Luke Gromen: “Peak Cheap Oil and the Global Reserve Currency” | The Great Simplification #91

On this episode, financial analyst Luke Gromen joins Nate to discuss how the availability of cheap energy has underpinned our current financial architecture and expectations – and what peak cheap oil implies for the future. A central part of this story is the rise of the US dollar as a global reserve currency tightly linked with the ability to purchase oil – subsequently leading to the US becoming a major exporter of debt. How have countries with economies based on natural resources and manufacturing differed in their response to geopolitical uncertainty in comparison to those who are based around finance and the service industry? What might the response be from countries holding US debt in anticipation of a declining oil supply? What does this mean for the future of global currencies in a simplified global economy and a finance system that will eventually need to be re-tethered to the finite nature of Earth?

About Luke Gromen:

Luke Gromen is the Founder and President of research firm Forest For The Trees, LLC, whose goal is to aggregate a wide variety of macroeconomic, thematic and sector trends in an unconventional manner to identify investable developing economic bottlenecks for clients. Luke founded FFTT to apply what clients and former colleagues consistently described as a “unique ability to connect the dots” during a time when he saw an increasing “silo-ing” of perspectives occurring on Wall Street and in corporate America. Luke has 25 years of experience in equity research, equity research sales, and as a macro/thematic analyst. He holds a BBA in Finance and Accounting from the University of Cincinnati and received his MBA from Case Western Reserve University. He earned the CFA designation in 2003.

For Show Notes and More: https://www.thegreatsimplification.com/episode/91-luke-gromen

00:00 – Episode Highlight
00:34 – Luke’s background
03:05 – Overview of Luke’s work
04:50 – Peak Cheap Oil: 3rd Oil Crisis
06:38 – Red Queen Problem
07:55 – Treasuries are more liquid than oil?
10:27 – Nate’s Wall Street background
11:51 – Cutting out the middleman
14:54 – China selling off US Treasuries
15:31 – Impact of freezing Russian Assets
16:24 – “Dutch disease”
18:39 – Does the financial industry understand the importance of energy?
20:31 – Why doesn’t the U.S. save our oil?
24:00 – BRICS+ and China
29:59 – Will currency reform happen?
31:15 – Will there be a World War in the next decade?
33:08 – What currency would replace the US dollar?
36:58 – How would the U.S. change how it manages debt if interest rates go up?
40:46 – How do rising interest rates impact emerging markets?
43:09 – Why hasn’t gold risen in price more?
44:27 – Will currency in the future be tied to something more physical?
50:01 – Is the U.S. and the West going to restrict use of gold?
53:49 – How would an energy productivity miracle help?
56:12 – Yield curve control
58:24 – How will the U.S. economy change in the next decade?
1:04:02 – Will people recognize we need to shorten supply chains?
1:07:53 – What advice would Luke give a leader?
1:14:33 – Will the U.S. middle and lower class be hurt by rising inflation rates?
1:16:56 – Luke’s thoughts on the environment
1:20:05 – Luke’s personal advice for viewers
1:24:09 – Luke’s advice to young people
1:26:51 – Luke’s biggest concern in the next decade
1:28:31 – Luke’s magic wand

#thegreatsimplification #natehagens #energy #dollar #finance #economics

The political power has resided with the debt  merchants, the exporters of debt. You know,   who has won in the last 40-50 years in this  system. It’s been the exporters of debt,   which is Washington and Wall Street.  And they still have a lot of power,  

They’re not going to want to hear this. I’m pleased to welcome Luke Gromen to The   Great Simplification. Luke works in the financial  industry. He founded Forest for the Trees, LLC,   where he advises clients on the  macroeconomic energy integrated   scenarios that affect the global economy. I worked on Wall Street 20 years ago and  

I have found very few Wall Street minded  people that integrate the centrality of   energy to our profits, our expectations  and the implication of peak cheap oil   has for growth and our institutions  and the way that our currencies work. 

Doomberg, Kiril Sokoloff upcoming is Lyn Alden and  Jeremy Grantham. Luke is one of those people that   is integrating peak cheap oil and energy with  10 to 25,000 hours of human labor per barrel   of oil. I think without understanding this,  we can’t see the big picture. He and I talk  

About currency reform due to energy decline  and what is going to happen to our financial   system in the coming decade is at least as  urgent to be discussed and planned for as   the ecological crises we face. Please welcome  Luke Gromen. Luke, welcome to the program.

Thanks for having me on, Nate, it’s great  to be here. I’m excited to talk to you. You might be asking, and my viewers might be  asking why you are on a systems ecology podcast.   And I’ll tell you. Because at the core of how the  human ecosystems function is energy and finance,  

And you are one of the few financial  professionals that I’ve come across that   from my systemic lens gets what’s going on. And I think for the environment and for   governance and for energy transition  and where the society is headed,   we need to understand the interlinkages  between energy and money. And I know you  

And your organization, Forest for the Trees  have been articulating this quite clearly.   Can you just start off with maybe giving  us a long-ish elevator pitch of you and   your organization’s worldview with respect  to the current global financial situation?

Yeah, absolutely. So I think the easiest way  to simplify it is in the absence of an energy   productivity miracle, which is a phrase we  use a lot, it’s something we can touch on   and what exactly that means, said energy  productivity miracle could take multiple  

Forms of varying degrees of either pleasantness  or unpleasantness, which again, we can expound   on. The bottom line is the debt backed fiat  currency system, as it has been structured   and existed since 1971 when Nixon took the US  off the gold standard, in our view, has reached  

Exhaustion for peak cheap energy, peak cheap oil  in particular reasons. I’m going to read a quote   to you that I think is perfectly summarizes it. So this quote was written in 1980 by the chairman   of the Bank of International Settlements, Jelle  Zijlstra, and it said “its second oil crisis could  

Be worked through slowly, but the international  financial system could not survive a third oil   crisis. The inflation would make it impossible to  recycle the petrol dollars to the oil importing   countries with any hope of repayment in real  terms, in oil terms. Trade would crumble and  

The system would be brought to its knees.” And so  at its core, peak cheap oil in our view means we   are now in that third oil crisis that the system  as structured cannot survive in its present form. 

I would break the world, and we look at the world,  into three basic categories of nations. You have   energy importing US creditor nations or regions.  So within that Japan, China, Europe, some others.   You have energy exporting US creditors under the  post ’71 system. So OPEC, Russia historically. And  

Then you have the US who runs twin deficits and  whose job is to essentially supply the dollars   by running ever bigger deficits to this system. The problem that peak cheap oil introduces to this   system is that as we are seeing the marginal cost  of global oil supply, so over the last 10 years,  

90% of global oil production growth has come  from US shale. So US has become the marginal   producer of oil. It is high cost and critically  the geology of shale is such that the Dallas Feds   surveys have been showing pretty consistently  from the producers they survey down in the  

Permian and elsewhere that they need eight to  10% on average growth in the price of oil in   terms of their breakeven. So their breakeven price  rises by on average eight to 10% in recent years. That’s because they have to dig deeper and  more complicated technology. Just to keep  

Technology up with depletion, they have  to increase prices eight to 10% a year. It’s depletion, it’s the Red Queen problem as I’m  sure you and many others in your pod. So basically   the Red Queen is running at eight to 10% per  year in terms of what they have to increase  

The price of oil to outrun the Red Queen. The  depletion, the decline rates in shale, the cost   of oil service equipment, et cetera, et cetera. The problem within that is the US government   cannot afford anywhere near eight to 10% interest  rates on its 33 trillion in debt that that would  

Imply. So basically we are now at a situation in  the global monetary system as a result of what has   been by far the biggest marginal producer  of oil in the world over the last decade,   which is US shale, energy exporters globally  that first group I talked about would have  

To be stupid to be blunt, to store surpluses  that they earn in dollars in US treasuries at   rates that are not compensating them at the  rising cost of the marginal barrel of oil,   right? If the marginal barrel of oil is rising  eight to 10% per year and treasuries are paying  

