We've Created "Unsustainable Systems"
JARED DILLIAN: I am Jared Dillian, and I'm here with Simon Mikhailovich of Bullion Reserve. Simon, we got to talk over the weekend. We did a little bit of a warmup for this interview, and you said that you lived in the Soviet Union until age 19. I want to talk about this first. Because I think it's relevant, just based on current events. Can you just spend a couple minutes talking about your experience? Why you left, stuff like that? You said, you lived in St. Petersburg.
SIMON MIKHAILOVICH: Yeah, I was born in St. Petersburg, I grew up there, right from just the [?] Street, which at the end of the street was the [?] Department. Those were the 1960s and 1970s. I was born in 1959, so relatively speaking, I caught growing up, I guess, the most benign part of the Soviet experience. Stalin was gone they weren't taking people in the middle of the night. There was still a police state, and if you opened your mouth, you could get hurt.
If you didn't open your mouth, if you said the right things, you could more or less conduct a normal life. It was a very difficult place to be. There was, aside from the material discomforts and the difficulty with getting anything, the economy was stagnating. There was absolutely no growth of any kind. People did the same thing year in and year out, same jobs, same places, no dynamism of any kind. Of course, now we know it is the era of stagnation. We didn't know that at the time.
Furthermore, a lot of symptoms that eventually led to the collapse of the Soviet Union that I have been observing here and I've spoken in some of these interviews, which is loss of faith or loss of confidence of the population in the policies of the government, loss of confidence in anything, they're being told, officially. Inflation, hidden inflation, lack of growth, lack of opportunity, politically repressive regime, you have to speak only politically correct things, you can't disagree. Your whole life is based on two realities, essentially, what you can say at home and what you can say outside of your home, and even at home, you have to be careful. All of these types of conditions, corruption, official corruption,
you have to pay bribes everywhere to get anything, massive regulation, tightly controlled population. All of that put together, it's brought to us, to my father and myself mostly, my mother didn't want to go, that there was no future here. There was no future. The system didn't work. People didn't seem to work. Same like here, you everybody was supposed to work, but you couldn't find workers. And when you found workers, they took the salary, but they weren't doing much. The saying was we pretend to work, and they pretend to pay us. Yeah, or they pretend to pay us and we pretend to work. It was it was not like this or that. I know that people think from
looking from the West that life in the Soviet Union was like some black and white movie, where you woke up in the morning, and you got your three ounces of bread with water. No, it was not like that. My mother made eggs for breakfast, and I went to school. We have holidays, and my grandparents had a little country cottage near the lake and all that.
It was a much lower economic level than let's say here, but there was normal life. Family gathered, and people have children and grandchildren, married and lead lives, but in a social and economic way, it was existence as opposed to living. We made a decision at some point that the system had no future, which of course it didn't as it turned out later. We left in 1978. I guess we started this process in 1977. It took us a year to get out.
Got completely expropriated on the way out, have to give up everything, citizenship, old property, old money. Suitcase, the person and $100 on the capital controls is all you were allowed to take. If you tried to smuggle something going through that border, you may not end up in the West, you may end up very far very deep in the east for a very long time. The stakes were so high that it wasn't worth it for most people to even try taking anything out. They were cutting seams of clothes. It was like that and you have to arrive
to the customers four hours ahead of your flight and go through a full complete like everything on the table. Every scrap of whatever is in your suitcase or on you, was on the table and examined and questioning and all that. Those are the circumstances of how we decided and how we left. Obviously, that left an impression on me that to some extent informs what I think now about what I see or observe going around me, wherever it is, I am including right here in the United States, where I've been for 43 years. JARED DILLIAN: One of the things, it was like the
first thing you mentioned in the parallels between the US and the Soviet Union was a loss of faith in politics, loss of faith in institutions. Can you talk a little bit about that, because I've been noticing that myself? SIMON MIKHAILOVICH: Well, this is all tied with propaganda. Everything in the Soviet Union was propaganda, the press was controlled by the government, all media was controlled by the government. The censorship of whatever people had access to in terms of official information was 100% complete. There was
absolutely nothing that could make into any form of media without being run by the censorship organizations that distributed censorship that existed throughout the Soviet Union. The information that people had to be from either Voice of America or some of the foreign radio stations that were broadcasting into the Soviet Union, were being suppressed by the technology at the time, they were being drowned out by the countersignals. It was hard to listen to, particularly in large cities. Then who you're going to believe? What you hear on the radio or your own eyes. Every five-year plan was overfulfilled, ahead of schedule, ahead of budget.
