Bankless - Did Macro Kill Crypto? with MacroAlf

Episode Date: November 1, 2022

Alf is the former head of a $20B investment portfolio, a passionate global macro investor, and the author of a free newsletter called, “The Macro Compass," available on Substack. On this episode, Alf helps us understand macro in a digestible way. What’s in our potential future? How bad will it hurt? How long will it last? Answers to these questions and much more in the interview. ------ 📣 Earnifi | Check For Your Unclaimed Airdrops, POAPs, & NFTs https://bankless.cc/earnifi  ------ 🚀 SUBSCRIBE TO NEWSLETTER: https://newsletter.banklesshq.com/  🎙️ SUBSCRIBE TO PODCAST: http://podcast.banklesshq.com/  ------ BANKLESS SPONSOR TOOLS: ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum  ❎ ACROSS | BRIDGE TO LAYER 2 https://bankless.cc/Across  🦁 BRAVE | THE BROWSER NATIVE WALLET https://bankless.cc/Brave  💠 NEXO | CRYPTO FINANCIAL HUB https://bankless.cc/Nexo  🔐 LEDGER | NANO HARDWARE WALLETS https://bankless.cc/Ledger  ⚡️FUEL | THE MODULAR EXECUTION LAYER https://bankless.cc/Fuelpod  ----- Topics Covered 0:00 Intro 8:00 What to Know About Macro 11:03 Tiers of Money 13:07 Deflationary Timeline 15:20 The Housing Market 17:33 The Inflation Remedy 19:54 Indicators 23:10 Global Credit Impulse Cycle 30:25 Can We Have a Soft Landing? 34:50 How Bad Will This Hurt? 39:29 Volatility in the Bond Market 52:18 Switching to Crypto Assets? 55:57 DXY 1:02:09 Bond/Crypto Market Cycles 1:05:30 What Will Make the Fed Pivot? 1:09:36 The Long-Term 1:15:45 Probability & Adapting 1:19:08 Generating Productivity 1:22:27 The Internet’s Unlock 1:23:40 Why Macro is Important 1:25:40 Action Items & Disclaimers ------ Resources: MacroAlf https://twitter.com/MacroAlf  The Macro Compass https://themacrocompass.substack.com/  Is It 2021 Again? https://themacrocompass.substack.com/p/back-to-2001#details  ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures 

Bankless Nation, welcome to another state of the nation. Very important topic, a topic that is top of mind for, I think, everyone in crypto right now. Did macro kill crypto? Can crypto recover? As crypto investors, what do we need to know about the macro environment? Is this going to be like 2008 all over again? Maybe something worse? What happens to our risk on assets like crypto?

When are they going to recover? All right, so who's our guest today, David? The guests on the show today, Ryan, is this guy named Macro Elf, who runs a macro-focused newsletter called the Macro. Compass, and he has produced some of the most just well-reasoned and thoughtful macro analysis that I've seen in the last six months or so. And it really, to me, answers the question, what does it take? What needs to happen for risk on assets, our precious crypto assets, to reach all-time highs again? What needs to happen before that happens? And the answer,

Ryan, is kind of a lot of things. And so we go through that in the show today. And like all of the things that we need to get past in order for us to accept risk again as like not just like investors in the crypto world. We all already accept risk. But what does it take for the rest of the world to also accept risk? Because that's what it's going to take for them to come back and pay attention to the crypto industry. And so that's really what we're diving into here on the show, Ryan. That's awesome. And before we get into this episode, we've got to tell you about our friends and sponsors at Earnify. Ernify is the ultimate AirDrop Checker. You could search for unclaimed AirDropes. to get notified when you match any ones. David, I found a lot of money using Earnify over the years.

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So go check that out. There's a link at the show note. Bankless.ccc-Earnify. You spell that E-A-R-N-I-F-I. You can find out more about this. All right, so, David, we're going to get into this episode. What should people pay attention to as we talk to Macro-Ealth? So this episode with macro elf is one part macro elf telling us the current state of macro markets,

which is useful, but it's also one part, a classroom. And so I learned a lot while doing some of my research for this episode with macro alf. And he's just a great educator that is simultaneously teaching us about how the macro world works, as he's also telling us about how it is right now. And so listeners should just kind of pay attention and be prepared to get your learn on about, you're going to learn about the structure of macro markets. And you're going to be able to understand the answer to the question, what will it take for the world to go risk on again?

Because he talks about the economy as a pyramid and how the bond market is at the very bottom of the pyramid. We really need to make sure that bond market does okay if we want people to go risk on. And so listeners should pay attention to that. There is a structure here in the way that the global macro economy works, and macro alf just really lays it out what that structure is. what the state of that structure is and how it's going to change in 2023 and 2024. And one day it'll finally change in our favor, but things need to happen first. So pay attention to all these details.

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So click the link in the show notes to join over 5 million users who are getting the most out of their crypto. The Layer 2 era is upon us. Ethereum's Layer 2 ecosystem is growing every day, and we need Layer 2 bridges to be fast and efficient in order to live a layer two life. Across is the fastest, cheapest, and most secure cross-chain bridge. With a cross, you don't have to worry about high fees or long-wade times. Assets are bridged and available for use almost instantaneously. Across's bridges are powered by Uma's optimistic Oracle to securely transfer tokens between layer two's and Ethereum. Across's critical

ecosystem infrastructure and across V2 has just launched. Their new version focuses on higher capital efficiency, layer two to layer two transfers, and a brand new chain with Polygon, all while prioritizing high security and low fees. You can be a part of Across's story by joining their Discord and using Across for all of your layer two transferring needs. So go to across.com to quickly and securely bridge your assets between Ethereum, Optimism, Polygon, Arbitrum, or Boba networks. Bankless Nation, super excited to introduce you to our next guest, Elf. Macro Elf, that is, he is the former head of a $20 billion investment portfolio. He's a passionate global macro investor. and he writes a free newsletter, which I think is the best in the game in terms of keeping up with macro.

It's called the Macro Compass. It's available on Substack. Publishes every week. Elf, thanks so much for joining us at Bankless today. Hey, Ryan. David, nice to be here. Thanks for inviting me. Alf, I think we need some help here, okay, because we need to learn a little bit more about macro on Bankless. We've done a number of macro episodes, people like Luke Grama and Lynn Alden, Jim Bianco, et cetera. And Macro is actually... a focal point, I think, for crypto right now. And I'm wondering if you could, Elf, help us through some of these topics, some of these things, but also put yourself in the position of a typical bankless listener. So somebody who's maybe a macro novice, but dangerous, know some of the terms,

is kind of financially oriented, but doesn't know all of the details of how bonds work, for instance. They're going to have some assets in crypto, right, because they're listening to bankless, and how can you not? They're also going to have some traditional assets. Maybe they're worried about the future right now. Things seem uncertain. We've got all sorts of things going on politically, globally. 2020 has been a tumultuous year. And maybe they're worried about their portfolio, worried about their money as well. So can you start us with the high level here? What do bankless listeners need to know about macro? What's going on right now? So, Ryan, what they should know is that macro is long-term trends and cycles that intersect with these trends.

And people shouldn't confuse the two. So right now we're in the middle of a very strong cyclical slowdown. Long-term trends, we can debate about those later. But first and foremost, right now, the cyclical macro environment we are will dominate the trend for the next year or two. And the cycle I'm discussing is a cycle that is diametracketion. is symmetrically opposite to the cycle we have seen in the second half of 2020 and in 2021, where both financial money, and we will define money later on,

but financial liquidity, as it's mostly called by commendators, was thrown at financial actors at an unprecedented pace, and the fiscal authorities made sure that real economy money, the one that reaches our bank deposits actually, was also increased at one of the fastest paces ever recorded under my metrics. There was the dual real economy money and financial economy money that was thrown at the system at once, at a very fast pace. And that led to the very sharp nominal growth increase that we have seen in 2021 and the inflationary pressures we are seeing now upcoming in 2022. But remember, Ryan, David, and the listeners, macro cycles and money generally works with a lag.

