WBD475 Audio Transcription

Economic Warfare in Russia & Ukraine with Lyn Alden

Interview date: Monday 14th March

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.

Lyn Alden is a macroeconomist and investment strategist. In this interview, we discuss the economic impacts of the Ukraine Russia conflict, including the effect of sanctions on Russia, wider global impacts, and the responses of individuals, companies, and nations.

“We’ve assumed global peace: no geopolitical issues, we’re all gonna kumbaya, get together; and as we enter a world where that’s not the case anymore, we have to put more resiliency into our supply chains, more duplication – so if you have to duplicate things, it’s inherently less efficient, and more inflationary, but more resilient.”

— Lyn Alden

Interview Transcription

Peter McCormack: Hi, Lyn, how are you?

Lyn Alden: Good, how are you?

Peter McCormack: I'm very good, thank you.  So, quite a lot's happening in the world.

Lyn Alden: Fortunately!

Peter McCormack: Yeah, I seem to have come a little early this month.  We made a show recently, called The Currency Wars, which talked about the potential that in the future, we might see some form of currency war.  It was a very popular show, everyone loved it.  And now, we seem to have fast-forwarded into what that conversation was about.  So, I thought it would be worth getting you on, start talking about this.  Just a broad question for you really, how are you taking everything that's happening in the world right now?  Because, war's never good, but it's also crazy to watch everything that's happening economically.  I'm expecting it's probably one of your busiest times.

Lyn Alden: Yeah, this reminds me a lot of March 2020, when basically there's a lot of things going on, and you have to quickly assess every asset class, make sure your framework is refreshed.  So, I mean, one is the humanitarian crisis, so just from a non-professional standpoint, that's just concerning in its own right.  And then, from a professional standpoint, the way I would describe it is kind of like how COVID-19 accelerated a lot of trends that were probably going to happen anyway, like a shift towards remote work, it just pulled things forward.  The same thing with physical stimulus and things that I think were probably going to happen anyway, it pulled forward a lot of that.  So, I think this event is pulling forward some of the Currency Wars things we discussed. 

But a research topic I've been focusing on for a couple of years now is the petrodollar system, the downsides of it, and the eventual trend towards decentralisation of that, or bifurcation of that, kind of a more multi-reserve, multi-polar system, and this sort of war can accelerate that trend, so that's how I'm interpreting it at this time.

Peter McCormack: And I guess you're having to think about this on two fronts: your personal investment thesis; but also, as now one of the leading macro speakers globally.  I expect there's a lot of demand on your time and people want to know what your perspective is on all of this?

Lyn Alden: Well, it's certainly been challenging for the inbox, that's for sure!  And I try to read as many as possible, and then answer those questions in articles I write, so I try to cover it at scale.  But yeah, basically there are a lot of things going on, and it just pulls forward so much, and it just requires a reassessment of every asset class.

Peter McCormack: Yeah, so let's dig into this.  This is kind of a strange war to observe from the outside.  Not only is it a war where we're getting to follow it on social media, but it's more a strange war because not only are the weapons of war bombs of propaganda, but money itself and commodities have now essentially become weapons of war, become part of the -- yeah, really they've just become weapons themselves.

Lyn Alden: Yeah, for the commodity part, that's always been a key aspect of war.  I mean, during World War II, security over oil fields was a key part of it.  That's why there was a significant amount of battles, even in the European theatre, outside of Europe.  A lot of it was to secure certain energy supplies.  And so, that's not new.

It is relatively new to have this level of financial warfare.  So for example, freezing reserves.  And this kind of begs the question of how much Putin anticipated, because they did make themselves sanction-resistant by focusing on gold and de-dollarising as much as possible, but they did have a very big focus on euro-denominated assets; and maybe he didn't expect that they would freeze the euro-denominated assets, it's hard to say for sure

But essentially, several hundred billion dollars of Russian reserves have been frozen by the West, by these sanctions, and that is equal to several years' worth of military spending for Russia.  I mean, it's a huge percentage of their GDP, a huge multiple of their annual military spend, so it's already been an extraordinarily expensive war for Russia to fight, let alone the devaluation of the rouble, the decimation of Russian savings, their stock market being imploded.  Then, there's also just the reserves themselves being frozen.  

That kind of shows this level of financial warfare that's happening, and their counterpoint is, "Hey, we control a significant minority of commodities, both for energy and also even for green tech".  Nickel, for example, is absolutely key for battery technologies as we currently known it.  And so, it's this war between what's going to happen first.  Is Russia's financial crisis going to kick in faster than Europe's and the rest of the world's commodity crisis?  We're kind of in this race between who can harm each other the fastest.

While they're not having a kinetic war between each other, the kinetic war is focused in Ukraine, but these greater powers are focusing on this financial and commodity war in the background of the actual physical warfare.

Peter McCormack: And your observation of this race, who do you think is struggling more?  We know, when sanctions are put in place, that it tends to harm the people before it harms the leaders, and it feels to me like historically sanctions don't usually work.

Lyn Alden: I think they're both unfortunately being very successful in terms of hurting the populations.  I mean, Europe's struggling with the energy crisis, Russians are struggling with the financial crisis.  From my reading of it, I think Russia is being hit harder faster, but it remains to be seen if that will be the case longer term. 

To the extent that sanctions help, I mean it's challenging because polls generally show, including western polls, that actually a decent number of Russians were in favour of this type of conflict, and that could diminish over time because of this.  Putin could lose political support, both of oligarchs and of the population, but it's unclear if that will work or not.  It could have the opposite effect, it could polarise them around Russia and away from the rest of the world.  I don't really have the expertise to determine how successful those will be, it's just an observation about what's happening.