In other words, every company beat its earnings estimates. Everyone every time, and there was nothing on the shelves. At some point, you say, wait a minute, something's not connecting here. I'm being told that I live in paradise and in the meantime, I'm spending three hours in line for toilet paper. Even though people kept saying, well, these are
temporary difficulties, we're building communism, this is just growing pains, but after a while, just like here, it becomes like growing pains. I'll be dead by the time this growth has ended. What's going on here? It's not happening. Then what happens is-- and this is the real problem and this is a problem here. As the government keeps saying things, by the government, I mean generically, authorities, keep saying things, and as some things pan out to be true and some things don't pan out to be true pretty soon. There comes a moment when people say, I don't know
which part of it is true, and which part of it is not. That's where confidence is lost. You can be 80% truthful, or 70% truthful, because, okay, fine. If you're 100% liar, people will catch up to you right away. But if you're a 20% liar, it takes a while because it's all mixed with truth, and so there's always an argument, well, maybe they didn't know about this. But eventually, when that happens randomly, but consistently, you say, I just don't know. Anything they say, I have no idea whether it's true or not. Since they lied periodically, I don't know what to believe. Then people start saying, well, I don't know what
they're saying but I know what I'm seeing. That's where the big disconnect comes. I would say that in the end, the collapse of the Soviet Union was not brought on by a revolution or was brought on by some sort of a huge economic crisis. There was a massive economic difficulty, but there was no acute crisis. It was brought on by this wearing down of credibility to the point where the elites themselves, or counterelites within the elites, said, this is all BS. It's not really working.
We need to do something, and they did it. The collapse of the Soviet Union was a political event as a result of this Glasnost and Perestroika, the liberalization of ability of people to come out and say what they want. Then eventually, that led to a change of regime which happened overnight. It was a political decision and there was no particular when we'd say about the collapse of the Soviet Union. There was no explosion when it happened. It happened on a Christmas night in 1991. One flag went down, the other flag went up, and everybody woke up in the new world and then hyperinflation, collapsing economy and so forth. That's what gives me the
creeps, if you will, with what I'm seeing here. JARED DILLIAN: I do want to talk about this a little bit more with respect to China later on, but let's get to the point. One of the things you emailed me, you were talking about the current conditions that we are observing are a logical outcome of globalization, financialization and virtualization trends. Financialization and globalization, I'm familiar with, can you explain these for me? SIMON MIKHAILOVICH: First of all, what do these words mean? Let's define them. Let's define the
terms but let me explain what I mean when I say that. Financialization, essentially is optimizing economy, to finance and asset prices. The simplest implication of that in real life, we can see in the behavior of companies that borrow money, let's say, at all-time low rates to buy their stocks back at all-time high prices in order to drive them to all-time higher prices, which is fine as far as it goes, but the money that's the company's borrowing is not going into creating new products, services, and predictable cash flows for the future. It's basically financial engineering to reduce the number of shares and thus juice up the price and the incentive, of course, is because the management of the company is being compensated based on stock options. That's what it means optimizing industry and economy around finance
and asset prices. The incentives aligned up not to produce the most sustainable, innovative, long term competitive, strong balance sheet companies, but rather short-term profitability at any cost, by any means possible. JARED DILLIAN: When do you think we made that switch? SIMON MIKHAILOVICH: I think that that goes back to the early 1990s probably. This is something that- - the financialization of economy started probably in the 1970s during the 1970s inflation going off the gold standard and expanding the money supply, and then essentially subsidizing-- this also has to do, financialization is a tack that we took in order to solve the systemic crisis that we had in the 1970s. The systemic crisis in the 1970s essentially resulted in a situation where for the next 40 years, growth in the United States and in the West in general has relied unfailingly and almost 100% on increase of credit. In other words, a portion of consumption, 70% of the US economy is consumption, and consumption is being subsidized to the tune of several percent every year by borrowing money. In other words, we're buying more than we otherwise could afford
by increasing credit. That has gone on for, like 30-- I guess you'd look back early 1980s is when this started. JARED DILLIAN: I remember this was in like the late 1990s. I used to read Barron's and Alan Eagleson work, the Up and Down Wall Street, I don't know if you remember that. SIMON MIKHAILOVICH: I absolutely remember that. Yes. JARED DILLIAN: He was obsessed with this issue,
and periodically, he would post a chart of total debt to GDP in the United States and it went from 150% to 200%. He was talking about this concept about we were financing consumption through credit and he basically said, this is unsustainable, so it's going to crash. And now, total debt to GDP is like 400%, so when is then? SIMON MIKHAILOVICH: It's a faith-based initiative. It's about confidence, credit, the word credit, comes from the Latin word credere, which means to believe. It's a belief. It's a belief system, just like communism was a belief system. It didn't work in real life, but it was a belief system. Guess what? On the strength of that belief, the Soviets controlled the largest country in the world for 70 years, 70 years, with total BS ideas, excuse me, but people bought into those ideas, and then, of course, a few bayonets for those who didn't get the message in time got them in line.
