The Next Financial Crisis Isn't In AI, It's In US Treasuries | Russell Clark

[00:00:00]If I look at people 40 and under, those in their 20s, their number one problem is they can't afford housing.

[00:00:10]If you want to get housing back to some more reasonable levels, you need to have wages rising to about 7% a year, so it's sort of doubling in 10 years, and then you need to have the housing market be flat in nominal terms, so falling in real terms. So, that requires you to have a real rate of about 3%, so people keep their money on deposit rather than sticking to real assets. So, that gives you an interest rate around 10%.

[00:00:40]And that's still my target for the year treasuries at 10% yield. So, the question you sort of ask yourself is, you know, how far could wages go?

[00:00:49]>> This episode of Other People's Money is brought to you by the Teucrium Soybean Fund, ticker SOYB. Let's get into it.

[00:00:55]Welcome to Other People's Money. I'm Max Wiethe, and I'm joined today by Russell Clark, a hedge fund manager based in London. Russell, thank you for coming on the show.

[00:01:04]>> Thank you for having me.

[00:01:05]>> You write a Substack as well as as managing a hedge fund, and I have been reading and following. You put out an interesting piece in the last week looking at the AI trade. A lot of people are saying this might be the end of a big speculative bubble in this AI trade, but but you pointed to another asset class that you think is far larger and far more speculative. Tell me why you think this other much bigger market is really where there is a lot of risk right now.

[00:01:38]>> Yeah, so I think Max you're talking about the treasury market. There are two questions there. Is the you know, is the AI market speculative, and why do I think treasury markets are speculative, if that makes sense. So, with the treasury market, I mean, normally if you look at for me, if you look at any big bear trade uh that I've seen uh in my investing career and even before it. Normally, there were pretty good signs that things are going wrong, but people just happily ignored it, partly because it's human psychology. It's if there's a problem and you have to do something about it, um it's always more comfortable just to ignore it if it hasn't been been a problem, if that makes sense. Um and that's, you know, just natural sort of human sort of psyche. So, you know, if you go back to like the GFC, for example, uh people people knew there was a problem in the housing market 3-4 years before it actually sort of blew up. Um and then there started to be a problem and everybody was like, "It's a problem, but it's a problem we can deal with. We've dealt with it before."

[00:02:45]Um you know, and then you had, of course, people saying, "Well, look, actually, you know, the balance sheets of these banks are so bad that this housing crisis is going to be a bigger problem."

[00:02:56]And then eventually everyone sort of accepted it. And I'd say with, you know, US Treasuries, uh in particular, but, you know, government bonds in general, is uh you know, for the last few years, particularly since COVID, there's sort of been this understanding by the electorate and by politicians that governments will spend whatever it takes to keep growth going, if that makes sense. So, if there's any problems, government will come in.

[00:03:23]Uh and with the Trump administration, they seemed to have gone to another, you know, even more extreme version of that in that "We'll spend what we need to spend and we won't tax anyone uh either." Uh in particular, the large corporates. So, you just want, you know, we're we're going to have the spending, but we're not even going to try and get the taxation uh in.

[00:03:44]And so, if you start looking at, you know, uh the sort of government what's the word, profit and loss statement, if you like, You know, its revenue now sort of barely covers its sort of mandated expenses of like social security, interest payments, and these sort of things. I think we're about 90%.

[00:04:03]So, that's excluding other spending like on defense, education, infrastructure, whatever you want. So, the sort of fundamentals of the the government sort of spending uh taxing your tax and spend have really broken down. And that's not just in US, it's also in Japan.

[00:04:22]Um and so, what's been interesting for me is that uh you know, I I sort of originally became quite bearish on Treasuries in 2022, mainly at that time, and there were other reasons, but mainly because uh when Russian foreign reserves were frozen, so they couldn't access them after they invaded Ukraine, uh I thought to myself, well, if you have foreign reserves, you know, if you're a Russian government with foreign reserves, and suddenly this money you're saving, you can't access, why would you save it in that place in the first place? And then, you know, you take that sort of thinking logic a couple more steps further, and you go, well, actually, why would any country that could theoretically disagree with the Trump administration, which is basically everybody, you know, why would anyone hold uh Treasuries as foreign reserves, if that makes sense?

[00:05:19]Um and so, you know, I I suspected we were going to see a natural flow out of Treasuries into gold for me. That was one thing I thought would happen. But, I also suspected that we'd see buyers for fixed income slowly, particularly government sovereign fixed income, slowly disappear. And that certainly, I think, has been the case.

[00:05:40]Um Treasury markets have held up relatively well, but if you look at markets that are more peripheral sovereign bond markets, Japan is a big one, you know, that's one of the biggest sovereign bond markets in the world, and the yields there have risen tremendously. Uh but the UK as well, the gilt market remains uh very unstable, if that makes sense. The long end keeps selling off.

[00:06:05]And I think, you know, the US Treasuries have held up a ride, but, you know, the the fundamental buyers of that are slowly but surely disappearing.

[00:06:13]I think the thing um that I try and emphasize people when I'm talking about is that you know, so I'm 52, so I'm getting old. I know I look much younger, but anyway, I'm getting on on. Um but this idea of you know, massive sovereign wealth funds, massive foreign reserves, is actually a relatively new one. Until 1980, the idea of holding another country's fixed income as a foreign reserve was unknown, if that makes sense.

[00:06:42]Uh all foreign reserves were basically gold. And then we have this long period where Japan started buying Treasuries cuz they stopped didn't want their currency to appreciate. China did the same, very other nations did the same.

[00:06:55]>> So when you see those like 500-year charts that say, "Well, the the reserve currency used to be the pound, and before that it was another European currency, and we go all the way back to the Portuguese, and say that people tie it to the strongest navy in the world."

[00:07:10]So you're saying that that that's not really how it worked going back. We we weren't owning bonds or currencies of other countries like we do today.

[00:07:17]>> So a foreign reserve currency is very novel, all right? That is a currency as a foreign reserve is novel. Gold used to be the only foreign reserve. And typically, the country that had the biggest army had the most gold for various reasons. Basically, they went took it from whoever whoever had it. So, if you lost a war, reparations tended to be big chunks of your your reserve would be sent to whoever won. That makes sense.

[00:07:44]>> Uh and so when you look to foreign, you know, I think you're confusing foreign reserves with sort of like the main trading currency or the the currency that was used for transactions if that makes sense.

