Below is the transcript for Paul Brodsky: The Seeds of Our Destruction Were - And Still Are - Sown in the Bond Markets
Chris Martenson: Welcome to another PeakProsperity.com podcast. I am your host, of course, Chris Martenson. And today, we are speaking with Paul Brodsky, co-founder and co-managing member of QB Asset Management, who I finally met in person at the recent Casey Research Summit in Phoenix, Arizona. And I have invited Paul to speak on our program because of his years of experience as a bond trader as well as his overall macroeconomic views, many of which are in agreement with the basic tenets of the Crash Course and my own writing.
So Paul spent several decades trading bonds and other securities for such Wall Street firms as Drexel Burnham Lambert, Kidder Peabody, Spyglass Capital, where he actively managed mortgage-backed security derivative funds for over a decade. Now it is important to note here that over 85% of investor capital in that last fund was returned by June 2006, before the wide-scale credit contraction. So Paul saw that coming and stepped out of the way.
Chris Martenson: Well, welcome, Paul; it is a real pleasure to have you as our guest today, I am really looking forward to discussing the bond market and its future with someone who has, I guess, an insider perspective.
Paul Brodsky: Well, thank you, Chris; it is a great pleasure to be on with you. I am a longtime fan, so it is a pleasure, and I am flattered.
Chris Martenson: Oh, well, thank you. You know, before we dive into the bond market, can you give our listeners a brief overview of your macro outlook for markets and assets? You know, I found the views you presented at Casey to be quite in alignment with my own, but that is not why I am asking. I think having your macro perspective helps set the stage here.
Paul Brodsky: Sure. Given our background, my partner Lee Quaintance and I come from, as you mentioned, a heavy bond trading background, having run desks, government-bond trading desks, and high-yield trading desks for banks. And given that background, we tended to focus always on monetary policies and fiscal policies as well as the old curves and volatilities and all these various arcane things that most sane people do not like to look at in the markets. But given that, we came to the conclusion that fundamentally the credit markets were not sustainable. And as we delved in further, we figured out, it took a while, but we figured out that credit and debt are obviously two sides of the same coin. This we knew for a while. But that when you looked through them, what we are really talking about is the currency.
Chris Martenson: Hmm.
Paul Brodsky: And it became very clear to us that what we were looking at was a terrible currency problem at its core. I will be very brief about this, but the source of this whole thing, we think, was the tremendous growth in overnight systemic repurchase agreements from 1994, which took us out of the malaise at that time, you may remember.
Chris Martenson: Uh-huh
Paul Brodsky: All the way through 2006, where a monetary aggregate called M-3 -- which was the only aggregate that included repurchase agreements, which is the process by which banks fund themselves with each other -- grew almost 12% a year. It is an enormous amount, and that basically tells you that this overnight lending among banks provided the fuel from which all of the term credit, or the 30-year mortgages ultimately, and the auto loans, and revolving consumer credit that, of course, has never paid down from whence that came. So in effect, we knew that the system became highly susceptible to any hiccup.
Chris Martenson: Interesting.
Paul Brodsky: And what we were looking at was an economy where, according to recent data, we have got $53 trillion dollars in dollar-denominated claims, according to the Fed. Well, I actually think it is higher than that, significantly higher than that, but let us just take their figure. On top of a $2.7 trillion dollars in actual money, or M-zero, or to put it another way, currency in circulation plus bank reserves held at the Fed.
Chris Martenson: Uh-huh.
Paul Brodsky: So the system is levered at least 20 to 1, and there is effectively 20 times more debt than money with which to repay it. And so that is a long-winded way of setting the table for where we come down in our macro views. Clearly, it has great ramifications, negative ramifications, for the currency, and given that the dollar is the world’s reserve currency, we think it has significant ramifications for the global monetary system in general.
