WBD343 Audio Transcription

The Truth About Inflation with Lyn Alden

Interview date: Monday 3rd May

Note: the following is a transcription of my interview with Lyn Alden. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.

In this interview, I talk to Lyn Alden, a macroeconomist and investment strategist. We discuss the growing concern of rising inflation, CPI as a measure and what the markets are signalling.

“CPI is a really crappy statistic for the most part… housing has gone up faster than CPI, food has gone up faster than CPI, healthcare has gone up faster than CPI, tuition has gone up faster than CPI, the cover price of the New Yorker magazine has gone up faster than CPI.”

— Lyn Alden

Interview Transcription

Peter McCormack: Lyn, hi, how are you doing?

Lyn Alden: Pretty good, how are you?

Peter McCormack: I'm very good.  I've just had my first vaccine dose.

Lyn Alden: Oh, nice!

Peter McCormack: So, if I collapse during the interview, Bill Gates has won!  Right, my favourite hour every month; looking forward to this; I've lots I want to talk to you about.  I do want to do a good chunk on inflation; I'm sure that's high on your radar. 

Lyn Alden: Yeah.

Peter McCormack: Not much has happened with the Bitcoin price since we last spoke.  It's gone up and down, but we're fairly flat from where we were.  But just before we start, what have you been generally looking at; what are you looking at right now?  What's on your mind, or what have you been thinking about over the last month?

Lyn Alden: A couple of things.  One is inflation base effect.  So, I don't know if we talked about this last month, but in case we haven't, or new people are sitting in, inflation's often compared year over year and so, last year, during April, May and June, inflation by most metrics dipped very low, because you had the initial shutdowns, things like that.  So when you're doing a year-over-year comparison, you can actually get some pretty high numbers, because you're comparing to a bottom of a dip.

Whereas if you were comparing to, say, February to February, it would be less extreme, because you would be comparing it to what was already a reasonably strong month, you know, before the pandemic.  So, we're going to get some pretty high headline CPI numbers.  And there are all sorts of issues with CPI.  I have charts coming out showing how most prices that we care about have gone up faster than CPI, but even the official CPI numbers are likely to be over 3% during this base effect period.  And you could overshoot to 4% or potentially higher. 

So, I'm watching that to see how the bond market responds to that.  The topic is going to be the idea that it's transitory, that this is an inflation spike; and because of those base effects, that's partially true.  But then, if you're a bondholder, how sure are you that they're transitory; or how big is this spike going to get; how persistent is it going to be; what's going to happen with ongoing fiscal stimulus?  And so, this could be an interesting period for bond market, gold market, Bitcoin market; just see how this plays out.

The other thing I'm watching is that as the base effect -- the other side of that.  As we look into quarter 3, that's some of the euphoria of really good year-over-year numbers.  So, it's not just inflation that has those base effects, it's also GDP growth and construction spending and retail spending and corporate earnings.  They all had a really bad quarter 2 of last year; that was their worst point, and so their quarter 2 year is going to be incredible.

But then, once you get into quarter 3, we pumped a lot of money into the economy.  Some economies are not really pumping a lot more; some of them are even starting to pull back and normalise.  So, some of the euphoria that's propped up assets ranging from Tesla to Dogecoin, basically across the board, good assets, good assets, a lot of that what's propped it up could start tapering and pose a challenge. 

The risk there is that even some good assets can dip and pull back if you get a broad market that isn't being held up by tons of stimulus anymore.

Peter McCormack: Right, okay.  Let's talk about some of these inflation numbers, because there was a tweet that got widely shared, I think it was last week, with a list of different commodities and various items, and it was showing the year-on-year inflation rate.  The headline, "Standout number was lumber", and I keep seeing various tweets relating to that; somebody saying, "A 2x4 is now $7; this is ridiculous".  But at the same time, the energy prices also had massively risen.  But I saw also Joe Rosenthal replied to somebody saying, "Well, what happened a year ago?" and we know that energy prices dropped quite significantly related to the COVID lockdown.

So, what are the standout signals for inflation that you're actually seeing and is there anything that's been slightly misleading?  And I say that, because I think sometimes bitcoiners can cheerlead some of these figures as an indicator that people should be investing in Bitcoin, but perhaps they're misleading.

Lyn Alden: Yeah, and I agree that some of them are misleading.  And it's one of those things where, because it's a sensitive topic, inflation, there are kind of misleading aspects on both sides.  So, the misleading part about some of those year-over-year numbers that Joe is correct about is that you're comparing that one year where commodities fell into a whole, because China just stopped buying energy, stopped buying copper; they were the biggest buyers; they were totally shut down.  And then you kind of exploded out of that big down part; so the year-over-year numbers are ridiculous.

But for example, if you back up and you look at commodities over the past 10 to 15 years, most of them actually are not all-time highs.  So, lumber is; that looks like a Bitcoin chart, and then you have gold touched new all-time highs in 2020.  It's been in a correction, but it still touched it.  Beef is at all-time highs.  But for example, the overall, if you take an aggregate of most commodities, it's actually been a 10- to 15-year bear market, because in the 2000s, you had a period of China had a fast growth rate, there was a lot of commodity command, we bought a lot of new commodity supplies online.  And then, when China slowed down and the whole world adapted, we've been in this period of commodity oversupply.

So, I think a lot of those year-over-year numbers, basically a lot of commodities are just getting back up to where they were before.  Oil's back up to where it was before the pandemic; there's some copper that are elevated, but still not at all-time highs; and then there are some that are at all-time highs, like lumber. 

But then the funny thing is, if you look at timber, which before it becomes lumber it's timber, that's actually not that expensive at all.  It's really about the bottlenecks of turning timber into lumber, so basically the refining that has to go into cutting that up and getting it treated.  So, a lot of that is about supply chain issues.  Same thing we're having in the semiconductor industry, where there are just not enough foundries to make the semiconductors. 

