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America’ is currently running an annual deficit at 9% of GDP.

That’s an extremely high percentage historically and we’ve practically never run a deficit this high with unemployment this low. We’re essentially running a wartime deficit in a peacetime economy.

And a big part of this deficit is the ballooning interest cost we’re paying on servicing our national debt — as interest rates have spiked from near 0% at the start of last year to over 5.25% today.

And it doesn’t help that tax receipts are falling vs last year.

As a country, we are bringing in less income and spending more on debt interest.

Today’s guest, Luke Gromen, has been loudly warning that this dynamic is resulting in a sovereign debt crisis — not just in the US, but in many other major nations around the world who are in the same boat.

What could such a crisis mean? And where are we in its timeline?


Luke Gromen 0:00
Four very destabilizing, things have just happened. So the price of oil pick up about 20% off the lows 1515 20% off the lows, you had the Bank of Japan widen out their yield curve control on JG B’s, you had the US get downgraded. And then you had the US Treasury come out and update their borrowing estimates, to note that they’re going to borrow what almost $1.9 trillion in the back half of this year. And when you put all of these things together, they are a very toxic combination that we wrote at the time of still believe are likely going to drive global capital costs up potentially nonlinearly. In other words, treasury yields global sovereign bond yields up nonlinearly at a time when they the world really can’t afford that.

Adam Taggart 1:12
Welcome to Wealthion and Wealthion founder Adam Taggart, America is currently running an annual deficit at 9% of GDP. That’s an extremely high percentage historically, we’ve practically never run a deficit this high with unemployment this low, we’re essentially running a wartime deficit in a peacetime economy. And a big part of this deficit is the ballooning interest costs we’re paying on servicing our national debt, as interest rates have spiked from near zero at the start of last year to over five and a quarter today. And it doesn’t help that tax receipts are falling versus last year. As a country, we’re bringing in less income and spending more on debt interest. Today’s guest, Luke Gromen, has been loudly warning that this dynamic is resulting in a sovereign debt crisis, not just in the US, but in many other major nations around the world that are in a similar boat. What could such a crisis mean? And where are we in its timeline? To find out let’s hear from Luke himself, Luke, thanks so much for joining us today.

Luke Gromen 2:20
Pleasure to be back on Adam. It’s great to be here.

Adam Taggart 2:22
Hey, always a pleasure. Lots of questions for you here, Luke. Let’s jump right in. But to kick it off at a high level, let me ask the question I like to ask you every time you’re on the program, what’s your current assessment of the global economy and financial markets?

Luke Gromen 2:36
I think the best way to frame the assessment is something we wrote about for clients three weeks ago, give or take, which is that for destabilizing things, or very destabilizing, things have just happened. So the price of oil pick up about 20% off the lows 1515 20% off the lows, you had the Bank of Japan widen out their yield curve control on JG B’s, you had the US get downgraded. And then you had the US Treasury come out and update their borrowing estimates to note that they’re going to borrow what almost $1.9 trillion in the back half of this year. And when you put all of these things together, they are a very toxic combination that we wrote at the time of still believe are likely going to drive global capital costs up potentially nonlinearly. In other words, treasury yields global sovereign bond yields up nonlinearly at a time when they the world really can’t afford that. And so I think that is ultimately going to be very destabilizing, it’s going to bring us back order regime of what we saw April through October of 2022, which was dollar up everything else down gold, gold, flattish everything else down with a potential kicker of oil up. So a very tricky environment that I think will ultimately accelerate and pull forward the Fed being forced back into QE or Treasury being forced into liquidity moves despite rising oil prices and rising rates and accelerating sequential inflation so it’s, it’s it’s gonna be an interesting fall winter and into next year, I think.

Adam Taggart 4:45
Okay, so what I hear you saying is, it’s nothing but sunshine and roses ahead.

Luke Gromen 4:51
You own oil and gold, you might you might see it as such but your own dollar maybe you’ll see it as such, but other than that, it can be a little tricky.

Adam Taggart 5:00
Okay, we’re gonna we’re gonna get to discuss this in depth, but just just to pull in a preview for folks, when you talk about the Fed having to step in QE, maybe cutting rates, that type of stuff in response to this toxic cocktail that you just mentioned. Do you have a general timing for that? Is that something you see happening by the end of the year? Is that something that’s in 2024? Later?

Luke Gromen 5:25
Well, we know treasuries coming in with Treasury buybacks in 2024. Right. So they say that’s not going to be liquidity adding, they say that’s going to be relatively small. Let’s see. So that would be you know, that was something I got wrong last year, which is I said that the Fed would be forced into liquidity to resume liquidity injections by the end of third quarter 2022. And that was wrong. That was wrong. Because Treasury did it. It wasn’t the Fed, Treasury fed, tightening Treasury yet loosen?

