Leverage on Leverage on Leverage

0:03 Hello listeners. Welcome to another episode of the Jacob Shapiro podcast. Rob Laity and I are back at it for our biweekly chats. Um, I would say if, if you're thinking of my chats with Rob on the spectrum of big ideas and abstract versus tactical and wonky. This one definitely leans more towards the wonky side.

0:20 We talk about record high gold prices. We talk about problems in private equity and what that means, uh, for both wealthy and retail consumers. We talk a little bit about artificial intelligence because you can't have a podcast that not talk about AI at least a little bit these days. And then close out with, uh, a fun little conversation about coffee.

0:39 Not so fun 'cause coffee prices are increasing dramatically up 33% so far this year. Um, if you have any questions, comments, concerns, anything that you heard in this podcast or you want to tell me something else, you can email me at jacob@jacobshapiro.com. Otherwise, take care of the people that you love.

0:53 Cheers. I will see you up. All right, listeners, we are back at it. It is Wednesday, October 8th. This will come out Friday. Uh, Rob, it's been a minute. How are things going in Paris? Everything fine. I assume it's cooler than the 95 degrees and 80% humidity I'm still dealing with here in New Orleans.

1:17 It is not 95, believe it or not. Um, but yeah, pretty, pretty quiet. You, you would never know there was quote unquote a crisis going on. Oh yes. You guys have a new, a new prime minister, right? Yeah. Uh, I was talking with, with my wife and she's like, but, but that's never happened before. Like that, that you have such a quick turnover in prime ministers.

1:41 And I, I suggested to her gently that maybe she hasn't looked far back enough in French history. Yeah. Not, not exactly a, well, I guess I mean periods of political instability and then, uh, and then punctuated by intense periods of instability. Um, well, how's this for a segue? Speaking of periods of intense instability, the first thing I thought we would talk about, 'cause it's in the headlines and, and you and I have not really talked about this on the podcast.

2:09 Is gold. And I, I know, I know to talk about gold because, uh, my sister geopolitical risk index asked me about gold the other day and I was like, wow, if it's getting down to you, people must be thinking about it. So we're up over $4,000, uh, in terms of the price, um, which is, uh, the, the price per ounce, I should say it's a new high.

2:31 Um, there, there's a lot of interesting data out there to, to cite. I think the, the most interesting ones that we could cite is that, um, gold is now a, is now a greater share of foreign currency reserves than US treasuries. Um, it's surpassed it in this past year. Gold now makes up 24% roughly of as a percentage of international reserves.

2:53 US treasuries are down at 23%. Now if you look, if you zoom back at the chart and you look to the 1970s gold peaked somewhere around 60% and US treasuries were down somewhere around 13%. Um. Or even roughly lower around there. So we've been here before, of course we were here during the stagflation era.

3:10 Um, if you look at just a chart from say, um, the World Gold Council about where, um, money when it come, when it comes to gold is going, um, it's actually relatively interesting if you look at sort of investment per ton, it's not like, it's not stagnant, but it's in the same band over the past 15 years.

3:29 Same for jewelry, fabrication, same for technology, but central banks really have been vacuuming up a lot of gold. Um, the amount of gold that central banks, for example, added um, in 2024 was almost quadruple what they did in 2020. Um, and it's well over double what they did basically from 2010 to 2020 if you took an average sort of annually.

3:51 Um, and then to complete the story, which makes it something that everybody wants to cover. The countries that have added the most gold reserves over the last 10 years, I'm sure you can guess. Rob, what do you think the top four countries that have added the most gold reserves over the last 10 years?

4:05 I would guess China, Russia. India and someone else. Who is it? Ding, ding, ding. You got one, two, and four. China, Russia, India. So it plays into the whole, oh, the bricks are coming. Oh, the unipolar world is collapsing, blah, blah, blah, blah, blah. Coming at number three is Turkey, which makes sense with inflation and everything else.

4:25 Um, I think the surprising one on the list is Poland. Poland is at number five, and Poland has been adding significant, uh, relative to their previous purchases. Their central bank has been adding quite a bit of gold over the past couple of years. Maybe we could read into the Rush Ukraine War there in general.

4:39 Um, the last thing I'll, in my litany of, uh, of stats here, uh, it related to gold. There's also been a lot of passive inflows into gold, into ETF holdings, which has always seemed a little bit strange to me. Like if, if the, if the point of gold is to have your hands on something physical that you could barter with when the world ends, oh, I, I own this much of a gold ETF is not really gonna help you when the zombies are beating down the door and you need to trade it for penicillin.

5:02 So, um. You know, that's also interesting. So it's, so it's in the zeitgeist and it's part of all of it. Um, where do you wanna go with this? I know that, you know, there's been a lot of talk about the behavior of gold is breaking down on the one hand and then you've got Ray Dalio saying, no, this is just the seventies and stagflation and we're gonna go back to that thing.

5:18 So Lidar way a little bit, Rob. It's, it's easy to get, it's easy to get overwhelmed and to think I should just buy a bunch of gold and stash it under my mattress based on the headlines right now. Well, what you shouldn't do is run out and buy a bunch of gold, I guess is the, the, the one, you know, we don't give financial advice here, but that is, that is simply what we're telling our clients right now because we've had people inquiring about adding to gold positions and, and access to physical gold is a big part of, of what we do.

5:49 And, uh, we've been advising against that right now. Um, and it's interesting what's happened in the gold market. Like if you look, if you look at the gold price, um. And I think this partly explains why the value of gold in foreign currency reserves has increased so much. You know, a lot of this is simply appreciation.

6:09 Um, 18 months ago, the gold price was $2,000 an ounce. So gold has doubled in value in a very short amount of time. Um, the other thing to, to note is that gold has really, has really run in line with the Trump administration's, you know, rise in the polls ahead of the election. And then post-election has just been kind of going straight up into the right.

6:36 So you had sort of, um, geopolitical, uh, tailwinds that has had been flowing through. But the, the thing that's interesting and, and the reason why I think things have gotten really frothy here is that other assets that usually move around with gold. Like silver, for instance. They didn't do anything earlier in the year, and it's only in the last month or two that you've had sort of a frenzy in, in the whole precious metals complex.

