WBD603 Audio Transcription
GBTC Leverage Death Rattle? With Steven McClurg
Release date: Monday 9th January
Note: the following is a transcription of my interview with Steven McClurg. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.
Steven McClurg is a Co-Founder of Valkyrie Investments. In this interview, we discuss the causes of the crypto crash of 2022 and the effects seeping into 2023. We talk about Genesis, GBTC and Valkyrie's proposal; how over-leverage and debt are leading to a breaking point; the positives of political chaos, and how Bitcoin could have bottomed out.
“Bitcoin goes in four-year cycles based on halving, and I’m sure two years from now when everything is fine again, and prices go up again, people are going to get excited, they’re going to get greedy, and they’re going to pump things up on leverage. And I hope people remember this point in time and say, okay, stop, cut it out…leverage isn’t bad, over leverage is bad.”
— Steven McClurg
Interview Transcription
Peter McCormack: Steve, man, how are you?
Steven McClurg: Fantastic, how are you, Pete?
Peter McCormack: You need the mic.
Danny Knowles: Sorry, pull the mic up; your voice is loud but it's not that loud. Do you want me to come and sort it? Oh, yeah, you're good.
Steven McClurg: Am I good?
Danny Knowles: Yeah, just a little bit closer.
Steven McClurg: A little bit closer?
Danny Knowles: That's good.
Peter McCormack: You can manage it.
Steven McClurg: That's what she said!
Peter McCormack: Good to see you, man.
Steven McClurg: Good to see you; it's been too long. Last time I saw you was --
Peter McCormack: We had a Sunday roast, didn't we?
Steven McClurg: We had Sunday roast together in London with the kiddos.
Peter McCormack: What's it called?
Danny Knowles: Hawksmoor?
Peter McCormack: No, we went to --
Steven McClurg: It was Gordon Ramsay's place.
Peter McCormack: Gordon Ramsay's place for a British Sunday roast.
Danny Knowles: Very nice.
Steven McClurg: Oh, man!
Peter McCormack: It was very civilised.
Steven McClurg: My kids, who are not civilised at all, they live for Sunday roast in the UK.
Peter McCormack: Well, our food gets a lot of criticism, but the Sunday roast is killer.
Steven McClurg: I can't wait.
Peter McCormack: You've got cool kids, by the way.
Steven McClurg: Oh thanks, you have cool kids too.
Peter McCormack: Yeah, they all just sat there being quiet and playing with their phones.
Steven McClurg: Staring at each other.
Peter McCormack: Yeah. No, it was good to see you, man; it was before everything went to shit!
Steven McClurg: Yeah. No, I think things had started going to shit.
Peter McCormack: Had they?
Steven McClurg: Didn't Celsius go down at that point in time?
Peter McCormack: Did you see the New York AG announce today they're suing them?
Steven McClurg: Yes.
Peter McCormack: Suing Mashinsky.
Steven McClurg: Yes, those are some really interesting articles that came out about Celsius in the last few days.
Peter McCormack: I've not followed, we've been here for three days making shows, I don't know what I've missed, but Mashinsky's an interesting one; I've had bad vibes from him for a long time.
Steven McClurg: Same.
Peter McCormack: I met him in Hong Kong at the TOKEN2049 conference. Interestingly, Justin was there with a whole entourage; met him for the first time. I met a bunch of people for the first time there, but I met Mashinsky, got these really bad vibes from him, and I've had them ever since, and I wasn't surprised when I found there was an issue with Celsius. I was surprised that so much other shit happened. But update me on Celsius then.
Steven McClurg: So, all the client deposits, per the documents, don't belong the clients, they belong to Celsius and the estate.
Peter McCormack: Because there's a gap between what they have and what their liabilities are, right?
Steven McClurg: That's right. So, it looks like all of client deposits will go to paying off liabilities first, potentially shareholders second, and depositors last.
Peter McCormack: Holy shit!
Steven McClurg: That's not good.
Peter McCormack: Help me understand because this isn't a UK thing, we don't have like the Bedford Attorney General suing Pete McCormack for lying to people about his football club, we don't have these state attorney generals; is it a state or city attorney general?
Steven McClurg: Well, you've got attorney generals of the US, of the state, of different districts, of cities, but this one in particular is being tried in New York.
Peter McCormack: State or city?
Steven McClurg: I believe it was a state attorney general that came out to sue Mashinsky.
Peter McCormack: Actually, I don't even know what an attorney general is to be honest.
Steven McClurg: It's essentially the lawyer that represents that particular jurisdiction.
Peter McCormack: Right, and so they're suing Mashinsky directly?
Steven McClurg: Yes.
Peter McCormack: For what reason; because they want to return as much net worth as he has to depositors on behalf of depositors; or because they want to put him in jail; or both?
Steven McClurg: I think it's a combination of both. It looked like, and I read the article very briefly, they're suing him for fraud, which means that they can go after his net worth but they can also go after triple damages. So, they can take anything he's taken times three, so they can essentially wipe him out and go to jail.
Peter McCormack: What I find really interesting about this last few months, what I can't wrap my brain around is why people, who are essentially successful, relatively wealthy compared to a lot of other people, have been so reckless that they've risked bankrupting themselves, risked destroying their reputation, risked destroying the lives of themselves and their family for what appears to be pure greed.
I never liked Celsius, but I think they could have built a fairly solid business without it being reckless, similar to, we've listed here, we've got a few here, 3AC, BlockFi. FTX is another one; if they'd have been responsible and not reckless, I feel like they could have built a big successful business. I just don't understand what these people are fucking doing.
Steven McClurg: Well, I think there are two things going on here, usually Ponzi schemes; let's just talk about those for a moment. Ponzi schemes don't start off as a Ponzi scheme; people don't say, "Oh, I'm going to go out and get people's money and then get the next guy's money and then give the first guy some of his money, and I'm just going to keep doing this until it falls apart", that's generally not what happens.
Generally, what happens is they're taking people's money and they think they have a good idea, they start managing it, something goes wrong and they don't want to upset their investors or they don't want everybody to pull out, so they're like, "Well, I'm going to make an exception this time". They might do something like somebody wants a redemption, or they might pay out a dividend just to keep everybody happy and keep everybody in so that they can make it up.
