BTC101: Macro Overview 4th Quarter 2022 w/ Luke Gromen

The Fed's rate-hiking campaign was justified publicly as fighting inflation, but Gromen has upgraded his estimate from a 5% to a 50-70% probability that the Fed is actually weaponizing the dollar against Russia and OPEC to break oil demand, based on the pattern of the Fed not responding to market dysfunction in treasuries, gilts, and mortgage markets the way it did post-2008.

“if you would've asked me in April, Luke, what are the odds that what the Fed is doing is not purely about fighting inflation or if it is about fighting inflation, that's actually code for, 'We need to break oil, we need to break Russia, we need to break the world to break oil demand, to break Russia,' I would've assigned a 5% chance to that maybe... What has proceeded with sort of each passing month and in particular after August... I couldn't help but notice they're not jumping in to fix it... the more, in my own mind I was thinking, 'Well, maybe it's not a 5% chance... Maybe it's 10. No, maybe it's 20.'... And then really post August... it would've gone maybe at that point it's up to 10, 15%, 25% chance, I went 30, 40, 50. And I think now we're really at this level where it is my base case. I think it's 50, 60, 70% shot.”

The Fed has lost 720 billion year-to-date on their bond portfolio via mark-to-market accounting, which likely exceeds the entire hedge fund industry's capital, meaning hedge funds cannot sustain similar losses and must exit positions, forcing them to sell treasuries at prices the U.S. government cannot afford.

“I saw last week that mark-to-market the Fed has lost 720 billion year to date on their bond portfolio. There's no hedge fund… I don't know the numbers, but I would suspect that's probably close to as big as the entire hedge fund industry. They can't take that, right? So they have shareholder or they have general partners, they have to make money.”

Between loss of liquidity in the U.S. treasury market or unemployment catching Fed attention, the treasury market problem arrives first because the treasury market is already experiencing dysfunction and will worsen almost without fail unless the Fed steps in with QE, while unemployment effects lag.

“Oh, it's the treasury market. It's the treasury market. This is a weird cycle... I think the treasury market already has an issue and it's going to keep getting worse and it's going to keep getting worse almost without fail for a number of things we've talked about already, unless the Fed steps in with more QE.”

The three-month yield at 4% exceeding the 10-year yield at 4.14% (13 basis point inversion) is an extreme signal that the Fed has overdone rate hikes, but this signal may not apply given inflation remains elevated and hasn't broken below the volatility range that generated 8% CPI.

“I'm looking at the chart right now. The three month yield is at 4% right now. The 30 year is at 4.1. That is crazy. I'm curious what your thoughts are. So I had a lot of people tell me that when the three month exceeds the 10 year, which the 10 years at 4.14... you're only 13 basis points of the three month exceeding the yield on the 10 year. And I've had a lot of people tell me that is a really strong signal to the Fed that they have totally overdone it”

Germany's PPI (producer price index) is 40%, indicating that when final consumer goods prices adjust, German inflation will remain elevated unless energy prices fall or energy supply increases, meaning German industry is collapsing in real terms and the euro is in structural trouble.

“I mean these are very tensed tectonic plates... PPI in Germany is what? 40%?”

Japan has 16 months of import coverage in FX reserves and is attempting to manage a two-front crisis: saving the bond market (JGB 10-year yields breaking multi-year highs, with some days showing no trading at all) and saving the yen (which has been crushed), by alternating between yield curve control and currency intervention.

“I mean, I think they are in the same two horses, one has problem where they've got to save the bond market, they got to save the currency and maybe they're taking turns trying to save one and then not the other... I saw last week I think that the JGB 10 year didn't trade for three or four straight days, right?... the second biggest bond market in the world if I'm not mistaken... the Japanese have 16 months of imports in reserves”

April 2022 Gromen predicted Fed would stop hiking by end of Q3 2022 (September 30) due to treasury market dysfunction forcing reversal, and this prediction proved accurate as treasury secretary expressed concern about illiquidity and gilt market broke—demonstrating that breaking things was the correct prediction even if weaponization motive was uncertain at that time.

“Back in April I wrote a report, I think it was April 27th. The title of the report was Why we think the Fed will stop hiking rates by the end of 3Q '22. So September 30th, 2022... My best guesstimate back in April was that by the end of September we were going to be seeing enough treasury market disfunction that they were going to get pulled back in.”

Putin's June speech (not covered well in Western media) explained that Russia cannot sell finite oil production for paper that devalues at 8-10% per year against energy because this would lead to Russian collapse and starvation; therefore Russia's 'red line' refusal to accept depreciating currencies for oil is a national survival constraint, not geopolitical posturing.

“Putin actually gave a speech in June and it was not covered well here of course, but he said something along the lines of they are printing, they're devaluing. There's seven and a half trillion in FX reserves that are devaluing by 8 to 10% per year. And that's the whole fundamental argument of gold, Bitcoin, right?... he is pointing out that you're asking me to sell my oil for paper that is going to fall, again in oil terms, by 8 to 10% per year. And he can't do that because his country will collapse.”