So, it's not even just the sanctions, it's all these self-sanctions as well.  So, a lot of companies are just saying, "We're not going to sell our products into Russia", and that includes a lot of the internet companies, the technology providers, things like that.  So, in addition to bifurcated supply chains, bifurcated commodity markets, that could contribute to the bifurcation of the internet, like how China and the rest of the world kind of have their own internets.  Russia could shift more towards the Chinese internet side, and so you almost have two internets around the world.

Peter McCormack: So, what kind of impacts are we are of that this is having on people within Russia; what are you seeing?

Lyn Alden: Well, one is that their savings have been just severely hurt.  The Russian stock market's been closed and totally impaired; it's just completely devastated.  And from studies I've seen, from by example, I think Meb Faber of Cambria Investments cited this, among the Russians that have stocks, which is not all of them, and whatever percentage they have in stocks, 95% of that is in Russian stocks.  So, they have very little global diversification, and Russian stocks were decimated.

So, a lot of people just had their savings damaged, then they had their stocks crushed, and then real estate remains kind of an open question.  So, that gets marked to market a lot slower, it's obviously a decent inflation hedge overall, but only if people want to buy those properties.  If people leave Russia where they can, that's obviously very detrimental to their real estate values.  So, pretty much across the board, among multiple asset classes, they're being hurt very poorly.

Now, the ones that are doing better are maybe the select few that do have a decent amount of international exposure to other assets.  It could be dollars, it could be US stocks, it could be gold, it could be Bitcoin.  So, Russians that do have those foreign assets are the ones that are holding up way better than their peers.

And then, we've also seen in Ukraine, for example, ATMs running out of cash, people trying to flee with money that they can get, and both Ukraine and Russia are pretty high on the crypto adoption index that Chainalysis puts together.  So, I believe Ukraine is number 4, Russia is something like number 19, and so both of those populations do have rather high amounts of Bitcoin and crypto exposure.  I don't know specifically the breakdown, because I think the crypto index just looks at multiple assets, but obviously it's generally Bitcoin-focused.  So, both of them do have a decent percentage of people that have those assets, and those that have them are more protected.

Peter McCormack: And in terms of the rouble being hit quite badly, what is the direct impact on that?  Is it mainly with regards to bringing in imports that Russia maybe perhaps relies on; how much defence can the Russian Government put against that; how self-sustainable can they be?

Lyn Alden: Yeah, so before the war, the rouble's already kind of weak.  And it's interesting, because the rouble, in some ways, before their reserves were frozen, if you just look at the fundamentals, the rouble was actually pretty strong.  So, it's the currency that's actually the most gold-backed of any major currency, meaning that their gold reserves as a percentage of their money supply were among the highest in the world, arguable the single highest, especially out of the major currencies.  Then they had very large reserves, but obviously a lot of those reserves were frozen, so their effective reserves as a percentage of money supply just went down significantly.  And of course, the sanctions can decimate their economy, which makes nobody want to own the rouble.

So, overall, that should be a very severe effect.  So, prior to the war, it was kind of a mixed bag.  On one hand, their import power was not very strong, but it also made their export power very good.  So, for example, one of the reasons that Russia is such a good wheat exporter is that, in addition to just the good geography for it, they have fairly low labour costs.  When you have an undervalued currency, if you run through what Russia's currency should have been valued at versus what it was valued at, it was essentially undervalued.  So, it's not good for their importing power, but it does give them a lot of export competitiveness.  That was all pre-war.

Now, with the war going on, they get most of the bad sides of it.  So, they obviously have a lot of trouble importing things, both from the strength of the currency, and the fact that many, many companies are just saying, "We're going to close our Russian operations [or] we're not going to sell to Russia", so their ability to get imports has been greatly impaired, except that they can still get their imports from China.  So, it kind of forces them to shift east, in terms of their import dynamics.

Their export competitiveness would get better, if it wasn't for the fact that again, a lot of places think, "We don't want to buy Russian products", but of course it's complicated, because their commodities are required around the world.  So, many countries were sanctioning where they could, but they couldn't sanction their commodities.  But then in many cases, Russia's then started to do that for them, and say, "Well, we're going to put export restrictions on some of our commodities, and make lists of who we don't want to sell our commodities to".  So, that's really where you get that kind of counterpoint, and then it becomes a race to see, does Russia go and solve it before Europe goes commodity insolvent, for example.  So, that's the background war we're having, in addition to the kinetic war.

Peter McCormack: So, there's a chance of the country going insolvent.  How does a country go insolvent; what is the actual impact of that?  Would that be a complete collapse of the country, perhaps therefore a collapse of the government?

Lyn Alden: In an extreme case, yeah.  I mean, there's a spectrum.  On the very extreme case, you have like a Venezuela situation.  A less extreme case, you have what's happening in Argentina and Turkey, and currently Russia now.  So, going into this, Russia looked very different than Argentina and Turkey, because Argentina and Turkey had a lot of foreign debt and pretty low reserves, so they were prone to financial crisis.  That's part of the reason we've been seeing such massive inflation out of them, and them having an inability to contain their currency.

Russia was the opposite, where they were built like a fortress position.  I even had a meme out there saying, they had trade surplus, low debt, high reserves, Putin was fairly popular in polls, both domestic polls and western polls, and then they did this and just across the board, all those things are getting damaged.  So basically, if they have a financial crisis, depending on how bad it gets, and at this early stage it's still fairly hard to say how bad it will get, but at the very least they're already now looking like Turkey or Argentina, with obviously very bad inflation, disastrously high interest rates, just a totally seized-up economy; and if the sanctions get bad enough and if they're cut off enough, it could look like Venezuela, you could have that sort of situation.

