China Trade Deal Doesn't Change Where We're Headed | Luke Gromen

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All right, everybody. Welcome back to another episode of Forward Guidance. And joining me today is Luke Roman, president and founder of Forest for the Trees. Luke, it's been a while since you've been on Ford Guidance, so it's great to have you back. How's it going?

It's great to be back. I'm I'm doing well. It's uh just enjoying spring finally breaking here in lovely Cleveland, Ohio. So, love it. And yeah, hopefully you had a restful weekend because we are recording on Monday. And you know, to say the least, every day you show back up, the markets on on on the start of the week, there's just endless things to talk about. So, yeah, we're recording here a few hours after we got some meaningful developments in terms of the trade deal from China and what is occurring there.

So overall, the way I see it is that the the Chinese government and and the US led by, you know, Treasury Secretary Scott Bessant and Trade Representative Jameson Greer seem to have enacted a 90-day pause where the effect of, you know, tariffs on the US side of things are going to be 10% plus a 20% for the fentanyl side of things, netting them out at 30% for the next 90 days. And on the China side of things, we're seeing them at 10%. And they've created a framework of sorts to be able to meaningfully negotiate because effectively when tariffs were as high as they were, above 100%, we were basically in an embargo and things were starting to look pretty sketchy. So I would love to just get the high-level analysis of what were your main takeaways from what you heard today from everybody.

Overall, I think it's still pretty early to tell for sure. I mean, for me, I think there's a couple key takeaways, which are uh they are who we thought they were on the US side, which is to say our view is that this was going to create treasury market dysfunction pretty quickly. Uh, it did, and as soon as it did, uh we saw the US weaken its soften its stance, and that's not to say the Chinese weren't feeling uh quite a bit of pain themselves, uh because I think they were, but ultimately, uh you know, as I look out from here going forward, I I don't see how you get some sort of deal that doesn't feature a much stronger Chinese yuan against a much weaker US dollar. Uh, which is kind of interesting because it's kind of we're seeing well the yuan is strengthening against the dollar today, but the dollar is strengthening against the euro and the and the uh um you know, the yen, the primary components of the DXY. So uh we're seeing a stronger dollar against them. We're seeing a weaker dollar against the yuan. Weaker dollar against the yuan I think is ultimately uh where this all nets out. Uh but I think I I think we were shown that we don't have a lot of staying power in any sort of deal, you know, that the Treasury market will again dysfunction very quickly, and just like Yellen and just like Biden, um they will respond very quickly to Treasury market dysfunctioning, which you know, it's really hard to be a tough guy in negotiations when when you know, I've equated in the past that the Treasury market amounts to badly broken ribs for an MMA fighter, and you might be the best puncher in the world, but you got badly broken ribs, you know, and the other guy knows what he's doing a little bit. You're in you're not going to be able to just stay in there and trade punches. You're going to have to, you know, be a little bit more tactical. So, it's still very early to tell. Let's see from from here. But, you know, it's it's risk on and and you know, as it stands right now, in my opinion.

Yeah. I'd love to dig in deeper to really understand where you think the constraints are in terms of the strategic imperatives, especially from the China side. You've had some really interesting analysis there on on some of their more high-level goals there. But it was really interesting to me to hear Treasury Secretary Scott Besson talk about how, you know, they don't want to fully decouple from China, but there is some strategic imperatives that they want to focus on where they want to have a more robust independence in terms of, you know, steel, you know, pharmaceuticals, semiconductors, etc. So, in terms of what you heard so far today, it sounds like you still believe that there's some form of a decoupling that needs to occur. And what does that really look like on the Chinese side as well? Because you have some really interesting insights on that side as well that I don't think have been heard enough.