Sometimes they have good intentions, I hate to call it good intentions but like, "Well, I can make up this hole", but as you keep trying to make up that hole, the hole gets bigger and bigger, and it's a certain personality, obviously, that thinks that way. So, that's usually how a Ponzi scheme evolves, they're like, "Well, if I can just keep it up a little bit longer, I can make up the hole", and that seems to be what had happened with FTX, it turned into a Ponzi scheme.
A lot of people say that, "Yeah, it was a fraud from the beginning". I don't know if that was the case, it could have been, but I truly believe that they had a hole that they kept trying to fill, and when you keep betting on black every time at the casino and you keep losing, eventually you think you're going to win but you don't; eventually, you're just wiped out.
Peter McCormack: Yeah, I think something else went on with FTX in that I saw the org chart of all the companies they'd bought and the structure of this organisation, and they seemed to have made a lot of investments. I know, myself, I look back at my career history, I built a very small advertising agency that got to like 35 people, and that was challenging, really challenging, and eventually that company failed, we lost a big advertiser and we had to shrink it and then eventually, it failed; that was hard. This is my first podcast; we've been through ups and downs, and it's hard, and this is a team of five people.
I don't know Sam's full career history or the career history of everyone who was alongside him, but to build a company that fast and buy that many companies, I feel like something ran away from them and just also didn't know what the fuck they were doing.
Steven McClurg: That's a real possible, and I don't know if you've ever been around the whole Silicon Valley group, they try to pump things up very quickly, and there is probably a lot of pressure to say, "Okay, well we just gave you money, you should raise around round and we're going to bring in all of our friends and we're going to give you even more money at a higher valuation", and you've got to figure out ways to deploy that capital. I'm not saying that that's what happened, but it seems to be pretty close to what happened, and then they just couldn't manage it.
Going back to the second thing that happens, that I think happened in all these cases, is a lot of people wanted to create a marketplace; Voyager, BlockFi, Celsius, FTX, they're all marketplaces. Marketplaces require two sides of the trade: there are people that are putting up their money to get returns, to get yield; and then people that borrow, and they have to pay a higher yield to borrow the money. Now, it wasn't a true two-sided market, I mean how many people out there do you know that were saying, "Oh yeah, I'm going to go borrow money from Celsius and pay 15%?"
Peter McCormack: Yeah, it's very rare, you've got the odd person here or there who wants to borrow, maybe they're buying a house; I know it happens. I tend to find the kind of people who borrow against a Bitcoin are the kind of people who have got a shit ton of it.
Steven McClurg: Yeah.
Peter McCormack: Like, "I've got 1,000 Bitcoin [or] 500 Bitcoin, I'm going to borrow against 50", and maybe at that time, it was $1 million, $2 million, and it's a small amount of their Bitcoin net worth, but that $2 million allows them to buy a house and they know their Bitcoin's still there and they think the price is going up to $100,000. That's the trade that I think, I could be wrong, I never felt like there were many people who want to borrow $1,000.
Steven McClurg: That's right.
Peter McCormack: But there are a lot of people who want to lend $1,000 and get their interest.
Steven McClurg: That's right.
Peter McCormack: 0.1 Bitcoin, 0.5 Bitcoin.
Steven McClurg: So, if there's not another side of that market, what do you do? They go out and find degenerates who are willing to borrow at a certain rate and you prop them up. If you go back to the list again, like Celsius or even Genesis, you've got to find those people that are willing to take the loans, and who are the only two major counterparties that are willing to take the loans? Alameda, Three Arrows Capital; they were willing to take sized loans to do a trade that they thought was never going to fail.
Peter McCormack: Look, we sat down last year and you called the top, you called the top and I ignored you! You called the top, man; I think it was November last year.
Steven McClurg: Yeah.
Peter McCormack: Fine. I never foresaw this kind of year coming where it was a combination of macro things happening that crushed the price, it was you who was telling me how correlated Bitcoin is, but then this collapse in the borrowing and lending market, like the two things hit it. And I'm not sure if that shortened the bull market or I'm not sure if it deepened the bear market. I'm looking to you and saying, "What does your crystal ball say?"
Steven McClurg: Man, it's a tough one because I made that call based on macro events, and that's what I'm better at. I didn't really expect, well I'll take that back, I expected a couple of these lenders to fail, I expected potentially Celsius, potentially BlockFi; I didn't think that it was going to be as deep as FTX and Voyager and all these other ones. But when all of those went down in the spring, it deepened it further than I thought it was going to deepen, and we're here for a while.
I don't think that we're going to $5,000 Bitcoin or $10,000 Bitcoin or maybe even $12,000, maybe we'll back to $15,000, but we're probably going to be here for a while, and we're going to be here for a while for macro factors, and we're going to be here until the equity markets catch up with us; equity markets are still behind the digital asset markets. We got here first because of those failures, and then we've had bigger failures with FTX which, again, I didn't predict. We can talk about FTX more, but I didn't predict that they were going to be a fraud; thank God we didn't have any money with them. Now, we've got the Genesis situation; the Genesis Situation, I think, is going to be bigger than FTX, but once that's out, I think we're gone, that's it, there's no more leverage out there.
Peter McCormack: Well, as Arthur Hayes said, he said -- do you remember the article I found you?
Danny Knowles: The one earlier, like March last year?
Peter McCormack: No, the recent one, he just said, "I think the market's bottomed because everyone who can go bankrupt has gone bankrupt, like there's nothing left". Obviously, we still have Genesis, but part of me thinks Genesis is priced in because everyone knows they're fucked. What are their options? They can raise more money but is anyone going to lend them money?
Danny Knowles: Is it worth just explaining this situation from the start for anyone that doesn't know what's going on?
Peter McCormack: Yeah, what can you explain about Genesis?
Steven McClurg: Well, here's what I know and here's what I think I know; there are two different things, right, and I guess I really didn't uncover a lot of this until the FTX bankruptcy. I knew that BlockFi was heavily involved in Genesis, as was Three Arrows Capital, but essentially what was happening was BlockFi didn't have another side of their market, so they were giving money to people like Three Arrows Capital, Genesis, who were then lending out and giving back a yield to Alameda, Three Arrows Capital once again.
