WBD600 Audio Transcription

2023 Bitcoin & Macro Outlook with Lyn Alden

Release date: Tuesday 3rd January

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 look forward to 2023: what’s happening to Japan and China’s economies, whether we are entering a recession, and how will investments, including Bitcoin, perform over the next year?

“If you have a recession, and you print a tonne of money and throw stimulus at it, you can get out of that recession quicker. But then you’ve done it at the cost of higher debt, and then potentially for a more inflationary rebound in the future, which then you have to then raise rates very quickly and potentially put yourself into another recession. And so there are levers you can pull, but every lever has a cost associated with it.”

— Lyn Alden

Interview Transcription

Peter McCormack: Hi, Lyn, how are you?

Lyn Alden: Good, how are you?

Peter McCormack: I'm doing very well.  Did you have a good Christmas break?

Lyn Alden: I did, what about you?

Peter McCormack: Yes, I did, yeah, I had a great break.  Drunk too much, ate too much, but had some lovely time with the family, so that was good.  This is our final recording of the year.  I know it's going out next year, but how has it been for you; have you had a good year?

Lyn Alden: Yeah, it's been a pretty good year.  Obviously it's been a challenging one from a markets' perspective; but from a business perspective, from meeting people and travelling around, I've certainly enjoyed the year.  So, different parts of the world are going through different things at the moment but for me, I've been fortunate enough that it's been a pretty enjoyable year.

Peter McCormack: And you've travelled quite a bit, you've got around, you've been to the conferences, you've spent a lot of time with other people; it's great to see.  You've kind of blown up this year.  You're probably too humble to admit it, but we recognise it.

Lyn Alden: Well, I think last year is the one where I had this big growth in terms of awareness, and this is the continuation of that; that's how I view this year.  And if anything, I get questions like, "What are you trying to do to grow next year?"  I'm like, "I'm not trying to grow next year, I want to consolidate, I want to focus on work/life balance, I want to streamline certain things".  So, certain things over the past, let's say 2020 and 2021, accelerated very quickly, more than I would have thought.  So, it's kind of been keeping up and trying to manage that.

Peter McCormack: There's a way of doing that quite easily, just charge more because you don't charge enough; I've told you that again and again!  And I know you're going to say, "I'm not going to raise my prices", but you can just charge more.

Lyn Alden: I guess the way that I approach it is I want to keep it accessible to people as much as possible; so, free content and then low-cost content.

Peter McCormack: All right, fair, you're a good person.  Okay, so we wanted to do a little bit of a review of the year and then talk a little bit about next year, what we're thinking about.  But when me and Danny were planning this show, we felt like we needed just to ask you a little bit about what's been going on in Japan.  Obviously, the Bank of Japan allowed their ten-year bond rates to reach 0.5% up from 0.25% and there was lots of talk about this on Twitter, obviously most of it I didn't really understand or why this was important.  Can you talk about what happened?

Lyn Alden: Yeah.  So I think first, we have to go back to what they were doing before this announcement.  So, Japan's doing something called "yield curve control".  So normally, central banks control the short end of interest rates, they'll determine the overnight lending rates, but the longer-term bond markets, like a ten-year Treasury, a ten-year gilt, a ten-year JGB is supposedly set by the market.  So, the government is issuing debt to finance itself, then the market is pricing that.

However, in very indebted countries, as long as that debt is denominated in their own currency, which is the case for developed countries, that's kind of the key differentiator between developed and developing countries in a market sense; as long as they're in that situation, they can override the long end of the curve too, not just the short end, it's considered more extreme policy.  A famous example that I like to point to is back in the 1940s during World War II, a number of countries did it, including the United States. 

So, in the United States, we were fighting World War II, our fiscal deficits were absolutely massive.  A lot of people envisaged that's being spent overseas, but a lot of it's being spent domestically; you're building manufacturing, you're hiring people, you're sourcing raw materials and there's this very inflationary, big expansion of the money supply.  So, inflation in the US averaged 6% per year that decade, from let's say the early 1940s to the early 1950s, and the highest inflation print was 19% year-over-year, and they just held bonds.  The short end of the curve was held near zero, and then the long end of the curve was help at 2.5%.  So, the entire Treasury yield curve was submerged well below the inflation rate, no matter how high inflation got.

The way that they do that is the central bank says, "We'll buy every bond that tries to go over this yield target", which is another way of saying -- because, when yields go up, it means bond prices go down -- it's another way of saying, "If bonds go below our price target, we will buy unlimited bonds to get them back up over that target".  Also what that does, that makes the private market want to do it for you, because if the Fed says, "Okay, we'll buy any bond that goes over 2.5% for more than a couple of days", and let's say during the middle of the day, you have a bond go up to 2.6%, well maybe JP Morgan wants to come in and buy the bond, and then they can resell it to the government the next day at 2.5% and make a little gain. 

So, it's almost like it can hammer itself down, because they know if it stays above that limit, the central bank will come in and just buy it back down to that limit.  So, it's reliant on the credibility that the central bank's actually going to do what they say.  They don't want to be left holding the bag if, on a random Tuesday the central bank says, "Actually, we're not going to do yield curve control any more", because all the people who are holding bonds get screwed.

Anyway, with Japan, because they're in a very high debt situation, when you have super-high debt, it's 100% debt-to-GDP, 200%, that's just the government debt; in Japan, it's over 200%, if you do the calculations, if they had 3% interest rates, 4% interest rates, how much of a percent of GDP would that be in interest every year?  It would be outrageous.  So they're kind of stuck in a similar environment where they're holding yields really low, and they were holding them before at 0.25%, so they were willing to buy any ten-year Japanese bond that tries to go over 0.25%.

Essentially what happens is most of the market just sells the bonds, other than certain pools of capital in Japan have to own bonds, big insurance, pension, things like that.  But if you're not a forced buyer essentially, if you have alternatives, you get out of Japanese bonds and essentially the Bank of Japan ends up owning half of them and the market becomes very thin and rarely trades.  Also it means that if the market is not allowed to express its view on inflation in appropriate interest rates through the bond market, they will instead get out of the bonds and sell the currency, so it ends up being expressed on the currency instead.

