WBD427 Audio Transcription
El Salvador’s Bitcoin Bond with Lyn Alden
Interview date: Tuesday 23rd November
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 macroeconomist and investment strategist Lyn Alden. We discuss the lack of yield in bond markets, El Salvador's bitcoin bonds, inflation and the direction and role of the Fed.
“Why don’t some large countries just print a little bit of money and buy bitcoin and stick it on their reserves for example; and if you were to see those cracks in the dam start to appear, and you were to start to see that happening, that’s potentially a really explosive moment.”
— Lyn Alden
Interview Transcription
Peter McCormack: Hi, Lyn, how are you?
Lyn Alden: Pretty good, how are you?
Peter McCormack: I'm very good, thank you. I'm very excited to be travelling again soon. I go to Miami next Sunday, so I'm very excited about that. Okay, as ever there's loads to talk about, I've got so many notes this week. I've got lots to talk to you about. I want to talk to you about volcano bonds at some point, because I've got so many questions that you've probably got better answers than me.
But can we start on currencies, because I've been tracking regularly over the last year what's been happening with the Turkish Lira. Also, my brother raised to me that Hungary is having issues with their currency this morning. So, are we potentially going to be seeing more currencies collapsing? How much are you tracking the various currencies around the world right now?
Lyn Alden: So, I track about 30 of them probably, not every single one. For example, I don't track Hungary very closely. Turkey's one I have been tracking, and the issue that you see generally in a lot of these emerging markets that have currency issues is that they have not enough foreign exchange reserves compared to their dollar-denominated debts. The difference between Turkey and Argentina is that Argentina, most of their debt is on the sovereign level. The private sector is actually relatively unlevered.
Whereas, Turkey is the opposite, so the sovereign's actually pretty unlevered, but it's a big corporate debt problem, and so they have a lot of US dollar financing; and a lot of it's connected to European banks. Also, they don't really have independent central banking, so the leader keeps firing the head of the central bank, and so they're basically not having independent experts try to quell that inflation. It's unclear if that would even help, right; it's not always helpful. But basically, there's multiple problems there.
So, Turkey's been on my list of bottom-ranked currencies for a while. A couple of times, it looked like they might have stabilised it and turned it around, but then they go ahead and break again. So, Turkey is at risk of ongoing inflationary problems and currency devaluation problems and the thing is, they have good underlying fundamentals. I mean, they have a strong manufacturing base, they have a great geography, they have good demographic trends compared to say Europe, for example. So, they have a lot going for them, but they have clearly some disfunction there that's really hurting their currency.
This generally goes in cycles, so every time the dollar has a strong cycle, so it had a strong cycle in the 1980s, it had another strong cycle in the late 1990s and it's been in this third cycle for the past five years or so, and every time it's in one of those cycles, it usually breaks certain emerging markets. So, in the 1980s, it was Latin American countries; in the late 1990s, it was the Asian Financial Crisis in Russia; and then, this latest one is more spread out, so it's Argentina again, it's Turkey, it's Lebanon, it's a bunch of these countries with no specific geographical descriptor.
Peter McCormack: Right, but why specifically is that happening to these specific countries; sorry, I don't really understand?
Lyn Alden: So again, it depends on the specific one, but generally they are ones that did not invest very well, and so they did not build up sufficient foreign exchange reserves, they built up too much dollar-denominated debt, and then they usually have some sort of political disfunction. So, Argentina and Turkey are very different political environments, but neither of them could be considered a particularly well-oiled machine at the moment.
Whereas, right now, for example, South-East Asia's not really having major currency issues at the moment, so they have their own political issues, but they didn't really run into this specific problem right now of having too much dollar-denominated debt compared to their reserves and other types of issues like that.
Peter McCormack: Right, okay. So, this is tied to the dollar itself?
Lyn Alden: Partially. Partially, the dollar's a catalyst, and so basically when you take on dollar-denominated debt, if that dollar weakens, that's good. It's like, if I took out a mortgage in pesos and then the peso goes down, that's good for me. But if I take out a mortgage in pesos and the peso doubles compared to the dollar, while my income is still the same in dollars, I have a problem. So, that's what corporations and governments do in emerging markets.
So, if the dollar strengthens, that's generally kind of like quantitative tightening into a recession. So, instead of them having easy monetary policy, their central bank's trying to tighten to stabilise their currency, and they have liabilities that they can't print away, and so they kind of fall into a spiral.
Peter McCormack: Right, but is Turkey also printing money like other governments are printing money, which is driving their own inflation?
Lyn Alden: Yes, they have very, very strong money supply growth at the current time, that's been a big contributor, and they don't really have their budget deficit under control. But again, they don't have a lot of, say, stored-up government debt, it's really their issue's more in the corporate sector. So overall, you have rapid money supply growth and then rapid price increases, and then you don't really have positive real rates either, so there's less incentive for people to want to save, or for foreigners to want to come and backstop the currency.
Peter McCormack: You see, what amazed me with Turkey is that they were targeting, is it 5% inflation? So, they're target is actually still what we would consider very high here.
Lyn Alden: Yeah, I might right now, they're well onto the double-digit inflation. So, for them, 5% would be a huge improvement compared to what they are now. So if anything, it's a somewhat realistic attempt, rather than saying, "We want zero inflation" from double digits. But clearly, they want it directionally lower. But yeah, it's funny, even 5% would be very, very high.
Now, the difference is that they have 5% inflation, their rates wouldn't be zero, like we have, say in the United States and the UK, so you'd have a different environment there. But yeah, you'd still have high inflation.
