Welcome back to the Timeless Investor Show. I'm Ari Van Gemeren, real estate fund manager, student of history, and your host today. There's a moment in every empire's life when someone has to make the hardest choice in economics, destroy the economy to save the currency, or destroy the currency to save the economy. In 1979, America faced that exact choice. And one man, Paul Volcker, chose to inflict maximum pain on the present to preserve the future. What happened next wasn't just an example of monetary policy. It was a premier amazing example of empire preservation. And the lessons for today's investors are not what you will think. Let me take you back to the 1970s. America was sick, not visibly dying like Rome in its final years, or obviously bankrupt like Weimar Germany, but sick in that deeper way that empires get when they start believing their own lies about their money. Jimmy Carter could feel it. In July 1979, he gave what became known as the malaise speech, though he never used that word. He talked about a crisis of confidence. It was striking at the very heart and soul and spirit of our national will. Carter was right about the diagnosis. America had lost faith in its institutions, its currency, its future. But he was wrong about the cure. All of this started in 1971 when Nixon closed the gold window.

Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connolly to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interest of the United States.

We're going off gold temporarily, he said. 54 years later, we're still temporary. But that decision unleashed something that has been building for decades, the great American inflation. Here's what Many people, including myself at some points, don't really understand. Nixon didn't close the gold window because he wanted to. He closed it because America was bleeding gold to finance the Vietnam War and the Great Society programs at the same time. We were trying to fight a war abroad and build a welfare state at home, and we were paying for it both by printing money. The Europeans, especially the French, figured this out. They started demanding gold for their dollars. Charles de Gaulle called it America's exorbitant privilege, our ability to print the world's reserve currency and export our inflation to everyone else. So by 1971, foreign governments were draining Fort Knox faster than we could pretend that it wasn't happening or that everything was going to be fine. So Nixon had to slam the gold window shut. It was supposed to be temporary. It became temporary. So by 1979, inflation was running at over 13% annually. Now think about that for a moment. Your money was losing more than one-tenth of its value every single year. If you saved a dollar, it was worth 87 cents 12 months later. Without any risk, without any investment gone wrong, just by existing in the monetary ecosystem that we live in. But here's what's really important to understand. This wasn't just about economics. This was about empire. The dollar's credibility as the world's reserve currency was collapsing. OPEC was pricing oil in German marks. Foreign central banks were dumping dollars for gold and other currencies. The same pattern we've studied in previous episodes were playing out in real time in America. Remember Rome's worthless denarius started as solid silver, ended up as worthless base metal. The Ottoman Empire's currencies went from carefully inspected silver to debased copper alloy. America in 1979 was walking the same path. We just didn't realize it at the time. The political establishment was doing what political establishments always do. They were looking for easy solutions. More spending, more stimulus, more money printing. Because that's what democracies will do When the going gets hard, they will choose the path that feels good today and defer the pain to tomorrow. And that is a truism of democracy. In my humble opinion, politicians will almost always make that calculation because they're not thinking long term. They are thinking about getting reelected in three years or four years or two years. And that's as far as their time horizon lasts. It's a big problem. It's a huge issue with democracy. But it's also true that empires that don't defer pain or that do defer pain don't stay empires for long. They fall apart. So let's talk about Volcker. So in August 1979, Jimmy Carter appointed a six foot seven former treasury official named Paul Volcker to chair the Federal Reserve. And Volcker understood something that most economists and politicians didn't. Sometimes You have to destroy the village to save it. So on October 6th, 1979, a date that should be remembered alongside Black Tuesday and the day Nixon closed the gold window, Volcker announced what markets later called Saturday Night Massacre. The Fed was going to stop targeting interest rates and start targeting money supply directly Translation, they were going to jack up interest rates as high as necessary to kill inflation no matter what it did to the economy. So within months, the federal funds rate hit 20%. 20! Let me put that in perspective for you real estate investors listening to this. Mortgage rates hit 18%. Credit card rates went to 25%. Corporate borrowing stopped. The pain was immediate. And it was brutal. Think about what we've just gone through with our increase. And we went from, what, 1% to 5%. Imagine going from 5% to 20%. Think about that. Unemployment shot to 10.8%. The highest since the Great Depression. Manufacturing collapsed. The Rust Belt got way worse. Farmers couldn't service their debt. and they lost family land that had been held for generations. Small businesses died by the thousands. Real estate crushed. Construction stopped. Sales stopped. The entire industry went into hibernation because nobody could afford an 18% mortgage. Volcker became the most hated man in America. Protesters surrounded the Federal Reserve Building. Homebuilders mailed him wooden planks, two-by-fours of messages telling him what he was destroying. One Democratic congressman called for his impeachment. But Ronald Reagan, who had campaigned on supporting Volcker's policies, quietly suggested maybe it was time to ease up. The pressure was enormous, but Volcker held firm. Here's what a lot of people miss about the Volcker period. It wasn't just about inflation. It was about something deeper. It was