Why the Next Financial Crisis Could Change America Forever ft. Danielle DiMartino Booth

[00:00:00] Cem

Welcome back to another episode of U Got Options from the Cboe floor, brought to you by Kai Media and Top Traders Unplugged. Today we meet with Danielle DiMartino Booth, the ex advisor to the Dallas Fed and author of Fed Up. I can’t think of a better time to be talking to her with Warsh becoming the new Fed president.

Where will he go? What will the new mandate potentially be of the Federal Reserve? Is it still inflation or are we talking about backstopping the Treasury and the debt? Lastly, what is the final end game here? How will we get out of this multifaceted tectonic plate mess? I believe we’re going towards a place where the US equity market gets backstopped by the Treasury, at the end here, we’ll see what Danielle thinks. Tune in, you’re going to love this one.

[00:00:48] Music

(Music)

[00:01:08] Intro

Welcome to U Got Options, an exciting series right here on Top Traders Unplugged, hosted by none other than Cem Karsan, one of the sharpest minds when it comes to understanding what’s really driving market moves beneath the surface.

In this series, Cem brings his deep expertise and unique perspective, honed from years of experience on the trading floor, to candid conversations with some of the brightest minds in the industry. Together, they unpack the shifting tides and underlying forces that move markets and the opportunities they create.

A quick reminder before we dive in, U Got Options is for informational and educational purposes only. None of the discussions you’re about to hear should be considered investment advice.

As always, please do your own research and consult with a professional advisor before making any investment decisions. Now, what makes this series truly special is that it’s recorded right from the heart of the action on the trading floor of the Cboe.

That means you might catch a little background buzz. Phones ringing, traders shouting as Cem and his guests unpack real world insights in real time. We wouldn’t have it any other way because this is as authentic as it gets. And with that, it’s time to hear from those who live and breathe this complex corner of the markets. Here is your host, Cem Karsan.

[00:02:25] Cem

Welcome back to another episode of U Got Options. Today, I got none other than Danielle DiMartino Booth. Such a pleasure to have her. I couldn’t think of a better time. With Warsh just getting started, an incredibly Important kind of fork in the road for the Fed in a lot of ways.

[00:02:42] Danielle

Absolutely.

[00:02:42] Cem

So excited to get into it. I know we have some different opinions, which always makes for a great conversation. And I’m excited to kind of dive into some of these topics today.

[00:02:50] Danielle

Let’s do it.

[00:02:51] Cem

Yeah. So, first of all, I kind of want to start with the big picture. What is your view of Warsh and where the Fed currently sits?

[00:03:04] Danielle

So, I think Warsh is walking into a hornet’s nest of dissent. I don’t think he’s got very many friends on that committee. I think they’re making that pretty clear in what they’re saying publicly.

Ironically, Powell might be one of his greatest advocates. He was very deferential in his last press conference in saying that he would step aside and make way for Warsh to be able to kind of create a consensus, or at least try. And Warsh is faced with the inflation that Americans are living, which we call that the headline inflation rate.

And Warsh is younger. He’s more in tune with the fact that we live headline, we don’t live core, and fertilizer prices are starting to fall into food prices. We’re seeing increases there. We’ve come back down to US$90 a barrel on West Texas Intermediate, but that’s still way north; US$25 a barrel north of US$65 a barrel before Iran. So, American families right now are having an extraordinarily hard time.

I don’t think that Warsh is going to be naive or stodgy enough to rely on the labor market indicators that are lying to Americans. I think he’ll look for more real time ways of gauging the labor market. He’ll get a lot of pushback from the staff though. There’s nothing easy here. And he could be facing a liquidity crisis.

The hits don’t stop coming if it’s private equity, or private credit, or private anything. And we have to bear in mind, as of 2024, the non-banking global financial system was US$258 trillion; that’s 51% of global assets.

Now will Warsh be faced with a liquidity crisis even if it’s in a sector that’s non-regulated, that the Fed technically doesn’t have any purview over? Yes, he will. Because so many of these non-bank players are now too big to fail, just like the big banks were too big to fail in 2007, 2008.

[00:05:13] Cem

Yeah. And I think the one thing you didn’t mention, I agree with everything you said, is that the national debt is to an Incredible level.

[00:05:26] Danielle

Well, I mean that’s a constant, it’s a constant problem…

[00:05:29] Cem

It’s unsustainable at the higher interest rates. Right? So, it’s interacting… So, I really think of it as like five major pressures right now. One, the market has just gotten… everything has become so financialized. The market is everything now. We cannot let markets collapse or go down because the amount of leverage in the system is so big.

Two, we have an incredible national debt that’s growing, and a major, major problem. Too, we have an inflationary problem, which you highlighted, which is not just a recent problem, it’s a problem that we’ve been facing that’s been now consistent for six years. Okay. On top of that we have populist pressures underneath the hood, which are part of what’s driving that inflationary pressure. But that populism itself is only getting worse, worse as markets go higher and higher. And a lot of these things are in contradiction to each other and are causing major, major pressures.

Lastly, we have a confrontation with China which is leading to not only proxy wars which also increase inflation, but supply chain potential problems which could be inflationary, a lot of other structural problems. This is a ‘bitch’s brew’ of problems underneath the hood. And Warsh is coming right into this moment.

The big question, and I think what was highlighted by Hank Paulson, just about four weeks or five weeks ago, when he came out to Bloomberg is (which I don’t think is a coincidence, him coming out and speaking about this) how do we sustain our debt in the face of inflation, a rising 10-year bond which is driven by populism and competition in China?

And the big question is really, is Warsh going to be willing to stand in the way of what is ultimately, I think, the only way out of this mess, which is inflationary monetization of the debt, some form of getting rid of debt over time or all at once in some form or another. And that means the Fed has to be fiscally prudent to do it or, you know, improve it with monetary policy.

