Lyn Alden: "The Myth of Frictionless Finance" | The Great Simplification #113

Lyn Alden:

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You are listening to The Great Simplification. I'm  Nate Hagens. On this show, we describe how energy,   the economy, the environment and human behavior  all fit together and what it might mean for our   future. By sharing insights from global  thinkers, we hope to inform and inspire   more humans to play emergent roles  in the coming Great Simplification.   I'd like to welcome Lyn Alden to the podcast.  Lyn is an investor, an independent analyst,  

very popular on social media. Like other guests  I've highlighted in the past, Kirill Sokolov,   Jeremy Grantham, Luke Gromen, and others to  come, Lyn looks at the world from an energy lens,   and it's my view that just looking at money  and technology the way that we did in the past   neglects energy and ecosystems, which is why  I only like to talk to financial people that   understand energy. Lyn has a recent book she wrote  called Broken Money about the past, present, and   future of money through the lens of technology.  This conversation was fast moving, no nonsense,   about how energy, technology and money integrate  for the future of our financial and our economic   system and the way that that's reflected in  current global events. Please welcome Lyn Alden.   Hello, Lyn. Welcome to the show. Happy to be here. It took us a while   to get this scheduled, but I'm  happy to have the conversation.  

We have multiple mutual friends, but  I've long followed your Twitter feed   and your newsletter and of all the bright  financial analysts, prognosticators out there,   you're one of the few that has really integrated  energy and how the biophysical balance sheet as   it were relates and influences the financial  situation of the world, so I'm keen to get to   your thoughts on some of that. Maybe we'll just  start there. You've always been in finance. When   did you start to realize that energy and its role  in our productivity and supporting society in   the future would be important to your story? I would say it largely came before that. Before   I went into finance, I worked in electrical  engineering. My background is in electrical   engineering, and so I kind of have that strong  physics background, the mathematical background,   and so I kind of inherently think in terms  of energy, matter, and the components there   that are in finance often abstracted away.  It's kind of like assume infinite energy,  

here's this problem, or assume away these kind of  real world frictions and what does the world look   like. Whereas especially as kind of an engineer, I  like to take those frictions back in and say, "No,   given these constraints, it's a different analysis  than what you see in kind of pure economics."   I've always been interested in that kind of  intersection between tech and finance. That's   kind of where my background blends together. So  just that focus on ... while most analysts are  

looking in one direction, while they're all kind  of focused on one thing, I try to use the skills   or the background, I have to bring a couple of  things together. For me that is the technology   of money. It's the importance of energy in the  system rather than just what are equity markets   doing? What are bond markets doing? Some of  these more kind of surface level financial stuff,   which the complication there especially, they're  so deep that you can go on those things and that's   where most financial people do. They'll focus  deeply on market structure. They'll focus deeply  

on fund flows. They'll pick their niche because  there's so many deep niches you can go down and   it just so happens that my niche instead tends  to take the broader components and pull them   back into finance, go back to the energy, go back  to the technology and try to pull those things   back in and find that intersection in finance. I totally agree with that and I agree with your   assessment of the general financial industry.  Is that changing at all? Are people starting  

to understand the ecology and energy minerals  materials are more important than they once   thought, or is it still kind of a fringe  group of people looking at it that way?   I view that as still fairly fringe. I mean, you'll  just kind of see it on graphs. They'll say, "Hey,   here's our expected copper consumption. Here's  our expected copper production. There's a gap",   and it's like a footnote in a report or just a  highlight and people go back to whatever 50 times   earnings stock that they're focused on. Generally  awareness of that tends to be more minimal,   which I guess makes sense given the incentive  structure because it's inherently rather short   term focused and short terms can even go out  to say five years. In the majority of the time,  

we're in a period where commodities are  relatively abundant and then there are decades,   maybe two decades, of commodity abundance and then  one decade of commodity scarcity in a CapEx cycle,   and then another two decades of commodity  abundance. That's kind of the pattern we've been   on. As long as you're in one of those decades,  it tends to be forgotten. For example, in the   1970s and the 2000s that was at the forefront,  but in the '80s, the '90s, the 2010s, so far in   the 2020s, at least somewhat, that's been less at  the forefront. Obviously certain recent events,   energy disruptions for Europe and things like  that have somewhat brought into the forefront,   but I think that until it's in a more sustained  context, it's harder for people to internalize.   It's very easy for people to say, "Well, that was  a one-time thing, that was transitory, that was   the shock. It's not a more structural thing." I  generally still hold the view that it's a fairly  

small component. Over the past decade or so with  the rising ESG movement, even then it was just   quantified as a number. It was like a scorecard.  It was like how to have the appearance of being   green versus the actual underlying reality of  being green? It's like how can we quantify this,   how can we market this more so than how can we  understand this or how can we actually do things   in something that actually is more sustainable? An example is just focusing entirely on one   number. Like carbon, for example. How can we  reduce this number or at least get this number   off of our balance sheet, on someone else's  balance sheet where it's not our problem versus   soil quality, water quality, air quality,  other types of different metrics. It's more   about that gamification, that financialization  and just kind of trying to put things into one   or two numbers and then put that onto someone  else's balance sheet. So no, I don't think it's  

been internalized yet by most participants. I agree with that. I don't know how much you know   about my work and my podcast, but I agree with  you. I'm looking at how the system works together   and it's not just carbon and it's not just  interest rates and it's not just inequality or   energy or oil. It's how everything fits together.  I think the market is both a narrow view versus a   wide view and a short term view versus a long term  view. With your couple decades and one decade,  