[00:07:57]Uh and they often was backed by gold. So it was like you know, really until 70 70s, you know, US dollar was always backed by gold. Uh you know, once the once the you know, British Empire started falling apart after World War I, you saw the pound sterling become weaker and weaker cuz they couldn't they couldn't make the the numbers work if that makes sense.

[00:08:18]>> Okay. So you think we're moving back towards a more historical period where where hard assets, particularly gold, make up the bulk of of foreign reserves or the concept of foreign reserves are are really going to go away?

[00:08:34]>> Yeah, I do actually cuz I think there was this if you look at like this and it's all a political argument. So uh this is not empirical. Uh so people often will argue with me with empirical data saying this is what's happened last 30 years. Why are you saying it's going to be different? And what I'm saying to them is that we're moving a changing political environment and this is going to be the outcome from the changing politics. And so I think what we saw of sort of post 1980 with like Thatcher Reagan revolution was this sort of move away from uh a focus on full employment and rising wages to more free market that prices move wherever they want. Then wages adjust.

[00:09:19]And wages going to adjust in two ways.

[00:09:21]You actually cut them or you let your currency devalue to make your wages lower and you're more competitive.

[00:09:27]And so I think from 1980s through to maybe 2016 or something like that, the option most the option that most countries took when they had uh property or a financial or a current account crisis of some sort was they would devalue.

[00:09:47]And this would push down the the wages of your domestic employees and you could then export your way back to growth. This was the model that was existed. Uh and Japan sort of took it to another level where they they bought treasuries to try and try and keep the yen weak to try and create, you know, inflation and growth that way. Um and part of those sort of arguments was also free trade. Um removing removing barriers, uh moving away from sort of government sponsored uh industrial organizations. So, used to be when I was a child, uh governments owned all the airlines, all all the big airlines. You know, they sold all of those, they got rid of those. Unions were moved off the books. Uh if you look at the states, you know, you used to have the big three, GM, Ford, Chrysler, were all heavily unionized and protected by the government. Post-1980, they invited the Japanese auto companies in and they basically broke the unions within those organizations. And so, you had this sort of very well, it's actually a globally very deflationary environment. And for countries that are very competitive like your Switzerlands or your Japans or even your Germanys, you know, they would see natural appreciation of their currency which they tried to offset by buying US dollars, mainly treasuries. And so, we had this huge growth in capital uh driven by basically trying to keep wages low um one way or another. But now I feel like the political environment's moved to moving back to getting wages up, having full employment, very sort of post-World War II type of environment. Not fully there yet, but getting there. You can sort of see it with US and investments into corporates.

[00:11:30]Uh you know, you can see it in a, you know, a sort of range of you know, um, it's a sort of range of different activities by governments now.

[00:11:39]And you know, increasing tariffs and other things like that. And so, you know, the way I look at it is we're moving back to this inflationary environment. Um, and so, governments are actually, if you look at Japan, it's a good one. It's It's uh, JGB market continues to sell off, yields keep going higher, but they actually can't seem to get their currency doesn't strengthen naturally anymore. They're actually coming under more pressure to sell their dollar reserves to try and keep the yen strong because when they let their currency weaken, it's actually causing real wages to fall. And the politics is sort of turning against them, if that makes sense. And so, my read of the world we lived in, lived in until, let's say, 2016 or 2020, is real world where we were piling up bigger and bigger piles of capital, which pushed down the cost of capital, pushed down interest rates. And now, instead of saving money, we're still spending it. Growth is really good, but inflation is much higher, and these big pools of capital are getting run down. And so, the the corollary of that is that interest rates starting to rise, and will continue to rise until politics intervenes again.

[00:12:51]And it's interesting, you know, if you look at all the sort of populist politicians around there, their always their biggest problem is always cost of living.

[00:12:59]That's always the issue that sort of comes back to bite them. But they still get voted in, they still seem maintain political power, and we haven't really seen uh, a decisive move away from that yet, I don't think.

[00:13:12]>> It is the number one voting issue, it feels like, here in the United States is the cost of living. Uh, you did make an analogy saying, you know, in in the GFC, we kind of knew that these problems were coming for 3 years before they really started to to come to roost in the markets. And I would argue that people have been talking about this problem with the Treasury market for much longer than 3 years, but it is starting to to come to fruition now. I mean, was it just the inflationary period post COVID that really opened the door despite the fact that people have been talking about the unsustainability of the debt buildups for for so long? Was that the moment that things changed?

[00:13:53]>> It's a good question. And uh you know, one of the things that I think works to my advantage. So, I'm an Australian who I lived lived in Japan, lived in Hong Kong, studied Japanese, uh you know, traveled around the world a bit. So, I tend to come at things as like a from a globalist perspective rather than a US perspective. So, all the you're right about people talking about Treasuries being unsustainable. But before we used to talk about Treasuries being unsustainable, we used to talk about JGBs being unsustainable. And people used to talk about JGBs being unsustainable in the '90s.

[00:14:26]Uh so, very famous economist, guy called I think Steve Roach, you know, said the 10-year JGB at a 4% yield is in 1994 was the biggest short in financial history. He of course was wrong cuz it went down to a negative rate eventually.

[00:14:43]>> But JGBs was known as the widow maker, right?

[00:14:46]>> Very very much so. It's not anymore, but it was.

[00:14:48]Um so, what I'm trying to say is that people talked about Japanese debt sustainability for nearly 30 years before it broke.

[00:14:58]Now, what I found interesting is I always thought the JGBs are pretty good leading indicator on US Treasuries.

[00:15:06]Um and back in 2020 when COVID started to kick off, what was really interesting was I think it was in March of 2020. So, COVID had just started kicking off.

[00:15:16]At that time, we didn't know if it killed everyone or not. Uh you know, we didn't know how long it would last.

[00:15:22]But the JGB market started to sell off.

[00:15:25]It rallied a lot into that as it always used to do.

[00:15:28]And then started to sell off.

[00:15:31]My read of that is that the Japanese sort of bond investors looked at the political environment, looked at the the political uh sort of uh sort of solutions to COVID that were being discussed, which was like huge credit protection, massive wage protection, lot of spending. And went, "Okay, the world's changed here." And they were trying to sell their JGBs.

[00:15:55]JGBs sold off very early. And if you look at JGBs, they've been much weaker than US Treasuries the whole way through.