Chris Martenson: Right, so this is a story of leverage which really began in the mid-nineties. So this is not any particular policy disaster that went off the rails in 2000 or even more recently than that. Interestingly, I have never connected the dots before between the overnights, the repo’s, and something else that really caught my eye in the mid-nineties. Actually, it was ninety-four or ninety-five, where the sweeps -- I don’t know if you know about the sweep programs; for the benefit of listeners who may not, what Greenspan did was he allowed banks to essentially dodge the reserve requirements by sweeping demand accounts. And what I mean by that is, if you have money in a checking account, that is yours to demand anytime you want. The banks have to hold a reserve against that, by law, 10%.
But banks were allowed through this policy tweak that the Fed had done, to effectively sweep that money out of that account just before the stroke of midnight. So that at midnight when they take the snapshot and say, How much money do you have you have to hold in reserve against?, they would sweep the money out of the way, the snapshot would be taken, look, there is no money, we get to hold very light reserves here. And then the money would get swept back in at let us say, 12:01, but during the snapshot period, oops, it would disappear. That is where I had chased back this credit bubble really got into high gear. And I thought it was due to the fact that banks were allowed to dodge these reserve requirements. Effectively running leverage far, far higher. Does that connect to the story for you?
Paul Brodsky: It does; it is all one and the same. We had a very, very loose bank regulator at the Fed. As a matter of fact, it looks as though everything was done so that banks could expand their balance sheets. And, which is ordinarily okay, nothing illegal about that except what we have is a situation where not only through sweeps and repo’s and an expansion of commercial paper and various other things that allowed the banking system to expand, and the shadow banking system, by the way, to expand. A number of regulations made it very easy for bond buyers out there, institutional bond buyers, to continually take on more and more debt that was being securitized. But everything, it seems, all dovetailed very nicely, so that banks, and on the buy side, bond buyers, portfolio managers, institutional money managers, could grow their portfolios and take on a lot of that debt.
Chris Martenson: You know, this all dovetails with all the things I was reading that Greenspan was very much in love, I could say, with the idea that somehow risk had been eliminated. That we had become sophisticated enough, and through our ability to manage derivatives and other very complicated strategies, that risk had more or less been eliminated. So sure, go ahead, lever up; you know, if we were at 10X before, go to 20X, no big deal, right? So now we are reaping the harvest from that particular sowing adventure. So here you were on the inside, you were watching this up close and personal, you were in the bond markets trading, so can you give our listeners a general primer on what a bond market really is, how does it work? When we say bond market, is it like a stock market, and if not, how is it different, how is it the same, what are we talking about when we say bond market?
Paul Brodsky: Well, like anything, there is no simple answer. And at the risk of over simplifying, which I am happy to do just to give a general overview, the bond market naturally is made up of many different markets. And there is no centralized exchange on which bonds trade. If we may, let us first take a look at the government bond market, because that acts as obviously the benchmark for interest rates.
Chris Martenson: Yep.
Paul Brodsky: And generally speaking, it is a very controlled, very systematic, very well-defined primary market, meaning bonds are issued by Treasury, through primary dealers. Generally, there are anywhere from 18 to 24 of them, depending on the environment and who has gone bankrupt and who has merged. But they are the largest banks, they are called primary dealers, and it is their obligation, if you will -- but it is really been a very profitable business, so no one feels terribly obligated -- but it is their obligation to bid at auctions, and auctions take place three or four days a week usually, every week. And in the form of very short-term paper, like bills and rolling and so on and so forth, to all the way out the curve, to longer-term notes and ultimately to long bonds, which are auctioned less frequently.
They tend to grab all the notice, of course. But every day, there is a significant amount of secondary market trading that goes along after these auctions and during these auctions. The auctions occur initially through an announcement by the Fed that they will auction X amount of bonds on this date, and suddenly, immediately, primary dealers will begin trading in that when-issued security. They will short the notional security that has not yet been issued, and they will try to cover at the auction. And so during the when-issued period, which went anywhere from a few days to a week before the actual auction, they will find a market for an interest rate, and obviously then they will try and cover at the auction.
