Hedgeye Investing Summit Fall 2024 | Daniel Lacalle, Chief Economist at Tressis

The US Federal Reserve devalued the dollar by 78% in 107 years since 1913, achieving the same percentage debasement as the Roman Empire's denarius in a shorter time period, yet this currency destruction is not widely understood by American voters or politicians.

“the Roman Empire is a very good place to start when it comes to debasing your currency back then they did it with the with the Daenerys uh taking its silver down from 90 to 50% but you know when I go back to that slide on slide 108 Daniel the you know this is this actually the Federal Reserve and this is saying something go to slide 105 the um the Federal Reserve took less time to devalue its currency by about the same amount as the Romans”

The concept of 'transitory inflation' is nonsensical because inflation is cumulative and accumulates over time; calling a 12-percentage-point increase in inflation rates (from 2% to 4% to 8%) transitory is equivalent to claiming weight gain stops when you stop weighing yourself.

“what the hell does transitory mean when inflation is accumulative what the hell is that exactly what kind of what kind of imile has to buy the fact of transitory inflation when inflation goes to four to 8 and from 8 to two that's a 12% inre increase in infl in inflation obviously now if I if I gain 10 pounds a year for the next and to the other I'm not getting any thinner so the idea the idea of transitory inflation is so ludicrous”

Foreign holdings of US Treasury debt as a percentage of total holdings have declined from 33% to 22%, and foreign demand for Treasuries relative to net issuance has fallen below 30%, down from over 100% during the 2008 financial crisis, signaling a fundamental loss of global confidence in US debt as a reserve asset.

“this chart is extremely important...the amount of GDP generated by every unit with every unit of public debt has declined by more than half in 10 years... foreign demand of treasuries relative to net insurances were higher than 100% so every time that there was any sign of not crisis but uh some sort of uncertainty in markets Bond investors globally central banks globally would pile on us treasuries I remember in 2008 in 2007 when it was 150% foreign demand for treasuries relative to net insurances well in the last figure it is less than 30%”

Unfunded and committed liabilities (Medicare, Social Security, pensions) are the most important driver of future monetary destruction in the US, more important than current debt or deficits, as they represent future claims on currency that must be issued.

“there's there's also an important factor that I think uh people should think about when we're all the time discussing about issued debt and we're all the time discussing about money growth so far but what people should pay attention particularly when they're looking at gold and other risky assets is unfunded committed liabilities what matters to be fairly honest US debt is a disaster us deficit is a disaster and that is an important part of the discussion but the most important part of the discussion is how much monetary destruction are we going to see in the future and how do you measure that by looking at the unfunded but committed liabilities”

The US dollar remains relatively stronger than other fiat currencies because all major central banks are making the same monetary policy mistakes simultaneously, making the dollar 'least bad' rather than fundamentally sound, while US citizens still suffer purchasing power loss.

“a lot of people actually come out and say well the US dollar is not doing so badly relative to other currencies that are as bad or worse in terms of monetary policy than the Federal Reserve because a lot of people forget you and I know and we've discussed it n numerous times monetary policy is not about who wins it's about who loses first yes is making all central banks make the same mistakes”

Ordinary citizens fight inflation by owning real assets like gold and silver, but most are told what to do by mainstream media and don't own gold, instead getting lied to about inflation while their deposits and wages are destroyed.

“and it is perverse because that's how you fight inflation you own it because the people and this is the sad part have to eat it right they they don't buy bars of gold they don't buy I'm buying junk bags of silver you know there they don't do that they get told what to do they get lied to and gold just says I'm going to go on my own see you”

The dollar has made lower highs in secular decline despite recent strength, showing that even periods of dollar strength are peaks in a longer-term depreciation trend.

“something that is in secular decline makes a lower high every time it goes up during its cycle”

The August 5, 2024 VIX spike to 65 in a single day is a major warning sign of market instability and leverage unwinding, despite claims that 'nothing has happened yet'.

“the vixs we're old enough to remember on August the 5th went to 65 in a day like I mean these are not not warning signs right on the very shortterm stuff”

Fiat currencies and government debt are fundamentally the same thing; therefore, the purchasing power position of citizens in the future depends entirely on confidence in the currency that government issues.

“people don't understand that money the way that we know it Fiat currencies and debt are the same thing so people what they need to understand is that the position that they are going to be in in the future is going to be dictated precisely by the confidence in that currency and it's very very dangerous very dangerous to believe that nothing has happened when it gets even more challenging in the future”

Debt-to-GDP is a misleading metric because GDP can be artificially inflated by government spending and increased debt (pushing up the denominator), while interest expense is a better measure of fiscal sustainability because it represents actual cash outlays.

“debt to GDP is a very bad ratio because GDP can be bloated with more government spending and more debt so the denominator gets pushed up uh and and so that's why the the interest expense figure that I mentioned before is so important”

The Federal Reserve's dual mandate of price stability and full employment is incoherent because monetary institutions cannot control employment through money supply expansion without creating inflation.

