Lyn Alden: Money Is ‘Broken’, Markets Face ‘Rerating’ Risks
What this covers
Lyn Alden, Founder of Lyn Alden Investment Strategy, discusses the outlook for a mild recession, risks to equity markets,
*This video was recorded on August 4, 2023
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0:00 - Intro 1:00 - Economic outlook 5:15 - Fitch credit downgrade 8:00 - Unsustainable debt levels 13:50 - Inflation outlook 20:00 - Unemployment and inflation 21:30 - Causes of lower inflation 24:36 - Higher interest rates vs inflation 26:30 - Fed's next moves 27:25 - Market outlook 30:17 - Attractive sectors 32:00 - "Broken Money" 37:00 - Best form of money
#investing #economy #stocks
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Lynn Alden argues that structural U.S. fiscal deficits combined with higher interest rates create a deflationary policy paradox: while rate hikes traditionally reduce inflation, at debt levels above 100% GDP, higher rates actually exacerbate deficit-driven money creation, making inflation structurally likely unless fiscal policy fundamentally changes.
- The U.S. has shifted from 40 years of falling interest rates offsetting rising debt to a regime of structurally higher rates, eliminating the tailwind that made high debt sustainable
- Unlike the 1970s when inflation was driven by bank lending (rate-sensitive), current inflation is driven by federal deficits (rate-agnostic); higher rates worsen deficits by increasing debt service costs, creating perverse incentive where monetary tightening increases fiscal expansion
- Japan's exceptional debt tolerance relied on positive net international investment position and private sector deleveraging—conditions absent in the U.S., making inflation the likely outcome rather than default
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The sources of money creation shifted from the 1970s (primarily bank lending driven by boomer lifecycle demographics and mortgage expansion) to the 2020s (primarily federal deficits); because higher interest rates successfully slow bank lending but are largely agnostic to government deficits, raising rates that worked to fight 1970s inflation may be ineffective or counterproductive against current deficit-driven inflation.
“so when people often think of inflation they think of the 70s and so in the 1970s the majority of money Creation in that period was from Bank lending uh and so you know starting in the in the early 70s the the early cohort of baby boomers that were born in the late 1940s they started turning into like marriage years home buying Years start of family years and so they would go out and and start increasingly buying houses uh with with often you know mortgage attached so basically there's a period of credit expansion”
The U.S. deficit narrowed significantly in 2022 due to both fiscal contraction (wind-down of COVID stimulus) and elevated tax revenues from 2021 capital gains and other economic activity from that boom year, but deficits have begun widening again in 2023 as the structural baseline deficits of 6-8% of GDP reassert themselves.
“during 2022 you know so many people are focused on interest rates whereas I think the deficit's not getting quite enough um overall Focus so during 2022 we had a narrowing deficit in large part because taxes were much higher that year because they were based on 2021 capital gains and and other economic uh you know impacts from that kind of boomier so 2022 is this period where the physical expenditures were kind of winding down somewhat uh and the tax revenue was winding up pretty well uh and so that was kind of a contraction event”
Without hard supply constraints (such as energy), inflation is more likely to manifest in asset prices than consumer prices; once structural supply bottlenecks appear (worker wages, energy prices), inflation is more likely to show up as consumer price inflation (CPI).
“if we have no major Supply constraints if you know we're in a very software oriented economy if you have structurally larger deficits but you don't really have any sort of hard Supply constraints then that inflation is more likely to show up in asset prices than consumer prices but as soon as you run into actual structural uh you know supply bottlenecks of some sort that's when it's more likely to manifest in terms of inflation”
Bitcoin is not yet widely accepted as medium of exchange because it has not yet achieved critical mass of adoption; money adoption follows the sequence: first store of value, then medium of exchange, then unit of account; Bitcoin is currently in the store of value phase and will require many more people holding large amounts before merchant adoption becomes widespread.
“I think that'll generally only be the case if Bitcoin is is much larger and more adopted and more widely held in liquid so generally you see you know money serves as multiple different um Solutions so it's store value it's me of exchange it's unit of account and you know generally it goes in that order”
Bitcoin's hardness (fixed 21 million supply and decreasing issuance schedule) becomes increasingly relevant as fiat currencies continuously dilute, making it progressively more attractive to global populations over decades as an alternative store of value.