In the meantime, the sales force at the banks, the institutional bonds sales force, will go out and solicit interest. And from their institutional investors, and ultimately they will find a parity at which, an interest rate parity, in which these securities should trade. So auctions tend to come off without too much of a hitch, because everyone has already pretty much made a market in them. And they are pretty well known how much interest that there is going to be before the auctions are actually held. That pretty much defines the Treasury market. Secondary market trading and treasuries is a very high-volume, low-margin business.
It is very liquid, and of course, this keeps the benchmark interest rate curve, off which all other tertiary bond markets trade. Now other bond markets, ranging from corporates and munis to high yield, of course mortgage backed securities, and then all the derivatives that trade based off of an interest rate or risk-free rates, along the term structure or anywhere from overnight out to 30 years, will trade off of the absolute yields on the Treasury curve. And so they will trade according to two things: one is, of course, their coupon, and the other is their risk of repayment. And for the most part, from here I think everyone pretty much knows how bonds trade.
They will, based on the perception of risk of repayment, they will trade back and forth in a day, and virtually all of the trading activity throughout all bond markets is done through voice by people on the phone, a buyer and a seller on the phone, and, or maybe an intermediary making the exchange.
Chris Martenson: All done by voice. You go to Bloomberg and you check the Treasury curve and you are looking at the rates all on there. There must be some electronic exchange for these as well, isn’t there?
Paul Brodsky: Well, there is, you do not see the inside markets that Treasury traders see at primary dealers. What you are seeing is a feed from brokers’ brokers. One of the brokers’ brokers that may have a contract with a vendor like Bloomberg to show the bid and offer sides of the Treasury market and the yields that accompany those prices.
Chris Martenson: Okay, so we have a lot of…
Paul Brodsky: So you are not seeing the actual inside price. But frankly, they are very close, if not spot on.
Chris Martenson: Okay, so very big, very liquid market, there is an auction that goes off with some regularity, but it is a Monday, Tuesday, Wednesday kind of thing. But every day we have this larger market trading. So I am China, I have just developed a surplus, I decide I want to roll them into Treasuries, those are going to flow into my custody account at the Fed. Do I go through one of the primary dealers and make an offer and pick up some Treasuries and then stash them over at the Fed? Is that how it works?
Paul Brodsky: Yes, you may be China going through, directly through, one of the primaries or all of the primaries, or you may be doing it through an off-shore account. Or you may be doing it through a London subsidiary. But yes, you would go through at auction, everyone needs to go through the primaries. You can go direct to the set. Generally, it is typically not done, or it is not done with regularity, because if that were to happen as a matter of course, your primaries, if you were the Fed, you want to keep a very good relationship with your primary dealers. And if it was done, if there was a lot of trading done off market, if you will, they would not be very pleased about that, because they would not know or feel as though they have as much control overpricing. And they would feel that they were taking too much risk.
Chris Martenson: Right, so the bond market, like any market, there is a bid and an offer, or an ask, and if there are no bids, the prices are going down until we find a market clearing price that works. Of course, as the price of bonds goes down, the yields go up. Is that so, in days when we see like the 10-year suddenly shoot up or gap down by say, something big, ten basis points, fifteen basis points, which are each basis point being 100th of a percent. What is happening there, is it just that the phones are ringing and there is just not enough bids, or there are too many bids and so we get those gaps?
Paul Brodsky: Yeah, that is it.
Chris Martenson: Okay.
Paul Brodsky: Nothing more complicated than that. Sometimes it is triggered by investor selling or buying; sometimes it is triggered by the traders at the primary dealers, choosing to lighten up or buy more, any specific issue.
Chris Martenson: Okay. You know there were excesses and mal-incentives that created this big credit bubble. You might date it to ’94; you might say that we have always sort of been in one since the decoupling from the gold standard. But at any rate, credit has been doubling and doubling again. And something that is quite mysterious to a lot of people is this idea that there were hundreds of billions, maybe trillions lost, certainly in the sub-prime credit default swaps and the CDO piles. What happened there? I mean, who got fleeced, who profited, where did that money go?
