The Last Trade E063: Soft Sovereign Default with Peruvian Bull

Jackson Mikalic (00:02.141) Hey everyone, welcome back to The Last Trade. Today I'm joined by Peruvian Bull and of course my co -hosts Jesse Myers and Michael Tanguma. Good to see you all. How we doing? Michael (00:13.929) Doing good, welcome back, Peruvian. Peruvian Bull (00:16.746) Hey, thanks for having me back, guys. I'm excited to be here. Jackson Mikalic (00:20.773) Yeah, last time you were on the show was fairly recently, but a lot has happened since then. And Marty was the host of this podcast. So we'll continue the conversation that the three of you guys had just recently, but really want to touch on a lot of the changing macroeconomic landscape. know, certainly a lot has happened with the Bank of Japan, even in the past couple of weeks. So, you know, Peruvian bull, maybe the best place to start just given your background. You know, you are Peruvian, right? But you're an expert and known for your work in the Japanese markets, among many other things as well. But it's good to have you on and maybe the best place to start would just be a recap. know we've covered it on past episodes here and you've covered it on other shows as well. But really, it's best to hear directly from you what's happening in Japan, what happened a couple of weeks ago in global financial markets, and then maybe what has happened since then in the past couple of weeks. Peruvian Bull (01:16.817) Yeah, absolutely. you know, I think we've already talked previously on the show about the history of the Bank of Japan and, you know, the Japanese monetary experimentalism that they've been undertaking for the last 25 plus years. But to quickly recap, you know, Japan faced the bursting of a massive credit bubble in early 90s, and they responded by starting to experiment with, you know, new forms of monetary policy. So that started with lowering the interest rate, the their target rate to 0 % in 1999. And then in 2001, in March of that year, they started doing QE. And a decade later, they started doing QQE, which is qualitative quantitative easing, which just means QE for certain assets. And then they eventually started yield curve control in September of 2016. And all of this served to essentially over leverage the Japanese economy and bring it to a place where know, interest rates were pinned at the zero bound and the only way to achieve yields was to lever yourself up. And so this environment, you know, being so low interest rate was conducive to what are called carry trades. And carry trades are essentially where you borrow in one currency and you lend it another currency that has a higher interest rate. So you can capture a spread between the two currencies. And so Japan became a major funding mechanism for these carry trades. They were a carry trade funder for the AUD -JPY pair. So there was a run in AUD -JPY where the currency appreciated, appreciated, that means the yen depreciated. then during the 2008 financial crisis, this carry trade unwound and there was a whipsaw and all that leverage got wiped out. And we're talking tens of billions of dollars every single day. getting wiped out. So it was very destructive to any carry traders who had gone in long on that trade. And in 2020 with the global central banking apparatus at zero, the carry trade was kind of on pause because there just wasn't enough spread to capture. starting in March of 2022, when the Fed started hiking, that spread started to grow again and the carry trade started to get put on again in earnest. Peruvian Bull (03:38.929) on JPY USD. And so what that meant is that functionally traders are shorting JPY and they're going along USD because they're borrowing again and then they're buying dollars and lent, you know, to capture that interest rate spread. And the interest rates start or the exchange rates started to blow out starting at 100 or so in 2022. And it blew out all the way to 150 and 160 this year. And the Bank of Japan has been trying, you know, throwing everything, including the kitchen sink. at this problem doing massive interventions. They tried to move the bands of yield curve control. They tried to do, you know, a dozen different strategies to figure out how to deal with, you know, this blowing out currency. essentially everything they did was not really like working. was, you know, let's say pouring a little water on the fire, so to speak. Like it was just, it wasn't enough. so They finally realized that what was one of the things that was stopping or was helping the carry trades was the lack of volatility in the interest rates that they had domestically. so starting in March of this year, they brought their target rate out of the negative bound and into the zero to 0 .1 % range. And then, you know, they've been doing interventions since then. And in late July, on July 31st, they finally shocked the market with a surprise interest rate hike all the way to 25 basis points. And 25 basis points doesn't sound like much, right? And it isn't, but for an economy that's this indebted, right? We're talking 263 % debt to GDP, 120 % private debt to GDP. It's a lot. And all these carry trades immediately started to get unwound. And so we saw that weekend on Friday, the NIC -A started falling. fell by 4 % that day. The next Monday, it opened lower and crashed 13 % in a single day, which was the worst day for Japanese equities since 1987. And for the next few days, was very, very, there's very high amounts of volatility. And the Bank of Japan essentially had to walk back their policy statements. they had said in Ueda had said in the meeting the previous week that they were essentially ready to, you know, Peruvian Bull (06:05.189) They were ready to start a hiking cycle and more hikes were seen as appropriate. And they wanted to bring the interest rate to what was called a normal rate for the economy. And he didn't specify what that was, but he just said it was higher than where we are now. And so that scared traders. And so on the next week in early August, he walked back these statements. said, okay, like calm down. We're not gonna, we're gonna pause those interest rate hikes. We're not gonna do anything more. And he said, we may even become accommodative if needed. And so that wording helped to soften the impact on markets. And I think, you know, hold us where we've been for now. know, USDJPY is around 145. A lot of the carry trades have been unwound. But if Japan keeps hiking, you know, we could be seeing a real deflationary crisis start to emerge there. Jackson Mikalic (06:57.627) Yeah, well, appreciate you walking us through that. know. You did that in even greater detail on the last episode that we had you on but it's important just to highlight the changes that have happened since then and in particular as you mentioned in July 31st and coming into August just the Systemic volatility that we saw across the board right like it wasn't isolated to Japan it happened in US equities Bitcoin of course sold off quite rapidly just acting as a Liquidity sponge and allowing people to shore up capital, but I mean it's remarkable right there's like 20 plus years Peruvian Bull (07:05.595) you Jackson Mikalic (07:30.563) of central planning and manipulating interest rates and really just to be accommodative to the debt burden that was growing in Japan. now it's, you say it best, right, Peruvian? Like they're really just stuck in a black hole of their own making or something like that, right? I mean, there's really no way out of this mess. And we're seeing now just how much volatility could be introduced from what