ED HARRISON: Welcome to "Real Vision Live." I'm the host for today, Ed Harrison. And I have the distinct pleasure of talking to FFTT Founder and President, Luke Gromen. Luke, welcome back to "Real VIsion."

LUKE GROMEN: Excited to be here, Edward. It's great catching up with you-- I always love talking.

ED HARRISON: Me as well. And as you know, I said right before this, I was preparing, I was super pumped, I said, to have this conversation with you, and in particular because I was reading one of your missives where you were going over the recent change that you had with regard to how you're thinking about the dollar. And when you're changing how you think about the dollar, you're changing a whole narrative in terms of the reflation trade, and there's a whole nexus of things associated with that. So let's go through your macro backdrop to get an understanding of what's changed since the last time you and I spoke.

LUKE GROMEN: Sure. So back on January 11, we wrote a report for our clients entitled, "The US Dollar and Volatility Likely To Rise Until Something Breaks as US Moves to Defend the Dollar System." And it's a tactical shift that we've made. I don't know how long it will last, but the gist of it was that the Fed really came into this year cornered in a way that I don't know was fully appreciated.

What I mean by that is you had a situation where the US needs more stimulus. You were seeing rates rise and the dollar fall, which as my friend Louis Gav says, always sets off alarm bells in his head, because that's a sign of a balance of payments problem. It's a sign of a currency crisis when your currency is falling and your yields are rising.

You had the dollar already sitting at pretty key technical levels in the 88, 89 range on the DXY. And so more stimulus, more dollar weakness risks touching off a more chaotic decline in the dollar. And really, I think the Fed's biggest fear is the combination of declining dollar, declining asset prices. Because that, then, suggests significant capital flight in a real way.

And so you're looking at this nightmare scenario for the Fed where the domestic US government needs more stimulus, really needs the Fed to monetize that stimulus, because the balance sheet and the global market foreign creditors, et cetera, private sector, foreign official sector-- the balance sheet doesn't exist, really, to absorb very much of those deficits.

Yet, the dollar's already at key technical levels where you could touch off a chaotic decline in the dollar and capital outflows driving US equities selling, at which point the Fed's only playbook would be to significantly raise rates, brake the economy, basically run the Paul Volcker playbook in 1980. And that's a whole separate issue. So our point was that it looked like the Fed was cornered, and two things really grabbed our attention in December and January that led to this tactical shift.

And they were two op-eds written first by former Treasury Secretary and Goldman CEO Hank Paulson back in mid-December entitled, "China Wants to Be the World's Banker." And then another one by Kevin Warsh-- former Fed Governor Kevin Warsh in early January all talking about the same thing-- that basically there's this capital outflow to China.

And they both highlight, to paraphrase my friend Brent Johnson, that China was drinking the US' milkshake. China's rates were higher. You were seeing significant capital flows to China. You were seeing dollar weakness. And so basically, these two op-eds were almost, to us, an admonishment to policymakers to basically start paying attention to the dollar.

And when we paired that with what we started seeing in the fundamentals and the macroeconomic fundamentals-- and what I mean by that is in 2020, the Fed bought more than 100% of US Treasury net issuance. The Fed effectively monetized US deficit in 2020. In 2021, the plan right now is for the Fed to buy significantly less than 100% of US Treasury net issuance.

And so when you look at those two things-- when you look at the admonishment from Warsh and Paulson, it sets up, actually, something that was written about by Soros and Druckenmiller and was discussed early on in the Trump administration, which was something we've referred to as the Soros Druckenmiller strong dollar playbook. Which is if you run tighter monetary policy at the same time that you increase US deficits, increase fiscal, what you end up doing is driving a stronger dollar, driving higher equity prices, driving higher interest rates as you begin to bring capital back into the US, attract capital to the dollar.

And so in the context of what warsh and Paulson indicated or admonished policymakers to do, to us, this sign that the Fed was not going to buy enough treasuries in 2021 as opposed to buying more than enough in 2020 suggested a near-term bottom in the dollar, particularly when you married it up with the factors we laid out before. And so paradoxically, at a time when no one's talking about the dollar milkshake anymore, it looks like the Fed and the US are starting to run the dollar milkshake again, to use our friend Brent Johnson's phrase.

And, now, this is a tactical move. Back in 2018 was the last time the US tried to do this-- back in 2Q '18 after you had the sell-offs in 1Q '18 in the markets where the dollar actually fell and rates were rising-- same kind of thing. You saw the Fed basically move to defend the dollar-- same thing, tighter monetary, looser fiscal via the tax cuts.

You crowded out global markets, you attracted dollar capital to the US. US dollar rose, US equities rose, US rates rose-- that lasted for about four maybe five months until 4Q '18, and then all those factors basically blew up risk assets. And I think the same thing's going to happen again if the US tries to run this playbook for too long.