I would say we've just had two centuries of  relative commodity abundance and cheapness,   and we're headed into a century that the opposite  is going to be generally the case. That's the   story that I'm trying to unpack here. This is not a financial podcast,   but I have had Jeremy Grantham and Kirill Sokolov  and Luke Gromen on because I firmly believe that   sustainability and climate and what's happening  in geopolitics and all those other things,   we have this giant financial speed bump looming  in the coming decade or so with the amount of   debt that we've amassed. Debt is a claim on  future money and money is a claim on energy  

and resources, and how the hell are we going to  pay all that back? I don't think enough people   in the environmental, sustainability, social  justice space are looking at that roadblock in   the future. I'm sure we're going to talk about  that. Do you have any response to that?   Yeah, I think there's often very different silos.  On one hand you'll get a group like Just Stop Oil,   and they're often very disconnected from what  that means on society. You'll see people, their   clothes are made out of oil, the paint they're  using is made out of oil the transportation they   use to get there is made out of oil, and they're  doing some sort of protest, about "Just stop oil,   just stop doing this", and they don't actually  realize that that means an entirely different   life cycle. It's very hard to support this many  people. It's very hard to support anything like   the current living conditions, let alone the  people that are in developing countries that   want to fully develop, that they want to reach  a general level of, say, energy consumption   or just master of their environment that  is more prevalent in wealthy countries.  

On the other hand, there's kind of just kind of  status quo, like you said. Basically assume that   the current thing just continues structurally  and that it's not an issue and that it's not   something to focus on. So I generally think  that there's just so many silos out there,   and I don't really take that into account  together. A chart that I posted a while back,  

a lot of people I'm sure with this podcast  are familiar with the long-term chart of   global energy consumption where it's this big  exponential thing and you can layer it to see   all the different types of energy that went  into it, so it's biomass and oil and natural   gas and nuclear and renewables at the top, and I  just put a little marker there that showed when   my father was born, because my father was in  his early 50s when I was born. He is a fairly   older father and he's actually in the ... The amount of progress we made just in his   lifetime or the amount of things that have changed  in his lifetime are huge, and yet you have this   big exponential curve and this little marker  that's actually kind of closer to the beginning   of it and it's like that's literally when my dad  was born. It's not that long ago is the point   I was making, which is that in one or two human  lifetimes, 200 years is two long human lifetimes,   and our entire world has dramatically changed  and the trajectory of that is, I think,   something a lot of people take for granted. They  don't realize how much of their current life cycle   or their current life details are heavily based on  the amount of energy they consume and the things   that have only really materialized in the past  maybe 50 years, 100 years, 200 years, depending on   which thing you're focusing on, and it's actually  a fairly recent and fairly fragile phenomenon.  

Well, we're drawing down the principle and our  stories about it treat it as if it were interest,   and we think somehow this will always be here. Let  me give you the mic to fully unpack your current   thesis. You recently wrote a book called  Broken Money. Maybe you can give a short   summary of that along with just expand on your  current worldview in several minutes. The state   of the world, according to Lyn, February 24. Sure. Broken Money, and a lot of the work I do is   focused on the financial side, even though, like  we mentioned, it ties into energy, it ties into   other areas that are of interest. But basically  kind of the main description of Broken Money  

is that it looks at money through the lens of  technology. A lot of monetary history books focus   on money through the lens of politics. What did  this political leader do? Why did he do it? How   did it affect this other nation? How did it affect  this? What were all these kinds of decisions   involved at the time? Whereas I look at it more  from the lens of technology, and the reason is   political things, political decisions affect  things locally and temporarily. For example,   a political leader can influence the direction  of one country in a different direction than   another country, whereas technological changes  affect things globally and semi-permanently,   at least as long as we have civilization. For example, if you invent refrigeration,   that transcends the local environment and  it transcends time. As long as we maintain   that status, refrigeration spreads everywhere,  and that's different than a political decision   that can come and go and weave around. I view  money in that lens, which is how did different  

technological advancements permanently change how  we interact with money or what we use as money and   how did it change incentive structures? Some of  those bring back some of those political decisions   into it. How did technology change what decision  points were even possible or how did they change   what is likely to happen? That was kind of a key  focus on the book and the short summary of it is   that for the past several centuries, almost every  friction in money was solved by centralization.   Moving gold around, for example, it's costly, it  slow, verifying it is expensive and challenging,   and so instead you say, "Okay, that's a friction",  and you rely on some sort of third party to   basically hold the gold and it's easier to  trade claims on that gold. But of course,  

you have to rely on that trusted third party  and when trusted third parties failed in various   regions or they got identified and connected  together, we'd build a layer below them. So   even other third parties, when they want to  move gold around or move gold ownership around,   they would have accounts at an even bigger third  party and say, "Okay, well, our client wants to   move gold, so they're shuffling our accounts  around and we're telling you to shuffle your   accounts around and you move this over time." My favorite source in the book was Money and   the Mechanism of Exchange. It's a book from 1875  that I cited in my recent book by William Stanley   Jevons and he talked about the state of the  financial system back then. About 150 years ago,   he was talking about the financial system,  and in some ways it was kind of like my book,   but the 150-year-old version of it, which was he's  exploring the technology of money in 1875, and   he's talking about how all these paper instruments  and the introduction of the telegraph, for   example, the Cross Atlantic Telegraph cable was  finished in 1866, and even though it was invented   in the 1830s, it took decades to actually be  placed across continents and across the oceans. It   took until the early 19th century to go across the  Pacific and kind of connect the rest of the world.  

