127- Is This the End? | Lyn Alden

Welcome to Bankless, where we explore the frontier of internet money and internet finance. This is how to get started, how to get better, and how to front run the opportunity. This is Ryan Sean Adams. I'm here with David Hoffman, and we're here to help you become more bankless. Once again, guys, the bankless journey has veered into macro territory because we got some big questions. These are tumultuous times in macro markets. And we brought on Lynn Alden, who is the perfect person to tell us more about this. And our basic question for Lynn, David, was are we gonna be okay? And her answer was kinda. It depends. Not really, it's complicated.

The big question is, how are we going to get out of this? And this is what we asked Lynn. A few things to look out for in this episode. Number one, what's the checkmate for central banks? When do they come to an end of their capabilities? Number two, why crypto is the only honest market left? Lynn makes the case for that. Number three, is this capital R recession going to turn into a Capital D depression? And number four, a theme of this episode is what decade are we in? Is this the 1940s? The 1970s? Or oh my God, is it the 1930s? I hope not. Number five, we end with some tips on how to prepare, just basic life advice, what you should do to store your value with your career, even in kind of your family world. David, this is just a great episode for us. I think put a lot of missing pieces together for me in all of the craziness that has been the last three months, maybe the entirety of this year of 2022 in macro markets. We've had wars, we have inflation, we have the Fed doing all sorts of craziness. Now we have a recession. What's that going to turn into? We get into all of those subjects.

Yeah, the fog of war for macro markets and even crypto markets right now is really, really thick. Everyone's confused. Multiple people from multiple different parts of the world have stated that this is some of the hardest times, the hardest market like sentiment to invest capital. No one knows how to invest or where to invest. People are just, they feel frozen. They feel like they have paralysis. And that's because the macro markets are so confusing. There are so many different things at play. And so we go through a list of them just with Lynn Alden. We talk about the choices that the Fed has made and the choices that the Fed has left to make, and how there's not really very many tools in the tool belt for their Federal Reserve. So those choices are kind of fixed. And so when we fix that steering wheel, where does that trajectory take us? And then we go into the macro, the external forces, commodity prices, energy prices, food prices. Those things are kind of fixed too. There's not really much influence or choice that we as humans have over these things. And so when we blend all these trajectories together, where do we go? And so that's ultimately where we conclude with this podcast. And then we finish off with, like you said, Lynn's advice. And her advice was grab your bear market buddy. Uh, because you know, you need to not go alone into the bear market. And so that's what I'll say now is as you go listen to this, grab your bear market buddy. Because

Listen with a friend.

Might need it.

Send this to a friend.

Yeah.

Guys, in all the chaos that's going on, I think you'll get a rare breath of signal from this episode because Lynn is always clear of thought and will help you shape the next decade and your outlook on it. We're gonna get right into the episode with Lynn Alden, Bankless Station, super excited to introduce Lynn Alden. She's back again on Bankless. Anytime Lynn comes on the podcast, you know there's something going on in macro, and today is no exception. Lynn is the founder of Lynn Alden Investment Strategy. She's a leaning expert in macro markets, focuses on long-term debt cycles and how that's impacting everyday markets. Of course, a ton to discuss on crypto, on fiat, on bonds, on equities, on whether Jerome Powell is gonna steer us off a cliff or whether we're gonna be okay. And so, Lynn, we want to find out what is going on. My first question to you first of all, welcome back to Bankless. It's great to have you. And then could you answer the question is this the end? Like, are we all gonna make it? I think a lot of people are worried. I'm worried myself. What's going on here?

Happy to be here. Thanks for having me. I think we can divide it into a couple different time frames. And so in the kind of the big macro scale, I've been using the framework of Ray Dialio, the long-term debt cycle. And so in that conception, it's the end of something big, right? But of course, the end is a long process and it can be a decade-long process. So I think that basically, you know, with the long-term debt cycle, every several decades, when you reach a massive amount of debt, when you go down to zero interest rates and you have kind of just massive amounts of debt in the system, usually you go through some sort of currency devaluation and system change, right? So it's not the end of the world, but it's the end of an era, basically. And I think that's something we're seeing in a number of markets. But, you know, to get less doomy than that, if we focus more on the near term, we're in a you know cyclical downturn. And not all cyclical downturns become recessions, but some subset of them do. And so when we look back over the past, you know, let's say pre-COVID, we had like a 10-year-long, you know, economic expansion in the United States. We still had three cycles within that decade long period of accelerating growth and then decelerating growth. And it's just that the decelerating growth never became negative growth. It never became an outright recession, even though you had a couple near misses there. And so what we've been in over the past more than a year now is a decelerating growth environment.

