WBD533 Audio Transcription
Why Bitcoin is an Inflation Hedge with Steven Lubka
Release date: Friday 29th July
Note: the following is a transcription of my interview with Steven Lubka. 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.
Steven Lubka is Managing Director of Private Client Services at Swan Bitcoin. In this interview, we discuss the true meaning of inflation, the different types of inflation, and why this means Bitcoin is the best hedge against monetary inflation. We also discuss the crazy alchemy of bonds.
“They’re kind of these two different paradigms. One of them, you’re bearish on humanity: you think humans aren’t going to do well, we’re not going to produce stuff, we’re not going to be efficient. The other one, you’re bearish on central bankers and governments. And I know which one I’m betting on - I’m betting on humans.”
— Steven Lubka
Interview Transcription
Steven Lubka: How long have you been doing these with the video and in person?
Peter McCormack: Well, so when I first started the podcast, it was in person.
Steven Lubka: Oh, really?
Peter McCormack: Yeah, so my first interview, I was in LA, and just called somebody up and bought the equipment on Amazon, went and did it, and then I pretty much did -- I can't even remember the first remote one I did. I think -- you started before COVID, right?
Danny Knowles: Oh, yeah, way before.
Peter McCormack: Did I do any remote ones before COVID?
Danny Knowles: Occasionally, yeah, you'd do the occasional one. But it really started with COVID.
Peter McCormack: Yeah, when COVID happened, we had to go remote, and that's when we introduced video. I think my 10th interview, with Lyn Ulbricht, I did with video, did it all myself and it was just too much work, and I didn't know what I was doing with the camera. So then COVID happened, and we did everything video, because Zoom was easy, and then COVID ended, and I wanted to go back to in-person, because it's a better interview. And then we're like, "Shit, we need to figure out how to do this!" I can't remember, did Jeremy do the first one?
Danny Knowles: I think so.
Jeremy: After COVID?
Peter McCormack: Yeah.
Jeremy: Yeah. In New York, at least.
Peter McCormack: How did that happen? Did I put a tweet out and you replied to it?
Jeremy: Yeah.
Peter McCormack: Yeah, and then you pitched and came in, and we did a few. We didn't do them all, did we?
Jeremy: We only did one that first time.
Peter McCormack: It was the Malice one?
Jeremy: Yeah.
Peter McCormack: Yeah.
Jeremy: And then we did a whole sweep, a whole week in New York, a few months later.
Peter McCormack: Yeah. So then, there was still the odd one we were doing remotely, and then we just made a decision sometime at the start of the year, "No more remote ones. We'll dedicate to doing it all in person", which comes with its challenges and its trade-offs; you can't get the interviews you always want. But it's about, this is the product now, if you think of it as a product.
Steven Lubka: Absolutely, yeah. I remember seeing it one day, and suddenly there was a whole video element to it, and I thought that was cool.
Peter McCormack: Yeah, and seven people work on the show now, which is amazing, because it started with me, then me and Danny, then me, Danny and Ben; and then it was Emma.
Danny Knowles: Emma and Neil sort of the same time.
Peter McCormack: Same time, then Jeremy and now Freddie.
Steven Lubka: And it started in 2018/19?
Peter McCormack: 2017.
Steven Lubka: 2017, really?
Peter McCormack: Yeah. So, the first one was something like 24 November 2017 and I think I did three. And then I didn't do any for a couple of months. Then I was like, "Shit, if we're going to do this, we've got to be consistent". So, I did one a week for about, I want to say a year, it might have been less; then I went to two; then we went to three during COVID.
Danny Knowles: Yeah, probably.
Peter McCormack: I feel like it should be every other day, personally. If we had our own studio, say we were based in Texas and we lived there, or even Bedford, I would do a show every two days; I think that's the right amount. But yeah, it's incredible how it's grown and how the team's grown, and we've become a real working unit and a machine, and we're very lucky to get to do this and get to hang out with my buddies!
Steven Lubka: Travel the world, stay in nice Airbnbs, talk to cool bitcoiners and interesting people.
Peter McCormack: You think you're cool, do you?! Yes, man. No, it is good. Anyway, Steven, nice to meet you.
Steven Lubka: Great to meet you.
Peter McCormack: You came as a strong recommendation from Cory. He was like, "You've got to talk to Steven, got to get him on the show, got to talk to him about inflation", hot topic right now, very hot topic right now. And the interesting thing about it being a hot topic right now is there seems to be a lot of confusion of what inflation is, not only on podcasts, not only with me, not only with some of my guests, but what has been reported in the media.
Steven Lubka: Absolutely.
Peter McCormack: Every time the price of something goes up, it's coined that it's inflation, but that's not strictly true, right?
Steven Lubka: Yeah, so it's widespread. I mean, you see this even among financial circles and the Fed and government and all these areas, people working at top banks. The definition of inflation has changed a lot over time. I think it's helpful to start with the original definition.
Peter McCormack: Well, I think what we should do just before that, because not everyone's going to know who you are, and I always think if it's your first time on the show, it's good to just let people know who you are, what your background is, so they can have some context around it.
Steven Lubka: Yeah, so my name's Steven Lubka and I run Swan Private for Swan Bitcoin, and if you haven't heard of that, that is essentially Swan's concierge high-net-worth arm. So, we work very closely, one-on-one, in a personal semi-advisory context with high-net-worth investors, small and medium businesses, family office, trusts, we now do retirement accounts; all the sorts of different accounts you would need. We try to provide a personal relationship for people.
The reason we do this is a few years ago, looking out at the market and interacting -- I worked as a consultant with high-net-worth investors for the last five years, so that's also my background; but it was looking out at the market and you had all these exchanges that had become really popular, we all really know them, and that works for people who are more tech-savvy. They want to figure out how to do a limit order and figure out how to use the exchange.
But there's an entire demographic of people that's used to the more hands-on financial services in the world. They're generally wealthier, they generally have already been very successful in life, and they don't want to put 150 hours into figuring out everything with Bitcoin, at least not by themselves. They want to just talk to somebody who can guide them, so they don't make all of the same mistakes that I think so many of us, myself included, did make when first getting into it.
So, we launched the product to provide that sort of one-on-one relationship, and it's been an incredible uptake, it's been hugely successful. I've personally, in just one-on-one calls, probably onboarded a couple of thousand high-net-worth investors, so it's probably up there in terms of some of the most just direct onboarding in the space; and as a group, we've done several thousand. So, it's a way we're getting a lot of those people into the space, into Bitcoin, helping to educate and helping to provide them really what they're looking for in a financial relationship.
Peter McCormack: What about you; what about your background; what were you doing before this?
Steven Lubka: Yeah, so before this, I was a co-founder of a software development agency, on the business side, I'm not a programmer, but we did traditional software development, some companies you might have heard of, but small and medium business. I led that for a while, and we grew that business. I got into Bitcoin about early-2017 before the bull market, and I very quickly realised this was something that was really interesting to me and I want to take the jump and try to make a career of it; I want to actually work in this space.