about whether America was still a serious country capable of making hard choices. Think about it this way. Every empire that's collapsed has faced and failed this exact test. Rome could have stopped debasing the denarius, but it would have meant cutting back on bread and circuses. The Ottoman Empire could have maintained sound money, but it would have meant losing some wars. Britain could have maintained the gold standard, but it would have meant accepting economic reality instead of financing empire through debt. They all chose the easy path, print money, debase currency, defer the hard choices to the next generation. Volcker chose differently. And in 1982, after this pain, something remarkable happened. Inflation broke. It fell from over 13% to under 4% in less than two years. The dollar strengthened dramatically. Foreign investors started buying American assets again. The foundation was laid for what would become the longest peacetime expansion in American history. And here's the key insight for investors. The cure was more painful than the disease, but it worked because it was credible. Markets believed that Volcker would stay the course no matter what. And that credibility, that trust, is what has maintained American monetary hegemony for another generation. So what lessons can we We as real estate investors and LPs and people thinking about this take from this story. Or said differently, why am I telling you this story? Because understanding Volcker helps you understand something fundamental about how wealth is really created and preserved. In 81 and 82, when interest rates hit 20%, most real estate investors got wiped out. As you can imagine, we're having wipeouts right now at a 6% interest rate. Can you imagine if it was 18%? The leveraged players, the guys betting on appreciation, the developers who needed cheap money to make their projects work, they all got crushed. But some investors not only survived, they thrived. Who were they? First, the cash flow focused operators. If your building was generating enough rent to cover expenses and debt at reasonable leverage levels, you could wait out the storm. Buildings that cash flow to 12% rates still cash flow to 18% rates. Second, the disciplined capital allocators, the investors who had kept powder dry, who hadn't leveraged up in the easy money years of the mid-70s. When distressed properties hit the market in 82 and 83, they were the ones with capital to deploy. Third, the long-term holders, the investors who understood that real estate is fundamentally about providing shelter, not about financial engineering. And when the monetary smoke cleared, people still needed places to live and work. You know who really cleaned up in the late 70s, early 80s too? The Persian-Iranian diaspora. Quick history lesson for you guys. When the Shah of Iran was driven out, and highly relevant given what's happening in Iran right now, this is an important story, Khamenei, was driven out, drove the Shah out of Iran when the Shah was overthrown in the Iranian revolution. He co-opted a pro-democracy movement of students to become the Ayatollah, the Supreme Leader of Iran. And the wealthy, the progressive, the less religious, and Jewish Iranians all fled Iran en masse. The timing is interesting. There's a reason... And those of you that don't know this, you're about to learn something great, that we call Los Angeles Terangeles. It is a huge minority of Terangeles. Los Angeles is Persian. And they arrived in Los Angeles at the optimal moment, the optimal moment, when Volcker had just raised rates. People were defaulting, losing their buildings. Buildings were trading at nothing. They had the know-how. They had some capital they had brought with them, and they were able to acquire huge amounts of Los Angeles, which is why today we call it Tarantulas. So all of this, this gives us what I call the Volcker test for modern real estate investment. It's not about surviving 20% rates. I don't think anybody could actually survive that. But it is about asking, what would happen to your portfolio if rates doubled from here? If we went from What would happen? Most investors would still get crushed, but some would survive and even thrive. What is the difference? They're not betting on cheap money continuing forever. Here's how I think you can go about passing the quote-unquote Volcker test. First, cash flow discipline. Buy assets to pay you a meaningful return from day one. Don't speculate. Don't speculate. Don't bet on refinancing at lower rates. Understand what level of risk they're taking. Financial engineering of returns with debt is a very dangerous game. It works until it doesn't work. And when it doesn't work, it's a disaster. We are finding that out today with many buildings. Third, own and supply-constrained markets. Own real estate where building is hard and demand is structural. When monetary conditions tighten, these markets will hold value better because the fundamentals are strong. The goal is isn't to survive the impossible. It's to build wealth that doesn't depend on everything going perfectly. So here's where this gets interesting for today's investors. And I've been mentioning this multiple times, but I kind of want to finish on this note. The setup we're facing now today rhymes perfectly, pretty perfectly with 1979. We've had more than a decade of essentially free money. The Fed funds rate was at zero for most of the period from 2008 to 2022. Asset prices have been inflated by cheap credit. Government spending has exploded. We've been financing consumption with borrowed money and calling it prosperity. Does that sound familiar? The difference is, and this is scary, the difference is that this time the debt levels are way higher. The political will for hard choices appears much weaker. And we don't have another Paul Volcker waiting in the wings. But here's what I think most investors are still missing. We might not get another Volcker because we might not be able to afford one. The debt levels are so high now that 20% interest rates wouldn't just cause a recession the way they did under Volcker. They would probably cause a complete financial system collapse, which means we're facing a choice between two bad options, inflate away the debt through currency debasement, I bet we'll do whatever one always does and we'll choose inflation, which