And then combined with the fact that this one is so inflationary, you know, kind of leading up to that, that this one is becoming more severe and it is kind of starting to look like a recession, at least by many indicators. So it does not look like a recession in terms of employment yet, but by most other, especially leading indicators, it does look more recessionary. And tying this into crypto, you know, to the extent that I'm here, historically, when you look at you know Bitcoin and crypto bull markets, a lot of people tie it to the Bitcoin halving, which I think is relevant to some extent, but it also actually matches up very, very closely with these economic accelerating and decelerating environments.

And so, for example, we can use the perching managers index. It's kind of a go-to macro indicator for economic acceleration or decelerating. It looks like a sine wave over time. And they average roughly three year cycles. And it just so happens that all the Bitcoin bull runs were during these rising PMI environments, and all of the downward or choppy sideways periods were in declining PMI environments. And of course, that all of crypto kind of goes up and down together, maybe with a little bit of a lag.

And a lot of what dictates the PMI environments is also liquidity conditions. And so central banks and kind of dollar liquidity around the world generally, you know.

one of the big questions was, for example, why is Bitcoin not serving as an inflation hedge? And of course that would extend to any sort of finite token. Why are these things going down when you ironically have high inflation and fiat currencies? And there's actually really good charts out there that show

You know, Bitcoin in particular, I use that one because that's what most of the macro people will look at because that's the biggest, most liquid one. And you'll see that you know in rising global M2, so rising global money supply year over year, Bitcoin does very well in that environment. And now we're actually in a period where money supply is growing more slowly than it was a year or two ago. And you have multiple central banks, mainly the Fed, kind of pushing back and strengthening the dollar compared to many other currencies. And so when you translate all that back into USD denominated global M2 growth, it actually kind of came to a standstill. So ironically, now that you know price inflation is happening with a lag from monetary inflation and some central banks are actually fighting back, it makes more sense as why we're seeing kind of downward price action in a number of assets, including Bitcoin and cryptocurrencies.

Lynn, you focus on like these long-term debt cycles, and you're really, really good at placing us in history, or at least like talking about what parts of history rhyme with our current phase. So I kind of want to pick your brain as to like where we are in the arc of this long-term debt cycle. And just for added context, we brought you on, I think our first episode with you was episode 48, January 18th of 2021. And we titled it The Death of the Dollar Dominance. And this was basically a prelude of things to come where the dollar was really just going to lose its place as like the king of, you know, global currencies. And like we've seen events, you know, especially lately, where you kind of see the writing on the wall. And then we had you on in August for episode 76, titled Inflation in 2021. This is when inflation really started to pick up, which is one of the things that we kind of predicted with that dollar dominance. We were going to see dollar inflation. And now here we are in July of 2022. And there's that like gif, that famous internet gif of that truck and it's hurtling towards a wall. And like you just know it's going to crash, but then it cuts and then it's going to crash and then it cuts again. It never actually crashes. But it that feels like the question that Ryan started with like, are we at the end? This feels like with just like extreme inflation, extremely high interest rates, this kind of feels like the last hurrah before we really start to see like the actual just reduction of the dollar dominance. Would you agree with this arc? And just overall, where are we on this arc, this long arc of the global debt cycle?

Yeah, so global debt cycles are kinda correlated to that global reserve status, but not necessarily the same thing. And so in the last kind of long term debt cycle we did see the transition from UK having global reserve currency to United States. One point I've been making for a while is that, you know

Now there's really no country large enough to have the only global reserve currency. That was kind of actually an anomaly that persists in history. It's not something that necessarily has to repeat over and over again. And then I think we're heading towards a more decentralized type of system. And I think that was somewhat accelerated by you know the events you've seen in Ukraine, right? So you have Russia initiated a war and then the West responds by cutting off their foreign exchange reserves. And then you kind of, you know, everyone kind of realizes around the world at the same time that wait a second, you know, the money like aspects of these reserves are maybe not as money like as people thought, right? If they can be censored, if they can be confiscated, you know, whether or not you agree with the reason, that now gives an incentive to a number of countries to be like, wait a minute, I mean, we're holding liabilities of countries that we're not necessarily fans of.

