Did Macro Kill Crypto? with MacroAlf

Thankfulness Nation, welcome to another state of the nation. Very important topic, a topic that is top of mind for I think everyone in crypto right now. Did macro kill crypto?

Can crypto recover? As crypto investors, what do we need to know about the macro environment? Is this gonna be like 2008 all over again? Maybe something worse? What happens to our risk on assets like crypto? When are they going to recover? Alright, so who's our guest today, David?

The guest on the show today, Ryan, is this guy named Macro Elf, who runs a macro focused newsletter called The Macro Compass. And he has produced some of the most just well reasoned and thoughtful macro analysis that I've seen in the last six months or so. And it really, to me, answers the question: what does it take? What needs to happen for risk on assets, our precious crypto assets, to reach all-time highs again? What needs to happen before that happens? And the answer, Ryan, is kind of a lot of things. And so we go through that in the in the show today, and like all of the things that we need to get past in order for us to accept risk again as like not just like investors in the crypto world. We all already accept risk. But what does it take for the rest of the world to also accept risk? Because that's what it's going to take for them to come back and pay attention to the crypto industry. And so that's really what we're diving into here on the show, Ryan.

That's awesome. And before we get into this episode, we gotta tell you about our friends and sponsors that. Alright, so David, we're gonna get into this episode. What should people pay attention to as we talk to Macro E.

So this episode with Macro Elf is one part Macro Elf telling us the current state of macro markets, which is useful, but it's also one part a classroom. And so I learned a lot while doing some of my research for this episode with Macro Elf. And he's just a great educator that is simultaneously teaching us about how the macro world works, as he's also telling us about how it is right now. And so listeners should should just kind of pay attention and like be prepared to get your learn on about you're gonna learn about the structure of macro markets, and you're gonna you're gonna be able to understand the answer to the question, what will it take for the world to go risk on again? Because he talks about the economy as a as a pyramid and how the bond market is at the very bottom of the pyramid. And we really need to make sure that bond market does okay if people are if we want people to go on risk on. Uh and so listeners should pay attention to that. Like there is a structure here in the way that the global macroeconomy works, and macroalph just really lays it out uh what that structure is and what the state of that structure is and how it's going to change uh in 2023 and 2024. And one day it'll finally change in our favor. But things need to happen first. Uh so pay attention to all these details.

Guys, let's uh level up on macro. But before we get into the episode, we want to thank the sponsors that made this possible. Bankless Nation, super excited to introduce you to our next guest, Elf. Macro Elf, that is. He is the former head of a $20 billion investment portfolio. He's a passionate global macro investor, and he writes a free newsletter, which I think is the best in the game in terms of keeping up with macro. It's called the Macro Compass. It's available on Substack, publishes every week. Elf, thanks so much for joining us at Bankless today.

Hey Ryan, David, nice to be here. Thanks for inviting me.

Uh Elf, I think we need some help here. Okay, because uh we need to learn a little bit more about macro on bankless. We've done a number of macro episodes, people like uh Lu Graman, Lynn Alden, Jim Bianco, etc. Uh, and uh macro is actually a focal point, I think, for crypto right now. And I I'm wondering if you could, uh, help us through some of these, some of these topics, some of these things, but also put yourself in the position of a typical bankless listener. So someone who's maybe a macro novice but dangerous, knows some of the terms, is kind of financially oriented, but doesn't know all of the details of how bonds work, for instance. They're gonna have some assets in crypto, right? Because they're listening to bankless, and how can you not? Um, they're also gonna have some traditional assets. Maybe they're worried about the future right now. Things seem uncertain. We've got all sorts of things going on politically, uh, globally. Um, 2022 has been a tumultuous year. Uh, and maybe they're worried about their portfolio, worried about their money as well. So, can you start us with the high level here? What do bankless listeners need to know about macro? What's going on right now?

So, Ryan, what they should know is that macro is long term trends and cycles that intersect with these trends.

And people shouldn't confuse the two. So, right now we're in the middle of a

very strong cyclical slowdown.

Long term trends, we can debate about those later, but first and foremost, right now the cyclical

Macroenvironment we are will dominate the trend for the next year or two. And the cycle I'm discussing is a cycle that is diametrically opposite to the cycle we have seen in the second half of 2020 and in 2021,

where both financial money, and we will define money later on, but financial liquidity, as it's mostly called by commentators, was thrown at financial actors at an unprecedented pace,

and the fiscal authorities made sure that real economy money, the one that reaches our bank deposits, actually, was also increased and one of the fastest spaces ever recorded under my metrics. That was the dual.

Real economy money and financial economy money that was thrown at the system at once at a very fast pace.

