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A risk isn't what you think is going to happen.

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Risk is what hurts if it happens.

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That lightning strike only catches one tree on fire.

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It's meaningless.

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The risk is the buildup of dry brush in the forest that allows that one lightning strike

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to spread tree to tree to tree to tree and burn the whole forest down.

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Positioning is the only thing that matters.

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I'd be very cautious about being too enthusiastic about TradFi getting their dirty little fingers

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into Bitcoin.

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I think it will inevitably bring leverage and danger to the process.

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Do everything you can to eliminate the unrecoverable so that you can pursue the unimaginable.

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David Dredge, great to see you.

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You've come highly recommended from a good friend of the show, Peter Dunworth.

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He says you're the man to talk about when it comes to risk.

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So we're going to get into it today.

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First of all, we should start by introducing you because first time on the show, I know you're not a diehard Bitcoiner, so people might not be aware of your work as much.

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Do you want to start with just giving a bit of background?

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Hi, Danny. Great to be on. Glad that our mutual friends hooked us up.

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I'm sitting here in Singapore, you know, 6 p.m. on the Friday before Christmas.

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I appreciate that.

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I run a little business here that's focused on long volatility, long convexity that our investors use us as a explicit risk mitigating strategy, insurance, if you want to think about it that way, so that they go out and take more risk and go out and participate more aggressively in growth assets and stuff.

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I'm a long, long time markets guy out here in Asia.

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I originally got to Singapore just in time for the October 1987 crash and spent many, many years in banks, most famously, arguably sort of building what would be the emerging market trading businesses for Bankers Trust, sort of a leader in the derivative risk innovation world back in the early 90s through the 90s and through the Asian crisis and stuff.

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So I have a lot of experience and still apply my skills in the world of financial derivatives and the complexity of derivative markets around the globe.

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And have sat through and seen and participated in sort of a front row seat in every market dislocation that's come along since the October 87 crash.

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And so I run a business that helps people manage risk so that they can grow wealth more efficiently.

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So with that October 87 crash, what happened? Was that when the stock market crashed? Was it 50% or am I out of base there?

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So the S&P, the U.S. stock market index, crashed 23% in one day.

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They call it Black Monday.

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Out here, we called it Blacker Tuesday because the next day out here, the Hang Seng Index in Hong Kong and what is now the AS51 index in Sydney, which was the ASX back then, crashed 50%.

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So those two local stock indices crashed 50% in the day.

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The best performing index in the world on that day was the Nikkei.

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It was only down 15% because it had this wild thing that nobody else had ever done, a circuit breaker.

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So when it went down 15%, it stopped.

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Now all indices have one of those.

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So were you working in risk management before that, or was it seeing the stock markets crash, you thought, I need to do something about this.

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I need to be prepared for these kind of black swan events.

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I was a very, very young man then, obviously.

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And I was a trader.

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So I was then working for Bank of America, and then I was an FX and interest rate trader and saw the just absolute devastation two weeks into my new role out here in Singapore.

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And it dawned on me that the simple measures and methodologies around risk management in what was, you know, then and is now one of the most sophisticated, largest banking, risk-taking businesses in the world, that they didn't have any idea what risk was.

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They didn't have any idea how to manage it.

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And so I've been sort of trying to figure that out for the last 38 years.

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and learned a lot along the way.

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And over time,

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have developed a reasonably good idea.

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I'll simplify it.

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You know,

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risk isn't what you think is going to happen.

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Risk is what hurts if it happens.

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Risk is about,

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as a good friend of mine,

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Harry Christian wrote in his book,

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a book he wrote,

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he says,

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risk isn't about predictability.

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Risk is about vulnerability.

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And so when you talk about risk,

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I think one of the things that people

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maybe commonly mistake for risk

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is volatility. But volatility is what you want. Like an investment without volatility is absolutely

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boring. Like there's no point in doing it. So how do you trade off the volatility and the

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unpredictability, the risk on the other side of it? Yeah, exactly. And I say all the time

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in my writing. So if your readers want to go and see, I put up a note that we, it's actually our

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investor letter that goes out to our investors, a part of it. We put up on our website at

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convex-strategies.com. And I refer to the traditional maths of the financial and economic

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world, that which we all get taught in school and that which runs the way banks and pension funds

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and insurance companies and wealth managers operate. I refer to that as sharp world. And

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I'm not referring to it positively in that sense. I'm referring to it as derogatory as I can.

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And at the sort of heart of that from an investment perspective is what's known as the Sharpe ratio. And so, as you said, in the Sharpe ratio, it's return over unit of risk, and they measure unit of risk as volatility of those returns. And that is absolute nonsense.

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And obviously, upside volatility is good.

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Downside volatility is bad.

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Average volatility is meaningless.

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And that thus leads to the dynamic that we're talking about here that's hard-coded into the financial system, into the regulatory construct of the financial system, that foregoing upside is risk-reducing.

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And so they want you to enter into things that are low volatility, suppressed volatility, asymmetric volatility, and then apply leverage to it.

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And they're going to claim that the leverage is not risk.

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It's the volatility that is the risk.

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And that, in essence, is what creates what we would call left-tailed or negatively skewed return dynamics, where you have foregone upside explicitly, think something very simple like a bond, where you don't participate in rising markets, you have a bounded potential return, the coupon, and you have probabilistically, based upon historical look back of defaults, reduced downside.

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But every time something goes wrong, it turns out you didn't explicitly reduce downside.

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You've still got it.

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And that sort of is what gets built into banks most prominently that leads to systemic risk because they end up having not enough capital to support the risk they're taking because they're always measuring the risk with these very, very flawed metrics.

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So how does Bitcoin fit into a volatility profile that you would look at?

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because historically, it's obviously been incredibly volatile

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to both up and downside.

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Over the last year, it's really not.

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I think we're probably down around $10,000 or something

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since this time last year, roughly.

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And it's not the year that anyone expected in Bitcoin.

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I think people were expecting a ripping bull market.

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And we saw a move to $126K.

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We're back down to $87K or something as of time of recording.

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How do you view it in terms of both historically

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when it was very volatile and what it's maturing into today. Yeah. So I talk all the time that

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a proper investment portfolio is the opposite of what Sharp World is telling people to do.

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So Sharp World is telling people volatility is risky, so avoid it. So literally, if you're in a

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bank, you're regulated to avoid it. And then it's telling you that low volatility is safe,

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So apply leverage to it. Well, the correct investment portfolio is the exact opposite. Own things that are thin-tailed, that have natural volatility, where you're getting rewarded with upside volatility for the downside volatility risk you're taking, and hedge with things that are fat-tailed, and particularly fat left-tailed, that have artificial suppressed volatility and attract leverage, which then limits the capital available when something goes wrong.

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And Bitcoin over the last five, six, seven years has been a fantastic thin-tailed investment.

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And so paired in a portfolio of other participating assets, it's been a very good compliment because it's rewarded you with upside for the downside risk you're taking.

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You'll know way better than me. I say all the time, and I don't really know specifically, that Bitcoin's had six 25% drawdowns in the last three or four years and is up 250%. That's a good reward for the risk you're taking.

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And then conveniently, in terms of the people that we work with, you know, in a diversified portfolio of risk-seeking participating assets, risk-managed with efficient risk-mitigating asymmetry negatively correlating, well, that worked really well in a year like 2022 because Bitcoin's worst year was a bad year for everything else.

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And so the things that we would provide as hedges, and when we're providing hedges, we're really hedging that correlation, the correlation of risk across assets that makes your diversified portfolio, your diversification lets you down.

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And so it's been a fantastic complement to people's diversified portfolios of risk-seeking assets. This year, in what's been a really good year for global equity markets, for gold, for various things, has been a mediocre year for Bitcoin, which had outperformed sort of all of them, ex-gold, up to a certain point.

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And then in the recent months, it's had a pretty good pullback.

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And it's been a pullback that obviously, you'll see it clearly than I do, has been somewhat idiosyncratic.

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It hasn't been part of a correlated market dislocation.

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You know, maybe you can say there's been some noise around some of the high-flying tech stock single names.

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But at the index level, indices have been certainly not troubled particularly in recent months.

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sort of, I don't know, when would you date the sort of origination of this sort of pullback in

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Bitcoin sort of September? It was probably early October. Yeah, early October. Roughly. Yeah. And

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so you had some noise around some of the other things, but that noise has kind of dissipated.

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And meanwhile, Bitcoin still, you know, give or take, you know, not at its lows, but maybe

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six or seven thousand dollars off its lows and you know i don't know exactly what drove that but

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i would you know again i when i talked to our friend checkmate and we had discussed over time

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about my thoughts about leverage and systems and how little leverage there actually was in bitcoin

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in particular because the native exchanges that apply you know you know finance or bitmex or even

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the one that went out of business?