So, you had an unusually weak year for the yen, because they were the one central bank that was really doing hard yield curve control at super-low rates while the rest of the world was trying to tighten.  And what we saw in the past week here was that the Bank of Japan adjusted their yield cap from 0.25% to 0.5%, which doesn't sound like a lot; it's still below the inflation rate, it's still unusually low compared to what you can get in most other developed country bonds; but it is a big percent increase.

Also, it goes back to that point where you spook the private market that's supposed to be doing the yield curve for you as much as possible because now, if a private entity comes in and says, "Well, I can just resell this to the Bank of Japan", you never know, Japan could come out and say, "Actually, it's 0.75% now".  So, it's harder to maintain a second target.  So, it's kind of a trade-off, because one thing I actually argued earlier this year was that Japan set the peg too low.  You could argue that they shouldn't have a peg but realistically, when you have debt-to-GDP that high, they're going to have a peg.  And then the question is, "Where do they set it?"  I think that they set it unusually low, because it's very hard for them to maintain it that low, and I think they're adjusting back up to a more maintainable level, but they have to re-establish credibility because people can say, "Well, they changed it once, why can't they change it again?"

Peter McCormack: Right, so if they're doing yield curve control, that is to protect their own debts from seeing too high an interest.  But how are they therefore buying all of those bonds to maintain that yield curve control; is that not just more debt?

Lyn Alden: So, they're creating new bank reserves to buy them.  So, debt is being issued as long as the Japanese Government is running a significant deficit, which they are.  So, that's where the debt creation's coming from.  And then the money to buy that debt is not creating debt, it's just creating new money.  So, the risk there is that they can be inflationary.  And so basically, more of that debt is being converted from being held by the private sector to being held by the Bank of Japan; they're printing money to buy them.  So, it's essentially debt monetisation.

The challenge of that environment is that basically they're saying outright that, "We need our bonds to lose purchasing power for the maths to work".  So, Japan has an official 2% inflation target; inflation's currently above their target; and yet they're saying, "We're going to cap yields at 0.5%", and the short end of the curve is at -0.1%, I believe, so it's the last remaining negative nominal yield.  So, when you look at the whole Japanese yield curve, it's submerged below not only the current inflation rate, but their target inflation rate. 

So, if you add everything together, they're saying, "Wait a second, you want bonds to lose value over time?" and then the answer's, "Yes, we do", because you can't have 200% debt-to-GDP and have positive real returns on your debt.  Basically, those bondholders have to be the bag holders, so that's the situation we find ourselves, that's peak fiat -- when you're this far into the system and all these debts have built up, that's kind of the release valve that you get to.

Peter McCormack: But then who's going to buy these bonds?  I know you say some people have to because they're mandated to; but outside of that, who would want to buy these bonds?

Lyn Alden: Very few people.  There are days where Japanese ten-year debt does not trade, which is remarkable.  These markets are supposed to be very liquid but in Japan's case, because it's been such a managed market for so long, the market has basically left.  So, other than pools of capital that pretty much have to hold it, and the Bank of Japan, there's really few buyers.  Some people might go in for a trade if they think something might happen in the near term, but there's very few pools of capital that want to hold these things for long periods of time, because you're being told upfront, "We're going to do everything in our power to make these lose value slowly".

So, most pools of capital do not want to hold them, so the biggest buyer ends up being the Bank of Japan; basically the central bank owns the debt of the government by creating new money to do so.  So, it's this big, recursive, turtles all the way down, fiat situation.

Peter McCormack: Is there any way out of it for them?

Lyn Alden: The short answer is, not really.  If you go back to the 1940s, they were effective at inflating the debt away.  So let's say the United States, we got up to over 100% debt-to-GDP, we did a decade roughly of yield curve control, basically nominal GDP grew much more quickly compared to the yields and the debt, and they were able to regain control of the situation and get the debt-to-GDP down; but that came from a number of factors.  One, the debt was partially inflated away, that was a key variable. 

But then also, they were able to shift from large fiscal deficits to austerity, because a lot of the expenditure obviously in the 1940s was temporary and could be ended as you got into the 1950s.  So, the United States, it's not like they started running surpluses and paying down the debt, but what they essentially started doing is stopped running deficits at least.  So for several years, they held nominal debt flat, while nominal GDP kept growing, and the combination of those bonds losing some of their purchasing power, and getting control of that deficit situation and having growth come back, was able to get them out of that trap.

But that was the best-case scenario.  If you look at bonds for other countries throughout the world from the 1940s, the United States was the one that was virtually untouched by the war, and so they came out strong, their bond market lost less of its value than the rest of the world, the numbers were far worse in Europe, Japan basically hyperinflated, if you were on the losing side or the less winning side of that whole global conflict.

The difference now is that in the 2020s, a lot of these are structural, a lot of them are aging demographics, built-in entitlement systems, promises made one, two, three, four decades ago, if not more, adjusted along the way; and so there's really few ways out other than trying to have it be a slow bleed rather than a rapid, all of a sudden.  So they want essentially, if you got a central banker drunk and you got them to be fully honest with you off the record and say, "What do you actually want to do?" they'll essentially say, "We want yields below inflation for a decade and hopefully not double- digit inflation".  So it's like they want that kind of sweet spot, they want to be able to maintain that, but of course that's challenging to do.

Peter McCormack: Gosh.  Is there anything here that's repeating now?  You said that the US bonds were largely untouched now with US interest rates quite high; are the US bonds seen as like a safe haven right now?

Lyn Alden: In a way.  But it's funny because a lot of people when they think the dollar is strong, it must mean that a lot of foreign investors are piling into Treasuries, but usually you actually get the opposite.  When the dollar is strong, usually fewer foreigners are buying Treasuries and it's because there's kind of these mechanistic forces there where the world has $13 trillion in dollar-denominated debt, and when the dollar is strengthening, it essentially means that their liabilities are hardening.

For example, if I if I took out a mortgage but instead of being dollars it was priced in Swiss francs, and the Swiss franc appreciated compared to the dollar, compared to my dollar-based income, that would have been a bad trade on my part.  My liabilities are hardening compared to my assets compared to my income, and that's essentially what happens in a lot of countries around the world when the dollar strengthens relative to their local currency.  So compared to their cash flows compared to their asset prices, their debts are hardening.