Adam Taggart 6:00
Sorry, let me interrupt you there. Because this was exactly my next question for you. Literally citing when you’re on the program earlier in 2022, thought that the Fed would would be forced basically to have to stop the interest rate hikes by q3 of 2020 to maybe even be forced to pivot. So my big question for you is going to be what happened? And really, back then, when you made that statement, we were under a 3% federal funds rate. Here we are today, fast forward a year later, basically, where the Fed funds rate of 5.25%. How is the system still running at a cost of capital this high given the concerns that you had flagged a year

Luke Gromen 6:46
ago? Sure. The answers not very well, right. So like I was just saying, the Fed didn’t stop. But Yellen offset more than offset Qt by running down the Treasury general account late last year, in the fourth quarter of last year, the dollar fell at a 40% annual rate. And although SQL weakening the dollar keeps the system together, it adds liquidity to the system, it adds upward pressure to asset prices. It makes FX hedge treasury yields more attractive for foreign buyers to buy. And so all of the things that we were seeing that we thought would force the Fed to pivot by the end of September, basically forced the Treasury pivot right around the end of September, maybe maybe two weeks after. So that weakness in the dollar from late September on driven by Yellen running down the TGA and no small part bought time for the system. The US banking system effectively saw severe strains in March, obviously, and the Fed once again, but it’s got a great PR, you know, this BTF p is not QE. Okay, great. They’re growing their balance sheet again, they are effectively doing a soft form of yield curve control by writing up the value that they will lend against treasuries relative to the market, they are basically capping treasury yields by BT FP. So the Fed did get involved there, they have that the BT FP numbers are still at near their highs, they have resumed they the Fed have resumed QT. And that then brings us into the into the second quarter. So we have BTF P liquidity injection calm the system down the banking system was breaking. And to be clear, it wasn’t necessarily a banking system problem. It was a treasury market problem, which was exactly what we talked about. It’s a supply demand problem. It’s a fiscal crisis, and the banks were upside down. And so the Fed could have said, Look, we’re not going to do anything. And if they wouldn’t have done anything, SVB Great. Hey, Oprah, you had 800 million and unsecured deposits or whatever she had by it’s gone. You know, billions of venture capital out there in California with you sitting in SBB. But by it’s gone, oh, you got to lay people off and bet sorry, Lam off. Oh, you got to crash the housing market is all those people sell their homes, they don’t have a job. Good. Lay them off. Now, I don’t think that’s what they should have done. But the Fed had that opportunity to do that. And, you know, I’ve always said we’re not operating at that anymore. It’s a switch off. There’s no little saw. They want to stop inflation. That’s what they needed to do. So we have this strange they come in, they paper over a BTF P etc. The second quarter. We get this. We run into the debt ceiling, which is wonderful because there’s no wish What’s the area of the crisis, it’s a supply demand prom and treasuries and the supply stops. So we al that plus AI, where we get this sort of narrative of, hey, AI is, you know, going to change the world. And I think it will ultimately change the world. But it isn’t going to change the world in the second quarter of 2023. And I think people probably got too negative, I think expectations got too negative relative to what happened given that. And so you had sort of this rally, you had no issuance, everything kind of stayed contained, and then we passed the debt ceiling, we get into the third quarter. And we have these four destabilizing things. And I think a critical moment in this whole process was June June 1, give or take, go Rosen. gearing, Rosenzweig came out highlighted us shale is starting to roll over, and it’s going to roll over in the back half of this year. And so the Fed and and the White House, they can play all these games they want, they can’t print oil. And so now while prices are starting to rise on them, and these other issues are starting to hit. So I think that is sort of the the sequence of events that you know, from from last fall where yeah, they weaken the dollar, they bailed out the banks, there was no Treasury issuance for a good chunk of a quarter. And you know, now all those things are going the other way. Here we are.

Adam Taggart 11:28
All right. Great explanation. I’m curious, just building off of what I said in the intro here of how high of a deficit that we’re running. You know, we’ve got the spending from the inflation Reduction Act, it’s now finally coming into the mix as well. But we are, you know, I think we currently have a 1.6% as our 1.6 trillion deficit right now. You just mentioned that the Treasury announced this go borrow like another 2 trillion in the second half of this year. I imagine just the general kind of excessive deficit spending also kind of helped buy some time, sort of another form of stock liquidity out there in the system. True.

Luke Gromen 12:14
Yeah, it’s it’s helping to inject liquidity into spending in liquidity into the system on some level, you know, particularly in a time when there’s there was no issuance on the other side of it. Right, right, of course.

Adam Taggart 12:28
So I’ve mentioned this a couple of times, I’d like to get your thoughts on it a couple of times recently on this channel. So we have the Fed, just jamming on the brakes. Right, that’s what’s trying to do to get inflation back down to 2%. Right? We have the banking system, putting its foot on top of the Feds foot, they’re continuing to press the brakes even harder. Banks are doing that, because they’re tightening lending standards, not necessarily because they care about inflation. They just, they’re fighting for survival. They just want to have less bad loans, right, given their fragility right now. But on the fiscal side of things, we’re jamming on the gas, right, like, what are they? How long can that persist for before you start creating undesirable consequences? And to a certain extent, the Fed has got to be looking at the fiscal side of things and saying, Guys, what the hell? You’re undoing everything I’ve been trying to do for the past year. Right. So can you comment on that mismatch right now between fiscal and monetary policies?

