VALUE: After Hours (S07 E28): Ben Kizemchuk on fiscal dominance, financial repression, passive flows and fiat currency

Transcript

Tobias: This meeting’s being livestreamed. I think that means that we are live. And this is Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guest today is Ben Kizemchuk. He is a Portfolio Manager at Wellington-Altus. How are you, Ben? Thanks for joining us.

Ben: Very well. I’m very well. Thank you. Nice to see you again. Thanks very much for having me on today.

Tobias: Last time, you and I caught up was 2017 in Toronto, possibly lamenting the massive underperformance of value at that point. [Ben laughs] It’s hard to imagine now given how the massive outperformance that we’ve seen since then. [Jake chuckles] Tell us a little bit about your practice and your philosophy.

Ben’s Clientele: From Lawyers to Crypto Bros

Ben: Yeah. Thanks very much. So, as you said, I’m a portfolio manager at Wellington-Altus Private Wealth. I’ve been here since this was just in the initial inception phase of the business. It’s been an absolute rocket ship of a business up here in Canada. I’ve been a very lucky guy to work with a lot of extraordinarily talented people at our firm.

My job here is I’m a portfolio manager and investment advisor. That means that I work directly with clients in helping them manage their wealth. Most of my clients are lawyers here in Toronto. I managed to get in early with them in the early part of my career.

Jake: Condolences.

Ben: Sorry. What was that?

Jake: Condolences. [Ben laughs] Just teasing, Toby.

Ben: No, no, it’s really great working with them, because they have a huge time constraint and they need outside professional advice. It just fits really well.

Tobias: It’s an ideal client.

Ben: It is. It certainly is. And so, I’ve developed real expertise in working with them, particularly through the career progression. Starting off in the early phase of being a lawyer, like being an associate all the way into self-incorporating. Some of them are partners at very large firms or managing their own firms. So, that was the very first big stage of my career.

And then, I’ll tell you just recently, over the past, I’ll say six or seven months, as my Twitter profile has been getting bigger, I have been taking on a whole new group of clientele of Crypto Bros.

Jake: Don’t say doctors.

[laughter]

Ben: Yeah. No. Again, my name’s been getting shared more on Twitter and getting more of a profile, and you’d be amazed at the generational wealth that’s being built up here in Canada. Canada always had like Ethereum, right, like that was always our big crypto foundational moment. But even beyond that, plenty of mostly young men, who’ve been making generational wealth, seven figures, eight figures in a very short amount of time.

These people have been reaching out. They need the money managed. They’re not looking to ride this risk into the sunset. They want to offload stuff and make sure that they’re providing for their families and all. So, yeah, two big groups of clients that I’ve been working with over the years.

Tobias: Do you find the Crypto Bros– What are they like as clients? Are they macro bearish?

Ben: No. I wouldn’t say that. I’d say that they have a real keen understanding of markets. I’d say that because they seem to be following stuff more. They’re younger. They’re around our age. Even into late 20s, I’ll say. These guys tend to be really plugged in, like the reading stuff.

The one really interesting thing I’d say they all have in common as well is beyond the crypto idea, is they have a real keen understanding of the supply and demand of money and money operations. So, I wouldn’t name that MMT specifically, but they seem to be more plugged into those ideas than your average investor. Maybe that’s just because supply and demand in the crypto world is the whole thing. But for whatever reason, they seem to really be on that idea.

Tobias: What’s MMP?

Jake: MMT.

Ben: MMT

Tobias: MMT. MMT

Ben: Yeah, yeah. Yeah. Yeah. Yeah.

Jake: Toby, you remember that.

Tobias: Is that dead now, that idea? Is that–

Ben: No, I don’t think so. I think if anything, the last– [crosstalk]

Jake: Have you looked at the-

Ben: That’s what we’re doing.

Jake: -budget deficits? [chuckles]

Ben: Yeah. Yeah. That’s exactly what I was going to say, Jake. If you look at the last three years, 2022 onwards, the only way you got that entire thing right was by understanding the fiscal framework that we were working in. The idea that the Fed was going to raise rates, but that was also going to raise the amount of money that the treasury kicked out to everybody through bond payments and interest payments, that was the saving grace of the economy through that whole period, especially 2023.

You needed to have a keen understanding of that MMT framework in order to get that part right. Otherwise, you thought the yield curve was inverting and unemployment- [crosstalk]

Tobias: I don’t think that–

Jake: Wrong

Ben: -and you’re going to get a recession.

Jake: Wrong. [laughs]

Ben: Yeah. And exactly, Jake, none of that happened because we had this huge fiscal spend.

Tobias: I confess that I believed all of that. So, please explain to us what has happened and what that means for the next 5, 10, so on– [crosstalk]

Understanding the Four Fs Framework

Ben: So, yeah. Okay. So, that’s actually really good because it fits in with the four Fs framework that I’ve been developing. So, before I get into that, I’m just going touch on the 4F’s big picture idea and then we can dive into what that fiscal part means. So, four Fs stands for fiscal dominance, financial repression, passive flows and fiat money, okay? All of these things have existed on their own through history in the US, outside of the US, but we’re living through a really, really interesting time where those four things are coming together at the same time right now. And that’s never happened. We’ve never had those four things together at once.

What’s unique about that in my opinion, is it sets up a foundation from which a post scarcity economy can bloom. So, post scarcity is a really fancy way of saying, like an AI economy. If you’re going to have an economy that was predominantly run by machines, with machines, machine labor, you would need a very specific springboard from which you could make that work. My opinion is that four Fs is that springboard economy. That’s what we’re in right now.