So what a lot of times is happening is there's a dollar shortage in those countries, so they go to their central bank and say, "Look, we've got to have dollars to service these debts.  Quarter after quarter some of these come due, we have to pay interest on it, we need some dollars".  So the central bank says, "Sure", and then they sell some of their Treasuries and then they loan out dollars to their local banking system that can then loan it out to their non-bank corporations, and so forth.  So usually, if you have a sharp rise in the dollar, you get a reduction; it's flat to down in foreign Treasury holdings.

So this has kind of been a year where there are some private foreign pools of capital that have been viewing the Treasury as a safe haven and going into it, but that's been offset by the fact that official sources, like central banks, have generally been trimming their Treasury holdings for a number of reasons, in part because of that strong dollar environment.

Peter McCormack: So where is safe to put money right now then?

Lyn Alden: That's the challenging thing of an inflationary environment.  The answer is, "Not that many places".  One of the best performing this year was ironically cash, so inflationary environment, it's ironic to buy cash.  If you look in the US system, if you hold dollars in a bank account you're getting paid near zero most likely, but if you're holding short-duration Treasuries or money markets, you're at least getting several percentage points to offset some of that inflation.  So cash is a safe haven to lose value slowly.

Another thing that's actually gone up this year is a number of decent dividend-paying value stocks.  They went into the year pretty cheap and have generally continued doing pretty good cash flows and paying pretty high dividends.  A lot of those have actually been some of the best place you could be; so you did better than cash, you did better than gold, you did better than most risk assets that went down and so those have been some of the best places to be.  And of course there's some specific sectors like energy stocks and things like that, that at varying points of the year did very well.  But a general rule was cheap, profitable companies that pay dividends has generally been the best bet this year.

We also have, I mean housing is coming down for obvious reasons, but it's still up year-over-year, and so especially in linear markets if someone bought a reasonably priced house earlier this year with a low fixed-rate mortgage before mortgage rates shot up, they're generally still doing pretty good with that trade, or that investment, however they want to view it.  So there have been a number of ways to either gain a little bit of value, or at least lose value less quickly than other places. 

But one of the remarkable things this year is that almost everything got hit.  So bonds, one of the worst years ever; stocks, pretty bad year; gold was flat, one point was up, then it was down, now it's kind of flat for the year; and obviously Bitcoin had a bad year; growth stocks had a horrible year, a lot of those looked like shitcoins basically; these unprofitable super-high-valuation companies just got killed.  And so there's been a couple ways to -- if you were like fully long energy or something like that, you made a lot of money, but outside of being very specific, it was a pretty hard year to make money on, so it was more about damage control.

Peter McCormack: So, everything I'd read with regards to Chinese debt, and we've discussed this before, it seems like it's high risk.  But I've also read recently with those -- we spoke to Doomberg yesterday and he said with the 180 that China's done on COVID might see them kind of kind of roar out and actually perform well.

Lyn Alden: So, I think there's a chance for that, because their equity prices are super-cheap because nobody really trusts them anymore, because Chinese policymakers can change their view at any time; you face delisting risk in much of the world if they were to invade Taiwan or something like that.  I mean a lot of those could be zeroed out for foreign investors in a similar way as any holders of Russian stocks.  You might have been holding a cheap, high-quality company; but if you if you held it when Russia went into Ukraine, you just got zeroed out, even if the company's still profitable.  So there's all these risks around Chinese equities in that sense.

The challenge with China has always been in their real estate market, that's where they culturally want to store a lot of value, very high population country, and then you have basically very, very high valuations on their real estate and then a lot of debt attached to it.  Then that actually also bleeds out to the rest of the world, so that contributes to why Australia has such high property prices; that contributes to why Canada has such high property prices; it kind of pushes out a lot of these Chinese buyers.  They're saying, "Well Chinese real estate is ridiculously priced, so we'll go buy in these potentially safer jurisdictions.  It's expensive, but it's not any more expensive than China".  And so they go out there and it pushes those valuations up.

The risk there, so on one hand China is deliberately trying to deflate their real estate bubble.  I mean their President came out and said, "Real estate is for living in, not speculating on", so the idea of a Chinese person having say five apartments, a lot of them are empty and they're just hoping for appreciation, they're trying to pull that kind of strategy in.  But that of course comes with all sorts of downside, that's basically slower construction activity, slower economic activity, people are not happy with their real estate holdings going down in price.  And so you have kind of a slow, controlled demolition that's happening there that they can only maintain for so long, in my view, and so I do think that the reopening is part of their realisation that they're pushing things pretty tight here, in terms of both the debt load as well as public sentiment.

So, I'm somewhat less bearish on China than the average person over an intermediate term, because I do think their reopening could be pretty effective for them in that sense.  I think the longer-term risks for China are that, one, they have pretty bad demographics; basically they're one of the more top-heavy populations when you look out over the next 10, 20, 30 years, and so that's going to be a challenge for them; and number two is that their geography has always just been challenging compared to say the United States, basically compared to some of these other places, they have certain limits to their geography that they've been struggling with for a while.

An Asian financial crisis is not my base case but it is something you have to keep watching, because with China you never really know fully what the date is like.  They selectively release data; under President Xi, they've reduced their transparency.  So for a number of decades, you had rising transparency, rising at least somewhat market-oriented economy and under President Xi, you've kind of reversed a lot of that.  So under that framework, it's hard to know for sure what you're looking at.  You pretty much had to disregard things like COVID statistics, you had to disregard certain growth metrics; but there are still some out there, but you have to take them with a grain of salt.  So, I'm less bearish on China than the average bear, let's say.

We also have to look at how that's going to impact the global economy, because one of the things holding energy down was Chinese lockdowns, that they were consuming less energy than they otherwise would or could have.  So if you look at Chinese jet flights, way down; construction activity, down; and to the extent that that either goes back up to 2019 levels or exceeds them, that's something coming back to the market and saying, "We're going to take an extra million barrels a day, two million barrels a day of oil", whatever the numbers end up being, and that that can put pressure on a tight energy market globally.

Peter McCormack: What about supply chains?  I know before, you've tracked historical prices for containers and the shipping costs around the world, and we saw that.  I think you and I discussed that during the COVID lockdowns, there was a massive increase in in costs.  Is there anything that you're seeing that's going to reduce the cost pressures of people who may be in places like the UK or the US who are importing goods, is there anything you're seeing there?