The interesting thing about Alameda was, my understanding, and this is based on a CoinDesk article so I don't know if it's true or not, that they had something like $3.5 billion to $4 billion in loans to Alameda at one point, something like $2 billion to Three Arrows Capital.
Peter McCormack: Genesis had these loans though.
Steven McClurg: Yeah, and this is all just going back to a CoinDesk article, which we don't know if it's right or not. Then $2.5 billion of the loans that were out to Alameda were called in Q2, and that was, again, according to the same article, but they still had about $1 billion. But we knew that BlockFi, as early as 2020, was involved in the GBTC trade, so they were taking some of their deposits but they were also getting lending to buy GBTC, they were holding it, selling it at a premium six months later, buying more, and that's how they were distributing their yield, and then other people caught on to Celsius. We actually saw a filing this week that Celsius owns 35% of the entire Osprey Trust.
Peter McCormack: I don't even know what Osprey Trust is.
Steven McClurg: It's like a competitor to Grayscale.
Peter McCormack: Okay.
Steven McClurg: So, we don't know how much they have of GBTC, but everybody was involved in this trade, and when it was trading at a premium, it was great, everybody was making money, loans going around everywhere, more shares were being created. The minute it's dropped down to a discount, everybody got stuck in the trade.
Peter McCormack: Because you've got to hold for six months?
Steven McClurg: Yeah, exactly. So, now, you have all these companies that have now gone bankrupt because they've lost money, they can't pay the yield, their deposits are tied up, and they owe money to Genesis but they're in bankruptcy, so you're not going to get that any time soon. But then you have the other people that have deposits with Genesis, like Gemini Earn, for instance, $900 million in deposits that they can't get back right now because they can't pay them back, and that's just one entity, there are a lot. I understand that there are a lot of other entities that have very large deposits with Genesis that they were earning yield on that they can't get out either.
Peter McCormack: Do we know the size of the deposits that were with Genesis and what they actually have?
Steven McClurg: We don't.
Peter McCormack: Nobody knows?
Steven McClurg: No.
Peter McCormack: Did you read Cameron's letter, public letter?
Steven McClurg: I did, yeah, I thought that was very interesting. It clearly laid out that they have $900 million with Genesis that they're trying to get back, that there are intercompany loans between DCG and Genesis, which is really interesting.
Peter McCormack: I thought it was really interesting for Cameron and Tyler to go public like that, to take it public like that.
Steven McClurg: I did too.
Peter McCormack: I'm glad they did because like let's have the conversation.
Steven McClurg: Yeah.
Peter McCormack: I saw them go back and forth with Barry. I don't know what the answer it, I'm well out of my depth here, but it's a really scary situation how everyone seemed to be lending each other money and it's almost like they were lending each other money and then using that, or something else as collateral and lending something else; it was just a like a multicompany Ponzi scheme.
Steven McClurg: Yeah, that's right, and what I find is really interesting is, yeah, everybody was connected, but they were all connected through one group, Genesis.
Peter McCormack: Genesis, yeah. So, when you say they're in bankruptcy, what does that mean; is that Chapter 11?
Steven McClurg: Well, it could be Chapter 11, that's typically where most of these companies are falling, they're falling in a Chapter 11.
Peter McCormack: Why would they do that; does that give him a period of grace to try and figure it out?
Steven McClurg: Well, in the case of FTX, they put themselves there so that they have a little bit of control, because if someone else puts you there, then you'd lose some of that control. So, very simply put, they did that to kind of protect themselves so that they could work out how they're going to pay all of their debts, and it might be 60 cents on the dollar, 80 cents on the dollar. We don't know what it is it, but it's for them to essentially restructure, and that's really the purpose of all of this, to restructure and figure out the legal way to do that because they're just so in debt, they can't pay their bills anymore.
Peter McCormack: Right, okay. Can you talk about the offer you've made?
Steven McClurg: Sure.
Peter McCormack: What could you tell me? I'll let you lead, because it's public.
Steven McClurg: Yeah, it's public, I can talk about the offer; there are probably some things that I shouldn't say and I'll keep those off. Essentially, we've launched a fund that is opportunistic in nature; we were looking at a lot of different opportunities in the market when they presented themselves, and we've just been kind of in a holding pattern since.
We were going to launch it in January, we were like, "Too soon"; Celsius fell apart, we're like, "There's going to be another shoe to drop", so we waited, and we finally launched it in October because we think we're pretty close to a bottom right now. We're just picking up things from either special situations or active dispositions, and one of the situations we identified was GBTC. We thought, "Okay, well, we're trading at a 47% discount right now", and at the time we looked at it in a very hard way, it was essentially buying Bitcoin at $9,000, which is a pretty good deal. By the way, that's still the case, buying Bitcoin at $9,000.
The idea is a few different things could happen. If an ETF is approved and it's converted, or if redemptions are made to the trust, or if there's a tender offer, all of these things are in the realm of possibility, then you would essentially be buying Bitcoin at $9,000 and then getting it at $16,000, which is as long as Bitcoin stays at $16,000; I think it's fair that Bitcoin's going to be in this range for a while.
So, we saw that opportunity and then, a few weeks after FTX, we noticed that they were heavily involved in Alameda and FTX, and we're like, "Oh, there might be something bigger going on here". So, we started looking at more of an activist play thinking that, "Well, maybe they're not going to voluntarily open it up for redemptions. We don't think an ETF is going to get approved this year for Bitcoin, so what are going to be our options?" Well, our options are to try to kindly convince them to open it up for redemptions, or at least to apply for redemptions, and to give everybody their Bitcoin at value.
Then a group called Fir Tree filed a lawsuit before we could get to that point, and then we said, "Okay, great, we're all for it. They're getting information, it's an informational suit, their shareholders, they deserve it under Delaware law, and that's good for everyone that holds GBTC, so that's a step that we never have to take". Then we thought about it a little bit and saw that Gemini was going after Genesis, and all these other creditors were going after them, we're like, "Well, there could be a bankruptcy situation here, and if there's a bankruptcy and you've got DCG, Genesis and Grayscale all involved, that's not good for the shareholders of GBTC".