And critically, given the much greater leverage in the system, I don't think we have four or five months. I think this is a brief bounce respite in the dollar as we are effectively running the Soros Druckenmiller strong dollar playbook for a period of time. But that was really the crux of our tactical shift and view that we wrote about for our clients on January 11.

ED HARRISON: Very interesting-- a lot of things to pick apart there. The first thing that I would say one of the comments that you made that caught my eye was the fact that the Fed is buying less than 100%-- much less than 100%-- of the US Treasury issuance. I would say that's de facto tapering in that sense. And what I'm thinking about is the de facto tapering is, obviously, dollar bullish. How do you think about that?

LUKE GROMEN: I agree.

ED HARRISON: Yeah, so that's the first part of this. Now, when I was on Twitter, I was saying to you that the thing that I'm looking at as someone who follows bonds is the yield curve-- how the yield curve is going, and what are the reasons that it's going there. What I see is a two-year, which is basically flat, since we've had the reopen. In fact, it's probably slightly down.

It's down to 11 or 12 basis points from anywhere from 15 to 20. And the difference to the 10-year is expanding over time. We got to 1.19% at one point, at which point the equity market puked, and we backed off-- we went down towards the 1% level. But it seems like we're in this new range now with 1% as the bar at the bottom, and now we're trending up slightly-- we're at 1.14%, 1.15% as you and I speak.

Talk to me about what's happening there and what's causing that. Is it related to this lack of soaking up of US dollar deficits by the Fed?

LUKE GROMEN: Yes, in short, I think it is. I think the narrative is primarily that it's around reflation. And I think there's absolutely an element to it. But to me, the under-reported side of this continues to be this broader, this bigger picture dynamic that we've been talking about ad nauseum since 3Q '14, which is foreign central banks have stopped buying treasuries on net over the last seven years. They haven't bought a single treasury on net, foreign official sector.

The global private sector, ultimately, can pick up the slack, particularly now that the dollar has fallen the way it has. That helps make adjustments within FX hedging markets that make FX hedge treasury yields more attractive to the foreign private sector. But ultimately, when you look at the size of these deficits and the projected size of these deficits, there simply isn't enough global private sector balance sheet to finance the US deficits on their own.

And so you're seeing, basically, the price of these bonds fall. You're seeing rates rise. And so I think that's the dynamic we're in. And I think the $64,000 question, to your point, is, what's the level on the 10-year that causes things to break? Because really what we're talking about here is a US balance of payments problem. It's not a relation-- we're going to get our reflation as a result of the Fed response to this US balance of payments problem. But ultimately, that's what I think we're watching in terms of this yield curve steepening, and particularly what's happening at the long end.

ED HARRISON: Yeah, by the way, as you were speaking, we got seven questions already. And what I'm trying to do is just have a normal conversation, and at some point, once we've given the macro view and we've expressed everything, we can start to pepper these questions in. But the more questions we get, the less time we have, because I want to make sure that people get a chance to pick your brain as well.

There are a number of things I was thinking with regard to that-- two things in particular, just in case I forget the second. The first thing that's always on my mind with regard to balance of payments and yield curves is the dichotomy between what's happening in the UK and the US. And let's run with this question-- the concept that just today the BOE told a UK bank that you have six months to prepare for negative interest rates.

And if you look at just sort of the macro picture there in the UK, it's very similar to how it is in the US. They're running a current account deficit. They're running a massive budget deficit. They also have a fiat currency where the alignment of the central bank and the government is 100% so they can finance those deficits through quantitative easing or whatever else they wanted to do.

But the yield curve in the UK looks very different than the United States-- both in terms of levels and also steepness. And now, the UK central bank is saying, prepare yourself for negative interest rates. In fact, the short end of the curve in the UK is negative, whereas in the US, it's not. And we have a steepening yield curve.

It sounds to me, just looking at those two, as if the market is saying, actually, the UK, we believe you, Bank of England, that you're going to do more to keep the Sterling low and to monetize these deficits. Whereas they're saying, no, we're sort of on the sideline. We don't know if the Fed is really going to come for [INAUDIBLE] bad things happen. So talk to me about how you look at this dichotomy between what's happening in the UK with negative interest rates and what's happening with the US.

LUKE GROMEN: So it's a really interesting question. It's a really interesting point. I think at least some, and maybe some big part of the difference is tied to the dollar as reserve status and the Treasury bond as global primary reserve asset-- or at least incumbent global primary reserve asset. Which is to say, the Bank of England is, I think, operating under a system of do what they perceive to be best for the economy, and the country, and financing the government. And that's their sole mandate.

And the Fed has really, in this context, not just the domestic economy mandate, but the management of the global reserve currency mandate. It's the old Triffin's Dilemma. In one of our recent reports, we referred to a great line in the movie "Sweet Home Alabama"-- my wife loves these rom-coms, so I've seen it-- but there's a great scene where the girl's trying to pick which guy to date. And her dad says, look, you can't ride two horses with one ass, sugar bean.