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FTX.

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FTX.

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They cut the guy's position

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when he runs out of margin.

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It's not like the TradFi system

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where they, you know,

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they give you a call the next day

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and say, you know,

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when it's convenient,

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send us more margin.

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You know, particularly

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if you're one of the big banks

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who is blessed by the,

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you know, monopolistic gift

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of the governments

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that underwrite them,

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they can keep, you know,

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running up under margin positions

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forever until the system collapses.

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but Bitcoin, the exchanges where the riskiest trading took place.

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I mean, imagine if one of the top two largest exchanges in TradFi went out of business like FTX did.

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I mean, talk about a systemic risk.

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But in that one, it's just the people involved in FTX lose money.

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That's the way it should be.

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But what's kind of happened, and this is what Checkmate wanted to talk to me about at the time,

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was this sort of proliferation of growth in the TradFi world.

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obviously the ETFs, and then more significantly in terms of what I'm rumored to be a specialist in

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or something I might understand, that the options on the ETFs and the evolution of that getting,

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adding sort of that TradFi style of leverage into the system and the evolution, inevitable evolution

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of the availability of these IBIT options, which dominate the volumes in that space,

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into the world that I really do focus on, which is the structured product, the complex,

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embedded, short volatility, yield-enhancing investment products, auto-callables and stuff

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like that, that really drive the leverage in much of the equity, interest rate, FX markets that are

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dominated by the TradFight world. And that's kind of, I think, probably why some sensitivity build up

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everybody's familiar with the leverage from micro strategy and, and DATS, I think you guys call them,

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you know, but you just got enough leverage build up in kind of a short time that you needed a

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so i'm just a simple bitcoiner david i uh i'm probably everything you hate about bitcoin is

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in the sense where i don't i don't do any hedging i just i'm almost 100 into bitcoin and i just leave

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it there and i wait that's all i do um and so when it comes to like the ibit options i know they're a

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huge deal but i don't exactly know how it changes market structure and the impact it will have on

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bitcoin the bitcoin market going forward like you say this is the thing you're an expert in so

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how do you think large option markets coming to Bitcoin will impact it?

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Well, you could think of options as leverage, right? So you obviously are well aware that if

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you lever up your position in Bitcoin at an exchange, you're taking a lot more risk for

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the amount of capital that you have. And you think you're going to get something for that.

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But of course, when things go wrong, you get stopped out, which has been literally the beauty

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or the thing that makes Bitcoin not risky is that the guy's position gets cut.

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The exchange grabs his margin, his position gets cut.

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So you could kind of, in a sense, only make as much money as the guy on the other side can lose

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because the position gets extinguished.

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But in the TradFi world, that margining isn't based upon a bunch of guys who are risking their own capital.

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It's based upon regulated financial institutions that are using really, really bad mathematical,

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risk and accounting rules.

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And this margining thing masks and the way they operate

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masks the risk in the tails.

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And so when you start getting a world where option sellers,

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volatility sellers can come in usually with somebody else money because they a fiduciary and they selling this optionality to harvest this image of enhanced returns Well almost without fail

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they're not accounting for the tail risk on it. And so you start to get undercapitalized risk in

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the system, which will start to make that underlying component negatively skewed. So you'll get the

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movement where it pulls it the direction where the weakness, the fragility is in the system.

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And so that vol selling, I'm in the business of vol buying. So that's me, in a sense, taking on

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non-recourse leverage, right? So I'm going to buy a put option. Let's say I'm going to buy a put

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option on IBIT. So somebody in exchange for the premium I'm paying them has underwritten the

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downside and I get all the upside. So if I buy a put and I go and buy I bet, if it goes up, I get

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that benefit. If it goes down, the disbenefit goes to the guy who provided me the non-recourse

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leverage. And for that, I pay him a fee. Now, in the long run of something that, you know, that is

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driven by its ups and downs, which is, you know, interestingly, particularly fat-tailed things,

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things that have low volatility, tight distributions will have fat tails, that the long-term compounding

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paths will be driven by the extremes, the power law, right? So the moments of the distribution,

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the average in a power law, you won't know until, you know, let's say we're at dinner,

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Danny and the other you know there's me and you there's checkmating there's Pete and

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etc and we're we're doing a survey of average wealth and we're going to try to guess the

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average wealth but we won't know what the average wealth is until the last guy who happens to be

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Jeff Bezos and he will be the average right he'll be 100% of the average because it's a power law

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distribution not a normal distribution like we were trying to guess the average height right

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nobody's height is going to be enough to fundamentally change the mean. But wealth is not

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normally distributed. It's power law distributed. And so when you create these fat tails through the

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suppression of volatility and the addition of leverage, the magnitude of the tail events

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will dwarf the mean and variance inside what you thought was a much more narrow distribution.

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And so the value of optionality grows in that because I want to get the infrequent low percentile but high magnitude outcomes.

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Now, in a naturally volatile thing, it doesn't work.

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You have much thinner tails.

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And so you're fine to just kind of be in there doing it.

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And so the guy who's selling that option who thinks, oh, good, I've collected this premium.

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And, you know, my worst case is, you know, one standard deviation downside only to find out that the one standard deviation downside was a lie in a world that is accumulated leverage and has significant uncapitalized risk that will generate this fat left tail when it occurs.

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So we obviously were talking a little bit before about how Bitcoin's volatility has dampened.

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And one thing I've not fully got my head around with the options is assuming Bitcoin volatility comes back, which I think it will probably both to the up and the downside.

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And it obviously trades 24-7 globally.

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Do you think there's going to be a lot of people who aren't managing risk using these Ibit options who are going to get blown up because Bitcoin can be so volatile and it does trade 24-7?

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Yeah, and even more so, and what did the TradFi world eventually really drives this accumulation of leverage and short volatility is these much more highly juiced structured product things.

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So the autocallables, the example, and I mentioned it on that conversation with Checkmate, you know, the first major institutional long-dated autocallables started coming out.

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And so one was issued on October 31st, and embedded in that is what they call a knock-in put, where the guy who's bought the note is getting a yield, but embedded in that without him really generally understanding it, he's short and at-the-money put that knocks in when the market's 25% down.

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Now, I don't know exactly. I haven't dug through all the details of it, but just a quick calculation that I did. The IBIT adjusted Bitcoin rate for that 25% down knock-in was $82,000. So where did the market go to just coincidentally on that Friday night, November, what was that, 21st? It went to $82,000.

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and then is that the market searching for max pain correct that's exactly what it is

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it's exactly what it is and so that's you know again triggering that sensitivity the you know

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whether it's the you know the the bank who's managing that risk hedging it and you know he's

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he's trying to manage negative gamma and or somebody and you know you drive it there and

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then once it knocks in the pressure's off and it recovers again at least in that short-term series

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of outcomes. So as someone who follows markets loosely, but obviously nowhere near as the level

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of view, is Max Payne just a meme? Because I see people say the market always wants to find the

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pain. What does that actually mean? And does it happen? It definitely happens. And to some extent,

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I've made a career out of it. Yeah, because again, this leverage means that you've got

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uncapitalized risk. So if people are levering risk based upon bad mathematical metrics,

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and again, in the financial industry, in the fiduciary industry, that's what everyone's doing.

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They're using things like value at risk and regulatory reporting and accounting nonsense

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and going out and taking risk, you know, massively asymmetric risk with other people's money.

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And so you get these accumulated undercapitalized tails in the system, and then it's like a magnet, right? Once it starts going there, it's an unstoppable train.

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Now, the analogy that I use all the time when I talk about endogenous risk, and so the way I would think of the world, Danny, is that all the risks that matter, a dredgeism that I say all the time, positioning is the only thing that matters because the risk that matters is all endogenous.

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It's not about predicting the unpredictable lightning strike that's going to catch the forest on fire.

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That lightning strike only catches one tree on fire.

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It's meaningless.

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The risk is the buildup of dry brush in the forest that allows that one lightning strike to spread tree to tree to tree to tree and burn the whole forest out.

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And in the financial industry, that risk, that interconnectivity of dry brush is leverage.

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And once that starts triggering a risk reduction, it causes this reflexivity where it just goes and finds where the most vulnerable part of the forest floor is. And that's where the fire is going to go and do the damage. And it's going to go and clean out those weak hands, that over levered or undercapitalized risk and cause the biggest pain. And that's the way, if you ask me, that's really how markets work.

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so the other thing that I've kind of been trying to figure out on the iBit options is

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if it's going to have a negative impact on Bitcoin price because it seems to me at least that

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in Bitcoin's history it's largely been driven by people like just retail and obviously ETS were the

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start of Wall Street really coming into this and with options which can be much larger on top of

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that is this like Wall Street taking over the Bitcoin price chart instead of being retail and

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What does that mean for it?