And so as 2020 and 2021 has happened and we now see the lagged effects of those, what's happening today actually will see its lagged effect happening in 2023 and 2024. Some of those locked effects are already happening and what effects am I talking about?

I'm talking about the effects of reversing the extreme money inundation, financial and real economy money that we have seen in 2020, 2021. So bear with me for a second. you have, when it comes to real economy money, when is the last time that the US government sent checks at home to people?

That's April 2021. It's been a year and a half since we have had the last meaningful fiscal impulse in the US. I can say the same for Europe. If you look at China, they're leveraging very, very aggressively at the moment. So the bank accounts, the real economy money of the private sector is now not growing anymore,

not nearly as it was in 2020, 2021. What about financial economy money? Well, the Federal Reserve and other central banks are in the process of making sure that that shrinks too, and that's quantitative tightening. It's the process of removing financial economy money, also called liquidity from the system. So now we're going to be seeing the lagged effects of this double tightening of real economy money and financial money. In the second half of this year, we are already seeing that, and then in 2023 and 2024. That's a cycle we will be in going forward. I think that's a really interesting way to parse apart the two kinds of money in the economy.

You're defining two different kinds of money, the money that we as individuals might interact with, the numbers that we see in our bank accounts, the cash that we keep in our wallets, and then what you're calling financial money, which is, I think, just like perhaps like a larger institution money, bank-to-bank money, things inside of what we call like financial system TM. And you're saying in 2020 to 2021, the paradigm was those, those, both of the supply of those two kinds of monies were just like going up bigly. That's what the paradigm was. And now the new paradigm is the inverse of that, where in 2022 to 2023, we got to pull that.

The leadership financial system has to claw that money back. So we're doing interest rates. The money's got to de-leverage the system. And you're saying that there's a lag time between what is happening versus what effects that that will take on the economy. Is that a fair synopsis of what you just said? That's a perfect summary, David. And the most complicated part is understanding that there are these two tiers of money.

The money that people use, the money that corporates use, is not necessarily the same money that financial institutions use, bank use, pension funds use, asset managers use. That's a financial form of money. 2020, 2021 was a combination of both tiers of money going through the roof. right now we have a combination of both tiers of money getting effectively destroyed or at the very least the amount of money creation in both tiers actually slowing down very aggressively and if you give it nine to 12 months 15 months in some cases growth slows down earnings slow down inflation slows down risk assets have a problem and actually if there is anything that works in those environments it's mostly cash or very defensive assets and that's effectively what we have been seeing in 2022 right

that's just the beginning, I would say, of the lagged effects of the double whammy monetary tightening that we are seeing since the very beginning of 2022. So is it fair to claim that because we saw inflation come in with a lagged effect, we had money issuance, money distribution, and then inflation six to 18 months later, you're saying like, well, that same effect of lag time will also happen for deflation. So, like, really, the already high-level takeaway is that throughout up to, maybe throughout, the 2023 and beyond, we're going to be in a deflationary environment. I would expect that there is no valid reason for which, cyclically speaking, David and Ryan,

as we have seen a nominal growth pick up, so real growth and inflation, both picking up in 2020 and 2021, we shouldn't see the reverse effect happening, where both real growth and inflation at the same time, slow, pretty aggressively in a disinflationary trend going into the second half of 2023 and 24. Remember, you always need to face in a lag. Some of these things work with a lag. The typical example is the housing market and inflation. So if you look at the housing market, basically in 2021, the second half especially, it was

incredibly hot. And that's because mortgage rates were very low. That's because people had received the boost to their income on top of that. So they had a lot of firepower to go and boost these house prices. Later on, rents also started increasing very aggressively. That was a story of the first and now even, second half of 2022, when this rent inflation plays into the overall inflation measures that the Federal Reserve is tracking.

Now, guess what happens? Mortgage rates have gone to 7%. In incomes are not growing anymore as they used to, in real terms, especially they're shrinking, which makes the housing situation completely unaffordable. So what will happen is that, again, with a lag, going into 2023, 2024, house prices are likely to fall, housing activity will fall, jobs will be lost, rents will stop going up,

and therefore also the housing-related component of the inflation basket will start going down. So again, it takes a little bit of time for this monetary phenomenon to feed into the economy and in asset prices, but ultimately, with the lag of generally 9 to 18 months, depending on what you're looking at, they do feed into real economy activity and asset prices. And you're just using the housing market as a microcosm of many other industries as well, right? Like maybe it's an easy narrative to explain in the way that like,

okay, housing market was once hot, now it's cooling down. And as a result of that cooling down, we're going to have like a drop off in the housing labor market and that's going to impact the economy. And I think you're just using this as a story that is probably true of many other industries as well and perhaps the global economy. Yeah, that is correct. So the reason why I'm using the housing market is because it's gigantic. It's because it's intuitive. It's because it's leveraged and it's because it's on everybody's balance sheet at the end of the day, either via rents or via mortgages or owning a house. So it's something that is very familiar, but the housing market represents roughly together with these ancillary activities in the US, around 15% of US GDP.

It's a relatively large sector because of its very, you know, relevant nature for everybody and because of its leverage nature, 87% of transactions in the US housing market are backed by a mortgage, which means that interest rates moving up or down, financial liquidity moving up or down, have a very immediate and leveraged impact on the housing market, which is also a large portion of the overall economy. That's why I've used it, David, but in principle I could have made similar assessment for European corporates or Chinese corporates or anywhere else. The principle remains the same.

If you throw real economy spendable money out, which means you increase the amount of bank deposits that we own, that corporates own, with a lag, will be inclined to actually spend some of this money, boost nominal economic activity, make earnings go up, make the economy grow, which was the story of 2021. Now, if supply is also bottlenecked, then inflation obviously goes up because the demand is artificially pumped up, while the supply can't be pumped up, and so you also have inflation. But now we are reversing that, and we are reversing that very aggressively, not only by stopping the real economy printers, so government deficits in the first place, but also by removing financial liquidity from the system.

And that's the job that not only the Federal Reserve, but also the European Central Bank, is now keen on doing. It's really interesting, Elf. So I think a lot of people, they're scared to kind of think about macro or talk about macro because it seems complicated. But what I love about the story that you just painted is pretty damn simple. All right. So just to kind of recap, we had this money creation period, both real and financial money,

2020 to 2021. And then nine to 18 months later, we pay for this type or the ramifications of that sort of money creation event start to show up. And we see that in asset prices going up, home prices going up, inflation going up. And that has been the story of the last 24 months. We've seen the effects of that money creation. Now we flipped and we're in a money destruction period where real and financial money is being destroyed, not being created, it's actually being destroyed. And so what can we expect on the other side of that? House prices to fall, asset prices to fall, jobs to be lost, incomes going down, and also inflation going down as well.

Will this be the remedy for inflation, do you think? Yes. Secretically speaking, I don't see any major reasons why. by such a withdrawal of accommodation from the system shouldn't result in the same move down in inflation. And Ryan, this is when I want to stress out that I'm talking about cyclical slowdowns and cyclical pickups. Right.

Remember at the beginning when David asked me about macro, you asked me first question about macro. I made a distinction between cycles, cyclicals, and long-term trends, right? So we're talking about the cyclical trend here. I would argue that we saw a cyclical upswing in nominal growth and inflation, we're going to be seeing a cyclical down swing now in inflation as well. When it comes to long-term trends, we might open another discussion.

