WBD535 Audio Transcription
Eurodollar & The Money Printer with Lyn Alden
Release date: Tuesday 2nd August
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 fundamentals of the current global economy: the Eurodollar system, central banks, money printing, debt, inflation and deflation.
“This is inherently a Ponzi scheme essentially, if there’s more debt than there’s money, it means those debts in aggregate can never be paid down. It’s not designed to ever end… it can only grow.”
— Lyn Alden
Interview Transcription
Peter McCormack: Morning, how are you doing, Lyn?
Lyn Alden: Pretty good, happy to be here.
Peter McCormack: Always happy to have you back. Danny's very excited about this show.
Danny Knowles: Always.
Peter McCormack: Danny's been down the rabbit hole the last couple of days. Ever since we interviewed Jeff Snider, there's been quite the healthy debate on Twitter, and I reached out to you, you said you don't agree with everything he says, but you agree with a lot of things he said. It's opened our eyes to a few things, and I think you've relistened to the show a couple of times, right?
Danny Knowles: Yeah. I relistened to it last night.
Peter McCormack: And, I think we, like some others, discovered the eurodollar system for the first time, which is something I'd heard of, but I'd just assumed it was just something to do with the Fed and it's the way they distributed dollars in Europe. I didn't actually have any idea what it was, what it meant, and it's kind of this, I don't even know how to put it. We were talking about it last night. Is it basically a group of people have just decided to create their own money?
Lyn Alden: Essentially, yeah! I would describe it as bad technology; basically the ramifications of having money that's not perfect, or that has all these very clear limitations. It's money that is both not completely auditable and that's soft and inflationary enough that encourages people to borrow it to buy other things. So the combination of basically as an incentive mechanism to keep growing, and that it's hard to track where it is, and that's a bad combination.
Peter McCormack: Right. We need to go back a few steps on this and get into the absolute basics of what it is, because I know there were some questions regarding this. I think some other people were like, "Hold on, what? It's just a group of offshore people creating their own money?" We actually talked about it. We were like, "Could we create our own one; could we create the Petedollar and we just trade it between ourselves and get Jeremy on it?!" I mean, is that essentially what it was?
Lyn Alden: Well for example, if let's say I owe you money, or I say, "You know what, you get us a round of coffees and I'll pay you back later", we've just created credit, and that is now an asset for you and a liability for me, and it's based on the fact that you're pretty sure I'll have the money at some point and we can settle it. And that's essentially what modern money is. Most money that we know of as money is credit.
For example, our deposits at the bank are the bank's liability, it's a form of credit, and they create new broad money when they make loans. So all credit, basically all money in the current form, the currency that we know, is a type of credit. So in that sense, yes, you basically create it; any two parties can create it, even us. But of course, it's much different when it's created at an institutional level. So, yes, the short answer to the question is, you can create money any time you essentially make a claim that you'll pay someone back later, and then they go and mark it down as an asset on their book.
Peter McCormack: Okay, so where did the eurodollar start though; how did it first get created?
Lyn Alden: Well, that goes back to the Bretton Woods era. The funny thing is, you can actually go back further because, are you familiar with the Hawala system?
Peter McCormack: No.
Lyn Alden: So, Hawala money transfer system, it's a money transfer system that still exists, but went from India to Africa, all across the Silk Road, and hundreds of years ago, I mean 1,000 years ago. Basically, if you want to transmit value and you don't want to bring gold with you, how can you do it? One thing you can do is rely on a set of trusted intermediaries. So, you have a network of Hawala money brokers and they know each other, they know each other's reputation, they know each other's tribe and family and they know each other very well.
So basically, one person in City A can go to a Hawala money dealer and say, "I want to send 10 ounces of gold to this person in another city", and that person in the city can then go to a different Hawala dealer, and those Hawala dealers, they connected, and they basically agreed to transfer value, despite the fact that no value was physically transferred; just one of them owes the other one now. So, they had these going back and forth, and they keep basically a ledger between themselves.
What that is is basically a decentralised ledger; it's like analogue Bitcoin back 1,000 years ago, and it still exists, it runs parallel to the banking system. So, if you want to send money, that's one way to do it, if you don't have banking access, or you want to go around the banking channels; that's something that exists and that's pre-eurodollar. The eurodollar system's basically just a modern version of that.
These systems pop up anytime you have some sort of shortcoming with money, because you can't just teleport gold to someone, you have a problem, that's where we get the Hawala system. And because dollars have limitations, we get the eurodollar system. So, the eurodollar system's basically just offshore dollars, and you can trace it back to the Bretton Woods era, so say the 1950s, for example, you can trace it all the way back to then, maybe the 1940s. It's basically just dollars outside of the United States that are loosely tied to the fact that the dollar's the global reserve currency and therefore, they're tied into that network effect.
Peter McCormack: But there are no real dollars in this system?
Lyn Alden: There are some. There are physical cash dollars overseas. I mean, most -- it's funny, there's more $100 bills than there are small bills, and most of those are overseas. But that's a very small piece of the puzzle. Most of the offshore dollar system is credit. It's basically, those series of claims, basically banks that owe other banks, or corporations that owe dollars to banks, and all of that is offshore.
For example, the Bank for International Settlements estimates that there's $13.5 trillion of dollar-denominated debt that's off the United States, and it's mostly not owed to the United States. For example, an entity in Europe might owe money to an entity to South America in dollars; or China now, they take a lot of their dollar surpluses, because they run big trade surpluses with theirs, they get tons of dollars. They used to buy Treasuries with them. Now they go and they make loans to countries in Africa, countries in South America, so you have this huge system of dollar-based debts and credit, and banking systems outside of the United States.
The difference is, in the United States, all the domestic banks are tied to the Fed. In Bitcoin terms, the Fed runs a full node for the onshore dollar system. They know roughly where all the dollars are. Each big bank is like a partial node, and then the Fed basically pulls those together, keeps track of where all the dollars are. But if a dollar is outside of that system, it's like a sidechain, and even the Fed doesn't really have a way to audit it. So, those are dollars that exist outside of it, but are loosely connected to it.
Peter McCormack: Didn't Jeff talk about these institutions using the eurodollar have a ledger between them that they all agree on?
Lyn Alden: It would be a series of ledgers. There's not like one spreadsheet that they're pooling around.
Peter McCormack: Okay, so is it just really a group of people agreeing who owes what money to who?
Lyn Alden: Yeah, a sophisticated version of that, yes.
Peter McCormack: I'm just trying to think, how does that inflate? Are they able to create their own new eurodollars?
Lyn Alden: Yes, because whenever an institution, domestic or foreign, loans money, they essentially loan fiat currency into existence. So, if I promise to pay you back $5, you now have $5 in your asset and that's money for you. So as an example, if I go to my bank and I want to get a car loan, I go to the bank, I say, "You know I'm creditworthy, I want the loan", so they put money in my account that I can then use and give to the car dealer. They've created new broad money that is a liability for me and an asset for them. So, that's essentially how it works.