So, I worked as a -- it started off just as a consultant for, like I said, wealthy investors, a couple of small venture capital firms that were navigating the space. I helped a couple of colleges accept Bitcoin and do stuff like that, and I did that for a number of years. So, background from consulting in the space, and also operating an agency for software development.
Peter McCormack: And how did Bitcoin grab you; what was it; what was your moment?
Steven Lubka: It's interesting. I feel like I had two Bitcoin awakenings a little bit. The first is, I saw it as technology and I thought, "Okay, this is this cool technology, it's this payment network, it's global, you can store it yourself, that's super-interesting", but it didn't fully click for me the importance of it. I thought, "That's interesting", and I was interested enough to jump into it.
But it really was only probably a year or two later where I truly had been working on developing a deeper understanding of how the traditional financial system works and currency dynamics and how the world works today. And the more I learned about how the financial system, how the monetary system actually operates, I started to see Bitcoin in a new light and I was like, "Oh, this isn't just a technology, this is actually a new approach to money, and the question of money is actually a very significant one in today's world; it's a problem that, in some angles, you could say is unsolved, or there are at least challenges that we're facing".
Peter McCormack: And that's why you've been going down the rabbit hole, researching, writing about things like inflation?
Steven Lubka: Yes, absolutely.
Peter McCormack: Well, let's get into this, because like I say, this is the hot topic at the moment. At the end of each month, well, is it the end of each month? About halfway through the month, people are anticipating CPI numbers, they come out now, their inflation number's gone up, people tweet about it and say, "Buy Bitcoin", etc. It's almost repetitive now; it's kind of losing its edge.
But it's such a hot topic, not only here, but people outside of Bitcoin Twitter into the private world of Facebook, I'm seeing people talk about it. This is probably the first time they've thought about inflation. It's on the news constantly, we've just made a film about it, but the real understanding of inflation is pretty incorrect by most people. So, you decided to attack this as a topic?
Steven Lubka: Yeah, absolutely. I think first of all, what you said is totally correct. I think inflation, and what is going on in this moment, has grabbed the average person's attention in a way that it never has before. I think the average person, in the last two decades, didn't care about inflation at all, and why would they? It was relatively low, it didn't really impact their life, but people are really feeling that today. From surveys I've seen, it is the number one political issue, it's influencing policy direction, Fed action; that's putting pressure on Europe, on Japan, there's a whole bunch of dynamics maybe we'll get into, but it's a big story right now and a big dynamic.
The issue, and one of the first things that I wanted to address in what I wrote and what I've been talking about is, the definition of inflation has not been constant over time. It's not correct to assume that the way people -- what people mean today, when you see someone on the media saying "Inflation", it hasn't always meant what they intend it to mean today.
So, the first definition, I think it's helpful to start here, was when paper currency was actually backed by gold. So, there was a physical deposit of a fixed amount of something tangible in the bank, and then the paper slip was just for transaction, and it was redeemable for the collateral. And so, the first definition of inflation is, let's say they had £100 of gold in the bank and just for conversation's sake, let's say there were 100 notes and every note was £1 of gold.
The banks, or the people holding the collateral, would actually issue more paper notes. So, there were originally £100 of gold, 100 notes, the issue another 100 notes, there's now 200 notes versus £100 of gold, but all the notes say, "Redeemable for £1 of gold". There's not enough collateral. And so, that process of issuing more of those paper claims was the original definition of inflation. So, quite literally, it was a debasement of the money supply. It was an expansion of the financial abstract layer of money here had been expanded, more had been created, and that was the original definition of inflation.
Peter McCormack: But if 100 people went and redeemed their gold, that's fine, but the 101st wouldn't have been able to.
Steven Lubka: Correct.
Peter McCormack: So, would they devalue the gold; would they change it and say, "Well, you can only claim half a pound of gold with your 100 notes"; is that what would happen?
Steven Lubka: So generally, the reason these dynamics worked is because people, unless they lost confidence in the paper money, they would not go to redeem it; there was really no reason to redeem it. And if they did try to do that, you've got a bank run, and those obviously did happen, and people don't get their money out. But that's the first definition, so the first time inflation is used, it's used in that context.
It goes on to continue to mean something similar, so monetary systems change, there's still gold backing -- at a certain stage in the US dollar, there's still gold, but the average person can't redeem it for it. And then we go to a fiat currency, and obviously there's no collateral there. Inflation still means, at this time generally, an expansion of the money supply, a dilution of the money supply. And then later on, I don't know exactly at what point, it starts to also be used to refer to consumer prices going up and increases.
Peter McCormack: And when it referred to an increase in the money supply, was it measured at that time? So, if there was a 10% increase in the money supply, was inflation at 10%? So, was it actually measured against that, or was it just a term to identify what was happening?
Steven Lubka: So, we're going to get into this I'm sure, but the money supply is really very difficult to measure, at least as I'm going to define it, so I'll leave that a little bit, just to say that you can define the money supply as just the amount of currency. In that, you generally have more ability to measure it, but I think that's actually also the wrong way to view it, and the money supply encompasses not just currency, but everything that functions as money, or is a money substitute.
So, yes, you could measure, and I'm not sure exactly -- they obviously didn't have a similar thing to CPI, or in what way those metrics were reported, it's obviously changed over different societies and civilisations. But it generally referred to the way that they were expanding it. Obviously, when we were on fiat, that expansion is tracked more cleanly.
Peter McCormack: Right, so give me an example of a money substitute?
Steven Lubka: So, I would argue that stocks are a money substitute, and that's kind of maybe a contrarian definition. But in the article, and I'm sure we'll talk about that, I think all assets are money substitutes in today's world.
Peter McCormack: Property?
Steven Lubka: Yeah, property, real estate, money substitute. It's a little more cumbersome than stocks. And I would even argue that bonds definitely are, and especially when they're used as collateral.
Peter McCormack: Okay, sorry, we're probably jumping ahead here, but say I buy a property, there's a housing boom, my house price doubles in value, I feel richer, and if I want to borrow money against that, I can?
Steven Lubka: Exactly.
Peter McCormack: And by virtue of that, there is an increase in the money supply, kind of; the actual supply doesn't increase, but there is a notional increase in the money supply, because it's the total value of everything. So, if we live in an economy that's just money and property and all properties double in value, then essentially there is a notional increase in the money supply, because I believe I can get money for that and then start spending it.
Steven Lubka: Exactly. So, this would only ever be a problem, this only ever unwinds if everyone tried to convert all the assets into currency. So, unless everybody tries to sell every stock and every home and everything and get US dollars for it, it never needs to add up, and the assets just function as money. And I'll give an example of this.
So, let's say you had a property and you wanted to sell that property, you wanted to sell it to me. And let's say I offered you 10% more than anybody else was going to bid. You're like, "It's great", but then I say, "Here's the deal, Peter, I can only pay for this in Apple shares. So, I want to buy your house, you want to sell it, I am committing to signing the contract, I am going to pay you 10% more than anybody else, but it's going to be in Apple shares".
Peter McCormack: Okay, sounds like a good deal.