Peter McCormack: Well, okay. So, what's going on with the bond market? I was reading something in the FT this morning, something by Daniel Fuss, the Chairman of Loomis. He was saying, "It scares me when I see what is given up in terms of natural prudence and caution. We'll have to wait and see how things play out, but the reach for yield has overridden the fear factor".
I was also talking to Greg Foss recently and he said, "There's no logical reason for people to be buying bonds now". The yields are, what was it, 1.4% on US Treasuries, yet with an inflation rate of 6.2%, you're essentially negative yielding close to 5%. So he said, "Anyone buying these is a moron". But the reality is, some people are mandated to. So, are people just having to buy something they know that is negative yielding?
Lyn Alden: Pretty much. I think there's a variety of reasons, and this has been one of my core themes going into this year, the idea of financial pressure, so high inflation but not correspondingly high interest rates. And I often use that comparison to the 1940s that we discussed before, because that was the big difference to the 1940s and the 1970s. In the 1970s you had high inflation, but you had high rates as well; whereas in the 1940s, you had high inflation without high rates.
Because a lot of the current situation looks like the 1940s, we're basically in a financially repressed environment. So, we have this high inflation rate, but central banks are still holding their short interest rates low at 0%, roughly, and then long duration of rates, they buy a lot of those bonds to take off excess supply from the market, they create collateral shortages and so you have this situation of positive yield curves in many environments, but very, very low, so depressed well below the inflation rate. And then, the interesting thing is you even see junk bonds on average now have a negative real yield, which I think might be the first time in modern history, where you're not even getting fully compensated.
Some of this is because of mandates, there are large pools of capital that have to buy bonds, they're regulated to; and then also, there are still institutions that believe it will be transitory and believe that it will normalise. Then you have retirees and things like that, they're not mandated to own bonds, but maybe they're 80 years old and they would feel uncomfortable being 100% in equities, being exposed to that volatility. So, they'd rather have part of their portfolio lose money slowly, than have 100% of it in equities.
So, it's across the board different reasons, but I would say, yeah, we're certainly in a period of financial repression where bonds are probably going to have negative real yields for most of the time going forward for quite a while.
Peter McCormack: So, I was reading this morning in Bloomberg that Morgan Stanley were saying that you should be staying away from US stocks and bonds next year and seek out better returns in Europe and Japan. I'm assuming we're in a very unique time, where the hunt for yield against the backdrop of high inflation is making the jobs of these people super difficult? What other options do people have?
Lyn Alden: So, it depends on the pool of capital. For example, there were regulations that made money market funds hold more treasuries, rather than corporate paper. That's an example of shovelling people into treasuries. We also see that banks, because they're not really lending too much, they've been buying treasuries, they've been net buyers of treasuries on average. Then also, you have insurance funds, for example, have to hold a lot of their float. Basically, they collect premiums and then they pay out claims, and they hold a permanent float. So, depending on the insurance company, generally billions or tens of billions of dollars of investable assets, and they basically get to earn the income from that, but they have to keep it super safe.
So, some insurance companies are 100% bonds and they might do mostly government bonds, but also some municipal bonds and some corporate bonds. Then you have a handful of them that can put some of it into equities. So for example, Berkshire Hathaway, Warren Buffet's company, does that. I also know that Cincinnati Financial, for example, does that. There are some insurance companies that venture out. We've also seen a trend of some insurance companies buying Bitcoin; that's been one of NYDIG's big approaches. But overall, insurance companies are very, very bond heavy, because they have to. They have to have low volatility to match their liabilities to their expected payouts. So, a lot of this is mandated.
But then you see, there are pools of capital that have some more flexibility, and they go out on a risked curve trying to get more yield and that does come with risk. So for example, pension funds, they target 7% or 8% returns, which is hard to do when historically, they've been bond-heavy portfolios, and bonds used to yield 5%, 6%. So, you had bonds, you had equities and you could make 8%, 9%, 10%. But now, with bonds so low, they've been allocating elsewhere, so they go into private equity, they go into some leveraged things.
We saw, for example, California's pension, they actually levered up a little bit. They basically levered up 5% of their portfolio to buy some of their riskier assets, they increased their risk and exposure. That's an example of these pools of capital that have some flexibility being pushed out on the risk curve, because instead of just having some of their portfolio in super safe assets, they increasingly want to go in these other areas, because they have certain targets that they have to reach. So, it's a really problematic environment. It's kind of like, when you squeeze all the juice out of the orange. We've propped up asset prices so high, that we're now starting to see kind of improper behaviour as people say, "Well, I can't own bonds, so I have to own riskier things", then they deal with that volatility.
Peter McCormack: What are those riskier things though? They're not just riskier bonds in other countries, like South America countries; are these other assets; are these corporate investments?
Lyn Alden: Yeah, there's different types. So, the simplest one is simply that they own more equities. So, they just have exposure to equities, which of course can have large drawdowns compared to bonds. Then the other options are, they can go into private equity, so less liquid investments, things that they can't necessarily cash out quickly, but they expect to do good returns over ten years, which they might or might not get.
Then, they can also get into corporate financing. So, in addition to just buying some, say, safe corporate bonds, they can also go into funding bank loans and other types of financing for firms that might not be investing great, so junk bonds essentially and junk loans. Then they can go into levered products, where you borrow a little bit, but you lend at a higher rate with some credit risk. They can buy emerging market bonds as well, so that's a source of high yield with more risk.