I think a key factor that's going to determine how badly Russia is impacted is, to what extent they can rely on China and to what extent they can renegotiate some of their commodities.  So, one point that I've made is that, countries with GDP per capita less than, say, $15,000 are less likely to go along with western sanctions, because they absolutely need the commodities.  So, when you have GDP per capita of like £3,000, you have less flexibility to decide who you're going to buy commodities from.

So, if Russia can shift where it sends its commodities to, they're already talking about building pipelines that would, say, redirect some of the European natural gas to China, for example, but those take time; and so, if they're able to navigate that, then they could stave off among the worst crises, but it remains to be seen.

Peter McCormack: I could imagine one of those pipelines though takes, what, years to build?

Lyn Alden: Usually years.  I mean, now they have a national incentive to throw everything possible at it, so I would cut off time from whatever the normal case is.  But when they built their, I believe it was called The Power of Siberia, it was a pipeline that does go to Russia and to China.  And, because you can imagine the amount of land space there, it's one of the longest pipelines around; it was well over 1,000 miles.  I don't have the data in front of me, but it was a very large pipeline, and that did take years to construct.

So, they essentially want to build more of those, and also make connections so that they can redirect European natural gas to them, rather than being separate systems, and that does take time.  Similarly, it takes time for Europe to build LNG capacity, so that they can become less reliant on Russian gas.  So, that's kind of the emergency situation.

You see, oil's more fungible because, except for very niche situations, where a region's cut off from supply chains, for the most part, there are less extreme oil pricing differentials around the world, because a barrel of oil can be transported relatively easily.  So, you get minor differences of pricing, but not usually huge differences in pricing.  Whereas, natural gas, because it's harder to transport, naturally has bigger price differentials between locations. 

But even before the war, we were seeing this between, say, Europe and America, where Europe at some points had gas that was like ten times more expensive than America, and that's because you either do pipelines, which is obviously very location-specific; or, you do LNG, which is rather expensive and has very limited capacity.  So, we can't just triple our LNG next month.  So, there's hard limits on how much you can do, and so that infrastructure takes time to build as well.  So, it's a mess on both sides, and it's one of those things where almost nobody wins from this conflict, it seems.

Peter McCormack: Okay.  Are we hearing any case studies of things which are happening on the ground in Russia, like the impact of this?  One of the things I heard about was, for example, they can't now import parts for Boeing, so there's a risk to the airlines, which was something that I hadn't considered obviously, but now I've heard about it, obviously makes total sense.  My dad was an aircraft engineer, they're constantly having to check the planes, and fix parts of the planes, and change parts of the planes, so that's just one example of a single industry for them that's now at risk, if they can't get the parts.

Lyn Alden: Exactly.  Both Boeing and Airbus can restrict their parts and suppliers can restrict their parts, basically the avionics providers and things like that, so that can cause issues.  We actually saw similar issues for Iran, because there were basically restrictions on parts to maintain their nuclear facilities, the nuclear power approach there.  So, when you have a very complex system and you get your maintenance parts cut off, that does, over time, degrade systems, and you can have things go offline, basically have to shut down powerplants, or shut down part of your fleet, because you're unable to maintain it.

Now, Russia does have obviously a very strong aerospace industry on its own, so it's maybe less impacted than some countries would be, but it's still obviously impacted by all of those shutoffs, including the aerospace ones.

Peter McCormack: And what about just general citizens; are there any particular pain points we're hearing about with regards to these sanctions or what's been happening?

Lyn Alden: Well, I think the devastation of the savings was obviously the big one.  But yeah, basically you're seeing consumer brands cut off, you're seeing shutdown McDonald's, you're seeing Microsoft, Apple; basically, all the normal products that you interact with are being one-by-one elected to not be sent there.  So, I think that because this has only been a short period of time, I don't study the anecdotal on-the-ground stuff as much as some other people do, some of the journalists would be much better people to ask about that than me, I focus more on the financial aspect.

But basically, so far it's been a short period of time.  The longer this drags out, obviously the more those things start to notice.  So, for example, if you have a laptop already, maybe you're not impacted by the fact that now it's going to be harder to get certain laptops.  But as you go on and you need a new one, well then it becomes a pretty significant issue.  So, over time this should compound, as they have less and less access to all these different western brands, and they're either forced to go without, or they're forced to shift east, in terms of the supply of goods and services that they use.

Peter McCormack: Well, my assumption is that there will be a kind of black market that opens up via somewhere like China, where certain entrepreneurs will see an opportunity here to, even if Nike's cut off, somebody can go to China and perhaps buy products and import them into Russia that way.  I mean, China doesn't pay attention to these sanctions themselves, right?

Lyn Alden: Yeah, they'll be able to do that.  I mean, they'll obviously be more expensive with all those steps.  And so basically, the Chinese-made products, specifically including the Chinese branded products, will be much cheaper than many of their western counterparts, to the extent that those western ones are available kind of indirectly.

Peter McCormack: Yeah.  Okay, I do want to talk about the wider impact on the rest of the world, but can we talk about specifically with regards to China?  We're seeing an impact here in, well I'm actually in the US, but we're seeing an impact on gas prices here, commodity prices; the same is happening in Europe.  Petrol, or Diesel, particularly in London, one petrol station hit £2 per litre, which works out about $10 a gallon.  So, when Americans are complaining about $6 a gallon, we're like, "Hold my beer", it's a lot higher in the UK.  But is similar happening to China, or is there little to no impact on them; what do we know about that?

Lyn Alden: So, China's being impacted.  Going into this crisis, they were already having, for example, spiking coal prices; that's a big problem for them, because they get a lot of their power from coal.  So, that's been an issue.  In addition to obviously the oil and gas prices are a problem for them, they had a less acute gas issue than Europe, but Asia has been impacted by higher gas prices as well. 