Paul Brodsky: It is a complicated issue. Obviously, you had winners, and we all know who they are, and that came from credit default swaps, as you mentioned. And the losers on the other side were effectively the taxpayer, because the losers were ultimately bailed out. That being anyone that had sub-primes on their books. Not all of them were bailed out, obviously real money if you will, and institutional investors that held sub-prime loans in their portfolio, and these were pensioners and money managers that were investing in bonds on behalf of pension funds. If they happen to own sub-prime, then obviously they were big losers as well, so that is real money, that is real investment, and that is very real to people. So what some might have a problem with is any banks that held any of the sub-prime paper that were considered too big to fail. And as a result of this sub-prime paper being devalued by, naturally by the markets, created solvency questions on the part of banks, clearly then that was an issue, and government stepped in to provide them with new reserves.
Chris Martenson: Right, so there were winners, they took their money, and then the losses ultimately are going to get borne somewhere. It is not like that there was money that just sort of evaporated. And we have not, we did not really allow a lot of debts to go bad. Some, some did: Lehman’s did, Bear Sterns’ did. Of course, the Fed took on a big chunk of those losses, as well. But by and large, given the amount of dislocation, we saw the losses were not truly recognized. Are those losses still lurking out there in your estimation at this point, or have they really been passed over to the taxpayer. And this does not have to be a U.S.-centric question, this could be a Euro question right now.
Paul Brodsky: No, I think debt is still probably marked too high on balance sheets. Certainly at banks. And so I think it is still out there; it is still lurking. It does not necessarily have to be recognized, ever, frankly, if the Fed produces enough inflation that takes them out in nominal terms. But it is still out there, and I would argue it is not only sub-prime, but as we are seeing now, it is turning into prime as well.
Chris Martenson: Okay.
Paul Brodsky: So there, I would say bank balance sheets are extremely weak, weaker than is generally acknowledged. But it is tough to fight the too-big-to-fail banking system, because obviously they have got a very strong ally.
Chris Martenson: Right, so when I think back to 2008, that did not surprise me a lot, what happened in October, because in September and in August, I was watching credit spreads start to widen out and blow out on all of kinds, particularly on financial institutions. So there are these warning signs that come. I am convinced that I have warned my readers that the next major economic dislocation, I mean a big one, most likely is going to be caused by revolt in the bond market of some kind. And we talk about that a lot, and there has not been an honest-to-God, vigilante bond market revolt in quite a while. So some have, perhaps, ruled that out as a possibility. I think it is still in play. I am wondering if you see the same dynamic possibly playing out? And then tell us what a bond market crash would look like. I think we just saw one in Greece; you know, one-year paper going off at 150% tells us something. To me, that is a crash, that is what one looks like. But do you share that view that such a thing could visit the U.S. eventually? And if so, what are the warning signs that give you just a little edge in this game?
Paul Brodsky: Yeah, actually, I am of two minds. We have not shorted bonds in our fund. Even though we feel pretty strongly that if the market were to naturally determine interest rates, they would be much, much higher than where they are now, maybe even double digits. In fact, probably double digits, rather than zero to 3%, as they are. And the reason we have not shorted them is because, frankly, a Central Bank, especially the Fed, has an infinite ability to create infinite amounts of money with which to buy debt.
Chris Martenson: Uh-huh.
Paul Brodsky: And they have shown a willingness to do that, and maybe it is our backgrounds, but we do not want to fight the Fed. On top of that, and that is just a worst-case scenario if there is no bids for bonds, we are presuming they would step in and buy and be the buyer of last resort so that Treasury would not go upside down. But even before that happens, most investors tend to think of themselves in their own situations and tend to extrapolate into a market. And that is not really the case, and certainly in the bond market. Levered investors, those willing to borrow to buy bonds, have incentives still to borrow a lot to buy Treasuries anywhere from 100 basis points or 1% to 2% to 3% and go out on the curve. Because if they can borrow 10 or 20 times, and buy a 2% coupon, then gee, suddenly they are clipping a 20% or a 40% annual income and they are only, and they know that they are on the side of the Fed who does not want to let interest rates go higher. And their only incentive, frankly, is to get to the end of the year so they can take out a bonus.