[00:16:03]Um and my my my feel is they still act as a lead, if that makes sense. The weird thing about the sell-off, and this is where I think is where it gets confusing, is that the more you push up wages, the more nominal growth you get.

[00:16:19]The better the actual financials for JGBs look.

[00:16:23]So, if you look at debt-to-GDP ratios, they're actually falling now cuz nominal GDP's growing. Uh you know, as you know, they you know, as they as they get growth going again. Uh and if you go back to the '70s, you know, when we had like 15, 20% interest rates in the States, federal debt-to-GDP was less than 20%.

[00:16:44]So, it's this sort of sustainability is not really issue. It's the politics of wage inflation that's the issue that drives, I think, drives where bond yields go. I think the sort of markets sit there and go, "What do I think wages in the States are going to look like in 20 years time? How much is this nominal how much of the If I buy a 30-year bond now, what's going to be the buying value of that uh principal when I get it back in 30 years time? Am I getting compensated for that?" And so, of, you know, do you think wages are only going to be 4 and 1/2, 5%?

[00:17:21]You know, in We're only going to see 4, 5% wage inflation for the next few years.

[00:17:27]And it is a it's a tricky one. You know, I certainly think while you have President Trump in power, you know, you would be thinking wage inflation would be higher than that.

[00:17:36]And I think the Japanese are doing the same thing. You know, wages in Japan are very low.

[00:17:40]And they now have sort of upward pressure. And they're sort of saying, "Do you know, is that the 10-year JGB at three is that enough compen- com- you know, compensation for where I think wages are going to be in 10 years' time?" And they they're sort of saying, "No." Um And like I think, you know, the the what people forget is like post-World War II, so FDR introduced the minimum wage in uh the states in 1939.

[00:18:08]At the time, it was like 35 cents an hour.

[00:18:11]Okay, 40 years later in 1979, it was three bucks 50 an hour.

[00:18:15]Right? So, it'd gone up, you know, 10 times in 4 years.

[00:18:19]Now, the federal wage minimum wage in the states now is still only seven bucks 25 or something like that. I know no one earns that anymore except for some very sad people in you know, some places. But >> There are some states. There are some states that still have the federal minimum wage in some places.

[00:18:36]>> people earn that anymore. Yeah, and like in in McDonald's it's kind of is more like 20 bucks an hour, I'm pretty sure.

[00:18:43]Uh you know, it doesn't matter where you are.

[00:18:46]So, that world is, you know, sort of changing. Um So, the question you sort of ask yourself is, you know, how far could wages go, right?

[00:18:56]And that's the question I ask myself.

[00:19:00]Um I try and come up with an answer to that. I don't know if it's a good answer. You can I I tell people my answer. I let them make their judgment. My answer is that um if I I at people 40 and under, if that makes sense. So, in in their 20s and 30s, so those in their 20s and 30s, their number one problem is they can't afford housing.

[00:19:22]They either spend too much on rent or they spend so much on rent they can't afford to save a deposit, this sort of thing.

[00:19:28]And so, I think, you know, you're going to get a generation of voters coming through saying, "We want cheap housing." And certainly you see, you know, both sides of the political divide are all pushing for more home building or cheaper housing. Uh you know, you and you have rent controls coming back in New York, that sort of thing. Um so, I sort of use that as a what I think is going to happen, is my view uh and why I have I think treasuries and interest rates go higher, is uh if you want to get housing back to some more reasonable levels, you need to have wages rising to about 7% a year, so sort of doubling in 10 years, and then you need to have the housing market be flat in nominal terms, so falling in real terms. So, that requires you to have a real rate of about 3%.

[00:20:21]So, people keep their money on deposit rather than sticking to real assets, if that makes sense.

[00:20:28]Yeah. So, that gives you an interest rate around 10%.

[00:20:31]Um and that's still my target for for the year treasuries at 10% yield.

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[00:22:00]So, 10% 3% real rate, so inflation running around around seven, basically around wage growth, wage growth keeping up with inflation.

[00:22:11]Uh wow, that's that is a very different world than where we are today.

[00:22:16]Um it's funny, you do see a lot of people commenting on the level of real interest rates right now and saying that it is so high, getting up above to approaching approaching that 3% level that you're talking about and and largely saying that this is that level of real interest rates is unsustainable. So, you believe that that will become the new normal uh to to see really really high real yields.

[00:22:41]>> Yeah, very high.

[00:22:43]Because you you'll be having government spending and pushing wage growth, pushing full employment, which is not what we've had for last 40 years. But, you have governments there.

[00:22:53]You know, and you think about all the strategic investment, all the sort of investment in semiconductors, all the investment into moving away from a Chinese supply chain, all these things. So, you have this sort of very tight market government pushing for that. Um but, you know, trying to sort of keep prices under control, particularly housing prices, which are very sensitive to interest rates.

[00:23:16]Um you know, that's the world that I see. Um you know, and that's where the politics is, you know. When you look at populist parties, they also sort of want broadly speaking that type of outcome.

[00:23:28]And so, that's all the world I see. Um uh yeah, you know, and here's a good uh you know, here's a good way of I think makes it easier to conceptualize, I think for people. And I've written about it a long time ago.

[00:23:43]I'll have to find that old note and republish it.

[00:23:45]Um but uh so, ever see Back to the Future II?

[00:23:52]>> Of course.

[00:23:54]>> You sure? Okay.

[00:23:54]>> I'm not that I'm not that young.

[00:23:56]>> Oh, you look very young. You uh So, anyway, when they get to when they get to Where is it? Uh 2015.

[00:24:04]It's from 1985.

[00:24:05]They go to 2015, 30 years into the future.

[00:24:08]And then Doc Brown goes to Marty McFly, "Here's 100 bucks.

[00:24:14]Go buy yourself a Coke."

[00:24:16]Right?

[00:24:17]And so, people in 1985 thought that by night by 2015, a can of Coke was going to cost close to 100 bucks. Maybe it was 50. 50 to 100, something like that.

[00:24:31]Um and if you go back to sort of 1985 and look at the long end of the bond market, it was around sort of 7-8% because that's what people thought inflation was going to be.

[00:24:44]And actually, they were completely wrong. Inflation collapsed below that.