Jake: Can you unpack each one of those just like–

Ben: Oh, yeah. Yeah definitely. Yeah. Yeah. I’d love to do that. So, it’s not quite industrial capitalism. It’s not quite AI machine economy. We’re right in the middle. This is what the transition from one to the other would look like. Because it’s not a light switch. You’re going to slowly gradiate your way through that.

Fiscal Dominance: Government Spending Takes Control

So, the first one, fiscal dominance, speaks exactly to, Toby, your question about what happens with this fiscal idea and where are we going. So, if you look at where we are right now, government spending in the US, federal government spending is up just shy of 25% of GDP, okay?

Now, if you look historically, and I’m talking all the way back, 25% of GDP is where you got to at peak government spending in prior recessions, prior crises, apart from COVID. Let’s just do ex-COVID and you look at the whole way back, 25% is where you’re peaking out of government spending.

Jake: That’d be like worse as well.

Ben: Yeah. Yeah, that’s everything. Like, the worst of the worst, you got to 25. That’s our normal right now. We’re at 25% right now and this is just the normal operating space of the economy. So, what that means, is that this huge amount of government spending is creating what’s called a fiscal dominance. That’s where the needs of the treasury supersede the needs of the central bank.

The central bank is powerless. It can’t really do too much about the treasury. It becomes almost subservient to the treasury. We’ve seen this before. Throughout World War II and then towards the end of World War II, you had the Fed at the time was specifically keeping rates low to help the treasury pay for the war. They did that as an explicit agreement.

And then, we have the treasury federal accord and they decided to make the Fed independent again. That’s the idea of central banking as we know today stems from that 1951 agreement that the Fed is independent and gets to call its own shots. What we have now is a situation where no matter what the Fed does, in my opinion, they can’t really change the course of the economy. And so, the example for that is, I’ll go back to the 2022, 2023 example. They raise rates by 5% in a year. You’re supposed to be restricting economic growth and the opposite happens.

Back in the World War II, this was like a cooperated agreement. This is just fiscal dominance almost by accident. I don’t think any of this was planned where they raised interest rates and they caused the treasury to start paying out a whole bunch of money, which saved the economy. But even though it’s emergent, it’s still the case. We’re still dealing with it. As time has progressed since then, I get the feeling and the sense that the Fed is waking up to what’s happening, and what they’ve done and how their policy choices may be constrained.

Tobias: So, do you mean they’re constrained in the sense that if they put rates up, you probably tip the federal government into– I mean, I don’t know if it can go into bankruptcy, but they’re going to struggle to make the interest payments if the interest rates are too high, because there’s so much debt there.

Ben: No. The federal government can just print money, however much money it wants. There’s no cap to it. This is where the fiat component comes in, right?

Tobias: Okay.

Ben: So, if we were dealing with a federal government pre-1971, right, when Nixon closes the gold window before then the federal government, all the treasury had to be backed by gold, right? That meant that you could not print too much money, because you had a very real and almost instantaneous inflation risk, if you were to print a huge amount of money back then.

1971 comes, and now you’re dealing with fiat and the government no longer has a backing to its currency. It’s just the full faith and trust of the treasury. That means that your only constraint to print money is the use of resources, like inflation. So, right now, if you were to print a huge amount of money, it’s really about can the economy absorb that money and put it into productive uses as opposed to, is there some gold backing or something else that’s backing the currency that’s going to give you that signal that inflation is running too hot or too cold for that matter.

Tobias: Keep going.

Jake: I want to know how it ends.

[laughter]

Ben: Okay. Right.

Tobias: I accept the proposition as it is, but I don’t fully understand it. Keep going. So, we’ve discussed fiscal dominance, right?

Ben: So, fiscal dominance. Okay. So, you have this idea that the government can keep spending and we’ll keep spending. Government spending has been growing by about five and a half percent per year since 1985 and pretty much on trend right now. There’s nothing that really stops that. A lot of that is just automatic spending and a lot of that is just congressional spending. There’s not a lot to be done with executive orders that can change that. And so, you’re on this trajectory where that’s just how it works. Your government is going to be spending about that much money, growing at five and a half percent per year.

Financial Repression: Managing Debt Through Low Rates

Now, switching gears to talk a little bit about the financial repression part. I think this may also help answer your question, Tobias. So, we’ll work our way to the fiat part of it at the end, but I think this may help illuminate that point. So, looking at the financial repression aspect of things, so financial repression is where the government steps in and actively intervenes in the market. Specifically, the bond market, but it also can be related in stocks. But most of the time you’re talking to financial repression, it’s about putting your thumb on the scales of interest rates.

Specifically, financial repression means that you are trying to set your risk-free rate, your benchmark rate below the rate of inflation or growth up here. What you’re trying to do there is you’re trying to artificially “keep rates low” while growth and inflation is up here, so you can inflate away the value of your debt. Now, I don’t think you actually need to do that. Or, sorry, I should say that, when would this apply? Why would you do this idea?

You would do financial repression if you are a policymaker and you thought that you had too much debt. If you think that you have too much debt, then you need to inflate away the nominal value of that debt, so that your economy can keep growing. So, the way that you would do that is you would find somebody to own all your debt or buy all your debt, so you can keep rates low. You want the economy to be running up here, so that growth differential basically grows, that you grow your way out of all that debt.

Jake: Yeah. If you got a killer hangover coming, you want to go ahead and hit that crack pipe, [Ben laughs] so you don’t get a hangover, right?

Ben: That’s one way of putting it, Jake. Sure. Yeah, to each of their own. Yeah. So, that’s the idea that’s been put out there currently, is that you have this big worry or this caution about the amount of debt. Now, I’m of the opinion that it doesn’t matter that the amount of debt that we have is totally fine. And because the government can print as much money as it needs to service the debt, there’s no real such thing as having too much debt.

