Transcript for Erik Townsend: Expect a US Price Shock as Black Swans Come Home to Roost

Transcript for the podcast: Erik Townsend: Expect a US Price Shock as Black Swans Come Home to Roost

Chris Martenson:  Welcome to another podcast. I am your host, of course, Chris Martenson, and today the very special guest we are talking with is an old friend and even a colleague of mine, Erik Townsend, private investor now and world traveler. Erik, it is a real pleasure to be talking to you again.

Erik Townsend:  Chris, it is fantastic to be back on the show with you. Last time we did this was 2008.

Chris Martenson:  Has it been that long! [Laughter]

Erik Townsend:  I think it has.

Chris Martenson:  It has! In addition, I think you were even here. You were here on the premises …

Erik Townsend:  I was interviewing you at the time and now we arewe are turning the tables.

Chris Martenson:  Absolutely! So, sowell, 2008! Fill me in. What you have you been up to?

Erik Townsend:  Well, it has been quite a long time as, as I think you have a lot of new listeners. Therefore, for people who do not realize, back in 2008 you hadn’t completed the Crash Course, and a lot of us were just on the edge of our seats waiting for the next chapter to come out. When Chapter 20 finally came out, a lot of people kind of took a step back and said, “Hmm, okay, what does this whole thing mean to me?”

In addition, I remember meeting you back then. One of the things that was most striking to me is you and your family have never run away in panic and thought the world was coming to an end. You have said, “Okay, look at what is coming. What does this mean to me and how do I improve my life now?” Not compromises or sacrifices, but leading a better, more fulfilling life; and in your case that was embracing resilience in your life.

My life is a bit different from yours, so for me I focused more on agility than resilience. I do not really want to live in one place in western Massachusetts for the rest of my life. I am kind of the world explorer kind of guy. And I frankly—also as I looked at the Crash Courseand I thought about it and looked at all the people who were focusing their efforts on preparing for something bad happening in the world—it seemed to me that most of the problems that have happened in history, whether it was the holocaust or the collapse of the Soviet Union or what have you—all involved people getting out of harm’s way. So I started focusing more on agility and just having, diversifying my plans.

So I still had a house on the coast of Maine, but I wanted to start looking outside the country. In case the US falls apart, where else would I go? And I thought, well, if the US falls apart, I would just go someplace else. And I thought, wait a minute. If the US was falling apart, that might be during a peak era, where going and researching other places to live could be prohibitively expensive for anyone on any budget.

And so what I have done for the last few years is really focus on living outside the US and exploring the world, and with an eye towards what Peak Oil will bring us and what I think will happen to the US economy. Just looking at what our options are and where we might live for the rest of our lives. Will we come back to the US or not—it’s still undecided. But I have been living in Hong Kong the last couple years. And for the last year and a half, we have been (my girlfriend and I) essentially on a massive trip around the world, not panicking, thinking the world is coming to an end, but really enjoying ourselves, seeing the world, and considering what different places have to offer and where we might live in the long run. And a lot of this was inspired, really by the work that you did in the Crash Course.

So I am going to be doing a, a whole interview on financial sense next month about this search for greener pastures, the trip around the world looking at different countries and what they offer as we consider living outside the United States. So we probably ought to leave that there for now. I know you wanted to focus on the macro picture, so maybe we should move on to that.

Chris Martenson:  Well, without stealing any of that thunder, where are we finding you right now?

Erik Townsend:  Right now, I am in New Zealand. Wellington, New Zealand.

Chris Martenson:  And what are you noticing there in terms of, say, inflation or the cost of living from your perspective?

Erik Townsend:  Wow. Holy cow, Chris. This is something for me. I have studied this. I have studied your work. I follow a lot of otherwell, studying the effects of inflation. You can understand it in your mind conceptually. But when you travel to other parts of the world where their economies are still strong and the effects of inflation have not been delayed, which is what I believe is happening in the United States, you really feel it. We were in Melbourne, Australia, a week ago. We went out to dinner and it was not really a super-fancy-pants place. It was a fairly middle-of-the-road casual dining restaurant. And I looked at the lists on the menu and I thought, boy, this, this heirloom tomato salad looks delicious. I am going to have that and I am just going to have the chicken potpie for dinner. That is a nice, modest, comfortable meal. The, the heirloom tomato salad was twenty-nine Australian dollars, about thirty-one US dollars …

Chris Martenson:  Ohhh.

Erik Townsend:  …and the chicken potpie, Chris, was fifty-three Australian, fifty-seven US dollars. And I am telling you, I do not care how much you have studied this and understand the implications of inflation on a logical or theoretical level, when you find yourself sitting in front of a fifty-seven dollar chicken potpie, holy cow. Something is going on.

Chris Martenson:  [Laughter]

Erik Townsend:  And I think what this thing is, is the inflation that has been exported from the United States through quantitative easing [QE] has pushed up prices of everything everyplace else. The US economy is still in such a slump that we really have not felt that big price shock yet, but it is coming. And it has really affected a lot of the world very harshly.

Chris Martenson:  Well, I think this is a perfect illustration, that fifty-seven-dollar chicken potpie of the macro story that we need to talk about, because what the US has been doing, and it is a plan, it is a strategy—forget all the talk about we support a strong dollar, too, and all that other stuff. It is not true. The only way out for the US, like many countries, is to devalue its currency and we have been doing that rather aggressively through QE. We have been exporting inflation. I love the chicken potpie story because when we get to a place like China, where people are living on two hundred and ninety dollars a month or something like that, if they are doing well, working at Foxconn, building iPads or something like that. Two hundred and ninety dollars a month, well, all of a sudden, when you take two hundred and ninety and you compare it to a fifty-seven dollar chicken pot pie, you understand that the exporting of inflation has really dramatic impacts on people from countries where they are not earning huge, wonder, multi-tens of thousands of dollar salaries. And the impact on those people, they often do not take it lightly. It is very serious business when your, your way of life is being eroded and really taken out day by day through this exporting of inflation.