What are your thoughts? Is he going to just to stand in the way of what’s, I think, ultimately inevitable in terms of some type of monetization of the debt, or is he going to be the first one to kind of step in and begin that process?

[00:07:52] Danielle

Well, see, you have to look back at when and why Kevin Warsh stepped down from his governor position on the Federal Reserve Board. And that was in direct protest of QE. He did not believe in the efficacy of the zero bound and was not being heard, or at least one voice of dissent was not sufficient. And so, he left. And in subsequent interviews he said QE was Robin Hood for the rich and that he wanted no part of it.

So, I think if there is a solution, that it’s going to take on a form of nothing that we could sit here today and anticipate under Warsh. Under somebody else, I think the possibilities are unlimited. Unless Warsh wants to destroy his credibility forever, then I don’t think you could say monetize the debt and his name in the same sentence.

[00:08:59] Cem

So, I hear you on his history and whatnot. But the simple fact remains that if he does not do QE, at some point, the debt is spiraling out of control.

[00:09:09] Danielle

Correct.

[00:09:10] Cem

And if you also raise rates in the face of inflation or do something along the lines to manage the inflation, you know, the Fed’s in a box. And if they do that, ultimately that leads to a market problem. Right? And the market problem, as we just talked about, is itself a major problem for the economy. 50% of all consumption comes from the top 10%, as we know. And again, the amount of leverage in the system, as you highlighted, is tremendous.

So, the Fed’s in an unenviable position, and Warsh is in an unenviable position. So, how does he navigate this? How does he create, you know, discipline, back up some type of inflationary prudence – price stability prudence, while not threatening the whole system?

[00:10:01] Danielle

You know, that’s a great question. I have no answer for that.

[00:10:05] Cem

Sure.

[00:10:06] Danielle

You know, BlackRock came out over the weekend. BlackRock was like, we think that there’s sufficient evidence on the labor mandate side that the Fed’s first rule should be a rate cut. They really went against all of the conventional thinking right now in the markets.

I think Warsh is wise enough to know that because Powell has been kind of trapped in this political quagmire with having criminal charges against him, that he probably understands why the labor mandate has been ignored. But I think he does try and get a few plain vanilla interest rate cuts off in 2026. I don’t know that he’s going to be successful.

Again, he is at risk. There are very few people, whether you’re talking about a Federal Reserve District bank president or anybody on the Federal Reserve Board, I mean, doves have become oxen drag. They’re actually speaking publicly against their own grain just to make a political statement.

So, if he’s walking into a situation where they view him purely as a political patsy. He’s going to have a hell of a hard time getting anything done.

[00:11:29] Cem

But cutting rates, ultimately, in this inflationary environment, first of all, that’s in complete disagreement with what the market’s pricing. Right? You would agree? But, importantly, doing that will be seen as being a bit of a patsy to the presidency and, you could argue, could lead to the exact opposite, which is if we’re in an inflationary environment the last thing you want to be doing is cutting. We’re actually at all time highs, a valuation bubble, obviously, by lots of metrics, if not all…

[00:12:00] Danielle

But you have to bear in mind, again, Kevin Warsh is younger. He’s not a PhD. in economics. This hearing things like…

Food companies came out in the Dallas Fed survey today and they’re like, we’re seeing unit declines, we’re seeing traffic declines. We are having our margins squeezed to kingdom come. We cannot raise prices. And a lot of them are just closing.

Small business bankruptcies are off the rails right now. Bankruptcy cycle is in full house of steam. So, somebody’s being harmed by the current policy because they don’t have pricing power because essentials inflation is completely off the rails.

Services inflation? We’re seeing disinflation.

Wages? We’re seeing disinflation in wages.

In fact, last month, for the first time, we had your average American worker (This is a good Financial Times article over the weekend) is now, on an inflation adjusted basis, losing money.

[00:12:59] Cem

Yeah, but lowering interest rates is a supply side response. At the end of the day those people who are hurting are not the ones borrowing money. Lowering interest rates for the bottom 50% of America, who does not borrow money. They cannot. So, with the real people that are hurt…

[00:13:15] Danielle

Businesses can’t.

[00:13:17] Cem

Small business can, but that’s supply. Right? Small businesses are creating, and this is the whole trickledown economics model. Right? We see where that’s gone. That’s what’s led to the inequality is the massive supply side response.

So, you know, for him to sit there and say, well the people are hurting, the economy is slowing (at least at the bottom end), and, by the way, we have a bifurcation. Clearly the high end is doing incredibly well. And in response to try and help the bottom end of the distribution, lowering interest rates doesn’t work. Right? That’s where the fiscal…

[00:13:47] Danielle

We have to bear in mind that Americans were told, while they had this massive run up in inflation for four years under the prior administration, that they were imagining inflation. They were kind of cuckoo even though they were feeling it. But the gaslighting was unreal.

And now in the current administration, they’re being told that the 69% of Americans who are being polled by the University of Michigan, very close to where we are here today, that they would think that the unemployment rate is rising. They’re being told that they’re cuckoo too. So, the gaslighting goes on.

I think that Warsh could establish much, much, much needed credibility with some honesty. So, instead of getting up at the podium and saying, “the labor market is solid”, as Powell’s been doing for years, simply being honest and saying, “you know what, this is not going to help you, but it might help the small business that’s going to employ you.”

And, by the way, we’re not going back to the zero bound. I’m not here to do a repeat of Robinhood for the rich because the rules of the road at the Fed are… The Bernanke doctrine that was created in the summer of 2007, at Jackson Hole, by Bernanke, illegally, by the way.

There was not a full quorum of Fed leaders gathered in a conference room and said that you must take the Fed funds rate to zero before you can engage in QE. I don’t think Kevin Warsh is your man for the zero interest rate policy that must predate the launch of QE, in any form. I don’t think he’s going to the zero bound. I don’t think he believes it.