The total amount of the government deficit is just all the money that is sitting in everybody’s wallets. If you were to eliminate the deficit completely, that means specifically that you’re taking money out of people’s wallets to give it back to government and then there’s no money. Like, the deficit is just the grand total of all the money that’s ever been printed.

Tobias: The debt.

Ben: Yeah, yeah, the total deficit and the debt. Yeah.

So, if you were to remove all the government debt, that’s all the money that’s sitting out there in the public’s hands, then there’s no money. So, you need that. That’s just a running total of all the money that’s ever been printed.

So, if you are the opinion, like if you went to school before 1971, you went to university, you went to university of Chicago or Yale or Harvard or whatever, wherever these policymakers went to school, and your professors certainly went to school before that time, you would have grown up with the idea of the economy operating on a gold standard where you had these constraints to money printing. That means that you would also have a constraint to the amount of debt that you could have.

If that’s how your framework was operating, you would necessarily think that you had a deficit problem right now. But because we were no longer under a gold standard, we don’t actually have that problem, but the policymakers think that we do. Therefore, the solution is financial repression. That’s what we’re getting right now. You’re having government intervening in different parts of markets in order to try and keep interest rates not necessarily lower, but stop them from rising.

Tobias: How are they intervening? What does the intervention look like?

Ben: So, there’s a couple different ways that you could do that. Most of the time, when you hear about financial repression, people automatically think yield curve control, and that’s something where the Federal Reserve or a central bank would step in and start actively buying the government’s debt to try to keep rates lower. That’s not happening. That’s not happening right now. So, just to be clear, that’s not how this part works.

One way that is looking like this is happening is through stablecoins. So, if you have a growing body of stablecoins out there and you say that all these stablecoins have to be backed by government debt, well then you’ve just created a buyer of government debt. So, that’s one really big way.

A second big thing, is if you’re going to expand bank lending. So, right now, you have this thing called a supplementary leverage ratio. Right now, actually, they’re debating and in the comments period of how are we going to remove the supplementary leverage ratio. This is one of the things you hear a lot about The Oval Office and the Fed battling these days. This is one thing that everybody agrees on, which is that we have this thing called the supplementary leverage ratio that was put onto banks in the aftermath of the global financial crisis. That’s when everybody was really mad about how much the banks lent out. So, they created this new thing to stop them from lending out as they were doing before.

Well, it turns out that putting that on really did hamper the bank’s abilities to lend. [chuckles] And maybe that’s not such a great idea anymore. And so, the discussion now is how do we remove this and to what degree do we remove this. Besant was actually even on TV in April at some point saying he called it a core set around the banks. And so, the idea is that this thing should be removed.

Back of the envelope math suggests that if you were to remove it, you could potentially open up or increase bank lending by something like $600 billion to $700 billion. That would require a whole bunch of government debt to back the reserves of the banks to let that part happen. So, there’s another pot of money that you could dump into treasuries right there.

Tobias: So, the stablecoins are an increase in the money supply that doesn’t get counted?

Ben: No. So, stablecoins are not actual dollars. They would be using existing treasuries or potentially buying treasuries from primary dealers to back the stablecoins. They’re not dollars. Stablecoins are not dollars.

Tobias: Okay. They’re one for one with dollars.

Ben: They trade like dollars, but they’re not dollars.

Tobias: Okay.

Ben: Right.

Tobias: Okay.

Ben: Yeah. For example, so the treasuries that are back in the stablecoins, these treasuries all have interest rates associated with them, the stablecoin holders don’t get any of that. So, it’s not a one for one. They’re meant to represent dollars. They’re meant to trade at the level of a dollar, but they are not dollars. They’re something new and different.

Tobias: So, stablecoin holders don’t get the benefit of any of the interest on it.

Ben: That’s right.

Tobias: So, the issuer of the stablecoin collects the interest, and you just get a unit that trades one for one with the dollar.

Ben: Yeah, that’s what– I can’t speak for every single stablecoin out there. There is all sorts of stuff that’s getting invented and put to market right now. But yeah, that’s my understanding.

Jake: That sounds like a bank.

Ben: Yeah. [Jake laughs]

Tobias: Okay. We’ve got fiscal dominance, financial repression.

Ben: And so, the financial repression idea, the reason you would do that– What’s actually happening there is you’re lowering volatility. Because if you can get all these people to own all of these treasuries, you’re creating effectively an arbitrage for the economy. If you can borrow down here and you can invest up here– So, borrow down here whatever the risk-free rate is, let’s say it’s four and a quarter and you can grow the economy up at 5%, then you have 75 basis points of effectively free money out there for the economy to go wild on.

The economy doesn’t need much. [chuckles] 75 bits, that’s a lot of growth. Somebody’s going to go out there and harvest that. So, basically, the purpose of financial repression in this context of the 4 Fs is it lowers the volatility of the system.

Jake: But Ben, haven’t we been running these deficits that are, what, was it 6% or something of GDP? Is that roughly right? But we’re only seeing growth rates, I don’t know, whatever, one, two. I think isn’t there some diminishing returns that you hit on the amount of debt and is it actually converting into real economic progress for us?

I get it when you maybe you’re an early country, and you’re borrowing to build railroads and all this infrastructure that’s going to last your economy for 100 years. But if you’re really just borrowing to pretty much pay for healthcare expenses, which is I think what the real mechanism looks like, do you actually get what you’re paying for there or is that just– I don’t know, I feel like something’s breaking down eventually.