Steven Lubka: Exactly. Your only concern is maybe going to be, is there some loophole here where I'm going to trick you, or you don't actually get the shares, because it's unusual. But your concern is not, "Do the Apple shares have value; are they good; do they have financial value?" That question never occurs, because they're as good as money, maybe there's a little volatility. So, as long as you had confidence that you're going to get those shares and the transaction's legit, you don't care that it's Apple shares and not US dollars, especially if you're making a little premium for it.
Peter McCormack: Yeah. But also, if everyone did try and sell and convert all their properties to dollars at the same time, a massive increase in supply, maybe demand isn't met, the prices of properties would fall again. So, we don't actually have that scenario. But the notional idea that all your assets are a money substitute, it kind of makes sense, because whenever you calculate your net worth, you don't calculate your net worth based on what's in your bank account; it's in your bank account and your property, and even the value of your business, the equity in your business.
Steven Lubka: Yeah.
Peter McCormack: Okay.
Steven Lubka: And you're never concerned that -- there's probably 100X more total financial value of assets than there are actual US dollars. The world could never fit all the assets into all the currency, but nobody's losing sleep over that, because we live in an economy and a financial system where the assets are as good as gold, they're as good as money, they're a near perfect money substitute.
Peter McCormack: But then you could have inflation without actually the government increasing the money supply?
Steven Lubka: And that's the key, and that's really what I've been trying to talk about. So, the traditional economic definition is, "There is only expansion of the money supply when a commercial bank issues a loan". The reason they define it that way is because that is the way in which new US dollars are actually printed, or actually created, and are injected into the circulating supply, the M2, the real economy.
So traditionally, traditional finance people and standard economic definitions are saying, "Okay, commercial banks lending, that's increasing the money supply, that's inflation of the money supply; S&P 500 going up, that's not. But I think that just like we've been talking about, that's wrong. And when the S&P 500 goes up and the value of all of these money substitutes increases, there is more financial value in the system, there is more money in the system.
A way that I like to think about this, and I think a way that would help people in general in just navigating the world today and how the world works, is to separate the financial from the real. What I mean by that is you have the total financial value of everything, all the stocks and all the currency, all the bonds, all of everything, and let's just say it's denominated in dollars, that's the total amount of US dollar value in the world.
Then you have all the oil, all the cars, all the homes, all the computers, the silicon, the nitrogen fertiliser, the plastics, that's the real stuff, that's where actual economic value comes from, and that's what really matters, that's what makes our modern lives so good. We live these great lives where we have air conditioning and we have abundant food.
People confuse the financial layer, which is an abstraction built on top of the real world of goods and services and commodities. But if that financial layer is getting bigger, but that is not accompanied by twice as many cars, twice as many homes, twice as much fertiliser, there's now a disconnect and there is inflation.
Peter McCormack: And, can that increase though, where you talk about, "It's not accompanied by cars and productivity", but can you include virtual items within that as well?
Steven Lubka: You can, to a certain extent. So, let's say we have a software, I create a business software, and every business that adopts this software has a 10% increase in productivity, that counts for sure. It's digital, it's not a physical thing, but it has improved real-world economic function. Eventually that digital thing needs to translate into something physical. As much as people are trying to adopt purely digital stuff, it eventually needs to somehow benefit your actual life. That could be telecommunication, like telecommunication is a real benefit of your actual life.
But to answer your question, yes. If that digital thing actually results in an improvement in the real quality of people's lives, then that does count.
Peter McCormack: Well, I bring it up, because in some ways, Bitcoin is a virtual property.
Steven Lubka: Yeah, totally.
Peter McCormack: So, how do you get to -- because, I'm now getting more confused!
Steven Lubka: Let me hop in on what you just said. So, Bitcoin is digital, but it's also abstract, money is an abstraction. But that doesn't mean money is bad, or that doesn't mean abstractions are bad, because the financial systems, monetary systems, are an extraordinary coordination tool for the real world of activity. Without money, without financial systems, real-world economic activity falls apart; it's completely inefficient to trade and to interact. So money and abstractions can have a profound impact on our ability to build abundant lives.
Peter McCormack: Right, okay. So, how do we get to an accurate definition of what inflation is; and, is this one that you've built yourself, or is this something you've discovered from other people, that a group of other people commonly agree on?
Steven Lubka: Yeah. So, I think Milton Friedman is very well-known for, he has a quote, I might not get it exactly.
Peter McCormack: I wrote it down here, so I can give you it perfectly, "Inflation is always and everywhere a monetary phenomenon, in the sense that it is, and can be, produced only by a more rapid increase in the quantity of money than in output". But when we talk about the quantity of money, he doesn't talk about money substitutes, or does he separately from this?
Steven Lubka: I don't know if he does specifically, but the concept of a money substitute emerges from the Austrian school, so I'm by no means the first person to say that these other things can function as money. But I do think that it's almost a first principles thing, if you just think through this. It's clear that you will accept an Apple share as much as you will accept dollars; it functions as money. I think it's only the modern economic dialogue that tries to shoehorn the definition of money into this really narrow thing. So, it's something I've thought about, but it's also something I'm by no means the first person to say this is the definition of inflation, or money substitutes are a thing.
Peter McCormack: But just now offer me what the definition of inflation is for you, and for the listeners.
Steven Lubka: The definition of inflation for me is an expansion of the money supply, so that can be printing more currency, but it can also be asset prices going up in a way that is not justified by an actual increase in real economic value. So, there's two things here.
Traditionally, people will say that when the S&P 500 goes up, and it doubles about every six or seven years, it goes up quite a bit; so, the traditional explanation for that is that the world got more productive, we innovated, we developed new technologies, we built more stuff, and that justifies the increase in the value of these companies. Maybe there's some traditional inflation that's part of it too. But I would push back on that as well.
So, if we say that the S&P 500 doubles, let's just say every six years, it might be seven, to me, if we think that that financial value is supposed to be a reflection of the real world and our actual society, that would mean to say that our society is becoming twice as abundant, twice as wealthy, twice as productive every six years. And I would challenge everybody to look at your life today, your home, your actual day-to-day life, your car, your job, and compare it to six years ago. Is your life twice as abundant? Maybe if you've been very successful it is, but for the average person, is their life very different today from six years ago? And if you go back another six years, has it doubled again? Has society doubled again? I would argue it actually hasn't changed much at all.
Peter McCormack: I think on average it hasn't, and actually yesterday we had on the show Jeet, do you know Jeet?
Steven Lubka: Yeah.
Peter McCormack: He's actually talking about, we're actually in civilisational decline right now, but we have this veil that is hiding this. So, we have this belief that we're richer and wealthier, but it's a complete myth, it's bullshit. We're actually going through complete civilisational decline. Yeah, I mean look, I get it, I agree, I understand exactly what you're saying. I don't think most people do. I think a lot of people right now feel certainly worse off than they did six years ago.
Steven Lubka: Exactly, yeah. And I think there's definitely a chance that Jeet is correct there, and we are actually in -- and depending on how you define it, I think it's obviously true to some degree. I don't know if I'm fully on that side, there's definitely a lot to be said for it, but I am 100% on the side that we are not in this exponential advance of technical technology development.
