The Breakdown - Lyn Alden on Bitcoin, El Salvador and the Unprecedented Macro Moment

Episode Date: December 22, 2021

This episode is sponsored by NYDIG. Today on “The Breakdown’s” “End of Year Extravaganza,” we’re joined by macro analyst and thought leader Lyn Alden.  Find our guest on Twitter: @LynAldenContact NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our holiday theme music is “Spike The Eggnog” by Two Dudes. The music you heard today behind our sponsor is “Dark Crazed Cap” by Isaac Joel. Image credit: 3alexd/iStock/Getty Images Plus, modified by CoinDesk.

One is that the market gets more sophisticated over time. And then two, the amount of new coins coming into existence is a smaller percentage of Bitcoin's market cap than it was in prior cycles. In addition, miners, especially in North America now, are holding a lot of the coins that they mine. So they finance themselves with debtor equity. And then they just retain a lot of their mined Bitcoin. So that influences having. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world.

The Breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, December 21st, and today on the breakdown's end-of-year extravaganza, we have the one and only Lynn Alden. I have sung Lynn's praises numerous times, most recently on my 10 other most influential people. I think she's probably the sharpest analyst, certainly the sharpest analysts who intersects digital assets, Bitcoin, and the macro, and always has a ton to teach you. You can't spend 20 minutes listening or talking with Lynn and not feel like you understand the world and markets better than before. And so with that, I gift you as part of this end of your extravaganza, 21 minutes or maybe even a little bit more,

with Lynn Alden all about what happened in 2021 and what we're likely to see going into next year. All right, Lynn, welcome back to the breakdown. How are you doing? Pretty good. Thanks for having me back again. This should be super fun. I was just telling you, these are some of my favorite interviews of the year. And I think you in particular, I'm really excited because there's so much juicy, interesting macro stuff going on, too. So let's dive right in. And I guess my first question is a big one. What do you think will be seen as the most important economic story of 2021? I would say overall probably the inflation situation because it broke out of a very long, structural, disinflationary trend.

And I think we're going to go through periods of acceleration or deceleration with inflation. It's not like it's, once you have inflation, it just keeps going up. I think we're going to have periods where it cools off. But the fact that we reached multi-decade highs on most types of inflation measures and that that kind of forced a shift in policy, I think is going to be a pretty important moment looking back. throughout this cycle. So obviously on the news headlines now, but I think it also has kind of long-term significance. Do you think that the inflation conversation that we've been having in traditional media or even kind of, you know, alternative media, is the inflation conversation we need to be having? Or is it a little bit too focused on just, you know, sort of the larger game of

Fed policymaking? So overall, I think there's too much emphasis on the Fed and perhaps even too much emphasis on supply chains, although that is a massive component, and not enough emphasis on fiscal spending and overall broad money supply growth, which is different than just bank reserves growing, which is what the Fed controls. Basically, there's less of a conversation about the transmission mechanisms that gets money out into the broad money supply. And I think that's a mistake that both investors and policymakers ran into over the past couple of years, which is that we were generally trained to think that basically no matter how dovish central bank can be, about how much quote-unquote money you print, it's not inflationary.

But what they were missing was that a lot of that just gets stuck in bank reserves. It doesn't actually expand the broad money supply, which is people's checking accounts, savings accounts, currency and circulation. And that if you have that combined with fiscal spending to actually get money out, it could be the type that we did with stimulus checks and things like that, or it could even be just tax cuts that are not balanced by spending cuts. way to do it, but essentially ways to get money to people is actually quite inflationary. And there are some of us that were kind of tracking that and expecting it, but it seems like

a larger percentage of people that I would guess have been blindsided by that fact. And I think that's not getting enough attention how important money supply is for inflation. What is different or what has been different about this sort of inflationary response to fiscal spending as opposed to the first round of QE or the first rounds, I should say, of QE and monetary policy response in the wake of the great financial crisis in 2008. So partially magnitude, but also type. So, for example, if you look at 2008, 2009, 2010, if you look at the money supply, broad

money supply, you can't tell there was a crisis. Nothing weird happened with money supply. And that's because you had some money that was destroyed from bank loans going bad, right? So you had a destruction in credit, which is a destruction of money. So you had a reduction of money supply from that. And that was counterbalanced by, you know, you had QE, but then you also had a fiscal response. But the fiscal response was just kind of enough to balance out those loan losses. So you recapitalized the banking system, but it's not like you went and billed out every homeowner, right?

