WBD364 Audio Transcription

El Salvador Macro Outlook with Lyn Alden

Interview date: Friday 25th June

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 El Salvador making Bitcoin legal tender, other countries adopting Bitcoin, the Lightning Network and the reverse repo market.

“In a market that’s so held up by quantitative easing and fiscal stimulus, when you start to see these reverse repos and the Fed starts talking about the potential for tapering next year… that certainly gives the market some jitters.”

— Lyn Alden

Interview Transcription

Peter McCormack: Hi, Lyn, good to see you again.

Lyn Alden: Hey, good to see you, welcome back to your country.

Peter McCormack: Welcome back to you.  We actually got to finally hang out in person; did you enjoy Miami?

Lyn Alden: Yes, it was a lot of fun there, definitely.  That size of event is not really my speed, but it was a lot of fun.

Peter McCormack: It is mine, I'm a bit of an extrovert so I like it.  I thought it was pretty wild though, so many people.  Did you have a lot of people stopping you saying hello; did you get spotted?

Lyn Alden: Yeah, I definitely ran into that, especially on day two when I gave my talk, that accelerated it a little bit, so I definitely had a lot of people coming up; was happy to see them.

Peter McCormack: Yeah, you did your talk with Liz Stark, how did that go?

Lyn Alden:  That went well.  I really like the work that she's doing over there, and the rest of the ecosystem is doing on the space.  I wasn't super planning on travelling around this time, but when she wanted to do that talk, I definitely was happy to do it with her.

Peter McCormack: It's an important talk, especially since you and I saw each other we have the small announcement of a country making Bitcoin legal tender.  I actually went back out to El Salvador after Miami, so there's a lot happening there, but I guess there's a lot we can talk about there.  As ever I've got loads for questions for you, lots of things I want to ask you, especially to do with reverse repos because that's something that people have been asking me about to ask you.

I really think a good place to start is with El Salvador, so just to kick things off, what was your read of the announcement?  What was your initial reaction?

Lyn Alden: That was actually pretty surprising news, there is buzz around the conference that a pretty big announcement was coming, and I figured it would be some new roll out from the company or something, so I was pretty surprised by the actual news.  It does make a lot of sense because if they're getting remittances and they're paying a big chunk of those fees to places like Western Union and Strike and other Bitcoin applications can make that more effective, by making Bitcoin legal tender they can eliminate the whole problem of capital gains taxes, and they can start to implement that into their banking system more, so it does make sense.

Also, the follow up about potentially El Salvador exploring mining using its geothermal energy, I thought that was equally as interesting, especially with the hash rate migration that seems to be underway now.

Peter McCormack: Yeah, but could they have not just changed the laws to exclude Bitcoin from capital gains tax?  That would have been a much simpler way to cover the remittance problem, or do you think they had to make it legal tender for this?

Lyn Alden: No, I think you're right, there could have been halfway measures; so there could have been excluding from capital gains taxes but still not having merchants accept it.  The problem there is that when people receive remittances, then they have to exchange it for cash, they can't really use it too much except for maybe specific areas that happen, like Bitcoin Beach for example.  This gives them more avenues, so they can either convert it into dollars or they can spend it on merchants right away; and I think overall that gives more access points.

I think ultimately, a lot of people will convert those to dollars but instead of having it go through centralised areas, they can give it to a merchant and then the merchant can do the conversion on their behalf; it basically gives people maximum flexibility about it.  The whole part about merchants having to accept it is one of the more controversial parts, but at the same time the country said that they would provide training and provide ways that more merchants can accept it.  Ultimately, they can't if they don't have a smartphone or something, then they're excluded from that.

Peter McCormack: I'm going to do what I normally do with you, Lyn.  I'm going to assume you know everything and ask you some of the things, like questions I've got on my mind, and if I push you into areas that you don't know -- but you pretty much answer everything I've ever asked you.

To begin with I wanted to ask you about the reality of being a dollarised nation; what is the reality of a country not having its own sovereign currency, the pros and cons?  The basics that I have been told is that it's great because they get to have a stable currency, which is quite rare in that region of the world, everyone knows what happened in Venezuela, but we also know Argentina itself and other countries that have quite high inflation rates, so they get the benefit of the stable currency; but not having their own currency, there must be a number of drawbacks as well.

Lyn Alden: Yeah, in some ways it's like flying on a gold standard, but messier.  Basically, they're relying on a currency that they cannot print, so they're reliant on getting those from the United States, so as you point out there are some advantages, so you don't get devalued quite as quickly.  You still get devalued, but not as rapidly as most emerging market currencies do.

On the other hand, if there is a liquidity crisis right, so their central bank cannot create new ones, if they denominate some of their debts in dollars, so if there is basically a dollar shortage, they can't service those debts; also, because the country is so reliant in part of how it gets dollars.  If you're a country that either has dollar-based debts or is a dollarised nation, you rely on exports or remittances in order to get dollars, so some countries could be, say, oil nations and they export oil, other ones could have other commodities or other types of goods; for this one in particular, they're heavily reliant on remittances. 

That basically gives them a lot of exposure to things like a pandemic obviously, but then also just any sort of recessionary downturn, that could leave a bunch of El Salvadorians in the United States unable to send remittances or having to reduce the amount of remittances they send because they lost their job or they're otherwise more economically stressed, so it's a mixed bag.  I certainly don't know everything, and I have not done a super deep dive on say El Salvador's economic workings.

Peter McCormack: When you said there that they're protected from devaluation of their currency more than other countries, are you saying that as the dollar devalues, that accelerates the devaluation of other currencies?

Lyn Alden: Not necessarily, the dollar can devalue in a vacuum.  It just happens to be that most emerging markets, because they have faster population growth, they have faster money supply growth, more bank lending, that they're more prone to their currencies going down at a faster rate than the dollar. 

If you look at a long-term trend of a basket of emerging market currencies, it gradually loses value against the dollar and against the euro or the Swiss franc and these other kinds of larger currencies, but it's not in a straight line, so it goes in cycles.  In general, for example, if you look at, say, the Indian rupee, and that's not exactly a country that's had major currency crises in recent years, it's just kind of is this generally more devaluation currency; basically, the exchange rate weakens over the long run.  That can be accelerated for countries that have a lot of dollar-denominated debts, right.

