FRMO Corporation (OTCPK:FRMO) Q1, 2023 Earnings Call October 18, 2022 3:00 PM ET
Company Participants
Thérèse Byars – Corporate Secretary
Murray Stahl – Chairman and Chief Executive Officer
Conference Call Participants
Operator
Good day, and welcome to the FRMO Quarterly Conference Call. As a reminder, today’s call is being recorded. At this time, I’d like to turn the call over to Therese Byars. Please go ahead.
Thérèse Byars
Thank you, Justin. Good afternoon, everyone. This is Therese Byars speaking, as Justin just said, and I’m the Corporate Secretary of FRMO Corp. Thank you for joining us on this call.
And now I have a little bit of housekeeping I have to do and that is this. The statements made on this call apply only as of today. The information on this call should not be construed to be a recommendation to purchase or sell any particular security or investment fund. The opinions referenced on this call today are not intended to be a forecast of future events or a guarantee of future results. It should not be assumed that any of the security transactions referenced today have been or will prove to be profitable or that future investment decisions will be profitable or will equal or exceed the past performance of the investments.
For additional information, you may visit the FRMO Corp’s website at www.frmocorp.com.
Today’s discussion will be led by Murray Stahl, Chairman and Chief Executive Officer. He will review key points related to the 2023 first quarter earnings. A replay of this call will be available for one month beginning at 7:15 this evening. To listen to the replay, instead of dial-in numbers this time, please use the link provided in the October 13, 2023, first quarter earnings press release, which may be found on the FRMO website by clicking the link called Information Statements and Announcements. This press release can also be viewed on the OTC market’s website by typing in the ticker symbol FRMO and clicking on the news link.
And now I’ll turn the discussion over to Mr. Stahl.
Murray Stahl
Okay. Thank you, Therese, and thanks, everybody, for joining us today. So it’s actually not very long after the annual meeting call. So not a heck of a lot has changed in the brief time since we had that call, but you can see the figures. So I’ll just — I’ll note a few things that I personally think are interesting, and I’ll await your questions. And I’ll talk about some things we’re working on. So shareholder’s equity, you will observe is a little bit shy of $189 million. Now that’s the key number, not the $345 million. That’s a bigger number because we need to deduct out the noncontrolling interest. Noncontrolling interest largely come from the consolidation of HK Hard Assets I and II. II, you will recall from our last meeting, we just started a few months ago. So it’s building up, and I’ll talk a little about that in a few minutes. I believe the $188.9 million, that’s our record. And the cash, I’ll call your attention to is a little over $36 million. And it’s particularly noteworthy, it’s over $36 million, because we paid some taxes and that drew down our cash a little bit.
So things are going very, very well. The reason I bring the shareholders’ equity and the cash balance to your attention and, of course, the investments at record levels as well, that we have more than enough liquidity to do what we want to do. What we want to do, of course, is build out our cryptocurrency business, so money is not the issue. The issue is crypto — the nature of cryptocurrency itself, I referred to this in the last conference call, and I’m going to emphasize it now because I think it’s worthy of emphasis. There are vectors like the price of cryptocurrency to the cost, I should say, of cryptocurrency machinery, what’s called difficulty rating, which is the number of machines you’re competing with to obtain the block reward and most important, in my mind, vector is what’s called the having, mean every four years, the number of Bitcoin you get for solving a block is cut in half. Now mathematically, if you reflect on this, I think you’ll see this step. That’s the exact same thing as if they double the price of the equipment. Generally speaking, the equipment is declining. But mathematically, it’s almost as if they double the price of the equipment when they do this. Why?
Because to generate the same number of coins, you would have twice as many machines, you would have to have twice the main machines operating. Bitcoin or cryptocurrency in general, Bitcoin, in particular, is very much like any commodity that it’s selling price to a large extent, has to be a function of the cost of production. So in last year plus, the cost of production was in decline. It is in decline because the equipment that you need to buy cryptocurrency declined in price a lot. How much did it decline in price over roughly a year? Decline in price in excess of 75% and it continues to decline. So imagine if we were wheat or soybeans or something that’s a little more tangible than cryptocurrency, imagine if we’re something like that. And the price of seeds, with the price of land, the price of water for irrigation, or even the cost of labor had declined by some such quantity. I think everyone would reasonably anticipate that the price of that commodity, wheat, soybeans, what have you, would decline to reflect it. Perhaps not to the exact percentage of the decline, but the customers, the consumers of these products would benefit to a very large extent, maybe to the entirety of the decline.
Crypto is the exact same way. Right now, if you do this, if you were to look at the price of crypto between now and June 15; June 15 is when the Federal Reserves started raising interest rates aggressively, the interest rates don’t have that much to do with cryptocurrency but any event; you’ll see cryptocurrency has not been very volatile at all, unlike its history. Why has not been volatile? Well, one is a thesis and one is a reality. The thesis would be, and this is a very big maybe, perhaps people who trade cryptocurrency are finally beginning to understand the vectors that largely govern the cryptocurrency price and pay attention that you really shouldn’t put in big orders for equipment, because those equipment prices are going to fall. And the machines will become your adversary in that they’ll decline at a rate faster than you’re actually depreciating them. It’s a big problem. Maybe people understand that, maybe they don’t. That’s my speculation, but the reality of things is that, can’t deny when the having this coming. It’s coming about 568 days. We may be a day off in that reckoning because I don’t check the number every day, but it’s something along those lines.