And also when you, obviously, when investors look at crypto, look at other asset classes at investment decisions, their time horizon can be very long, especially if they're very young and they want to invest in something for the next five to ten years. Nevertheless, risk management through micro-cycles is very important. So I always want to talk about both. I want to make sure that people have the right frame of thinking when approaching macro. So the trends are maybe a different story, but cyclically speaking, I do expect inflation to slow down. Yes, in 2023. And Alth, this money destruction period, it sort of started happening, would you say, at the end of 2021, but definitely into 2022. Is that the case? And so this is why you're saying, like, we can expect to pay for that,

like now and for the next, you know, nine to 12 months, nine to 18 months into 2023 and 24. Is that a rough timeline of this cycle? So, Ryan, I build a metric that encapsulates and proxies the growth in real economy money. So financial money is one tier and real economy money is the other. So I try to measure whether us as the private sector and corporates are actually getting our bank deposits pumped up or not, or to which extent is this acceleration of real economy money there. And under that G5, so the five largest economies, basically,

pulled together that credit impulse metric basically peaked in the fourth quarter of 2021. Now, very punctually, if you ask me, nine months later, so roughly by the half of this year, the first half of this year already, we started seeing the first signs of forward leading indicators actually slowing down. PMI service went down, the first cracks appearing a bit in earnings, some companies were more defensive when announcing earnings. Now, we have seen in these earnings releases that Amazon and other large companies are starting to see some hits when it comes to earnings, right?

Those are very large companies, systematically important global companies. You are seeing very evident economic slowdown already. Now, how long does it take for inflation to slow down? That's next lag. And here, Ryan, people should understand that in macro, there are forward-leading indicators, coincident indicators and lagging indicators.

Now, credit impulse is one of the most forward-leading indicators of all. It tells you whether real economy money is being printed or not. And that peaked in Q4, 2021, and after that, it's been slowing down. Six months later, survey forward-leading indicator, PMI service, ISM service, other surveys, actually start to decline. 12 months later, so round about now, you start to see earnings declining. Next leg to fold is going to be the labor market. The labor market is a coincidence indicators.

Companies will actually first try to cut discretionary spending and only later on adjust their head count if they see the economy is lowering down. It's not an immediate process. So the next shoe to fall will be the labor market, somewhere between next quarter and a quarter after that at the beginning of 2023. And only when the labor market cools down, Ryan, you can have wages cooling down, which means the nominal spending power of people also goes down. They'll need to be more conservative, they'll spend less,

spend less, the demand side of the economy will get a big get, and inflation will slow down too. Also, the housing market will have slowed by then, which means that with a lag, rent pressures will be slowing down. All of that, I expect to happen in the second half of 2023, until to the point where in 2024, I expect federal funds rate below 1%. And remember, we'll be picking at roughly 5%, more or less at the end of this year, beginning of next year. I expect Fed funds to be below 1% in 2020. Wow, that's a big change. I want to actually share this metric that you were just referring to the global credit impulse metric. And, you know, one question about this cycle. So again, we're still talking about the cycle. We're not talking about the long term. We'll talk to some of the, talk about some of the long term implications. But what I'm now showing is macro elf's global credit impulse cycle. And one thing I notice here, which is kind of a question about this cycle, specifically. specifically, Elf is, it seems higher.

The high seems higher and the low seems lower than previous cycles. This chart goes all the way back to 2004, if I'm correct. And I want to ask you specifically about this cycle, have the poles, the extremes, the rapid upswing and the rapid down swing on all of our numbers been far more, I don't know, I guess the word is maybe volatile, than previous cycles? What is unique about this cycle compared to the last? Is this cycle different? It's a very smart observation, Ryan, and this cycle was unique for two reasons. The first was the combination of real economy money printing and financial money printing at the same time,

which is something that rarely happened in modern history after World War II. And the second thing that made it very unique is that there was an exogenous shock, which was the pandemic, that basically made the foundations of our leverage system tremble. And it trembled because of an exogenous shock, which effectively led to a response, which was not very easy to measure. The United States printed over $5 trillion in real economy money. This is government deficit,

which means that the government blows a hole in their balance sheet, and it throws money at the private sector without taxing them. That's what it means. It's unfunded money spending, and it ends up on the balance it top us its money that's been spent for us. $5 trillion, Ryan. It's 25% of GDP. This is a warlike fiscal response, even like a large war, I have to say. So effectively, the exogenous shock was an event where policymakers couldn't really measure the amount of stimulus that was needed.

and so they ended up doing too much in certain jurisdictions. The US is a typical example where these ended up overeating the system. And we saw the chart you pulled up there, have you seen these cycles, these wings, right? You pump up the system and then you drain this money creation. Have you seen what happens to earnings? So those orange dots or these blue dots on the chart were actually earnings per share in the S&P 500. So how much the companies are actually growing their earnings year over year lagged. by nine to 12 months.

So again, give it a little bit of time. Give it nine to 12 months to see the effect of this monetary expansion. Earnings grew by 52% in 2021. This is just gigantic. Now, obviously, when you withdraw, now very abruptly, that stimulus, what happens is that you should expect

economic activity to slow down at least proportionally. Also, the other point is that our system becomes more leveraged as we go on. And now we move to discussion a bit to the trends, right? Because so far we talked about cycles.

But the way that our system works is the following. We, after the 80s, we are not able to engineer organic growth anymore. And how does an economy engineer organic growth is by having more people participating to the economic growth, which means labor force growth, good demographics. We have a lot of kids entering the labor force. We have a young population that produces. or and or this population is very productive.

So it's the productivity of labor and the productivity of capital. If you sum up labor force growth and productivity, you obtain what's called potential growth, which is the organic growth that an economy is able to generate without cyclical boosters, just by its own means. Now, in the 80s, potential GDP growth in the US, according to my estimates, was roughly 4.5%. Every year the US would deliver 4% real GDP just by its own means.

Why? Because demographics was good, population was young, productivity trends were good, etc., etc. Now, after the 80s, there has been a massive decline in this trend. Demographics has turned against us. The population ages. We have much more retirees than new people entering the labor force. In many jurisdictions over the next 20 years, the labor force will shrink. Think about that. It's like the pie of people contributing to economic growth will become smaller. How can you expect an economy to generate organic growth year after year

if there are less people contributing to economic growth? Via productivity, maybe. Yeah, sure, we have had some productivity pickups. But as technology has already widespread pretty aggressively through many sectors, the marginal productivity increase every year becomes a bit more complicated to engineer. We still grow in productivity every year, but we have already done the bulk of penetrating technological advances to our sectors, which means that if I take Germany, German potential growth, real growth,

just looking at demographics and productivity, is roughly 0.7% a year. Which politician will accept an economy growing at 0.7% a year? That's like a Japan stagnation kind of environment. So what do we do? Well, we give it a booster. We give cyclical boosters to our economy, which means we create credit, we create debt. We basically lever up our spending power today, borrowing from the future. We lever up our balance sheet.

We go to a bank and we ask for a mortgage, a bigger mortgage, a bigger and bigger mortgage to be able to afford a house that otherwise, with our means, we wouldn't be able to afford. It's credit creation is the process of levering up the entire economy balance sheet. And now if you sum the public sector and the private sector, balance it, if I take total economy debt in China, in Germany, in the US, in Japan, everywhere I look, we are anywhere between 300 and 400% of GDP. Because we keep doing the same. We lever up at this round and then we make leverage cheaper.

Interest rates are lower at every turn. And now borrowing at 4% allows you to borrow this much, but borrowing at 3% allows you to borrow more and then borrowing at 2% allows you to borrow more, etc, et cetera, et cetera. So this is the process we have been ongoing for now 40 years. And this process is just there

to make sure we can supplement very poor organic growth with cyclical boosters. And that also explains Ryan why you see these cycles being every time having a higher top and a lower bottom, basically, because you're trying to lever up the system more and more at every iteration. Alpha, we definitely want to talk about the longer-term theme here

because it does seem like maybe the plane is running out of runway, right? I mean, we've tried this act a few times. I also want to talk about kind of the precision of the cyclical analysis that you're presenting us because I like the simplicity of it, but I also like the kind of the cause and effect nature of it. It's we did this thing, right? and then this is the cause and we see these effects on the other side of things. And so when I hear a lot of people talk about macro, it's all, much of it seems like very

probabilistic. Like this could happen and this could happen. But like you're kind of saying, no, this is this is sort of an inevitability. I'm picturing like a python eating a rat or something, you know, for its breakfast. And it bites and then, you know, the rat has to like travel through the rest of its body. And that process might take some time, but that is exactly like it has to get to the into the Python's body and be totally absorbed by it. And that's just an inevitability. And that's what you're presenting as kind of the cycle.