[00:24:46]They already the politics for getting inflation under control had really changed. You had the WTO, all these things, but people basically think what's happened to them in the past going to happen to them in the future. It's it's just a human condition. And so they couldn't they couldn't conceptualize this idea that prices wouldn't keep rising at a very elevated rate, even though they had voted in Ronald Reagan and had Volcker running around. In their minds, they just thought inflation would always stay high.

[00:25:17]And I'm saying that was for me that was a good illustration of how humans generally just sort of say what's happened in the past going to keep happening into the future. Um and so I think we're going back to we're going to go through a period of a very long period of above much higher inflation.

[00:25:36]Um and people are going to get used to that and they're going to slowly demand So I think you've already seen it in the results. If you look at like bank results that just came out like last week, loan growth is through the roof because if people going I think in I think prices going to go up 7 8% a year and they let me borrow at, you know, four, it's a bargain.

[00:25:59]Right?

[00:26:00]Uh and so so you should see loan growth accelerating. We've seen that in Japan.

[00:26:05]I expect we're going to see it we've seen it in the States as well. You're going to see it everywhere. And the only way to get loan growth down to control the inflation will be higher and higher interest rates.

[00:26:14]>> How do you square this longer-term view with a lot of people in the Treasury market are playing an extremely short-term game of trying to figure out whether is it going to be this meeting or next meeting where they're going to hike and it feels like Treasury rates are are really trading around and even gold, I mean you could argue that this big sell-off in gold was that people had had such high expectations for rate cuts coming in this year and now we're potentially getting hikes and and obviously gold for so long has has traded off of that real interest rate and we're just seeing it continue to go higher when when people were expecting a big reversal in that and the change in real rates has has driven gold. So, so many of these asset classes, it feels like, are being pushed by short-term expectations. You have this long-term view.

[00:27:00]How do you work around these short-term moves with still keeping this long-term view in in front of you?

[00:27:08]>> Back in the old days when I used to manage uh money uh so at Horseman.

[00:27:13]The way we had this approach capital world, and the big thing that people always misunderstood was that inflation was going to be lower. And they didn't understand the metrics about that, but we used to have a sort of beggar-thy-neighbor devaluations used to happen where wages would be dropped in different parts of the world, and they kept wages relatively low everywhere and kept uh sort of inflation in check. And so, you know, the way I used to think about was, okay, I'd be looking at which exchange rates looked mis- most mispriced.

[00:27:45]When were they starting to show signs of correcting? And then, you know, manage money around that.

[00:27:52]Because that's the way the politics worked.

[00:27:54]These days I still look at the world and I think about well, you know, I think interest rates are going to be much higher than what the markets expect. You know, where is that priced in correctly and where isn't that priced in correctly, if that makes sense.

[00:28:09]Um and you just sort of move from one place to a to another place.

[00:28:14]And if I look at like something like gold, gold for me tends does do well when you know, the Fed is sort of talking about cutting rates or doing stuff like that because then people know nothing's nothing's there to stop you know, assets rising with rising wages.

[00:28:30]Um but, you know, it's you know, it so, the way I try and do is just have a number of different assets all all fitting in with this idea of higher rates and then trying to manage around that, you know, moving capital between where it's priced incorrectly and where it isn't. Um, and you know, generally that's how it works for me. It's sort of just but you know, it's the the opposite of how I used to do it, which was always looking at where currency risk was not priced correctly.

[00:29:01]Now I look at where interest rate risk is not priced correctly and try and stay, uh, you know, as close to that as possible.

[00:29:09]>> You brought up the the housing market before and you think we're going to need housing prices to basically remain flat, nominally decre- decrease, real, um, you did give the caveat that you take a global view, but I think a lot of people think about the housing market particularly in the US. You know, we just had this bipartisan bill come through, uh, trying to address these high these high housing prices and Trump basically refused to sign it and has come out multiple times and said, "I don't want to hurt all of these base by and large older people who have huge amounts of home equity. They're just one, they vote more, it's a huge voting block and and the American people have used home equity value as a piggy bank for decades.

[00:29:57]Um, and despite what the young people want, lower housing prices, there's a bunch of people who never want their house price to go down. I mean, do you think there's going to be a winner in that tug-of-war? And will it be the older or the younger people?

[00:30:11]>> US is a difficult one cuz it's such a huge country, um, and there's so many different dynamics going on there. Uh, but if I if I start with the UK and then I can try and talk about the states. In the UK, for example, it's really happened. So, if you look at like high-end property markets in London, for example, have done nothing in nothing in in nominal terms for the last 10 years. They're pretty much where they were pre-Brex- Brexit. Uh, and that's even with the pound being weak and you know, growth being okay. You know, you've just seen this sort of really decline in nominal rates in line with the US and the UK gilt market has been much weaker.

[00:30:47]Um and you've seen wages go up. So, you really had some rebalancing going on there. Um the issue now is that they they're trying to you know, they're trying to push through this sort of build more policy which is you know, difficult because you're taking on even more entrenched interests. Uh you know, and uh Starmer talked about but couldn't do it. You know, maybe the new Prime Minister can.

[00:31:14]Um but that I think that trend is is going to be ongoing. And in the US, you know, certainly again, if you look at like sort of the high-end markets like New York market, like the top end there, I think is probably trickier these days. Um you know, because I think you you can see the legislations coming in. So, in the UK for example, high-end properties now in London anyway you know, attract an extra surcharge. Uh I think a similar type of policy is coming in the states.

[00:31:46]Um and these things can get very dramatic.

[00:31:52]Um you know, if you London, which is a very old property market, you know, at certain point, you know, houses got broken up into flats because they were would avoid a lot of taxation issues and made financial sense. And then last, you know, 20 years or so, the flats got amalgamated back into houses cuz they made more financial sense.

[00:32:13]And so, you know, where tax goes, property markets and markets in general tend to follow.

[00:32:19]Um and so, I sort of see that as an ongoing process. But I certainly you know, Trump I think you know, I mean he really has 2 years left. Um you know, I just don't see him going for a third term uh even though he probably thinks he can. Either question is The question is who who replaces Trump on the right as a standard bearer is an interesting one.

[00:32:45]>> They're passing things like millionaire, you know, pied-à-terre taxes here in in New York City. So, certainly what you're saying about tax policy, obviously we're having um you know, millionaire, billionaire taxes being proposed in in places like California and you're seeing capital move, but that is one of the differences I would argue between the UK and the US is that there are competing tax regimes and it might be the thing that extends it a little longer is that it's not driven by national policy so much and in the short term different jurisdictions can compete for that high-end dollar uh with more attractive tax policies.

