Mike Green of Simplify Asset Management explains why the real risk in today’s markets isn’t something obvious like the Fed, inflation, or tariffs.
Passive investment flows have quietly changed how markets function beneath the surface and have created a major systemic risk.
We explore why markets can appear stable while becoming increasingly fragile, why regulators are unable to act, and what this means for investors thinking about risk, liquidity, and capital preservation.
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Transcript
Monetary Metals:
Welcome back to the Gold Exchange Podcast. I am joined by Mike Green, the Chief Strategist and Portfolio Manager for Simplify Asset Management. Mike, welcome back to the show. I want to start off with my favorite movie, which many of you might not know, The Princess Bride. And in The Princess Bride, one of the characters, Vizzini, is put into a battle, a death battle of the wits, to see who can outsmart the other with a poison chalice.
And yet there is a meta strategy, a metagame happening Vizzini ultimately does not understand. So Mike Green, I want to start my first question in our interview. What is the meta game and a meta strategy that investors are missing today in markets now?
Mike Green:
Wow, that swings us in a direction I didn’t fully anticipate. Look, the work that I’m most known for is my work around the impact of passive investing and systematic index style investing, particularly market cap weighted. What that’s done is it’s removed an element of information from the market.
Historically, markets were a function of individuals conducting analysis of the value of the security, then comparing that against the price and using that distinction to determine whether or not they thought it was an attractive investment. That process is naturally mean reverting. It encourages you to sell when prices go higher. It encourages you to buy when prices fall below your estimate of fair value. Now, it never worked that smoothly. Let’s be very, very clear, right? As an investor, I can have my clients take money away from me. That removes my discretion.
Likewise, clients can give me money. And in many ways that removes discretion as well. It forces me to consider where to put new capital to work, even if I don’t necessarily think it’s a particularly attractive environment. I have the option in most situations of holding cash, but if I build a portfolio that’s 50 to 100% cash, you’re not going to pay me for it.
So you take the money away. That has been lost with the shift to passive investing, passive index investing, and in particular, the allocation of funds through retirement accounts like 401(k)s. Case in which the money flows through automatically as a function of your employment and is allocated to securities on the basis of their market capitalization rather than a calculation around discounted cash flows. That means that the money has to be put to work. And the minute you recognize that, you recognize that you’ve now lost the information content about the value of the securities.
And candidly, you’ve also lost the information content about the forward-looking prospects of the business because nobody is actually doing that calculation or the marginal investor is not doing that calculation. That’s kind of the biggest meta game that’s going on right now is that we have moved from a market in which information was largely about the cash flows associated with the underlying security to increasingly information about the character of those cash flows coming into the investment market.
Monetary Metals:
So the last time we spoke, Mike, my impression was that there’s this kind of strategy which works on the individual basis, something like a buy and hold, the S&P 500 index fund, but on a broader kind of public good basis, if everyone does the same strategy, at some sort there was a breaking where, yes, the collective logic actually breaks down, even though the individual logic always holds.
So when would we see that potential breakdown begin to happen?
Will there be signs where investors can say, wow, I listened to Mike Green on the Gold Exchange podcast. He came on and he said, these flashing signals, these warning signals are here. Or will this happen all of a sudden overnight and investors will miss this major crash?
Mike Green:
The quick answer to that is there are definitely signals that we can look at. So this is actually a slide I created, believe it or not, in 2017 as I began the process of doing this. None of these have been updated in any meaningful way, with the exception of the last one, portfolio effects dominating cash flow and discounting effects. I can dig into that with a little bit of detail just to explain what’s meant there.
But the things we should be looking for is an increase in correlation between securities, an increase in valuation of securities, regardless of the fundamentals as passive share grows, reduced market elasticity, raising the risk of extraordinary price movements, and increase in market concentration as momentum bias leads to the largest companies becoming larger.
A reduced stability for new companies become public, and I wanna put some caveats around that. There’s actually some interesting stuff that’s underway right now. Of course, facilitated by Elon Musk and SpaceX and et cetera. And then the last one, the portfolio effects dominating cash flow and discounting effects, that also should, we should see a significant increase. And unfortunately, as you see with these, all of these factors increase the risk of investing in this manner.
And unfortunately, at this point, the jury is really no longer out that actually all of these have now come to pass. And so this was one of the primary contributions of my research was identifying that most of the analysis that had been done on markets was largely a function of thinking about the difference between active and passive as a stock, basically how much was in each pool. There was no real consideration of the flow dynamics, meaning how much of the marginal capital is being invested in this manner. My contribution was identifying that it was really the flow that determined many of these components.
The stock is an amplifying factor to it. And I just again want to emphasize when I say stock, I don’t mean stock price or stock market. I mean the quantity of active versus passive. And so unfortunately, now a decade after I began this research, an increasing number of academics have come to the same conclusion, we still remain uncertain about what the future holds. But unfortunately, my most recent work is actually suggesting that we are very rapidly approaching a point of terminal decay in which all of these factors are representing a very significant risk.
The easiest math to think about is we’re about 53, maybe 54% passive in market capitalization at this point. My model suggests if that number crosses 80%, regardless of the flow characteristics, we effectively enter into a terminal event. And as many investors may know, my initial work on this back in 2016 led to the creation of a trade around the XIV, which was an inverse volatility ETF in which all of these factors had coalesced to the point that we exceeded 70% of the daily volume coming into a systematic strategy. My analysis back then was this would result in a terminal event.