In the longer run, one thing it looks like China's doing is that, a lot of these western companies were forced, or pretty much had to divest their Russian assets, pennies on the dollar, kind of just mark them down and get out of those positions, so China has already stated a willingness, an interest, in potentially coming up and scooping up some of these Russian energy commodity assets. 

So, that continues the Belt and Road trend that China has been doing, where instead of reinvesting their dollar trade surpluses into treasuries, they've been investing them into making loans to developing countries that generally give them access to commodities or infrastructure.  And so, it seems like this kind of gives them an upper hand in terms of getting bargain-priced energy and commodities.

Peter McCormack: Right, and if they're potentially one of the only buyers that Russia has available, they're going to be able to negotiate particularly low prices on these commodities?

Lyn Alden: Well, at least on the commodity interest.  I think over time, Russia will probably be able to access a number of markets that don't really have the ability to select where they get their commodities from.  So, maybe we can look at countries like India, countries like Brazil.  We'll see over time, the longer this drags out, I think Russia will probably be able to find buyers for its commodities. 

But during this period where they need capital, and many of their assets are selling very cheaply, that does give China a window to come in and get a lot of those assets.

Peter McCormack: I'm struggling to see who actually is really benefiting from this, from what appears to be a -- and I understand the full historical context of this, the accusations of NATO placing missiles closer to Russia, but this is a global lose/lose right now?

Lyn Alden: That's why the extent of this conflict was somewhat surprising to me.  I mean, I don't think a lot of people would have been surprised by some activity around eastern Ukraine, around some of those borders.  But the extent of this attack surprised me and surprised many, because as you point out, there's almost no winners from this.  So, the vast majority of Russians are not benefiting, many of them have gone over and fought and died; Ukrainians are obviously not benefiting; Russian oligarchs are not benefiting; it's hard to see who is benefiting from this.

I think, if this drags out, China could be a beneficiary potentially, for the reason we discussed.  It gives them a little bit more influence over Russia, because basically Russia now has fewer options.  And so, it might be good for China, it's hard to say for sure.  It also gave China intel on what would happen if you tried to invade an area.  It kind of gives China a playbook of, "Okay, we need to avoid this problem, we need to avoid this problem".  So, I think they might be a beneficiary.

But overall, there are people that focus on geopolitics and cultural histories obviously a lot more than me, so for me it looks irrational, but it doesn't look like there's any winners to me, really.

Peter McCormack: What about Ukraine?  Does it still have any type of functioning economy?

Lyn Alden: So, partly what we're seeing is that Russia is seizing some of their shipping assets and things like that.  And so part of why wheat, for example, is so expensive is, one is Russia is a big wheat exporter, but so is Ukraine.  So, to the extent that Russia is able to control large portions of Ukraine, I think what we're seeing is that we're missing a harvest season, we're missing a planting season over there, so that's going to affect global wheat prices, and just global agriculture in general. 

Then obviously, it's hard to function even in an inflationary economy, let alone a war economy; it's very hard to have a functioning economy.  You have well over 1 million refugees spreading into the rest of Europe, and so it is hard to call that a functioning economy at this current time.  And so, that's obviously impacting a lot of that region, but then specifically, it contributes to the commodity shortfalls that we see worldwide.

Peter McCormack: And wheat prices, why are they so important?  Is it because they are a benchmark for other agricultural prices, or is it just because wheat is such an important part of the production of so many food staples?

Lyn Alden: Basically, as one of the -- so, along with soya beans and rice, I mean wheat is a huge staple for human consumption.  Now, we can talk about the health of eating a lot of wheat, for example, but it is a huge source of calories for people around the world, and it's in almost everything.  I mean, it's not just bread and pasta, it's an input to all sorts of processed foods, all sorts of staples that they eat around the world.

So, for example, Egypt gets a lot of its wheat imports from Ukraine and Russia.  So now, I think they put out basically a restriction on exporting some of their food staples, because now every country in the world has to reassess its food security and say, "Okay, are we getting enough?"  Because, when you have revolutions -- when you have food prices go up, that's how you get revolutions.  When people can't put food on the table, that's when they just go out on the street and protest and they're even willing to get violent, because they kind of have nothing else to lose at that point. 

Pretty much the number one priority of any government in the world is making sure their people are fed and that there's no food insecurity problems, at least if it's possible.  So, spiking wheat prices, in addition to being highly inflationary in general, is also a big barometer usually for social upheaval, especially in some of the more vulnerable countries out there.

Peter McCormack: Are we seeing any anecdotal evidence of that?

Lyn Alden: Well, I mean this is all happening in a number of weeks, so it takes time for these shortages to kick in, besides just price going up.  But the longer this goes, you'll see higher and higher food prices.  I think the cleanest example is the Arab Spring a decade ago, when that was correlated, and many would argue, caused or partially caused by, that's when you had the last spike in foodstuffs.

So obviously, you already had simmering tensions, and it's often the case that the spike in food price is like the final nail in the coffin, where they say, "Okay, now we're going into the streets, now we're going to protest".  Kazakhstan had issues like that with energy not that long ago.  That was a big contributor to what sparked their protests.  And so, this whole wheat shortage, or wheat price spikes, are just kicking in now.  Essentially, the longer they go, as they go more weeks and more months, that could trigger protests, revolutions around the world, as well as just suffering.  Even if there's no major social upheaval in certain countries, just the poorest people have trouble affording food.

Peter McCormack: It's strange to follow this.  I don't feel like I've ever lived through these types of events, certainly not in my adult life, and food and energy security seem to be the things that have been most challenged during this time.  And in a time of globalisation, you look at, say, a country like the US, which both imports, but exports oil, which you'll probably give me really good reasons for why that happens, but it feels like we might go through a phase of deglobalisation, because there is so much risk with events like this, that countries can't rely on their imports from other countries.