At the moment, the vector of the having, which as you’ll recall, has the effect of essentially doubling the cost of producing Bitcoin, because you need twice many machines to produce the same number of coins. That’s more or less in balance with the decline in machines. And machines keep declining at the same rate, but it’s a lesser price. So lower the price of machine, if it declines by the normal weekly roughly 3%, it’s going to have less impact on the price of Bitcoin or the cost of producing Bitcoin. And then dominant vector will inevitably be the having, as it gets closer and closer, closer, becomes more and more dominant. So we fully anticipate that the price of crypto in our case, largely Bitcoin, is going to go up.
You might say we know that, why don’t we go ahead and buy a lot of machines as well, I just gave you the answer. Because in any given period, including the period in the future, the machines are likely to fall in price. We don’t want to have no machines. We just want to have enough machines to take advantage of the momentary profit in Bitcoin and then we’re redeploying some of that Bitcoin to buy more machines. So it’s the appreciation of Bitcoin that we generate, because don’t forget, when you buy equipment, you are paying for it in Bitcoin. I’m quoting where I do quote, it’s my practice, dollar prices for the equipment, and they are normally on websites expressed in dollars, but the vendors won’t accept dollars, they accept Bitcoin. So one of the ways of looking at Bitcoin. I think it’s a very good way to look at it.
Basically, you spend X Bitcoin for a number of machines. The machines will last for a given number of years. At the end of that time period, what you hope to achieve is the machines will be largely worthless, but you have produced more Bitcoin than the number of Bitcoin you expended to purchase the machines that you might think of as a natural interest rate on Bitcoin, the way you multiply your Bitcoin. So we were just waiting for an opportunity to start buying machines, which we are in the process of doing with our various entities. Our various entities, just to remind you, are Consensus Mining, which is — will be quoted somewhere around December 1. Winland that we own roughly 30% of, Winland now called Winland Holdings, formerly known as Winland Electronics that we own roughly 31% of. And we would love to buy more, but we’re in a quiet period for Winland. We can’t buy more. But during the quarter that just elapsed, we were buying more Winland and we’d like to increase our holdings of Winland. Why do we want to increase our holdings in Winland?
Because Winland is growing the number of Bitcoin it has in the manner I just described. And then last, but certainly not least, we own 7.1% in Horizon owns over 50% of HashMaster. HashMaster do several things. It mines for its own account. It is a hosting company, meaning it hosts other people mining and, of course, it repairs machines. That’s strategically very important for us because if you have machines and the one certainty you have about machines is sooner or later, they will need repairs and it’s very good to have this available to us. So that’s our business. We’re going slow, because we basically — if you look at it, we avoided what other people refer to as the crypto winter. We may not have another crypto winter if people come to understand how cryptocurrency works. Time will tell if that is the case. But we have every intention of expanding the cryptocurrency business gradually in a sensible way, and it’s worthwhile noting before I take some questions that crypto is as exciting as it is to us.
The whole project could still fail. It’s possible. Personally, I don’t think that’s likely but it’s possible. If it were to fail by looking at the balance sheet, you’ll see our cryptocurrency mining assets. Those are the machines. It’s not the entirety of our crypto investments. So the crypto investments, which are the coins, that’s included in investments. So it’s placed somewhere else. Normally, we’ve read all the numbers, which we didn’t do this time, I think, because we read the numbers last time. Am I correct in that, Therese, that we read all numbers last time, how many coins we had of every type? We do that certainly.
Thérèse Byars
Yes. We did. Definitely we did.
Murray Stahl
Okay. So we’re not reading it because it didn’t change by much other than the fact that it went up. And generally speaking, it’s going up every day. The machines we’re buying basically, we’re looking to replace machines that are worn out. I dare say we bought the machines very well. So I’ll just mention this. I think I mentioned in the last meeting, but you might recall, over two years ago, we purchased the machines which we swapped with Winland for a greater stake in the company. Those machines have been operating very well for over two years. If we were to sell those machines today and we are using them for two years, it’s also worthwhile noting that we depreciated machines over three years. So the machines are 70-odd percent fully depreciated. We could sell them today for more than we paid for them. So you have to be very, very judicious in the way you buy machines. At the moment, we’re just buying some machines to replace the machines that we believe are reaching the end of their useful life. So it’s not going to be a big purchase, it’s not a big deal. And we’ll update you further. Hopefully, over the next quarter, we’ll be able grow the cryptocurrency business in the same way we’ve been growing it in every quarter, and we’ll give you an update then.
But those are the main things we’re working on. One other point I want to mention, which deals with HK Hard Assets. So HK Hard Assets One, you’re well aware, our biggest position is TPL. We funded HK Hard Assets II with some TPL shares we had them and when they give the portfolio life, the objective is to buy other things. So we have 1, 2, 3, there are 4 other investments in the Hard Assets that we are in the process of purchasing. Hard Assets already generates, I would say, a decent amount of cash flow for x months of life, and we’re going to be building that up aggressively over the next year or at least it is our desire to do that and we’ll have to see what happens. So that’s the update, not a major change from what happened in the annual meeting. One other minor point, I keep saying one other minor point, but it is a minor point and it is one. You’ll note on our balance sheet the mortgage that we have, that is the building in which HashMaster operates. It is ours, but you see the amount that a mortgage, it is our belief that the building is worth twice what we paid for it. And the mortgage is only 70% of what we be paid for it.
