The Breakdown - Why a Strong Dollar Is Bad for the US and Bad for the World, feat. Lyn Alden

Episode Date: May 21, 2020

The dollar has a unique role in the world due to its reserve currency status. For many years that status has created incredible opportunities for the U.S. Increasingly, however, some are wondering if the global standard has outlived its usefulness - not only for the world but for the U.S., too.  In this illuminating conversation, one of FinTwit’s brightest minds, Lyn Alden, shares her perspective on: Why we’re at the end of a strong dollar cycle Why the Federal Reserve is terrified of the global dollar shortage The difference in creditor vs. debtor nations The concept of the Triffin dilemma  Why Japan has been able to print money without seeing rampant inflation  Why we have inflationary and deflationary forces competing to influence the U.S. economy  Why debt is going to matter more than ever  What alternatives to the USD system might look like

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond. This episode is sponsored by ArisX.com, the Stellar Development Foundation, and Grayscale Digital Large Cap Fund. The Breakdown is produced and distributed by CoinDesk. Here's your host, NLW. Welcome back to The Breakdown. It is Wednesday, May 20th, and guys, I am so excited to share this conversation with you. Regular listeners will know that I've been spending a lot of time recently on asking questions about the fundamental design of the global monetary order, specifically as it relates to the place of the U.S. dollar in that system. I think it's one of the most essential questions we have right now is whether the dollar is still serving both the U.S. and the world as the world's reserve currency.

This question in some ways, I think, was part of the provocation behind Libra. It was the provocation behind Mark Carney's idea of a synthetic hegemonic currency that he proposed at Jackson Hull last year. It is part and parcel of China's push for a digital yuan, and I think it has massive implications around the world as we see the dollar react to the context of the COVID-19 crisis. At the end of March, I noticed a thread from Lynn Alden that totally knocked my socks off that related to the dollar. It introduced a set of concepts that are not normally talked about, as it relates to the dollar, including the status of creditor and debtor nations and what trade imbalances between people actually do to the dollar conversation. I knew as soon as I read

this that I really wanted Lynn to join to share her expertise about the dollar and about the economy writ large, and man was I, my expectations were exceeded. Let's just put it that way. Lynn Alden is the founder of Lynn Alden Investment Strategy. She's been called by people like George Gammon, a Fin twit rock star. And I absolutely have to agree. She focuses on value investing with a global macro overlay and has a background in both finance and engineering. As you'll see from this conversation, Lynn speaks to a huge amount of data and context in her analysis and draws upon case studies from around the world to form her opinions. It's this sort of quantitative, non-ideological, non-dogmatic thinking that I think is so

important right now. So I hope you enjoy this conversation about the world economy, about the status of the dollar and whether it serves us and the world as well as it should anymore as much as I did. So as always, when I do these long interviews, we edited only very mildly to keep the tone of the conversation as close to as it really was. Let's dive in. All right, I am here with Lynn Alden Lynn. Thanks so much for joining today. Hey, thanks for having me. So as I was just mentioning to you, I've been following your work for a while now. And I think a thread that you had on the dollar really, really captured my attention a few weeks ago. It's something that, as regular listeners to the breakdown know,

is a topic that's really important right now and is something that certainly those not only in the Bitcoin community, but then the economy at large are thinking a lot about. So I want to get into that, but I want to kind of start farther back and maybe define some of these key terms. Let's start with your thesis going into this crisis, that we were nearing the end of a dollar,

cycle. What does that actually mean? Yeah. So the current monetary systems have been in place since 1971, which is that, you know, none of the currencies are pegged to anything other than, you know, essentially that the dollars kind of pegged to oil in a way indirectly. But since over those 50 years, roughly, there have been three super cycles of dollar strength and weakness. So the first one, it peaked in the mid-1980s, and then it had a long decline. the second one peaked in 2002, and then it had a long decline. And then this current one has been in a peak for several years now starting in 2015.

So that's kind of the overall long-term cycle. Of course, there's different fluctuations each year, but those are the three very large changes in the dollar. And every time the dollar has one of those massive spikes, something breaks because the whole system is levered to the dollar, and the dollar dictates all the liquidity in the world as far as trade and currencies go. So in the 1980s, it broke some of the South American economies. In the late 90s, it broke some of the Asian emerging markets. And then recently, it's impacted Turkey, it's impacted Argentina, and it's slowed growth worldwide. and then in many ways it also negatively impacts the United States.

So, for example, if you chart corporate profits in the United States, you overlay the dollar with it, whenever the dollar is in one of those giant peaks, you generally see a long, flat, kind of sideways growth in corporate profits because they have trouble growing in dollar terms when the dollar is that strong. There's so much to dig into, but let's keep trying to unpack this for folks. So part of the issue has to do with the dollar-denominated debt, right? And in a world in which debts are denominated in dollars, but businesses are conducted in the local currencies, the strength or the increasing strength of the dollar can have really deleterious effects, right?

We're seeing that in Lebanon right now. We've been seeing that for the last six months in Lebanon. It's an example that we used a couple weeks ago on this show where this is not just a net importer nation. They import literally everything. and the 1,500 Lebanese pound to the dollar peg that they've had since 1997, or they've been trying to maintain totally broke, and with it has kind of ensued a lot of chaos. So is that the story?