Lyn Alden: Yeah, so to your prior question, there are different types of oil.  We often think of it as just oil, but there's actually multiple types of oil.  And there are refineries that are designed to work with certain types of oil.  So, you get funny situations where you have to both import and export.  So, you might have to import a certain type of oil and even if you produce oil domestically, it might not be the same type as your own refineries are geared towards.  So, as I was talking about, this infrastructure takes years to build, and it's designed with pretty long lifecycles, decades, so that's not something that just turns overnight.

So, the United States, for example, designed to refine, we have a lot of refineries, for example, that work with Middle Eastern oil, as an example.  So again, there are petrochemical engineers that can go into way more detail about that whole thing and what our exact percentages are, but it's important to be aware that, even in something that you would conceptualise as simple, like energy processing, it's just as complex as the global supply chain. 

If one little piece is messed up, these things that you don't even think of, start to break down.  And so, in addition to how complex our global supply chains are, like we talked about, even getting parts to service an airline, so basically how complex that all is, all the semiconductors, all the commodities, all the little components that go into all these designs, in addition there are commodity issues.

Another example is fertilisers.  So, natural gas is a key input into fertiliser, Russia has a lot of the raw materials that go into fertilisers, and so that can also impact not just wheat prices, but agricultural prices across the board.  So, that's part of why this situation is so extreme, is because there are very specific things that can cause massive shortages and massive suffering if you're without them.

Peter McCormack: Okay, let's talk a little bit more now about what's happening to more of the western world.  We've talked about petrol and diesel prices up in the UK, gas prices here up in the US, commodity prices are up.  We were already in challenging economic times.  Let's start with inflation.  So, inflation figures came in at 7.9%, I think, yesterday.  The CPI figures, would those figures already have been arrived at prior to these events, or do they include these events?

Lyn Alden: So, these pretty much would have already been arrived at prior to these events, for the most part.  And so, it's really the next few prints that I think are going to be heavily impacted by these.  So, for example, I've been on the inflationary side, but I've also been on the side that we might start peaking by the second quarter; inflation might not normalise, but it could kind of top out and chop around for a period of time. 

The caveat that I had, I said, "Okay, what is the risk that's not cracked; what is the risk that inflation just keeps soaring higher?" and it would be some sort of energy shortage, some sort of key thing like that.  And so, this war as a catalyst certainly adds fuel to the inflationary fire.  So, we already had inflation from money printing, from other shortages going into this.  And now that you have an acceleration of commodity shortages and bifurcation of global supply chains, that should add further fuel to the inflationary fire.  So, it remains to be seen how long this is going to go.  But we start approaching more like the 1970s at this point, in terms of energy security and overall inflationary levels.

One thing I pointed out recently is that we have the most negative real yields on, say, short-term US treasuries since 1951.  So, currencies are getting devalued at a rate that has not been seen for quite a long time, and that's using the official numbers.

Peter McCormack: All right.  I'm sure you don't want me to ask you this question, but what is the range of inflation numbers we could see maybe next month?  Do you think we could be going into double-digit inflation; could we go to 15% inflation?  Because, when I look at the price rises for various things within the supermarkets, I look at the increase in petrol prices, we're not talking about 5%, 6% inflation prices here, we're talking about things that are going up 10%, 20%, 30%.

Lyn Alden: So, I think the official numbers, so next month, using that specific timeframe, next month or two, I don't think you'll see a gigantic gap, because if you look at the way the calculation works, a very big chunk of it is actually home.  So, there's owners' equivalent rent and rent and things like healthcare.  So, those are unlikely to change rapidly in a month.  If anything, we're seeing home prices kind of level out to some extent; they're cooling off compared to what they were doing the past two years.  So, there's a big chunk of the CPI Index that won't change much.

Now, the part that is going to change a lot is the food and energy, so that's the part that's going to be spiking up by double-digit percentages, and that's where everyone kind of has their own unique inflation basket.  So, the official CPI number, it will be hot, but it might not be as high as you think.  But then, for example, let's say you're someone, your house is paid off, and you have a pretty tight monthly budget, maybe you're living on fixed income, for example.  So obviously, a big chunk of what you spend on goes towards food and energy.  So, someone in that situation, their effective inflation rate would be double digits.

So, I think the "real numbers" will be at least in the low double digits.  I wouldn't expect to see the official numbers show double digits right away.  But the longer this goes on, you could hit double-digit official CPI in the US.

Peter McCormack: This is something Eric Weinstein talked to me about.  He said, "Having an official CPI figure is actually mainly useless for most people.  Actually, people need to weigh up being able to calculate their own personal inflation numbers".  I'm not sure if that's something that's particularly possible, but I think you're alluding to the same point there.

Lyn Alden: Yeah.  So, inflation's an arbitrary basket.  What they do is they take a sample of what the average household uses, so what percentage of their expenses goes towards housing, what percentage of the expenses goes towards medical care, what expenses go towards transportation, and they formed this "average" basket.  And then they track over time what happens to the inflation of that basket.

But then it's further tricky, because instead of doing home prices, they do owners' equivalent rent, and they also do hedonic adjustments.  So, basically if things get better over time, like if a car gets better than it was five years ago, even if the price doubles, they'll say, "Well, it kind of stayed the same, because sure, it doubled, but it got better".  And they'll also do replacements.  So, for example, if a prime cut of meat goes up in price, they'll assume that you rotated to a lower quality, or a lower price cut of meat. 

