“Nothing Stops This Train” | Lyn Alden on Fiscal Dominance

what these Technologies do is they allow people more freedom of choice in whatever country they're in they're able to go outside of their borders and and get assets or get monies that they can't get just purely internally basically the biggest tool we have against basically complete kind of replay of Prior fiscal dominance periods or the effectiveness of capital controls and it's I think it's worth defending welcome to bank list where we explore the frontier of fiscal dominance this is Ryan Sean Adams I'm here with

David Hoffman and we're here to help you become more bankless bankless listener if you want to survive this decade as an investor as a market participant maybe even just as a as a citizen in whatever jurisdiction you're in you can't draw on the last 40 Years of financial history that is a lesson today we have entered something different Lyn Alden calls this fiscal dominance David and I think this is absolutely key to understanding both crypto and the new world we've entered a few topics we get into today number one this new era of fiscal dominance why is

it inevitable number two Central bankers and fed interest rates do they even matter anymore number three how this world of fiscal dominance will feel what assets to hold what assets not to hold and number four how will crypto farare in this new era what about Capital controls are they coming to take your crypto we check in with Lynn every now and then just to get an update on the macro world what's going on out there and if you pay attention to Lyn's Twitter timeline you will have noticed just a reoccurring meme show up on her Twitter timeline called Nothing Stops

this train and I think after maybe the 20th or 30th time I saw a Lyden tweet talking about how Nothing Stops this train I was like maybe I should ask ly about what the hell that means uh and so that's how we got to this podcast here today uh what is what is that train and why is nothing stopping it uh was basically the motivation for this episode and this uh 90-minute master class in fiscal dominance was the answer so I feel very educated like I always do anytime Lyn Alden comes on the podcast so let's go ahead and get right into

that conversation with Lyn Alden all about fiscal dominance but first a moment to talk about some of these fantastic sponsors that make this show possible especially Kraken our favorite place to get out of fiscal dominance if you do not have an account with Kraken consider getting out of fiscal dominance with Kraken today there is a link in the show notes to getting started if you want a crypto trading experience backed by worldclass security and awardwinning support teams then head over to Kraken one of the longest standing and most secure crypto Platforms in the world Kraken is on a journey to build a more accessible inclusive and fair Financial

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Bist program because every time we bring her on the podcast I know we're going to get into a a subject in some exhaustive detail get educated along the way and once again coming to this episode to help us answer Lynn welcome back to bankless thanks for having me back happy to be here so so Lynn I think DAV and I want to explore this topic by way of meme if that works for you so this is a meme I'm showing it on screen right now that um you posted on Twitter I don't know if you created this meme or you you sort of seated around and really popularized it and so if people haven't

seen this before it's kind of the classic um there's a bus it's a like going over a train track and there's a train so that the top frame is the bus uh like going over the train track and there's a train sort of like in the like just about to hit it and the second of course is where the train just plows right into it and the first frame with the bus going over the train track says how markets trade for the past 40 years uh and the second the train is called fiscal dominance and Nothing Stops this train so this is like the imagery of we

are about to get hit by a train and we have to get out of the way so Lynn can you explain this meme because I think the the framing of this entire conversation is is based on a train that's about to hit us this train of fiscal dominance so what is this train what is fiscal dominance sure so you know Market regimes go through these long periods of time where they trade a certain way and there's certain forces that impact them and so over the past 40 years um the United States and much of the rest of the developed world has been

in monetary dominance and the kind of the simple way to put that is that a monetary policy is is very effective at either kind of re accelerating or slowing down an economy uh and impacting inflation and most of the money creation is coming from Bank Lending basically credit creation or credit contraction which is why those monetary levels levers are are powerful but in fiscal dominance um that situation becomes reversed which is that very large debts and and and fiscal deficits uh

specifically public debts and then and then fiscal deficits those are bigger drivers of inflation or disinflation or rate of rate of nominal economic growth and those sort of things and the Central Bank in this case the FED in the United stat starts taking a backseat their options become constrained by what's going on on the fiscal side because when they raise their lower interest rates it doesn't impact the fiscal side in the same way that it impacts Bank lending credit creation that kind of thing and

so you know a lot of people they have these back tests they have you know here's what happened over the past 20 30 40 years for example that stocks and bonds are often in inversely correlated for example um but going forward people that were looking at those metrics they were super important during a monetary dominant era are less likely to be um those metrics are less relevant is is what that kind of that Meme means that basically all these kind of ways of doing things all these expectations that people developed they made sense over a period of time but if it's true that we

are entering a different type of Market environment and developed countries have been in this in the past just not in anyone's current trading Lifetime and Emerging Markets go through this on a more regular basis you know kind of more frequently but developed countries have not been in this for a long time and so a lot of people's Mentor mental models are kind of tuned around monetary dominance and not around fiscal dominance so that's what the meme means and that's and we we can unpack what some of that means to put it in its most simple terms is it accurate to say that monetary dominance is simply the fed the