You know, mostly the top kind of got billed out, not really at the bottom. And that's actually similar to the 30s, but less extreme. So in the 30s, you know, you had massive loan losses and you had an uptick in fiscal spending. but the uptake in fiscal spending was not as big as the loan losses. And so you had an outright contraction of money supply. So after the global financial crisis, it was like that, except it was almost perfectly balanced. Whereas then if you go to the 40s, after the 30s, that's when you had massive fiscal spending without any sort of contraction in loan losses.

And so you had a massive increase in the money supply, which was more inflationary. And then again, we're kind of in the same cycle where the 2020s, unlike the global financial crisis, we had minimal loan losses because we did absolutely. massive fiscal spending, not only to businesses, but also to households, and basically just expand to the money supply to prevent insolvency, with the caveat being that now we have more money chasing fewer goods. And then you combine that with some sort of real-world constraint. In this case, it's supply chains and energy, and especially in European energy, these different constraints, and that's where you get inflation, price inflation.

Just kind of circling back on the supply chain piece, your kind of perspective is not that the supply chain issues that have been identified aren't playing a super important role in this. It's that it is almost a catalyst or something that was going to be a catalyst. Regardless, there was going to be something there like that, that kind of was playing that role. Yeah, I would describe it that there are two really key variables to get price inflation. So one, it's almost a possibility of widespread price inflation without a rapid increase in the broad money supply. Right.

So it's broad money supply increases are kind of unnecessary but not sufficient condition for price inflation. And the other component is some sort of real world constraint. So when you have periods of unusual abundance, like, say, United States in the late 1800s, right, just almost unlimited land, or, for example, Australia during the past 30 years and the rise of Southeast Asia as an economic power is basically well positioned for that. When you have this kind of new market opening up, whether it's new land or new labor or something like that, you can have quite a big disconnect between money supply and private. inflation because you're not really running into constraints. You have tons of abundance. Same thing if you happen to be in the part of a commodity cycle. We have tons of spare capacity and things like that. But if you have that broad money supply increase and you're also running into physical constraints. So it could be labor constraints, could be energy constraints,

could be infrastructure and supply chains. That's your prime to get inflation. So the fact that we know we've already been through a multi-year commodity bear market. So we're not as loose. We're we're tighter in terms of commodities than we were before. And then you combine that with how we've globalized our supply chain to such a degree that, no, the past few decades, it's been very disinflation to outsource all that labor and to have all of that kind of global specialization. But we essentially sacrificed resiliency for that efficiency. And so when we finally got a shock to that system, we're kind of paying the price for disinflation. So it's not necessarily that we have supply constraints now. It's almost surprising we haven't run into this before because we kind of set

ourselves up for this. So I would say, yeah, it serves as a catalyst in the sense that it's one of two really important pieces of the puzzle for how you get price inflation. Super well articulated. So we just had the, when we're recording this episode, we just had the FMC meeting and we've sort of signaled that we're moving into a different period with the Fed. When you look across, you know, what we learned this week or, you know, at the time of recording and what, you know, we're now anticipating next year, how do you think this inflation? story is going to play out. Is the Fed's response going to be sufficient? Are they going to be almost immediately kind of back against the wall? How to politics figure into this with midterm elections?

I guess I'm just interested kind of in your like, if inflation was the big story from 2021, how it might shape the 2022 that we're moving into. So I think the Fed is capable of deflating asset prices to some degree. It can give headwinds against certain types of asset prices. It's hard for it to impact inflation as it relates to supply chains unless they're willing to kill demand, put the economy into a recession. And so I don't really view minor changes as being an impact on inflation. I think the bigger story that could impact inflation is the reduction in fiscal spending. And so 2020 and 2021, we're very big years for things like stimulus checks and child tax credits and things like that. And we still have some unclarity about aspects of the buildback better plan.