But he was exploring how we have this system  where information can now move super quickly and   the underlying assets rarely ever have to move. This is where it's, I think, relevant for this   kind of current discussion. On one hand,  he's saying, "Look how efficient this is.   This is so beautifully efficient that the gold  rarely ever has to move, and all these claims   can just trade on top of it." On the other  hand, he's like, "Because it's so efficient,   it's become levered 20 to one, and should 5% of  people ever show up and want their gold back,   the system doesn't have it. It's basically a  giant game of musical chairs that can never   stop." What we know from history, of course,  is it did stop in World War I and all the gold   pegs broke and all the inflation emerged, and that  kind of system had to completely change again.  

Then it kind of stopped again  15 years later, right?   Yeah. It never really even got completely fixed  during that part and then it kind of got entirely   reconstructed. It just shows that relying  on centralization works until it doesn't.   It was fascinating reading his descriptions  back then, having the benefit of seeing what   happened in the decades and centuries that came  after that. One of the things that Broken Money   explores is that even after that time, almost  every friction in money was solved by greater   and greater centralization and greater and  greater detachment from what's happening at   the underlying physical layer of things, and that  in recent years, there's some degree of momentum   to kind of shift that back to varying degrees. For example, Bitcoin is something I explore that   can, for example, allow transfers of value and  have an underlying ledger that is not centrally   controlled, that you have kind of a peer-to-peer  updated ledger that's backed by energy in a way   that has kind of rules-based scarcity or  rules-based transactions associated with   it. There's other things as well. For example,  there's decentralized communication protocols.   We've had kind of periods of greater and greater  communication centralization, and now some of that   can potentially be changed back and pushed in  the other direction. A lot of what Broken Money  

focuses on is how technology over time created  this really big gap between transaction speeds   and settlement speeds, so anything that involved  information could be greatly accelerated.   Prior to the telegraph, even if you were  transmitting just information or transactions to   someone, it couldn't realistically go faster than  foot, horses and ships, for example. Even if you   were just updating a ledger, the ledger itself had  to move to some other location in order to make   that possible. Ever since we entered the telecom  era, we've been in this period where transactions   are way faster than settlements, and we've always  used centralization for that gap, but now there's   technology to make that less needed. Is Jevons paradox ultimately a monetary   observation, a monetary phenomenon? I mean, I've  always thought about it from the concept of the   steam engine, "Oh my gosh, we're going to get  more efficient, so we won't need as much coal",   but actually we need a lot more coal because  we scaled steam engines. But from a monetary  

technology perspective, if we were improving  the efficiency of the monetary system,   it meant that that would expand commerce  around the world and have those claims on   reality move faster and faster in the system? Yeah, Jevons had a number of different areas of   focus, and so Jevons Paradox didn't come from  this particular work, but obviously ties in in   a certain way. It's the idea that when something  becomes way more efficient, we end up using a lot   more of it. So instead of our needs reducing to  that, we fill the gap. A really good example I   think is things like data storage, for example.  When we reduce the cost of a megabyte of storage,   instead of spending way less on storage,  we instead use way, way more storage. We  

use thousands and millions and more megabytes.  That's a general thing we've seen with energy.   It's a general thing we've seen with computing. Even in blockchains, for example, obviously   there's a very tight constraints associated with  those systems, and generally the use case of it   will fill whatever is presented, whatever is  possible to fill, it finds a way to be filled   because that's historically what we do. In fiat  currency terms, it's another way of saying that  

any system that can be abused will be abused.  For example, if a ledger is very flexible,   over time it's very likely that the full  flexibility of that ledger will be used. If,   for example, it's a debase-able ledger, it  almost certainly will be debased because it's   possible to be debased. A lot of these things  end up kind of tying together in that way.   So how broken is our money system? I kind of separate that into two different areas.   There's kind of the developed market answer and  the developing market area. In developing markets,   it's been acutely broken for a long period of  time. The way to think about that is that there's  

160 different currencies, roughly speaking,  and each one is basically a currency monopoly,   and they use a centralized ledger. If you  happen to be born in one of these countries,   which is where the majority of people are, your  wages and your savings get devalued at a very   rapid pace and you have a lot of frictions in  terms of connecting with the rest of the world.   For example, there's roughly 40 currencies in  Africa, roughly 30 currencies in Latin America.   We can imagine in the United States,  if we had a currency for every state,   all of the frictions that we'd have. Then further  imagine not just in terms of payment frictions,  

but if you had a business in New Jersey and  you took out debt in New York dollars and   your cash flows are denominated in New Jersey and  Pennsylvania dollars, and then there's some sort   of exchange rates shift, now you have to take that  all into account. You have all these additional   overhead to worry about in your business because  you're navigating all these different currencies.   That's what a lot of businesses have to do  globally and then those consumers in those   countries have to deal with the fact that their  local ledger's constantly getting debased.  

