The Great Financial Reset Has Begun | Marieke Flament & Nicolas Colin

26:36And so fast forward to today, and sorry for the long answer, but if you assume as I do that we've now reached the maturity phase of the current techno-economic paradigm, which I call that of semiconductors, computing and networks, then that maturity phase should give birth to a new financial system. And so if I have this conviction, then I look everywhere for signals that the financial system is changing. And having written about that for one year and a half with Marik, I have gathered a lot of such signals and organized them in a coherent way. And that's really the thesis behind the idea of a great financial reset.

27:21Demetri Kofinas:What were the underlying forces that led Nixon to end convertibility? And here, I don't mean the proximate reason of gold reserves being drained, but what led to that. And then how did that end of Bretton Woods serve as a forcing function for what really is a cornucopia of financial innovation? I mean, you're talking about junk bonds, LBOs, Bloomberg terminals. There isn't just one form of financial innovation. So flesh that out for me a bit, if you can. Yes. Oh, by the way, one that I forgot was the invention of passive investing. The 1970s is also the launch of Vanguard by John Bogle. And the institutionalization of finance and the development of investment frameworks that now define largely how people invest their retirement savings, which have also come to replace savings as the primary mechanism by which people plan for their retirements.

28:16Yes, at least in the US, not so much in Europe.

28:19Demetri Kofinas:Yes, correct. So start first again with what were the underlying drivers that led to the end of convertibility? And then how did the end of convertibility lead to this just broad cornucopia of financial innovation? So I have two answers and maybe Marie will have other ideas, but one answer I heard from Martin Wolf on an episode of the Outlawed podcast, I think last year. And he was saying like the US had spent so much for the Vietnam War and for Lyndon Johnson's great society in the end of the 60s, that normally it would have had to devalue the dollar to adjust for having spent so much and restore balance in the system.

29:04But because it was humiliating for the hegemon that the US was to devalue its own currency, especially since the dollar was really the anchor for the whole international financial system, Nixon just said, now we won't devalue. Let's just cut the cord and bring this system to an end and let exchange rates float. So that's one explanation. The fact that the US had spent so much and was refusing to assume the consequences of that. The other is more generic, but it goes back to the conversations, Maric, we've had about inflation and hard assets, et cetera. So one of our interviewees, because Currency of Power is also a podcast, and the very first interviewee actually was Mac Green, whom you know.

29:52and we asked him about his skepticism about Bitcoin. And so difficult to do justice to the whole thesis, which is fascinating. But essentially what he says is that you can't anchor the entire economy on hard assets because hard assets by definition have a limited volume.

30:11Demetri Kofinas:Lack of elasticity. Yes, lack of elasticity. And if your economy is growing well, if you have technology, if you have productivity, et cetera, the economy can grow indefinitely well beyond the volume of hard assets. So if you pick one hard asset and the economy is productive, at some point there will be tension because you'll need more money to reflect all that additional value brought about by productivity. And the hard assets in limited volume won't be enough to anchor the whole thing. And so at that point, you have two options. One option is to go into - that are listening, I just wanted to clarify because this conversation, I've heard it often over the years.

30:52Demetri Kofinas:The key insight here, I think, is that borrowing costs go up. If you don't have an elastic currency, the cost of borrowing money becomes punitive and that reduces the potential for growth. And that's essentially the insight. Yes, exactly. Exactly. And then you go into deflationary mode and you've missed an opportunity. You could have created more value, but because you force yourself to anchor the entire economy on a hard asset that is limited in volume, then you can't grow as fast. And so that's why every regime that relied on some hard asset, whether the gold standard or the Bretton Woods regime, which was a gold standard by proxy of the dollar, was ultimately brought to an end, not because it didn't work, but because the economy grew so much, thanks to technology mostly, that we had to let go of the hard asset and find something else to anchor the economy.

31:43And so I think fundamentally, that's what happened in the 1970s. It's that mass production, the techno-economic paradigm of the day, had brought about so much value, so many jobs, so much wealth, widely distributed across, especially the US middle class, that all the gold in the world was not enough to sustain this massive value creation machine. That's also when you start seeing things crack. It was like, you know, De Gaulle and his prime minister at the time, Giscard is not starting to talk about like an exorbitant privilege. And I think, you know, you mentioned like it's not just about gold and sending ships and not wanting to ship that, but there is like cracks into how the system is perceived and how that position works.