[00:33:28]>> Yeah, but the big comparison is always California and Texas. Um and what is interesting about Texas is that they have a far more uh relaxed building uh code if that makes sense. So, they've been able to build houses much more readily and keep them cheap. Uh while Californian housing is notoriously expensive.

[00:33:49]Uh and you can see the sort of California Democrats are definitely moving to uh let's build more housing type policy, get rid of you know, restrictions on and regulations on building. So, you can see the politics is sort of you know, I have this view that ultimately it doesn't actually matter who you vote for, you're going to end up with the same policies anyway.

[00:34:11]It's just a matter of style. Uh you know, you know, it's like when people vote for Biden after Trump, he didn't really get rid of the tariffs. He didn't really change a lot of policies that Trump had in place. Um you know, and it's the same and I think in the UK it's uh even with a Labour government uh in place we haven't seen huge dramatic shifts in the policies of the conservative government had in place. Cuz ultimately, all politicians are the same. They just want to get reelected. They just do whatever they think the public want or say they want to be reelected. I don't know if that makes sense or not, but the shift is definitely to the left.

[00:34:57]>> In this world where real estate is is doing nothing nominally, losing you value in a real basis, treasuries equally don't look super attractive, bonds don't look attractive, what what is the investment behavior going to look like and are we maybe getting a little preview of of what the future looks like in in the form of of rampant speculation on equity markets um and and a reach for even more yield than in private credit markets. Um how much how much is the future going to look like a supercharged version of what we're seeing right now?

[00:35:38]>> So, if you go look at the '70s, the '70s the markets were very up and down.

[00:35:43]Uh but, you know, it was and they really moved on what they thought interest rates were going to do.

[00:35:48]Um particularly the Fed, you know, if Fed's going to be you know, loose on the interest rates and the markets soared and then very volatile, but in you know, in in real terms they were going nowhere.

[00:36:00]Uh and sometimes I feel we're getting close to that. The big sort of issue that I'm struggling with a little bit is that in the '70s, if you owned oil and gold, right, which is the two related assets, you did fine. Those were the two assets to own.

[00:36:18]But that was because oil was the oil was the real key to economic growth everywhere and supply was restricted, not just with OPEC, domestic US production was restricted through the Texas Railroad Commission, which is an FDR type policy. Uh and so once I've got deregulated, all market became more stable.

[00:36:38]I can't help but feel that the modern modern growth is actually all driven by semiconductors or computers, if that makes sense.

[00:36:46]And so that's why semiconductor prices are like the new oil, um oil from the '70s. Certainly we're starting to see that, you know, Nvidia chips have been very highly priced for a long time now, 5-6 years. You know, they've looked very expensive, and I thought you know, historically semiconductors don't stay expensive because we just build new ones, build new fabs.

[00:37:09]And they haven't come down. And now what we started to see is, you know, the more, you know, generic chips when I say, you know, the generic like DRAM, NAND, they're now priced like Nvidia chips. If that makes sense.

[00:37:24]Um and you know, there is a restriction on the supply there. We basically don't let the Chinese buy behind equipment to make them.

[00:37:31]You know, and the Chinese have been the marginal supplier for all product all sort of productive equipment for last 20 years, 20-30 years almost.

[00:37:39]Um and so I sometimes wonder if if you strip down the sort of semiconductors from markets, would we already be looking like the '70s?

[00:37:48]Uh and there are certainly some signs of that. You know, I see you know, profound weakness in some areas. Uh you know, mainly driven by interest rates. Uh whereas the sort of semiconductor area keeps this up.

[00:38:02]But you know, it's already affecting margins for like Microsoft, you know, Meta, these other things. So, you've got this sort of strange you know, it's not quite a perfect analogy, but it's not a terrible analogy either, if that makes sense. But you know, we are edging towards a different type of world, I think.

[00:38:22]>> So, you have the businesses that rely >> on, you know, cheap capital to to fund themselves. The whole business is is set on that. And And you think those businesses are going to be harmed.

[00:38:31]You've got financials basically hitting all-time highs. They They benefit from these higher interest rate environments.

[00:38:38]Um and then and then you have the the mega trend of semiconductors and AI companies.

[00:38:45]Um you know, there is tremendous debate right now. Very few people sit in the middle on this about whether um it's fair for the prices that we're seeing in in the AI supply chain um and in questioning whether it's a bubble. I mean, do you have a view on on the pricing of of these AI-related equities right now?

[00:39:08]>> So, I have a view.

[00:39:10]Uh a lot of people don't disagree with this view, which is fine. I don't have a problem with that. But, I'll just say, you know, it's my view. Um So, I think what's happening with with AI, this is my my view of it, is that you know, the sort of LLMs got invented.

[00:39:26]And I think very quickly, you know, the big, you know, CEOs of some big companies worked out that this was going to break down the moats of, you know, the very profitable businesses.

[00:39:37]Particularly for Google, like you know, I know I I rarely Google search anymore. I I tend to search for everything in ChatGPT first cuz I get cleaner, better answers.

[00:39:47]Um you know, so if I was Sarah as Google, I'd be thinking, "Okay, we might, you know, we're going to our advertising business is threatened." Um and, you know, you start thinking about all the other business software business getting threatened. So, you start you go, "Okay, these big companies with hugely profitable businesses are going Okay, we need to spend. You know, we need to spend cuz we got to protect the, you know, try and build a new moat."

[00:40:11]Which is fine. And, you know, I think that was the first stage of it. I I the real problem has been that uh Elon Musk with SpaceX has basically sort of said I want to be in the AI business as well.

[00:40:24]I'm producing compute. I've got ideas for making even cheaper compute.

[00:40:28]Uh the satellite-based data centers.

[00:40:31]Who knows? You know, I know a lot of guys who fancy themselves as scientists or financial scientists say it's impossible.

[00:40:40]And I'm like, yeah, but he's already built about three or four impossible businesses and destroyed the incumbents.

[00:40:46]So, you know, I think for me, like, having Elon Musk uh come into the data center compute business has probably got a lot of these sort of big CEOs thinking we just have to spend and spend to try and make it as expensive as possible to try and keep them out. I think a good analogy is, you know, he launched Tesla.

[00:41:10]A lot of companies were very slow to get EV products. You know, they were trying to protect their legacy products.