For example, I go to Egypt every year, and my  family and friends there are dealing with the   Egyptian pound and the debasement that it  goes through. Every year, roughly speaking,   the money supply grows by 20%, which means that  everybody's kind of on a very fast treadmill to   try to get 20% wage increases, how to not get  your Egyptian pound savings devalued by 20%.   In countries like that, does that result  in a higher consumption profile of when you   make money, you spend it right away  on things as opposed to saving?   Pretty much. It results in one is higher  consumption, but two, it also results in kind of  

malinvestment of where you store your savings.  For a lot of these types of countries, their   equity markets are not as attractive as, say, US  equity markets and so real estate tends to be the   place that they store value. Of course, the risk  in that is that you can over build real estate,   you can build ghost cities, you can build tons  of empty capacity. You're using resources mainly   for the idea of saving because you associate  real estate with saving, but then you think,   "Okay, if I want to have a little bit of excess  savings, if I have my own real estate needs met,   and I don't particularly trust the stock  market in my country for fairly good reasons,   what else can I do if I want to save a little  bit more?" It might be get a second property.   If everybody does that, or if a big percentage  of people do that, you end up with overbuilding   empty properties or building too quickly and then  having them sit idle for a long time until the   population expands into them, and it's not  the most efficient use of resources. China  

went through a similar thing, which is that  there's a lot of interest in having second,   third, fourth condos, for example, as a method  of savings, especially with debt attached to it,   and then you get a property bubble, you get high  valuations, you get a lot of debt attached to   that and some of that is largely because of people  don't want to store in the currency. They want to   store in something else. In Egypt you'll tend to  see a lot of these empty properties because that's   what people are using as their savings vehicle. You also see there'll be black markets in dollars,   there will be gold, interest in gold and  jewelry and things like that. It either  

comes in the form of not saving for the future  and consuming or saving things that are maybe not   the most optimal thing to save in, and that they  actually have kind of a negative externality by   people saving in them. Then the second part of the  question is when we look at developed countries,   I would say the problem is it's less acute  than we see in developing countries, but it's   kind of the same thing, and just the magnitude's  turned down. For example, in the United States,   our currency is debasing, but obviously not as  quickly as you're seeing in other countries. And   so, people are doing a similar thing. They're  monetizing the S&P 500, they're monetizing real  

estate to varying degrees. They say, "I don't  want to store too many dollars, I don't want   to store it in these other things." But that  does have some negative externalities to it.   So, for example, if everybody stores  their value in large cap stocks,   those stocks get a monetization premium and  then they can go out and issue more shares   and they can go out and buy smaller companies  or displace smaller companies, for example.   Or for example, if we bid up the price of  real estate and we buy second and third homes,   it makes the cost of affording a home  more challenging for someone who just   wants the home for their shelter, that they  actually want it for its utility purpose.   And so, monetizing things of utility tends to  have those negative consequences and that the   main difference between developing countries  and developed countries is mostly about the   magnitude or kind of the obviousness  and the acuteness of the problem.   And a little bit, I think is the wealth and  income inequality aspect as well. I think it  

was one of your charts I saw that the top 1%  of wealth owners in the stock market owned   over 50% of the stock market wealth, and the  top 10% own 90%. So, if the Federal Reserve   in our system is going to maximize stock  market valuations, most of the population   doesn't participate in that. And I don't know  how that maps to Egypt or China or other places,   but that is also an externality of how our  system, our money system is 'broken'.   Yeah, it's a really good point, and one of the  ways I phrase it is that the current incentive   structure basically makes people play a game  of blackjack with the system, which is that in   blackjack you want to get up to 21, but you don't  want to go over. And in the current fiat system,   there is a strong incentive to take on  leverage, but not so much that you go over,   that you blow up in a recession. So, kind of,  the incentive structure is get close to source of   money creation, take out leverage at low interest  rates, short the currency, and buy scarcer assets   with it. And then, what complicates it is it's a  global game. So again, 160 different currencies.  

And so, if you're kind of near the  source or near the top of the system,   you have all these different levers you can  pull. You can short this currency over here   and buy real assets over there. And there's a lot  of value to be gained from that arbitrage, which   is for the most part, not really adding value,  but it's kind of siphoning value off the top.   And on the other hand, if you're farther  from the source of money creation,   if you're lower in that kind of money pyramid,  and you're primarily trying to work for a living,   you're saving in the currency that other people  are shorting, and you're earning your wages in   currency that other people are shorting. Even in a hard money system, obviously  

larger and safer entities are going to have lower  costs of debt, and that's a strategic advantage.   But the current system really amplifies that gap  because one of the key sources of wealth creation   has basically been to short fiat currencies in  various ways and buy scarcer assets with them.   Even the entire multi-decade private equity  industry is larger, more connected entities   with lower cost of financing being able to  go out and accumulate and restructure smaller   businesses. And so, I think that what this  system does is kind of this global arbitrage   just increases that gap because there's  so much of it that is the financial side   more so than just the real asset side. So, let's get into energy a bit. How do  

you think the global oil production decline  rates and what's coming in coming decades   will affect the leverage and the financial  story that you just unpacked? In other words,   how are the price of money and the price of  energy linked in a leveraged fiat system?   So, partially where they're linked  is that the money system itself is   this structurally inflationary system. So,  the number of money units keeps going up,   the number of debt units keeps going up. And by  its design it almost has to, that's kind of the   structure of the system. It has those- For the last 50 years or so, right?   Yeah. Before the 1960s, I  

think it was a coin flip whether it would go up or  down. But since then, yes, every single year.   Yeah, the way it's been structured. So,  that obviously conflicts with a more finite   resource base. And the way that shows up  is that if you look at, say for example,   annual money supply growth in the United States is  something like 7% per year on average. Obviously,   it was higher during the pandemic years. Lately,  it's been in a period of contraction. But over   a multi-decade period, going back to  the 1960s, it's averaged about 7%.  