Federal Reserve uh interest rates whether we're cutting or increasing them just like what whatever the FED is doing and then fiscal dominance is whatever the government is doing whatever like more top down control about like who should get what who should get tax cuts who should get uh subsidies and so like one is one is the Fed one is the central bank that's monetary dominance and the other is the government is that like a simple way of understanding this yeah pretty much and I guess the one thing I would add is that monetary dominance is the combination of the central bank and then the broader banking system the

commercial Banks um their rate of lending or or not lending as well as different things the central bank is doing to try to accelerate the amount of lending that's happening or trying to slow down the rate of of lending that's happening that's all monetary dominance and then as you said basically all the fiscal side all those different things um that's fiscal dominance and fiscal uh you know when deficits are lower when public debts are smaller monetary dominance tends to be occurring that basically all those monetary forces are bigger whereas when you build up 100% or

more debt to GDP uh on the on the specifically on The Sovereign level um and you're running above Target deficits that are not really one time things they're more structural um that starts to override the power of that whole monetary side both the central banks and then even the broader banking system so that that bus that Ryan described in the meme how markets trade for the past 40 years I've heard this take from a number of different people that really the whole entire investment strategy over the last 40 Years or or so has just really been one trade which is uh the

debasement of currency the the um dilution of the US dollar and really it's a matter of like how fast or slow slow the FED is doing that all all other Investments have really been Downstream of that and this is what you're saying is actually coming to a close this is like the market structure that has defined the last era of anyone's like trading memory uh and you're saying that this this era is is likely coming to a close soonish because fiscal dominance is coming to replace it because something about fiscal dominance is not

stopping this train that train is not stopping this is kind of like the summation of this meme uh yeah more or less I think the thing I would add is that it's not just de basement per se because debasement happens under fiscal dominance as well um it it's really about that kind of 40 Years of of declining interest rates uh and and then the Tailwinds that that provides to a number of different asset classes so uh we kind of started from this high point in this in this current ERA of very high interest rates and then you go through 40 Years of every time there's a recession you can cut rates um generally

inflation is is on you know even though it's it's still positive it's it's declining from what used to be a high level to eventually by the 2010 you got to a pretty low level at least for Consumer Price inflation there's obviously different ways to measure inflation but declining inflation rates declining interest rates and basically all that was offset by Rising debt to GDP so you know over time more and more debt piled up on households more and more debt piled up on the public Ledger and that was offset by the fact that indust rates were declining and it kind of fed on itself because lower interest

rates allow more debt to accumulate um and then higher debt levels tend to slow down economic growth and kind of put pressure on a lot of things which which ends up kind of pushing interest rates down uh that that's kind of one of those tools that they use to kind of Kickstart the next um expansion out recession and the problem is when you run into zero and then you kind of start going sideways to up in terms of interest rates um you no longer have that offset for all those debt levels and private debt levels Peak around or shortly after the global financial crisis um whereas

public debt levels are still going up and when you look at history of how these kind of really long-term debt Cycles play out so not just the cyclical debt Cycles but these kind of more generational debt Cycles when they play out it does tend to happen in that onew punch where first you kind of hit some private sector maximum and then you start rotating that onto the public sector uh the debt starts getting transferred so for example you know you bail out the banks you kind of recapitalize them and and push a lot of the debt more on The Sovereign level and then same thing with with the response

during during and after the the pandemic and lockdowns a lot of the more private debt was kind of indirectly transferred to the public level so you have a little bit of deleveraging on the private side but that gets pushed up to the public level and that eventually comes out in currency debasement and fiscal dominance issues and so basically I think what the era that's behind us is that ever lower industry environment the structural disinflation uh from a high level environment and now we kind of go forward in an environment that really hasn't been seen in the in the developed