I guess maybe a question to you, though, is is there any way to avoid this sort of cyclical outcome? Like this talk of soft landings, right? Is this just fed speak? Is this just banker speak? or is the plain speak reality that maybe if central bankers didn't have to put on an act, maybe they'd just be saying, look, we did some things and we created a lot of money, and now we have to absorb the rat, basically, and this is the inevitability of what's going to happen. Let me ask you, is this totally prescriptive, or can we get around this somehow?

Can we get a soft landing? No, we can't. It would be my answer. Now, the issue is, of course, I also think in probabilistic terms, Ryan, and what I describe might come across as inevitable, but I managed a very large investment book. I have been proven wrong plenty of times, and therefore I am very aware of having to be receptive

to the fact that your base case probabilistic scenario might not play out, right? So what I say is what my macro models and indicators actually tell me ahead, and I assume that to be the base case and that's probably coming across as very, very strongly opinionated base case because it is.

When it comes to central banks speak, that's another of funny experiences I've had the chance of going through when I was running this $20 billion book is that when you go and talk to policymakers, to be honest, Ryan, all they want to say is what the prescription tells them to say.

And the prescription is to come across as very balanced, preserving the status quo, and preserving a controllable outcome. That's what they want, right? So if you think about it, I found very impressive that Powell at the Jackson-O speech in August, he went outside this normal prescription. I'm quoting him now, at top of my head. He said something like the pain that households will need to go through to bring down inflation is an inevitable consequence

of the process of tightening monetary policy. Now, he's talking about households experiencing pain. That's not central bankers' jargon. Now, Jerome Powell, who's rumored to have redacted his speech completely a few hours before the Jackson whole speech, it's a very strong indication of how uncomfortable policymakers are at this stage. Because not only this is not a status quo environment anymore, controllable environment anymore. Not only that, but actually it's way beyond any

comfortable zone area, which makes them want to move even more than proportionally aggressive. They need to act and put themselves in front of the curve to try and regain that little credibility left before it's totally lost, which makes them want to act very, very strongly. I saw you put up a screen with the, with these exact words. I'm not sure I quoted him perfectly, but the gist was that one. Alpha, a lot of listeners, both Ryan and I are millennials, and so we remember when we're younger going through 2008, and that was my first experience of like, oh, an economy is this thing that can be bad sometimes, and I think that's just like a memory that a lot of bankless

listeners have. When we say that there's this coming era of deflation and depressed market activity and less growth. The only frame of mind I have to compare this to is like 2008 and like the years after that while it took like years and years to recover and produce a normal economy again. How when we use that as our anchor point, like how and we talk about households going through pain, how much pain we talk in? Like how are people going to feel? How is the average US economy worker going to feel over the next like two years? I expect the year. I expect the year. US to lose about 2 to 2.5 million jobs next year. That will bring unemployment rate up to roughly 5.5 to 6%, which is a pretty high unemployment rate for the US, but if you think about

it in historical terms, it's not skyrocket high. Nevertheless, we're at 3.5% now. To move up to six in one single year, it's quite a lot of pain. The historical parallel that I like to draw year, David, is for the older listeners, it's late 2000, beginning of 2001. I wrote an article on the macro compass. It's free for people who want to check it out, which really compares today with that period. I see a lot of parallels. Now, bear with me for a second. In 2000, we saw a dotcom mania. Anything that had a dot com after its name was growing, you know, at whatever, it was basically doubling in share price in a few months. Can we say the same about the excessive risk-taking we have seen in some of the tech stocks,

in some of the alt-coins, in some of the more risk-intense risk-taking corners of the market? We might want to say the same, right? We have seen ARC, for example, dropping 80% now in basically a few quarters as the result of that stellar increase, that ARC or any other, I'm using ARC, I could use any other high-beta risk-intense asset cost. out there. Second thing, inflation back then was over 4% for five quarters in a row. Now, today it's much higher than 4%, but it gives you the idea that inflationary pressures were persistent and way above the Fed target, which also limited the ability that the Fed had to accommodate

in case things got worse because inflation was way above their mandate. We also had, at the end of 2000, the first quarter where earnings started to wobble. Does it remind you of anything? With a lot of earnings downwards we have seen today in very large companies, we have seen meta, we have seen Amazon, you know, we have seen some of these earnings actually starting to wobble. Now, what happened in 2001? Because now if this parallel works, we're basically looking into 2001, like now we are looking into 2023. What happened is that earnings dropped very materially, 10 to 15% in 2001. That's a pretty sharp drop in earnings. In earnings, unemployment rate shoot up, and inflation started dropping only later on in 2001,

which also allowed the Fed to cut rates by 150 basis point in six months. Pretty decent cutting cycle, right? So then what I did is I looked at asset classes performance. I looked at, okay, what happened when the economy was weakening enough that bad with labor market losses, with earnings dropping, that it forced the Federal Reserve to cut interest rates? what happened to asset classes. Now, equity markets dropped another 15%.

The dollar kept appreciating, even if the Federal Reserve was cutting rates. That makes me think that this Fed pivot that we often hear about that has been so misplaced this year, when and if it happens, it happens probably because things have gotten so bad in the real economy that there is nothing to be happy about

the Fed pivot in the first place. Now, there will be a point when the Fed is easing enough and economic damage has already been done and incorporated that we will have a very good buying opportunity for risk assets in general. Another cycle where to basically pick up this lack of what's been left on the table, but I don't expect that to happen anytime soon. And I think, I definitely want to get into that conversation with risk assets and their future. But in order to get there, I kind of want to start with the bond market. because all things start with the bond market, doesn't it? And there was a tweet that Ryan and I talked about on a couple, like, Friday weekly roll-ups ago, that the tweet was about, it was a graph that compared the volatility of Bitcoin to the volatility of the 10-year treasury.

And for the first time ever, Bitcoin is less volatile than the 10-year treasury. And, I mean, crypto right now is actually very, very just like volatility depressed. Things are kind of flat right now, so we're in this unprecedented flat moment. But still, the point still stands when the 10-year treasury is more volatile than Bitcoin. That's definitely like saying something. And when I first interpreted this tweet, it was kind of like a victory lap for the crypto industry. It's like, look, our industry is becoming more stabilized, it's becoming more mature. Like we always knew that crypto would become less and less volatile as it got bigger.

And we're seeing some of those first signs of that. And then after reading your articles and consuming some of your content, I would then realize that perhaps victory lap of celebrating the volatility. of the 10-year treasury market is not actually the thing to be happy about. Alf, could you walk us through the significance of volatility and spreads in the bond market and kind of what it means for everything else? The vital question for investors right now, David. The levels of realized volatility in the treasury market are the highest since the great financial crisis, effectively. And let me walk you through what does this mean for asset allocators.