Is it a dollar debt issue, or are there other parts of the story that make this dollar strength even more complicated? The dollar debt is the big thing. And the reason it's set up like that is because for the past 50 years or so, most international trade, a large portion of it happens in dollars. And then specifically, almost all oil purchases happen in dollars. So even if Europe buys oil from Saudi Arabia, they still pay in dollars, even though neither of them use dollars in their own economies. So all these countries around the world, especially emerging markets, some of them have sizable like dollar denominated debts relative to their GDP. And to offset, that they hold treasuries as reserves. That allows them to defend their currencies that they need to and also to support their dollar obligations if it comes down to it. So some countries have a lot of reserves relative to their dollar denominated debts, which keeps them pretty safe. But some of

these countries have very low reserves relative to their dollar denominated debts. And those are the ones that we're seeing crises in. So that includes Argentina, Turkey, Chile, countries like that. The additional layer of complication on this has to do with the dollar shortage versus the shortage of actual dollars versus dollar treasuries, for example, right? And what happens when the dollar strengthened? So this is something that I know you've spoken a lot about. Basically, you know, in a crisis as the dollar, as people flee or try to get to dollars,

what they have to do is often sell other types of U.S. assets like treasuries, which can have its own type of impact, right? Yeah, if it gets to the point where trade slows down. So normally they have dollar-denimated debts and they service those debts with ongoing revenue and ongoing trade. But if those corporations and in some cases sovereign governments, if they can't get dollars because trade has slowed down due to a global slowdown or global recession, then their other resort is, is that they have to sell U.S. assets to get dollars so they can service those debts rather than to fall. So we've generally seen a pattern where whenever we have these sharp dollar spikes during economic slowdowns, foreigners start selling their treasuries. So we saw it happen in 2016, and then we saw it happen again in mid-March, when the dollar index went up to about 103, and foreigners sold $250 billion of treasuries in March until the first.

Federal Reserve started setting up currency swaps and other ways to get them dollars without them having to sell treasuries and other assets. Why would just, I think it's really valuable for our listeners to play this out, why would the Fed care about those other entities selling treasuries, right? What is the potential impact of that action? So essentially, it's to protect the U.S. Treasury market. That's the reason they sell. cited and the data supports that that's true. So years ago, the U.S. was a creditor nation, which means that as a country, we owned more foreign assets than foreigners own of our assets.

And that can include stocks, bonds, and real estate. But ever since the mid-1980s, we switched over because we've had persistent trade deficits as part of us maintaining the World Reserve currency. And so years of persistent trade deficits have accumulated dollars overseas, and they've recycled that back into owning U.S. assets. So currently, Americans own about $29 trillion in foreign assets, whereas foreigners own $40 trillion in U.S. assets, which means there's an $11 trillion difference. And that's, you know, about 50% of last year's GDP. Back in 2008, our position there, it's defined as the net international investment position, that was about negative 10% of GDP. So we've actually, we've deteriorated significantly over those past 12 years.

And because foreigners own such a large portion of U.S. assets, including $7 trillion in U.S. treasuries, if there's a dollar shortage, they start rapidly selling U.S. assets, as we saw both in 2016 and then again in March of this year. And this one was particularly severe because the whole treasury market became illiquid. We saw even though yields went down early in the year in response to the crisis, during that period, Treasury started selling off with stocks in mid-March. And the whole treasury market just became illiquid. The Fed cited this in their meeting minutes and their press releases. So the Fed started buying treasuries up to 75 billion. a billion a day for several days. And then they increased their liquidity offerings to try to

get dollars to what are essentially our creditors, you know, foreign nations that own our government debt that have lent us money so that they don't have to sell those treasuries to get dollars. The natural question becomes, so this is, you know, we had this setup, basically where the Fed's set up effectively repo operations with other nations, right, or credit swaps or dollar swaps, right, with these other countries in order to curtail this behavior? Yeah, both programs. There's one that's an outright currency swap. That's only with a select number of nations, a little bit over a dozen of them.

And then there's also an international repo operation where instead of selling the treasuries on the open market, they can lend them to the Fed in exchange for dollars. Got it. And so the question becomes, if the Fed is so concerned with a, you know, this sort of behavior vis-a-vis treasuries, why not just buy them all? Well, they've actually, they've bought more treasuries than have been issued since the repo crisis in September and October. So they actually currently are buying all net new issuance of treasuries. They don't really want to buy more than they have to because, you know,

they don't want to monetize $7 trillion in foreign-held treasuries. That would significantly weakened the dollar most likely. It also would just, you know, a lot of those foreigners need treasuries to maintain reserves. They use it for supporting their currencies. So getting that all on the Fed balance sheet is not something they are trying to do. Yeah, by the way, I ask this sort of big, dumb question only for the sake of we're living through this period where things that were once sacrosanct. and totally off the table become on the table.

So I feel like it's useful to maybe draw some of these lines where we can now as everything gets up for grabs a little bit. Yeah, well, it's not far off because I think going forward, it looks like the Federal Reserve is going to be the primary buyer of Treasury. So they're not necessarily going to get all treasures on the balance sheet, but most treasury issuance going forward is most likely going to end up on the Fed balance sheet. What do you think has changed over the last 10 years to, or maybe it's less time than that, to make it the case that the Fed has moved from sort of a buyer of last resort for these treasuries to the primary buyer?