So that is where—I think that is part of the lens that is really important to get your observations and anecdotes out around. Because when China—we read in the paper, and the Chinese finance minister says, “Hmm, we are really not comfortable with all this money printing you are doing,” there is another story under all of that, which is illustrated in what you just said, I think.

Erik Townsend:  Yeah, and I think something that I have seen that nobody seems to be talking about is, I think China has quite a bit of pull here. In that as QE happens—and I am convinced it is going to happen sometime this year, I do not know when—it is going to export so much inflation to China that it is going to be almost intolerable for them. And I think that we are forgetting that if China says, “Okay, guys, we have had enough of this. If you do any more QE-ing we are going to dump the US Treasury bonds that we are holding and we are going to use the money to save our own economy.” If we see that kind of reaction from China, it really could put a monkey wrench into the plans of the central banks to inflate this all away. I think that whether it is that mechanism or another one, at some point we are going to get to a hard wall here where you cannot just print money forever without the unintended consequences coming back and biting you. I just described one mechanism that might cause the unintended consequence to create a feedback loop that comes back and bites the central banks so they have to stop what they are doing, changing everything. Now that might not happen, but there are a dozen others that you can think of in terms of mechanisms that might cause a sudden stop in quantitative easing. And if that happens, we are really going to see a roller coaster ride in the economy.

Chris Martenson:  Okay, well, then in order to gauge that risk, let us back up a tiny bit. You say you think QE is likely. That is your assessment. Why do you hold that view?

Erik Townsend:  Well, I think it is just, what else are they going to do? As far as I can tell, this whole economy is being propped up by stimulus and money printing, really, since 2009. And I think that what is going on is we have forgotten that we are literally changing the—I do not know if you want to call it changing the terminology or changing the paradigm—but what is going on here is, we used to use words like “solution” fairly accurately. Now as we are just creating these Band-Aid fixes to temporarily put symptoms of problems at bay. We are calling those solutions, and we are actually behaving, and when I say “we,” I mean collectively market participants are behaving now as if the EPB printing money in order to buy some more Greek bonds and put a bid under that market was a solution to the European sovereign debt crisis. And it is obviously nonsense. The ECB printing money just dilutes the value of the euro and causes more reason in the long term for people to flee away from making investments in euro-denominated sovereign debt.

So it does not solve anything. But we have gotten to the point where we are so overwhelmed that the market is thinking in terms of these Band-Aid patches as being actual solutions to problems. And I think as long as that is the case, we are going to continue to apply these Band-Aid patches, which are things like printing more money, until it all comes to a head. When it comes to a head and how it comes to a head, I do not think anybody is smart enough to predict accurately. I just laid out one scenario, which could cause it to happen. There are probably dozens more.

At some point, though, we are going to get to a point where we cannot handle any more printed money and I think that the black swans that have been leaving the market alone for several years are going to come in force. And it is interesting to me to listen to Jim Puplava’s outlook at the beginning of the year. Because on the one hand he is looking at the same information as I am, and on the other hand, he comes to a very different conclusion. And for anyone who, who does not follow Financial Sense, Jim basically said, look, leading economic indicators are all turning up. There are some black swans out there that you got to look out for. But as long as the black swans leave us alone, we are going to have really a positive, up year in the stock market in 2012. Everything is looking good. LEIs are looking good. It is going to be great.

The way I look at it would be almost the same, but with a very different conclusion. I think that Jim is right, that if you ignore all the macro-data, which is what the markets are doing now, the stock market is trading cyclically and, I think, ignoring all of these structural risks. It is going to keep trading higher because as long as you keep printing money and keep papering over these major structural problems, you will continue to see growth in equities. But where have these black swans been? I think they are in Jim’s neck of the woods, but I am hanging out with Jim studying Austrian economics. I think the black swans have been hitting us with Miramar and Top Gun training. That noise you heard when MF Global blew up on Halloween …

Chris Martenson:  Yep.

Erik Townsend:  … I think that was an echo of the Black Swan Aggressor Squadron departing Miramar. They are on their tanker now getting fuel, ready to take down the global economy. And I mean it just blows my mind. I do not think that we have ever seen a larger basket of major macro structural risks that everybody is aware of. It is not like nobody sees these things. But we have just somehow put them all on the back burner. Do not worry about China. Do not worry about Europe blowing up. Do not worry about Iran. Do not worry about the carry trade unwind in Japan that you have just written about recently. Do not worry about Peak Oil. Do not worry about the domino effect of China and Japan going down, taking out other economies that depend on them. Certainly, Australia is one of those, a place we just visited. Do not worry about a-hundred-and-twenty dollar bread. It is all fine. The LEIs are looking up. And we just seem to be in this cyclical trading mindset that it is going to continue to last until something breaks. And I think that when something breaks, it is going to break big. And … 

Chris Martenson:  This thing breaking big. I, I am interested, though, when you say the markets, the markets are trading higher cyclically and ignoring these major structural risks. I have this very confusing sort of an outlook, which is [that] I do not always trust the markets anymore. I do not know that they are telling us useful information, and so right on the front page of I believe it was yesterday’s Wall Street Journal, so your days, it is, it is Thursday, February—what is it today, the twenty-second? Yesterday’s Wall Street Journal, they, they said, gosh, is this not—we have a strange phenomenon we would like to discuss with you here. The Russell 2000, just a percent or two away from all-time highs—it is up 38 percent this year—it is up like this huge amount over the past year—and would you know it, money flows from retail investors have been negative every single month through that entire run. What is going on? Because normally the retail investors are piling in or they have been piling in or they are providing some of that fuel. Not only have they not been providing fuel, they have been subtracting fuel from that. Who is buying the rusty [13:15]? We have all these people selling, who are the retail investors. It means the market is no longer really made up, I guess, or is sensitive to the retail investors. And, and how do you, how do you interpret that information?