Is that just physical bills or  is that the broader metrics?   It's broad money supply. Our bank accounts, our  physical bills, all the things that we count   as money. That general number is going up by  about 7% a year. In developing countries, it'll   be generally higher. So, it'll be 10, 15, 20%,  sometimes more depending on the country. And so,  

that's this structurally inflationary backdrop,  but then it's partially offset by technological   and energy deflation to varying degrees. So, for example, it's way easier to   manufacture a computer of a certain set  of specifications now than it was 5, 10,   20 years ago. And so, we've gotten better at  manufacturing, plastic toys, anything that's   industrialized, anything electronic based. But that deflationary pulse due to technology   happened while energy and resource  total availability was still increasing,   and that may have an inflection point  coming to a country near you soon.  

That's what I was going to tie it into. So  basically, we've had this kind of multi-decade   period where inflationary money supply mostly  offset by deflationary technology gains,   energy abundance, things like that. So for example, if you have money supply   going up by 7% a year, let's say per capita  money supply going up by 5% a year or 6% a year,   but then you're getting 3 or 4% more productive  every year, you're getting more energy, and   you're also using that energy in more productive  ways. Like a processor, for example, does more   calculations per unit of energy than it did two  years ago. That combination of more energy and   then more energy productivity has been offsetting  at least most of that inflationary pulse.   And where energy ties into it is if we do get  to a point where our energy growth slows down   and/or reverses, or the other component, if we  stop getting more productive with the energy,   or our rate of energy productivity decreases,  then we no longer have that offset.  

I think somewhat of a comparison is for the past  40 years in the United States, we had a rising   debt as a percentage of GDP, but it was offset  by 40 years of falling interest rates. And so,   interest expense was not really a problem  for 40 years. But what we're finding out   in recent years is after you get down to  zero rates, you start going sideways to   up in terms of interest rates, and you still  have that very high and climbing debt load,   then suddenly you no longer have that offset, and  interest expense is actually more of a problem.   And so, if you carry that analogy over to what we  just talked about, if you don't get these offsets   that we've been getting for all this kind  of ongoing money supply growth, debt growth,   kind of just growth and paper assets in general,  that's when you get more quality of life problems,   more inflation problems, more problems with the  way the system's design, and the assumptions   that go into the design of that system. I'm going to get back to that, but let me   timestamp this right now before I ask you the next  question. It is 2:40 P.M. Central on Wednesday,   February 21st. Around 20 minutes from now, NVIDIA  is going to announce their quarterly earnings. As  

of right now, before that announcement, and  you and I don't know what that's going to be,   the value of NVIDIA, the corporation, is greater  than the entire energy sector of the S&P 500.   Can you opine on that for a second? So, I currently view the energy sector as   undervalued. I think people fail to appreciate how  critical that is. Even those processors obviously   use a lot of energy, and they're going to  use a lot more energy in the future. So,  

NVIDIA's future growth, the ability to grow  into that valuation, that's premised on the   idea that their revenues and their earnings  are going to keep going up in the future. And   all of that is ultimately energy-based. And so, one thing we've generally seen in   history in the markets is that  they go through these kind of   disinflationary cycles and inflationary cycles. So, in disinflationary cycles, energy is fairly   abundant, materials are fairly abundant. And so,  as money supply grows, a lot of that value goes   into financial assets. And so, the valuations  get pumped pretty high and the cost of capital   is fairly low. And then, what generally happens is  our demand keeps going up, because prices are low,  

there's not a lot of new supply coming online. And  eventually, we actually start to get pretty scarce   in those raw materials. And then, we go through  a decade or so of more scarcity, higher prices,   that then facilitates a CapEx cycle. And then,  all those valuations end up being overdone.   So for example, in the 1960s, you had the  Nifty Fifty, kind of these overvalued blue   chip growth stocks, and they were doing very  well fundamentally. They were the Disneys,   they were the Coca-Colas, they were Xeroxes,  they were these big growth industries that had   great fundamentals, but they got bid up to 30,  40, 50, 60 times earnings. And then, when the  

United States and the rest of the world went into  energy-material shortages in the '70s, obviously   all these valuations were pressured, even as  their fundamentals continued to do pretty well.   And then, we went through a period where all  the energy names did well, the commodity names   did well, these kind of more real assets,  until we had sufficient CapEx oversupply,   demand destruction from high prices in  certain parts of the world. And then,   we kind of entered this period again of inflating  another disinflationary bubble. That went all the  

way up to the dot-com bubble. So, oil was cheap,  commodities were cheap, all these things were   kind of left for dead. Everybody was focused on  dot-com names, and that of course unraveled.   And then, the decade after that, the 2000s,  looked a lot like the '70s in the sense that   material costs were going up. Oil went from  $20-something a barrel to $140 a barrel. It  

kind of pressured all the valuations that  were kind of bid up in the prior time.   And so, I think that we risk going through a  similar thing, which is that we're very bid   up in terms of technology valuations, which is  not to say that some of the fundamentals won't   continue to be good for another 10 plus years  or so, but that the multiples we're placing on   them are kind of assuming that energy is not a  problem, that raw materials are not a problem,   and should those become a problem, I think you  have a very significant overweight. There's a lot   of claims for the energy that actually exists. Energy-materials not being a problem, also ecology   not being a problem, geopolitics not being a  problem. There's a lot of not being a problems  

priced into those valuations, because it's siloed,  matching the past, and projecting it forward into   the future by a lot of people by my analysis.  So, let me move on to this topic. There's so many   topics I want to ask you. Jeremy Grantham, I have  a lot of respect for him because he's devoting a   lot of his time and energy towards solving some  of the environmental problems we face. He said  