There's this very common belief in Silicon Valley and tech investors that we are living in the fastest increase of technology that we've ever seen. I very much disagree with that, and we have to start from first principles here. If you look at the life of somebody who was born in, let's say, 1900, and you look at what their -- obviously, they go through the Great Depression and there's the war; but if you look at their actual life, their actual life was transformed with regularity. We develop all these technologies, like your house actually changes, you get air conditioning, you get a refrigerator, electricity, telephones, cars, all these. There are really broad-based transformations of tangible technology.
From the time you were born in 1900 to the time you died, if you were fortunate, in 1990, the world was totally different, your life was irrevocably different. And if I look back on the last 20 years, from 2002 to 2022, outside of cell phones and efficiency in computers, and the TV is thinner, but it's still a TV, we had a TV back then, I don't see that life has changed that much at all. It's good, it's great. I just want to echo that our lives are fantastic today. We live in an extraordinarily abundant world, the most abundant it's ever been. But the rate of change and improvement, I do not see as going very quickly. I think we've hit a stagnation.
Peter McCormack: Yeah, I completely agree with you. So, what is the use in actually having a correct understanding of inflation; and what are the problems with just attributing price increases as inflation?
Steven Lubka: So, the point of having a correct definition of inflation is first, it centres the dialogue, and I believe very fundamentally that we need to have this recentring where the actual world is the real value, and the financial world is a useful tool that help us coordinate it. Having the right definition is important because it gets rid of the smokescreen. You were talking about this, I think, a little bit with what you said with Jeet's comments; but when we only define inflation as issuing of more currencies, that's how we get to this point where, "Oh, well QE isn't inflationary. The central banks' QE policies, they're not inflationary", and we can talk about the actual bond dynamics there.
But this big asset bull market, stocks going up, all these things going up, that's commonly seen as, "Oh, that's not inflation, we're not creating inflation". But if we define inflation in the way I'm arguing we should, what you see is that what actually happens there is you have a fixed, or let's just say it's growing at 2% a year, or whatever, the real world of actual things, let's say it's improving at 2% a year. But then, the asset market is going up 10% a year.
So, if the value of all of the financial assets is increasing faster than the real world of actual economic activity and stuff and what people want, then essentially the money is being debased. There is more money chasing the same, or a supply of things that hasn't grown as much. And in that, there's a fundamental distortion there, there's a dilution of your value; so many people have talked about it in this space, but you're constantly chasing inflation, you're constantly having to make up for your lost value, and ultimately it's an inefficiency.
Financial and monetary systems are essentially an information system. They are a way in which the system, the economic system, processes data in the form of price. So, when we go to the supermarket and we buy a loaf of bread, we just see the price of that loaf of bread. But contained within that price is everything that has impacted that; how much wheat was produced; the cost of transporting that wheat across the ocean, the efficiency. And so, the price signals which are often talked about, are these data points and an information system that processes all of this in a way that I couldn't, you couldn't, no singular human being has access to all of the information that's contained within price and within a financial system.
But that signal, the fidelity of that data, it gets distorted when you're constantly expanding and changing the money supply, and it results in capital misallocation, wrong investment decisions, all sorts of chaos.
Peter McCormack: Yeah, that's a lot of what Jeff Booth spoke about last time I was with him, talking about how the expansion of money supply distorts the money, distorts the system, and that does lead to malinvestment. But what I'm trying to understand here, help me work through this. We can have inflation because the value of assets like property increases, and that would come hopefully from the world becoming more productive, people having more money, maybe wanting to move up the housing ladder, but that feels like a positive thing.
But we can also get inflation from expansion of the money supply, and yes, if you're near the spigot, that benefits you great. But generally speaking, if that's diluting the system, that's negative inflation. Both of them can drive inflation, but one feels positive and one feels negative; does that make any sense?
Steven Lubka: Yes, it does make sense, it makes perfect sense. So, I think in just tweaking, refining the definition just a tiny bit, I would say that inflation is where there is the increase in asset prices that is not driven by economic activity or improvements. So, if it's going up because, let's say I'm a CEO, I'm a founder and I create a company that can extract nitrogen from the air and convert it to fertiliser, this is a huge problem in the world, we could stop using so many resources, that adds a tremendous amount of economic value to the world. Let's say my company is instantly worth $1 trillion. There's now $1 trillion of more financial assets.
But my company has now also added $1 trillion of real value to the world in this scenario. So, I would say that's not inflation. You could argue that any increase, you could say that is. I don't think that's as helpful. I would say that's not inflation, it's only when they're mismatched. And that's very hard to define. I'll be the first to say that is very difficult to get a quantitative measure of, to define. I don't know exactly how you would actually measure that in an accurate way. But it's functional in a way to think about the world and to view inflation.
Peter McCormack: And if you have the definition, how do you measure it, and how do you interpret that measurement to yourself? I mean, I even spoke to Eric Weinstein about this, where he said that, "The problem with measuring inflation is, what does that mean for me? My assets are different from yours, my purchases are different from yours", so how do we actually use inflation ourselves to react to it?
Steven Lubka: Yeah, absolutely. So, I think to answer that question, it is on a personal basis. You need to see how this myriad of economic factors of money supply dilution, assets prices going up and how that translates into the actual prices, so the traditional consumer prices of the stuff you're going to buy, and that impact is going to be different for everybody. I mean, to answer your question, that is something that can only be navigated on a person-by-person basis.
Somebody who has owned their home for 20 years, and somebody who is paying rent in Miami, they're impacted in a very different way from the rent component of CPI. So, the actual real number of consumer price increase, that's going to differ on a person-to-person basis. And that's one reason that even if we're just looking at CPI and we're just looking at consumer price increases, which I'm saying is different than inflation, but even if we're just looking at that, that measure is very, very inaccurate. It's like a one-size-fits-all number that may in no way match your actual consumption patterns or my actual consumption patterns.
Peter McCormack: Do you know Jeff Snider?
Steven Lubka: Sounds familiar.
Peter McCormack: Yeah, so we had him on the show this week and we were talking about inflation with him, and we were talking about the massive increase in prices that we're seeing at the moment across the board. He said, "This is not inflation". His view is that the government has been printing a lot of money, expanding the money supply quite significantly, ever since 2008. But when you look at the inflation numbers, it's only recently that we've seen a large increase in inflation, and he's saying, "What's happened?"
He said we closed down the global economy and we put a shock in the system of the supply chains and logistics and we also have a war. He said, "The reason energy prices are up has got nothing to do with an increase in the money supply, it's actually from a lack of investment in energy, and it's also because the war has seen the prices increase". He said, "That's a price increase, that's not inflation". And he said, "The majority of other things has gone up because we stopped and economy and restarted it".
So, he doesn't think the money that's gone into the system has caused these price increases. Do you think that's a fair observation?