Actually Saifedean, in his book, The Fiat Standard, goes into this, the nuts and bolts of it, that essentially money creation as we know it, how you "mine" for your currency, is you make loans, for the most part. There are ways to bypass this system by the government; that goes into the whole money printing thing. But most money creation historically happens because banks are making new loans.
Peter McCormack: But there's certain rules the banks have to keep to in terms of creating these loans?
Lyn Alden: Yes, because they have assets and liabilities. And if their assets fall below their liabilities, they're insolvent. And so, they have to make sure that when they make a new loan, which is a new asset for them, that it doesn't just go away, because they have capital on the line and their assets are some mix of risky or conservative loans.
For example, conservative loans would be like they make 30-year mortgages to someone with a perfect credit score; or, they own US Treasuries. Those are pretty conservative assets. The riskier assets might be making car loans or credit card loans, or things like that. So, if some percentage of them, let's say 10% of their loans, don't get paid back, they're insolvent; that's roughly their buffer. So, they have to be very careful, that's kind of their constraint; and that's why they don't have $1 quadrillion created every week is because if those loans default, that bank's at risk.
Peter McCormack: The US obviously can monitor and manage the creation of dollars within the United States, but it really can't do much about the creation of eurodollars?
Lyn Alden: Not much, no. I mean, yeah, they're basically outside the regulatory scope. So, even in the United States, they have a number of levers they can pull. They accelerate loans or decelerate loans, but they don't have fine motor control over it, because at the end of the day, it's a bunch of individual transactions. People have to demand loans, and then banks have to be willing to make those loans. So, there are strong and weak levers that the government or the Fed can pull to accelerate loan creation, or reduce loan creation, but it's not like they can just pick a number and have that many loans created.
Then, when you go outside of the US, because it's outside the regulatory purview, yes, they have even less control over that system and they have very little way to audit that system.
Peter McCormack: And, do we have any understanding of what the Fed thinks of this system; is it good for there, is it bad for them?
Lyn Alden: It's different with time. That's actually where Jeff, he pointed out, and he collects all the quotes from all the different officials and everything like that; one of the famous quotes from decades ago was, "It's our money, but it's your problem". That's been one of the old quotes.
Peter McCormack: But does the creation of the eurodollars, the growth of the eurodollar, does that cause -- I'm trying to think how to word this. Does this have economic implications for the dollar in the US?
Lyn Alden: Yes. I would say it structurally contributes to trade deficits in the United States, and it also causes financial problems when that system contracts, so there's to be a recession of some sort, like the COVID crash March 2020, or during the Subprime Mortgage Crisis in 2008. When large events like that happen, it ricochets back and it hurts US markets. The reason for that is, if you go back to the BIS, they say it is over $13 trillion in dollar-based debts.
Now there's also, depending on the number at any given time, we just had a pretty big market correction, so probably numbers are different; but let's say, roughly speaking, if you look at the IMF data, the US data, foreign assets are something like $40 trillion or $50 trillion in US-denominated assets, and that's built up by the fact that they've on average, not every country, but on average, they've run trade surpluses with the United States for decades, let's say China for example, or Switzerland.
They get all these dollars and then they buy US assets with those dollars. So, it could be Treasuries, that's what they used to do; now they increasingly buy stocks. They can buy US real estate, so a Chinese firm could come in and buy US commercial real estate, or they can even buy a bunch of single-family homes; they buy US assets. And one problem is, if there's ever a contraction in the eurodollar system, they start selling, because they basically need dollars, because credit's been crunched, it's owed in dollars, debt represents demand for that currency.
So, if you have a dollar-based debt, you have a demand for dollars, because you have to service your debt. And so, when you have these crunches, everybody wants dollars at the same time. One way you can get dollars is by selling your dollar-denominated assets. So for example, March 2020, there was a dollar shortage, so the Foreign Secretary in aggregate started selling Treasuries to get dollars. So, the Treasury market went illiquid, and then the Fed had to reliquefy it, by creating dollars to buy Treasuries. So, they basically had to move the knobs around for how many dollars are in existence versus how many Treasuries were in existence, at least outside of their balance sheet, to placate the eurodollar system essentially.
Peter McCormack: And, just to repeat, why is it you think the eurodollar system is a bad system, you think it's bad money?
Lyn Alden: Well, because one, it's opaque, it's hard to audit. I mean, imagine a blockchain that you don't really know the supply of, and you don't fully know the rules for how new units are created or destroyed; you kind of know but you don't really know.
Peter McCormack: Is that Ethereum you're describing?!
Lyn Alden: Just any! And then, number two, because it's fiat currency, there's just no constrain on supply really, other than basic rules; and it encourages debt accumulation, because there's a natural incentive to borrow on something that gets weaker over time to buy something that gets stronger over time, as long as you don't get over your skis.
Peter McCormack: Right. So, why has it expanded so quickly?
Lyn Alden: Because of that incentive. Because one, there's not a lot of checks and balances on it; and then two, there's a couple of reasons. One is, if you want to make a foreign loan, if you want to loan money to someone in Argentina, as a particularly extreme example, you don't really want to do it in their currency, because they're going to pay you back in severely weakened currency. So you say, "Okay, I'll loan you money, but it's going to be in something like dollars or euros or yen; it's going to be in an international, more stable currency". The dollars' by far the biggest international lending currency, because of the network effects and because of the reserve currency status. So, you'll loan someone in Argentina in dollars, but not their local currency.
Now, in some countries that are less extreme, let's say Brazil, they have the option of borrowing their own currency in many cases, but will pay a higher interest rate. So if they want to basically take some risk and get a lower interest loan, they might be willing to take a loan in dollars. But the risk is that if the dollar ever severely strengthens compared to their cashflows, which are probably in Brazilian currency, they can be squeezed on that. So, there are natural incentives for that to grow over time.
Peter McCormack: Okay, this might sound super-simple, but I just want to walk through the logic of how this works. So, an Argentinian business wants to borrow dollars, they borrow from this bank, the bank then creates the loan, which becomes a liability for the bank.
Lyn Alden: It becomes an asset for the bank.
Peter McCormack: An asset for the bank, and a liability for the borrower, sorry. But the borrower then needs to access these dollars, so how do they physically get the dollars? Does that get transferred from that bank to their local bank?
Lyn Alden: Yes.
Peter McCormack: So, there'll be a bank in Argentina that will accept that?
Lyn Alden: Yes.
Peter McCormack: Where's the actual money?
Lyn Alden: It's just a ledger. I mean, for example, in the United States, our broad money supply is over $20 trillion. Something like 90% of that is not paper money; paper money is a tiny percentage. Most of it is literally just ledgers. My bank says I have this much in my account, let's say you're an American, you have a certain amount in that system. You could have dollars in your offshore account that's outside of this system; it's all basically ledger based.
Peter McCormack: So, they transfer it to the Argentinian bank. What actually happens there though? Because, what I'm trying to understand, and I know this is going to sound super-dumb; what I'm trying to understand is, what has the Argentinian bank taken on? They've updated a ledger to say, "This person's account now has [say] this $1 million". But say this person comes in to withdraw, they want to get some of that, so they need some cash from that, where is that supply coming from, and what is the relationship between the two banks on this, say, $1 million, because this is the bit I never understand?