So, on one hand, focussing on those year-over-year numbers can be misleading.  And for readers that know what those base effects are, that can even turn them off.  They think, "Okay, people in this industry don't know what they're talking about".  On the other hand, people that are saying there's no inflation, especially over these several years, are also misleading, because CPI's a really crappy statistic for the most part.  And I actually have a chart coming out later today that just shows housing has gone up faster than CPI; food has gone up faster than CPI; healthcare has gone up faster than CPI; tuition's gone up faster than CPI; the cover price of the New Yorker magazine has gone up faster than CPI, a lot faster.

So basically, we've had a couple of deflationary areas, like consumer electronics, or things that you can outsource to China.  Those have been globalisation, technology; they've really pushed down the cost of things.  Same thing; your cell phone can now do what ten of your electronics could do a decade ago.  So, that's been the deflationary area. 

But then pretty much anything you can't outsource, or that isn't automated, has gone up faster than CPI and for most household budgets, that's still where they spend most of their money, you know, housing; education for their kids or themselves; healthcare costs, either through themselves or through their employer, which eats into their compensation total; those are the areas where we spend most of our money.

So, it's one of those things where we have had pretty significant inflation over the past 10, 20 years, but that year-over-year number is still somewhat misleading for how fast it's been.  Some of the things I'm looking at are the producer price index, which is kind of a precursor to inflation; that's been spiking.  You can look at the bottlenecks of industry, like we talked about the semiconductors, we talked about lumber, we've seen that in shipping over the past few months where there are only so many containers and container ships.

So, we have had various supply chain issues and that's how I'm monitoring it, whereas it's often the case that the truth is in the middle and that's what I'm finding here with inflation as well, that we are getting an inflationary impulse from the fiscal spending, but it's not like inflation is absolutely massive in that 12-month period.

Peter McCormack: Yeah, I don't even know if I retweeted it myself, but I did take a step back and reconsidered it and thought, "Is this misleading?"; look, there is a fear and a risk of inflation, but are we cheerleading this as bitcoiners as a way to support out thesis on Bitcoin; I worry that we do that sometimes.  And I was trying to theorise with, what is going on here with lumber?  Is it because house prices are going up?  I know out in the US, for example, a lot more properties are built using wood; is there an increased demand for housebuilding?  Or is it anything else?

I know for example here, because of the lockdowns, a lot of people have been doing work on their houses.  I spoke to a friend who's a plumber.  He said they've never been so busy.  There's so much demand and because of that, there's demand for electricians, there's demand for plasterers, there's a demand for carpenters; so, is this just some pent-up demand, you know, the economy's finding a place for people's money to go, because they can't have holidays; they're not going out to restaurants and to dinner?

I kind of wondered, is it part that; also, is part pent-up demand with the economy starting to pick up again as people come out of lockdown?  Is it a temporary inflationary event based on supply and demand, less so than an increase in the money supply?

Lyn Alden: Yes.  So, lumber does have some of those temporary issues and so as you point out, basically in many countries, especially the United States, there's been a movement from city to suburbs and this big grab for single family homes that, in the US at least, and some other countries, are made of a lot of wood.  Then, there has been a lot of remodelling and there is a bottleneck in terms of how many sawmills out there are able to turn timber into lumber.

There's also a money printing component because, for example, if you didn't have the fiscal stimulus, if you didn't have the stimulus cheques, the unemployment benefits, then few of these people would have been able to afford it, there would have been more solvency events, so the prices would not have been able to go up as much as they did.  Same thing, I've often pointed out that over the course of this pandemic, personal incomes are up, even though unemployment's down, and that's because we did various aid programmes to keep people floating and so that allowed them to keep spending and do things like that. 

So, there is an element where the fiscal stimulus was a part of these prices going up, but for these individual things that are going up way too much, like semiconductor shortages or lumber prices, that's also due to specific supply chain issues that, given enough time, should be rectified.  So for example, I wouldn't buy a lot of lumber here and hold it for five years, however long it lasts anyway, but basically this has capacity to eventually address itself; whereas there are some other areas like, say, copper where you can't just bring a lot of new copper to market.  So, mines take a decade to bring online; it's been challenging to find big deposits; so, there are areas where there are commodity bottlenecks.

Actually, I find when it comes to economists predicting inflation, I think a big blind spot that a lot of them has is the long-term, say 15-year, commodity cycle where you have these periods of there's tons of commodity demand, so a ton of people go out and find new commodities, then they oversupply the market, then we enter a long bear market and no one does any capex, or at least capex goes way down because it's unprofitable to do all the exploration and bring these mines up; and then eventually, you get really tight commodity markets.  Then, price starts going up and then, "Oh no!" and we're behind on our capex.  So, you have to spend years keeping up with that.

So, that long-term commodity cycle has a big impact on inflation, especially when you also consider different policies that are increasing the broad money supply, which is what we have seen over the past year, where the broad money supply has gone up a lot and that certainly has been a big factor for prices.

Peter McCormack: So, it's a mixed and complicated and more nuanced picture than people may be believing is happening there; that's fair.  So, can you back to, what was it you were referring to a moment ago; you said there's something you were looking at that's the precursor to inflation?

Lyn Alden: The producer price index.

Peter McCormack: What is that telling you?

Lyn Alden: It's basically, what does it cost producers to make things and also, you can look at different -- there are surveys that are done every month and also you can find out that companies are talking about inflation in their supply chains.  So basically, before inflation reaches consumer prices, it often shows up earlier in the supply chain, where producers are selling their products to other producers more; so, a company buys from another company.  Those prices start going up and if the company can't pass its prices onto consumers, then they get a margin squeeze.