7:06 And to me, that suggests, you know, a different dynamic in, in what's driving gold away from sort of true geopolitical hedging and buying, and the sort of central bank buying that, that you're referring to and toward, you know, your sister taking a flyer because everyone's talking about it. Um, and that's, that's usually when things are due for a good long reset or a digestion period.

7:31 Um, incidentally, golds, if you look on a monthly basis, so just look at momentum just, and, and as a reminder, momentum is, is an oscillator. So momentum, you know, reaches a certain point beyond which it really cannot go. Uh, and then it oscillates back toward some mean over time. If you look on a monthly momentum basis, gold has never been this overbought, this extended this, this on fire, um, going back at least 40 years.

8:05 So, um, yeah, it's been a, it's been a huge winner. Um, and, and the drivers behind that aren't going away, which we can talk about with the fundamentals. But in terms of tactics and timing, you know, it's, no, it's, no, uh, it, it is no surprise that we're talking about gold 'cause everyone is talking about it.

8:26 But that's exactly when you don't want to be jumping in with both feet. You know, caution is, is the word of the day, and, and you'll most likely get an opportunity to, um, to allocate there, uh, at a, at a better place. Well, I mean, let's get right into it. So what are the drivers, um, that you're seeing?

8:44 I, I also neglected to say, um, you know, the last time that go, that gold as a percentage of international reserves, um, the last time it was equivalent with US treasuries was 1996, which is also an interesting year to sort of think about and bookmark as when treasuries were overtaking gold and now we're sort of back to where we were like, I don't know, are we headed back in that direction or are we headed someplace new?

9:05 I have, I have trouble, um, dealing with that, but, but what are those drivers that you're thinking about that are gonna continue to, in the long term? I think what you're saying drive price appreciation. Um, I mean, some of them are pretty obvious. Uh, money printing is, is, you know, not to, not to, uh, beat a dead horse, but that that is real and it is happening.

9:28 We were joking about the French government being in crisis. You know, that's what it looks like when a government actually tries to, you know, balance its budget and, and make some effort to do that. The US is just, that's not really on the table at the moment. Um, and that shows up in, in the gold price.

9:46 The other one is, um, just on the reserve situation. I, I think that's the more interesting conversation 'cause it's less obvious, like the other one is very important, but everyone kind of understands this, you know, even at a, at a basic level. And sometimes you just don't wanna overthink it. Like that is happening.

10:03 It's going to continue unless something drastically changes. But on the balance of payment side, um, I think it's interesting to look at what specific players are doing. You mentioned like a China for instance. Um, they're in an interesting situation because a lot of countries in some form. Have been pegged to the US dollar because it has been the linchpin of the global system and they find themselves in an interesting situation.

10:28 'cause the US dollar has been a, um, sort of an outlier on the negative side against a lot of currencies, but not all of them. So if you look at the Chinese Renmin B for example, over the last year, um, it's really sort of a mixed bag. Uh, it's down, um, 7% against the Euro because it's tied to the dollar and it's following the dollar down against the Euro.

10:54 Um, but it's up about 5% against the Indian Rupe and it's about flat against Brazil and Australia's currencies. So if you think of it, the former as, okay, China's biggest export market at the end of the day, um. Is the US and Europe. So they're, they're looking pretty good in, in, in terms of, you know, their European exposure, at least on exports.

11:21 And then they're importing a lot from Brazil. They're importing a lot from Australia. That's fine. It's not changing very much. 'cause those currencies have actually stayed pretty steady against the dollar on the Renmin B by extension. But then they've lost ground against India, which is sort of this emerging competitor trying to move in and take export markets.

11:38 So it's not, um, it's not a big surprise that they might feel like they have some freedom to loosen up that peg a little bit to shift their reserves. Like those tectonic plates are shifting in terms of the role that the dollar has played, um, in that system. And, and it's interesting to see how some of these different players are responding in different ways.

12:00 How much can a country like China realistically do that though? I mean, like, they can't, there can't be a gold backed remin be, right? Or, or can there be. Um, not practically there, there wouldn't be enough gold to do that. I mean, it would, it would be putting China into a situation that it has no interest in, in getting itself involved in, in terms of, you know, hard money and, and strapping itself to the mast of gold supply and, and all those sorts of things.

12:30 Um, no, it's, it's, it's not really that, I mean, China uses, China uses its foreign reserves to manage its currency exposure for the most part, um, because it needs to have some kind of foreign reserves in order to, because it's running this still a significant current account surplus. So it has an excess of foreign assets.

12:52 It has to hold them in in something. Um, mm-hmm. So it's not really a change in the underlying mechanics of the monetary base in China or what they're trying to do there. It's more within that portfolio. How do you shift between, between different assets? Um, I would not be surprised if they, um, if they diversified across some more currencies based on, you know, which countries they're doing more trade with.

13:19 Um, but yeah, that's, that's really sort of the change is that the US is not really the only game in town. And that weakness in the dollar relative to a lot of things is, is making things a little bit tricky for the Chinese because, you know, for example, if you wanted to import from India, all of a sudden that got meaningfully more expensive in the last mm-hmm.

13:42 Three months. Um, or, you know, import from, uh, uh. Uh, import from the European Union or whatever. So yeah, that's, I I take your point on China's size being prohibitive, but as a thought experiment, could you imagine in the next couple of years that a there, um, there might be a country out there that decides to move back to a gold peg currency like El Salvador has, has, has talked about doing this with Bitcoin and has make, you know, has made waves about trying to Bitcoin to use Bitcoin in their economy.

14:15 Could, could she see like some small state, like trying to do that sort of thing? Or do you think that's crazy? No, I think it's quite the opposite. Like El Salvador is a unique case because they're a tiny country with no credibility as institutionally. Uh, really. So it's, and with no currency, like they've been dollarized since like the nineties or whatever, so, yeah, exactly.