So, there are ways to smooth out and lower that number, compared to if you just look at a raw number, if you just pick something like, "What are bacon prices doing over a long period of time?" generally you'll see that prices like that are a little bit higher than what the CPI basket's saying, because you don't have those hedonic adjustments, you don't have those replacement things kicking in.

Peter McCormack: Right, so for anyone listening, rather than watching the video, as Lyn explained that they have a way of smoothing out this number, she had a wry smile across her face, a little grin!  I mean, you're basically saying it's kind of manipulative.

Lyn Alden: Yeah, every change that they've done to the CPI Index has been lowering it.  So, it's not like they say, "Okay, we wanted to make this more accurate, and this will state inflation's a little higher than we were previously saying".  No, that never happens.  Every change they make to it is, "Well, it's actually a little lower, because if you take into account XYZ…", so yeah, you do get this understated level.

There's still informational value in the CPI Index, but you have to know what you're looking at, and break out certain things from it, if you really want to go into the specifics, because you do have this kind of artificially-constructed basket with hedonic adjustments.  And again, hedonic adjustments, they seem to go in one direction.  So, a lot of services got lower quality over the past couple of years.  So, flying is less pleasant than it was before, and it was already unpleasant.  But are they having negative hedonic adjustments in terms of flying?  No, of course not.

Peter McCormack: No.

Lyn Alden: So, hedonic adjustments and ways that they recalculate the index generally only point towards ways to try to understate it to some degree.

Peter McCormack: So, this transitory period that we've been sold seems to be going on a bit longer than I think they expected, and I'm going to assume you're not agreeing with any of these mainstream articles that have been coming out recently, trying to explain to us why inflation is good for us?

Lyn Alden: No, I don't believe inflation's good.  It was, in some ways, I viewed it as inevitable at this point.  With so much debt in the system, there's almost nothing that's going to happen, other than trying to inflate their way out of it, so it's not surprising.  I think, if you were to ask me two years ago, when I was calling for inflation, would I expect it to be almost 8% officially?  Probably not.  Even as someone in the inflationary side, this has been a stronger inflation surge than I would have guessed.

Obviously, war's adding to that now.  But even before the war, this was already just in place.  So basically, when you have the combination of a rapid expansion of the money supply with various constraints, so it was supply chain constraints, commodity constraints, labour constraints, any sort of constraint, you're going to get price inflation.

Peter McCormack: Well, do you know what one of the weird side-effects of this is that, even with this business that I do, we have contracts, we have advertising contracts and some of them are multiyear.  When me and Danny went to get coffee earlier, I was saying to him, "Do you know what, we probably actually need to have an inflation clause within the contract?"  Is that something that -- I guess what I'm getting at is, I thought of this just now, it's something I just thought, "Shit, I should really be considering this".  Is that something that's generally considered, or do you think it's something a lot of people are considering, like myself, as a new clause they need?

Lyn Alden: So, in some of the longest-term contracts, it's pretty common to have inflation components.  So, for example, if you operate a pipeline, for example, and you're regulated for what you can charge, usually they will have inflation components.  The same thing would be true for long-term leases for real estate, they often do have an inflation component.  It's because, when you expect to operate a contract for years and decades, you start to take that into account.

Now often, shorter term, two-, three-, four-, five-year contracts, often those won't have those types of things.  So, one of the challenges in inflationary environments is that there's just more frictions in terms of doing business, because when prices aren't stable, it's hard to do long-term planning, and it's hard to structure contracts, it's hard to determine how much you're going to pay your input providers, because you don't even know what you're going to be able to charge your customers.

There are some companies that naturally have quick turnover.  An example would be a toll road.  There are people driving through paying all the time, whereas if you build something, you order raw materials, you make these contracts come in, you hold some inventory, it might be a six-month turnaround until that's a finished product.  And so, if you've contracted your selling prices and you didn't have the same duration on your input prices, you could do all this work and then not make a profit, because your profit margin was 5%, and that got deleted by inflation, for example.

On the other hand, if they structure it very well, they can benefit from it.  They can be, "Well, we managed to have long-duration input costs, so we managed to have adjustable selling prices, and so we did great in inflation".  So, that's where investors have to be careful about things they invest in, because they try to find ones that can adjust their revenue faster, while having a lot of fixed costs for their inputs.  But just in general, from an economic standpoint, it's just a more challenging operating environment for most types of companies, when you have unclear inflation and pretty high inflation.

Peter McCormack: And, what are the world economic risks right now?  I was speaking with Nic Carter the other day, and he said, "Humans flourish in a time of low commodity prices.  With high commodity prices, this brings a lot of economic risk into the system".  What are the kinds of more second-order effects that maybe someone like I might not consider, or somebody listening to this show might not consider?

Lyn Alden: Well, one would be the risks of political upheaval.  I just talked about people, especially in developing countries, but this also can impact developed countries; so they take generally different forms.  So, if you're a presidential administration in a developed country and you have high inflation, you're much less likely to win re-election.  And if it's in developing countries, you're much more likely to have just outright protests and revolution.

Another thing is that it could contribute to a recession, because people have to spend more of their money on gasoline, on electricity, on food, and therefore they can buy fewer iPhones, or they delay their phone upgrade cycle, they delay other purchases.  They might skip a vacation.  So, if their necessary input costs go up, they have to cut down on discretionary costs, and so that's how you can get a recession.

That's why, you have can have a stagflation recession, where commodity prices are high.  Basically, the 1970s would be a key example.  So, high commodity prices, but you'd go through periods of severe economic softness, because people are getting squeezed in their pocketbooks.

Peter McCormack: And, can you point to any historical examples where we've been through similar times and, some of maybe your predictions of what could happen and how we may come out of this situation?