Something that has been I I've had a hard time figuring out in my own mind as I've watched this situation transpire over the last, you know, probably three and a half, four months now, I guess they were maybe just short of uh four months since they were inaugurated, has been the amount of contradictions in the US policy, which is we want to decouple, but like we don't want to all the way decouple, right? We want to get pregnant, we don't want to be all the way pregnant, um you know, we want to decouple, but we don't want to have treasury market dysfunction, you know, we want dollars recycled into America, but we want to make everything here, too. Uh, you know, we want oil at 50 so that we get 10-year yields down, but we we also want to produce a lot of oil. And so there there's been a lot of things they've been saying which are nonsensical. They don't they they're contradictory. They they they can have one or the other. They can't have their cake and eat it too. And that's one of these which is this, you know, to me when Bessant says something like that, he's far too smart a man to actually believe it. And so then I go, okay, what's he really mean? What are what is he what is he covering for? Because the fundamental dynamic of the China-US trade relationship, of the US's position in the world is we export dollars, we export treasuries, we export financial assets, and we import stuff. That's it. And so if we don't want to export ownership of our assets, you know, and it's it was great when it was treasuries only, right? That's just basically sending away magic tokens that we can create out of thin air in return for real stuff. It stops getting quite as funny when it's hey, here's shares of Apple, here's control of our ports, here's farmland, these are real for real. And so when we hear strategic decoupling, I keep going back to the same thing that I've been saying for three, four years, which is we can reshore, and if we do, the real value of the US Treasury market must be crushed: yield curve control, capital controls, and oh, or we can kind of continue, you know, this status quo where within 5 to 10 years, China's going to make most of our military equipment for it for us with which we're surrounding them. So, when I hear Bessant say that, he knows that. He absolutely knows what I just laid out. So, what's he really saying? I don't know. To me, it suggests that there is a a dog that doesn't bark in this whole discussion today, which is there's some sort of FX deal, restructuring of the monetary system component. And like, who knows? It's purely speculative on my part. But when I just look at like what he's saying and knowing how smart he is, like I have to believe he's stupid, like like galactically stupid to like take at face value what he's saying. And and we know he's not galactically stupid. So, there's something else there. Ultimately, I think we'll get some version of, you know, basically a much weaker dollar, yield curve, if if we want to reinvest um in this country um and I so you know, let's see to your point about, you know, saying one thing but doing another, and especially when there is that dissonance, another thing I heard from from Treasury Secretary Scott Bessent is he mentioned that most of the discussions in those talks over the past weekend were about the balance of trade; there were no discussions about currency accords of of the like, but to your point, you know, we're seeing the yuan strengthen. We're seeing bond yield surge today as well. There's some interesting correlations that are happening there. So, what is it about the currency side of things that you feel like is that's where the big game is at hand? And to your point, do you feel like that's something that they actually talked about or is that just coming down next? And you know, we just have to hash out the the high-level terms of trade first, get that settled with and then move on to the currency side of things?

Look, balance of trade is currency, right? It's not that America is not competitive. It's just that America is not competitive at 7.2 against yuan, 5.2 against yuan, 4.2 against yuan. America's probably pretty competitive. Maybe 3.2, I don't know. You know, that's kind of like one of those things where I hear Besson say that, it's maybe he's being cute. Maybe he's being disingenuous. Maybe he just does not want to say the word "I'm going to devalue the dollar," uh or something that can be construed as such. But if he's talking about balance of trade, he's talking about the dollar versus D1 cross rate. Full stop. You know, something I' I've I've posted on it a couple different times. People say, "Well, we need to worry about the balance of trade." Well, China ran a $900 billion surplus uh good surplus with the world last year. China imported 1,384 tons of gold last year. If you price gold properly, China China runs a flat balance of trade. If you take that as 1384 tons of gold, put it at $22,000 an ounce, that's that's all right. China's now running balanced trade. Wow. Where would the dollar trade today if gold was at $22,000 an ounce? Probably probably quite a bit lower. Like quite a bit lower. And that's the fundamental issue of like this dissonance of we want to have our cake, we want to eat it, too. Um, you know, my interpretation of him saying, you know, we want a stronger dollar system and and and a weaker dollar and those two things are not mutually exclusive, as he's said a couple times in the past dating back six to 12 months, that's some sort of deal that you know, if you have if you're settling more in some sort of neutral asset where you're as the as the pivot point to meaningfully weakening the dollar against the the yuan, you know, that's something that could work, but again, that's that's a huge change, and I don't think that's something he would dare talk about, but it balance and you know, until it's announced, right, um but balance of trade, balance of trade is currencies, full stop, like that's that's the only like that's that's that's the lever. That's the lever.

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I I want to bring in gold into this dynamic as well. It's it's interesting to see its reaction to this trade deal where it's just been taken out to the woodshed of sorts today, but it feels, you know, I'd be curious your thoughts if that's mostly just, you know, the speculative capital that moved in in terms of some sort of fear of US dollar hegemony decreasing and, you know, now that speculative capital is is being, you know, churned through, the real game at hand. Do you still believe the real game at hand is one this idea of the yuan being devalued against gold? And then within that framework as well, do you think there's that side of the side of things on the US side as well? I know you've mentioned how it was really interesting to you that gold was exempted from tariffs and and so would love to just hear do you think that was an important point to some of these negotiations here and how does that all play out in terms of of where gold sits within that framework?