Lyn Alden: Well, there has been a significant disinflation this year of a lot of those shipping prices, and a lot of it was demand curtailment.  So, as prices got very high and as you started to get stimulus being cut off and as you started to get tighter monetary conditions, it put pressure on the buyers, and that allowed those markets just to somewhat more normalise.  The concern I have is that I think that a lot of people are looking -- it's kind of a false sense of security.  Some of those extreme moves were always going to come off, those extreme levels don't just stay there; eventually, "High prices are the cure for high prices", is the old saying and so that's played out.

I think the longer term thing is the fact that we had multiple decades of globalisation, so basically you had a pool of capital and then you had number of pools of labour, let's say China, former Soviet States, that kind of thing, and the last three to four decades were basically about tying those two things together saying, "Okay, we have capital, you have labour.  Let's build factories there, let's build XYZ there and then ship it, let's build infrastructure"; and now, in a less trustworthy world and a more multipolar world, we're seeing either a reversal of that trend or at least a slowdown and a stoppage of that trend.  That means that more of the cost pressures get pushed back on their own markets.

So, I think we're in a more structurally problematic environment for supply chains where, for decades, you could ignore resiliency and focus on efficiency because the world was just always getting more and more unified and safer.  And now, when you can't rely on that fact, when you have to assume what if XYZ happens, what if this country invades that, what if relations between these two countries break down, what happens to my supply chain, you have to bake in more resiliency and that comes at a cost.  So, I think that the longer-term story is that we're probably in a somewhat more inflationary environment in that regard, but the extreme edges are taken off because there's not that huge burst.

Another thing about COVID is that, in addition to the stimulus and things like that, it also rapidly changed people's behaviour in a short period of time, which supply chains are not good at dealing with.  So for a while, everybody stopped flying and instead they started buying electronics and remodelling their home, and so that activity just rapidly changes what people need and that puts a lot of pressure on those areas.  Then there's been a kickback where they say, "Okay, now we've remodelled our home, we're not going to remodel our home for five years, we want to go on a lot of flights now".  So you have almost a pullback and so you have disinflation in some of those goods that were inflated to begin with, and now you have plenty of activity and flying and hotels, and things like that.

I think that as that normalises, we come back down, but these longer-term trends are probably still here.

Peter McCormack: Well, we've seen that with our travel, right, Danny?  I mean when COVID ended and we first started travelling, we were able to get flights ridiculously cheap.  Danny was flying Business from Australia because it was so damn cheap!  And over the last, I would say what, 12 months, Danny, would you say they've doubled in price?

Danny Knowles: At least doubled.  I think my last flight to the US was double what a Business flight used to cost.

Peter McCormack: Yeah, our travel costs have essentially doubled in the space of a year.  Also we've noticed our Airbnb costs, because you know what our setup is; the Airbnb costs have gone up massively.  There's a place we rented previously where they essentially doubled the price, and I can't tell if that is -- it feels a bit like what you said, that the supply dropped and now there's a massive increase in demand, but the supply hasn't come back.

Lyn Alden: Yeah, so I mean for flights, for example, supply is not fully back, and it also just ties into the whole rotation I just discussed where around the margins, if more people want to do one thing at the same time, let's say buy goods or refurbish their home, that's going to put a lot of pressure there.  Then everyone says, "Okay, we did that the last few years, now we're all going to travel, we're all going to do things we couldn't do for the past few years", and start ramping up in that regard.  There's less international restrictions on travel, which persisted pretty long in many cases.  I mean back in earlier this year, there were still tons of restrictions that have eased throughout this year.

So, as those have eased, basically there's more and more people that are flooding in to travel, and things that while supply, at least for flights and things like that, is still not fully ramped up.  And so I think we're going to see probably a similar phenomenon where when we look back, let's say a year from now, two years from now, it's hard to say exactly how long it goes; but I think some of these extreme prices will cool off to some extent, because you'll either get supply coming back online, or those high prices will then deter some people.  They'll say, "Okay, we got some travel out of our system, this is getting really expensive.  Let's stay home this year", and then the market can normalise.

But then I think longer term, the question becomes energy security and gradual deglobalisation.  Those are I think the longer-term inflationary drivers, where some of these were shorter term.

Peter McCormack:  So, do you think these are actual trends that come in this deglobalisation?

Lyn Alden: I think in rate-of-change terms, yes.  So when people hear deglobalisation, I mean it depends on what you mean by that, because it could mean that in the extreme sense, let's say US and China don't trade anymore.  Is that going to come anytime soon?  No, but I think it essentially means that you've tapped out a lot of the easy adjustments.  We've already picked the low-hanging fruit of globalisation which was essentially, going into the 1980s, let's say, China was very impoverished and opened up to the world.  So that was, okay, here's hundreds of millions of workers and then there's large pools of capital that said, "Okay, let's join that"; and then you had the fall of the Soviet Union in the early 1990s, so we had a number of states there able to open up; and so you had this basically huge environment that was just ready to come together.

I think a lot of that's already been done and then now we see Russia separating, China closing off, more tensions, more tail risks being realised; again, what if China does do something with Taiwan; what does that mean for all the US companies, the infrastructure there; does that mean that the US freezes Chinese assets; do they want to hold their assets in the United States the way that they used to?  

You also have, for example, all the way back in 2013, China, when they announced their Belt and Road initiative, they announced that it's no longer in their best interest to keep accumulating Treasuries.  So it's not like on day one, they just sold all their Treasuries; but what they essentially did was they hit a high-water mark for how many Treasuries they want to hold, and then they're just flat to down, even though they're still running giant trade surpluses in dollars, and they're just funnelling those dollars to other things, essentially loans to African countries, South American countries, Southeast Asian countries, all sorts of different projects.

So, I do think we see a more multipolar world and that the low-hanging fruit of globalisation is behind us, but it doesn't mean that we backtrack on all of our gains right away.  It just means, especially for national security industries, let's say semiconductors, certain energy things, there's a realignment and a renewed interest in resiliency and backups.

Peter McCormack: Yeah, you've said to me a few times that you think the 2020s is really going to be a decade where the story is inflation.  Do you still feel this; do you feel like the inflationary pressures are going to drop; how are you reading it right now?