something on my podcast that I pushed him on and  he didn't respond. He doesn't seem to think that   debt is a problem, and I know others share that  belief. There's a lot of people that follow modern   monetary theory, where actually think is a good  description of how money comes into existence   and why a sovereign nation won't go bankrupt  as long as it can produce its own debt, except   all of this debt actually is relative to a same  biophysical energy, materials, and things. So, how  

big of a problem is debt? And just to add one more  factoid, U.S. government debt, which gets a lot   of focus on, is 34 trillion odd. But standardly,  Druckenmiller recently pointed out that our total   unfunded liabilities on Social Security,  Medicare, these softer claims are upwards   of 200 trillion. And even at 34 trillion, that's  100,000 per man, woman, and child in the U.S. So,   how big a problem is debt from a energy-material  perspective that you were just expanding on?   So, I view this as a significant problem, and I  think that a lot of people kind of took the wrong   lessons from the last few decades. So, back in the  late 1980s is when the famous debt clock went up.   And then, in the early 1990s, Ross Perot ran the  most successful independent presidential campaign   in modern history, and it was based on the debt  deficit. That was kind of the peak zeitgeist for   especially the public debt being a problem. I think most people that would remember that  

are like, "Wow, it wasn't a problem. Look at  how many cans we've kicked since then."   Exactly. That's the point I was going to make,  which is that a lot of that ended up being early,   because what they did not necessarily  see is the level of disinflationary   offsets we'd have over the next 30 years. So for example, China opened up to the world,   so you had Eastern labor connect with Western  capital, and that enhances productivity. Then   you had the fall of the Soviet Union, you had  basically all those resources come to connect   to Europe and connect to the rest of the world.  And all these silos opened up. That was a very   disinflationary kind of structural period. And so, we had this rising debt, rising money  

supply, but a lot of these offsets. And  also technology, automation, internet,   things that just add a lot of productivity  to our lives. So, both the physical reality   and then the digital realities basically  gave us 40 years of falling interest rates,   which offset the rising debt to GDP. And so, that ended up being early. And   the lesson that I think a lot of people took from  that was, "Debt doesn't matter. Look at all these   people that were talking about the debt 30 years  ago and nothing bad happened and they were just   kind of crying wolf." And I think the problem is  that the thing we should have taken away is that   basically we underestimated how many offsets there  are or what would happen over a given 30-year   period. But it doesn't mean you can extrapolate  that necessarily indefinitely in the future.  

Now, there's debates around how  far you could extrapolate that,   so what is going to be the ecological and  technological offsets of the next 10, 20 years,   that's certainly debatable. But the longer you  go out, you start running into certain limits.   And I think the most tangible example is just  that the rising debt we've had has been offset   by 40 years of falling interest rates. That's kind  of the mathematical way to express it. And now,   we're no longer in that period, and that's  because we've entered some real world frictions.   Our global supply chains are disrupted for any  number of reasons. First was the pandemic and now   it's war, and it's multiple reasons kind of coming  together. Should we get energy supply disruptions,  

that would be yet another input into that. Should  we get copper or other raw material disruptions,   that's another factor that goes into it. And so, we no longer have that kind of accelerated   period of globalization and kind of untapped  capital that we're able to pull in. All of the  

people that were in China and in the Soviet Union  for a period of time were basically human capital   that was not being utilized anywhere near their  full potential. And so, that was pent-up. And so,   30 years of that was able to kind of connect  to the rest of the world, offset a lot of the   debt. And I think it's the wrong assumption to say  that the next 30 years are going to be like that.   We might still have obviously some offsets, AI and  technology, but I don't think that the energy or   the human aspect, I don't think we have a lot of  those offsets going forward. And so, I think that,   kind of like how people in the late '80s or  early '90s were making wrong assumptions about   the future, I think the pendulum has swung so far  to the other direction that now people are saying,   "Oh, it's not going to matter anytime soon, or  maybe it's not going to matter at all." And I   think that when we look back 30 years in the  future, that's going to be the opinion that   we kind of say, "Why did it matter?" Or, "What  assumptions were they not having that they maybe   should have had?" And so, I think a lot of people  took the wrong lesson from the last 30 years.  

I agree with that. How do you think modern  currencies are going to hold up in a,   "We can print money, but we can't print energy  or copper," era coming our way. Can the dollar   maintain a global reserve currency status, and  for how long? And if it doesn't, what comes   after? What are your thoughts on that? So, I think we've seen a lot of emerging   market currencies, because they have limited  outside demand and they often have to finance   themselves with other currencies like dollars or  euros. When they can't print their liabilities,  

they face the real prospect of problems. And the United States' currency, and to some   extent other major currencies are kind of based  on the premise of that the status quo is going   to continue. So, in the 1970s when the United  States went off the gold standard, there was...   People that study that period or people that  invested or lived through that period, in my case,   it's obviously studying it from after the fact,  but there was a really real concern that this was   not going to work. But then, after they stabilized  things, and we kind of went through 40 years,   we've been in this period where fiat currencies,  at least the big ones work because of all these   offsets, all of these kind of major structural  offsets that we have. And I think that if we do   enter a multi-decade period where those offsets  are less, or even worse case scenario, reversed,   if instead of... You can kind of characterize  it, "Do those offsets continue to slow down or  

reverse?" And that's what I think is- When you say offsets, is that akin to   saying productivity improvements? Yes. Basically, that either you have   more raw materials to work with, and/or  you have the additional layer of you're   able to put those to more productive use. So for example, you have a computer that does   1,000 times as many calculations for the same  amount of energy that a computer did several   generations prior. Or you've made a refrigerator  that can cool things for half the energy that it   did 10 years ago, for example. All those different  rates of productivity, some things we can make   marginal improvements on. Other things, like  electronics, we've made major improvements on.  