Ben: Yeah, that’s a really good question. So, to answer that question, I’ll back up. Economic growth comes from one of two sources. There is only two places that can create money. The first is the federal government, the second are banks.

And so, when the government creates money through the collective profit equation, which is just basically rearranging of the GDP equation, that necessarily supports corporate profits. So, when government money goes up, corporate profits go up. It is one for one.

Previously, I mentioned government spending has been growing by five and half percent on average since 1985. If you look at the average GDP growth, nominal, over the same period, it follows the exact same trajectory. Almost literally the exact same trend line of GDP growth over that time frame. That’s because that rate of money growth is what’s powering GDP higher.

Now, you do also have the component of growth that’s coming from banks and credit expansion. So, when people are lending, that’s the thing– Since 1980, everybody has come to this idea that the primary way that economies grow are through credit, because interest rates went down and we had a huge 40, 50-year period of credit growth came up. That started to taper off in the mid-2010s and then that really hit a low in 2022 when interest rates came up. So, this is that transition period where we’re moving now from that credit driven economy towards a government driven economy.

So, it’s like baton’s been passed. And so, there’s a lot of, I’d call it the ideology right now, is that governments don’t know how to do anything. All the economic growth comes from credit growth, which is a product of banks. But I don’t think that’s necessarily true. If you look at the long history of world affairs, you’ll see that the highest rates of economic growth in history through different countries have always been when governments have been in charge of creating money, not banks. Even in the US’ own history, you look at the coming out of the 1930s was a massive wave of growth. That was a lot to do with government support and government money printing. That is because of the collective profit equation.

When governments are printing money, that means that you are basically providing a huge safety net to the economy. You’re printing money, that money gets put to work. Businesses use that, that’s literally profits for businesses. As banks see that safety net develop, then they start to lend again. That’s when lending starts to pick up. That’s theoretical aspect of how it works and we’re actually seeing that playing out now in real time.

We had government pick up the baton in 2023, 2024. Now, in 2025, we’re finally starting to see banks lend again. Literally just in the past few months, we’re seeing loans and leases start to accelerate higher and various– If you look within loans and leases, all the various subcategories are starting to look the same way. They’re all starting to move higher. So, I’d say that this is actually very characteristic of a pattern for economic growth that we’re living through in this little mini microcosm over the last five years, let’s say.

Tobias: I think this is fascinating. I don’t fully understand, believe, but I want you to keep on going, because we’re two points through–

Ben: Yeah. Okay. All right. Yeah.

Tobias: Let’s get through the Fs, and then I want to understand the implications for equities for value, you know, this is a value podcast.

Passive Flows and the Rise of Mega-Cap Companies

Ben: Yeah. So, the third F is passive flows. This is a pretty new dynamic. So, right now, depending on who you ask, somewhere around 45% of market activity is represented by flows into passive investment products. So, you can think about the Vanguard VOO or SPY or some big index product that follows one of the big indices.

This is primarily channeled into these products through retirement accounts. So, generally, on the third week of the month, at some point, the money from everybody’s paychecks for the automatic retirement contributions go into the market and they get put into these index tracking products. Most of that’s coming from younger people, because they’re working. They’re the ones who are saving, all right? It tends to be the older generations who are still more active investors, let’s say, versus passive investors.

But this is starting to have strange new effects on the market. If you just do this once or twice, it’s not a big deal. If you just take a whole bunch of money and you just plug it into buying these index products, that’s fine. It’s not a big deal. But if you continuously do this over and over and over again, you start to introduce a feedback effect in the market. That’s because when you do this, let’s say, you put $1 into the market, disproportionately more of that dollar is going into the largest index weightings versus the smallest index weightings. If you do this over and over and over again, you’re buying more and more and more of the larger companies and less and less and less of the smaller companies, and you start this bifurcation happening.

I think we can see this right now. I don’t think that’s too much of a stretch to imagine that that’s happening to the Mag 7 versus the S&P 493 right now. It’s not just about the cash flows, like, yes, the Mag 7 have way higher cash flows than everybody else. But that’s not the whole story. There is more to it. There is this very real plumbing effect that’s this passive effect.

Now, I’ve got this idea that this is not just about either plumbing or valuation. This is also a cultural shift in how we’re looking at companies. I’m calling it the enterprise owned state. So, everybody’s familiar with state owned enterprise. In China, for example, the US Postal Service, in Canada, post office is a state-owned enterprise. This is different. This is where those companies are getting so big and so ingrained into the apparatus of the US that there is no US without those companies.

Like, the US does not exist without those companies, and their influence and what they do to not only conduit policy but also receive benefit from policy and also to support policy. They are one and the same as the US government. That idea, if you think about it, turns those companies into what I’m calling quasi sovereign risk-free entities. So, if you think about what like a sovereign bond is risk free, like a US government bond, we call those risk-free bonds, this would be the idea of risk-free companies. I don’t mean to suggest that you should go out and call these things low risk and pile them into your account just in case there’s anybody who’s [chuckles] thinking that’s what I’m trying to suggest here. But I’m thinking more of a conceptual basis. If we go back in time, remember banks being too big to fail, this is like an economy that’s too big to fail.

Jake: So, would you say– [chuckles] Okay. Let’s say, we get to like five years from now and the revenues are nowhere near they need to be enough to justify all the spending that happened on AI. Is the Fed going to buy servers at inflated prices off of Microsoft or something to prop up the Microsoft state owned entity?

Ben: No, I don’t think you’ll have to do that. I don’t think we’re spending enough on AI. Everywhere you look at, you see the spending on AI, and the comparisons being made to prior cycles.