Them 4.3% right now at the tenure, they’re  better off leaving the oil in the ground. With one exception maybe is that treasuries are  more liquid than oil and things in the ground? Yes, all else equal. But even then, if they dig  out or if they produce oil, sell it, store those  

Surpluses in treasuries, at some point they are  going to reach their own decline or depletion   problem and they’re going to have a pile of  treasuries for them to go out and re-buy the oil  

That they just sold to the world and it’s going  to buy them a lot less oil than what they shipped.  So basically, yes, in the short run in  financial market terms, yes. In the long   run that as you’re managing a country, as you’re  managing the sustainability of your FX reserves,  

If you’re a politician in these places and  you don’t want to have a very bad personal   outcome for you and your family, you have  to start thinking about this problem. So   it’s a problem for the energy exporters. For the energy importing creditors who have  

Historically stored treasury bonds, treasury  bonds were kept relatively fungible relative   to the price of oil. In other words, if I  was China, if I was Europe, if I was Japan,   I did trade with the United States, I ended up  with dollars, I bought treasury bonds. Those  

Treasury bonds I could rely on within a range to  maintain their purchasing power in oil terms over   time. Because when you look at Europe, when you  look at Japan, when you look at China, they are   creditors, but what are they short? They’re short  energy and more broadly some other commodities. So  

This problem affects them too. They can no longer  store their wealth earned from surpluses in trade   with the United States in treasuries because  they will find themselves short oil over time. For the people that understand what you just said,   this is pretty fricking  horrifying, the implications.

It’s a Mexican standoff because the  United States can’t let rates go to   eight to 10% either. Because we let debt get  too high because we did a bunch of really…   We spent a lot of money over the last 20 years  and didn’t get a whole lot out of it. So yes,  

We are in this the third oil crisis that Zijlstra  wrote about in 1980. It’s here, it’s here now.   It’s a Mexican standoff and it has to result  in major systemic change in some way, shape   or form. And as I said, that can be pleasant or  unpleasant depending on how things go from here.

So you and I just recently met, and to  tell you just a little bit of my history,   I worked on Wall Street, I was at Salomon Brothers   and Lehman Brothers and looking at credit  markets and fixed income and commodities,  

And then I kind of had an environmental  epiphany. And the last 20 years I’ve been   working on systems ecology and the environment  and human behavior and anthropology and systems.  But my brain still remembers Wall Street times.  So it’s really refreshing to me to hear someone  

Who understands finance but also is using words  like peak cheap energy and the Red Queen. I’m   terming what’s coming as the biophysical phase  shift, which is where society used to measure   our wealth and our future prospects pretty  much solely in a money and technology sense,  

And now it’s energy and ecology and commodities  are going to be primary and that has massive   implications for a world that measures our  wealth in papers and digits. So yeah, keep going. That’s exactly how we’re looking at it as  well, right? So historically you had energy  

And you had trade and you had the dollar in  the middle. So you had these surpluses, dollar,   energy and everything flowed through the dollar  and the treasury market as a storage of dollars   for future energy purchases. And so what you’ve  been watching happen since shortly after the  

Great financial crisis has been the arbitraging  of basically the cutting out of the middleman,   the arbitraging of this situation  where, it started with China and Russia.  So China is looking at the situation and you  can see it by their actions. They’re going,  

Why am I going to store my wealth in treasuries  for future energy as I get these dollars coming   in from trading with the United States? That makes  no sense for a number of different reasons. Number   one, as we just talked about, the geology of US  shale as the biggest marginal oil producer over  

The last 10 years by far simply is not conducive  to treasury bonds maintaining their purchasing   power in terms of the marginal oil barrel. So basically my treasuries are never going   to buy more oil on average than they do right  now. They’re not going to be able to rise in  

Value relative to oil on average in the  future. So why store in treasuries? You   know what I’ll do instead? I’ll take the  dollars and instead of buying treasuries,   I’m going to cut the middleman out. I’m going to  cut the Americans out, I’m going to go straight  

To Qatar and I’m going to say, sign me a 27-year  deal on gas. I will commit to buying gas at this   price for the next 27 years. I will take these  volumes, take or pay, here’s the dollars. Boom. 

I mean 10 years ago, you can find a story from  late 2013 how China came to control an OPEC   country’s oil. By 2013, the Chinese had signed so  many of these forward deals, dollars now for oil   in the future from Ecuador, they controlled like  70 or 80% oil of Ecuador’s future oil production  

Until the mid-twenties. So basically you saw  China go, wow, there’s a problem. Peak cheap   oil is a problem. How do I fix this problem? There’s a number of different ways to do that,   but one way you do that is you stop storing your  surplus in treasuries, and instead you cut out  

The middleman and you do the deals directly with  the commodity producers for future supplies of   oil. That introduces other issues you have to  manage hedge, et cetera. But that gets rid of   your primary issue, which is you’re China, you  have a bunch of treasuries, you wake up one day  

And suddenly your treasuries that you thought  were going to buy you a hundred barrels of oil   now buy you 50 barrels of oil or 40 or 30 and you  have a serious political problem on your hands. And in fact, China has been selling  off their US treasuries recently. Yes?

They haven’t bought an incremental  treasury since 2011. I mean,   I’m sure they’ve bought and sold,  but on a net basis, their treasury   portfolio has not risen since roughly 2011  or 2013, depending on how you measure it. So things are maturing and rolling  off and they’re not adding.

And they’re not adding, and instead  they’re deploying those funds into   things that will much better  store value in energy terms,   whether that be oil supplies,  refineries, ports, gold, et cetera. Well, the other shooting ourselves  in the foot is when we froze all the  

Russian assets. Good or bad, that sent  a signal to the world market that whoa,   maybe holding our savings in US  treasuries isn’t as safe as we thought. I think that’s exactly what the message  was. And I think there are elements within  

The United States that saw that as a good  thing. Ultimately, there are interests in   the United States government that also see  this problem that China’s been addressing   by basically cutting out treasuries, which  is to say the US, the way the system works,  

Ends up driving a form of dollar Dutch disease  for the United States and Dutch disease – I don’t understand what that is. So Dutch disease is an economic term that is used  to describe what happens when a country suddenly  

Finds itself in position of vast natural resource  wealth after the Netherlands with, I think it was   probably the Groningen field back in the fifties.  But basically, oh my gosh, we found this giant   source of natural wealth and as a result, so much  of the attention, wealth development, et cetera,  

Goes to commercializing and developing that source  of wealth that all of the other industries in the   country atrophy and die off and go elsewhere. And so it was termed Dutch disease,   but you see it very regularly across a  number of different OPEC nations, nations  

With natural resource wealth. Where you rarely  see it described is in relation to the dollar   and the treasury market. But to the extent the  United States, as the FT said it four years ago,   the United States is the Saudi Arabia of money.  We’re the Saudi Arabia of dollars, we can print. 

Well, what has happened as we became the  Saudi Arabia of money, we got Dutch disease,   we don’t manufacture anything anymore. Our defense  industrial base withers on the vine. And so there   are interests in the United States, typically  around the defense and intelligence communities  

That realize the dollar and treasury market system  as it has evolved over the last 40, 50 years is no   longer a one-way street positive for US national  security. Because ultimately in a war, you can’t   throw dollars at people. You can wad them up  and throw them as hard as you can, but you’re  

Probably not going to kill them with that. And  that’s what they’re seeing in Ukraine right now. Well, in a war or just in a smaller world where we  need local and regional supply chains and need to   produce our own things, you can’t throw dollars at  that. You need factories and machinery and skills.

And for that you need energy. Yeah. And for that you need energy. So I want  to get to the currency thing in a minute,   but let me ask you a couple more questions. Sure, sure, sure. Clearly, when you go to conferences  and you’re very financially connected,  

People understand that oil and gas and energy are  important, but I don’t think too many people yet   understand that energy is the currency of  life and underpins the entire edifice. And   you often write that a barrel of oil has 25,000  man-hours of labor in it. I would handicap that,  

I say 10,000 because we’re more efficient  at getting the muscle power, but still it’s   like years of our work is in a barrel of  oil. So how many people in your industry   understand that, that energy is fundamental  to society in our past and in our future?