“the problem is that uh price stability Unemployment uh think about this Keith you and I've discussed this a lot of times people here in in Europe or in Japan they say well we should do like the FED because the FED has a target of Full Employment in its mandate I say what what does a monetary institution have to have an Unemployment uh Target how how on Earth do you put together monetary uh Aggregates and and liquidity uh with employment oh more debt is going to create more jobs ridiculous no”

US equity market structure is 100% a function of Federal Reserve easy money policy, with investors forced into leveraged short-term bets (zero-days-to-expiration options trading) as rational response to perverse incentive that central banks will always bail out downside.

“the entire stock market um and let's just talk about that the structure the market structure that we have today is 100% a function of Federal Reserve easy money policy now let's discuss that right through the lens of zero days to expiration options trading the most levered bet short-term bet you can make”

Fed officials deliberately craft policy and messaging to obscure their actions from accountability, not due to incompetence but by design, allowing them to pursue fiscal support while maintaining an appearance of independence.

“the problem is the following everyone that is watching us says well why do people that are intelligent that know about economy or maybe they don't but they talk about it why are they saying that because it is the perfect tool of nationalization of the economy what what what you don't what we many people don't understand is that this is not due to incompetence this is due to design”

Two generations of traders and investors have seen only expansionary Fed policy for the past 20 years and assume this is permanent ('always will happen'), creating dangerous complacency about currency and financial system stability.

“we have two generations of traders that have seen nothing but uh expansionary policies and therefore what uh they they take for granted uh what a very short period of time in monetary history which is what we have lived in the past two two decades less than two decades as uh something that has a always happened B will always happen”

The third element insulating Japan from stagflation is a unique cultural and institutional framework where people save in low-return government bonds with zero real returns, effectively making themselves poorer—a sacrifice that cannot be replicated in the US or elsewhere.

“the third is that in Japan what you have is a massive culture of supporting the the fabric of the industries with a very challenging uh and very difficult to rep replicate environment in which people save and they actually save in uh in Bonds in public bonds that generate no real return so they're actually getting poorer that's not going to happen in the United States”

The Federal Reserve cut rates by 50 basis points in September 2024 in an economy with 3% year-over-year GDP growth, robust employment, inflation still above target, and no recession signals—this was not a response to economic weakness but a bailout of government debt.

“the second sign of panicking came in September when they decided against every indication of what they're supposed to be looking at to cut rates by 50 basis points in an economy that according to chairman Powell had no evidence at all of signs of recession or risks of a even a downturn... inflation still above the fed's Target”

The US will not experience Japanese-style deflation despite high debt because the US has opposite demographic characteristics (immigration and younger population pyramid), imports more than it exports, and issues a reserve currency facing declining global demand, forcing stagflation rather than deflation.

“why Japan did not enter into stagflation okay there are three elements no that are important number one is the demographic element Japan is an aging and diminishing population both things aging and diminishing no that is deflationary to start with number two Japan is a country in which Industries are huge Savers in World Reserve currencies... the third is that in Japan what you have is a massive culture of supporting the the fabric of the industries”

Interest expense on the US federal budget has become the second-largest item even with low interest rates, indicating that fiscal dominance and crowding-out effects will worsen as rates normalize.

“the interest expense in the budget sares even with low rates to now the second largest item in the budget”

Central banks have abandoned monitoring monetary aggregates as their primary policy tool and now discuss unrelated topics like climate change, representing a fundamental shift away from price stability mandates.

“we have grown accustomed uh you and I remember when central banks were actually uh monetary institutions that paid attention to monetary Aggregates now we have monetary institutions that talk about anything except monetary Aggregates anything I mean it's crazy when you when you read the fomc meetings minutes but if you read the ECB ones in which they talk about climate change in which they talk about I don't know the ABA reunion it doesn't even matter it's ridiculous”

The Federal Reserve and ECB claim inflation was due to supply chain disruptions and external shocks, but when those shocks reversed (supply chains normalized), inflation persisted, proving the monetary explanation was always correct.

“inflation is due to supply chain disruptions the Ukraine war and the Gaza conflict uh therefore we're going to increase rates they're like what I don't understand what is what is the connection if you have if you if you're saying that it's not a monetary phenomenon why are you taking monetary measures to reduce inflation”

The Federal Reserve's 'higher for longer' rhetoric lasted less than 18 months before reversing to 'lower for longer', demonstrating inconsistent communication strategy that damages central bank credibility.

“hire for longer lasted less than 18 months which is the the biggest joke I've heard in my life okay the he went on on TV and all all the media and said we have to be used to hire for longer 12 months later lower for longer what you know so this is this is”

Federal Reserve inflation forecasting and GDP forecasting track records are horrible, yet the Fed remains treated as an authority that should not be questioned despite decades of demonstrated incompetence.

“the track record of the FED in predicting inflation predicting GDP and predicting unemployment is horrible so why would you even think of of listening to them when they say that inflation is transitory”

McCulla's inflation nowcast model predicted inflation would rise from 4% to 8-9% when the Fed was calling it transitory, demonstrating that accurate models contradicted Fed guidance, proving the problem was not model failure but willful ignorance of available data.