world since the 1940s um Japan's been in it kind of first in this cycle among the developed world you see it occasionally or or pretty frequently actually in the emerging world but it's it's not something that a lot of developed Market um participants have a lot of experience with at the you know in kind of their their current careers because it's all it's all been one trade which is indust trades keep going down valuations of both bonds and stocks keep going up and they tend to be counter cyclical you know they tend to be inversely correlated with each other

um but that environment is is Messier going forward in in more inflationary environments stocks and bonds tend to be more correlated um and also you start to get generally during fiscal dominance you get a rise of capital controls and other issues like that um which can manifest for example in this industry it can manifest in in attacks on privacy tools or self- custody or basically the ways to move around Capital so there's there's overlap there um and that's just a it's a it's a environment to be aware of and I would argue that there's not a a moment in time per se where you go

from monetary dominance to fiscal dominance like you're not in 100% of one and zero in the other it's just kind of change over that happens and I would say there's there's different ways to analyze it but I would say at least since 2019 the US has been in uh fiscal dominance more or less and when it starts to you know go over there's like you know a year or two where you're kind of in fiscal dominance and maybe you're briefly out of it again then you're back in it until until it gets so strong that you're more persistently in it so ever since early 2023 we've been in it

probably more persistently but kind of this whole Co era and and even just a little bit before it um this was kind of this is has been a multi-year kind of transition toward fiscal dominance ly there's so much here to unpack and I I think we're just like peeling back the the layers of the the onion here but I I want to make sure that um listeners get kind of their econ uh 101 um definitions of of of fiscal dominance and versus monetary dominance uh by way of um maybe

example right so um fiscal dominance that is like a govern so so both both fiscal and monetary I guess policy is what governs the the money system of any sovereign country right so we understand that there's these two pieces and uh in order to identify like which is which when we see things like uh quantitative easing or um like you know buying buying of of uh bonds or interest rate increases or decreases um all of the

Drone Powell fed type of activity that's going to be more the the monetary policy type controls uh whereas on the fiscal side when we see see things like you mentioned I like covid the covid stimulus or the PPP loans or even like more recently the inflation reduction act kind of like Congressional we are spending this amount on X program that is more on the the fiscal side of things would you say that's accurate what what are some like examples in each so that uh listeners can good good at

identifying the differences between monetary and fiscal yes that's accurate I think I think we can make the example more clear by referring to time periods uh and so for example when people think of inflation they often think of the 1970s the 1970s was a very inflationary environment um that was mostly uh inflation from Bank lending so there's really there's two main ways that new Broad enter circulation one is um fractional Reserve Bank lending and then the other one is um uh monetized fiscal

deficits so and you can quantify the size of what's happening there so in the 1970s I mean they they were running deficits but if you look at kind of the how much new bank loans uh are created each year um that's a that was a larger number than the size of the fiscal deficits that year and especially when you when you kind of look at that over any say roll 5year period um and so basically more money's coming because banks are lending and the reason that was happening uh there's a bunch of reasons but basically

the the Baby Boomers were entering their home buying years so you had a big demographic surge a lot of people kind of hitting their their period of peak credit formation and back then houses were cheaper so people could buy homes earlier they bought them often in their in their 20s or you know sometimes early 30s but they could start buying homes on average earlier than people do today so this big generation coming into um their home buying years their family formation years this kind of peak credit formation banks are making a lot of loans you have money supplies going up very quickly uh

and then you ran into price inflation because you had that higher than normal rate of money creation at the same time as you had obviously constraints in oil supply um and we're also running some background deficits that weren't helping even though they were they were smaller force and the way to get that under control was that Paul vulker the head of the Fed raised interest rates to the highest level they've ever been in the United States and the reason that was effective was because you know the the federal government only had 30% debt to GDP so there was not a lot of debt on

the the the public sector and there really wasn't even a ton of debt on the on the private sector but he was able to raise rates super high and what that did was that slowed down borrowers wanting to borrow money you know who wants to borrow money at double digits uh especially if that's much higher than the inflation rate so real real high nominal rates and real high rates compared to the you know kind of measures of inflation and so that really slows down the ability and the desire for people to borrow money and it slows down that rate of Bank lending it kind of puts the economy into a a credit

contraction recession um but you kind of wash out some of that inflation from the system you kind of reduce demand enough to allow Supply to catch back up to it and so that was that's an example of monetary dominance and action both the the cause of inflation uh and then the response to to having that high inflation uh whereas another big inflation period in the US was the 1940s and people don't really think of that uh decade when they think of inflation but that was roughly on average as inflationary as the 70s um but that was