That’s a good question. It’s a minority. I mean,   it’s still a severe minority,  but it’s getting less. Because of Ukraine maybe. I think that’s a big part of it. I think that’s a  part of it, where you’re seeing this recognition.  

Our GDP was, I don’t know how many times  bigger than Russia as we measured it. However,   the Russian’s, GDP, was energy and producing  weapons and not a lot else, and ours was a lot   of selling houses back and forth to each other  at ever higher prices and selling stocks and  

Bonds back and forth to each other, ever higher  prices. And when you get into a crisis, a war,   it boils everything right down to the essentials.  And what we’re seeing is the Russians are able to   outproduce us. They’re able to out manufacture the  mighty United States in part because of this Dutch  

Disease, this de-industrialization that has taken  place around the dollar over the last 50 years. We are really complacent as a nation, are we not? Oh, yes, absolutely. So from an energy perspective that we can  print money but we cannot print energy,   only extract it faster, wouldn’t a wise  longer term outlook, visionary government  

Try to keep our own oil in the ground and  print dollars and buy other people’s oil? Yeah, you would think that they  would. There have been those that   argued some of what we did over the last  50 years was a version of exactly that,  

And I think there’s something to be said about  that. I would say that generally speaking,   the leadership that was in power  during that, during the Cold War,   I would say is far wiser than the leadership  we have had over the last 25 to 30 years. 

I also think if we use that lens, it gets really  interesting when you say, okay, what changed that   all of a sudden we started producing our own  oil again instead of if everybody still loved   the dollar the same way and nothing had changed  around the dollar, why would we ever produce our  

Own oil shale when we could still print as many  dollars as we wanted and bought everybody else’s   oil? Unless that had started to change globally. And I think at some level it started to, I mean,   to be clear, I think it was largely a free  market reaction in terms of the technology  

With long laterals, steerable laterals in the  shales, the high price of energy, the low cost   of capital with the Fed cutting rates. With  that said, if you go back to the seventies,   you can read different documents where there was  a recognition by Kissinger and some others around  

Kissinger that once US oil peaked in 1970 for  the first time in terms of production, that they   were dangerously exposed to OPEC and the Soviet  Union in terms of US oil imports going forward   and geopolitically it made sense to diversify and  hedge that. Well, how do you do that? There is a  

Recognition you can read in various history books  and declassified documents, et cetera, from State  Department that there was an understanding that  if you remove the gold backing of the dollar,   you weaken the dollar enough, you send  the price of oil up in dollars enough,  

You will make economic basins that were, with  a gold-backed dollar, uneconomic. Basins such   as Prudhoe Bay, Alaska, such as UK North Sea,  such as Deep Water, Gulf of Mexico, Canaveral,   et cetera. There was a recognition amongst certain  US policy makers that weakening the dollar to  

Increase the dollar price of oil as a geopolitical  hedge and diversification to reduce US dependence   on OPEC and Russia in the ’70s, there was a  recognition of that. It’s a lever people don’t   often think about, but I think when we had wiser  policymakers, I think they did think about it.

I like to refer to our culture and our  policymakers as energy blind and let’s   move on to BRICS and Russia and China. It was  just announced that Iran and other countries,   UAE, that are not only oil producers but  oil exporters have joined BRICS Plus,  

Or whatever you term it. I’m not sure I sent  you this chart I made earlier in the week,   but if you add up all the countries now in  the expanded BRICS, it accounts for over 50%   of the exportable oil in the world, not the  production, but what’s left after internal  

Consumption is accounted for. And the barrels  of oil that are purchasable in the world, 50%   or 51% is from Russia, Saudi Arabia, et cetera.  Does this longer term spell some biophysical   phase shift in the reserve currency situation,  or what do you think this means, if anything?

I think we are watching real politic happen  ultimately, and what I mean by that is China   is the biggest oil importer in the world. China is  the biggest trading partner with the Gulf Nations,   the GCC nations and with Russia and with basically  everybody for that matter. China has an energy  

Shortage problem if you look at the system as it  is currently structured, and what I mean by that,   if we can go back four years, Kyle Bass gave  an interview on, I think it was either Hedgeye   or CNBC, but the point was this, China’s got  a finite FX reserves in dollars. China needs  

To import oil and other commodities to a lesser  extent in dollars. China’s economy is growing,   the price of oil is rising, and as the price  of oil rises that consumes dollars fast, finite   dollars faster. As China’s oil demand goes up to  support their growing economy and they’re growing  

Debt, the supply of dollars goes down faster. Ultimately, oil imports, if they’re only in   dollars, will cause China to run out of dollars.  Once they do, they have to shrink their economy,   shrink their oil imports. That is a catastrophic  economic outcome, catastrophic political outcome  

That would look very much like the Southeast  Asian Crisis in the late 1990s. Massive   devaluation of the yuan, great shrinkage in  Chinese living standards, political problems,   et cetera. That is a non-starter for the Chinese  Communist Party. How do they get out of this?  

There’s a couple ways they have been managing and  getting around this for at least 10 years now,   closer to 15 years or more. Number one, as  we talked about before, instead of storing   dollars in treasury markets, you begin going  straight to the source and you sign the long-term  

Supply agreements with the actual producers of  energy. Step two, you start building a military   and defense capabilities that prevent the United  States Navy from cutting off your oil supplies.  They have done that with nuclear hypersonic  missiles to basically keep the Straits of Malacca  

Open. And then the third thing you do is you begin  working toward buying oil in your own currency and   arranging trade arrangements. Now, who’s going  to trust the yuan? Not a lot of people 10,  

15 years ago. What are they going to do with  the yuan if they get it? And when I say they   oil surplus nations, what will oil surplus  nations do with yuan 10, 15 years ago? Not   a lot. There’s only so many plastic trinkets they  can buy now, high quality 5G plus Huawei equipment  

Infrastructure, nuclear power plants, weapons. There’s a lot that China has moved so far up the   value added curve. What I think we are watching  evolve with the BRICS is a system where China   will have the ability to buy oil in yuan and other  commodities when they want to. The resulting yuan  

Surpluses at oil importing nations, which like you  just said, having joined the BRICS with over 50%   of global oil, exportable oil, some of them will  end up with yuan surpluses. When they do, they   can use those yuan to buy Chinese goods, Huawei 5G  equipment, it’s nuclear power plants that they can  

Then use to build desalination, blah, blah, blah.  Things to improve the living standards for their   own people. Gasp. Wow. To the extent that these  energy exporters buy what they need from China in   terms of goods to improve the living standards and  infrastructure of their countries and still have  

Yuan left over as sometimes happens depending on  the price of oil, et cetera, China has facilitated   the settlement of surpluses, yuan surpluses  in physical gold in Shanghai, in Hong Kong,   in London, and while nobody trusts yuan, everybody  trusts gold. Alan Greenspan said the only currency  

That’s better than the dollar in 2014 he said was  gold. I think we are watching this system evolve   before our eyes, and as such, I think BRICS  is a center or a proxy for that. And as such,  

I think these nations joining the BRICS I think  is a very important signal in terms of the   willingness to engage in this multicurrency,  energy pricing, net gold settlement system. Two part depressing question. Part  one, how do we navigate the next   decade without currency reform? And  part two, how do we navigate the next  

Decade without a global war? When all the  things are going on that you just said. Currency reform, I don’t see how  it doesn’t happen. There’s going   to be one way or another currency  reform. Not only is it going to come,   it’s already happening. We have a  chart we’ve showed clients before,  

Have put it on Twitter before 2014, in late 2013,  the People’s Bank of China came out and said,   “It’s no longer in our interest to grow holdings  of FX reserves.” It was basically China saying,   “We’re done buying, growing our holdings of  treasuries.” This was 2013. Since that moment,  

We have seen US holdings of treasuries by global  central banks decline by almost $600 billion,   which is unprecedented going back. Central bank  holdings of treasuries never fell for the 50 to 60   years before 2014. Since then they are down about  5%. It’s about $600 billion. Gold has gone up 300  

Billion. We are moving towards that. I think  currency reform will happen. It is happening.   A war? I’m optimistic that it won’t happen  simply because of mutually assured destruction. If there’s anywhere war, we’re all  screwed. Let’s avoid it at all costs.