Steven Lubka: I generally agree with that. So, we'd have to break it down into what percentage of it is that and what percentage of it is the money that was printed. But I'm generally on the side that -- and he said it, you just said it, those are price increases, they're not inflation. So, I am generally on the side that a lot of the price increases we're seeing are because of actual disruptions to the supply of energy and really brilliantly, yes, the lack of investment into it. That is huge.
I mean, we have underinvested in energy tremendously. I mean, we've underinvested in the real world tremendously. So much of our capital has gone to VC investment in Silicon Valley, and so little of our capital has gone to energy production, agricultural efficiency improvements, steel, concrete, fertiliser, all these things. But in that, there's a really great point, and I give two scenarios of this in my article.
Peter McCormack: Yeah, that was great, you should work through that.
Steven Lubka: So, in the article, I give two scenarios were CPI in the United States goes up. And so, the first scenario is, just imagine a theoretical country, and this country is responsible for 40% of all copper production in the world. We use copper, it's very important, we use it in electronics, in electricity. So one day, the country gets overthrown by anti-industrial rebels, and these are people that think the modern world is bad, and we need to discontinue and go back to an agricultural lifestyle.
Overnight, the copper production goes to basically nothing, so the world is shocked by this. Electronics go up, renewables become prohibitively expensive and countries have to juggle their energy supply and burn more fossil fuels, like what we're seeing in a lot of places right now. So, CPI goes up to 15%, because there was an actual disruption of the real world. And so, that's scenario one.
Scenario two is the United States gets overthrown by rebels. This time, it's modern monetary theory rebels.
Peter McCormack: Stephanie Kelton!
Steven Lubka: Yeah. She leads the charge and she overthrows the Treasury, and we implement $5,000 cheques to every man, woman and child every month, and this money just gets printed by the Fed and gets distributed. Now, there's all this money in the system, people obviously buy more stuff, it stresses the supply of things, there's not enough stuff, we see the same sorts of things; electronics get more expensive, there's energy constraints, countries have to pivot and burn more fossil fuels.
Both of these scenarios produce a world where, let's say, CPI is 15%. In one case, CPI is 15%, because 40% of global copper production is offline. In the other scenario, CPI is 15%, so there are increases in the prices of goods, but it's fundamentally driven by solely monetary creation. I say, which of those scenarios should Bitcoin protect investors from; in other words, which scenario is Bitcoin going to go up in? Some people think both, but I say it's only the second one.
Peter McCormack: Yeah, and that makes sense, because if you think it through logically in this random country, what did you call it again?
Steven Lubka: I called it Randia.
Peter McCormack: Yeah, Randia. Now, say the rebels get overthrown and a new capitalist government comes into power and they restart production, you'll have a massive increase of copper into the market and the prices will come back down, so you'll get a price fall. But in the second scenario, where Stephanie Kelton and Andrew Yang have implemented UBI and increased money in the system, that money's never coming out. So, that raises up the baseline for the cost of goods.
Steven Lubka: Correct, yeah.
Peter McCormack: And, this is where it gets super-interesting, because we're going to get into why people have been saying, "Bitcoin's failed as inflation", and you disagree with that.
Steven Lubka: I do disagree. In the example we just talked about, so in that second scenario --
Peter McCormack: Sorry, so our problem at the moment is because we've had both at the same time.
Steven Lubka: Correct, there have been both. And so, let's just walk through that. In the beginning, there was tremendous monetary creation. So, the US prints a ton of money to bail out COVID and everything else. Bitcoin goes from $10,000 to $69,000. Let's make no mistake, when they printed money and they expanded the money supply, Bitcoin was one of the best-performing assets; it went up tremendously. If you bought Bitcoin before there was inflation, aka printing money, you did very well. The Bitcoin hedged you against the expansion of the money supply.
Other things went up in value too, and we'll get into that later on of, yes, stocks go up; yes, houses go up; but Bitcoin went up more and there's a discussion there. So, Bitcoin goes up, there's inflation and it protected investors. And that money creation started circulating through the economy. And that's the other thing about inflation of the money supply; it doesn't show up in consumer prices immediately or evenly, because it circulates in different ways depending on who got it, how they spend it, what the supply situations are there.
So eventually, that printed money gets its way through the economy and it goes faster because they actually did stimulus cheques, and you start to see the prices of goods come up. But they haven't been printing money for a while, so that was the initial inflationary impulse, and Bitcoin did very well there.
Later on, we have this other inflationary wave, that is really centred in food and energy, and it's because of the war, it's because of supply chain disruptions. We can't separate that from decades of underinvestment, so let's be clear. The war was the spark that set everything ablaze, but we built up a pile of kindling for decades by not investing in this stuff, so we can't just blame the war; that's not the right way to look at it. But the war did kick it off.
That is the other sort of inflation; that is a massive disruption of supply and literally countries do not have access to enough natural gas, enough fertiliser, enough food. Sri Lanka's in a devastating crisis, other countries are in devastating crises, price of gas in Europe is hugely expensive. That's the other sort of inflation, and that's where the CPI is coming from right now. We had the impact, and there is still some of that impact from the printed money. But most of what we're seeing today, I believe, is that actual supply disruption.
So, not only should Bitcoin or gold -- neither Bitcoin nor gold nor other inflation hedges should protect you from that. In a world where there are supply disruptions, the world is poorer. You don't get to hold an abstract financial instrument and get richer when the world gets poorer. The only way you can do that is you have a derivative on the price of oil. Okay, that works showing an oil producer, or whatever. But apart from that, there's no inflation hedge that works in that way. And so, that's the inflation we're seeing today, and so Bitcoin's not going up with that.
You add to it actually, in my definition of inflation, not mine, but the correct definition of inflation, it's disinflationary, it's anti-inflationary. The money supply has been contracted tremendously, stocks are down enormously.
Peter McCormack: That's interesting. Okay, right. Because, there's a been a correlation between the S&P and Bitcoin, and so if stocks are falling in price, naturally Bitcoin should. But have you measured the actual total supply of money and money substitutes; has that actually shrunk?
Steven Lubka: Yes, it's down tremendously.
Peter McCormack: And that's why Bitcoin's also down?
Steven Lubka: In my opinion, yes. And there are scenarios, theoretical scenarios where stocks could come down and Bitcoin could go up. But in reality, we're looking at a world where interest rates are up, so the Fed is contracting currency dynamics; stocks, which are just another part of the money supply, are down enormously; housing is kind of down, or at least has stopped going up as quickly; and, the bond market has been contracting. So, across the board, all the aspects of the money supply that I would point at, they're all contracted, they're all down. So, that's actually the opposite of inflation.
So, if we're saying Bitcoin is an inflation hedge, there's actually not inflation right now. We're in a monetary contraction, we're not in an inflation, we're in a monetary contraction with consumer prices going up.
Peter McCormack: But what is the reason that Bitcoin contracts with them? Is it because the people that hold the assets, they're losing value in their stocks, and so they want to hold cash, therefore what can they liquidate; is that what's happening?
