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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Hello, and welcome to the Confluence Mailbag Podcast. I'm Bill O'Grady, advisory director investment management, and joining me today is our CEO and CIO, Mark Keller. The idea behind this podcast is to replicate the question and answer sessions from the old AG Edwards investment strategy committee's open mic from earlier in this century. Now to submit questions in the future, email us at mailbag@confluenceim.com. Each month, we're gonna select four to five of the most common, provocative, and interesting questions we receive, and Mark and I will address them.
Bill O'Grady:So without further ado, let's go ahead and tackle the one. So a question comes in. A few years ago, we had a call with Mark Keller, and he correctly predicted the forward ten year US treasury level. What's your view on the ten year treasury? The big beautiful bill was not taken well by the bond market.
Bill O'Grady:Well, at start, a proper ten year forecast from Mark Keller. I I find that astounding.
Mark Keller:That's kind of amazing. It it is. Yeah. It's This doesn't always happen. Who knew?
Mark Keller:I I am thankful for this questioner to have remembered it. Most people don't remember my my good calls, only the bad ones.
Bill O'Grady:Yeah. Well, that that is a that is a occupational hazard of this business. So why did we start with this one? Well, what's going on in in the ten year treasury right now I think is the most critical issue in financial markets because we are seeing the ten year behavior really showing some striking changes. We've seen divergences between the ten year yield and the dollar.
Bill O'Grady:We've seen outflows. And to kind of sum quickly where I think the issues are, number one, interest debt service is really starting to become a problem. Net interest payments are now about 18% of revenue and are projected to reach 20 plus by the end of the decade. And even more striking is net interest payments now exceed our defense spending. This is not something that can continue forever.
Bill O'Grady:Now, this gets really complicated, in my opinion. It gets tied into the dollar as a reserve currency and the treasury as the reserve asset. So if you go back to the 70s, one of the things that we saw was a lot of market volatility. We saw interest rates reach unprecedented levels. We saw gold prices soar.
Bill O'Grady:We saw the dollar weaken. And the kind of the general consensus is that, well, that was just a big inflation problem because the Fed didn't do their job. I think it's actually much deeper than that. I think that after gold was no longer transferable from the US treasury at the end of Bretton Woods, the world didn't have a a reserve asset. And it took Volker taking interest rates to, you know, astronomical levels to restore confidence in the treasury as the reserve asset.
Bill O'Grady:There's a tendency, I think, among financial people to conflate the reserve currency and the reserve asset. I think you'd be better off keeping them separate in your mind. So the key question now is how are we gonna get this debt service down?
Mark Keller:I have no idea. Yeah. Me either. I'm not expecting it, to be honest with you.
Bill O'Grady:Well, we've seen a few things out of the administration that I think are interesting. is there is clearly some kind of effort to have foreigners bear the cost of bringing down US debt service costs. So one of those ideas floated around is the Mar A Lago accord, which wants foreigners to swap their current treasury holdings for very long dated low interest rate bonds, so called century bonds. And to get that, you become inside the tent, so to speak. You get low or no tariff restrictions on your trade with The US.
Bill O'Grady:You you become part of the Commonwealth. And if you don't agree to that, you're outside of it and you'll face high tariff barriers and perhaps all sorts of other incendiary, actions that that will hurt you. We don't really know how this works, but in effect, it's kind of a partial restructuring of US treasuries and we don't know how the world will handle that.
Mark Keller:What you're talking about is financial repression for non citizens. Yes. Yes.
Bill O'Grady:And and the problem is is that if that doesn't work or doesn't work sufficiently, then it's going to become financial repression on Americans.
Mark Keller:Yes. And which is what we've done in the past. And when you and I were in the seventies and if we had savings accounts back then, we we had a limit on how much the government you know, the the the savings and loan or bank could pay on that. That was an example of that. I mean, I think it was five and a quarter toward the end when inflation was running around 10%.
Bill O'Grady:And So you got a toaster.
Mark Keller:But you got a you got you got a toaster. Yeah.
Bill O'Grady:But most I don't know if our listeners remember this, but back in the day, you know, the savings and load would pay you five and three quarters percent, the highest the law would allow, and a toaster.
Mark Keller:And a toaster.