[00:15:28] Cem

I think differentiating so dramatically between lower interest rates and QE, yes, they’re different and they act in different ways. I hear you. But at the end of the day, it’s a matter of relatively small percentages. They both act, generally, in the same way through the monetary…

[00:15:46] Danielle

But zero bound out acts very differently. If he was to come out and say, choose the new zero, that would get a lot of respect on Wall Street.

[00:15:56] Cem

But we’re far from the zero bound right now. Right?

[00:15:58] Danielle

We’re far from the zero bound, but we were far from the zero bound when the pandemic hit.

[00:16:01] Cem

We can talk about…

[00:16:02] Danielle

We got there in a heartbeat.

[00:16:03] Cem

I agree with you. It’s a different conversation when we’re at the zero bound. I think, right now, with interest rates at, you know, 4% and a 5% (Right?), they operate in the same channel. They’re both, essentially, providing liquidity to corporations and wealthy individuals, I would say. Yes, interest rates probably work a little bit more towards maybe not the 1%, but more towards the 10%.

[00:16:30] Danielle

Sure. I mean, we know that’s the case.

[00:16:32] Cem

Yeah. Because small businesses, as you mentioned, real estate, etc. (Right?), that channel…

[00:16:35] Danielle

That, of course, is not the top decile. All businesses, real estate…

[00:16:40] Cem

Well, we’re talking concentration…

[00:16:43] Danielle

Talking about kind of a second decile which nobody ever talks about.

[00:16:45] Cem

Sure. We can draw that line. I don’t want to get too pedantic. I think we agree on the major point there. Right? They’re both supply side measures. By definition of monetary policy is supply side. The purse strings, in theory, are fully governed by Congress, and fiscal policy, etc.

That’s changing, but the Treasury is more, and more involved there. But I want to be clear, that is not the Fed’s domain in theory. The problem increasingly though is if you do interest rates and you’re not thinking about, you know, lowering interest rates and you’re not thinking about the inflationary aspects as much, and you’re willing to let inflation run to bolster the economy, you’re saying you’re doing it primarily to help the poor, or arguing, at least, that the inequality problem… that you have a bifurcated economy and people are hurting.

The problem with that is you’re using the wrong tool to do that. At the end of the day, interest rates themselves are not the thing that’s going to help. It’s going to help markets more than it’s going to help individuals on the bottom. We’ve seen that historically. I mean this is the old Arthur Burns…

[00:17:54] Danielle

We disagree there. I think a zero bound would help markets at the margin, but I don’t think that a few interest rate cuts are going to help what the private market needs. What the private market needs, which again is bigger than the regulated.

The non-banking system does not want an interest rate cut or two. The non-banking system wants somebody to get zero interest rate policy and reinstate it so that they can keep on with all of the financial games that they’ve been playing for decades that have made them bigger than the regulated financial system. And they want QA to be relaunched and they won it yesterday.

[00:18:30] Cem

As an ex-member of the Fed, I’m sure you’ve read Arthur Burns’ treaties, in the ‘70s talking about…

[00:18:38] Danielle

We’re not in the ‘70s, remember that. In the 70s we had aggregate levels of employment increasing. We had aggregate levels of income increasing. The inflation sucked, the stagflation…

[00:18:46] Cem

We’re not in the 70s yet.

[00:18:49] Danielle

But, we had rising…

[00:18:51] Cem

We’re in the late ‘60s I think or early ‘70s, but we’re heading…

[00:18:54] Danielle

But the point is, aggregate income was rising. Right now we have aggregate income falling. So, you cannot use an Arthur Burns type of playbook because right now there is less money to be spent by households. And that’s a huge differentiating factor which is why we’re seeing services disinflation and wage disinflation.

[00:19:15] Cem

Arthur Burns, after being at the helm of the Fed for as long as he was, basically his final conclusion was that, in these environments, the Fed is useless. The Fed does not have the tools or the ability to affect inequality, to manage inflation when it’s secular (Right?), and driven by structural forces. The populism of the period, which started with the Great Society program, was affected by the Vietnam War, was exacerbated by the OPEC crisis (a lot of things that rhyme with today) were driven by the same forces that are driving this structural inflation today.

[00:19:55] Danielle

That could easily drive us into structural inflation tomorrow, what you’re talking about.

[00:20:00] Cem

It already is. It has been.

[00:20:01] Danielle

We’re not at structural inflation right now.

[00:20:03] Cem

… The Fed has been unable to affect that for years. So, if we don’t agree on that at this point…

[00:20:09] Danielle

That has been a thorn in the side of the of President, excuse me, a former Fed chair Powell. But they’re also not gauging inflation. Now we have two months in a row of falling home prices. We have falling rents outside of AI affected cities. That is the largest…

[00:20:29] Cem

With a bifurcated economy. It’s very uneven. So, we agree that like not all inflation… and whose inflation are we’re talking about is very important as well. Right?

[00:20:38] Danielle

Now the wealthy are kind of freaked out about falling prices. They’re unhappy about that. So, as long as the stock market hangs in there. If we continue to see the trend growing because mortgage rates are prohibitively high right now. But most people who want to engage in a house…

[00:20:55] Cem

But the bottom 50% are not able to engage. And so…

[00:20:58] Danielle

But they do benefit as home prices fall because rents continue to fall on the back end of that. And that is a good thing for the bottom 50% is that housing disinflation, that housing deflation is…

[00:21:10] Cem

That assumes lowering interest rates won’t increase asset prices of that good, which they always do, particularly if you’re lowering interest rates into an inflationary environment.

[00:21:18] Danielle

But that brings Kevin Warsh back. I think he’s going to continue to roll mortgage backed securities off of the Fed’s balance sheet. And, given his druthers, if there is some kind of a cataclysmic event, I don’t think he’s buying more mortgage backed securities. I think he’s going to continue to roll them off and he won’t go there.