So, say you're in a relatively poor country and sources of capital outside of your country want to invest in your country, they're unlikely to give you loans in your own local currency.  Instead, they'll often do dollar-based loans or to a lesser extent euro-based loans, maybe depending on where they're from.  For example, China will do dollar-based loans to countries in Africa for example, and so it's not necessarily that they're using their own currency, but they're using generally one of the top two currencies.  They'll make a loan to these countries, and it could be to their sovereign government, say in Argentina's case, or it could be towards their corporations, as in Turkey's case.

That country now has debts in a currency that they cannot print and so, if that currency rises substantially while their local currency devalues, they can run into major issues.  It's kind of like if your revenues denominate in dollars but your debts are all priced in gold, you'd have a big problem if gold were to appreciate against the dollar; the dollar would devalue against gold.  Some of those emerging markets face the same sort of problem, where they have a natural tendency to devalue. 

There are some exceptions.  There are some emerging markets that went through serious problems in the past, like for example during the Asian Financial Crisis in the late 1990s, Thailand was kind of at the epicentre of that, so they had a big devaluation of their currency.  They didn't have very high exchange reserves, but over the next 25 years they really learned from that lesson and so Thailand built up really big foreign exchange reserves.  They've actually had one of the most stable currencies in the past decade for example, and they haven't really had that persistent devaluation against something like the dollar.  Whereas you see basically India going through what some of these countries going through and every country has their own dynamics.

Peter McCormack: What is the reality of the impact on the country in terms of raising money?  We've discussed a lot in the past about using bonds for raising money and I've come to understand the strength of the currency impacts the rates at which you can borrow, and also because the ratings agency rate the currency.  If you're a dollarised country, if you don't have a sovereign currency, you don't have the ability to raise money in the bond market?

Lyn Alden: If you're a country and you don't have your own currency, you can still raise money in the bond market.  An example is all the eurozone countries right.  Greece does not have its own currency, but it raises money in euros and so the euros are the shared currency of multiple countries.  All these other types of countries, if they don't have their own currency, they could still raise capital. 

El Salvador does have bonds outstanding.  I assume they're dollar based, I haven't actually dived into their capital markets, but they do have bonds outstanding and that's common in emerging markets, where they will have bonds denominated in dollars or euros or sometimes in their own currency as well, it depends on how developed that market is.

Peter McCormack: I guess how those bonds then would be graded would have to consider two things: one, the stability of the currency, so if they're issuing bonds which are dollar based, then obviously that's a relatively stable currency; but at the same time there will be a separate consideration for how good El Salvador is at paying its bonds back?

Lyn Alden: Exactly, they would look at things like how much debt they have relative to GDP.  Say they're dollar based, they would look at how much debt there is relative to dollar inflows, so it's like a debt-to-income ratio type of metric.  They would look at past default history, if the country is a serial defaulter, obviously they're going to have less benefit of a doubt there.  There is also economic instability or political instability, if you don't know who is going to be in charge next year and there's no strong institution of reliable governance, countries would have lower ratings.

You see that for example in, say, Russia where they actually have pretty strong finances when you go down: they have their own currency, but they have very high reserves, they have very low debts, but their credit ratings are not super high; I mean they're not bad but they're not super high, because Russia did default back in the 1990s.  By then it was less than a decade old in its current political formation, and they've come a long way since then and the rating agencies have recognised that.

But even though their financial metrics are actually quite sound, their ratings are a little bit lower than you'd except from just looking at the numbers, because they're getting a Russian discount.  You're getting some political risk, corruption risk, sanction risk, economic concentration risk and just the fact that it's still classified as an emerging market and so it still has that more recent history of currency turbulence or default.

Peter McCormack: In the bond markets, I've talked a lot to you in the past about hedging your investments.  I'm a moron, I only have Bitcoin, you're smart and you hedge your investments across multiple different asset classes.  Within the bond market, do people tend to hedge across multiple countries then?

Lyn Alden: It depends, if you're in a developed market, so say you're an American bond investor or a British bond investor, a lot of times they're just concentrated in their own country.  The same thing with say stock pickers; if you're holding a mid-cap equity fund in America, you might just be picking American mid-cap equities.  The same thing for bond managers.  Generally, if you're an emerging market bond manager, usually you have multiple country exposure at that point, especially because emerging markets can go through major cycles and so there could be periods where one country is just not a great lending environment at the current time.

So, by having multiple countries, you can kind of go to whatever needs lending or has the best risk-adjusted returns based on your assessment, and so the broader they can be -- it is kind of a trade-off.  The more specialised they are in a few markets, the more they can maybe get that market right.  On the other hand, they want a handful of markets that they can rotate capital to, based on what's going on.

Peter McCormack: In terms of the US, I'm going to assume there's a benefit to other countries being dollarised, not just in terms of subordinate in the currency but also for political reasons?

Lyn Alden: Countries that are dollarised are either generally very small or economically tied to the United States or they lost their currency before.  Those types would be on the more impoverished end of the emerging market spectrum, so they would not even be classified as full emerging markets, they would be more like frontier markets or other classifications.

The big challenge there is just that all of their circulating currency therefore is reliant on an external country, the United States, that could choose to sanction them and block dollars going to them; that basically could tighten and change monetary policy.  They're relying on an external centralised source of monetary policy.  Say you backed your currency by gold, you might have some gold mines in your country, you can literally mint money; whereas if you're El Salvador and you're relying on dollars, there's nothing you can do to mint dollars locally, you either have to sell exports to get dollars or you have to get remittances.  Again, you could be sanctioned so now you're basically subordinate to this other country; you've given up some of your sovereignty because this other country can just literally shut you off from your money source at any time.

So, there are a lot of drawbacks, but often it's kind of a fallback option if countries start to lose their currency, it gets weaker, you start to generally see black markets develop for dollars or euros.  For them, it becomes it harder currency and then if it fails completely, you can have a period or in some cases, a more permanent stretch of just the country literally gives up and just reverts to using the dollar for the foreseeable future.