And so the Fed is trying to ride two horses with one ass, and the Bank of England has already picked their horse. They're willing to let the currency do what it's going to do. They can move to negative interest rates, because they don't have the reserve currency. The issue for the Fed is if they move to negative nominal rates, they're $7 trillion-plus in dollar-denominated FX reserves sitting around the world.

And if they move into negative territory, where that's basically the Fed declaring that we are going to start stealing back via negative rates the accrued surpluses you have earned from trading with the United States over the past 50 years under the dollar-centric system, it would stand to reason that that $7 trillion would start bidding for 0% for high yield FX reserve or reserve asset alternatives.

And on top of that list is gold, and you can argue now as Bitcoin gets bigger, Bitcoin. And so what the Fed has to manage that the Bank of England really doesn't is this reserve currency management dynamic. And if China was still a small player in the world like they were 20 years ago, the Fed might be able to get away with doing it anyway-- with running the BOE playbook.

But the reality is the Chinese are offering 3%-plus on the Chinese 10-year. And yeah, they have capital controls, and yeah, there are rules of law differences. And it all comes down to we're at 1% and they're at 3%. Do you feel like that extra 2% pickup in this world is enough to compensate you for those risks? And what we've seen over the last nine months, six months, whatever you want to look at, the world is saying, on the margin, we're willing to take that risk.

You can see the capital flows moving. Eric Goldman came out a couple of weeks ago and said they expect $140 billion of bond flows to China this year. That's $140 billion of capital that under the way the system used to work belonged in the Treasury market. That's our money going to China. And so that, I think, is really the dynamic.

I don't know if it's so much that people don't believe the Fed can do it. I think it is more that the Fed is trying to ride two horses with one ass. And those horses are increasingly running in diametrically opposite directions. And they're going to have to make a choice really soon. And that ultimately ties back to why I think this dollar bounce probably won't last all that long.

ED HARRISON: Right. Very interesting. So why don't we pivot for a second. I want to get to the second thing that I was going to ask you about was the stimulus package. But let's go back to that, because I want to pivot to China since you're talking about China. I think that dynamic is interesting, especially when you think about coronavirus, where the Chinese, that's where the coronavirus started.

They seem to have done relatively well with overcoming the problems associated with it. And now they were actually the best country in the world in terms of growth of the large countries in 2020. And they're back on track, allowing them, by the way, to be able to not do massive monetary stimulus, massive fiscal stimulus in order to support their economy, because their economy is still roaring along.

And we're no longer at the point where they're just doing stuff in order to keep output up. There's actually demand for Chinese goods and services. So they have a 3% yield versus the 1%. Where's this headed in terms of China's role in the global currency system and also in terms of the value of the yuan?

LUKE GROMEN: So I think ultimately, this yuan is going higher, and probably a lot higher. That's the easier part. The question-- and it's a great question again-- is it gets to the heart of a discussion that I've been having for a long time. And I think people are starting to really see it play out-- some of the dynamics we've been discussing. Which is forever, people tell me, Luke, the yuan is not going to replace the dollar.

And forever, I've been saying the yuan doesn't want to replace the dollar. China has no interest in structuring their system like the dollar system's been structured post-'71, because it requires them to hollow out their manufacturing sector, send their jobs overseas somewhere else, run massive deficits that in the long run bankrupt their economy. And the Chinese actually plan for the long run, unlike our government which runs two-year election cycle at best, and from putting out fire to putting out fire.

And so what China's really been doing is managing-- they don't want the want the yuan to replace the dollar as the dollar was from '71 to the present. They want to shift the system towards a multi-currency system where, ultimately, the valuation of your currency relative to other currencies is a function of your current account balance relative to those other currencies, and a function of your pile of reserves relative to those other currencies.

And two things about that-- number one, that's the way currencies worked for basically all of human history up until 1971. And so what we think is normal is actually the biggest aberration in probably 2,000 years, with the exception of very small eras around worst. And number two, this isn't my speculation-- the head of the PBOC, Zhao, wrote about this in 2015, I think it was-- might have been 2016.

But he flat out said, currencies will increasingly trade based on balance of payments, current account balances, and on reserves. And so when you look at that, what all this means relative specific to your question is, people say, well, if I take yuan-- if Saudi or Russia take yuan for their oil, what are the Russians getting? The Chinese don't have a big enough bond market.

And people are conditioned to think that that's the way the world works is we have to have this big bond market to recycle the flows-- resolve it all in the capital account like the US has done since '71. And the reality of what China is doing is they're resolving these imbalances in the trade balance, in the trade account. And so what they're doing is basically, well, what's backing the yuan? If I have yuan, what do I get for it?

And the answer is, it's settled in Chinese goods. And when you look around the world at all of the nations that trade with China-- number one, they're the number one or number two trading partner with basically everybody on Earth. And there's this great chart that I have that