So, we decided that we would simply put a proposal out there to all the shareholders at GBTC, open letter, saying that, "Look, we should have a vote and we would be happy to take over the trust. We have experience running trusts, we have experience running ETFs, we have experience running closed-end funds as a team, not necessarily at Valkyrie, but in our past, I've been involved in actually taking over a publicly-traded closed-end fund in my previous job and then managing it and managing getting people their redemptions, so our team has a lot of experience here. If something goes wrong, let's vote on us taking over as sponsor and getting people their redemptions".
Peter McCormack: So, the shareholders can vote for it to be moved under Valkyrie's management, they can do that, and DCG or Barry have no choice in that?
Steven McClurg: No.
Peter McCormack: How does that even get organised?
Steven McClurg: Well, what you have to do is gather enough votes so that you can demand a proxy vote.
Peter McCormack: Okay.
Steven McClurg: What's happened since we published our letter is other people have been organising other people. David Bailey, for instance, has been out there organising a grassroots campaign of gathering up all the people that are shareholders of GBTC to say, "Hey, look, let's organise here, Fir Tree filed their lawsuit, we're taking active position". I was working on Christmas Eve, I probably had eight hours of phone calls on Christmas Eve of people calling us, legitimate people that own shares at GBTC, saying, "How can we help?"
Peter McCormack: Yeah, so there are multiple things happening here.
Steven McClurg: Yeah.
Peter McCormack: There's the management of the trust but there's also that you believe that trade with a discount is a good trade, because at some point the owners of those shares will be able to redeem them for Bitcoin at some point.
Steven McClurg: Yeah. So, yeah, I think there are probably enough people, according to what David has collected, I'm not involved in what he's doing but I see what he says, and according to what he's collected, it's probably 10% already, which is enough to affect a vote. So, then there could be a vote to change a sponsor and then, if there are enough people that vote for it -- now, I think Grayscale would fight it tooth and nail.
Peter McCormack: How? Do they fight it and they try to get people to vote against it?
Steven McClurg: Yeah, they'd probably get people to vote against it, they'd probably say, "Well, we don't have to hand it over", and it really would come down to Delaware Chancery Court.
Peter McCormack: So, then a bigger, wider question I have for you is that everything was going well for Bitcoin, the price was good, Tesla had bought some, Michael Saylor had bought most of it, lots of positive projects, investments, everything was going well, yes, the macroeconomic hasn't been great, but we expect things like that, but the decisions or behaviour of four or five institutions/companies/funds have really like fucked it up for everyone. When you look at this and you consider the future of Bitcoin, how do we stop this happening again; can we stop it happening again? Will people learn from this?
Steven McClurg: I hope so. Look at all the pain we went through at the end of 2017, 2018, it's all jumbled in my head, you had all these ICO projects that were coming out that were complete scams, and they were pumping up the price of everything because everybody was getting excited about it, and then it all came crashing down.
By the way, people yell at the maxis. I don't consider myself a maxi, I consider myself Bitcoin only as a digital currency. I like all technologies, but as far as Bitcoin goes, I'm like, "This is the going to be the digital currency", in my opinion; everything else is something different. But I appreciate these people that are the loud maxis because they remember what happened in the ICO scams and they're out there trying to protect this ecosystem. So, yeah, I absolutely appreciate them. They get annoying, a lot of them, you know what I mean? They're doing what they think is right and they are protecting the newbies.
So, what's happened in this particular cycle is a ton of leverage was created to pump the price; $69,000 wasn't the right price for Bitcoin, that was a pumped over-levered price. I think, in this last cycle, I was pretty vocal on it, on a lot of the leverage. Caitlin Long, there were a few other people that came from banking, Wall Street, like Caitlin and I did, that were saying, "This is a problem", and every chance we could, we would talk about, "Okay, let's find out how they're making yield, let's find out how Celsius is making yield", and they never would say, and we told people to avoid those platforms, and we avoided them. Anybody that was trying to produce a massive amount of leverage, we were avoiding them.
I hope that people will speak up in the next cycle. Bitcoin goes in four-year cycles based on halving, and I'm sure two years from now, when everything is fine again and prices go up again, people are going to get excited, they're going to get greedy, and they're going to pump things up on leverage and I hope people remember this point in time and say, "Okay, stop, cut it out". By the way, leverage isn't bad, over-leverage is bad.
Peter McCormack: Yeah, and you can't really stop leverage, right?
Steven McClurg: No, you can't. How do you buy a car without leverage; how do you buy a house without leverage, right?
Peter McCormack: Do you think there can be a market for borrowing and lending with Bitcoin?
Steven McClurg: Yes.
Peter McCormack: It can work?
Steven McClurg: Yeah, there just has to be a two-sided market, and it's not going to be these ridiculous yields that we're seeing. I think there's a market out there where somebody has Bitcoin that they collateralise because they need to buy something. That's really how I see it, right. If I'm holding my Bitcoin and I don't want to have to sell it and pay taxes when I sell it, I can collateralise it to borrow some dollars to buy a car, buy a house, something like that, and that's fine. There's a reasonable interest rate that you would pay on that, and then there's a reasonable rate that somebody else would borrow against it; it happens all the time.
I think, as the ecosystem grows, there's going to be a reasonable lending market there, but it has to be two sides, it can't just be some pop-up lending platform or marketplace that's one-sided and have to go find people to run a hedge fund with your money; that's not the proper way of offering leverage.
Peter McCormack: Do you think then perhaps the market isn't mature enough for it at the moment and that's why it happened?
Steven McClurg: Yeah, it's not mature enough for it. This is how banks work, when you put money in a bank, the money's just not sitting there, the money is used to lend people money to buy houses and cars; it's really simple. There's due diligence done on the people, and sometimes they get over-levered and blow up and things go wrong, but generally banks work out until they get into exotic instruments, like they did in 2005 through 2007.
Peter McCormack: Okay, back to your crystal ball, which I should have listened to, Danny and I should have listened to when you sat there and told us, I'm going to ask you what your outlook is for the year. You don't have to give me a definite answer, but like what are the range of things that you're thinking about and looking at on the macro environment because we are so correlated to the macro environment?