14:37 So I don't think they're a model for anything that matters in terms of size or importance. The big countries are, are really what matters. Um, and really the, the question is when you go into these situations where everyone is basically printing debt levels are gonna be rising for everyone, and they are rising for everyone.

15:00 You know, the, the corollary is to look at something like the early 1930s and not necessarily, oh, the great depression and that background, forget about that. But really more the, the adjustments that different countries made at different times in response to what other countries are doing. So, like, I didn't explain it super well, but this notion that the weakness of the dollar opens up pathways for countries like China for, you know, the European Union for India to do different things with their currencies.

15:32 I think that's kind of the takeaway. Like the, the, the great book on this subject is called Who Adjusts, um. By Beth something or other. I forget. I don't have enough. You would think I would prepare these things before these talks. Thanks Beth. We appreciate you. Yeah. With that Beth, she's great. That's Simons Beth Simmons.

15:51 You can, you can edit that out, put in, uh, uh, the actual name. But, uh, but the key thing about this was that the pressure that builds up on all of these major nations is to follow the lead of what the largest nations are doing. So if you were to look back at the thirties, like even countries that were determined, like you asked about hard money and countries trying to back their currencies with hard assets.

16:19 Even the countries that were had the most trauma from, like the first world war that had the largest incentives, the strongest desire to retain strong currencies, they all gave up the ghost eventually. So France was the last one in 1935 to basically say. You know, we, we can't do this. We're, we just have just lost too much competitiveness.

16:41 We're suffering at the expense of all these other nations that have already devalued and now we have to devalue. And I, and I think probably you see some version of that over time with most of the large countries. So you wanna find these nations, and we've talked about places like Switzerland or Singapore, which operate under a different logic and are small by definition, and have very unique sets of incentives, um, relative to those big countries.

17:09 If you're looking for currencies that are likely to remain tough. Yeah. Um, it's Beth, Beth Simmons or, or Beth Simons. Um, and it's weird. You can buy, you can buy who adjusts used on Amazon for $2 and 22 cents, but the, the Kindle version is $81 and 65 cents. So quite, I, I dunno if it's printed in Gold leaf or, or what's going on there for the Kindle version, but that, that seems a little exorbitant, doesn't it?

17:37 For a Kindle version. It's an arbitrage opportunity right there. Um, well, so maybe one of the last things to, to ask you about this, um, when you, when you look at who the top holders of gold, just in terms of, you know, in metric tons, it's the United States and it's not even close. The United States has more official gold holdings than the next three countries combined.

18:00 Um, and those three countries, by the way, are not Russia or China. They've been adding considerably, but the next three countries, at least as of February this year, I know if China's maybe broken into the top five with some of their recent purchases, it's, it's Germany, Italy, and France. To your point, um.

18:12 But if you think about the dollar is down roughly 10% on the year next to a basket of currencies, whereas gold, as you mentioned earlier, it's up 50% just this year to date. And over the last two years, you know, has more than doubled. Um, I mean, so did the United States just shave off a, can it shave off a trillion dollars off the deficit?

18:31 'cause the value of gold just continues to appreciate up into the right. I don't know. It's, it seems like the US is almost hedging on itself there, doesn't it? Well, I don't know offhand how much gold the US has, but if you look at the government's balance sheet, I mean, it is, you know, basically what you're saying is do, does it have sufficient assets on its balance sheet that are appreciating to offset the rising amounts of debt?

18:56 And the answer is not in a million years, like, not by a long shot. Like, I don't even need to have the numbers in front of me to, to make that conclusion. Yeah. Well, I mean, if. If the value went up 50% every year for the next 10 years, like maybe you could eat a chunk of it. But I, I think to your point, that we're not gonna see 50.

19:17 Well, I don't know. I mean, do you think we're gonna see 50% annual increases on the price of gold over the next 10 years, even with money printing and geopolitical risk and everything else? No. And that's why getting back to the start of the conversation, which I know sounded very like tactical and investing, but it's important to think about those numbers critically.

19:38 There's no way that gold is going to appreciate by 50% per year over 10 years, because that is ex like exponential, exponential increase over that period. Just, just for context, if something grows at a 15% rate for 10 years, that is a multi-fold. That's like a six bagger. I don't, I don't know the numbers off the top of my hand, but that's huge because of the power of compounding.

20:04 So to have something. You know, where gold is up 50% year to date, it's doubled in 18 months. As I say, it's never maintains that it's way too hot, like it needs to cool down. You could have a two year period where gold does nothing. That's totally plausible. Like the US isn't Weimar Germany, like, we're not at that stage in terms of the amount of money printing going on.

20:31 I mean, there's, there's issues, but let's not get ahead on the, on the narrative here. Um, so, you know, if we're in a situation where Gold does do that, then we'll have, we'll have the zombie I issue, you know, knocking on our doors and much bigger problems to, uh, to deal with at that point. Um, but yeah, so you know, fundamentally it's sort of a slow grind.

20:56 Gold should grow in line with the growth of US money supply and how much demand US money supply plus some risk premium. How much do people wanna own gold? 'cause they're scared of owning other things. You know, the thing that people forget about gold and real assets in general is they don't yield anything.

21:14 They have negative yields you have to pay to, to store them. Mm-hmm. Which is expensive. Um, and it's a pain, which is why, you know, under normal circumstances, the negative yield scares most people away. So you need to balance that risk premium against the storage costs, against, you know, the underlying drivers in terms of M two money supply and all of those things.

21:38 That's, that sounds really boring. Um, but that's sort of the, the slow math that will just grind out over the course of years as we, you know, shift from one narrative to the next. But yeah, that's, that's a long-term view. Yeah. I mean, while you were talking about it, I was, I was just looking at the amount of, of US reserves and I mean, it's over 8,000.

21:59 Metric tons. But there's also, there's also a wrinkle here, which is the US values, the official value of US gold is pegged at a $42 22 cents announced price that was set by Congress in 1973. So technically the value is at 11 billion. Even though as we're saying today, prices have gone to $4,000 an ounce.

22:20 And apparently there was even speculation, um, earlier this year when Scott Besson said something offhand about, uh, you know, marking the government's gold market to, to market, um, which suggested, okay, that 11 billion could become 800 billion, 900 billion, a trillion, which to your point, is not gonna cover us deficit.

