Transcription
You start with a 60/40 portfolio, uh, that has some frictions, uh, in a fiscal dominance environment, especially the 40% bond portion. Uh, so my general view is, you know, to tailor it toward a more debasement, uh, uh, environment. If you swap out at least a portion of those bonds with gold, um, that's that's beneficial. You get kind of a similar volatility profile, but generally better returns. And you can also consider swapping a portion of the equities with Bitcoin, um, where you have a similar high volatility asset. Uh, and uh, it's, you know, that's, it's been an attractive mix so far. So I'm bullish both.
The United States is currently running fiscal deficits of about 6 to 7% of GDP. That's a massive number, historically more in line with wartime spending or periods of extreme crisis. But today, this has become the baseline, not the exception. Alden describes this as a "run it hot" economy. In practice, it means the government continues injecting capital into the economy regardless of whether growth is strong or inflation is under control.
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And I think the US is in a somewhat similar boat, which is that basically, uh, the background now is like 6 to 7% of GDP deficits. Uh, kind of a "run it hot" economy, especially if you're on the receiving side of those deficits. Um, and, uh, punctuated potentially by, you know, little periods of of crisis. Um, it could look like the 2019 repo spike. It could look like the 2022 gilt crisis. And, and in the US, we saw kind of similar but milder things where the Treasury started changing, uh, some of the ways it issues bonds. Uh, and so I think what that, that's kind of how I view it. I, I've been actually using the phrase "nothing stops his train," uh, which has both bullish and bearish connotations because it basically means one, virtually no attempt to slow down the deficit is going to work. Um, uh, which is bearish. On the other hand, it is kind of pointing out that it's also not going to derail in the next year or two or three. Uh, that this is going to be going on for most investment time horizons. Uh, which I generally, you know, look out five-plus years on the longer end of my time horizon. Say, I, I think this, this issue at least goes probably into well into the 2030s. Uh, so I'm bullish and long both, and I have been for for many years now.
Um, you know, gold obviously has the the long-term history and the irreplaceability, uh, as a, as a hard physical money. Uh, gold. Bitcoin is 16 years old, so it's, it's, it's newer than gold. Um, but it has portability, uh, enhancements compared to gold, and it also has absolute scarcity. Uh, so over time, it, it, you know, right now, for example, its supply growth rate is lower, uh, than gold. Um, it also has certain kind of benefits of speed. So, for example, you know, if we both had a Bitcoin wallet, we could hold up our phones, and I could scan your QR code, and we could make a payment right over this call. Whereas, if we were to do something with gold, it would require a chain of of credit and counterparties, uh, in this type of environment. Uh, so they have different pros and cons. Um, and then especially when we consider that there's a global world. So in the United States, maybe don't think about crossing borders, uh, too frequently, but in many parts of the world, people are in Lebanon, people are in, you know, name the country that's having some sort of currency crisis or political crisis, and people might save their assets and want to leave with them, uh, which is not always possible with with, you know, other types of bare assets or securities and things like that. So a self-custodial portable ledger, uh, is very attractive. Um, I kind of view it like a new protocol. So there's Ethernet, there's Simple Mail Transfer Protocol, there's Internet Protocol, there's USB, um, there's all these kind of communication standards that we've kind of solidified around for many decades. And I view generally Bitcoin as achieving network effect, uh, dominance as a communication of value. Um, so obviously, it's a more, it relies on our technological connectivity to varying degrees. Um, it's robust to handle shocks. You know, if your power goes out, you still have your keys, for example, uh, you just can't transact in the moment. Uh, so it is quite robust. Uh, but it's a different system than gold. Uh, so I think that they serve different purposes. Um, Bitcoin currently is around one-tenth of the size of gold. So you're talking about like a $2 trillion network compared to like an estimated $20 trillion monetary network. Um, and that's, that's in a sea of, you know, like a thousand trillion worth of global assets. So, you know, when when major banks kind of look around and they try to estimate how much real estate's out there, and global equities, and global currencies, and global bonds, and gold, and art, and Bitcoin, and everything else. Um, these are both kind of tiny percentages, and I think they're both growing into, um, that much larger sea of assets. Um, I think Bitcoin is moving faster because it's starting from that smaller base, uh, and it's younger. Um, but, you know, they, they often go up and down at different times. Uh, and I've, I've generally been long both.
And one of my, um, kind of recommendations, or the way that I've been doing it, at least, is to say, if you start with a 60/40 portfolio, uh, that has some frictions, uh, in a fiscal dominance environment, especially the 40% bond portion. Uh, so my general view is, you know, to tailor it toward a more debasement, uh, uh, environment. If you swap out at least a portion of those bonds with gold, um, that's that's beneficial. So you get kind of a similar volatility profile, but generally better returns. And you can also consider swapping a portion of the equities with Bitcoin, um, where you have a similar high volatility asset. Uh, and, uh, it's, you know, that's, it's been an attractive mix so far. So I'm bullish both.
For about 40 years, from the 1980s until 2020, the US operated under monetary dominance. In that era, bank lending was the primary driver of growth. Central banks could accelerate or slow the economy by adjusting rates, which affected credit creation. But now, with US debt exceeding 120% of GDP, we've shifted to fiscal dominance. Deficits and government spending now drive growth more than bank lending. And when the Fed raises rates, the effect isn't what it used to be.