Steven McClurg: Yeah, I think from a macro perspective, and I'm going to talk specifically to the US because a lot of other markets follow it, but in the US, the Fed is going to raise rates at least 100 basis points more, inflation is still a factor despite a lot of people saying that we're --
Peter McCormack: 100 basis points is 1%?
Steven McClurg: Yeah, another 1%.
Peter McCormack: Yeah, okay.
Steven McClurg: It could be 150, it could be 200 basis points.
Peter McCormack: What's the current rate?
Steven McClurg: What is it, 475? Yeah. So, that's going to make a tough environment, because companies that have corporate debt are having to borrow now at a higher price, which means their debt surplus is higher, especially high yield bond issuing companies, so junk bonds. Those companies can barely make their debt service as it is, but if rates go higher, it's going to be a lot tougher and then you're going to have a lot of situations like Toys 'R' Us and Sears and some of these other ones that we remember in the last ten years.
It's going to be very difficult for these companies to buy commodities, produce something, sell goods and pay high rates to just keep their companies operational, and a lot of these companies should have failed in the last ten years anyway, but low rates kept them alive, which is why we were producing a lot of junk into the market and people overconsumed.
So, I think that starts going away, some of those companies start going away, it causes equity markets to go down, so potentially double-digit default rates in corporate bonds over the next 18 months.
Peter McCormack: When you say "double-digit default rates", what do you mean?
Steven McClurg: Like 12% of all junk bonds default.
Peter McCormack: So, what does that actually mean, like 12% of companies or 12% of the economy?
Steven McClurg: 12% of all the companies that issue junk bonds.
Peter McCormack: Okay. Why do people buy something called a junk bond if it's junk?
Steven McClurg: It's not really junk.
Peter McCormack: Okay.
Steven McClurg: I came from the fixed income bond world and we called it high yield, because it yields a little higher.
Peter McCormack: But it's more high risk?
Steven McClurg: It's high risk.
Peter McCormack: Yeah, okay, I get it. So, what is the impact of that?
Steven McClurg: Well, oddly enough, the high yield bond market is highly correlated to the S&P, and a lot of people don't realise that, because a lot of those companies are in the S&P or have relationships with companies in the S&P. So if you get to say, we'll be conservative and say 8% to 12% of all rates and high-yield bond issuing companies, that means the S&P could drop, that means liquidity comes out of the system, and liquidity's already coming out of the system with rates going up, the S&P could drop another 20%; it's already down 20% over the last year, so we're probably talking another 20%. And by the way, the Fed doesn't care, the Fed doesn't care if the S&P goes down 20%, they don't care if corporate defaults are high; they care about two things: inflation and unemployment.
Peter McCormack: Right, but in trying to reduce inflation, they're going to raise unemployment or do the jobs just migrate to other jobs?
Steven McClurg: Well, that's kind of what's happening right now, is we have a lot of open jobs but it's mostly in the service sector and in the manufacturing sector and/or the farming sector; people don't want to work those jobs. People want to work at Twitter and drink mimosas in the morning, work for a couple of hours on a beanbag and go to early lunch with their friends and go for the rest of day. I don't know if you saw those videos.
Peter McCormack: I did see those videos.
Steven McClurg: They're amazing.
Peter McCormack: To the point where I almost thought, "Is this real?"
Steven McClurg: Yeah.
Peter McCormack: Like where they talk through their day; have you seen these videos?
Danny Knowles: No.
Peter McCormack: It's like, "I got to work and I got myself a green tea mocha thingy with a vegan almond brownie, and then I went to my pod and had a meeting, and then I went for lunch at this place, and then I went for dinner where we had mimosas, then we went to this place and went dancing"; to me, it looked like it was satire.
Steven McClurg: But it's not.
Peter McCormack: It's not satire.
Danny Knowles: Who produced this?
Peter McCormack: Someone is telling their day on TikTok or some bullshit.
Danny Knowles: Oh, okay.
Steven McClurg: I actually think that the companies were producing this because they were trying to hire people and they've like, "Look how great it is working here, look how great it is to work at LinkedIn".
Peter McCormack: "You do no work, you eat and drink all day, and then you get drunk in the evening".
Steven McClurg: Yeah, that's right.
Danny Knowles: It's like our job!
Peter McCormack: Hey, I'm five days no beer.
Steven McClurg: It sounds crazy but there weren't enough people to hire and they needed bodies, and they couldn't overwork people because people would just leave, so they're like, "All right, fine, you can work four hours a day and do whatever the hell you want, and we just need bodies to do a couple of things", but that's all gone now.
Peter McCormack: Now they can't find enough people to fire!
Steven McClurg: Yeah, that's exactly right.
Danny Knowles: I know the Fed has mandates to keep unemployment low, but aren't they doing everything at the moment to do the opposite?
Steven McClurg: Well, their mandate is to have stable employment at a lower rate, but right now unemployment's too low; so, 3.5% is too low, 5% I would say that's a fully employed system. Just think about society, 5% of the population are unemployable, it's just basic behavioural science, so when you have 3.5% unemployment that means 1.5% of the workplace is just completely unemployable.
Peter McCormack: They're fucking idiots.
Steven McClurg: Yeah, and then you can't hire anybody because nobody wants to leave the jobs that they have.
Danny Knowles: So you need to crush demand to get that 1.5% out of work?
Steven McClurg: That's exactly right.
Peter McCormack: Right, so when you hear about demand destruction, you think, "That sounds fucking idiotic! Why would you want destruction?" but actually there's a logic to it.
Steven McClurg: Well, there is, and here's the logic; we had a good ten years after the Financial Crisis where we had easy monetary policy but inflation was pretty muted. The reason why was wage growth, so wage inflation, wage growth is what drives inflation. And everybody said, "Well, inflation's coming" like, "No, not until wages grow", but then we started having less and less employees for the jobs that we needed because inflation was low and because we had easy monetary policy. Then, all of a sudden, inflation crashes because people are getting 10% more a year because they can't find people to work.
Peter McCormack: Right, so are you saying that inflation comes from wage growth?
Steven McClurg: Yeah, it's one of the things it comes from, but yeah.
Peter McCormack: Okay, so basically you're saying the good times are over?
Steven McClurg: Yes.