It's just those different types of things, so either loans, equities, or just different types of riskier bonds. That's the overall risk, that they go into things that have more probability of permanent capital loss, in a nominal sense, and also more volatility, so they can have a 20% downturn in a portfolio that is supposed to be pretty safe. So, you can imagine, for example, an 80-year-old might not want to be 100% in equities, they might not want to be exposed to the possibility of a 40% downturn in a year. And traditionally, they've been advised to have more bonds exposure, but with bonds being such a bad investment, they find themselves between a rock and a hard place, and then they often want to buy more equities. So, it makes sense in some ways, but it does come with risk.
Peter McCormack: Can they buy Bitcoin?
Lyn Alden: Yeah, they can buy Bitcoin, and that's something I've been advising since 2020, that basically people have different numbers for how much Bitcoin's right for them, but zero is not the right number for most people anymore. So, for obviously some people with super high conviction, they don't want to own anything other than Bitcoin and they're willing to accept crazy drawdowns and crazy doublings and triplings in price; whereas, obviously other investors with maybe less conviction, or less volatility tolerance, for them it's putting Bitcoin as some non-zero position in their asset. So, they might take some of their bonds and put it in Bitcoin.
So, even if you have part of your portfolio as a melting low-volatility ice cube, you have this other part that over the next five years, hopefully rapidly appreciating in price, and kind of balancing some of that out. So, you have kind of a mix of low volatility without necessarily losing value. So, there are different strategies like that. I do think more of them should probably turn to Bitcoin. We've seen some pensions get into Bitcoin, but they've been somewhat slow. They prefer, I guess, more levered kind of Wall Street products than Bitcoin so far, but I do think overall that Bitcoin would be a better choice.
Peter McCormack: But what about volcano bonds? What did you make of that?
Lyn Alden: So, they're basically doing the Michael Saylor playbook for a country. So, they're issuing debt, my understanding is in dollars, and using that to buy Bitcoin and buy Bitcoin mining equipment. So, if that pays off, that could be tremendous. I don't know what the yields will be, I haven't looked into the full details. I think they're doing partially over liquid.
Peter McCormack: 6.5%.
Lyn Alden: 6.5%, okay.
Peter McCormack: Yeah, that's what they're offering.
Lyn Alden: And so, yeah, basically that's classic for emerging markets. And it's tricky, because their normal debt is not really considered investment grade, which is the case for many smaller emerging types of countries. So, this one's obviously more backed by clearly what they're investing into. So overall, I think it's constructive. I think it's a pretty smart idea, and it's one of those things where, if Bitcoin goes up a lot in price, and if they're bringing the right expertise to have effect rates of return on their mining equipment in that environment, that could work out really well for them.
My understanding is that obviously, geothermal is very attractive energy to use. The climate is not super ideal for Bitcoin miners, so overall you would generally want to have experts there to make sure that it makes financial sense at the end of the day, when you take into account the construction costs, the expected return on investment for the miners, the low energy, combined with the fact that it's hot and humid. So overall, again, like most things out of El Salvador, I'm always interested in that, I'm hopeful for that, I'm bullish on that, but there are risks.
Peter McCormack: As I remember, I could be wrong, but I'm pretty sure I saw it's a 6.5%, he called it a coupon, right?
Lyn Alden: Yes.
Peter McCormack: I like that. And I think there's a five-year lockup. And what they said they were going to do is they were going to spend half of it on Bitcoin, and my assumption is the rest is used for other projects, maybe mining. But if they're buying $0.5 billion of Bitcoin with a five-year lockup, I guess their thesis is, in five years' time, Bitcoin will be worth more and therefore, if their debt's denominated in dollars, then if Bitcoin does a 5X, there's little risk to them. But I think it feels like they're playing the "Bitcoin continues to go up in price" game, that every cycle will continue to see a multiple-X increase.
Lyn Alden: That's similar to how Saylor structured his capital structure. So, they did a couple of rounds in MicroStrategy. The first rounds were convertible, so super low interest rates, but then they can dilute the equity. Then, I believe the final bond round they did was basically something like 6%. Basically, it was a bond that had pretty high yield, and the expectation was that if Bitcoin goes up substantially over the next five to seven years, it more than compensates for a 6% cost.
Their lockup period, their duration of those bonds, it varies a little bit, but I think it was five to seven years. Then, they switched to issuing equity in order to buy more Bitcoin. So, that fact that El Salvador's doing a similar timeline, I think makes a lot of sense. A lot of Bitcoin investors say, for example, that five years is probably an ideal timeline, where you have high probability of getting returns out of it.
Historically, anyone who invested for four years made money, usually less, but if you invested for three or four years, you made money, even if you bought at major tops, for example. Now, it's one of those classic disclaimers, like the past is no guarantee of the future, so there's no guarantee it has to do that for the next four or five years. But overall, because he's locking in that longer-term debt, it is a smart thesis, if someone's super high conviction on Bitcoin, which obviously El Salvador's President is.
Peter McCormack: So, with that five-year lockup, or referring specifically to Saylor, will he have to sell the Bitcoin at some point to pay the bondholders?
Lyn Alden: Not necessarily. So, if Bitcoin goes up or stays roughly where it is, most likely the bonds would be refinanced. So, when the bonds come due, you just issue another bond offering to cover them. The only time it gets messy is if, let's say Bitcoin does go down quite a bit over five years, so some sort of catastrophic outcome for Bitcoin, and Bitcoin's down in price and the market is spooked by that and doesn't really want to refinance those bonds anymore, it's possible that the company would have to issue equity in order to cover its expenses, or it could potentially sell some of its Bitcoin.