Erik Townsend: You know, I do not pretend to understand how it all works. But I think that we are in an election year and somehow, some way, the Obama Administration is able to influence a lot of things including the Fed that is supposedly independent but does not really appear to be, in my estimation. I think the agenda here is all about propping up markets and general sentiment in the country in advance of the election. And I think the big thing that they seem to be wrestling with, if you cannot quite please all the people all the time, there is no good way to prop up the markets by printing money and just putting – printing government money to put a bid under everything. Because if you do that, you blow oil prices through the roof and that is going to cripple the economy. Okay. We need a scapegoat for the oil prices. Let us get ready to do something. We are going to get ready to rumble with Iran here. We are going to make them the bad guy somehow for the fact that oil prices are going up.

I see an overall agenda that is about propping up markets, however it is that they do it, through money printing and influencing the media and whatever else is going on. And it is all about, from now to the election, everything has got to be all roses. And I think that that is what is driving this and I think the strategy is probably—and I am not saying I think this is going to work because I think it could all come tumbling down before it gets to this. But I think that the strategy of whoever is pulling the strings on these puppets,  is if we can get to a new all-time high on the Dow, which is only about 9 percent away from where it is right now today. We will be able to lure retail back into the stock market and we can maybe get another bump from there. It will all come crashing down at some point when the macro kicks in and people get in touch with reality again. But if we can somehow prop things up just a little further, we can get retail suckers back into the market. And I think that what is going on is – probably they are not seeing that happening. The people who would like to make that happen are influencing others in order to do these potentially non-economic trades in order to bump up the value of indices to get to new all-time highs. You are seeing it in – with the Russell and I think you are hitting it in the next few months with the Dow, assuming they are able to keep this party going.

I just do not understand why it, it seems like the bulk of investors are not dealing in reality mode with Europe. You look at what is going on in Europe. Nobody is talking about a real solution to any problem. They are talking about short-term Band-Aid fixes that will last a few months at best. And it all has to blow up at some point and nobody seems to be taking it seriously. I just do not know what to make of it.

Chris Martenson: It is very interesting to me too, I am almost 100 percent convinced this is true --doing everything they can to keep asset prices inflated. The Fed has even written Op Eds in the Wall Street Journal penned by Bernanke ostensibly as a ghost writer, but saying, we are very happy, wink, wink, that the stock market continues to go up as we dump money into it. So clearly it is, it is part of the agenda to keep the markets going up.

The mysterious part to me is how they have managed to shoot themselves in the foot. So I do not think these are a bunch of really super-clever guys and gals who have, who have managed to figure out how to rig markets to the upside. Because what did they do with MF Global? They took – they sucked more confidence out of the market by failing to pursue that aggressively in favor of the retail investor, of, of the small person. They let big cats skate on, on what is inarguably just theft and fraud. There is just really no other way to term it at this point in time. And all the while pretending, throwing your hands up like it is too complicated to unravel, where did the money go? We do not know. You know. As if money could actually disappear in our system. It cannot unless you put it on pallets and bring it into Baghdad Airport, it is all traceable and trackable.

So it is just crazy to me that this, this, this idea that one of the things that we really do need—I agree with your thesis, we, we really need, if we want the markets to really power higher—we need retail to come back in. In my position, I get to work with people who saw that, interpreted it correctly for what it is, who are now scared of any brokerage, possibly rightly so, really questioning whether they even want their money in the US or whether it needs to be in any brokerage at all or what do we do? And it, it just adds to this general pervasive sense of fear and uncertainty in the markets. And I am not talking about average people who have 401(k)s who look at them once a year. I am talking about very professional, active money managers are in a state of confusion, uncertainty, surprise, shock, around what is going on. With MF Global being literally a symptom. There are dozens of other things we can point to that all collectively say, this system is really in trouble. And the people who are ostensibly in charge of it seem not to be aware of the magnitude of allowing that rot to continue without being addressed on some fundamental basis.

Erik Townsend: Oh, I agree completely. And I think there is a very simplistic thing at play here. It, it is not a high tech concept, but I think that people in general go through these social moods, and for all of our lifetimes recessions have always lasted for two or three years at most. It is time for this to be over on everybody’s mental clock.

Chris Martenson: Mm hm.

Erik Townsend: Now people like you and I look at this and say, no, actually, there are good examples when the structural macro-factors were this far out of whack the Great Depression lasted ten years. Most people do not experience life that way. Most people say, well, I have been through the 1982-83 recession. I remember it was two or three really hard years, then it all got better.

I think that everybody just has it in their gut that it is time now for things to get better, and they will just interpret almost anything with a bias towards, well, we are – it is the end of this. It is all over now. And you saw this in the, in the Great Depression. There was a big move down. It looked like everything was recovering, maybe even moving back towards all-time highs. Then you saw the bigger, deeper downturn when people realized, no. We have not solved any of the structural problems that got us here. There is no pot of gold at the end of the rainbow. We have got to deal with our problems before it gets better. And I think we are coming up to that point where we realize, no, it is not getting better. It is time to deal with the problems and we have not anything since 2008 to deal with any of the structural problems in the economy. All we have done, and all our political leaders have done, is to paper over short-term problems with Band-Aid fixes that do not solve anything.