Peter McCormack: Would Argentina's dollar market be considered a black market?

Lyn Alden: The exchange rates there on the black market are different than the official exchange rates.  I haven't been there in maybe seven years, so I don't cover that super closely, but for example in Egypt people generally often appreciate having dollars.  They don't mind getting dollars because the exchange rate can differ from the official exchange rate. 

That was especially true about five years ago.  Egypt broke their PEG, so around that time there was a big gap between like the black-market exchange rate, which is essentially the real exchange rate, and the official exchange rate.  You see that popping up in different markets where what the government says their currency's worth is not necessarily what supply and demand are dictating.

Peter McCormack: I've experienced it in two countries, so when I went to Venezuela I experienced going to a restaurant, everything was priced in the bolivar, but they wanted paying in dollars if you could and they would recalculate the price for you.  I also had it in Cambodia.  I mean, I expected it in Venezuela, I went there expecting it; but when I was in Cambodia, I wasn't actually prepared for that, but actually people wanted the dollar, and they have this strange thing whereby they would inspect the note and if there was any blemish or tear on the note, it would be rejected.

Lyn Alden: Interesting, yeah, I'm not sure why.

Peter McCormack: I've got no idea why, but it was a really interesting experience and a chance to try and explain to my children the benefit we have of a stable currency in our country and why people might want dollars in different countries.  Have we ever experienced or has there ever been an incident of a dollarised country being shut off, being sanctioned?

Lyn Alden: Not to my knowledge but it is a threat and it's something I don't know, I mean there are countries that get cut off all the time, right, so I mean Iran's been a constant source of sanctions.  They're not dollarised in the official sense, so there is a long history of countries that get cut off from the rest of the world due to sanctions: North Korea, Iran. 

Then you have softer versions of that, so you have, for example, Germany was working with Russia to build a pipeline between them and so both sides wanted that, and the United States was threatening sanctions over that.  So, that's an example where you don't have to be as crazy as North Korea to be on the risk of getting US sanctions, you can just be doing things that for whatever the reason the United States is not thrilled with what you're doing and that stick of sanctions is always there.

It's one of those things I don't know, there's a lot of small countries that use them and so I wouldn't say no, but I'm not sure.

Peter McCormack: There's another question I've got that's probably slightly unfair, but do you know much about the process of a country becoming dollarised because one of the things that was crossing my mind when I was there, I was thinking about it, it's like how do you go through the process?  Suddenly you need an injection of enough capital into the country, you need to ensure everyone has dollars.  I don't know if that's anything you've ever looked at but it's certainly something I'd be interested in. 

It also makes me think about that they don't have the ability to print the currency, do they have to keep track of how many dollars are in the country?  Do they have to keep a set of reserves?  How does the banking infrastructure work?  What happens if there's too many dollars leave the country?  How do they ensure they have enough of a circulating supply?  Are those things you've ever looked at?

Lyn Alden: I'm actually curious to those questions myself, it's not something I've deeply looked at.  It would probably be very hard for them to track how much currency they have, because a good chunk of it would be physical in their case.  In say the United States, most dollars are in the banking system, they're easier to track, only a minority are physical.  The same would be true for euro or British pounds in their countries.  Whereas, if you're talking about an emerging market, a big chunk of the dollars they would be physical, so they'd be harder to track. 

That's a really good set of questions and I'm not sure how they go about it and have actually thought of that myself; it's just not an area that I've done a lot of research on.  There are emerging market economists that can probably answer those questions.  The Bitcoin critic Steve Hanke --

Peter McCormack: That guy!

Lyn Alden: -- I bet he could answer those particular questions, very well.

Peter McCormack: I might approach him, I just can't tell him that it's for a Bitcoin show, because he's not a big fan.  He's a bit of bullshitter as well, I've been tracking some of his tweets, he was talking about the remittance market.  One of the interesting things is, he was criticising Bitcoin as remittance to El Salvador, because you have to sell it back on the exchange; but he completely missed the point that actually, you don't. 

You have got this situation, yes, it's small in El Zonte, but in El Zonte you don't have to sell your Bitcoin to get dollars; almost in every location, you can spend your Bitcoin.  That comparison whereby it's actually more expensive than remittance because you need to sell to the exchange is actually false.  That's one of the things that I'd like to talk to him about.  Are you thinking of visiting at all?

Lyn Alden: El Salvador?

Peter McCormack: Yeah.

Lyn Alden: Not on the near term but it might be neat to try it out eventually.

Peter McCormack: It's so good, Lyn, honestly.  I've been four times now; I really want to get back there.  You've got everything there, it's relatively cheap, you've got great food, it's sunny all the time, you've got the beach and now obviously a Bitcoin project to track.

Okay, so a few other things I'm thinking about, with regards to El Salvador.  When you heard they were essentially becoming a -- they're already a dollarised nation and they're essentially a bitcoinised nation now; one of the things that was on my mind, thinking about why they may do this and why they may have forced people to accept Bitcoin, one of the things I was thinking about is that they've created this policy whereby if you spend 3 Bitcoin, you get permanent residency.  Were you in the Spaces where they joined, the Twitter Spaces?

Lyn Alden: Not that one, but I saw the general notes afterward of what was said.

Peter McCormack: What was interesting they said, "You just have to invest 3 Bitcoin", and it's not a fee you pay to the government, it's just investments.  You can buy a house, a car and a property and they said, "It doesn't matter what happens to the price, it'll be 3 Bitcoin".  One of the things I was thinking about is what it appears they're trying to do is have an injection of Bitcoin into the country and then that will be circulated or held by people; but if Bitcoin continues to perform as it does over the next five or ten years, that Bitcoin held in the country will increase in value relative to the dollar which will raise up the net wealth of the country.  That was my interpretation of why they're doing this.  I'm assuming you have your own interpretation.

Lyn Alden: That would be my interpretation as well and that goes back to your previous question of if the country is going to dollarize, how do they get dollars; how do they ensure they have enough dollars; how they track dollars?  So, if you're seeing a country bitcoinise, one of their initial things they have some Bitcoin from Bitcoin Beach, they can get remittances, but they probably don't have a ton of Bitcoin there; you'd know more than me how much Bitcoin they might have. 

