Speaker 1: We always pride ourselves on staying ahead of the curve. We don't tell you what just happened, we tell you what's going to happen, and obviously that's more valuable to investors. Higher international monetary system is driven not by the Fed, but by Eurodollars, by money that banks lend to each other, so that they can support their balance sheets and lend to customers, or offer transactions to customers, if they will. And the main transaction is the 800-pound gorilla, if you will, is approximately one quadrillion dollars of derivatives. Options, futures, forwards, swaps, swaptions, you know, I could go on and on. By the way, for those who aren't familiar with the term, a quadrillion is a thousand trillion. So we've got about one quadrillion or one thousand trillion dollars in derivatives. All of that, almost all of it, has to be backed up by collateral. I could say, you know, if I'm a hedge fund and you're Morgan Stanley, and I call you up and say, I want a $5 billion total return equity swap, which is basically a derivative basket of stocks, and I can buy and sell stocks all day long, up to $5 billion. It'll be notional. You'll pay me the profit or loss, the dividends, but I don't actually own the stocks. I just have a $5 billion swap with you. And then you go out and maybe buy the stocks and hedge your position. You'll do that for me if I'm a big enough hedge fund or sovereign wealth fund or institution or whatever, but you want collateral. I don't have to give you $5 billion worth of collateral. I just have to give you enough, a little bit of foundation and the mark-to-market losses. So if I lose money on that deal, I will give you that much collateral until such time as we close it out, etc. So collateral is the key to the whole quadrillion dollar structure I described. What can be collateral? Well, basically securities, but we're in a stage now where banks and hedge funds and others are becoming suspicious or nervous about each other's credit. And these are the early signs of a global liquidity crisis, which is different than a recession and different than a, called a plain vanilla financial crisis. Liquidity crisis, you know, is when you're getting ready to turn off the lights. So what's good collateral? Well, used to be a lot of things, but today banks are saying to each other or to their clients, we don't want your corporates. We don't want your stupid mortgages. We don't even want treasury notes that are past like two years. We want treasury notes, maybe with a haircut or six-month bills, four-week bills, 30-day bills, the best, absolute best, most liquid form of collateral. Well, okay. First of all, there's a scarcity of that. There's a collateral shortage and banks desperate to prop up their balance sheets or else we're going to get some treasury bills and they're bidding for them at prices that produce yields to maturity lower than what the fed will give you for free. So if I'm a bank and I can call the fed and the fed will give me some treasury bills and I give them cash under an agreement to unwind that and the interest rate on the cash is whatever. Why would I go out in the market and bid on a treasury bill that pays me less than what the fed will give me for a phone call? Why would you do that? The answer is you need the bill. In other words, you don't need an expanded balance sheet. You don't need more credit. The fed, you need that bill to pledge as collateral on this quadrillion dollars of derivatives. And that's what's happening. So how do I get a bill from Deutsche Bank or Credit Suisse or UBS or Unicredit or Barclays or anybody else? I need dollars. The bills are denominated in dollars. So if I want to buy them, I got to get some dollars. So there's a huge bid for dollars that can be used to buy the treasury securities to pledges collateral to prop up the balance sheet. And that's what's going on behind the curtain. That's the plumbing. That's why the dollar is strong, even though everything about the US economy is weak, meaning recession, long-term depression, deficits, trade deficits, political dysfunction, borderline civil war. It's all bad. But if I'm Deutsche Bank, I need those dollars to buy treasury bills to prop up my balance sheet.