A couple things. One is entitlements, just demographics have changed. So now that the baby boomer generation is fully in the phase of their lives or they're receiving benefits, we've become very top-heavy with our social program. so Social Security and Medicare. So we're paying out a lot of benefits, and we have kind of more structural deficits now. And then on top of that, debt as a percentage of GDP over time is increased significantly. So, you know, before the GESNAE crisis, it was like 60% of GDP, federal debt. And then in response to that crisis, they brought a lot of that basically onto all that leverage in the banking system.

a lot of it pretty much ended up essentially in the treasury market on the federal balance sheet. So we went up to over 100% of GDP. And then lastly, foreigners are, whenever we have a strong dollar period, foreigners generally don't buy as many treasures as they were. So starting in early 2015, foreigners haven't really been buying that much treasuries. So for several years, domestic sources were able to buy those treasuries. but we kind of ran out of balance sheet room here in the country, both on bank balance sheets and pension balance sheets and investor balance sheets. So for running out of both domestic and foreign lenders, then essentially the Fed becomes

the primary lender, the primary buyer of treasuries. So going back to kind of something fundamental that you were discussing before, can you explain the idea of a creditor nation versus a debtor-nation? versus a debtor nation and how sort of these, the relationship between a currency and a country's economy is normally allowed to go. And where I want to get with this is the unique place of the U.S. dollar given its role as the world's reserve currency. Yeah.

So the net international investment position is a measurement of how much assets that the, like, how many foreign assets that country owns compared to how much of their assets foreigners own. And if they have a positive net international investment position, they're basically a creditor nation. And if they have a deficit, then they're a debtor nation. So the world's largest creditor nation is Japan. And they have positive 60% of their GDP in terms of their net international investment position, meaning they own a ton of foreign assets. And foreigners, even though they own some Japanese assets, they don't own nearly as much as Japan owns of their assets. They also own, for example, over a trillion dollars in U.S. Treasuries.

They're one of the biggest lenders along with China, foreign lenders to the federal government. But then they also own stocks. They own real estate. They own corporate bonds in the United States. And generally speaking, countries that are credit nations that have very high net international investment positions, they usually have pretty strong currencies because they build up those positions by having consistent trade surpluses, and they've managed to build a very large amount of reserves. So they're buffered against currency crises and other problems that can come up. Whereas countries that don't

have very large reserves and that don't have a lot of foreign assets generally find themselves with liquidity problems and even solvency problems if there's a global recession or dollar shortage. So you used the example of Japan before to talk about sort of the relationship between credit or debtor status and the way that money printing or quantitative easing or whatever kind of, you know, you want to call it, impacts currencies? Yes. Could you go into a little bit of, you know, so one of the things that's happening now is I think people are trying to make sense of, they see kind of the money printer go

burr meme getting popular, not just on Bitcoin Twitter, but kind of across Finn Tuit. And they say, oh, we're, you know, in the zone for inflation. but then other people point to the example of Japan as someone who's printed a huge amount of money but hasn't experienced that same sort of kind of rampant currency devaluation that I guess people would expect. Yeah, one of the main differences between Japan and the United States is that we're total opposites in terms of creditor and debtor nation. So they're the largest creditor. We're the largest debtor in terms of absolute terms. There are some countries like Singapore that have their larger creditor nation, relative to their GDP than Japan, but Japan's the largest and absolute terms.

And there's a couple of things that Japan has going for it that are more deflationary for them than it would be for the U.S. if we were to print that much. In addition to demographics and everything, the main thing is that they have a pretty consistent trade balance. So they export products and services roughly as much or more than they import. And combined with the fact that they used to run very large surpluses, they've built up all those foreign assets. So they also have all these foreign income streams, dividends, interest, all these different source of income coming into the country from their foreign investments. So combined with their trade balance, they have a positive current account surplus, which is just more money flowing into the country over year.

And that gives them a wide latitude to print pretty aggressively without cost. causing some of these problems in the near term that people would think. Because they've printed, the Bank of Japan's balance sheet is over 100% of Japan's GDP, which is way more than the Fed has printed and way more than the ECB is printed. But the main thing is because they have a trade balance, it really prevents their currency from weakening more than you'd think. Well, and even it was interesting hearing you describe, I think it was on George Gammons podcast, how when that printing started, there was some

amount of devaluation, but the natural kind of float or flow of trade balances quickly resolved it by having net exports be more valuable for a little while because the currency was weakened. Yeah, I did a case study on Japan. And so in 2012, they actually had a trade deficit, which is pretty rare for Japan. and it wasn't very big on international standards. Like it's smaller than the U.S. has now. But for Japan, it was a pretty big thing.