So, basically there are precursors you can watch about inflation and some of those, they tend to be bigger swings than the final number.  So, during a recession, they can fall a lot more than inflation can; and then during booms, they can go up a lot more.  But they generally tell you the direction of what's happening with inflation a couple of months in advance.

So, that's kind of the stuff to watch and again, part of that is related to supply chain issues that are localised due to, you know, we've made an unusual number of changes over the past year, like our housing choices suddenly changed more rapidly than normal, things like that; but then it's also due to an increase in the broad money supply.  So, those are a couple of things worth watching as it relates to estimating inflation a couple of months out.

Peter McCormack: What's the producer index showing you?

Lyn Alden: Last I checked, it was something like 7% year over year, which points to CPI likely touching over 3%, potentially touching over 4% as we get these spring reports; so April inflation reported in May, May inflation reported in June, so we'll see what the headline numbers are.  And some of them, of course, like the bond market and other big markets care about the official CPI numbers, even though those generally understate based on the typical basket of a household expense.

Peter McCormack: Is the CPI a fair measure of inflation, because one of the things I struggle with inflation is I think it's one of those things that's quite relative?  It may be a good measure of the changes in the cost of living month on month for people; but for example, someone like my children, it doesn't really affect them.  But what does affect them is if house prices accelerate to such a rate where maybe they're in their 20s and they will want to buy a house; it's really pushed it out of reach for them.  So, is the CPI a fair rate of calculating inflation; should we have multiple calculations; is it just a good one for the government?

Lyn Alden: Yeah, it's good for the government.  I think there should be multiple kinds of measures of inflation and sometimes there are.  I mean, that's why those things like producer price indexes are useful.  You can also just look at, what is the raw commodity index doing, so what are commodity prices doing; that's one of the big factors of inflation.  Generally you don't have strong inflationary periods without commodity prices also going up a lot.

But like I said, over the past decade, the problem is the big areas of spending that most people spend their money on have gone up faster than wages and have gone up faster than the official CPI.  So, that includes housing, that includes food, that includes healthcare, tuition, childcare, things that you can't outsource or that are not deflated away by technology and smartphones and things like that.  Whereas on the other hand, your TV got cheaper, your computer got cheaper, but those are generally pretty small percentages of the household budget; so some of those other things are really important.

Another factor that's weird about housing is that obviously, CPI does not take into account most asset prices, so it doesn't take into account asset price inflation, the stock market or private businesses; it only partially factors in real estate, but it does it in a weird way.  So you actually have a thing where houses have gone up faster than inflation in most markets, so they've outpaced inflation; but then for example, because we've been in this multi-decade trend of lower and lower interest rates, including mortgage rates, the actual monthly payment to afford a house hasn't really gone up that much, even though the cost of the house has.  So, that can push down the quirky, wonky cost of owning a shelter. 

However, it's unfortunate that that doesn't change the fact that people still have to take on more debt relative to their income in order to afford that house.  So basically, it just means that of the monthly plan that they're doing, more of that at least goes to the house than goes to interest, to the bank, but basically those policies are still propping up housing prices.  So an ideal case would be, especially for new people entering the market, for housing prices to be cheaper than they are, especially on a ratio of housing price to median annual wages.

Peter McCormack: Is there any risk whereby we come out the long-term debt cycle, and I don't know what point that will be, but then interest rates will then start to go up and people might be trapped with payments they can't afford on houses they've taken on with these low interest rates; is that a serious risk; is that a serious concern for central banks when setting interest rates?

Lyn Alden: Well that was a big factor in what caused the Subprime Mortgage Crisis back in 2007, which was that these people, they bought at the -- there was predatory marketing really done by things like banks and then people bought into houses they couldn't afford and so a lot of them, the way they did it was, they had a really, really low variable rate and so after five years, that had a contracted thing where it could bump up to a market rate and suddenly, they couldn't afford that house anymore, which they really couldn't afford from the beginning; but now, they literally couldn't afford the payments.  So, that triggered this cascade of defaults that happened.

So, that's not a problem for people that have, say, 30-year fixed rate mortgages, or even 15-year fixed rate mortgages.  I know different countries all have different practices for what is normal for a housing financing scheme; so, it is a factor for variable rate mortgages.  So generally, after a long-term debt cycle, usually interest rates normalise, but there's always a question of what is a normal interest.  And obviously it changes based on what society's doing, what demographics are like, whether there's a period of technology boom happening.

Technology doesn't really happen linearly.  We have these big discoveries, like using oil or the internal combustion engine, or electricity, or the internet and smartphones, so you have this burst of growth and that can temporarily suppress costs for a number of years.  But over time, interest rates should eventually normalise, but I wouldn't expect at any time very soon. 

It's one of those things where, if you had a theoretical environment, like say the free banking era in the United States, where you didn't have a centralised yield setter, then you have different institutions setting different rates, which is actually what we see in the crypto lending markets, where you have different entities setting rates.  Some of them are more conservative than others, so you basically are willing to accept a lower rate; other ones push that more.  So, you saw that in banking systems in some periods of time.  Whereas lately, we've had a more centralised rate-setting mechanism, which doesn't necessarily correlate with what the cost capital otherwise would be.

Peter McCormack: Right, okay.  Last question on inflation, because you mentioned there the producer rate at around 7% would hint to a maybe 3% or even 4% CPI inflation rate; what numbers are concerning?  I know it's for different people; what numbers would be starting to, say -- I don't know if it alarms you, Lyn, but makes you really think, "Okay, there's a problem here"?  What numbers do you think concern the government, or do they not?  Is this what we've talked about previously; would they want higher rates so they can clear their debts?  What numbers perhaps should people listening be concerned about?  Sorry, tricky one.