So generally, in a good environment, the answer's no. Something would probably have to not have worked out very well.
Peter McCormack: Okay, so even with El Salvador, they would constantly look to refinance these bonds. And I think they've talked about potentially issuing $10 billion bonds over a certain period. I guess the game theory is, if this proves to be correct, other people will start issuing Bitcoin bonds. Do you see any risk here that there would be too many people trying to enter the Bitcoin market to issue bonds?
Lyn Alden: What, so enter the Bitcoin market, like buy Bitcoin by issuing bonds?
Peter McCormack: Issuing bonds to buy Bitcoin. Is there any kind of systematic risk we build up with this?
Lyn Alden: If it gets big enough, yes. So, one of my concerns that I've been watching, more so than that type of bond, is the collateralised Bitcoin lending. So far, that's a small percentage, as far as I can piece together from some public numbers of, say, Bitcoin's realised cap, for example. Now, the issue is if that amount of debt gets super high, that becomes super common to do, everybody takes out loans against their Bitcoin, then the issue is that everybody has a liquidation point around the same level.
So, 30% loan-to-value is common, right, so let's say Bitcoin has one of its gigantic drawdowns and it goes down 70%, but then it triggers the fact that so many people have these collateralised loans, where Bitcoin loses 70% of its value subject to liquidation, and then you could have a self-fulfilling loop, where Bitcoin keeps getting liquidated in order to finance these debts, and that causes more entities to have to liquidate, and because the debt is too high relative to the amount. Now, I think we're a long way off of that, but that's a risk.
It's a little bit less risky with bonds, because if they're non-callable, if they basically have a fixed term that goes out years, and they're all going to be issued at different times, so they're going to be staggered in different ways, I think that's normal. Like how there's a lot of debt tied to real estate and it's one of those things where, because real estate's pretty low volatility, it can withstand quite a bit of debt connected to it. Some places do become excessive. I mean, China's an obvious example, but also parts of Australia, parts of Canada, parts of Europe and then lately, parts of the US become rather excessive. The valuations become propped up and then there's a lot of debt tied to that. So, if those valuations ever go down, that becomes a structural problem for that country's GDP.
Now again, Bitcoin is a long way off of that. If you add up all the debt out there that exists that is in some way used to buy Bitcoin, that's still a very, very small number in the grand scheme of things. So, I think that process probably has a much longer runway to go before I'd be concerned about that.
Peter McCormack: Just so I can understand a little bit more about how this works, so if they issue this $1 billion bond and it has a 6.5% coupon, that's $65 million, if my maths is correct; is that something that's paid annually, so they essentially have to generate $65 million to pay the bondholders annually?
Lyn Alden: It would depend on how that bond is contracted. So basically, I could have read up a bit more of it, if I knew we were going to go into detail!
Peter McCormack: Sorry!
Lyn Alden: No, but essentially, the common thing is, say, payable twice a year. So generally, they would pay $65 million a year spread out in two payments; that would be common. Theirs could have different terms. Generally, some short-duration bonds, they don't pay interest. Instead, they issue it at below face value and then pay out face value by the end, whereas these longer ones normally do have interest payments. So probably twice a year, and yeah, they'd have to have dollars to cover that.
Now, they could issue more debt to finance that, but that depends on how much the market is willing to take before they consider it a major credit risk. So, if they were to keep increasing their debt faster than they were getting results, the market might baulk at that. But also, they do have dollars and they do have basically activities that they can draw from. So, yes, they have to make sure that they can cover those interest payments.
Peter McCormack: So, the play here seems to me, and tell me if I'm incorrect, but they issue a $1 billion bond, they buy $0.5 billion of Bitcoin of which they hope or predict, over the next five years, that might itself do a 5X, or something or other, which gives them $2.5 billion, let's say, of Bitcoin. The other $0.5 billion, say they spend that on mining infrastructure; and as long as that generates $65 million a year of profits, that pays the bondholders.
Then, come five years' time, they could refinance the bond and continue to do that. So long as they can continually pay that $65 million a year, they're sat on the backdrop of this ever-growing value of Bitcoin. So, it seems quite smart really, as long as Bitcoin continues to go up forever?
Lyn Alden: It's a very similar play to what a lot of entities do with real estate, where you never sell the real estate, you just keep refinancing it over time as it goes up in value. Bitcoin is basically a more volatile version of that. Obviously, it's got less track record of 13 years, but the potential gains, if you're right, are massive.
This is the game theory of different countries, where El Salvador has less to lose, in some sense. They basically already have economic issues, there are a variety of problems there that they're trying to solve; and so, if they're right about this, that really moves the needle for them. If they issue dollar-based liabilities and they buy Bitcoin, and if they start cutting down remittance costs, with the whole Bitcoin legal tender laws, and if they do attract more capital and more people want to go there, that could be a huge boon, that could be a giant turnaround.
Bitcoin doesn't even have to go up 5X in order for that to pay off. If it doubles over five years, that would still pay off, as long as it goes up more than 6% or 6.5%, whatever the number is. Let's say we want it to go up more than 10% a year for the next five years, that should have covered itself. And of course, if it goes up 5X or 10X, that's a huge game-changer for them, especially compared to other countries in the region, basically their peer countries.
Peter McCormack: Yeah. So, the only risk to them, like you say, is a collapse in the price; and if they couldn't refinance the bond, is that a potential? And at that point, do they then have to sell their Bitcoin to then pay out the bondholders? What happens when a bond can't be refinanced?