[00:41:16]And now, you know, Tesla's worth multiples of the entire old sort of internal combustion engine producers.

[00:41:26]I feel like the the tech space sort of going through a similar sort of Okay, we don't spend, we're toast.

[00:41:32]Um you know, because a a lot of the sort of pushback I get on AI, a lot of the negative research I read is no one's ever going to make any money uh on AI with this much investment.

[00:41:44]Number one is the same one. I don't think investment's going in because of the AI, it's going in to protect the existing hugely profitable businesses that Google, Microsoft, even even Amazon have. You know, they're trying to You know, trying to stay you know, at the cutting edge and try and keep uh Elon Musk at bay. That's my read of it. And and I think all of these guys also remember the dot-com bust.

[00:42:08]They remember it very differently to how investors remember it. Investors remember it as, "Oh, buying all these whiz-bang companies with no bust to zero. The guys that survived to run the big tech companies now are the ones that kept investing all through the downturn.

[00:42:23]You know, and they remember all they remember is the guys that stopped investing disappeared.

[00:42:29]Right? So, you know, and the SoftBank he kept investing the whole way through.

[00:42:34]You know, he's now richest man in Japan.

[00:42:36]That's So, the mentality is totally different. Uh which is why I am I'm skeptical on the uh I'm going to come in tomorrow and read that Microsoft Meta, Google, Amazon have all cut AI CAPEX by 50% and all the semiconductor stocks are down 50%. I'm very skeptical skeptical of that possible future headline because I feel like the first one to cut spending loses.

[00:43:08]It's almost like in the states when you have a civil lawsuit the first one to come to their senses loses.

[00:43:14]That's the sort of condition we're in now, I think.

[00:43:16]>> Another difference is we don't have the the ghost fiber or anything that the fiber that's being completely unused in the 2000s. I mean, you look at these charts of GPU availability and you know, we just had a big new model come out in China and everyone's talking about how deflationary it is for the pricing of AI.

[00:43:37]Um but they don't have enough compute to support the demand for the model, right?

[00:43:41]Um that that even if we get these cheaper, more efficient models that we just don't have enough compute and we're right back where we were. Um it does bring doubt about the potential profitability of the you know, frontier labs. Who who's going to be the model provider that makes any money? But um I I don't think it it bodes bodes negatively for for uh CapEx in any way, these developments that we're seeing.

[00:44:12]What about the potential for these developments uh to impact your view on labor and wages? Arguably a big reason that that people are spending so much on this is they do see perhaps the same world that you do in terms of labor and these companies that are by and large reliant on on labor to to maintain their profitability see that as a risk and and they see this as a potential out. I mean, do you do you believe that AI is going to throw a wrench in this higher wage, greater value of labor world that you see?

[00:44:46]>> I don't think so cuz I think the AI is mainly negative uh to be honest with you, mainly negative with sort of the professional classes have had their wages move in line with asset prices.

[00:45:00]So, you know, so people who aren't priced off minimum wage or you know, that sort of thing.

[00:45:06]It's more the sort of accountants, lawyers, fund managers, uh high-end doctors, you know, these these sort of people who sort of price relative to, you know, whatever the market value is.

[00:45:21]I think AI's most vulnerable for them uh is my read. Um which I think is sort of part of will fit in naturally with with the politics that we're going into of like, you know, how much should the CEO be earning relative to the lowest paid worker in their in their company. And that's an old discussion that's, you know, and that ratio has been going up and up and up for years.

[00:45:46]I can see that turning. And AI could be part of that, you know, in that you know, it sort of more narrowly defines what is actually worthwhile and what has value.

[00:45:57]Um yeah, so I don't think it affects it. I mean, you got to remember like uh, in the post World War II period, right?

[00:46:06]The big technology that suddenly came out, you know, suddenly in 1945 was nuclear, right? And nuclear and jet engines and you uh, the car, you know, the car became much more common post World War II, you had much more huge technological transformations. But at the same time, wages went up 1,000% over that period.

[00:46:30]Um, so sometimes, you know, the technological change and wages are actually two separate discussions. It's a political discussion. Um, it's the technology is more who who gets the money and who doesn't.

[00:46:44]Um, but you know, the the the whether wages are going up or not is a political discussion. At least at least to my view.

[00:46:51]>> If that just makes labor unprofitable relative to digital labor, for for lack of a better word, um, you know, we'll just see unemployment will will remain extremely low, but labor labor participation is is going to drop. Like, do you don't think that that's a possibility where wages are high, unemployment is low, and this is a problem? I mean, we've seen falling labor participation, you could argue it's a demographic trend more so than a un you know, lack of demand for for labor, but uh, you know, that that's a trend that has been going really since the GFC.

[00:47:28]>> It's it's hard to find an example where technology has suddenly caused, you know, a huge increase in unemployment. It tends to be financial factors.

[00:47:38]Uh, normally with technology, at least to my read of it is you get a new technology comes in, companies do a process of it better.

[00:47:46]They tend not to fire that many people, but they sort of And then you get new technologies, new companies coming with through that using the new technology much better, and then they sort of expand massively their employment. Um you know, and they you know, that tends to be the way it works. Um I mean, it just uh uh if you look at like how much technology's improved and how many jobs that used to exist have disappeared, you know, normally we just move move somewhere else. I I know people are worried about that, but I've yet to you know, see a real example of it working that way. And certainly AI, I think what I see with AI, it's uh from from my perspective, is as it gets used more and more, people are sort of recognizing AI products more easily. Oh, they go, that's slop. That's AI-generated Substack or whatever. And they instantly devalue it. You know, that makes sense.

[00:48:46]So, what my sense of it and I and this is true of my on my Substack, I don't use AI for any of the writing cuz the way it writes is very generic, PowerPoint-ish, uh not always logical, loves to use a lot of dashes. It doesn't It's sort of It's nice if you're a really terrible writer, it's great. Uh but I don't think it adds much value. Uh and I think people get turned off by it. So, what I feel like is with AI, it's sort of it makes very easy, low-level stuff easier to do, but the high-end stuff, it adds the value to the high-end stuff because like, oh, you know, you need to have a lot of skill now. I can see you need to have a lot of skill to write that way. And I think that's always been the way. Um once something becomes more mass-produced, you you tend to sort of put more value on high-quality stuff. Clothes is a good example. You know, clothes used to be very expensive and now we mass-produce it in China and India and places like that, but we still pay, you know, few thousands for like an Italian suit.