We can't dismiss the fact that the power of ideas and power of dissuasion of large governments, and particularly when a large number of people are benefiting from these conditions. Who's benefiting? The people who are in the position to make decisions, the decision makers are benefiting from these conditions. The Fed governors are trading the market in front of the announcements that they make. When you have those kinds of conditions, it's possible that it goes longer than one could imagine. I think the financialization started in the 1980s, 1970s and 1980s. I think globalization started in the 1990s. There's a great interview
that I would recommend to anybody who hasn't seen it, I've tweeted about it before, from 1994 with Jimmy Goldsmith, late Jimmy Goldsmith, who was a British financier, who wrote a book, I think, called The Trap and Charlie Rose interviewed him for about an hour about that book. He explained in that book very coherently how this outsourcing to China is going to ruin us all. When you listen to that interview, it is positively prophetic. Globalization, essentially, and he explained it there and that's what it was, is it sounds like nice, it's all bringing the world together. What the economic substance of that is, is importing cheap labor and cheap resources. Economically, it's similar to colonialism in a
sense that the empire, the core empire, marshalls resources in the periphery of its dependence, or its counterparts, whatever that it controls in some way to obtain for the main country, cheap production or cheap agricultural goods or cheap resources that are less expensive than they would be in the home country, or if the home country were buying it from a similar country. In other words, from another emerging markets, we'll call it these days. I don't know why we still call China emerging markets. It's one of the largest economies in the world, I don't know. I think it's emerged. That's the idea. The impact of globalization was
this disinflation, which is obtaining cheap goods, and producing those goods in factories that didn't have labor laws, that didn't have environmental laws, and all those costs that would have had to be borne and would be part of every little thing that we buy, little trinket that we buy. They're just not there, so the trinkets have become cheaper than they otherwise would be. Now, when you pair that with financialization, which is optimization, not to robustness, not to sustainability, but optimization to short term financial results, and you pair that with digitization, which enables the whole thing, why do I say it enables the whole thing? It enables the whole thing, because you can't manufacture stuff in China and ship it here without real time communications. You can't because all the drawings, and everything gets emailed back and forth instantly. I happen to know this, because my daughter works at a company that manufactures stuff, a consumer products company, and so I can see what they're doing and how the conversations with factories are real time, changes are made real time. Without digitization,
without the technological revolution, that level of outsourcing would simply not be feasible or possible. Neither the same level of financialization would be feasible or possible. Derivatives. We have trillions of dollars of derivatives, we didn't have that. The digital world removes a lot of limitations that the physical world imposes. JARED DILLIAN: I want to talk about globalization for a little bit. We went through this free trade revolution in the 1990s. Clinton was a very free trade president, we signed NAFTA. At the time, you had these economists that talked about comparative advantage, and Ricardo and stuff like that. You know how comparative advantage works. We had this arrangement with the east
where they exported goods to us, and we exported finance to them, and that worked for a long time. Why did it stop working? SIMON MIKHAILOVICH: Well, we just saw what happened with COVID and with supply chains. When you optimize something to no margin of safety, it works beautifully until you need margin of safety. When do you need margin of safety? You need margin of safety when there's a disruption of some kind or when something happens. Here, we see COVID happen, disruption of supply chains, and all of a sudden, we realize that this whole just-in-time world that we build is subject to disruption basically, on a global scale and immediately, essentially.