Luke Gromen 13:34
Yeah, it depends on what side of the house you’re on right as to what’s undesirable, right, what’s normal for the spiders chaos for the fly. And so when you hear the US government saying, we have these geopolitical goals or imperatives in Europe, with Russia, etc, when you hear the US government say we need to move away from China, we need to reassure our productive capacity. We cannot produce shells, to support an industrial full war with a major power. Because our base, our industrial base has been so hollowed out over the last 25 years. You need to spend, you need to inflate you need industrial policy, you need all those things, all that fiscal that has to happen. So the DoD is like, hey, great, do it. Treasury is saying hey, you know, I’ve got you know, I need the strong dollar to try to place this paper and the Fed saying, hey, I need you know, I need I need low inflation because otherwise, you know, Jerome Powell, his legacy is going to be destroyed and the Feds credibility is going to be destroyed. Look, the last 30 years the winners have been the Fed Wall Street and China. Not the Mad America. DOD is like listen, we can’t fight a war. We’re borrowing Money from China to build weapons made in China. You know, with components made in China, this, this doesn’t work. And so it really comes down to, you know, the Fed and Treasury are trying to preserve the strong dollar for the primacy of the bond market. It’s no longer in the interest of America. Or if you if you want you, you and I tweeted about this yesterday, you can have one of two things, you can have a strong dollar, low inflation, low rates, in which case, you are not going to be able to pursue the geopolitical policies that America is trying to pursue. Namely, the United States will need to buy components from China to build a weapons to encircle China, if we have a strong dollar. If we have low inflation. If you think that’s a bad thing, then guess what the bond market has to get killed on a real basis in inflation adjusted terms, because what has to happen is we run 1012 15% of GDP deficits, and the Fed makes noise and tries to tighten blah, blah, blah, blah, blah, until rates get too high. And once rates get too high, the Fed faces a choice. Dear Jerome Powell, do you want to keep raising rates and keep money tight, and forced the US government to make 40 to 60% cuts now permanently, permanently to defense and entitlements? Because those are the only two things you can cut other than Treasury spending, to stop those deficits that matter, and nothing else matters. It’s entitlements, interest defense in that order. So Powell, do you think your legacy will be helped by cutting entitlements? And by cutting defense tomorrow, permanently by 40 to 60%? Which is what Stan Druckenmiller estimated, needed to be cut in his presentation out at USC a few months ago? Or are you going to do your job in situations like this the job that the DoD wants you to do, which is buy the paper, Cap yields, do QE finance it and do what’s best for America in the long run, rather than what’s good for bonds in the short run and good for Wall Street in the short run? And that’s, that’s the decision. That’s what’s that’s, that’s some version that’s gonna play out over the next couple years.

Adam Taggart 17:19
So where does inflation and cost of living fit into all of this? So in other words, you know, if the deficit spending keeps going on for as much as it is, that is inflationary, right. The average person is feeling the pain pretty strongly right now. It’s a big part of what’s driving Powell to protect his legacy. I don’t want to be the Arthur burns that just let inflation run wild, right. The administration has, I’m sure, you know, they want to please the defense industry and deal with some of the things that you were talking about, but at the same time, they want to get reelected. Right. You know, they don’t they don’t want to be going into the voter booth with inflation. resurging, right? So, yeah, there just seems to be so many crosscurrents here, I don’t really see anybody can kind of have their cake and eat it too, no matter which policy they pursue.

Luke Gromen 18:09
No, I mean, it really comes down to look for the last 40 years, bondholders and Wall Street and China won, and Washington DC. That’s we got Richard, and then the working class, the middle class America got poor. And we have to decide if we want to continue that to its natural terminus, which people in the Rust Belt of America can tell you is we can’t buy anything from China. Right. So that’s the part I find that the coasts of this country don’t recognize that, in particular the East Coast that China can win, China has won in the middle part of this country. And that was part of the country need to decide do we want to retain the real value of our bonds? Or do we want to actually compete and the outcome to that if they decide they want to compete? Is that the yes, it’s going to be wildly inflationary. Yes. If you own a lot of bonds, you’re gonna go from wearing diamonds to wearing cubic zirconia to wearing cracker jack and a string. You know, you’re gonna go from eating blame and blame Mignon like you have for the last 40 years to eating dog food. Sorry, like that. It goes the other way. The flip side is the people that last for the last 40 years. US middle class us working class, they’re going to win, right? quote unquote, win. Yes, inflation is going to go up but look at you know, everybody’s got a 2.9% mortgage if their wages go up 15% A year are they winning or losing?

Adam Taggart 19:52
All right, I’m gonna want to dig into this more with you. But let’s, let’s keep going through through this arc here. So still staying at a relatively high level, you have, I think for a good long while now, you know, beat the drum of the global sovereign debt crisis, right? We’re basically, you know, countries are getting to a point where the cost of servicing their massive piles of debts really become constraining, just for the general operation of the nations themselves. For I remember correctly, you said the US what is it? It’s either like, you know, get get busy defaulting or get busy inflating. I think what you said right from members,

Luke Gromen 20:37
like That sounds right. Yeah. From from Shawshank Redemption. Yeah, yeah.