Lyn Alden: Yeah, well one is that the vast majority of it will never be withdrawn. If you tried it, they'd just be, "We don't have the physical dollars". That even happens ironically in the US sometimes.
Peter McCormack: But let's say even they just spend it. They go and pay another supplier $200,000, what is the relationship between the ledgers, because this is what I can never get my head around?
Lyn Alden: There's a series of ledgers. There's no one spreadsheet that they all have, but the one with the closest would be the Bank for International Settlements, that tries its best to keep track of all this. But each bank is managing their own ledger, and because it's double-entry bookkeeping, their ledgers, they have to reconcile with other banks. There can be both loans and securities, so a larger entity could issue securities, bonds, whereas small entities will generally use loans, and use a mix of both as well.
Peter McCormack: I still don't get it. Do you understand it?
Danny Knowles: I think so, yeah.
Peter McCormack: Explain it to me. So, what has the Argentinian bank done?
Danny Knowles: I think you're getting hung up on the idea of actual dollars moving.
Peter McCormack: No, it doesn't even need to be that. But in the end, I don't understand the actual movement of the money.
Lyn Alden: It goes back to the Hawala system.
Peter McCormack: All promises?
Lyn Alden: All promises.
Peter McCormack: So, the Argentinian bank, they've got a commitment to pay back the $1 million to the other bank?
Lyn Alden: Yes. And generally the way it will work is, a European bank will loan dollars to a South American Bank. That bank will then loan some to their local corporation that actually makes something. So, they owe their bank, that bank owes this other international bank, and this chain of -- so if one entity defaults, it can default up through the chain.
Peter McCormack: So, this is how we just get massive expansion of the money then; it's just all this credit being created?
Lyn Alden: Yes.
Peter McCormack: It's crazy.
Danny Knowles: I think it would be interesting, what are the benefits from this system? The broader economy, have there been social benefits?
Peter McCormack: Growth.
Lyn Alden: I guess one of the steelman cases for it is, let's say you are in Argentina. If there is no way to lend dollars to an entity in Argentina, would anyone loan them anything? It would be hard to then bootstrap a new company, bootstrap some sort of operation. If you don't have domestic stock of savings and capital and you want to access a more developed, richer country's capital, that's a mechanism that allows it to happen.
There are some countries that have made strong use of it, I mean Taiwan, for example. There are countries that started impoverished, they borrowed money, they used it extremely productively and now they're very wealthy, or far wealthier than they were. They have positive capital now, they have pretty high per-capita wealth, they're productive, they have current account surpluses. So, that's the best case for why the system exists, that there are people making use of it.
If no participants were ever getting value out of it, it wouldn't exist. We basically lack other language, we lack other ways to transfer value in a way that we expect it will be paid back.
Peter McCormack: I guess there's no way to destroy it though; it will continue to exist?
Lyn Alden: As long as dollars are recognised as money, some semblance of this will exist. It could exist in different forms and different sizes, but yeah. There's the eurodollar system, there's also the euroeuro system, it sounds funnier; the euroyen system.
Peter McCormack: A euroeuro system?!
Lyn Alden: Yeah, because euro in this context just means offshore. So there are, for example, euros in North Africa, or euros in South America. They're just a much smaller network. So, you do have these other fiat networks, it's just that the dollar's bigger than the rest of them combined.
Peter McCormack: All right. Well, listen, the next thing I want to talk to you about is money printing, because it gets referred to a lot, a lot of people talk about money printing, but I don't think we've ever been really clear on exactly what it is; the memes you see, helicopter money being distributed, or the guy on the actual printer. I don't think we've ever gone to a very clear case of what is money printing, and also what isn't money printing, and who prints money? Does the Fed print money? I mean, I know for the creation of dollars, they actually have to print dollars; but in the context where people say they're just creating new money, do they?
Lyn Alden: The Fed creates base money, so that's actually the part of why this debate exists, is that there are different types of money. We've just talked about how money is credit. So, base money is a liability of the Fed. For example, a commercial bank will have bank reserves. Where does the bank keep its savings account? The answer is, at the Fed. So, just like your savings account at your bank is your asset and that bank's liability, the bank keeps their savings account at the Fed, which again is just a ledger with the Fed, and that's a liability for the Fed.
Peter McCormack: Why do they need to do that?
Lyn Alden: Because that's how they've chosen to construct the system. So, if you go back to a gold standard fiat banking era, banks would self-custody gold in their vaults, and that would be their core collateral, and people could deposit gold, people could withdraw their gold, they could make loans based on the gold. But instead, we've replaced gold with mainly two things: one is savings at the Fed, so they store their "cash" at the Fed; or two, they hold Treasuries, they hold nominally risk-free securities. Those two assets form the "risk-free" part of the asset base for banks.
So the short answer is, the Fed can create base money, but they can't create broad money by themselves. There are other ways to do it, but they can't do it themselves, meaning that the Fed can't put $100 in my account. They can buy Treasuries from my bank and give them more cash in exchange for those Treasuries, or mortgage-backed securities, but they can't then go to one of their customers and just say, "We're just going to give you $100 and not take anything", they can't do that. Other entities can do that, but the Fed can't by themselves.
Peter McCormack: Right, so when people talk about the Fed printing money, it's just not true?
Lyn Alden: Not in that sense, no. They can create new dollars out of thin air, but it's base money and then they can use that to buy certain financial assets.
Peter McCormack: Okay, so they can print money for themselves?
Lyn Alden: Yes. So, for the Fed, their assets mainly consist of Treasuries and mortgage-backed securities.
Peter McCormack: And when they do this, is it an independent action, or is it usually under some agreement working alongside the government that says, "Hey, the economy is struggling, you need to go in there and print some money and buy some of this"?
Lyn Alden: With the conception of central bank independence, that is legally and supposed to be a unilateral decision by the central bank, based on their written mandate.
Peter McCormack: Bullshit!
Lyn Alden: So, that's based on employment levels and inflation levels. That's what they're supposed to do. Now, in times of crisis, like the 1940s or 2020, you get a lot working together. Basically, whenever the system gets super-high indebted, you start to get a lot of coordination, loosely or directly, between the entities.
Peter McCormack: Okay, so in terms of money printing, they can print money to go and buy Treasuries, or go and buy -- do they buy equities as well?
Lyn Alden: The Bank of Japan buys equities; the Fed currently cannot.
Danny Knowles: I think it would be really useful to go right back to the start. I'm sure we've done this before in the past, but actually explain the relationship between the Fed, the Treasury and the banks, and how it actually happens.
Lyn Alden: Sure. So, the Treasury is the federal government, that's the arm of the federal government. So, if Congress borrow money -- well, when they tax money, they spend money, and if there's a difference, they can also borrow money. So, all those agreements to do that are passed by Congress, signed by the President, and then the Treasury's job is to figure out exactly how to finance that.