Bill O'Grady:And toward the end, it it actually got to be vacations in in Hawaii. I I got a a toolbox one time.
Mark Keller:Oh, very nice. Very old plastic toolbox. Very good. I I doubt it has lasted.
Bill O'Grady:And knowing you, you probably still have
Mark Keller:it somewhere. It's in it's it's in a it's in a back of the garage somewhere. But the the the difference, of course, between non citizens and who live someplace else and citizens is that you risk chasing them into the arms of your global competitors and adversaries.
Bill O'Grady:That's right. And and there's another element of this too. It almost looks as if The US is trying to tell foreign investors we're not open for business. And if they take us at our word, this leads to some significant shifts in investing behavior. One of the things that we have been watching now for a number of years is the steady underperformance of foreign assets, especially foreign equities compared to The United States.
Bill O'Grady:It it's become kind of epic. And really since 02/2008, there has been no really decent argument for owning foreign stocks. That could change. Could not only see weakness in the dollar, but foreigners who have clearly moved a lot of money here decide, well, we're we're just gonna take our money home. One podcaster I listened to when asked, well, how are the Europeans gonna pay for rebuilding their defense industry?
Bill O'Grady:And he goes, on the back of their holdings in the S and P five hundred.
Mark Keller:Mhmm. I've got a buddy who has a podcast himself. And I was listening to it the other day and he made a very wise comment. He said, I don't know if we're gonna win the trade war or not, but I think we've already lost the capital war. And yeah, yeah, money is we're beginning to see a steady march of capital out of US securities.
Bill O'Grady:So this is something that we are paying very close attention to here at Confluence. Pay attention to it in the asset allocation portion of our business, but we also have an international business too and it has actually been performing quite well and getting a tailwind frankly from the macro environment, which is not something we've been able to say really for a long time.
Mark Keller:Getting a tailwind but I'm also happy to say that we've been outperforming our macro benchmarks in that area well. So, yeah, it's nice to have a tailwind. And if you can combine that with good stock pickings, even better. I I had another observation on this question, you know, just more simplistically because as you know, I think simplistically.
Bill O'Grady:Where You do sign my checks. Know, I I I would never call you simple.
Mark Keller:You're short. Your your name is short. So it's it's not a not a hard thing to do. The the you know, we we had this long term period roughly from 1981 to 2020, where the the bond market was in a strong secular bull phase. It had its good moments and bad moments, but it just kept powering up and money kept coming here to The States.
Mark Keller:But the big driver behind it was inflation peaked and just kept coming down. And I think we've passed that. I know you believe the same thing that we've begun a long upward march in long term interest rates primarily because the fundamentals that drove inflation down are now moving the other direction.
Bill O'Grady:I couldn't agree more and I think this actually touches on another very important point. We basically frame history through stories, through narratives. And the narrative that came out of the 70s was that Paul Volcker rode in on his horse and he slayed inflation. And it's not that Paul Volcker didn't do some very important things with slaying inflation. He was a bit player.
Bill O'Grady:What really slayed inflation were the actions of Jimmy Carter and Ronald Reagan, which aggressively deregulated the market for financial services, for transportation, and then it broadened to other areas and we subsequently opened up The US economy to the world. It was deregulation of globalization that really brought inflation down. Well, what Volker did was he proved to the rest of the world that The US would be willing to subject itself to austerity to preserve the value of the treasury market and thus gave foreign governments and foreign investors confidence that this was an asset you could hold for basic saving. And, in some respects, the story of the nineteen seventies was we didn't have that. And what we're risking now is creating an environment where we do go back to the seventies.
Bill O'Grady:Now there's a famous scene I always like to to refer people to in the in the movie airplane where the stewardess comes out and says, I want you all to assume the crash position. And then every you've got people jumping up, you know, on top of the the seats and getting into the luggage area. If you've never seen it, Google it on YouTube. It's it's hilarious. We risk doing something like that.
Bill O'Grady:If the rest of the world begins to think, oh my gosh, The US isn't willing to subject itself to preserving the value of of the bonds I hold, I gotta do something else. And I think it's no accident that we're seeing gold prices do what they do. This is this is a part and parcel of that fear. I I have as a
Mark Keller:as a result of this belief that we are now in a long term bear market for bonds and rising inflation, I don't think well, to use the tailwind phrase, we don't have a tailwind anymore. We have a headwind for bonds. And for long bonds in particular from 10 out to 30, you just in my view, you can't buy and hold forever like you could before. So that means in my view, term bonds, let's just stay in the treasury world, are trading vehicles. And I suspect that the questioner who applauded my good judgment on bonds was that he happened to catch me at a time when I thought bonds were a little expensive.