Absolutely. And the sense I get when  I talk to people in the military and   intelligence communities in the United States,  I think there’s absolutely an understanding of   that. You hear the bravado and the rah, rah  from certain people in public areas about,  

“We’ve got the best military and they can’t  stop us, blah, blah, blah.” When you have quiet   moments with serious, sober-minded military  intelligence professionals, they admit that   there is absolutely a level of mutually assured  destruction, not just from a military standpoint,  

But from a financial market and standards of  living standpoint. It would be horrifying. I fully agree with you. I hope you’re right.  I think the military intelligence people do   get it. It’s the State Department type of  people that I worry about. On the one lens,  

Everything you just described makes me  incredibly bearish on the US dollar and   our standards of living. But on the other hand,  we’re 90% energy independent. We import some oil,   but we are abundant in coal, natural gas.  We’re growing renewable energy. Europe  

And Japan and other countries do not have that  biophysical underpinning. The US dollar is bad,   but I can’t imagine another currency that would  replace it unless it’s something biophysical   like gold or land or energy SDRs or something  like that. What are your thoughts on that?

I think you described it very, very well, which is  peak cheap oil is going to force this biophysical   issue. We’ve been seeing Russia and China in  particular others central banks acknowledging this   defacto by how they have rearranged the deployment  of their surpluses. They’ve stopped moving them  

Out of sovereign debt and they’ve moved them into  gold and hard assets, and that could even include   equities, et cetera. The paradox of the way the  dollar system is set up, which is that there’s   a lot of dollar denominated debt outstanding, as  you move to multicurrency energy out of necessity,  

As China does this out of necessity, there’s a  huge overhang of dollar denominated debt that   needs a constant supply of dollars to service. Because every year you’ve got interest,   so you need more dollars to service that. All  else equal, there is a monstrous bid for dollars,  

Which is an oversimplification, but just for  illustrative purposes. As you start shifting   small amounts of the global energy trade away from  almost all dollars to some yuan, some euro, some   yen, et cetera, you’re going to effectively, as  that oil comes out of the ground and is paid for  

In these other fiat currencies, you’re basically  creating new supplies of these fiat currencies.  You’re increasing supply of yuan. We’ll just  use that one. But there’s not a monstrous   bid for yuan. There’s not a lot of yuan debt  outstanding in the global markets. Yuan supply up,  

Not a lot of demand. What happens to yuan? It goes  down. Flip side, to the extent you divert a small   amount of energy production away from dollars into  yuan, you’re going to shrink the supply of dollars  

Just a little bit. It doesn’t have to be a lot. It  hasn’t been a lot. However, there is a monstrous   bid, monstrous demand for dollars from the install  base of dollar debt as the system has evolved over   the last 50 years. Paradoxically, as you move  global energy pricing away from the dollar,  

It actually mechanically drives the dollar  up against these other currencies. Slightly   smaller supply of dollars, huge demand,  demand up supplied down a little price up   and vice versa for the yuan, yen, et cetera. And we’ve been seeing some elements of that in  

The way things have traded. Now, ultimately, it  is very bearish for the dollar and for our living   standards, barring this energy miracle  because of what we started describing,   or started the podcast by discussing, which is  these foreigners are no longer financing our  

Deficits. When we talk about foreign central  banks not having bought treasuries for almost   a decade now, the US debt in that decade is up  11 or $12 trillion. Ultimately, the Fed has to   print the money to pay for these deficits, and  that causes a weaker dollar in the long run.

This is why my dad, when I was 13, told me where  babies came from, but did not tell me where   money comes from because it’s so labyrinthine to  understand all this. Money comes from commercial   banks giving loans, and now governments’  deficit spending. Let me put this together.  

The foreigners, China and other places are more  reluctant to hold and invest in treasuries given   the logic that you described. At the same time,  the United States has to deficit spend more for   entitlements and COVID relief and all kinds  of holes and mouths to feed in our economy,  

Et cetera. We’re borrowing more money. How  does it work when we have done all this the   last 15 years with relatively low interest  rates? You said that we’ve grown our debt   $11 trillion in the last decade. Not only  have we doubled, a 50% increase in our debt,  

But now what if rates go up? What if rates  go to 4, 5, 6, 7%? What does that mean, Luke? I think that factors into the decision tree  that our creditors, that we described before,   the energy importing creditors and the energy  exporting creditors. I think that’s factored  

Into their logic of ceasing to buy treasuries.  They don’t have the, rather than say they don’t   have the luxury of not having to run a portfolio  that’s marked to market on a monthly basis or   quarterly basis. They can look out and ask that  very question, “How is the US going to afford  

This?” And the answer is either the United States,  when you look at what we spend all this money on,   the reality is there’s only three things big  enough to cut, it’s entitlements. We’re spending   call it almost 65% of treasury receipts, record  treasury receipts by the way, on entitlements,  

Defense about another 25% of record receipts. And  then incredibly in the aftermath of the Fed hikes,   we’re at about 30% on a proforma basis  of treasury receipts is going to go to   interest as a result of the Fed rate hikes. And that hasn’t fully reset yet. By the time  

All is said and done, it’s going to be closer to  40%. After that, everything else we spend money on   drops off dramatically. The point is, the US has  two choices, as rates have risen, it can slash   spending on entitlements, it can slash spending on  defense or it can print money, buy down interest  

Rates via QE and yield curve control, in which  case the dollar and inflation and in particular   energy inflation, given the bottleneck constraints  that we’ve been discussing there, that’ll be the   release valve. And I think part of the message  in the long run of US creditors, both energy  

Importing and exporting, moving away from storing  wealth and treasury is they don’t know when it’s   going to happen, but they know ultimately the  end game is the Fed’s going to print the money   to basically smooth over the deficit holes and  that the dollar will be the release valve. And  

That will be extremely inflationary in  a particularly very energy inflationary. Not only the Fed, but the Bank of  England, the ECB, the Bank of Japan. Because to your point, the treasury bond  is the risk-free rate for everything   else. If treasury yields go up a  bunch, corporate borrowing rates,  

The Bank of Japan’s borrowing, or excuse  me, the Japanese borrowing rates, et cetera. Let me double click on that because if rates in  the US go up significantly, what is the impact   on the emerging markets and all the countries in  the world that have had to peg their borrowing to  

The US dollar? And doesn’t that create an  emerging markets crisis like in 1999 with   long-term capital? Doesn’t this really hurt the US  but it crushes some of these developing nations? The short answer is yes. The longer version of  it is that it accelerates the de-dollarization  

Of global energy markets, and we’re seeing  that happen. When we talked before about the   need of China and others to gain the ability  to buy oil in their own currency as a matter   of national security, because otherwise  they’ll run out of dollars. Yes. What  

I just described will accelerate the pace of  dollar shortages as the dollar rises, as rates   rise. If you’re the average emerging market,  you’ve got big dollar outflows for two things,   dollar denominated debt service and energy. And you can’t service dollar denominated debt with  

Anything other than dollars. And what they will  do, what we are watching happen is as this dynamic   plays out, like you said, where it starts drawing  down dollar reserves as a result of the stronger   dollar, as rates rise, as interest rates rise on  the dollar denominated debt for these countries,  

They have two choices. They can shrink their real  economy, they can default. I guess there’s really   three choices. Default, shrink the real economy.  That’s the same decision, or they can accelerate   the pace at which they shift to buying energy in  their own currency. And you’ve been seeing that  

The Ghanaian government has done that recently,  using again, gold as a measure. Argentina to a   lesser extent, and taking yuan swaps to repay  the IMF. It accelerates the de-dollarization   flows. It doesn’t necessarily stop the currency  depreciation, but it keeps the energy flowing.