So it is that — and one other point I keep saying one other point, but I’ll make it yet another point, pay very close attention, if you will, to our security sold short and look at the profit, that is a significant generator of capital for us, and it continues to be. At the moment, we’ve been expanding let’s say, last — we’ve been expanding the short position. So there are some interesting things to do there. You’ll note that’s going to grow. It hasn’t grown in the prior quarter. Now it’s a good time for it to grow. So expect it to rise not a huge amount, but a little bit.
So I think that includes all the general remarks and maybe now is the time to go to questions if you have them. Therese, I would be delighted to answer them.
Question-and-Answer Session
Operator
[Operator Instructions]
Thérèse Byars
Yes, I do. And the first 1 is, would you explain the noncontrolling interest? Why do you need to show? And who are the owners of the noncontrolling interest? I’m assuming they’re not owned by FRMO. Is that correct? So the book value is then?
Murray Stahl
Okay. So the book value of FRMO — let’s do it this way, the book value of FRMO is $188.9 million. That’s what FRMO has. Noncontrolling interest come from two entities. The major one is HK Hard Assets, and the second one is HK Hard Assets II. So why do we show it? Because FRMO controls that capital. And number one, that’s the correct accounting treatment. Who are the other people? Well, the other people are largely yours truly. So I may be — if I’m not the biggest investor in HK Hard Assets II, I am up there. So I didn’t look recently, I may be the biggest investor in HK Hard Assets, no I’m close. There’s FRMO, obviously, and that’s an investor. There is Horizon Common, I’ll describe what that is in a second. There is myself. And there’s Horizon Kinetics, a different Horizon Common, I’ll explain a difference momentarily, and there’s a peak shareholder of Horizon FRMO and then there are a couple of small shareholders. Those are the owners basically.
Horizon Common represents a lot of the capital that was extracted from Horizon Asset Management. So if you might recall, prior to 2011, there was a Horizon Kinetics, there was Horizon Asset Management and the Kinetics Asset Management. And they were owned by the same people. They did more or less same thing. Kinetics would run the mutual funds and Horizon would do the individual accounts and do the research. It’s probably the cleanest way to explain it. And everyone will always ask why do you have two separate companies? Why don’t you have one company that will be easier to understand? So we combined them.
But over the years, Horizon had produced a lot of capital that was in Horizon. So we merged the investment management companies. It didn’t make sense to have that kind of capital in the investment management company known as Horizon Kinetics. So it became separate. So the function of Horizon Common Private Company is just to invest capital. How much capital is in Horizon Common? If you’re interested, it’s something on the order of — it fluctuates every day. But it’s something on the order of $185 million, something like that. Might be more by now, something like that.
So it’s not insignificant. It’s not far from the shareholders’ equity of FRMO. So it’s just our capital. It’s run — but it’s run by and owned by the people at Horizon Common. So my money is there in Horizon Common. You could say, if you look through, I’ve got a pretty big stake. And then I have a personal investment in HK Hard Assets I and II, and I add to every month. Even though the month is not over, I’ll probably be adding to it this month as well. Why do we show it? Well, apart from the accounting treatment reason, that’s the correct accounting treatment, it really represents its information for shareholders. How much capital, if we want to do something, FRMO could deploy if it chose to deploy. Now beyond the capital, there’s also the margin lines, which we never really use. But in the case of FRMO, it’s something like $95 million or $96 million or say $97 million. And in the case of Horizon Common, it’s probably another $30 million, $40 million. So there’s a lot of buying power there. It’s enormous buying power. It’s just that we never found anything we really want to buy in size. So all the buying we’ve done has been incremental, and it’s added up to a lot of money over the years. There’re total assets, which you will observe, the last line on the FRMO financial statement, balance sheet, exceeds $371 million.
If you go back, and you’ll see that from our website, sometime many years ago, it was a small number. So we’re trying to disclose everything that we could think is relevant, so people can see what our cards are. That’s where we stand. So I hope that’s a thorough and transparent answer. But if not, I’m happy to address other parts of it if need be.
Thérèse Byars
That sounds good. All right. The next question is much broader. It’s about inflation. And it is in the first quarter of 2022 Horizon Kinetics commentary, management mentions that a recession is not a long-term concern for oil investments because the shortage is structural and that it doesn’t matter whether there’s lower economic activity. What does management see today as the most convincing or credible bear thesis to FRMO’s long-term structural inflation or energy shortage thesis? Does management have any thoughts on the knock-on effects on society of being correct on their long energy thesis and what the end game for FRMO’s investment thesis looks like?
Murray Stahl
Well, that’s a lot of questions, but let’s go through it. So there is no guarantee that we’re going to have inflation. Based on what we see right now, it’s the best judgment we can come up with. Number one, we could be wrong. Number two, the world can change and we can change with it. So we’re not in love with the inflation thesis. And incidentally, inflation is not such a great thing for society. It’s actually very harmful. It’s socially very divisive and it creates a lot of problems. So we don’t desire inflation. The problem is this. And let’s just look at — I’ll use the United States budget as an example, but it’s the same problem in every country. The only difference is numbers. So — and I wrote about this, it’s just isn’t announced yet. My last thing I wrote about dealt with this subject. So anyway, the United States government revenue, in round numbers, let’s call it $4.8 trillion, government spend in round numbers $6 trillion. And they might have spent some more money than $6 trillion is, we don’t know, and no one knows.