Mark Keller:And my guess is the coupon I don't remember the specific occasion, but my guess is the coupon on the thirty year was around four, maybe even in the high threes. And you you and I have made no secret that we kind of expected 5% was kind of a target on those. And yeah, you can if you're inclined to go short and I'm not a person who shorts bonds, if you're inclined to go short, yeah, at 4%, you're taking a little risk there. On the other hand, when you get up to around 5%, you know, just maybe there's a trade there. But the risk, of course, is that through every cycle, it may bump its head at 5% every so often, but one of these times it's going to go through it.
Mark Keller:And that's why as a general rule, we're telling people to just unless you're a trader, just avoid the long end of the curve and let's stay short because at least when you're under ten years, especially under five years, you can just ride the yield curve in and again, eventually get your money back.
Bill O'Grady:That's right.
Mark Keller:And start over. That's why laddering a bond portfolio and short to intermediate maturities make sense.
Bill O'Grady:We'll wrap up with this thought. There was a famous trade that started in the early aughts where investors were shorting Japanese government bonds. This trade affectionately became known as the widow maker because JGBs didn't fall in value. And that's because the Bank of Japan decided they weren't gonna let that happen. Now the Bank of Japan owns half of the Japanese government bond market.
Bill O'Grady:What ended up working, and it still took a little while for this to happen, was being short the yen. And we could have a situation where the Federal Reserve loses a portion of its independence. This is known as a term known as fiscal dominance. And the Fed decides it's gonna put a cap on yields. And from a nominal investment perspective, you won't lose money on bonds.
Bill O'Grady:You won't make a whole lot, but you'll get your coupon. And, you know, in nominal terms, you'll look fine. In terms of real return, you're going to get eviscerated. That's one of the things that we're paying a lot of attention to. But the point is that the positioning may not be to be bearish the bond market as much as it is to be bearish the dollar.
Bill O'Grady:Let's move on to the question. This is more of a portfolio question. How long have you held SHLD in your asset allocation models? SHLD is a European defense stock ETF. Was it before Trump took power the time and what drove the inclusion?
Bill O'Grady:Well, it coincided. We entered it in the first quarter rebalance, which was done in early January. Can you talk about the geopolitical environment that now currently supports your continued holding of this in terms of respect to The US and administration comments about defense spending? Germany is increasing its spending on defense and taking responsibility for Europe's future. Is 2% going to be as large as it gets or is it going to get bigger?
Bill O'Grady:What would cause you to remove, given the activity? ETF is up a little over 40% since we put it in place, even if there's a reason to do the near term, which is questionable. Well, I'll start out here. We added the position in late January, but it should be understood that this is part of a continuum. We'd actually been in US defense stocks for more than a couple of years.
Bill O'Grady:In addition, we had also, for a while, held a cybersecurity ETF as well. So we were leaning into defense already. The idea being that as the world becomes more dangerous, defense spending was likely to go up. One of the things we had not seen, however, was defense spending outside The US and China go up a lot. Now, obviously, the Russians are spending a lot on defense, but that's a pretty difficult market for an American investor to invest in.
Bill O'Grady:In fact, it's probably a pretty difficult market for a Russian to invest in. This is something, when we made the shift, was based on the idea, and this is an idea that we've actually been thinking about really since the inception of the firm, that The US hegemonic role could not be sustained because of domestic politics, that our political establishment had been unable to create a situation where they could maintain hegemony and maintain domestic stability. Something had to go. And we kind of speculated that the election of Barack Obama reflected this, and then that swing to Donald Trump is another reflection of this. But we'd been keeping our eye on when does this shift happen?
Bill O'Grady:And we kind of felt like in the Trump term that this was more likely. So that's why we took and made the move. And it wasn't just in the asset allocation portfolios. We've done something similar in the international portfolios
Mark Keller:as Yes. And in our international portfolios, the members of the macro team, including Bill, sit on our investment committee. I was just looking back at their history as long ago as three years ago, started prodding us to include some defense stocks our international portfolios for the reasons you just stated. Our one actually went in April of 'twenty two. We put another one in December of 'twenty three and then a one a year ago last month.