And they also had large fiscal deficits. You know, this was not that long after the global financial crisis, and they hadn't really recovered yet. And so they started printing dramatically. And the Bank of Japan's balance sheet was something like 30% of their GDP. And over the next several years, they got it all up to over 100% of GDP. And when they started doing that,

currency weakened considerably compared to the dollar. So there was something like 75 yen to the dollar and then it weakened as much as 125 yen to the dollar. But in 2015, even though they never stopped printing, they barely even slowed down printing. Their currency stopped weakening and it actually started strengthening relative to the dollar. And that was because their trade balance over those three years from 2012 to 2015, by weakening their currency, they essentially weakened their importing ability, and they made their exports more competitive. So that helped fix their trade deficit back to being balanced, and their current account went positive.

And so that way, even though they kept printing, their currency didn't really weaken more and more and more because there's kind of an equilibrium there that if the weaker it gets, the more competitive their exports get. And so you can't really print yourself too deeply into a trade surplus. So as long as there's more wealth flowing into the country than flowing out, which is the case when you have a positive current account, even though Japan kept printing, it's weakening effect on the currency stopped after that point. Support for this podcast and this message come from Eris X. With Aris X, you can trade spot and regulated futures on cryptocurrencies through

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Now, can you kind of building off from that explain this idea that's kind of embodied in Trippin's dilemma or Triffin's paradox that the scenario or the setup for the world's reserve currency is simply different in some ways? Yeah, so for many countries, if their trade balance gets too out of whack for too long, they usually find themselves like Japan did where their currency changes considerably. So a country that runs persistent trade deficits a year after year after year, usually what happens is, you know, whenever the next recession or when next crisis comes around, their currency devalues significantly enough that it basically forces the country to have a more balanced trade situation. So their currency gets weak enough where, you know, their importing power weakens and their products and services get more competitive. And that currency weakness, it can be painful for citizens.

of that country, but it can, you know, as long as the economy remains intact and the country doesn't become like a failed state. So as long as you have, you know, the basic framework there, it can be a healthy thing where the country is able to kind of stabilize and then become more competitive and have a more balanced trade position. But the U.S. dollar, because it's the global reserve currency and it's the only major currency that energy is priced in and most commodities are priced in and because there's so much dollar denominated debt, there's this extra layer of demand for the dollar, whether or not we have a trade balance or not. In fact, in order to supply enough dollars to maintain World Reserve status, in order for countries to be able to

solely buy oil with dollars, we have to make sure that there's a lot of dollars out there. and that manifests itself in strengthening our currency to the point where even when we're not competitive in trade, we never really normalized back down to having trade balance. So even when our currency weakens, it rarely weakens enough that we become balanced with trade. So year after year, decade after decade, we have a trade deficit that never really corrects itself like we saw from Japan and like we saw from a lot of these other nations. So in that system, who are the winners and losers of kind of this persistent trade deficit and just the strength of the dollar without the ability to correct? Some of the winners have been countries whose currencies are able to stabilize.

So, for example, Japan's been a winner, Germany's been a winner, China's been a winner. a lot of the countries that have these persistent trade surpluses with the United States, they're the ones that win because we basically ship them our supply chains. And so they remain competitive on the world scene, whereas except for certain areas, we become uncompetitive, especially in industrial production and exports. So we're competitive in software, but we're not very competitive in making cars that foreigners want to buy compared to. let's say, German or Japan. So the one that hurt the most is the American working class, you know, the people that would make a lot of the products that we've essentially shipped outside United States, all those supply chains.

So I want to come back to this point sort of on the other side of the COVID conversation, as we're seeing a lot of people have or take a different point of view, I think, on domestic manufacturing, maybe in the wake of this. But before that, what were your feelings about the dollar coming into this year, coming into, or before the COVID-19 shutdowns and the crisis? And how has what has transpired since changed or reinforced those views? Sure. So every year I publish an annual report that ranks different currencies based on a variety of metrics. And in 2018, and then again in April of 2019, I ranked the dollar about average.

I ranked it better than the euro, and it has strengthened compared to the euro. But starting in early October 2019, after the repo spike, that's when I started shifting to a more bearish view on the dollar, essentially because the U.S. was basically forced to shift from a tight monetary policy to a looser monetary policy. And that can be a significant contributor to a weaker currency. So for the next three months or so, right into the year end, we saw the dollar weekend pretty significantly for a three-month period. But then in the first couple months of the year, the Federal Reserve balance sheet stopped increasing.

And my view at the time was that that was most likely temporary. We could look under the surface and see that they were continuing to buy treasuries and monetize the debt. but they were also able to wind down the repo lending a little bit. So I was expecting that to work itself out by maybe March, April, and that they would go back to balance sheet increases again because they'd still be buying treasuries. But then, of course, the COVID-19 hit. So at the moment, I was near-term neutral on the dollar.

But then that, when that started happening, just like the case was in 2016. And then also in 2008, we had this dollar spike because again, most of the trade shut down. We had oil price declined. So there was just not dollars flowing around the international system. And yet all those dollar debts still existed. So I became near-term uncertain on the dollar. I started tracking it more frequently. And my main view at the time was that although we were getting a dollar spike, that it would probably be briefer and lower than some of the dollar bulls expect because of the Fed's massive response they have to do if they want to protect the treasury market. And is that what we've seen play out? So far, yeah. The dollar index got to

103 in March at the peak. And that also was the bottom, roughly within a couple days of the bottom of the equity market. And since then, the dollar index has it came back down to about 100. it's fluctuated in a pretty narrow band. It's stabilized. You know, there's always possible we're going to get another spike later this year, but at the current time, it has stabilized back down to under 100. And that's because whenever you get these dollar spikes, foreigners have to sell U.S. assets.

