So today let's talk about two things. First off, let's talk about what happened in the markets because it looks like we're having a bit of a meltdown in the momentum trades. And secondly, let's talk about 1873, the new book by Liaquat Ahamed, which was who's also the author of Lords of Finance, one of my favorite books on financial history.

All right, starting with the markets. So if you look at what happened over the past few weeks, what's very clear is that the market has largely been driven by the AI stocks, specifically the semiconductors. So we know there are bottlenecks in RAM and the companies that have been making RAM have been making a lot of money and the market has basically been pushing those stocks vertical. The vanguard of all this is the KOSPI index, the Korean stock market index, which has doubled this year. Now, a lot of this is just leverage and momentum, right? People are buying a lot of stock on margin, through options, so forth and that's pushing it up. If you look at a KOSPI index, you can see that it looks like it's kind of losing momentum and maybe even V-topped and that's reverberating in a lot of US stocks as well, where Micron is not trading that well, and many AI names aren't as well.

Now, this could just be some of the leverage cracking, and people looking for a narrative. It's often like that, but there have been some compelling narratives over the past week that suggest that, you know, this there are real cracks in the AI trade. For example, last week Meta is talking about leasing their selling their excess compute capacity to other people. So, you know, the narrative being that there's been a scarcity of compute. If that's the case, why is seemingly Meta having so much compute they don't know what to do with that they're leasing it out to the market?

You also have other narratives that it seems like more and more US companies are open to using open-source Chinese models as a way to save costs. Now, the open-source models are not as good as US frontier models, but they are a lot cheaper and good enough. And of course, you also have Alex Karp of Palantir going on going on TV and kind of suggesting that the future is open weight models. For context, Palantir has been losing a lot of contracts throughout the world, where foreign governments don't feel as comfortable working with Palantir. The fear being that maybe Palantir is just going to send all that data that they give, the foreign governments send them to the United States government, which, you know, probably happens. So, there seems to be more of a concern of both sovereignty risk, but also data privacy risk as well, and that pushes people towards open weight models, which is very bad for, say, Anthropic and OpenAI.

Another thing we have to think about this is to think about how Amazon is reportedly operating. So, a lot of times, for example, some small businesses would begin to sell on Amazon, and their products could become very successful, and there are many reports that what Amazon would do as a giant giant platform would be to notice that these particular products are doing very well. And then come out with their own generic Amazon branded product and basically undercut all the small businesses and take the market. Many reports of them doing things like that. If you have a closed ended model, the closed ended model people could do something similar. Whereas if you are a corporation, you use your you use your closed ended model, send them all the data and it does help your business, but then the closed ended model gets all your data, is able to come come up with a product that is comparable to whatever your business is doing. Say that you're a law firm, maybe all lots of law firms use just just for example closed ended model. Closed ended model learns a lot of expertise from that data and comes out with their say lawyer AI app that basically tries to compete with law firms and maybe put some out of business. So, there's always a fear of having your data stolen and of course sovereignty risk. So, it does seem that it's becoming increasingly clear to many people that the future of the model layer in the AI system is going to be open. And maybe the value chain value comes at the application level with which of course will be subject to a lot of competition as well. And of course at the moment the compute is still very profitable. So, anyway, you have some more cracks as to just where the value is and of course a lot big source of demand for all this compute are the frontier models who are training themselves and that takes compute and maybe if closed ended models are not as profitable, they won't be spending as much to train them. So, that could be some impact of the demand. In any case, looking at price action, looking at narratives, more cracks in the AI model in the AI narrative.

Now, something else to note is we also got a lot of data and a little bit of Fed speak the past week. We had Kevin make his debut on a panel with at Centra, which is the ECB's Jackson Hole. So, he was here on stage with other prominent central bankers in the world talking about policy. Now, as someone who committed to not giving forward guidance, he gave none, but he did have slightly chatter that was interpreted to be slightly dovish and that is his views on AI, where he talked about AI as upfront being inflationary as people build out data centers, but afterwards disinflationary as those investments begin to pay off, which kind of is really a just a normal standard interpretation. It's kind of true anywhere, right? If you build a factory in the beginning you need a lot of labor, you need a lot of materials, and that could be inflationary, but once factory is complete, then you have more production and that's disinflationary. So, wasn't really that special, but it is again him going back to his core thesis that it AI is probably going to be disinflationary through higher productivity.