I ended up being right. We did very well on the trade. And what we’re really seeing now is effectively the extension of that into the S&P 500 or a total market exposure. So the quick answer is we don’t know exactly when it happens. It is going to be flow dependent. Again, that contribution versus withdrawal component is going to be critical. But regardless, we’re getting very close to the point at which a crash of a magnitude that is candidly unfathomable is increasingly embedded within the markets.
Monetary Metals:
So, Mike, if I’m an investor listening to this podcast right now, I’m hearing, well, there’s this risk to the S&P 500 that maybe people aren’t paying attention to.
Maybe it’s time instead of thinking about return on my capital, more about return of capital, what can investors do to kind of either hedge their portfolio, hedge this risk, or is this a risk that is basically completely unhedgeable and we’ll all have to hold our breath and see what happens?
Mike Green:
Unfortunately, there are actions that individuals can take, but in aggregate, anytime you sell, you’re selling to somebody else, right? So as a society, we cannot we cannot hedge against this risk. We can accept it and we can start to change our behaviors to ameliorate it. That was the original impetus for me actually going public on this initially after the XIV and my work was proven to at least have some value. I largely approached the regulators and said, this is an issue. Unfortunately, the lobbying activity of the passive complex, the vanguards, Blackrocks, center of the world is far more powerful than Mike Green.
It seems like an unfair competition. And it is. It’s an unfair competition. The reality is regulators are largely captured. You can’t imagine a regulator saying something along the lines of, well, we’re going to restrict passive investing and force people to pay more to active managers. And honestly, I can’t argue that they should do that until the risk has actually been proven. The scary story I tell around this is soon after the XIV, I went to the Bank of International Settlements, spoke with them. They came back and said, yeah, we largely agree with your conclusions.
And my reaction was, oh, that’s fantastic, right? This is 2018. Like, we can do something about this. And their response is, yeah, no, you don’t understand. There’s nothing we can do because of the regulatory framework that I just articulated. The only outcome of them raising the alarm would effectively be they would be targeted by the passive complex, they would lose lose their jobs, and as a result, they just have to wait for the event.
The BIS is actually added to the literature at this point, having written similar concerns to mine, but the simple answer is that regulators are not going to do anything about it. On the individual basis, there’s good news and there’s bad news, right? There are things you can do. Ironically, I think we’re seeing some of that with the narrative around dollar debasement or gold, etc.
Which is really just a way of saying we want our way out of this system. Now, in the process of doing that, you will bid the price of gold up to the point that effectively it creates its own systemic risks. And I think we saw a small example of that in the past couple of weeks.
So it really goes back to the same thing. Like, you can’t get out as a society. We are somewhat trapped by this dynamic. All I can really hope to accomplish is to make sure that people are aware of what is actually causing this so that when the event does occur, we can start rebuilding in a more structurally sustainable framework.
Monetary Metals:
Mike, one thing I always find so interesting about your analysis is that it doesn’t focus on many of the similar threats that you hear in the gold world, whether it’s the Fed and QE or inflation or the BRICS currencies, but actual systemic issues that are maybe hidden under the surface, but a lot of investors are not taking for its full danger.
When we’re talking about the stock market, a lot of investors say, you know, I’m a gold investor, I’m a real estate investor, I don’t deal with the stock market. How would this type of danger possibly affect people who are more of a hard asset or a commodity space as compared to someone who has an S&P 500 portfolio or a stock and bonds portfolio?
Mike Green:
Well, the really simple answer to that, unfortunately, is that everybody owns assets in relation to other people, right? So let’s say you put 100% of your portfolio in gold. Other investors start to figure this out and start bidding up the price of gold. Do you then sell your gold for US dollars in a time period when liquidity facilitates that exit? Or do you wait for the event and suddenly wake up and discover that nobody else has any money?
And if that’s the case, then your price of gold will fall. That, unfortunately, we’ve seen play out repeatedly. In 2008, for example, on the liquidation of Lehman Brothers, we discovered that there were lots of levered holders of gold who needed to raise cash to meet debt obligations. In crypto, you see this as repeated liquidations that occur against levered positions.
Whether you’re levered or not, the simple reality is somebody else is, and that person is the marginal capital that’ll define the price action from that point. So this is unfortunately the definition of systemic risk. You can’t actually diversify away from it.
Monetary Metals:
And I also want to ask about countries that, you know, in some ways have been seen as attempting to diversify away from maybe not systemic risk in index funds or passive investing, but the dollar or the US dollar more generally.
That could be China, Japan, these BRICS countries as well saying, you know what? We don’t want to be as much in the dollar world. We want to be maybe in a multipolar world, either with our own currencies, with gold. How much do you think that matters to this story as well, where there’s a less maybe flows going to the US market or maybe more flows going to the US market as the cleanest dirty shirt in the laundry argument continues to play out?
Mike Green:
I mean, the quick answer is yes, we are absolutely seeing that, although I don’t think it’s for the same reasons that we were discussing on an individual basis. China has recognized in the aftermath of the US’s restrictions on Russia’s access to their reserves, that holding their trade surplus earnings in a treasury account, in treasuries exposes them to the same risks, right?
They don’t want to have that exposure. And as a result, they have done things like diversify into gold, where again, they are playing the same underlying game. If everybody figures out they’re going, that we need to rotate into gold, we drive the price of gold really, really high. People use leverage to increase their exposure to it.
And as long as the systems remain in place to enforce debt collections, which mechanically have to remain in place, in a financial market, you will be subject to the same underlying phenomenon as it relates to gold, et cetera. What you can’t guarantee in those regimes is whether it is a good outcome to remove the restrictions of U.S. influence on them, or whether it is a bad thing, right? In many ways, what most of these countries are doing is not dissimilar to choosing to join the ruble bloc in the post-World War II era as compared to the U.S. dollar bloc in the post-World War II era.