Steven Lubka: There's a ton of actual market dynamics, from fear and losing confidence, to your getting margin called on your loan, or your stocks are going down, to Three Arrows getting liquidated and Celsius failing. So, there's a million micro-factors. But the bottom line is, when the total value of all financial assets and the money supply is down tremendously, I mean it's common. We've been in this space, we've talked about, "Bitcoin is here to protect you from money printing and from expansions of the money supply". It has other functions too in censorship resistance; I'm not talking about those, but those are also a critical part of Bitcoin's identity, but I'm focused on the store of value piece here.
Peter McCormack: Right, okay. So, if we go back to CPI, CPI can be kind of a useful tool, as long as it's not just linked to inflation. I mean, it's good to have a general understanding of the increases in price. Yes, it can be totally wrong. It can be reported at 9.1% and it actually feels like 15% for you as an individual. But to have that general understanding that prices are increasing, that's useful. To attribute it as inflation, or down to inflation, is the mistake.
Steven Lubka: Correct. So CPI, I think, is directionally correct. It may not be the actual number, it may not be 9%, it may be 15%, the "real increase of consumer prices". But I generally think it's directionally accurate. If it's going up, those prices are probably going up; if it's coming down, those prices are coming down; it's just the number isn't exactly correct. So, that CPI increase, it could be driven by actual inflation, aka increasing the money supply; or, it could be driven by supply disruption, and both of those are an option.
Either way, the CPI itself is not inflation, it's a lagging indicator, and that's the other thing to understand with it. We've talked about this a little bit, but they print money, there's actual inflation of the money supply, and then that will translate to consumer prices going up; there will be CPI increases from that, but it's a lagging indicator.
Peter McCormack: So, would it be more helpful therefore if money was backed by something? So, whether it's gold or Bitcoin, if it was backed, would that help to get a better measure of inflation?
Steven Lubka: So, in a world where money -- if you take away the power for money to be created from thin air, it dramatically simplifies this equation to a really manageable extent, I mean that is the bottom line. Part of the reason there can be so much monetary expansion is because the Fed has countless tools to increase the monetary supply. Not that they even do the stimulus cheques, but it's not just stimulus cheques; there's QE, there's repo markets, there's swap lines. There's all sorts of tools that most people, and even myself included, don't understand in sufficient detail.
I mean, this is something that I think isn't talked about enough, but there is no human being on this planet that understands all the intricacies of the global financial system. It is more complex than anybody has truly detailed knowledge of.
Peter McCormack: And it's a big fucking mess! Okay, so let's just flip to housing for the moment. Housing's the one area of the economy that hasn't been hit too hard just yet. But there are concerns that interest in new house-buyers, or the number of people interested in buying a house, that is slowing down, I've seen some data based on that. If the housing market was to cool and we were to see a housing crash, that would most likely therefore lead also to a fall in the price of Bitcoin, because that would be a contraction in the value of substitute assets?
Steven Lubka: Yeah. If there was a dramatic housing correction, then that's going to spill over into stocks and that's going to spill over into people's spending behaviours, and yeah, that's most likely going to be a drag on Bitcoin. It's hard for me, I don't see Bitcoin as going to the Moon because housing's collapsed 20%.
Peter McCormack: It's really interesting, because we've gone through the cycle now where prior to the last bull run, where we were seeing increases in the expansion of the money supply, and bitcoiners were saying, "Look, Bitcoin is a hedge against inflation". And then, Bitcoin's hit $70,000 and we've started to get inflation numbers and Bitcoin's been falling since, people have been saying, "Well, Bitcoin isn't an inflation hedge, it's not an inflation hedge, because look, the price has fallen at a time when we've got high inflation".
But actually, it has completely performed as an inflation hedge, but it's because people haven't been accurately describing what inflation is, or fully understanding those numbers.
Steven Lubka: Exactly.
Peter McCormack: So, if you knew it, the way to time it is, you want to be buying Bitcoin when you're getting indicators that the government's going to increase the money supply, it's going to happen.
Steven Lubka: Correct.
Peter McCormack: But if you get to the point where you feel like, "Oh, recession's coming, we're going to see some tightening here", perhaps the stock markets need a correction, that's the time to exit Bitcoin.
Steven Lubka: Yeah, if you're looking to trade Bitcoin and that's how you're managing it, that's the general yardstick. When the money supply's going to contract, that's certainly not going to be bullish for Bitcoin; and when the money supply's going to expand, that's going to generally be more bullish for Bitcoin than any other asset. I'm sure people listening at this point, some people have thought, "Well, Steven, when they print money, everything goes up, so you're just saying that Bitcoin is anything else. Everything goes up when the Fed prints money", and I understand that pushback.
To address that, Bitcoin, by virtue of not being real, it's not a real thing, Bitcoin isn't tangible, it's an abstract money and it's digital too, to boot; even if it was gold, I would still say it's technically abstract, is what its real financial identity is. But when they are manipulating the abstract layer, so the financial layer, and they're engineering that, if you can hold an abstract monetary instrument that isn't real, it doesn't have cashflows, it doesn't have debt, it doesn’t need maintenance, it doesn't have property taxes, you don't have to rent it out, you don't have to do all these things you have to do with other assets, money is essentially a virtuous bubble, so it's this bubble that doesn't need to come down. It can command really whatever price it needs to if it's just money.
So, in a world where they're printing money, Bitcoin is this pristine, pure inflation hedge where, yes, stocks will go up, yes, housing will go up. You could buy those things and you will get more dollars as those prices increase. But if you buy a stock, that stock has competition, they could make a bad product decision, they could get disrupted; and the same thing with houses in different ways. People could move to different areas, there could be a hurricane, all these sorts of things. Bitcoin has none of those risks.
We live in a world where all of these financial assets are essentially just trying to catch the wind of inflation. I would say that a single-digit percentage of broad asset growth is because of real productivity, real economic increases, and the rest of it is just inflation. Single digit, maybe 10%, 15%; it's a low amount. The majority of it is actually just inflation. So, these assets have been turned into these liquidity proxies, investors buy them, and most of the gains they're getting are just inflation. They're not really betting on one of these companies making twice as many products, or having an engineering breakthrough; maybe in some cases, but broadly no.
Bitcoin, it's not this imperfect liquidity proxy, it's not this thing you're trying to turn into a store of value. That's just what it is, it's just money, it's this beautiful instrument that is designed to protect your financial value. So, when they are messing with that layer, I see Bitcoin, yeah, I think it's going to move directionally with monetary expansion, so are other assets. But Bitcoin is a much cleaner way, it's generally, for the foreseeable future, I predict that it's going to go up more than those other assets, and it obviously also has other benefits, like you can store it yourself, you can transact with it, all the other stuff.
Peter McCormack: Well, yeah, because it's inelastic. And if more people start to consider it as a hedge against inflation, then we will naturally see -- well, it could even become even more volatile again.
Steven Lubka: Yeah. I think there are scenarios you could see volatility. I think everybody expects the volatility is going to go down. But depending on -- some people expect we're really entering into turbulent financial times, and I think whether or not that happens, it's reasonable to believe that, and yeah, you could see it increasing, volatility. You could look at gold in the Weimar Germany. I don't know if you've seen that chart?
Peter McCormack: Yeah, I've seen it.