[00:21:37] Cem

And you can say that that’s more likely based on his character. Yeah, and you can want that. That adds a level… I agree from a principled, like from a Fed principled independence perspective, I can understand why you’d want that and why that is more sound long-term policy. We agree on that.

[00:21:52] Danielle

And just stay in treasuries.

[00:21:55] Cem

But that’s sound, long-term policy. And in order to get from where we are, to sound long-term policy, there is a problem because you cannot go the path that you’ve gone for 40 years and then try and reverse with the level of financialization that we have and not crater the economy, crater the markets, crater… Yeah, I mean more than huge risk. It’s almost one to one at this point.

There’s no way this market can handle a 30% to 40% decline that lasts multi-year, or anything along those lines, without not just recessionary but depressionary crisis. What Warsh is up against is he’s being asked, essentially, what’s more important: the independence of the Fed, the independence of managing the current situation that you’re in or saving and smoothing the business cycle? Which is the whole reason the Fed is created in the long run. Right? If he goes this route, what does Warsh do now? Let’s look. That’s the first act.

If he takes that step and then the market craters, ultimately, or inflation…

[00:23:02] Danielle

On average, an 11% drawdown in the first three months… This is post World War II, On average, the average Fed chair has seen an average 11% decline in the stock market in the first three months of their tenure.

[00:23:14] Cem

But then what comes after that? Right? Then you have to respond with QE. Then you have to respond. So why do you know that’s the path?

[00:23:18] Danielle

I guess. … that means you have to go to zero…

[00:23:20] Cem

If your goal is to smooth the business cycle, why would you do that first step, which then leads to a market route, which then ultimately leads to your QE afterwards. You’re ultimately just…

[00:23:33] Danielle

Hope’s not a strategy. But we can all hope that he is not faced with what Powell was faced with in 2018.

[00:23:42] Cem

At the end of the day, I think what you’re arguing for is noble. It is also… The theoretical concept of the Fed, the independence of the Fed largely depends on it. So, we agree on all those things.

I believe in some level of people responding to incentives and, at the end of the day, the five things that I mentioned at the top of this are all pressuring. They’re like plates, tectonic plates, and the amount of pressure in the system, it may seem calm, but the amount of pressure in the system is so dramatic that a single shift is going to create massive earthquake level reaction.

So, he has to see that, he has to know that and he has to be walking through the process right now trying to manage that outcome at the end of the day. And putting in front of that reality that pragmatism, a level of theoretical ‘what they should do to maintain independence, etc.’, I think, is unlikely because the incentives and the pressure in the system are so big.

It doesn’t make Warsh a bad person, by the way.

[00:24:52] Danielle

Bessent could help, though. Bessent could easily launch a massive buyback.

[00:24:59] Cem

Yeah.

[00:25:00] Danielle

…at the long end of the curve. It could easily shock the market, and go that direction, and take some of these… It would not please some of the largest traders of off-the-run bonds, one of whom used to be headquartered here in Chicago. But Bessent could announce a massive buyback.

[00:25:18] Cem

So, who washes Warsh’s hands? So, this is the point. Warshaw does not act independently like he has to operate within the administration.

[00:25:23] Danielle

The treasury can buy back treasuries on its own.

[00:25:27] Cem

Yeah.

[00:25:28] Danielle

It can. The Treasury and Bessent can do that independent of any Fed and that would actually really help Warsh.

[00:25:34] Cem

True. If it’s the same thing…

[00:25:37] Danielle

It’s not the same thing if Bessent’s doing it versus Warsh doing it. It’s not the same thing.

[00:25:41] Cem

Well, in terms of the market outcome, it’s the same.

[00:25:44] Danielle

Right. But in terms of impinging upon Fed independence, it’s not.

[00:25:46] Cem

From the focus of Fed independence, I agree with you. But the point is I think, whether it’s all Warsh, whether it’s Warsh or Bessent, this (in my opinion) is inevitable. And importantly (and I already kind of mentioned it briefly) we, just four or five weeks ago, I think this is the one thing that way too few people are talking about.

I think it in this news cycle nowadays, like, you pass by things so quickly. The most important thing, by far, that’s happened in last four or five weeks, is Hank Paulson coming out to Bloomberg and telling the world, multiple times, that we have a Treasury crisis coming, and that we have to prepare for that crisis, and that we need to backstop the treasury market.

[00:26:30] Danielle

So, who would you rather have at the helm right now, at Treasury, Paulson financial crisis era, or Scott Bessent? I’m curious.

[00:26:38] Cem

Well, listen, as a practitioner, as a hedge fund manager, as somebody who understands markets, I think the market having been so financialized, demands… I mean I want to make this point, I’ve made it before, but US$300 trillion of equity exposure in the world, if you count private equity, if you count private businesses, internationally, mark goes up 20%, you create US$60 trillion, give or take of new collateral. That dwarfs the Fed’s balance sheet and dwarfs the fiscal response.

[00:27:10] Danielle

Who do you think is a better market practitioner? Hank Paulson or Scott Bessent?

[00:27:13] Cem

What I’m saying… Bessent, it has to be because that’s why he’s in that role. No doubt about that. That doesn’t mean Hank Paulson… I want to be clear. I don’t think Hank Paulson went on Bloomberg and said this without (he’s a very thoughtful person), without talking broadly to Treasury and wanting this message to be out there. That I see as a major trial balloon that hasn’t been discussed broadly publicly. And what that’s telling you, for the first time out loud, that it’s coming.

What we’ve known for a long time that the only way out of this debt mess and backstopping essentially the debt issue with inflation the way it is, is ultimately to monetize the debt. Now whether that’s the Fed or the Treasury, or the Fed and the Treasury working in concert together…

[00:27:56] Danielle

Would a massive Treasury buyback not bring down rates, the long end, and allow the Treasury to replenish some of those?

[00:28:04] Cem

Sure., but at the end of the day we have government.

[00:28:06] Danielle

I understand, but would it be nice to fund government at lower long-term interest rates and quite issuing so many bills?