Adam Taggart 20:42
So, you know, we’ve talked kind of about what’s happening right now in this moment in time. But But zooming up to a very high level for a second. Where are we in the timeline of your global sovereign debt crisis? Your your from a family of baseball players, you know, kind of what inning are we in? And where do you where do you expect this to go probability wise, but both us but also relative to the major other major powers? Yeah,

Luke Gromen 21:08
sure. I would say we’re probably in the seventh inning, maybe the eighth inning. Wow. So wait, okay. And the reason I say that is is quietly in the first half of this year, fiscal first half, right. So that is for q 22. Calendar for q 22. Calendar one Q 23. Those six months of the US government’s fiscal year after mean that would have been six months of tightening is the starting period that maybe seven of the Fed tightening, and with rates way lower than they are today, by the way, and before the effects of those tightening has really been felt which is starting to be felt. us true interest expense entitlement. And Treasury spending was above Treasury receipts, the US government on a full year basis after just the first six months of tightening before all the effects really were felt. And before they’re in the interest reset was fully done. was already in a position where the US government couldn’t afford what’s effectively its true interest expense out of tax receipts. You’re done. And that’s like, I’m fascinated to see people say, Well, I want to buy long term debt here. Okay, great. But to me, long term, treasuries, long term, really any debt? It’s like picking up nickels in front of a steamroller. I mean, you might get some and maybe it’s maybe you have a trade. I don’t have an opinion on that. But you don’t do well, in this business long term picking up nickels in front of a steamroller. The US government can’t make its interest payments. Without the Fed printing the money. I get involved. And that’s, that’s why I say we’re in the cemetery thing. Like that was that was it’s almost September, so that was six months ago. So yes, stocks are up in the second quarter. That’ll buy you some time on the receipt side. Now with that said, April, May receipts were friggin disaster. So on a trailing 12x amount of trailing three month basis. Year over year, US Treasury receipts were down 20% Through Matt only been I think three other times in the last 23. last 40 years. They’ve announced 20%. Year over year.

Adam Taggart 23:18
It was sorry, interrupt. I’m just curious how much of that shortfall is because my state has pushed out its tax payments until bill I can’t remember exactly when but later this year?

Luke Gromen 23:33
Yeah, like October, that’s got to be a good chunk of it. Right. So if you think California is 15% of payments. So if you assume that California was flat year over year, which is a heroic assumption, because California is very California’s income is very asset price driven and asset prices had a disastrous 2022.

Adam Taggart 23:54
It’s very true. Yep.

Luke Gromen 23:56
So if you make the heroic assumption that California was flat, which your budget would tell your own budget to tell you, there’s no friggin way. Given what the deficit out there has done, they would still be down five, right, that would give a key so it would have been down five, so it’s probably down eight to 10. With California, you will see a pick up a little bit later this year. But the the bigger point is, is that we also haven’t seen the interest expense interest is going to keep resetting and keep resetting and keep resetting. And the more of the long end goes up, receipts are gonna, you know, receipts are gonna fall and we’re in sort of a Mexican standoff on the housing market, right where people that are in 2.9% mortgages don’t want to sell those will. I don’t know when but that you know, unless you get much lower rates. Those will reset lower and tax receipts will keep it so you’re it’s only the one piece of good Tupiza good news, California you’re going to have a one time benefit Assuming they don’t give you guys another break with these floods and stuff. And then number two, you did have, you know, markets are up here today. And so all else equal if they can keep markets up, that’ll help, that’ll help as we go to next year. But sort of everything else, it’s only going to get worse.

Adam Taggart 25:22
All right, and it’s only going to get worse under current trajectory. Now, there’s a lot of people just to your point about bonds, and we’ll talk more specifically about bonds in a bit. But you know, on the bond side, they’re saying, Oh, I agree with you look like it’s gonna get nasty. And as soon as the Fed is able to, like, once it feels like it’s got inflation under control, it’s going to pivot, right? Or these higher rates are going to in lack of inflows, they’re gonna, they’re gonna start causing some bigger systemic breakages that we’ve seen to date, and whatever inflation is that Feds gonna say that Sorry, I gotta, I gotta forget that battle for a bit. I gotta save the system. And we’ll pivot. So you know, I think the argument for people that are that are piling into long bonds, which in your opinion, right now is going after nickels in front of the steamroller. They would say, and I’m not saying you have to agree with them. But I’d like to hear your response. They would say, No, no, we just we know that this system, the higher rates are going to win at some point in terms of breaking the system and the Fed is going to be forced to pivot. And that’s why we’re piling into the long bonds because we want to ride the reduction in yields, once the Fed starts buying.

Luke Gromen 26:34
The problem is oil is at $5. And us shale is rolling over and US shale has been 90% of global production for the last 10 years. Energy inflation will explode higher if they pivot. So yeah, I mean, you could probably make money doing it. They might they might be right. But like, to me, it’s such a suboptimal expression. I would much and that’s gonna shark,

Adam Taggart 26:55
can you just explain why the Fed pivot? Would it cause energy price inflation to skyrocket?

Luke Gromen 27:00
Oh, yeah. Because because you’re gonna be stimulating the economy in by cutting rates into into declining oil supplies. Got it? Okay. Yeah, so now, you know, it’s, when I look at that I hear I said, Okay, great, what warm bonds do you want to own if I told you oil is going to be you know, 120 under that scenario? And the answer is probably not. Because if you look at inflation breakevens against oil prices, it’s like, you know, five, five year US inflation breakevens against oil, it’s like perfect correlation. And oil is going up. So it’s like and and Powell and the White House SPR releases have broken us shale and US shale was 90% of oil production growth. Over the last 10 years. They don’t know what they did. They don’t realize that it was it was I recently called it the piece de resistance of Pennywise Pound Foolish policies after 35 years of Pennywise Pound Foolish policies.