And no one knows because if we had a recession, I just gave you two numbers, what can we reasonably infer would happen? Well, if there is recession, people are going to lose their jobs. The chances are stock market is going to go down. There’ll be less capital gains taxes to be paid. So that $4.8 trillion, the government might not get $4.8 trillion. How much would they get? Well, it depends on how severe the recession is, it depends how big the employment rate is, it depends on how many people take early retirement and they have to collect their social security. It depends on if people lose their medical insurance, because of unemployment, they have to depend on Medicare or maybe Medicaid. Depends on if people need food stamps if it’s getting that bad.
So it depends on lots of factors. So we don’t know if you read me, other than we can say it’s probably likely to go down. And the expenses, which I just mentioned, they’re likely to go up. And the most important of those expenses, even though it isn’t the biggest, is interest on debt. And why do we know for sure that’s going up? Well, one, the debt keeps increasing. And you can follow that, by the way, on treasury, the treasury with daily fiscal statement. You can see how much money the treasury takes in every day, how much money they need to borrow every day. Literally, you can follow it every day if you want to. And it’s actually unbelievably interesting.
Anyway, the interest rate is higher and the fiscal balance, that’s going to go up. So if we don’t have inflation, what — and we had a recession instead, what’s going to happen? It may be the $1.2 trillion deficit in extremis, hard to know what it’s going to be. It may be beyond the ability of the nation to fund under normal circumstances. Certainly, I don’t want to give a big tax increase during a recession, because it might make — probably will make the recession worse. And what if there was an escalation of the military conflict like Ukraine. Let’s say, it escalated, which is a very realistic possibility and wars cost money. What would happen? So the most reasonable thing is if we’re not going to have inflation, the numbers are far, far more problematic than if we’re going to have inflation. So based on what we see, it’s more reasonable to assume they we are going to have inflation, because of the debt issuance and the structural deficits, not the budget itself, which is a problem, but the structural deficits of investing in commodities generally, we haven’t done that as a global community for about four decades.
Now we’re getting to pay the price of that. So it’s a problem now specifically for the next month or so, let’s just give you a couple of data points. In last, call it, 10 weeks, 12 weeks, whatever it happens to be, U.S. oil production has declined by 200,000 barrels a day from 12.1 million barrels to 11.9 million barrels. Not that big a deal, but it’s 200,000 down, not up. The strategic petroleum reserve, the sales in the next couple of weeks, the energy department is going to sell over 15 million barrels. Next couple of weeks, chances are the oil price is not going to go up. That’s a lot of oil to put on the market.
But when we release the number for this past Friday, I believe the strategic petroleum reserve balance is going to be something around 400 million barrels. But we’re going to sell, let’s say, 8 million barrels of oil a week, 8 goes in the 400, only so many times. So it’s pretty obvious that can’t continue forever. And it might not be a good idea to sell your strategic petroleum reserve all the way down to zero.
Next data point. These are just data points that anybody can get. It doesn’t take a lot of research or whatever. So next data point is OPEC is cutting production by 2 million barrels daily, and that’s going to start in early November. I don’t remember what day, but I don’t think it matters. So that’s a lot of oil. Next data point, December 5, the Europeans will not be able to buy Russian oil. So under the European version of sanctions, the European nations can buy Russian oil up to December 5, 2022. Russia as far as they’re concerned, is still in the market and if they are going to stop buying it, then they’re going to have to find another source. So all those data points are coming up. That’s the basis of the inflation thesis. We are not in love with it. And if we need to redeploy, we’re going to redeploy it to something else. But at the moment, it doesn’t seem like it’s a good idea to us. So we leave well enough alone, and there you have it. So I think I’ve answered every part of that question. Did I miss anything, Therese?
Thérèse Byars
I don’t think you did.
Murray Stahl
I hope not. If you think I did, let me know, and I will address it.
Thérèse Byars
No, I think you did. You included the energy thesis and so on. So that’s good. All right. The next one has to do with the money supply. Currently, M2 velocity is near all-time lows. And my understanding is that of the bank reserves that are created from quantitative easing, only a very small amount of that actually makes it into the real economy via the credit creation mechanism of direct lending. While the M2 monetary base has certainly been increasing, this does not mean that the current monetary supply is less or greater than in previous times. We can actually see that total U.S. credit growth has been at a much lower trending rate ever since 2008. Could management comment on the possibility that M2, while a fine measure for the monetary base, is not an effective measure of the circulating or supposedly expanding money supply? Are there other composites of metrics to justify the currency debasement thesis? Is there a risk of an availability bias of information here? Just as an example, revolving credit lines are functionally similar to money, but not accounted for an M2. Got a lot of questions there.
Murray Stahl
Okay. But I’ll sum it up in one, because actually it was — it’s — I didn’t know was to get this question, but it just so happens — it’s not out yet. I was writing about this. As I mentioned earlier, the treasury fiscal statement. So they put out a daily fiscal statement. So you can go to it. And I — what I wrote, I used September 30, it’s not that long ago, 2022. So you can look at any day. The reason I use September 30, 2022 is that’s the last day of the fiscal year. So you get to see the yearly numbers. So it’s kind of interesting from that standpoint. But — what I would ask you to do is look at the issuance of treasuries. Now when I say issuance because we’re talking about last days’ issuance treasuries, we’re not interested in the net amount. Like how much money did the government borrow? In other words, how much did the United States government debt increase over the fiscal year, which is over $2 trillion, a lot of money. So we’re just talking about velocity, because most U.S. treasury debt is short.