Peter McCormack: Is the Treasury independent of the government?
Lyn Alden: No, it's part of the executive branch.
Peter McCormack: Part of the executive branch. So, if there was a change of power, I mean I've brought it up a few times, these guys keep laughing at me, they only think I've read one book; it's called The Fifth Risk.
Danny Knowles: It comes up in every interview!
Peter McCormack: It doesn't! But there's so many things I've learnt from this, and one of the things was, when Trump came into power, there's this whole process where they have to get all the staff ready for the handover of power, because this is something he basically didn't do. Is this one of the things, that the Treasury would be run by the Democrats and if the Republicans win the next election, they would put all their own people in?
Lyn Alden: Yes, and they have to get through Congress. There are ways around it, because you can have somebody acting for a while who's not approved by Congress, but yes. Basically, the President, his staff and Congress put these people in.
Peter McCormack: And Mnuchin, was he head of the Treasury?
Lyn Alden: Yes.
Peter McCormack: Okay, and so they have, what; what's their mandate, the Treasury?
Lyn Alden: Their mandate essentially is to finance the government. And so, for example, when Congress wants to spend something, they don't specify, "Okay, issue this many bonds in this denomination and this many bonds in this maturity", they leave the details to the Treasury. So, the Treasury has to figure out how to finance that. They also operate the Mint, so the physical printing of coins, for example.
Peter McCormack: Okay, so they can print money?
Lyn Alden: Yes, but even then, they can't just print money and give it out, there's legal restrictions.
Peter McCormack: Okay, so the Treasury, they have their mandate, they also finance the government's projects, which have to go to Congress to get approved. Do they hold an account themselves?
Lyn Alden: They have an account at the Fed. It's called The Treasury General Account.
Peter McCormack: And, when they want to spend money on certain things, they want to send $40 billion to Ukraine, Congress passes this, where does that money come from?
Lyn Alden: A couple of ways. One is they tax it from the population, or they borrow it from the population, either domestically or internationally. Now, this is where you get into actual money printing. Let's say we want to repeat what happened during COVID, where they actually literally put money into people's accounts. This is not something the Fed could do on their own. The Treasury mostly can do it on their own with a caveat that they need someone to be able to buy their bonds, because they didn't raise taxes with anyone, they didn't tax me and then send money to my neighbour. They did send money to my neighbour and they didn't have that money from anywhere.
So, they issued a bunch of Treasuries, they basically took out a lot of debt, and then they sent money to people directly, broad money, in their accounts that they could actually spend. Now, who bought those Treasuries? The Fed with new dollars. Now, there's legal rules, so the Fed are not supposed to just buy from the Treasury. So, the Treasury sells it to a primary dealer and then they sell to the Fed. So, the Fed is buying on the second-hand market with new dollars, to basically pay for all of this financing.
You know like a scene in a movie where if generals want to fire a nuke, you can't just have one general be able to fire a nuke?
Peter McCormack: Yeah, two guys, two separate keys, yeah.
Lyn Alden: Yeah. So, money printing essentially is like the Fed and the Treasury working together. They put in their key, and then that's how you print money. If you have those powers combined, if you have Congress and then the Fed monetising that spending, you could send everyone $10,000, you could send everyone $100,000, and it's not pulled from any other real source of dollars; these dollars are just put into existence.
Peter McCormack: But there are implications of this because, okay, the Fed wants to -- let's go, there's a Bigger Spending bill; say they want to spend $2 trillion. They haven't got enough money from tax, as you said, so all they can do is create bonds. But they need a buyer of the bonds, there's not enough people out there that want to buy them, so they go to the Fed. The Fed prints the money to buy the bonds.
Lyn Alden: Yes.
Peter McCormack: And so, they transfer the money and they take hold of the bonds. So, the Fed is essentially sat on a whole bunch of US Treasury Bonds?
Lyn Alden: Yes, and mortgage-backed securities, yes.
Peter McCormack: And mortgage-backed securities. What implications does that have for all the other people in the broader market who are buying Treasuries, because it seems to me this is devaluing the idea of a Treasury?
Lyn Alden: Essentially, yeah. Now, it's actually a very nuanced relationship, because until 2008, it was mostly financed by the private market. But if you look at any country, they get to over, say, 80% sovereign debt-to-GDP, usually their central bank becomes their biggest buyer of ongoing government debt from there, because it's very hard -- if Japan has 250% sovereign debt-to-GDP, which they do, it's hard to find balance sheet space for that, actual who wants to buy all that debt? The answer is, not many. Their banks own some, their pensions own some, but all the excess, they need to sell essentially to their central bank through intermediaries. So, that's the system we find ourselves in.
Now, until recently, you would think that when the Fed's buying Treasuries, it pushes down yields, but it's actually not the case. So normally, when they're buying Treasuries, yields are sometimes even going up, and that's because it's creating risk-on conditions, so a lot of other private actors are then selling their bonds and buying equities. So, you don't get that correlation where, when the Fed's buying, yields are lower; when they're not buying, yields are higher. That's also what throws people off.
During crises, that's when actually they drive yields down. So for example, in the 1940s, when we were fighting World War II, they capped yields. Right now, Japan's capping yields, Bank of Japan, so they can drive yields down.
Peter McCormack: Is capping yields, yield curve control?
Lyn Alden: Yes.
Peter McCormack: Okay, and that's usually a bad sign?
Lyn Alden: They generally only resort to that when debt is so high relative to the economy that they force the market to accept negative real yields, even if the market is trying their hardest to override that.
Peter McCormack: And then, what is the next natural step after that?
Lyn Alden: Well, it's not great; devaluing those bonds. So, in the 1940s, this is one of the cleanest examples we have of this with data. In the 1940s, the United States did yield curve control for nearly a decade, from the early-1940s to the early-1950s. They capped short-duration Treasuries at 0.375% and they capped long-duration Treasuries at 2.5%. Inflation averaged about 6% during the decade, it spiked as high as 19%, and they held that 0% to 2.5% band for most of that time. So, if you were holding Treasuries --
Peter McCormack: You got screwed.
Lyn Alden: -- you got screwed. And eventually, that reduced debt-to-GDP, because nominal GPD, largely because of the inflation component, went up significantly. So, even though federal debt never went down, it just started eventually going sideways as they started shifting to austerity, we got the debt-to-GDP down.
Peter McCormack: It's a sneaky way to pay off your debts.
Lyn Alden: Yes.
Danny Knowles: Who are the primary brokers; are they people like Goldman and banks like that?
Lyn Alden: Yes.
Danny Knowles: And, when the Treasury are going to issue these bonds, are those banks guaranteed by the Fed that they will be a purchaser of those bonds?
Lyn Alden: Yeah, part of being a primary dealer is that you agree to buy Treasuries at "reasonable prices"; you're always supposed to be bidding. Now, the problem is that you don't have an infinite balance sheet, so you can't always bid, but you're supposed to always be able to bid, and that's why generally when you see debt-to-GDP get this high, there's this much sovereign debt in the market, usually the central banks are taking chunks of the supply off the market, so that no other balance sheet gets crowded out.