And in addition, we've increased the overall  base amount, how much oil we pull out of the   ground in a given year compared to 50 years ago. So, fiat currencies are kind of based on the idea   that both of those variables are going to keep  going up indefinitely. And the problem I think is,   one, we start to enter problems when that rate  just slows down. Maybe it's still going up,   but it's not going up at the rate that it used  to. So, the offsets are shrinking. And then,   two, of course, it would be more severe  should one or both of those things reverse,   if we no longer get more raw materials from a  finite planet, or that the rate of productivity   growth on those slows down in some way. And one thing from an engineering perspective   people kind of take for granted is they  assume that technology is kind of linear,   or at least that it's smooth, that every year kind  of makes marginal improvements. Whereas technology  

in any one area tends to be more bumpy. So, an example of that is for thousands of   years humans wanted to fly. They made basically  zero progress on doing that. Then they made some   significant progress with hot air balloons  and Zeppelins and things like that. But it   really wasn't until you combined hydrocarbons and  aluminum, and then you go from Wright brothers   to people on the moon in one human lifetime. But then, we kind of hit some slowdown, so that   the amount of aerospace improvements in the past  50 years have been a lot smaller. In some cases,   we've even gone back from what we were capable  of doing 50 years ago, because technology is   not this smooth thing. We can run into really,  really hard limits, that the amount of energy  

or the amount of ingenuity to overcome them is so  immense that we get stuck for a period of time.   And people, they've seen the past 50  years of electronics growth and other   types of productivity growth, and they just  extrapolate that for another 10, 20, 30, 50,   100, 200 years. Whereas in reality, we can  hit certain slowdowns or certain ceilings,   where either the raw materials themselves are  the issue or the productivity growth hits one   of those heterogeneous periods where we've kind of  hit some limit and we either stall for a period of   time until we unlock something else or unlock  some other area, or we lack those offsets.   And my concern for quite a while now, at least  15 years or around 15 years, is if we didn't   have leverage and debt in the system, once we run  into that wall that doesn't have any more offsets,   as you say, then there would be a decline,  a gradual decline in the physical size and   complexity and scale of the economy. However, every time in the last 20,   30 years that we run into an economic difficulty  and there's a shortage, or price problems,   or a recession, we want to bail people out  because of the metabolism and the momentum   of the system. And we do that by printing  money or adding debt to the system. And so,  

the amount of leverage built into the system  makes me fear a Wile E. Coyote sort of event   when this biophysical phase shift rears its head. So, let me get into a theme that you've been   writing about for a while, and that is fiscal  dominance. And it seems inevitable to me that   we are going to have to borrow more and more money  rather than tighten our belt and face austerity,   and that seems a little bit endgame-ish to me in  this financial regime. Could you define fiscal   dominance and explain why it's important, and  your views on it in the coming decade or so?   So, fiscal dominance is basically a description  of where the central banks' tools for controlling   inflation are less effective because of  what the fiscal authority's doing. So,   if we think about what a central bank's primary  tools are, it's interest rates and balance sheet   size. And mostly what they're trying to do is  encourage or discourage bank lending. Because  

in many decades, most new money supply growth,  broad money supply growth is from bank lending.   So for example, the 1970s, we had higher average  inflation. And that was in large part because we   had higher than average credit creation, because  we had the baby boomers beginning to enter their   home buying years. So, the early baby boomers  were born in the late 1940s, and by the early   '70s they were entering their home buying  years, their household formation years,   as you had expanded credit usage at the same time  as you had... Actually to the energy point, you   had 100 years of conventional U.S. oil production  that was going constantly up, start to flat   line and then go down. So, we had a real world  constraint combined with that credit creation.  

And going back to this point, the Federal  Reserve's main tools are about basically   trying to slow down credit creation if inflation  is too high. Or if they perceive a deflationary   collapse of the system. Then they instead say,  "Okay, how can we encourage lending to stop   contracting and to start re-accelerating again?"  So this idea, we'll cut interest rates. We'll do  

QE and things like that. The problem is that if  you're in an environment where bank lending is   the much smaller factor at money supply growth,  and instead it's largely fiscal deficits that   are determining the source of money and spending  in the economy, then those monetary tools become   less effective. So for example, the most extreme  one is the 1940s. So you obviously had very high   money supply growth, very high inflation, and that  was not because banks were lending much. In fact,   bank lending was very muted. It's because of World  War II. It's because of all these monetized fiscal   deficits going to fight the war, going towards  industrial policy. When the GIS got home,   you put them all through college or technical  school and finance, all that kind of stuff,   so a lot of it's domestic spending as well. And that's just overriding pretty much whatever  

banks are doing. And so the Federal Reserve's  tools for modulating the rate of bank lending   are fairly irrelevant in that fiscally dominant  environment. And so we're seeing a similar   phenomenon in the 2020s, which is the deficits  are so large, the fiscal deficits are so large,   that they're a structurally larger impact on the  economy, a more stimulatory and inflationary force   than bank lending itself. And the Federal  Reserve's tool is somewhat mixed there,   because in the 1970s, public debt as a percentage  of GDP was 30% or so, and most of the money supply   growth was coming from bank lending. So if you  raise rates super high, although on one hand you  