Peter McCormack: Now we're doing a bit of a reset, a necessary reset, and do you think those interest rates will stay high for how long?
Steven McClurg: Well, I think they go up and stay up for at least the next year.
Peter McCormack: Okay. So, that's a problem for the government because they're having to pay high interest on their bonds and their debt.
Steven McClurg: That's right.
Peter McCormack: So, what can the government do about that? They've got a lot of fucking debt; it's like in the UK, we've got a lot of debt.
Steven McClurg: Well, here's the breaking point, you nailed it, okay, absolutely nailed, this is where the breaking point comes. Inflation's not going away, unemployment's not going away, the US just passed a $1.7 trillion omnibus bill, that means stimulus, that means they're driving inflation while the Fed's trying to control it; a lot of the stimulus is also creating jobs.
Peter McCormack: I saw that; they're going to build bridges.
Steven McClurg: That's right.
Peter McCormack: Biden's going to build bridges, but is that in preparation for the 12% destruction?
Steven McClurg: No.
Peter McCormack: Oh, it's not?
Steven McClurg: No, I don't even know what this is; this is just pork barrel spending.
Danny Knowles: When does this start?
Steven McClurg: Well, it starts this year. So, you've got all this money that needs to be processed in the system, free money, more jobs, higher inflation, while the Fed is trying to lower jobs, or increase the jobless rate and lower inflation; so the two are at odds right now.
The nice thing about having Republicans control the House again, and I'm not a Republican or a Democrat, couldn't care less about any either one of them, but I like stalemate in government because that means no more spending, no more bad policy-making; in the US, it's good when no one's in control, and then there's chaos. I actually like the fact that right now, they can't decide on a House speaker. That means they can't get anything done; that means they can't do anything to mess anything else up!
Peter McCormack: Yeah, again, explain that to me because I've seen, who's this guy, McCarthy, who they thought would be the House speaker and then he didn't get it; what's going on here? Explain this a Brit.
Steven McClurg: As a Brit, it looks very similar to Parliament.
Peter McCormack: Okay.
Steven McClurg: So, Parliament has all these factions and they try to form a government, and your government's not formed until you have your preliminary, until the Prime Minister is elected. Then they can't do anything, so there's no government that can do anything. It's the same kind of thing with the House; no laws can be passed until the Speaker of the House is actually chosen.
Peter McCormack: Why can't they agree a Speaker of the House though?
Steven McClurg: Well, there's a small faction of the Republican Party of about 20 people, most of them are newly elected, and I would call them anti-government establishment.
Peter McCormack: Interesting.
Steven McClurg: And they're saying, "Look, we don't want somebody from the establishment that's been a sitting politician for a long period of time, that's passed all these laws, that have increased spending, given away money, like all the problems that we see coming". By the way, I kind of agree with them!
Peter McCormack: I always think green politicians, and when I say "green"; new, not as in the environment, these kind of green politicians come in with good intentions, realise they can't make change and just become part of the system.
Steven McClurg: Look, AOC, I was a massive fan of AOC in the beginning. By the way, I agree with probably like maybe less than 10% of her policies.
Peter McCormack: But she's radical.
Steven McClurg: She is radical.
Peter McCormack: Yeah, she has a pop, right, she'll stand up and say things to people.
Steven McClurg: That's right.
Peter McCormack: Yeah.
Steven McClurg: The purpose of the House of Representatives is to represent the American people, and she represents a demographic.
Peter McCormack: Yeah.
Steven McClurg: She deserves to be there all day long, and there's this other woman, what was her name? She's one of the loud Republicans right now that's voting against McCarthy. Boebert; I'm botching her name, she's a Congresswoman from Colorado. She's basically the AOC of the Republican Party, but she's loud, she's obnoxious, but her voice deserves to be heard because she represents a part of the demographic, and that's what I love.
Danny Knowles: Lauren.
Steven McClurg: Yeah, that's right. That's what I love about what the House of Representatives is supposed to be, and when AOC came on, she went up against this establishment politician that didn't care about his constituents and she read a grassroots movement, got him out, and she was loud and she opposed her party, she opposed the establishment and now she's the establishment.
Peter McCormack: Yeah, she's definitely the establishment.
Steven McClurg: Yeah.
Peter McCormack: I saw one of those, she was in like a town hall meeting and they were calling her out on voting or what she was voting for, and I also found that whole kind of "Tax the Rich" dress kind of bullshit. And I just feel like that's what happens, people just go in, they want to make change.
Steven McClurg: They become rich and they don't want to tax the rich anymore!
Peter McCormack: Yeah, exactly, they don't want to tax the rich anymore. Fine, so you're hoping for deadlock.
Steven McClurg: I love deadlock, I love deadlock in government. So, I don't believe any more of these big spending bills are going to be passed because there's definitely a big enough constituency in the House that's going to block it. So, without the House passing anything, I think we're going to be in good shape, I think we can finally work out of the system all the other bills that were passed, and now we've just to decrease the government budget.
Peter McCormack: So, no more money for Ukraine?
Steven McClurg: Yeah.
Peter McCormack: Well, you say that, we had the conversation yesterday with Matthew Pines; do you know Matthew?
Steven McClurg: No.
Peter McCormack: He's part of BPI, really interesting guy, and he was talking about the big issue that the government have is the amount of things they have to finance: they've got to service debt; they have to keep investing in the military, because China's growing their military; they can't afford the bond market to collapse, but you've got China and Russia exiting from the dollar and trying to create alternatives; you've got massive social security liabilities. He was saying, "What are you going to cut; where are you going to cut?" What is it, there's a tax receipt of $6 trillion in the US, ish?
Steven McClurg: Yeah.
Peter McCormack: I get $1 trillion to the military -- where does the cut come?
Steven McClurg: So, this kind of goes back to government spending versus Fed policy right now, and they're at odds. In order to fund government spending, you have to issue bonds, but the Fed's not buying bonds right now, they're not adding to their balance sheet and interest rates are going up, so that's kind of the silver bullet so to speak. The one thing, if inflation and unemployment's not going to change, the one thing that could cause the Fed to change course is a failed Treasury auction, which means that you've got to issue all this debt to pay for the things that you want to pay for, that you've already passed laws to pay for, and it costs more to do it because of the higher interest rate, and there's nobody to buy the bonds.