And that led to the very sharp nominal growth increase that we have seen in 2021 and the inflationary pressures we are seeing now upcoming in 2022. But remember, Ryan, David, and the listeners, macrocycles and money generally works with a lag. And so as 2020 and 2021

Has happened, and we now see the lagged effects of those.

What's happening today, actually, we'll see its lagged effect happening in 2023 and 2024.

Some of those lagg defects are already happening. And what effects am I talking about? I'm talking about the effects of reversing

the extreme money inundation, financial and real economy money that we have seen in 2020, 2021. So bear with me for a second. You have, when it comes to real economy money, when is the last time that the US government sent checks at home to people?

That's April 2021. It's been a year and a half since we have had the last meaningful fiscal impulse in the US. I can say the same for Europe. If you look at China, they're deleveraging very, very aggressively at the moment. So the bank accounts, the real economy money of the private sector is now not growing anymore, not nearly as it was in 2020, 2021. What about financial economy money? Well, the Federal Reserve and other central banks are in the process of making sure that that shrinks too. And that's quantitative tightening. It's the process of removing financial economy money, also called liquidity, from the system. So now we're going to be seeing the lagged effects of this double tightening of real economy money and financial money. In the second half of this year, we are already seeing that. And then in 2023 and 2024, that's a cycle we will be in going forward.

So I I think that's a really interesting way to parse apart the the two kinds of money in the economy. You're defining two different kinds of money, the money that we as individuals might interact with, the numbers that we see in our bank accounts, the cash that we keep in our wallets, uh, and then uh what you're calling financial money, which is I think just like perhaps like larger institution money, bank-to-bank money, things inside of what we call like the financial system TM. And you're saying in 2020 to 2021, the the paradigm was uh those both of the supply of those two kinds of monies were just like going up bigly. That's what the paradigm was. And now the new paradigm is the inverse of that, where in 2022 to 2023, we gotta pull that but uh the the leadership financial system has to claw that money back. So we're doing interest rates, uh, the money's gotta deleverage the system. And you're saying that there's a lag time between what is happening versus what effects that that will take on the economy. Is that a fair synopsis of of what you just said?

That's a perfect summary, David. And the most complicated part is understanding that there are these two tiers of money. The money that people use, the money that corporates use, is not necessarily the same money that financial institutions use, banks use, pension funds use, asset managers use. That's f a financial form of money. 2020 2021 was a combination of both tiers of money going through the roof. Right now we have a combination of

Both tiers of money getting effectively destroyed, or at the very least, the amount of money creation in both tiers actually slowing down very aggressively. And if you give it 9 to 12 months, 15 months in some cases, growth slows down, earnings slow down, inflation slows down, risk assets have a problem. And actually, if there is anything that works in those environments, it's mostly cash or very defensive assets. And that's effectively what we have been seeing in 2022, right? That's just the beginning, I would say, of the lagged effects of the double whammy monetary tightening that we are seeing since the very beginning of 2022.

So is it is it fair to claim that because we saw inflation come in with a lagged effect, uh, we had money issuance, money distribution, and then inflation six to eighteen months later. You're you're saying like, well, that same in uh effect of lag time will also happen for deflation. So like really the the already high level takeaway is that throughout up to through maybe throughout through 2023 and beyond, we're going to be in a deflationary environment.

I would expect that there is no valid reason for which, cyclically speaking, David and Ryan, as we have seen a nominal growth pick up, so real growth and inflation both picking up in 2020 and 2021 and 2022, we shouldn't see the reverse effect happening where both real growth and inflation at the same time slow pretty aggressively in a disinflationary trend going into the second half of 2023 and 2024. Remember, you always need to face in a lag. Some of these things work with a lag. The typical example is uh the housing market and inflation. So if you look at the housing market, basically in 2021, the second half especially, it was incredibly hot. And that's because mortgage rates were very low. That's because people had received a boost to their income on top of that. So they had a lot of firepower to go and boost these house prices. Later on, rents also started increasing very aggressively. That was a story of the first and now even the second half of 2022 when this rent inflation plays into the overall inflation measures that the Federal Reserve is tracking. Now, guess what happens? Mortgage rates have gone to 7%.

Incomes are not growing anymore as they used to, in real terms, especially, they're shrinking, which makes the housing uh situation completely unaffordable. So, what will happen is that again, with a lag going into 2023-2024, house prices are likely to fall, housing activity will fall, jobs will be lost, rents will stop going up, and therefore also the housing related component of the inflation basket will start going down. So, again, it takes a little bit of time for this monetary phenomenon to feed into the economy and in asset prices, but ultimately with a lag of generally nine to eighteen months, depending on what you're looking at, they do feed into real economy uh activity and asset prices.