Essentially, if there was no QE, if they forced Treasuries in the market and there were not enough buyers for them, the yield would start to rise and start attracting marginal new buyers. But they'd have to sell other assets to buy, and so there's kind of natural constraints on how much the market can buy, especially in a short period of time, let alone just in general, how much balance sheet they have that they want to allocate to Treasuries at a certain yield.
Peter McCormack: It's quite a neat little system if you get access to it, if you can control it. It feels like there should be constraints on it, because there are these rules, but there should be some constraints on the spending. It just feels ridiculous, because everybody else is paying for a few people's small spending mistakes.
Lyn Alden: Yeah, and the way they try to limit it is, going back to that generals' analogy, there's multiple people that have to sign off on it when you get the crazy actions. So, for example, the Fed are appointed by a combination of the banks and by Congress and the President, and then put into long terms. So, they're directly or indirectly backed by the people in some way. Then, in order to do the outright money printing, so not just Fed actions of buying Treasuries to cap the yield, but actually sending money to bank accounts in exchange for nothing, that requires Congress, the Senate and then the President to sign off on it. It's like this distributed system, where you need a lot of people all to agree to do it. It's not like one person is just out there doing it.
Peter McCormack: No, but I've seen it in the House of Cards, where all the horse-trading goes on behind doors, "Okay, you want that? Well, I'll approve it if you sign off for this memorial to be built in my town, or this legislation to be passed". It's fucking bullshit. Sorry, excuse my language.
Lyn Alden: In 2019, there was a BlackRock paper, called Dealing with the Next Downturn, and one of the advisors to the paper was Stanley Fischer, former Fed official. And they basically said, "Interest rates are super-low, debt is super-high, there's not a lot of space left just for monetary stimulus", because generally cutting interest rates encourages more borrowing, it helps reflate the debt bubble, so that's why that's considered stimulus.
But they said, "Interest rates are already so low, that's not going to be a very powerful tool, because they can't really go much below zero". So they said, "In the next recession, that's not going to be enough, so you're going to have to do large fiscal stimulus, up to maybe and including helicopter money. The problem is that that can be inflationary and can drive yields up, which can then defeat the purpose of stimulus. So, the central bank's going to have to do a soft form of collaboration where they buy a lot of those bonds and hold yields pretty low for a while.
"The problem with that system", and this is all in the paper, "is that it could get runaway inflation, and therefore you'd have to have a way to really control that". This was all written in 2019, and they then followed it step-by-step in 2020 and 2021. Of course, they didn't say there was going to be a pandemic. I mean, they probably didn't expect this big of a number.
Peter McCormack: I don't know, it's BlackRock, they maybe started it!
Danny Knowles: When -- sorry, I'm just trying to get this all straight. When the Fed buy the bonds from the primary dealer, they pay with reserves, right?
Lyn Alden: Yes.
Danny Knowles: And, is there any difference between how they can be spent to "real dollar"?
Lyn Alden: Well, you can't just go out and buy coffee with reserves. It's wholesale money, it's money at the bank. So basically, a bank can spend their reserves, when they send money to another bank or they make a loan, things like that, but that goes to another bank's reserves. So, any individual bank can adjust their own reserves, but the banking system as a whole can't create or destroy reserves.
Danny Knowles: So, it just acts as collateral for them?
Lyn Alden: Yes.
Danny Knowles: Right.
Peter McCormack: Did you see that money printing has made the news and the political landscape in the UK?
Danny Knowles: No.
Peter McCormack: So, during the leadership debates, because I don't know if you saw that Boris Johnson stepped down, but there's a leadership battle at the moment, and the previous Chancellor of the Exchequer, Rishi Sunak, he's one of the people vying for Prime Minister and he's discussing what he's going to do about inflation. I can't remember, one of the previous Tory leaders came out and accused him of being the money printer and blaming him for inflation, and that's the first time I've directly seen politicians essentially admitting there is essentially a money-printing process. Usually, they just talk about borrowing; they never talk about the fact that they're money printing, and what the implications of this are.
If you search for, "Rishi Sunak, money printer", see if you can find who it was who said it. I can't remember his name; he was a previous Tory leader.
Lyn Alden: One point I'll make, one thing I find in macro circles, because all this recent, "Does the Fed print money" debate, this all happened in 2020 in macro circles. That's why I wrote those articles back then, that was the most common question in interview circuits back then, using these broader macro type --
Peter McCormack: Macro Twitter!
Lyn Alden: Macro Twitter, yeah, and Fin Twit! And I generally find, not any one analyst in particular, but I find a lot of analysts are fighting the last battle, which is common in any industry. So, in 2008, when the Fed started doing QE for the first time in modern history; they actually did it in the 1940s, but they didn't call it that back then. So, they started doing QE for the first time in modern history, buying Treasuries, buying mortgage-backed securities, a lot of people were like, "This is going to be hyperinflation. They're just printing money. Look, the balance sheet just doubled; look, it tripled. It's going to be the end of the world", and that obviously never happened.
In fact, you had pretty low inflation for the entire 2010s decade, even if you adjust for the CPI shenanigans. If you just look at commodity prices, they were generally weak that whole decade, just as an example. So, you had pretty weak inflation that decade, despite the fact you had a lot of balance sheet expansion. What they were missing at the time, what those analysts that were expecting all of this inflation were missing, was that there was no transmission mechanism to get that money to the public.
Inflation happens when people's broad money increases, so everybody gets more money in their bank account and they still have roughly the same amount of stuff they can buy with it.
Peter McCormack: Is that because, if the mechanism isn't getting into the public, it's getting locked up in different corporate places?
Lyn Alden: No, it's just staying in bank reserves, and essentially it's getting into financial markets. So, there's actually a pretty strong correlation globally with QE and asset prices.
Peter McCormack: Right, so you can have commodities and general prices not increasing, but you can have the stock market continue to grow and grow?
Lyn Alden: Yeah, it can be great for the stock market, great for the real estate market; basically, inflation for financial assets.
Peter McCormack: Then it sounds to me like QE really is just friends giving friends money?
Danny Knowles: It just collateralises the banks, right?
Lyn Alden: Kind of. But remember, when they do QE, they're taking an asset in return.
Peter McCormack: Of course.
Lyn Alden: So, the Fed is creating a new dollar and then swapping that brand new dollar for a Treasury or mortgage-backed security, and that adds liquidity to the market. But it's not like the bank that received that just was given it; they had to give it up. But essentially then what they do, let's just say you are a pension, or you're a bank and you own -- let's say you're a pension and the Fed wants to do QE, you can sell some of your bonds to the Fed and you can go out and buy other bonds, or you can go out and buy stocks. And so basically that money does get into capital markets, it doesn't get into consumer accounts. It's not like my bank account's $1,000 richer and I'm going to buy more oil with it.
Peter McCormack: Yeah, but it's good for CEOs and Wall Street bankers; it's crap for mom-and-pop shops.