Speaker 2: The dollar is divorced from the fundamentals that generally back up fiat

Speaker 1: currency. Correct. Completely divorced. You can say it has been since 1971, but with good management with Henry Kissinger and the Petrodollar deal and James Baker with the Plaza Accord and the Louvre Accord, Alan Greenspan, the maestro and all that and good growth during the nineties, you know, whatever you think of Bill Clinton, we had the longest strongest expansions in US history. That's the kind of the good news. I'm very low inflation. I haven't really seen much inflation until recently in past years. Different. There just wasn't a lot of inflation. In fact, they were a little bit about default. So yeah, all of a sudden confidence in the dollar, which was maintained notwithstanding the absence of the gold standard is one would think starting to erode, except if you can't get it or you can't get it at a price or the dollar gets too strong, et cetera, the yields get negative, et cetera, et cetera. What happens is, and this is happening, the banks are reducing their balance sheets and it's just a matter of time in my view, not guaranteed, but one could see a situation where suddenly some major player goes bankrupt. They can't meet a collateral call or a bank gets in distress or there's a run on the back. Now we're back to 2008. This wouldn't look like 2020. This would look like 2008 except worse energy shortages because of the Biden energy policy, you know, empty shelves, a supply chain breakdowns bottlenecks at the port of Los Angeles, not enough truck drivers, higher fuel prices get passed along. Everything arrives by truck at the end of the day, it could come by boat or train, but somewhere in that delivery transportation channels, there's a truck and they run on diesel. And when the price of diesel goes up, the price of everything in the truck goes up because you got to factor the delivery costs into the cost of the counter. That's kind of what's going on from the supply side. Demand side inflation, what's called demand pull inflation is mostly psychological and those consumers get it in their heads that prices are going up for whatever reason. Maybe they actually are going up and they extrapolate from that, or they have other reasons for believing that. And so what they do is they pull demand forward. And I lived through this in the seventies. This was what was happening in the 1970s. You want to buy a refrigerator or car or new suit or clothes or anything. And you're like, you know what? I better go buy it now right now, because it's going to be, if I wait three months or six months, it's going to be a lot more expensive. So you do, but what are you doing? You're pulling all that demand forward and your fees on itself. Prices are going up because there's more demand possibly combined with supply shocks. And then when the prices go up, it validates the narrative is like, oh, see, I told you prices went up, better go buy more and it just feeds on itself, but they're very different. So the fed, it's one thing to say the fed can't do anything about the supply side inflation. If that's what it is and higher prices. Yeah, it's inflation as we measure it, but is it really inflation or is it just a logistical problem? But the fed can't do anything about it. The fed doesn't drill for oil. They don't drive trucks. They don't pilot ships and they can't do anything about it. They can do something about the demand side, which is destroying demand. So now we're in a situation, by the way, we're not all the way to vanpool inflation yet in the seventies. It also started on the supply side with the Arab oil embargo in 1973. Then there was a second embargo in 1979 from the Iranians. So those supply shocks did tip over into the demand side. And then it just has a life of its own. We're not at that point yet. We're getting dangerously close. We definitely have it from the supply side. It hasn't yet affected the consumer side of it. In fact, consumers are pulling in their horns. I mean, you know, they say the cure for higher oil prices is higher oil prices. In other words, if the price goes up, people will drive less. Or if you lost your job, you might not be driving at all. So there's another way for those prices to come down, which is the high prices themselves, destroy demand by themselves. And then that results in lower prices. And that is happening. We have seen inflation come down a little bit. I know it was higher than a lot of people expected beginning in the middle of last year, but they are starting to come down a little bit right now. But the demand side of it has not yet caught fire, but there is something else the Fed can do. They can destroy demand. So how do they do that? We're raising interest rates. So what happens? Credit card rates go up. Mortgage rates go up. New housing purchases slow down. Car financing, leasing rates go up. So people stop buying new cars, et cetera. If you do that enough, you can destroy demand, but it's at a very high cost because what are you doing? You're putting the economy in a recession. So can the Fed deal with supply side inflation? The answer is yes, by destroying demand and putting the economy in a really severe recession. So nice job that that's between a rock and a hard place, let it go. And, you know, they'll take a long time to fix the supply side or crush demand so much that it fixes itself, but at a very high cost. And the Fed is doing the latter. It's a very, very imperfect, blunt instrument, but they are destroying demand. Now, here's the policy question. Does the Fed know what they're doing? The answer is always no, they never know what they're doing. They pretend they do. They say they do, but they don't really