Lyn Alden: So, I view us as in a disinflationary cycle within what will probably be an inflationary decade, and that's something that I've been estimating for a while.  If anything, it actually came a quarter later than I thought.  So if you look at my writings before, I thought that the peak in inflation would come in probably Q2 of this year and it dragged onto Q3, I think in a large part because of Russia; they just added fuel to a fire that was already there and extended it a little bit.  

But essentially, you have a lot of that stimulus money wearing off, a lot of that demand destruction or at least demand slowdown takes place, and so now we're in this period where central banks are fighting back, fiscal authorities are trying to fight back, trying to gain control of that inflation; it's working better in some markets than others.  So, my overall expectation is that we're in a disinflationary environment.

But when we look out at say 2024, 2025, I think that's where we risk having another inflationary spike, because the energy situation is still not fundamentally resolved.  Basically, by releasing US oil, by China being shut down partially for a while, there's been ways to keep oil from skyrocketing; but if you want to have another cycle of growth ahead, let's say after we get through 2023, if you go into 2024, you want another cycle of growth, well we haven't seen a lot of new energy supply come online and so that's ready to be a problem all over again.

Peter McCormack: Are you seeing anything with regards to investment in new energy supplies?

Lyn Alden: So around the margins, there's some.  Basically US shale oil, there's actually a recent survey that they do quarterly throughout Texas, for example, to see what the plans are of energy CapEx, and there's really nothing remarkable.  I mean basically, everyone's saying inflation's transitory, we're not going to chase this, we're not going to radically increase our energy production.  And then you have policies like windfall taxes in parts of world and things like that where they say, "If we don't even have good clarity on what percentage of our profits we get to keep from this, maybe we should just hold off for now and not invest".

I think partially private sector decisions, and then partially public policy implications, contribute to pretty low new investment, so it certainly looks it's going to be higher than this year, but not way higher.  That's compounded by the fact that a big percentage of that amount that's going to be higher is inflation.  So when you factor out and say, "How many actual barrels are we going to get online to offset our declining existing wells?" I think the answer is, "Not much".  I mean, we've already seen a flat line in US shale rebounding, so we still have not hit our high-water mark in terms of US oil output, the pre-COVID level.  I think there's a good chance you will eventually get to that level, but the initial several months of say 2021, and things like that, we were rapidly going back up in terms of oil production, and now we're rolling over and flatlining because the marginal barrel is always that much harder.

For example, analyst Luke Gromen would describe it as peak cheap oil, which is that there are plenty of oil and gas sources still out there throughout the world, but that we already have a lot of low-hanging fruit; and so we're turning towards things like shale that for example rapidly depletes.  You have to keep heavily investing in it in order to just maintain the output, let alone grow the output.  Then you have other unconventional oil sources that on average can be somewhat more expensive, and then you have some of the cheapest sources of oil, like a lot of the Middle Eastern oil, for example, that's not really growing any more.  So I think that's the trick environment, that you need quite a lot of CapEx in order to get an amount of oil that is that is not much higher.

Peter McCormack: Yeah, when we spoke with Doomberg yesterday, he pretty much said that any rational energy policy needs to have a nuclear central to it, and the main issue with that is it takes so much time for these projects to come online.  Are we seeing anything changing in that?

Lyn Alden: I think we've seen changes in the narrative, so we've seen a rapid shift in the desires to shut down existing plants, that's been pretty quick; Japan's also accelerated their reopening of some of their reactors that they've closed since Fukushima; and so around the margins, you have seen that.  Also, China's building nuclear reactors, India's building nuclear reactors, some Middle Eastern countries are building nuclear reactors; but as you point out, those take quite a while.

The funny thing is, you look back in the 1970s, those were built pretty quickly.  Part of why they take a long time now is regulations, and things like that.  Obviously, you want you don't want a Chernobyl 2.0.  Part of why that was so bad is because it didn't even have the concealment dome around it, and so obviously you don't want unscrupulous nuclear builders.  But we've hit this point where it's choked off, like in the United States, it's almost impossible to build a new nuclear reactor, it's just not a business you want to get into. 

So part of that's our own doing, that it takes so long.  It doesn't fundamentally take that long; it takes longer than a coal plant, but there's no law of nature that says a nuclear plant has to take six, seven years to build, and so that's partially our own doing and just the state of the global construction industry, especially in developed markets, things take longer.  It takes us longer to build a skyscraper now than it did the Empire State Building in the 1930s; that's kind of where we're at.

Peter McCormack:  Do you remember that came out some time last year, where an escalator in a New York subway cost like $27 million to build?  You could probably find that, Danny, some ridiculous project.  I'm sure it was a New York escalator that took three years and it might even be more than $27 million; I'll leave Danny to find that.

There's been a lot of talk of recessionary pressures and that maybe we're entering a recession.  I've got anecdotal evidence from friends who run their businesses who are talking about things feeling like they're slowing up.  What do you see your side on that?

Lyn Alden: So, I think it's been somewhat surprising how resilient so far the economy's been to recession, but I still think the picture does not look very good for 2023.  It depends on a few different variables.  So right now, for example, the US yield curve is inverted, which means that the ten-year Treasury is a lower yield than the three-month Treasury.  The last eight recessions, the yield curve inverted before the recession, and there's been no false signals.  So it's never inverted and then there's no recession.

Now the caveat though is that sometimes recession happens two months later and sometimes it happens two years later, so there's a pretty wide gap for how long it can take for a recession to materialise, number one; and another challenge is that monetary policy happens on a lag because, especially in the United States and a number of other countries, a lot of the debt is fixed rate.  So just because mortgage rates, for example, shot up dramatically does not mean that the average American homeowner is paying a higher mortgage rate.  Basically it means that fewer mortgages get taken out at those higher rates, fewer people ever want to leave or sell their current home, they want to lock in and keep their current mortgage rate.  And so basically, a lot of those are unaffected by the increase in rates.

So what happens is, quarter after quarter, potentially year after year, as rates are at a higher level, some percentage of debt matures and gets rolled over; some corporate debt matures, it gets refinanced at these higher rates, some people just have to move, things happen, and so low-interest-rate debt gets refinanced at higher rates and that eats into incomes, it eats into things that they otherwise could spend money on.  More of it goes to bondholders, banks, things like that and away from the non-financial industry, and that can contribute to recessionary conditions, especially because if you look at office commercial properties, they've never recovered yet from the combination of COVID and remote work.