Lyn Alden: Yeah, it depends on what assets you are focussing on.  So, from what I'm looking at, the maths shows that about 3% CPI this spring is just the entry fee; so that's from base effects alone and moderate inflation, you should touch around 3%.  Now, if you were to get 5%, that means there's more than people are expecting.  So, there are numbers like that to watch out for.

Now, from the government perspective, obviously different central banks have different policies.  Right now, for example, they generally are looking for more inflation and it's their way of measuring it.  And so, for example, the Federal Reserve uses core PCE, which kind of like the CPI basket, is not a fantastic gauge of inflation; but from their perspective, they want that to run hot.  So the Fed's long-term average annual inflation target is 2% a year.  The way they measure it, it generally undershot that for most of the past decade, so now they want to overshoot it a certain period of time, so that they can have it so that, in hindsight, it averaged 2%.  And again, that's the way they measure it.

So, the challenge for them, it looks really bad if, say, PCE is 3% and they say, "We're still going to hold interest rates to zero", because that means if you're holding money in the bank, then based on the way they're measuring inflation, you're losing 3% a year.  And also, there are concerns that if inflation gets out of control, how hot are the Fed going to let it run?  So, they have a delicate balancing act; they're going to push the narrative that it's transitory and they're also going to push the narrative that they "have tools" in case inflation gets out of control.

The problem is, their tools are also things that would crash a lot of these bubbles that we see, so that kind of goes back to how, as we look later this year, we have to be mindful about some of these central banks maybe trying to taper some of their activities, because they could start causing some fun activities in the market, you could say, where the bulls and bears wake up a little bit and things don't operate so smoothly.  So, that's how I'm watching that play out.

Another factor, when we look at inflation, is the idea of transient inflation, but that implies the prices go up and then come back down, so that's what you think of when you hear "transient inflation".  But what history usually shows is that inflation often comes in bursts, so the rate of change of inflation is transient; but then it inflates, but then it stays up to that level and that's a new plateau.

So for example, if you look in the 1940s, you had three inflation spikes and they were transient in terms of what the annual inflation rate was so it didn't keep accelerating, but it never came back down; it just went up to that new level and stayed there.  And of course, you can have individual things come back down like, you know, for example I think lumber will not be at this level permanently. 

There will be individual things that come back down but for example, we're starting to see companies like Coca Cola, or Procter & Gamble, raise prices and I don't think you're ever going to see those -- they're not going to be, in 2022, "Oh, the pandemic's over; we're going to go ahead and reduce our prices".  No, we've permanently increased the amount of money in the system, so a lot of these prices will be sticky, even if they don't go up at the same rate every year.

Peter McCormack: And we're also seeing shrinkflation.  I read a really good tweet the other day, an emailed newsletter from Marty Bent, where he shared something from a guy who was showing, I think it was just a packet of kitchen roll that had gone from 160 sheets down to 140 sheets, a very sneaky and easy way of getting away without increasing your rate.  Are you seeing much of that as well?

Lyn Alden: Yeah, that one, there are analysts pointing that out.  So, I know Jason Burack has pointed that out a lot, the idea of shrinkflation.  And there are a bunch of analysts that follow that.  The tricky thing about that is it's hard to measure.  So in theory, the CPI baskets are supposed to adjust for that sort of thing; they're supposed to have a like-for-like kind of comparison, but in practice I don't trust that to actually be happening.

I even posted a thing where the Economist has the famous Big Mac Index, where they just track the price of a Big Mac and it's iconic, it's funny; but also, it's useful in the sense that it requires multiple commodity ingredients, plus labour and energy, to make it, so it's actually not a terrible inflation measure; at least one of them.  So, that has gone up faster than CPI; not quite as fast as the broad money supply's gone up, but it's gone up faster than CPI. 

But then, of course, some of the questions from commenters are, "Well is the Big Mac the same as it was 30 years ago?"  So, probably not!  If they trim round the margins, if there's less beef in it, if they've added a couple of processed ingredients, things like that.  So, it is really hard to track a perfect apples-to-apples comparison; and that's one of the reasons that one of the rawest consumer price inflation measures is raw commodities, because copper is still the same as copper and oil's still the same as oil and gold's still the same as gold.  So, those input costs are important to watch.

That's one of those things where we have gone up a ton in the past year, but still the 2010s were a decade of consolidation and bear markets for commodities and so the risk is that, as we look out to the 2020s, this whole decade, I think we could see another decade that looks more like the 2000s, or the 1970s, or the 1940s where you have a rise in general commodity prices.

Peter McCormack: Wow, okay.  The next topic I wanted to cover with you is Biden.  I know you've touched on his tax proposals over the last month but generally speaking, he's been in office for a few months now.  Have you got a read on how he's doing; have you got a read on the economic policies from his, I don't know what you would call it in the US; we'd call it -- you'd call it "an administration", right?  What's your read on the performance of the Administration so far; have you got any indicators of policy direction?

Lyn Alden: Well overall, they seem to be trying to channel the FDR concept of government going big on aid and fiscal spending and things like that.  That's obviously going to be a controversial thing, because there are some people that are loving that, some people that are hating that; obviously the vaccine rollout in the United States has been one of the more successful ones, so has the United Kingdom, so they have that.  That was also set in place before, so they continued to accelerate it.  That's been one of the areas where the United States has been doing very well.

In terms of the fiscal spending, the big controversy coming up is how we define infrastructure.  It's actually a pretty bipartisan issue in many countries, including the United States, that we need some degree of infrastructure spending, that basically in the United States, for example, most of our interstate highways were built in the 1950s and 1960s and a lot of those bridges are still the same.  It just needs a lot of work.  Our roads are not very good.