The lead times, this started several months ago, but the lead times are very short, and then you get into a big problem. I believe that this is causing a reassessment on the part of many companies as to when their supply chains and how much inventory they need to carry and where do they need to manufacture. Beyond the companies, the governments, they discovered that let's say personal protection equipment is made in China. Antibiotics are made in China. A lot of things are made in China apart of what we used to call civil defense. Essential goods and services that need to be accessed or potentially cranked up in terms of manufacturing in case of emergency, and now we're discovering that the capabilities to manufacture them are not onshore, they're somewhere, and then we can't get them because we don't have enough containers and so on and so forth. I think what we discovered simply is a disruption like COVID has revealed the fragility and the lack of resource, backup resource in this entire firmament that we've built on the strength of these technologies, and basically leverage.
That's what leverage is, it works both ways. JARED DILLIAN: Yeah, the other interesting thing about the just-in-time inventory, so I got an MBA in the late 1990s. That was like the thing that everybody was talking about just-in-time inventories. Just-in-time inventories make sense during a deflationary environment, because if you're carrying inventories, they're losing value. You don't want to carry a lot of inventory, you want to carry it as little as possible. In an inflationary environment like we're
in right now, it actually makes sense to carry more inventories, because the value of those inventories are actually increasing. It incentivizes people to carry more inventories. SIMON MIKHAILOVICH: There's another aspect to it. This whole just-in-time inventory concept came from Japan. Remember Japan was going to defeat the world, or not defeat the world, but own the world and the [?] were the way to do business and so forth. They're like in the 1960s, the conglomerates. But in Japan, the just-in-time inventory, it's a domestic industry, of course, if it's Ford, and the suppliers that are within miles of each other, maybe that makes a lot more sense.
If you're carrying just-in-time inventory, except that it's coming from 10,000 miles away, and there are two ports or three ports through which it all can come and all the things we're seeing now, there's a whole other angle to it. There's just physical limitations to what you can do. Yes, financially, you're right, but in terms of practical ability to manage that without disruption, it depends on everything working just so at all times, and sometimes no. JARED DILLIAN: All of this results in a lot higher prices. Because what we're experiencing right now
is not globalization, but deglobalization. We're reversing what's happened in the last 20 years. If we are onshore this manufacturing, and we carry these high levels of inventories, this inflation that we're experiencing, it's not just monetary inflation. The Fed gets a lot of the blame, but it's actually more of that. COVID actually sparked off this deglobalization and we're going to have high inflation probably for 10 or 20 years. SIMON MIKHAILOVICH: No question about that, and
that's what you and I discussed before we started is I wanted the point of this conversation not to be a transitory, non-transitory, therefore, what should I buy? The point is that I believe we're going through a secular shift in conditions and that this secular shift started with the with a crisis of 2008. It's essentially that business model of just-in-time globalized, cheap capital, high leverage, old derivatives. That model met its match, if you will, in the 2008 crisis. Since then, we've been carrying forth on extraordinary monetary policies, extraordinary
fiscal policies, extraordinary measures to control the markets and the interest rates and the cost of money. We have not had a free market of any kind. Whatever problems may have been before, they've been exponentially increased since 2008. The last 12 years, I think, is a, I don't know how to say it, it's a chronic patient on life support, basically. Now, we took another turn down with COVID and that's why I think that we are undergoing through a protracted repositioning, global repositioning, geopolitical repositioning, economic, geoeconomic repositioning that will have very far-reaching consequences financially and economically and us having it but without an abrupt end, if you will, yet so far. JARED DILLIAN: I want to get back to what you were talking about in the credit cycle.
Now, we had a credit cycle in the pandemic in 2020 that lasted about eight days. SIMON MIKHAILOVICH: Yeah, yields spiked to like 10%, 11% for about a day or two and then that's it. No defaults, or very few defaults. JARED DILLIAN: The Fed started buying corporate bonds, they bought the corporate bond ETFs. I actually wrote about this in my newsletter today,
the consequences of that are going to extend out for decades, because the Fed has withdrawn most of that support from the corporate credit markets. Corporate bonds are free to trade lower, but it's very hard to short a corporate bond with the expectation it will go lower if the Fed can, again, come in, and basically provide a put in support the credit markets again. I failed to see how we're going to have a real credit cycle in the next 10 or 20 years with the constant threat of the Fed stepping in and doing this again. SIMON MIKHAILOVICH: Well, look, the truth is
nobody knows anything. We don't know. The future is unknowable, and we can't know it. We know the past, we know the present, we can analyze what we see in the present, and make judgments as to how sustainable and whether it makes sense or doesn't make sense, but we don't know how long it goes. We do know from history, from long history that while what's going on today is unprecedented in scope, because of the technologies, because of the conditions, because of a lot of different things.