Adam Taggart 28:00
Okay, and just to kind of pile on that particular worry spot. You know, we’ve had oil and natural resource specialists on this program, a fair amount. And they have all said that we have under invested in capex in this space for a long time anyways. But now in the past couple of years with the whole, you know, green, green movement, whatnot, the fossil fuel companies have been getting the message from Washington, like, hey, we kind of want to put you guys out of business. So they have a, they’ve had a real disincentive to continue to invest, because they don’t know if they’re going to what the conditions are going to be like for them to get a return off any big investments they’re making today. So, you know, as Rick Rule has said several times in his program, he’s like, even if demand just stays flat for the next decade, which it won’t, it’s going to go up. But even if it just stayed flat, we are already going to have pretty big shortages of a lot of these will certainly oil but but a lot of other key resources, because of decisions made 510 15 years ago to not invest, right. So it’s just going to compound what you’re talking about likely to compound what you’re talking about.

Luke Gromen 29:16
And this is this is why it’s so destabilizing. Is Yeah, if you look at US oil prices relative to five year bond breakevens, you know, your your inflation breakevens, right. They’re like one to one, they’re very tightly correlated. So oil goes up. Bonds are going down like that. That’s the end. So that’s the issue. So you know, and we had some control over that while we had a shale industry. But thanks to Powell, and thanks to Biden, they just put a bullet in the shale industries ability to grow production for the next two, three years. So guess who’s in charge of oil now for the next two to three years? Who What do you think he wants to do? The US bottom line Do you think he wants the US bond market to have a good time?

Adam Taggart 30:02
Yeah, no. Got it. And just for folks understand the reason why I talked about how the administration is sort of sending signals to the oil industry that like, look, you know, we want to try to replace you guys over time with green alternatives. Reason why you’re mentioning how killing the shale fields as I understand it, is it really what enabled the shale revolution to happen in many ways was the cheap credit. Yeah, there were three things

Luke Gromen 30:29
to show, right? It was it was the lab steerable lateral technology that really allowed productivity to rise, it was expensive oil, which was a bunch of cheap money, and it was cheap money. You know,

Adam Taggart 30:43
money’s gone. Yeah,

Luke Gromen 30:44
that’s the cheap money’s gone. And there’s some geological issues here as well. You know, the, the, the, the A locations are largely gone at these price ranges of oil, you ate at the a fracking locations, you’re down to your B, and C, fracking locations, that they just aren’t as productive, which means you’re gonna make even costs go up. So that’s, that’s the connection that most there’s, you know, part of what I do with FFTT is trying to go across silos, right? There’s silos. And so there’s like the silo bond world that’s looking at, you know, back to your original, your original question of like, what would I say to them? They’re in their silo. And they’re saying, Yeah, hey, every other time they break something, then people bid the fonts. And the people are over here in the energy silo, we’re going, guys, like, there’s no friggin supply growth like, and, you know, something we’ve noted, historically, and I said 90% of global oil production growth roughly has come from shale over the last 10 years. So if we take that offline, if they just stopped drilling us shallow shale is going to pull like 20 to 30% annually, after a bit of a lag. rig count has rolled over, the thing that the people on the bond side aren’t getting is that the worst recessions in history going back 70 years saw global oil demand fall by 4% 1980. as nasty as that recession was global oil demand only fell for in 2020, we shut the friggin economy down globally, basically, global oil demand fell 8%. And I just said 90% of global oil production growth over the last 10 years is going to fall 20 to 30% on a sustained basis. This so they the energy silos going, guys, guys, hello, McFly. And the bond guys are like, hey, they’re gonna break something. And then and they might be right. As I say it’s a trade, it’s picking up nickel in front of a steamroller, because they might very well be right. And then entered the energy silo is going to take over and enter is going to be 151 6171 80. And like, there’s no long term bonds you want to own if if I said oil is going to be 150, a year from now, which would show me the list of long term bonds, you want to own the answers. None of them not at these yields.

Adam Taggart 33:00
All right, got it? And I think you just answered this. But but there are people that would raise the question, Well, okay, look, if these if this high cost of capital, these high rates gets to the point where things are breaking. Right, and we finally, you intimated this earlier, but I would love to talk about it with you. But we finally start really seeing the lag effects arrive in full force. Right, a lot of the stimulus that you and I talked about earlier, right, that came from the Treasury and the deficit spending this year that the stimulus that wasn’t really on the radar in 2022, right? It pushed out the recession that everybody thought was going to come right. But did it? Did it? Did it dissipate the recession? Or did it just push it off into the future? I think you would say correct me if I’m wrong, it just delayed it, the lag effects are going to come they’re going to they’re going to be big and real. So could that throw the economy into a substantial recession? And if so people would say, well, that will bring down demand for oil, and we won’t have to worry about high oil prices. But what I just heard you say is is like man, I really I mean, recessions don’t necessarily knock oil demand down as much as you think. Then again, you know, the relationship between demand and price and oil sometimes is a little wonky. So anyways, what are your thoughts on all that?