Danny Knowles: Which is similar to what happened to the UK?
Steven McClurg: That's exactly what happened in the UK.
Danny Knowles: And you think that's likely?
Steven McClurg: I think it's extremely likely.
Danny Knowles: So then the Fed has to step in and backstop?
Steven McClurg: That's right.
Peter McCormack: Then what does that mean?
Steven McClurg: Well, that means that everybody's at capacity, they can't buy any more of these bonds, and the Fed has to step in and say, "Okay, fine, we'll start buying bonds to our balance sheet". When that happens, they've just injected liquidity in the system and now we just kind of go right back up.
Peter McCormack: The party starts again?
Steven McClurg: Yeah, that's right.
Peter McCormack: Get back on our beanbags with our mochas!
Steven McClurg: Yeah, that's a pivot, by the way.
Peter McCormack: Yeah.
Danny Knowles: So, is it the primary dealers that buy the bonds?
Steven McClurg: Yeah, that's right.
Danny Knowles: So, people like JP Morgan or whoever?
Steven McClurg: Yeah, there are dealers out there that are the primary dealers. They're kind of dealing it and selling it out to a lot of the large asset managers, governments; China used to be a big buyer of bonds, they're not anymore, they're holding steady. Other governments around the world have to buy US Treasuries to peg their currency to the US dollar. So for instance, the US loves to call China a currency manipulator; well, they also love China to buy their bonds, and that's how they manipulate the currency, by buying US Treasuries.
Danny Knowles: But for those primary -- do they have to buy bonds; do they have to turn up to the market, like JP Morgan or Goldman or whoever? They don't?
Steven McClurg: They don't.
Danny Knowles: So, if there's no demand from the other side, they'll just not bid?
Steven McClurg: Yeah, that's right; that's what's called a failed auction.
Peter McCormack: So, do we want this?
Steven McClurg: Kind of.
Peter McCormack: Just because we want the party back?
Steven McClurg: We want the party back, yeah. I'll tell you what we really want, what we really want, this is the most sensible thing that could happen and it's never going to happen so this is the second-best thing, is for our government to restrict spending, to create a budget that is balanced.
Peter McCormack: Are you fucking crazy?!
Steven McClurg: I am crazy, yeah. That will never happen; I live in dream world.
Peter McCormack: Yeah, I've brought this up a few times, we interviewed a guy called Dan Tubb recently, @Kingbingo_ on Twitter, in the UK, and we were talking about why our government can't get out of the situation they're in. Tax receipts are about £1 trillion the UK, spending's about £1.15 trillion, so basically, they're increasing debt by about £100 billion to £150 billion a year.
We went through an exercise of saying, "Well, if you just wanted to be at breakeven point, you need to take --" it was about £120 billion so you're not increasing your debt. But if you want to pay it off, because the debt itself is like £2.5 trillion, if you want to pay it off over 20 years, you actually need to take £240 billion out of the budget, out of the spend. As we went through the exercise like, "Where are going to take it from? Okay, what's your number one spend?" The number one spend is the NHS.
Danny Knowles: Which is about £240 billion.
Peter McCormack: It's £200 billion.
Danny Knowles: Yeah.
Peter McCormack: But he did say a large part of that is depreciation write-offs; but anyway, £200 billion. Now, nobody's going to get rid of the NHS in the UK, they're always just going to increase spending on it because it's a political weapon. The second biggest thing is servicing debt, which is £120 billion; well, you can't get rid of that.
Steven McClurg: That's right.
Peter McCormack: So, we were going through the list and it was like what do you cut; where do you cut £240 billion from it? No, look, you can, because what you can do is go and privatise half of the NHS, cut the budget for that in half. There are other areas to cut it out, but there's no political popular decision here. Nobody is going to get voted in who says, "By the way, we're going to cut our budget by a quarter, that means your pensions have been halved, the NHS is paid for if you earn over £20,000 a year, there are no free bus passes for OAPs". All the shit that they can cut, they're not going to cut it. So it's like what you're saying, I get it.
Steven McClurg: Yeah, I mean here, in the US, it's like military spending, well, the military complex isn't going to let that happen.
Peter McCormack: No.
Steven McClurg: Pensions, Federal employees, you go down the list, none of that's going to happen. The best thing you can do is pause, and that's what's going to happen for the next two years, we're going to have a pause.
Peter McCormack: Yeah, one thing I was thinking about, Danny, you know in the last interview we just did with Josh, was it Hendrickson?
Danny Knowles: Hendrickson, yeah.
Peter McCormack: Do you know Josh? He's just an Economics Professor, teaches at State of Mississippi.
Danny Knowles: Ole Miss.
Peter McCormack: Ole Miss.
Danny Knowles: Another BPI guy.
Peter McCormack: Yeah, he was saying to me, he was explaining the problem, he said the problem is is that governments used to, at time of war, they'd have to borrow a lot more money. But after a war, that spend, that massive spend on military would be cut, so their tax receipts would be able to be increased to pay off the debt; it was a very simple thing. He said, the problem is governments have essentially become massive insurance companies providing Medicare or social security or welfare, all these different insurance products, which essentially disincentivise people to go out and work and be productive; he was saying that's the primary issue. It's like the issue in the UK, what do you cut? My only thing I can think, and I might be being completely naïve here, but we have to find a way of weaning ourselves off these massive government insurance products.
Steven McClurg: That's right.
Peter McCormack: How do you do that? Do you borrow a massive amount now and you say, "Okay, anyone who's under 30, state pensions have gone, you've got to start preparing now. Anyone who earns over £50,000 a year has got to pay for their healthcare, and then in 10 years, it'll be £40,000". Can you borrow a massive amount and wean yourself off; is that a logical way to do this?
Steven McClurg: No.
Peter McCormack: No? Fuck! I thought I was going to sound very smart then!
Steven McClurg: Well, here's the problem, right, whether you're a governor of a state of the President of the United States, you have term limits, okay.
Peter McCormack: No, but you're saying it's not going to happen, are you saying it wouldn't work or you saying it's not going to happen because of political cycle?