Now, I always like to think in big picture. terms. So try to picture with me a pyramid. And the pyramid has several building blocks all the way up to the top. And the base, the very base of the pyramid, the layer which is supposed to be the most stable is actually the bond market. With the underlying repo market and all the money markets behind, those are the very basis of the pyramid. Now we are shaking this base very aggressively with this high level of implied and realized volatility. What does this mean? Okay, who are the way of in the market. The wheels in the market are institutional allocators, pension funds, banks, you have asset managers, the BlackRock, the PIMCOs, the large pension

funds, the sovereign wealth funds, you need to think about those. They have asset and management of several trillions of dollars, trillions of worth of dollars. Okay, so these guys have an asset allocation mandate. They can buy bonds, they can buy equities, they can buy credit, they can buy commodities. The bond market is a bonds are often a decent allocation of these guys. And there are structural reasons why. So if you're a pension fund, imagine that on the liability side, what you need to do is you have this pension premiums,

pension contributions, you need to service in 20, 30, 40 years for your clients, right, which makes you prone to interest rate volatility. You have this fixed cash flows. You have to service in 40 years. In the meantime, there will be a lot of interest rate volatility. And you have some returns to make on the asset side to make sure that you can pay these pensions over time. So therefore, you need to generate returns

and you need to hedge some of this interest rate volatility that happens to hit your liability side. An asset that generate returns and hedge its interest rate volatility is a bond. A bond allows you to generate a certain fixed returns at a fixed income instrument and also allows you to hedge this volatility over time. Now, that makes a pension fund a natural buyer of bonds.

It's a big whale that naturally will be buying bonds. A bank, same story, by regulation banks need to own liquid assets. Liquid assets are assets that can be liquidated very quick or repoed in the repo market and transformed in cash very quickly. So if depositors come all of a sudden and withdraw their deposit very quickly, banks can service this deposits. It basically limits the risk of bank runs effectively. It's new regulation being put after the great financial crisis, which makes banks big buyers of bonds because the regulator has told them that they need to own liquid assets. assets. Okay, so basically they will be buyer of bonds, naturally speaking over time. What happens if the asset class they count the most on for fixed returns, stability, low levels of volatility,

what happens if that asset class becomes very volatile? What happens if the base of the pyramid becomes very volatile? The second, third layers of the pyramid are credit, corporate bonds. They are mortgage-backed securities, equities. They are riskier trying to. of this pyramid I just discussed. If the base is very solid, it's very stable, pension funds, banks will be looking for additional returns. They will be looking for taking a little bit more risk up the pyramid because the base fulfills all their basic needs.

And as that is stable and volatility is very low, they can buy credit spreads, they can buy equities, they can buy mortgage-back securities. But now make the base shake. When the base shake, obviously what these investors will do they will be forced, mechanically forced, to divest the riskier investment at the top because if the very basis is becoming shaky,

imagine what happens at the top of the pyramid, David. So what happens is a natural risk inclination that brings this large way of large institution to dispose of their investment portfolios that are the least close to their mandate. Their original mandate is to secure risk-free returns and to hedge interest rate risks, not to go and buy some fancy CLO or weird structured housing market bond to generate a little bit of yield on top.

That's okay when volatility is very low. But when volatility is eye in the bond market, they pare back their risk. And I've been there. I've had the CFOs, I've had risk managers, stopping on your shoulder when things are getting shaky and saying, do we really need that Chinese bond that you bought to make 8%? We don't need that anymore. Sell that. So then what happens is a cascading of events where the big whales dispose of their risk assets, puts pressures on price, puts pressures on other investors to dispose of their risk assets, etc, et cetera, et cetera.

And is this what the words contraction or deflation seem to just resonate really hard here where like if we're talking about a pyramid and the foundations of the pyramid are shaking and everyone gets scared, everything is just contracting. everything comes down from the top. And so this is the same conversation as like when we say an economic contraction or an economic deflation. These are the same words. Yeah, basically, yes. So you need to imagine that if the base of the system is shaking, the edges, the fringes of the system are the ones hit first. So very leveraged companies, emerging markets that are very reliant on external funding. hey, nowadays not even emerging markets,

you can say the same for the UK or Europe. Have you seen where the pound or the euro went? So if you shake the very core of the system, what happens is that the most exposed, the most fragile, the more leveraged fringes of the market than to suffer first. And that's what we have seen. The second thing we haven't really discussed about

is that you can move the base of the pyramid in two ways, really. You can make it shaky, make it very volatile, or you can literally withdraw some of the base from the system. Like, have you seen one of these games where you can just withdraw a single stick of wood from one of these towers and you can still keep it in balance? Yeah, Jenga. But right now, what we are doing is we're withdrawing small pieces of woods from the very base and those pieces of woods are financial money.

We are making sure that the Federal Reserve balance it shrinks, but most importantly, that bank reserves, which are money for banks, money for the financial system is getting withdrawn from the system. So bear with me for a second. So the bond market is shaky, and banks have less bank reserves, which are money for banks. Now, these bank reserves, which shrink effectively when the Federal Reserve shrinks their balance sheet,

there is a lot of monetary plumbing into that that we can cover if you guys want, but simplistically speaking, if the Fed shrinks their balance sheet, bank reserves will shrink too. And when these bank reserves shrink, what happens is that banks have less money for banks. These bank reserves are used to settle transactions with other banks, to do repo market transactions between banks, to buy and sell things between banks.

And these bank reserves do never enter the real economy system. Never. It's just a separate tier of money. But now you're reducing these reserves. So banks have less liquidity for banks. which means obviously at some point they will be less keen in engaging with a lot of liquidity providing transactions because they themselves have less liquidity for banks, right?

So why would I want to share this liquidity with markets? Why would I want to lubricate the repo market? Why would I want to be very liquidity providing towards others? The more you shrink this base, the more banks will become more risk-averse and more prudent with their liquidity-providing exercise. What happens when you dry up markets from liquidity is that you increase systemic risks.

Do you remember the 2019 repo blow-off? That was mostly because bank reserves were dropping very, very aggressively as the Federal Reserve was ongoing with quantitative tightening, which reached the breaking point where banks said, I'm sorry, but I don't have much liquidity, bank money for myself. So I'm going to completely stand back and not provide liquidity, not lubricate,

the repo market, which if you remember is one of the base layer of this pyramid. So we are not only making it shake when it comes to price volatility, but we're also making it less lubricated effectively by removing the amount of bank reserves from the system. Arbitrum 1 is pioneering the world of secure Ethereum scalability and is continuing to accelerate the Web 3 landscape. Hundreds of projects have already deployed on Arbitrum 1 producing flourishing defy and NFT ecosystems. With a recent addition of Arbitrum Nova, gaming and social daps like Reddit are also now calling Arbitrum home.

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letting the fuel development environment go beyond the limitations of the EVM. If you want to learn more, there's a link in the show notes to see how you can get involved with a fuel network. So, Health, let me give you a Crypto-Bro fantasy story here, and I want you to, like, you know, bust the bubble or see if there's any truth here. So I think the crypto world sort of sees the base shaking, right? You know, the pensions, the whales, they're looking at their bonds, and they're like, these yields are terrible. I am losing a lot of money on these things. And so the crypto fantasy is that rather than buy more sovereign bonds, for example, they switch out the asset. and they start purchasing Bitcoin, they start purchasing ether, they start swapping into

crypto-based assets that aren't backed by nation-state economies, right? This is like a whole fantasy story, hasn't really happened yet, but this is, I think, what the crypto world hopes for. Maybe not at this stage, but at some stage in this cycle, Alf, you've been in this position. Is there any hint of realism to this? type of a scenario? Will they start to look at other assets that aren't based on the bond system, something that is maybe a self-sovereign type of bond or a commodity type of money? At the moment, there is none, Ryan, to be honest. Just a fantasy. Just a fantasy. Let me give you

an example. As a friend of mine would define it, Bitcoin for boomers, which is gold. That's definition it would give to gold, Bitcoin for boomers. Gold is something that everybody is familiar with in the policymaking circles. Everybody knows gold. We've even had a gold standard. I mean, it's really something that people are familiar with in that circle, in the regulatory policymaking circle, right? Gold sits on most large central banks and Ministry of Finance balance sheets all over the world

as a reserve asset. Everybody's familiar with gold, right? Now, if you're a bank and you want to own gold as a form of liquid asset instead of owning bonds, instead of owning bank reserves, you would decide, again, to go outside the system and say,