22:39 But I mean, it's a meaningful chunk. And if we're talking about money printing, um, I mean, that seems like a pretty novel way to print money. Like the US government has not been shy about trying to find pennies under the couch cushions. So if we, if we really are headed to that. Sort of space. I, you could imagine the White House being like, well, we have this quote unquote $11 billion worth of gold, let's mark that to market.

23:02 Like, like let the good times roll. I don't know, I guess you would need Congress to weigh in there too. I'm, I'm sort of new, um, when it comes to these gold regulations, but I mean, may maybe we'll see the government try to play with that. You could imagine that sort of happening if, if you're getting desperate, you know, well, what would they do with it?

23:18 Like, this gets back to, uh, you know, I think at some point we were talking about the, the government monetizing its other assets. In the last year we had a conversation about this. I guess the question is, what, what do you think the government would do with the gold? Is it gonna sell the golds and what is it gonna do with the dollars?

23:37 Like it can print dollars times at once. Mm-hmm. I mean, I, I guess if, you know, if you were a normal fiscal conservative, you could sell some gold and pay off some debt, but that's probably not what they would do. I mean, president Trump is talking about giving, uh, stimulus checks to people based on the tariff revenue that he's getting.

23:52 So probably more bread and circuses if we're getting to the point where they're, they're doing those things, it just, it just underscores what you're talking about. I don't, I also have no sense of what that would do to gold prices. Um, I guess theoretically it would increase them. I, I don't know. Uh, you would be putting a lot more supply theoretically on the market though, or would you even, and then there's, of course, this all gets into conspiracy theory land because all of these metric tons are in Fort Knox and there's a lively community out there that says they don't exist.

24:20 And Elon wanted to get into Fort Knox in order to, to make sure that the gold was actually there. So, I mean, this gets us down to some very shady rabbit holes Very quickly I thought Goldfinger irradiated all of that. No. Um, uh, yeah, I mean. If it is, call it a trillion dollars. Like, just to put these numbers into context, say the US government owns a trillion dollars worth of gold, that's 3% of the current government debt.

24:49 That's outstanding. Mm-hmm. So put another way, that's about six months of the current rate of deficit accumulation by the government. So you could take all that gold, assuming it didn't move the market at all to sell a trillion dollars worth of gold, which I think you might wanna dribble that into the market over time, uh, to say the least.

25:11 Um, you know, you buy yourself six extra months of, of the current rate. So, yeah, I mean, I'm not sure if it's gonna move the needle all that much. Yeah. Well, it's, it sounds like as, as, as we close the, the gold chapter of the conversation, we, we should, we should rename the, the podcast sober bullishness.

25:31 Is that I, I think that's a way of describing what you're talking in about. Yeah. I, I mean, it's, it doesn't make for good audio or good podcasting, I guess. But I mean, that's, that's the analysis, unfortunately. Um, sober bullishness, well, don't I have it on? Good. Don't, don too bullish right now, though.

25:49 Rain. I have it on. Good authority, Rob, that from one of my very good friends. Shout out to you, Harrison, that he listens to the podcast to fall asleep. So for that sober bullishness might be really, really effective. So this is a, a two stop shop. You can get, you can get help sleeping by listening to the podcast, and you can also get insights about what's going on with gold.

26:05 So, there you go. Um, second part of the conversation that I, I wanted to jump into and here I, I really just wanna let you riff, but I'll say a couple of things, um, on our internal platform and listeners, if you're looking at our internal platform. We rank things in, in numbers of importance of a one, two or a three.

26:22 Three is, eh, you should look at this sometime this week. Two is you should probably stop at some point today and check this out. And a one is meant to be stop what you're doing and read this. This is important. Um, it's very rare that we throw ones on the screen. Uh, but Rob threw a one for an article about, um, basically, um, private equity captive insurer portfolios, which I will let you get into the sort of wonky part of using insurance capital for data center deals and, and other things like that.

26:50 Rob, the other thing that I wanted to point out though, um, a friend of the podcast, Beth McLean, actually had a big piece in the WA in the Washington Post about this, about private equity, uh, wanting normal Americans to be able to invest in them because the industry needs cash. And this goes back also to a White House executive order.

27:09 Um. From August, which you can read also if you're having trouble sleeping. Even the title of it is relatively boring. Uh, president Donald Trump democratizing access to alternative assets for 401k investors. Um, but one of the things that is in, um, that executive order from August is that President Trump wants, um, more than 90 million Americans who participate in employer sponsored defined contribution plans to be able to invest in alternative assets such as private equity, real estates, digital assets like cryptocurrency, because they offer more competitive returns and diversification benefits.

27:45 You can read that as mag, that, oh, president Trump is allowing, you know, these things that were the province of qualified investors and the uber rich to come into your 4 0 1 Ks or to Bethany McLean's point. Uh, these guys have soaked up all the money they can from them and they need to go after retail investor because they're in trouble.

28:04 So this is something we've talked about once or twice on the podcast this year already, but. Rob, I think you should beat the drum a little bit. And I also think what you said about the insurance capital and the data center deals is interesting 'cause I'm also seeing that in general with just how insurance funds are trying to do this and how it's all just kind of this, it, it makes me feel dirty when you start to interact with this part of the financial system.

28:27 So there's your softball, knock it outta the park. I will bang the drum a little bit. Um, the, the background to remember on all this, and the thing that really matters is that when you're entering a volatility spiral, which I don't know how many times we've used that term on, on the podcast, maybe 42 at this point.

28:49 But when you're entering a volatility spiral, which is what we've been experiencing, um, liquidity rises in value. It, it becomes more important to have liquidity, to have the ability to shift your plans, shift your assets, uh. That's coming home to roost in a, in a major way. And the group that's in the crosshairs is the private equity complex, private equity and private debt.

29:15 'cause that is another major growth, much smaller than private equity, but also, you know, you can lump them in into the same bucket. Um, but you know, the thing, uh, a lot of people have talked about this and to say it's a slow motion car wreck, I don't think is an exaggeration. Um, these groups are exhibiting just the classic signs of needing to find the greater fool.