You know, what does that mean? What should we hold instead? And so I do think that we are now we are starting to see, for example,

Gradual shifting away from the treasuries by Russia was obviously early to do it. China's been doing it since 2013. You know, Japan has been a big buyer of treasuries, but now they kind of have to protect their own currencies. So they're they're not really buying treasures anymore either. And you've seen, for example, in some of the economic forums Putin has called for kind of you know alternative payment systems, you know, cooperation with some of the other peers like between Russia and China or Russia and India, for example. India's actually stepped in, even though India is more of a, you know, somewhat of an ally to the West than you know, compared to China or Russia, they stepped in to buy massive amounts of Russian crude. And so I do think we're seeing a little bit more of a multipolar world emerge rather than a unipolar world. You know, just kind of a US dominated global order, I think, is shifting into kind of a more multipolar, you know, multiple centers of power.

And right now we actually the dollar index itself is very strong. But that's in large part because it's heavily connected, you know, it's heavily based on the Euro and the Yen, and Europe's obviously having a very specific energy crisis, more so than even the rest of the world, and Japan's doing yield curve control with a very tight cap. And so basically it's one of those things where

You know, it's not that the dollar's weakening right now, it's actually quite strong, but the global demand for it, especially among foreign central banks, is drifting towards that more decentralized model. And if anything, over the past decade, we've seen a mild uptick in gold usage among central banks because, you know, obviously something like Bitcoin or these others are nowhere near big enough or stable enough for that for most of them to be interested. And so gold is kind of the, you know, the self custodial inflation protected asset that they could turn to if they want to, you know, hold money for a long period of time and not have counterparty risk.

So we have central banks that are definitely following the

Reducing the dollar dominance playbook. But we have the DXY, the Dixie, which is like the dollar strength index, having like I think 20-year highs or just really, really strong right now. And uh, so I want to ask you about the dollar milkshake theory, which I'm pretty sure you're familiar with. The idea that before there's a collapse in the dollar, there's a significant strength in the dollar because so many debts are dollar denominated both inside the United States and outside the United States, that even if we are on the precipice of like a total reduction in dollar dominance in the world, first people have to buy dollars to pay back their debts. And then the big like crash and reset happens. Do you ascribe to the dollar milkshake theory? And do you see that as the evidence of what's going on in the macro markets as supporting that theory?

So I think that the theory has a lot of merits. And I've actually met and and discussed and debated with the you know the person who proposed that theory, Brent Johnson. You know, got my acquaintance with him. And, you know, when people, when macro people debate that theory,

Mm.

you know, the ones that understand it, it's not so much they disregard this theory. The question is, how does that theory end up? And so basically that for people that are not familiar, that the point goes that, you know, United States is global reserve currency. That doesn't just mean that central banks hold it. It also means that it's the currency that most offshore debt is denominated in. So if an entity makes a loan to a developing country, either their government or a large corporation there, they often don't want to do it in their local currency. They'd rather do it in a harder currency. I mean, that could be dollars, euros, yen, things like that. And a dollar, of course, is the disproportionate one there.

And also, it's not even mostly US entities that are necessarily making those loans. Entities in Europe or Japan or China will go out and make dollar based loans to, you know, a country in Africa or a country in South America. And so as a result, the world outside of the United States has, according to the the Bank for International Settlements, something like $13 trillion in US denominated debt.

Now that's somewhat offset by the fact that the whole world outside of the US has something like 50 trillion in US denominated assets, right? So the US has run these gigantic structural trade deficits, actually about, you know, $14 trillion worth of trade deficits over the past, you know, call it 25 years or something like that. And they take those dollars and then they buy US assets. So they buy treasuries, those started to become kind of worse investments. They shifted to buying U.S. stocks.

They buy US real estate and things like that. They kind of pile it into financial assets. And so basically, when it comes down to the dollar milkshake theory, the point is that

if there's any sort of disruption in dollar cash flows, the strength of the dollar goes up dramatically because all of that debt represents demand for dollars. And so they have to basically they have a short squeeze. They have to buy dollars if they want to cover their own debts or or try to service them.