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I think that's a great question.

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I think in a sense, I think that is the question.

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I've been known to say, and this goes back before there ever was a Bitcoin,

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and what, you know, I guess I wouldn't have used the term TradFi,

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but now that we're all used to it, I'll say TradFi,

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but I would have said Sharp World.

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TradFi destroys everything, right?

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because it brings this leveraging dynamic driven by the regulated institutions who have no skin in the game.

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So they're always happy to take on destructive risk that is allowed, in fact,

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incentivized by their regulatory risk and accounting construct that creates the systemic risk that necessitates,

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that brings financial crises and necessitates global bank bailouts every decade or so.

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And sort of, you know, if you think about it, the great example, the easiest example, Danny,

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I mean, think about, I mean, you're maybe too young, but, you know, even today,

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what could be safer than U.S. houses?

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You've got the world's strongest, most advanced economy, most wealthy economy,

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most dynamic economy. You know, what's safer than the guy owning his own house? And yet the

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TradFi system managed to blow that up in 2008, right? It found a way to tranche up and take

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advantage of regulation that was, I'll argue, and like, trust me, you know, explicitly constructed

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to try to subsidize homeownership. I mean, think about all the rules in banking and in tax treatment

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and government mortgage guarantee organizations, Fannie and Freddie, and the risk-weighted asset capital preferential treatment on mortgages,

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and then the rules around tranching and collateralization and building out mortgage portfolios and super senior tranches of subprime CDOs that get treated like a risk-weighted asset

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because you've played this accounting game of buying insurance from a monoline insurer

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who's a AAA-rated guy because he only insures AAA-rated mortgages.

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And because he's AAA, he doesn't have to collateralize any of the insurance.

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And the thing gets a zero-risk rating asset, and you can leverage it infinitely

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and say it's no risk and pay yourself bonuses every year on the crude income.

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Well, that whole thing destroyed the U.S. housing market,

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They destroyed the global banking system, right?

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You know, so I'd be very cautious about being too enthusiastic about TradFi getting their dirty little fingers into Bitcoin.

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I think it will inevitably bring leverage and danger to the process.

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Yeah, I think it's going to be really interesting because like as Bitcoin is often described as Bitcoin being the Trojan horse into the traditional financial system.

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And that, you know, it's this like uncorruptible thing, which I believe it is.

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but only time will tell if that's actually true.

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So you've obviously been in markets a long time.

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Were you around, like, working in the markets in 2008?

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Yes, I was.

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And did you spot this coming then?

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Well, I was, at that time, I was still in the banking industry.

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And so it was very easy to spot what was coming because I worked in a bank.

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One of the things I say all the time,

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so another analogy that I use all the time, Danny,

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in terms of investment strategies and how you should manage your investments is the race car analogy.

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In a multi, a 40-lap Formula One race, who wins the race?

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Well, the guy with the best brakes, right?

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Because the guy with the best brakes doesn't crash and he can drive faster.

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And so when I'm talking to people about risk,

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Most people, when they're thinking about risk, want to predict the future unknown course of the racetrack.

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But the actual risk, the only thing you can control is your car.

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So what you want in terms of risk management is a resilient, robust, dynamic car.

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You want good brakes so that you can go out and test your car on how to drive it faster.

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better aerodynamics, better tires, different steering, transmission, stronger engine, right?

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Skills, right? So in a bank perspective, if I'm around a bunch of bankers or regulated financial

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fiduciaries, everybody always says, Dave, what do you think the risk is? Do you think it's

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geopolitics in North Asia? Or do you think it's recession in Europe? Or do you think, you know,

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all these random exogenous things out there. And I say, no, the risk is your balance sheet.

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Why are you looking out there? All the risk is right in front of you. And if you're sitting in

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a room full of bankers and you say, well, your risks are almost certainly driven by the lack

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of capital to the things that you've been told you can account for as riskless. So you've applied

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a ton of leverage to them. And the interesting thing is, so is he, and so is the guy sitting

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next to you and so does the guy sit next to him and so does the guy sit next to him because you're

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all following the same rules and paying on the same incentive structure and so you know if you're

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inside a bank and you understand what a bank does it's pretty easy to see where the risk is built up

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because you're doing the same thing that everybody else is doing and you know where there's no capital

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and again you know u.s mortgage structures that had been gamed to ad infinitum but you know not

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just that all of the lack of capital around complex structure derivative type activities

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was massively undercapitalized and you could see that kind of stuff coming.

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And I'm sure you've seen the movie, The Big Short.

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There was all kinds of guys inside saying, hey, this is a problem or, you know, margin

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call or all of those saying, hey, this is a problem and getting told, you know, what

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was the famous Chuck Princh quote?

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You know, yeah, we know it's a problem, but, you know, as long as the music's playing, we'll keep dancing because that's how they get paid.

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And they're not getting paid to grow the wealth of the bank over the multi-lap race.

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They're getting paid based upon each lap.

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So they're just trying to sort of match the average lap speed because they believe they start over each lap.

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They're not trying to compound growth and compound wealth.

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They're just trying to get through the year and collect money.

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And so they're happy to, you know, in the old analogy, you know, pick pennies up in front of the steamroller.

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See, the thing that I find frustrating about this kind of thing is that, and this is talked about in Bitcoin a lot, in the sense that when money is broken, everyone has to be an investor plus a risk manager.

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And if you're just like, I don't know, a doctor or a lawyer or a teacher or something, you shouldn't have to think about all this.

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Does the sort of fiat currency world frustrate you?

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Oh, it's so much.

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It's my enemy.

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And again, Sharp World is my enemy.

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It's funny, you know, and people joke about this because, you know, your followers and listeners can go and track me down and hear me talk at things at podcasts and interviews and conferences and stuff.

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And I am a very vocal and have been for 30 years outsmoking critic of Sharpe World of the regulatory construct of banks and a very outspoken critic of the practices of central banks and how they manage monetary policy and the sort of inflation the commitment to generating inflation particularly asset inflation and the wealth segregation that goes along with it Now on the other hand the practice of Sharp World is what provides the opportunity that my business lives off of So the cheap convexity that very highly efficient

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asymmetry that allows our investors who, you know, tend maybe not to be just individuals,

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but there are some wealthy individuals, but are institutional, to allow them to sort of delegate

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that breaking, that risk management to us and then go out and just figure out how to drive faster

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and do what I would, you know, crudely call the easy part and just go and own stuff that goes up

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when things are good, goes up when fiat's being debased, that goes up when asset inflation,

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which I'll argue, you know, sort of been the sort of singular growth policy since that 87 crash,

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Since the first time Alan Greenspan cut interest rates because stock markets were falling, which started the first time in the October 87 crash and then basically evolved into the Greenspan put that was implemented all over the world and became inflation targeting central banks, beginning with the New Zealand Central Bank and then standardized around the world, where they every time asset prices fell, they cut interest rates and keep propping the asset prices up.

391
00:38:13,560 --> 00:38:34,420
And they drove growth through the wealth effect of asset inflation, concentrating the wealth in more and more hands and concentrating, I don't know if you go and see the numbers, the consumption that drives the growth in places like the U.S. in particular in more and more, you know, fewer and fewer hands and the bigger and bigger and wealthy people.

392
00:38:34,420 --> 00:38:46,320
It's sort of a, it's funny, the same people who make fun of trickle-down economics from the Reagan era of that he was going to cut taxes and then the wealth would trickle down every because they get more jobs.

393
00:38:46,500 --> 00:38:52,260
They seem very happy to implement trickle-down asset wealth because that's literally been the policy.

394
00:38:52,260 --> 00:39:00,200
And that, of course, then leads to, again, back to the endogenous problems and the sort of fragility of systems.

395
00:39:00,200 --> 00:39:07,720
It leads to this sort of geopolitical fragility and leads to economies that are really downstream from the markets.

396
00:39:08,000 --> 00:39:11,420
So I say all the time, economics is downstream from markets.

397
00:39:11,700 --> 00:39:15,640
But you don't have – markets don't fall because there's a recession.

398
00:39:16,100 --> 00:39:17,920
There's a recession because markets fall.

399
00:39:19,380 --> 00:39:21,600
So, I mean, you sound like a Bitcoiner, David.

400
00:39:22,040 --> 00:39:22,740
That's for sure.

401
00:39:24,740 --> 00:39:27,840
I'm not a disbeliever, that's for sure.