[00:28:13] Cem

Well, the second they start to come in with lower interest rates it’ll keep raising those interest rates. I mean, there’s a point here where, at some point, we need to create more dollars. Right? Like you can’t…

If the Treasury doesn’t borrow money, how does the government spend?

[00:28:30] Danielle

I completely understand the working everyday dynamics. I’m just saying that that Bessent has other tools…

[00:28:38] Cem

For a time… At some point they have to keep borrowing money. At some point that money has to come from somewhere and that’s where the Fed has to come in.

[00:28:43] Danielle

But they could be borrowing at the longer end…

[00:28:46] Cem

Yeah, I think that that all assumes…

[00:28:49] Danielle

That a friend of mine…

[00:28:51] Cem

… that they lower interest rates enough to then borrow at those lower interest rates without pushing them back up. And I don’t think any of that’s possible ultimately. Like, mathematically it just doesn’t make sense unless you have the Federal Reserve able to hit the print button on the other side.

But the big idea here is that debt problem is, given the other pressures, it only has one way out ultimately. Right? And the fiscal, you know, this train doesn’t stop, you know, that stuff is still very true. And that spending is only increasing. It’s not going…

[00:29:27] Danielle

I think that spending could go parabolic in 2028. I think voters could vote in a Gavin Newsom. I think that’s entirely possible.

[00:29:35] Cem

It’s likely…. We’re seeing it. And when it’s been likely for a decade and it’s going to continue. We agree.

[00:29:42] Danielle

And if that happens, then you have a structural inflation problem.

[00:29:46] Cem

It’s already there, though. It’s in the structural inflation problem. It’s growing.

[00:29:50] Danielle

It’s not structural yet. Right now, it’s being driven by many different forces. But because the layoff cycle is where it is, and because the need for money to spend today is what it is, if you were to have a Newsom as President, and implement the policies theoretically… They would mirror image what was implemented after COVID, and you would be paying people to not work, And this is the third class of 2026 that’s just crossed college stages all across the nation with no jobs.

So, if you’re going to satisfy that populace then you’re going to pay them to not work. and that will be, it’ll be structural, but it won’t be where it is today, It’ll be three times that level. You’ll have double digit inflation as far as the eye can see.

[00:30:34] Cem

Yes, it’ll get dramatically worse, but that’s the trajectory we’re already on is my point. It’s not like we’re not on that trajectory and It’ll be a flip. I think the thing that people miss, policymakers in general miss, the broad public misses, and they attribute like populism to just the fiscal spending part. What most people don’t realize, if you put up tariffs, which ultimately protectionism is the cousin of populism. You can’t have populism without some level of protection. That’s why we’re having immigration policy, that’s why we have tariffs.

All those things are deeply tied into populism at its core. And once you do that, that creates global conflict. That creates a commodity crisis. Because now you have multiple countries bidding over commodities that are centralized in certain places.

This is why the OPEC crisis happened in the ‘70s. It’s not a coincidence. It’s why we’re seeing the same stuff again. It’s why Vietnam happened at the time, why the Cold War expanded during the time. All those things are tied to populism. People don’t see them independently, but they’re all incredibly linked.

[00:31:27] Danielle

I couldn’t agree more.

[00:31:28] Cem

All that’s driving the structural yield on…

[00:31:30] Danielle

The ten-year treasury, yeah, people just do not connect the dots. The Yield on the 10-year treasury, on February 27th, that Friday, closed at 3.96%.

[00:31:39] Cem

Yeah.

[00:31:40] Danielle

There was a serious risk that the private risk illiquidity bomb was about to be detonated. And lo and behold, that night missiles flew. And we had a supply shock overnight. So, rather than have the 10-year under 4% which Bessent understood…

[00:31:58] Cem

…how critical it is.

[00:31:58] Danielle

Because illiquidity… the Fed policy has squat to do. You can debate inflation and labor markets all day long.

[00:32:06] Cem

No, no, they can’t…

[00:32:07] Danielle

But in an illiquidity crisis, the Fed is completely cut off at the knees and they are prompted to print money.

[00:32:16] Cem

Yeah.

[00:32:16] Danielle

Overnight.

[00:32:17] Cem

I promise the same thing. Which is, those incentives are all there under the structural realities, under the forces I just laid out, there’s no other way out. It’s all about incentives, and then monetizing the debt. And whether it’s the Fed or the Treasury to ultimately be inflating your way out of this mess.

[00:32:37] Danielle

Because it was a deflationary shock. It caused that 10-year to close at 3.96%. And they cannot have a deflationary cycle. A deflationary shock has accompanied every single launch…

[00:32:51] Cem

Yeah. So, we’re on the same page. The question is, if you have this, and all the incentives pushed to inflating away the debt, that creates a major problem for the debt in the short term. You have interest rates go higher. So, you have to, somehow, try and manage, in the short term, that debt. And this is why I believe that Warsh will be forced, whether he likes it or not, regardless of his character, regardless of anything else we feel, he’ll be forced much… Arthur Burns, by the way…

[00:33:22] Danielle

Ben Bernanke was forced to launch QE in 2008.

[00:33:26] Cem

Arthur Burns gets talked about, like lampooned about, cutting rates as inflation was going higher. But the reality is he fought that impulse initially. He wasn’t the lackey everybody makes him out to be, early on. Eventually, you can argue…

[00:33:41] Danielle

Bernanke didn’t fight. He willingly went to the zero bound. He willingly launched QE, and, at the same time, in the same breath, he set the Fed’s 2% inflation target.

Couldn’t hit it though…

[00:33:53] Cem

Yeah.

[00:33:56] Danielle

…because of the transmission mechanism of monetary policy. And that’s why, in the decade or so after Bernanke imposed the 2% inflation target, he hit it 11 separate months. I mean the QE was flowing into the system. It was benefiting, it was widening decay, it was going straight to the wealthy. Zero interest rate policy was blowing up the financialization…

[00:34:18] Cem

But it’s been the case for 40 years.