They’re effectively saying, I want the freedom to operate as I see fit. And so the Soviet Union provided that benefit to various countries that chose not to embrace American hegemony. It can be the right answer, right? I just want to be very, very clear. You could be better off going with China. I would push back against that analysis though, because we actually know that China’s behavior around the world has in general been far less munificent and benign than has the United States. The Soviet Union’s model was ultimately flawed because of its focus on command and control. Command and control is an inevitable feature of any government system, right?
That’s what a legal code is, is you can do this, you can’t do this, right? It’s much more focused on the can’t do. Removing those restrictions against governments like China, et cetera, and removing the limitations that the US system of, you know, global order, right? A laws-based framework. It’s hard to argue whether that’s good or bad because we don’t know how it plays out. It, again, depends on the actions of the players going forward. So, you know, my hunch is that China has such inherent contradictions embedded with its own economic model.
People, by and large, are ignoring those in the hopes that they can avoid the influence of the United States. I don’t think that it’s going to play out that way. The second thing that I would emphasize is that part of the description of flows moving to the United States or away from the United States, increasingly the world itself has adopted these types of investment strategies, and this actually has created some really perverse consequences.
I would highlight that the UK’s adoption of some of these frameworks has actually set conditions under which the default allocations in retirements in the United Kingdom are such that only 15 cents of the average retirement dollar actually is retained within the UK. If you mechanically think about the implications of that, that means that the UK is going to receive far less investment than it otherwise would receive.
And I think unfortunately that that is another predictable impact of this, that what we end up seeing is more and more money effectively driven into a malinvestment frame to use an Austrian term. In which we’re simply chasing the relative price, the market capitalization of companies around the globe, as the first mover advantage towards passive that pushes up those valuations, it means the United States has become more overvalued than the rest of the world, and perversely, the rest of the world through its retirement approach is increasingly subsidizing that.
So you’re damned if you do and you’re damned if you don’t. Again, this is the definition of systemic risk, and in an increasingly integrated world or a world that is heavily integrated regardless, there’s no escaping the Spanish Inquisition.
Monetary Metals:
And I want to ask you about the rest of the world versus the U.S. Obviously, there’s been these tariff wars, these trade wars, even potential geopolitical conflicts. Do you see the fact that there could be a more multipolar world as competition to the United States?
Do you think that is potentially helpful because more countries say, Hey, we’re not going to do this index option, we’re going to maybe change our tax laws. Do you think that the competition between countries or multipolar worlds, do you think that overall will actually help the United States because there’s more of a bit of a competition happening? Or do you think that basically because of this fractionalization that it will be worse for everyone overall because of the competition?
Mike Green:
Well, I think competition in the in the capitalist sense, right? Competition that spurs innovation, that lowers costs, that drives innovation is always a good thing, right? When you talk about competition within the base layer of monetary systems or of trading relationships, that’s actually inherently restrictive. And so it drives everybody to a lower global maximum Even as candidly, it does introduce some elements of diversification, right?
So there is actually value in having multiple computing systems, even though they reduce the aggregate output if those systems reinforce anti-fragility to steal the frame from Nassim Taleb. There’s also another component though, is economies become less integrated and as the costs associated with that loss of integration, that loss of efficiency that I was highlighted, if that translates to less adequate outcomes or more stress on sovereign balance sheets, it can often lead to conflict. And conflict is inherently a destructive act that lowers everybody’s aggregate output in a meaningful way. And I think, unfortunately, we’re seeing elements of that play through.
Monetary Metals:
So maybe if I get this right, there’s this level of peak globalization where, yes, we’re all on one supply chain, we’re all in one big happy family, but of course the systemic risk there that if one thing goes wrong, whether it’s COVID or a war or some supply chain issue, that we’re all in the same boat and we’re all sinking together versus, well, if it’s a bit more diversified, a bit more decentralized, yeah, maybe the aggregate output is a lot less, but maybe the systemic risk from one country having a virus or one country going to war with another is lower.
But because of the internal balance sheet conflicts or the issues with each country, the threat of war or fighting, which is, of course, is bad in terms of output economically, is also there. So do you think we’ve hit peak globalization and maybe that’s a good thing?
Mike Green:
I think we have probably hit a local peak. And again, defining it as a good thing depends on the outcome. Right. It actually turns out so, I mean, one of the things that I would just emphasize is that, you know, there’s the very famous quote, right? Practical men who fancy themselves exempt or slaves to a defunct economist.
By and large, I would argue that the West in particular has become slave to the teachings of Milton Friedman, which have almost no empirical basis whatsoever and candidly have very caustic implications to society, which I think unfortunately we’re seeing now manifest in an increasing manner. It actually turns out that this is a variant of a Minsky type framework, right?
That move towards globalization encourages fragility in the system in favor of optimization or quote unquote efficiency. That raises the risk of exactly what you highlighted, modest disruptions or major disruptions can effectively put us all in the soup together for greater risk. But the bigger issue is actually what you’re doing when you optimize for efficiency is you are exposing yourself to another factor, which is volatility. And that really sits at the core of it. The tools for analyzing volatility are poorly fleshed out within traditional economics.
We tend to think about things as settling in an equilibrium. The reality is there is no equilibrium, right? There will be constant disruptions and constant new signals that are received. And so the question is how effectively can you navigate from point A to point B?