Whatever number they have they almost certainly want more, especially if they want more merchants to accept, if they want to have it grow in market share a little bit and be a more commonplace, so it's natural that they want to get more Bitcoin there if possible.  It's also basically a way to have another -- basically they have diversified their monetary base a little bit if they can get Bitcoin up to a meaningful share against the dollar.  Even going back to your other question about has there ever been a country that's dollarised and cut off from sanctions, one thing that comes close, and actually this is relative to El Salvador, is the IMF. 

So basically, a lot of these emerging markets that take out dollar-based loans and debts, when they run into problems, because inevitably if they end up having a lot of dollar-based debt there is usually some sort of cycle of a dollar strengthening cycle or a recession where they end up having trouble servicing those debts and they need dollars; and one of the major purposes of the IMF is they have essentially this big basket of dollars and they can go around making these additional dollar-based loans, instead of pure investment purposes, they're more strategic purposes, and they can say, "Hey, I see a problem there.  We can go ahead and give you dollars or loan you dollars, you'll of course pay them back, but in addition we will dictate parts of your fiscal and monetary policy as we see it".

That is an example of a country ceding additional control over some of its own sovereign choices because it's reliant on dollars and therefore because it's relying on, say, the IMF for a bailout.  That is actually an intermediate case where they may not be sanctioned from the dollar, but there is an external organisation that has a lot of control over them basically dictating parts of what they can or cannot do.

Peter McCormack: How does the IMF operate?  How does it raise its own money that it can issue for bail outs?  How is it governed?  I don't know too much about it.

Lyn Alden: That was established decades ago.  It is part and parcel with the petrodollar system, and the Bretton Woods system really, this whole modern era of dollar dominance.  There's multiple countries that are involved to ensure that it's funded, led by the United States.  You have these institutions like the World Bank of IMF that are almost error-correcting mechanisms for the system.  The system on its own is not super well designed, it's not super sustainable, it's not very self-correcting and so a lot of these countries, they get dollar-based debts, the dollar strengthens and then they default on their debt and then there's a big economic crisis.

These institutions come in and they say, "Okay, we can give you that loan, but you have to change this", and it softens the volatility a little bit but it also, in the long run, makes these countries more reliant on these external organisations.

Peter McCormack: Yeah, that's what it appears to me because the only time I ever tend to hear about the IMF is when it's bailing out other countries, but it always appears to be basket-case countries and I just keep wondering, "Do they ever get this money back?  Does it even matter?"

Lyn Alden: They do a large number of small projects and a lot of those individual projects do get paid back.  There are others that do outright default a number of times, like say Argentina for example.  So, it's kind of like the cost of doing business, so it's almost like that's a way for the United States and some of these other countries to extend their reach and this is a cost that they basically absorb if needed.  The IMF also does things like it publishes research, and does things like that; but yeah, the main purpose we always see in the headlines is the IMF doing bailouts or dictating policy to various countries.

Peter McCormack: We're seeing that hostility towards this Bitcoin decision from the IMF and the World Bank and it does make me think of -- I'm not sure if you listened to my interview with Alex Gladstein about the petrodollar with him and Nic Carter, but he raised this idea that potentially the second Gulf War was to do with Saddam Hussein started selling his oil for euros over the dollars.  He said there's never been a real explanation for why that war happened, but if you actually look at the money, if you follow the money, it was not long after Saddam Hussein did this, he asked the question, "Was this a war to protect the petrodollar?" 

Conspiracy theorists will probably say yes; I mean I don't know either way, but I guess El Salvador adopting Bitcoin is a threat to the IMF and it is a threat to the World Bank, especially as other countries are signalling their interest.  We've had this wave of countries signalling: Paraguay, Panama, Ecuador, Brazil, Mexico, Tonga, Honduras.  There are potential bills being submitted in both Panama, and I think it's Honduras and Paraguay in the short term.  The guy from Tonga is speaking quite regularly on Twitter Space on Twitter about this; he actually mentioned that 45% of the country's GDP is remittance.

Lyn Alden: Wow.

Peter McCormack: Yeah, wow, like that was a massive wow because he talked about -- I think he said, "If they move remittance to Bitcoin, that would add an additional $40 million", I can't remember if it was $40 million to the GDP or $40 million in terms of tax receipts for the government.  I think it was the latter, and I'm interviewing this week and I'll ask.  As we see a whole load of countries signal for Bitcoin, I guess this is a threat to the dollar.

Lyn Alden: In a sense, yeah.  From the IMF's perspective, it's hard to read exactly what they're thinking.  I am sure that there are some economists there that haven't studied Bitcoin or they're sceptical on it, so they could be naturally worried that if Bitcoin's volatile or loses value, that it could be bad for El Salvador.  On the other hand, I do think there are other ones that are maybe of the opposite concern that Bitcoin could do well and that therefore, it basically impacts the global monetary order that's been in place for a while.

I mentioned before I had my own petrodollar article back in December of last year, and I did talk about that Iraq connection and it is hard to assert, "This happened, therefore this happened", but basically the reasons given for the war ended up not being true.  It is also true that they basically did switch to euros shortly before then, and that the highest stage where this idea was put forth was by Ron Paul in Congress back then.  He basically gave a speech in Congress that I linked to in my article where he talked about this connection. 

There has not been a great track record of -- there's all sorts of dictators in the world and they tend to get left alone, but if the dictators mess around with the money system that's when they tend to attract some of the ire of these external sources.  I guess, put it there.

Peter McCormack: What other things have you been thinking about with regards to El Salvador adopting Bitcoin, because it's a risky thing?  I interviewed the President, and I had a meeting with him beforehand and I said to him, "What can the Bitcoin community do?"  He was very clear, he said, "Look, this has to work.  I've got a very high approval rating but if this is a failure, I'm done; my rating could drop".  There's obviously many benefits should Bitcoin continue to be successful, wider adoption.  They could become the MicroStrategy of countries, but what are the other risks or trade-offs that you've been thinking about with regards to this?