29:45 Um, and if anyone is out there saying that they want to give retail access to something where they didn't have access before, and they're doing so for magnanimous reasons, you know, run the other way. 'cause it really means that they're looking for the next patsy and they're getting desperate. And that's, that's exactly the case here.

30:04 I saw a stat the other day someone on Twitter posted, which I thought was pretty funny, that there are now more private equity funds in the United States than there are McDonald's restaurants. Something on the order of 8,500, um, which is just like an anecdote that reveals the issue. And you know, what you're seeing now is you're seeing the liquidity dry up demand is going away even as they're trying to get retail into these things.

30:32 Large money endowments, real asset investors are trying to shift away because they need liquidity. I just read a, an annual report from a large family office, uh, yesterday. In that report, they invest all in private equity, and they said something in the, like, the official glossy report. Hopefully this year we will get more liquidity for our, for our LPs because, you know, clearly that's a, a pretty urgent thing that they're, that they're talking about internally and, and that's clearly happening.

31:07 So what you're seeing is you're seeing a lot of kind of pass the buck, kick the can down the road financing schemes. So, um, trying to raise money for secondaries, continuation funds, basically things where you're not even making new investments, you're just raising money to shift the old investments into a new structure, into a new holder, to give liquidity to the people who want out.

31:32 So that is growing in a huge way and against a backdrop of enormous demand. 'cause all these funds are out there and they've raised all this money and now they need to roll it over. The thing that caught my eye, and the reason that I put it as a number one with a little, you know, police siren alert, uh mm-hmm.

31:51 In our, in our knowledge platform, um, was this rev re revelation that the, um, buyout funds who have captive insurance companies, uh, that they run lots of corporations of captive insurance companies, but the buyout funds, uh, have their captive insurance companies investing in their own funds. So you have leverage, uh, on top of leverage because insurance is leverage.

32:23 In other words, you're borrowing from claimants in the future. So you're taking that leverage to invest in these leveraged LBO funds, continuation funds. And then the thing that really killed me after that was now in addition to investing in their own funds. They're using their craft of insurance asset pools to invest directly in data center assets.

32:48 And that is, like I can tell you right now, gonna be the biggest cluster of the next five years really for, for two points. You know, for two reasons. I mean, the number one thing is it is a classic case of overestimating and being over optimistic about, uh, how much demand will emerge for something where capacity is exploding exponentially.

33:10 Mm-hmm. And I mean demand for AI oriented data centers. And the second thing is underestimating how bad it is to lend money against a depreciating asset that's also levered against the demand. So, for example, the value of these GPUs is leveraged to how much use you get out of them. So it's a depreciating asset.

33:34 Um. Both because it's, it's, it's highly levered to the end demand, but also because of technological, uh, change and disruption. Like you're literally lending against an asset that's at the heart of all of the innovation and, and things happening every six months in new AI related asics and, and chips coming out.

33:56 Like, these things are gonna be obsolete in like three years. And yes, you can use them for inference and people have argued that, that there's less that you can do with them. But just the amount of over optimism, the amount of sort of blithe disregard for what is on the other side of the hill, like this is setting up to be a problem of massive proportions.

34:20 And captive insurers are investing in those, the captive insurers are leveraged on the private equity funds. The private equity funds are then borrowing to continuation funds, their own stuff that's out there. And they're desperate for real money investors to keep writing the checks. Like all of this is coming together to be, to be a big problem.

34:44 So that's, that's my story. Yeah. To, to, to, uh, quote it was Elisa Wood who said this, uh, who's at KKR? She said, quote, there are 19,000 private equity funds in the United States. There are 14,000 McDonald's in the United States. How are there more private equity funds than McDonald's? That's actually crazy.

35:01 Right. Um, and it's a nice metaphor too, too in terms of the relative health of, uh, of eating at McDonald's versus, uh, dining off the buffet of these, uh, 19,000 private equity firms that you're talking about. Also, I mean, in the, in the article that you posted on the platform, I mean, it talked about how, you know, there were insurance fund managers who were investing.

35:19 Or who are buying debt from data centers that had several years worth of operations and performance behind them. But one of the big shifts is that they're now deciding to invest in data centers that will be built. So it's not even that they have any sort of data about, you know, operations or anything beforehand.

35:36 They're saying, no, these things are going to, we're gonna need them, so we need to build them. I'm and invest them now, and we have capital and they need the capital to build the data center. So it's a match. It's a match made in heaven there. And that, I mean, we can get into sort of data center demand and, and what that means.

35:51 But before we leave, um, private equity, I mean, I imagine we have two class of listeners. We probably have listeners who are like, okay, so what, like I wasn't investing in private equity in the first place. And then we may have listeners who have significantly more assets and maybe did invest in a, in a PE fund or fund to funds or something like that.

36:09 Or maybe they're even bigger than that and they've invested significantly in a private equity fund. So Rob, if you were talking to each one of those people in front of us, like. Should the, should the consumer retail investor, aside from running for the hills from these things, be worried about what this might mean for markets in general.

36:25 Um, or is this really just a problem if you're already exposed to these things and is there anything you can do if you're already exposed to these things? So if you are already invested in private equity, um, I mean, this is an issue that we're dealing with at bespoke right now where we're helping clients work their way out of either funds where you have limited options because you, you've signed a legal document to, um, to provide capital, um, or direct investments in companies where you have a lot more leeway.

36:59 So, um, there's a lot of sort of asset value there if you go and, and seize it now and sort of work on the assumption that new capital is gonna be hard to come by. Um, so a lot of our work on the private side has been sort of. Battening down the hatches on companies that clients own directly. Um, you know, that sort of thing.

37:23 So if you are in that situation, I, I think thinking about how you can do that is gonna be a key part of the, the playbook. Um, more generally, you know, I think there's a, the complacency is going away 'cause I think a lot of private companies are finding it difficult to raise capital in the last few years.