seems to be like such a little amount of Peruvian Bull (07:56.987) Hmm. Jackson Mikalic (07:58.201) interest rate increase from the Bank of Japan, but it's like ends up sending massive shockwaves through the system. So really, there's so much fragility that we need to be paying attention to as investors. One thing maybe to touch on unless Michael or Jesse you want to hop in, but I was really curious like we have next month the Federal Reserve maybe lowering interest rates, right? So that of course is going to start compressing the spread of the carry trade even further. And typically, know, easing policy in the U .S. would be accretive to the economy and for financial markets. But now there's kind of this dynamic where It could potentially unwind the carry trade even further. At least that's how I understand it. And then I think even today, the Bank of Japan came out, one of the policymakers there and said that they would potentially increase interest rates again if inflation remains to be a problem. So you kind of got us caught up in the past couple of weeks here. What do you think of the... coming weeks and months in terms of like US policy and Bank of Japan policy and how that could impact markets. Peruvian Bull (09:09.617) Sure. So yeah, think, I mean, generally, a rate cut in the US is stimulative to our equity markets. But I think you're right in saying that the contradiction there is that for the carry traders, know, they're spread, they're highly levered on this spread. And so if the spread moves, you know, the ones that are the most levered get liquidated first. And so if ironically, if we see the Fed hiking, we could see a temporary pullback in markets across the board. I'm talking crypto, Japanese equities, US equities, domestic corporate bonds. It could be almost a universal sell -off because carry traders have plowed long into almost every single asset class that they've been able to get their hands on. But in the long term, my base case is still that US equity markets are going to continue to climb higher. And that's just because of the fundamental mechanisms of how you know, our modern markets work, right? And I've kind of said this before, but you know, the, in my opinion, value investing is dead and it died in 2008. And now the entire market is just completely dependent on Fed liquidity. so whenever Fed liquidity is coming, markets will rally. And if Fed liquidity is leaving, then the markets will fall. And there's, that's just simply how things work now, the correlation between the Fed's balance sheet and You know, the S &P 500 is now like 0 .89. So it's like almost one -to -one and it's extremely difficult to, you know, imagine a scenario in which lowering interest rates and the Fed continuing cutting cycle is not long -term bullish for US equities. And again, I'm not saying that actually there's a fundamental value case for those equities. It's just that nominally they will go up because this is what we've seen in the past. This is how we've seen the system has changed and this is what is going to happen. Jackson Mikalic (11:10.203) Yeah, Michael, you're on mute. Michael (11:13.631) Sorry, that's such a great point because I think traditionally it's brought up around inflation and historically the past 30 years you could argue what inflation was but if you look at empty money supply that's probably the closest proxy and it's generally been like roughly 7 % I believe year over year. That's just like, should be our benchmark moving forward about the amount of capital that needs to be injected in the system to keep it from deleveraging and it goes back to there's too much debt, not enough dollars. And that only accelerates, so inflation only accelerates in the benchmarks in real terms, only accelerate or decelerate in like what a, anybody's portfolio will return and it just gets harder and harder to beat that. Sorry, the money supply is just a perfect proxy for where this is all ultimately headed. Jesse Myers (Croesus) (12:00.666) Yeah, I did a little analysis of that same question a couple of years ago and just looked at the CAGR on the M2 chart. And if you go back like a decade, the CAGR was like 5 % a year. And then it kind of, there was a little bit of an inflection point, jumped to like 6 % a year. And then for the last half decade, we've been in a 7 % a year kind of environment. So just kind of speaks to the... ratcheting up of of monetary based growth and and and i agree with michael that really is the the best proxy for true inflation is mt expansion Jackson Mikalic (12:43.985) Yeah. Michael (12:44.063) Yeah, PB, a quick question on something less on the, it's more of the qualitative than the quantitative. You referenced the 236 % debt to GDP and we hear about, you know, Japan and the monetary policy and how it's an anomaly and everybody references like they can get away with it and like all these things, but there's this notion of from a societal perspective, what has transpired and from the number of births to women working, older people dying, like everything. And you being a student, feel like of that specific situation, I don't know if you could share insights into that and how it got there because I don't think that I even personally fully appreciate why the reference from less capital production equates to all the things that have effectively occurred. And that's kind of where we I mainly think about or ask that question because this is a it's a pretty pretty cursor to where we're basically going in the US, if that makes sense. Peruvian Bull (13:43.505) Yeah, no, think that's accurate to certain extent. Yeah, no, the Japanese situation is really interesting, right? Because that 263 % public debt to GDP, they are easily the most overlevered country in the entire world. And again, it really dates back to the 1980s and 1990s, where if you read this book called Princes of the Yen, which is a really great expose on the Japanese central bankers and their desire to essentially reorder the Japanese economy post World War II, they began engaging in extreme forms of monetary policy. So, you know, in 1970s and 80s, they were enforcing what were called window quotas for the banks. And so what that meant is they would call the commercial banks and give them a nominal yen amount of loans they had to make every day. And so they were telling that they were calling, you know, loan books, mortgage offices. Right? Like they're calling, you know, private consumer credit. They're saying, Hey, we need to create 500 billion yen, you know, per day of, of credit. And that started to create this massive credit cycle that started to ramp up through the seventies and eighties and overinflate literally every single Japanese asset. And so, you know, they got to a certain point where the, the palace, the Imperial palace in Tokyo. Just the polished grounds were worth the real estate was worth more than the entire than all the real estate in California and You know something like that is just purely indicative of a complete and massive bubble right Japanese equities Japanese stocks in the late 90s were worth more than several g7 countries combined It was just completely unsustainable and so then in 1990 when the deflationary when they stopped doing these window quotas and started restricting credit the entire system started contracting heavily. So we saw Japanese equities fall 60%, bonds fall 60, 70%, certain types of real estate fall 75%, just a huge contraction across the board. And this resulted in, sadly, a demographic crisis for the Japanese because rates of suicide and depression skyrocketed, especially