[00:34:19] Danielle

But it didn’t go to the people. And what happened after, the reason we got inflation taking off like hell in a handbasket, was because what happened after COVID destroyed the transmission mechanism of monetary policy. You no longer had to go to a bank to get the money. The government just handed it out directly deposited into individuals bank accounts. The money was there. Those with the highest propensity to spend it overnight. And we had double digit inflation.

[00:34:48] Cem

You’re absolutely 100% correct.

[00:34:50] Danielle

That’s what monetization of the debt does. It hands money directly to the people, and bypasses the banking system.

[00:34:55] Cem

Correct. You have to drive money to people, directly to people. Agree, to people broadly. You can create inflation through fiscal spending like we did…

[00:35:05] Danielle

Only because we destroyed the transmission maintenance. We took banks out of the process. Which Bernanke either never figured out or was never prompted to do.

[00:35:16] Cem

Yeah, the reason we were able to drive a structurally deflationary process is because we, for 40 years, have been responding to every crisis with a monetary response with supply side economics.

[00:35:32] Danielle

Right. Post COVID was the only time we gave the money directly to the people. And then we got inflation…

[00:35:37] Cem

Because, and I think we agree on this, because, quite frankly, inequality got to a point that populism has gotten so big that now, when there is a crisis, you can’t just print more money. You have to get money to people…

[00:35:48] Danielle

That’s why people are angrier today than they were back then. Because all it did was create inflation and then the stimulus went away.

[00:35:56] Cem

Well, actually, despite the inflation, the actual inequality was normalizing a bit before we flipped back, now, to a supply side response, which is what we started doing now, in the last year and a half. The anger is because, actually, we’re now moving back away from that fiscal response.

[00:36:16] Danielle

Real wages are falling. So, people’s wages are not covering the rise in inflation. They’re cutting back on essentials. They’re shortening their summer vacations. They’re dying with gas prices where they are. They’re spending… Actually, CPI for food printed at 0.0% two months ago. People are buying less food.

You don’t anger people more than when they’re telling their family, sorry, we’re not going to be able to take a vacation this year because we just don’t have money for discretionary spending. There’s nothing that angers people more. And by the way, now you have to pay back your student loans and your parents have to…

Answer me this, 2028, let’s say it’s not just the 52.5% of Americans who are Gen Z and Millennial. What if Gen Xers, what if their parents, my age, joined them because they’ve got kids living at home? We have data back to 1900. We’re writing about this. We’ve never had this many multigenerational households in the history of mankind. You’ve got class of 2024, the class of 2025, class of 2026, under unemployment rates at 50% among these, moving back in with their parents in droves.

Their parents are pissed. What happens if Gen X joins Gen Z and Millennials at the polls in 2028?

[00:37:34] Cem

Yeah, it’s going to happen. It’s already happening. It’s just an addition. It is in the process of happening. It’s clear where this is going. Baby boomers are dying. They’re the ones that support a more supply side policy.

[00:37:46] Danielle

They own those stocks.

[00:37:47] Cem

Millennials are coming to political dominance and everybody below them is just joining to that wave. That’s clear. And that peaks in ‘35, ‘36, ‘37. We 100% agree.

With a limited amount of time (we have about 10, 15 minutes here), I want to posit the idea here that ultimately, based on what we’re saying, that the Fed’s mandate, which is essentially managing inflation relative to maximum employment. Right?

[00:38:13] Danielle

They’re inherently in conflict.

[00:38:15] Cem

They’re inherently in conflict. If anything, they’re in a box now and they have, you know, in this Arthur Burns moment where they really can’t do much.

[00:38:23] Danielle

They’re at a level of last support.

[00:38:25] Cem

Yeah, but they can’t do what they’ve essentially done for 40 years because they have an inflationary problem which is structural and secular. But given all the pressures in the system, the one thing that is front center, above that, is the debt of the United States. The debt of the United States is to a point where, with structural increasing inflation, it’s just unsustainable. The numbers go to infinity. Right?

And at the end of the day, my opinion is that the largest, the most important mandate of the Fed, it’s unspoken now (and I know you probably won’t agree with this), but it’s going to start shifting. And people can refer back to this in four years and eight years, they’re going to start shifting to prioritizing the debt of the United States over even inflation. They are going to ultimately say, let inflation go at the cost or for the benefit of managing the US debt and monetizing the debt.

I think that is the one part we have never seen in the United States. And it’s something that changes dramatically the whole way the structure works.

[00:39:35] Danielle

In fact it destroys the Republic along the way very quickly. And it destroys the risk-free status of the US Treasury, and it destroys the reserve currency status of the US dollar.

[00:39:44] Cem

I agree, but it’s the only way out. It’s the only way out.

[00:39:47] Danielle

The only way out…

[00:39:48] Cem

It’s the only way out of the debt problem. It’s the only way to preserve, in a sense, the actual fundamental structure of the Republic. It may destroy the heart of the Republic along the way. It will definitely shift the structural: what is allowed, what’s not, the rule of law, in certain different ways it’ll change goalposts. But that happened in Japan already. It already happened.

[00:40:15] Danielle

Japan never had reserve currency status.

[00:40:16] Cem

Yeah, yeah. I mean well, they were backed by the US. The US backed them in terms of the reserve.

[00:40:21] Danielle

I have three sons, I have one daughter. The one daughter is the only one who stuck with it. They all learned Mandarins at the age of four.

[00:40:27] Cem

Yes.

[00:40:27] Danielle

Slow it now.

[00:40:28] Cem

Yeah.

[00:40:28] Danielle

I mean everything you describe is why I had her learn Mandarin. You’ve always got to have a backup plan.

[00:40:36] Cem

I agree.