Chris Martenson: Uh-huh.
Paul Brodsky: So economics is kind of taking leave and the bond market, the Treasury bond market has, is no longer, we think, a true signal of interest rates, where they should be, or a true signal of inflation. It is an interest-rate curve that has been distorted by terribly distorted incentives as we see it. So we understand that, we do not think it is right, we would rather have markets be free to adjust to where they should be, but frankly, we do not see that happening.
To your question specifically about will we have that, and will we have something similar to what happened in Greece here in the U.S., we do not think we are ever going to get to that point here. And it is not because we are proud Americans and we think that the U.S. is better in every way than every foreign land; that is not the case at all. We think it is not going to happen here because if anything dire happens in terms of interest rates, like the threat of rising interest rates, number one, you would see the Fed's balance sheet come under severe stress. As we understand it, if long term rates rise 55 basis points, pardon me, let me take a step back, as we understand it, the Fed's balance sheet is already levered 55 times. And if interest rates rise, we have heard between 40 and 50 basis points, it would make the Fed's balance sheet insolvent.
Chris Martenson: Hmm.
Paul Brodsky: So purely from an incentive standpoint, from obviously the central bank as well as levered bond buyers, which are the marginal price setters for the bench mark interest rates, we do not see really a high probability that interest rates are going to go higher. And taking a step back then, the situation as Greece, as you mentioned, you know short-term interest rates are on the moon, we do not see that happening in the United States because we can print and monetize our Treasury debt. Where as Greece cannot, and it is unclear that Germany is going to make the decision to do that. And so that is why you are seeing, it is as though if California did not have the printing press, and Washington -- or, a better example would be Ohio, presently -- you would see Ohio Municipal Bonds trading at 100% or higher. But obviously Ohio has the Fed and Washington willing to create dollars should something happen.
Chris Martenson: Okay, so…
Paul Brodsky: They come under the bigger umbrella of the United States.
Chris Martenson: Yes, I agree, do not fight the Fed is very sage advice, has always been. Suppose, for the moment, though, that somehow things do get away from the Fed, they find themselves following, not leading the market. It has happened to them before. It has not happened recently, but certainly, that used to be the case. So I do not know, so there are all these people who have bond funds that are levered up 20 times, 10 times, some big giant number, and all of a sudden the rumor comes through the grapevine that China has decided enough is enough and they are quietly liquidating their custody account into what ever bids they can find. Would we not find that those levered bond funds would potentially get caught in the equivalent of a long squeeze, in essence? I mean, they would have to get out there and start liquidating into this madness. Is that a possibility? Let us admit that it is a possibility; how probable it is, is another question. Do you think the Fed has, with its infinite capability, can really step in and battle that?
Paul Brodsky: Well, functionally, yes, they can. Because again, let us say China has three trillion in dollar reserves (just to pick a round number). Yes, the Fed could print five trillion if they wanted to. They would always have more money than bonds outstanding, number one. And they could always assume anyone else’s debt, because there is literally no limit. However, you bring up a very good point. If there is, for whatever reason, and by the way, let me tangentially say I noticed a quote on today’s Bloomberg from Hillary Clinton as State Department Secretary. She was saying something to the effect that to be in the State Department today you have to be able to follow a Bloomberg screen as much as what is going on politically and diplomatically.
Chris Martenson: Uh-huh, okay.
Paul Brodsky: So I say this because I think the problems that the Fed and U.S. Treasury are facing in terms of its debt are not only a economic problem, or an economic issue; I think negotiations go deep and go wide. And obviously supporting U.S. Treasuries is something that I would argue has ramifications beyond just an economic decision in the politburo in China. But, having…
Chris Martenson: Yeah, on National Security.