Lyn Alden: One of the big risks is just the volatility.  One of the criticisms of Bitcoin and why it's maybe not the ideal legal tender is that it's highly volatile.  As problematic as the dollar might be, it's generally more convenient to have, say, prices listed in dollars because they're not going to change week to week in most cases.  For example, lately we've been in a more inflationary cycle, so we see prices going up, but in general these more managed currencies have these periods of stability, whereas something like Bitcoin, because there's no safety nets, there's no triggers that can shut it off if it goes down a certain amount, it can be highly volatile as we're seeing today.

One of the risks there is that you could just have people maybe not want to accept it on a wide scale and they're basically given the option and they don't pick it for one reason or another.  I think also we saw, for example, some of the risks where that could open the door to other altcoins coming in; it's now a bed for scammers to go in there and say, "I see you like Bitcoin, so here's …"

Peter McCormack: My shitcoin.

Lyn Alden: Exactly.  I think that's a big risk.  Two is just that it, for whatever reason, just doesn't work.  Maybe they don't attract enough capital, maybe they don't really -- they put a lot of work in, and it doesn't change a ton.  But overall, I'm pretty optimistic on it.  I think that their reasons for doing it are understandable in the sense that they are getting a lot of remittances, and this is a more efficient way to do it potentially.

Then two, if they end up tracking some capital, based on if people can invest 3 Bitcoin and get residency and maybe build a business there or just come in, improve the real estate, improve more local businesses, it is a way of attracting capital or at least a potential way of attracting capital; it remains to be seen how much they'll do it.

I've even seen online a number of people, because they want it to succeed there, they're willing to give just free donations, so they're not even trying to get residency, they're just willing to send some sats over to local businesses.  The cool thing about it is with charities, if you're trying to give international aid, it's always been challenging because you don't know how much your money really gets through to the end goal; you don't know how much gets lost on the way, there's tons of corruption.  Even if there's not corruption there's well-meaning people, there's friction. 

Whereas if say a local business, they can have like a code, they can have their address and basically people can send sats directly to local businesses or local people; and so it's basically a different way of doing aid that is potentially more effective.  I'm sure Alex Gladstein can talk more about that type of subject.

So, overall there are a lot of benefits they could get from this, but there are risks relating to the volatility, the opening for altcoins, things like that.

Peter McCormack: I just did a little Google; the global remittance market size was valued at $682 billion in 2018 and projected to reach $930 billion by 2026.  There's a real incentive to move to a remittance market which has low fees, instant transfers, solves a number of problems of the traditional remittance market.  You could see how, if El Salvador -- I think it's 15% of their GDP is remittance, if a large percentage of that moved over to…

There's two sides of the remittance: there is just using Bitcoin itself; but there's also the Strike side, which is sending synthetic dollars over the Bitcoin network.  If by moving to that you can increase the GDP of the country because you're removing fees, you can see the case study being something that just spreads globally.  I'm wondering, as more countries adopt Bitcoin, do they become stronger together; do they form coalitions?

I saw that the development bank of South America, I can't remember the actual name, is supporting El Salvador in its roll out of the project.  That group, that development bank, supports 14 countries as I believe, and it even includes South Korea and Taiwan which I didn't know about; I don't know if you're aware of any of that.  But it just feels like if they get this right, this could be the first domino for a number of other countries.

Lyn Alden: Yeah, I think one of the more interesting pieces of news after the volcano mining, of course, was like the half a dozen political leaders from other countries that also expressed similar interests.  They can't move as quickly as this country can because they don't have a president with that much approval and that much control over legislation and stuff, for better or worse, but they can have a politician there that's raising it in congress or getting it on the radar.  I think it comes down to watching it be either successful or unsuccessful in El Salvador and that could influence other nations to move ahead.

We have to be careful about reading too much into it, so for example when MicroStrategy bought Bitcoin, so far there's not been a flood of other companies putting -- obviously none of them have really done what MicroStrategy did where they put most of their reserves into it.  There's been a handful that put a small percentage of their reserves into Bitcoin, and so that wasn't the start of some floodgate.  Maybe looking back two years from now it will be, but it's not like a year later, there's a floodgate.  I think it could be the case that El Salvador remains the only one for a little while or that some of these other ones start dabbling to some extent, but there's certain conditions that make them right for it.

One is countries that are already dollarised, and that are already reliant on remittances, those are the ones that are at most probable of trying something like this out.  I think at the very least it makes sense for all of them to call Jack Mallers and basically say, "How can we cut our remittance fees?"  Because as you point out if you have hundreds of billions of dollars per year in remittances flowing around, that's tens of billions of dollars of remittance fees, potentially over $100 billion eventually, and that could be reduced to near zero and that's very impactful for people that are sending small amounts, for which those percentages make a world of difference.

Peter McCormack: Michael Saylor's in an advantageous position where they made their first move at the start of a bull market, so they're in a very good position in that I think it was like his original buy of that first $1 billion or so, whatever it was, was an average price of around $11,000, $11,500.  He's in the green, it's easy for him to make future decisions.  You look at Tesla and Elon Musk, their initial buy is now in the red; I think their average price was $35,000.  So, I think MicroStrategy is in a unique position. 

I think other companies having a minor amount of exposure is advisable or is something they can consider, but to make a move like MicroStrategy has done, especially after the recent draw down, I think it's a slightly different position.  I am going to come onto that because I've got a MicroStrategy question for you, but there's two other things I want to cover in El Salvador. 

You did your presentation with Elizabeth discussing the Lightning Network.  One of the most interesting things about El Salvador is that my expectation is the majority of day-to-day usage will be on the Lightning Network.  The Lightning Network is integral to this, whereas historically the majority of Bitcoin being used, by my experience, has been on the mainchain and moving relatively larger amounts; well, not moving $5, $10, it's $1,000 or thousands. 

I have been using the Lightning Network when I'm in El Salvador.  I turned up on the most recent trip without any dollars and I didn't care.  I did end up using the ATM, because I've not used one before, but everywhere I go I know accepts Bitcoin, so I was just paying on the Lightning Network, and the Lightning Network is super important to this.  You've been doing some work tracking the Lightning Network, tracking the growth of the network; what can you tell me?