Jake: Is it going to look more than the US government wanting 15% of sales of NVIDIA’s that are selling to China [Ben chuckles] or in taking 10%?

Tobias: Stake in Intel?

Jake: Yeah. 10% of Intel.

Ben: Yeah. So, I do think that we’re going to see more government intrusion into these markets. I do think that that’s a tax. When government’s buying Intel, that’s a tax. That’s not supporting intel. That’s buying Intel’s profits and keeping them for government, that they become part shareholders. But because the government is a shareholder, that’s the tax, that’s just a– [crosstalk]

Jake: Or loses.

Ben: Yeah. Yeah, yeah, fair enough.

Tobias: We’ve done that with GSEs too with the Fannie Mae & Freddie Mac?

Jake: Sure.

Ben: Yeah, yeah, yeah.

Jake: Conservatorship.

Tobias: And in the bed sport, the mortgage-backed securities. Sorry, we’re getting a little bit off track. It’s my fault.

Ben: Yeah, yeah. So, I’ve used the example as well. If you look at the Trump inauguration days, if you look up there, who was up there with them? It was those Mag 7 companies. It wasn’t like teachers, firefighters, blue collar workers. It was the CEOs of the world’s largest public companies. Not even necessarily private company. It wasn’t the Koch brothers up there, It was the public companies. That was a very real message.

This is another thing. This is the stock market economy. Growing up investing. We are all in the same age bracket and everything that we’ve been told about investing, is there’s a difference between the economy and the stock market. But what if there isn’t anymore? What if the amount of fiscal spending creates all this money that needs somewhere to go and it finds its way into the stock market where it’s getting pumped up into these huge companies that become so huge and integrated into the US economic system that they literally can’t go anywhere else. And so, you have to support them.

How would you support them? If you had to, you wouldn’t go out and buy their servers, you would keep printing money and you would make those companies the very first stop of where that money goes. So, the US government becomes their biggest client, stuff like that. Look at Palantir, for example.

Jake: Sounds rather– [crosstalk]

Tobias: Dystopian.

Jake: Yeah. Cancerous, [crosstalk].

Ben: I get that a lot. I get that a lot. I don’t think this is dystopian. I don’t see quality of life going down here. I don’t. I look around the world and I think everybody’s living relatively the best lives that we’ve had in decades. I don’t think this is all to create some control economy or some surveillance economy either. I mean, there are aspects of that. Data gets tracked, etc. But I think quality of life’s improving. But before we get too deep into implications, let me back up and do the last F, the fiat part.

Jake: I thought it was going to be a different F word for all of us.

[laughter]

Tobias: I’ve got a fifth– [crosstalk]

Ben: There are five Fs today.

Jake: Yeah.

Tobias: Actually, I’m going to have a sixth one.

Jake: Yeah.

Fiat Money and the End of the Gold Standard

Ben: [laughs] All right. So, the last one is fiat money. So, we’ve already touched on this. In 1971, Nixon closes the gold window, and now the US government can expand and contract the money supply by the stroke of a pen or a keystroke, more aptly. That didn’t exist before then. That makes things a lot easier when you’re dealing with periods of economic slowdown. If you look at the history of the US economy before 1971, you see, it is absolutely riddled with periods of inflation and deflation, and sometimes in very rapid succession.

That is really, really hard for business owners and basically an economy to operate, if you have this back-and-forth yo-yo effect. Yes, that website, what happened in 1971 and everybody likes to say the world started falling apart when this happened. I think completely the opposite. If you look at post-1971, yes, inflation has been a one-way street going higher, but you have stepped massively away from repeated frequency of these massive economic recessions and depressions for that matter.

If not for 2020, which itself was a very brief recession lasting, what, two months, three months, we would have been right now on the longest streak of US history without any recession from 2008 to present day. But even counting that 2020 recession, we still have a massive win streak, basically you could call it. I think that’s a lot to do with fiat money, because if you can expand the money supply when needed in when things are slowing down, you can help the economy. Again, that goes back to that collective profit equation.

Jake: Ben, what would be your counter argument to the idea that if a civilization can just print their way to permanent prosperity, we would have figured that out in the last 5,000 years.

Ben: Well, we hadn’t, because I don’t think that there was a good way of keeping track of that. 1971 was the blockbuster Netflix moment for policy making of currencies. That was a real change in the way people thought about money supply, where there’s no tether and there won’t be a tether.

Historically, whenever we’re dealing with these periods of big money printing, the idea was always that we are going to return to some backing at some point. That was completely gone in 1971. It took a while for it to filter out and go through and make its way into the public common knowledge. But there was no intention to ever go back. I think that’s a big part of it.

Well, in a fiat money system, you do still have the very real resource constraint, where– You’re still constrained by resources, right? You can’t just print your way into prosperity, because you will run into the inflation boogeyman at some point who says you can’t do it anymore and then things will go very bad very quickly. But we’ve been able to manage it so far. I think we’ve done a pretty good job of it. We look at the deficit spending right now and I don’t see that we have an inflation problem. Inflation’s still been trending lower. If you want to talk about government deficits being a problem, let’s look at Japan and look at zero interest rates forever basically until recently.

The monetary operations under a fiat system are very different than under a gold system. They share the same terminology, which gets everybody confused, because you’re using the same words to describe different concepts.

Just to give a good example that, under a gold standard, your interest rate on government debt is meant to stop you from taking gold out of the treasury. So, that’s why when you are looking– There’s very famous thing about– Niall Ferguson put it out there about when spending on interest exceeds spending on defense, something like that, your government http://cut cost. That’s because that only works under a gold standard. Because under that standard, if your interest rates get too high, you need to have a lot of gold in your treasury in order to make that happen. You don’t have that much gold in the company and then economy falls apart, because everybody keeps trying to pull the gold out and it goes bust.