Paul Brodsky: Having said all that, yes, of course it is a possibility if they decide, if we anger them for whatever reason and they decide as retribution, and maybe it is an economic decision that they just do not want to own Treasurys any more and they decide to liquidate. I would suspect at that point, you would see a, maybe even a formal devaluation, of dollars. And we could go into that in a bit if you would like, but I would think that is the point at which you would see obviously the Fed would have to come and buy a bunch and monetize a lot of debt. But my guess is that would see something more formal. And you would go into a weekend and you would come out of the weekend with a completely different new monetary system.
Chris Martenson: Okay, interesting. So where I am, what I am hearing here, is a fairly simple story then, had a very long, very protractive credit bubble, it ran up pretty hard. And the Fed has nearly infinite or probably infinite capability to just manufacture credit, or what we call "money," out of thin air. All U.S. debt is denominated in U.S. dollars in this point in time, so there is really no external forcing function. So, guess what, printing can always happen. You started all of this by saying that when you peered through this landscape, what you saw was actually a currency risk. Let us go there for a second, if we could. What do you, how would that play out, if it does not really play in a big bond market route, something has to give in this story. You are saying it is the currency; what does that play out like?
Paul Brodsky: I think the Fed is going to have to continue printing. They are going to go significant QE3 at some point; I do not know exactly what form it will take, but they are going to have to monetize debt. The process of doing that is, I am sure your listeners know, is when you buy debt, you print money with which to buy it. And which moves new money out, ostensibly into the system, but as we have seen, it only goes into banks as excess reserves. This process is the exact process of inflation, so if you print a dollar, you are diminishing the purchasing power of that dollar through dilution. And it is a very easy thing to understand more dollars chasing, let us say, the same amount of goods and services and assets, must drive the price level higher for those goods services and assets. And so what we see happening is, through this process of money printing, we will have rising prices that rise much faster than wage growth or income growth, and it is going to make the ability to service debt that much harder.
The point here is that they can make the appearance of growth happen by just printing money and raising the price level. Yet real growth will contract at the same time. And to get your mind around this, I think the easiest way to think of this is, let us say, last year I produced four widgets and I charged $2.00 a piece for each and my output was $8.00.
Chris Martenson: Uh-huh.
Paul Brodsky: This year, after, say, the Fed prints a lot of money, I can charge $3.00 for my widgets but I can only sell three. Well, I had to fire a person who produced the widget. However, my output this year was $9.00 instead of last year's $8.00.
Chris Martenson: Uh-huh
Paul Brodsky: So it looked as though we have output growth, and in nominal terms, we did. However, I had to fire someone who was a consumer and so on and so forth, and a taxpayer. And so the real economy actually shrunk, while nominal growth grows. And so this is what has already been happening. The pressure is the fundamental economic pressures that build, through this juggling act of trying to keep all the balls in the air by printing money and giving the appearance of growth, and trying to instill confidence among consumers and among factors of production, and among manufacturers, and so on and so forth. It really can’t last if there is no fundamental reason for it to continue. So in reality, we think that they will print a lot of currency, the real economy will shrink.
However, the good side of this whole thing, in an aggregate sense, and I am not judging the merits or whether or not it is moral or anything along those lines, but since the U.S. and Western Europe and Japan, the great majority of our populations are indebted. By printing all this money, the prices will rise and eventually even our wages will rise, but the only thing that won’t rise, is the amount we owe. And so this process of inflation reduces the burden of repaying debts. Both in the private and the public sector. While it does not reduce the debt at all, but it does act as a de-leveraging. You can de-lever either by letting credit deteriorate -- and that has all terrible ramifications because you actually do have real contraction in the economy -- or you can print money up to meet the notional value of the debt. And those are the two ways to de-lever, and I think they are clearly going to print money, and that is the process of de-leveraging they are going to take. Thereby inflating the way the burden of paying the debt.
