The Breakdown - Post-Modern Monetary Theory

Starting point is 00:00:04 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 nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Sunday, March 27th, and that means it's time for Long Reads Sunday. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review or if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pot. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. And speaking of

Starting point is 00:00:52 FTX, the first thread in today's show comes from none other than FTX CEO Sam Bankman Freed, aka SBF. Last Friday, Sam dropped a 50 tweet thread about post-Mod modern monetary theory. And if you are wondering if those of us who work with Sam regularly have any better sense of how he found time to write and drop a 50-tweet thread in the middle of everything else he's doing, the answer is absolutely not. However, the theme of this and the second thread, which is going to be from Lynn Alden, is trying to understand what makes this economy tick and what that might suggest about where we go next. Sam writes, between inflation and recession, post-modern monetary theory, aka number go up.

Starting point is 00:01:37 I should disclaim this by saying I have very little training in macroeconomics, and am mostly piecing this together based on a bunch of different thoughts from people much smarter than I. Much of this is probably wrong, not financial advice. Over the past decade, Western Central banks have increased monetary supply, a lot. Why? Well, let's start with a case where printing money doesn't do anything and then find the differences. Let's say the government prints 50 cents for each dollar that exists, and air drops those dollars pro rata on everyone. So if you had $6 before, you have $9 now. This doesn't accomplish anything, really. It's just a $1.5 for one stock split in the U.S. dollar. If a loaf of bread costs $4 before,

Starting point is 00:02:15 it costs $6 now. Everyone has 1.5x as many U.S.D, and all prices go up, 1.5x. So what does printing money do? Well, let's say that instead of giving out the 0.5x new money pro Rata, you give it out to some public goods project, or you give each person an equal amount rather than pro rata to their old wealth. Now there's real inflation. Why might you want that? Well, it's basically a tax on USD holdings. It disincentivizes keeping your wealth in dollars, and so it incentivizes investing or doing commerce. Maybe you just think people are scared or risk-averse, especially during a recession, so you can use inflation to counterbalance fear in markets. But for that to work, someone has to end up holding the dollars after the commerce is done.

Starting point is 00:02:58 Who is that holding the bag? Maybe it's foreign governments and this is the tax on them getting your stability. Maybe it's people cashing out. Alice founds a company XYZ. She runs XYZ for a while, all her wealth is in XYZ and she wins to inflation. After she's made a bit of money, she sells it to investors and holds USD. It decays a bit, but she secures a comfortable life. Finally, let's say Bob wants to buy a widget from Alice. It costs Alice $5 to make and it's worth $7 to Bob. In theory, Alice should sell it to Bob. But Alice wants to make a profit, so she might charge $8 and then the economy isn't efficient. By incentivizing transactions and investing over holding U.S.D, maybe inflation can cause some positive sum transactions to cross the bid-ask

Starting point is 00:03:38 spread, so to speak. Okay, so there are some reasons that moderate inflation can be good. By essentially disincentivizing holding fiat, it can compensate for the risk and spreads involved in commerce, causing positive sum trades to happen. It makes sense, then, that monetary supply started increasing more quickly in 2008 in 2020, the recession in COVID, respectively. Increased fear in the markets, and so maybe some quantitative easing was useful to compensate. How much, though? Well, I don't know for sure, but I think a reasonable heuristic is, you want it to make sense for companies to invest in their operations. If the typical company has a price-to-earnings ratio of around 20, then it's taking on risk to grow capital at 5% per year. So inflation had better

Starting point is 00:04:18 be less than 5% per year. And in fact, since 2000, inflation has averaged about 2.3%. 3% per year. So far, everything looks reasonable. The government keeps printing dollars, it causes 2.5% inflation, it offsets the risk of investing and scales up during recessions when the risk is the highest. So what's the worry? Well, let's return to the rate of monetary supply increase. M2 has been about $20 trillion. Also, recent monetary supply, debt, etc., have been increasing at about $3.5 billion per year, so roughly 17% per year. That's up from 10% over the past decade and 3% over the 2000s. Uh-oh?

Starting point is 00:04:52 And so we reached the first deeply weird fact about the modern economy, that monetary supply has been increasing at about 5x the rate of inflation. Why? Which metric is correct? Has QE been roughly correctly targeted, or massively overdone? Well, inflation is measured via CPI. CPI is bred in gym memberships and clothing and tuition. CPI has only increased a few percentage points per year recently. But not everything is part of CPI.