So if you look back at 2008-2009, the market bottomed right when the dollar peaked. And again, in March of this year, the market bottomed right when the dollar peaked. So you can kind of think of as a control system. So whenever the Fed is not loose enough, you're basically going to get liquidity problems. You're going to get dollar spike. You're going to get foreigners having to sell U.S. assets, including treasuries.

And you're probably going to see the Fed have to step up and provide more liquidity if they want to protect the system. So when analyzing dollar strength, you have to take an account both the natural forces of all that debt out there. but then also what the federal response has to be if they want to protect the treasury market. So one of the interesting things is that there's kind of a debate right now, whether the thing that we should be most concerned about is deflationary forces or inflation, right? And both of them can be, the narratives can be a little bit narrow, right? And the money printer go burr meme leads to inflation. And deflation on the other side is sort of just a byproduct of relentless technology and people having no demand. But, you know, you spend a lot of time looking at

this in the context of actual currency flows. What should people be concerned with right now? Is it either or or is it a both-and and it's based on timing and factors like that? It's a both-and based on timing, in my view. In the near term, deflation is more of a risk, especially for discretionary goods. So, you know, no one's really buying cars too much at the moment. So you're not going to see a price increase in cars. But essentials like food, we're seeing some inflation in that supply chain. So with the sheer amount of debt and also the amount of wealth that has been lost, at least especially back in March and April, we've recovered some of the wealth loss since then.

But whenever you have, even though the money supply has increased pretty substantially due to the Fed response, we've seen a reduction in people's net worth from their stocks. We could see some home equity reductions. We don't know yet. It's too early to say. So if you look back during the great financial crisis, for example, even though the Federal Reserve printed a few trillion dollars, that was actually smaller than the amount of U.S. household wealth lost during that period. And it took several years to recover.

So essentially now we have that playing out. but on a swifter scale. So we lost some unknown amount of net worth. We've already covered a lot of it. And we're seeing printing. So we have a deflationary debt, you know, kind of collapse happening if it was unaddressed. But then to address that, we've had the more inflationary fed response.

And at the moment, it's roughly a tie. So we saw a decrease in broad inflation. We've seen some targeted areas of inflation. But going forward, the amount of support. that governments are probably going to provide to their citizens, especially the United States, because so many people are, you know, millions of people are unemployed, that those money taps are unlikely to stop anytime soon. And we're probably shifting towards a more inflationary environment over the next several years.

Do you think that the extent to which it is an inflationary environment is correlated with the amount of money that's actually getting into the hands of regular citizens versus is sort of the corporate industry backstopping we've been seeing? Oh, yeah, that's a key thing because if you look back in 2018, most of that QE that was done, people back then feared that it would cause inflation. But in addition to being offset by all of that temporary wealth destruction, also most of that QE never really made it to the people. It mostly recapitalized banks.

So going into that crisis, banks had very high leverage ratios. They had very little cash reserves. So the Fed basically created a lot of dollars and then bought some of their assets. and recapitalized banks. And, you know, some of it trickled out to the public, but most of it just stayed within the banking system. But now we're seeing that a lot of the QE is going to the people. So, for example, the $1,200 helicopter checks that a lot of Americans received, that was funded by, you know, the treasuries issuing treasury securities and the Federal Reserve's printing money to buy them using the primary dealer banks as intermediaries. same thing for the extended unemployment benefits and other programs that are aimed to make up for the fact that Americans and small businesses are losing money, you know, by providing them with temporary income to offset that.

And, you know, those programs have all sorts of issues. Some people benefit more than others. But as a general quantitative fact, it is getting more to the public and more to the general money supply than it did back 12 years ago. Well, and you have to think, too, that in addition to just the actual net increase in assets, we're seeing a pretty significant and rapid Overton window shift on how people think about this, right? I mean, this has been the greatest coup for any sort of MMT or UBI, even for people who come back from completely different perspectives, right? It is normalized this because you have an entire citizenry who's saying, well, if every industry in the world is getting bailed out, you know, and they didn't have. any protection, they didn't have any resilience built through their systems. Why wouldn't you also bail out the citizens? So it feels to me that there's also this psychological dimension to

it. Oh, yeah, after spending trillions of dollars to bail out Wall Street back 12 years ago, it'd be hard for them not to do it today for the people when the people need it. And that's kind of the path they set up for themselves. And so we're at the point where the treasurer and the Fed are essentially working together. And you have bipartisan support for multi-trillion million dollar stimulus packages to try to help people. And yeah, it's definitely the environment we created of the past decade. I guess a lot of people are also trying to figure out what's the end game, right? And part of the appealing logic of something like MMT is that basically what it's saying is that this party can go on forever. We're not playing a game of musical chairs.