That turns out to be heavily influenced by your resistance and your robustness against volatility. So, you know, the answer is no, I don’t think we’ve hit peak globalization. If I project us forward 500 years, my guess is we will be a radically more integrated society across the globe than we are today. But if we hit a local maximum, I think the evidence is pretty clear, yes.
Monetary Metals:
And talk to me, Mike, about the demographic shifts we are seeing happening potentially by 2035, which is only almost a decade away.
That we all hit a peak in population numbers, how much does that matter to investors thinking about maybe investing in commodities and this idea of the pantry or things like the stock market where maybe there’s just less people or gold, less people investing in an asset, how much do demographics matter in the investing context?
Mike Green:
Well, first of all, I think demographics are actually incredibly important, so I can’t overemphasize that. Secondly, I think that they are a very slow moving phenomenon that unfortunately forces us to to only consider things after they have gone to an extraordinary degree, right? Many people have focused on Japan’s demographics, for example. Japan, because of the surplus that existed in their country and because they did not have to defend themselves operating under the U.S. umbrella, they were largely able to harvest a significant fraction of the wealth and investment that they made around the world.
Today, a country like Japan is uniquely exposed because so much of their investment post-1990 has flowed into China, which is unaligned with the United States and Japan. And this raises a very real prospect that the assets that Japan has accumulated over the past 35 years in places like China actually don’t belong to Japan. So it can lead to non-linear outcomes that change very, very rapidly.
Unfortunately, looking a lot like that XIV chart that I highlighted. If China were to invade Taiwan and nationalize all of the assets that Japan or the United States has in China, the United States would be fine, Japan would be in the soup.
Monetary Metals:
And in terms of investing in gold and commodities, you talk about this pantry effect where, hey, I need whatever, 50 pounds of meat and 50 pounds of steel, and yet with less people, of course, that pantry effect diminishes. How important is that? Is that going to be just a slow erosion in the pricing power for commodities, or will that actually have a non-linear shift over time?
Mike Green:
My hunch is that it’s going to be proved to be somewhat non-linear, and there’s a variety of factors that are hitting there. One is particularly for things like agricultural food stuffs, those largely exist too, as I described in one of my pieces, feed human beings, right?
There is an element of agriculture that has been repurposed for feeding machines in the form of ethanol, for example, as we shift away from fossil fuels, which is somewhat inevitable in our transportation sector, that demand for agriculture will disappear, right? Likewise, A sizable fraction of agriculture goes not to feed people, but to actually feed other agriculture, right? It takes about 16 units of grain to produce the same caloric output in a beef as it does in actual grain content itself, right?
There’s this thing called manure that comes out the other side of a cow that is wasted caloric energy. My strong hunch is that we will discover as we move forward in innovation that not only will we see fewer mouths to feed, but we will ultimately come up with solutions that prove to be superior to nature’s production of proteins that ultimately mean we will use far less agriculture for those purposes as well.
So, my analysis is that agricultural commodities in particular, broadly what I describe as human food, which would include oil, for example, for transportation, to a certain extent, natural gas for heating as compared to electricity generation, et cetera, that we are probably very close to, if not past, the peak of those demands.
Whereas the demand for what I call machine food, which is really electricity, steel, copper, et cetera, could have a very different trajectory as we radically increase the number of machines that are designed to complement humans within the system. This shouldn’t be a surprise. We’ve broadly seen this play out throughout history. Wheat has done a very poor job of holding its purchasing power. Copper has done relatively well.
Monetary Metals:
And do you think over time that same logic will, you know, advance even quicker with the AI story where AI needs, you know, steel for the data centers. It needs electricity, of course, to power those data centers. Nuclear reactors to provide base power load, whereas something like a hamburger is maybe not going to be as important in the future because whether it’s fake meat or genetically lab-grown meat, do you think that that is going to be an even exacerbated story in the future?
Whereas in the past, we’ve slowly industrialized, we’ve maybe slowly eaten more or less meat. Do you think that this story is even more exacerbated going forward?
Mike Green:
My hunch is yes, right? I obviously can’t know that to be the case, and I do want to emphasize that energy is by far the most important of those that we’re describing. Basically all other commodities are derived from the application of energy to raw materials. Wheat is a combination of solar inputs and fossil fuel inputs in the form of fertilization. Fertilization itself is effectively a way of of accelerating the recycling of the materials that have been used.
So it’s just very hard for me to imagine that this is not an acceleration along that path. On the short term, unfortunately, the West has by and large experienced an energy glut that has been a byproduct of us outsourcing much of our material production to China. If you just mechanically think about the United States 25 years ago, as China achieved access to the WTO, most favored nation status and trading relationships with the United States, we had tons of factories that needed that energy that now sit idle.
That freed up capacity within the electricity and energy generation space that created a period of time in which the US was effectively able to harvest excess capacity as compared to needing to build new capacity.
That seems to have ended. And so what we’re experiencing right now is a bit of competition between the human need for natural gas, for example, for producing electricity to run our computers in this experience, or to heat our homes, et cetera, we’re suddenly finding that there’s a very high value added competitor for that, right? Do I lower the temperature of my house by one degree? Is that catastrophic? No, right?
But what it actually does is it means I’m a little bit less comfortable, and the offset to that is I have more processing power for AI, right? There’s a point at which humans turn around and say, man, I’ve already lowered the temperature from 68 to 67 to 66.
I’m not going to 55. 55 is damn cold. I’m actually sitting here shivering in my house right now in the middle of ice, a frozen tundra effect in the mid-Atlantic region. The simple reality is that human beings are going to be less tolerant of that shortage and scarcity. And I think unfortunately this creates political blowback against the growth of things like AI. So the answer is yes. I do think you’ll see an acceleration to it.