Lyn Alden: Yeah, I mean over the past, it must be seven months now, I've been paying particular attention to the Lightning Network.  I first wrote about Bitcoin in late 2017, passed on it, then revisited it in early 2020, and so I wrote a series of articles throughout early-mid 2020 about Bitcoin.  Then really, as I got some of that core stuff out of the way, I increasingly shifted my research towards Lightning Network because that was an area that in my view was not getting enough attention, compared to what the potential was.  Then moreover there are signs, when I started writing it six months ago, seven months ago, pointing out that I think it's a sleeper hit, it's something that's not getting a lot of attention, but it's really starting to reach critical mass, we're really starting to get these killer apps for it. 

It's one of those things where building up Lightning is a process.  It started as a white paper in 2015; then they had to do a set of standards so that different companies could implement Lightning and have them be interoperable; then the SegWit update on Bitcoin allowed Lightning to be actually built; then from there you have no liquidity, because Lightning's all about liquidity, number of channels and nodes.  Basically some degree of network effect has to start from virtually nothing, and so you had a couple of years of building that out.  You have companies like Lightning Labs that are then building tools so that these other apps can then come and start using the Lightning Network more effectively.

Looking back about the beginning of this year, Lightning started to reach critical mass, where it was pretty usable.  Somebody could send a reasonable amount of Bitcoin over it and then basically, liquidity was high and then when you see things like Strike Global, they're actually starting to use them for specific purposes like cutting down remittance fees; it's getting pretty interesting. 

So, I started covering that space and I do think that one of the whole takeaways from the Bitcoin Conference was that Lightning has reached critical mass, so it's used for streaming sats from gaming, it was used in auctions, and then now of course the El Salvador news.  I think it's at the point where if you look at overall Lightning capacity, it's really accelerated lately, so how much Bitcoin that network can support.

It's one of those things where the numbers might not be as large and exciting as some of the DeFi projects, because Lightning's inherently not about gambling, it's not about casino type of coin trading; it's about building out a payment network and so it's been that kind of slower, longer grind to really lay the foundation, rather than something that just went up straight in a straight line.

Peter McCormack: We need to talk about volcanoes.  I did a show with my friend Harry Sudock the other day, trying to learn a lot more about the energy sector, how energy moves, etc, and we covered everything.  We covered nuclear, solar, we covered hydroelectric, we covered coal, we covered everything.  The one thing we never covered was geothermal; it just didn't come up on our radar.  And about two days after we recorded came the announcement of volcano mining, something that just never even crossed my mind, I just didn't even think about it; and it's become this beautiful meme online, people are adding volcanoes into their names on Twitter.

Actually, it's a really interesting idea, but the thing that I'm most interested about is this idea of volcano bonds.  It was something Jack Mallers raised; have you looked into those; do you know much about them?

Lyn Alden: Not into those, but I know the basic idea is essentially, that is another way of them raising capital.  You can collateralise by you have access to this revenue now, so instead of lending to a pool of El Salvador's government, you're lending to something that's collateralised by certain revenue streams or certain assets.  There obviously would be different ways to structure that, but that's certainly a possibility and you know there'd be bitcoiners out there that'd be happy to buy those, even just for the LOLs!

So, the idea of geothermal's actually really important, because an example would be Iceland.  They have a large geothermal component to their energy and so by extension to that, they have very, very low energy costs.  But there is a trouble there.  Generally, you want to export things you're really good at, but it's really hard to export electricity; you can only go a few hundred miles. 

So, one thing they do, aluminium for example takes a ton of electricity to refine it into its final form.  So, you get the aluminium out of the ground, but it's mixed up and you have to use a ton of electricity to separate it and get it into its final form.  They have an industry where a lot of places in the world will ship their ore to Iceland and then they will use their super cheap electricity to refine that into finished aluminium and ship it back out.  That's basically a way of essentially exporting their electricity, their surplus cheap electricity, without doing it literally.

Bitcoin mining is another potential way where a country can, if it has for whatever reason, some sort of super abundant electricity, it could be that they're unusually good for hydroelectricity, it could be that they're unusually good for geothermal energy, they have some of these super cheap sources that are renewable and long-lasting; they can say, "Okay, we're going to go ahead and use some of that to mine Bitcoin or process aluminium".  That's one of the ways that they can raise revenue and in addition to people potentially going into El Salvador with 3 Bitcoins and investing them there, that volcano mining, that geothermal energy, could be a pretty meaningful source of revenue if they get some serious miners onboard that know what they're doing and make that work.

Peter McCormack: I guess the state could mine themselves, at the location of the sites.  As I believe it, it's not cheap to set up.  We're talking over $100 million maybe hundreds of millions to set up these geothermal locations.  Listen if they do a volcano mine, I think I would buy it for the LOLs, just out of interest.  I'd probably be on the phone to you, "Lyn, how do you do this?"

Lyn Alden: Exactly, I think a lot of people would.

Peter McCormack: I didn't think we would talk about El Salvador that much; I have got just two or three other things I do want to cover with you just before we finish, but I am so interested in the El Salvador project and see what happens, so I'm sure we'll talk about it in the future.

I'll keep it simple: one of the things I wanted to ask you about, MicroStrategy now owns over 100,000 Bitcoin, they've essentially got over 0.5% of the total supply.  Should we read into that in any way; are there any potential negatives for them having such a large percentage of the supply?

Lyn Alden: You mean for MicroStrategy or for Bitcoin as a whole?

Peter McCormack: Both.

Lyn Alden: Their risk is that because he's continued to dollar cost average into it, even though his initial purchase was very low, below $11,000, his current cost basis is, I think, in the mid to upper $20,000, last I checked.  He is susceptible to negative press if Bitcoin would fall to say $20,000 or something; so if it falls below his cost basis, he's susceptible to negative press. 

Now, because he owns a lot of the controlling, he owns the dominant share of controlling votes, and he's structured the debt smartly so it's not like it's all callable, there is not really risk of near-term liquidation, he can get through that.  Certainly, some of the positive press, the feedback loop he's had as his decision resulted in profitability could revert it if you were get to Bitcoin falling below that cost basis.  That is the risk on their end.