There's chairs enough for everyone. What are the real concerns about about how far this can go and what happens on the other side as it relates to, you know, something like the U.S. dollar and currency. Well, one of the significant concerns is that it can devalue currency relative to everyday goods relative to productive assets. And we actually see, if you look back in history, hundreds and even thousands of years, all civilizations go through these currency devaluation cycles. And, you know, different people have focused on it, like Dalio, Ray Dalio is focused.

a lot on this recently where he points out the long-term debt cycle. And so the last time we had this was the 1930s. We actually had smaller ones in between then, including the 1970s. But over time, countries often get out of debt bubbles by devaluing their currency. So that's most likely what we're going to see over the next decade. This will probably be a decade that in many ways mirrors the 1930s and the 1970s in terms of seeing rapid currency devaluation compared to things like gold compared to productive assets, once we're on the other side of this deflationary COVID-19 shock. Yeah, I mean, this is certainly what we're seeing from a lot of different unexpected angles.

The Bitcoin community has been paying a lot of attention to Paul Tudor Jones jumping in with both feet and writing extensively about this idea of a great, monetary inflation and creating this whole methodology to rank different stores of value, which ended up producing them to open themselves up to get into Bitcoin. So certainly there's a lot more chatter about this being a realistic possibility than it feels like there was even six months ago. Yeah, if you look back in history, the only other time that federal debt as a percentage of GDP got this high was during World War II, the 1940s.

And the way they dealt with that was that the Federal Reserve and the Treasury worked together a lot like they're working together now. But instead of funding a virus response, they were funding the war. And what they did was the Federal Reserve agreed to lock treasuries at a yield of 2.5% or below. And so it was like 0.38% for T-bills and it went up to 2.5% for the long end of the Treasury security market. And to do that, in order to have that peg, they had to basically buy any treasuries that were starting to trade over that amount. So their balance sheet grew pretty substantially. And they didn't call it quantitative easing at the time, but that's essentially what it was. That was, you know, people think it's a new thing, but, you know, they were doing that in the 1940s, where they were essentially monetizing U.S. debt.

and then by locking the yield curve at 2.5%, even as inflation during that decade in 1942 and again in 1947, inflation spiked into the double digits, but they still locked treasury yield at 2.5% using their balance sheet as their ammo to do that. And that had the effect of treasury holders, even though they were all paid back nominally, they lost on a real basis compared to CPI, compared to, stocks compared to real estate compared to silver. Gold was pegged to the dollar, so that was a little bit different. But the Treasury and Fed working together essentially inflated away the federal debt as a percentage of GDP over the subsequent decade. Do you think that any of the, call them larger sort of secular trends, things like like technology wrought deflation, right? Technology pushing a downward force on prices of things like education or healthcare or real estate or trends that might stem from political shifts on

the other side of this, such as a push to bring manufacturing back home, could impact how these scenarios play out? Oh, yeah, definitely. Technology is a very deflationary force just because it increases our productivity so much. And then if you, if you, back to the second point of what you said, bringing supply chains home, that's a somewhat more inflationary variable because part of our disinflation over the past few decades is that we've continually outsourced our production to cheaper and cheaper places in the world. So one of the reasons that electronics have gotten cheaper, in addition to improving technology, is that the labor to assemble them has gone down dramatically. So instead of paying an American with expensive

health care and that has a higher standard of living to assemble our cell phones, we've outsourced that to cheaper places in the world. So if we're looking to make our supply chains more resilient and closer to home, we're basically going to stop exporting that inflation to other countries and start potentially experiencing ourselves. And then how that plays out, it depends on the different magnitudes of the variables. So technology, is deflationary, whereas bringing supply chains back is more inflationary. But the main variable is most likely going to be intentional policy responses to try to increase inflation, including up to helicopter checks if they have to, because in our current debt-based system,

sustained deflation doesn't work. So deflation, the natural impact of deflation can have all sorts of positive effects, but the one environment where it doesn't work well is when you have this much debt in the system. So from their point of view, they want to essentially inflate away at least the federal debt and then as much other debt as possible to make it so that long-term holds of that debt kind of get an invisible tax of inflation. So even though they get back all of their returns anomaly in the treasury market, the Federal Reserve is likely trying to replicate what they did in the 40s and the 70s. And they've already talked about it. They've already had Federal Reserve officials come out and say back in 2019 that yield curve

control is likely a future policy option. And I would argue that in March of this year, when the Fed came in and started buying $75 billion a day in treasuries, for that month when Treasury market was selling off, that they've essentially already started soft yield curve control. They just haven't formalized it yet. What do you think we're going to see next from the Fed? I mean, so you kind of mentioned more of this yield curve control. Do you think we're going to see negative interest rates?

I know that's something that is top of mind for a lot of folks right now. I don't know if we will or not. I hope not because country after country has showed that it's not a very effective policy. I can see why they'd be drawn to it because if you have this temporary period of deflation, but your interest rates are zero, then you actually have a pretty high real interest rate compared to what you came into the recession with. But negative interest rates, financial system is just not set up for negative interest rates. So it basically kills the financial system.