402
00:39:27,840 --> 00:39:34,140
do you think there's a future like a near future you know give it 10 20 30 years whatever you want

403
00:39:34,140 --> 00:39:39,260
to whatever number you want to pick where this kind of fiat sharp world doesn't exist anymore

404
00:39:39,260 --> 00:39:48,460
and we move to like a hard money standard again um i'm not good at time in fact in a sense my job

405
00:39:48,460 --> 00:39:55,360
is solving the problem of time uh i don't know when the lightning strike's going to come i just

406
00:39:55,360 --> 00:40:03,500
know how much risk there is in the forest. And so I would say inevitably, yes, that this is

407
00:40:03,500 --> 00:40:09,300
unsustainable. So solutions are going to have to be found. Exactly what those, you know, whether

408
00:40:09,300 --> 00:40:13,120
the fire is going to start because of lightning or because kids are playing with matches or

409
00:40:13,120 --> 00:40:17,760
which direction the wind's going to blow, I don't know. But there is a lot of fragility in the

410
00:40:17,760 --> 00:40:24,020
system. I'll go back to this sort of basic core, the thing that I believe is at the very core of

411
00:40:24,020 --> 00:40:30,400
the challenges, and that's the population demographic problem. And that problem, as I

412
00:40:30,400 --> 00:40:36,860
would define it, isn't declining population, although that has obvious complications itself,

413
00:40:36,860 --> 00:40:43,820
but by far the greater problem is declining working age population. And so this gets really

414
00:40:43,820 --> 00:40:51,440
to the heart of Bitcoin, because the declining working age population, let's reclassify them,

415
00:40:51,440 --> 00:41:00,720
declining taxpayer and saver population. And so I say this all the time that I find it as the

416
00:41:00,720 --> 00:41:10,360
single biggest weakness in those who purport to make policy, economic policy, is how can they not

417
00:41:10,360 --> 00:41:16,240
factor into everything they do this simple sentence that I say, so tell your listeners,

418
00:41:16,720 --> 00:41:20,980
every time somebody says something to you, every time Rachel Reeves in the UK, you're in the UK,

419
00:41:20,980 --> 00:41:21,480
right, Danny?

420
00:41:21,780 --> 00:41:21,900
Now.

421
00:41:23,300 --> 00:41:24,000
I am at the moment.

422
00:41:24,120 --> 00:41:24,900
I actually live in Australia,

423
00:41:25,060 --> 00:41:25,840
but I'm here right now.

424
00:41:26,180 --> 00:41:26,300
Yeah.

425
00:41:26,480 --> 00:41:28,520
Every time Rachel Reeves talks

426
00:41:28,520 --> 00:41:31,080
or Governor Bailey talks

427
00:41:31,080 --> 00:41:32,580
or Governor Bullock talks

428
00:41:32,580 --> 00:41:35,140
or, you know,

429
00:41:35,320 --> 00:41:36,560
Scott Besson talks

430
00:41:36,560 --> 00:41:41,320
or Awaita-son talks in Japan,

431
00:41:42,480 --> 00:41:43,420
at this sentence,

432
00:41:43,420 --> 00:41:44,820
at the end of whatever they said,

433
00:41:45,620 --> 00:41:47,460
and for every year going forward,

434
00:41:47,600 --> 00:41:48,940
there will be fewer taxpayers.

435
00:41:48,940 --> 00:41:55,800
And that will, in a significant way, clarify the nonsense that's coming out of their mouths.

436
00:41:56,220 --> 00:42:04,980
Because how can you continue to borrow from the future to try to facilitate, maintain,

437
00:42:05,320 --> 00:42:10,840
sustain growth today, knowing that in the future, there will be both fewer taxpayers

438
00:42:10,840 --> 00:42:13,040
and fewer savers?

439
00:42:13,380 --> 00:42:15,920
So there's fewer bond buyers in the future.

440
00:42:15,920 --> 00:42:20,440
There are fewer sources of revenue for the governments in the future.

441
00:42:21,280 --> 00:42:40,380
And now over on, I'll argue, and I noted this as my notes, I would argue that we've been under financial repression, that a big part of the subsequent implementation of BIS regulatory capital guidelines, what's known as Basel I, Basel II, and now Basel III, is in essence financial repression, right?

442
00:42:40,380 --> 00:42:44,420
It's using the banking system to own a shit ton of government bonds.

443
00:42:44,420 --> 00:42:51,520
And the government keeps issuing those bonds and then regulating banks and pension funds and insurance companies to own them.

444
00:42:52,520 --> 00:42:59,820
And so this financial repression has had the intent of keeping interest rates below growth.

445
00:43:00,360 --> 00:43:12,420
And when they did that back in post-World War II era, that allowed the debt that had accumulated during World War II to subside.

446
00:43:14,420 --> 00:43:25,200
Difference back then was the governments were shrinking after the war, and the private sector had wiped out all of their debt in the Depression and the austerity years during the war.

447
00:43:26,100 --> 00:43:36,000
And you had the, what I call the pig in the Python, the largest population cohort, the baby boomers, were just barely in the jaws of the Python.

448
00:43:36,000 --> 00:43:50,600
And now, 80 years later, 70 years, 80 years later, you have all-time peak government debt, all-time peak private sector debt, and the pig is coming out the other end of the Python.

449
00:43:51,680 --> 00:43:59,000
And they're no longer the largest taxpaying, largest saving bond-buying cohort.

450
00:44:00,000 --> 00:44:04,200
And the cohorts behind them and every subsequent cohort is going to be smaller.

451
00:44:04,200 --> 00:44:28,380
And this is what drives this problem and creates this sort of inflation feedback loop, because as you debase the savings of the now retirement cohort who saved in your bonds because they were quasi forced to through the regulatory construction around the fiduciary system,

452
00:44:28,380 --> 00:44:54,580
They go into retirement with not enough wealth to offset the rising cost of living that you've imposed on them. And so that requires ever more subsidy from the government to cover their longevity, their unemployment, their Social Security, their retirement benefits, their medical benefits, etc., which requires more taxes from a smaller taxpaying cohort.

453
00:44:54,580 --> 00:44:58,780
who are also burdened by the higher cost of living.

454
00:44:59,560 --> 00:45:04,480
And so once you tax them more and they consume at a higher cost of living,

455
00:45:04,780 --> 00:45:05,100
guess what?

456
00:45:05,140 --> 00:45:07,640
They have less money left over to save.

457
00:45:08,560 --> 00:45:11,520
And so eventually you have to financially repress more.

458
00:45:12,200 --> 00:45:14,880
And central banks have to become the buyers of the bonds

459
00:45:14,880 --> 00:45:17,980
and things that sometimes they call quantitative easing,

460
00:45:18,200 --> 00:45:20,740
although last week they called it not quantitative easing

461
00:45:20,740 --> 00:45:23,200
when they announced they were going to do it, right?

462
00:45:23,200 --> 00:45:27,300
and you create this loop where it just keeps going.

463
00:45:27,460 --> 00:45:32,300
So until you stop debasing the savings of your populace

464
00:45:32,300 --> 00:45:36,800
as they move from savers and taxpayers to retirees

465
00:45:36,800 --> 00:45:40,700
and, you know, where necessary, subsidized in their retirement

466
00:45:40,700 --> 00:45:43,420
because their savings won't cover the higher cost

467
00:45:43,420 --> 00:45:45,300
because you've debased the value of their savings

468
00:45:45,300 --> 00:45:47,160
by forcing them to own bonds.

469
00:45:47,860 --> 00:45:51,020
And, you know, they weren't smart enough to get on board Bitcoin

470
00:45:51,020 --> 00:45:52,660
to finance their retirement.

471
00:45:53,200 --> 00:45:55,140
It's a very difficult loop to get out of.

472
00:45:56,020 --> 00:46:00,680
And so to your point, the long answer to the question, it's a complicated world.

473
00:46:01,400 --> 00:46:07,660
You're going to have to figure out how to solve this problem, and you need to end that loop or you blow it up.

474
00:46:08,760 --> 00:46:09,440
It's scary.

475
00:46:09,560 --> 00:46:17,420
I was actually talking to someone on the show just recently who was talking about Social Security potentially going bankrupt by, I think, 2032 was the year that they gave.

476
00:46:17,420 --> 00:46:20,580
and so if we do have like an aging demographic

477
00:46:20,580 --> 00:46:22,000
more reliant on

478
00:46:22,000 --> 00:46:24,660
social security retirement schemes around the world

479
00:46:24,660 --> 00:46:26,660
and becoming more heavily reliant

480
00:46:26,660 --> 00:46:28,000
on Medicare and

481
00:46:28,000 --> 00:46:30,680
like the NHS here in the UK

482
00:46:30,680 --> 00:46:32,960
it gets

483
00:46:32,960 --> 00:46:34,280
messy really quick and

484
00:46:34,280 --> 00:46:36,760
is the only way out of that essentially to print more

485
00:46:36,760 --> 00:46:38,640
money and so when I ask like

486
00:46:38,640 --> 00:46:40,460
does the fiat system die

487
00:46:40,460 --> 00:46:42,660
is that because

488
00:46:42,660 --> 00:46:44,800
of this they end up having to do a huge

489
00:46:44,800 --> 00:46:46,760
print which then ends up in some kind of like

490
00:46:46,760 --> 00:46:54,840
hyperinflation event? They don't have to, but that is what they have chosen to do, right? So,

491
00:46:54,840 --> 00:47:00,560
again, I'll argue this really goes back to 2000, but, you know, accelerated post-GFC, accelerated

492
00:47:00,560 --> 00:47:06,380
again post-COVID has, you know, really gone global. You could argue it started with my good

493
00:47:06,380 --> 00:47:11,500
friends in Japan who, you know, added more fuel to that fire today with their own policy nonsense,

494
00:47:11,500 --> 00:47:14,500
and they've chosen this.