Let me ask you two questions about gold. One,  everything you just said makes complete sense.   We are not going to shrink entitlements,  we’re not going to shrink the military,   therefore we have to print and try to  inflate our way out of this. I just  

Don’t see how that’s not going to happen.  The markets and financial participants,   even if their energy blind have to see this, why  isn’t gold already not at four or $5,000 an ounce? I think ultimately it’s interesting when we talk  about energy as the real currency as real money,  

The price of gold in oil has risen  almost 4x since 2008. The gold to   oil ratio has gone from eight to  nine barrels an ounce to almost 30. But if energy is the real money, why  isn’t oil the thing that’s going up? Because oil’s very difficult  to store. It has a very low  

Stock to flow ratio. It’s commodity properties. That’s the difference. You can buy gold and  store it, but you can’t do the same with oil. Not in any real way. Unless you have some tankers sitting around,  because that was my second question about gold  

Is gold is more biophysical than digits and  linen that are the dollars in our wallets,   but it’s still not, you can’t eat it. It  doesn’t have a productivity attached to   it. Do you foresee in not this decade,  because I think we’re too close to it,  

But do you think future human societies in the  decades ahead could have a currency tethered to   something physical like land productivity, energy?  Or is that just too remote of a possibility? I think the reserve asset will be tied to it, I  think. And you’re seeing that happen. That’s why I  

Say we’re already a decade into this. When central  banks stop buying treasuries and buy gold instead,   they are storing their wealth in a reserve  asset with a direct energy tie, which I think is   critical to maintain that energy purchasing power.  When you ask, “Why hasn’t gold risen more?” The  

Answer’s pretty straightforward, which is, we know  demand for gold has risen. We know gold is finite,   and if the price hasn’t risen, it’s really  formulaic. They have created synthetic supply   of gold somewhere else. And how did they do that?  The expansion, really the unlimited expansion of 

Paper gold derivatives over the past 30 to  40 years has allowed policymakers to manage   the price of gold, right? So, if to the  extent that unallocated paper gold demand,   unallocated gold demand centered in  London primarily increases. So basically,  

If you have a demand for ounces, you can either  increase the price or you can increase the number   of claims on the existing pool. And that  ladder is what has happened over the years.  Now, that then gets into a very interesting  situation, and again, why peak cheap oil will  

Force, is forcing monetary system change, is that  when you hear me say central banks have stopped   buying treasuries and instead are storing  wealth in gold, restoring reserves in gold,   when we hear me also say nobody trusts the  yuan, but by offering credible physical gold  

Settlement of any oil surpluses in yuan  at the Gulf Nations in Russia in gold,   what you’re doing is effectively tying oil to  physical gold, physical oil to physical gold,   not paper gold, physical, which is important  from a price discovery standpoint for gold. 

Because as you were just pointing out, the  difference between oil and most other commodities   in gold is the stock to flow ratio. So oil, you  buy it, you use it, it’s gone. And so the stock   to flow ratio, which is just all the inventories  out there relative to the daily usage, when oil  

Inventories get high, it’s maybe 1.3 stock to  flow ratio. And when oil gets really tight,   it’s maybe 1.1. It’s just not that efficient  to store a lot of oil. The flip side, the stock   to flow ratio of gold is like 65. So, basically  all the gold ever produced is still out there in  

Some way, shape or form by and large, there’s some  marginal consumption for industrial uses. However- Except for the stuff I buried  in 2008 in my back land here,   and I still haven’t fricking figured  out where I buried it, but go on.

… Well, precisely. When you have a 65  stock to… So the stock to flow ratio can   be simplified down to the number of shells in  a shell game, right? So if you have a commodity   with a stock to flow ratio of 1.1 to 1.3 like  oil, you can’t separate physical fundamentals  

From price for very long, because the stock and  flow ratios are so small it’s going to show up,   right? So you have 1.1 to 1.3 shells per p. If  the stock to flow ratio of gold is 65, there’s  

65 shells per p. And so, they can play games by  creating paper unallocated supply to manage the   gold price. And they’ve absolutely done that. And  I can go chapter and verse for a long time, but I   won’t, on examples of that happening in history. However, peak cheap oil is a forcing function on  

The breaking of that unallocated gold market  because again, as peak cheap oil breaks,   indicts, makes unworkable the debt backed  fiat currency system where you store your   reserves in sovereign debt as we discussed is  happening, and you store it instead in gold,  

They’re not going to take paper gold, they’re  going to want physical. And so, as you connect   oil and gold, gold stock to flow ratio will drop  towards oils and the price will start to react. You’ve mentioned a couple times Russia and China.  So gold is increasingly the reserve go-to choice  

Of what some call the evil axis of Russia and  China. How likely do you think it is that the   US and the West are going to try to vilify gold  and possibly try to restrict its use similar to  

The US did in the 1930s? And they’re kind of  doing it now with crypto. Do you think that’s   possible? Because if they don’t do that things  could get out of hand, or what are your thoughts? I think it’s very possible they could.

How much of the world’s gold reserves  do the United States have, roughly? Oh, 8,000 tons on, call it 32  or 33,000, so about a quarter. So a quarter? Yeah, so very well represented. And so number one,  that’s part of the reason why I’m not convinced  

That they will, because it actually will be in  the interest of the United States for the price   of gold to rise. It recollateralizes the system,  it weakens the dollar, it will free up more oil   supplies in the way we talked about with the ’70s. So, it’s possible they will, and there are  

Definitely interests that want that in Washington.  But again, quietly, much smaller number of   interests, there are people in Washington tied  with the defense and intelligence community that   understand the need for a neutral reserve asset.  Basically, we are seeing the Biden administration  

Run this reshoring, the increasing investment in  electrical grid, all this domestic infrastructure,   this basically industrial policy we’ve  seen the Biden administration do, that is   in direct contradiction to the global monetary  system as it has been structured since 1971. 

In other words, since 1971, the US’ job is we  run deficits and if we need to shut down our   manufacturing and import it from elsewhere  to run more deficits to supply the dollars,   that’s what we do. So if we’re actually  bringing stuff back, relocalizing,  

That means the global system is changing. That  means the global monetary system is changing.   And if that is going to continue to happen, you  have to have a neutral reserve asset. You can’t   have both treasuries be the primary global reserve  asset, which means treasuries remain the biggest  

Export of the United States and reshore. If you  want to reshore, you have to move to a neutral   reserve asset. This is understood at certain  levels in Washington. And that’s why I say,   to the extent it is in the interest of the US  defense industrial base that has been hollowed  

Out and to relocalize in supply chains, there  are interests that understand that a higher   price of gold is not necessarily against US  interests the way it was for a long time. What a profound observation historically,  that one of the richest, most successful  

Nations in the history of Homo sapiens’  largest export is their debt certificates,   at a time when we’re realizing that energy  underpins all economic activity and we’re   passing peak cheap oil as you’ve mentioned many  times. Seriously, that’s like in the early Warner  

Brothers part of a Wiley Coyote cartoon. I want  to get to some synthesized questions on this,   but let me ask you one or two more things that  you mentioned earlier. You’ve said several times,   barring an energy productivity miracle, what’s  on the horizon that… Why would that help,  

And is there anything on the  horizon that you’re seeing there? Yeah. So, an energy productivity miracle  would basically offset the dynamics that   peak cheap oil is putting in motion. So  basically, to the extent that the world   is concerned about the real value of sovereign  debt and treasuries, specifically relative to  

Their needed energy inputs now and in the  future, that would allow them to say, “Oh,   okay. I’m not going to run out of energy. The  real value of debt is not going to collapse   against energy. I can buy debt again, we can  move back toward that other system. We don’t  

Need to change the system as radically  and as quickly as we seem to need to.” But it’s not specifically energy productivity  in this case because we could have a miracle   in some energy technology that has nothing to do  with liquid fuel that is the transport vector of  

The global system. So, it’s kind of got to  be a miracle in that arena as well, right? Yes, basically or it’s equivalent. So, you  commercialize small fission and build the   infrastructure and now all of a sudden you  actually can… And you don’t have battery  

Material constraints, and so now we can run EV  cars and trucks to replace those fuels. So yes,   exactly. You raised a great point in  terms of the liquid fuel constraint. And do you see, in your research at your firm,   do you see any promising energy  productivity miracles on the horizon?