Mark Keller:It's by the model 7.5% in defense related companies and all of them are among our best performers and one is actually our top performer over the last year. And all three of them we have in our international opportunities portfolio, which is our concentrated portfolio, which they're each 7.5%. So we've got a pretty good bet there. As you can tell, as a firm, we believe that the world is breaking up into blocks. This is Patrick's thesis.
Mark Keller:This means each block is gonna have to be able to fend for itself. And if The US is not going to be the global hegemon, and in particular, the only member of NATO who spends a reasonable amount of money on defense. They're going to demand their other NATO members spend like amounts. It's really good for foreign firms. So we put our money where our mouth is.
Bill O'Grady:Yep. Well, another way of thinking about this, and this kind of relates to the question, how is The US going to reduce its debt service? Well, one of the ways to do that is to cut spending. And we haven't really thought about cutting defense spending since the end of the Cold War. But now we could be in a situation where we are forcing foreigners to bear more of the defense burden, meaning we will bear less of it.
Bill O'Grady:And that again means that foreigners are gonna have to fund more of their own defense, which means that they're gonna wanna use their own companies to do so.
Mark Keller:That's right. And of course, we must remember why we did this in the place. It wasn't because we just wanted to be in charge for because we we we think we're smarter than everyone else. We didn't want them to go back to work to war. It reminds me of that, great Norm MacDonald
Bill O'Grady:Oh, god. Yeah.
Mark Keller:Mind, you know, routine. I think he did on David Letterman about twenty Yeah. Something years ago, maybe
Bill O'Grady:That's another one you should Google. Yeah. Yeah. Yeah. MacDonald, Germany.
Bill O'Grady:Yeah.
Mark Keller:Well, yeah. Just exactly where he says, you know, a lot of people worry about Russia and they worry, you know, about Iran and China. He says, I'm worried about Germany. Yep. Goes on to say something.
Mark Keller:I don't know if any of you are history buffs,
Bill O'Grady:but Yes.
Mark Keller:Yeah. Google that, folks. That that's that's our our YouTube.
Bill O'Grady:I will warn you upfront. Go to the bathroom and order a pizza. His his his routines are are notorious for taking But a long, long time. But But the point is funny.
Mark Keller:Yeah. The point is we defanged Europe Yes. A reason. For a reason because we didn't want them fighting each other and because we correctly saw the the big enemy was the Soviet Union, and we wanted to face off mano a mano with them. And and and we didn't wanna have lose control of that situation.
Mark Keller:That, in the long run, turned out to be a very good decision. But post Soviet Union's decline, you know, that things then we started backing off on our on our defense spending. No one spent in the Western world is spending a lot on defense. And needless to say, we're we're things had to change.
Bill O'Grady:Well, this gets back to something we've said for a long long time, a term we coined called intergenerational forgetfulness. You know, that generation that fought the second world war is is steadily moving off this earthly pale and none of them, I think, have any really influence left except maybe in the Senate where they're propped up and sent out to vote occasionally. But if you went to those people and said, hey, look, we're gonna let Europe rearm, they'd like, well, you understand that, you know, in my lifetime, we fought two wars because these people don't get along. I always get a kick about, you know, folks venerating Western civilization. It's kinda like, yeah, but, you know, the the these the Europeans don't they fight a lot.
Bill O'Grady:It's part of the reason why they conquered the world is that they got really good at fighting each other. When they went out to fight everybody else, they found out they were a lot better at it than they were because they hadn't done that. Now that we're saying, oh, these guys can do this themselves, our our great grandparents and grandparents would be like, you've you you kids lost your minds. This is a dangerous thing to do, but this is where we're going because we have become acutely aware of the costs, and we no longer remember the benefits. Question number three.
Bill O'Grady:Oh, and by the way, just to wrap up that SHLD, we were probably not going to get rid of that anytime soon, but good portfolio practice may lead us to trim. We might do that, but I think this is something we're committed to for a while.