I don't really see a huge risk for Bitcoin to have an entity control 0.5%.  We already see this to some extent with the large custodians that they control more than that, so they basically control them on behalf of other people.  There are risks to the narrative; I often separate actual risks versus narrative risk, so I've done that before with Bitcoin energy where I don't view Bitcoin's energy consumption as a problem, but I view the narrative around that can be a problem.

Similarly, one of the often spread-around facts, people like Bitcoin critics will spread around the idea that 90% of Bitcoin is owned by 2% of the addresses or something like that, and they're leaving out the fact that those are generally custodian addresses that are owning Bitcoin on behalf of millions of people.  I think a lot of them honestly don't even know, so some of them could be purposely misleading; whereas actually, there are other investors that I respect that I've seen share that statistic and I just think they don't know that those are custodian addresses.

So basically, if you start to have companies become these figureheads or these large owners, it can make it look more corporatised and I think this in some way is part of what we saw during this recent altcoin bull run, is people said, "No, Bitcoin's too expensive, its boomer coin, it's corporate coin, so I'm going to go buy dog money".  So, it didn't work out well for most of them, other than the ones that maybe bought before the big parabolic rise, but that's a risk; so, there are risks related to unit bias. 

Now with the bear market, Bitcoin's unit bias is decreasing but people often either don't realise Bitcoin is divisible; or they know it's divisible, but they think it's just unsatisfying to own 0.1 Bitcoin.  So, the community shifting towards sats makes sense, because it's kind of how doge is attracting people because they could own a lot of doge because each coin was cheap.  So, unit bias can be a real thing but then in addition, yeah, if you have these corporations own big pools of Bitcoin it can make the narrative a little bit more challenging. 

That's an inherent trade-off, because in order for Bitcoin to reach very, very large market capitalisations, you're naturally going to have institutional adoption of it; but then, if you get institutional adoption of it, there are risks related to capture or the narrative losing some of its steam.  It's just something that I think the community has to always push back on and always focus, and I think they've done a good job there. 

When they saw the Mining Council stuff they were like, "Wait, so now we're doing behind closed doors agreements on things?" and they kind of pushed back on that and so I think so far, the Bitcoin community has been pretty careful about not having heroes; or at least we know when they get heroes like briefly Elon Musk, the second they misstep they're pushed away.  So, I think there's that trade-off between these large pools of capital versus Bitcoin still being mainly retail phenomenon.

Peter McCormack: The last thing I want to touch on you is just some general macro outlook.  I've missed all of this because I really wanted to talk about El Salvador with you, but we did have the CPI inflation rate hit around 5%.  That was seen as a surprise, not by everyone, but that was seen as a surprise; we have the comments from Jerome Powell.  What's your general read on inflation right now?  I saw in your update that you think for the year, it will range between around, I think you said 4.7% and 5.1%; what's your general read?

Lyn Alden: That was the May inflation reading, it came out in June, but it was for May.  I think that the one for June that'll come out in July will probably be in that 4.7% to 5.1% range, most likely, but then after that it's probably going to go somewhat lower in that year-over-year terms, because you're looking at harder base effects, so the May is the peak base effect month.  You're comparing it to May of 2020, which had a dip in CPI at the lowest point.

Peter McCormack: All right, thank you.

Lyn Alden: As you get out to July, August, September, October, months like that, even if you still have pretty significant inflation, you'll be comparing it to those same months last year which is when inflation was already rebounding a little bit, and so I think that the year-over-year numbers could start to relax down to 4.5%, 4.0%, maybe as low as 3.5%, but I would kind of aim towards that 4% range.  I think that in the rate of change terms, there's a good chance that you'll get a relaxation of inflation.

We're already kind of seeing that in the media where they're saying, "Oh, so commodity prices are going down, this was transitory all along", and I think the key takeaway is that some of these prices will come down, they probably won't come down to where they were before this increase in the money supply; then even when they come down, and then eventually level out, they are still at risk of price increases in the future.  So I think that, for example, when you look out either later this year, or multiple years in the future, I think energy prices going up is another potential catalyst for inflationary pressures.

This one was largely driven by food, semi-conductors and non-energy commodities and I think there's a good chance that either later this summer or next two, three, four years, that energy shortages are another contributor to another round of this type of inflation.

Peter McCormack: Okay, we'll keep an eye on that.  Last thing, because I don't want to keep you too long, I want to ask you about the reverse repo market and then I'm going to talk to you about what I think I want to do next month with you and see what you think about that.

So, the reverse repo market hit $755.8 billion.  Two people have asked me about this, they're like, "Can you ask Lyn what the hell the reverse repo market is?"  I think you might want to explain what the repo market is first, before you explain that.

Lyn Alden: Yeah, basically the way I've been describing this is kind of the opposite problem of what happened in 2019, when we had the repo rate spike.  The repo market is this overnight lending market between financial institutions, and the Federal Reserve has these operations where they can provide liquidity to that market or absorb liquidity from that market.  When they do a repo operation, basically a financial institution that has treasuries can give some of those treasuries to the FED, in exchange they can get dollars; so it's like a short-term collateralised loan and they can have different terms.  They can be overnight, or they can be for several days or weeks or longer.  It's kind of this way to temporarily convert between treasuries and cash that makes the market more liquid. 

What we saw, for example, back in 2019, in September, the overnight lending rate, the repo rate, was super calm and then it just spiked out of nowhere, went up like 7% literally overnight.  It's one of those things where the average person in the street had no idea it had happened, but every single person who follows macro or is any way related to Wall Street, every single person, that was the shock heard around the world seeing that repo rate just spike up like that.  That marked the end of Federal Reserve quantitative tightening.  So for year prior to that, they were reducing their balance sheet, reducing reserves in the system; but starting with that spike, the Federal Reserve had to come in and start increasing their balance sheet and they haven't stopped yet, almost two years later.

That was before the pandemic; that was late 2019.  And the reason essentially was that you had a mismatch between the amount of T-Bills and reserves, and so they were reducing reserves while the US Government was running very large deficits, something like 5% of GDP deficits prior to the pandemic.  So, you had a lot of T-Bills, not a lot of reserves, and so essentially what happened was that there was just too many T-Bills, not enough reserves.  