If you look at third-party measures of infrastructure quality around the world, the United States is pretty weak in that regard.  So overall, there is infrastructure work to do to give a lot of those materials better, replace lead pipes that people drink out of, have faster internet, have more widespread access to fast internet; things like that that can actually boost productivity.  So, you put $1 in and you get $3 of economic activity out, because you're allowing people to work more.

Peter McCormack: Just a question on that: is there also another incentive to invest in these infrastructure projects during tougher economic times, just to create employment, to create jobs?  I know that's something that's happened quite regularly in the UK and during recessionary periods, we tend to have seen our government invest in infrastructure projects.

Lyn Alden: Yeah.  The general idea there is that, those recessions tend to be periods where you have a lot of people looking for work.  Sometimes you have lower prices; this time it's not really the case because of the aid we've had.  But in most recessions, you have lower prices, because there's less demand for commodities and so they come and say, "Well, if we're going to build a Hoover Dam, this is the time to do it".  So, you get people to work, you make use of the fact that there's that extra capacity in the system.  That goes back to that classic economic idea of trying to have a countercyclical spending policy to smooth things out.

The controversy in the current Administration is how you define infrastructure; so, in addition to those obvious forms of infrastructure, there's also things like childcare, or things that a lot of people don't have access to childcare, so that can actually impede their ability to work.  So, there's a desire to put money into that, to basically expand childcare, make it more affordable for people, but that doesn't fall into the traditional idea of infrastructure.

So basically, the way the politics are working in the States right now is that they're able to pass things; they have a totally divided Senate.  So, there are 50 people at caucuses with Republicans, 50 of the caucuses with Democrats and when that's the case, which is very rare actually historically, you have that perfect 50/50 split, the Vice President is the tiebreaking vote.  So that's obviously the Democrat Kamala Harris.  

The thing there is, you need every single Democratic vote in order to do that.  So if even one is not onboard, that person has a lot of power.  So, there have been, especially one kind of centrist Democrat that has put the brakes on some of these programmes; and then there are a couple of others that are also, certainly if you were to get into things like raising long-term capital gains taxes from 20% to 40%, there'd be a handful of Democrats that would not support that.  So overall, the big question later this year, and all the way through the midterms is, to what extent will they be able to pass an infrastructure bill?

So, the Republicans are proposing a more strictly infrastructure bill that's several hundred billion dollars; and then there's Biden's bigger plan which broadens the definition of what infrastructure is, but that has some challenges getting through the Senate.

Peter McCormack: Can we talk about some of these tax proposals as well?  So, the US corporate tax rate from 21% to 28%, am I right; I read this in your report, but I haven't actually researched the number?  Is this taking it back to before Donald Trump?  Didn't Donald Trump reduce the corporation tax level?

Lyn Alden: Yeah, it brings it to the halfway point.  So, the headline tax rate was 35%; under Trump it went down to 21%; and so this will bring it up to 28%, which is the midway point between those two numbers.

Peter McCormack: Sorry, I was just going to ask, when Donald Trump reduced the corporation tax, is this what is defined as a trickle-down policy; if they're paying lower tax rates, they've got more money to invest, more money to grow the economy?  Was there any impact on that scene from Donald Trump reducing those rates?

Lyn Alden: That's the idea of that kind of policy, that ideally they would invest more.  One thing I wrote on my newsletter back then, that was years ago, was that most of that is going to go to share buybacks and dividends.

Peter McCormack: I don't buy trickle-down!

Lyn Alden: Yeah, because we actually had previous examples where there's, say, under Bush for example, there's a tax holiday that let corporations bring money back and that flew into share purchase and dividends.  Because, in many cases, corporations already invest in the amount they think is appropriate.  Basically, they have a reasonable confidence that they can build a new factory and they will still have demand for that, those products and services, and that they're not investing for lack of more capital; and so when they have extra capital, they put it into dividends and share buybacks which is very good for, say, me as a shareholder.

Google, for example, just had an earnings report and they announced that they were going to do a $50 billion share buyback and that was great for the stock price.  And so that tends to not be an area that has a lot of economic impact, at least long term.  You get that growth spurt for a year when everyone's excited, but that's not super persistent.  It's one of those challenging things.  In general, I'm in favour of low corporate tax rates, but that's not the same thing as saying that if you lower it, we're going to get a ton of new jobs right now. 

I just think different places have to be competitive to make sure that corporations want to be in their jurisdiction and kind of allow them to function; that's just how it works out, where some types of tax cuts have bigger impacts than other ones.  So for example, if you cut payroll taxes, we've had this thing over the past couple of decades; part of the reason that the big FAANG technology stocks have done so well is that they're not very labour-intensive, except for Amazon. 

So, if you look at a long-term trend, corporate tax rates keep going down, right, so not even just a headline number; the actual effect of corporate tax rate after the headline number and various loopholes and deductions and things like that, that keeps going down and down and down; whereas, payroll taxes have gone up and up and up and have then gone sideways.  And then, also the cost that they have to pay for their employees' healthcare keeps getting more expensive. 

So, we have a general trend where it's actually very costly for either a corporation or a small business to hire someone, because we have high payroll taxes on them and their costs of supplying healthcare's extremely high; whereas on the other hand, the actual bottom line is taxed very lightly.  So, if you happen to be not a labour-intensive business, like let's say you're Apple and so, rather a small portion of your expenses go to labour, then that's basically a very good situation for you; you can do very, very well in that environment; the same thing for, say, Netflix.  So, Netflix is mostly a digital company.  They have very few employees per revenue that they get, so that benefits those types of companies.

On the other hand, if you're a labour-intensive company, then actually your tax rate's kind of high and when you include those payroll taxes and other sorts of burdens, that's why we've had an environment that's actually been challenging to hire people, or for people to keep up a big percentage of their paycheque.