Lyn Alden: Yeah, it's good for financial markets.
Peter McCormack: Therefore, surely that drives the wealth divide?
Lyn Alden: In general, yes. I did a whole article on this, because this is also something that's good for a meme, but it's over-simplified. And so, for example, if QE was the biggest driver of wealth concentration, you would expect to see logically that countries that did more QE as a percentage of their GDP would have more wealth concentration, right. We actually find that's not the case, and in fact somewhat of an inverse correlation.
So, no one's done really more QE than Japan, and Japan has oddly low wealth concentration. When you look at Europe, they did more QE than the US, but less than Japan. Depending on what country you look at, they generally are less wealth-concentrated than the United States, and usually a little bit more than Japan. United States did less QE than the ECB or Japan, but have more wealth concentration. So, it's not the only variable that affects this; that's my point. There's a bunch of other variables and a lot of them are fiscal.
Peter McCormack: Right, so where you disagree with Jeff, Jeff was saying QE doesn't drive inflation. You disagree with him and say it can do. So, can you essentially both be right? If there's a mechanism to get the money out to the general public, that will drive inflation; but if the mechanism is just to shore up the banks, it doesn't drive inflation?
Lyn Alden: For the most part, yes. So, QE by itself is not a very inflationary thing for consumer prices, meaning the price of commodities, the price of everyday goods, because there's not more money chasing more goods. What's inflationary is when there's large fiscal stimulus that is generally monetised by QE, and then that fiscal stimulus gets out to the public.
When I talk about the last battle, so a lot of people were saying, "That whole period from 2008 to 2014, all that QE wasn't inflationary"; I'm like, "Well, yes, but also there was not a lot of fiscal stimulus back then". Around the margins, you had fiscal stimulus, but if you look at the broad money supply, there was no big spike in that whole period. You had a big spike in base money, you recapitalised the banking system, but you did not have a spike in broad money, meaning the accounts that people like me and you have at our banks. So the actual money in circulation among market participants, that did not really increase at any noticeable rate.
Peter McCormack: But when that 330 million, or how many people got their stimulus cheques, what were they; $1,600?
Lyn Alden: We had a couple of rounds of it. We had $1,200, I think then we had $600, then we had, what, $1,400. Then you had childcare tax credits, then you had PPP loans for small businesses that turned into grants, a bunch of different rounds of stimulus.
Peter McCormack: And do we know how much that was in total, the total value of that?
Lyn Alden: Last I checked, something like $6 trillion.
Peter McCormack: So, that is $6 trillion of new broad money?
Lyn Alden: Yes. So, unlike the whole 2008 period, if you look at a chart of broad money, it goes straight up, because now there's actually a mechanism that's getting out to the public. It's not just base money going up, it's broad money going up. People actually have more money in their account, so they can go and spend it at restaurants and things and rent and houses and whatever they want.
Peter McCormack: So I think one of the things that's been getting confusing recently is that we've seen a massive increase of prices of a range of things. You call it gas, we call it petrol, that's gone up significantly; energy prices have gone up; travel now is one of the things I've noticed. My flight costs have gone up massively. Everything's going up. But what Jeff was saying is that you have to separate what is inflation and what is an increase in prices, and some of the increases in prices have come from a couple of things.
So, we have a war in Ukraine; that's caused an increase in the energy prices, so that's one thing. Without that war, that might not have happened. He said also you've had, coming out of a pandemic, when you come out of a pandemic, there was essentially a massive increase in demand for things, and one example would be the airports struggling in the UK, because they'd laid off all the baggage handlers and they haven't got them back. So, there's those things.
What would happen, the previous example, he showed that a similar inflation of prices was after World War II; that was very similar. That was the chart he showed us. But the problem we've got now is that we've got that happening at the same time that we've just come out of massive stimulus. So, some people are blaming all of these increases on price, they're kind of saying, "All this inflation is coming down to what the government's done", but actually it's a myriad of things. Am I making sense?
Lyn Alden: There are other factors, yeah. And a point that I made in my articles is that one big variable is the money printing, specifically the broad money. The other variable is things like commodity CapEx, you know, have we invested enough to make commodities abundant and cheap, or not? If we had a world with unlimited oil and you print a lot of dollars, you might not get a big price spike in oil, because there's just endless amounts of it, everyone has excess. So, as soon as the price goes up a little bit, they're like, "Sure, I'll sell the oil". But if you have a constraint in how much oil exists, and there's a lot more money in circulation that wants to buy that oil, the price is going to go up quite a bit.
So, there are real-world constraints on logistics and commodities, those things in particular that are the other side. They're the supply variable, with money printing and money supply being the demand variable. If you look at the 1940s, and this is the part where I disagreed with Jeff on; he would say, "That's not an example of real inflation, that's supply-side problems", so I have these charts that I've used in articles, for example. If you look at the 1940s, you had these huge spikes in inflation, huge spikes, then it comes back down, then another huge spike, then it comes back down. When that's all said and done though, if you just zoom out at what did the CPI do in the 1940s, each one of those spikes, it went up, and then it stayed at a new higher plateau, and then it went up and stayed a new higher plateau.
Peter McCormack: So, if it's not coming down, then it's not transitory, that is because of the increase in the broad supply?
Lyn Alden: That's because of the increase in the money supply. So, the speed at which it happens in a short period in time is related to how much money's been created in a short period of time; and also, what are the specific bottlenecks. So, there are certainly individual prices during, say, the 1940s or during now that spike to crazy levels.
Let's say in April 2020, everybody wants Clorox, because everyone wants to disinfect everything. There's a huge Clorox shortage, people are like, "Well, I'll give you Clorox, but it will be triple the price". When that period ends, Clorox is probably going to come down in price a lot. That's not up to a higher plateau. I mean, some of it might be, but some of the extreme spike will come off. But it's the aggregate average price level. When that stays at a permanently higher plateau, that is because there's more money permanently in the system.
We saw that in 1940, so we had these crazy spikes; but when it settled back down, it settles at a much higher plateau each time. We saw that in the 1970s, we saw that to some extent in the 2000s to a less extreme, and then we're seeing that now. So for example, when Chipotle raises wages and raises burrito prices, we're never seeing those -- it's not like when this is all done they're like, "Okay, we're going back to our prior burrito price". Those are permanently higher, because there's permanently more money in the system now.
Peter McCormack: Yeah, well we had, I don't know if you saw it, we had some wage increases in the UK announced yesterday; nurses up 5%, was it?
Danny Knowles: Not sure.
Peter McCormack: Yeah, so there's a lot of striking at the moment in the UK, a lot of unions striking and various things from pilots and trains. Everyone's striking because we're seeing quite high inflation. And there's been a massive increase in wages, to a level I've not actually seen, for the public sector. It's around 5% for nurses, similar for teachers. Have you got it?
Danny Knowles: Nurses went from, yeah, £32,000 to £37,000.
Peter McCormack: Yeah, okay.
Danny Knowles: I've not seen teachers.
Peter McCormack: Teachers and then police as well. This is a massive commitment by the government.