And I think, as you said at many times and some of the other, a few commentators on the Internet have, have pointed out, our political leadership does not understand the problem. They misdiagnosed the solvency crisis for a liquidity crisis and they keep not understanding why yet another liquidity injection has not solved the problem. It is not ever going to solve the problem and we are not going to get to a solution until we get to an accurate diagnosis. And I do not think we are there yet.

Chris Martenson: Oh, I agree, and, and the risk here is that the longer we have the misdiagnosis, the more we are going to be applying the wrong medicine. And you mentioned that, that we have not really solved anything. I will go further and say that I see more derivatives in the system since 2008. There is a higher level of aggregate debt across the globe. It has been transferred certainly from private into public balance sheets, but there it is. So we have, we have really just been trying more of the same. And if it turns out that that is the wrong diagnosis, and in fact the ailment was too much debt, adding more liquidity and, and not addressing solvency and adding more debt is really adding and making the situation worse.

So I see all of these things as risks, right, so we, we add more derivatives and they are more complicated and we do not really know who the counterparties are. And I, I mean that honestly. I do not think anybody has a handle on that. And we are just adding more and more debt. We are just pushing it from here to there so the ECB owns it now instead of private investors in Greece. Whatever. It is still debt in the system. And I want to cycle back. So you mentioned we have potentially this squadron of black swans taking off from Miramar. Can we – let us talk about some of these black swans, because in my mind it will not take much really, it could just take like a dark brown swan at this point. It would not take much to spook the system, and there are so many things out there that, that could be potential candidates here in 2012. So let us – what are the big black swans on your radar screen? Maybe if we could start – we, we talked about Europe a little bit. Do you see Europe as a potential black swan or is that a known quantity at this point?

Erik Townsend: Well, I think that what is most likely in my mind is that we will continue to dilute ourselves. They will probably come up with some kind of a—I use the word solution in quotes—another “solution” will be announced. A deal will be announced that is a stay of execution on Greece for a few more months, and I think that the US administration will do anything it can to influence getting the ultimate blowup of Europe to be somehow delayed until after the November elections in the US.

At some point, though, I think that Europe comes back and finally blows up on us. Maybe that will not be until next year. As much as I am absolutely resolute that there is no solution to any real problem and can be no solution, there are plenty of ways that you can paper this over and do a Band-Aid fix that lasts a few more months. And I think they will probably continue doing that through most of 2012.

Iran is another story and my gut on Iran is that it, at this point is a strategic tool. They know they are going to fight with Iran at some point. They know that Obama is not going to win the election in November with hundred and fifty dollar oil prices and seven dollar gasoline if it comes to that unless there is a good scapegoat. So everybody can feel like the President is doing the right thing—in order to fix this problem, that people that do not look like us, created it. It must be all Iran’s fault! I do not know exactly how it is going to go down, but I have the sense that the Iranians know this because there was a very, it seemed to me, smooth process that went along—some sabre-rattling with Iran, then kind of a delay. We are going to wait six months and you guys in Iran, you better watch out, because in six months we are going to really put the screws to you. Iran has come back and said, look, you want to rumble? We do not want to wait. We are going to shut off the oil to Europe right now. We are going to push this. And the only reason I could imagine that the Iranians would bring outside pressure, potentially military pressure on them, is that they are playing a poker game. They know that it is much better for them to force this issue at a time when the US does not want to deal with it as opposed to fighting with the US at a time when the US does want to deal with it.

So I think it will be very interesting to see – if Iran is able to push the West’s buttons in order to bring this conflict to a head sooner than the West would have liked to have dealt with it. My gut is that what the Obama Administration would have liked is to keep Iran kind of on hold, at bay, not really getting into any direct military conflict, and wait until it is almost time for the election. Let it – at that point gas prices are spiking. You are blaming speculators and you are blaming Iran and you are – the President is taking military action in order to bring gas prices back down. Most people buy that story, really feel good about it, and in a time of recently initiated war, the incumbent usually gets reelected because everybody is feeling a sense of dedication or loyalty to the patriotism of whatever is going on. The times when wars tend to not get the incumbents reelected is when they are old wars that everybody feels should have been over by now. So I think they want fresh conflict with Iran around the time of the election and I do not think they will be able to hold it off that long. I think the Iranians are going to basically push the issue and say, we have to deal with it.

Chris Martenson:  Well, the US has not been sitting idly by and sort of waiting for a better time. If you have been following what we have been doing to them economically and financially, they – those would have, if they were in reverse being conducted by Iran against the US, everybody would consider them acts of war. There are these goadings, little stick poking at the hornet’s nest, as it were, and I do not know what they are meant to accomplish besides to let Iran know that we are, we are there and, and we are watching and, and we are very interested in them doing something differently. And so here is the thing. I mean I have read a number of analyses on this at this point, and it turns out that it, it would be a – this would be a pretty tall order for Israel on its own to take care of business.

So let us assume for the moment that taking care of business means some bombing campaigns conducted and Iran’s nuclear emissions are scuttled as a consequence of that. Well, first of all, you cannot really know what the effectiveness of a bombing campaign is until you get on the ground to look at it. And second of all, it is a pretty tall order, given the hardened nature of the specific sites—there are three. Israel only has so many planes. They only have so many weapons and, and long story short, it seems unlikely that Israel could conduct this on its own without significant US support in some way. You know, active, direct military support.

