in the SMR vision so far in terms of how it's been expressed is that traditionally those modules all come from different factories.

So a single company for example Westinghouse or Okolo, they could be a reactor. Designer, but something that often surprises people is ok. Low, for example, is a fully remote company. They don't have a factory. So what happen is the reactor designers send the design of their SMRs to dozens of different companies who each have their own factory.

And when those mod modules come together at site, they don't fit. They have reworks and slowdowns, and that's why Vogel went 10 years over schedule and $15 billion over budget. So if we think about. The best approach to SMRs in our view, what that would be a single factory that takes raw materials in and outputs modules that we know will fit together.

In fact, we've integration tested them in the factory, and then when they come together at site, it's way faster and way easier. And by the way, they're all sized properly for mass transportation. That's what we think is really the proper incantation of the SMR vision. And so that's what we're working on at all though.

Erik: I think we're very much aligned in our thinking because I've always said that what matters about small is it's small enough that you can ship it in the existing container, ship based and, flatbed, truck based global infrastructure of logistics. But the other side of this is. The time to actually build the onsite part of it.

And it blows my mind when I see Westinghouse bragging about this is gonna be great because with the AP 300 SMR, we're going to be able to build the entire reactor in only four and a half years. And I'm thinking, wait a minute, isn't that how long it takes the Koreans to build a conventional nuclear power plant?

It seems to me, Matt, that we should be striving for four and a half months at most to take a entire nuclear power plant that was factory built and set it up and hook it together and I don't mean the site work and grid connections, but once you've got the site prepared and you ship in all the stuff that comes from the factory, I think it should be months less than a year to completely set it up, hook it up, and get it running.

Is that realistic? And how long will it take to realize that vision? 

Matt: I think we might talk about this a bit later, but our first power plant we are building currently. All in, it'll be under a year in terms of start to finish on turning that thing on. And the whole goal here again is to turn nuclear from a project into a product.

And so if you're doing more in parallel in the factory it allows you to, at the site really reduce the work that's involved. For example. If you're trying to make nuclear deployable more quickly and more predictably, a really dumb way to start is by digging a gigantic hole. Because different sites have different water table, different rock hardness, and that can introduce a lot of variability between sites, which can slow you down, and you really wanna try to make it so that every project is the exact same.

As predictable as possible, and that's where you see the speed benefits. So yes, we believe that it will be possible and it almost already is to deploy these reactors at this scale in under a year. And that's even accelerated further by some of the new licensing pathways under the current Trump administration around DOE authorization, categorical exclusions for NEPA and more.

So the somewhat short answer is yes. That will be possible, and it's gonna have to be to keep up with the pace of development that the hyperscalers are demanding. 

Erik: Matt, you've mentioned something called industrial process heat a few times in this interview, so I want to come back to that and understand in a little more bit more detail what that means.

Only 38% of global energy is used to make electricity in the first place. What we normally think about when we're discussing nuclear reactors, of course, is making electricity. Now another 25% of global energy goes to transportation fuels, but almost a full quarter. Of global energy consumption. That's nearly as much as we spend making all of the transportation fuels that we need combined to power the entire global economy. The rest of that last quarter of global energy production goes into something that's called industrial process heat.

Examples of that are smelting, steel, making concrete, and so forth. Why are light water reactors poorly suited to delivering process heat? And what's better about advanced nuclear reactors in order to better solve that problem 

Matt: with light water reactors, the reason they can't go to as high of a temperature is because water is the coolant and water boils at around a hundred Celsius.

So the. The way that water-based reactors have essentially made their designs to date is they apply a lot of pressure, hence the name pressurized water reactors, to allow the water coolant to go up to as high as 300 Celsius. But if you look at industrial process heat applications, most of the applications occur at temperatures greater than 300 Celsius.

So with advanced reactors using high temperature gas or sodium, or mold and salt. You can achieve temperatures in the range of 500 to 800 Celsius, and that unlocks essentially roughly half of all industrial process, seed applications globally, which could be decarbonized and replaced and powered by nuclear in order to reach the higher temperatures.

Still, you could. In theory, you use more advanced nuclear designs or electrical assistance to reach those higher temperatures. So it's still possible with nuclear. But at the lower temperature from 500 to 800, you get a really nice benefit on efficiency. Because traditionally when you make electricity with a nuclear reactor.

Two thirds of your heat energy overall is going to waste heat and only a third is converting to electricity. But if you are doing industrial process heat, you can essentially use the heat coming straight outta the reactor and use a hundred percent of it or much more of it using, much more efficiently than than the electrical use case.