495
00:47:14,640 --> 00:47:17,240
And so if you stay in this loop,

496
00:47:17,320 --> 00:47:18,980
we build a model.

497
00:47:19,880 --> 00:47:21,720
I had some interns here for the summer

498
00:47:21,720 --> 00:47:22,520
and we build a model,

499
00:47:23,040 --> 00:47:24,520
what they call an agent-based model

500
00:47:24,520 --> 00:47:27,400
on population demographic issues.

501
00:47:27,640 --> 00:47:29,520
And it shows once you're in that loop

502
00:47:29,520 --> 00:47:32,100
and your fertility rate's declining

503
00:47:32,100 --> 00:47:34,460
and you start to get the imbalance

504
00:47:34,460 --> 00:47:37,340
between retired turtles,

505
00:47:37,420 --> 00:47:39,540
we call them in the model,

506
00:47:39,960 --> 00:47:41,480
retired turtles and working turtles.

507
00:47:41,500 --> 00:47:57,780
And if the government is subsidizing the decline in overall productive resources relative to unproductive resources, and they end up having to do that to print money because the smaller productive resources can't cover the tax burden of doing that.

508
00:47:57,780 --> 00:48:14,560
And then they themselves have less savings when they go into retirement. It becomes an impossible loop to solve. And the only solution for it, you know, I'm getting a little bit economic geeky with your crowd, but the only solution for it, the true solution for it is productivity gains, right?

509
00:48:14,560 --> 00:48:20,520
You have to make the fewer workers more productive so that there's more productivity.

510
00:48:20,520 --> 00:48:26,260
They have to have higher real wages, not persistently lower real wages.

511
00:48:26,400 --> 00:48:35,720
You can't constantly debase their earnings, a la Janet Yellen, you know, joking about it in 1996 when the Fed was talking about going to inflation targeting.

512
00:48:35,880 --> 00:48:39,040
And Alan Greenspan thought the inflation target should be zero.

513
00:48:39,040 --> 00:48:41,720
and Janet Yellen thought it should be 2%

514
00:48:41,720 --> 00:48:44,360
because workers wouldn't know

515
00:48:44,360 --> 00:48:46,640
they were having their real earnings debased

516
00:48:46,640 --> 00:48:49,220
and the benefit to the corporate,

517
00:48:49,420 --> 00:48:51,520
to the employer would encourage him

518
00:48:51,520 --> 00:48:52,400
to hire more workers

519
00:48:52,400 --> 00:48:54,460
because he's kind of getting the 2%

520
00:48:54,460 --> 00:48:55,240
that they're losing.

521
00:48:56,300 --> 00:48:56,880
And that's literally,

522
00:48:57,140 --> 00:48:59,400
that's in transcripts from the Fed.

523
00:48:59,500 --> 00:49:00,500
I wrote about it one month.

524
00:49:01,440 --> 00:49:02,960
Janet Yellen was my econ professor

525
00:49:02,960 --> 00:49:03,800
in grad school.

526
00:49:05,480 --> 00:49:06,640
It's so insidious though

527
00:49:06,640 --> 00:49:08,240
because before I got into Bitcoin,

528
00:49:08,240 --> 00:49:12,440
I didn't even necessarily think inflation was a bad thing.

529
00:49:12,560 --> 00:49:14,140
I thought if we were at 2% inflation,

530
00:49:14,200 --> 00:49:16,260
that was a sign of like a healthy economy.

531
00:49:16,480 --> 00:49:18,200
And like these are the lessons you're taught.

532
00:49:18,360 --> 00:49:21,020
And then as soon as you kind of see behind the curtain,

533
00:49:21,140 --> 00:49:22,960
you realize everything was a bit of a lie.

534
00:49:24,380 --> 00:49:26,400
So the productivity is an interesting one though,

535
00:49:26,400 --> 00:49:28,680
because the obvious place where that could come from

536
00:49:28,680 --> 00:49:30,000
is through like AI and robotics,

537
00:49:30,000 --> 00:49:32,400
which is seemingly going to be a really big part

538
00:49:32,400 --> 00:49:33,580
of the economy in the future.

539
00:49:34,080 --> 00:49:36,100
Do you think that could actually save

540
00:49:36,100 --> 00:49:44,080
the central banks around the world in the short term? I guess maybe. I don't know. I don't have a

541
00:49:44,080 --> 00:49:54,860
lot of... I like AI as it functions as a simple tool, but I don't have a lot of respect for it.

542
00:49:55,900 --> 00:50:03,520
AI or LLMs, the sort of current version of AI that's actually available for use is an LLM.

543
00:50:03,520 --> 00:50:08,920
And an LLM is exactly like Sharp World, right?

544
00:50:09,440 --> 00:50:16,920
I coined, so if your readers want to go, I wrote one of my notes that I titled The Polanyi Paradox.

545
00:50:17,340 --> 00:50:18,900
Have you ever heard of Michael Polanyi?

546
00:50:19,480 --> 00:50:19,760
No.

547
00:50:20,540 --> 00:50:26,500
He was a philosopher, scientist in the mid-1900s.

548
00:50:26,500 --> 00:50:32,880
and he coined, actually another guy, David Alter, a current economist, coined, referring to him,

549
00:50:32,960 --> 00:50:38,740
the Polanyi paradox. So what Polanyi is known for is what's known as tacit knowledge. And the

550
00:50:38,740 --> 00:50:46,440
Polanyi paradox is known as we humans can know more than we can tell because we have tacit

551
00:50:46,440 --> 00:50:53,020
knowledge. So we can know how to ride a bike, but we can't necessarily write down the mathematical

552
00:50:53,020 --> 00:51:02,380
formulas of physics to explain it to somebody, right? But we know, we know that jumping off,

553
00:51:02,680 --> 00:51:11,600
you know, using a Nassim Taleb fragility analogy, that jumping off a one meter high fence 10 times

554
00:51:11,600 --> 00:51:16,300
won't hurt us. But jumping off a 10 meter high fence one time probably will.

555
00:51:16,300 --> 00:51:32,780
All right. That's tacit knowledge. It's skin in the game. Right. Well, I coined the reverse Polanyi paradox in this note about LLMs and the reverse Polanyi paradox about LLMs goes, AI can tell more than it can know.

556
00:51:32,780 --> 00:51:42,420
right ai will answer every will answer every question it actually knows nothing right and

557
00:51:42,420 --> 00:51:50,780
all it's doing is taking its entire corpus of it the data set and saying on average what's the next

558
00:51:50,780 --> 00:51:58,700
word right it's just another normal probability distribution saying that in the course of

559
00:51:58,700 --> 00:52:06,580
human data that I have access to, what's the middle of the distribution? And I'll put that

560
00:52:06,580 --> 00:52:11,540
word next. And it's really remarkable how it does that and how quickly it does it and how fast it can

561
00:52:11,540 --> 00:52:19,540
read stuff and order it that way. But again, taking science again, going to Claude Shannon.

562
00:52:19,540 --> 00:52:26,460
Claude Shannon's the father of the modern day digital age. And he wrote when he was a PhD

563
00:52:26,460 --> 00:52:33,100
student back in 1950-something, the mathematical theory of communication, and what's known as

564
00:52:33,100 --> 00:52:39,620
Shannon's entropy, which is the math behind how information moves. It's bits and bytes. He coined

565
00:52:39,620 --> 00:52:46,440
the word bits. And what Shannon would tell you is there's no information in the expected.