But if there’s nothing to pull out, if there’s no gold to pull out, there’s no gold backing under any of this, then that whole analogy doesn’t work anymore. The government interest rate is a policy rate. It’s not meant to represent something that you can pull out tangibly from the government to get your money back. So, that’s a really big change.

Now, the other thing too on that, is now we’re talking about making currency programmable, not just in this one way. I mean, programmable in the sense of like you can expand it or contract it. That’s programmable in one way. Now, we’re talking about programming it in all sorts of different ways.

So, I read a lot of central bank literature, stuff they put out there regularly, their research. You can see that they’re talking about different ways to make currency– Well, one thing they’re talking about is making it non-hoardable, right? So, what if you had a dollar, and after you spent that dollar, it could no longer be transferred? How would you do that? Well, you need something like a stablecoin or some contract based crypto, what if you had a dollar that was only available for six months and then expired? So, why would you do something like that? Where would you use that idea?

Well, if you were in a big economic slowdown and the economy obviously needed money, you as a government could provide that money to the economy, but you could put extra terms on it saying that, “Okay, we’re going to print 100 billion new space coins, but these space coins are going to expire in six months.”

In doing that, you can now change the runoff aspects of it, the follow-on aspects of that, being one of the big downsides about printing money every time you get into a recession is there’s somebody on the other side of that hoarding it, and it adds this huge inequality problem. Because all through history, when are the most number of millionaires and billionaires and possibly future trillionaires, when are these people created? When are these people minted? They’re minted right after these massive crises, because they’re on the other side of receiving all that government money that’s just been printed. So, what if one way to reduce that issue of inequality was to make that currency that you just made non-hoardable, non-transferable.

Tobias: So, you buy a good with this money, and then the storekeeper has this dollar that’s going to expire, what do they do? They go back to the government and they say, “I’m going to buy a dollar’s worth of whatever that you’re going to give me in exchange for this thing?”

Ben: Yes.

Jake: Who takes the dollar, when there’s 10 cents left on it?

Ben: You can buy a government bond with it or something like that. This isn’t pie in the sky stuff. This is http://cut stuff that’s actually coming out of world’s central banks.

Tobias: You don’t think this is dystopian, a little bit?

Ben: I think dystopian is letting wealth inequality keep going on the same pace it has. If you do that, then you’re in real dystopian territory. I think that right now, the solutions to some of the biggest problems that we’re dealing with are found in the idea of moving towards an AI economy using these new tools. I mean, it’s worth a shot at least. We’ve tried all sorts of things and this inequality problem is not going away. I think we owe it to everybody to try something new.

Jake: That expiration sounds like the worst part of the Cantillon effect, where it’s like the person at the very front of the line gets to use it at full strength and then [Tobias laughs] pull the ladder up in the tree– [crosstalk]

Tobias: The last person.

Jake: Yeah. No one else gets to use it at that point. Like, that seems worse.

Ben: Yeah. Well, that’s the stimmy check. Those are the stimmy checks in 2022 that went out. That’s the Cantillon effect. Those things went out, they got printed, they got right into the hands of people and they put them to work. So, the idea there is what can we do to limit the wealth inequality aspects of that money. So, those are the four F ideas. So, those are the four big things that are coming together now at this point in time that make this point in time unique. I think that they make it extraordinarily difficult to have a recession.

We might have these parts of some tepid slowdown parts, if you even want to call it that, but not really. Consumers keep consuming, because there’s this money that’s being printed over and over and over again. It’s making its way into companies. We have a lid on interest rates. It’s making its way into the market. The whole reason that we can operate this way is because of a fiat money system, not a gold backed system.

Tobias: I think those are fascinating ideas. Let me just give a shoutout. We’ll do veggies, then let’s come back and talk about the implications of this.

Jake: Sounds good.

Tobias: Petah Tikva, Israel. What’s up? Santo Domingo. What’s up? Winter Park, Florida. Warren Buffett’s always in the house, down in Winter Park. Lewes, Delaware. Tampa. Tallahassee. Brandon, Mississippi. What’s up? Chabiza? I don’t know if I’m saying that right. Kennesaw, Georgia.

Bethesda. Denver. Mac’s in Valparaiso. What’s up? Jupiter, Florida. Gothenburg, Sweden. Just jumped a bit. Hold on. “The meanest streets of Gerrards Cross.” What’s up? Surbiton, London Suburbia. Jupiter, Florida. You’ve already won, Sam. I always say that. Madeira Island, Portugal. Wiltshire, England. Boise. Temecula. That’s a good place too.

Jake: It’s a good spread.

Tobias: “Thanks for the veggies.” Slav Elenkov tipped us. Let me just scan down here a little bit. Okay. JT, do you have some veggies for this week?

Jake: I do. Let’s do it.

Tobias: Let’s hit the veggies. Market, 11:16, we’re a little bit late today. [Jake laughs] 16 minutes past the hour.

Jake: All right.

So, you see a face in the clouds, a dragon in the wood grain, a Fibonacci signal in a candlestick chart. It’s not really a hallucination. That’s really just humanity. What you’re experiencing is something that researchers call pareidolia. I believe that’s how it’s said. And that’s our brain’s evolutionary knack for spotting patterns even when there’s no real pattern to be found. Here’s the mystery that I want to explore today.

If this concept was meant to help us survive, why does it so often lead us into trouble? We’ll look to the humble pigeon for answers. So, some fun pigeon facts that everyone was dying for, I know. They have excellent color vision, even beyond what humans can see. They found that they can distinguish between different artistic styles, like impressionist versus cubist paintings.