Yeah, I think it's getting sold off on a, you know, Johnny-come-lately traders selling, you know, selling it off on on, okay, well, there's not going to be something very short-term. Uh, I think it's the absolute wrong thing to do if you look out more than, you know, sort of very short-term. Ultimately, you know, I kind of keep coming back to the same thing, which is if the US wants to run a flatter balance of trade, the reality is the Chinese are way more productive than we are, and it's not even close. And part of the reason they're way more productive than we are is they're investing way more into robotics, productivity, etc. I mean, I was seeing an article a couple months ago where they have a factory. They don't even have to have electricity in the factory because it's all robots and they know how to make in the dark and they they know the movements and so they just produce this stuff literally with robots in the dark. And it's an example. It's Chinese. So, who you know, you've seen the investment in robotics. Point is is that that means we cannot compete unless we either significantly invest in robotics, which you're going to need to do, or and to do that, oh, by the way, a lot of those robotics will probably have to come from China or maybe Japan or maybe South Korea, but again, it's it's likely to be inflationary if you are investing significantly in in property, plant, equipment in this country, particularly given the labor situation here, which is already tight, uh and the lack of skills because we spent 40 years focusing on financialization rather than than skilled trades. And so you've the only like the lever to balance that fact that they're more productive than we are is currency. It means the dollar's got to go down a lot against the the yuan, and that's tricky because that's inflationary, and if that's inflationary, that's also a problem for the bond market. And so you kind of keep coming back to like this the elephant in the room is that you're the bond market is the constraint, like the Treasury market is the constraint, and the sooner they want to keep pretending that it's not and and sort of you know, putting band-aids on it, they're just better off just sort of amputating, you know, yield curve control, capital controls, devalue the dollar, go. And so, you know, is that what they're discussing? I don't know. Probably not. I don't know that they want to be that drastic. But I think that's why Bessant keeps sounding this cognitive dissonant, dissonant points, which is that it's the constraint. He can't really do much without hurting the Treasury market either way. Deflation hurts a Treasury market. Inflation hurts a Treasury market. Will they let it they can't take pain for more than a week or two in the Treasury market. So like they might as well just like get it out of the way. But yeah, I do I do want to dig a bit further into this the bond market as the leading constraint in a second, but I do want to better unpack, obviously, everybody on their mothers know that the goal now is to narrow the current account deficit with with China and to recalibrate the capital account because basically the main flow has been we give a bunch of treasuries out out to China. Now, what is also interesting from the press conference that President Trump mentioned this morning is that he said that China was opening was was keen to open up their market to the US. And so I start to think about the idea that okay, if we start to try to get, you know, actually like US goods into China, not just treasuries. Do you see that as a as a meaningful rebalancer to that terms of trade? And what did you think about that overall of this opening the market?

No, I don't think I mean, I think about it, I go, okay, what are we gonna send the Chinese that don't have a bunch of Chinese components in it and that the Chinese aren't, you know, we gonna send them weapons? No. Uh, we going to send them AI chips? We've already told them we're not going to do that. So, like pretty much everything else, I don't know. I if you if you X out defense, if you X out AI chips and some of our leading-edge, cutting-edge technology, which I I don't think we're going to send for national security reasons, what else is there that the Chinese don't make for us or make better than us or both? Uh, and I don't know what that is. Um, I mean, part of me thinks that's that's part of the reason for the trade war in the first place. Like I think there's a national defense imperative side which is you know, we're borrowing money from China to build weapons to face down China using Chinese components. This has to stop. And that's I think the defense department's been pushing for that for a while. But I think more recently there's been an aspect of the trade war where corporate America is waking up. The blue chip, you know, untouchables in America are waking up and going, "Oh my god, we're losing." And not only are we losing in China, soon we're going to be losing elsewhere around the world. And it's fascinating to hear these these execs talk the way, you know, my union leader late father-in-law talked about the Chinese 20 years ago. You know, oof, we're losing. We can't compete with this, you know. So, it's I think part of the reason corporate America has been sort of okay with tariffs and some of this is they see themselves losing, right? Like Tesla's losing to BYD, Apple's losing massive share in China. It's only a matter of time till they start losing share outside of China to Huawei and others. And so when you have these national champions on the US side, you know, Deepseek was a perfect example. America thought it was winning in open open AI, etc. And all of a sudden it was like, whoa, wait, what? And so we've kind of seen this over and over and over. You know, I saw this 20 years ago in in sort of the, you know, when we followed construction equipment at a firm that I I worked at in my former life. I was like, all this Chinese stuff is crap and it's never going to overtake Caterpillar. And then all of a sudden it's like, well, you know, 5 years later they're kicking out Caterpillar stuff and and you know, I don't even remember if it was CAD or not specific, but the point is that they were replacing US brands with with you know, domestic-made brands, and did they probably steal the IP? Yeah. Like, grow up. How stupid are you? You know, you sent the stuff there. People I had a conversation with that someone recently where they're like, well, they have ch they have taken our IP over and over and over and over and over. I'm like, okay, after the first or second over, like, who's the idiot? Why did you keep sending stuff there? And it's either greed, naivete, or stupidity. Which one is it? It's really a combination of all three. So, I think there's I don't like I hear, yeah, we're going to send stuff there. Like, the reason they're there in the first place is because China was going to be this huge market for American companies. And so, to me, it's just like like are we really going to recycle that one again of like, hey, America, China is going to be a great growth market for Western companies. I'm like, we tried that. Like, what's the only difference now is the Chinese stuff is way better than it was 20 years ago when that was going to be true too. So to me when you sort of take a step back from that and go that's nonsense unless the dollar is absolutely hammered so that the American stuff is super cheap and and that opens the door. Otherwise, like the Chinese like the stuff that Chinese will want the Americans aren't going to sell. And it again to me it points back to a neutral reserve asset of gold, right? Or you know, hey, fine, you know, we'll we'll settle in gold, and but if we're going to do that with the deficits we're running, it's going to have to be at a much higher price or we'll run out.

It it feels to me like you are still in the camp of it feels like we are we going in, you know, we're at peak globalization, and now we're going to head into a world where we have the US as the core economy and then the countries that associate with the US and then China and then the countries over there that associate with with China and trade there. Do you still believe that that's the event the eventuality that even though they they don't want to say we don't want to fully decouple, just when you when you play out the game theory like you just did right there, that's where we're headed regardless?