I'm going to own an asset that is a form of money that doesn't belong to that financial system in the first place, to that financial design in the first place. Well, that would be something that I guess people would be okay, with when it comes to an idea. And again, gold is a concept that policymakers and regulators are

familiar with. Yet, gold is treated like, can I swear on this podcast? It's treated like dog shit by regulators. So if you're a bank and you buy gold, you get treated extremely bad from a regulatory liquidity standpoint so you do not meet your ratios. The regulators are not friendly towards gold as an asset. And on top of that, you cannot even from an accounting perspective get friendly. treatments that banks are looking for when owning this very large amounts of liquid assets. And we are talking about gold, again, something that these regulators are very familiar with. Now, try to think about Ethereum or Bitcoin in this context. Right now, Ethereum or Bitcoin are basically seen as so-called mark-to-market assets for banks,

which means, yes, you can buy it. Nobody forbids you from buying a future maybe or an ETF that tries to replicate that a exposure, but you are going to be basically treated as if you're gambling on this asset. This will be treated with no regulatory friendliness at all, no accounting friendliness, nothing. And there is no concrete signal that this is going to change anytime soon. Wow. So you're saying this doesn't even solve the problem for that base layer of whales because they're not even buying gold, this scenario. So to think that they would buy Bitcoin or ether is just like a completely.

completely unrealistic. The way you need to think about this is the following. The system is regulated and built around, let's say, a financial system we have designed and used for now hundreds of years. And that system basically makes use of bonds and makes use of financial plumbing that includes the repo market, bank reserves, shadow banking, etc. etc, et cetera, et cetera. That's the prevailing system we have had for at least 100 years. What would be the incentive scheme from regulators? And remember, these regulators are the same

guys that I talked about before when I said they want controllable outcomes, they want status quo, they want something they feel comfortable with. What would be the incentive scheme for them to cause a revolution in that system? There is no incentive scheme. And I'm not saying it's the right thing to do, to completely ignore this. But again, in macro, in investing, it's not about what we want to happen, is about the cards we are given with to play poker with. My mentor always said, ah, it's not about the hand you wish you were dealt with. It's the hand you have that you have to try and maximize. And right now, we have an incentive scheme from regulators and policymakers that completely prevents them from looking for creative solutions to these problems.

you are correctly identifying. Yeah, it's an interesting juxtaposition where all the theory of like crypto, Bitcoin, Ethereum is that we want these things to become the new foundations, the new bottoms, the new base of the pyramid, but still in reality, they are at the very tippy top of this like scale of risk. And so maybe it's just a little bit too idealistic,

a little bit too soon. And Alfa, I just want to like check my reasoning all about one thing. We've been watching the DXY, just climb, climb, climb, super strongly. That is because the DXY is a measure of the dollar, which is at the base of the pyramid, right? And so the dollar climbing to new strengths is indicative. And while Ether and Bitcoin are going down in price, like, that's because the dollar's at the base and Bitcoin and Ether are at the top of the pyramid. That's correct reasoning, right?

You are so right. We talked about the base of the system looking at it from a very domestic system perspective. If you broaden your perspective to a global pyramid, and you look at the base of this global pyramid, you still will find repo markets, the bond market, and you will find the dollar at the very epicenter of this pyramid in the building block. Our system is built around the dollar. Another way to think of it is that the dollar

is the denominator of the good stuff and of the problem. So let me try to explain what I mean. The dollar accounts for 10 to 20% of global GDP and world trades. That's it, 10 to 20. I didn't say 80, only 10 to 20%. Though when you look at how much the dollar accounts for as a share of cross-border payments, effects transactions, bonds issued by jurisdictions not in the US

that want to borrow in a foreign currency, the dollar accounts for anything between 60 and 80% of these transactions. So what I'm telling you is that, let's take Brazil as an example. Brazil exports stuff we need. Soybeans, commodities, oil, they export a lot of stuff, right? Now, to grow their business with the world, they basically decided, together with everybody else, to use the dollar as the denominator of their transactions. Soybean contracts are in dollar, oil contracts are in dollars.

Everything that they export basically is denominated in dollars. Now think of this for a second. If you're a Brazilian corporate and you want to lever up your business, you want to produce more of this stuff, you want to export more of this stuff. You probably will be wanting to borrow in dollars. You borrow in dollars, you can boost your dollar spending activity, and you can then export more stuff in dollars. This is actually what we have done.

Emerging market debt denominated in dollars was roughly $2 trillion, somewhere like in 2000, and it's now $6 or $7 trillion. So we have went 3x on this dollar-denominated emerging market debt. That's all fine and dandy. as long as dollars keep organically flowing towards Brazil. But what happens when growth slows down? And, you know, developed markets don't want many of these soybeans or oil anymore because the economy is slowing down.

All of a sudden, Brazil can't sell stuff denominated in dollars anymore to the same extent it could before. Wait a second. They have liabilities in dollars. They have incurred in debt denominated in dollars. So what happens then? What happens is that you go to the core of the pyramid. which is the dollar. The dollar becomes the denominator of the problem. And everybody wants to

get their hands on the dollar to make sure that they can pay off their debt, denominated in dollars, because they are not getting these organic dollar flows anymore. So it's a dash to the dollar. It's a de-leveraging episode where the denominator becomes the problem. Everybody wants it. Everybody needs it. And so the dollar goes up in value. And the fringes, as you said, David, the extremes, the things that are the farthest away from being the very core of the system are the ones that suffer the most in that environment. That's exactly what we have seen in 2022. We have seen economies slowing down.

We have seen the Federal Reserve making dollar access more tight, more expensive. And we have seen all the fringes. And with fringes, I mean, even the UK, even Europe, has become vulnerable to currency depreciation because they are maybe closer to the core, but they are not the core, the epicenter of the global pyramid, is the dollar, the dollar bond market,

and the repo market. So it doesn't sound like as an investor who lives at the top of the pyramid, if you will, like most of my net worth is crypto assets. It doesn't sound like crypto assets, risk on assets, the fringes, are going to reach new highs until like we get over this like new paradigm

of the market. Like we are the, if we want like new all-time highs in Bitcoin, Ether, all our risk assets that most bankless listeners have, we need to wait for this bond market to stop being so volatile and for spreads to become smaller, right? And we're just going to be probably sitting on our hands until that happens. How long? How long are you sitting on our hands for? So as we see.

What's the trajectory of bond market volatility? So we're talking about cycles now again, David. We had a nice discussion about trends and structural drivers of every. everything, we go back into cycles. So if you look at the timing there, you should expect that basically the double whammy money contraction plays its logged effect through the economy in a way that people lose their job. I'm going to say that very openly. So unemployment rate goes up, inflation slows down and the Federal Reserve can accommodate and make sure that it lubricates the system again, and that the government as well can become a bit more lenient in their

fiscal stunts all over again and then you're again back into the moment where both layers of money actually are thrown to the system not withdrawn but they're thrown to the system once that happens you allow a little bit of a lag and risk sentiment will be building up again so these cycles generally take roughly one and a half to two years which means you are already in the cycle itself you have seen Bitcoin Ethereum all major crypto in digital assets take a drawdown which was to be expected, and it's easy with hindsight, but if you follow the line of thought

and the double Wemimmonetary line of thought I just followed was to be somehow expected. Now you are in the middle of it, most likely you will get, I would say, another leg of weakness upcoming. Once that is cleaned and the bond market has stabilized, that should happen roughly in the second half of next year. I would expect that the labor market

has already taken a large hit enough when inflation is slowing down enough that the Federal Reserve can be more a commodity. So when that happens, as you go into 2024, you will have a completely different setup. You will have also what I call the tourists of an asset class being flushed away. People that are in the asset class because it's a momentum thing. It's not something they really understand or they are comfortable with. It's just a momentum play.