Remote work was always going to happen to some degree.  What COVID did was say, "Okay, we're going to take the next five years of remote work and push it into three months", that trend was rapidly accelerated.  And so even as it bounces back somewhat, a lot of companies have already decided that they need less office space than they used to, and so there's higher vacancy rates for example in New York office real estate, I'm sure many other cities as well, including cities throughout Europe, cities in other countries.  And so over time, as those holders of those properties have to refinance their debt at higher rates, that just puts pressure on them.

I think that it's one of those things where we're in a more stagnant environment right now and we'll see if it descends into an outright recession.  So right now, US unemployment for example looks like it's bottoming and may be turning up a little bit; you see consumer confidence, CEO confidence, measures like that are very low.  The one saving grace that is somewhat I think keeping things afloat is that if you look at this year, the dollar index was soaring, which again to my prior point earlier in this discussion, puts a lot of pressure on the entire world.

But in the second half of the year, you've had a rollover in the dollar index, it's left off some pressure.  And so that's been a constructive environment for a lot of developing countries, a lot of just indebted entities around the world, and it's given them a little bit of a breath of life.  Combined with China's reopening, that's the one variable to keep watching to say, "Okay, the US is in some ways purposely putting itself into a recession to try to regain control of inflation", but then the question is, as the market looks at their inverted yield curve and maybe stops paying more for the dollar, it allows these other indebted entities around the world to potentially stabilise and start doing okay.

So I'm perhaps less bearish on the rest of the world than the average person is, but I still think that 2023 does have a lot of risks for recession or near recession, just overall weak economic growth.

Danny Knowles: One thing that I heard, when the interest rates first started going up when that was first announced, a lot of the more Austrian Economists were making out that the economy wouldn't survive any sustained period of high interest rate, but it seems to be doing fine.  What is it you think they got wrong with that?

Lyn Alden: I think partially right, partially wrong.  So for example even myself, if you said, "How high do you think the Fed's going to be able to tighten interest rates before they start causing problems?" my number was probably around 3%, but they've already been able to get up to 4%.  I think part of it was how quickly they did it because as I mentioned before, a lot of this operates on a lag.  It's almost like there's very little difference.  If you go to 0% to 3% in one year, or 0% to 5% in one year, that almost doesn't make a difference, because refinancing activity came to a halt pretty much.  So it's almost like that extra number barely matters in the near term.

Where it starts to matter is quarter after quarter, as this plays out; that's where I think it starts causing issues.  So I think it's a matter of time rather than just height, in terms of interest rates.  Also, it's always hard to measure how much excess liquidity is still in the system.  So people got stimulus cheques, they got childcare tax credits, PPP loans to turn into grants, so basically millionaires were given another half a million, things like that.  That's just money that's sitting there and they drain that out over time, it starts getting diffused throughout the economy, and so some people had higher savings rates or higher savings stashes stored away than I think some analysts realised.  So I think quarter after quarter, it gets harder, the comparisons get harder from prior quarters as conditions stay very tight.  So I think that's probably one way to look at it, that these things take time.  

Then also, the way I was phrasing it was, "The Fed can tighten but they can't normalise" which is that a lot of people are like, "There's too much debt, the Fed can never raise rates".  Well, of course they can in the short term.  I mean if you look for example at US debt, the average maturity is something like five years.  Now, it's somewhat front-loaded because you have 30-year debt on one hand, and then you have trillions and trillions of dollars in T-bills, which that all refinances within say a two-year period.  And so, if they raise rates to 5% overnight, it doesn't mean that all US debt is now 5% higher.  It basically means that starting with those T-bills, some of the existing short-term debt starts getting refinanced at higher rates, and then it turns into the one-year Treasuries and then the two-year Treasuries, and basically more of that maturing debt gets refinanced at higher and higher rates.  And so there's a very big difference between say holding rates at 5% for five years versus doing it for one year, because more and more of that debt gets refinanced at that higher rate.

The way I would phrase it is that, the Federal Reserve is unlikely to get back to a period of positive real rates and then maintain it for years, but they can get to either positive rates in the near term, or they can get up to higher rates while inflation's still high.  For example, what's remarkable is that as much as the Fed is tightened, they're still below the official inflation rate year-over-year; and so they're still in negative real territory.  Now they are higher than inflation break-evens, which is supposedly the market's estimate of forward inflation, so they're positive in that sense; but they're still below trailing year-over-year inflation.  So they've tightened, but it's not like they've done a Volcker or a 1970s thing yet.  That's how I'd phrase some of those aspects.

Danny Knowles: And so, the tightening was meant to carry on until 2024, I think is what the Fed said; do you think they'll last that long?

Lyn Alden: So, I think that they might maintain levels that long.  I mean, the market and even the Fed's already pointed to early 2023 as when they're probably going to start topping out in terms of their rates, and then the question is, "How long can they hold it?"  That will largely depend on whether or not a recession materialises or not.  I mean, if a recession starts to materialise they're going to get a lot of pressure to pull back.

If a recession manages to be narrowly avoided, let's say China reopens hard enough and the weaker dollar gives enough countries around the world a boost to hold up the equilibrium, and we narrowly avoid recession, then you can stay tighter for longer.  Also, if inflation returns and the Fed is still holding rates within say 100 basis points of where they are, you could have an environment where they're actually not that tight on a real basis.  So, I think that the question becomes, "What are they going to do with quantitative tightening?"

So you could potentially hold rates where they are, but then stop selling bonds, for example.  That's a way of slowing down your tightening while still trying to be somewhat tight.  So I think there's kind of a range of options that they can do.  It's still not fully clear how that's going to play out.  I think that eventually they're going to run into problems with the Treasury market, where you can have a strong dollar and the Fed continues to sell bonds.  So far, in the second half of the year, because the dollar weakened and because they drained the Treasury General Account a little bit, they've been able to keep selling bonds.  But if you don't have those variables, let's say in the first half of 2023, then I think the Fed's quantitative tightening gets pretty challenging for them to maintain.