Yeah. I mean, I think everybody has some level of fear, real or imagined, of an inability to compete with China. And we frequently hear, you know, China is they just are they're just overproducing. It's just a factory. It's it's, you know, who was it? Bessent or Lutnik or somebody said it was like the uh um you know, the dance of the the uh brooms in in uh uh Disney, right? Where Mickey's got the brooms and there's one broom creates a new broom. You know, the wizard thing. That's true. And it's also a perfectly rational response to what the US side has been, which is the same the opposite side of the same coin, which is just creating dollars, creating dollars, creating debt, creating debt, creating debt. So I think there is a peak globalization. I think we're going to re-regionalize. I think you're seeing that. I think certain Asian economies have real concerns around China and their ability to compete with China. I think ultimately you're going to just see those countries trade more with each other and you know, I think the US you know, will probably try to sign deals with with South Korea and Japan to try to sort of reshore you know, the the setup is very is is reminiscent in some ways of of 1945, except opposite. In other words, you know, the United States looks like a country that's lost a war. We got a million people dead of drug overdoses in the last 15 years. And we've got an industrial base that's been severely damaged, not by war, but by trade war. And if we go back to 1945, you had some you had millions of people dead from literal war. And then you had industrial bases that were destroyed by literal war, not trade war. And so there was sort of a a boom in the aftermath of World War II where the US rebuilt

The world. Um, and there were two, you know, poles, if you will, right? The Soviets sort of built their sphere of influence, and we built our sphere of influence. And, you know, maybe we get two spheres of influence like that again. That's entirely possible.

But part of, you know, part of it is is the US is reprising the role of Europe there. Like, we need someone to come build stuff for us because we really can't on our own. And so, I think there's a goal to try to get the Japanese and the South Koreans to do it. It's going to be really hard without the Chinese. So it it's, you know, it's again it's this dissonance of well we don't want to completely decouple from the Chinese; we just want to decouple the way we want to decouple, and and you know, some of it is just look the US has been left in a really bad position by really dumb decisions for 30 years by its by its leaders—dumb/greedy/shortsighted—and so like that's, you know, what is globalization now? The the traditional flow of what we've done that is I think absolutely dead. This sort of hey we send dollars and they recycle the dollars into our financial markets, you know, so China ends up owning, you know, providing all our defense and owning all of our stocks, you know, brought to its natural, you know, extremist conclusion. Like I don't think like that that's over, but there's still parts of the US, as we've seen in the last week, it's like well we want to be, you know, sort of half pregnant, you know, we want some of that but not all of that, and you know, the reality is is that you can't be half pregnant; you're either pregnant or you're not, and and you're either you're either going to connect with them or you're not because the dollars are fungible, right? You can't say, "Well, those dollars are only good for this." No, not unless you put up capital controls. Not unless you and you can't have capital controls between the global reserve currency and the world's factor, China. Like, you put up capital controls that are too much, you're not the reserve currency anymore.

And that, you know, that to me, again, you kind of tie it back, because like you're going to have to net settle in gold, you know, maybe maybe someday Bitcoin, but it it keeps going back to the system needs to change. If we don't want the Chinese recycling into our markets and they're not dumb enough to just buy treasuries because we need negative real rates on treasuries, we can't afford it without, and they're not dumb enough to stockpile negative real rate treasuries, then you've gonna have to do something to change a system to kind of balance those two competing needs.

Yeah.

Yeah, to that point about being half pregnant throughout this transition, I I wonder about countries like Vietnam. Do you think they'll be able to play both sides throughout this? And also Taiwan, we haven't even talked about Taiwan yet. And obviously there are some very fascinating FX movements that happened in in Taiwan in the leadup to this, and yeah, like these type of countries that are trying to play both sides. Where do you think they net out throughout this transition?

I had a meeting with somebody, you know, once removed from one of the one of the most highly influential people tied to tech in Southeast Asia. This is 2018 when China was smaller than when they are now and less far along, less consumption than they're doing now, etc. And they said, "Look, if you guys make us pick, we're going to have to choose China." And this was a US ally. This is a tech company and a US ally. We would have to choose China because they're just so much bigger. They're so much bigger. They're so much more growthy. Um, you know, the the penetration rates when you look at the per capita consumption of stuff in China versus the US, I don't know how they'll choose.

I mean, I think for me, Taiwan, I don't think there's going to be any Chinese invasion of Taiwan. Why would they invade? Like, number one, the place is going to get trashed. And then that's not good for anybody. And and by the way, that makes China the villain uh in this whole thing. And and practically speaking, the Chinese have shown a willingness to be very very patient. And if they just kind of keep increasing business ties with the mainland, then they can wake up in 10 years, 20 years, 30 years, you know, and they they maybe just regain it without firing a shot, without even having to take this sort of drastic action. So I I continue to think there's not going to be a war in Taiwan.