32:24So I think that's actually definitely, you know, the premises of what we are seeing. And then the question becomes, which is also like one of the questions that has always been, you know, a trigger in particular in crypto world is, okay, so if fiat currency is backed in essence by nothing, then what is it, right? And so you have also like within this timeframe, the birth of a petrodollar system. So we could say, okay, is then the dollar, you know, representation of energy and therefore of oil, or is it something else? But I think all those conversations are linked from the fact that it was ultimately linked to gold, doesn't allow enough elasticity, there's cracks in the system, needs to change, becomes, you know, there is more freedom to basically print more money, but then what is it?

33:07And then there's actually a petrol dollar system that puts itself in place. And then is that system, the system for the future in particular, if we move into an electro state, right? I mean, maybe we'll come back to it, but I think there's also for the great reset that we're seeing, what's very interesting is the modern history, right? From 2008 and how we saw financial crisis and so on and so forth. So I'll pause here for now because you might have follow-up question, but I think we should also look at why we think now there's this great reset happening and what are all the trigger points that actually we have thesis about.

33:36Demetri Kofinas:Yeah, no, I'd like to do that. Let's linger here a bit longer. So there was a broad expectation that Nixon's de-pegging of the dollar from gold would lead to a devaluation, a long-term devaluation and loss of that exorbitant privilege. But in fact, by decentralizing the international financial system, the dollar actually became stronger. And to your point about the petrodollar, what we saw was capital recycling back into the United States, driving the value of the dollar up so high, in fact, the international governments needed to come together under the Plaza course in 1985 to drive the dollar value down.

34:15Demetri Kofinas:And so I think that's an important observation because it has ramifications for a lot of the work that you guys are doing in terms of what the implications would be for dollar backed stable coins. Is that right? Absolutely. And I think that's actually spot on. There is this like almost the, you know, enabling the peg to the goal to be finished enables this printing of money and this decentralization of the dollar in other places. Right. And now you have that with the petrodollar, but also with the euro dollar, which is like, OK, if two counterparties are outside of the US and they need to have dollars where there is actually exchanges that are made, but it's not dollars that are directly controlled from the US and benefit.

34:52And actually, I think there is such a strong parallel with what we're seeing today, for example, with stable coins. And Tether is a perfect example of that. There are people anywhere, everywhere in the world, as long as they have actually a digital wallet, they can have dollars in their pocket. And that's also an outsourcing of dollar. And I think the strength in a way of the dollar has always been to believe that outsourcing its currency is a better mechanism rather than actually strengthening it. So it's like, let it flow, don't fully control it. But at least it's in everybody's hand. And by being in everybody's hand, one, you can also dictate the rules, right?

35:28Because that's your money that's floating in the world. But you basically have that that is in everybody's hand. So there is absolutely a parallel. And Nicola and I have debated a lot, like, you know, are stable coins the new petrol dollar? Are stable coins the new euro dollar? Are stable coins actually something different? And they're like the money for compute because compute is the new oil, right? We've played around with all those different ideas, but I think you're totally correct that what it enables in 1970s is actually that it enables the outsourcing and therefore the more free-floating decentralization of the dollar.

35:58Demetri Kofinas:What I've long argued is that the dollar is the most decentralized currency on the planet. Would you agree with that? 100%. It is everywhere. And the more we look with Nicola, we are like, okay, China will de-dollarize. And then you look at it, it's actually fully, it's completely linked. So it is very decentralized. It's everywhere. This is of course a very controversial statement to make to Bitcoin, Austrian economists and libertarians at the time that I was making it. But I feel like most people think of the dollar as this thing that Uncle Sam has and that he emits to the rest of the world and that the rest of the world can decide at some point, well, we just don't want this anymore and we're just going to take something else, which I feel like is really an inaccurate view of what the dollar is, which is at its core, a denomination.