Overall, I think that they're going to maintain some degree of tightness throughout 2023, but exactly how tight will partially depend on what happens with recessionary conditions, while also keeping in mind that it's not as tight as you'd expect, given how high inflation is relative to some of those rates.

Peter McCormack: If we do enter a recession, Lyn, what are the signals you're looking at for that; and what would the impact be, what are the things that people should be aware?  Like, what do we think that the impact would be on equities; what would the impact be on Bitcoin; what are the historical things that have happened during a recession?

Lyn Alden: One thing I'm looking at is Purchasing Managers' Index, both the US one specifically, and also other countries, because that gives you a good sign of, is the is the economy expanding or is it contraction, especially the manufacturing side of the economy.  So, services tend to be more recession resistant, so hospital workers don't generally get fired in a recession, for example, whereas say manufacturers often do; you often have that more cyclical type of slow down.

So, one is I'm looking at those more cyclical aspects to the economy; I also then look at things like freight index, how much stuff's being transported around, because that impacts how many drivers you need, that impacts warehouse usage, all sorts of things like that.  So I look at that chain of behaviour there.  I also look at unemployment.  So historically in the US, if unemployment rises by 50 basis points, meaning 0.5%, like if you go from 4% unemployment to 4.5% unemployment, if you get that much, it never stops there, it just keeps going up for a period of time and then you get this spiral into recession.  Maybe they're expecting this time it's going to be different.  If you look at the Fed models, they're expecting higher unemployment, but not way higher employment.  Historically that's been something that doesn't really happen very often.  

Another thing I look at is that because this recession has impacted higher wage workers more actually, so there's been a shortage in things like say food workers, and a lot of people losing their jobs are like tech workers, Silicon Valley workers, a lot of those people have severance packages and so they don't go and apply for unemployment right away; so it doesn't necessarily show up in say the initial unemployment claims data as quickly as it would if people in the working class, or say the lower half, the middle-income class gets laid off.  So I think that that can slow down how that shows up in the data.  But I'm looking forward now to 2023 to see if we start to get more unemployment rate ticking up.

I look at the combination of PMIs, unemployment and things like that, as well as the Atlanta Fed does a pretty good real-time estimator for what the quarterly GDP is going to be like.  So in this quarter, they've been tracking what they think it is going to be by the end of the quarter, which of course isn't reported until the next quarter; all throughout next quarter they'll be tracking it, which again we won't find out until Q2 what Q1's GDP was.  So, I look at that as a somewhat real-time estimate for at least the direction of where things are headed, as this plays out.

Peter McCormack: And would you say the global markets are so intertwined right now that if we have a recession, it's a global recession?

Lyn Alden: Partially yes, but maybe less than other people put it, because if the US has a recession, the Fed gets less hawkish, which likely takes some pressure off the dollar, which then gives the rest of the world a little bit of a reprieve.  You kind of have these cascading things that all impacts at once, but then one of the impacts starts undoing one of the other impacts.  So, that's one way to look at it.  Then I realise your prior question I didn't fully answer was, what happens to different assets in a recession; what happens to equities; what happens to things like that?

Peter McCormack: Yeah.

Lyn Alden: So, one thing I'll point out is that 2022 was mostly about valuation compression.  So, as the dollar was hardened essentially, so higher rates, higher dollar index, that put a lot of valuation pressure on a lot of companies.  So it's not that companies' earnings fell apart, it's that instead of paying 25 times earnings for a stock, people said, "Let me pay 18 times earnings for that same stock".  So you had basically a reset in a lot of medium-growth companies, so not hyper-growth, but not value, like these middle-of-the-road companies' profitable growth, for example.  

Then you had unprofitable growth that got absolutely crushed.  And a lot of this is because, if the ten-year Treasury pays you 1% a year and you want to then go into equities instead, you say, "Okay, what is the target rate of return I want on equities?" and you might say, "I want 5% better than Treasuries, so I want at least a 6% return", so you'll pay a pretty high multiple for those equities, because you're comparing it to what is essentially a very overvalued Treasury.  On the other hand, if the Treasury is yielding 4% and you still want a 6% equity risk premium, then you want a 10% return on your equities, and so you're going to pay a lower multiple for the same equities; you want basically a higher dividend yield, a higher earnings yield, different ways to measure it.

So, as you've gotten higher long-duration bond rates, that puts downward pressure on a lot of equity valuations, especially growth-oriented equities more so than value-oriented equities, so that's been a big story this year.  Also, a stronger dollar puts some pressure on gold, countering some of the other things that should be beneficial for gold.  And then also, as we've seen, the whole crypto industry was just heavily intertwined and indebted, so the speculation pressure poured out, things blew up, obviously Bitcoin got impacted by it even though it wasn't at the heart of that whole thing, and so that's all been negative.

Generally if you look historically at Bitcoin's price action, it does follow global liquidity very closely.  And so as liquidity pulls out, Bitcoin's done poorly; it's even done more poorly than I thought because some of the industries were so -- like FTX blowing up this spectacularly was not really on most people's radar, for example, and so that's all done very poorly.

If we go look at 2023, I think instead what we're going to see is a story about corporate earnings starting to get weaker; so some of them might get negative, but other ones might just not grow or might shrink a little bit that year.  That's likely to put ongoing pressure on equities, not necessarily because they're earnings multiple is going down any more, but because their actual earnings are just not doing very well.  On the other hand, that gives assets that are not valued for earnings a chance to do better, so things like gold or Bitcoin, where there are more liquidity plays or anti-dollar plays than earnings plays.  

So I do think that you could see for example a bottom in Bitcoin before you see a bottom in equities.  I do think you can have a better year for gold than you do for stocks, for example.  I think that as a base case, that's the type of year I'd expect for 2023, unless or until I start to see evidence that says otherwise.

Peter McCormack: Right.  And traditionally, and I know this is probably a tricky question, but how long would a recession tend to last; and what can the central banks do to help bring us out of it?  I was chatting to Preston Pysh and he was saying that he thinks that the central banks really need to be doing something in Q1, Q2 to release the pressure.

Lyn Alden: Recessions can last as little as a few months.  I mean technically, the COVID recession in the US was classified as a recession in hindsight; it was very short.  On the other hand, the recession amid the 2008 Crisis was very long, it lasted well over a year.  And so there are different impacts, both in the private sector and from the public sector, that can either shorten or lengthen a recession.  Usually there's a trade-off with that.