We know that in history, there were many episodes like this, they were not exactly like this. The opening line of Anna Karenina in Tolstoy's Anna Karenina is, all happy families are alike. Every unhappy family is unhappy in its own way, meaning that every crisis has its own unique features but we know how unhappy families end, usually in a divorce. How you arrive there may take different number of years and different types of circumstances but that's where we're going, I believe. When you say for the next 40 years or for the next 10 or 15 years, so I just look. The yield on high yield bonds right now is about 4.4%.
Inflation is running at 6%. This is high yield bonds, this is not government bonds. Forget about the fact that they're negative real return of 2% a year. What about credit risk? Well, so there's zero for credit risk. Well, I guess technically, there's 325 basis points of spread from the Treasury. That's 1.5% with 6% inflation. What sense does this all make?
People say, why isn't gold going up? Well, I say why should it go up? Why aren't bonds going down? It's all part of the same thing. My answer to all that is, what is manipulated here are incentives and confidence, not the actual markets. Yes, of course, the markets are manipulated, but you can't manipulate the market without manipulating confidence, and manipulating incentives, but you need people to want to do certain things, even though those things don't make sense. Like, is it rational to buy Shibu Inu coin? Well, on the one hand, it's irrational because it's a joke. On the other hand, it's rational, because it's a tradable asset that's going up and people want to make money on something that's going up. JARED DILLIAN: And real rates are negative 5%. SIMON MIKHAILOVICH: And real rates are negative
5%. What we are observing cannot be divorced. You cannot say, oh, it doesn't make sense but it's going on, and therefore it will continue to go on forever. My experience with unsustainable systems, my personal experience, is that they go on, and they go on, and they go on much longer than anybody thought. That Soviet Union let's say would go to the point where when it collapsed, on a Christmas Eve, not a single foreign intelligence agency, Western Security Service has predicted it. After "predicting it" or expecting it for 70 years, they actually didn't see it coming. My answer to what you're saying is,
whatever happens to stop this, we won't see it coming. We may see it coming in theory, like one day, it will come, but we're not going to see it coming specifically. That's the dynamic of bubbles. That's why vast majority of people lose all their money. Because when do you sell? Anything anybody sells, they're sitting there biting their elbows is the same [?] because whatever it is they sold is higher than it was when they sold it. So, how can you keep selling and then it keeps going up and you feel like you're missing out? That's the problem. That's the problem. Even people who ostensibly made a fortune, most of that fortune is still-- all those eggs are still in the same basket.
JARED DILLIAN: We talked about manipulating confidence. My career started in the late 1990s and I've seen two big losses of confidence, one after the dotcom bubble, which, by the way people forget how bad that was. It was a very mild recession in economic terms, but that bear market lasted almost three years. That was really, really tough, and of course, the financial crisis. I hesitate to say, you said we can't see it, but at some point in the future,
we won't be able to manipulate that confidence anymore. SIMON MIKHAILOVICH: It could be an event, or it could be a geopolitical event, or it may come from China, or it may come from Russia. People are not paying attention. There are significant policy changes happening both in China and in Russia, pivotal changes, that may have very acute and unpredictable impact on events. I advise everybody to follow it. These are not small changes. These are very big, directional changes, which, by the way, is one reason why I don't think that China is coming back as the cheap manufacturing hub for everybody forever. They've made some policy choices there
in terms of directing their own internal economy and production resources, that will alter that. It's not a collapse overnight, it's just things have changed, things are different. We are operating at a very high level of leverage to everything being the way it was in perpetuity without anything going wrong. That's the point. Nobody's taking insurance out. The markets are clearly betting that everything's fine. That's what they're betting, and if anything's not fine, then the Fed will fix it. That's the bet. Huge bet. Better not be wrong. That's what I say. JARED DILLIAN: Let's talk about China for a second. We're talking about credit bubbles
and the biggest credit bubble in the world is in China. Just massive amounts of credit creation in China. It's much bigger than what we had in the financial crisis in terms of scale. A lot of people were focused on Evergrande, but not really, it's the bigger implications of Evergrande. The whole real estate sector has at least a trillion-dollar market cap. What does it look like? I had somebody say to me a couple of weeks ago, they said, everybody prints in the end. Is that the future for China? Is that how this plays out? Like, we have a massive amount of money creation in China, they export inflation to the rest of the world, it gets worse. SIMON MIKHAILOVICH:
I'm not an expert on China, or neither I'm an expert in Russia, but I would say that just in my gut, based on my experience in the Soviet Union, I'm not a fan of the Chinese model. I think that when I was in business school, the same story was being told about Japan, that they have this ministry, MITI of trade and industry that could just regulate and tip off these big conglomerates as to what they needed to do and that that level of cooperation and direction from the government was really a perfect system that the Western decentralized system could not match. We know what happened to them. I am not a believer that China, with its communist ideology and the fact that Xi Jinping is president for life and the fact that they think that they can tweak whatever they unleashed in their capitalist spurt there, they can manage all that. Just the government can come and just do a little bit here and a little bit there and all flowers will blue. I don't believe that. I realized that completely free markets and predatory capitalism
has its own issues and runs afoul reality as well, and perhaps there's something in the middle. What they're trying to do, it hasn't worked for the Soviets and I don't think it works. It's not a model for the world. At some point, leadership in the world requires an idea that people are willing to sign on to. I don't see any idea coming out of China, like compelling American idea, or the compelling Western European values that carried us through here for the last few 100 years. I don't see any intellectual capital coming out of China in that way that would allow it to do
what everybody thinks it's doing. I'm not an optimist on China personally. JARED DILLIAN: Yeah, these are the questions that people were asking about China maybe 5 to 10 years ago because their version of state directed capitalism, state directed investment seemed to be working. I don't know if it was the Financial Times or one of the publications but it said maybe this is superior to the American model. Like you said, it's the exact same things that people said about Japan in the late 1980s and in the early 1990s.
If you think about what's happening in China's real estate sector, if you go back 2012, there was a 60- minute show that had a segment on the ghost cities in China. SIMON MIKHAILOVICH: Yes, I remember that. JARED DILLIAN: How they were building these giant cities with no people, and they were going to move people into it, it was all state directed. It was funny, because people watched this on TV, and they were very bearish on China.
Like you said, things take a long time to play out. Nine years later, you have Evergrande and the whole real estate sector is trading in low single digits. It really took, it took that long to play out but it's state directed capitalism, and it's not going to work. SIMON MIKHAILOVICH: It's not going to work because I think experience has shown time and time and time again, that it's impossible for any central authority to calibrate something as complicated as economy for hundreds of millions of people. It's just not possible. They can be successful for a period of time. Totalitarian regimes are very, very efficient at marshaling resources on huge projects, industrialization, electrification, infrastructure build, they're very good at that.
They're much better than that than free enterprise system, but to actually maintain innovation and to run an economy on a sustainable basis, that has never been done. I don't think it's possible to do it. It has to do with human nature. It has to do with the level of corruption. Corruption is directly correlated to the central control. The more permits one needs to get, the more permissions from government or sign offs or whatever one needs to get from people who are making, let's say $60,000, $70,000, $80,000 a year, and these people are signing on the millions and millions and millions of dollars of allocations to private companies that are going to make fortunes, whose owners are going to make fortunes, that just creates incentives that it's humanly impossible to contain. Okay, you can contain it on a small
scale in a small country, but on a scale of a country like China or the United States or Russia, it's impossible. Russia has been corrupt forever, because Russia has been totalitarian forever. Because government has controlled, even under the Czars, even under the capitalist system, they control everything. There's always massive corruption. I think that this is all
human and history is very clear on that. I think increasing the corruption in the United States, official corruption in the United States is directly tied to the increase of the role of government in the economy, which is not to say the government should not be involved in modulating or moderating or enforcing the law or enforcing the rules of the road but it's different from actually allocating resources and directing contracts and directing money to different places. President Eisenhower saw it coming. I've said that before, everybody, every American citizen should read Eisenhower's farewell address that he delivered in January of 1960 or 1961, I'm sorry. You have to read it, you have to read the full thing, not just the military industrial complex.
He specifically described exactly where we are today. He specifically described the dangers of government allocating massive resources to private industry and directing those resources and the potential for corruption and malfeasance that this creates. Here we are. It happened. It happened to us. That's part of the problem. It's systemic in China but it wasn't systemic to our system, but we changed our system to make it systemic to our system. Because the system we have now is a different system from the American system 100 years ago. JARED DILLIAN: One of the things you want to talk about, I'm going to skip ahead a little bit, is the gamification of investing. It's funny because
I have a brokerage account, and I do all my trades by voice, and I never use the app. Recently, I opened a Coinbase Pro account, and I bought some cryptocurrencies. I was telling people, I'm like, man, this is fun. The technology in these trading apps is unbelievable in terms of analytics and looking at market depth and stuff like that. I'm like, this is absolutely incredible.