36:41Demetri Kofinas:It is a lingua franca. It's like English. The rest of the world speaks English. No one forces them to speak English. It isn't that easy to stop speaking English, and it comes with all sorts of network effects and conveniences. And so what would you think, if you were to try to explain to people what it is about the dollar that makes it so sticky and powerful, as we go further into this conversation about financial innovation and dollar backed stable coins in particular, what would that be? Yeah, I can't remember, but we went through a detailed list of everything that makes the dollar so enduring and sticky in our podcast interview with Jess Olverson a few weeks ago.

37:20And off the top of my head, one is obviously the network effects. It's the same as a language. If I'm transacting with a counterparty in Brazil, they speak Portuguese, I speak French. The two languages are very close in general, but the easiest way to understand each other will still be switching to English. And it's the same for the dollar. If we try to transact in euros or reals, well, maybe we'll sell it's too complicated or too risky because the market is not deep enough to secure the exchange rate over the duration of the transaction. So maybe we'll switch to the dollar, which is known, safe, liquid, et cetera.

38:04Demetri Kofinas:And in both cases, you don't need anyone's permission. You don't need any permission to use dollars or to speaking. Yes, exactly. And so that's one factor, network effects. The other factor, which was the conclusion of our discussion with Jess, was that the financial rails matter a great deal. That is how convenient and how easy the financial system makes it to use a specific currency for a specific transaction. And because the dollar is so massive, there have been so many investments in the infrastructure that supports the dollar across the world, then it's usually the default solution because those are the financial rates that everyone uses and they've been over-invested and they're very convenient and very easy.

38:56So you could argue that maybe the euro is close enough from a convenience perspective, especially within the euro zones, SEPA, et cetera. But yes, so those would be two reasons. Yeah. And I think we find them back also in, you know, when stable coins pick up, why they pick up, right? One is actually availability. You need to be able to have access to a currency. Where is it? And for the dollar, whether it's like correspondent banking or the rails that Nicola was mentioning, all of that, like the rails are there, right? So the availability, the system, it works. And it's been built over years. But if you look at it again, like we were talking about the 70s, not that long ago, right?

39:34In a sense. And the second part is really important is once you have actually this network and the rails that are being built, is that within it, there is liquidity. There is very deep liquidity. So it's almost endless. And so it works. So the system, wherever you go in the system, even in like the most remote places, there will always be liquidity for you to be able to have access. And that's really the thing that works. So for today, and that's some of the question that also we look at, for today to actually change that, it is so prevalent everywhere. The network is so deep and the liquidities are like so deep also that actually to change that, it's not going to be a matter of like, you know, days or years.

40:08It's going to take a long, long time. And it's all about network effect, right? So anyone that wants to start, if anyone would want to actually become the reserve currency of the world, big question mark. But if anyone wants to start that, you know, it's a cold start thing, right? You can build the rails, but then you can build the rails and nobody comes on it, or you can build the rails, but there's no liquidity, so it's not working. But to me, it's really that. It's like the infrastructure, the liquidity, which is again what we see in crypto.

40:32Demetri Kofinas:And US public debt markets are what provide a big chunk of that liquidity and the ability to manage outstanding liabilities and funding requirements, which is I think also something that people don't appreciate when they look at the state of US finances and they say, who wants to own US government debt? Well, the primary reason that people want to own US government debt is not because they think it's a better long-term investment than, I don't know, gold or art or something else, but because they need it. They need dollars if they have outstanding liabilities and they need to manage those outstanding funding requirements.

41:04Demetri Kofinas:And I think this is something we'll have a chance to certainly talk about in the second hour when we discuss sort of where things could be going in the larger macro picture. Let's now, I feel like we did a a good enough job establishing the analog of the Nixon shock period to the London Big Bang. And we discussed two aspects. One was the set of primary drivers that led to the end of Bretton Woods. And then we didn't talk as much exactly about the forcing function that led to the financial innovation, but we certainly gave examples, and Nicola did, of forms that that financial innovation took. What are today's drivers?

41:38Yeah. So that's where I would call that modern history. But I think there's a few drivers that have happened. So one, 2008 financial crisis, also the birth of Bitcoin, right? And we can debate, you know, related or not, whatever, but like financial crisis, birth of Bitcoin. So you have now a technology that enables transfer of value in a peer-to-peer fashion with the rest of, you know, the industry, as we've discussed a bit before, which is like, you know, Ethereum and smarter and smarter blockchain that enable you to do better and better things. So to us, 2008 is definitely like a shift into what's happening.