Mark Keller:Yeah, and I should remark, Bill and I are giving our responses to your questions here. We're giving our personal responses and our personal thoughts. As a firm, we work collaboratively.
Bill O'Grady:Yes. That's right.
Mark Keller:So we are not the gurus who make all the decisions. Let's put it that way. We may think of ourselves as gurus, but we don't make all the decisions. We work collaboratively.
Bill O'Grady:Of course, we when they don't listen to what we say, we act like parents that say, well, you know, now that I'm bailing you out, this this was this is no reflection on anything my son has ever done, by the way. Question number three. This is on on AI. A rising percentage of companies abandoning most of their generative AI pilot projects. I'm not really I don't know if that's really an abandonment.
Bill O'Grady:I think there was clearly a shot across the bow from deep seek. But everything I'm seeing affect the news today, we're recording this on June 3. And the news today is Meta's contracted with a utility to directly get nuclear power from them. So, no, I I think the big firms, like, the big tech firms are still, you know Yeah. Full speed ahead, damn the torpedoes.
Bill O'Grady:But but it does bring up the whole notion that who is going to benefit from this? And this kind of takes us back to the '90s, and turned out the internet was a game changing technology. It's just figuring out who to own to get rich from it turned out to be much more challenging than it looked in the late '90s.
Mark Keller:Yeah. I mean, I read something a long time ago that I think is true, or at least it was until maybe the last ten years. And that is the users of technology usually make more money off of great breakthroughs in technology than the creators of it. Now that has changed a little bit given the operating leverage and network effects of the Internet, and that has allowed monopolies to thrive. So it may not be true anymore.
Mark Keller:But the fact is, the users of technology can save a lot of money when they use that technology effectively. And I think businesses were looking at AI with a combination of excitement that they can reduce costs, maybe by eliminating jobs, but fear in how much it was going to cost. And so I've kind of been imagining this bank CEO running a large regional multi bank system who prior to the DeepSeek announcement, was talking to his CFO and said, How much is this going to cost us? What? We're going to have to spend an extra $1,000,000,000 a year on CapEx just to convert our call center to AI.
Mark Keller:That's that's when
Bill O'Grady:you call your investment banker and and do a strategic
Mark Keller:Yeah. Strategic move. Yeah. And and then after deep seek, his CFO comes in and says, Hey, wait a minute. This may not cost as much as we thought.
Mark Keller:Because Chinese have figured out how to make AI that's good enough for a lot less, and maybe we'll be able to use that. Right now, you know, we all think of AI is as like asking asking the a your AI machine, you know, just describe, you know, how fusion works. But that's not what most business problems are. Most business problems oh, you got a call center and you get 10,000 calls a day, but 9,990 are on the same 15 questions. So you don't need an AI well, to put it this way, you don't need, you know, an f 22 jet to fly from St.
Mark Keller:Louis to Kansas City. You know? Actually, a Cessna will do just fine. And I think think of it that way. We're that's that's the big change that we've seen happen this year in in AI.
Mark Keller:A lot of businesses won't need to spend a whole lot of money. But when you are creating the the you're create you're you're in the front lines. You're the so called hyperscaler. You have to spend the money because you you you've got you know, if you if you're Alphabet, you're Meta, you're Apple, you're any of these companies, you're Amazon, Microsoft, you've got to be at the forefront. That's how they've always got to where they are.
Mark Keller:So they're literally spending, well, as Alphabet said recently, dollars 70,000,000,000. Just think of how many companies don't even have a $70,000,000,000 market cap. I'm guessing probably at least two thirds of the S and P, maybe 80%, doesn't have a $70,000,000,000 market cap. And these guys and Meta's doing the same, they're spending that annually. There's going to be a ton of money spent on this.
Mark Keller:But the users of technology, they're looking at this and they say, I'm going let those guys spend a lot of money. I think we can get by on a lot less. Now, that's yet to be proven, but I think that's what's going on here. And it's going to be, you know, these giant companies, just think of them like utilities. You know, your local electric utility had to build big power plants and make a huge investment and, you know, and you got to plug in your toaster.
Mark Keller:That's kind of what I think is gonna happen with AI.
Bill O'Grady:Yeah. I I would tend to agree with that. It takes a long time when a new technology emerges to figure out how to use it best. Both of us have been around long enough to know when every executive had a secretary. And we're now to the point where with all the technology available to us, you can kind of get by without one.