I mean, if if we were forward thinking again as the US, we'd be like, "Okay, these business ties with Southeast Asia are likely to continue. Let's really do some sort of industrial policy uh to bring back stuff." And you've seen it certainly on the margin uh but it's not been wholesale. It's been like poor man's, you know, like like pigeon industrial policy. Sort of like, you know, we're going to build three fabs in Arizona. And that's great, but like until you are subsidizing, you know, the the teaching of welders and the teaching of semiconductor engineers, like like welders in this country shouldn't have to pay a dime to get educated. Semiconductor engineers in this country shouldn't have to pay a dime to get educated. Um, you know, sort of the whole supply chain so that we wake up in 10 years and go, "Wow, like now we can compete if we need to, if we want to, etc." But again, it's it's starting to be less anathema than it was say 5 years ago, 10 years ago to do something like that. But there's there's there's still not this sense of urgency because again, oh the bond market, like that's that's not free markets. That's not what we do. Which again, it's just if you step in and support the Treasury market every time it starts to throw up on itself, you're not a free market. So just freaking embrace it. Do industrial policy. Do what's right strategically for the country. But there's still this view like, well, we're a free market except anytime the Treasury dysfunctions, they come in and they do something. But but it's still we're not centrally planned. Well, no, you're just literally putting out fires on a centrally planned basis, which is again no way to run a country, a serious country at least.

So, you know, I I'm kind of rambling because I I you know, I don't know like can Vietnam be part of a solution around China? Sure. And like take a look at the relative sizes of the country. Take a look at the infrastructure. When you talk to people in in in sourcing like yeah Vietnam can be part of it but like like China is seven of the 10 biggest container ports in the world. It took China 30 years working at the fastest pace in human history to build that infrastructure. So do you think that the Vietnamese can you know best case the Vietnamese is going to take 30 years best case. Best case and oh by the way does anyone remember what happened to commodities while China was doing that? What happened to commodity inflation? Imagine what would happen to commodity inflation. You did that. Again, you go back to this elephant in the room, which is the US bond market will throw up on itself. It will dysfunction if you have something like that again. So, there's just, you know, I keep no matter which way I talk around it, I keep coming back to the same thing, which is they're playing with their food until they do industrial policy, yield curve control, capital controls, devalue the dollar, devalue the debt, the GDP, and reset the system to something where the dollar is still the reserve currency, but gold is the neutral reserve asset, then we can compete. Otherwise, we're just, you know, it's just like, okay, here we go again. I might as well just go to the beach for the next three months because this like like what like what are they doing?

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Restriction supply. Okay, let's let's dig into the situation in the bond market and the fiscal path. And just to contextualize it a little bit here is, you know, based on some napkin math that I've seen so far, based on where the effective tariff rate is at this juncture with this new trade deal, it's around 12.5%. So 12.5% effective tariff rate. We're running a 7% of GDP fiscal deficit. And then now you have what's coming forth in terms of these major tax cuts that are coming down the pike. When you start to balance all of these together and also Doge, you know, which was originally saying about two trillion in cuts, we're now down to about 150 billion. It's it's it's basically, you know, that's just a couple days worth of interest expense, right? So, when you put that all together, what's your outlook for the fiscal path from here on out? And and how does that get intersected with with the bond market here?

You know, I have not rerun the math with the tariffs where they are. I just looked at I think they did I don't know like 30 billion in a month or something like last last month and I don't know sort of what that represented relative to sort of where we were and where we are. You know, I've seen 500 or 600 billion a year in interest or excuse me, in tariffs, maybe even 700 billion. And as as best case scenarios prior to where we are today and if you look at what the US collects from its bottom 90% of taxpayers on the individual side, it's like 675 billion. And so in sort of a perfect, you know, vacuum, in theory, a lot of, you know, what we what we were collecting on tariffs before that moved could offset Trump basically cutting income taxes to zero for like the bottom 90% of individual taxpayers. That assumes no other offsets, etc. Um, and then I don't, you know, that is also tax cut agnostic. I don't, you know, I've not sort of run that math. That would be very stimulative, you know, and so that's where it starts to get some of the reflexive uh the reflexivities of of that. Okay, if that's stimulative, then the economy grows faster, economy grows faster, 10-year yields probably go up, 10-year yields go up, like does that restrict the economy? Does that drive a higher interest expense? So now the deficit's bigger and it's it's very difficult once you get to sort of the second and third derivatives of of what it could be. But just on a strictly in a vacuum basis, the tariffs, you know, could help. It could be a huge political tool. Um, you know, I don't think anybody in the bottom 90%'s gonna gonna dislike, you know, having their their taxes cut significantly, maybe to maybe to zero conceivably.