So we could get an extension of some of those programs as well as other programs. Some of those have like a slower release time, right? So they're not like stimulus checks that are kind of front-loaded. Some of those are longer term. So whether or not that passes or not, I think it's going to play a role on inflation. But essentially my base case is that we're still going to see housing inflation, keep ramping up for a while. When the semiconductor shortage gets resolved, that's a big one.

That should alleviate a lot of the used car prices that have been a big part. of the inflation basket. So I think we're going to get an ongoing rotation of the types of things that are contributing to official CPI going up. The Fed is tightening, which is interesting because you have to compare where they should be, quote, unquote, should be compared to where they are. So if you go by the Taylor Rule, which is kind of an algorithm to determine roughly where the Fed should be in terms of interest rates, it takes into account inflation and GDP growth compared to trend. And it suggests they should have their rate at 7.5%. And it's funny because if you look at the past 40 years, they spend more time above the Taylor Rule than below it. And of course,

the Taylor Rule level changes based on those conditions. But they spend more time above it. But ever since the global financial crisis, we've been in this high debt period of financial repression where they've spent most of the time below the Taylor Rule. And this is the biggest gap below the Taylor Rule on record, ever since that was invented. We have to go back to the 1940s to find a time where inflation was as hot and the Fed was holding rates at zero. So I think they're going to tighten, but they're still tightening from a position of being behind the curve. And I think that contrary to people that would say criticize them for that, I don't think they really had much of a choice. The choices that I strongly disagree with the Fed on were made two, three decades ago.

And that a lot of these recent decisions are just kind of ramifications. You know, you're choosing between bad options. Like every policy is a policy error. And so it's kind of like pick your poison. And so I kind of just view them as tightening from purposely behind the curve. it has had that feeling of this tightrope where there's almost no good response and no one's going to be completely happy. And so the best you can hope for is it doesn't seem like a total catastrophe as this new policy is being announced. Nighting sponsors this podcast and they are the go-to Bitcoin company for banks and credit unions

as well as corporate treasuries, fintechs, and hedge funds. Learn more at nightig.com slash nLW. That's nydig.com slash nLW. Let's shift over to Bitcoin and the crypto world for just a minute. What do you think was the most important story or event in Bitcoin or crypto this year? I guess it's tricky because it started in 2020 with microchadogy, but I would say 2021 was kind of the year of institutional Bitcoin acceptance and even to some extent broader crypto acceptance, which was interesting. And so, you know, we've seen a number of banks get interested in custodian of Bitcoin or partnering with custodians. in some cases, they're willing to own things like the great scale Bitcoin trust.

They've taken the asset class more seriously because the asset class has become large enough. Once it gets in the ballpark of being a trillion dollar asset class, and then as it has regulatory clarity in some ways, that becomes very interesting for institutions. So I think that's been a big story. I would say maybe tied with that is the hash rate migration out of China. That was kind of like, you know, this longstanding weight on business. Bitcoin, I guess, you could say, is having 70% of the hash rate or whatever the number was at any given time in China.

And the fact of that migrated, so it kind of decentralized and westernized the hash rate. But then also that it gave the Bitcoin network a chance to show how it had 100% uptime while half of its, you can call it, server capacity essentially rotated. Whereas you can imagine if Amazon Web Services was given a weak notice to move half of its server capacity overseas, you'd have really bad disrupt. Whereas all the Bitcoin network did is slow down a little bit and then bounce back. I think so too. I'm actually working through right now.

Before I start to these interview series, I'm going to do my own kind of version of this. I'm going to ask myself, and that's kind of at the top of the list for me as well. You spent a lot of time with institutions in an advisory capacity, just them kind of listening, learning from you. In addition to just what we've seen kind of on the surface in terms of involvement, have you seen a maturation or increasing sophistication in terms of their understanding of, of Bitcoin specifically or the digital asset class as a whole? In my view, yes.

I mean, I, for example, have talked to pension funds, and they can just talk about Bitcoin as an asset class, which would have been unheard of years ago, right? So it's just kind of another asset class for them. It's obviously a very high volatility, unclear asset class for them. But it's an asset class nonetheless. I mean, one of the most surprising things to me is NIDIG's work with insurance companies. So the fact that you have life insurance companies putting Bitcoin on the balance sheet, they were kind of early adopters of that, which I was somewhat surprised by.