Mark Keller:It just We went from having a secretary who arranged travel for you to not needing a secretary because we had a travel department that arranged all that. And then maybe you outsourced it to a local travel agency and now you can do 99% of what your travel needs on your phone. And that's how technology marches. And unfortunately, jobs are eliminated along They are. Along the way.
Mark Keller:And I think the scary part for me about AI has the potential to eliminate jobs at a much faster rate than we've seen before.
Bill O'Grady:It does. And I guess what keeps me up at night is that, you know, I've asked a few questions of AI and I know enough about the topic where I can see, well, this is a hallucination. It's saying this is true, but it gives me no reference. And at this point, a lot of the experience I'm having with AI is similar to talking to a college sophomore that knows everything but can prove nothing. If we're heading into a world where your ability to critically interpret what AI generates becomes what's really valuable, how do we teach young people to think critically when we don't give them entry level jobs that usually facilitate your ability to do that.
Bill O'Grady:And that's going to be tricky. I don't have a good answer for that. Question number four, and this one is really more for you, Mark. I'd like to hear Mark and Bill's thoughts on the retirement of Warren Buffett and the ascendancy of Greg Abel as the new CEO. As I always like to tell people on an on individual stocks, I have people to do that.
Bill O'Grady:And so I I don't know if I'll have a whole lot to say here, Mark, but I'm sure you'll have a ton. So Well
Mark Keller:what's on your mind? Yeah. This is fascinating and it's not, you know, ground that hasn't been plowed before. We've seen CEOs retire, even great ones retire before, great ones who served a long time. Warren's in a class by himself.
Mark Keller:Not only has his stock outperformed virtually every other stock over the sixty years that he has ran Berkshire Hathaway, but almost sixty years. But he's lasted so long. So he's run it well and he's ran it a long time. I will say that we're still evaluating what we think the future holds for Berkshire Hathaway. We own the shares, the Class B shares in several of our strategies.
Mark Keller:So this is a close to home question and we have not come to a firm conclusion. So what I'm going to give you is my own views on this. And you will we work collaboratively, so not everybody in our in our shop may agree with me. But Warren has stepped down as CEO, but he will remain as chairman of the board. I can tell you in virtually every case where a CEO has remained on the board, chairman or not, they continue to have substantial control over the company.
Mark Keller:And I expect that that will continue. All indications are that his successor, George Abel, who will take over in January, is a very capable executive. But as long as Warren is sitting in the chairman's seat at the board, I expect he will have a lot of influence. And so I don't look for real big changes until either Mr. Buffett passes away or is somehow otherwise incapacitated.
Mark Keller:At that point in time, then control, real control passes to the board. And the board's going to have some tough decisions to make as time goes by. And those decisions really revolve around the fact that this company is so diverse. And can it retain the Buffett premium when Mr. Buffett is no longer running the company.
Mark Keller:It has been my view that eventually, and this may take three, four, five years, it's my view that eventually the board will determine to break the company up into various pieces and spin them off. That could include paying out, well, you'll you'll get pieces of paper like dividends, maybe a railroad, then electric utility. Or you may get a big chunk of cash. It's well known he's got $300,000,000,000 plus in cash. So it'll be very interesting to see how they determine it.
Mark Keller:A comparable situation was Henry Singleton and Teledyne. This was a long time ago. Everyone who remembers this company and Henry has gray hair, if any at all at this point. And but this is what his board did. Henry had one of the best records of anyone in American business.
Mark Keller:And I expect that will eventually happen even though many of his you know, he doesn't want it broken up. He's made that plain. But, know, executives cannot control the companies they founded and ran from beyond the grave. That the board at that time will have a fiduciary responsibility to do what's best. We have had discussions that were oddly enough internally that were were discussed in yesterday's Wall Street Journal.
Mark Keller:And that is the the real succession concern we've had for a while is who succeeds Ajit Jain, who is the head of Berkshire Hathaway's insurance operation. He's been running it for, oh my goodness, almost forty years now. And he is he's brilliant, and he is the secret sauce in their insurance businesses, which is their largest business. And he is 73 years old, and it's thought that he's probably gonna retire soon. And who's going to replace him?