So the treasury is constantly redeeming debt and constantly issuing debt. And the numbers are just — they’re unbelievable. So what I am going to do, if you’ll bear with me, I’m going to just log on and read you a number. And the reason I’m going to do that is because if I read from my notes, you wouldn’t believe it. but I’ll get it in a second. So you just need to bear with me. I wasn’t expecting to have to do this. Let’s see if I can get it, just bear with me for a second.
Anyway, rather instead of keep everybody waiting, I’ll just read my notes. So the actual debt issuance. Now remember, this is not how much debt increase or deficit, this is just the debt issuance and the debt redemption. The debt issuance was and get ready, $149.8 trillion with a T. The debt redemption was $147.3 trillion with a T. So that’s the velocity. In other words, what is velocity supposed to measure? Velocity is supposed to measure what people are doing with their money. But people are — the reason the velocity is low is because the 3 governments and the 3 governments are federal government, state government and local government, this number — these numbers I gave you are just federal.
Their spending represents 45% of the gross domestic product. And because it goes through the Department of Treasury, rather than the banking system, it’s so huge. It’s such an important part of velocity, and we’re not picking it up. We’re not measuring it. We’re looking at what the people are doing. It’s still a lot of money, what the people are doing. We’re not looking at what the governments are doing. I just gave you the federal numbers. There are the state numbers, there is just local numbers, numbers are even bigger. And that’s what’s happening to the velocity. We’re not looking at it because somehow, we’re not properly picking up what the government has done to velocity. And I believe that big problem. So just as far as getting data rather that reach conclusion. It’s just if you want to reach a conclusion, you got to get the right data, you got to figure out what the government is doing. So 45% of every dollar that’s spent in this country annually is spent by one or several of those branches of government. Now actually, as huge as that number is, it’s 45%. It’s worse than that. So why is — actually, it’s much worse than that.
And the reason it is much worse than that is because that number is not counting the government-sponsored organizations, like Fannie Mae and Freddie Mac and Ginnie Mae. So they also have debt. And they also spend money, and they also back mortgages, et cetera, et cetera, et cetera. And those balance sheets, they are in the multi-trillions. So I mean begin to add up — a lot of that debt is short, I mean to begin to add up how much of that rolls over every year, except it’s a really big number. Now if we really wanted to do it, I couldn’t add it in had I wanted to and be thorough and be complete, which unfortunately, I’m not being right now. I could have added in the Bonneville Power Authority. I could have added in the Tennessee Valley Authority. There’s lots of governmental organizations.
There is the U.S. participation in the world bank. There’s U.S. participation in International Monetary Fund. There’s U.S. participation in the Bank for International Settlements. I haven’t even added up what the Federal Reserve has done and the regional banks at the Federal Reserve, what they’ve done. So number is just astronomical. So we just had — all those entities collectively are absorbing a great deal of the monetary action. So we’re not really, in my humble opinion, we are not measuring it properly. So I’ll just leave it there. What say, I miss something, Therese? Hopefully, I didn’t.
Thérèse Byars
I think that was thorough. Next question, a lot of the monetary debasement arguments seems to rely on the idea that the Fed will pivot from their rate hike cycle and step in to monetize U.S. debt as the hiking cycle to fight inflation starts to affect financial markets in a politically unbearable way. What are management’s thoughts on the relationship between stock valuations and both tax receipts and the government’s ability to service its debt? Would higher rates from the Fed actually stimulate production of goods by spurring credit supply from banks who would be more eager to lend to solve its businesses at these more profitable terms? I believe this was a position of the economist Walter Bagehot among others.
Murray Stahl
Okay. Well, I’m not sure what the banks — I don’t even think the banks know what they’re going to do. Situation is too fluid. I don’t think the banks have a good plan what they could do it. The Federal Reserve, it’s pretty easy. Federal Reserve has to stand behind treasury, whether it wants to or not, you can have a very interesting and lively debate, I just won’t participate because I don’t know what they’re going to do. But you have to stand behind the treasury. So there is a whole series of scenarios where the treasury might find it very difficult to finance the deficits. Deficits might get very, very large in a lot of different circumstances. And they’ll have no alternative. That’s what I believe will happen.
Now we look that reserve all of a sudden become accommodative and lower rates to prevent recession. Possible. Personally, I don’t design a huge probability to add it’s possible, but the central bank would lose a lot of credibility if they did that. So they’re committed to a certain policy. And I think they are going to have to see it through. I think the consequences of not seeing it through. You see the Bank of England, they didn’t see their policy through for very long, and it’s having a very bad impact on the country. Now raising rates as they did have a lot of consequences that are detrimental, not the least of which is just people have to pay more for their loans. So let’s look at it this way. If you’re a student, let’s say you borrow X dollars to complete your education. So let’s say that amount was $100,000 just for the sake of argument, where you going to pay it back over decades. So raising interest rate 2%, if that’s what the number is, adding 2% to the interest basically, and you’d be assuming you’re going to pay back that debt over decades, it doubles the price for college education, even raise tuition.
That’s the problem. That my contention is when you do that, interest is an expense to people. At the end of the day, what’s difference, I would argue, between raising the rate and asking to pay more on interest or having to pay more on gasoline. So if you got to pay back your student loan, you haven’t locked in the rate, which a lot of people didn’t because they couldn’t afford to. Now your college education costs just doubled. That has consequences for people, they’ll carry — that they will carry with them for most of their adult lives.