do. They understand what I just said. Not really. So what are they going to do? They're going to keep raising rates because they got to crush inflation. Jay Powell does not want to be remembered as a new Arthur Burns or William and Chesney Martin. He wants to be remembered as, if anything, the new Paul Volcker. And that's what Volcker did. Leave aside, whether that was really the problem, but that's what he did. So Powell is going to keep raising rates and they may raise them 75 basis points. And you're like, wait a second, Jim, you said we're in a recession and unemployment's going to start to go up and there's demand destruction because of higher interest rates that may result in declines in housing pricing. Inflation may cool off. So why is the fed raising rates into weakness? And the answer is because they don't get it. They're always the last to know. And they're very political. Don't let anyone tell you the feds, not political. So here we have the situation where the inflation is coming from the supply side. Fed can't do much about it. They can destroy demand, but that'll throw us into recession. So why are you raising rates into what may be both a coming recession and a global liquidity crisis, which we just talked about? The answer is that's crazy. You shouldn't do it, but it's the fed and they probably will. The difference between a recession and a depression, this is not well understood. Recession is very numeric. There is a referee, something called the National Bureau of Economic Research based in Cambridge, Massachusetts. It's a panel of, I believe nine, you know, kind of PhD level economists. They decide when a recession started and when it's over. And therefore when the recovery began, et cetera, they're not an official body. The government kind of goes along with what they're saying, but even when they call it, it's their opinion and people are guided by that. But just to be clear, it's not a government agency, making these decisions. Their rule of thumb is two consecutive quarters of declining GDP. That's the rule of thumb. Now there's more to it. They look at unemployment. They look at incomes. They look at a number of other factors, but based on the rule of thumb, we're already in a recession. The loss was not as big, but it's still a loss, still in the red. So we've had the two consecutive quarters of declining GDP through at this point, several revisions by the US government. So based on the rule of thumb, we're in a recession. Now, Janet Yellen, who doesn't know much about this and the white house and others are saying, well, we're not in a recession. They're either changing the definition or if you want to be a little technical about it, the national bureau of economic research hasn't said so, but that's not unusual. What's normal is that the national bureau of economic research can wait three months, six months, sometimes a year before they call the balls and strikes. And for that matter, it's not unusual that the recession's over before they tell you it started. So I don't expect to hear from the national bureau of economic research until late this year, maybe early next year. And oh, by the way, wouldn't it be interesting if they waited until after the election. So don't underestimate the political twists and all this. I mean, that's definitely there. So I'm not waiting for them. I've seen the two consecutive quarters. I believe it's getting worse. I was there. Bank of Atlanta has a tracker. They're showing that in positive territory, but it's been trending down from about 2% to 1.9% to 1.6%, et cetera. That's also not unusual. They have a very interesting statistical method. I give them a lot of credit, but what they do, we went on wall street, takes the data, the GDP data comes in, you know, some of it weekly, monthly, quarterly, whatever. And you got to get all the data for you to make a final call. So what wall street does, they take the data they've got and they extrapolate. They say, well, based on, you know, regressions and correlations, et cetera, we think it's going to end up like this. And they're usually wrong. Atlanta fed does something different. They take the data you've got. Instead of extrapolating it, they say, well, what if this is all we have? What if this was the only data we had? As to the unfilled pieces of the Excel puzzle, we'll have an estimate based on what we know. That's what they do. But one of the results of that is the estimate. Again, this is a rigorous method. The estimate tends to decline over time because if you're in a recession, it's getting worse. By definition, the bad pieces are going to come in later in the quarter. They started positive and ended up negative. We'll see where it ends up. I don't have to call the third quarter, but it wouldn't surprise me if we're saying the recession continue to the third quarter, even as the National Bureau of Economic Research is to make up their minds. So in my view, we're in a recession, but there's no, again, just to be clear, we all have our views. There's no government agency saying who's right or wrong. They don't do that. The depression is completely different. People say, well, okay, if a recession is two quarters of declining GDP and a depression is worse than a recession, then a depression must be, you know, 10 quarters of declining GDP. That's not true either. You can have growth in a depression. And we did. The great depression eventually dated from 1929 to 1940 was severe technical recession from 29 to 33. And then another technical recession at 37 and 38 from 1933 to 1936, the economy grew. Now the problem was growing from a very low base. In other words, unemployment, the first term of the Roosevelt administration went from like 22% to 12%, but