among young men. Peruvian Bull (16:04.953) And the ability of people to form families also fell because so many jobs got destroyed. And the of Japan just kept going with these policies. And then in the late 90s, they decided, they're like, OK, we want to reverse this and reorder the Japanese economy to, again, be more financially vibrant. We want to reinvigorate the financial markets because they've been falling for the last decade. So that's when they started to engage in this. you know, QE, ZERP policy, know, QQE, your yield curve control, all this stuff that they're doing. And what it essentially did is now, you know, their entire economy is built on over -financialization. They have created a financialized monster, gargantuan monster that they can't back out of now. And the net effect of that is you have an economy that is, you know, needing constant and continuous QE. and monetary stimulus of all forms. so raising rates by any amount will trigger this house of cards to collapse. And the US has already been starting down that path. had eight years of near zero rates after the 2008 financial crisis. And then we finally started hiking in late 2016, early 2017. And then we had to pause hiking in late 2018 and then start cutting again in 2020. already started to get trapped in this bubble. But I think if time goes on, if we go back to 0 % interest rates, that will further trap us in this debt bubble. Because like I said in that famous piece I wrote called Financial Gravity, if you bring interest rates to the zero bound, it creates a dilemma where bad debt doesn't get extinguished from the economy. It just adds on more and more and more. And so each time you lower rates, it becomes harder to raise rates in the next cycle. So it's counterintuitive, lowering rates will just burden you with debt even more as the Japanese have found out. Jesse Myers (Croesus) (18:07.13) Yeah, and that's why the 25 -bit rate hike after 20 years of zero is a non -starter. It completely breaks everything. So I'm curious about, think, there's like the classic Hirschman capital data point of 51 out of 52 times since 1800 that a country has reached 130 % debt to GDP. They eventually defaulted, soft or hard defaulted on their debt. And the one exception is Japan, is present day Japan. And you're sort of talking about how the steps they took through the 90s. And it feels like the US right now with our Dutch GDP of something like 125 right now, we would maybe be in the early 90s in terms of where Japan was then. And that, I think for a lot of people, would make them think, we're fine. We've got 30 years of runway, right? But I think, and I think you think that it's a bit of an exception for Japan for a variety of reasons. And I'd love to hear your thoughts on like, does the US have 30 years if Japan has been able to run this way for 30 years without running into any problems? And if not, why? Peruvian Bull (19:29.585) That's a really good question. That's a really good question. So I think there's a couple of answers to that. First is, right, the demographic issues in the US and Japan are wildly different in scale. We have our own demographic issues, but Japan is a unique outlier in the sense that they've had basically a falling birthrate for the last 25 years. And this started actually in the nineties with, you know, the birthrate going below replacement level and basically staying there for the last 25 something years. The amount of old people aging out of the workforce has been increasing steadily every single year to the point where, you know, in modern day Japan, more adult diapers are sold every year than baby diapers. So their population is aging, you know, completely. And old people, generally when they get stimulus checks or they get some form of, you know, asset price appreciation, they don't sell those assets immediately and spend them. They keep them there, hold them and save them for the grandkids or save them for their retirement or their later life care. So because of that, there won't be a huge, those are some factors that will lower monetary velocity and reduce the likelihood of inflation arising in Japan just naturally. You also have to remember Japan is a large external creditor. So most of their, a lot of their excess savings. goes abroad and gets invested into, into us equities, into European equities, into us bonds, treasuries. So, you know, they have a positive current account. They're a trade, they have a trade surplus. So they're a net exporter. so there's a lot of things going for Japan that helped to bolster it financially, despite the fact that they're building up all this debt. Now, to answer your question on the question of, you know, inflation and debt, you know, will you hard default, soft default? The part of the reason why Japan was able to get away with what they did is because they they matched monetary austerity in the 90s with fiscal austerity. So they didn't run large scale fiscal deficits from the federal government and they didn't launch massive spending programs to try to bail out the populace. They essentially just let the populace. They sit back and said, you know what, let's let let's let things happen. Let's the populace. Let's let let's see what happens. Let what happens happen. Peruvian Bull (21:54.819) And so they stood back and just let things go. that is in, in some sense, it's bad for the underlying economy because fiscal stimulus, you know, despite the fact that a lot of Austrian economists think it's wrong, which is, know, morally you can have a problem with it, but Keynesians are right that in a depression or a recession, fiscal stimulus can help to, you know, push the economy out of, kind of stag stagnant scenario. but. With the U .S., we're already running 7 % deficit to GDP, and that's only projected to rise. And if you remember that deficits are, I term it as like the release valve for the financial economy into the real. So the bigger the fiscal deficits, the more treasury bonds that get sold by their treasury. That means money is being transferred from the financial economy, banks. brokers, commercial banks, pension funds, central banks, all of them, when they're conducting monetary easing, if the federal government of the country is also running large fiscal deficits, those bonds are being sold to the banks. The banks hand them over bank reserves. Those bank reserves go into an account called the TGA. Those bank reserves magically switch into M2 money because that has to be spendable, right? If the government's going to go out. buy tanks and planes and pay for social security and Medicare and Medicaid and build hospitals and infrastructure, that has to be spendable in the real economy that can't be bank reserves because bank reserves are only restricted to financial institutions. So once the government pairs the high level borrowing with a high level of spending and monetary accommodation, that results in inflation, which is what we saw in 2020. We saw this massive wave of inflation because for the first time we were pairing a large fiscal deficit with monetary easing. In 2008 in the US, we didn't have inflation because we were pairing monetary easing with pretty small deficits. And that mostly just counteracted the deflationary force of 2008 anyways. And so the reason why we don't have 30 years this time is because we can't run and we're not running the Japanese playbook. We're not running 1 % deficit GDP. We're running 7. And that's only going to get worse as time goes on. With 10 ,000 baby boomers retiring every single day. Peruvian Bull (24:20.529) and interest expense already