Peter McCormack: So, the next thing is the long-term capital gains tax rising to around 40%.  I know this isn't particularly popular; you don't think it will pass through; but, do you get some indication here about the direction that the Administration's taking, rather than whether this policy itself will get through, or do you think there'll be a compromise; and what's really going on here, because it's this continual, gradual increase in taxes across the board?  But, are taxes really going to solve the economic problems that the US Government has right now?

Lyn Alden: So in general, that's a very big jump that they're proposing, which is why I think it's unlikely, because if you go back to that 50/50 split, there'll be a bunch of senators that do not support that large of an increase.  My base case assumption is that they'll probably get a small increase through.  They might get a 25% hairline corporate tax rate; they might get a bump up to 25%, maybe even 30% long-term capital gains taxes; I doubt they're going to get that 40% number, especially because when you factor on state taxes, you know, there are some states that will be over 50% for those. 

Those include some of the blue states, so it's going to be tricky to get some of their senators on board, or even some of their representatives on board for that type of increase.  So, the general trend we're seeing with this Administration is they want to, say, tax the 1% at a higher rate, then they want to provide more support for those other programmes we talked about, like infrastructure, childcare, services like that; and obviously, when you have that kind of dynamic, you're going to have that controversy between people of different political parties and getting something like that through the Senate.  So, that's one of those challenging political things.

Peter McCormack: Yeah, and it also feels like there's a very kind of interesting social, let's not say "experiment", but there's this interesting migration test going on in the US right now where people are realising, "I can just move", probably a bit more than they realised pre-pandemic, where most people were fixed due to where they work.  We've had this move to certain companies being able to offer homeworking a lot more, but also people are just a little bit fed up of the major cities and we're seeing people move to the likes of Florida, Wyoming and Texas.  Are you seeing an impact of this; is this something you're measuring or looking at at all?

Lyn Alden: There has been a migration towards some of these more suburban, or some of these sunnier or lower-tax states; that's when they've been happening.  Another thing, the kind of opposite anecdote to that, economists have generally been surprised, because in economic models, you kind of always assume perfect rationality, that everyone's a robot and just kind of optimises what make sense.  And, there's been this trend where people move for jobs less than you think.

So, if your local factory shuts down, you think okay, people will move to where the jobs are; but actually, a pretty small percentage of them move.  That's because, in practice, it's kind of that network effect where, say you have a spouse and they still have a job, and say you lost your job, so you work mobily and you can go somewhere else; well, unless both of you can move, that's a challenge.  Then of course, if you have parents in the area, so say you have a kid and the grandparents help take care of the kid sometimes, are you going to have them move to; same thing with friend networks?

So obviously, over time, as we get more digitised, it's easier to move, it's easier to get in touch with people, it's easier to work from different locations; however, it's not as easy as, you know, a lot of people who are able to move are people who have the means to do so; they basically have the money to move; they have the option to work from home; they have that more mobile choice.  Whereas a lot of people, it's sticky and it's actually challenging to move, because you can't get everybody separate from their jobs at the same time, go find new jobs; and it's actually a pretty big challenge.

Peter McCormack: That's fair.  Okay, I'm going to do a bit of a switch now, because there's a whole other topic I want to ask you about, and this was somebody asking me to ask you about this.  We often hear that the gold market is manipulated by paper gold and I've seen some commentary regarding, "There isn't enough gold to support all the paper gold claims".  I don't know about this myself; I'm sure it's something you've looked at.

I think something we would possibly therefore care about is paper Bitcoin and claims to paper Bitcoin and is there a chance that Bitcoin could be manipulated in the same way?  I'm not sure this is something you've looked at at all; is it something we should be concerned about?

Lyn Alden: I think it's something to watch.  So yeah, basically, when it relates to gold, the paper market is quite large relative to the physical market.  So one thing, for example, that you see during these big price movements is that often, let's say in March 2020, we had a big selloff across the board; gold fell, the paper gold price fell; but if you were actually buying gold coins, they either stayed the same or got more expensive and were actually hard to find.

So, if you wanted to get gold in hand in a week, that price didn't go down; whereas, if you wanted to buy a gold ETF or buy gold futures, where you cannot redeem it, or it's very challenging; they basically purposely make it hard to redeem it.  So some ETFs, you can't redeem it at all; futures, you can, but it's the exception to the rule, so it's this long process to actually go through it and do it.  So, those paper markets are meant to make it more efficient, but it also means that more people can have exposure to gold, or think they have exposure to gold than they actually do.

It's one of those things where it's like musical chairs; if everybody demanded physical gold at the same time, there's not enough gold for that to happen at the same time.  So, that has expanded; basically have you have that flexible supply to meet that perceived demand, and then most people are satisfied that they think that they hold gold.  It's one of those things that most decades, that works, but there have been periods in history where a gold pool can fail, because everybody demands it at the same time.

Now with Bitcoin, it's easier to settle, so you don't have the transportation costs; you don't have the auditing uncertainties of proving a bar is real.  And so, because Bitcoin has that technology that allows it to transmit more, there's less of a reason to have it to be so centralised and there's less friction that dissuades people from being able to do that approach.  So, as it relates now, the paper market is a smaller percentage of Bitcoin's market capitalisation than is the case for gold.

That's something to monitor to see that that continues to play out, or if it becomes more and more paperized, for lack of a better word!

Peter McCormack: Okay, let's talk a little bit about Bitcoin, then I'll let you go.  I'm going to quote you here; I just took something from your report, "Interestingly, Bitcoin both broke out and broke down since then, which was somewhat expected", you set two different price ranges.  So, I guess because we're in a bull market, your expectation was that we would break out; but if we didn't break out, then perhaps support would fall.  But, we've been through both.