The big data release, of course, was the nonfarm payrolls report, which the market interpreted to be weak and priced slightly lower chance of Fed hikes. Again, on the margin though, it wasn't a in a big impact. So, the takeaway was that the headline jobs created was lower than expected, right? Much lower than expected. Uh at the same time, the unemployment rate declined unexpectedly, and that seems to be largely due to account of a rather large drop in the labor participation rate. So, when you look at this, I think it's kind of a mixed report. So, on the one hand, you can say that the headline jobs number created declined, so that is directionally weaker, but at the same time, Fed officials have been emphasizing repeatedly that they're not focusing on the headlines number created because of changes in demographics. They don't really know what would be the right number of jobs to create each month. It could be as low as zero. So, they've been emphasizing the unemployment rate as a better sign as whether or not of the health of the labor market and that declined. However, of course, the decline as many have pointed out is due to a drop in participation rate and the doomers can go and say, "Oh, there's so many people who are desperate and dropping out of labor market and so that's why the unemployment rate is lower." The doomer interpretation is always stupid. So, that is totally possible that some people do this, but you know, this thing fluctuates up and down, right? So, uh we've kind of risen a lot post-pandemic. Maybe it's a bit normalizing. Maybe people are just watching the World Cup. Maybe they are just hustling. Maybe they are just gambling in the stock market. It's hard to say. It could just be a data error. So, I think it's uh always wrong to reach for the doomer interpretation. Like, for example, the doomer interpretation for uh a jump in zero DTE option trading or uh spending actual circulation is that people are so desperate they can only make it by gambling, which is totally stupid because, of course, maybe some people are doing that, but uh everyone likes easy money, right? So, even you have the dentists, you have the doctors, people are well-off, you even have the president of the United States gambling bigly in crypto and all sorts of things, right? Everyone likes easy money. Everyone likes to gamble, no matter how desperate or well-off you are. So, that, of course, the desperation doomer interpretation of this phenomenon is just not very good and I think it would similarly not good for the drop in the labor force participation rate. Now, it's possible the Fed officials could look at this and say that, you know, a drop in participation rate makes the drop in the unemployment rate less valid. So, we'll see what they say uh fits in the coming weeks.

So, let's talk about I'll talk about what happened. So, what happened in 1873? So, basically there was kind of a global boom in speculation. So, France lost the war to Prussia and had to pay Prussia a lot of money. So, they floated bonds and basically uh collected the money and sent it over. And this kind of what led to a huge infusion of cash into the Austrian-Hungarian Empire and well, that part of the world. So, what happened was that this fueled a tremendous boom in speculation in that part of the world. And what happened was that you know, like speculators began to build more stuff. And so, that means that real estate prices go up and that broadens the wealth effect. That creates more collateral for banks to lend against. And you had an overall huge boom and the preferred measure vehicle of speculation for at that time for them was stocks. And so, people began to gamble furiously in stocks. You had all sorts of people create startups uh just to issue stock. And there was just a huge boom. And in in to that, as France lost war, there was a lot of capital flight out of France into places like the UK, and that also brought a lot of money into the UK and fueled a speculative boom there.

Something to keep in mind was at that time uh was on the you know hard metal standard, right? So, money money was gold and silver. So, when you have capital flows, that's literally people taking bunch of gold and silver and moving it to another country, and the money supply of that country does increase. It's different than how it is today where we have floating currencies. Now, if I were to take a lot of money from Japan and move it to the United States, that does not impact the amount of money in the United States. It impacts the exchange rate, right? So, you sell Japanese yen, you buy dollars, the dollar strengthens. But back then, when everyone was on the you know gold or silver standard, when you move capital, you this country that this country that receives financial flows actually does have more money, and so that actually does um give people more money to spend.