Bigger picture, the deficit's, you know, it's like you've you've you you're spending, you know, we we highlighted for clients last week, you know, we we hear over and over we're in this new cold war, new cold war, new cold war, new cold war, right? China, Russia. Great. Okay. Interest expense is already above on a net basis above defense. For the prior 85 years of US history, that had never been the case. In fact, during the hottest part of the cold war, um well, like let me during the cold war, defense was never less than 4% of GDP. It's 2% today. Sorry, it's not 2%. It's it's uh it's actually more like 2.7. So, it's closer to four today. Sorry. It's closer to four today. It was never less than 5 to 10 as a percent of GDP historically. And you go, all right, well, if we're in a new cold war, you know, defense is going to be 6-8% of GDP. So the the the 7% deficit we're running today is going to have to go up another two to 300 base points. So you're 9 to 10%. And that assumes, you know, interest, you know, they're still repricing some of your interest. You know, entitlements are running at 70% of receipts. Receipts are running at all-time highs. Receipts are dependent on stocks going up. Stocks need to go up 10, 15, 20% a year just to basically make the fiscal math work and to to drive enough receipts. So when I put it all together, I think the deficits are going higher and I think the market's going higher because ultimately if the market doesn't go up by 10 to 20% a year, the market being S&P 500, you're going to have deficits creating Treasury market dysfunction and then they'll come in and have to create, you know, whatever liquidity or take whatever policy or to to drive make sure that equities are constantly setting new records to fund the government.

Yeah, I would love to unpack further. Obviously, there's the nuclear option that you've referred to a couple times here of yield curve control where they just outright cap the long bond at a certain rate and say we will buy unlimited amounts of bonds to protect that rate just like what the Bank of Japan did, what the US did after World War II. But I also want to hear a bit about what are some of these smaller levers that can be pulled in the interim before we get to that nuclear point. We've heard a lot of talk from uh Treasury Secretary Scott Bessant about ramping up Treasury buybacks potentially to either further alleviate liquidity constraints there. Obviously, the big issue there like when they when the Treasury market really seizes up, it's those off-the-run bonds that are super liquid. That's really seizes up. So, trying to improve that. There's also been a lot of interest in stable coins coming recently from the Treasury market, which is a really interesting new category of marginal buyers of US Treasury debt. So in light of this situation where we're not exporting as many treasuries to the rest of the world, what are some of these more nuanced tools in the toolkit that that can be used?

Yeah, I mean I think the Treasury buyback, you know, Besson's talked about that. Um, you know, it's interesting if you look at the price of uh the Treasury futures long bond price. uh from the moment I noticed this the other day actually for the first time since Yellen started buybacks in May of '24 it looks the the the futures price it looks like there's been a floor under the price that's that's a you know yield curve control light price action uh so I think a that's something they can do b I I would argue he's already begun ramping that up right so since Yellen last 11 months the buyback program has been in place there's a total 169 billion that has been bought back per the latest TBAC report. Of that 169 billion in the last three months, Besson's done 75 billion. So about half of the buying in a quarter of the time. So he has accelerated the pace. It's certainly you know you like that's fine. You know it's basically sort of active treasury management of you know you know issuance what have you. Um, you know, obviously they've done a lot of things over the last 10 years between regulating banks into buying, regulating money markets into buying, regulating pensions or incentivizing pensions into buying via tax result uh uh benefits under Trump's first term in 2018. Uh, stable coins certainly could be another form of that. Um, you know, again, in the in the latest TBAC report, you know, foreigners in total are buying about 30 to 40 billion a year or a month, excuse me, of of Treasury bonds and notes. Um, and in the first quarter, in the latest quarter, they bought between 180 and 200 billion a month of bills. So, foreigners are still buying treasuries, just they've shifted to the front end. You know, by way of comparison, 10 years ago in 2015 with 18 trillion in debt as opposed to 36 and change now trillion in debt, uh foreigners were buying 30 to 40 billion a month of bonds and notes then. So literally we've doubled the debt and foreigners have not increased their monthly buy rate of bonds and notes in that time. It's it's shifted to the front end. And I think that, you know, speaks to your point on on T-bills and and and stable coins. And I think it's why the US administration is so focused on them as a policy lever which is you know Besson last week came out and said hey you know digital assets could create $2 trillion of demand for stable coin for for for securities for you know T-bills because the reality is that it's unlikely that stable coin issuers are going to issue a bunch of stable coins and then buy a bunch of 10 and and 20 and 30-year treasury bonds. The duration mismatch is too great. So it's it's probably going to be mostly if not all T-bills. And so what you're really talking about when he says that is a a much higher price of Bitcoin because in my opinion you know you got 200 billion of stable coins give or take now it's probably closer to 240 billion but of total stable coins in the world. He's talking about two trillion of you know digital asset demand for US securities potentially that's that was a Treasury Department number from the TBAC supplemental report two weeks ago. Look, the implications of that is if if if he thinks you can get two trillion in stable coins, right now you have 240 billion in stable coins in a $2 trillion Bitcoin market cap. So if he thinks he can get two trillion in stable coins, to me the implication is he thinks, you know, you you can make the case at least I don't know what he thinks. I don't want to put words in his mouth. He make that his math to me suggests that you're going to need at least a 5 to 10x increase in the market cap of Bitcoin in order to drive the stable coin sort of, you know, keep that ratio the same, right? two trillion in Bitcoin market cap over 200 billion in stable coins 10x. You want 10x. You want two trillion of stable coins, you need 20 trillion maybe of of Bitcoin. Well, that's up 10x from here. So, you know, hair cut it. Say it's only up 5x from here. Say it's only up 3x from here still. So, that's the first thing is when when when we hear, hey, stable coins are going to fund it. Yeah, maybe. It makes me real excited, you know, for my Bitcoin position for sure. Uh but then secondly, let's not let's not sell short. What he's saying is we can't issue at the long end, so we're going to issue at the short end. And that's you're going to run two $3 trillion deficits heavily financed in the bill markets. Like that's that's very inflationary over here.