Starting point is 00:05:16 Is there a bias here? Is CPI measuring the right thing? I don't know what right means here. Let's try again. Is it correctly measuring the impact of monetary policy? Well, over the past decade, there's been a huge increase in the amount of money in circulation. Where did that money go? A, the world becomes digital. B, the world becomes financial. C, borrowing becomes way easier. A means that the titans of Web 2 made a lot of money. B means that the Titans of Finance made a lot of money. C means that A and B can borrow against their equity that they have either created or invested in, increasing the liquid capital they have. All three of these

Starting point is 00:05:54 point in the same direction. The richest people from 2022 are worth a lot more than the richest from 2007. Some of this is the rich getting richer. Some is new people climbing higher than anyone from 2007. But one way or another, it's happening. The richest people are worth 3x as much as 2007's richest, but median income has only grown 33%. And the thing is, what drives CPI? Well, CPI is basically bread. Elon Musk is worth roughly one million times as much as the median American. Elon Musk does not eat one million loaves of bread per day. So CPI tracks the median American more so than the average one. And in fact, CPI inflation has been roughly in line with median wage growth. So, okay, if Elon Musk doesn't buy $1 million of bread, what does he buy $1 million

Starting point is 00:06:39 of? In particular, given the amount of wealth that has gone towards creating the richest in history, the assets whose prices have appreciated, the place that the 17% annual monetary supply increases have gone, are assets that a single person could spend millions of dollars on. So yes, cryptocurrencies, but also stocks and high-end housing and private planes and art and NFTs and sports teams, which really are themselves NFTs, in general, things you can invest in have gone up a lot, and things with limited supply, as have Giffin goods. Nexo is the go-to platform for all things crypto. Invest in the hottest coins out there and start earning risk-free interest of up to 20% APR, paid out of

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Starting point is 00:08:43 When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. So, okay, CPI inflation has been somewhat stable, but other measures of price inflation have been huge, because CPI is in line with median wage growth and markets are in line with invested capital growth. And if you average those out, you get something closer to what the monetary growth implies. That real true inflation has probably been closer to 17% than 2.5%. And 17% is a lot. So in the end, I think that in some senses, the straightforward answer is the correct one.

Starting point is 00:09:19 That inflation has been here the whole time hiding in plain sight. The worry, then, is hyperinflation, devaluation of the U.S. dollar and serious economic impact. Does that mean that monetary policy has been bad and reckless? I don't know. It's complicated. Because we've only been talking about the inflation side of monetary policy. And again, it's not a coincidence that this has been the decade of QE. In 2008, almost every bank failed. And then in 2020, the world economy half shut down for two years.

Starting point is 00:09:47 And somehow, not only did we make it out with the financial system intact, but we made it through COVID without a recession. In fact, markets hit all-time highs. Oh, wait. I mean, partially what happened. and probably was that commerce and investment were incentivized by loose monetary policy. And partially, the governments effectively provided desperately needed bridge loans to companies that were going to have a bad few years because of COVID. And so to some extent, we made a

Starting point is 00:10:10 trade as a world. We accepted higher inflation that generally makes some sense in return for weathering a huge financial storm remarkably well. Yeah, price increases hurt, but honestly, it's way better than if you tacked 2008 onto COVID. There's another side to this too, though. number go up. See, if all you do is stock split the U.S. dollar handing everyone an extra 50%, it has no real impact. As long as everyone mentally multiplies all price charts by two-thirds after the split. But if you don't adjust how you look at the charts, then it seems, I guess, like everything just went up 50%, which is bad for inflation, but great for markets? And so some of what's happened over the last decade, and especially over the last few years,

Starting point is 00:10:49 is that bad things happened, e.g. COVID, but markets went up instead of down, because we increased monetary supply. And I guess it tricked some of us into thinking that they were going great because number go up, when really that 440 SPY buys about as much stuff today as 330 SPY bought a few years ago. So what does all of this imply for the future? Well, on the one hand, inflation, true inflation, is high, really high, high enough that it would generally be worrying. Does that mean markets will keep going up, especially given that even CPI inflation is now high? Maybe, but maybe not. Because to some extent, that should already be priced into efficient markets. As soon as the world realized what was going to happen to policy because of COVID, prices

Starting point is 00:11:30 should have adjusted to the full increase all that future QE would bring. CPI increasing this year doesn't make markets go up more. Markets already knew that the monetary supply had increased and didn't have to wait for CPI to move. Instead, CPI increasing this year had the effect of increasing political pressure to reduce inflation by tightening monetary policy. So increased inflation indicators sometimes lead to decreased inflation because of policy reactions. So I don't know what this means going forward. On the one hand, there are real signs of tightening policy for the first time in a while. On the other hand, even the proposed rate hikes are a lot less than true inflation probably is, barely making a dent in real rates. And also, there's a war going on now on top of COVID.