“our inflation nowcast said it was going to go from 4 to 8 and it went to nine... to say nobody knew because by Design we're not supposed to know I think that that's that is the thing is that basically it's the dishonesty”

Gold and Bitcoin are hitting all-time highs because central banks are rebalancing away from dollar reserves toward gold, and citizens are losing confidence in monetary institutions and fiat currency solvency.

“that's why you've seen you got Bitcoin back over 60,000 that's why gold has gone roof to all-time highs... Gold's been around for a long time why is it hitting all-time highs right now”

The 96% of Americas trade invoices denominated in dollars and 79% of rest-of-world trade invoiced in dollars shows structural dependence on dollar stability, making dollar debasement globally consequential beyond US borders.

“96% of trade invoices in the Americas are in dollars and actually a little known fact but you know 79% of the rest of the world's you know is is is too so you know if you think about that chart Daniel”

The path of current US fiscal policy leads to secular stagnation with elevated debt, not a debt crisis in the Greek style, as government debt crowds out private sector investment and productivity growth.

“A lot of people say oh my gosh this is going to trigger a debt crisis and they think of a debt crisis in a sort of Greek way no Greek drama type of way it's not going to happen like that but what it leads is to stagnation and persistent inflation basically uh the risk of stag stag stagnation and persistent inflation”

The Fed's transition from provider of 'liquidity of last resort' to 'liquidity of first resort' is dangerous because it eliminates the consequence of poor risk management and creates moral hazard for all financial participants.

“the central bank has gone from being the provider of liquidity of Last Resort to being the provider of liquidity of First Resort yes that is exceedingly dangerous in any shape or form and the only way in which it ends is with the destru of the purchase and power of the currency obviously”

Money supply growth in 2008-2009 did create inflation, but it manifested as asset inflation and multiple expansion rather than goods-and-services inflation, because the economy was broken and velocity collapsed, allowing central banks to escape accountability by hiding inflation in asset prices.

“it's insane as you mentioned so many times it's insane to hear people say that money supply growth doesn't create inflation because it didn't do it in 2008 well number one it did number two there was massive asset inflation and number three money velocity collapsed is that people seem to forget that you are basically uh transferring the inflation that goes to goods and services in an economy that is not doing well to asset inflation and multiple expansion and multiple expansion is the only bet today in in global markets almost almost to a te”

The perception of a global reserve currency can crumble very quickly as warning signs accumulate, requiring extreme caution about assuming the current system is stable.

“you have to be extremely worried about uh how quickly the uh the perception of a global Reserve currency can start to crumble and and and again coming back to all that we have been mentioning the warning signs are already there”

Asset price volatility will increase and indices will diverge globally based on the level of monetary destruction in each country, requiring investors to actively protect against currency debasement rather than assuming stable purchasing power.

“this is going to bring higher volatility this is going to bring tremendous disparity between uh different indices all around the world depending on the level of monetary destruction in one and the other”

Japan kept inflation low despite high debt because Japanese corporations and households are massive savers in foreign reserve currencies (dollars, euros, pounds), which reduces inflation pressure because capital stays offshore rather than chasing domestic goods.

“Japan is a country in which Industries are huge Savers in World Reserve currencies in dollars and euros and pounds cuz they export a lot and the and people are big Savers okay so that is also something that reduces the risk of inflation because they're bringing in loads of uh foreign reserves”

M2 money supply (which was about $4 trillion pre-2008) has grown to over $21 trillion today, representing an explosion in monetary stimulus, particularly through the massive COVID-era expansion.

“this is showing you M2 from it's it's at over $21 trillion”

The difference between academics/Fed analysts and practitioners like McCulla is that practitioners look at data and follow where it leads, while academics try to force data to fit pre-existing theories—this is why Fed models consistently fail.

“when you analyze the economy Keith you are looking at data all the time and you know and what you are not doing is trying to sort of uh pigeonhole a theory to ignore the data the data is telling you that something may not be right or that something may be right the problem of Academia and the problem that is f that is filling central banks and the people that are filling central banks is what what you read for example from Paul Krugman on inflation they say we got inflation wrong but all the models were saying that there was no risk of inflation so the the problem wasn't the models the problem was that something else happened”

Central banks are attempting to impose Central Bank Digital Currencies (CBDCs) while simultaneously destroying confidence in monetary institutions through poor policy, creating a contradiction: they're trying to implement digital currencies while undermining the credibility needed for those currencies to function.

“they want to impose uh Central Bank digital currencies while at the same time all that they are doing is making people less confident in the monetary institutions”

The real danger in continued currency debasement is not acknowledged by most because 'nothing has happened yet'—yet physical reality shows inflation in goods, depreciation in currency, and reduced global demand occurring simultaneously.

“the infamous words that we read all the time in financial media saying nothing has happened yet nothing has happened yet what the hell does that mean you know is that is what do you mean nothing has happened yet first inflation second reduction in global demand for US Dollars third uh weakening of the bank for buck uh return on on investment of the US dollar what do you mean nothing has happened but more importantly the idea of accelerating and doing worse because nothing has happened is the same as if I go 200 M an hour down the highway and say hey I haven't killed myself accelerate it it's ridiculous”