I I want to dig into that point a little bit further and I'm going to ask this intentionally simplistic, which is just why why can't a reserve country just issue a ton of bills? like where's where is the constraining factor on the idea that we're just going to you know we're not going to issue any long duration we're just going to issue 0 to 5-year basically from here on out. What is the constraining factor around that that allows them to not actually do that in practice? Why is it risky to do that?

The constraining factor is inflation and and in particular domestic inflation. Right? So we can look back foreign central banks haven't bought any treasuries on net in 11 years. Uh we know that. So like that that that's already been broached. They're not buying they're buying gold instead. And so they're kind of looking out, you know, to me the read of that for the last 11 years has been the Americans can't make the math work unless they you unless inflation runs higher than yields and great just buy gold. The domestic constraint is just it's just inflation. And so you know you that and and when you say it's just inflation it's just the political because the politicians really don't care about us. They just care about getting reelected. So, you know, they didn't care about inflation at 8% in 2021 and then in 2022 when there's election, it was like, oh no, you know, we got to get inflation down. And so that is that's the constraint. That's it. That's the only constraint. And so, you know, you that's it's going to be inflationary. The reality politically in this country is like half of the people by virtue of our you know of our electorate which is very divided depending on which color is occupying the the the white house right and red occupying the white house then the red people are going to believe them when they tell them inflation's three and not 10 and the blue are going to be oh it's higher and these inflationary policies and then you know the the blue guy gets in the white house and they're going to do the same thing and you know everyone who votes blue is going to say oh inflation's actually three. It's not 10. And all the red people are like, "Oh, it's 10, not" and so it's, you know, me, I'm sort of like the, you know, I don't care either way. I'm just going to watch my Bitcoin and gold go up every year because it's 10 and I don't care what you tell me. You know, it is what it is. Over time, they're going to go up with that. So, yeah, it's it's yeah, the constraint on it is just inflation. And you know, at some point the bond market really revolts, but like the more you go at the short end, you know, you know, a sign of the times of where macro is at right now is we've gone 45 minutes without even mentioning the Fed or Jerome Powell.

But I want to I want to bring that dynamic into the conversation now because we're starting to talk about Okay. Well, if we're I I I I assume you still have the running assumption of higher than the 2% target inflation and that that is not that is not entirely unintentional due to just how high the debt levels are relative to GDP. So, obviously, we had the we had the FOMC meeting last week and it's it's quite clear that they are on a on a full-on pause and if we're getting a further deescalation in terms of tariffs, that makes their job a lot easier.

Yeah. How are you thinking about the Fed right now and how this sits within this entire framework that we just talked about?

I don't know to be honest. You know, same in a tough spot. They're in a tough spot, right? Because like let's not mistake like we're still talking about 30% tariffs on China. Like just because it was 145, like there's an argument that can be made that what just happened with the deescalation was we took absolute collapse of the economy where you would get a moment of deflation before you literally started hyperinflating as shelves went empty. You just took a a very deflationary momentary impulse off the table, right? Because now we're going to just we're going to get a normal flow of goods after a bit of a lag. It's just all going to be 30% more expensive from China and everyone in their mother, even if they're, you know, look, if if you're a businessman and you're comp you're not making stuff in China, but you're competing against someone who's making stuff in China, you're an idiot if you don't raise your prices 25%. Why wouldn't you? And so I think ultimately like you can make

The case that actually what just happened is increases the impulse to raise rates if you're looking at it as a central banker would look at it, which will be interesting if that's the correct interpretation. I suspect you know we'll get about 3 days of rally here, and then everyone's going to start freaking out about the bond market again and about rate hikes again. You know, we'll see. But again, for me, it always keeps coming back to that like at the end of the day, the US has a debt problem. It is the reserve currency issuer. They've got to have significantly negative real interest rates.

So, it's this constant, you know, yin and yang between the Fed trying to maintain their, you know, their credibility on inflation while simultaneously not being willing to be the first Fed to let a US Treasury auction fail. And those are the kind of the two constraints on either side. And so, those constraints are still there. They haven't changed. Um, you know, right now we're I think kind of comfortably between the two, but you know, let's see how that plays out over the next 3 months.

Um, okay, so just to wrap up this conversation here, I do want to explore a little bit around what would be the invalidation of this whole thesis you talked about, which my assumption of that would be genuine austerity from the government, you know, going from 7% of GDP fiscal deficits to something a lot more normal. Um, how do you how do you discount that possibility in terms of your framework? Because as as the way that you you outline it, it feels quite clear and inev I I agree with 99% of it, but how do you discount the possibility of Okay. Oh, crap. You know, the society is fed up with inflation. We need actual austerity, or else they're going to kick us out of Congress. How do you think about that risk?