37:44 Um, but there is sort of this complacency that private equity is just going through a rough patch or you just have to wait it out. I think what is not really being envisaged, envisaged by most people is the notion that this is a multi-decade wave of liquidity, risk being, being a good thing that is now turning the other way where you could have years and years of.

38:13 Liquidity shortages, difficulties managing private businesses that aren't self-funding, um, asset valuations declining significantly, um, in the private markets, you know, just like in the public markets. Um, and that is a scenario that I think many have not planned for. And even if you are stuck in a lot of these illiquid vehicles or liquid companies right now, you can still start planning for that longer term kind of outcome and, and building liquidity and resilience against that.

38:46 That would be the, the advice that I would give more generally. Is that gonna play out in public markets though? Do you think? Like it's that big of a will the ripples extend out that far? Yeah, I mean, risk assets are connected at the hip everywhere you go. Um, you know, it's, it is a tricky thing because private markets are, or I'm sorry, public markets are in a weird barbell sort of situation now where.

39:13 There are areas of great froth and valuation excess, but it's mostly concentrated in large companies, companies perceived as quality and the AI bubble, the AI trade. Whereas a lot of smaller companies and sort of the, the majority of stocks never have recovered from the 2021 bubble and are still like clanking along at the bottom in terms of sentiment and valuation and things like that.

39:43 So I think you're starting to see that flow through, not in, you know, the s and p 500 index or the things that most people look at when they look at markets. Um, but there's signs of that valuation premium starting to melt its way out of the market. Hmm. Um, I don't know if you also saw this, uh, like there was a story in the Wall Street Journal just a couple weeks ago about how like Microsoft or even a.

40:10 Microsoft in particular, but has lower borrowing costs in the US government that people are, are willing to like buy Microsoft bonds, um, over treasury bonds. Um, because Microsoft, I guess, is seen as a little bit more reliable, which backs us into, I mean, all, all roads lead to AI here. And you, you mentioned the data center example as well, and I wanted to to pick your brain a little bit about that because the, I, I threw a number one on the knowledge platform myself last week, which, which was this Jerry Newman article about ai.

40:37 Um, and he's actually agreed to come on the podcast in a couple weeks, so we'll have a more in depth conversation with him to rehash, um, what he talked about. But, um, to, to sum up his point very succinctly, he says not to think of AI in terms of, say, the semiconductor revolution or as a revolutionary new industry that's gonna create all these investment winners.

40:54 But to think of it as. Similar to something like containerization or to railroads, which if you invested in containers when containerization was created, uh, you didn't do very well. The companies that did well were downstream. It was Ikea that was the, you know, the best investment in that world, not the actual company that came up, that came up with containerization itself.

41:13 And he talks about AI in that context. Um, and I bring that up just because, um, you know, you're, what you're talking about is that we're, we're. Probably building too much capacity in these data centers, which seems hard to imagine the narrative for the past couple of months that we can't have enough data.

41:31 Everybody's using ai, electricity prices are skyrocketing. 'cause the amount of power that we're gonna need to power the AI models that are gonna take all the jobs away from us and our children and, and everyone else. Um, am I right in reading you that what you're saying is that this is, this is inevitably going to be a data center bubble that we're building too much capacity for what we're talking about?

41:49 Or do you cut the other direction? I mean, uh, we, we haven't caught up about this in the last few weeks, but the, the narrative on AI is also changing so quickly. I mean, like even in, in the course of the last eight months, like go back to where we were in January. Nobody was talking about AI the way that they're talking about it right now.

42:03 Nobody was talking about data centers and power prices and everything else. Um, the way they're talking about it right now. So how do you see that? I think the, there, there's two things that people commonly mistake. The first is the timing. Um. I have no doubt that there's gonna be exponential growth in demand for AI and, and all of the tools that people are building right now.

42:29 How quickly it takes that growth to, to emerge, I think is the real question. You know, we've talked about this notion of the trough of disillusion. You know, this is just the natural course of events with every technology. But like, you could look at railroads, canals, you know, semiconductors, electric capacity, build out, like whatever it is.

42:53 There's always over optimism at the beginning. And then, you know, the trough of disillusion and then sort of you get into realistic expectations. Um, I think this is no different. So that's one thing in terms of timing. Um, the other thing which is more related to, uh, Newman's, uh, uh, piece that he wrote is, is just this notion of value capture.

43:18 So. It's wonderful if demand for AI services grows exponentially. If people aren't paying you for that or they're not paying you what you thought you were gonna get paid for that, then you have a problem in terms of generating a return on these very expensive assets that you're building and you're raising capital to build.

43:38 And I think that's, that's the main thrust of his argument, which, you know, he's very much preaching to the choir. Um, in June of 2024, we had a whole conversation about this. I think you called the episode, let's talk about artificial intelligence. But at that time we were talking about at this notion of centralized value capture versus diffuse decentralized value capture.

44:04 Um, and you know, at that time I was saying that I thought. You know, as new one is, is saying now that a lot of the value accrual is not gonna go to the central infrastructure builders. That this is sort of, um, you know, the apotheosis of the computing revolution in the sense that, you know, as, as he points out in the piece, in the early stages, building the initial infrastructure to enable compute was a very centralizing thing where you had a lot of value creation by companies.

44:38 And now we're reaching the point where the benefits are diffusing and the competition is already established and the players are there, they're competing along the same channels. So a lot of this build out is going into the, into the system to enable this. But there's enough competitive, uh, uh, sort of pressure established that consumers are gonna be able to not have, like, they're not gonna be captive to any of these guys.

45:06 I think that's, that's the way to think about it. Um. It's similar to the electric grid build out. Like if you look, I, I always find it shocking if you actually go back and look at the 1920s, which was really the, the heyday, you know, similar to today, consolidated Edison had operating margins of 27%.

45:28 They were hugely profitable business, hugely profitable. And they spent the next like 50 years seeing those margins just get squeezed down, squeezed down, squeezed down. 'cause the benefits of electricity once it reached a certain maturity, um, were diffuse. And it, the, the value was created by the companies using electricity to do new and creative and innovative things.