And and you're just using the housing market as a microcosm of many other industries as well, right? Like maybe maybe it's an easy narrative to explain in the way that, like, okay, housing market was once hot, now it's cooling down, and as a result of that cooling down, we're going to l have like a drop off in the housing labor market, and that's going to impact the economy. And I think you're just using this as a story that is probably true of many other industries as well, and perhaps the global economy.

Yeah, that is correct. So the reason why I'm using the housing market is because it's gigantic, it's because it's intuitive, it's because it's leveraged, and it's because it's on everybody's balance sheet at the end of the day, either via rents or via mortgages or owning a house. So it's something that is very familiar, but the housing market represents roughly, together with these ancillary activities in the US, around 15% of US GDP. It's a relatively large sector because of its very relevant nature for everybody and because of its leveraged nature. 87% of transactions in the US housing market are backed by a mortgage, which means that interest rates moving up or down, financial liquidity moving up or down have a very immediate and leveraged impact on the housing market, which is also a large portion of the overall economy. That's why I've used it, David. But in principle, I could have made similar assessment for European corporates or Chinese corporates or anywhere else. The principle remains the same. If you throw real economy spendable money out, which means you increase the amount of bank deposits that we own, that corporates own with a lag, will be inclined to actually spend some of this money, boost nominal economic activity, make earnings go up, make the economy grow, which was the story of 2021. Now, if supply is also bottlenecked, then inflation obviously goes up because the demand is artificially pumped up cyclically while the supply can't be pumped up, and so you also have inflation. But now we are reversing that, and we are reversing that very aggressively, not only by stopping the real economy printers, so government deficits in the first place, but also by removing financial liquidity from the system. And that's the job that not only the Federal Reserve, but also the European Central Bank is now keen on doing.

It's really interesting, Elf. So so I think a lot of people um they're they're scared to kind of think about macro or talk about macro because it seems uh complicated. But what I love about the the story that you just painted is um it's pretty damn simple. Alright, so uh just to kind of recap.

We had this money creation period, both real and financial money, 2020 to 2021. And then

nine to eighteen months later, we pay for this type or the ramifications of that sort of money creation event start to show up. And we see that in asset prices going up, uh home prices going up, inflation going up.

And that has been the story of the last 24 months. We've seen the effects of that money creation. Now we flipped and we're in a money destruction period where real and financial money is uh being destroyed, not being created, it's actually being destroyed. And so what can we expect on the other side of that? Houses price house prices to fall, asset prices to fall, jobs to be lost, uh incomes going down, uh, and also inflation going down as well. Will this be the remedy for inflation, do you think?

Yes. Cyclically speaking, I don't see any major reasons why

such a a withdrawal of accommodation from the system shouldn't result in the same move down in inflation. And Ryan, this is when I I wanna stress out that I'm talking about cyclical

Slowdowns and cyclical pickups. Remember at the beginning when David asked me about macro, you asked me the first question about macro. I made the distinction between cycle, cyclicals, and long-term trends, right? So we're talking about a cyclical trend here. I would argue that we saw a cyclical upswing in nominal growth and inflation. We're going to be seeing a cyclical downswing now in inflation as well. When it comes to long-term trends, we might open another discussion. And also when you obviously, when investors look at crypto, look at other asset classes, at investment decisions, their time horizon can be very long, especially if they're very young and they want to invest in something for the next five to ten years. Nevertheless, risk management through macrocycles is very important. So I always want to talk about both. I want to make sure that people have the right frame of thinking when approaching macro. So the trends are maybe a different story, but cyclically speaking, I do expect inflation to slow down, yes, in 2023.

An alpha this uh money destruction period. It sort of started happening, would you say, at the end of 2021, but definitely into 2022, is that the case? And so this is why you're saying like we can expect to pay for that like now and for the next, you know, nine to twelve months, nine to eighteen months into 2023 and 2024. Is that a rough timeline of this cycle?

So so Ryan, I build a metric that encapsulates and proxies the growth in real economy money.

So financial money is one tier and real economy money is the other. So I try to measure whether us as the private sector and corporates are actually getting our bank deposits pumped up or not. Or to which to which extent is this acceleration of real economy money there? And under that, G5, so the five largest economies basically pull together, that credit impulse metric basically peaked in the fourth quarter of 2021.