do make the fiscal deficit worse because you're  paying more interest on your debt, the negative   impact you do on bank lending is bigger, so you're  slowing down bank lending at a faster rate than   you're increasing fiscal deficits, and therefore  tends to be a recessionary disinflationary force,   which is what Paul Volcker and others intended. But if you fast-forward to the current time and   you have say 120% or more than the GDP and  slower bank lending, if you raise rates to   try to combat that inflation, it ends up being  somewhat less effective because although on   one hand you do slow down the rate of bank  lending, the amount you increase the fiscal   deficit through interest expense is physically  larger. And so the Federal Reserve's tools become   far more mixed or insufficient or sometimes even  pro-inflationary and backfire to some degree. And   that's how you describe fiscal dominance, which is  that the Federal Reserve's tools don't necessarily   do much or sometimes can exacerbate what's  happening from the fiscal side, which is not   at the Federal Reserve's control  and not at the bank lending's   control and not really at the public's control. So could I summarize that and describe it a little  

bit differently as as we approach this biophysical  point of reckoning, the Federal Reserve and other   central banks are less and less relevant? So I think that there's overlapping themes   there because, for example, when they went  through it in the forties, it wasn't because   the biophysical reality was met yet. It was  largely that monetary and fiscal and debt   phenomenon. If you go through that environment  while you also run into biophysical realities,   that'd be a very different environment. It'd  arguably be a worse environment to go through   because the way that they got out of that prior  time was through that fairly young population and   the fact that they still had a lot of runway left  in terms of, say, energy extraction, energy usage,   technological growth. And should you try  to get out of a similar fiscal dominance,  

but you don't have a lot of the capability  either because your human capital is different,   so you have a much higher ratio of retirees  to young people or working people.   Or, if you run into limits of how much energy  you can get out of the ground in a given year   or how much copper and other raw materials  you're able to produce in a given year,   then you could obviously have a much harder  time getting out of that type of tailspin than   you would if you didn't have those issues. Tough question. From a biophysical perspective,   meaning that money is a technology that greases  the economy globally and allows commerce,   but money is spent on things that require energy  and natural resources, from that perspective,   isn't the Federal Reserve itself functioning  as a highly leveraged hedge fund given the   amount of paid in capital they have and  how much bonds they have on their balance   sheet relative to the biophysical story? Essentially, yeah. And as long as you have  

inflating money supplies against a backdrop of  scarce resources in a finite world, you have that   inherent mismatch. Whereas if instead you had a  scarcer or more rules-based money system that kind   of matched the more scarce or rules-based  based natural system, you probably would   have more equilibrium there. One of my friends,  Jeff Booth, the way he likes to describe it is,   and I think others have put it in a similar  way, that if you have abundance and money,   you have scarcity of other things. And if you  have scarcity of money, you're more likely to have  

abundance of other things up to a point obviously,  because if you end up monetizing other things,   you end up using those in a way that makes their  utility value less affordable for the people.   So if our money's weak, like we talked about  before, we go out and buy extra properties and   leave them empty. We go monetize the S&P 500. We  go and just save our value of things that are not   necessarily a void of having those negative  externalities. But if you had a money system  

that matched more of the ecological system, you  could arguably have more equilibrium there.   So you have a popular newsletter, provide  investment advice to clients. Most people watching   financial podcasts care about making money now or  in the next week or quarter based on market moves.   If I relieved you, Lyn, of that pressure and asked  you to forecast things for the US global economy,   interest rates, the whole system, for 10 years  from now without the noise of the intervening   years, would that be easier to do? What would you  opine the world looks like in the early 2030s?   So there's a lot of obviously decision points that  can affect that path. We don't know what's going   to happen with certain geopolitical conflicts  along the way that could drastically change the   end state of where those head up. But I think one  of my higher-conviction views is that within the  

next 10 years, energy is going to be a lot more of  a concern than it is now. And so that right now,   we're in one of those cycles where energy seems  abundant and therefore we can bid up all these   other financial assets very high. But that when  we fast-forward and look back at this environment,   I think it's highly likely that people  are going to say, "Wasn't it crazy that   a couple of tech stocks were valued more  than the entire energy sector?" for example,   or that people thought that they extrapolated  certain things into the future and assumed certain   trends that didn't necessarily materialize. That would be my higher conviction view,   that owning those things that are inexpensive and  that people take for granted that they're going   to continue to be as abundant or as inexpensive  or as accessible as they are now in the future,   both for the US economy and then obviously a lot  of these markets are globally interconnected.  

And so I think that's likely going to be a  theme. I'd be very surprised if we make it   another decade without having another  need for at least a big energy CapEx   cycle to sustain what we currently have. I don't have clients, but you might think that   the future is my client and I'm trying to educate  and inspire humans around the world to play a role   in what's coming. Just taking finance and making  money off the table, how can we navigate what's   coming in a more benign way than the default?  Because the default to me is continuing every   few years' economic problems that are papered  over by more and more debt at the same time that   energy is depleting and becoming less available or  more costly or both. And there's a real explosive  

potential there where society doesn't make it  through that bottleneck. So how can we take this   discussion in a proactive way, not to make money,  but to make better decisions as a culture on   what's ahead? Do you have any thoughts on that? So I think part of it, obviously it starts from   what you do in your own life before it  goes up to the global level. So basically,   in their own lives, people can determine where  they want to live in the world, where they want   to have balance with the people around them,  the environment around them, and to focus their   energies and their attention less on consumption  and more on other types of things. When I first   started writing online, even though I eventually  started writing more and more about inv

2024-03-20 20:08

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