566
00:52:47,160 --> 00:52:55,820
All learning and growth comes outside the expected outcome. And it's what we don't know

567
00:52:55,820 --> 00:53:01,200
that matters. It's not what we do know that matters. So I have very little hope in the current

568
00:53:01,200 --> 00:53:11,020
formation of AI. And I have a lot of doubt that the promises of generative AI will produce what

569
00:53:11,020 --> 00:53:20,060
they claim it will produce because I struggle to understand how AI learns because the current AI

570
00:53:20,060 --> 00:53:27,660
doesn't learn at all. It just expands its data set and gets a better probability of what the

571
00:53:27,660 --> 00:53:32,340
next word is, but it still hasn't actually learned anything. And it only knows the average of what

572
00:53:32,340 --> 00:53:38,680
everybody already knows. And one of the things I criticize central bankers with all the time,

573
00:53:38,680 --> 00:53:44,180
because they also seem to be incapable of learning and that, you know, it's a Nassim

574
00:53:44,180 --> 00:53:50,180
telebism without accountability, there can be no learning. If you're never punished for your

575
00:53:50,180 --> 00:53:56,500
mistakes, there's a big difference between reading that sticking your head in the fire will burn

576
00:53:56,500 --> 00:54:02,800
and sticking your head in the fire. So it sounds like you're kind of fading the eye part of AI.

577
00:54:02,800 --> 00:54:10,080
You don't think it's actually intelligent. So there's probably, is there anything else out there

578
00:54:10,080 --> 00:54:15,100
that could increase the productivity to a degree that could save the current financial system if

579
00:54:15,100 --> 00:54:20,880
it's not going to be AI? Or is that it's like single shot? No, I think there's a whole bunch

580
00:54:20,880 --> 00:54:25,680
of things out there. And almost all of those things are things that we haven't thought of.

581
00:54:26,320 --> 00:54:32,140
And that's kind of the whole point. And so finding things, you know, Elon Musk.

582
00:54:32,140 --> 00:54:33,300
Right, through some energy or.

583
00:54:33,400 --> 00:54:33,560
Yeah.

584
00:54:34,040 --> 00:54:41,060
You know, Elon Musk building, you know, energy and mining capability on Mars.

585
00:54:41,620 --> 00:54:43,940
Nobody had on their bingo card 10 years ago.

586
00:54:44,300 --> 00:54:46,920
And now this crazy guy said, what if we did this?

587
00:54:47,500 --> 00:54:51,980
You know, and so it's always the, you know, and again, this is another investment thing.

588
00:54:52,000 --> 00:54:57,180
And this goes sort of in line with, I was having dinner with my dear old friend, Pippa

589
00:54:57,180 --> 00:54:57,560
Momgren.

590
00:54:57,920 --> 00:54:59,160
Ever heard of Pippa Momgren?

591
00:55:00,300 --> 00:55:01,140
I have, yeah.

592
00:55:01,140 --> 00:55:04,460
a geopolitical economist strategy person,

593
00:55:05,260 --> 00:55:06,860
and also an ex-banker's trust alum.

594
00:55:07,900 --> 00:55:11,200
And, you know, we think we were all brainwashed the same way.

595
00:55:11,200 --> 00:55:14,200
Nassim Taleb and me and Bippa all brainwashed the same way

596
00:55:14,200 --> 00:55:17,800
in our banker's trust days when we were actually in the risk business.

597
00:55:18,840 --> 00:55:32,940
And something I say you know the key to risk management or the key to life is to try to you know to do everything you can to eliminate the unrecoverable so that you can pursue the unimaginable

598
00:55:34,340 --> 00:55:37,940
And that's how I advocate people manage their risk portfolios.

599
00:55:38,060 --> 00:55:43,560
That's the brakes on the car so you can go out and explore, you know, the capacity to go faster.

600
00:55:43,560 --> 00:55:45,560
And so cut off those wings.

601
00:55:45,680 --> 00:55:47,260
Stop focusing on the average.

602
00:55:47,260 --> 00:55:53,240
stop doing the simple, cut off the risk of the negative tail that you'll never recover from,

603
00:55:53,580 --> 00:56:00,320
bankruptcy and insolvency in wealth management or death in life, and go and find the thing that

604
00:56:00,320 --> 00:56:08,120
nobody else has ever thought of. And the human race has an unbelievable track record in solving

605
00:56:08,120 --> 00:56:12,740
problems. It wasn't that long ago that people would have told you that we're going to run out

606
00:56:12,740 --> 00:56:18,180
food because population is growing too much. Now we've got to solve the problem that, you know,

607
00:56:18,180 --> 00:56:23,840
something that history books don't really have a record of is how to deal with population shrinking.

608
00:56:24,740 --> 00:56:30,280
And that shrinking, you know, sort of being hard-coded over the next two or three generations

609
00:56:30,280 --> 00:56:36,960
because the birth rate decline, the fertility rate decline is already hard-coded in those that

610
00:56:36,960 --> 00:56:42,300
were born behind the next few generations. And so we need to figure out how to cope with that and

611
00:56:42,300 --> 00:56:47,420
coping with it by, and, you know, again, I wrote about this this summer. I think the note was

612
00:56:47,420 --> 00:56:52,900
called preservation and, you know, linked to a paper that was done, commissioned by the G20 and

613
00:56:52,900 --> 00:57:00,600
done under the oversight of the BIS in 1998 that said all this stuff. Said, you know, we should not

614
00:57:00,600 --> 00:57:06,440
borrow from the future. We should focus on investment and productivity. We should, you know,

615
00:57:06,440 --> 00:57:13,240
instead of going with what BIS, think about what the initial Basel I did, it provided the, you know,

616
00:57:13,260 --> 00:57:22,640
sort of maximum subsidies, banking subsidies, the minimum capital required to own these assets and,

617
00:57:22,640 --> 00:57:29,320
you know, pay yourself bonuses on the annual accounting revenue to government debt and mortgages.

618
00:57:30,500 --> 00:57:35,820
Well, how much productivity comes out of government debt and mortgages? Shouldn't banks like they once

619
00:57:35,820 --> 00:57:40,500
used to do, lend to businesses, to startups, to small businesses, to community businesses, to,

620
00:57:40,600 --> 00:57:47,620
you know, guys that are out creating the actual productivity that allows growth. But we went the

621
00:57:47,620 --> 00:57:52,260
opposite way. And now we're going to suffer through trying to solve that. So I think there

622
00:57:52,260 --> 00:57:57,640
are all kinds of solutions that nobody's thought of. And maybe AI is that solution or certainly is

623
00:57:57,640 --> 00:58:03,600
part of that solution because it is a fantastic tool. And, you know, what it can do, nobody really

624
00:58:03,600 --> 00:58:05,580
knows. What it currently

625
00:58:05,580 --> 00:58:07,780
does do isn't anywhere close

626
00:58:07,780 --> 00:58:09,500
to what people are telling you it will do.

627
00:58:09,920 --> 00:58:11,140
But maybe they get it there.

628
00:58:11,540 --> 00:58:13,640
I don't know if this is recency biased, David,

629
00:58:13,720 --> 00:58:15,720
but it feels like we're living

630
00:58:15,720 --> 00:58:17,700
in the most interesting times for good

631
00:58:17,700 --> 00:58:19,560
or for bad. Everything you've talked

632
00:58:19,560 --> 00:58:21,480
about then, and then in the macro world,

633
00:58:21,960 --> 00:58:23,780
it's, I mean, things are a mess.

634
00:58:25,020 --> 00:58:25,760
But I'm

635
00:58:25,760 --> 00:58:27,640
very conscious of your time, but before we close out,

636
00:58:27,680 --> 00:58:29,640
I wouldn't mind just getting a little bit into the macro side

637
00:58:29,640 --> 00:58:30,440
of things, because

638
00:58:30,440 --> 00:58:33,500
QT in the US has now come to an end

639
00:58:33,500 --> 00:58:35,500
and they're doing their not QE QE.

640
00:58:36,620 --> 00:58:39,480
Rates are getting cut while inflation is still pretty high.

641
00:58:40,600 --> 00:58:43,600
Fiscal dominance is a story that, like,

642
00:58:43,660 --> 00:58:45,360
I'd never even heard the term fiscal dominance

643
00:58:45,360 --> 00:58:46,240
until a few years ago,

644
00:58:46,280 --> 00:58:48,440
and now it's kind of the thing that everyone's talking about.

645
00:58:49,800 --> 00:58:51,120
How much of a mess are we in?

646
00:58:51,160 --> 00:58:52,900
Like, you're always looking for risks in the market.

647
00:58:53,040 --> 00:58:55,200
Like, what are the big risks that you're looking at right now?

648
00:58:56,160 --> 00:59:00,860
Well, again, I see risk as leverage, as imbalances,

649
00:59:00,860 --> 00:59:02,780
so I don't think about future events.

650
00:59:02,780 --> 00:59:14,960
I can see where there's a lot of fragility, build-up brush, fingers of fragility to use, pair box, sand pile, self-organized criticality language.

651
00:59:17,600 --> 00:59:30,980
You don't have to be too much of a rocket scientist to understand that still, going back where you got a real sniff of it in 2022.

652
00:59:32,780 --> 00:59:38,240
There's a lot of uncapitalized risk leverage in government bonds.