Now, very punctually, if you ask me, nine months later, so roughly by the half of uh this year, the first half of this year already, we started seeing the first signs of forward-leading indicators actually slowing down. PMI service went down, the first cracks appearing a bit in earnings. Some companies were more defensive when announcing earnings. Now, we have seen in these uh earnings releases that Amazon and other large companies are starting to see some hits when it comes to earnings, right? Those are very large companies, systematically important global companies. You are seeing very evident economic slowdown already. Now, how long does it take for inflation to slow down? That's next lag and near I and people should understand that in in macro there are forward leading indicators, coincident indicators, and lagging indicators. Now,

Credit impulse is one of the most forward leading indicators of all. It tells you whether real economy money is being printed or not. And that peaked in Q4 2021, and after that, it's been slowing down. Six months later, survey forward leading indicator, PMI service, ISM service, other service actually start to decline. 12 months later, so roundabout now, you start to see earnings declining.

Next leg to fall is going to be the labour market.

The labor market is a coincidence indicator. Companies will actually first try to cut discretionary spending and only later on adjust their headcount if they see the economy slowing down. It's not an immediate process. So the next shoe to fall will be the labor market, somewhere between next quarter and the quarter after that, at the beginning of 2023. And only when the labor market cools down, Ryan, you can have wages cooling down, which means the nominal spending power of people also goes down. They'll need to be more conservative, they'll spend less, the demand side of the economy will get a big hit, and inflation will slow down too. Also, the housing market will have slowed by then, which means that with the lag, rent pressures will be slowing down. All of that I expect to happen in the second half of 2023, until to the point where in 2024, I expect federal funds rate below 1%. And remember, we'll be picking at roughly 5%, more or less, at the end of this year, beginning of next year. I expect Fed funds to be below 1% in 2024.

Wow, that's a big change. Uh I I want to actually share this um metric that you were just referring to, the global credit impulse uh metric. And um, you know, one question about this cycle. So again, we're still we're still talking about the cycle. We're not talking about the long term. We'll we'll talk to some of the talk about some of the the long term implications. But what I'm now showing is um macro elf's global credit impulse uh cycle. And one thing I notice here, which is kind of a question about this cycle specifically, elf is um

It seems higher. The high seems higher, and the low seems lower than previous cycles. Because this chart goes all the way back to 2004, if I'm correct. And I want to ask you specifically about this cycle. I don't know, I guess the word is maybe volatile than previous cycles. What is unique about this cycle compared to the last? Is this cycle different?

It's a very smart observation, Ryan. And this cycle was unique for two reasons. The first was the combination of real economy money printing and financial money printing at the same time, which is something that rarely happened in modern history after World War II. And the second thing that made it very unique is that there was an exogenous shock, which was the pandemic, that basically

Made the foundations of our leverage system tremble. And it trembled because of an exogenous shock, which effectively led to a response which was not very easy to measure. The United States printed over $5 trillion in real economy money. This is government deficit, which means that the government blows a hole in their balance sheet and it throws money at the private sector without taxing them. That's what it means. It's unfunded money spending. And it ends up on the balance sheet of us. It's money that's been spent for us. $5 trillion, Ryan. It's 25% of GDP.

This is like a w uh this is a warlike fiscal response, in even even like a large war, I have to say. So effectively the exogenous shock

uh was an event where policymakers couldn't really measure the amount of stimulus that was needed.

And so they ended up doing too much in certain jurisdictions. The US is a typical example where these ended up overeating the system. And we saw, if you the chart you pulled up there, have you seen these cycles, these wings, right? You pump up the system and then you drain this money creation. Have you seen what happens to earnings? So those orange dots or these blue dots on the chart were actually earnings per share in the S P 500. So how much the companies are actually growing their earnings year over year, lagged by 9 to 12 months. So again, give it a little bit of time, give it nine to 12 months to see the effect of this monetary expansion.

Earnings grew by 52% in 2021. This is just gigantic. Now, obviously, when you withdraw now very abruptly that stimulus, what happens is that you should expect economic activity to slow down at least proportionally. Also, the other point is that our system becomes more leveraged as we go on. And now we move to discussion a bit to the trends, right? Because so far we talked about cycles.

But the way that our system works is the following.

We after the 80s we are not able to engineer organic growth anymore.

And how does an economy engineer organic growth is by uh having more people participating to the economic growth, which means labor force growth.

Good demographics, we have a lot of kids entering the labor force, we have a young population that produces. Or, andor, this population is very productive. So it's the productivity of labor and the productivity of capital. If you sum up labor force growth and productivity, you obtain what's called potential growth, which is the organic growth that an economy is able to generate without cyclical boosters, just by its own means. Now, in the 80s,

potential GDP growth in the US, according to my estimates, was roughly 4.5%.

Every year the US would deliver 4% real GDP

just by its own means. Why? Because demographics was good, population was young, productivity trends were good, etc. etc.

Now, after the 80s, there has been a massive decline in this trend. Demographics has turned against us.