Lyn Alden: They're never coming back down.
Peter McCormack: They're never coming back down. Also, these people are pissed off, because they know what inflation's at, so they know they're still being screwed.
Lyn Alden: Yeah, in the United States, we had multidecade high wage increases in a year, so something like 6% on average, which is actually a pay cut in real terms. So, official inflation's 9%. If you measure it in another couple of ways, it's probably at least lower double digit, maybe 12%, let's call it, and you got a 6% wage. So, you actually got a wage cut in real terms; you can buy less restaurant outings with it, you can buy less fuel with it, you can buy less house with it.
Peter McCormack: Yeah. So, one of the things that's coming up a lot at the moment, where people are talking about civilisational decline. We had it with Jeet, didn't we? I think even Jeff brought it up. So, in these scenarios, these nurses' wages are going from, did you say £32,000 to £37,000?
Danny Knowles: Yeah.
Peter McCormack: A £5,000 pay rise would seem like a good thing. But we know all these people, everything they're spending their money is getting more expensive. Houses are getting smaller and more expensive, and some people can't afford them; shopping's getting more expensive. You see in our town centres, we're getting more and more of the big retailers leaving, and more of the low-cost retailers coming in. There's a complete squeezing of the middle class. Is this happening purely because of inflation? Is inflation driving this? Is this the damage it does; it just erodes out value?
Lyn Alden: Yes, but it's correlated. I mean, basically the inflation's happening in part because that's happening, and then inflation circles back and makes it worse. Inflation doesn't come out of a vacuum. If we didn't have super-high debt already, if we didn't spend decades building a very fragile but efficient global supply chain, we would be in a better place to absorb some sort of economic shock. So, because we're already in a very disadvantaged position and we've already had issues building, and we haven't invested a lot in natural resources for the past five years globally, when we get an external shock, then it's like you're facing a deflationary crash.
Deflation's good in a low-debt system, but in a very high-debt system, the whole system's built on credit expansion and inflation, mild inflation. You get a deflationary crunch, that threatens all the debt in the system.
Peter McCormack: Because it becomes even more expensive to pay it off?
Lyn Alden: Yes. It threatens the way the whole system functions, because everyone's debts harden relative to their economic output.
Peter McCormack: Who benefits in a deflationary environment; people with savings?
Lyn Alden: Savings and bondholders.
Peter McCormack: Savings and bondholders, okay.
Lyn Alden: Yes, unless it gets bad enough that the whole system collapses. So, banks hold Treasuries as their collateral, the Fed holds Treasuries as their collateral, you have savings in the bank. If there's a big enough deflationary crash and there's no money printing, let's say, the Fed's not printing money to buy bonds, eventually it squeezes so hard that defaults happen; you would default all the way up to the top, because there's just not enough dollars to support all the debts and to refinance all the debts.
Basically, you would deflate until it's worth nothing. So, it would get more and more valuable, and then it would be just like a Thanksgiving turkey, where then it's not worth anything. So, the other option is they inflate, so they print money and they hand it out to people, they keep the system going, they add more chairs to a game of musical chairs. There's not enough people that can sit down, so they keep adding more chairs.
Peter McCormack: But the government has the most to lose in this scenario, because they hold the most debt. That's why they have the incentive to drive inflation.
Lyn Alden: Yes.
Peter McCormack: Now, when I spoke with Avik Roy, we talked about the compounding impact of inflation on the poor, and he said even at a low level, even at 2%, it has a compounding impact on the poor. But at the same time, if a deflationary environment is that catastrophic, how do we even know what a fair system is? Lyn, solve all economics for me right now, and you've got five minutes!
Lyn Alden: Well, that's a good question. I would say the problem is, the system we have now is so artificial, so it's like the America online of money. It's like this walled garden of this carefully curated environment. So, people have money in the banks, the banks have loans out to other entities, and there are centralised policymakers that are making sure that it doesn't hit the guardrails. If inflation gets too high, they try to pull it down; if it starts to deflate and threaten the whole collapse of the system, you try to add more money to the system.
Essentially, there's more debt than there is money, so that's the problem. I mean, it's generally a Ponzi scheme essentially. If there's more debt than there is money, it means that those debts in aggregate can never be paid down. It's not designed to ever end; the system can only grow. That's problem number one. So, it can only ever grow; all debts are claims for dollars and there's not that many dollars. So when you start to get too many of those claims called in at once, some sort of deflationary impact or just massive crisis, they say, "If you just let this play out, everything goes to zero, because there's more debt than there are dollars, people will sell assets to get dollars until the whole system eats itself down to nothing".
Peter McCormack: But is that kind of what's happening now and why the dollar's going up in so much value?
Lyn Alden: In a way that's happening globally, yes. So, when they start to see that happening, let's say domestically, let's finish that point, they say, "We're not going to let that happen, so we're just going to create more currency units, we're going to add more chairs to the game of musical chairs". So, the whole point of musical chairs, for the one person listening that doesn't know, there's more people than there are chairs, so someone's not going to get a seat when they all sit down.
Peter McCormack: We were getting taught scarcity at birthday parties and we didn't even realise!
Lyn Alden: Yes! But the central bank and fiscal policymakers together can be like, "Well, let's just add another chair to the system", and you just keep adding chairs to make sure that everyone can always sit down, or at least enough people can sit down that you don't get it all implode.
Peter McCormack: It's like a participation trophy.
Lyn Alden: Who benefits or hurts is partially based on income levels, but it's also partially based on specifics. So, if we look actually at the 1940s and 1970s, some of the most inflationary decades in the United States, we actually had wealth concentration contract a little bit, which means that it actually spread out a little bit. That's because a lot of the people that were really impaired were actually the wealthier people. But it really depends on the specifics of how it's handled.
So for example, if you're middle class and you have a house with a fixed-rate mortgage, you probably actually benefit from some degree of your inflation, because your mortgage is getting inflated away, your house value is going up; and if you can roughly keep your wages more or less in line with inflation, give or take, you're doing okay in that environment. If you're super-rich and you have a lot of assets, but not a lot of debts, you're fine with the system, you're not necessarily inflating away a ton of debt, but your assets are holding up.
If you are impoverished and you have a little bit of savings, but you also have credit card debt, but the credit card debt is a super-high interest rate so it's not getting inflated away, you're screwed. Or, if you're a retiree and you're getting social security cheques, and you're not a wealthy retiree, you're making ends meet on a fixed income, if that income is not keeping up with true inflation, you're getting squeezed. So, there are pockets of winners and losers throughout the system that are not necessarily just what income level they're at.
Peter McCormack: It's almost like we need a decentralised form of fixed money to protect ourselves.
Lyn Alden: One that was super-auditable, self-custodial, yeah.
Peter McCormack: Yeah. One last thing, just an observation with Jeff that I thought was super-interesting, because when we reached out to him, he was like, "I'm not really into Bitcoin or crypto", and I said, "Don't worry, we always talk to people who aren't". And then, at the start of the show, he started describing what he thought a perfect money would be, and he basically described Bitcoin.