NASA, before they sent humans into space, were training pigeons for potential space missions. Pigeons can remember human faces, even hold grudges. Their studies have found that they can recognize individual people in and will treat them differently based on past interactions, like whether someone fed them or shooed them away. They have extraordinary ability to find their way home, of course, from hundreds of miles away, even if they were released in a place that they’d never been before. They use a combination of the Earth’s magnetic field, the position of the sun and even these low frequency sounds that humans can’t hear and they use all this to navigate.

During World War I and II, pigeons were used to carry crucial messages across enemy lines, and some even receiving military medals for bravery. And then, of course, oddly enough, Nikolai Tesla famously fell in love with a pigeon and reportedly said, “I love that pigeon as a man loves a woman, and she loved me.”

[laughter]

So, I’ll leave that one where it goes. So, anyway, let’s travel to a psychology lab. We see people in white lab coats, and they’re training pigeons to peck at these screens. At first, the game is very simple, like, they have a Monet painting on the left key and a Picasso on the right. These birds, they aren’t just memorizing sets of images. They’re actually generalizing patterns. You could show them a Monet that they’d never seen before, and they’d still get the classification correct. If these pigeons had Bloomberg terminals, they’d be the original technical analysts.

But then, the experimenters up the ante. They introduce ambiguity. They start blurring the images. Maybe half a Monet mashed with a Cubist fragments. It really turns into really a Rorschach test. Oddly enough, the pigeons then double down. They’re the more distorted the image, the more confidently they’re pecking. And the birds, they start seeing Monets and in every smear of spilled ink, basically. They’ll see a Picasso in a popcorn ceiling. If this sounds familiar, it’s because, we, humans also see patterns all the time where none exist. In our case, the cost isn’t just a mistime peck. It could be real dollars.

Let’s just imagine this silly idea of a pigeon hedge fund manager. He’s trained on a very simple signal. Every time a little red triangle appears on the screen, it pecks the buy button, and voila. The breadcrumbs of returns arrive on schedule every time. On a down day, that’s red, it buys and it gets its reward on the bounce. After enough of this reinforcement, this association really starts to lock in. But then, things start to get a little bit messy. The triangles maybe get a little blurry or the red shifts to magenta. Maybe buying doesn’t always lead to an immediate gain, but our little pigeon in his Armani suit just keeps pecking away.

Now, why? It’s because he remembers. He remembers when the pecking worked and it wants that dopamine hit of the breadcrumb again. But the environment changed and the pigeon didn’t notice. This is what data scientists might call overfitting. A model is working well in historical data, but it collapses in the wild going forward, because it’s also learned a lot of the noise along with the signal.

So, in investing, we see overfitting all the time as this narrative addiction. The Uber for X, the next Amazon is XYZ, AI is the new electricity, you hear lots of different things. We peck because it once worked, or because we’ve seen others peck and win in that way. And so, let’s just look at a real quick biological detour here, where our brains evolved in these environments where false positives were very cheap and false negatives were fatal. So, what does that mean?

Like, if you mistook the breeze for a predator, you lost a moment of calm, but you live to fight another day, no real harm done. But if it was the opposite and you thought that it was a gust of wind but it was actually a lion, well, you became lunch and you didn’t pass on as many copies of yourself. So, we’re built for over detection of patterns. In the jungle, this wasn’t evolutionarily adaptive, but now in the modern world where there’s a lot of stochastic chaos and zero-sum competition, it’s not so clear that’s good for us. So, we inherited this pattern recognition, these story constructions, they’re calibrated for savanna survival or we are, but not really necessarily stock selection.

So, let’s see if it’s also not just visual. A lot of it is actually narrative patterns that we’re looking at as well. So, it’s a little bit beyond the pigeons. So, the pigeons weren’t actually that dumb. They’re just conditioned. We do the exact same thing with our prior training that we get rewarded for. So, every bull market has conditions, a new class of investors to mistake luck for skill. Every meme stock cycle trains us to associate narrative and virality with investment merit. Every era has its number go up technology. The market gives us this reward for patterning matching until it doesn’t, and then it can punish us until we’re kind of like Twain’s cat that won’t sit on a cold stove either.

So, what do we do? Throw up our Hands, stop looking for patterns at all? Probably not. It could still be a very useful feature for the human OS. It’s not like you can turn it off even if you wanted to. When it’s done well, it actually goes by another name, which is creativity.

So, perhaps, we should try to use that creativity in the studio and not on stage. So, what do I mean by that? In the studio, you can generate patterns freely. AI is super helpful for this. It’s incredible for helping you think through things. On stage, that is maybe in your portfolio, you should only act on signals that fit with rules that you wrote down in advance. A little less ad libbing, little less jazz.

So, how do we get less jazz? Ask yourself the base rate. What happens most of the time for bets like this? If you don’t know, you’re improvising. And that’s not really investing. If you can’t sketch the causal chain or thesis on the back of a napkin, it’s likely that it’s a story that might be leading you to trouble. You could run premortems and set trip wires. Define in advance, what would make this bet become signal versus noise. Set price and time and thesis mileposts that you need to see in order to see if you’re on track for your thesis.

When one of these tripwires hits, you don’t negotiate with yourself. You just execute what your best played plans were. You don’t talk yourself into the why you should change your course. Sizing for a little bit of uncertainty. Smaller when something is potentially fragile. Larger maybe when it’s more robust. Survive first and then optimize second, like nature does. Of course, journal and keep score timestamp hypotheses with your probabilities. Briar scores are amazing. Red team the narrative, try to beat it up. AI is quite helpful at arguing the bear case of something for you. If it wasn’t obvious, basically this last minute is all a backdoor pitch to use Journalytic. Everybody already knows that.