The short answer is no, not that  won’t require basically yield curve   control implemented by the Fed to monetize  industrial production. There are small- Can you explain that? Because I actually think  we’re headed for yield curve control as well,   but I don’t think we’ve talked  about that on this podcast. What  

Is yield curve control and why is it important? … Yield curve control is just  the central bank drawing a line   over the bond market in terms of yield.  So basically the Fed comes in and says,   “We are not going to allow the 10 treasury  bond to trade above 4%.” And they print as  

Much money as they need to ensure that the 10 year  treasury never goes above 4%. So basically by- So that’s what Bank of Japan  has been doing with the JGBs. … Yes, exactly. So here’s a naive question, hold on a second.  If we’re worried about higher interest rates  

Because the government has to pay a huge amount  of our tax receipts to servicing our debt,   they could just say, “No, the market  clearing interest rate of five, six,   seven, 8%, we’re not going to allow  that, we’re capping it at 4%.” So that  

The government’s going to only pay 4% on its  interest. But meanwhile in the back door here,   we’re going to be printing a lot more dollars to  pay for that. Is that what you’re talking about? Yes. The release valve is the real value of  the dollar, and that’s exactly what the United  

States did during World War II. As Japan bombed  Pearl Harbor, shortly thereafter the Fed said,   “We’re going to cap the 10 year US treasury bond  at 2.5% and the three month 3/8th of a percent,   and we will buy whatever the government  issues.” And nobody lost a dime in their  

Treasuries for those five years  in nominal terms. In real terms,   those bonds fell sharply, particularly after the  war ended and the rationing of goods came off,   real rates in the aftermath of World War  II shortly thereafter. Real rates are   just inflation adjusted interest rates.  Real rates in the United States bottomed  

At negative 13%. In other words, inflation  was 15 and your interest rate was two. Yes. Okay. Let’s put this all together, Luke. This  spells an ominous economic future for the   United States and for most of the world.  Can you synthesize this? And of course,  

There’s not one outcome, it’s  not a binary thing, this or that,   there’s a distribution of possible outcomes.  But what economically could you envision in   the next decade in the United States based on  everything you’ve explained so far? What would  

It look like to the average person and what are  some things that are quite likely in your opinion? If we don’t get that energy productivity miracle,   which could be some sort of VAT. They  could also be things like the United  

States overthrows Putin and gains control of  Russian resources and is able to redirect them. Not going to happen. Not going to happen. If, I’m not wishing  for this, I’ll caveat this. When we talked   about the big expense being entitlements at  65% of receipts, if something, God forbid,  

Happens to a quorum of the most expensive baby  boomers in terms of healthcare and benefits,   where they… If you said, “Luke, I know  for a fact in three years, two years,   the unhealthiest 60% of baby boomers  will be dead.” And if that’s the case,  

That’s an energy productivity miracle in  ways, because you are going to reduce the   draw on resources. I’m not wishing for that,  I don’t think it’s going to happen, but it’s- No, no, no, no. Just conceptually,  these are all long shot things,   but if those things don’t happen, then what?

… Then I think you are in for a, in the  not too distant future, a dramatic rise,   potentially non-linear rise in global capital  costs, which means interest rates. United States,   global sovereign debt, corporates, everybody. And  I think that ultimately, given the obligations of  

Governments and western social democracies in  particular, drives them as a group into some   form of yield curve control, possible varying  degrees of capital controls light. Some of that   could be in terms of conversions into gold and  Bitcoin and things like that, to your prior point. 

The net of it is, I think we are in for a period  at some point in the next decade where real   interest rates in the United States, inflation  surges in the United States, across much of the   world and real interest rates are drastically  negative for a period of several years. So you  

Go through a period of time where inflation is on  a sustained basis in the United States, 10 to 15%   for several years at a time, and ultimately the  real value of this debt that is ultimately the  

Problem is eroded in commodity terms and energy  terms. And we wake up at the end of this period   of time, debt to GDP in the United States and  other western social democracies is at much more   manageable levels from which central bank can  raise rates without blowing up the system. And  

Basically, you have what amounts to a debt jubilee  on a real basis. The government gets a debt   jubilee by virtue of high rates of inflation and  yield curve control for a span of several years. Except that debt is a claim on future energy.  But when we issue money today, the money is  

Spent on real infrastructure and real things with  energy. That can’t be inflated away. So to me,   the real economy has to shrink relative to  today based in the scenario that you stated. The financialized economy, yes. Not so  much… Basically the GDP of the energy  

And the infrastructure and some of the trades  will… A good way I think to think about it,   is right now in the United States, this is not  for political reasons, but we have the blue   states and red states and we’ve all seen the  map. And if you look at the map, blue states,  

Red states, we’ve seen these articles that  have highlighted that essentially the blue   states subsidize the red states, right?  The blue states are your surplus states,   and the red states run deficits within the  United States Union. And so the blue states,  

Which tend to be much more highly financialized  than the red states, subsidize the red states.  What this world would look like is effectively  reversing of that, where your red states are   producing oil and food and goods and the prices  of those things relative to the things that the  

Blue states tend to produce more of, bonds,  financial assets, paper assets, movies. Movies, spas. Exactly. So you end up with the reversal  where all of a sudden the red states will   be subsidizing the blue states as  a result of that or after that.

But what about… I can see that, but it  depends what global and US oil production   are. And it also depends bigly on the  complexity risk between here and there. Absolutely. Because there are so many different supply  chains and contracts and little spark plugs  

That are made somewhere. And so, what do you  think the likely impact on global supply chains,   is there going to be a recognition that we need to  shorten supply chains, especially for key goods,   and is that some advice that you would  give to someone thinking about this stuff?

Yes, it is advice I would give them. I think  there has been some recognition of that among   policymakers. I think you raise a great point  too, as it ties back to the prior point of,   “Can US and western policy makers constrain  gold in that world?” And if the bottleneck  

Is energy as we think it will be relative to  dollars, treasuries, paper, financial assets,   that ties back to why I think it might be  so important about the BRICS in particular,   a session of these energy producers to the BRICS  or the entry into the BRICS is, gold you can  

Separate the western interests especially  can separate from the real economy. Oil,   they cannot. And we saw that with Russia.  What’d we do? We sanctioned everything,   everybody and their mother in Russia, everything  and their mother in Russia except oil,  

We didn’t touch oil. We’ve tried to cap it, but  even then the oil has kept flowing. And setting   aside grades and et cetera, oil’s fungible. So, if oil’s the bottleneck and the BRICS   understand that the situation in peak cheap  energy necessitates a new reserve asset,  

Then whatever the sort of gold, the oil ratio if  you will, if they say, “Listen, we value gold at   a 100 barrels of an oil per ounce, not the 30  barrels that they do in London and New York.”,  

The fungibility of oil will make the global  market go to a 100 barrels of an ounce. And   it ties back to your point on supply chains, which  is, if they decide that, which they can by virtue   of their share of oil production, by virtue of  their share of population, by virtue of their  

Share of real production of basically everything  else, then the Americans and the English can say,   “Well, no, no, no, that’s not the right price.”  And they can say, “Fine, then you don’t get the   spark plug. You don’t get the complex supply  chains. Call us when you’re serious and you’re  

Ready to pay a 100 barrels an ounce.” So you can see, you control oil,   you can control the value of the reserve asset  and by extension you can control the dollar,   the value of the international trade, value  of the dollar supply chain. So yes, all of it  