Now, an interesting observation also just looking at this from a lens today where interest rates are largely set by central banks, back then when you had this huge influ- infusion of money um in into these markets, say Vienna, interest rates declined, right? Supply and demand, much more money flowing in, more money more money flowing in, and interest rates, of course, being at the price of money, declined and more more money to lend. Very different than it is today where it's not so much supply and demand. That has an impact on spreads, but it is what the central bank sets it to do.

Now, at the same time, you also had this huge boom in speculation in the United States, but it was a little bit different. At that time, the United States was building out railroads, and railroads were something that was heavily subsidized by the US government. So, you had all sorts of railroad companies popping up and issuing debt at that moment. And they were offering pretty good returns and there was a lot of speculation there. So, again, a lot of froth over there. One recurring story throughout all this narratives is that um you know, back then people were really uh a lot of people were bribing the government to get deals done. In the US for example, you companies, banks, railroad companies, massive bribery into and of public officials to be able to get deals done.

In Euroland, speculation was widespread. You'd have you'd have shoeshine boys, you'd have um you know, waitresses, you'd have aristocracy go and participate. And the aristocracy, of course, being politically connected would then lend their credence by sitting on boards of all these random companies uh to try to, you know, uh gin up interest for their stock. So, tremendous amounts of I guess you could say corruption between the public where the public sector is uh public officials are basically uh boosting private stock private stock prices uh for their personal gain. Uh just something people talk about a lot today and which happens a lot today, but again, was something that happened I think back then to a very large extent as well. It was just uh seemingly totally normal back then in the US to just go and bribe people and get your permits or whatever and then um uh for example, there's a lot of story a lot of stories back uh in the book where the US government back then, again, beginning to trying to raise more money, issue treasuries, and the investment bank that would get those deals was one that would uh furiously lobby for political connections, would get all these people connect to the treasury, would pay them off and so forth to be able to get these deals to underwrite uh treasury debt. So, who knows, maybe that's how it still happens today. But, in in any case, back then much more explicit.

Now, one other thing that I thought was super interesting and I want to read this passage about um about how some about actually Charles Dickens described the United States back then. So, I'm going to read it. So, early travelers from Europe, like Charles Dickens in 1842, had remarked on their taste for speculation and their desire to quote make a fortune out of nothing. As London's Spectator would later write, "Millionaires in America make corners as if they had nothing to lose, as if they were only an extensive game. An Englishman fears poverty excessively, and a Frenchman shoots himself to avoid it. But, an American with a million will speculate to win 10. And if he loses, take a clerkship without thinking much about it." The peculiarity makes them the most dangerous business gamesters in the world. So, guys, we have always been degenerates since hundreds of years ago. The Americans have always liked to speculate and gamble. It's just part of our culture and maybe part of our DNA as well, right? The United States is a place that's far away. In order to come here, you have to be someone who is just going to be more at least not risk-averse because you are uprooting yourself and coming uh to a foreign land far away, right? That that has to be in your DNA. So, you know, I I think just rampant speculation is just uh I guess it's an American thing to do. So, anyway, when we see that today and we've seen that recurring throughout the years.

Now, ultimately though as what happens is that speculation ultimately ended into a bust. And this bust is interesting because it led to a period of significant deflation, say prices dropped 30-40% over the next couple of decades. Now in thinking about what actually drove that bust and period of deflation, we have to keep in mind that back then there was no central bank with price stability mandates. So, you know, the government really wasn't in charge of say 2% inflation or something like that. You know, deflation happens, you know, it's like the weather. It happens.

