We've Created "Unsustainable Systems"

We've Created

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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

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