means you want to own real assets, not financial assets. You want to own things that hold value and currencies weaken, not things that are promises to pay and weakening currencies. So how do you position for this? How do we build wealth that can survive either scenario? whether we get another Volcker or we get continued monetary debasement. And I just want to be clear, I don't think we're going to get another Volcker. And I don't think we have the political appetite, nor the will, nor the desire, nor do I even have the desire for them to raise interest rates to 20%. I think it seems like inflation is getting a little bit more under control, but our debt level is out of control. So let's think about this. The Volcker test that I proposed isn't really about surviving 20% rates. It's about building portfolios that don't collapse when rates move against you. The main thing, the main thing that will protect you, in my humble opinion, is owning long-term fixed rate debt where it makes sense. If you can lock in rates for 10 to 30 years on cash flowing properties, you're essentially, essentially shorting the dollar at government exposure, right? Think about this also when you think about debt. It's a really important point. I'm not sure everyone understands this point. Fixed rate debt becomes less painful for you over time because the currency with which it's funded with is debased over time. It's good to be a recipient of long-term debt in an inflationary environment because your interest payments don't rise and the value of that debt. Remember the example where we said 13% inflation and the next year your money was worth 87% of what it was before? It's the same with your debt. It's the same. So if you have long-term fixed-rate debt and you have a bet that the economy is going to continue to inflate away its problems, taking long-term fixed-rate debt on real assets is a genius move, is a powerful move, as long as you can lock it in. Lock it in. So here is the deeper question that Volcker's story raises. Do empires need philosopher kings to survive? Do they need leaders willing to be hated for doing what is right? Volcker was unelected and essentially unaccountable. He imposed massive pain on millions of Americans to preserve the integrity of the monetary system. From a democratic standpoint, that is quite troubling. But from an empire preservation standpoint, it isn't. worked the ancient romans understood this they had a concept called the dictator not in the modern sense but a temporary leader appointed during crisis with extraordinary powers to make unpopular decisions the idea was that sometimes democracy is too slow and too accommodating to deal with existential threats so volcker was effectively america's monetary dictator for about four years, and he saved the empire. But can we count on finding another Volcker when we need one? Can democratic systems make hard choices when those choices involve short-term pain for long-term preservation? I am not optimistic, which means we as investors need to plan for a world where monetary discipline might not be imposed from above We need to impose it on ourselves. Here's what I want you to take away broadly from this episode. Paul Volcker understood the difference between saving the system and saving the people in it. And in the end, he chose the system. It sounds harsh, but think about it historically. Every empire that's tried to save everyone in the short term has ended up destroying everyone in the long term. Rome tried to keep the bread and circuses going through currency debasement. It worked for a while. But eventually the whole system collapsed and the dark ages followed. Volcker chose temporary pain to avoid permanent damage and it worked. As investors, we face the same choice every day. We can chase yield by taking on more risk, more leverage, more complexity. We can bet on easy money continuing forever. We can prioritize today's returns over tomorrow's security. Or we can build and think like Volcker. Boring discipline. focused on long-term credibility over short-term performance. The choice you make will determine whether you build wealth the last generations or just ride a bubble until it pops. One last thought. I started this episode by saying that every empire faces the choice between destroying the economy to save the currency or destroying the currency to save the economy. Volcker chose to destroy the economy temporarily to save the currency permanently, and it worked. But what if We don't get another Volcker. What if the next time we face this choice, we choose differently? Then, as I said before, you will want to own assets that appreciate when currencies depreciate. You want to own things that cannot be printed. You want to own real estate in places where people have to live and work, regardless of what happens to the dollar. Because here's the thing about empire collapse. It's not the end of the world. People will still need shelter. Commerce still happens. Wealth still gets created and preserved. It just flows to different assets and different people. The question is, will you be positioned to receive that flow or will you be holding promises that become worthless when the monetary music stops? That's what I wanna leave you with today. Paul Volcker saved the American empire through monetary discipline, but he was the exception, not the rule. Most empires choose the easy path and face the inevitable consequences. As investors, We cannot control monetary policy, but we can control our own discipline. We can build portfolios that don't depend on easy money forever. We can choose boring assets that work in any monetary environment over exciting trades that might only work today. Think well, act wisely, build something today. Timeless. If you enjoyed this episode, please share it with your network and leave us a review on whatever platform you're using. It really helps the show grow. And if you haven't already, subscribe to the Timeless Investor newsletter on Substack, where we deep dive into these themes with historical analysis and practical application. The link is in the show notes. I really appreciate you guys joining me this week for this deep dive on Paul Volcker and an incredible turning point moment in American and monetary history. I look forward to seeing you all next week thank you for joining me have a great week.