[00:40:36] Danielle

It’s not a good backup plan if what happens in 2028 happens…

[00:40:40] Cem

I don’t thing, though… Ithink that’s an important part. The confrontation with China is critically important because the one lever that the United States has, you just mentioned it, is the exorbitant privilege of the US dollar still, so at this point, we could argue.

[00:40:52] Danielle

China doesn’t want reserve currency status, at all.

[00:40:55] Cem

Not at this point.

[00:40:56] Danielle

Not at this point. They’re not in the position…

[00:40:56] Cem

They’re not in the position to. But that is the trump card, no pun intended. At the end of the day, if you have the exorbitant privilege of the dollar, in theory you can print and print. Right? And you can now fund, you can monetize your debt. That we know. Right? And then you can ultimately also, in theory (and I think this is the second big point), not only do I think that we’re shifting focus from inflation versus unemployment but I think we’re shifting the role of Treasury and Fed towards more of a China like model but with the exorbitant privilege of the US dollar to help fund infrastructure build out, competition with China, etc. I, I think in other people’s…

[00:41:37] Danielle

Those are good things. You just mentioned two good things.

[00:41:41] Cem

Yeah, yeah. I mean good or bad…

[00:41:47] Danielle

That’s Eisenhower level stuff. Our infrastructure is third world compared…

[00:41:49] Cem

But the difference is we’re doing it through printing. We’re doing it through… which is very different than what…

[00:41:54] Danielle

The private sector.

[00:41:56] Cem

… what Norway’s doing great. You know, you could argue that they have their own sovereign wealth fund they’re creating…

This is, again, if you’re the US, you should use the resources you have. And if you have the German privilege of the dollar, it’s the greatest asset of the United States. It’s the greatest lever vis a vis China. It’s the only way, actually, when I look again at those five things that were pressured against, it’s the only way, actually, out.

And so, I’m going to say it right here. I think there is a move towards not just the creation of a… We know there’s a creation of a sovereign wealth fund but I think the size and scale of the essential money printing that will essentially go into buying US companies, and a build out essentially that will rival anything we’ve ever seen in terms of the structure. We could argue that that’s definitely a risk.

I mean, I don’t want to speak in absolutes. What I can tell you is if we don’t do something like this, we will lose to China. The west broadly will. It’s on that path. If they don’t do it, as well, the debt problem is unavoidable. And the financialization and the size of the equity market is also unsustainable without it. So, this is…

[00:43:06] Danielle

What do we do with the population?

[00:43:08] Cem

The population. Well, this is another thought. Solving this… it’s the only way you can solve the populist problem without pricking the equity bubble as well, because…

[00:43:20] Danielle

What do you do with the non-working people?

[00:43:23] Cem

Yeah. So, this is what I’m actually saying. So you’re Instead of giving UBI there’s a form of UBI. Instead of giving people ultimately just dollars, you’re giving them equity. You’re buying them in to the equity markets, which supports the equity markets and invests in the industrial capacity and the businesses of the United States. You’re also helping tax the rich by ultimately taking equity… They could sell the stocks.

[00:43:50] Danielle

Yes, they can sell the stock.

[00:43:51] Cem

They have assets then. They don’t have assets otherwise.

[00:43:54] Danielle

They would sell the stocks if they didn’t have food on the table.

[00:43:56] Cem

Absolutely, absolutely, or something that looks along those lines. But, at the end of the day this will drive hyperinflation. We can agree, if they do this, any form of printing money, especially going into equity markets, will drive an incredible amount of more asset inflation than we’ve ever seen in these environments. Usually in these environments, like ‘62 to ‘82, what you actually end up seeing is equity markets do very poorly, particularly in real terms. But under this type of a model where you are instead not buying just treasuries but vis a vis the treasury buying equities themselves…

[00:44:32] Danielle

That is what every…

[00:44:33] Cem

… that also resides…

[00:44:35] Danielle

Things where I have a discussion. A few years ago, I was at Camp Kotak fishing with my buddies and everybody I spoke to, everybody I spoke to said inevitably the Fed just buys.

[00:44:46] Cem

Yeah. And Japan’s already done it. So, there’s a precedent. Right?

[00:44:50] Danielle

National banks have done it enough.

[00:44:52] Cem

Right.

So, I think that’s the one thing that everybody is underpricing or maybe part of why markets are doing what they’re doing in the face of all of these concerns ultimately.

[00:45:01] Danielle

I think there’s some structural forces behind there.

[00:45:03] Cem

I’m just saying, if there’s any argument for a forward-looking efficient market (which I don’t fully agree with it), is this reality that ultimately the response to this is to buy the equity market itself because there’s no other way out. It’s the only elegant solution for all these problems.

[00:45:20] Danielle

Do you think Kevin Warsh would be the person at the helm?

[00:45:23] Cem

I think Bessent will be the person at the helm. I think it’s going to happen in the next two and a half years. I think the Bessent has already launched a sovereign wealth fund. They’re already talking about… I think the Fed is forced. They don’t have a choice to ultimately…

[00:45:34] Danielle

No, no, no, what you’re describing is the Fed going away. Right?

Merriner Eccles stayed at the Fed, in 1948, because Truman wanted him out because he wanted for the Treasury to take over the Fed and he stayed. And then there was the 1951 accord that separated the Treasury from the Fed. And since then there’s not been a merger.

What you’re suggesting is…

[00:45:56] Cem

There is going to be a forced merger. And I’ll tell you why I think that…

[00:45:59] Danielle

I don’t think Kevin Warsh…

[00:46:00] Cem

Well, let me ask you a question, again, I’m all about incentives, not his character, or anything else, because those things ultimately get you know… People with character also have been under incredible pressure to do what they have.

[00:46:13] Danielle

Powell did not believe in QE when he started.