The U.S. policy response to oil price concerns should be industrial policy (building refinery and energy infrastructure, funded by Fed money printing), not rate hikes or price controls, because fighting energy inflation through monetary tightening is self-defeating when the U.S. is energy-constrained.

“the economic stuff is not going well. We're not winning. The sovereign debt side is not winning. Energy is winning, number one, which suggests the policy response shouldn't be Biden getting angry and talking about the refiners cutting prices. It should be industrial policy, Fed-funded, print the money and build the infrastructure and screw inflation. Let it go. Who cares? Screw the bond holders.”

Baby boomers are unusually inflationary (contrary to standard economic theory that aging cohorts are deflationary) because they accumulated $35 trillion in net assets through government policy that sterilized deficits into asset markets since the 1970s-1980s, and COVID wealth creation followed by mortality anxiety has created a 'YOLO trade' where they are spending down assets into real consumption faster than usual.

“the boomers are extraordinarily inflationary... because of their $35 trillion in net assets... acquired... in no small part policy that really began being implemented in the '70s and definitely in the '80s was US government deficits were sterilized in asset markets... they made whatever for 40 years... they could take 15% of those X dollars and put it into the asset markets... we don't count asset inflation as inflation, right? That was inflation... fast forward 40 years, these boomers have $35 trillion net assets and then you scare them... they're going to die way sooner than they thought... you've got 35 trillion in assets and a generation that is putting on the biggest YOLO trade in the history of the world”

Japan's JGB (Japanese Government Bond) 10-year did not trade for 3-4 consecutive days recently, indicating a liquidity breakdown in the world's second-largest bond market, which is trading 'by appointment' and no longer functioning as a continuous market.

“I saw last week I think that the JGB 10 year didn't trade for three or four straight days, right?...it's trading by appointment as it is, which is incredible because it's the second biggest bond market in the world if I'm not mistaken, or at least it used to be.”

However, gold will ultimately re-establish primacy because governments and energy producers will demand physical settlement at certain thresholds, forcing a return to commodity backing regardless of paper instruments stacked on top; this suggests that whoever has cheapest energy will win long-term, incentivized by strong currency and productivity improvements.

“if once a quarter or once a month the oil supplier says, 'Uh-uh. I want physical and I want physical at this rate,' that's going to be your price... whoever has the cheapest energy, wins... How do you have the cheapest energy? Two things, strong currency and productivity.”

Leading economic indicators broadly suggest transition toward recession or worse, even if headline inflation data shows recent moderation, indicating a disconnect between inflation prints (which lag) and real economic deterioration (which is current).

“Now, if you look at all these other leading indicators, I think a lot of people would tell you like, 'This thing is grossly transitioning to a recession or worse.'”

Oil contains the energy equivalent of 25,000 man-hours of work per barrel, which at $20/hour valuation means each barrel has a real value of $500,000 (not price), and Western policymakers fundamentally miscalculated the cost of attempting to strip 10 million barrels daily of this value from Russia without catastrophic blowback.

“The value of oil is there's 25,000 man hours of work contained in one barrel of oil. The value of a man hour work is 20 bucks an hour just for easy math. Every barrel of oil has a value of $500,000 per barrel and Russia produces 10 million barrels a day.”

The only resolution to the fiscal unsustainability problem is 'fully reserving the debt': either the Fed puts the eurodollar market on its balance sheet, or the Treasury instructs the Fed to revalue gold to $31+ trillion, creating a deposit to the Treasury General Account that allows debt buyback and eliminates U.S. government debt entirely.

“they're just going to have to fully reserve the debt. It's all that's going to happen here. All we're sitting around doing is waiting for the trigger that forces them to fully reserve the debt... the Fed puts the Euro dollar market on its balance sheet in three months... the treasury could instruct the Fed to revalue the US official gold to $31 trillion... and by doing that, that creates a deposit into the treasury general account... And then the treasury can take the money and buy back all the debt and US government will be debt free.”

Michael Saylor's statement 'The inflation won't end until the wars end' encapsulates the constraint: energy inflation is driven by geopolitical conflict over energy settlement and reserve currency status, not monetary policy alone, so disinflation without resolution of the settlement question is impossible.

“Michael Saylor recently tweeted something out and he just said, 'The inflation won't end until the wars end.' I'm assuming you agree with that... Yes. Yeah. I mean, yeah, war's very inflationary.”

In a plain vanilla recession (20% decline in tax receipts), combined with 9% COLA increases across Social Security, Medicare, Medicaid, and Health and Human Services per recent Social Security announcement, entitlements would consume 85-90% of federal tax receipts (conservatively), leaving only 10-15% for all discretionary spending and interest.

“Plain vanilla recession, 20% decline of receipts, 9% COLA across... So let's just say it's 9 across entitlements, which is Social security and total entitlements and Health and Human Services... applying that to Social security, Medicare, Medicaid, Health and Human Services, 9% inflation. No enrollment growth... You're looking at just entitlements in the United States being around 85 to 90% of tax receipts next year.”