this year projected to be about one trillion again. This train, like Lin -Alton says, nothing stops this train. And so as this continues, I think the deficits will increase, the monetary accommodation will have to increase, and therefore inflation will continue to rise. Jackson Mikalic (24:40.689) Yeah, that was an excellent primer. And it really sounds like then we are in the early stages of a soft default. And so is Japan as well, right? Because if you look at the U .S., just to use our country as an example, most people are fine with accepting a nominal return right now of five percent, right? Or thereabouts with U .S. treasuries. I think there's like six trillion dollars or so parked in money market funds at the moment. Those people have effectively Accepted whether they realize it or not that they're okay getting paid a negative real return because we know over the past couple of years that the rate of monetary expansion has been greater than a five percent nominal rate, so Correct me if I'm wrong, but we're kind of already in those early stages of a soft default Are we not like we haven't gotten to the point yet where that the GDP will start to decline which I guess is what will need to happen to actually reset the monetary system, but we are at a point now where whether people are realizing it by purchasing these securities or they don't, they are kind of losing purchasing power year over year. And right now I guess it's somewhat bearable, but it could become a point where that rate just happens so quickly and people are really just getting drained out of their savings, which presents all sorts of other demographic issues that you mentioned a bit about Japan. Peruvian Bull (26:00.997) Yeah, absolutely. Yeah, I think we are in the early stages of in the US and globally, right, as soft default because this level of debt to GP cannot be maintained forever. And as we're seeing with the debt spiral, you know, accumulation, this, this thing is unfortunately an exponential process. And that's why the Fed essentially has to step in, right? There's only so much capacity on commercial bank balance sheets. There's only so much private credit that can buy treasuries even at these rates. So that's why they need to find new sources of funding and they already have submitted a letter the ISDA which is the Internet the International Securities and derivatives Association They I believe it's securities are it might be something else, but they essentially submitted a letter to the Fed and the OCC asking for an SLR exemption for treasuries basically allowing them to buy treasuries without putting capital against pledging capital against those treasuries in case of losses so allowing infinite leverage. And you know, there's been other moves, of course, you know, there's been TGA reverse repo, the fed's been trying to manage these accounts to draw them down to add liquidity to the system without blowing anything up without having to restart QE. But long term, my base case is that they're going to have to restart QE no matter what, because just this debt issue is too bad. I mean, we saw in three days in August, we saw the debt go up by 130 billion over a weekend. And something like that. Is you know someone else did said that that was all the debt accumulated in the u .s Up until world war up until and past world war one because world war one was like 85 billion dollars or so So they're like imagine All of the debt, you know borrowed by the u .s Or the total debt level borrowed by the u .s up until world war one and we did that in three days Jesse Myers (Croesus) (27:51.118) Yikes. Yeah, I'm remembering a, it might have been Luke Gromann. He was making the point of like one of the key ingredients or somebody was, one of the key ingredients for a soft default is basically what has to happen is bondholders have to get screwed. You have to destroy bond value in real purchasing power terms by having inflation run higher than the yield on those bonds. And, you know, he likes to point out that the one way to do that is what happened in Israel in the 80s, I believe, where they allowed inflation to run at like 100 % for like two years. And you basically have a reset on the real debt levels, debt in real terms. that's one option. The other option is to, to run at a small, negative real return for many years. And, the key ingredient there is to make it so that the bondholders don't realize that they're destroying value by holding bonds during that period. Because otherwise you sell the bonds and, and, and, and then they trade it, you know, they trade it below, par and, and the market corrects itself. Michael (29:17.896) you Jesse Myers (Croesus) (29:20.026) And and that's kind of what we've been doing right like if it's necessary for bondholders to not realize that they're losing value and we exist in an environment where CPI is supposedly 3 % and yet m2 is growing at 7 % and Bonds are yielding 5 4 5 percent That's that's the ingredients right there. So I think it I think it is we are we are in the Michael (29:37.936) you Jesse Myers (Croesus) (29:46.848) non -urgent, non -crisis mode stage of a soft default where they're trying to pull the levers, but the reality is that things are not aligned where we should not be expanding deficits if we're trying to get out of, if we're trying to soft default on our debt, we should not be adding to it at an increasing rate. not all decision makers are aligned on this. Strategy because they don't realize that this is what is happening or needs to happen so, you know, it's you're never gonna get it done if if Lawmakers are spending at an increasing rate because they don't realize that this is a crisis and and that the only way out is to sort of screw over bondholders You know, so I think that I think that all speaks to like we are in the early stages of this and And yet it's in effectively being done Michael (30:35.74) Yeah, they're Jesse Myers (Croesus) (30:43.096) And so eventually we'll get to a point where they have to take more radical actions. Michael (30:48.734) I would imagine we could go back at least to 71, but definitely 08, right, in the soft default, and the notion, which you're describing, is like the 60 -40, right? Like the 60 -40 is the commitment to the soft default, because it's just understood that I'm gonna hold 40 % of my wealth and bonds, and I'm just gonna, I'm subconsciously accepting this, you know. negative real yielding return and it's increasingly becoming greater. But that just like conversation at 64 days still embedded and then it ties into the past year we've had the multiple conversations of Fed speak, right? Because the second you start to move past what the target inflation is, now you start to question all your returns. So you have to anchor them to this lower bound that we all know is not true, but we just accept and talk about. And then that's where the unemployment comes in and all the other like second and third order derivatives of. the monetary policy and how it's impacted. So that 60 -40 is just this like feels like a very key component that's intertwined in all of this because that's just the basis of all portfolio theory and how people manage their capital and people are anchored to that. So anything that moves from that is just a small deviation from how you're gonna like accept your ultimate default year over year, your return profile. Jesse Myers (Croesus) (32:04.314) Yeah, absolutely. The unassailable wisdom is that 60 -40 is wise, right? And then, of course, that becomes your attack vector to try to pull off some wealth destruction that's necessary