So, there's a few interesting things that happened that made this significant disinflationary event. First off, of course, we had a period of very high speculation, tremendous amounts of leverage. So, when it all eventually came tumbling down around 1873 and it happened in a rolling fashion, happened first in Vienna and then eventually to other parts of the world. Um people lost a lot of money. So, many people were totally ruined, right? Leverage and bust totally normal. Um what actually made this particularly interesting and led to a prolonged period of disinflation. Um not disinflation, that's not the right word. Deflation, outright deflation was that there was also a change in the monetary system.

So, just as money was becoming scarce because you had deflation and you had tremendous negative wealth effect, usually the central bank would come in like they did in say 2009, 2008, come and increase the money supply to try to ward off deflation. Uh you had actually had the opposite happen and it happened by accident. It happened because at that time a few countries were on the bimetallic standard, so gold and silver, but there was a global movement almost by accident to move towards a gold standard. So, uh as countries moved away from silver and there were countries like the UK were which were purely gold and you had countries like France that were bimetallic and the US also had a kind of a bimetallic standard as well. But as countries moved towards only gold, then what that means by definition, there's just going to be less money because silver is demonetized. And so, that exacerbated the deflationary impacts of the of the bust.

And this was basically a political decision. So, in the US, there was recurrently a lot of debate to try to remonetize silver and if you studied let's say AP US history, you would have remembered Brian Jennings' famous speech, "You will not crucify us upon a cross of a cross of gold, right?" That was the populist trying to remonetize silver to increase the money supply to alleviate deflation. Now, deflation had a very uneven impact in the US. If you were wealthy, say you were the financial centers in the northeast, you liked deflation because you owned a lot of bonds and your money is more valuable. But if you were a farmer, which which was the vast majority of the country, you saw the amount the price you would could get for your goods sold decline. And at the same time, you had debt that would had a fixed interest rate. So, you know, you were suffering, getting squeezed. So, this was something that actually cut across pop party lines within both Republican parties and the Democrat parties. You had people arguing for hard money, you had people arguing for soft money.

And at the end of the day, over and this happened over a few decades, it was ultimately in the decision to basically move to a gold standard was something that was by the count of the book almost by accident in that the guys who were voting for this really didn't understand what it meant. And um but the powerful lobbyists, they they seemingly did and they were able to get get that and successfully ward off attempts to go back to a bimetallic standard. So, this was a political decision as monetary policy is, has been, and will always be. And that kind of further squeezed the the the economy in the US and throughout the world. Scarcity of money exacerbated the the deflationary impacts.

But in addition to that though, you also had ongoing technological developments. The increase of mechanization, for example, really did increase productivity and that of course increased productivity means you can produce more with the same inputs. Deflationary impact. And at that time, there was also the creation of the railroads. So, now you have railroads that can more effectively, more efficiently ship things across long distances. That significantly decreased the shipping costs. And so that also reduced the cost of goods. So, you had all these impacts that were basically pushing down prices for a few decades. And that's kind of how it happened. And eventually, again, you know, your prices don't go down forever. It did stabilize. And part of it was basically just due to a stroke of a luck. So, there were new gold discoveries that came about. And so, the money supply just kind of naturally increased. Um and that kind of took things away.

So, it really was a different setting back then, different monetary policy, different politics, and uh just a different historical context. But again, we see the same things repeat over and over again today. Should we have a bust today in the markets, we have a, you know, different monetary system that is more elastic, and we have a different policy apparatus that will guard against deflation. So, uh that is going to be pretty unlikely. So, and I think we all know what the policy reaction will be.

But in any case, I I thought there was, oh, there's small tidbits that I thought were very interesting as well. Um as uh as deflation happened, people thought that the deflation was happening because of cheap imports from abroad. And so, they actually erected huge tariff walls uh to prevent uh foreign goods from coming in and basically competing with local goods, which is kind of something that we're doing right now. Fun fact, at the time, the US actually also erected a tariff barrier on Canada uh because they kind of wanted Canada to become the 45th state at the time. So, again, a lot of things that happened in now have happened before. It's kind of interesting to see history repeat.

All right. In any case, this is the book, 1873, very easy read. And that's how I prepared for today. Talk to you guys next week.