[00:46:16] Cem

So, I want to make sure we’re not talking just about his character but about his incentives. If Warsh is faced with a situation where let’s say Bessent (this is very hypothetical)… This is going to sound extreme but I want to paint a picture. Let’s say Bessent et. al. creates a sovereign wealth fund, funds it with a couple trillion dollars. They already have US$1 trillion or so dedicated from Fannie Mae and Freddie Mac. But let’s say they take other extraordinary measures and start the sovereign wealth fund. In the process of that they then say we’re going to borrow against the assets that we have and also borrow another US$3 trillion to fund and make this a US$5 trillion sovereign wealth fund. This let’s say this happens in the next year and a half… Just painting a picture. This is possible. It sounds crazy to most. We’ll come back to the tape in four years and see how crazy it was. I have a history of saying crazy things that seem to come true way more often than people realize.

But let’s say it happens in the next two and a half, three years. What then, with the another US$3, US$4 trillion dollars of debt?

[00:47:19] Danielle

You mean US$3, US$4 trillion in addition to what’s being created every…

[00:47:23] Cem

… every three months anyway. Right? We’re creating a even bigger debt problem which then ultimately is unsustainable, which leads to even more borrowing.

[00:47:32] Danielle

… everything you describe…

[00:47:36] Cem

More specific, the collapse of the Republic.

[00:47:38] Danielle

No, I don’t I don’t think…

[00:47:39] Cem

What are the steps? What are the steps that lead to the collapse of the Republic? At that point Warsh is then forced to make a decision.

The Fed has to respond at some point to…

[00:47:50] Danielle

There’s a banana republic if the Fed is absorbed into the US treasury. There are no…

[00:47:56] Cem

Well, I mean, we weren’t a banana republic before the Fed. So, the arguing that is also not necessarily true as well. Right?

[00:48:02] Danielle

We could let the market go back to ’70…

[00:48:05] Cem

And taking ourself off the gold standard and doing what we did in ’71…

[00:48:07] Danielle

It’s crazy stuff.

[00:48:08] Cem

Yeah. It doesn’t. That hasn’t… taking us off the gold standard, people argued, would make us a banana republic…

[00:48:11] Danielle

The dissolution of the…

[00:48:12] Cem

You could argue we’re already a banana republic.

[00:48:15] Danielle

The end of the Republic is as we know it…

[00:48:18] Cem

“As we know it,” that’s the key. Right?

[00:48:19] Danielle

As we know it.

[00:48:19] Cem

That’s the key.

[00:48:20] Danielle

People actually want to be born here and grow up here as opposed to leaving for another country.

[00:48:24] Cem

My point to you is that I think Warsh will not have a choice, and if he doesn’t want to do it he will leave. And that’s possible. But my guess is he has thought through the things that we are talking about and that he ultimately realizes that if he’s put in a situation, he will do what he has to do. He has given the signal that ultimately, I’m going to be fiscally disciplined. I’m going to try and keep the independence of the Fed. I’m going to do the xyz. But ultimately my role is to smooth the business cycle and be here to manage the business cycle and make these hard decisions.

[00:48:55] Danielle

He’ll go down in history as being the person who dissolved the Fed.

[00:48:58] Cem

He will be Arthur Burns in history. Yeah.

[00:49:00] Danielle

That would be…

[00:49:01] Cem

Not necessarily because he’s a bad character.

[00:49:03] Danielle

That would make the evolution of Warsh ten times worse than the evolution.

[00:49:10] Cem

Yeah.

[00:49:11] Danielle

Why he would choose that, I don’t know. And he certainly is not sounding like that now. So, it will be the biggest pivot in the history of mankind.

[00:49:22] Cem

There are structural problems. The last thing we’ll touch on. I’ll be very quick here. I know we’re limited on time here, but there are structural problems that we don’t think about with the Federal Reserve.

When we created the Federal Reserve… I know you agree that the Federal Reserve is broken in the way it operates currently. Right? But I would actually argue one step further, that the Fed at its core, its creation is a series of contradictions.

Our founding fathers would be probably rolling in their grave if they realized that we were creating something that would ultimately smooth the business cycle. Because the whole foundations of America…

[00:49:59] Danielle

They have been spinning in their graves since the Fed was giving the employment thing.

[00:50:02] Cem

Yeah, I think it starts well before because the problem is, at its core, if you smooth the business cycle, if you respond with one tool, with one limited set of mandates to a very complicated problem again, and again, and again, ultimately, that smoothing of the business cycle, it disrupts the fabric of what America is.

[00:50:22] Danielle

Absolutely, and then I wrote a whole book about that. I wrote a whole book about Greenspan creating the Fed put. And the distortions that introduced into US Markets, and the idea that the Fed will always back it.

[00:50:33] Cem

But that’s core to the Fed’s mandate of smoothing the business cycle. Right? Of controlling markets. At the end of the day, if you stop crisis from happening or try and limit crisis at the core, America’s ability to pass…

[00:50:48] Danielle

It’s longer America.

[00:50:49] Cem

No, no, actually.. Yeah. Well, that’s true, yes, because at the end of the day, the unanimity that’s needed by Congress to pass laws, to make amendments, to make real structural changes, depends on crisis itself coming.

I would argue the coming crisis that we are highly likely to see at some point, in one form or other, massively inflationary or deflationary, is ultimately going to drive a crisis which is needed. It is the only way to reinvigorate the system and ultimately create an outcome that will refresh and allow America to continue for the next hundred years.

[00:51:22] Danielle

That suggests bad players and financialization being eviscerated, which would not be a bad thing. We go back to being a capitalist…

[00:51:29] Cem

We agree on that. I think the Fed, though, at its core is structured at a very distance in a way that has good intentions to smooth the business cycle, to create a better outcome for people over the short-term, but ultimately breaks the whole.

[00:51:43] Danielle

We disagree there. I think Greenspan wrote that.

[00:51:46] Cem

A spirited debate. Wonderful having you. Thank you so much for coming and I think this will be a great one.

[00:51:58] Ending

(Music)

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