It kills bank profitability. And it can have opposite effects. It doesn't increase lending. So I really hope they don't go to the negative interest rate route. Yeah, I mean, speaking of negative interest rates and where it has or maybe hasn't worked very well, what's your perspective on Europe right now, and in particular the euro? I know there's a lot of conversation about this as well. And, you know, we've had this interesting moment where right as the European project is really called upon,

you have nations who are sort of moving farther apart rather than coming closer together. Yeah, from a quantitative perspective, the euro is similar to the yen, where Europe has a positive current account, so they have more money flowing into the continent than out of the continent. And that's, you know, because the euro has a lot of problems, but being overvalued is not one of them. So generally, it's a very competitively priced currency, meaning that, you know, their products and services are pretty competitive on the global market. So they have good trade balances, good current account balances. But then those, unlike Japan, unlike the United States, the fact that they have a monetary union without a fiscal union creates all sorts of qualitative risk factors. So even though the currency itself might be quantitatively cheap, there are all these qualitative problems, you know, between Italy and Germany as they sort out their totally different fiscal programs, even though they have the shared monetary union. So that's a huge tail risk to consider over the next several years is, you know, back in eight years ago, we saw the European sovereign debt crisis play out.

And that was essentially fixed with QE. But now we're seeing kind of the second round of that because COVID-19 is exacerbating sovereign balance sheets that were already very large, especially in southern Europe. and they're going to have to sort that out one way or the other. And that could be that they change the way they handle their currency. They could have potentially members leave or they can try to unify their fiscal policies a little bit more closely. So another part of the world that I'm interested in your take on, I'm not sure if you've been following the kind of digital currency conversation. But last year we had Facebook basically announce something that was sort of the, the equivalent design of a modern-day bank or, right, with Keynes proposed, which would be a

currency that was pegged to a basket rather than any sort of individual free-floating currency. And, you know, they didn't say they wanted to replace the World's Reserve currency. In fact, they went to pains to say that the U.S. dollar was still the most important part of that. But what it did is, again, it triggered another round of conversation where a few months after that, Mark Carney, the then Bank of England governor, spoke at Jackson Hole. said the world needed a synthetic hegemonic currency, right? Same idea, but from central banks instead of from this random American corporation. And then you had China who really started

to pour on the gas of a digital yuan initiative that went back five years. They're now in the middle of testing this in a couple of provinces. They have major partners. And it's very clear that they're going to roll this out sooner. And some countries, including Japan, have been really nervous that this is a play for kind of expanding the economic influence, the monetary influence of China. And I guess I wonder, not necessarily just about the specific, the digital currency, but whether you see China coming out stronger, weaker, kind of neutral from this crisis. Well, from a geopolitical perspective, they probably have a lot more risks of the next couple of years than they had previously because they were already dealing with trade issues,

and now they have a fallout from the perception of how they handle. of the virus, how much they disclosed about the details of the virus. And they also have a very leveraged financial system. But for the broader point, the current monetary system is certainly kind of hitting the bounds of where it can go without breaking more. Because if you look back 50 years ago, the United States was a larger percentage. of the global economy. And we were the largest commodity importers.

And so in some ways, it made sense to have commodities priced in dollars because the U.S. was the largest buyer of them. But even back then, like you brought up the bank core. There were economists that saw that this would eventually be a problem. And they proposed a more neutral reserve asset. But the dollar went out. But now, you know, decades later, the U.S. isn't even the low. largest import of commodities anymore. That's China. And yet we still price most commodities and dollars. And as you've seen from March, the Federal Reserve is essentially on the hook.

If they want to keep their reserve status, that means that whenever we have these big dollar shortages, the Federal Reserve has to either bail out the system or they see foreigners selling U.S. assets to get dollars. And that causes large sorts of problems in our economy. And then in addition, the strong dollar, as we pointed out, it never gets a chance to weaken enough so that our supply chains are often uncompetitive. So neither for the U.S. or the world is the current system really benefiting anyone anymore. Very few interests are served by it. And the way that that solution takes form could be many different paths. And for years, they had all these chances to do it in orderly fashion.

So we'll see if they still do or if it kind of comes up in a more disorderly fashion. So you could have multi-currency oil pricing. We have, say, the dollar is used to buy oil, the euro is used to buy oil, the yuan, the yen. You can have a couple major currencies that are all used to price oil. And that would broaden the number of currencies that are used for commodities and probably also diversify the types of debts that different countries have. So we don't have this big debt-based global dollar shortage like we have now, where the whole world is essentially trying to use one country's currency for everything.

Instead, you have a broader basket of major currencies. Or you can have that in like an SDR package, which essentially, you know, like a bank or. or you could have an agreement to use neutral assets like a central bank crypto or a gold, things like that. So there's a bunch of different forms they can take to have a more neutral settlement asset that is not tied to one nation's currency. And in addition to benefiting global liquidity, that would also benefit the U.S., even though it would be rough at first, because it's, to allow our currency to find its equilibrium and allow supply chains to come back and to make American products more competitive in the global marketplace. It's really interesting.