[00:49:53]You know, because it is noticeably better.

[00:49:58]>> It is noticeably better, and the argument has always been that an ounce of gold is what what buys you a suit these days.

[00:50:04]>> Yes, that throughout throughout history, an ounce of gold and the price of a well-made men's suit are about the same, and I can tell you having just been in the market for a suit, $4,000 is about what it it'll run you to to pick up a a nice Italian, you know, handmade suit.

[00:50:24]Um so, the it has held. It has certainly held at least for right now.

[00:50:29]Um So, so it's interesting you don't see it going that way. And And argue with this might fit in with your political view. I mean, do you think that that there is a risk to the AI spending trade that could come from politics? You know, I live in New York State. We just banned data centers for a year. It's by and large extremely unpopular both the technology and the infrastructure build-out around it. Whether those arguments are are uninformed is another debate to be had, but it's an extremely unpopular new technology that people are very scared of. Are you concerned at all that that the spending could be hit a road block that's political?

[00:51:10]>> It could do, but I think the politics I think the politics is much more supportive.

[00:51:15]So, generally speaking, uh the one unifying characteristic of Americans is they love to win. Love to win everything, you know. And they're sort of in a AI race with China.

[00:51:26]So, I can understand New York State blocking development this sort of stuff, but if uh if it becomes perceived that uh the US is falling behind China in any way, shape, or form, then you know, the political will will be there to cuz no one in the world will look weak on China, uh would be my observation.

[00:51:48]Uh neither left wing or right wing politicians.

[00:51:53]Uh and you know, I'm pretty sure you know, if you look at the way the Trump administration talks about AI, they you know, it's a technology they want to own and dominate. So, I I I I I strongly see the politics negative there. In fact, you know, if anything it becomes a strategic asset like nuclear, so everyone's trying to get it, you know. Um and so the spending should be there.

[00:52:15]Uh you know, the only the only thing that could really slow it down I think is a big recession.

[00:52:21]And that would be again a political decision. So, getting the Fed to jack rates to like 10% try and stop everything. And I guess the the real issue, you know, I think a lot of people have because of the past we grew up in and lived through there. So, when they have a big problem with my arguments is like we've had recessions before. Going to come back again. I just go the thing is I think austerity where governments come in and they suddenly stop spending is as a political policy dead in the water. I just don't see it. Um and without that, you know, the growth will be good, inflation will be strong.

[00:53:02]Uh and these things will continue for the foreseeable future. I just don't see a political environment right now where we all sort of go, "Do you know we'll take some austerity?"

[00:53:14]Because we want to get interest rates lower, inflation lower, and we're tired of these boom days that we've had. I don't I just don't see that politically.

[00:53:22]Uh I don't see any politician pushing that cuz they're all terrified uh of the of the populace both on the left and the right.

[00:53:31]So, the spending will be there. And if the spending's there inflation will be there, too.

[00:53:37]>> So, you think that AI will probably be put into sort of like the military spending category where it doesn't really matter what um the people want. I mean, you could argue here in the US people have said we want lower military spending for a long time and it has never happened.

[00:53:53]So you think it's just one of those one of those categories that's just going to be unaffected by the populace will of the people.

[00:53:59]>> Yeah, I think at the moment because it's you know, it's too strategic of an asset.

[00:54:05]You know, I just can't see any US politician being the one to say they lost the AI war with with China. I just you know, I just don't feel like that's something that's conceivable.

[00:54:17]>> We've seen a pretty strong momentum unwind right now just because the CapEx doesn't stop and the spending continues doesn't mean that asset prices can't react negatively to some headlines or just you know, there's no rule that says that stock prices have to follow fundamentals and and that has played out many times in history.

[00:54:39]Um you know, people are very exposed to this trend. The Punch Bowl tends to get pulled away after people have some pain, right? Nobody wants to to take it away while the party is going on. I mean, do you do you have any concerns about the level of exposure that people have that the triple levered ETFs, the speculative fervor that we have around these stocks and and the potential for pain there despite robust strong fundamentals?

[00:55:10]>> The triple levered ETFs is like fundamentally a bad idea. Uh you know, you know, just you know, my experience with these types of structured ETFs they tend to cost retail investors a lot of money.

[00:55:24]Um you know, and they're you know, primarily targeted at them.

[00:55:28]Um so yeah, I could see an unwind there.

[00:55:31]Uh you know, it's like with everything if it's like the old saying, you know, if as long as you don't get too greedy, you'll be fine. But I think the rise of triple levered single stock ETF like an SK Hynix or Micron is really it's about being greedy.

[00:55:48]And the problem you've got, as we've seen in financial markets before, is like when you get an unwinding in these types of products, so you have to sort of they don't they do move away from fundamentals, they move to basically the the pain point where people are forced to capitulate.

[00:56:03]Um I think we're still seeing that in the in the sort of memory trade at the moment. I mean I think I I was pointing out in my Substack it's uh yeah, the memory stocks are very weak, but memory pricing has actually been very strong this month.

[00:56:18]Um you know, so it sort of points to you know, excessive it was excessive greed, excessive long positions.

[00:56:28]And the market has just sort of decided to come and to take your money from you, if that makes sense. Uh how long that goes on, I don't know, but you know, as you've seen before, it can go on for a while. Essentially, the LTCM blowup was very similar. They they got too levered.

[00:56:44]The market realized they were levered, so they came and took all their money from them.

[00:56:47]Uh and so you you do get these out blowups from time to time.

[00:56:51]>> I actually have concern about the way that AI technology is impacting the research that people do.

[00:56:58]Arguably, in past speculative bubbles, people kind of knew that they didn't know anything, that they were playing with you know, half of the information.

[00:57:07]And now you've got this machine that can tell you anything you want to know. It tells you that you're a genius. And you can put in well, this is my thesis, and it'll say that is a very strong fundamental thesis, Max. You you you've really been thinking hard about this. I mean what And and I think that that's something that people don't quite get, that that the market doesn't care about your knowledge of the technology or the fundamentals or whatever, that that it can find that pain point and you've got a lot of people out there who think, well, I've done all this research. I understand where how important this thing is in the supply chain and they think that that's enough. Um and that they deserve returns because of that knowledge. And I I I just have a lot of concern that that that will actually create some serious negative feedback loops on on any potential leg down.