Then you have Robin Hood and stuff like that. Talk about the gamification of investing. SIMON MIKHAILOVICH: Well, unfortunately, I literally left in the other room, I had a couple of bills that I wanted to show, but that's okay, I can describe them. I have a bill from-- a 100 Mark bill from 1910, or something like that, German marks, great paper, beautiful engraving, real money. Then I have a bill from 1923, I think a billion marks.
Everybody have seen these bills from Zimbabwe, and whatever. That's not the point. The point about that bill is that the paper is cheap, and not engraved, offset print, and one side is printed, and the other side is blank. There's no printing on the other side of the bill. The point is that people inherently understood that that money was funny money. The same thing happened in Russia during the revolution of the 1917, the currency was printed on rolls, like toilet paper, but they were little and they were just rolls and you just ripped off a certain number of pieces of paper. That is a tangible signal that this is funny money.
In the system that we have with digitization, there is no signal that you're dealing with funny money. None at all, because you're dealing with these apps where you swipe right, swipe left. Therefore, at no point do we get a signal that something is going on with our money. The same thing with production of money. Now, Germany ran out of ink. The Federal Reserve is never going to run out of digits. They have the computing power so they're just pushing the buttons and creating more money, and there's no tangible. There's no factories that are churning out this money in the 24/7 trucks that have been delivering it and the quality of it is bad. We don't have any of that signal. Dematerialization separates us from our ability to perceive them.
Now the other aspect of that, gamification, is okay, so go to Las Vegas, anybody who's been to Las Vegas knows how it works. You walk in, there's a big hole, there are no plox, it's always night. Every time a machine wins, and the machine's a program to periodically win, pandemonium. Ringing lights, action, everybody runs, screams, all that, the excitement of games. What is the Robinhood app? Every time you do a trade, there are flashes, there's fireworks, bing, bing, bing, bing, bing, bing, bing, this is the same technology. This is how we bought it. This is how Manhattan
was bought for beads and trinkets. People are excited by trinkets. I'm not making light of it. That's our psychology. The Indians, the Native Americans were excited by these objects, manufactured objects that they've never seen. We're excited by swiping right and
swiping left and seeing the flashes and all these charts popping up in the Lights, Camera, Action. Again, I'm not making light of it. Propaganda works. This is a form of propaganda. This is a form of influencing people's emotions, appealing to people's emotions to elicit certain behaviors. That's what this gamification does. You had to call your broker before, the broker
told you something story, then you place the order, then they nailed you the confirmation. This is all instant gratification, you can be in and out of a security in seconds. Since you can be, people are, and if you make $3, bing, bing, bing, bing, bing, bing, bing the lights are flashing and please, again, don't take lightly what I'm saying. This is real stuff. If you read Kahneman and Tversky about human response to marketing and human response to ideas, this is all real estate game theory. This is all real stuff.
Humans are humans and we are prone to certain types of stimuli, and we respond to certain types of stimuli. That industry has been leveraging technology in tapping into human propensity for instant gratification and the thrill of gaming. Investing which used to be providing capital, savers providing capital to enterprises to create real value in the real economy are essentially now playing at the roulette table with bells and whistles, and people keep winning. Of course, if you keep winning, you keep playing. Why would you stop playing? Except the game is Texas Hold'em,
every next Hampton can take down the whole table. Everything is on the table. You know that Kenny Rogers song, don't count your money while you're sitting at the table? All right, well, everybody's counting their money while they're sitting at the table. That's exactly what's going on. All this money is created inside this ecosystem and it feels real, and it is real for as long as somebody can cash out, but if God forbid, that's it. JARED DILLIAN: One last thing I want to ask you and then we'll finish up is talking about passive investing. If you go back to 2017,
or 2015, 2016, 2017, Vanguard was gathering huge amounts of assets. They got to like five, five and a half trillion of assets and within the financial community, there was this panic about passive investing, because it was growing very rapidly. Ultimately, it got to about 50% of assets under management, and then it stalled. Today, about 50% of assets is passive and the rest is active. Japan is higher, I want to say Japan is like 65% or 70%. Actually, nobody talks about this anymore. It's one of the subjects that just disappeared and yet the ETF industry is still growing and growing and growing and gathering more assets.