Now

Where that theory I think becomes somewhat self-defeating is that if the dollar spikes too much, like what we're seeing right now, and what we saw back in actually in March 2020, during the you know, kind of the worst of the COVID crash, it starts to cause, ironically, US recession, global recession, global liquidity problems, and then those foreign sec uh entities start selling US denominated assets in order to get dollars. So you start to get problems in the US treasury market, illiquidity problems, because the foreign sector stops buying or outright starts selling them in order to get dollars. And so, you know, first it hits other countries, but then it ricochets back into us. And I think that right now we're kind of in that phase where it's ricocheting back into us, and that's an environment where almost nothing other than dollars does well, including US assets, US stocks, you know, multiple things start selling off. And then of course Bitcoin and crypto is being so volatile and a smaller market, they generally, you know, there's some of the earliest things in the fall, they get crushed. But even things like, you know, equities, real estate, gold, just assets around the world sell off because basically this unit of account is strengthening so much and causing kind of forced selling.

That's interesting. Yeah, it's interesting how interrelated all of these things are, Lynn. And you know, you talked about sort of subscribing to Ray Dalio's long-term debt cycles, overarching thesis. And I've recently read his book, um, you know, Principles for Dealing with a Changing World Order, where he kind of looks historically at other empires and kind of the rise and fall of their monetary systems as well. And so you kind of wonder if this is sort of part of the fall of the US as a monetary leader. And I think you're indicating that, well, you know, before that happens completely, there might be an erosion, right? And there might be some pluralism in terms of the monetary instruments used. But I'm curious if you could kind of ground us with any historical analogs here. So is this like something that happened in the 1700s? Should we go back to our history of other empires? Or even I've heard so many people talk about this as the 1940s. Maybe that's a good analog, you know? Or others have talked about the inflation of the 1970s. Some people, when you start using the recession word, people immediately think back to 2008, which was in most listeners, uh, I guess every listener's lifetime who's probably listening to this. And it also feels like, hey, if things get really bad, if the recession, the R word turns into the D word, are we entering a 1930s type time range? So are there any historical analogs for this that come to mind for you? Or is this just the 2020s? It's it's completely independent thing and brand new?

So it's a good question. I mean, I think that that quote that is either correctly or falsely attributed to Mark Tra Twain is really applicable and I've used it a number of times, which is history repeats. I mean history doesn't repeat, but it does rhyme.

And so analogues I think are actually really useful, but of course there's no perfect analogue, and if you go back far enough, technology is totally different. And so basically the twenty twenties, you know, are their own thing.

But we still learn from periods of history. You know, but I think that the base is to understand different analogs so that one can then see how they're different from that. If they don't study history at all, they're completely blindsided, they think it's all unprecedented, whereas actually there were rather similar environments. And so I think we can divide that into two parts. One is the, you know, you mentioned Dalio's principles of focusing on that global reserve and rising and falling empires. And then that's different from maybe this current macro environment, even though I think they're related. So in that book, one thing he does is actually he'll take an empire and he kind of goes back in history. So there's, you know, kind of the call the Chinese one, the United States one, the UK, you know, the Netherlands. He goes back in time, maybe 500 years or so, and he tracks these handful of empires and he grades them on multiple scales, right? So there's like their education, their military power, their economic size, their global reserve currency status, basically the acceptance of their currency by their various trading partners in other countries around the world. And there are some that are more leading and lagging than others. So education, for example, is a rather leading one where that starts to rise before many of the others and then starts to fall before many of the others. Whereas the other ones, you know, because of network effects and momentum that takes a long time to turn around, those are more lagging. And so global reserve currency is actually one of the most lagging ones where all those other things come into place first and then their currency gets widely accepted. And then even as some of those other ones start to clearly deteriorate, the global reserve currency is kind of the last one to roll over because there's still so much network effect and usage for it that it's, you know, it's the incumbent. It's very hard to displace until.

All the other pieces are are there. And so Dalio often points to China as kind of the rising power compared to the United States, which is in many ways compared to the United States was the rising power compared to the UK.

I think that there is some accuracy to that, but I mean I don't think that, you know, transits into you know, 20 years from now we're all using the yuan, right? I think that's not what that means. I think that ultimately we're going to is again a more bipolar type of world, you know, maybe a tripolar world, whatever you want to call it, but not this kind of unipolar world. I mean, after World War II, which is maybe the closest analog, because that was the rise of the United States over the United Kingdom.