Lyn Alden: So, one option is they default, which is they say, "We can't pay you back". Generally with countries, there are restructurings, or they'd have to sell their Bitcoin, sell other assets. They might have to sell with interest. If they had that state-owned energy company, I don't know the exact legal structure, but for example, you could privatise that. You could sell that to raise capital, pay off the bonds, so there's a variety of ways they could finance it.
Generally, you want to avoid that situation, because you don't want to have to sell something at an inopportune time. You never want to be forced to sell something, because then you're a price-insensitive seller, you just accept whatever valuation you can get. If Bitcoin's down, they might not want to sell when it's down, but they might have to. So, yeah, that's generally a situation to avoid, but you have that combination outcome of either defaults, or selling valuable assets in order to cover liabilities.
Peter McCormack: You see, this could inspire other countries to do the same, especially in the region. I know, for example, Paraguay is very interested in using their hydro dams to mine Bitcoin, but other countries in the region could see this and say, "Hold on a second, we can do this, we can issue similar bonds". And if this becomes something that a lot of other countries start doing, it becomes a self-fulfilling prophecy, because it takes so much Bitcoin off the market, then the thesis has proved correct?
Lyn Alden: Yeah, it's also that some people have been talking, "Why don't some large countries just print a little bit of money and buy Bitcoin and stick it on their reserves?" for example. If you were to see those cracks in the dam start to appear and you start to see that happening, that's potentially a really explosive moment, where you could have hundreds of billions of dollars of different types of liabilities issued in order to buy Bitcoin, which then is so big for a market that's still kind of small.
Even though right now, for example, as we talk, Bitcoin's in somewhat of a correction, we still see that the exchange bounds of Bitcoin is hitting multi-year lows, and it's because there's not a lot more being created obviously, it's pretty late in its distribution schedule, and there's this increasing tendency for strong-hand people to come in and buy it and put it into cold storage, whether it's retail hodlers, or these institutions that say, "Hey, we have this five-year view. We're going to buy Bitcoin and just stick it away".
So, yeah, if you start to see that on a national level more, that's the early signs of kind of a hyperbitcoinisation, basically that Bitcoin quickly ascends at least to, say, the scope of gold, where it becomes an actual recognised international reserve asset. So, right now it's not there yet. Most countries don't take that seriously as a reserve asset, but the next level up is kind of that gold level, where you're worth several trillion dollars and you become commonly held in reserves.
Peter McCormack: Well, it's what Pierre Rochard calls "the speculative attack", in that you buy, print, borrow sovereign currencies to buy Bitcoin. It feels a bit like to me, and Lyn, you can probably predict this better than I am, but if El Salvador was to do this, and then other countries look to do this, the bond rates on the Bitcoin bonds could actually start going higher, and could this be a scenario where it's almost inverse to the US Treasuries, in that we're seeing lower and lower rates on US bonds, and Bitcoin bonds could go higher and higher, because they're more reliable?
Lyn Alden: Well, it depends. Generally, if a bond is considered safe --
Peter McCormack: It holds a lower rate.
Lyn Alden: -- its yields should be pretty low. Now for example, let's say El Salvador's Bitcoin goes up a lot and then they refinance this amount of debt in the future, they could potentially get a lower rate, because now they have a lot more collateral backing up that loan. The alternative is that they could keep the rate roughly the same, but issue a lot more bonds.
So far, if you look at the catalogue of who's issued bonds, MicroStrategy's been the obvious example. We just saw Marathon, I believe they're the largest Bitcoin miner, they already actually bought Bitcoin on the open market, and now they issued debt in order to basically a combination of buy Bitcoin, buy miners, just general expenses. They actually discussed this on the Bitcoin Mining Council, the prior live stream they had, where a couple of the miners talked about that, during the Saylor playbook, on their own balance sheet.
You don't really see that amongst gold miners, for example, they don't issue bonds to buy more gold, they sell the gold that they get. Whereas, an interesting thing that we're seeing in the mining space is that they're not really selling the Bitcoin that they're mining anymore, at least a lot of the ones in North America, they're just hodling it on their balance sheet. Then, some of them are actually going a step further and issuing various types of liabilities to buy more.
Then you see El Salvador do it, and so generally it's companies or countries that have high conviction and they don't feel they have a lot of career risk for doing it. So, Saylor owns a large percentage of his company, especially the voting rights; miners obviously, because their main purpose is to own Bitcoin, they feel they can do it; El Salvador, I guess he feels like he's in a tight spot, their country, they want to do something big, rather than these incremental changes, so he's going for it.
I think the reason you see it slow among other countries or corporations is that there's career risk, so there's not a lot of gain for the person, the treasury, of that company. If they get that right, at the size they would do it, they'd get congratulated, but it wouldn't change their career. Whereas, if they're wrong, they lose their job. So, there's that career risk, and that's why you generally see more bureaucratic institutions move slower, whereas these smaller, more periphery entities are able to just, one decision-maker makes the call, and they just push forward with it.
Peter McCormack: It's fascinating. I sometimes wonder if our beloved Satoshi is around and watching all this, and admiring what's been happening, because I'm pretty sure he wouldn't have predicted that we would have had these huge mining operations and governments issuing bonds to create mining operations. How this has evolved, I don't know, it fascinates me. I don't know if you're equally fascinated by it.
Lyn Alden: Oh, definitely. I mean, it's funny because Hal Finney wrote about this back in, what was it, 2010, 2011; he kind of imagined how big it could get. He was one of the more vocal people in describing how big it could get, so I think he'd be maybe less surprised.