Those would have been completely washed out. And the set of macro circumstances will look much more favorable for, risk assets in general, including digital assets at that point, but unfortunately I can't see that happening much earlier than late 2023, unless if I'm proven wrong, the Federal Reserve decides to stop tightening the screws much earlier than what I expect. But that would mean that inflation has already slowed down or that the Federal Reserve is happy with inflation at 6% or at 5%. And I don't think they will be happy because it doesn't fit their mandate. It doesn't make regain any credibility to the central bank itself.

So I think this fits into the broader conversation of like, when pivot, Fed, like Fed, please pivot so my assets can go up up in price. What I heard from you is 2023. It was just going to be a year of flat, maybe down. But, like, you kind of painted a picture of like, well, there is a timer on eventually the, quote, Fed will pivot. What's going to make the Fed pivot, though? Like, what are the indicators that we're really going to be looking for?

So there are two ways to pivot, and neither of those is a good one, which is there is a systemic liquidity crisis that will make the Fed pivot between brackets. If the base of the pyramid is at risk of being destroyed, then the pyramid wouldn't exist anymore, and nobody wants that, policymakers included, so that make sure that that doesn't happen. Now, that kind of systemic risk means a blow-up, in the repo market or treasury markets being completely dysfunctional or the repo market blowing up. We haven't really seen any major evidence yet.

The treasury market is becoming a bit more illiquid. It's a function of volatility. If it's so volatile, how can you expect it to be very liquid as well? Were that to happen, the Federal Reserve would need to intervene. Very similar to what the Bank of England did when the UK pension fund industry was about to blow up as well. But that means we are witnessing large systemic risks. Liquidation in risk assets. People need collateral.

They will be liquidating any asset they have first in a panic mode until the Federal Reserve intervenes, which means that probably risk assets will have to have a drawdown before the Federal Reserve intervenes. So it's a delayed Fed pivot that doesn't really help price action before they actually get there. And the second way to pivot would be if the labor market gets hit so bad that inflation starts to slow down

and people are losing their job and they can't spend money anymore. And the Federal Reserve is like, okay, maybe we did enough damage. We can slow down a little bit. And that would be translated into better risk sentiment six to nine months ahead. Now, that I think is the most likely path ahead, which makes me want to think that we're going to see some pain through the real economy and risk assets still between now and the first off of next year. And then, you know, going into the second off of next year,

I think the set of circumstances will be more friendly, for the Federal Reserve to pivot, credibly pivot, not because they want to rescue some asset class. I'm sorry, they don't care about where the equity market is. If it's three and a half or three point nine, actually they care, negatively care, if it keeps rallying because it defeats the purpose. They want demand to slow down.

How will demand slow down if people see their 401K is going through the roof? They would be probably spending more. So they need the labor market to slow down, risk assets to be really contained in order for these lagged effects of tighter, double MMI monetary withdrawal to fit through the economy and only when enough damage is done, they can credibly pivot back. The picture of your painting sounds like the Fed is only going to pivot at the last available moment and not a moment sooner than that.

Imagine, David, they are driving their car looking in the rear view mirror instead of looking in the front window. And that's how they're driving their car. They're looking at the moment when inflation will slow down. Well, inflation is the most lagging indicator of all available. I mean, I rank them by leading coincident lagging. Inflation is amongst the most lagging of all, which means basically they're driving and they're looking back

rather than looking in front. That's by design. That's because of their incentives scheme and their mandate is to slow inflation. And they've been so wrong that they cannot accept any once anymore. They'll be like, I don't care. I know I'm going to make damage. Again, quoting Powell, households will need to go through some pain. Those are the unfortunate consequences, which means I fucked up.

Now I need to gain my credibility. And I will be driving, looking in the rearview mirror. I hope Powell can drive this economy like James Bond then because it's pretty difficult to drive that way. Alpha, let's zoom out. So we talked a lot about the cycle. But I want to get back to this conversation. that you mentioned earlier of like, hey, we've been doing these cycles, these kind of oscillating debt cycles for the last 40 years. And we don't live in the 1980s anymore. This is the 2020s.

And with real productivity declining across kind of the modern world, where is the next leg of growth actually going to come from? And I want to bring in, you know, another analogy that we've seen in the macro world, which is, you know, Ray Dalio's long-term debt cycles and this concept of you have kind of this 80 to 150 year period of time where there is some established monetary order, like a new world order. The world order that we're living in is kind of like the post-Bretton Woods, post-World War II, new order set up in like the 1940s and the late 1940s. And then you had this era of prosperity and you had debt cycles and then a big wealth gap

and debt burst. That's kind of the peak. On the other side of that, you get printing money and credit, revolutions and wars, a lot of political instability, debt and then political restructuring, and then it plays again. The shorter term cycles that you're talking about, Dahlia describes that, well, these shorter term cycles kind of just oscillate around this long-term debt cycle. And so I guess my question is, is this kind of the rough mental model that you use for thinking about the long term. And then like, so how many more cycles do we have, mini cycles do we have until this full debt cycle plays out? And we have to go all the way back to the base layer and establish a new world order. Very good questions, Ryan. And yes, I think along the same terms,

but I visualize this a little bit differently. Instead of this bell curve that you just showed from Dalia as a long-term trend, I tend to think of growth and inflationary long-term trends. And so they look like a straight line up with an angle of growth that really depends on at which point in the structural long-term cycle are you in. And so this was a very acutely sloping, positively sloping long-term line in the 80s because structurally we were growing very strong and we discussed about demographics and productivity.

And now the slope of this curve is kind of flatlining very aggressively. over the world, right? And then around this line you have cycles. You have cycles that dictate the macro cycle we are in. And those are interplaying with each other, but they're really a separate thing. One lasts roughly 12 to 18 months, while the slope of these long-term lines actually changes maybe over a decade, not earlier than that. So right now I see the long-term trend, basically, for growth and inflation being nominal growth in general, being pretty flat, right? And the cycles around being now a downward cycle. Now, the problem becomes when the long-term trending line for nominal growth becomes effectively

flat. And that's basically, I think the roadmap is Japan for that. So Japan had a very upward sloping curve, good demographic, good productivity until the 70s, and then demographics started slowing down and productivity too, and they started printing money and credit like there was no tomorrow. And that was the real estate bubble in Japan in the late. 80s, beginning of the 90s, when the Imperial Palace of Tokyo was worth more than California. So just to give you an example of how much that bubble was going fast.

Now that bubble burst. And what happened then, you would expect, right, Ryan, is that you go towards Dahlio's low end of that chart, which is a restructuring of some sort. You need to have social unrest, basically, that leads to a restructuring of some sort. Have we had one in Japan? Not really. We remain stuck in that printing money and credit kind of thing forever over and over again. And it's been over 30 years that Japan has been in that situation, if you think about that.

The US or Europe are not Japan for a bunch of reasons. So there are also cultural things that come to play here, where in Japan people are coming out of retirement and trying to work more hours to make sure that it can contribute to economic growth. and I can't really imagine the US or Europe going towards the same cultural cohesion kind of path. So the situation is much more culturally fragile in the Western economies.

It's very hard to predict exactly when. But social unrest, I do agree with Dalio there, is one of the indicators that something is brewing under the surface where people are becoming tired of these iterations. Because we're talking about iterations. We're trying to fix a slope that is becoming flat by iterating the same cycle all over and over again. And as you correctly pointed out before,

sometimes it's a higher top and a lower bottom, which makes people very uncomfortable with this cycle in the first place. And the wealth inequality makes them feeling not particularly rewarded by this cycle in the first place. And social unrest, there have been plenty of episodes already happening. I can take Europe as an example where at every election, you get a more extremist government. Being left or right, you get any way people voting for something new, something that sounds a new promised land that will break this cycle. So far, we haven't reached the breaking point, but the more you proceed ahead, especially in Western economies where there is less cultural cohesion towards sacrificing its own good for the public good, let's say, maybe a bit like Japan does, it makes a situation more

inherently fragile. And it's hard to say exactly when, but we are definitely walking towards that path ahead of us. with social unrest, I think, being one of the most evident signals that that's already happening. Is this where kind of the probabilistic analysis comes in of like, what's the probability that we get one more of these kind of cycles before everything breaks and there's a big reset or two more or three more? That's probably impossible to say precisely in the way that you can more accurately predict the shorter term cycles.