[00:57:55]>> I don't think you need AI for that. Uh I think it's you know, if you took when I took some you know, people I meet who like invest into crypto, not Bitcoin like specky specky crypto, I go, "How did you find that? How did you find that coin?"

[00:58:11]They go, "Oh, it's my WhatsApp group. We all talk about how great it is. It's the next big thing." I'm like, "Okay."

[00:58:16]You know, and their basis is an echo chamber of like, "Oh, this coin's going to be the next big thing."

[00:58:21]You know, and you know, run into them a few years, you know, mark a few months later and go, "How's it going?" They go, "I don't know. I can't bear to look at my crypto portfolio anymore, so I don't."

[00:58:30]You know, and that is uh So, I you know, AI maybe have replaced WhatsApp groups, but humans have always humans always rationalize positions. Uh even I do it. Uh it's why I like I prefer uh managing other people's money because it helps me stay disciplined because you still have to think about I don't know, I own this asset. How do I explain it to this person? You know, uh whoever, you know, who's entrusted me.

[00:58:59]And you know, if you can't explain it, then you go like, "Well, I can't own it." Whereas when I it's just my own PA money, I might hold onto an asset far too long because I think, "Oh, I'm a genius. It'll come good at some point." You know, so having that third-party discipline is out there.

[00:59:15]But you know, people have done crazy stuff for as long as there have been markets before AI turned up and for random reasons as well, you know. Uh Yeah, so it's uh maybe it makes it worse. I think it just stays the same.

[00:59:29]>> Let's close out with a a little bit of assessment of other risks maybe that we haven't talked about. Um what are the areas that you think, you know, people should be the most concerned about um if rates do continue to move higher? What are the the areas of the market that are sort of most mispricing this interest rate risk that you talked about as being sort of this new framework for you?

[00:59:51]>> I'm amazed in the sort of private uh credit private equity space, private credit in particular.

[00:59:57]You've seen like uh gated redemptions, particularly in that Clearwater uh one. Um so I was just looking at it.

[01:00:05]And what was surprising is yes, they had large redemptions. They also still had large subscriptions on the other side.

[01:00:11]It was just that the redemptions had sort of overwhelmed the subscriptions for the first time. And so then they put in a, you know, a gate on redemptions to try and manage that process.

[01:00:21]Uh I couldn't help but think you know, okay, so they got redemptions, they had subscriptions. What happens when there's no subscriptions at all?

[01:00:28]When people suddenly go, oh, I'm getting you know, 7 8% in money market funds, why am I bothering with this illiquid private credit fund that I don't know anything about uh where asset values are really weak.

[01:00:42]Um you know, these these things are, you know, I think we mentioned before how, you know, problems in something for 2 3 years before they actually metastasize into something worse.

[01:00:54]And certainly private equity private credits have problems now for a year and a bit.

[01:00:58]Um which I found very strange, particularly with private equity, when they were talking about liquidity issues. This is they talk about liquidity issues with credits friends at all-time lows and stock markets at all-time highs.

[01:01:11]I'm thinking, how can you have how can you have liquidity issues in that environment?

[01:01:16]That makes no sense to me.

[01:01:18]Uh I think it just shows that the quality of the assets within those businesses are very problematic. I think they are of all the sort of businesses I look at, they're the ones most hopeful that the Fed comes in and cuts rates back to zero and bond yields fall back to sub 3% or something like that.

[01:01:36]Cuz they built their whole model about ever lower interest rates, um, which they're not getting.

[01:01:42]And you know, that's an area that, you know, I think it's like very typical, in my experience, is like there's a problem, people get worried about, stocks fall for a while, but then it sort doesn't become any worse, and then they forget about it. And then the problem's still work their way through slowly but surely. And that would be the area that I think, you know, much higher interest rates could potentially cause much bigger problems.

[01:02:07]>> Okay. And then specifically, like the the listed asset managers, um, you think that they they are potentially at risk of of continuing to drop? I mean, they haven't fared very well for the last year or so. Financials are doing well, but it's the banks, not the asset managers.

[01:02:25]>> Uh, it's probably a good way to sort of, you know, go full circle.

[01:02:29]You know, when I was talking about like pools of capital sort of dwindling, like sovereign wealth funds, I also think like the pools of capital that have ended up in private equity, cuz it private equity really is like this pool of capital that is going out and trying to make you more money by buying a but not actually doing anything. They're not making anything.

[01:02:48]They tend not to be investing either.

[01:02:50]They just buy firms, financially rework them, and then give you some money back. Uh, you know, this idea of of falling pools of capital, shrinking pools of capital, should be extremely negative for businesses like this, because cost of capital rises, that's negative, and the pool of capital upon which they've been able to draw upon to raise these phenomenal amounts of money, should also be getting smaller.

[01:03:13]Uh, and so I see, you know, if this sort of in the in the world I think we're going to, these are much more problematic. You know that you know, private equity, private credit, these businesses all turned up uh in the '80s after we sort of moved away from the pro-labor uh policies that existed. You know, they're really sort of for me big vestiges of a pro-capital era that I think is coming to an end.

[01:03:41]>> Well, and arguably just the amount of money that's flown in flowed into the sector has has narrowed the the arbitrage that was available. Just the the big difference between private market valuations and public market valuations.

[01:03:54]That has completely closed and you know, if you look at the the memory companies, you can get you can get cheaper valuations cheaper forward valuations in the public markets now with huge amounts of growth.

[01:04:07]>> Potentially, yes.

[01:04:08]>> Yeah, potentially. It's a big if. It's a big if. Perhaps the biggest if right now in markets.

[01:04:13]Well, Russell, we will end it right there. People can read your Substack.

[01:04:17]What is the What is the URL these days?

[01:04:20]>> Uh it's uh russell two L's hyphen clarkew.com.

[01:04:25]So, w www.russell-clark.com.

[01:04:30]>> Wonderful. Well, thank you so much for joining us today and and uh sharing this. People, I highly recommend going to subscribe to the Substack. We'll do it again soon.

[01:04:38]>> Thanks a lot, Max.

[01:04:39]>> Thanks for listening. Interested in learning about the Teucrium Soybean ETF SOYB?

[01:04:43]Click the link in the show notes for more information and get Teucrium's free ebook why investors are increasingly turning to commodity ETFs. Until next time.