Steven McClurg: It would never work, no, it would work, but it would never happen.
Peter McCormack: Yeah, that's different.
Steven McClurg: Yeah.
Peter McCormack: So, I'm not a complete dumbass!
Steven McClurg: No, but it would never happen, but it goes back to term limits. So, we should be putting term limits on Congress, Senate; there's people that have been there way too long.
Peter McCormack: Yeah.
Steven McClurg: But the flip side of that, the problem with term limits for governors and presidents is that, if you're only there for eight years, you can issue as many 10-year, 15, 20-year bonds, 30-year bonds that you want to do things to make yourself look good and let the next guy worry about it.
Peter McCormack: Yeah.
Steven McClurg: And that's always the attitude, it's like, "No, I'm going to spend as much money as I can to give myself a legacy and then let the next guy worry about how they're going to pay for it".
Peter McCormack: Yeah, I mentioned this thing before, I kind of feel like governments should manage a budget.
Steven McClurg: Yes.
Peter McCormack: And if you want to borrow outside of the government's budget, then that should be forced to a national election, "Okay, this government has been in power two years, they want to borrow this much money for this reason", that forces a general election, so the public get to decide.
Steven McClurg: That's right.
Peter McCormack: So, the public are forced to educate themselves on why this is a bad idea. I'm full of naïve ideas, by the way.
Steven McClurg: It's not that naïve because in California, one of the things that I liked about California, I disliked most things, but any time that you wanted to issue a bond and spend money, you had to put it to a general election and people got to vote on it.
Peter McCormack: I feel like a lot of people really don't understand how it all works as well. Whenever there are any problems, you can see friends or family complain about this, "Well, the government should pay for this", like they do have this endless pot of money; they do, but they don't understand this endless pot of money has implications.
Steven McClurg: That's right.
Peter McCormack: Oh man! All right, Steve, listen, let's finish on, I'm not sure it's a positive note, but anyone listening going, "Oh, okay, this sounds like bullshit", how would you advise people, without giving financial advice, how would you advise people to prepare or think about the next year, two years?
Steven McClurg: So, when it comes to the world of Bitcoin over the next year, I actually believe that, even though I think the equity markets are going down, recession is already here, it's going to get worse, Bitcoin's probably in a bottom range right now. So, I don't think we go up any time soon, maybe not until Q4, maybe Q1 of next year, but we're at the bottom, so that's a positive note.
Danny Knowles: Stack sats!
Steven McClurg: It's like it can't get any worse for Bitcoin, stocks will go down. Stocks have to catch up with Bitcoin because we kind of came down in an exasperated way and stocks are just not catching up, but no, we're at the bottom.
Danny Knowles: What do you think about housing?
Steven McClurg: Housing is sort of regional right now; there are some areas, like Austin for instance, where housing prices are starting to drop, and this is a very popular city.
Peter McCormack: But they went up really quick.
Steven McClurg: They went really quick; people are worried about it, but all it is is a reversion to the mean.
Peter McCormack: Yeah.
Steven McClurg: We're not talking about we're going below what it was two years ago, we're just coming back down to earth a little bit, and that's perfectly fine.
Peter McCormack: Yeah.
Steven McClurg: But yeah, housing prices, I do believe home sales are slowing down dramatically; people can't afford mortgages at this rate. So, yeah, it's going to be a reversion to the mean, some areas are going to stand pretty strong, some areas are going to just kind of really fall flat, it just all depends.
Peter McCormack: All right. Well, listen, fuck, man! You didn't tell me we were going to get Steve in and make us all miserable!
Steven McClurg: It's not that bad.
Peter McCormack: No, Steve, it isn't. Look, we need the reset, it's obviously everything's stupid. One of the interesting things, I got an email from my bank this week saying that, "Good news, your savings will now get 2.5% interest".
Steven McClurg: Yeah.
Peter McCormack: Let's temper this; with 10% inflation in the UK, I'm still losing! But the idea of getting interest, a meaningful interest, because it was like 0.1% when I opened the account, to a 2.5%, is great. The think the trend is right, the trajectory is right. I don't actually myself want us to get back to these 0% interest rates or 1% interest rates because I think they drive wealth inequality in a bad way. I think there should be a cost to borrowing capital; I don't know what that cost should be. A 5% interest rate when you're buying a house doesn't sound crazy, and like my dad, he was like, "Yeah, historically, I used to pay that".
Steven McClurg: That's right.
Peter McCormack: It's we're not conditioned to it.
Steven McClurg: Yeah. My parents paid 12% when they bought a house in the 1980s.
Peter McCormack: There you go. So, I feel like we're resetting, I just worry we go back to the crazy bullshit of cheap credit.
Steven McClurg: I hope we don't.
Peter McCormack: Yeah.
Danny Knowles: Is it inevitable though that we end up back at basically 0% interest?
Steven McClurg: I think it's going to be hard for us to get there any time soon. I truly believe that, when there's a pivot, and it'll probably be due to a failed Treasury auction, the Fed will buy assets to the balance sheet but the rates will remain high. I can't imagine the Fed dropping rates below, say, 3% in the short run, or even in the next few years. I think it stays high and we just increase the size of the balance sheet.
Peter McCormack: All right, man, listen, do you want anyone to go and read anything, see anything, follow anything; shall we send people anywhere?
Steven McClurg: I don't know, where should we send people?
Peter McCormack: I don't know. Do you want them to go and read your offer?
Steven McClurg: I've got a really good one for you to read.
Peter McCormack: Okay.
Steven McClurg: This'll blow your mind, just because my background is in behavioural economics; Caroline, you know Alameda Caroline's dad is a behavioural economics professor at MIT. In the 1990s, he wrote a paper on the prisoner's dilemma. Go read that paper, go look it up, read it, because it's exactly the same principles that she followed in turning in SBF; you'll find it fascinating.
Danny Knowles: I want you tell us more.
Steven McClurg: I'm going to pause right there and let you read it.
Peter McCormack: All right, man. Listen, we'll go and read it. Steve, good to see, as always.
Steven McClurg: Good to see you.
Peter McCormack: I love coming to Nashville, love hanging out. Thank you, man.
Steven McClurg: Absolutely.