So it has extra economic benefits there as well. But yeah, fundamentally you can think of it as data centers will be the ideal initial customer to bring the cost down and it unlocks all these other markets to help bring industrial process heat to be decarbonized with nuclear around the world.

Erik: Matt, I can't thank you enough for a terrific interview. But before we close, I want to give you an opportunity to pitch what your company is working on, because frankly, you're the only advanced nuclear company that I've found that shares my own vision for mass producing, not just nuclear reactors, but entire.

Nuclear power plants in Gigafactories for the sake of cost reduction. It's that Henry Ford concept of bringing the cost of nuclear way down by mass, producing it in a gigafactory, so that all that has to happen on site is setting it up and hooking it together as opposed to any kind of custom building of anything.

Again, listeners, in the interest of full disclosure, I am an investor in Matt's company. Matt, give us the elevator pitch on Aalo Atomics. What are you working on? When will your technology be ready for commercial deployment? And where can our institutional investor audience find out more about your company and its business plan? 

Matt: Thank you again for having me on this. This has been a real honor and privilege. We are all atomics. We're mass manufacturing nuclear power plants that are purpose built for powering AI data centers.

We started around two and a half years ago, and at that point we were two people. Now we're 140. To date, we've raised 180 million and we're on pace to turn our first nuclear. Power plant on in under Just a few months. I can't say exactly when that's confidential, but it is very soon. So hopefully when I say that, the audience is shocked.

Because going from fanning to fission in three years is very unprecedented. But right now we are raising our series C. It'll be 500 million to a billion, and the use of this fund will go towards the first gigawatt factory. So scaling out our 40,000 square foot. Pilot factory space that we've already built into a million square foot facility that will have the ability to mass produce at least one gigawatt per year initially, and then scale up to five and then 10, and then likely around 20 gigawatts per year per factory in the not two distant future.

So essentially we're turning the first plant on in the next few months. It's a 10 megawatt plant that's purpose built for powering and data center at the end of the year. It'll achieve full power operation. And that's the aggressive internal goal on powering the world's first cot, nuclear planted data center.

And it'll be a great demonstration of something that I think we'll see a lot more of in the years to come. Yeah, thanks again for having me on and it was a real pleasure. 

Erik: Matt, I'm really excited about what you're doing. That's why I invested in it. But I just want to probe a little bit on the business plan because first of all, I think you're doing exactly the right thing, but selling a nuclear power to data centers sounds to me like selling private jets to rich guys.

Is your strategy eventually to get to the point where you can bring the cost down enough mass, produce these nuclear power plants at a price point where you don't have to be an AI data center to afford one. And can you give us a rough sense? I know it's it's probably an unfair question, is that two years out, 10 years out, 20 years out, when do we get to the point where factory mass production brings the cost of nuclear down to the point where it starts to compete with the cost of fossil fuels?

Matt: So I think the interesting is right now, if you look at the Hyperscalers builders of data centers. The price point they're seeing for net new natural gas production is in the 10 to 15 cents per kilowatt hour range. We're seeing as the current pipeline gets tapped out, new fracking, new pipeline expansion has to be.

Built out. And that also adds costs and delays. So the interesting thing is, even at the speed that we're talking about right now for, and the scale for powering data centers today we can come in at a price point right around that same range initially. So by, by many measures coming in right off the bat, being competitive with the ideal oil and gas solutions for this customer.

But as in order to. Displace much more of oil and gas. It'll have to get cheaper. And we believe within n equals 20 to 40 or so. So in other words, after the first 20 to 40 reactors, which would be around, five, call it five to 10 pods getting well below 10 cents is fully within range.

So it doesn't have to be in the thousands to see a very good price point, but in order to eventually get to 3 cents, which is a very aggressive number, it's our, essentially our company mission. That is more of the multi-decade effort, but I'd say probably in the early 2030s to mid 2030s getting below 10 cents is very achievable.

Erik: Matt, I'm really excited to be investing in what you're doing, and I just wanna say that I hope that other companies will come to the table and share your vision and my vision of mass producing nuclear energy in factories so that all you have to do is set it up and hook it up on site as opposed to custom building anything on site.

And I think it's really going to be important that the western nuclear industry embrace this idea because frankly, the People's Republic of China. Gets it. And they're working hard on this too. And if we wanna be competitive in the west, more companies need to follow the lead that Matt's company is taking.

So that's my soapbox for this episode. I wanna move on now and encourage everyone to stay tuned for our post game segment. After the feature interview, ironically, we happened to go a little bit off of our usual macro theme for this nuclear focused episode in a week where the world went To Hell in a hand basket.

And we've got lots to talk about around Iran, the evolving geopolitical situation and so forth. And that's coming up when Patrick Ceresna joins me as Macro Voices continues right here at macrovoices.com.