I also think the ramifications of that are going to create some social distress that we’re already starting to see the early signs of.
Monetary Metals:
And in terms of this social distress, you wrote a very interesting piece that went super wide talking about this idea of a new poverty line. And, you know, whether the on the margin, this stat or that stat or, oh, you know, 40,000 for child care or 30,000 for child care, it clearly hit a nerve. Lots of people were interested in the article. It got shared, it got debunked, it got re-bunked.
Everyone was talking about this article in terms of the average American who’s seeing, you know, price inflation, they’re seeing purchasing power fall. Maybe they don’t understand the VIX or the S&P 500 or even really how index funds works. They just go to work. They put money in their 401k, what’s something that they should be focusing on just to make sure that their life is materially getting better over time rather than feeling the squeeze over time?
Mike Green:
Well, unfortunately, this is, you know, the piece that you’re referring to, my life is a lie, as you pointed out, did go very viral. It had well over 2 million readings versus my normal piece, which was read by about six people, including, you know, people inhabiting a, you cardboard box under a overpass.
The most important thing is just education and actually helping people understand that what they were experiencing was not actually a unique experience. When you mentioned the debunking, the re-bunking, there were lots of claims by policy analysts that, well, these numbers are absurd, right?
Poor people don’t do X or poor people will negotiate for Y. The reality is that analysis that they’re conducting is deeply, deeply flawed in its construction. For every complaint I heard about the accuracy of the article, I received somewhere in the neighborhood of 2,000 emails from people saying, oh my gosh, this is exactly what I’m living through.
Thank you for articulating it in terms that people can actually start to understand. I’ll give a really simple example of that, right? In economics, we think of inflation as the year-to-year change in the price so if the price of milk, if that was the only thing we were purchasing, went from $1 to $1.02, that would be 2% inflation.
We saw a peak in that rate of change in 2022 that began to approach 8-9%.
That’s a historically high level of inflation, particularly on a global basis. It was a global phenomenon, not just a US phenomenon, and it was largely a byproduct of both both one, shutting down and then attempting to restart the economy, which creates frictions, and two, the willingness in the West in particular to allow the rise of pricing power and monopolies or increasingly concentrated markets in which competition does not force those prices down.
You can see that very materially in companies like PepsiCo, which announced that for five years they basically had tried to maintain pricing discipline, and now they are seeing unit volumes start to fall, and so they’re starting to cut prices.
The economics profession largely looked at that and said, well, inflation is transitory. And that actually turned out to be correct in the way that we define it. It retreated very, very quickly around the globe. We’re now watching inflation numbers fall well below the 2% threshold that has traditionally been thought of as stable prices. But that unfortunately doesn’t help the person who only had a dollar of disposable income if the price of milk has now gone to a dollar two.
Too, they can’t afford milk. And so what we’re increasingly hearing about is what I think is the more accurate observation that plays into my piece on the poverty line, which is this is an affordability crisis. Your ability to participate in a modern economy is increasingly challenged on the basis of the price level as compared to the rate of change of that price level.
And so, you know, like the economist profession did itself no favors by failing to understand that this was actually what was occurring. And by and large, we don’t yet have the policy prescriptions meant to deal with and address this issue of affordability as distinct from year to year inflation metrics.
Monetary Metals:
And how much do you think this, if you want to call it affordability crisis, is A, playing into the rise of people like Zohran Mamdani, these kind of populist figures saying, Hey, I’ll give you away free busses, free food, free rent, what free what have you, as well as the Trump saying, hey, we need to focus on inflation. We need to focus on affordability.
There’s too many immigrants here who are buying up houses or what have you. How much do you think that that is going to continue where we see populist leaders offering, you know, free giveaways, free goodies without actually fixing the structural issues, whether it’s, you know, more housing supply, whether it’s fixing this passive index discussion. Do you think that we’re going to settle down and say, hey, America, it’s time to have a hard conversation? Or do you see more free giveaways and free goodies?
Mike Green:
Unfortunately, I think that at least in the short term, we’re leaning towards the latter. Franklin Delano Roosevelt actually said it extraordinarily well, that people who are hungry, people who are not satisfied, people who are unable to meet their obligations, are uniquely subject to the risks of populist movements and dictators or tyrants who emerge and say, I will solve this problem, just give me control. We are definitely seeing an element of that play through.
One of the reasons that happens perversely is you see a country like China that has a much more command-oriented economy in which the government can largely dictate many of the actions taken by both the private sector and the state sector. That creates efficiency in debate. Are we going to build this train station? Yes, we’re going to build the train station. We’re not going to debate it. We’re not going to discuss the spotted owl or the three toed newt and the potential implications on the environment.
We’re going to do it, right? That creates an element of efficiency, but it also reinforces that fragility framework. What if that person gets the wrong solution? That’s what leads to the collapse of a Venezuela under a Chavez, for example, where the state has effectively articulated we want to do X without fully comprehending all the steps that are required to achieve X in an economic framework.
There’s a very famous essay, Nobody Knows How to Make a Pencil. And it’s really true, right? Like, how would you make a pencil? You gotta know how to chop down a tree, you gotta know how to compress the wood shavings, you gotta know how to make the graphite, you gotta know how to make the rubber to put the eraser on there, et cetera.
There’s no one individual that makes a pencil. We all work together. And when we talk about a system that’s integrated like that, taking advantage of the framework of Adam Smith and specialization of labor, which is really the core of the observations of capitalism, the reality is we are interdependent. And the more fragile that system becomes, the more risk that exists as we make ourselves individually more robust.