here. Peruvian Bull (32:04.607) Mm Jackson Mikalic (32:19.749) Yeah, and to PB. Peruvian Bull (32:19.953) Yeah, exactly. And imagine this, like we're at 7 % or deficit GDP without a formal recession, without, you know, the US being in a large scale war, although we are kind of funding to proxy wars and without a banking crisis, you know. And so it's like, if we're already here at 7%, what's going to happen if something really bad breaks out? What's going to happen if we have you know, another commercial banking crisis, or if there's another large scale war that opens up, or if there's some sort of, you know, economic or, you know, natural disaster that just spurs a bunch of government spending. Another virus, right? Monkeypox. Although I don't know if that one is really as viral as they say it is, but you know, if there's another crisis here, it's just gonna send this system into overdrive. I think that's a real risk that people need to keep an eye out for. Jackson Mikalic (33:14.877) Yeah, what continues to shock me is that we must be in an echo chamber because PB, one of the things you said earlier that I agree with is really after 2008 fundamental and bet. fundamental value investing has died, right? So there was a world where all the best investors were all value investors. They were able to do the channel checks, dig into the financials, understand total addressable markets and competitor landscape, and they were able to allocate capital to undervalued companies, and they were able to beat the market by doing so. Michael (33:28.03) you Jackson Mikalic (33:48.443) But it seems like so obvious to the four of us that really any asset class, whether it's Bitcoin or it's real estate, precious metals, equities, what have you, are really all proxies for global liquidity, right? So I feel like it's so obvious at this point just... And this is kind of a similar conclusion I came to in 2020 personally. And when I began to allocate more seriously to Bitcoin myself, first introduced in 2017, but really in 2020, had a front row seat to Wall Street. was doing hedge fund research and private asset research. And what was remarkable to me was all the people who made the most money in 2020 and 2021 were just long the market, right? Like there was not necessarily any, they were all really sharp people, much smarter than I was. And it was a privilege to be able to get to know these people and their investment strategies. But the thing was, if you were long, when liquidity was expanding at like an astronomical rate, then obviously you're going to make money. And if you were, you know, more hedged or you were, had more of a neutral bias or short bias and you kind of were left behind in that massive run up. And now, that's my personal framework for investing is, and why I've ultimately come to Bitcoin as the name of the show, the last trade, that's where I allocate my capital personally because I've came to this conclusion. But PB, I'm curious your thoughts, is there anything that maybe we're missing or why is it so obvious to us, but maybe some of the other folks in the TradFi space? are continuing to struggle with maybe the realities of this like kind of fiscal dominance and global liquidity, know, sloshing around and moving all the assets. Peruvian Bull (35:30.353) I think it's just hard for them to break from the mental mold that they've been using for the last 35, 40 years. Buying bonds has worked largely until the last four years. Buying junk grade, buying commercial grade, buying treasury bonds. There was a guy in, I think I heard this story about a guy working at Solomon Brothers who took out a loan on his house, like a lien against his house. and bought a bunch of treasury 30 year notes or 30 year bonds in 1981 and retired. Like the interest was 16 % and he was able to retire completely and make millions of dollars just from interest and compounding math. So he was able to just continue to roll this paper forward and make a ton of money. And a ton of traders did the same thing. You could go long bonds, you'd go long equities. and everything would just make money. So the 60 -40 portfolio made complete sense. And if there was a risk of a recession, the Fed would ease and so the bonds would gain value and equities might sell off for a little bit, but then they'd recover pretty quickly and then they come back to all time highs. And so that playbook, right, has, worked in the 1990s, it worked in the early 2000s, it worked after 2008, it worked after 2020. so it was really, it was... Michael (36:41.245) you Peruvian Bull (36:52.785) up until 2022 that this was working really well. But once the Fed started hiking and interest rates globally started rising and bonds really started to get battered, that's when all this fear started into the market and people started to realize, holy crap, are we in a new paradigm? And I think for the majority of participants, they still haven't fully swallowed that pill yet. It's very hard because again, most, median age of an asset manager in the US is what, like 67? So, you know, a lot of them or I should say the I think it's the average age. a lot of them are, know, and the, on the lower bound, it's around the 40 year old Mark. And so we're, we're dealing with the people who, class of people who are between 40 and 65, 70 years old, who have are generally the boomers or Gen Xers who have managed money professionally for the last 30, 40, 50 years at set in some cases. And their playbook has worked. Literally flawlessly until the last two years and so it's really hard to come and tell those people. You're wrong. There's a new paradigm shift. Everything's gonna change. You should be buying Bitcoin You should be shorting bonds. You should be buying equities when they could just say hey, like what are you talking about? I've managed money professionally for this long and Long bonds long equities always works and it's low risk and there's low variance and all these models prove it out And don't want to do anything that the rest of money money money managers are not doing it because of doing because if I do then you know something then I could be an outlier and then I'll be wrong and I'll lose money and so that bias I think is crept in and it's taken hold and it's very hard to uproot Michael (38:33.182) And that's the thing that's funny about this. I was looking for a quote and the quote that came up was a Chinese proverb that says, if you want to know what the water's like, don't ask a fish. And you reference the 67 year olds. If you want to know what money is or what economy is, don't ask somebody that's played in the financial system the past 70 years, because it's a similar thing that they've been living in an aberration, anomaly outside of the past, call it a thousand years where you had sound money. And so they're just, they know a system and that's why it's hard to break from it. It's a fascinating thing because we all have these conversations daily and it's one by one slowly. And I think 2020 was, that's what's interesting about being in this space that 08, 09. Satoshi, the white paper came about, but 2020 has been like the most instrumental that I've heard from individuals. And there was like two components. There was amount of liquidity that was pushed in the system. But the other part that doesn't get brought up a lot was that generally people have the rat race they're tied into, so they don't have the time to look at this stuff. And ultimately everybody was locked in a box in 2020. And so you literally had the time to be like, what is happening here? And then it doesn't take... You know, it's