45:52 And you could use a similar, uh, kind of framework to think about ai. I think, um, where this is, this is gonna be great. It's gonna be really, really great for lots of people, but it's gonna be limited. Um. In terms of the amount of value that's gonna be accrued and captured and squeezed by, you know, by a smaller number of people because the scarcity is, is not there in the same way as it was during the early days of compute.

46:23 Yeah. I think that the, I think the thing I'm stumbling on here is just that, I mean, a lot of these data centers are being built and we're seeing the increase in electricity prices as a result of the growth and demand for electricity from these data centers as well. But what you and and Newman are talking about is that okay, but we're built, we're probably building too many data centers.

46:44 So like when we get five, 10 years into this process, like there's gonna be so much competition and a lot of the people who built these data centers are gonna be in trouble, including these insurers that you're talking about who are investing in these things. Does that mean that power prices are also gonna go down?

46:58 Does that mean that these data centers just become, um, as, as, uh, Marco Pap said to me the other day that they just become pickleball courts. I mean, do they, do they continue in the, like, I, I, I don't, I sort of get, I have these two different paths and I don't understand where they intersect. Can, can you help me?

47:16 Um, the data centers are not gonna be pickleball courts. They're going to be used. Um, the question is when and at what price. And that, I think is, that's the key distinction. So it's a good thing for society to put this, you know, pp and e into, into place. It's just we're probably putting too much too soon.

47:39 And you're probably gonna have to restructure a lot of the capital that's going into these and financing them because it's not set up to the actual economics that are likely to result, you know, three years from now when. We'll get the answers to the question of, well, how much demand was there in 2028 four for these services, and was it enough to sop up all of this at a price that can sustain the returns that the captive insurer of Apollo requires to lend money to this new build data center?

48:11 You know what I mean? Yeah. Does that mean that electricity prices though, are sort of participating in the bubble in the sense that people are overestimating the amount of electricity that is gonna be used by these data centers three to five years from now, and that then we will see a reversion in electricity prices rather than the sort of scary 20% year on year projections that even the Department of Energy is talking about?

48:34 Or to your point, like if the data centers are gonna be used and they're gonna be there, it's just when and at what cost? Um, you're still gonna need the electricity to power the data centers. So even if you figure out, even if the data part of that gets resolved in the way that you're talking about the power part of it.

48:48 Sort of separate. Does, does that make sense? The, the question I'm asking? Yeah, but I think it's really, there's so many moving pieces in there. I don't think you can give a linear answer to that. 'cause you have like the demand side. Yes. Demand for AI workloads, if you wanna measure it that way, is gonna grow exponentially, like guaranteed over what time period.

49:12 Like whatever. We can argue about that, but it's gonna happen. Um, energy efficiency is a huge factor in this. The energy efficiency of the chips, the energy efficiency of the data centers themselves like that is a huge unknown. And that's only gonna get better and not worse, right? So you have that factor.

49:31 Then you have the supply factor, which is right now energy prices are going up not because of demand, but because you've had a marginal increase in demand that hasn't been matched by supply. 'cause the permitting and the build out process is a giant cluster fuck. For lack of a better word. So do you have improvement on those issues?

49:51 You know, and then you have the energy mix shifting very drastically to renewables and things that are deflationary in nature. You have, you have, uh, energy storage starting to become a bigger factor, which is, you know, going to also grow exponentially and help to smooth out, um, you know, the duck curve in some of these renewables.

50:11 I mean, all of these things have to go into the soup of your analysis. Um, I think generally speaking, an advanced society sees energy prices. The cost of energy go down over time, and if you have bumps in the road, that's one thing. But I would be just shocked if we were here seven or eight or 10 years from now, and energy prices were higher than they are today, regardless of any exponential, crazy outcome on AI demand.

50:44 Okay. Um, let's close out on something that is near and dear to both of our hearts and something that, um, you and I have always looked at, um, sort of tangentially as a hobby, Rob, which is coffee prices. Um, I think eggs have made a lot of noise this year. Uh, but the second highest annual inflation rate for any CPI category, aside from eggs is coffee.

51:05 Um, up almost 15% year on year in July, it's up about 33% from where it was a year ago. Global coffee prices are hovering year of 50% high. Um, some of that is related to weather, uh, both Brazil and Vietnam. So the world's number one and two suppliers, um, had some difficult weather recently. You also, of course have the Trump administration tariffs specifically on Brazil.

51:29 Um, this goes back to, you know, uh, Howard Lunik being questioned about why there are tariffs on things like bananas and him basically implying that you would, this would bring production back to the United States and news flash to Mr. Lutnick. We're not gonna be growing coffee and bananas inside the United States for reasons that I should hope were obvious.

51:46 Um, you know, things are getting serious because, um, just a couple weeks ago we had bipartisan legislation. Being introduced to Congress that would exempt coffee products from any tariffs. So both Republicans and Democrats joining hands to say, uh, this is a bridge too far. We must exempt Brazilian coffee from these tariffs that President Trump, um, has imposed.

52:08 Uh, we don't have to spend too long on it, Rob, but I know that you, I know that coffee is a, is a, is a favorite of yours and it's a favorite of mine. So anything you wanna say about the chart or just coffee prices in general? I guess you're not, are you that affected sitting in France? How are things for you, do you have some special colonial relationship with the former Indochina to get the prices cheaper?

52:25 I don't know. Well, the irony is that Brazil has been redirecting its exports from the United States to Europe. So we've, you know, sort of experienced the weather impact, which is not insignificant. I mean, the, the weather had been the main driver of coffee price increases up until really the Trump administration came in and, and made the decision on Brazil.

52:54 Um, but yeah, for the most part it's, it's an interesting case study of how tariffs are decided unilaterally, but trade settles multilaterally because what the Brazilians have been doing is they're redirecting their own exports to Europe and to Columbia actually. And Columbia is redirecting its domestic consumption into exports to the US 'cause they don't have the tariffs.

53:20 Um, and all of this hasn't even really hit yet because roasters in the US are still working down their inventories and I think probably hoping that the tariffs will get pulled. But this is, you know, getting to some of the conversations we've had about the timing of how this flows through inventories and the length of the supply chain are, are something everyone forgets.