42:12There's another shift that is actually also very interesting, which is more 2014. And in 2014, actually, when Russia invades Crimea, and then there is sanctions that are being put on Russia, that's a wake-up call for many in actually the world. And that wake-up call is, oh, hang on. If sanctions can happen at that level, and maybe next it's us, right? Next, we are the country. And one such country that looks at that very closely is actually China to think through and to say, okay, wait, if that happens to Russia, maybe it could happen to us. So how do we build something that's independent and self-sufficient?

42:47And Nicolas has this amazing concept, which when he talks about China, he looks at like a self-sustaining society. I think it's really like thinking of like a full stack society, how to build that. Part of that is actually building the rails and having rails that are independent and that no one has oversight with and can cut. So that's the second shift that we look at 2014, which I think is very interesting. COVID is another very interesting moment in this, again, like massive shift of how everything is happening. Not only because of like, of course, what happens and most of us are locked in our flats, but that enables actually some massive acceleration of everything that's digital, right?

43:21So if we were still debating, you know, is money going to be digital or not? What's going to happen? Like there's no doubt there's a tremendous acceleration of actually digitalization to that. And then there is Trump come back, right? And with Trump come back, the Genius Act and all the laws that are basically starting to emerge and are being put in place to actually also fully embrace like a technology with the understanding that actually the dollar has power through network effect, but that the money of the future is technology and that therefore this is actually an instrument that is actually really important to protect.

43:54So I don't know if you want to add anything, Nicolas, but I think in modern history, when we look at more the points and everything that we see has been happening to start creating this moment of this great reset, those are some of the key moments. Yes, I would add an older episode, which is, I think, when the US ceased to be a surplus nation and became a deficit nation from a trade perspective and current to count perspective. That really echoes Ray Dalio's discussion about the rise and fall of empires. And basically what he explains is that when the empire stops being a net exporter and becomes a net importer, which happened to the US sometime between 1976 and 1982, also the 1970s, it creates a dynamic like at first it's a very low you don't see much at first but in the end it peaks in terms of discontent because the empire imports so much and has to provide everyone with its own currency so that's where we are like the fact that trump was elected twice in 2016 and then 2024, mostly because of his trade agenda, like putting an end to the US being ripped off by the rest of the world, re-industrializing America, etc.

45:22All of that implies that the dollar has to cease to be the reserve currency, and you need to re-array trade barriers, and you need to reverse the trend that started between 1976 and 1982, which is when the US ceased to be a surplus nation and became a deficit nation. And so you have those macro imbalances that are piling up and culminating now with China having this massive trade surplus, including the US. And Ray Dalio, another thing that he says is that, So effectively, the reaction to that is that the empire becomes predatory towards others, which is exactly happening with Canada, with Europe, with South Korea, etc.

46:10But he says the last thing that gives in in the imperial construct is the reserve currency. That's the very last thing that will still be in place when all the rest is gone. And in a recent podcast conversation, geopolitical analyst Marco Papic was reminding us that Britain ceased to be the largest economy in the world at the end of the 19th century. It was passed by the US back then. But the pound sterling remained the reserve currency of the world until the end of World War II, when it was finally decided that, okay, we need something else. It'll be the dollar anchored peg to gold. And that was Bretton Woods.

46:59But through all of those things, Britain ceased to be the largest economy in the world. Then it didn't lose World War I, but World War I was a massive blow to Europe and to everyone in Europe, including Britain. Then it tried to go back to the gold standard, then had to go off the gold standard in 1931. Then World War II, the Holocaust and everything that happened. Europe completely destroyed, Britain in ruins because it's been bombed down by the Germans. You needed all that for the pound sterling to cease to be the reserve currency. So the dollar, if you extrapolate from that following Marco's reasoning, the dollar is here to stay for a few more decades.

47:44But the signs that its demise will happen at some point are already here if you know where to look.