So, so here is the US. It has very interestingly been poking at Iran. And I think you are right. If Iran has any advantage at all, it is to control the timetable of this a little bit. It was funny. Europe was like yeah, in July we are going to stop buying fuel from you. Like well, it is warm then and you are suffering through one of the coldest winters on record. I am sure that works for you pretty well. But Iran, I think, if they are going to exert any influence on this, is going to say, how about now? How about February? How does that work for you? And, and so there is this game going on. And we have seen multiple iterations of this game. This is the third or fourth time I have seen the sabre-rattling with Iran. What makes it different this time in your mind than the other three, which essentially led to no, no conflict?

Erik Townsend: Well, what I see that is different if you look at there was a lot of sabre-rattling right early the first week of January or so. And it seemed like the US was going to try to push an actual military action to happen in Iran soon. Then we saw this backing off where they kind of said that, that threaten of embargo, we are, we are going to delay by six months. And it seemed like somehow between the US and Europe they changed their mind and they wanted to delay the interaction with Iran. Now Iran is saying, well, wait a minute. If you are going to threaten to embargo our oil in six months, we are going to stop selling it to you now and we are going to find another buyer now. I think that is causing the US and Europe also to come back and say, okay, we have to deal with this now. I agree that the actions against Iran have been acts of war, but so far they have not responded with violence, too, but I think that they will soon. What I see, though, is maybe the, the ability of the West to manage this is, as well as they wanted to. I – what was that movie about producing the war where they just wanted to create the public – Wag the Dog.

Chris Martenson: Mm hm.

Erik Townsend: The, the movie about the, the war being produced for public consumption. It seems like Iran is not going to play that game. They are going to change the timetable even in a way by bringing some pressure on themselves earlier than, than most people thought they would. They are going to keep throwing a monkey wrench into the work. I think it, it is looking to me like it is going to come to a head sooner rather than later. But we will see what happens. The thing is two-hundred dollar crude oil is very likely if we see an eruption of a full conflict in Iran. That will cripple the global economy. I do not care what the pundits are saying or, or how long the market continues to rally. Eventually, the cost of energy will prevent the productive economy from functioning profitably and growing. And it, it has got to come sooner or later.

Chris Martenson: So two hundred dollar oil is a likely outcome if, if we attack Iran. That is certainly a black swan. Let us shift pretty much all the way across the globe. China. Do you see any risks there?

Erik Townsend: I think that QE3, and actually the QE that is already going on from the LTRO operations in Europe is exporting so much inflation to China that they are not going to be able to tolerate it. And the big risk in China is food price inflation. You do not have a democracy so the leaders there do not have to worry about getting reelected. What they do have to worry about is food riots and they run their economy on a pretty fine line. They are just a little ways away from food crises getting to the point where people cannot afford to feed their families. And that is when you get major unrest in China. I think that that could happen as a result of QE3 and more quantitative easing around the world. The rest of the world getting into essentially a, a major round in the competitive devaluation agenda that so many western nations have of printing more and money to dilute the value of their own currencies. This all has the effect of increasing the cost of food in China. And when that happens, I think at some point, China has a fair amount of leverage. Because if they were to say to the US, look, we cannot tolerate this QE you guys keep doing. You have to cut it out or we are going to dump all of our treasury holdings. The US cannot allow China to dump all of its treasury holdings.

And I think – you wrote recently about changing the rules. I think that the treasury market is going to be the place where we see the most profound changing of rules. I think that suddenly people who bought things that they thought were saleable in the open market find out that certain categories of investors get restricted and limited from liquidating their holdings. You have to do this over time or something changes or the rules change under the threat of conditional default that make it harder for people like China to just dump their treasury holdings. China would not react well to that or any kind of threat along those lines. China would potentially ratchet up the trade tension that already exists between China and the West. And I think you are just looking at yet a, a potential for a whole calamity which by itself could take down the global economy just in China’s reaction.

You also have to remember that China and Japan both are really in very tenuous circumstances. You wrote about Japan recently and the effects of the carry trade unwind. But you look at a country like Australia now. Now Australia—we just came from there—is – their economy is still booming. It feels like 2006 United States when you visit Australia. The employment is good. The economy is good. Everybody is happy. Everything is going strong. Restaurants are busy. It is just cranking along. Well, 47% of Australian GDT is exports of coal and iron ore to Japan and China. So what if China and Japan both get into major economic dislocations? You could take out the Australian economy overnight. And what would that do? Where, where are all of these trickle down effects? And how many different parts of the global economy would suddenly get taken down when one viral event happens? And I think that between Japan, China and Europe we are looking at a huge, huge macro-risk before you consider the whole Iran thing. So I just think that the overall picture is more ominous than I have ever seen before and at the same time we are seeing the equity markets ignore it to a greater degree than we have ever seen before. And I just do not know what to make of it.

Chris Martenson: Well, that, that is a disconnect. And, and the larger disconnect, which you just framed very nicely, which has been bothering me for a while is, I look at Japan and I see a country that is teetering. They are not over the impact of the tsunami. They have got, I think, 52 of 54 of their nuclear reactors are in shutdown. They are, they are limping through a severe power shortage at this point in time. It will get more exacerbated this summer. They have just become, for the first time in 31 years, an export-deficit nation, meaning that their, their trade deficit is now in negative territory. And they need just an incredible amount of money flowing into the country to satisfy the outrageous levels of deficit spending that they are undergoing, because they are still engaged in, in what effectively is a pretty monstrous QE program. And they are trying to weaken the yen and printing and doing all these things. So I see Japan as fairly weak.