generally what we talk about, not an IQ test, it's a common sense test. So if you have some time and you look at the problem, you're like, well, there's, you know, and you look at Bitcoin, like, that might actually all make sense. But just, it's historically people don't have that time afforded to them to just assess what's going on. Jackson Mikalic (39:59.037) Yeah, that's a great point. And PB, the other thing too, as you mentioned, is people have confirmation bias and really what we're talking about as it relates to traditional assets, you're right, it's worked in many different cycles and paradigms, it's 6040 has arguably been a good way to allocate capital and preserve wealth really up until recently. And you mentioned 2022 as an inflection point just with like correlations breaking. I really think one of the big forcing functions for Bitcoin adoption will be when Bitcoin begins to be included in indices and active managers have to benchmark against these, right? So if the index holds some at like, let's say it's a global macro index that has all these different equity exposures and, or let's say it's a commodity index, right? And it has all these commodity exposures and ag and energy and what have you. Peruvian Bull (40:36.337) Mm -hmm. Jackson Mikalic (40:55.645) And then there's an exposure to Bitcoin as a digital commodity as well. And if Bitcoin is driving positive returns and it's, you know, kind of punching far into the right in terms of attribution and managers who don't have exposure to Bitcoin are underperforming the benchmark because of that, then they're going to start getting a lot of calls from their investors asking, you know, why are you underperforming the benchmark? I'm paying you two and 20 or whatever it is at the fund. And I could be getting better returns in a passively managed vehicle where it's a fraction of the cost. So in my mind, and maybe that's just the world I was coming from, active managers will almost be forced to adopt Bitcoin at some point. Of course, there's the flip side and bear markets underweighting it relative to a benchmark would likely put you in a better position. But as we know, Bitcoin compounds quite nicely on an annual basis. And I really think that's how it will get into a lot of portfolios and how active managers will have to adopt it just to continue to generate alpha and provide value to their investors. Peruvian Bull (42:01.841) completely agree and I think that's what's going to change, right? Change the paradigm is that FOMO. Once you start seeing massive institutional allocation to Bitcoin and once their portfolio is right, I mean, this has been done a thousand times, right? Sharp ratio improves, total returns approve, risk adjustment returns improve. Like on every single metric, you see an improvement in portfolio, even if you just added one or 5 % allocation to Bitcoin. And so it's going to be extremely hard to argue against that in the long term. Michael (42:03.454) Thank Peruvian Bull (42:30.671) But right in the short term, this is a battle of the minds. This is a battle of bias and that takes time to overcome. Jackson Mikalic (42:37.627) Yeah, totally agree with that. Maybe, you know, we could shift gears a little bit. One thing I did want to touch on was Wyoming, because Michael was out there last week hanging out with all the Federal Reserve policymakers and wanted to get Michael's thoughts just on what he saw. He was at the Salt Blockchain Symposium, which is a digital asset conference. Michael would love to hear you talk about that and then PB, Jesse, whoever would love to juxtapose that against maybe what we heard coming out of the Fed in Jackson Hole last week as well. sounds like, know, rate cuts are projected to happen in September and PB, as you mentioned, we have probably global liquidity easing coming soon after a period of like kind of consolidation and tighter policy. Michael, maybe you can catch us up on what happened in Wyoming first. Michael (43:28.614) Yeah, for sure. think that there's a perfect dovetail from what PB was talking about in portfolio and portfolio theory or adding Bitcoin and the results that we've talked about. Where I think on conversations like this, we've naturally, can you guys hear me okay? Okay, randomly. So we're all positive on Bitcoin and where it sits in portfolio in the math, but something just dawned on me that I wanted to throw out. it has to relate to the Wyoming conference that probably like anybody would expect, there was a lot of, know, TradFi that's breaking into space and also digital asset, crypto native folks. And there was a lot of discussion around real world assets, tokenization, crypto, know, Solana was there. There's a lot of the things that you would naturally see in the market thinking about Bitcoin and crypto conflating them together, thinking about it as risk. And, you you want, you know, one, 2 % of a portfolio allocation. And obviously we have a different message here. We talk to individuals that you want to isolate crypto versus Bitcoin. Crypto, can think about it at best if you have to play nice as a venture bet and that it could go to zero and it could go to, you know, it could maybe in a short order outperform Bitcoin. But ultimately a lot of these things are not, they're not money. Bitcoin is money. It's more of a gold 2 .0, bond, and it should be thought of as a different asset. And so... My personal thought has been like this will win over time, this conversation, and it's part of our thesis and our strategy. But something just dawned on me in the sense of because of the over -financialization of Wall Street and the need for increased revenue margins and all those things, and we saw this fee compression with the ETFs, what if the misalignment of incentives is you keep it conflated? and then you show all these other products because you have higher margins and higher fees. There's Solana ETF or these other things. the, what we see and we combat daily is this notion of diversification, portfolio allocation, that it's crazy for anybody to think about why you would put anything over a couple percentage points into BTC. We're saying that, and we obviously know we're right because we've been living through this, but. Michael (45:49.331) the market's not saying that and the market will increasingly not be incentivized to say that for a number of reasons. And so that just like dawned on me in this conversation, like I'm happy to talk more about Wyoming, but like there's this notion that maybe it's not as straightforward as a Sharpe ratio and putting it because you're not incentivized to do that because there's other products that are in short order, maybe outperform, but on a long enough hot time horizon, you have the benefit of not having that quick. return to show them and so three, four years later obviously the proof's there but everybody can sell snake oil in short order like venture can return here, all the things that are associated with something that's not in the best interest of the end client if that makes sense. Jackson Mikalic (46:30.651) Yeah, I mean that makes a lot of sense just because the... Bitcoin ETFs, at least in the US, are very commoditized, right? They all practically use the same custodian. They're virtually the same product. It's just a different sponsor of that ETF. So Michael, point makes a lot of sense just in terms of trying to find edges for these other companies to get into like more exotic crypto products where they can actually maybe be one of the only people to offer this or the only firm to offer it. And then also just get a lot of revenue tied