I would have guessed that they would have come later. So the fact that there's an interest in the insurance industry on Bitcoin is fascinating. And so overall, I would say that it's overall developed in an interesting way. I think more people have come to realize it. I guess when you look at the broader space, Wall Street got interested in Defi pretty readily. Probably fast than I would have guessed, because I would have guessed that they would have have been more concerned about some of the technical challenges that still exist in that ecosystem, some of the centralization issues that exist in that ecosystem.

But in hindsight, a lot of Wall Street people are not engineers, right? They're not kind of caught up on those details. They understand things like liquidity, arbitrage, things like that. And a lot of institutions kind of adapted to that space. Now, one thing that's challenging there is that unlike with Bitcoin where the regulatory landscape is more clear, that's still a space that has very unclear regulatory. issues that I think are coming. So there's questions like, what is the security?

A lot of things are probably security in the space. And so that's still being sorted out. It would even be a kind of a measure of progress for a lot of these institutions or just the participants within those institutions to be able to distinguish between, you know, Bitcoin, DFIs all as perhaps connected technologically in this sort of digital asset space, but as relatively distinct phenomenon. I mean, is that something you're seeing or is that still kind of, case by case in terms of how much people can differentiate between different parts of the industry.

Good question, because I think that is separating more and more. Some institutions, maybe because they're later to the space overall, they might be a little bit behind some of the, say, the more sophisticated retail that have already made that separation. But I think that's direction that it's going, that you know, you started from like a very small asset class. It was very, very highly correlated and people couldn't really tell the difference between different types of assets. People would think, you know, that other cryptos are types of bitcoins, right?

That's the kind of language. And then there was the popular like, you know, blockchain, not Bitcoin language from years ago. I think we're seeing a separation where Bitcoin is the money play, right? So any other digital asset that tries to be money is like dwarfed in terms of scale by Bitcoin. And then you have the whole separate smart contracts base. And comparing those is kind of like comparing Tesla and gold or, you know, whatever the case may be, not necessarily in terms of returns, but in terms of how different they are as an asset class. And so I do think you're seeing some separation there between the different use cases. What's your perspective on Bitcoin cycle theory at this point?

Are we in sort of in the midst of another kind of four-year-having driven cycle, or is there kind of a break in that into something that's either a super cycle or just a different fundamental alignment? My base case is that the having is going to be less important going forward. I do think this prior to and after this recent having, I expected it to be a big deal. And I think that it was, right? So basically you have the combination of hoddlers buying into Bitcoin and then you get a supply shock. So anyone who follows commodities knows if you get a supply shock, right? If supply gets cut in half, that's generally good for price if demand is relatively

persistent. And even though in Bitcoin, it's well telegraphed, you can pretty much say almost to the day when the having is going to occur well in advance, it wasn't a very efficient market. And so it's not as though people were arbitraging that ahead of time. And it's a time. and until you actually run into the supply squeeze, it's just not really going to go up. And so I think that that was still an opportunity that was kind of just left on the table. I think going forward,

one is that the market gets more sophisticated over time, and then two, the amount of new coins coming into existence is a smaller percentage of Bitcoin's market cap than it was in prior cycles. In addition, miners, especially in North America now, are holding a lot of the coins that they mine. So they finance themselves with debtor equity, and then they just retain a lot of their mine Bitcoin.

So that influences the having. Then you have things like gray scale Bitcoin Trust is now slowly selling Bitcoins because it's trading below net asset value, so it can't really buy more, and it's paying its expense fee by selling. So there's kind of that mild selling pressure. So overall, basically the new supply from miners is a smaller percentage of the network, and therefore it should diminish over time, especially when you have these other dynamics at play.