Mark Keller:That's a really, really key decision. But these are kind of decisions every company has to deal with and that we deal with on a daily basis with almost every company that we have. Management teams are constantly in flux. And how companies and how boards name and who they name to be their the the next generation of leaders is extremely important and and we're watching this really closely.
Bill O'Grady:Question number five. Do you think the US government will embrace digital currencies? If so, how would this impact the dollar as the reserve currency? Would confluence consider Bitcoin and other crypto as legitimate investment options that you might use them in your portfolios? This whole discussion gets extraordinarily complicated.
Bill O'Grady:I wrote a geopolitical a few years ago on central bank digital currencies, and as I did the research on it, some of the most profound issues in economics revolve around defining money. Seems real simple at and I can tell you, you can get into the swamp in a minute as soon as you start asking Socratic type questions about, well, what do you think money is? But broadly speaking, money gets issued by two entities in society, the private sector and the government. And what we're seeing overseas, China and the EU especially, is that both central banks there are actively creating central bank digital currencies. This development gives governments an enormous amount of power because the whole basis of private sector issued money, Bitcoin, Ethereum, so on and so is that they're outside the clutches of government.
Bill O'Grady:They become a cash like instrument independent of the cash issuing facilities of, in our case, The United States Treasury. So for example, you could decide as a country that you were going to make a fiscal expansion in form of digital currency, but easily then set a drop dead date. So the money is only value or only has value for ninety days. Let's say you wanted to give a short term boost to the economy. Or you could say, yes, we're going to give you this money, but you can't spend it on imports or you can't spend it on entertainment, drugs, pornography, things like that.
Bill O'Grady:So the potential for control is huge. Because of that potential, there has been a strong reaction in The United States against having the Fed issue a central bank digital currency. So our digital currencies are are private sector based. Now I I always joke about this. If the government came out with a bit of social software and said, hey, We're gonna issue this.
Bill O'Grady:And, you know, several times during the day, why don't you get on there and just tell us what you're doing? Just, you know, what you're cooking, who you're seeing. I mean, you would have riots in the streets, but a private sector company does that in The United States. We're oh, yeah. That's cool.
Bill O'Grady:And I'll fill out all these, surveys too while we're at it. I mean, it's it's amazing the amount of trust Americans have in the private sector and mirror image how much we distrust our government. So we have gone the route of having private companies issue currency in in the form of digital currency. Digital currencies kind of have the aspects of gold and that they are independent of the government. They have proven to be extremely effective in avoiding currency controls.
Bill O'Grady:In countries with hyperinflation, like Zimbabwe and Venezuela, crypto has become extremely useful because it gives you some store value in terms of your currency. In The United States, it it has become sort of a form of paper gold. In fact, there's a strong generational effect. People under the age of 40, if you tell them that you're gonna have inflation, their their quick response is to buy Bitcoin. People older than 40, their response is to buy gold.
Bill O'Grady:So it it kinda houses itself in in that in that bailiwick. This administration is become in in it's probably the most crypto friendly administration we've ever had. And interestingly enough, within the crypto community, there's a high degree of of discomfort with this because they're afraid that getting in bed with the administration on this will actually become a backdoor way of getting government interference or government monitoring of of how crypto is used. I'd I still don't know exactly how crypto is is going to work. I'm watching, frankly, what I'm much more focused on now is the whole stable coin idea.
Bill O'Grady:Stable coins look to me like a they're going to evolve into a more sophisticated form of money markets. And they could end up reducing payment costs dramatically. So it is essentially a new form of money, and really it's a new form of payment that is definitely, I think, quite interesting. One of the most recent Odd Lots podcast was recorded at a Princeton University forum on money. One of the speaker they had three actually monetary historians.
Bill O'Grady:All of them were quite good. But the one guy was like, there's really nothing new here. It's just every time you end up with a new technology that facilitates payment and the movement of money, we go back and rediscover all the issues all over again. So I think that's like what you kind of find with gold is a form of Grisham's law, that bad money drives out good. We all have heard stories of the guy who paid for a pizza with a Bitcoin early on.