to that and care less about the Bitcoin product because it's just vanilla and it's the same right as everything else. And then I think the other important point you mentioned too is most of the market Okay, like, you know, the four of us and people who listen to this are kind of in the minority as it relates to how we think about Bitcoin. Like we view it as typically a risk off asset. But if you're conflating Bitcoin with the broader crypto space, and at best it's a one, two, three percent allocation of your portfolio and it's viewed as something that's either going, you know, zero or to the moon, right? Like a typical just like all the retail crypto shilling out there. Then, yeah, I mean, we're kind of like in a totally different league. Just like how we think about this and how does it How does Bitcoin actually fit into all the themes that we're talking about from a risk -off perspective, not from let's just throw something at the wall and see if it sticks and see if we can make some money on it in the process. Jesse Myers (Croesus) (47:54.254) Yeah, yeah. And I think, you know, there's another theme in there too of I think we too quickly jump from, you know, Wall Street's here. They're the smartest people in the room. They're going to get it. They're going to understand they're going to they're going to point their clients towards Bitcoin rather than crypto. And the reality is like every time any new cohort shows up to Bitcoin and crypto. that cohort goes through the learning process of making the same mistakes. Every person ends up making the same mistakes when they first arrive. And that has meant going through the path of altcoins and making that error only to later realize that all that is a house of cards. And the only thing that you really want to own is Bitcoin. And so Wall Street and, you know, ETF providers and wealth managers, they're all going to make that mistake. and they're going to shepherd. Unfortunately, they're going to shepherd their clients into making that mistake as well. And eventually they will learn. I think, you know, people who are in the Bitcoin space already, who are already understand the value proposition of Bitcoin. I think we have to brace ourselves for that and prepare for our friends. and our family telling us that their wealth manager said that the Solana ETF is a good idea to balance out your Bitcoin exposure. know, like that's coming and we just have to accept that everyone is gonna make the same mistake. It's just part of the process of learning here and we have to be patient and also help guide those folks towards what they will eventually learn, the hard way or the easy way. that Bitcoin is the only thing they want to have. Michael (49:52.86) Yeah, and there's a really important part in all of this that doesn't get discussed enough, it's that... kind of like loose monetary policy. hate using this term, know, fiat, because it's charged that you throw it at everything. But this notion of too much liquidity drowns out unity economics. And so the idea of compression around custody exists in the traditional finance world. And so it poured it over to the Bitcoin and digital asset world. And so when these asset managers look at the space, they all sit in a room, and I know this firsthand, and they're all trying to figure out how do you make money from a market that's telling you you can't make money from a market? Like you can't custody, you can't do anything. It's a race to zero and that's absolutely false It's a fallacy baked into the market because ultimately nobody holds Bitcoin very long because nobody gets educated on what it is So their exit liquidity or their custodian gets hacked and they lose it and so this is natural education that we provide and what we, it's taken time to become proud of because anybody listening to this is like, it's easy, you buy it and you hold it. But everybody that's gone through multiple cycles knows it's not easy because there's always somebody trying to steal your Bitcoin. And there's always some counterparty trying to steal your Bitcoin, whether it's an exchange or somebody trying to break into your house or whatever, increasingly becomes more treacherous waters. And so there's real value to be delivered in what we think about in this notion of multi -institution custody, different institutions getting involved, because that's the asset appreciates. You can take fees on that. Financial services around it. Michael (51:17.436) but then ultimately the education about why it's Bitcoin versus this other stuff because you can play the game in short order and pushing to like crypto, but on a long enough timeframe, kind of the tide goes out and you find out who's swimming naked and who was pitching you the snake oil. And that's just an interesting dynamic because it's, it's some probably malintent that's built into the market somewhere, but a lot of it's just misalignment of incentives of not knowing that you can't make money here. And then now you have to naturally go out to further out on the risk curve and you end up rugged in your clients. So it's just a very interesting aspect and like to Jesse's point Wall Street comes in they have no notion of any of that because this is just well it looks like a stock or a bond it's just completely different. It's a fascinating place to be in and that's kind of ties into Jackson the Wyoming event because there were some of the most reputable firms there and everybody. know, Brian had a really great recap. He was there as well in a weekly newsletter. And in paraphrasing him, it's like everybody's talking about these use cases, but they're hinting at, they're trying to find a use case. And they're also... afraid to say that there's no use case, but behind closed doors, most people will tell you like they don't know what this what's happening behind the stuff other than Bitcoin and then stable coins. But when you really break down stable coins or any tokenization, it doesn't get talked about enough. But it's basically there's three layers of counterparty risks that exist. And they ultimately have to net settle where does he underline and you don't necessarily need a blockchain. But nobody has these conversations because they're not incentivized to. So we just like, I think there's a use case because we can build the solution. We can raise money on it. We can do it. So it's just an interesting period, I think, to Jess's core point. Because Bitcoin's so emergent, we lived through this on micro examples with individuals and smart companies, and now we're just gonna live through this at the larger scale. And it's effectively why we exist, because people are gonna get rugged, and we just want to lower that magnitude of ruggedness, ultimately, to a lot of the things we're developing are just standards in the market. Jackson Mikalic (53:18.225) Yeah, the best use case is a savings technology that's globally accessible and can be sent anywhere in the world instantly and for near zero fees. So I think that's a good use case to focus on personally. Jesse Myers (Croesus) (53:28.12) And yeah, and yet somehow the world doesn't know that yet. When Michael was talking, I was reminded that, know, I was at Bain before getting into falling down the rabbit hole and there's a macro trends group at Bain and all they do is study macro and put out their perspective, you know, so that the partners can talk about that with their clients and, you know, it's part of the value proposition of, you know, engaging with Bain. And the macro trend guy has for a long time referred to Bitcoin as a hammer looking for a nail. Which is to say