Chris Martenson: Yeah, there are all kinds of reasons that there is really no opposition to the idea of printing. At the political sphere, they love it. Politicians tend to get tossed out during deflationary episodes. Inflation, you know, they tend to hold their jobs. So there is a job, jobs creation act for political people buried in there. And also, government cannot tax deflation. Meaning if I hold an asset like a house, and it inflates 100%, some of that is taxable, depending on the size, or any asset that inflates, that is a taxable moment. A deflating asset is not a taxable amount. So you cannot tax deflation. There is another reason why we hate deflation, because it does not perpetuate the entire model of continued growth. But you know at some point, in every credit bubble -- and this has been true through all of history, and Reinhart and Rogoff certainly proved that -- at some point, you just hit the limit; you cannot go any further. Even leaving aside that we remove the natural resource pressure from Peak Oil or from other resources, or that there are natural limits being hit, forget about all of that. There is always a moment when your credit bubble just cannot go any further. There are no more noses that can fog mirrors, that can take out a loan. In your estimate, you are looking at all of this; they have been pulling on the ripcord of the chain saw as hard as they can trying to get this thing started again. Have they? And if they cannot, do we not just face some sort of deflationary outcome anyway?
Paul Brodsky: I think before we ever get to a truly deflationary outcome, meaning output contraction, shall we say, the Fed will formally devalue the currency, which will solve all these problems. They can do it tomorrow if they chose.
Chris Martenson: Isn’t everybody trying to devalue their currency?
Paul Brodsky: Well, they would devalue it, and not against the Euro, or not against the Yen or the Renminbi. That alternating currency devaluation tag team, whack-a-mole, beggar-thy-neighbor policy works, obviously, for exporters, and it works in the very near term. But it really does not solve the problem, which is all of these currencies are baseless and are losing their purchasing power versus the goods and services with inelastic demand properties. Such as natural resources and things of scarcity.
Chris Martenson: Uh-huh
Paul Brodsky: So it makes perfect sense that while they are trying to politically, through policy, devalue their currencies versus other fiat currencies, that is not a long-term solution. When I say devaluation, I mean against the currency that is scarce and that policy makers cannot manufacture because ultimately it comes down to if I have a widget that I want to exchange for money, no matter where I am in the world, the money I want in exchange, I want to know that that’s going to have. I want to have confidence in it that that is going to retain its purchasing power. And it will get to the point ultimately where the one I am going to want is something other than what you are offering. There is precedent obviously, that gold has backed money. And we happen to think that that is the end game. Ultimately, you will see probably the Fed formally devalue the dollar versus gold. After 40 years of it being untied, and that is all. This is just the pendulum swinging back, we think. And they will do it at a price, a gold price, in dollar terms, that will reflect the amount of past monetary inflation that we have seen.
Chris Martenson: Yikes.
Paul Brodsky: Or something close to that.
Chris Martenson: That is a big number.
Paul Brodsky: It is a big number. We think it is about little north of $10,000 currently.
Chris Martenson: Uh-hu.
Paul Brodsky: And you know, it is not, it is a nice round provocative number, but actually, it is not how we got there. We got there by using the old Bretton Woods model of taking monetary base and dividing it by official gold holdings.
Chris Martenson: Monetary gold.
Paul Brodsky: And that was how we got to the $35.00 an ounce number for years and years and years, from 1945 to 1971. When we went off the Bretton Wood model, and Nixon went off the gold standard, the gold exchange standard in ’71, we have inflated the monetary base. And most of that has come just recently, to the point where now an ounce of gold would be worth a little north of $10,000.
Chris Martenson: Right.
Paul Brodsky: We think they have got a lot more to go, but it is going to be some big number, that is the point here. When they ultimately formally devalue. And then peg it.
Chris Martenson: And then peg it, so it is basically a return to a gold standard of a sort, of some kind, and so that is a pretty big monetary event, obviously.
Paul Brodsky: Well it is, it is not – it – right now it sounds terribly radical. In the sweep of a few generations, it is not that radical. Who would have thought, you know, as preposterous as that sounds today, in 1968, it would probably would have sounded preposterous to think that we would not be on a gold exchange standard.
Chris Martenson: Yeah, well, you could not have...Paul, you could not have gotten me five years ago, if you had said, Can the U.S. Government trillion plus trillion deficits for three, four years in a row, spending 40% more than they take in? I would have said, no way. But here we are.