And so I think there's still be cycles in the sense that there's still kind of the long-term holder distribution cycle where someone buys in, then they have like diamond hands, and then it goes up, you know, five, five X or 10x years later. And then now they're willing to distribute some back into the new buyers that are coming in and in FOMO into that space. And you can kind of monitor that with on-chain metrics, right? So they don't really tell you anything about what Bitcoin's going to do next week or next month, but they give you kind of a context for some of the things that are happening. on exchanges, I mean, off of exchanges, like on chain. And so I do think that kind of hoddlers to distribution cycle is still relevant, but I think that could be decoupled from the clean kind of four-year having cycle. Yep. Let's go kind of broader again as we start to round the corner here. What's something that you're paying attention to that you think everyone else should be,

or you're surprised that others aren't paying as much attention to as you are? I guess I would say a couple different areas. So I would say in the digital asset space, I would say, I don't think enough people are paying attention to the upcoming regulation that's probably going to happen with stable coins and smart contracts in general. I think that's really relevant to pay attention to. I think if we look broadly, market participants are not paying enough attention to how these things could impact global payments. Ever since the 70s, and really going back before then, the global financial system works a certain way. We have these kind of established pipes, for lack of a better word.

And stable coins and cryptos in general, Bitcoin, it goes around that. And then when you also apply that technology to central bank digital currencies, like China, for example, they can go around that. And so you have this kind of, you know, what used to be these kind of big trunks between certain connections gets more web-like. It's just more connected at multiple points. And I think we're going to see a change in how global finance works that I don't think a lot of people have seen yet.

And even people that are kind of watching that slowly play out, it's hard to say what direction it's going to go in different directions in different countries. So on one hand, I think some countries are more adept to regulated stable coins, for example. Other ones will go the CBDC route. Some of them could combine those two options. And then other ones like say, you know, obviously El Salvador has gone on the Bitcoin route. I think you could see potentially a couple other countries do that. So I think in the traditional macro space, not a lot of people are seeing how digital assets could impact macro.

Just dead on. And I think that we're the only glimpse of that we're getting is the sort of regulatory fervor and intensity suggests that there is a gut level sense that these things are significant, right? At least among some regulators. Last question for you, what's one prediction you have for 2022? So it's hard to say because these timelines are always tricky. if we look back at long-term risk assets, this is called the SMB 500, for example, generally they do well during tightening cycles,

which is interesting because people will expect that stocks can't do well when the Federal Reserve's tightening. But actually, raising rates generally is a good environment for equities. And the reason for that is not because the rate increases are good for equities. I mean, they can be good for some financial equities, but for the most part, the correlation is more like shark attacks and ice cream consumption tend to be correlated. And the reason is because, you know, they both happen in summer, right? So, you know, people go to the beach more in summer. They eat more ice cream in the summer. And so ice cream and shark attacks have that funny correlation, even though they obviously have nothing to do with each other. And so rate hikes tend to happen when the economy's strong enough to support them. And stocks generally do well in strong economic environments. You tend to have that correlation. Now, that correlation has been weaker ever since the global financial crisis, where markets have been more reliant on some sort of stimulus holding them up, especially because now.

Now that rates are so low, it's more about balance sheet size, but also rates can matter. And so generally, whenever the Federal Reserve is not increasing their balance sheet, the S&P 500 had trouble going up, you know, ever since the global financial crisis. Whenever you had these consolidations in the balance sheet, you often got a consolidation in the S&P 500. And the only exception, really, to that rule, was in 2017, instead you had, you still had the flat balance sheet. You had rate hikes. you had a really strong stock market, but that was in large part because you had fiscal stimulus coming down. You had basically corporate tax cuts and other tax cuts that were not balanced by spending cuts. So you essentially had a fiscal stimulus, and that was very good for markets,

obviously. So absent monetary stimulus or fiscal stimulus, markets have generally had a rough time. So overall, I mean, after a very strong second half of 2020 and a very strong 2021, I'd be more concerned about some of the broad indices maybe in the most of 2022. Now, going into the year, we're still actually increasing our balance sheet. I'm not necessarily calling a crash or anything like that, but I think we're going to see probably more chop in some of the equity indices. Now, of course, if we pass the biggest version of the build back better plan or something happens like that, I mean, you know, that could certainly deviate from that expectation. But I think basically 2020 is a year where investors would have to make sure they know what they own and at what price.

Lynn, it's always awesome to have you on the show. I appreciate you taking the time. And I hope you have a really wonderful holiday. Can't wait until we do it again. You as well. Thanks for having me. As we wrap up, I just want to say thanks again to Lynn for being here, affirming everything that I said at the beginning of this episode, always enlightening, always fun to learn from. And for you guys, I appreciate you listening. Until tomorrow, be safe and take care of each other. Peace.