Peter McCormack: $100 million a coin, I think he said, didn't he?
Lyn Alden: Yeah. And we also talk about if banks start using it as their reserve asset, and then basically he predicted the financialisation of Bitcoin. And, the quote that always sticks out to me from Satoshi is that he said he's sure that, "In 20 years, it will either have tremendous volume or no volume".
Peter McCormack: So, you should probably buy some, just in case!
Lyn Alden: Yeah. And basically, his overall point was that he's not sure it would work out, but it's either going to be a tremendous failure, or it's going to be a tremendous success. There's not a lot of middle ground in his view, and so far obviously, 13 years into that 20-year vision, it's on the tremendous success path. So, he's been correct about that.
Peter McCormack: Yeah, and I don't see us going backwards from here.
Lyn Alden: I don't.
Peter McCormack: It feels like we've gone too far now, it feels like we have the regulatory protection in the necessary markets; not enough here in the UK or Europe, unfortunately. We've just not been forward-thinking enough, and I think the UK specifically missed out on an opportunity with Brexit to be a leader in this, which is a shame. I think Europe is being massively left behind by El Salvador, as well as the US, but I feel like the US is very forward-thinking with this. I feel like if you have the regulatory protection of the US, then you kind of have most of the western world, and that's fascinating.
Also, I need to talk to you about inflation. I know we discussed this in Spaces recently, but not everybody would have joined us for that. And we saw the very surprising figures coming out of 6.2%. Since then, we've had the UK announce figures of 4.2%. Still can't seem to be able to explain to my friends why this is an issue, and I've been telling them for quite a long time and trying to get them to listen to the podcast, but what were your reactions when you saw 6.2% inflation?
Lyn Alden: So, kind of that it was in line with expectations, slightly on the higher end, because my overall window that I was expecting was, I wasn't sure it was going to be higher than the prior number; my only conviction was that it was going to be around that height, so it wouldn't really being going down yet. So, there was kind of that big range where nothing would have surprised me. If it was over 6.5%, I would probably have been surprised.
It's also partially that you're not just expecting inflation, you're also expecting how they're going to measure inflation. So for example, a big component is the housing component. That's what's driving up a lot of the 6.2% figure that we're seeing in the US now. So, earlier in the year when we were getting 4% or 5%, housing was a big drag on that. And even though housing prices have gone up a lot, owners' equivalent rent, which is actually what's in the inflation basket, had not yet come up yet; it was still a very low number, so that was actually pulling the average down.
But now, we're starting to see that those figures are pushing it up, so rents in the basket are going up in owners' equivalent rent. Now, they're still behind what you'd actually expect, if you look at what housing prices did, and if you look at data aggregators for what rent prices are actually doing. These are actually still understated. So, when you anticipate inflation print, partially you're trying to figure out what's inflation going to be; and then also, you're saying, "What is the government's measure of that inflation going to be?" which is why I don't try to predict it too specifically, I just know a range that it's going to be in.
So generally, we can look at at least another quarter or two and say, because of the real estate situation, we're probably going to have sticky high inflation for at least those two quarters. Then, as we move forward, we'll get more and more visibility. So, it's possible that could eventually top out for a period of time and relax, and or something else could happen; we could have another energy crisis, we could have some sort of issue like that which gives us another leg higher. But at least with the visibility we have, while it's hard to say the exact number, it's relatively straightforward to say that inflation's likely to be elevated and sticky for at least two more quarters.
Peter McCormack: Okay, could it go higher? I mean, one of the criticisms that we heard from the likes of Preston Pysh, our friend, and Greg Foss is that 6.2% is the lowest number they could get to, based on how they measure inflation. But most people are saying that everything they're buying, whether it's petrol or houses, everything is much higher than 6.2%, so there is the suspicion that inflation is much higher.
Just to add into that, who was it I saw recently that said that the strange thing about inflation is, inflation's very personal, because it depends what you're spending money on. The government measures it against a basket of assets, but the things that you buy might be a lot higher. But do you think we could be going higher than 6.2%?
Lyn Alden: I do, especially if it shows up in the owners' equivalent rent, which is like a third of the basket. So, as a data point, Invitation Homes is the largest homeowner in the US, it's a publicly traded business that owns a lot of single-family homes, and they raised rents by 11% year-over-year on average. They have this big nationwide complex of homes, and that's not showing up yet in the CPI. The CPI, when they look at rent, they're calling it something like 3% or 4%; they're not calling it 11%. So, that still has a runway to go.
So, I wouldn't be surprised to see 7% or 8% official CPI prints. Again, I don't have a specific number, because again you're trying to estimate the quality with which they're going to measure the number, rather than just predicting the number. So, that's hard to say what they're actually going to report what the number is. But based on the next two quarters of housing growth, that's certainly possible, unless it's offset by something else. If we have some sort of collapse in auto prices, or something like that, that offsets those housing prices going up, that could maybe keep it in the 5% to 6% range.
So, there are a couple of variables involved and levers to do, but the high conviction thing I would stick to is that housing inflation is going to at least keep it sticky around roughly where it is, or higher, for the next two quarters, and then it will need more visibility and data points to look out the next couple of quarters.
Peter McCormack: What kind of number would shock you?
Lyn Alden: So, I guess the high end right now, so broad money supply growth in the United States is currently 13% year over year, roughly. You can briefly have price increases go up faster than money supply growth, not really in a sustained way, so you saw that briefly in the 1970s; you didn't really see that in the 1940s. So, generally 13% is kind of my rough-end high estimate. Now it doesn't mean, again, you could touch it for a quarter. It's hard to sustain above that.