Paul Brodsky: Here we are. And the issue now is one of leverage. We’re so far over our skis that the driver, the economic driver has become, and decision making among most all economic participants, is, can I service my debt rather than what do I want.
Chris Martenson: Uh-huh, great point.
Paul Brodsky: And at that point, economic function begins to collapse, and I am not saying that there is going to be suddenly a free market and we are going to go back to a Utopian barter economy or anything like that. What I am saying is, the government will want to retain control, the only way they will be able to do that, is through going back, is devaluing. As they devalued it in 1971, the irony is, they will be going back to a gold standard or a quasi-gold standard. I think that the method that they will do that, you know, they will print a lot of money with which to tender gold at some big number. That will be highly inflationary. And then they will probably make a market, target a gold price as today they target Fed funds and interest rate. They will target a gold price. You know we will buy your gold at $10,000 we will sell you our gold at $10,200, and if too many people tender, then they will take the price down and vice versa. And what I think that would do, that is not a gold standard by the way, that is maintaining a credit market, in effect. However, it would still place a little more pressure on lenders to watch their backs in terms of the unreserved credit that they are carrying. And it would probably, more than anything, just instill confidence.
Chris Martenson: Uh-huh.
Paul Brodsky: In dollar holders. After the devaluation.
Chris Martenson: Yes,
Paul Brodsky: That it would retain its value. We do not think they are going to go about, you know they are going to go to a fully reserve lending system, we do not think that is in the cards. We think banks will still cheat and lend out much more than they have. They will be able to inflate another day. But we think that there will probably be an event that attempts to push the reset button, which would instill confidence, and probably, in all likelihood, be pretty stimulative for the economy. And we think that is what it would be.
Chris Martenson: So that all fits and makes sense. So do you have any advice for the average retail investor looking to maybe not swing in for the fences, not looking for a lot of risk here, just looking to preserve purchasing power? I am guessing gold fits into that for you. Is that the kind of landscape we are in right now? We are just seeking to simply hold on to what we have and while the dust settles?
Paul Brodsky: Well, yeah, I think if you look at gold, it is a -- and you start to think of it as a currency, which it is, and not as a commodity, a volatile commodity -- all gold does I think, is handicap the likelihood that there will be a de-leveraging or a new monetary system. And at $250 an ounce it was a very, the market thought it was a very low likelihood, and $1,600 it is a higher likelihood, and if there is a reset in the global currency regime, maybe gold becomes worth $10,000 or even more, who knows, or something not even $10,000, whatever they can get away with. But it is some bigger number. So yes, in answer to your question, I would say, gold should be thought of as cash in the best currency. I would suggest anything scarce with inelastic demand property, and that is of course how we get energy and how we get agriculture and various other things. They should be considered very strongly.
Chris Martenson: Okay, good.
Paul Brodsky: Things I would stay away from are over-levered assets that depend upon new credit issuance or a new debt being assumed, I should say, to drive earnings.
Chris Martenson: Okay, and that is great advice. How about your fund at QB Asset Management; can you let our listeners know a little bit about that and where they can find out more about it if they are interested?
Paul Brodsky: Well, it is a private fund for accredited investors only, so there is very little I can talk about.
Chris Martenson: Okay.
Paul Brodsky: But I am sure if anyone wants to talk to me about it, I can be reached at PBrodsky@QBamco.com.
Chris Martenson: Okay.
Paul Brodsky: And I would be happy to speak with anyone or correspond with anyone who might think that they are interested.
Chris Martenson: Okay, well, fantastic. That is all the time we have today. I really want to thank you for your very clear explanations there. I hope we have really covered the bond market and let people know how it works and also your views. Very interesting -- don’t fight the Fed, they are pretty big, they have a printing press, they are not afraid to use it, count on it. And if I can sum it up thusly, so Paul, thanks a lot, and I really appreciate your time today.
Paul Brodsky: You bet, Chris; thanks so much.
Chris Martenson: All right, bye-bye.
Paul Brodsky: Bye-bye.