If you have a recession and you print a ton of money and throw stimulus at it, you can get out of that recession quicker; but then you've done it the cost of higher debt, and then potentially for a more inflationary rebound in the future, which then you have to then raise rates super-quickly and potentially put yourself into another recession.  And so there are levers you can pull, but every lever has a cost associated with it.  So, policymakers are trying to figure out what combination of levers they want to do.

Right now, it seems that I think they're going to be slow to do stimulus, and so I think this could be a longer, more grindy type of environment, that's maybe less deep than people think.  A lot of people are afraid of a 2008 repeat.  The reason I'm not, at least not as a base case, is because if you look at 2008, the US banking system was very, very weak, it was very levered, so banks had a very low exposure to safe assets, like cash reserves or Treasuries, and they had a very high exposure to real estate loans, subprime, auto loans, just all types of riskier assets that can lose nominal value, and that all imploded pretty severely.

In the decade that followed, if you look at a bank balance sheet, it looks the opposite of how they looked in 2008; so they were actually overexposed historically to Treasuries and cash, and they were underexposed to loans.  So, while they can take a hit, I mean they're not unscathed if there's a recession, I don't view banks as being the epicentre of it, at least in the United States.  European banks are on average not as strong, in my view, but at least in the US, you don't have that centre weakness at the heart of the financial system, instead it's dispersed elsewhere.  It's dispersed in any corporation that is marginal and has its debt servicing costs going up over time, as it has to rollover its debt.

If you look at for example the recession after the 2000 bubble, I mean one is that that bear market in equities grinded on for quite a while.  You never really actually reached, especially in inflation-adjusted terms, the US stock market never reached 2000 highs in the next runup going into say 2007, you only roughly matched the prior highs before then obviously crashing into the Great Recession.  It wasn't until the 2010s decade you actually fully eclipsed the 2000 highs in equities.  The recession in the US after the dotcom bubble was a pretty shallow one, but it was very bad for asset prices and the bear market in asset prices lasted a while.

So I think you could get one like that potentially, where you have a more stagflationary-type recession; it's not a big bank implosion the way that 2008 was.  But as the prices, instead of this sharp V bottom and then straight up, they just grind for a while, sideways down, maybe a year they go up but then they don't get to their prior highs for a while.  I think a lot of sectors are probably going to be like that, where we could look back five years from now and the market's gone nowhere in a big choppy trading range for quite a while, at least for things like the S&P 500 and other things that went into this environment expensive and are now paying the price for how expensive they were.  And as their earnings are chopping around and as their valuations are chopping around, they don't have that feedback loop that drove them up to those highs to begin with.

Peter McCormack: Right, okay listen, I've got two more questions for you Lyn, because I know your time is precious.  When we chat at the end of 2023, do you think Bitcoin will be a higher price than it is now or lower?  I know that's unfair, but we just want to test you!

Lyn Alden: It's hard to make one-year predictions with something so volatile.  My expectation would probably be higher, but I also would say I would also doubt that it'd be all-time highs.  

Peter McCormack: Yeah, I'd agree with that.

Lyn Alden: So my expectation would be somewhere between higher than here, lower than it's been.

Peter McCormack: We'll take that!

Lyn Alden: Caveat that, I mean if something severe happens and you have some sort of crazy liquidity crisis, I mean it's not out of the realms of possibility that it could be lower.  But my expectation would be somewhere between here and prior highs.

Peter McCormack: Yeah, I like that.  You know what, your overall tone was a lot more I think optimistic than I expected.  I was not hugely confident for 2023.  I took the optimistic parts from this conversation.  Okay, just a final question, what are you looking forward to in 2023?

Lyn Alden: That's tricky.  I think I can separate into macro and Bitcoin, I guess.  I guess in macro, in the first half of the year, I want to see what happens with a lot of these indicators.  A lot of times, the way I phrase things, just I'm very confident in how things are going to go for the next six months; and other times, you're more of a pivot point and my uncertainty's higher.  For example earlier this year, I was more adamant of risk-off conditions; and now I'm, are we going to keep that going into a full-on recession or are we going to have a global-led rebound?  So my certainty in the next six months is higher than it was say eight months ago or something like that, and so I would to see more of a resolution in some of that data to point me to a higher confidence position there.  

I also think for Bitcoin, my interest is in probably infrastructure scaling, so things that Breez is doing with Lightning, Breez, Blockstream, making the back end more efficient; things like Fedimint, I think they're going to be at full gear throughout 2023; I think ways to make the network more private, more scalable, not just for Lighting but just overall Bitcoin usage, anything that makes Bitcoin more fungible and gives people a bigger range of options to use, so they can use the base layer, they can use Lightning, they can do something custodial if they want to; there's this whole stack that they can pick whatever serves their need the most.

So for me, it's looking at the classic bear market building situation.  For example, I'm in a fortunate position because I advise Ego Death Capital and I get to talk to the founders, that we're looking to invest in or that we have invested in, and just see the work that they're building and see what they plan to do, and trying to do our best to help that happen.

Peter McCormack: Brilliant.  Danny, I can't believe Lyn didn't say she was looking forward to Real Bedford winning the league in 2023.

Danny Knowles: That's just no good!

Peter McCormack: I thought she was one of us, come on!  All right, Lyn, brilliant as ever, you're an absolute superstar.  It's been a great year working with you and making all these shows.  Hopefully we'll get to hang out again in person.  Is there anywhere you want to send people to?  I'm going to obviously say, if you've not subscribed to Lyn's newsletter, you're an idiot.  There is a free version and even the paid one's only $200.  Just go and sign up and stop being an idiot.  But is there anything else, anywhere else you want to send people to, to look at?

Lyn Alden: No, that's it.  Check out lynalden.com, sign up for at least the free newsletter and then check out premium if you're interested.

Peter McCormack: No, sign up for the premium one, it's $200.  Is it still $200?

Lyn Alden: Yes.

Peter McCormack: It should be more but it's only $200.  It's the best $200 you'll spend.  Lyn, you're amazing, we'll see you soon.  Thank you so much for today.

Lyn Alden: Thank you.