Steven Lubka: It's up and down, up and down, and that's during a time where gold was basically the best thing to own, that was the best way, and yet the volatility increased. So, I think that's definitely reasonable.
Peter McCormack: So, how would you explain then the runup we had with Bitcoin in the last couple of years kind of followed the typical, every-four-year cycle? But you wouldn't explain the previous cycles as people hedging against inflation. Would you say -- how do you square that circle, because it's almost like Bitcoin has matured over this last four years and has become correlated to the rest of the economy; is it coincidence?
Steven Lubka: So, in the previous cycles, there was still tremendous monetary expansion going on. I mean, since 2008, which is literally from the moment Bitcoin was born, we have been in an era of unprecedented monetary expansion. So, there were fits and starts, and I might be wrong on this, but I even believe the top in 2017 coincided with the Fed contracting, hiking rates and contracting the monetary supply. So actually that top, I believe, actually coincided with that point. But even if it didn't, even if I'm wrong on that timing, we have been in an era of unprecedented monetary expansion, where the entire story, Bitcoin's ups and downs, has coincided with that.
Now, earlier on, there were much more significant existential risks to Bitcoin. There were questions if it would even survive, if after Mt. Gox, who even knows what this thing is going to look like; the fork wars; is Bitcoin ever even going to get adopted? So, in those earlier times when Bitcoin is much younger, I think you can obviously say that a lot of the investment, both people buying it and people getting worried and selling it, had a lot more to do with just, "Is this thing going to survive? Is it going to get any measure of adoption? We think it's the future. We think it's a scam". That had a much larger role in the beginning and then as it's matured…
Something I see today in this cycle compared to 2018; in 2018, after the run, I felt that people were legitimately concerned about the future of Bitcoin like, "Oh my God, we got swept away in this whole wave. What if this is just nothing? What if this is hot air?" at least for people new to it. And I'm not embarrassed to admit I had those concerns.
Peter McCormack: I had them, Danny's had them, we've all had them.
Steven Lubka: Yeah, we've all had them, and that was a real concern in 2018. It's like you're hungover after the party and you're like, "Man, was I wrong? Does this just have so much more risk? Is it so much just less likely to do what I thought it was going to do?" But in this cycle, I don't know many people that have that same concern, or same degree of concern. I think there are risks of, "How low do we think it's going to go? What's going to happen?" and maybe some regulatory questions. But the sort of existential question of, "Is Bitcoin even real; does it even have any substance?" most people, I think, aren't thinking that.
That's just one of the differences, is as it's matured, its performance, its value, its success I think has been more tied to what's happening in the world, and how we're going to navigate the current environment, rather than just, "Is Bitcoin legit?"
Peter McCormack: And do you think Bitcoin will remain intrinsically linked to decisions of the Fed, or do you think it eventually just decouples?
Steven Lubka: As long as fiat currencies, the central bank paradigm is the dominant monetary paradigm, Bitcoin is a contrarian hedge against that. That continues until a world where Bitcoin is in some way the primary monetary paradigm. In a world where Bitcoin is just money, then it has a very different dynamic. And I'm not speculating on -- I think there are multiple outcomes. I don't think that it's just inevitable that Bitcoin becomes the dominant paradigm of money.
I think there are scenarios, and I might catch some heat for this, but I think there are scenarios where, in the same way that gold has existed alongside fiat currencies, I do think, and I do think for the foreseeable future, Bitcoin just exists alongside fiat currencies. And I think there are scenarios where it could become the dominant paradigm, and I think there are other scenarios where it is still successful, it is still widely used, it is still adopted, but there is also another monetary system going on. I think both of those are options. I think as long as Bitcoin is a contrarian, minority monetary system, in relationship to a dominant one, it's going to have this dynamic.
Peter McCormack: So, now you know this and you've gone down this rabbit hole, how's this changed any of the ways you maybe consider about buying Bitcoin, holding Bitcoin, or anything to do with your conviction?
Steven Lubka: So, to me, this really doesn't weaken my conviction. This in no way, I think, weakens the argument for Bitcoin. Let's think about this from scratch. What do we want Bitcoin to be? Do we want Bitcoin to be this asset that only does well when the world gets utterly messed up and everything is screwed and we don't have enough stuff; is that the only scenario we want Bitcoin to do well on? Consumer price and supply chain problems are bad for people, they're bad for the world. They're literally the human race becoming less abundant and poorer; is that what we're betting on? Are we just so worried that humans are not going to be able to operate society that we need to own this asset?
Or, do we want an asset that protects us against irresponsible central bank decisions? There are these two different paradigms. One of them, you're bearish on humanity, you think humans aren't going to do well, we're not going to produce stuff, we're not going to be efficient. The other one, you're bearish on central bankers and governments. I know which one I'm betting on; I'm betting on humans. What I'm concerned about is the governments, the money spending, the debt, the central bankers. This is the system we've implemented.
I want the asset that protects me against that. I don't care if things go down, if Saudi Arabian oil production goes offline. We will figure it out and if we don't, we have much bigger problems.
Peter McCormack: So, I'm going to be keeping a much closer eye on what the Fed is doing. We had Preston Pysh on the show recently. He thinks a massive print is coming.
Steven Lubka: I do too.
Peter McCormack: Yeah, you do too.
Steven Lubka: I do too. They're trapped.
Peter McCormack: Yeah, so they're trapped, and he thinks they're going to print like they've never printed before, potentially trillions. And if that does happen, then we would expect Bitcoin to go up.
Steven Lubka: Precisely. That is what I think. Bitcoin will go up dramatically when the direction of monetary expansion changes, which is going to occur, unless something very unexpected happens, when the Fed pivots. That pivot could be -- it doesn't necessarily have to be rate cuts, because there's an increasing probability that the Fed may actually have to bail out Japan or Europe, or both.
There was a precedent in 2008, there's something called "swap lines". Basically, it's literally QE for other countries. It's saying, "At the Fed, we're going to print money and we're going to buy your bonds, we're going to buy the Japanese Bonds, we're going to buy the Euro Bonds". I think there's a meaningful probability that one or both of those occur. In that, the Fed could continue hiking rates in the US, while also printing money to stabilise Japan or Europe in the crises they're facing. So, that could be the form of a pivot. There is monetary expansion there, they could start to cut rates. They could even just slow down the hikes.
Peter McCormack: Hold on, because we hit the eurodollar parity, and that's a huge risk to the US if that continues, because that would make American exports too expensive.
Steven Lubka: Yes.
Peter McCormack: So, is the idea to buy up European Bonds by the US Government, print money to do that, to bring the prices back?
Steven Lubka: So, it would have the result of lowering the value of the dollar, which we need that. We can't sustain -- where the dollar is today is ultimately not going to be good for us. First, it hurts them. So, when the dollar goes up a lot, it hurts foreign countries first, but then it comes back and hurts America. So, America doesn't want it to stay as high as it is, so that would be beneficial. But I don't even think that's the main reason; that's an added benefit.