Depends on the complexity, but you can see how  these things can be used in a way that, again,   because people don’t think about the primacy of  energy of oil relative to the financial assets,   they don’t see this yet by and large.  Some, it’s a small minority that sees it,  

But I think a lot more people are going to see it  when it hits them over the head in coming years. Yeah, I happen to agree. That’s what I’ve  called this podcast, The Great Simplification,   because we’ve complexified by adding energy  and if we have suddenly the same amount or  

Less energy than before, we almost by definition  have to simplify the way we solve problems and   the way our society is structured. So let  me ask you this and then I’ll get to some   closing personal questions. So you, your  organization, the people that follow you,  

The people that invest with you are focused  on the financial markets. But what advice   might you give to a leader in either local or  state or federal government or a future leader   who is persuaded by the logic of what’s  coming our way, what sort of policy or  

Macro advice outside of the financial markets  might you suggest that wouldn’t get them fired? That’s the tricky part is- I know … the challenge in this scenario, and I’m  not advocating for this, I’m simply making an   objective observation, is that in scenarios  like this where you are effectively in a  

Wartime emergency type situation, authoritarian  setups have an easier time doing things than  nations that are on a two-year election cycle and  much more heterogeneous in terms of the political. Well, put a finer point on it, Luke.  Cheap oil supported liberal democracies.

Yeah. It absolutely did. And so, to answer  the question, not to dodge the question,   I would say you are going to need to run.  We’re now getting to a point where you have   to make a longterm strategic decision, which is  implement industrial policy to build resilience,  

To build anti-fragility, to build  re-localizing supply chains. And the   cost of that is going to be the real value  of your currency relative to commodities   and it’s going to be the real value of your  bonds. The challenge is that politically,  

Particularly here in the United States  and to a lesser extent in the UK,   the political power has resided with the debt  merchants, the exporters of debt. Who has won   in the last 40 to 50 years in the system? It’s  been the exporters of debt, which is Washington  

And Wall Street. And they still have a lot of  power, they’re not going to want to hear this. Well, and yeah. See, that’s the problem is as  we get closer to this biophysical inflection   point that you and I are discussing, it’s going  to become less able to have this conversation,  

And no one’s going to want to do these things  until it happens. And it’s going to happen   suddenly. That’s part of the reason I’m doing  this work is so we get more humans thinking two   or three steps ahead at kind of the inevitability  of the money energy nexus and start planning for  

The things that you’re mentioning because  I don’t think we’re going to get a lot of   warning. It may be five or seven years off, but  we’re not going to get a whole lot of warning. No, and you can already see, the crazy thing  is when central banks stop buying your debt,  

That’s a warning. When they buy gold, that’s a  warning. When China stops, when they start buying   up supplies of this stuff. So, by way of framing  of how far behind our leaders are in this way of   thinking, there’s a great book by Helen Thompson  called Disorder and it’s very focused on energy,  

Energy policy, et cetera. At any rate, I’m about  halfway through but very early on in the book,   she notes that in ’03 when the United States said,  “And now we’re going to invade Iraq because they   have WMD and they supported Al-Qaeda,” despite  very we’ll say minimal evidence to support  

That. Chinese leaders, she said, “Took that as a  sign that there was something wrong with global   oil supplies,” because the American leadership  had historically been sane, sober, et cetera.  And so, their read on this seemingly insane  move, this completely illogical move was there’s  

A problem with oil and oil supplies, and what  do we do to start fixing? They termed it their   Malacca problem. Their Malacca problem was 5  million barrels a day of oil plus goes through   the straits of Malacca, which can be shut down  very easily by the US Navy. And so, they got to  

Work on it. But this is 2003 they were thinking  about their Malacca problem as a sign. So, a 20   year headstart and our leaders still aren’t quite  there with the exception of some small groups. Oh, we’re drawing down the strategic petroleum  reserve to keep gas prices a little bit lower.

Yeah, to support, basically, to support the bond  market, right? Because when oil prices went up,   what happened in financial markets was our oil  importing creditor friends, China, well is China   friends? China, Japan went into current account  deficit positions. What that means is basically  

They were burning down cash. Well, what do they  sell to raise cash when they’re burning down cash   because energy has gotten so expensive? They  sell treasury bonds that they’ve stored up.  You could see last year it was adding to  the disorder in the Treasury bond market,  

And so it’s very poorly understood that this  SPR rundown, the US faced two choices last year.   When oil went up a bunch, great. Let’s take the  strategic approach and use the price incentive to   drive consumption savings, to drive investment in  production. Or let’s sell the SPR down to get oil  

Down and just stuff all those problems that are  real problems back under the rug for a second,   because the Treasury market’s getting upset. And  of course the US leadership being US leadership   chose the Treasury market and the short-term  expedient rather than the longer term, hey,  

Oil’s 120? Awesome. That will get people to  start converting into better fuel efficiency   and to EVs and to increasing production,  and all these good things strategically. What a mess. Let me ask you two more questions on  this and then I’ll move to my closing questions.  

So, we have a wealthy country but we have a  lot of inequality. There are a lot of people,   many double-digit percentages of our citizens  have nothing or close to nothing. So,   in the environment that you’re predicting with  10 to 15% inflation, et cetera, doesn’t that  

Crush people with 30 grand in their savings  and they just have it in banks, and all the   things that they’re paying for are going up  substantially in price? In the scenario that   you’re projecting as likely, doesn’t this really,  really hurt the middle and lower class in the US?

The short answer is yes. The longer answer  is that it depends on what they’re doing,   right? If they are lower and middle class because  they’ve been part of the blue collar and trades   workers and laborers in this country that have  been on the wrong side of the financialization  

Of the economy over the last 50 years, you’re  starting to see little signs of this. When you see   UPS drivers getting 170,000. When you see around  me, plumbers making 300 to 350,000 in Cleveland,   Ohio, when a nice house is 250, 300,000, maybe  350,000. There is a rebalancing that will  

Take place. It will require in a lot of cases,  flexibility. But to the extent you are a laborer,   skilled trades, et cetera, it’s very possible  in that 15% inflation, depending on your area,   you may be seeing 10, 15, 20% wage inflation  at a time when your 30-year mortgage is three. Right.

So, there’s puts and takes. But yeah, if you  don’t have or are unwilling to flex to that,   be part of that area that  is benefiting already and   I think we’ll benefit greatly as we  rebuild and restructure and reshore,   unfortunately sadly, I think it is a very  difficult environment possibly for them.

Speaking about the environment, what do you  think about the environment? Climate change,   biodiversity loss, plastics, some  of the other externalities that   are not included in the prices of the  goods and services that we pay for? It’s a tragedy of the commons problem, right?  Ultimately, in terms of because nobody pays  

For the externalities, here we are. So again, it  comes down to what’s the right thing to do is to   better reflect what the real price is. That  ultimately is not just a political question,   because who decides what the right price is?  Because now you make an assumption about a  

Future discount rate based on the deterioration  in the environment, et cetera, et cetera. What’s   the price of fresh water? Well, to me in Ohio,  it’s really cheap. I lived next to Lake Erie.   To a guy in Arizona, it should be very expensive.  So, it’s not just a political question but it’s  

An unpopular one, because in the end you have  to pay more. The answer is pay more to account   for those tragedy of the commons. We all like  living in clean areas and we pay taxes for it. And whatever your political or  personal value is on that issue,  

Peak cheap oil is going to make  society’s ability to pay more tougher. I say that all the time in my research. Oil  and energy, energy broadly, oil specifically,   is nature’s discount rate. So, peak cheap oil is  just going to increase the discount rate on every  

Other asset. Basically, every asset that everybody  owns, their house, their car, Amazon, trucking   companies, whatever, with the exception of two  assets, they all have implied in their value   a full and growing supply of cheap oil. You take  away the cheap oil, what’s the value of a house in  