My view is a little bit slightly different.  I've been watching these liquidation events with interest, because I follow one of the bot alerts that alerts you at the point where there's a liquidation event.  At some points, my Twitter feed is completely overtaken by these alerts; it's incredible the amount of liquidations that are happening.  I'm just wondering, is there potentially too much leverage; are there too many people trading with too much leverage and too much risk in the system, and that's making it easy pickings for those who can move against them or countertrade them?

Lyn Alden: Going back to that point about the "break out or break down", basically we were watching this Bitcoin consolidation play out.  And so, if you start making lower lows, that's not good for the technical signal; you obviously want to start making higher highs; so there were certain points I was watching and I was like, "Okay, if it breaks below this level, that's a little bit concerning; if it breaks above this level, that's great; my base case is it would break out", and then the funny that happened was it broke out, then it went below the range.  So, I was like, "This is actually a mixed signal here; we have to keep watching this".

So, one of the risks to watch out for is, during the 2013, that previous bull market, two bull markets ago, you had that double cycle.  Anyone that looks at that long-term log chart, you had a big blow-off top, then you had a really deep and long correction, then you had another one.  So, the question of this cycle, is it going to look like 2017 where it keeps going up with 30% corrections; or is it going to have a much weirder pattern where it goes up and then it has a six-month or longer big correction?

Just because we have investors that are price-sensitive and they don't want to have a big drawdown, it's just useful to watch that and see what's happening.  Obviously, different people have different characteristics for how they want to trade it or hodl it, so you can have a strategic holding, but then also you want to focus in on what the tactical price is likely to do over, say, a 6- to 12-month period.  So, I just tracked that for readers basically to see, how does this asset class compare to what other asset classes are; what are the risks; how bullish are we with, say, a six-month view, compared to the long-term view?

So, generally what we saw with this latest liquidation was mostly good news, in the sense that we cleared out some of the leverage and it bounced off of those areas we'd want to see it bounce, those metrics that determine, like the SOPR, that ratio --

Peter McCormack: That's the output profit ratio? 

Lyn Alden: Yeah, exactly.

Peter McCormack: Do you want to explain what that is?

Lyn Alden: It's that measure that shows basically, if it starts going below one, it means that a decent amount of people are now selling at a loss, so they're selling below their cost basis.  Generally, if you look at Bitcoin's history, that only happens in bear markets.  Usually, in bull markets, where you go down and touch around one or slightly below one, that tends to be a bottom of a correction, because very few people are willing to sell at a loss in a bull market.

So, if that were to start breaking down, you'd say okay, actually now we might be in one of those bear markets where you're not having that very strong uptrend.  But this latest correction did kind of bounce off that; that range, once that ratio got slightly below one, which was good to see.  So, I still remain bullish on Bitcoin in a tactical sense, let alone that longer-term sense, but there are certain levels to watch to make sure that that thesis stays intact.

I think these inflationary base effects and things like that, over the next quarter, are likely to be beneficial for the protocol and for prices in general; but I think as you get later this year, there are some challenges relating to potentially broad selloffs that could occur in asset classes, just because so many asset classes have been bid up to high levels, there's so much speculation and things like, you know, we saw the NFT craze; we saw the Dogecoin craze.  In traditional markets, you see tons of securities that are trading at extremely high valuations. 

So if we start to get some degree of tapering, or some degree of, let's say there's gridlock and there's no fiscal spending coming and so suddenly, some of the justifications for the market to just keep going up and up and up start to not be there anymore, then you could get a broad selloff in asset classes, which could circle back and touch Bitcoin as well.

Peter McCormack: This is why I think the part sale of Bitcoin by Tesla is super interesting.  I think it triggered some bitcoiners in thinking, "Elon, I thought you were a hodler; you're meant to hodl forever like that rest of us?"  Also, Elon claiming this was a test of liquidity, which -- well, you laugh at it and I part-buy it.  I was discussing this with Dan Held yesterday.  I've got a slightly different theory around it in that, I don't think Elon Musk cares about Bitcoin the way some bitcoiners do.  I think he cares about money, he cares about the impact of a crappy dollar, or inflation, against his ability to run his business.  I think that's an important point and I can see why he has the incentive to buy Bitcoin because of that.

But, I also think his primary concern is Tesla, SpaceX, his various companies and ultimately, whatever the value of the Bitcoin he bought is now -- he bought $1.5 billion; say it went up to $3 billion, I don't know, whatever.  But I can imagine he's just sat there like some docile hodler, waiting for some ten-year thesis to play out to sell it.  I think he and his team are probably very much analysing, looking at previous cycles and saying, "Well, look, this Bitcoin we're holding; it could be flat now, it could go up to $100,000.  We should start planning to exit part of our position, because we need these funds to run our business". 

I don't think it's beyond the realms of possibility that he's looking at it purely as a trade and how do they maximise this trade over a year, versus him being a philosophical long-term hodler?

Lyn Alden: Yeah, I don't really buy the idea that it was a liquidity test, because he tested liquidity when he bought it; that was kind of a big test.  And you could do metrics to analyse what liquidity should be.  I think it goes back to -- it's actually hard to say, because the funny thing was, he only sold part of the position and Bitcoin was only part of their cash balance to begin with.  So actually, you can phrase it in such a way that it's a big position or a small position for them.

What I mean by that is that the funny meme out there is that Tesla made more money by buying Bitcoin once than they made in their entire history of net income of selling cars, because they've always been operating at a loss, or very recently they're in a breakeven mode, where if you include the credits they get for renewables, they're kind of at that breakeven point and they're starting to report an actual profit, mainly from those credits.

But, they basically made more money from Bitcoin from this whole business of selling cars this whole time; so it's kind of a funny metric in that sense.