I’m going to exit the system and buy gold. The unique feature of gold is that it then becomes an asset that is not really available for other people to use. You’ve got it in your, you know, it’s buried in a tin can in your backyard, right? How is somebody else going to use that collateral? The minute you expose it as collateral, you expose it to the leverage effects that we were talking about before.
And so you can’t actually be a productive member of society. That process is the, another way of saying the paradox of thrift under John Maynard Keynes. If we all individually decide that we’re going to, you know, save a thousand dollars or buy a gold bar, you know, to protect our family against a potential outcome, The reality is, is that we create another systemic risk.
Monetary Metals:
Mike, I want to get to a rapid fire section with you. So I’ll ask you questions all over the map and you can answer as short as you want with just one word or as long as you’d like. So first I want to talk about this American dream as a call option idea.
Of course, call options benefit from having some volatility, right? If we just make them super boring, well, what’s the point of having this call option? So in a way, are we hoping for a little bit of volatility?
Was Trump the volatility? Was that that volatility passed? Are we hoping for something to shake up the American system so the American dream becomes alive and well again today?
Mike Green:
Yeah. So this was a piece that I wrote, and at least I thought it was pretty compelling in terms of the argument that, you know, really what we want to do is we want to build a system that is robust to volatility, that rises in value as uncertainty and new opportunities emerge.
That’s one of the reasons why a call option actually benefits in its pricing from volatility, even as volatility is generally perceived as bad thing, right? And there is a lot of truth to that, right?
If I don’t know if I’m going to be eaten by a crocodile on my way to work every day, that’s a lot of volatility that reduces my willingness to go to work and be a participatory member of society. That is a bad volatility. If by going to work, I’m constantly participating in a system that is skewed to the upside, again, emphasizing that call option framework, that’s a good thing. I can go to work confident in the knowledge that my bases are covered, and that by and large, I’m participating for upside as compared to meet an immediate obligation.
The sad thing is, is if you think about policy on those terms, it’s very concrete steps that we can engage in.
Education, instead of being thought of as something we have to do because we have to do it, actually becomes a statement that we want to give the maximum number of people access to the tools and information that would allow them to capitalize on the opportunities so that there’s millions and millions, actually literally billions of participants who are all thinking about what could I do to make life a little bit better for everybody else and in the process capture a small fraction of that in my own surplus.
The more people who are educated and thinking that way and not focused on like, where do I sleep tonight, the better our society ends up being. If you think about the world in this way, it frames policy, in a manner that we can actually manage against these components. And unfortunately, that’s not how we think about it.
Monetary Metals:
What about the AI story? AI can educate people, it can help people be a part of the global marketplace, they can learn quicker, they can ask questions that they’ve never had before.
Or is AI just a better version of Google? How important is the AI story to Mike Green?
Mike Green:
The AI story is incredibly important because in part it actually represents what I call the productization of services. And so this is actually a really important concept for people to fully appreciate, right? Everything at the end of the day is effectively a service. Am I entertained?
I turn on a television, the television and the material that is broadcast over that television serves to entertain me. It plays into my desire for leisure and entertainment. A refrigerator preserves food for an extended period of time, so I need to spend less time in a hunter-gatherer framework figuring out how do I get fresh food every day?
The existence of a grocery store likewise consolidates all of my hunter-gatherer activities within a give or take 10,000 square foot space that allows me to very quickly and efficiently hunt and gather meat and cheese and bread and milk and all the things that contribute to a variety in my diet that make me a more effective and healthier human being capable of living for a longer time, accumulating more knowledge, et cetera.
These are all things that are effective productization of services. The most famous examples of this are ones that occurred in the late stages of the first part of the industrial revolution, really the household revolution that occurred around the time period from 1900 until about 1930.
If you think about a washing machine, a washing machine is just a robot that does one thing. It doesn’t do it in a particularly sexy way. It doesn’t talk to me, or at least most of them didn’t talk to me.
But it does replace a washer woman, which was one of the primary mechanisms of employment for women who otherwise wouldn’t have had sources of income. You would take your washing or the washer woman would pick up your laundry and do it for you if you had the surplus to pay somebody to do it. The machine productized that.
The difference between a machine and a human is that a machine takes somewhere in the neighborhood of 35 minutes to roll off of an assembly line if it’s programmed with software with the knowledge of how to wash clothes that’s very quickly replicable. It radically reduces the quantity of investment that’s required to create the equivalent of a washer woman who would have required somewhere in the neighborhood of 20 years worth of nutrition, education, continuing nutrition going on, again, that human food versus the machine food of electricity, in order to replace the washer woman.
And by the way, like just, it’s an absurd example, but if the only washerwoman in the community were to be struck by a meteor or a lightning bolt, would society lose the information on how to wash their clothes?
The answer to that is a little bit obviously no, but you can think about that very quickly, that that’s part of what happens in very small societies, like island societies like Easter Island. You know, you lose your medicine, man, you lose the technology, you lose the technology that’s embedded in a single individual who knows how to make bows and arrows or whatever the the appropriate component is, that’s then lost and you have to subject yourself to the random reinvention of it.
The past 1000 years, I’m sorry, basically since the invention of the printing press, have really been about a broad diffusion of knowledge and capability that makes it easier for society to recover from those. That’s volatility resistance, going back to that phrase. And as we talk about AI and its ability to consider complex projects, like, how do I route orders through an ordering system? Or how do I respond to communications by other human beings that are asking me very complex things in an email chain?