But it does seem like we are, I don't know, it's 10 p.m. two hours till midnight, kind of thing. Like the clock is ticking and it's getting later in this cycle. Would you say this? And then also, Alf, like,

how do we get out of it? Is there a way to actually transition peacefully? Or is this just not the way of human beings? There is no new world order or a transition to something that doesn't exist

that involves power because that's what we're talking about. We're talking about transferring power from one source to another. And there is no transmission of power. that goes on in a very friendly way in history that I'm aware of. Right? So that is by definition.

And the last comment I want to say is that there is one thing of the engine that suggests to me that we are relatively late in that kind of long-term cycle clock. That is the fact that in order to make this cyclical boom and bust, basically, small cycles within long term trend, you need credit to be cheaper at every iteration. You need that to become accessible. that cheaper rates to everybody at every iteration. Think about the housing market. If salaries are not growing and you want the housing market to grow 10% a year,

the only way to do that is by making the new mortgage actually cheaper than the old one. So you borrow at 2% a house worth $500,000. If the next guy can borrow at 0%, all of a sudden that house is worth much more, simply because you lowered borrowing rates, not for any other reason. Salaries haven't really changed, right? This iteration tends to stop when you reach interest rates at 0%. So Japan hasn't been able to engineer this credit booms anymore because rates have been at zero forever.

So the next marginal buyer doesn't have more power. He has exactly the same borrowing rate that the guy before him had. And so house prices in Japan in real terms have grown by 0% for basically 10 years. So this wealth generation effect, this cyclical credit booms that we do, become more difficult when interest rates are pinned and you can't really lower interest rates for the next borrower to feed this cyclical credit upswing. Now, we have gone very close to that point in Europe and in the US, and now we have a room where rates are very high because we need to fight inflation.

I do expect Fed Fund's rate to be below 1% in 2024, which will make the new credit iteration, the new credit cycle marginally more difficult at every iteration. until you reach a point where, yeah, you want to generate credit, but rates are already at 0%, where are you going to bring them, which makes the new borrower less powerful on the margin, let's say. So this cycle tends to become a bit less powerful than it was in the past. And this might be a breaking point, actually. And if I'm right on that, I think the next decade or two

might prove to be more difficult to engineer with the same model than the last 40 years were. Elf, one other, I guess, crypto-utopian perspective is the potential and the promise of technology. I mean, we are big believers, obviously, in the technology to drive improvement. I remember reading, listening to a podcast from Tyler Cohen, who's an economist in the U.S., and he wrote this book called Stubborn Attachments, where he makes the case that in order to have a peaceful society that exists or a democracy of any kind, you actually need growth. Because if you have negative growth, everything fractures. People start talking about how to split the pie rather than grow the pie and you have political divide and you have division, which leads to wars the civil kind or wars of other countries and the election of autocrats and everything that falls from that. So growth is an imperative.

And as you look at kind of like the true productivity levers in sort of your macro exploration, how do we actually generate productivity in a world where we've got declining demographics, for example? I mean, some pockets of the world have better demographics, Africa, some emerging markets, certainly, so maybe there's hope there. But in kind of the fully emerged world, Western democracies and such, is our way out technology? Is that the only way we actually achieve positive, real economic growth? And is there a story there? Is there some hope that you see in the numbers from this? Yeah, so there are two ways. One would be a 2020. industrial revolution of some sort where instead of industrial revolution you basically have a new discovery that all of a sudden changes the productivity slope completely like like it was for the

industrial revolution for example and the invention of the motor back then now the today i mean what's the probability of that i don't know it's a one-off event very low probability high impact event that we have a discovery of some sort that boosts productivity all of a sudden the other way to boost productivity growth over time is to make sure that technology permeates as many sectors of the economy as possible. And today the economy is service-based for roughly 70% of our output,

which means that the technology has, most likely already permeated a lot of the services sector. I mean, look at us, you guys are in the US, I'm in Europe, we're having a chat over, I don't know, whatever Riverside we're using, but any, any... 1080P, high-deaf, fidelity, yeah, It feels like you're sitting right across from the elf.

Yeah, there you go. So that kind of technology, one might argue, has already decently permeated the service sector. Not all the service sector, but to a certain extent, yes. Which also, when I hear that technology is going to increase productivity, I'm like, where is the marginal gain going to come from? You will be increasing your productivity. Yes, you will. Every year productivity in the U.S. grows by roughly 1%. More or less, maybe a bit more.

If you want a productivity boost that more than offsets the population declined, demographics, headwinds we have ahead of us, we need some sort of one-off boost, which might happen. But I find that to be a low probability event, high-impact event, that is very, very hard to predict. Elf, was the internet such a, you talked about the Industrial Revolution, which is beyond the, obviously, the age or a time range of anyone listening. But how about the internet?

That is a major innovation. Did that show up in the numbers of increasing productivity? It could. It could especially if it would unlock some potential that is for sure. Unfortunately, very undertapped and underused, especially in certain parts of the world, that had not much access to productive Internet over the last decade. So that could be actually one way to untop some productivity growth, which haven't been there. I only wonder whether those will be systematically important to offset the basically certain demographic edwins that we have ahead of us.

If I look at labor force growth over the next 20 years, most Western economies, and China included, by the way, will have their working population decline. So the pie when it comes to people contributing to economic growth, that pie actually is getting smaller. So we not only need productivity, but we need fast productivity to more than offset that working population drop. And that's going to be quite a hard task, I think. Lots of headwinds ahead for us, Alf. But I think there is hope while we remain building and while we have these open conversations about these topics and stay educated. I mean, in previous events like this throughout history, very hard to find someone as knowledgeable as yourself to actually talk about these issues. So it's a big step in our ability to actually keep ahead and be educated on topics like these.

Now, if I want to thank you for making some time for us today, I guess do you have any closing thoughts for bankless listeners, anything you would summarize for us? Yes, I would say macro is important for investors in all asset classes, and 2022 has proved to be exactly a very clear example of that. And macro might sound scary. I know that. I understand that. It's full of jurgren. it's very complex, but it's beautiful. You need to get your hands dirty into monetary mechanics, how money works, how economies interact with each other. And understanding macro is an exercise of basically trying to put together a never-ending puzzle. It's always a discovery.

It's a learning journey, effectively, that will make you a smarter investor, whatever asset class you're involved in, including digital assets. I think macro is so important and has been so underrated for so many. years. I'm happy to a certain extent that this environment has been so macro-volatile that voices like mine, but not only mine, there are plenty of good guys out there and girls are now getting to share some of the knowledge that I have or we have accumulated when, especially me working in the institutional setup, having the chance to talk to prime minister, central bankers, understanding their thinking, talking to hedge funds, being a portfolio manager myself, I encourage every

bankless listener to try and get themselves more into macro because it's the place to be to understand really what's going on and getting an edge also in the digital asset space. 100% agree. I think bankless listeners, you've got to add macro to your portfolio of skills in this space. And Elf, thank you for simplifying some of these contacts for us today. We appreciate you. It's been my pleasure to be here. Thank you, guys.

Some action items for you, Bankless Nation. Number one, you've got to check out Macroelph's blog. That's at the MacroCompass.ubstack. dot com will also include a few goodies for you in the show notes, including a link to the global credit impulse cycle that we talked about during this episode and Alphs post. Is it 20, is it 2001 again? That's the big question. We got into that post called Back to 2001. That's free for everyone. Of course, risks and disclaimers. Macro is risky right now. So is crypto. Everything is, I guess, in the world today. But especially crypto, especially D5.

You could definitely lose what you put in. None of this has been financial advice. As usual, we're headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.