Well, you put all that together and the last thing Japan needs in this situation would be two-hundred-dollar-a-barrel oil. The last thing the entire world needs is two-hundred-dollar-a-barrel oil. Except for maybe some thin, political benefits that would accrue to certain incumbents and whatnot, really high oil prices coming from a conflict like that certainly are no help to anybody, not the debt markets, not the financial markets, not the rickety countries that are now teetering. None of that. So, so it is just mysterious to me when I look at it. I am like, really? You? Iran? Now? Now is a good time? Because we have been goading Iran in ways which they could react and, and say, that is it. We have had it. We are tired of being poked. Here is our response and it is military. That would not be unthinkable.

So I do not understand the calculus being applied there. It is, it is, it is odd to me. And just as odd is this disconnect between whatever the equity markets apparently are looking at and what I am looking at. And on a risk-adjusted basis I do not see much there that is really compelling in the stock markets. But maybe that is the key term here. With interest rates at zero percent, just put your CalPERs hat on a minute. You are, you are the, the largest pension fund in the country, right, in the US. So you are the California Pension Retirement System. CalPERS is sitting there and they have got to get 7.5 percent stated return year after year or they fall into an actuarial compounding black hole, and they are getting exactly what from bonds at this point in time? On an average yield? Two percent, maybe? Three? Something like that? And across their entire bond portfolio? So how do you make up the difference?

Erik Townsend: Well, what I think would be even more striking is not just the fiscal black hole that is ahead of them. But if you were looking at a problem like that intelligently, then what would happen if CalPERS’ trustees would be out saying, look, we need a public conversation in the State of California about what we are going to do here. Because we have not fallen into this hole yet but it is in front of us and we cannot create a bridge over it. We are going to go down this hole at least a certain depth. We Californians need to come together and decide what we are going to do with the available resources that we do have rather than just lying to ourselves about a fantasy that is never going to happen. But nothing remotely like that is happening. And as you see, all of these major structural risks that face the entire global economy, none of the governments in question are doing the necessary work to say, okay, it is time to face the music, folks. This is what we are dealing with. This is what it looks like, what is going to happen. That leads me back to your earlier comment about if the problem here is too much debt, how could anybody in their right mind possibly think that adding more debt is going to solve the problem? Well, I have a hypothesis for you, Chris, to how maybe that makes sense to some people.

Chris Martenson: Okay.

Erik Townsend: And it all rests in your recent article about changing the rules. What if the purpose of the new debt was to rearrange who has the debt, who is holding the debt, and what form it is being held in so that we can have a major unprecedented round of changing the rules to re – essentially to redistribute wealth in a way that would have been previously unheard-of. Well, look at as an example what happened to civil rights in the United States since 9-11 with – between the Patriot Act and FISA and the HIRE Act, now in NDAA where you have the government giving the essentially unlimited authority to lock people up, throw away the key without ever pressing charges. Your right to trial by jury and speedy trial and confrontation of your accuser. All that stuff is out the window. Forget the Constitution. We are making new rules because we have got to fight terrorism. Well, look at the magnitude of the macro-event, the major global economic dislocations that you and I both see on the horizon. If 9-11, which was two building and a, a few thousand people losing their lives, could allow us to throw out our Constitution. Then I think a mini- or macro- a major global economic dislocation could easily allow us to throw out the rule of contract law and simply say, governments are in charge of redefining who has all the wealth, who has the assets. This whole thing is going to get reset and we are going to go to a global currency while we do that. If your agenda was to cause that big picture outcome over the next few years, wouldn’t you want to be redefining the debt and put more of the debt off of the private books and onto the public books where the government has more direct control over what the terms and conditions of those instruments are?

Chris Martenson: Well, I certainly think I would. And there was a director of PIMCO maybe four or five years ago postulated that one easy way to sort of solve the big external indebtedness problems of the US but also other countries was to simply not – create two classes. Are you an internal holder of my sovereign debt or an external holder? Sorry about you external holders. I mean it was a, it was a legitimate thought piece from a very big bond firm which was saying, you know, we could just sort of have one of these enforced international jubilee kind of things. If you are going to go down that, that route, I think, well, what does it really matter? So this is something I do not know that, that some deflationists really internalize as a possibility, but if the Fed is holding a trillion Europe bonds and the Europeans are holding a trillion US bonds and they both just wink at each other and cancel them off their books, what just happened?

Erik Townsend: Well, I think that the question in my mind is if you were trying to put the government in a position to redefine, who gets what wealth according to their own crony standards? You would want to create exactly this kind of situation where you can create a crisis that is so bad that you have to do something dire. And then you take over with force majeure and the governments in charge are handing it all out. I would not see the US and Europe both nod-nod-wink-wink, let us just cancel out both of our debts. What I would see them doing is saying, let us continue to rack these things up so that we have more and more chips that we can push around and change the rules with. And – so I guess I am not following where you, where you are going with the US and Europe just cancelling each other out.

Chris Martenson: Well my point is that once a central bank takes an asset onto its books, it – there is really nothing, that says it has to then get it back off its books by selling it into the open market. It can just let it expire there, if it wants to. And what just happened? Nothing. The money stays out in the, in the economy and the bad – the debt or even, even if it is not a bad debt, whatever debt it was, just went away. It is entirely possible to, to have these bad assets go into central bank vaults, if you will, onto their balance sheet and just evaporate there and disappear. It is, it is something – it is a possibility. And if, if it either that or we face the possibility of a system-wide systemic failure that drags entire countries down and plunges the world into darkness and war. Sure, they will do this other thing, which is just – it is just printing. I am just making my, my oldest argument, which I have been carrying as my main investment thesis, which is; of the possible outcomes that are lying before us here, the easiest one to stomach, I think both temporally, politically, from a career standpoint for most of the involved individuals is to just print. Print a little more and, and buy up the bad debts as they come available and just stuff them away. And I think make them go away in their minds. It is – what, what happened to the Bear Sterns books that the Fed took on? And the Maiden Lane? They have just been winding that stuff down. I do not know what is happening to it. But it has just sort of been evaporating off of the – like sublimating off of the Federal Reserve balance sheet. To me that seems like the, like the preferred strategy at this point.