that was the last time we were in fiscal dominance uh and so in the 40s Banks were not lending much at all that was not a a period of Rapid Bank lending instead uh the obvious context was World War II uh and so they had already gone through the Great Depression so they already had the big private debt bubble pop and they started rotating that more to the public Ledger um they kind of got stuck in this period of stagnation but then you know as populism grew around the world partially because of economic reasons um war broke out and when it came to war they did these massive

fiscal deficits the biggest deficits relative to GDP we've ever seen they were even bigger than what happened in the 2020s um and you know a lot of that goes to fighting the war but it you know that's going to commodity development that's going to Manufacturing when the gis come home it you put them through college and technical school and subsidize their mortgage and it's you know it's kind government spending programs basically exactly yeah really big really big stimulus in various ways and that and it's a lot of that the bonds they issued to fund all that because it's a it's a tremendous amount

of bonds they were bought by the you know the Federal Reserve increasing their monetary base uh then they were bought by the commercial banking system on fractional Reserve leverage um and so you had this huge spike in the money supply but it was not because Banks were lending it was because these really big monetized fiscal deficits were plowing money into the system uh and the Federal Reserve they were basically captured by the treasury so they kept rates low despite the fact that inflation was very high because if they raise rates it wasn't going to change the decision of

Washington you know they're not going to not go fight this battle because of what the fed's doing uh they're not going to change any of that and so it's not it's it's an entirely different tool set around that and So eventually after the war they pivoted more toward austerity and they had a number of kind of things in their favor to grow out of that problem uh but that's an example of fiscal dominance at its kind of its most extreme um whereas the 70s was more so a monetary dominance and and today in Emerging Markets you see um often there

is fiscal dominance happening the probably the best the clearest case of fiscal dominance today is Japan so they have over 250% debt to GDP um you know Bank lending is not at a very high rate at all some of the lowest rates of Bank lending in the world their money supply increase that is still fairly slow but the increase that does happen is largely because the government's running deficits and then the central bank is helping to monetize those deficits and so in higher interest rates are have a

mixed success record of dealing with that because it's not like it's not like they're going to change their government spending much based on what the Central Bank does in the same way that the private sector responds and so I think that's kind of a good Baseline to set it is is where is the money creation coming from and what tools are able to slow down or not slow down that money creation I think I think this is great and I I think that uh every no one listening has really lived through a fiscal dominance era so we're we're going to have to bring in some of those examples later in the episode where you talk about you the US in the 1940s and

like what was that like or Japan today or like um an emerging economy an emerging country like may maybe we can draw parallels uh there but I I want to ask you another point on the timeline that is probably closer to lived experience for uh the listeners to this podcast and that is something we all remember which was uh 2008 and the big Bank crisis now applying what we kind of like just learned here Lynn and you check me uh we were squarely in monetary dominance territory and the tools to like fix the financial system that was

utterly broken and like plunging us towards uh the deepest recession maybe depression since uh the the 1920s and 1930s was a monetary intervention and it was almost squarely a monetary intervention where rates dropped down to like you know zero uh and there were the bank bailouts of course quite quite famously and that's where like some of us started to learn this um like very esoteric term called quantitative easing these were all monetary policy instruments I don't

recall much of any fiscal policy intervention in fact that was some of the the criticism here and there was like an entire social movement uh Occupy Wall Street for instance why you you you you bailed out the bankers uh use your your instruments of monetary policy but there was no fiscal policy intervention like people didn't get stimulus checks like uh you know Main Street didn't get bailed out and so uh check check me on that was that purely monetary policy intervention and like if so why didn't we use more fiscal policy at the time or

like some combination of both so that was that was kind of the beginning of where fiscal started to become relevant so that was a mix of monetary and fiscal response um because that was a private sector um debt blow up for the most part um and so the biggest response there was monetary mainly in the form of cutting industr to zero and then doing quantitative easing um there were some fiscal components but as you pointed out they were more targeted on banks so some of the bank bailouts involved a combination of monetary and fiscal policy because they did things that the

FED is not authorized to do on their own and so some of that was actually injecting solvency into the banks not just liquidity but the other parts was was monetary um to the extent that there is fiscal support to the rest of the economy that was pretty minimal so for example there was things like Cash for Clunkers I do remember this that was like um what they they it was a government Pro program to like buy your used car was that what this was yeah basically it yeah it incentivize people to get you know get rid of their older car and buy a newer car try to help them out while also helping out kind of of