653
00:59:38,240 --> 00:59:43,640
So government bonds were piled onto regulated balance sheets.

654
00:59:43,820 --> 00:59:49,480
Nobody with their own retirement money was buying 30-year bonds that yielded zero.

655
00:59:50,960 --> 00:59:58,320
And yet, all of the major governments in the world hit their peak all-time bond issuance when they yielded zero.

656
00:59:58,940 --> 01:00:00,080
So somebody was buying them.

657
01:00:00,140 --> 01:00:02,700
In fact, somebody was buying more of them than ever in history.

658
01:00:02,700 --> 01:00:21,660
Well, who was that? Regulated financial institutions. And so you get this dynamic like Silicon Valley Bank, a bank that a regulated, a heavily regulated bank goes out of business, goes insolvent, following the rules because it owned U.S. Treasury bonds.

659
01:00:21,660 --> 01:00:35,680
So, again, my famous quote, which I quoted way before Silicon Valley Bank went out of business, banks don't go out of business taking risk. Banks go out of business levering that which they can account for as riskless.

660
01:00:35,680 --> 01:00:47,620
Right. And so banks were told these bonds, U.S. treasuries, French government bonds, gilts, boons, JGBs, Australia were riskless.

661
01:00:48,320 --> 01:00:54,180
And, you know, inside even non-developed countries, their domestic bonds are riskless.

662
01:00:55,200 --> 01:00:59,060
Greek government bonds are riskless to everybody in the world because they're inside the eurozone.

663
01:01:00,100 --> 01:01:03,060
Indonesian government bonds are riskless to Indonesian banks.

664
01:01:03,060 --> 01:01:16,300
And banks aren't that, you know, banks are pretty creative. They'll figure out a way to use derivatives to leverage that up even more and still get it treated as a zero risk weighted asset, even though it's another round of leverage on top of their 30x leverage already.

665
01:01:16,300 --> 01:01:37,900
So, you know, it's not hard to see. And then, you know, you get the stupidity like the liability driven investment strategies in the UK where pension funds are levering long dated duration gilts 5x and accounting that is risk reducing for their otherwise, you know, equity portfolio.

666
01:01:37,900 --> 01:01:40,800
only to find out that they need to get bailed out

667
01:01:40,800 --> 01:01:43,400
because all of their risk is the leverage and the gilts.

668
01:01:44,200 --> 01:01:48,100
And so that still remains arguably one of the biggest risks in the system.

669
01:01:48,100 --> 01:01:55,160
And you can see how the back end of everybody's bond curve

670
01:01:55,160 --> 01:02:00,040
has behaved this year as all of the central banks have cut rates.

671
01:02:00,900 --> 01:02:02,700
None of the long end rates have come down.

672
01:02:03,420 --> 01:02:06,240
In fact, today, thanks to our friends at the Bank of Japan,

673
01:02:06,240 --> 01:02:13,240
they're all going up aggressively. And so that's still a major problem, maybe the major problem in

674
01:02:13,240 --> 01:02:18,440
the big global system, because that's where the systemic risk is. The systemic risk without fail

675
01:02:18,440 --> 01:02:23,060
will be in the banking system, because that's where the bulk of the protected leverage is,

676
01:02:23,100 --> 01:02:30,840
and that's where the sensitivity when things go wrong are. Having said that, one of the things

677
01:02:30,840 --> 01:02:35,840
that has been proliferic in its growth in the last couple of years

678
01:02:35,840 --> 01:02:41,700
has been the leverage going into the high-flying stocks,

679
01:02:42,440 --> 01:02:47,160
the Mag7, the crypto, you know, micro strategy,

680
01:02:47,300 --> 01:02:50,040
a great example of a high-flying stock

681
01:02:50,040 --> 01:02:53,560
that inherent in its own construct is leveraged,

682
01:02:53,960 --> 01:02:59,680
and then all around it in the financial engineering of TradFi

683
01:02:59,680 --> 01:03:06,240
attracts more leverage. So, you know, let's take a levered micro strategy and embed it in a three

684
01:03:06,240 --> 01:03:13,320
times levered ETF as though that makes sense to somebody or do auto callable these highly levered

685
01:03:13,320 --> 01:03:19,400
vol selling strategies on micro strategy. And so the proliferation of that over the last several

686
01:03:19,400 --> 01:03:26,340
years has been a big part, in my opinion, of the noise that we saw in iBit and fed through into

687
01:03:26,340 --> 01:03:32,420
Bitcoin in October, November, and that we've seen in some of these names like MicroStrategy,

688
01:03:32,680 --> 01:03:39,740
who's getting it from both sides. And eventually we might see in other high-flying

689
01:03:39,740 --> 01:03:45,700
meme stocks. So those are things I think, you know, we saw quite a bit of volatility around them.

690
01:03:46,440 --> 01:03:51,280
Some have recovered, some have not recovered, MicroStrategy being a great example.

691
01:03:51,280 --> 01:04:00,940
AI related things, you know, that sort of cycle of internal trading.

692
01:04:02,020 --> 01:04:07,820
I'll lend you money to buy my product and we'll both say that we've done this big deal and our stock prices will go up.

693
01:04:07,820 --> 01:04:12,220
And then those will get embedded in three times levered autocallable structure, you know.

694
01:04:12,780 --> 01:04:18,200
And so that stuff seems to me to have gotten pretty juiced and attracted quite a lot of leverage.

695
01:04:18,200 --> 01:04:25,500
Japan itself, it just structurally is a very interesting place. And I've long said,

696
01:04:25,940 --> 01:04:31,180
obviously, I hope I've made it clear, I don't know when or where lightning is going to strike.

697
01:04:31,280 --> 01:04:35,180
I don't even know if lightning is going to be the thing that starts the fire. It's usually the thing

698
01:04:35,180 --> 01:04:42,740
that you weren't anticipating that surprises you. But I've long said, and I don't necessarily agree

699
01:04:42,740 --> 01:04:48,400
with them, but people are more familiar with what they call the Lehman crisis, thinking of Lehman

700
01:04:48,400 --> 01:04:54,120
as the trigger of the GFC. When we get more time, I'll tell you what was the actual trigger. We can't

701
01:04:54,120 --> 01:04:59,320
do that today. I've long said that the next trigger is going to be Japan, that Japan is the likely

702
01:04:59,320 --> 01:05:09,100
spark because of the fragility in the Japanese market system economy after the longest period,

703
01:05:09,100 --> 01:05:17,840
35 years of manipulating interest rates, manipulating the price that should balance between

704
01:05:17,840 --> 01:05:27,620
borrowers and lenders, savers, investors, speculators, hedgers, importers, exporters.

705
01:05:28,120 --> 01:05:33,080
They've decided instead of you, you know, hundreds of millions of participants coming

706
01:05:33,080 --> 01:05:38,140
and finding an equilibrium balance where you're happy to participate, we're going to set it here.

707
01:05:38,140 --> 01:05:55,900
And we're going to set it there and keep it there for 30 years. And now the market's decided they've had enough of that, and the transition away from that is proving challenging. And I think still has a reasonable possibility of being the kind of thing that triggers some of these problems.

708
01:05:55,900 --> 01:06:02,720
because if Japanese investors who are the largest net international creditors in the world,

709
01:06:03,360 --> 01:06:10,140
so Japan Inc. is the biggest foreign bond owner in every government bond market in the world.

710
01:06:10,660 --> 01:06:17,200
And if they decide they need to bring money back to buy their own bonds that are circa 250% of GDP

711
01:06:17,200 --> 01:06:22,740
and the Bank of Japan is in theory running down their bond holdings,

712
01:06:22,740 --> 01:06:29,120
They're running down their bond holdings at a pace that will get them to some target in 100 years.

713
01:06:29,280 --> 01:06:31,760
So they're not exactly selling off the bonds they bought.

714
01:06:32,120 --> 01:06:33,800
They're just not buying them as fast.

715
01:06:35,080 --> 01:06:36,180
You know, that kind of thing.

716
01:06:37,260 --> 01:06:40,180
You know, and we had it today.

717
01:06:40,340 --> 01:06:49,000
I guess, I don't know if you saw the European announcement about the $90 billion commitment to Ukraine.

718
01:06:49,000 --> 01:07:18,980
So the EU, they're going to issue bonds out of nowhere. So there's been, to my knowledge, nobody voted for this. It's not been in any approved budget, but they're going to issue bonds, get 90 billion euro, give it to Ukraine over the next two years, collateralize it with the money they've frozen from Russia, and then force Russia to pay.