AI effectively productizes much of that knowledge and represents the same risks and opportunities as the transition from washer women to washing machines. So it plays a huge role in it.
And I think it’s incredibly important, but I also think we have to be very aware of the demands that we’re putting on the system as we roll that out. Once again, really the electricity and the availability and pricing of electricity is something that we really have to spend a lot of time thinking about.
Monetary Metals:
Next rapid fire question for you. We’ve obviously talked about the Fed a lot in gold spaces.
How important do you think the Fed is, whether it’s Fed independence, who the next Fed chair is, do you think that people are over indexing on how important the Fed is, or they may under indexing on how important the Fed is?
Mike Green:
It’s interesting. So when I give my presentation, I actually make a point that I almost never mention Federal Reserve policy. Policy, right? And the reality is I think the Fed is far less important than we broadly give it relevance. I think really good examples of that.
I mean, for the past decade, we’ve watched charts produce and say, oh, it’s all about money printing, right? Look at the Fed balance sheet versus the S&P 500. Well, when that relationship breaks down, we don’t reconsider it and say, oh, well, maybe it’s different. I don’t know. This is, you know, things are screwy, right? Must be a bubble.
The reality is that those things don’t really mean the same thing that we think policymakers rarely matter. They only matter when they create constraints on a system that prevent people from doing stuff. And I do think that unfortunately right now, we have inappropriate monetary policy that is facilitated by a Federal Reserve and in particularly a chairman who I would describe as intellectually incurious and largely without a model of how the world actually works. Works. We raise interest rates because we think it lowers inflation. We lower interest rates because we think it stimulates economic activity.
And the simple answer is it depends. If there’s a huge quantity of debt outstanding, as in the United States or Japan, and you raise interest rates, what you’re actually doing is increasing fiscal stimulus.
If you lower interest rates, you’re removing fiscal stimulus. Is that pro-cyclical? Contra-cyclical? It’s really hard to no. And so I think one of the unfortunate byproducts is that because we do not have very well formed models of how these things actually impact markets, we tend to over index on it because it’s a little bit like our giant rain dance, right? You know, we can point to it and say, Hey, we did something about it, right?
We appealed to the rain gods and they brought us rain. But if we appeal to the rain gods and they don’t bring us rain, well, then we must have done something bad that we haven’t yet figured out. And so they’re withholding it from us. So let’s try a whole bunch of other things. Let’s burn some witches for example, right? You know, that was the old world. The new world is really one that is supposed to be governed by the scientific method in which people are able to articulate a hypothesis and model of the world and then actually test against it.
The problem is, how do you do that in a controlled framework within economics? Right? It’s, you know, you don’t learn how to fly the plane while you’re flying the plane. You know, you, you theoretically are supposed to learn it beforehand, and then they give you the controls of the plane.
And by the way, you keep learning because you you keep experiencing new things. But if you aren’t intellectually incurious, you don’t ask yourself, why when I press this button, did this happen last time? You just press the button again because you see the same problem. And that’s not the right answer to monetary policy.
Monetary Metals:
Talk to me about this debt and debt servicing cost. Obviously, you know, now the debt interest payments are higher than the military. You see this stat, this headline, is debt important?
Is the MMT critique right? Well, we can always just print the or is there something more important?
There’s some certain number when we hit 150% debt to GDP, or is there some other catalyst or does debt maybe just not matter as much as most people think?
Mike Green:
I think it’s unfortunate that we call it debt at the sovereign level. We don’t really have a great term for it, but I do unfortunately think that the MMT framework is correct in that it accurately describes that governments can’t go bankrupt in their own currency.
But they can produce too much currency and create loss of purchasing power or more accurately loss of debt cancelation, which is really what currency plays a role in. The way I try to frame it for people is that they’re actually what I call financial primitives and they behave very similar to the components of options as well. Currency is simply money, quote unquote, is simply that which cancels debt. That’s what it exists for.
I go to the coffee shop, I say, I’d like a coffee. I’ve entered into a debt contract in which they are going to deliver a coffee and I’m going to deliver that which cancels the debt, i.e. money, right? It’s a microtransaction. We don’t talk about all the debt that has been incurred in the process of that or the cancelation of that debt, but that’s really what’s ultimately happening. At the sovereign level, debt exists for a different reason.
It exists largely as a liquidity management tool. It basically says we’re going to print money into existence and then we’re going to offer people an incentive not to spend it, which would cause the potential inflation, you know, too much money chasing too few goods.
We’re going to create this fake entry and we’re going to pay you an interest rate to not spend that money. That’s really what sovereign debt is. And so the question is, how much money do I have to offer people to avoid them spending it? It’s why we encounter hyperinflation when the real resources in the economy, the quantity of goods effectively falls precipitously versus its prior level, that causes prices to rise.
And our response to that is, okay, let’s give people more money so they can buy these things as compared to the thoughtful application of that money to produce more of those things. It’s why the quick answer is, yes, it matters, because it’s functionally a measure of how much we’ve had to of these quote-unquote fake securities we’ve had to introduce to prevent people from spending money and driving inflationary conditions. And there is a point at which I have to start increasing that interest rate in order to discourage people from spending it.
But the simple reality is there is no set level. It is largely tied around the capacity of the government to do something else, which is taxation. Taxation is that which destroys currency, right? You’re effectively taking it and saying, yeah, you’re getting nothing in return for it, right?
That’s how you destroy currency. And when you encounter states losing state capacity, as the United States unequivocally has, or many other countries around the world, particularly smaller countries experience, you run a very real risk that you lose the ability to effectively collect taxes. And at that point is when the real crisis begins. It’s not about the debt per se. It’s about the ability to tax.