Luke Gromen 34:20
It would depend on the speed of the recession versus the speed of the decline in oil supplies. Right. So ultimately, the decline in oil supplies is going to win. But initially, absolutely, I mean, we saw that in in April 2020, oil prices went negative. That that that kind of thing can happen. But it’s not sustainable. For a number of reasons. And this, this gets back to the point to that I think, on the bond side people aren’t paying enough attention to is the US net international investment position. Right. So let’s say they’re successful in getting oil prices down. Let’s say they fight inflation, they get the dollar up. Well, the dollar going up is going to force, foreigners around the world as we are seeking to sell dollar assets to buy dollars to get dollars to serve us dollar denominated debt, well foreigners own seven and a half trillion in US Treasuries. And we know the US Treasury needs to place just short of 1.9 trillion in the second half of this year alone. Who’s the buyer? Who’s the buyer for that amount of paper? Not the banks anymore. They were buying they in the Fed, were the buyers for the last two, three years, banks are out Feds out. So what are we gonna do? Simple, we’re gonna find the rate where there’s buyers. But that’ll make bonds go down. And that’s like, it’s literally happening on people’s screens, and they just refuse to believe it. Yeah, because it’s never happened this way before, because they’re ignoring the net international investment position. Another thing that people are missing is that up to 2008, the US net international investment position was never more than negative 10 to 12% of GDP. In 1989, when Japan blew up right up peak and rolled over us net international investment position was negative 2% of GDP. US debt to GDP was 50%. US debt to GDP is 120%. And the net international investment position is negative 65% of GDP, means foreigners own $18 trillion net, not gross net of assets, they can sell if the dollar gets too strong, and they will sell them and they are selling and when you need cash, what do you sell? You sell what you want to sell what you can what can you sell? Right, here’s the seven and a half to go. So I’m gonna have trend,

Adam Taggart 36:42
downward pressure from the sales? Let me I hesitate to ask this question because it opens such a massive door that we don’t have time for in this discussion. But your your, your good thought opponent on Twitter. Brent Johnson, you know, has the dollar milkshake theory, it’s actually been a good while since I’ve talked to Brent. So, you know, he may have evolved his thinking, and I may be unaware of it. But from previous conversations with him, you know, he has said, look, a lot of those same issues are going to be impacting a lot of other countries as well. And, you know, if there, if there is a global recession, if there are hard times, you know, a lot of countries are in even worse shape than us. And when people get scared of both you have the Euro dollar dynamics that are pushing capital towards the US as Euro dollar loans, start defaulting or whatnot. But, um, but he would generally say, Yeah, you know, in times of panic, capital runs to safety. And even though there’s lots of issues, you know, are there better deep liquid markets out there than US Treasuries? And, you know, a lot of the concerns you’re talking about still get just sort of washed over by just panic capital around the rest of the world flowing in rather than net selling our treasuries. What were your

Luke Gromen 38:06
goals already here? That’s that’s the net. He’s been exactly right. When I say the net international investment position in the US has gone from negative 10. And oh, eight to negative 70, you know, two years ago. That’s, that’s the capital flowing here.

Adam Taggart 38:22
That’s that flight to safety has already happened. It’s all here. Now. It’s all here.

Luke Gromen 38:26
It’s all here. We’ve been hocking our family silver for, you know, cheap stuff from China. So I think one of our primary disagree now he will say, well, relative to others. Yeah. Look, if you want to structure like he will say. The others are in more trouble. Yeah, exactly. And I totally agree. What are they going to do? We’re my, where our views disagree is? Yes, others are more trouble. What are they going to? Do? They need dollars? Yes, we agree. Okay, what are they going to do? They’re going to sell their dollar assets. Like, he keeps saying the capital is going to flow here. Yes, some capital will flow here. But I met there is no capital to flow here. It’s already here. And they need dollars. They don’t need apple. They don’t need treasuries, they need dollars. And so they will sell Apple and treasuries and real estate, etc, to get those dollars. And you can see this unwinding in the other direction. Number one, you can see it in the net international investment position since 2021. It’s gone from negative 70 to negative 65. So literally December of 21. It was negative 70. It’s now negative 65. So just unwinding five points of net international investment position as a percent of GDP. Look what it’s done to the Treasury market, right the worst year in the treasury market. We the worst bond market in 150 years last year. That was five points. Now we have another 65 points to get back to where we were in Japan. The Fed crashed the front brakes way before

Adam Taggart 39:57
that. Okay, great. And on that point, I I’m gonna share my screen here for a second with a chart that you tweeted out the other day. Can you see the chart here? Look?

Luke Gromen 40:08
Yeah, full credit to that goes to Mike Green at Prof. Plumb, Bob Elliott retweeted that it was a piece from a piece that Mike Green had publicly available over the weekend. But yeah,

Adam Taggart 40:21
okay, so this shows what you were talking about. And it really, you know, it visualizes the, the sea change that’s going on here that you were just talking about. So is there anything else on top of this that you want to mention? Because you’re right, I mean, right now, the Treasury market is, you know, it’s revolting.