You know, in some ways, since the end of the Cold War, we've been implicitly withdrawing from one side of the global monetary system, which is the U.S. security guarantee, right? And that's been accelerated, obviously, over the last eight years, call it. in kind of an Obama presidency that didn't really want to spend much time on things, and then a Trump presidency that really wanted to kind of finish off that global order explicitly as part of its mandate in some ways. But we haven't necessarily backed off the monetary side. And it sounds like part of what you're saying is that this is a system that even for the U.S.,

when we hear things like a strong dollar and our America hat flares, and we say, oh, that must be a good thing, right? But what you're kind of saying here is that this is a system that at this point may not really be serving anyone to the best of its ability anymore. Yeah, essentially, the strong dollar has resulted in exporting a lot of our supply chains. And I think the best way to think of it is that in an ideal world, we neither want an artificially strong dollar or an artificially weak dollar. We want a dollar that is equilibrium. So we want one that is competitive, that gives Americans a lot of purchasing power internationally, but that also is not overpriced so that our products and services become uncompetitive and too expensive in the global marketplace. Because that eventually corrects itself to the downside, even though it can take decades.

And we're kind of at the, you know, probably getting close to the tail end of that. So going forward, instead of thinking in terms of strong dollar or a weak dollar, the best to look for, is a dollar that is at equilibrium and that makes exports and services competitive without totally destroying the purchasing power of our citizens. In the next few years, how do you see this playing out for different assets? How does gold play into this? If you spend any time with Bitcoin, how does Bitcoin play into this? What does the dollar do?

Where are you looking? Or maybe even a better way to ask, so I don't put you quite on the spot in terms of predictions, is what are you watching? What are the key signals around these different areas? Mainly when I'm watching is liquidity indicators and also political developments, specifically in the U.S., about what we saw earlier with checks going out to people, like all these different stimulus packages to get money into the hands of people, because that's where we're probably going to see more liquidity come from. we're probably going to see those types of policies persist longer than consensus currently thinks.

And that can be inflationary and that can substantially increase the number of dollars out in the system. And in the near term, I mean, over the next couple of years, that can help relieve the global dollar shortage that's become very acute. But then longer term, that would be very beneficial to assets like gold, potentially for Bitcoin, even more. potentially to certain emerging market equities that have been really beaten down over the past five years in the strong dollar environment and that are trading at historically reasonable valuations, things like that. So the main thing I'm watching is just different policies that would impact the abundance of dollars both domestically and internationally. So by way of wrapping up, you had a really great tweet.

the other day, where you said, remember when people were saying high corporate household debt levels didn't matter because debt servicing costs were low thanks to low rates, that argument didn't age well. Absolute debt levels suddenly matter when income get shut off and thus promotes fragility. So now corporations and small businesses around the country and world had to scramble for government funds within the first month of revenue loss or face total insolvency. Then the government is in the position of picking winners and losers, privatizing profits, and socializing losses. I think this is dead on. When you, you sit back and think about this, do you think we're headed for more fragility solved by more

government intervention? Or do you think that there's a possibility of taking a different path where we redesign for something that looks closer to resilience? That's a big question. I'll come down to the will of people and how well people can come together to figure it out. Debt is definitely one of the biggest contributors to fragility. So, you know, for years, people justified high corporate debt levels by saying, well, you know, industry rates are so low. So their debt payments are still a small part of their income, which works as long as things are going very smoothly. As long as there's no inflation, as long as interest rates can stay so low, as long as there's no massive disruption to income sources that can work. But that just showed how fragile we are, that, you know, within weeks,

of the economy having to stop, we had to have trillions of dollars in spending and corporate bailouts and helicopter checks just because the system is so levered, so without cash, and so with high debt levels. Generally, we talked about before how over these long-term cycles, they're usually these periods of these periods of currency devaluation. And historically, even though they're very volatile times, usually the aftermath is a more resilient system because you basically have destroyed some debt in percentage terms, in real terms. So it can be a very disorderly change, but then on the other side of it, you've deleveraged either nominally or at least in real terms and you have a base to move forward from there. But it can be terrible while it happens.

and how well they handle that, like how well they thread that needle, how much they have an orderly versus disorderly currency devaluation, that can shape a lot of how it moves forward after that. Well, Lynn, really, really appreciate your insights. For those who want to follow along, for those who want this annual currency report, where can people find you? Linnaulden.com, and on Twitter, it's Lynn Alden Contact. awesome really repose it at the time this is great thanks for having me the most interesting thing

about this conversation to me is that there is this interesting implication just sitting there around the status of the dollar as the world's reserve currency where it's not clear to me that it serves the world anymore and that's fine but it also doesn't necessarily serve the u.s And the thing that's so striking is that it's hard to imagine the world shifting to any system unless the U.S. is willfully part of that. The U.S. is the most dominant economic power. It continues to be the most economically dominant power in the world, despite everything going on. And to the extent that the U.S. wants to preserve that world reserve currency status, it's hard to see how any other initiative does anything other than kind of nibble at the edges of that dominance.

However, if the U.S. were to make the decision that it was no longer in its strategic interest to be the world's reserve currency, to have the additional burden of demand for U.S. dollars to service debts, to have to be forced into basically effectively always running trade deficits for that reason, then something very dramatic and different could occur. So I don't necessarily think we're there yet. I think that the political idea of having the U.S. move away from the dollar as the reserve currency is something that will take a generation potentially to actually shift and think about. But I do think that the Overton window on this idea has changed dramatically, and it's going to be really interesting to see how this discussion plays out over the coming years.

Thanks to Lynn Alden for joining us for the show. I really appreciate her time. And I appreciate all of your time for hanging out and listening. So until tomorrow, guys, be safe and take care of each other. Peace.