Industry um but that was you know that's like basically laughing stock in terms of size compared to the things we saw in these recent years there also I mean they they they gave a little bit of a boost to seniors it was like a tiny little stimulus check um if you were unemployed your your benefits were a little bit higher than normal so around the margins there was a little bit of fiscal support but more of the fiscal support was was directed to the banks to recapitalize them and then it was a very large monetary response and when you look at another way to phrase it is

how what is the fiscal support relative to so for example during that kind of 2008 2009 period a lot of loans went bankrupt so they defaulted and and one of the one of the few ways to really destroy money in the system is to default on a loan or or pay back Al loone and and don't you know don't refinance it actually pay it back um those are methods to to you know either rapidly or or slowly reduce the amount of money supply in the system and so during that period because of of loan defaults the money Supply would

otherwise have shrunk a little bit and the fiscal support that they did was about the same size as the loan defaults um and also just the Slowdown of lending that occurred and so they basically balanced it in such a way that instead of getting deflation we just had like zero inflation or like really low inflation you might have had like a couple quarters of of you know the way they measure it deflation um but it wasn't like some gigantic huge thing that was way bigger than the amount of loans being destroyed whereas when you fast forward to say the

2020s the stimulus checks were you know order magnitude bigger the the the stimulus checks the child care tax credits the PPP loans that turned into grants the corporate bailouts the you know down down the line all these all these kind of things that happened and the magnitude of those was way bigger than the loan uh defaults and so that was a net huge increase in the money supply in a way that did not happen in 2008 so 2008 was like hints of fiscal still mostly monetary where uh by the time you got into the 2020s

monetary policy is still a present Force but the fiscal side is is so much larger then is this too simple an explanation so both the fiscal and monetary policy interventions like increase generally always like in the direction of increasing the the money supply it's just a matter of kind of who gets it and when a policy tends towards monetary policy intervention then uh asset prices get inflated right we certainly saw that from like the time of you know the interventions in 20 like onward just massive uh run-ups in

stocks and all sorts of risk on assets and on the other side when uh there's a fiscal policy intervention that tends to go towards um kind of like I guess more directed to to Main Street and um wage increases or direct stimulus checks and that causes inflation of a different type which is a bit more of the Consumer Price Index CPI type inflation so is that uh oversimplifying the explanation of saying monetary policy equals asset price in inflation uh fiscal policy uh like intervention increase equals uh

Consumer Price Index CPI inflation I would say for the most part I mean fiscal fiscal can do both I mean fiscal when they use it is is probably it's generally a more powerful tool than monetary um so it can actually impact both asset price inflation and Consumer Price inflation um whereas monetary policy is is is generally more impactful on asset prices um it gets a there are some levers of course where monetary policy can impact CPI um you know for example if a currency has uh negative

real rates nobody wants to hold it um if they raise indust rates it could convince more of the foreign sector to to go and hold that currency which helps it find a floor so it stops devaluing and therefore it can you know say put a lid on Energy prices or other import prices so both of those types of policies can affect um asset prices or um uh consumer prices but it largely depends on who's being stimulated so if you're mainly stimulating banks for example that's not going to contribute to Too Much CPI growth whereas if you're

sending money to households um you are going to impact uh Consumer Price inflation at a at a much more level a higher level and another Factor that's kind of worth um clarifying here is it's not just the size of the deficits or the monetary policy intervention it's also the amount of aggregate debt that's on the public Ledger uh because that's why um if it builds up enough it starts to kind of invalidate monetary policy so an example of that is during the 70s federal debt to GDP was 30% right so

when they raised interest rates when vulker raised interest rates um it it put down pressure on private sector lending but at the same time it put upward pressure on interest expense from the government uh which is ironically kind of stimulatory that's that's money that's that's a fiscal deficit that's flowing out from the government to whoever holds those bonds and so you're basically you're you're with one hand you're pushing down the other hand you're kind of stimulating but because federal debt was low and most of the money creation was coming from Banks the

downward pressure was a lot bigger than the upward pressure which is why it was effective whereas when you go to today when you have over 100% de the GDP um the problem is that when they raise rates they do put downward pressure on the private sector lending we've seen that in the current data lending is slower than it was a couple years ago because rates are higher people aren't rushing out to buy homes or you know Rel leverage their homes and you know Corp corporations with high debt are running into issues so it is putting downward pressure but the problem is that the interest expense that it increases for