Starting point is 00:12:11 there will be pressure to prevent markets from crashing, which means, well, you know. So in the end, I don't know what will happen going forward. I wish I were smart enough to see the future, rather than just the past. But I guess my main takeaways from MMTR, A, it probably led to significant serious inflation. B, it also probably prevented a recession. Those are, sometimes, two sides of the same coin. And also, C, QE equals number go up, equals easy to get financing, equals number go up, equals easy to get financing equals, et cetera.

Starting point is 00:12:41 We have accidentally been exploring postmodern monetary theory as a society, a system designed so that numbers mostly just go up and up and up and up as they mean less and less and less. Thus, Bitcoin and oil and nickel and SPY and houses and art and bonds and VC fund sizes and private markets and pretty much everything marked to market. Now, there is way more than we could possibly get into in Sam's thread, especially because I have another thread from Lynn that I want to make sure we get to. But I think this last point that we actually have been living inside this very different experiment, not that it's about some future state, is a really salient point.

Starting point is 00:13:19 We often see ourselves as the shapers of our own destiny without realizing that the forces of destiny are already shaping everything that we're doing. I also think Sam's point about the politics of inflation catching up this year and that, in fact, being the most important factor in inflation this year is dead on. The real question, it seems to me, is going to be the political will to see growth actually slow through economic and monetary policy? Will this administration, will this Congress, will this Federal Reserve, be willing to tame inflation if the cost is recession? It's a high price to pay for any politician. All right, and now the one and only Lynn Alden.

Starting point is 00:13:59 She writes, The modern financial system is based on the premise of constant and relatively smooth growth indefinitely, including persistent credit growth. War and commodity shortages threaten the whole model. A low-leverage system can take shocks. For example, a solid business with little or no debt can have its cash flows go up and down based on economic conditions without blowing up. Up years are fun, down years aren't, but it's okay either way. A high leverage system can't take shocks. If businesses, households, and sovereigns are all highly levered, it requires constant growth to avoid a systemic meltdown.

Starting point is 00:14:34 A lack of sufficient commodities makes it very, very hard to grow. Households and companies then have trouble serving their debts, and those creditors have trouble paying their own debts, etc. Employment slows, tax revenue falls, sovereign deficits widen, and get monetized by the central bank, etc. In a low leverage system, high commodity prices can result in recessionary conditions, higher interest rates, and thus less demand. The demand size, shrinks to match the tight supply side. Meanwhile, new capital is incentivized to come in and bring new commodity supply to market. But such a high leverage system blows up if it encounters those recessionary or high rate conditions. The result is usually currency devaluation, stagflation,

Starting point is 00:15:12 like an emerging market recession rather than a typical developed market recession. Besides financial leverage, one must also consider social leverage. In times of relative political unity and a strong social contract, people are willing to go through hardship and sacrifice, viewing it as being in this together. But in times of unusually high wealth concentration, strong political polarization, culture wars, and decaying institutions, people have a much lower threshold for hitting a breaking point, protesting, becoming extreme. When the pandemic hit in 2020, governments printed trillions of dollars.

Starting point is 00:15:42 Investors were shocked, but historians were not really. Governments did so because they were so financially and socially leveraged that they couldn't just take a shock and move on. Too leveraged for that. Similarly, the system is not well prepared for commodity shocks, either shortages or price spikes, nor is it prepared for any degree of de-globalization and a shift from supply chain efficiency towards supply chain resilience. 10, 20, and 30-year back tests during structural globalization and disinflation are not very

Starting point is 00:16:08 informative here, yet people still use these shorter-term models. These are instead 50-to-80-year type disruptions, long-term debt cycle stuff. So I think the interesting thing that this adds to what we were just discussing is the question of whether it really is a political choice to allow a recession to happen. or whether the system is actually structurally incapable of handling that recession. My last note will be that Sam and Lynn end in some ways on the same note, which is that the only thing in some ways that we can do in these moments is look to history. Cold comfort for people living in the present, but what else do we have?

Starting point is 00:16:47 Well, we have great thinkers like the people I featured today, and we have awesome engaged listeners like you guys. I want to say thanks again to my sponsors, nexus.io, Arculus and FtXXX, for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, Breakdown listeners, come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web3, and the Metaverse, and is designed

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The Breakdown - Post-Modern Monetary Theory

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