53:43 You think, oh, the tariffs are announced and then the next day the prices go up? No, no, no. Like it takes months for the inventories to run down and for the inventories to. The higher priced tariff inventories to get into the inventories and then they get sold. So there's a lot of moving parts here and a lot of like chicken being played.

54:02 Um, but yeah, it's uh. It's a, it's a, it's a, it's a nice encapsulation of a lot of the issues going on here in terms of tariffs not having the intended effect. Yeah. And I, it was on my mind in part because the, the small roaster that I buy my beans from down the street here in New Orleans, um, they had a sign just two to three weeks ago, um, and near the bags of beans where you buy 'em in the coffee shop that said, Hey, we've held off raising prices as much as we possibly can, but we can't wait any longer.

54:32 And it was a pretty significant price increase, which I don't mind. Uh, they like roast incredible coffee and I love it. And it's one thing where like, you know, they could increase it another 20%. I'd still be buying 'cause I'm, I'm addicted. Um, but to your point, like they ran down their inventory and they could no longer push it off.

54:47 Now they're a small artisanal roaster, so probably larger operations of your Starbucks are gonna have more inventory. But at least it's starting to show up there. And I know my, my, I, you know, I've, I've talked for a long time about if, if, if I ever was a complete and total bajillionaire, that I would just like source coffee beans from some, you know.

55:05 Uh, grower down in Latin America and bring the beans in myself through New Orleans and, and roast them myself, which was never cost effective. Um, unless the market continues to go like this. If you continue to get bad weather because of climate change and more tariffs and more problems, especially between Brazil and the United States, which, which don't seem to go away.

55:23 I don't know, maybe that idea's not so crazy anymore developing that sort of pipeline. And I, I think it's also an interesting, you know, you talked about it how tariffs impose unilaterally, but things. Settle, um, multilaterally, um, I, I think it's, it's also an an interesting case study and whether, and whether at what point, um, you start maybe not thinking of something like coffee as a commodity anymore, where you have to start thinking about it in terms of direct connections with growers and direct connections to consumers and consumers willing to eat those higher costs because they have, as I do with my coffee shop down the street, like some kind of appreciation for what they do or brand loyalty, uh, and willing to spend a higher amount of,

56:02 of your disposable income on that thing. We talked about that Jerry Neuman article. One of the most incredible statistics in that article was you go back a hundred years. The average American was spending more than half of their disposable income on food and clothing, and that has declined to 16%. And we hear much wailing and gnashing of teeth when the price of eggs goes up and when coffee goes up.

56:22 But beneath all the fetching, I'm going to the coffee shop and I'm buying the beans, or people are going to the grocery store and buying the eggs. They're bitching the whole time about it, but they're buying those things. Um, and I wonder if, if, if we're getting into this sort of part of the volatility spiral, if we're just gonna have to accept that these things are gonna cost more, um, and may, maybe they won't, like, maybe tariffs against Brazil will go to the wayside because of bipartisan cooperation in Congress.

56:47 And maybe we'll get one or two good seasons going forward. And this will all seem silly by comparison. And everybody, or anybody who is dumb enough to listen to me and do their artisanal roasting operation will say, God damn Jacob Shapiro for saying that, uh, in, in 2025. But I don't know. It's, it's also just, just something percolating in my mind there.

57:04 I don't know. Well, it's, it, it's interesting language that you use. 'cause what you're describing is coffee, going from being a commodity, meaning something that flows and meets demand wherever it is. And you can't distinguish between coffee that comes from one place or another for the most part to, you know, place being more important to, to the market fragmenting to being less commodity like, um, and that's great when you have like something like coffee.

57:36 It's fun. It's a nice thing to talk about. Yes, because it's a, it's an artisanal, you know, product and it's really cool to get it from different places and it tastes different. Cocoa is similar but you know, a lot of products you don't necessarily want that, like steel, uh, for example, I know that, I know Tomas is gonna say, oh, I just not, uh, sufficient to fix Neo of how wonderful.

58:02 This type of Australian steel is for this, but for the most part, most of those markets you want to work as giant global machines that are getting things to you as efficiently as possible, and there is no differentiation. So, um, yeah, it's, uh, it has, its, uh, positives, but for the most part, breaking down the global trade system is not great.

58:28 Well, and I joked about it with, with making fun of lutnick because he's the easiest person to make fun of in the world. But I know, and we won't have time to get in into this in depth in the podcast, but one thing that has been in the, on the front pages now, which has been sort of on my radar since the beginning of the year, is the plight of US farmers and particularly Midwestern row crop farmers with the tariffs on China and China not buying soybeans.

58:48 And is President Trump gonna redirect tariff revenues to the farmers? Um, and what's gonna happen to all those soybeans being grown? Are they gonna become renewable diesel? Is it gonna be ethanol 2.0? Um, and you know, one of the things I've been banging on the table with for the past, you know, 10, 11 months is, you know, the, the US is no longer the low cost producer of lots of these different things that used to be treated as commodities.

59:09 So either what is left of small to medium sized US farmers are gonna sell out to larger companies or operations that are gonna continue to treat these things and as commodities and move them around globally. Or you're gonna have to think of different ways in different markets that you're gonna sell different types of products to, rather than just like planting a bunch of, of soybeans in general.

59:28 You can obviously probably tell which one I think would be better for society, but I think that, you know, um, based just on the way things are going, like we're moving in that, in that opposite direction, which is ironic 'cause everything about tariffs was supposed to be about, you know, the breakdown of trade.

59:43 But what if we're here six months from now and there is some kind of US China deal and you've just got bigger and bigger corporations, whether it's in data centers or in big food or in any of these others that are actually just like trading more themselves and are figuring out exemptions to all the different tariff rules.

59:57 And it's all about who's scratched my back lately and, and, and things like that. So, I don't know. It's, it's an interesting point that we're at in the cycle. Rob, anything else you wanna tell the listeners before we get outta here? Go, go, go drink some coffee. Go drink some coffee. I need to get my second cup so Cheers.