Luke Gromen 40:46
And it’s gonna keep from all the beatings in the treasury market at the long end are going to continue until the Fed until the dollars weaken meaningfully will stop, that’s it, you weaken the dollar treasuries will get better, but if you weaken it too much, that’ll create a problem too. But for the moment, the beatings in the treasury market will continue until the at the long end until the dollars we can meaningfully. To me this chart, I tweeted about it this weekend. This chart shows you when the US went into fiscal dominance when the market began, forget about when the US went into fiscal dominance. This chart shows you when the market began discounting the US going into fiscal dominance, which is the US can’t pay its debt without the Fed printing the money.

Adam Taggart 41:30
Okay. So I mean, this, this is a big deal, in the way in which you’re, you’re portraying it. There’s an old term from the 80s that we hadn’t heard for a long time, but you know, the bond vigilantes, right, it’s when the bond market kind of wakes up and says, Hey, you know, I don’t really believe what you policymakers are selling me, and I’m going to start taking yields, you know, higher, because I want to be compensated for the greater risk that I see in the system. And so, you know, basically, that’s what you’re saying, and is going on here.

Luke Gromen 42:07
Well, I would I would add, I would add that I think, you know, when these two lines were running together, those what the bond vigilantes are telling you right, now, they’re telling you, the United States is Argentina, because what they’re telling you is the rates are going up, and US government can’t afford that they’re going to print the difference. So what do you do when structurally, you know, I’m not talking about making a trade for bonds here, there, I’m talking about you run $200 billion, your sovereign wealth fund. And the United States starts raising rates like that. And you do the math, it’s not hard math at sixth grade math, that’s times rate, times whatever else they’re spending on time’s receipts, you make a pretty basic adjustment about the interest rate sensitivity of the US government and their tax receipts. And you go, they can’t afford those rates without printing the money. When you’re running, you know, you want to run 200 million and you want to try to trade it Hey, God bless you. Good luck. You run a 200 billion. You know, what you do? You buy stocks, you buy stocks, and you sell bonds, just like that chart shows, because stocks will hedge your inflation and bonds will get killed on a real basis. That’s what that chart is telling me.

Adam Taggart 43:18
Okay. All right. Just to let you know, I’m only on bullet number three of like, 15 that I we go for a bed, we’re good. It’s a sign of a great discussion. So well, let me wrap a couple of questions together here. How much higher? Do you see him going from here? In let me kind of wrap into that to how how likely do you think it is that the Fed will win the inflation war? Right? Because once the Fed has inflation down to 2%, it’s got a lot more leeway. Right? But inflation is still sort of sticky, right? It I’ve sort of brought up the Pareto Principle, we’re presumably maybe the the easy 80% Spend done now. It’s the hard 20. Right. So inflation and knock on effect of interest rates, you know, what, what do you think?

Luke Gromen 44:21
How so? Do I think they will be successful getting back to two? No, I think there’s a reason why Jason Berman, who was Obama’s Chairman of the Council of Economic Advisers in the Wall Street Journal with an op ed today saying we should the Fed should increase their inflation target to three

Adam Taggart 44:38
to three and just call it done. Mission accomplished. And Paul

Luke Gromen 44:41
Krugman saying, hey, it’s a good idea to just go to three. Thank you. March told us, they can’t go to two unless they’re willing to stand aside and let the banking system come unhinged. And let the Treasury market really dysfunction and if they’re not willing to do that, And then they’re not going to probably not be able to get back into.

Adam Taggart 45:05
Okay, so just to be clear, do you think that we are in a secularly higher era of inflation looking out over the next decade plus than what Americans have been accustomed to for the past couple of decades?

Luke Gromen 45:17
Oh, my God. Absolutely. Like, yes. 100 times? Yes.

Adam Taggart 45:21
No brainer. Okay.

Luke Gromen 45:22
It’s a no brainer, right. Like, I mean, you know, the article yesterday in the Wall Street Journal, you know, for now, the 40 year run of China’s economic miracle is over. Great. Maybe, maybe not, let’s say it is. What’s the correlate of that? Right. 40 year run of Chinese disinflation to the US bond markets over?

Adam Taggart 45:45
Right. No more cheap stuff. No more cheap services? Yep. Yep. Okay. Yeah, exactly. Alright, so similarly, on the cost of capital side of things, interest rates, they were talking, I think the tenure is what like, four and 4.3% or something like that. We’re like five and a quarter, like I said, on the federal funds rate. The Fed is is guiding us that they’re almost done, maybe maybe even done cutting. But but they’re keeping the door open for at least one more rate hike. Do you think that that’s likely do you think Nope, this sucker is going a lot higher for a lot of the issues that you’ve mentioned at the beginning of the discussion here? Or, you know, do you think they they move the inflation target to 3% Mission accomplished, now we can pivot?

Luke Gromen 46:38
I think they probably go higher. And the reason I think they go higher, and it’s ironic, it’s going to ultimately completely discredit them. raising rates is going to discredit them. But the reason I think that is I think they’re losing control on oil, oil, I think it’s gonna go 8590 100 105 Whatever. And I think II with that with the with the easiest comps behind you tougher comps coming on inflation, you’re gonna start seeing inflation pick back up. And the US has no ability to control it. shales rolling over SPR, who knows where that is, but, you know, they’ve largely run that down. That’s

Adam Taggart 47:24
it. I’m starting to inject just make sure we understand is your confidence that oil is going to go higher in the relatively near future? Are you tying that specifically to Fed policy, meaning the more expensive it is to borrow, the harder it is for drillers to drill? You’ve already talked about productions decreasing too. So that’s making things even worse. But is it sort of a direct relationship between cost of capital and output? Is that Is that why you’re so confident that if they did keep hiking shells?