Bill O'Grady:If he'd have kept that Bitcoin, he could have bought Domino's. You know, it it if something's going up in value, it doesn't make much sense to use as a medium of exchange, which is why we needed to create stablecoins. But one of the issues of creating stablecoins from a financial system perspective is you have to prevent it from being run. There's a stablecoin bill that's making its way through Congress now and that's one of the things they're trying to figure out. Anything you want to say on top
Mark Keller:of that? No, just will underscore something you said earlier and that is the American public is extremely distrustful of government and that's the big difference between digital currencies and dollar bills and gold. No one knows where that dollar bill has been. If you buy a Krugerrand or a Maple Leaf, yay, it's yours and don't know anything. Government may not even know you have it.
Mark Keller:With digital currencies, yeah, it's government digital currency, they know everything that you're doing and everything you're spending. And if it's corporate digital currency, I expect that, you know, they the corporations will will know everything about it. So it's, you know, it's getting this is this is the and and don't suppose that forever the government will and corporations will not share data.
Bill O'Grady:Oh, sure. Yes.
Mark Keller:You know, they don't accept when they're required to, but that's only here. You know? I mean, there's a lot of in a lot of countries, the corporations are completely under the the thumb of the government, and there's no such thing as corporate data that is separate from governmental data.
Bill O'Grady:It's a blurry line. Best way to think about
Mark Keller:it. Yeah. And so I I but but I'm with you. I I am shocked, you know, the things that people will post digitally for the entire world to see on their Facebook pages. And they wouldn't dream of taking that same data and putting it on a billboard out in front of their house, but they'll do it on a bigger format.
Mark Keller:Right. But because it's on this little phone, you think it's small.
Bill O'Grady:You know, it's on my computer, and it's only with my friends.
Mark Keller:And Yeah. So so I I And everybody else. So I I tend to think of digital currencies, yeah, is one is, digital gold on the one hand, basically an investment on one hand, but on the other hand, it's a it's a privacy invasion. And I I'm I've been waiting for Americans to say, this is far enough. I don't think I want to let Amazon or Google or Apple know that much about me.
Mark Keller:Haven't seen that limit yet. It's really fascinating.
Bill O'Grady:No, we really haven't. And the last part of that question, we actually monitor Bitcoin very closely. And now again, it is really hard to value it. We have tried, we're still trying. And it I don't know.
Bill O'Grady:But would we consider it? Yes, we would consider it. But with this caveat, we are a separate account manager and we have very few products that are outside of that genre. And so we are dependent on the platforms that we contract with to provide services. And some of those platforms have restrictions on using Bitcoin exchange traded funds.
Bill O'Grady:So that sort of limits us what we can do. May still do it, but it may not be universally available if we ever do implement it.
Mark Keller:Yeah, the only question that might be tougher than what is money is what is the intrinsic value of Bitcoin? Yeah. Yeah. I'm at
Bill O'Grady:a loss. Well, intrinsic value is basically in the eye of the beholder. That was one of the things that came out of this Odd Lots podcast was that every one of the commentators said, Yeah, money is a social construct. We use it because it's really effective. And if you go into the history of money, there are two narratives that emerge.
Bill O'Grady:One is that, well, money is a shortcut to barter. That's if you take economics in most colleges and universities in The United States, that's what it'll be described as. But there's a whole other line of thought that money is credit. And kind of where that comes from is that in the spring, the farmer needs help planting his fields. He hires you to do that.
Bill O'Grady:He promises you that at harvest, you'll get x amount of his harvest for the labor that you did. But I need to get something now. So I take my chit from the farmer to my local merchant and maybe buy something with it, and then he takes that chit. And lo and behold, if he trades it, that's promise, that credit, that debt is now acting as a medium of exchange. And in fact, what we find throughout history is that these two forms tend to interact.
Mark Keller:For most of the last two thousand years, that credit was a creation of the government. And then we come full circle, Bitcoin, crypto perhaps is a credit that's not the creation of the government. And yeah, can money be effectively separated from the governments in control? And that's a good question because there's a lot of governments that have ceased to exist and that money often turns into wallpaper. That's right.
Bill O'Grady:Or or curios. You know, we've we've all seen confederate, you know, confederate money in museums and and the like. I think we'll wrap it up here, Mark. Today's discussion is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements are expressed or subject to change without notice.
Bill O'Grady:This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineers, Dane Stole. We'll be back with you next month, with another mailbag podcast. Until then, stay safe.