47:53Demetri Kofinas:Which is also consistent with the observation that the dollar is a denomination. It is a independent thing that people can continue to use and contract in, even if the United States or the US empire is no longer around. So it explains the lag, in other words. I want to share a few thoughts before I move us to the second hour, because it seems to me, having read your work now for the writings that both of you have been putting out on Currency of Power, and Nicolai, your stuff at Drift Signal for at least two or three years now. It seems that you each have grown less certain about whether America will be able to maintain its financial hegemony or dollar dominance or whatever term you want to use for as long as maybe you initially thought when you were working on your theses around dollar backed stable coins.

48:46Demetri Kofinas:First of all, is that accurate? Am I correctly reading that from your most recent piece on the Great Financial reset. Yeah, I think you are, right? Because, well, one thing is, I think through our work, one, we've actually started also to disentangle what it is to be a reserve currency for what it is to be a currency used in trade, right? And I think actually that distinction is very important because as Nicolas say, you could continue to be a reserve currency, but maybe some other stuff is being used in trade, right? Which I definitely think is probably some of the signals that we see with China.

49:19But one of the other realizations has been the dollar is so entangled everywhere. So for example, I know that people look at China and they say, oh, it's going to take over. But the reality is that if you go to Hong Kong, which by the way is the key door from China to the rest of the world, if you go to Hong Kong, the Hong Kong dollar is pegged to the dollar. There's a fixed rate, that's it, it's pegged. So it is in a way the Hong Kong dollar is dollar, right? There's an exchange rate that's straight to that. So it's way more intertwined in everything that exists out there. I think in our work, what we found really interesting is that this idea that if you are sat around members of the government in the US and you start putting the pieces of everything that's happening and you say, okay, what is the next financial innovation?

50:06What do we need to think about the next generation of things? And then you start pondering that, well, maybe stable coins as this next generation because they have all the tools and the instruments that you could actually require for continuing to be able to dictate trade and to actually have an oversight. We haven't talked yet about financial regulation and oversight and freezing and being able to seize and so on. But this is part of the power of the dollar, right? If it's happening in dollar, it's there. So I think the point that we found really interesting was to say, okay, there's this technology that can come up and do that.

50:38Now, how fast? How fast can this transition be? uncertain, right? So I think we, I don't know, Nicola, what would you say? But yeah, I feel personally, I've grown a lot into, things are not like they look on the headlines, definitely not. It's catchy to make a headline, like the dollarization is there. I'm like, well, hang on, it's going to take way longer.

51:00Demetri Kofinas:Well, I think so. I think in the second hour, we'll have a chance to discuss what has changed. And I think one thing that's changed is this administration's policies or sort of what we expected their policies to be and the seriousness with which they pursued the agenda of financial innovation and re-regulation of the financial system and what has actually consumed the energies of the Trump White House. When I was asking you about analogous drivers today, you touched on two that I had previously identified from your work, one of which was the re-architecting of the financial system and of money itself primarily through the widespread adoption of dollar-backed stablecoins.

51:38Demetri Kofinas:Another was the geopolitical fragmentation and localization as other countries began to feel the need to protect their own capital reserves from being expropriated to US dollar-backed stablecoins. And the third, which you didn't mention, but which I want to talk about the second hour, is machine-to-machine commerce as the increasingly dominant layer of the global economy. And what does that really mean when we build all these automated systems that then need to engage in commercial activities? And do we need, by definition, a new sort of financial system or financial innovation to do that? And that seems to be, in my opinion, a primary driver.

52:16Demetri Kofinas:And one more thing for sure that I want to talk about in the second hour, guys, is what is both of your views on the likelihood or inevitability of debasement of capital controls and other means through which to achieve financial repression? Does the rise in treasury yields, for example, suggest concerns about the state of US finances? Does it reflect to some degree just the preference that investors have for pouring more and more money into the AI trade? So I'd love to have a broader macro conversation when we head into the second hour as well. For anyone new to the program, Hidden Forces is listener supported.

52:53Demetri Kofinas:We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access to the second hour of today's conversation with Marik and Nicola, head over to hiddenforces.io slash subscribe and sign up to one of our three content tiers. All subscribers gain access to our premium feed so you can listen to the rest of today's conversation on your mobile device using your favorite podcast app, just like you're listening to this episode right now. Guys, stick around. We're going to move the second hour of our conversation onto the premium feed.

53:27Demetri Kofinas:If you want to listen in on the rest of today's conversation, head over to hiddenforces.io slash subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces genius community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.