Luke Gromen 47:54
Yeah, I had a conversation with a friend of mine gray beard was, you know, trading Eurodollar markets in the 70s. And he goes, Luke, what’s going to be really interesting is when it starts happening, if they go too far, you’ll get what you had in the 70s, which is look, finding and exploring and drilling for oil is risky, and capital intensive. There’s a high cost of capital and an administration that doesn’t really want you to do it. So if you’re an oil producer, why go through all that hassle when you can just take your cash and put it in treasuries for three months at six? Exactly. Yeah. I’m not drilling, I’ll make 6% risk free. Except if they all start doing that. Oil production is gonna fall 20 30% a year in the in the US. And guess what is bad is China is China as well. oil imports are rising double digits. They’re on separate another record year of oil imports, India’s oil consumption, where India is booming

Adam Taggart 49:01
is what I hear. But that’s all coming from cheap Russia supply right.

Luke Gromen 49:06
Another own goal by the US administration. Indian oil consumption is 1/15 of the United States 115 With three times the population. China’s is still only 1/5. And they’re the biggest oil importer in the world. And the Fed is encouraging shale to not drill and we’re the biggest marginal producer over the last like it is not well understood that the US ran there was a gambit raise rates, strengthen the dollar cap oil, the SPR and hope Russia breaks before us shale rolls over and ready with banking system breaks. And yes, Russia is hurting. Yes, the ruble is down to 95 You know, up from 100 but it went back back that 100 Whatever. Russia is not breaking Like, yeah, shale rolling over. It’s very inflationary, very inflationary deficits are inflationary. China, US sort of the cheap stuff from China. deagle was all this, like, everything is on one side of it. And everybody just wants to buy long term bonds, because for 40 years buying long term bonds work, I don’t, I don’t understand it.

Adam Taggart 50:19
Okay. All right, well, we’re gonna get in a moment to what you like, one thing I just want to mention on this whole shale thing, because it’s another kind of nail in the coffin, in terms of supply is shale wells deplete asymptotically, unlike conventional wells, which deplete on a bell curve, right, so conventional oil well, has a much longer lifespan, there’s this thing called the Red Queen syndrome, where where you’re drilling for shale oil, you have to keep drilling more and more to keep production where it is because your early wells are just asymptotically running out of supply. So it just means to your point, like when when we compromise production, it falls off much faster in the shale field than it would you know, say back in the 70s. When we we were

Luke Gromen 51:07
having if you’re or if you’re Russia, or if you’re Russia’s oil production, right? Or if you’re Russia is exactly the major flaw in the whole US policy. And it’s it’s fascinating, Adam, nine out of 10 discussions I have with people on Twitter or et cetera, that want to buy bonds. They say, well, the US is the biggest oil producer in the world. And that’s the extent of the discussion. Like no, no, you don’t understand the geology. What do you mean? They don’t understand that geology. Most of these bhanwar don’t understand that geology. If they did, again, it says siloing right. The oil guys are like Hello, McFly. There’s a problem coming here. And the bottom guys are like no, no, deflation is coming. Great. Let me buy the long end. Yeah, might be a trade, there might be a trade there. But like, if nickels in front of steam

Adam Taggart 51:53
well, and we’ve talked about this a lot over the years. I mean, you have people that kind of look at they’re in the feds, probably the most guilty of this anybody else. But they look at the economy or certain elements as closed systems. And they don’t look at them as the other systems that they depend on to work. So why is Luke spending so much time talking about oil industry? Well, because without energy, you cannot power an economy.

Luke Gromen 52:18
That’s exactly it. And that is a major, major oversight. And for a long, long time, dollars equal energy dot, you know, treasuries equal energy. And we are seeing in real time that disconnection between the dollar and energy and treasuries and energy, you’re seeing people circumvent that right when China says, Hey, we just signed a 27 year LNG deal with the UAE or with Qatar, excuse me. And then they sign a second one. Like the way the world worked from 19. Sheet 1971, at least up until recently was China sells crap to the US US cents dollars. China takes the dollars, they buy treasuries and they pulled those treasuries for a rainy day when they need to buy LNG. Right. Now, what are they doing? They’re going straight to the source and going here, you take the dollars, and you promise us we will rebuy a 27 year supply of LNG, and then we’ll do it again. Because we would rather own a 27 year supply of LNG in the ground than we would the equivalent amount of treasuries they’re telling you what’s happening, people just refuse to see it. And that then looks over well who buys those treasuries. But thanks well, who buys them if the Fed the banks don’t know buddy, the rates go up until we figure out who’s gonna buy bread we hope that that rate that clearing rate doesn’t bankrupt the US government. Oops, receipts are below true true interest expense already, that we’re so I would say we’re on the seventh day then.

Adam Taggart 53:54
So do you see us then? Is the Japanification of the US inevitable at this point?

Luke Gromen 54:01
Do Yeah, but it’s gonna Yeah, the Japanification of the US is going to feel like the Argentina is Asian.

Adam Taggart 54:07
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