Monetary Metals:
Mike Green, it’s been fascinating. One more rapid fire question for you. Ozempic, Wegovy, they’ve taken over. People are feeling better, they’re losing weight, maybe even living a bit longer. How important is this to your macro outlook?
Maybe people will be eating less McDonald’s, so we got a short McDonald’s. Maybe people are living longer, so we need to invest in long-term care facilities. How important is the health revolution or the longevity revolution to Mike Green?
Mike Green:
Well, first I want to be clear, I think that they are related but distinct, right? So when you talk about longevity, that largely for the past hundred years has meant more and more people living a decrepit lifestyle in which they become wards of the state or those who can take care of them.
I think the better analogy with Ozempic is actually addressing all the concerns that were raised that said, obesity is the problem of our time and it’s creating all these catastrophic health conditions.
And eventually we’ll be spending all of our money on diabetes or various other ailments associated with obesity. I wrote a piece a couple of years ago upon the first introduction of GLP-1 in the early data on this that actually highlighted we’d had this discussion before about tuberculosis. And so tuberculosis was a modern disease. It was a byproduct of people being in close communicable conditions. It’s a bacteria that is actually spread by, you know, phlegm in fact, and so as more and more people lived in close quarters, they were increasingly exposed to tuberculosis.
Tuberculosis is like obesity squared in terms of its impact, right? The only cure for tuberculosis is for you to move to a sanatorium and effectively give your body time to recover in which you are not strenuously working.
That took an extraordinary number of people out of the labor force that otherwise might be active participants and the costs of servicing tuberculosis, just to help people frame this.
In 1900, I believe that they were somewhere in the neighborhood of 600 sanatoriums in the United States. By the 1930s, there were 400,000. Many of the hospitals that we think of, many of the facilities that we think of, were actually built during that time period in order to address this societal need to segregate that population, not all that dissimilar from what we should have done during COVID is to separate the, you know, the actual vulnerable as compared to shutting everybody else down.
If you had done a projection in 1930, you would have said, you know, in another 50 years, 50% of GDP is going to be allocated to the treatment of tuberculosis. Last year we spent $4 billion on tuberculosis in a $32 trillion economy because nobody has it anymore. We developed to technology called antibiotics that solve the solution. I would argue GLPs are the same thing for the obesity component. Now, the question is, do we use those tools to broadly facilitate not just people looking better and feeling better, but also making them more active participants in society?
That changes some of the calculus around it, right? Do we restrict access from insurance companies to antibiotics to treat tuberculosis? No. Do we restrict access to GLP-1s and more advanced GLPs to treat obesity? Yeah. Right. Isn’t this great?
We can call it the profit motive, et cetera, and we flow it through an insurance system that is intentionally designed to maximize its profits by minimizing costs, not by improving outcomes. So it unfortunately encapsulates many of the problems that we have in our time today, where it’s a question of how broadly do we want to distribute these solutions?
And how much do we want to embrace them is what they should be, which is productivity enhancements, improving people’s ability to participate in the economy. Or do we want to treat it as effectively cosmetic surgery and be like, oh, look how attractive my green is now that he’s skinny as compared to when he was fully fleshed out. I think eventually we’re going to get to the point where we think about it as a participation component and a tool to improve participation. But we’re not there yet.
Monetary Metals:
Mike, thank you for doing the rapid fire section. Always fascinating. Final question for you. What’s a question I should be asking all future guests of the Gold Exchange podcast?
Mike Green:
Wow. I mean, I will tell you the thing that I always try to enforce with people is check to see if they have a model of why gold goes up. Goes up, right? Check if they have a model for why prices change, right? Scarcity is not an answer. You can have very scarce supply, but nobody really wants it, right? Herpes would be a really good example.
How do we price that in the market economy? Well, we price its avoidance, right? The more widespread it is, actually, the less value it has in terms of avoidance, because basically everybody has it. The more scarce it is, the more willing we are to avoid those components. Gold actually has many of the same properties.
There’s a scenario in which participation in gold markets becomes a scarlet letter that says, Hey, I choose not to join my comrades in participation in the economy. I’m stepping out of this thing. I’m not going to participate. That could be viewed as socially undesirable, and you could theoretically create conditions under which the price of gold has a negative value associated with it, right? Very few people consider it in that context.
And so I would just encourage people to, you know, make sure that they have a fully formed view of the world before they articulate the right answer for everybody.
Monetary Metals:
Well, the Vizzini of our time, Mike Green, thank you for joining me. People are obviously going to want more Mike Green. Where can they find you and learn more about simplify asset management?
Mike Green:
Well, again, I never traffic in the obvious. So if they are still interested, you can find information on my work at www.simplify.us. We’re an ETF company focused on various ways to modify those underlying market exposures, whether reducing risk, increasing income, et cetera. You can follow me on Twitter where you will see the Vasinii avatar, which candidly was there when I didn’t think anyone would actually know who my green was or think it was relevant.
But you can find me @profplum99 and if you’re interested in my longer form thoughts, I write weekly, roughly, basically every week on a substack called yesigiveafig.com that’s where you would find things like the poverty line analysis or the analysis of Bitcoin market structures, et cetera. And the last thing I would say is that I’m getting very close to finishing my book on the impact of passive investing. That book is called the Greatest Story Ever Sold. And it should be hitting bookstores sometime this year.
Monetary Metals:
Mike, so excited to read the book. We’ll be the first buyers. Thanks so much for joining us. We’ll have to have you back on again soon.
Mike Green:
Thank you for having me, Ben.