Erik Townsend: And I think that is exactly what I was alluding to, is when you start with something like Maiden Lane. You tell the taxpayers, look, we are buying, we are buying this stuff up. It is not really a bailout. We are just transferring it from the private to a public balance sheet. But do not worry. It is not bailout. We are just buying this stuff for what it is worth. Well, of course, they are actually paying ten times more than it is worth. And then eventually it gets sublimated off of the Fed’s balance sheet—I, I like that expression—in a way that nobody ever really finds out that, you know, that was a bailout. You were just taking the bankers who paid you a lot of campaign money and you were repaying that favor by buying stuff that was worth nothing at par and sticking it on the public balance sheet where it eventually would be kind of forgotten about through this preface you are describing.

And I think that is exactly what I am saying about redistribution of wealth. What would it mean in a capitalist system if we were to allow the system to reset itself? Would it mean all the banks that took these – extended and ridiculous amount of credit on the – against lousy collateral—they would actually go bankrupt because they made some bad bets. We are saying, no, we are not going to do it that way. We are going to buy those bad bets for them at par. We are going to bail the banks out, put the government in the position where it has taken all of the, the losses that should have been taken by the private sector. And then we are going to find a way to make that go away so nobody notices what happened.

And that is exactly where I see this all going, is the, the cronyism is going to continue. The people who are best connected are going to have their interests protected through fairly complex and unobvious mechanisms that allow the government to take the debt out of the private sector, the bad debt that should stay there where people should be punished for having made those bad loans in the first place. They are going to come off scot-free and ultimately it is the middle class and the taxpayer that are going to eat the cost of this. And it will happen in very complex and unobvious ways so that most people cannot figure out what happened to them.

Chris Martenson: Well, and, and not one man in a million can diagnosis inflation. That is sort of a, an altered Keynes quote right there. And, and this will result in inflation. And, and it has to at some point in my mind, because ultimately what we are talking about, whether it is the Maiden Lane – we are getting down to the minutiae and we are discussing the complexity of it or any of these other things with the complicated acronyms. What is happening here is that somebody went into an incredible amount of debt. That debt resulted, like all debt does, in an equal and offsetting amount of money. That is out there doing things. It built subdivisions. It bought yachts. It, it took trips. It did stuff. But the debt remained and then the debt starts to go bad and the Federal Reserve buys that or some other central bank or the government itself buys that and takes that off and puts more money out into the system in – to, to purchase that debt.

And so ultimately we are just stuffing more and more and more money out there. And this ultimately results in inflation. It has not yet made official statistics very much, in the US at least. But it, it certainly is going to at some point. And here is where we – if we combine the two big theories out there, one is we are printing money like crazy because we think it is a liquidity crisis. So look at all these liquidity events. Central banks everywhere are doing it across the globe at this point in time. And then we take this other concept, which says that, oh, wait a minute. The economy is actually real things. It is goods and services. It is tangible things I can point to, touch and receive. That is ultimately what this money is a marker for. Hey, how is that doing? And we, we look at where we are in the peak oil story. We look at a hundred-and-twenty-plus dollar Brent. We look at energy where it currently is, which is, of course the number one substance for, for creating things economically.

So I put these two big spheres together and it, it is just everything that I have been doing, Erik, over all of these years in, in trying to talk about and warn people about these two big things that are happening. That money printing is a very natural human tendency. It is that we can see historically and it is happening before our very eyes today again on the one hand. And then on the other hand this idea that there are limited and limiting supplies of some very critical substances out there right now. And when we put those two pieces together, it is really a perfect storm for someday, sooner or later, for there to be just, in a very obvious way to all the participants, vastly more quantities of money out there than there are goods and services. Well, that is just inflation.

Erik Townsend: Well, and believe me, the inflation—it feels in some ways like it has not happened yet. But the inflation has already happened. The fact that there is already too much money in the system driving prices up is happening around the globe. It is magically suppressed in the United States and part of that suppression is real prices are not increasing in the US the way they are elsewhere. Part of it is the fuzzy numbers reporting. But when you find yourself sitting in front of a fifty-seven dollar potpie, trust me, inflation is already happening.

Chris Martenson: It is, indeed. And of course, one of the great sins of the US central bank is to not have considered asset inflation a form of inflation. New Zealand, where you happen to be, their central bank does consider asset inflation, inflation, and they control it carefully. I have always admired them for that. House price inflation, that is asset inflation. It is inflation as far as they are concerned. In the US, Greenspan/Bernanke continuing the tradition of this thought -- oh, no, no, no, no. Assets, assets are different. We like asset inflation. And so in many ways I am looking at the stock market going up and we might be tempted to feed that into our LEI machine and say, oh, well, the LEI is going up. And, and because it is going up, stocks are going up. And because stocks are going up the LEI is going up. I love that little loop that it has got going.

But if what the LEI is tracking is a stock market that is not going up for what we would call the right reasons, meaning it is really fundamentally a good value and that is what the price rise is signaling. But instead it is inflating, and it is inflating because there are really unattractive options out there in bond territory—who wants to get zero percent on their money? In fact, sometimes fiduciarily, certain trustees are prevented from chasing either zero percent yields or yields in bonds that are anything less than full investment grade. So their universe of things they can invest in shrinks and so bang! off they go into stocks because there is really nowhere else to go. That is a very classic dynamic.