it was still 12%. I mean, 12% wasn't an improvement, but nothing to write home about. The point being depression does not mean continuous declining GDP growth. It means this depressed growth growth below trend. So if your potential is three and a half, 4%, which it probably is in the United States, it's not necessarily higher than that, except for short periods of time. If your potential is, you know, three and a half, 4%, you're growing at 2%, which by the way, from 2009 to 2019, which annual growth rates were 2.2%. We had 10 years of 2.2%. Not a lot of variance around that. Not, we know 5% quarters. There were no, there was one mildly negative quarter, but it really kind of crowded around that central Tennessee. But if your potential is three and a half and your actual is two and you have depressed growth and imagine two curves, one's going up like this and the other one's going up like this, that gap between potential and actual, that's depressed growth. That's lost. Well, it's now well into the trillions of dollars as well because we're in a depression. I would argue we've been in a depression since 2007. Now economists don't like the D word, the word depression, because it doesn't have a rigorous mathematical definition in a technical recession. Right now. We'll see if it gets worse. My expectation is it will. We haven't had a depression since the 1940s and we're not in a recession. So pick your experts, but the white house and the government don't have a very good track record of this. As that relates to the dollar, people say, well, okay, you have massive budget deficits. You have for a while, but they're now multiple trillions of dollars per year. The baseline deficit going into the Biden administration was a trillion dollars a year. When I say baseline, it's like, that's what the deficit would be. If you didn't do anything, kept all programs going and taxes about the same, but they piled on actually going back to Trump in the pandemic, $2 trillion relief bill in May, June, 2020, there was another approximately trillion dollar relief bill. The end of Trump's term in December, 2020 Biden comes in. He's like, well, I can top that. You know, Trump had his relief bill. I'll have mine. And we had the American recovery act or whatever they called it. February of 2021. That was about another $2 trillion on top of that. Then we had the infrastructure bill. That was just under a trillion. Now we have, they stopped calling it build back better. That was the worst marketing campaign in history, but the inflation reduction act, which will actually increase inflation, but that's about another trillion dollars. We just had $300 billion of student loans. Forgiveness sounds, you know, like peace, love and understanding, except the taxpayers have to pay that. When you forgive the student loans, it goes into the budget deficit. People don't understand the accounting, but that's how it works. You don't have a deficit when you make the loan. It's carried on the books as an asset, but if you forgive the loan, you have to write it off. And then that does hit the deficit at that time. So we're talking about, oh, at this point, on top of baseline deficit, the US debt to GDP ratio is up around 130% going higher. Who else has like 130% debt to GDP ratio? The answer is Lebanon, Greece, and Italy. That's your lunch table. This is the peer group that the United States is in, not counting Japan. Japan's in a world of its own, but they're much higher of that. That's what the modern monetary theorists say. Hey, look at Japan. They're 300%. We could triple the debt and it's all good. That's not correct, but that is what they say. And Congress is acting that way. So with all that, budget deficits, trade deficits, high debt to GDP ratios, out of control, spending, et cetera. Why is the dollar strong? People are like, well, hey, people should be getting out of the dollar. It looks like the end of the world. Well, it's not. And here's why. There's a dollar shortage around the world. And people say, how can that be? You know, the bed printed, you know, $7 trillion of money. You know, M zero actually higher than that. I think we're up to 9 trillion. They just flooded the zone with money. So yes, they did print over $7 trillion of base money, so-called M zero. That money didn't go anywhere. The Fed has the Fed print money. Well, they buy bonds from dealers, from the big banks, the so-called primary dealer. So the open market desk at the Federal Reserve Bank of New York calls up Goldman Sachs. It often tenure notes. Goldman says, here's a price. Okay, done. Goldman delivers the notes to the Fed and the Fed pays Goldman. And that money comes out of thin air and Goldman takes the money and gives it back to the Fed. This excess reserves doesn't go into the real economy. Nobody borrows it. Nobody spends it. Nobody lends it. All that happens is at the Fed, you're building up both sides of the balance sheet. You're building up the asset side with us, treasury securities, and you're building up the liability side with deposits from the primary dealers in the form of excess reserves. So that money doesn't do anything. I mean, it's printed if you want to say that, but it has not caused inflation. The inflation comes from, as I discussed earlier from the supply side, you know, the price of oil, supply chain disruptions, wheat, food, gasoline, et cetera. Inflation is flooding in and it's exacerbated by fiscal policy. What I just described about the money cream, that's monetary policy. Okay, but fiscal policy, which is the five or six or probably $7 trillion of deficit spending. That's helicopter money. When the federal government, the Congress and the treasury handout checks, that's helicopter money.