You know, most of the world was devastated. United States was kind of like almost untouched, right? And so we were building our allies, we were helping rebuild some of our enemies. I mean, we you know, we had kind of the last intact manufacturing base, and that was kind of uh, you know, becoming like a hyperpower status, which is which is pretty rare in history. And so I, you know, outside of something like that happening, I think that the era we're going into is somewhat more decentralized, somewhat, you know, different poles, and just you have the relative diminishment of the United States. I mean, we have something like what, four or five percent of the population at our maximum height, we were like two-thirds of global currency reserves. That's kind of an inherently unstable system. It's kind of it's hard to maintain that level of dominance. And I think we're naturally drifting towards where's the population centered, where are these different sources of power? And so I do think that we're headed in that direction. And then tying it into historical analogs in other areas, like what is this inflation similar to, what is this economic environment similar to?

I have been using the forties as the closest comparison. And the reason I've been doing that is so

when people think of inflation, they often think of the seventies, right? So they just go, that's the one they think of.

But the environment was quite different and the causes of inflation were quite different. The one similarity, I think, was the shortage of energy. But outside of that, you know, most of the money supply growth in the 70s was you had a demographics boom. You know, the baby boomers were entering their home buying years. You had a lot of bank lending happening. And so, you know, when commercial banks make loans, that increases the broad money supply. And then, of course, on top of that, you had some fiscal problems, but the deficits were actually much smaller. And a lot of that broad money supply was happening because of the banks. You also had pretty low debt as a percentage of GDP. And so, you know, Paul Volkel, for example, the head of the Fed at the time.

Could raise rates to double digits to try to, you know, kind of purposely put the US in a recession, stabilize the dollar for international creditors, and go from there. Right. So I think it's both the causes and solutions to inflation were quite different than what we're seeing today. And actually, I think a closer analog is the 40s,

which was, you know, you didn't have a lot of bank lending, you didn't have a lot of demographic expansion, but you had, you know, after the 30s, actually let's go back to the 30s. So you had this, you know, obviously 1929 crash,

and you had a decade long depression.

And you had rising populism both between countries and within countries, and that took different forms. I mean, obviously in Europe, you know, you had the rise of Nazism.

And that obviously contributed to global conflict. You also had populism in the United States, multiple other countries because of that tough economic environment.

And then eventually when you ran into the forties and you started to get that conflict happening and you worked out a lot of the leverage in the system,

you had, you know, huge fiscal expenditures, right? Because a lot of it was to fight the war and to kind of rebuild things after that period of you know stagnation and populism. And so the inflation that we saw in the 40s was very fiscally driven. It wasn't bank lending driven, it was very fiscally driven. So you had a sharp increase in the money supply.

And you had very high public debt to GDP, which means that the central bank couldn't raise rates to double digits because you'd bankrupt the federal government. And so they just held rates low anyway, despite significant inflation, and you had this huge fiscal driven inflation.

And I think that, you know, what we've seen over the past, you know, call it fifteen years has kind of been a replay of that, where

We had the 2008 crash. In many ways, it, you know, I have a whole bunch of charts out there that show it's it's very similar to the 29 crash in terms of it being a private debt bubble that unfolded. And then, you know, throughout the whole 2010s,

we had what in many ways was a mild depression. I mean, emerging markets basically they had,

you know, almost no, you know, except for China and a couple others, most of them had no dollar denominated GDP growth over a very long stretch of time. I mean, if you look at their stock markets, they've gone sideways in dollar terms for for 10, 15 years. You know, many of them have not had, you know, kind of substantially new highs in dollar terms. Even in the United States and elsewhere, you had unusually slow GDP growth. You had rising populism and tensions in the United States and Europe and many other countries.

And so we're going to be able to do

You know, going into this, we're very, very leveraged. And then we have, you know, the pandemic, and we have, you know, this this very leverage system hit by an external catalyst. And so we have something that looks like wartime finance in response. You know, trillions and trillions of dollars printed, ends up being a very inflationary as one would expect. And so I think that in many ways the 2020s are resembling the 1940s, but then there are some differences. So in the 40s, going back to Ray Dallo's conception, the United States was a rising power. We were running trade surpluses. Now we look more like the UK looked in the 40s, where structural trade deficits were kind of the incumbent power.

You know, we're more deindustrialized due to kind of shipping our supply chains overseas. And so there are a bunch of differences, I think. But I think the people should be familiar with the 40s if they want to have a you know kind of a decent macro framework here.

So is there a vague way where this plays out like the nineteen forties except the US is the UK?

Something to that effect?

Well, I think in terms of