I am looking at the stock market going up and wondering how much of that is just the equivalent of inflation and – meaning that when we track the GDP, we track what is called the real GDP. Not the nominal GDP. Nominal is the total number. But from that we have to subtract inflation, because guess what! Inflation is not real and so we pull that out so we have an understanding of what is really happening. In my mind, things like part of the price of oil, part of the price of commodities today, part of the price of a college education I am staring for my 17-year-old and next year, part of what I am seeing in my healthcare costs every year, part of what I am seeing in the stock market. They are all just symptoms of this incredible amount of quantitative easing that has been going on.

Erik Townsend: Oh, absolutely. And I think there is even – just to strengthen the argument you already made. We cannot forget that the whole definition of a recession versus a depression lies entirely on a contraction in GDP that lasts over a period of years. And the conventional definition is a 10 percent reduction in real GDP is a depression. If you were to use realistic inflation numbers, the GDP-deflator that the BLS calculates, if you were to do that realistically, use say ShadowStats numbers, you would find that we are in a bona fide depression, that we have been in a depression for a few years now. If you are honest with yourself and you recognize this is not the worst financial crisis since the Great Depression, this is the next Great Depression and it is happening around us right now. If you accept that, as just a fact and you look at what the prices are, in the face of what is actually an economic depression and we are still seeing the—even in real terms—record numbers on, on prices on things like oil, something is going on here and it is not sustainable now. You just wait ‘til the economy starts to look like it is recovering. Because it is completely unsustainable then.

Chris Martenson: Fascinating. You know, we – I have the sense you and I can talk about this for many more hours and we have come up on the end of our time. So I, I want to reserve the right to continue this conversation before too much more time passes. And if certainly if any black swan comes along, or even a dark brown or gray one, I hope you and I can talk about it.

Erik Townsend: Well, hey, it is always a pleasure and I look forward to coming back and we’ll do part two when circumstances warrant.

Chris Martenson: Well, I bet they will soon. Have a happy 2012 and yeah, do not eat any fifty-seven dollar chicken potpies on my behalf. Make sure you are really enjoying that when you tuck into it.

Erik Townsend: [Laughter] Well, it is not really possible for me to enjoy a fifty-seven dollar potpie. I went through it as more of a learning experience about what is to come.

Chris Martenson: [Laughter]

Erik Townsend: And it is a sobering experience. So thanks very much for having me on and I will look forward to talking to you again soon.

Chris Martenson: Alright, Erik. The pleasure has been mine.

Erik Townsend: Okay.


Transcript for Paul Brodsky: The Seeds of Our Destruction Were - And Still Are - Sown in the Bond Markets

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 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

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.



The Martenson Insider - June 27, 2011

In This Newsletter
  • Likely Outcomes of the Debt Ceiling Drama
Zav's picture

Interest Rates and Inflation

Chris and Axel both have repeatedly said that the future is not going to be like the past. I have given a lot of thought to this statement and one of the conclusions I have come to where the future is not going to be like the past is that we are going to have high inflation in the United States, it has started and it is going to get worse. This inflation is being driven by demand for commodities by the growing economies. Lets examine at what is different this time from the past.

hucklejohn's picture

Here's the Setup for the Con of the Decade

Charles Hugh Smith of www.oftwominds,com puts out one the most thought provoking blogs out there.  Here is his latest.  It's so good I am putting it out in full text:


The Martenson Report - Finding Shelter From The Storm

Monday, April 4, 2011

Executive Summary

  • GDP growth requires energy, and the Fukushima disaster has just set back nuclear's expected contribution by years (decades, likely)
  • Trading strategies for an end to QE, by asset class (stocks, bonds, currencies, commodities, precious metals, real estate)
  • Why this will be more damaging to the economy than the 2008 correction
  • Fukushima's likely impact on the energy market
  • Why the priority now for investors should be on wealth preservation
  • The odds QE will resume later in the year

Part I: A Global Tsunami, Courtesy of the Fed

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Finding Shelter From The Storm

legamin's picture

Good news, everyone! That pesky recession is over. -Geithner

"Over the past two years, the Administration, along with Congress and financial regulators, implemented emergency policies that ended the worst recession since the Great Depression and put the nation on a path to economic recovery."


The Martenson Report - Don't Worry; They'll Just Change the Rules

Wednesday, January 12, 2011

Executive Summary

  • Why the inevitable market correction will be triggered by a forcing event, and which one is most likely
  • Why the US has too much debt
  • Why state bailouts are inevitable despite the Fed's denials
  • Why there's "not enough oil to repay the debt"
  • Why the cost of debt service will drown us, even if interest rates remain low
  • Why the bond market will be the canary in the coal mine
  • The key signs to watch for that will signal the endgame is playing out
  • Recommended investment classes for preserving wealth 
machinehead's picture

Treasury yields crash to record lows

A slow-motion crash is underway in Treasury yields:

Oct. 8 (Bloomberg) -- Treasury two- and five-year note yields slid to record lows as data showing U.S. employers cut more jobs than forecast last month spurred speculation the Federal Reserve will buy more bonds to stimulate the economy.

investorzzo's picture

Foreigners cut treasury stakes; rates could rise

The $53 billion decline in holdings of Treasury bills came primarily from a drop in official government holdings. They fell by $52.3 billion. Holdings of foreign private investors dropped by $700 million in December.

Can't help but wonder if rates will be forced up and bonds will become very unpopular to hold.