Similarly, let’s say you just happen to live in an area where you need an automobile [Tech Difficulty] rate, well the interest rate was so low adding two percentage points to it dramatically raises the cost of a car. And actually, the interest expense increase on financing a purchase is actually greater than the inflationary impact on the price of the car itself and the gasoline, you have to buy from the car — you have to buy for the car. So to me, I just don’t see that monetary policy once you have this kind of debt is going to be very effective in doing anything, whether it’s inflation or anything else.
So the problem basically was monetary policy, by the way, was invented 100 years ago, they knew that more than 100 years ago, it was rigorously practiced 100 years ago. The idea was when the economy gets a little too vibrant, you raise interest rates and you’re slowing it down and meaning you reduce effective demand and reducing effective demand by enough, you will calm the inflationary pressures. But that’s the society, at least American society, 100 years ago and the governmental sense it was not a very leveraged society. In a corporate sense, it was not a very leveraged society.
Today, we live in a massively leveraged society. Even though relatively by historical standards modest increase in rates, is inflationary in and of itself. You just raised their day’s expenses by a lot. So the very thing I would argue, and this isn’t my personal view, so — and I think I am already in this view, but you worried about inflation, just raised everybody’s expenses, so you created the inflation. What are they supposed to do. If somebody has a student loan and they can’t afford to pay to student loan, because the interest rate is higher, they’re going to have to get a raise. That’s simple.
Let’s look at oil. Well, how do you think oil comes to the market? What do you think stands behind the refinery? It’s debt. So how do you think they’re able to afford to constantly retrofit of the refinery for all of the environmental requirements that the refinery has to comply with. The refinery company borrows money and now they’re going to pay more for it, though a lot of energy companies are leveraged. If you’re not going to leverage, well, then you’re going to have less capital available. Equity capital is almost impossible to raise in the energy world. So not — they’re not raising capital or capital they can raise or willing to raise is more expensive and otherwise, even equity capital raises interest rates and lowers PE ratios, it raises cost of equity capital. So if you make the capital more expensive and simultaneously do everything you can by selling strategic petroleum reserve to lower the price of petroleum, maybe for very sensible reasons are you going to get more oil, you are going to get less oil. If you get less oil, how is that going to attribute to it — how is that not going to contribute to inflation.
So for all those reasons, I don’t think the monetary policy is being waged is going to be all that effective. And the best thing is the central bankers, the world can do, one other thing I should have mentioned, I should have mentioned at the outset, just occurred to me right now. I neglected to mention, so I mention it now. Raising interest rate, as you’ve observed, has also increased the value of dollar that makes U.S. exports a lot more expensive around the world and makes foreign goods cheaper to the United States. From that point of view, foreign goods are cheaper, that’s actually fighting inflation, but it’s also recessionary.
So even with the greater purchasing power of the dollar in international markets, we had this kind of inflation. We can’t raise the dollar much more or we know we’re really going to have a recession. So we’ve had because we import a lot of goods in America. We’ve had the benefit of a strong dollar. It’s the strongest inflation fighter you can get. We’re about to end the period of dollar increases, because it’s just the inflationary — the recessionary pressure is just too great. And we’ll have to see what happens to that. So there you have it.
By the way, it also raised the inflationary pressure for foreign countries, because oil is priced in dollars. So oil might go down, but that currency goes down as well. The price of oil for them is going up. So inflation is a worldwide phenomenon. You have to solve it on a global basis. I don’t think you can have a local solution to the inflation problem that’s another point I’d like to make. Anyway, I’m done. I think I’ve said enough on the subject unless you say more, Therese?
Thérèse Byars
Well, you might with the next question, it’s quite a long paragraph with a few questions in it, but I’ll just read it from beginning to end and then we can take it from there. In past thought exercises, for example, in the second quarter 2022, FRMO earnings call as well as the HK commentary from the fourth quarter of 2021 and the first quarter of 2022, the idea is proposed that the Fed is currently trapped into letting inflation run hot for the long term based on taking the total collective U.S. debt and applying some uniform rate increase across all debt instruments and comparing that increased interest expense to current GDP to illustrate the risk of a contraction in GDP and subsequent recession.
Here, management appears to assume that the vast majority of the total collective U.S. debt is essentially of short maturity, recurring and nondiscretionary, thus giving the rate hikes an immediate impact on interest expenses. What is management looking at to make the determination that this exercise is close enough to the real world to be useful? Could management break down — do you want me to continue with the rest of the questions?
Murray Stahl
Go ahead. Go ahead. Go ahead.
Thérèse Byars
Could management break down the —
Murray Stahl
I thought it was over. I didn’t realize, but keep going.
Thérèse Byars
Could management break down this explanation in a bit more detail as well regarding by what economic logic this additional interest expense is interpreted as being taken out of or reducing GDP to create a contraction? And there’s more. If the issue is a debt death spiral and the Fed stepping in with money printing for tax receipt deficits on interest expenses and entitlements, then what is management looking at to determine that new U.S. Treasury issuances could not be made without moving rates and thus causing such a spiral to fund these deficits or that taxes could not be raised sufficiently to cover? Do you want me to go back to the first part of that?