So generally, if you were to breach maybe 10% official reported inflation, I'd find that pretty surprising at the current time, but overall in my base case, it's just sticky and high. It's one of those things. Also, a lot of people have hubris in that they try to measure it exactly or say exactly what it's going to be, and of course you're combining multiple factors here.
So, you're combining actual things we can measure. So part of why I expected high inflation is because I already saw this big increase in the money supply and I was pretty sure that was going to trickle onto price increases, which is what we're seeing now, so there's that that's somewhat measurable. Then you also have psychological things, so how people's tendencies change. Then you have details like, is the winter going to be cold or warm, because that can affect energy prices, which then can affect everything else.
So, there are multiple variables that I wouldn't even try to fully guess and be, "Okay, it's going to be exactly 8.2%, give or take 0.1%" that's too specific. But I can look at it and say, here's the money supply growth rate, here's the historical relationship between money supply growth and price increases, then we have this big range around the price increases, because we actually have to determine how accurately they're going to measure that, which I don't have a super ton of faith in.
So basically, if we start getting into double digits, I'd be surprised, at least in the current environment. If we see an acceleration of money supply growth, then that changes that calculus.
Peter McCormack: So, if we were to see, say, plus 10% inflation, I think 10% as a marker would be considered very high, what kind of reaction do you expect to see? Do you think that would force the hand of the Fed; do you think they would have to change things; do you think we would see interest rates raised?
Lyn Alden: I think you would see some more reaction, yes. Now, the problem is, in order to give real yields in that environment, you'd have to raise rates like 11%, and that's not going to happen. So, they've been talking about potentially accelerating their taper. So, currently the Fed's plan is that from now until about mid-2022, they're going to be reducing their rate of asset purchases to eventually maybe get to zero.
Peter McCormack: Do you believe them?
Lyn Alden: So, I do believe they're going to try that, yes. Now, they left it open, because they have a minimum that they're going to buy, but they actually don't have a hard cap. If there's any moment of disfunction in the treasury market, if there are any sort of liquidity problems, they can just buy more that week. So, they're not actually fully committed to that plan. That's them saying that they're committed to a lower minimum that they're going to buy over a period of time.
But I do think they're going to slow down their rate of asset purchases. There are various signs that basically the banks are already so stuffed full of reserves, it's not doing a ton anyway. And because of certain collateral shortages, there's this demand for T-Bills. Again, it actually goes back to the regulation; there's all this regulation that basically forces entities to own T-Bills, and so I do think you're going to see a reduction in asset purchases, combined with the fact that the Treasury's going to be reducing its average maturity of bonds, so financing more of its debt with shorter-duration Treasuries, because that's where the demand is. So, I do think they can do that for quite a while.
I think the bigger question is, how long can they do that? So, I have little doubt that they can do it for a period of time; I have doubts that they can sustain that. So I think eventually, you would get another slowdown and have another round of QE and then, while this all plays out, I don't think rates are going to get anywhere near being positive real rates, meaning that even if they start to say, "Okay, this inflation's a problem now, we're getting 8%, 9%, 10%", or say it's sticky around 6%, they'll say, "You know what, we're going to start raising rates by a quarter, we're going to go up 0.25% at a time". That just doesn't cut it.
So, I think around the margins, you'll see directionally trying to tighten, but it's just not necessarily sufficient to actually make that money worth holding.
Peter McCormack: Do you think anyone has a harder job than Jerome Powell right now?
Lyn Alden: Honestly, I always say I wouldn't want the job. I have to say, there are obviously manual jobs that are much, much harder than that. But from a financial standpoint, it's choosing various ways to lose. There's no way to win and you're just trying to lose slowly! So, I'm surprised, I don't know why he wants another term.
Peter McCormack: He just got it.
Lyn Alden: Yeah, he just got announced to have it, and he's already rich, and I don't know why he doesn't want to go to work for Wall Street again and just get out of this. I don't know.
Peter McCormack: He's going to get blamed for everything.
Lyn Alden: Yeah. I always point out that, back in the Greenspan era in the 1990s and the early 2000s, I think the Fed had meaningfully different decisions they could make, that they didn't have to go down the route they did at all, and they did. They kept cutting interest rates, they kept basically helping Wall Street wherever they could, and they've essentially trapped themselves, because now there's so much debt that they can't ever realistically raise rates any time soon, without a major currency devaluation happening first.
So now, it's just around the margins they can make mistakes, but really they're just so trapped into a corner that I don't even blame them anymore in some ways. The people that are running it now, it's just a mess, so I wouldn't want that job!
Peter McCormack: A lot of bitcoiners talk about ending the Fed. Have you ever gamed that through? Do you think it's possible to not have the Fed, realistically?
Lyn Alden: Yeah, I mean in the United States, we went through periods of time where we didn't have a central bank. The Fed is our third central bank.
Peter McCormack: Okay, I didn't know that.
Lyn Alden: Yeah. Basically, when we were founded, we had one, and it had an Expiry Charter and they let it expire. Then they had another one, that one expired as well. The current version, the Fed, was created in 1913. So, during the late 1800s and into the early 1900s, there was no central bank.
Essentially how that works is banks would, in that environment, they'd have gold as their reserves, or at least a lot of their reserves, and they'd issue liabilities against those reserves; and if they go bankrupt, they go bankrupt, and you'd have to be very careful about institutions that you'd put your money in, because you can't lose it. But on the other hand, you don't really have that central control.