Uh, so it partially ties into what I mentioned before, that higher rates, uh, in some ways, accelerate things rather than decelerate things, as they would under a more monetary, uh, environment. You know, if you go, if you go back on why that inverse correlation historically exists, uh, you can think of gold and the dollar as two competing monies or currencies, things that, things that people can hold. Uh, and gold, uh, based on most estimates we have from the World Gold Council and others, has a supply growth rate annualized of something like 1 or 2% per year. We look at new mining, plus the tiny amount that's lost, and then the estimated stocks of refined gold that exists in the world. It's got this growth rate of 1 to 2%, averaging around 1.5%, which is pretty reasonable. Uh, in most contexts, it doesn't pay you a yield to own it. If anything, you have a minor expense for for storing it. Um, whereas dollars or dollar equivalents like Treasuries, uh, they, uh, dollars historically grow at about 7% in supply per year, broad dollars. Most other developed market currencies are similar, with emerging market currencies generally being higher. Um, and you do get a yield offsetting that. Uh, now, in in many years, especially recently, especially throughout the 2010s, uh, that yield is way lower than the supply growth rate. And so you can think of it as like a net, a net result. If you get a, if you're a 7% supply growth currency and you get paid 3% on it, uh, you're having, you're facing a 4% annual dilution rate. Um, and so basically, a lot of investors, uh, there's various mechanisms that they do this, but generally speaking, when they perceive the currency is harder, so they have a higher interest rate compared to, um, the the growth rate of that currency, they're more likely to say, "I'm willing to hold that currency." But in environments where the yield is is nowhere near compensating for that that growth rate, they say, "Well, I might as well hold gold because, you know, I can, I can self-custody it. Uh, it doesn't have that debasement rate." Uh, so the lack of yield doesn't, is not a big deal because I'm not getting much of a yield with the currency either. And so you have that historical correlation. Um, and what, what's interesting about 2022 and thereafter is that normally, this aggressive move by the Fed, this kind of pretty rapid tightening, and a pretty high interest rate relative to the money supply growth rate at the current time, that would normally put downward pressure on gold. But, but gold, and and Bitcoin, and equities, and a lot of other kind of assets with some degree of scarcity to them, they pretty much resisted this this downward pressure from rates. And I think that that largely goes back to my my prior point that there's been a regime change, that higher rates don't slow things down, uh, as much as they used to, or or more probably, a more nuanced way of saying it is that the the overall result is not as slowing. They still put down as much downward pressure on some sectors as they always have. For example, commercial real estate, the volume of of residential, um, home sales and things like that. All of that is pressured by the higher rates, but it blows out interest expense, which which does flow into the economy. Um, and it blows out other other parts of the, the federal deficit. Um, and so when you're in fiscal dominance, rates don't really have the same effect, uh, against gold and other hard assets, uh, as they do during monetary dominance.
So basically, it's a new regime change, right? Uh, and so it's a different investing environment than most people are used to over a, you know, call it a 40-year investing time horizon. Basically, anybody alive and trading today. And so for the past 40 years or so, kind of before 2020, we can call that period monetary dominance, uh, and that's an environment where, for example, bank lending, and by extension, the central bank that, you know, does has various tools to accelerate or pull back on commercial bank lending, that's the more dominant thing, uh, that that causes kind of business cycles and contributes to what's going on. Um, and what happens over time as as debt builds up, especially on the public side of the ledger, so the federal ledger, uh, we gradually shift over more toward fiscal dominance, uh, which is to say, uh, that fiscal deficits are now larger than the amount of new bank lending, uh, in a given year, and even the amount of bank lending plus, uh, net new corporate bond issuance. Um, and so fiscal dominance is a, is a more driving, uh, aspect of the economy. And then also there's the added issue that, um, you know, when the, when central banks try to slow down inflation or slow down the economy in general, when they raise interest rates, they do that to try to slow down bank lending. And the problem is that, you know, when you have say, 30% federal debt to GDP, that works pretty well because when you raise interest rates, you slow down bank lending, uh, and you, while you do contribute to the federal deficit because you contribute to the federal government's interest expense, the the slowdown on bank lending is larger. But when you fast forward to the present day, and you have something like 120% debt to GDP, and you raise rates, uh, while you do slow down bank lending, you actually blow out the fiscal deficit even bigger, even by by a larger absolute dollar amount. And that's actually somewhat stimulating for for parts of the economy that are receiving it, and somewhat inflationary as a cost of that. Uh, and so basically, their tools work differently, uh, when you have fiscal dominance. Uh, and it's not just like a one-year thing or a multi-year thing. It's kind of a new regime that we we find ourselves in more structurally compared to that that past four decades.
So instead of acting as a pure break, higher rates now act more like a redistribution mechanism. They hurt housing and commercial real estate, but they boost government outflows in certain sectors of the economy. The net result is more complex and often more inflationary. This is why Alden emphasizes that we're not in a temporary cycle. This is a structural regime change. Investors need to recalibrate their expectations because the tools central banks once relied on simply don't function the same way anymore.