719
01:07:19,000 --> 01:07:23,940
pay Ukraine that money in reparations, and then Ukraine will pay off the loan with the money that

720
01:07:23,940 --> 01:07:30,440
they get from reparations. So they haven't strictly confiscated Russia's assets, but they've used them

721
01:07:30,440 --> 01:07:35,780
as collateral for this loan to the Ukraine that they're going to fund issuing bonds. And so this

722
01:07:35,780 --> 01:07:39,480
gets to, again, back to the government bond issue, something that I've written a lot about that I

723
01:07:39,480 --> 01:07:46,200
refer to as the Hunger Games. So this Hunger Games competition of who will be the last guy that can

724
01:07:46,200 --> 01:07:54,520
issue bonds to the last taxpayer and saver. And so this competition that now Germany has waived

725
01:07:54,520 --> 01:08:01,020
their constitutional debt ceiling and started what they call the Made in Germany to bring capital

726
01:08:01,020 --> 01:08:05,400
back to buy German bonds so they could build a military, which I saw the guy announcing he's

727
01:08:05,400 --> 01:08:09,700
going to start drafting people involuntarily into the military if they don't start signing up

728
01:08:09,700 --> 01:08:15,680
voluntarily. And now the EU, who, you know, doesn't have it, hasn't had an approved budget

729
01:08:15,680 --> 01:08:21,960
in history, has just announced that they're going to spend another 90 billion that nobody's voted for

730
01:08:21,960 --> 01:08:30,420
by issuing bonds. And the Japanese, you know, the every JGB on the curve has made a new,

731
01:08:30,500 --> 01:08:35,640
you know, 40 year high in yields today or whatever, as that bond market gets nuked,

732
01:08:35,640 --> 01:08:40,680
because Bank of Japan refuses to raise rates fast enough to stop the inflation.

733
01:08:41,580 --> 01:08:47,480
And so if the Japanese ever decide they're going to bring money back to buy JGBs,

734
01:08:47,540 --> 01:08:49,700
and the Germans decide they're going to bring money back,

735
01:08:49,880 --> 01:08:53,120
Germans are the second largest foreign bondholder in most markets,

736
01:08:53,120 --> 01:08:56,940
and the EU is now competing, where does that leave France?

737
01:08:57,640 --> 01:09:03,960
So France, who relies heavily on Germany and Japan to fund their markets,

738
01:09:03,960 --> 01:09:07,300
not to compete with them on bond selling.

739
01:09:08,060 --> 01:09:10,980
And so these sorts of things are always percolating out there.

740
01:09:11,040 --> 01:09:17,600
But meanwhile, you know, the core strategy of the guys who own the printing presses is to inflate assets.

741
01:09:18,540 --> 01:09:22,160
And so what you can't do is sit out.

742
01:09:22,160 --> 01:09:28,720
You can't say, oh, this thing is so messed up, I'm just going to sit on cash because the inflation will eat you alive.

743
01:09:29,340 --> 01:09:37,420
And now Bitcoin has been an unbelievable good protector to date of that inflation, of the asset inflation, of the printing of money problem.

744
01:09:38,300 --> 01:09:39,940
Hopefully it can continue to be.

745
01:09:39,940 --> 01:09:47,640
Now, what we would advocate to all of our investors is you've got to own things that participate if it keeps going the way it has been going.

746
01:09:48,440 --> 01:09:52,880
And owning that stuff has been very rewarding for the last 50 years.

747
01:09:52,880 --> 01:09:59,320
Since QE started, since March of 2009, owning participating assets has been good.

748
01:09:59,320 --> 01:10:17,960
And then you also need to own something that provides highly asymmetric, negatively correlating risk so that when you get GFCs or European credit crises or COVID or 2022 rate hikes to try to restore some stability,

749
01:10:17,960 --> 01:10:32,320
You have something that's mitigating that drawdown and allowing you to stay in the market, not getting forced out of your Bitcoin or out of your gold or out of your NASDAQ or out of your Nikkei or whatever that may be.

750
01:10:32,320 --> 01:10:53,360
And that combination of something that is, back to the race car analogy, that is accelerating on the good parts and aggressively decelerating on the bad parts, that's responding, reactive, is the way to deal with the uncertainty, the unknowability of the future path, is to have a car that's very resilient.

751
01:10:54,400 --> 01:10:55,400
I love the race car analogy.

752
01:10:55,400 --> 01:10:55,960
That's great.

753
01:10:56,480 --> 01:10:59,820
I mean, the whole macro world seems a complete mess at the moment,

754
01:10:59,900 --> 01:11:03,240
but I guess the good news for you is that you're going to be in a job for a while.

755
01:11:04,760 --> 01:11:05,120
Yeah.

756
01:11:05,400 --> 01:11:08,980
Well, you know, we always say, and I say it every day,

757
01:11:09,120 --> 01:11:12,040
we and our investors hope we never make money, right?

758
01:11:12,040 --> 01:11:14,860
You never want your insurance to make money, right?

759
01:11:15,060 --> 01:11:17,220
But then your job is, once you've got the insurance,

760
01:11:17,320 --> 01:11:20,540
is to go out and take advantage of it, to go out and drive the car fast,

761
01:11:20,540 --> 01:11:24,820
you know, find the opportunity that knowing you've got, you know,

762
01:11:25,400 --> 01:11:27,980
Good safety net allows you to go take.

763
01:11:28,420 --> 01:11:30,880
What you need to avoid is the opposite of that,

764
01:11:30,960 --> 01:11:33,180
which is what Sharperl is trying to force you into,

765
01:11:33,700 --> 01:11:37,240
of saying, well, you know, let's do these covered calls.

766
01:11:37,820 --> 01:11:39,360
Let's do a covered call strategy

767
01:11:39,360 --> 01:11:42,480
where you have all of the downside volatility risk

768
01:11:42,480 --> 01:11:44,340
and a capped upside.

769
01:11:44,780 --> 01:11:47,040
Well, if you're going to take the downside volatility risk,

770
01:11:47,040 --> 01:11:49,840
the reward should be the uncapped upside.

771
01:11:50,420 --> 01:11:53,060
Why don't we turn that around and cut off the downside

772
01:11:53,060 --> 01:11:54,460
and go get the upside?

773
01:11:54,460 --> 01:11:58,480
So let's cut off the unrecoverable and pursue the unimaginable.

774
01:11:58,840 --> 01:12:00,040
It's a very good motto, I think.

775
01:12:01,260 --> 01:12:02,380
Yeah, I love that.

776
01:12:02,960 --> 01:12:06,160
David, I'm very conscious that it's late there on the Friday before Christmas.

777
01:12:06,960 --> 01:12:08,960
I massively appreciate the time.

778
01:12:09,040 --> 01:12:10,100
I've really enjoyed this.

779
01:12:10,280 --> 01:12:12,160
And I'd love to do it again at some point.

780
01:12:12,600 --> 01:12:18,760
Maybe we should do a history lesson on layman and get into why Japan could be the start of this next fire.

781
01:12:19,140 --> 01:12:20,940
But thank you so much.

782
01:12:20,940 --> 01:12:24,060
Tell everyone where they can go to find your work and everything that you do.

783
01:12:24,460 --> 01:12:54,400
Yeah, so I'm not active, but I at least note on LinkedIn and on X. On X, I'm at Convexity Dredge, and on LinkedIn, I'm just David Dredge. We note up there whenever our monthly updates go up on the website, and the website is convex-strategies.com, and there's, I don't know, at least 100 monthly updates talking about all this stuff, talking about the science, the math, the flaws, the way things work, and the way I think they should work, the mistakes that central banks make.

784
01:12:54,460 --> 01:12:59,760
month after month after month, and then a whole bunch of, you know, podcasts and interviews or

785
01:12:59,760 --> 01:13:06,700
presentations that somebody got to record over the last decade or so up there as well. So there's a

786
01:13:06,700 --> 01:13:13,140
lot of information there. And I always say this, and, you know, when somebody thinks to check the

787
01:13:13,140 --> 01:13:17,820
info mailbox at the website and share with me things that somebody's asked a question,

788
01:13:18,160 --> 01:13:22,080
they'll be surprised how often I respond. I like talking about this stuff.

789
01:13:22,080 --> 01:13:22,500
I love that.

790
01:13:24,060 --> 01:13:25,840
Thank you so much for the time, David.

791
01:13:25,960 --> 01:13:27,060
I hope you have a good Christmas,

792
01:13:27,300 --> 01:13:27,860
and I will,

793
01:13:28,460 --> 01:13:29,400
we've got to do it again.

794
01:13:29,580 --> 01:13:30,360
I really enjoyed this.

795
01:13:30,400 --> 01:13:31,100
We'll do it again soon.

796
01:13:31,840 --> 01:13:32,140
Awesome.

797
01:13:32,280 --> 01:13:32,680
Thanks, Danny.

798
01:13:32,780 --> 01:13:33,520
Really appreciate it.