When we were on our call, I was telling you about an ETF and you said, well, that's an algorithm that's-- and I said, no, it's actually an actively managed ETF. Talk about the impacts of passive investing and where this is going. SIMON MIKHAILOVICH: Well, best of investing is another form of leverage. It's basically making investment decisions not based on merits of any particular company or industry but placing a general bet on the market as a whole, which is placing a bet to these conditions that have allowed the markets to rise indiscriminately and you have companies inside these markets that have not made money ever, and yet being valued higher and higher and higher. It used to be success, used to mean that the company, while private, has become profitable to the point where it can become public, and that was success. In other words, becoming public was the reward for building a successful business,
because now, you could sell it to the public. Whereas now, they sell the business to the public before success and that's success. In other words, the definition of success is creating an idea that can be pitched and sold to the public and then the proof of the pudding will come later.
In other words, the profits and everything will come later, so success comes on the front end, and then we'll see what happens after that. What passive investing to me is another exercise in leveraging dematerialization, where 50% of the market is making a directional bet that the size of the economy, the size of profits, the size of these companies, or profitability of these companies will continue in aggregate to increase indefinitely. That's the bet. JARED DILLIAN: It's really a bet on economic growth. SIMON MIKHAILOVICH: It's a bet on economic growth, but it's also bet on 5000-year highs making new and new highs. It's not buy low, sell high, it's buy high and expect it to go higher. That's the bet. Now, whether that bet is a sensible bet, it has been for people who have made it to date. The question is, is this a sensible that forever? Again, I don't know,
but history and common sense suggests that if something is unsustainable, it won't be sustained. It's a question of when, it's a question of how or how badly, but I don't think it's a question of whether. I think it's not an if, it's going to happen. There's going to be a reorganization. The whole point of what I'm saying
is it's not that we are going down the oceans, down underneath the water. What I'm saying is that there has to be a major reorganization of balance sheets, of claims, of financial claims against real assets, and that that reorganization will produce winners and losers. Passive investment is not set up for that. Passive investment is set up macro all winner.
When you have 50% of the market that suddenly is not performing and needs to sell, the question is to whom? To sell to whom? To the Fed that prints more money? I don't have answers to these questions, I don't think anybody does. People just assume that somehow it works out. Now, I'm not in the investment business, it's important to understand I'm not in the investment business, I'm not predicting any trades, I'm in the insurance business. I picked to be in physical gold, because I don't want to make these bets. Because I wanted to find something that's outside of this world that can sit there and exist independently, and then one day potentially be a resource, or become a resource, a reserve that can be deployed if these arrangements don't work out. It's like you have your fire insurance because if the house burns down, you can't afford that outcome. People essentially are selling their fire insurance because they think that the premiums
that they save can make them more money in the market or in crypto or in some other place. Now, they're all in and there's no insurance. Okay. There are people who do that, and maybe they'll get away with it. I don't think so, history doesn't think so. There's no precedents for that, but people think it's different this time. They always do think it's different this time and in some way. See, the problem here is in some ways, it's always different this time. It's not like it's never different. It's always different, but in a big
sense, it's not. The details are different. Yes, every tragedy has its own specifics. bull market is just-- everybody wants to know why prices go down. Nobody ever asks, why are prices going up? Have you noticed that? Nobody's pounding the table. JARED DILLIAN: I asked why prices are going up? SIMON MIKHAILOVICH: Well, you do, and that's your business. That's why you have a letter that people want to read. I'm saying nobody's pounding
the table in MSNBC demanding an explanation as to, what the hell is going on? Why are these prices going up? Nobody does that. They take it as a given, it's good prices are going up. The only ask when they're going down. Well, I think it's important to know why something is going up. You may be surprised in the end if you don't know the answer upfront. I think that's the issue, and that's the point. We have levered everything to a particular outcome, with no margin of safety. That's what I see as a problem, as a huge problem. That's why I think a lot of people are going to end up getting hurt, because it's a very strong pool of these profits and of this market and of this gamification, bing, bing, bing, bing, bing.
That's my view, but I'm not saying I know the future. I don't know any better than others. I'm just trying to be prudent, and I think people who are in a position to lose a lot have to think about it. JARED DILLIAN: Yeah. That's a good place to stop. Simon, thanks for the interview. This was awesome. I really liked it. I really like talking to you.
I hope to see you on Twitter, I hope to see you around. Get to talk again sometime. Thank you. SIMON MIKHAILOVICH: For sure. Very good. Thank you very much. Great talking to you.
2022-04-10 04:36