it's a great technology, but it doesn't have any use case or any application. There's no reason for it to be. And that is still the official position, well, I guess his unofficial position of his perspective about what... what Bitcoin's value is, which is to say that people whose entire job is to study macro and at a place like Bain still don't think that Bitcoin has any use case, any value proposition. So if you just listen to Jackson recap what the value proposition of Bitcoin is as a savings technology, you're ahead of the curve. You're ahead of what the information that's being disseminated by the experts at Bain and Company with regard to what Bitcoin is and where it fits in the macro landscape. Jackson Mikalic (55:05.341) Yeah, and maybe to tie it back into just kind of like looking ahead now. So it's the end of August, got a handful more months of the year, and then we're looking into 2025. Ultimately, we've described the use case of Bitcoin as just a better form of money and savings technology. you know, the important thing behind all that is the ability to protect purchasing power, right? So it's like... Fundamentally Bitcoin exists within the context of not having to trust centralized entities that issue a currency, that manipulate currencies, that censor transactions, et cetera. So the reason why we've kind of coalesced around this technology is to protect our purchasing power from the continued debasement of the dollar and other fiat currencies. So like PB, maybe you could just like let us know what you're paying attention to now through the end of the year into next. What are you seeing in terms, like what are the most significant things to pay attention to from a macro lens? And maybe we can wrap it there. Peruvian Bull (56:06.865) Sure. So yeah, I'm looking at several key indicators. know, one is, you know, Fed liquidity, also looking at global net liquidity, you know, with the Bank of Japan still continuing with monetary easing and with the Fed deciding to start to pivot, it looks like there's going to be a breakout in global liquidity, which is going to be, like I said, bullish for risk assets, including Bitcoin. You know Michael Howell of liquidity wars does a lot of great work on this and he has pointed out that You know for every one unit of liquidity added gold goes up by you 1 .5 X and Bitcoin goes up by like 5 X so it goes up by multiples of the liquidity that's added So Bitcoin is hypersensitive to liquidity and if there's going to be a long -term, you know global cutting cycle beginning in the next, you say 12 to 18 months, we're going to be seeing, in my opinion, a price appreciation of Bitcoin and a breakout of this zone. Of course, the other main indicator I'm looking at is the USDJPY. Every time we're getting back to the 150, 160 level, the Bank of Japan is deciding to do something crazy, whether that is the interventions or that is hiking interest rates or changing yield curve control bands, doing whatever they can to figure out how to stop their hurts from currency from depreciating. That's like a very big driver here because Japan as the largest global sovereign creditor, you know, they own a trillion dollars of US treasuries and they own, you know, well in excess of a trillion dollars of US equities, several trillion dollars actually. And they're the largest external like foreign holder of both commercial and junk bonds in the US as well as just bonds generally, like they own a large chunk of bonds in the entire global ecosystem. And so if their economy is forced to de -lever, we could be seeing a bond route globally. Now, I'm not saying that's going to happen. I think the most likely scenario is that the Bank of Japan and the Ministry of Finance are going to have to swallow the hard pill that their currency is going to have to be the release valve for the pressure that's built up in their financial system. So they're going to have to say, look, clearly can't hike rates because that causes a Peruvian Bull (58:30.277) you know, 1990s style deflation in our own equity and bond markets. We can't really continue to do the interventions because that's just throwing money into the fire. just buying time. So we're just going to have to let this thing ride. And so that means the Japanese yen is going to devalue significantly. And carry trades can continue to add, you know, add leverage to the Japanese economy while feeding liquidity to the U .S. because carry trade is borrowing with one currency and lending to another. So it will add liquidity to US markets and further bolster US markets into the end of the year. So I think that section is really key to watch. What happens in Japan will determine, will help determine what happens in the rest of the world. But I would say those are my two main indicators I'm looking at. Jackson Mikalic (59:21.669) Awesome. Michael (59:21.736) Very well said. When you mentioned, P .B., earlier, the princes of Yen Book, I just had this realization of this island far off with some guys determining monetary policy. And like, well, what if they have friends that they want to, you it was just more visceral of like, this isn't the U .S. and this isn't central bankers here, but it's just these guys and why wouldn't, and it's obviously all the same, but it's just gonna make a lot more sense in a future state where we're like, wait, people? Peruvian Bull (59:37.115) you Michael (59:46.942) created the monetary policy before, it wasn't just like fixed and just ran. It's just a very funny thing that just to look back at, everything you described is just a product of human nature at the end of the day and we shouldn't be able to control the numbers on a screen or what like sets the cost of capital, but we just accept it. Jesse Myers (Croesus) (01:00:06.554) and all of the carry trades in the world basically when they're between currencies are people finding arbitrage opportunities between different shaman groups and what they have said. that's what so much of the financialized economy is based on is people exploiting the differences in what different groups of shamans have said about what the price of money should be today and going forward. It's all so ridiculous when you zoom out to that level. And of course a monetary standard that cannot be changed and nobody controls will win out over such an inefficient system of different shamans on different islands all over the world. Peruvian Bull (01:00:50.192) Mm Jackson Mikalic (01:00:52.923) Well said. yeah, Peruvian Bowl, really good to have you on as always. Great catching up with you. And maybe before we just hang up here, where could the folks who don't know you find you online? Where would you like to hand them off to? Michael (01:00:53.299) Very well said. Peruvian Bull (01:01:08.753) Sure, so I have a Twitter which is Peruvian underscore underscore bowl. I have the sub sack which is dollar endgame dot sub sack comm I also have a website called the dollar endgame where all my old writings from 2022 and earlier are are located And I have a YouTube under Peruvian bowl as well So if you want to find any of my video or written content, you can check me out there I have a NOS sir. That's also I've been posting more on you can find that and pub in my expanded bio on Twitter Jackson Mikalic (01:01:38.245) Awesome, yeah, I gotta protect that free speech. thanks again for making time. PB, always great to have you on. And yeah, for anyone who's not following him already, certainly go check out his work. It's phenomenal. Peruvian Bull (01:01:49.859) Awesome. Thanks so much guys. Michael (01:01:50.354) Thanks for joining us.