Lyn Alden: So, the three closest decades would be the 2000s, the 1970s, and the 1940s.  Those were generally the inflationary, commodity-boom decades, and obviously they had very different magnitudes.  So, the 2000s were considered a rather favourable decade, and part of why you had a commodity boom is that you had the rise of the "BRIC" nations, so Brazil, Russia, India, China.  You had a dollar weakness, and so that contributed to an emerging market boom, and they had a rapid increase in their commodity consumption, at a time when commodity supplies were rather constrained. 

So, you had a big uptick in commodity prices, but it was generally, for the most part, a good thing.  Not that those price increases were good, but it was happening for rather good reasons.  The world was, in some ways, booming.  Now, that eventually turned into the subprime mortgage prices, and then also high oil prices contribute to the recession we eventually had in 2008.  So, by the end of that period, it was negative, but overall that's, in some cases, the best example you can think of.

The one prior to that, the big commodity boom before that, would be the 1970s, and that's where you had severe supply constraints.  So, the United States found oil in the second half of the 1800s, we had almost a century of just constant increase in our annual oil production.  Occasionally, you'd dip, but it was a structural increase, and that peaked in 1970. 

So, in 1970, US oil production peaked and started to roll over structurally, at the same time as baby-boomers across the world, including the US, were coming into home-buying years, so you had basically a lot of commodity demand, and you had limited commodity supply, so the United States became more reliant on Middle Eastern oil, so that opened up all sorts of geopolitical conflicts and shortages and inflation.  So, that was biggish.

Now, part of why we had low commodity prices recently is because the US's structural decline in energy production reversed because of shale, so we added a lot of new energy to the world.  That seems like it's probably behind us.  We're still obviously producing a lot of shale, but we're not rapidly increasing our shale production.  We're not maybe at the limits, but we're closer to the limits in terms of how much oil production we can produce.

But anyway, you had the 2000s, you had the 1970s, and if you go back before then, I've been using the 1940s as my closest macro comparison in terms of fiscal monetary policy; the reasons for inflation were more -- in the 1970s, the inflation was bank-lending driven.  You had a demographics boom, and of course fiscal added fuel to the fire, you had the guns and butter programme, you had the Vietnam War, but a lot of that inflation was bank-lending driven.

In the 1940s, a lot of it was purely war spending, so banks were not lending much, people had hardship, and a lot of the inflation and commodity price spikes you saw were obviously because of fiscal stimulus to support the war effort.  So, that was a very big year for commodities, and you had price controls, you had wage controls, you had shortages, people had to use substitute things.  They would literally change what physical coins were made of to try to conserve more important commodities.  That's how extreme it gets in some of those decades.

I do think we're going into -- I've already been in a commodity bull market camp for the 2020s, and if we're going to have outright war, I've been using the 1940s comparison and I always say, hopefully there won't be the kinetic war.  But now, if we're actually moving into the kinetic war, then it's unfortunately even closer to the 1940s, because you have those geopolitically-driven commodity shortages.

Peter McCormack: Do you think we could be heading for a very difficult decade, or is this something that might be a couple of years, or is it all dependent on how long this war takes?

Lyn Alden: So, I think we are in a rather challenging decade.  That was my view before the war, and the war just adds to that view.  Now, I don't think it will be a straight line.  If you look at the 1940s and the 1970s, it's not like just inflation was constantly going up the entire decade.  You had periods where it looked like it was getting better, and then it would get worse again, and then it would better again, then it would get worse again.

So, my base case would be to see the 2020s do the same thing, where high commodity prices could eventually trigger a recession and hurt demand for commodities, then you could get a cool-off in prices.  Then, you could get stimulus, then you could get another uptick in terms of the prices.  So, I think those will be cyclical, to some extent, but I think that the structural backdrop will be one of less abundance.

The past 25 years have been characterised by abundance, in a sense that the world was able to just -- we didn't have to worry about resiliency.  Supply chains were emphasising efficiency over resiliency.  Everything was just-in-time delivery, lean manufacturing, do everything you can to minimise your inventory, because that's efficient and it boosts your return on invested capital for a company.  So, we've kind of assumed global peace, no geopolitical issues, we'll all going to "kumbaya" get together, and as we enter a world where that's not the case anymore, we have to put more resiliency into our supply chains, more duplication.  So, if you duplicate things, it's inherently less efficient and more inflationary, but more resilient.

So, I think because we've, in some ways, enjoyed artificial abundance, where it was not designed to handle any shock, whether it's a pandemic, whether it's a war, it doesn't matter, it's just not designed to handle any shock, and so it's inevitable that that period was going to end one way or another.  Now, the specific way or the specific time could have been different, but it was just asking for disruption.

Now that we have multiple disruptions, I do think this is going to be a more challenging decade, in terms of the chance that you go to the store and they have exactly what you want in any colour you want, for example, as a privilege case, that's more challenging now.  And then obviously, the more extreme event, some people have trouble even just getting food, just getting food at reasonable prices.  So, there's this big spectrum for how badly could be affected.

Then, you could add things like cyber attacks.  So, there's all sorts of things that could go wrong, so one of the things I've been recommending is that people should have reasonable stockpiles of things they need.  So, don't assume that the global supply chain is going to work perfectly efficiently all the time.  Because companies don't have very big inventory, I think households should have decent inventory, they should try to offset the lack of resiliency in global supply chains, by having their own inventories.

But of course the challenge is that not everybody can build an inventory at the same time.  If everybody tries to hoard, that's when shelves go bare right away.  So, I think the key thing is to try to do mild, gradual hoarding over time, where you build up what you have, so you can get through multi-week or multi-month periods of severe shortages of things.