In most markets, basically pricing is really important. We would baulk at, say, if the Treasury Department set the prices of turkeys. We'd be like, "No, we want supply and demand to determine the price of turkeys". But basically in this modern central-banking era, they control the price of money, which is interesting, because it's one of the most universal prices. They set short-term interest rates, the overriding market forces, and they determine what they believe interest rates should be.
Whereas, in that more free-banking type of model, you'd have different banks set different interest rates, and they'd have different levels of risk. We're kind of seeing a microcosm of this in the Bitcoin space. We have these different kinds of "Bitcoin banks", and some of them are perceived as riskier than others and they have different rates compared to others. And, they're not FDIC-insured, so if you deposit assets and then that entity has financial problems, you might not get those back, or not get all of them back.
So, you generally have a similar environment there where this one bank might have a bad reputation, they might have a history of issues in the past, they might be luring customers in with higher deposit rates that might or might not work out; then you might have very conservative institutions that are much more perceived as having a lower probability of having any sort of problem. So, yeah, I do think there are structures that work without a central bank.
Peter McCormack: Okay, so it's just a reputation market? It's free banking, you have a reputation market, similar to what you have with bonds, right? There's different rates of return depending on how much a risk that country is; you'll get a higher rate with Argentina than you would get with the US. Do you prefer that model?
Lyn Alden: I think longer term, yes, that's an ideal model. I think preferably, you'd have institutions set interest rates, rather than a central entity. Even just the United States, we're a country of 330 million people, and the right rate for the south might not be the right rate for the north, for example, so there could be regional differences, let alone individual banking differences, for what the national interest rate should be in that market. So, I think that's something to be aware of.
Overall, that kind of comes directly tied with sound money, because the current system, the way the whole fiat system works, it's inherently tied to central banking, you can't really separate the two. But yeah, if you had an environment where the actual reserves were some sort of sound asset, whether it's gold in the past, whether it's Bitcoin in the future, whatever the case may be, then you can make that free-banking model work, because their reserves are not tied, they're also not liabilities of any other entity.
They can kind of do sharing. So a bank, in addition to holding gold, can hold treasury bonds as collateral, they can hold another bank's, say, liabilities as collateral, so you have to be careful of things like that. But as long as at the base of it is some sort of bare asset, like gold or Bitcoin, then it's workable.
Peter McCormack: Yeah, I guess that's why, when we have Bitcoin, we don't really need a central bank, which is great. Okay, we should probably finish by talking about Bitcoin. So, we set a new all-time high recently, we tagged $69,000, and we dropped down again. This second leg of the bull market just doesn't seem to be getting going. I've seen different people have different perspectives on this. What's your take at the moment with Bitcoin, Lyn?
Lyn Alden: So overall, I would say this recent leg up kind of looks like the leg up we had from July. So, back then, it was all the way down to $30,000, then it popped to over $50,000, then it corrected down to $40,000, then it popped all the way up to well over $60,000 to new highs, and it's since corrected down to the $50,000s. So, so far, that's actually pretty symmetrical. You generally don't see bull markets go straight up.
So, if it were to stabilise in the mid-$50,000s and then start heading higher, that's actually super healthy; that's really healthy. I think the big concern you'd have is if you start breaking down below the mid-$50,000s, then you're in more of a consolidation pattern, so that's not necessarily super bullish over, say, the short term to intermediate term.
You've had people on your programme that are on-chain analysts, so they cover the space more than me, but I do pay attention to some of that. Some of those are a little bit bearish, but I would say the majority of the ones I look at are still bullish. So overall, like I think we mentioned before, the number of Bitcoin on exchanges keeps reaching new lows. You have to go back all the way more than three years to find a period, and this is unlike any prior cycle.
This is the big wild card that makes this cycle so unknowable, that in all those previous cycles, the number of Bitcoin on exchanges kept going up. At most, you'd have a few months where it went down. It just structurally went up, because you had the growth of exchanges, you had a lot of new supply be coming to market, because you still had kind of an inflationary distribution schedule back then. But over time, as the halvings keep happening, and as the exchange industry's matured, now you have a structurally declining amount of Bitcoin on exchanges. So that, over the long run, is structurally bullish.
So, I'm still bullish overall. But basically, we want to watch certain levels and see if we're still making higher highs and higher lows and if we overall have intermediate-term momentum, or if we have to think out another year before we start to see crazy upside action. I try to avoid these specific price targets that people make, and they have the specific model, and they say, "This is what Bitcoin has to reach by this time". When I've been asked to give one, I do give price targets.
I called for the trillion-dollar market cap back when it was a third of a trillion; we got that. And then I've been eventually looking for $100,000, either maybe by this year, or the first half of 2022, and I still think it's, at least for the 2022 version, I think that's still certainly on the table as a viable option. But I think the longer-term picture is what I'm focusing on.
Peter McCormack: All right, Lyn. I think we can finish up here. Always amazing to talk to you and really looking forward to seeing you next, because we're going to record a show in person, which is going to be entirely different, because we've never got to do that, which is always my preferred way. I think we should do a review of the year, talk about what we think's going to happen next year, but I really look forward to that. I've loved every interview we've done this year, so thank you and I will see you very soon.
Lyn Alden: Thanks for having me, and yeah, we ran into some technical issues this time, but next time will be in person, so we'll have a much smoother one, so hopefully people enjoy this.
Peter McCormack: Okay, well I will see you soon, Lyn. Take care.