[laughter]

So, to wrap this all up, markets are these probabilistic jungles. But we carry this stone age gear that’s not that dissimilar from a pigeon’s if we’re being honest. This mismatch explains why we overreact, why we chase heat, why we cling to stories and charts and gurus and why we draw naively straight lines up and to the right and maybe why the most successful investors often make it look very boring. I think there’s a clue in that. They don’t need a story for every single tick in the market. So, final words. Be creative like an artist, verify like an engineer and size like a bookie.

Tobias: Brilliant. Good stuff.

Jake: Thanks.

Tobias: Ben, we’ve got about five minutes left, so we don’t have a lot of time. The one question that came to my mind– The thing that stands out to me, if we have this unfettered money spending and we live in a world where resources still are, they have to be mined and things have to be manufactured and put together, aren’t we creating this massive inflation and aren’t we seeing that in lots of different respects?

I think vegetables between June and July in the states were up 40% month over month, which is a big jump. Meat’s done something similar 40% month over month. Those sort of things may not be showing up in CPI, but it’s inflation that people are actually paying at home. We’ve got high house prices relative to incomes. Isn’t that asset price inflation the consequence of all of this?

Inflation Dynamics in a Fiat System

Ben: The house thing is a little bit more to do with the supply of homes being built. But in terms of the general CPI inflation story, I mean, inflation has been coming down. I think that’s without a doubt, notwithstanding that vegetable prices may have been up 40% in the course of a month.

Jake: Well, the rate of increase has been going down. We’re never getting anything back.

Ben: No, no, there’s no deflation. That’s not the point. Deflation would be very, very bad. You don’t want to live in a world where this goes in reverse.

Tobias: I don’t know about that so much, but yeah.

Jake: I wish my dollar went further when I went to the grocery store.

Tobias: When you buy a TV, you like deflation. When you buy a computer, you like deflation.

Ben: The thing that you want to look out for here, is that the rate of government money spending has a lot to do now with the amount of interest that the treasury pays out. So, even if the treasury goes from four and a half to four and a quarter percent as the September cut is probably going to happen, that still means that the government is still going to be pushing out more money through the interest payment channel to everybody else. That’s because if you look at the total composition of government debt, we went from a total weighted average coupon of about 1.89% at the end of the 2020 up to just over 3% now.

Basically, what we’re doing there is we’re replacing all of the low interest debt that we put out there 10 years ago in 2015 at [chuckles] minimal rates. All of that is now getting reissued now essentially at whatever the current rates are. Most of it is coming out of bills, which means it’s going to be four and a half right now and then after September, maybe four and a quarter. The idea there is that it’s still dragging the net interest costs for the government up. That’s your new inflation rate. The big difference is now the total amount of government debt is larger than GDP. So, every 1% increase in that coupon is 1% of GDP in terms of spending. So, that’s your new inflation rate.

So, I think that what’s going to happen is CPI– Whatever measure of inflation you want to use is going to now gravitate towards whatever the weighted average coupon is a government debt. It has to mechanically, in my opinion, because this is new money that the government is printing and sending out into the world. So, that’s the gravitational anchor now for inflation.

So, whatever that number is is what I think inflation will cling to. So, I think that CPI is probably going to keep floating up higher until three and a quarter, maybe up to three and a half into the end of the year, possibly higher than that, if we have some tariff stuff that that happens. Some increase in cost from tariffs. But that is the new anchor point, I believe.

Tobias: Just before we run out of time, we’ve got about two minutes left. What are the implications for equities and for value? I mean, it sounds like this is just a continuation of what we’ve seen where there’s no mean reversion here.

Investment Implications: Equities, Bonds, and Gold

Ben: There is no mean reversion. There’s only trend divergence, not convergence. If you’re going to keep the passive system going, this means that Mag 7 equities, in my opinion, these things just keep going higher. Market goes up into the right. I’m not so sure about the rest of the S&P 493. To me, I don’t know what that trade is. That trade is a lot harder, in my opinion, than owning the things that are going up into the right. It’s a pretty clean, clear signal, in my opinion.

Bonds, I don’t like them. If they were to turn up and go higher at some point, maybe I’d be interested, but not now. Gold’s been very interesting. I own a lot of gold in the portfolio. Basically sticking to things that are working, improving themselves. I don’t like mean reversion as a trade, because in this environment, the 4 Fs, it’s very hard to tell with something that’s not working anymore if it’s wrong or if it’s just not ready yet. I’d rather stick with the things that I know are working and going up.

Tobias: Yeah. It’s a fascinating framework. I appreciate you coming in and outlining for us here today. We are coming up on time, so please tell us how folks can get in contact with you or follow along with what you’re doing.

Ben: Yeah. So, hop on my Twitter, @benkizemchuk, K-I-Z, E like echo, M like Mike, C-H-U-K. Or, just type me into Google, I’m on the Wellington-Altus website, you can get at me through there.

Tobias: He’s a great follow-on Twitter, folks. I really enjoy it. JT, Journalytic, any other final words?

Jake: No, just thanks Ben for coming on and sharing really interesting viewpoints. Appreciate it.

Tobias: Yeah. We’ll have to have you back to air it out a little bit more. Thanks, folks. We’ll be back same bat time, same bat channel next week. We’ll see everybody then. Peace.

VALUE: After Hours (S07 E28): Ben Kizemchuk on fiscal dominance, financial repression, passive flows and fiat currency

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