Peter McCormack: Okay, that's quite severe, and we did see that during the COVID crisis, where people were stocking up on loo rolls and pastas.  We had it, our local supermarket shelves were bare.  You couldn't get pastas, you couldn't get rice, you couldn't get certain tinned food, it was strange to see.  And I guess the preppers would already have been doing this.  I also imagine people listening, Lyn, are going to be thinking, "Well, what else is Lyn doing?"  What are you doing to economically protect yourself; where are you making sure you're resilient economically?

Lyn Alden: Well, one is making sure you have all these inventories, because even the best case, so the less dramatic case is just that, if you have paper towels and non-perishable foods, what are the chances that the price of those things are going to go down in the next couple of years?  So, it's better inflation-adjusting cash than cash.  If you never need to rely on the stockpiles, there's that.  And of course, the worst-case scenario is it keeps you comfortable and safe during more severe periods.  So, there's that.

Then, two, for investments just being diversified and having things that benefit from inflation and that protect you from inflation.  So for example, if you're worried about energy prices, you can own energy companies.  If you're worried about commodity prices, you can have commodity companies.  You can have things like gold and Bitcoin to protect you from devaluing fiat currencies, and there are multiple ways to play it, depending on how much volatility and how much diversification or concentrations one wants in their portfolio. 

But I think the emphasis is on being defensive, being diversified and being resilient against an inflationary decade, even though there will be periods of time when some of those inflation hedges are overdone.  So, everybody will rush out and buy energy stocks, and then maybe you get some sort of de-escalation of the conflict, and you go through a year where those investments don't work out well.  But then, like I said, you could have fiscal stimulus and you come out the other side with even higher prices.  So, it won't be a straight line, but I generally still prefer inflationary types of assets.

Peter McCormack: All right, okay.  Last thing I wanted to ask you about, with the great cancelling of Russia, Treasury bills are no longer risk-free, ownership is no longer risk-free; if you are on the wrong side of the US Government, they can cancel you, which also feels like a geopolitical mistake.  We talked before about currency wars; it feels like we're headed into a system that's going to split into three: the dollar will still exist as a reserve currency; we will see growth of the digital renminbi; and hopefully, and something I've obviously bet on, is that Bitcoin is the lifeboat that a lot of people consider they might use, because they don't want to be stuck in one particular system, they want maybe a permissionless system.  How are you looking at this?

Lyn Alden: Yeah, so I think that these events accelerate a multi-polar reserve system.  So, I think that there are already signs of that happening.  So Russia, for example, was already starting to price its energy in more than one currency, we were seeing more trade between India and Russia, and China and Russia, and even Russia and Europe.  Some of that was getting euro denominated, more of their trade was euro denominated. 

Obviously, this accelerates it, where every country, especially ones that are not particularly friendly to the West, is probably re-evaluating their reserve practices.  The Wall Street Journal ran a piece called, "If Russian reserves aren't really money, then the world's in for a shock".  So, in addition to the fact that T-Bills and Eurobonds and all these things, in addition to the fact that they pay interest rates that are well below inflation rates, so they're undesirable as a long-term store of value, now they can also be censored.  They always could be, it's just now there's more awareness that those tools are willing to be used.

You could even do things like selective defaults, you could do things like freezing reserves.  So, in theory, that increases the desirability of reserves that can't be cancelled.  So, the knee-jerk one is gold, because that's the one that central banks already own.  It's already big and liquid, something like a $12 trillion estimated market, less volatile, and so for example, the biggest chunk of Russian reserves that are not frozen are their gold reserves.  And so, you look around at the countries and think, if I was running a country, I would think, "Why don't we have more gold than we have now, compared to what we have in terms of dollars or euros and things like that".  So, that's number one.

Then, yes, the longer you look out in the future, the more attractive Bitcoin arguably becomes as a reserve asset.  So right now, at less than a $1 trillion market cap, and as a rather volatile asset, it is challenging for them to put that into their reserves in very large amounts.  I mean, you could have obviously smaller countries or smaller allocations to it.  I think it shows up first in things like sovereign wealth funds, because if you define something as an investment, you could get away with more volatility than if you define something as a reserve. 

So, by their nature, central bank reserves are supposed to be very conservative, so things like currencies or gold.  Whereas, sovereign wealth funds, they buy things like equities, even some central banks buy equities.  But for the most part, you see equities focused in sovereign wealth funds.  So, Bitcoin could start there, basically companies could buy Bitcoin-related investments, or they could buy Bitcoin, so these sovereign wealth funds, and then the bigger that Bitcoin gets, the more widely held it is, the more liquidity there is, the less volatility there is, the more central banks could start looking at that as a viable, neutral reserve asset, because it fixes two things for them: one, they have an asset that can't be frozen by a unilateral third party; and two, they also can go around sanctions, and they can have permissionless payments.  And so, that is something that you'd think would become more attractive to countries around the world.

Peter McCormack: All right, Lyn, thank you for this.  You're the smartest person I know.  Every time I get to ask you these questions, they directly impact the things I do.  Anyone listening, if you've not yet signed up to Lyn's newsletter, go to her website.  Is it still $199?

Lyn Alden: It is, yes.

Peter McCormack: It's not inflation-adjusted?!

Lyn Alden: No, but I will say the one thing.  When I set the original price, I was originally going to put it at $149, but because I was expecting inflation, I was like, "Let me just put a couple of years of forward inflation component in".  So, that's one reason I've not raised prices, is because I priced it in such a way that I was fine with the current number.

Peter McCormack: Well, it's the best $200 I spend a year.  But thank you for this, I really appreciate it.  Looking forward to seeing you in Miami and catching up again in person, and I appreciate you coming on early to do this.  It's going to be a really helpful conversation for many of the people listening, so thank you and I will see you soon.

Lyn Alden: Looking forward to it.