On the other hand, they weren't like MicroStrategy, where MicroStrategy put virtually their entire treasury into Bitcoin, whereas Tesla only put a fraction of their cash balance in anyway.  So, I'm kind of surprised that they were willing to sell it so quickly, because you'd think that that Bitcoin is their hedge, that they're just going to let it run; and I figure maybe if it goes up 5X or something like that, they might be willing to sell it.  But it's kind of funny that they trimmed it after a 2X, or whatever the number was.  I don't even think it went up that far since their buying period, but I could be wrong.  I think it's somewhere in that 2X area.

So, yeah, we'll see how it plays out.  I mean, Elon claimed that he didn't sell his personal holdings; he claimed that Tesla was testing liquidity; we'll see how that plays out.  We had another announcement of a company that added Bitcoin to their balance sheet as well.

Peter McCormack: Yeah, that was 2% though, right?

Lyn Alden: Yeah, and I think that's going to be the norm.  That's what Square did.  The number of companies that want to be like MicroStrategy, I think are very few and far between; whereas, a lot of those companies we talked about before, if CPI is, let's say, even 2% and they're getting near 0% on their cash or T-Bills, which is where they hold their corporate treasuries, they basically have a melting ice cube.  Then there's always the risk that inflation goes up to, like 8% one year; do you know what I mean?  Basically there are tail risks to their big cash positions.

So, if they put a small percentage into Bitcoin and that goes parabolic, that kind of defends the rest of their cash position.  And yet, if Bitcoin goes to zero, then it doesn't really care, because they put 2% in.  And so, that's the risk reward that a lot of those corporations are attracted to and so, I think that's what you're generally going to see for corporate treasuries, most of which won't be hardcore philosophical hodlers like Saylor.

Peter McCormack: Yeah, I mean I think Saylor is -- I don't really like answering for somebody, because really only he know, but just thinking it through, I think originally it was an idea and he's become quite a vocal supporter of Bitcoin now and I think he's become more philosophically driven over time.  But also, there is a game theoretic incentive for him to promote Bitcoin as well, so I'm not always sure with him.  But I wonder how much time he's spending on Bitcoin versus MicroStrategy these days, and is there the incentive for him to work on MicroStrategy much anymore?  He's probably way more incentivised to work on Bitcoin and promote Bitcoin in some ways.  I don't know; it's all super interesting.

Okay, final question: GBTC premium is down to -19%, which seems a lot and quite scary for some people and some of those who have been critics of people who have been trading the GBTC premium.  But you're saying that makes it look attractive.  Help me understand this, Lyn.

So, I'm pretty sure that Grayscale holds the Bitcoin in reserve that supports the price.  If it's such a negative, that seems like a good buy, because you're -- I know you don't own the Bitcoin as such, but you're essentially buying something that's being massively undervalued?

Lyn Alden: Essentially, yeah, you're buying something for 80 cents that cost $1.  But, it depends on what your purpose is.  So, for example, I like self-custodying Bitcoin, for example; it's one of the pros of it.  But for example there are people, say you have a Roth IRA; that's an American retirement account, for example where you have the brokerage, you could stick GBTC in your Roth IRA as a percentage of your assets and that gives you Bitcoin exposure that's tax free. 

So, GBTC used to be a very unattractive vehicle for that, because you basically would be paying a 30% premium over Bitcoin to have the privilege of having Bitcoin in your Roth IRA.  Now, you can buy it at a discount.  And, it's not the same thing as self-custodying Bitcoin, because you do have counterparty risk.  You have to assume that there's not some catastrophic theft of GBTC's Bitcoin, which is unlikely, but it's not out of the realm of possibility.

On the other hand, for people that have been investing in closed-end funds for a while, these discounts are not unusual and people are used to arbitraging them.  So, I'm kind of approaching it like that where I look at it like that and say there are ways that GBTC can do to eliminate that almost 20% discount.  That doesn't mean it can't go lower.  I'd be surprised if it went below 20% for a long period of time, but we never had this situation in Bitcoin before, so it's possible.

My overall case is that I think that's the market sending a signal that GBTC's fees are too high, because back when GBTC was the only game in town, they could get away with charging pretty high fees and having a premium and people still paid for that.  But now you have a bunch of new funds, you have a Canadian ETF, you have a bunch of other ways that people can access Bitcoin.  In addition, the exchanges and these other platforms like Swan, basically the ease of buying Bitcoin has gotten better.  So, the selling point for GBTC to exist and charge as much has gone down.  And so, if they were to reduce their fees, it's possible that would reduce the discount that people are paying. 

Then in addition, the long-term thing is that if they do get permission at some point to convert to an ETF, that would eliminate the discount.  So, practically overnight, you have that big gain there.  So, it's kind of an arbitrage on basically the probability of an ETF conversion or a fee reduction.  There are also things they could do, like they could sell Bitcoin and then buy back GBTC shares.  That's what some closed-end funds do; so, they hold a basket of stocks and then for whatever reason, that whole basket of stocks is trading at a discount to NAV that's pretty deep.  They can sell some of their shares and then buy back units of their own company, and that's actually accretive to people that own it.

So, there are kind of those things that they can do there, if the discount gets deeper and deeper to the point where it gets silly.  So, it's something to watch for people that care about arbitrages over time.

Peter McCormack: Awesome, brilliant, amazing update, Lyn, as ever; I always learn so much from you.  Okay, cool, well listen, I'm going to let you go.  I had something else to tell you; what was I going to tell you?  Oh, you're not going to be in Miami, are you; that's right?

Lyn Alden: Not this time, no.

Peter McCormack: Not this time.  Well, hopefully we'll see you at some point in the US this year.  I've found a way to get in, so I'm going to be in the US in a couple of weeks; I'm very excited about that.

Lyn Alden: Nice, congratulations!

Peter McCormack: Thank you, thank you.  Well, listen, have a great month and I will see you in May.

Lyn Alden: Yeah, sounds good.