The real reason is literally to maintain the social fabric, to keep society operating, in the face of a profound energy crisis. And that's the case in both Japan and Europe. Europe, it's obviously the natural gas, Putin/Russia dynamic, that's making things very expensive over there. Japan, they're not a natural energy producer, so they have to import most of their energy in the form of fossil fuels. And because they've been engaged in yield curve control, the yen has fallen precipitously, meaning it's more expensive for them to import energy. So, they basically just need money to buy oil and to buy energy.
So, it's literally a question of social stability. There's plenty of people to listen to that are pessimists. I'm not a pessimist. I say these things to talk about the issues and talk about the scenarios. I think humans are very resourceful, so I'm not saying this as, "Everything's going to fall apart", but Japan needs that support, or they're going to be in trouble. So, I think that is going to happen, and that will give them breathing room, and it will cement their alliance with the US.
My point here though is that there's all these different angles in which the Fed could pivot; there's all these different angles at which they can start to expand the money in the system without necessarily cutting interest rates 100 basis points, or restarting QE, and I would expect that's what we're going to see. We're not just going to see Jerome Powell come out in a couple of months and say, "QE's back, baby, we're going to print so much money, more money than you've ever seen!"
Peter McCormack: "Let's go!"
Steven Lubka: Yeah, that's absolutely not going to happen, because he would lose credibility. That's the other pressure they're under; it's very important for them to maintain credibility, and so they're walking a tightrope.
Peter McCormack: Damn. Is there anything I've not asked you in this that you wish I had?
Steven Lubka: I want to talk about bonds.
Peter McCormack: Yes, please do; alchemy.
Steven Lubka: Yeah. So, this is something that I think is really fascinating. So, if you talk to the average traditional finance, or traditional economist, there's this thing you've probably heard that said, "QE didn't print money. That's because there's no commercial lending, dollars aren't created and CPI didn't go super-high, and that's why they say that". I think that's wrong and I want to give the example, because I think the bond example is really fascinating.
What a bond is, and I think this isn't always clear, let's say I lend you $10,000. I say, "Peter, here's $10,000", I transfer it from my bank account.
Peter McCormack: Thank you!
Steven Lubka: And you agree to pay me back $10,500 in two years; a couple of payments, some interest, then you pay it all back. Great. The bond is nothing more than that agreement. It's a promise, that's literally all it is; there is nothing else to it. It is just you telling me that, "Steven, I'm going to pay you back $10,500". That's the bond. And so in that scenario, there is no money creation, because I take $10,000 from my bank account, I send it to you.
You now have those dollars, no money's been created. You have to pay me back $10,500, but in order to do that, you need to get the extra $500 from somewhere, from operating your awesome podcast. So, you do what you do best and you generate some extra money and you use that to pay me back. Great, no money creation, it's completely neutral, healthy, productive, functional; we need that.
But now, what happens if I take your promise, your abstract agreement, and I go to a bank and I say, "Hey, I need a loan. I need $5,000 because I want to take an awesome vacation, and I want you to lend it to me. I don't have any collateral, except I've got this agreement from Peter. You know Peter, he's a trustworthy guy, he's good for the money, he's going to pay it back".
Peter McCormack: I'm good!
Steven Lubka: Yeah. And the bank says, "Oh, of course, great. That's a good quality bond. We think there's a really good chance that that money's going to get paid back". And so, I deposit the agreement, your promise to me, as collateral, and they lend money to me against it.
Now hold on. There's now $10,000 that I transferred to you, and there is now this thing that has been created from thin air that is the bond, that is now being valued at $10,000. There are now two things. There is now twice as much financial value in the system. And the bond has been created from thin air. It's not an asset, it's actually debt. You could not pay that back, or there could be issues, or it could get paid back partially, and we have now suddenly done this incredible alchemy where a nothing, a promise, a promise that is debt, is now considered an asset.
Not only is there now $20,000 of value in the system, the $10,000 actual dollars that I gave to you, $10,500 that's been created from thin air in the form of an asset that's used as collateral, but now the bank prints, actually prints, real, traditional currency creation, $5,000 and lends it to me. There's now a total of $25,000 that has been created from my original $10,000, and it can get worse.
Now that bank can take its loan to me and say that's a bond, and they can give it to another bank, who can give it to another bank. And suddenly, there's $50,000 of financial collateral in a system that all started from $10,000 actual dollars.
Peter McCormack: Sounds like how we got what happened in 2008 and the contagion from that. Is this essentially rehypothecation?
Steven Lubka: It's also what just happened in crypto; it's also Three Arrows; it's also Celsius. I mean, specifically Three Arrows. It's a story as old as time.
Peter McCormack: Is this basically one of the problems of fractional-reserve lending?
Steven Lubka: Yeah, it's one of the problems of rehypothecation. But specifically, there's rehypothecation and then there's this strange thing where debt is an asset, and that's weird.
Peter McCormack: Because debt is a liability?
Steven Lubka: Debt is a liability, debt is not an asset, but we have built this entire system where debt is an asset.
Peter McCormack: Because we trust that people will pay back too much, we don't allow for mistakes.
Steven Lubka: And so what happens if you pay me back?
Peter McCormack: Everything gets paid back.
Steven Lubka: Everything disappears.
Peter McCormack: But it's not $50,000 being paid back.
Steven Lubka: It's $10,000.
Peter McCormack: Yeah, it's $10,000 being paid back through the system.
Steven Lubka: So, you making good on your debt of $10,500 extinguishes $50,000 of liquidity from the system. It's actually bad for the system in some ways. You paying back your debt is bad. Isn't that crazy?
Peter McCormack: It's fucked up.
Steven Lubka: How did we think that is a good way to operate a financial system.
Peter McCormack: I'm not going to pay you back, dude. We're going to see this shit collapse.
Steven Lubka: The banks are cheering!
Peter McCormack: Damn. Man, this was fascinating, this was really, really interesting. Danny, you got anything you want to add?
Danny Knowles: No, I don't think so, that was really good.
Peter McCormack: Yeah, really, really interesting. Right, if people want to follow you, read more of your incredible work, where should they go to?
Steven Lubka: Yeah, so you can follow me on Twitter, we'll get my bio on the episode. It's @DzambhalaHODL, you won't know how to spell that, we'll get it plugged in. We'll get the article we'll link to, Bitcoin and the True Definition of Inflation. That's hosted on Swan, so we'll link that up.
Peter McCormack: What are you working on next?
Steven Lubka: What am I working on next? I'm working on onboarding another 1,000 people to Bitcoin.
Peter McCormack: No, what article?
Steven Lubka: I don't know.
Peter McCormack: You've got to go deeper with this.
Steven Lubka: Yeah, they'll be more.
Peter McCormack: Go into the contagion stuff a bit more, that will be fascinating.
Steven Lubka: Okay.
Peter McCormack: We should do this again. I mean, let me know when you've worked on something else and we'll let you know when we're in town. We will definitely do something again, but this was fascinating. Yeah, wow. We should go and eat and jump in the pool.
Steven Lubka: Let's do it!
Peter McCormack: All right, great to meet you, man, thank you.
Steven Lubka: It was great, thank you.