I think it's like no risk. I I mean, I watched for it, but like yeah, 2Q 20 2Q22, we did have austerity. US Treasury outlays in the second quarter of 2022 were down 30% year-over-year. And by the third quarter 2022, the bond market broke again. And Yellen came in and weakened the dollar dramatically. Like for me, it's not can they try? Of course, they can try. It just won't work. And number one, it won't work. But I manage my own personal assets based on keeping a liquidity position such that the US government will break before I break. That's all.

All right. So like we've seen it third quarter 22. You know, they did austerity second quarter 22. By third quarter 22, markets tanking and the and treasury yields are going up with a tanking market like the US government cannot afford that unless they are going to nominally default on their treasuries, which I ascribe a probability of zero to uh they have to do something, and they did; they weakened the dollar then again in 3Q23, same kind of thing; they know it wasn't austerity, but so like when you look at austerity, there's only so many things they can cut, you know, that the the the they spend I don't know they spend 7 trillion a year roughly. They take in 5.2 trillion of receipts, right? So right now we're looking at, you know, trillion8 deficit. Of that 7 trillion they spend five, you know, let's let's look at it from a receipt side. 5.2 trillion in receipts. 3.5 trillion of that right now are entitlements. Okay. So are they going to cut entitlements? There's no freaking chance. Not like it's not going to happen. Interest right now trillion5 gross. Okay, they could cut that, but that's it's not gonna make me feel any worse about gold, Bitcoin, and stocks.

All right, and and oh, by the way, if they do that, we know what happens to the bond market. We saw it in the fourth quarter last year. Bond market got killed after they cut rates. Okay, defense in the middle of a cold war. Remember, we we're only spending 3 4% on defense. We've always spent six to 10 in a cold war. Are you really going to cut defense? No. Okay, so three and a half one and a half trillion plus another trillion that gets me to six trillion. That's a trillion of deficit, right? Five, six. Yeah, that's a trillion a deficit on 5.2 trillion of receipts. I haven't even touched national parks, education, veterans affairs, which is now a $400 billion a year line item because all the stupid wars we've had. Uh, labor on and the rest of everything they spend on. So the only things they can cut that matter, they can't cut. And if they do cut, it's going to hurt the bond market.

So then to me, like what invalidates it? Look, if if if we overthrow Putin and install a Yeltson and the Harvard boys go over there and start selling off Russia peace meal to American oligarchs at, you know, pennies on the dollar and only sells their resources in in dollars and then we use that to choke off China and then China tips over. Like, yeah, that's going to invalidate that. Is that going to happen? No, probably not. Especially since we lost in Ukraine, you know, we couldn't even produce our own weapons enough. You know, we got outproduced four to one in Ukraine according to uh NATO Secretary General a couple months ago. So that's probably not going to happen.

The other thing that you'd have to watch for is like some sort of you know significant decline in in in boomer mortality or increase in boomer mortality, right? If if a bunch of boomers died quickly, then your your you know your health care you know that that three and a half trillion a year were given to the boomers is not only going to shrink meaningfully, but their assets are going to go to their kids and the kids are going to spend it because they're in peak spending years. That's that would invalidate this, right? Anything that basically took boomer mortality up a lot quickly uh would invalidate this. U you're not seeing that in the data. U but other than that, even a productivity miracle doesn't really help you unless it arrives at just the right pace because if it arrives too fast unemployment goes up. Unemployment goes up bond market's going to break again inflation. And if it arrives too slow it doesn't matter anyway. So you know I spent a lot of time thinking and watching for things that would invalidate it. And like, you know, in theory, you know, a a a Ukraine war where Russia, you know, the ruble actually became rubble and Russia lost, like that would have possibly, but didn't go that way.

Mhm. Absolutely. Um, all right. Well, just to wrap up this conversation here, it sounds like, you know, despite the obviously positive trade deal announcements that came with China over the weekend, it sounds like you think the trends are still set in the same direction. There's no real change in those. There's just some on the margin, you know, improvements, but overall it's it's still the same way you see the world as it stands today as it were on Friday.

Yeah. I think all from from an ending point, I think, yeah, because at the end of the day, they need asset inflation to make the math work. Um, they need negative real rates to make the math work. And, you know, I don't think there's been a real, you know, remember what what was going to happen. We came into this year, right? we were going to doge two trillion and we were going to force Japan and South Korea and China to buy our debt and Europe to buy our debt and we were going to term it out to 50 years and you know we were going to choke off China and they were going to collapse and like like none of that stuff's happened right we're sort of right back to where we started. Um and so I you know until proven otherwise I've got to kind of stick with with what the math says is most likely to happen which is something's going to happen to basically force a negative real rate environment u more aggressively.

Awesome. Well, Luke, I can't thank you enough for joining the show. Really great to catch up with you. And uh where can folks go if they want to see more of your work?

Sure. Uh, check us out fft-lc.com for more information about our uh mass market institutional research products and obviously on XLuke Groman Lu K-N. So, thanks for having me back on.

Amazing. Appreciate it, Luke. All the best.

You Thanks.