Western banks were regulated after 2008 to hold more safe liquid assets (treasuries) so that in the next crisis they could sell them rather than needing a bailout; however, this policy created a systemic risk where in a credit event, all banks simultaneously become sellers of treasuries into an illiquid market, creating the exact crisis it was meant to prevent.

“Coming out of the '08 crisis, policy makers regulated all these western banks into buying more safe assets so in the next crisis, they didn't have to bail them out. They would have these safe liquid assets to sell...So guess what the safe liquid asset is? So in America, the high quality liquid asset, the tier one is treasuries. It's treasuries...because it's the same problem that the British pensions had. They're going to have to turn seller to treasury. It's not liquid. The problem's at the sovereign level now.”

Gromen forecasts an 'air pocket' in employment and GDP spending coming in December or the third week of January, driven by boomer wealth destruction: after stock market losses and housing equity declines, boomers who received their quarterly statements will shift from 'slow spending' to 'stop spending now,' collapsing demand unless the Fed QEs in Q4.

“there is a moment coming, there is an air pocket coming of employment, GDP, spending. I don't know what month it's coming, but it's probably in the December or third week of January... they're going to get their statements and go, 'Stop spending.' Not slow spending, Like, 'Stop now.'”

The economic war between energy and Western sovereign debt is being tracked via a scorecard comparing UK gilt yields, inverted 10-year U.S. treasury yields, U.S. SPR inventories, and oil prices; as of the time of discussion, energy is winning because gilts and treasuries have been 'killed,' oil is flat from the invasion date, and the U.S. has run its SPR down to 40-year lows.

“We did a chart that shows UK gilts, inverted UK gilt yields, inverted 10 year US treasury yields... the US SPR inventories and the price of oil. And that's our scoreboard. Who's winning, right?... The economic war, who's winning? And the answer is, energy's winning. Gilts have gotten killed, treasuries have gotten killed. Oils basically flat from the day they invaded. It's up a little bit. And that's what the US having run its SPR down to the lowest levels in 40 years.”

Revaluing U.S. gold to $31 trillion would result in gold trading at multiples of current prices ('six figures'), but would create dollar purchasing power of 'two eggs' per dollar—the system would be debt-free but highly inflationary.

“Gold will probably have six figures, but then you will be out of debt, right? I mean you will get every dollar you're paid, I promise. It's going to buy you two eggs.”

Preston Pysh expresses frustration with academic economists (like 'Nobel laureates' and 'Professor Fax Machine' who argue 'debt is money we owe ourselves') who have lost connection with real markets and will experience a 'shell shock' when forced to exchange digital fiat units for actual energy-intensive goods.

“It's amazing how people that just spend their life in an academic setting that have not participated in real functioning markets can just get totally… They can dupe themselves into thinking that this is a real economy. And boy, oh boy, it's going to be a shell shock for a lot around the world thinking that they can just take these imaginary units and just funnel them into somebody's digital web browser and all a sudden that means that they should have physical, real, quantifiable, energy intensive things in their lives.”

After debt is fully reserved/wiped through revaluation, equity ownership remains concentrated among the same actors who were responsible for overleveraging, unless external forces (inflation shifting power from paper holders to energy producers) force a power redistribution, making the solution incomplete without addressing wealth concentration.

“And those are still the same people that are going to go out and they're going to play the Wall Street game of levering up under this new monetary system the same way that they just lever it up before because you're dealing with the same entities controlling that equity that are acting irresponsible and just levering their relationship and their close proximity to the printer in the first place.”

Federal Reserve Chair Powell is trying to avoid being seen as the next Arthur Burns (who was blamed for stagflation in the 1970s) by appearing hawkish on inflation, but this motivation is ego-driven and will lead to repeated policy errors as he continues tightening beyond what economic conditions warrant.

“Harald Malmgren had a great tweet earlier this year inferring that, like you said, that Powell didn't want to be the next Arthur Burns, that he was embarrassed by how wrong he was and he's going to be wrong again because his choices”

Pysh argues central bankers are desperate to tame inflation before pivoting to QE to make the whole thing 'look like it was under control the whole time,' rather than Gromen's weaponization hypothesis, suggesting this is simpler explanation of Fed non-response to treasury breaks.

“they know this is it. They have to do something to break inflation to hopefully be able to go back to QE as it's kind of on its way down and make the whole thing look like it was under control the whole time, right?”

Treasury yields will move from current 4% to 6% in 3-4 weeks sometime in Q4, driving 30-year mortgage rates to 8.5-9% and creating states that cannot function with simultaneous 8.5% mortgages and 9% gasoline prices due to arithmetic impossibility of debt service at those rates.

“I'm talking… Oh yeah. You could have mortgage rates at eight and a half in a month. I mean, and I think that's ultimately where this is going. I think we're going to see the 10 year treasury go from four to six in three weeks, four weeks at some point this fall or this fourth quarter.”