Murray Stahl
No. I get the basic idea and you can guide me if I missed part of it, which I inevitably will. So basically, the entire debt of the country doesn’t obviously mature in one year or even two years. There are some people, that’s the problem with inflation. There are some people, who locked in long-term rates, other people didn’t. So it’s dangerous to generalize, and that’s true. However, we can do is, let’s just get — we can use indexes to get a basic idea of where we stand. And the most important sector, the debt market — is the part of the debt market where the credit is questionable.
I would argue, the most important part of debt market is the high yield market. That’s the market where the balance sheet is most leveraged. That’s the market where if we had credit problems, that’s where it’s going to be expressed. I think most people would agree on that. So if I go to the high-yield bond index, I’m using the iShares high-yield bond ETF as a proxy, but there are other ETFs you can use. But I think you would get a similar number. The weighted average maturity of the iShares high-yield corporate bond ETF is 5.39 years. What it is? So here we stand and we can say 20% a year, more or less, it’s not exact, but I’m just rounding down. But 20% of the debt is going to mature every year in the high yield sector. And that’s what you have to worry about. In the banking sector, there’s another part, which are what they call leveraged loans. On the one hand, they’re at the top of the credit hierarchy with the much shorter maturities, the average maturity might be something like three years, a lot more debt coming due. There is dangerous. They — the banks like to make them, because they have higher coupons than conventional high yield, but they have shorter maturities. The rates on bank debt are floating.
So irrespective of maturities, whether you’re at three years or five years, whatever, on leveraged loans, the bank adjusts the rates instantaneously. That’s another sector you have to use, and that’s the problem. Problem is that not that the entire debt structure of the country is vulnerable to high interest rates immediately. It’s that the most credit challenged sectors of the market are very vulnerable to high rates. So — and that’s the problem with monetary policy, that’s a problem of inflation. If it was uniform throughout the entire society, you could make generalization as an investor, as participant in economic activity, you could somehow adjust to it.
The problem is it’s not uniform society. So what’s going to happen is the least creditworthy segment of society is going to be the first credit segment of the society to bear the burden of higher rates. And that’s what makes it so dangerous. It’s not everybody. There are plenty of people who have 30-year mortgages. They have locked in very low rates, and they won’t have a credit problem.
But there are some people that are credit challenged and the rate is floating. There are some businesses. Now what happens and that’s certainly not the majority of the country, but that might be 10% or 15% or 20% of the country. What happens if they are challenged, those businesses are challenged by those high rates. They owe the money to otherwise creditworthy companies. The otherwise creditworthy companies are themselves 10x leveraged. They just have good credit. Your typical bank is 10x leveraged. It doesn’t have a lot of tolerance for credit problems.
So a small segment of society can create a big problem. That’s the sort of way we’re looking at it. we’re not saying that a 1% or 2% rate increase is going to affect everybody uniformly. Actually, we’re saying quite the opposite. So sorry if I gave the impression that we were looking at uniformity in society. We’re not looking at uniformity. We’re looking at the stress placed on a relatively small segment of society, but that stress by that small segment of society might be unbearable. And think of all the debt that’s now packaged into tiers and they are low grade tiers and there’s very little tolerance at lower-grade tiers. These would be the B minus tiers, whatever and leverage loan packages. You’ll see the consequences, I believe, within next year. There won’t be very — there would — there won’t be slight disruptions and it might be. But we’ll see what happens.
Thérèse Byars
So just curious, I know that you have touched on this. The last part of that question was, what is management looking into — looking at to determine that new U.S. Treasury issuances could not be made without moving rates and that’s causing such a spiral to fund these deficits or that taxes could not be raised sufficiently to cover?
Murray Stahl
Well, taxes are easy. So let’s do the tax part of the first. So we’ll just look at the figures, I believe, I just had my notes here with me. I’ll check it in one second, I’ll be with you to give you an accurate number. I believe, and we’ll see if I’m right, I wrote this down, there’s 125 million taxpayers — income tax payers in United States of America, 125 million people. That’s it. So the workforce of the United States, I’ll give you some numbers. I wrote this in the Compendium. So most of you don’t believe it, but these company aids its government. U.S. labor force, meaning the people who are working and pay taxes, in the year 2000, there were 159.6 million people that worked and paid taxes.
Today, it’s 158.8 million people who are paying taxes. Now of those 158 million people, who are in the workforce, about 30-odd million of them have income that’s so low, they don’t owe any taxes or at least nothing that requires them to file a tax return. Therefore, the entire system is dependent on the 125.8 million people. Now of the 125.8 million people, 23.3 million people work for the government, that’s both federal government, state government, and local government. Now all those people pay income taxes, of course, but their salary comes from the taxpayers and can come from no other way. So if you net them out, the 125 million, let’s say, minus 23. It’s 102 million people. They’re carrying the burden to support a population of 335 million people.
And then, most of the people — so we let out the lower income people. Most of those people are not far from the 40% bracket. Now 40% in federal income, they’re in the 30s, for sure. That doesn’t count state taxes. It doesn’t count local taxes. It doesn’t count property taxes. It doesn’t count sales taxes. It doesn’t count gasoline taxes and so on and so forth. The average person, if you look through, is paying well over 50% and arguably, probably over 60% of their income in taxes. We can’t raise taxes on those people unless you want to have inflation, because they’ll just — they’ll demand and they’ll be entitled and they’ll get it. They’ll demand increases.