But what he did say is that his main issue with Bitcoin is it can't be a medium of exchange while it's so volatile, because that would be catastrophic. We came to that conclusion; we were like, "Well, if it continues to be volatile --" because what we were questioning last night over a drink, me and Danny, if Bitcoin's always volatile, this might be the case, then we're always going to need something stable as a medium of exchange alongside it. Do you think through that much at all, the volatility side of things?
Lyn Alden: Well, with Bitcoin's curve of adoption, I would put it into two separate camps. One is when it's this new thing and it's reaching whatever total adjustable market it's going to one day reach, we don't know, the future's always unknowable, we don't know the full-scale risk; but let's say it's going to go up to some very large share of the market. Right now, it's nowhere near that. It's held by actually a pretty small percentage of the population, there's hidden pockets of leverage in the system like we've seen with some of these lenders; for example, it's often used as collateral to make bets on altcoins and things like that, so there are multiple things that can add or decrease volatility.
When it goes up in price a lot, a lot of new people discover it for the first time, or at this point they've heard of it, but they might not have really looked into it, and they start to look into it again. So, new buyers flood in, that adds upward volatility, and then when you get that leverage and that speculation, you get sharp downward volatility.
If you go through, let's say, five more of these cycles and we're 20 years in the future, and Bitcoin is a more steady state and it's held by 30% of the world population, whatever number it is, you'd expect it to be a lot less volatile in that environment than it is now. So, I generally agree that in the very early phases, unless you specifically need censorship resistance, or unless you're in an unbanked environment, for a lot of people in developed countries, Bitcoin is not the ideal medium of exchange, unless they're deplatformed, or they just really want to use it, they're super into it. But it's really about what it looks like years from now.
I think part of what makes it valuable now as a medium of exchange is the fact that it gives you that optionality, it gives you that resistance to deplatforming, that portable money that you can move around the world, self-custodial. I think those are the attributes that make it super-valuable now. Then, as we see more maturity, more adoption, more Lightning Network, better user experience, I think that makes it better and better as a medium of exchange.
Peter McCormack: Awesome. Danny, any final questions?
Danny Knowles: Yeah.
Peter McCormack: Another hour of questions!
Danny Knowles: This is going back in the conversation a bit. But Jeff talked about there being a lack of liquidity, and that QE doesn't add liquidity to the system. But I think both the system and liquidity are kind of vague-ish definitions. Can you explain actually what liquidity is?
Lyn Alden: That's where I think I would disagree with Jeff if he made that statement. So basically, let's use an example. So, liquidity is basically how much buyers and sellers there are and whether or not, if you're a large holder of an asset, if you could sell a ton and not really move the price too much, that's a pretty liquid market. Whereas, if you go to sell it and that moves the price of the whole market, there's not enough buyers and sellers to just absorb that.
Peter McCormack: It's like what we see in crypto, right?
Lyn Alden: Yeah.
Peter McCormack: The shittest of the shitcoins have low liquidity and the price moves around more.
Lyn Alden: Yeah, there are tiny cryptos that I could move, which is obviously super-low liquidity.
Danny Knowles: Show-off!
Peter McCormack: She's crushed it recently!
Lyn Alden: So, going back to an example, in March 2020, you had a lot of foreign sellers of Treasuries sell their Treasuries at roughly the same time, and that's because they needed dollars. And one thing they can do if they need dollars is they can sell their Treasuries. So, they sold their Treasuries, and the market went completely illiquid, it literally broke. The Treasury market, which is supposed to be the deepest, most liquid market in the world, along with currencies and oil and a couple of other giant markets, broke. Basically bid-ask spreads were very wide and there just weren't a lot of buyers and sellers; the whole market froze.
So, the Federal Reserve had an emergency meeting, and then over the next three weeks, they did $1 trillion in QE. It's the fastest basic QE we've ever seen in the US, to reliquefy that market. They basically created a lot of new dollars and they became the marginal buyer of Treasuries, because a lot of entities on net wanted to sell Treasuries, and there was no bid, there were no buyers. It's not because they thought the price was wrong, or they thought XYZ; it's because they just didn't have the balance sheet capacity to absorb that. There was no buyer that said, "I have a lot of dollars and I want to buy a lot of Treasuries right now". So, the Federal Reserve came in and they did reliquefy that.
We also saw that in late-2019, the repo spike, where first you had repo issues, so the Fed reliquefied the repo market by participating directly in the repo market. But then also, they went out and started buying T-bills, because there was basically an oversupply of T-bills relative to reserves; foreigners were not buying a lot of T-bills at the time. And so, the Federal Reserve came in and bought T-bills with new dollars. So, they absolutely do reliquefy markets.
Now, any one entity is not getting free dollars, but it's adding liquidity to the market; that's essentially what the main function is. That's especially important when the Treasury wants to issue a lot of Treasuries at once, or if, for whatever reason, you have a lot of existing holders that want to sell at once. And then of course, in the Federal Reserve, if you go back to some of their older quotes, this goes back to the idea of, "Is it temporary or is it permanent?"
So, the Federal Reserve, back after the initial QE, after the Subprime Mortgage Crisis, some of the Fed presidents were like, "Look, once the market returns to normal, we're going to sell these Treasuries. We just add a liquidity to the market, we're not a permanent financier of government debt. We didn't just print money to buy bonds and hold them forever; that would be deficit monetisation, that would be Banana Republic stuff. No, we just added liquid to the market, but when liquidity returns we're going to gradually sell these Treasuries back into the market".
Of course, every time they try a little bit, they have to stop pretty quickly. So, you keep ratcheting higher in both the total Treasuries held as well as the percentage of Treasuries held, because they are basically a permanent source of balance sheet financing for the Treasury.
Danny Knowles: Boom! I've actually got one more. He also said that since 2008, banks have been relatively risk-averse and they're not taking enough risk now. Do you think that's true?
Lyn Alden: I think that's true, but I think I'd phrase it differently. So, it's true that banks are being far more conservative with their lending standards. But the difference is, I think I would describe that as a good thing. I don't think we need more and more credit creation. Now, in the context of a system as currently designed that needs credit creation, that's a bad thing. So, I agree with him on the facts that are happening. He's right that there's much slower loan growth, banks are being far more conservative with their lending, and that basically impairs the normal fiat economic growth prospects, because there's just less credit available.
But yeah, I think that's because the system as itself is already -- there's too much credit in the system as is, and it's not something that they can keep growing forever. It's just basically an inherently flawed design as it is now.
Peter McCormack: It's all a bit mental, it's all a bit crazy. Well, I think we need to try and get you and Jeff in a room together and rattle through this, I think it will be very popular. Actually, we said about today, I think we need to get you, Preston, Jeff, Luke, who else? Greg.
Danny Knowles: Greg, Lawrence.
Peter McCormack: Lawrence, yeah, Jeff Booth. Let's get you all in a room and just rattle all this shit out. Lyn, you're amazing, thank you so much for this.
Lyn Alden: Thanks for having me.