So, the Fed had to come in and say, "Okay, we'll fix that.  We'll start providing more reserves essentially", so they first started doing temporary, those repo operations, and then when they realised it was more structural, so they actually started permanently buying T-Bills, so creating new bank reserves to buy T-Bills and resumed this period of quantitative easing.  Now, they've done so much quantitative easing for the past year and a half that actually, now there is excess reserves in the system.  So, there's tons of reserves and they bought so many of the T-Bills that there's actually now a mismatch where there are too many reserves compared to the amount of T-Bills in the system available for the private sector to buy. 

T-Bills are really important for structural reasons for the financial system, because they can collateralise them, they can do all sorts of things with them.  Basically, you have an issue where if there's too many reserves and not enough T-Bills, you could have T-Bills rates go slightly negative, so even though the Federal Reserve is not going into negative rate territory like Europe is, they're just holding rates around zero, they saw an issue where their T-Bills were trying to go slightly negative, just because there was essentially not enough supply compared to demand, just because the Federal Reserve bought so many of them.

There's a couple of ways they could fix that: one is the Treasury can start issuing more T-Bills, they can basically release fewer long duration treasuries and more T-Bills; or the Fed can say change some of its buying patterns; or they could do this reverse repo facility where they can say, "Hey, we can take some of those excess reserves off your hands, and give you out some T-Bills temporarily" and so it's basically the opposite dilemma of 2019.

This was compounded by the fact that the Treasury General Account was drawing down.  And so, when the Treasury issues bonds, they sell bonds, they raise cash from some of those bonds, and they have this big pool of cash.  What do they do with it before they spend it?  They store it at the Federal Reserve, in its own gigantic account.  So, if they issue bonds at a faster rate than they spend money, then that TGA, that Treasury General Account, goes up and basically sucks dollars out of the system, because that's like dollars sitting in a void not being used anywhere else; that's a dollar-tightening event.

On the other hand, if they start spending more money than they're issuing bonds for, they draw down that TGA and basically push money back into the system, back into bank reserves.  Normally their Treasury General Account is a few hundred billion dollars.  During 2020, they brought it up to record highs of $1.8 trillion.  They basically issued a ton of treasuries ahead of time, faster than they spent it, just so they had this big war chest, and they were just kind of weren't spending it for a while.

Starting early 2021, the Treasury said, "Okay, now we're passed the crazy part, we're going to start drawing down this Treasury General Account", so we've been in this say four-month period of the Treasury not issuing very many treasuries and spending rapidly so that the TGA is being drawn down and we basically put an extra over $1 trillion back into bank reserves pretty rapidly.  When you combine the fact there's still quantitative easing happening, banks basically literally have more reserves than they know what to do with and so a lot of that is spilling back over into the Federal Reserve with these reverse repos.  So, it's the exact opposite problem of 2019; so you have too many reserves, not enough T-Bills, and so we're seeing that reverse repo activity take off.

Peter McCormack: It doesn't sound a hugely negative thing.

Lyn Alden: Both the repo spike and the repo activity and then this reverse repo, they naturally attract sensationalist headlines.  Back in 2019 there were a lot of people saying that there's some bank about to collapse or banks are going to -- and I kept saying, "No, no".  You had two camps back then: on one hand, you had mainstream journalists say, "Oh it's no big deal, it's just a technical matter"; on the other hand, you had sensationalists accounts saying, "Are banks going to collapse?  This is like 2008 all over again". 

The reality was that it was basically a shift towards deficit monetisation, which is a big deal but it's not the same big deal that those accounts are pointing to.  It's not a bank failure or an upcoming bank failure.  Now, we're seeing a lot of concern about reverse repo activity and there are some real ramifications of it, but it's not indicative of say some near-term collapse or anything like that. 

What are the more concerning things for financial markets is that, when reverse repos first took off back in 2014, that started signalling the end of quantitative easing.  So, when the Fed started to see that, they basically saw that there was excess liquidity, and so they eventually began tapering their asset purchases.  And so, in a market that's so held up by quantitative easing fiscal stimulus, when you start to see these reverse repos, and the Fed starts talking about the potential for tapering next year their asset purchase rates, that certainly gives the market some jitters.

You can have plumbing issues, or you can have liquidity tighten up a little bit, but that's different from some sort of financial timebomb about to go off.

Peter McCormack: Awesome, do you want to hear what I think we should do next week?

Lyn Alden: Absolutely.

Peter McCormack: It might require a bit of homework.  Do you know my good friend, Nassim Taleb?

Lyn Alden: Yeah, I'm familiar with his work, but right now all his tweets are protected.

Peter McCormack: You have to follow him.  Me and him are good friends and he's quite hostile to Bitcoin right now, and he's written his black paper and I'm going to spend some time looking at it.  I wonder if you and I should try and dissect it, go through some of his arguments against Bitcoin.  There's a couple of things I think he makes good points, because I've already had a look, but what do you think about doing that; dissecting his black paper?

Lyn Alden: I'd be happy to.

Peter McCormack: Excellent.  I will get Ben to send you a link to it in advance and I will give you all my key points I think we should look at and I think that will be a bit of fun.  Anyway, it was nice to meet you finally, hopefully we'll do it again sometime, get to hang out again.  I think Bitcoin 2022 might be like 50,000 people and even wilder, which will be exciting.

Lyn Alden: We'll see how long the bull market or bear market goes, that could dictate how many people show up!

Peter McCormack: Yeah.

Lyn Alden: I did love meeting you and a lot of other bitcoiners in the space.  You interact with people online and it's really nice to meet them in person.

Peter McCormack: It was a bit of an all-star BBQ we actually met at; we were at VJs which was pretty insane.  It's great to see you and fingers crossed Bitcoin won't be in a big bear market, I'm very excited to watch what's happening in El Salvador and let's catch up next month, let's do a dissection of Nassim's black paper.

Lyn Alden: Absolutely.

Peter McCormack: All right, Lyn, good to see you, take care.

Lyn Alden: Bye.