And by the way, it is even worse than that, because there are some inelastic expenditures that people have to make, they didn’t make in the past, which is health insurance. So a lot of people are insured by their employers, but the employers have gradually and inexorably passed on the cost of the insurance to the employees. So you bring home x dollars in your paycheck. But you also have to pay for your health insurance. You have to count that as well. So there’s not a lot of flexibility in that. Now as the first part of your question, will the rates increase because the federal government is issuing too much debt. Only if — the only reason, the only way I would see that happening is if the creditworthiness of the United States were to come into question. In that circumstance, yes, then they try issuing debt, it’s going to be a problem. At the moment, nobody really questions the creditworthiness of the United States. So the history of last 120 years is littered with nations. Everyone took their bonds, because nobody questioned their creditworthiness. And perhaps they should have questioned their creditworthiness.
So lots of countries should have had the creditworthiness questioned, wasn’t questioned and people live through [Inaudible]. It may one day happen in United States of America. I hope it never does, but you can’t exclude the possibility anyway. If it were to happen, that would be the circumstance, if the creditworthy of the nation were questioned. I hope that is thorough and complete.
Thérèse Byars
I believe it is. And the last question. Our inflation is underestimating the unique political and military advantages that the U.S. and U.S. dollar has, when making historical analogies versus, say, Turkey, Argentina or any other countries with twin deficit issues.
Murray Stahl
Okay. Well, all I can say to that is that there was a time 100 years ago that Argentina had a higher standard of living than the United States. Argentine debt, they’re more creditworthy than U.S. debt. As a matter of fact, there was a time that Czar’s Russian bonds were considered more creditworthy than American bonds and U.S. treasuries. So these things have a way of changing and changing very, very rapidly. So if you look at the 20th century, how many nations can we count that were once creditworthy and where the bond holders got nothing, I literally mean nothing. And we say the Austro-Hungarian Empire, the Ottoman Empire, the Tsarist Empire, the German Empire, the Japanese Empire, the Republic of China, the People’s Republic of China, Republic of China that became the People’s Republic of China in 1949. So you own Chinese bonds, what happened? You can paper your walls with them.
So the 20th century is replete. And these are all big countries. I’m not even talking about the small countries. 20th century is replete with examples of nations that just borrowed too much. Many, many, many examples. So we could have a very nice lecture and go on for hours, just listing the countries that got themselves in trouble. The temptation, if you start from a creditworthy posture, is irresistible, to borrow money. So it was only 100 years ago that the British Gilt was the signature security in the world and then Britain fought the First World War. And became a creditor nation, never really recovered. And it happened really fast. So we need to be mindful of that.
So I just try to stay out of debt myself. FRMO you can see, we pretty much stayed out of debt, and that’s the way we like it. And I personally would recommend that for a lot of nations as well. But of course, that’s unrealistic, and that’s not going to happen. And there are very few circumstances in history in which debt, while not viewed as excessive at the time, proved to be excessive and became problematic. So it’s hard to imagine a nation that used debt aggressively, it didn’t have ultimately a very serious problem. And in most cases, they just didn’t pay it back or it became debased. So they did pay it back, but they paid in inflated dollars. That became problematic. That’s the best answer I can think of giving.
Thérèse Byars
That was the last one submitted before. I know that you probably can’t discuss this, but I know that there are shareholders who are very curious about Texas Pacific Land Corp. And I just wanted them to know that we’re not ignoring it, but I’ll leave it to you to say, why perhaps you can’t talk about it, certain aspects of it.
Murray Stahl
Well, it depends on the question. So why don’t you give me a question, and I’ll — then I’ll —
Thérèse Byars
No, it has to do with the proxy vote now and the many proposals that are on it, especially the share issuance.
Murray Stahl
I’d rather not. Do you understand, if you’re on a Board, I hope you understand there’s limits to what you can say; and be a lot of fun to talk about it, but just can’t talk about it. So it will have to remain there and what will be will be.
Thérèse Byars
Thank you, Murray. That’s good answer, and I hope that, that’s satisfying to the shareholders who were curious about it. So that was our last –.
Murray Stahl
Well, it’s probably not satisfying because the question is, what are you going to do about A, B, C and D. That’s really the question. But of course, this is not the forum to undertake it.
Thérèse Byars
You are constrained by being a Board member and I respect that, and I’m sure they do, too. I hope so. Anyway, that was our last question, so I believe that unless there are any other comments you would like to make, that brings us to the end of this conference call.
Murray Stahl
Okay. Well, I just want to thank everybody for attending and listening, and I really must say I think the questions are great. I enjoyed them and don’t hesitate to submit them. And that’s something we didn’t address, that’s a concern of yours, I mean we’ll get you an answer. So we’re trying to be as transparent as possible. And I just want to emphasize the cryptocurrency aspect of it, that we’re focusing on it, even though it’s a small part of our assets, it’s very important to us. We’re thinking about it constantly. And nothing is set in stone.
So if the world changes, we’re not — whatever our posture is with regard to inflation or cryptocurrency, we’re not wedded to it. Though if it proves that circumstances are different than those we believe were going to materialize, we have no hesitancy in changing our posture. So I hope you take that to heart. And again, thanks for listening, and thanks for your support. And of course, we’ll reprise this in about three months and look forward to talking to you then. Thanks a lot, and good afternoon.
Operator
Thank you. And that does conclude today’s conference. We do thank you for your participation. Have an excellent day.
Be the first to comment