A far out exurb in a place like California where  public transportation stinks? You take oil to 15   bucks a gallon, the value of that house collapses  if that person needs to get into LA from whatever,   60 miles away, 50 miles away. Commercial real  estate falls, et cetera. Only physical gold,  

Self-custodied or custodied outside of the  banking system and self-custodied Bitcoin,   both of which have energy components within  them do not have that counterparty risk,   that energy counterparty risk because  they have energy embedded in them. We could probably go on for hours. I  think I said it earlier, but I don’t  

Talk to people like you that often. I’m  talking to scientists and anthropologists   and activists and philanthropists. So, I  kind of miss talking to Wall Street people,   but I don’t really miss talking to Wall Street  people. But let me ask you some closing questions  

That I ask all my guests. You have been  working as a macro observer of the United   States and the global economies as a career  choice. So, given everything you just told me,   what is your personal advice to the viewers of  this program at this time of global upheaval and  

Anxiety and this currency reform and potential  inflation and other things on the horizon? I would say invest in maintaining  and building personal relationships,   personal health, anti-fragility in your  life, in your finances. Stay under-levered.   Don’t go out and borrow a bunch of money  because… I’m not saying not to borrow any,  

But make it productive and don’t over lever  because the volatility in financial markets,   in economies around what we describe here,  around some of these potential processes could   be very great. That’s what I’ve done in my own  life. Those are the things that really matter.

But you earlier said there’s  going to be a debt jubilee,   so wouldn’t the game theoretical move  be to actually lever since it’s going   to be written off in the future?  Somewhat facetious, but not totally. Well, it’s a great facetious question because  it highlights a very important point, which is  

If… There’s a chart actually from my friend, Dan  Oliver, Myrmikan Capital, and it shows one of the   great… Let’s take it to the extreme, right?  Extremes inform the means. One of the great   hyperinflations of all time was in Weimar, Germany  from 1918 to 1923, 1920 to ’23. We’ve all seen  

Some version of that chart, right? So basically,  gold goes from 10 Reichsmarks to a trillion   Reichsmark over five years. Everyone’s looked at  that chart and said, “Yeah. Wow, okay, if there’s   going to be a debt jubilee, if there’s going to  be high rates of inflation, the optimal strategy  

Is borrow a bunch of money, buy that asset on  leverage and then just let the inflation go.”  Personally, I had thought that myself, too. I’d  only ever seen that version of the chart. Then I   saw this chart from my friend, Dan Oliver, and  it shows the month-over-month price change in  

The price of gold as the Reichsmark was going  from 10 to a trillion in gold terms, basically   going to zero in gold terms. What it shows is  that if you were levered, levered long gold- You were taken out.

In the greatest hyperinflation in history, you  lost all of your money four or five separate   times in five years. And that’s why I say the  vault, I don’t think are people understand…   They’ve started to see glimpses of it on Wall  Street, right? When we’ve seen the two-year  

Treasury note trade like Dogecoin back in March.  When we saw the repo rates spike in September ’19   from two to 10 overnight, and the Fed come in  immediately and do not QE. We’ve seen little   glimpses of the type of volatility that this could  spur, and that’s in assets that we’ve never seen  

Or volatility. As you know, as a former bond guy,  the Treasury market doesn’t trade like Dogecoin.   The overnight repo rate that underpins everything  else doesn’t go from two to 10 in a day. No. But it has started to, and that’s why I  think it’s so critical to be under-levered,  

Prudently levered against either productive assets  or a place you can live and grow with your family. It does bogle the mind to see how many  monetary claims on our physical reality,   how many tens and hundreds of trillions  of digits are out there relative to the  

Amount of oil and forests and copper and  gold, et cetera. It really is something.  So, second part to the previous question, what  about young people? What advice do you have   to young listeners, who are becoming aware?  Even if they might not understand some of the  

Archaic and esoteric terminology you’re using  on finance and treasuries, et cetera, they can   kind of squint and see the picture that you’re  painting. What sort of advice would you give? It’s going to sound cheesy, but fall in  love, start a family, go to an art museum,  

Find what you’re passionate about. Because, yes,  on one level it’s very scary. On another level,   that opens up lots of opportunities for doing and  talking about things or engaging in things that   you can do as a career, as a life’s purpose,  that otherwise wouldn’t be available to you.  

Just me talking to you, hopefully hundreds  of thousands of people or millions of people   will listen to this around the world, and that  type of reach was simply unavailable even 10   years ago, five years ago, and yet here we are. Then I think it’s just having mental flexibility  

Of… It’s like Bruce Lee said, “Be like water.”  I think 95% plus, I say this, I have three boys   and I say this all the time, that 95% of life is  just showing up, trying and then being persistent  

When it inevitably goes pear-shaped when you  try it the first and second and third time. So,   show up, be persistent, try, be persistent,  fall in love, start a family, but whatever it   is that really moves you. Because it’s easy  to get worked up about the finances and the  

Possible environmental implications of the  peak cheap energy. All these things we’re   talking about, the geopolitics. But all the best  things that have happened, I’m 40, late forties,   everything, all the best things that have happened  for me in my life are tied to having spent time  

With my family. Invested time with my children,  pursuing a passion. For me, it’s macroeconomics   and talking with clients and writing reports  about it, whatever. Pursue those things that   make you happy and that are the really good things  in life, whatever those happen to be for you.

I have a feeling I might know how you’re  going to answer this, but what is one   specific issue that you are most concerned  about in the coming 10 years in our world? To me, the thing that’s scary,  the most concerning thing to me,  

I don’t want to say scared but most concerning  thing is the intelligence and foresight,   strategic foresight of Western leadership leading  us into a, what I still think is a tail risk,   really bad outcome. That, to me, and part of  that is because over the past several years,  

I have been increasingly disappointed and  surprised, quite frankly, at exactly how   poor the decision-making has been. That is  not just a reference to American leadership.   The Europeans in the last 18 months, to me,  stunningly, stunningly bad leadership. Like   galactically, stunningly bad leadership.  So, those are the things that concern me.

Yeah, we don’t have a governance model nationally  or internationally to face what’s coming. That   is what scares me. Everything emanates from  that. Yes, peak cheap energy is the cause,   but if we don’t have better governance, we’re  in for a tough road. I agree with you. So,  

If you could wave a magic wand and there  was no personal recourse to your decision,   what is one thing you would  do to improve the future? One thing. I would actually, if I  could just do one thing, I would give,  

And this is, again this is going to  sound cheesy, but I actually really,   there’s I think a kernel of truth here that I  think is really important. I would give every   child a mom like the mother my boys have had.  I think you’d have a much more peaceful world.  

I think you would have people that are armed  with the ability to have a governance model to   talk about the things we talked about. I just  think you’d be in a much better place. So,   that’s what I would do. My boys have been very  lucky, I’ve been very lucky, but that’s what I  

Would do. I think that would go a long way  in fixing a lot of the world’s problems. I totally agree with you. The irony  is, is the care and the home things   that the mother of your three boys  have done are not included in GDP.

It’s funny, there’s a meme that I’ve seen  before where, especially in today’s day and age,   as the boys were growing up there was a little  bit of a, well, I stay at home and you sort of  

Said that quietly. I remember a meme totalling  up the GDP value of what she did. I said to her,   “I can’t afford you. I’m going to need to downsize  because I’m not making enough money to pay for all  

Of this as it is accounted for in GDP in theory.”  So, you’re exactly right. And that doesn’t even   include any of the tragedy of the commons problems  that a great mother fixes, right? In the long run.

Well, and this is what’s at stake is figuring  this out. What is it that we really need for a   productive and sustainable society going  forward? I know you’re a very busy man.   Thank you for taking the time today  to talk with me, and to be continued.

Absolutely. I hope so. I really enjoy our  conversations. I’ve been a long time admirer of   you and your work, and so it was a real thrill to  be able to do this. So, thanks for having me on. If you enjoyed or learned from this  episode of The Great Simplification,  

Please subscribe to us on your favorite podcast  platform and visit TheGreatSimplification.com   for more information on future releases.