“if more people hold a larger amount of it and part of it's just its own hardness basically as Fiat currencies keep diluting over time and as Bitcoin stays with its very stable and decreasing uh monetary issuance I think over time that appeals to a large and larger Global audience”
The crackdown on S&P's 2011 downgrade of the U.S. was based on debt ceiling impasse, and in the years since, the number of AAA-rated corporations has declined from four to two, showing progressive loss of AAA ratings across the corporate and sovereign landscape.
“back in 2011 s p did their downgrade that was based on a debt ceiling impasse uh and you know back then there were four companies that were AAA uh and now there's only two that are AAA”
Japan and the United Kingdom are the only two countries in the past two centuries to successfully manage very high debt levels (approaching 200% of GDP) without inflating their way out, through distinct mechanisms: the UK via Industrial Revolution and colonial wealth extraction, and Japan via decades of private sector deleveraging offsetting public debt growth and maintaining a large positive net international investment position.
“there's been two countries over the past say a couple centuries that have managed to hit those very very high debt levels without inflating it away uh and so one of them was the United Kingdom in the 1800s uh they managed they got up to something like almost nearly 200 at the GDP and they managed to pay much of it back in real terms um but they benefited from the Industrial Revolution and you know kind of colonial wealth extraction from the rest of the world”
The Philips Curve (inverse relationship between unemployment and inflation) does not hold quantitatively in practice due to global offsets and is not a reliable framework for understanding inflation; while labor tightness matters for inflation, the statistical correlation between unemployment and inflation is weak when examined across actual historical data.
“historically if you if you run the data if you just if you for example if you do a scatter plot between inflation and unemployment you won't see a lot of correlation so I I generally don't subscribe to that view uh you know in a in a fully closed system there's some logic to it that basically if you're running the economy hot uh and you have insufficient workers um obviously then you know low low unemployment uh and high inflation could be somewhat correlated to each other but in the real world when you have um you know Global offsets and things like that it doesn't really function in practice”
The 2001 recession was mild despite being severe for the stock market because unemployment remained relatively low and year-over-year real GDP only reached flat (not significantly negative), showing that severe bear markets can coincide with mild recessions.
“an example would probably be the 2001 recession so even though it was a very bad uh period for the stock market by most indicators the recession itself was mild another thing you can look at is um year of year percent decline in Real GDP so in most recessions that goes negative year over year um whereas in the 2001 recession for example you actually pretty much just went down to like flat year of year”
Historically, there have been few periods where equity markets rally or avoid correction during recessions, but in high-inflation recession scenarios, equities can hold up better in nominal terms than expected because inflation drives nominal price appreciation that offsets real deterioration—though this typically occurs in emerging markets.
“sometimes we have a higher period of inflation you get equities that don't necessarily do well in real terms but they hold up better than you might expect in nominal terms you know for example if you look at Emerging Market recession often the stock market in local currency terms doesn't look like a recession it's often going flat to up in that type of environment of course that's a pretty extreme environment because you have you know usually substantial Emerging Market level inflation along with that recession”
During sector-specific downturns like the dot-com bust, broad indices fell sharply but defensive sectors like healthcare, REITs, and energy producers experienced much less volatility, suggesting that during a mild recession, sector-specific performance variation will be significant.
“for example during the.com bust you know the the NASDAQ came down tremendously but if you were looking at say Healthcare stocks or REITs or you know the price of oil or energy producers there was a lot less drama in those parts of the you know the market or pricing around that area compared to what we look at when we see the major indices”
International money transfer systems are antiquated and rely on multi-decade-old correspondent banking infrastructure, making it faster to physically drive a suitcase of cash across the US border than to wire money internationally, exposing the inefficiency of current cross-border payment systems.
“when you start sending money Between Borders you start running into how Antiquated some of the actual systems are behind the scenes we're kind of relying on you know multi-decade old correspondent bank cops if you're trying to send money uh internationally and I think a lot of that is just due for an overhaul I I often make the joke that it's faster if I drive from where I am Vancouver to Seattle with the suitcase full of cash that it is to wire somebody in the U.S”
Payment methods will continue to exist as layers on top of Bitcoin; Bitcoin functions as a settlement network with the Lightning Network providing fast exchange capability, so most people won't transact on-chain continuously; multiple ledgers will coexist with Bitcoin serving as the deep settlement layer.
“I think most of the payment methods we're used to will still be here right so for example most of these other things can serve as layers on top of Bitcoin Bitcoin is more of a settlement Network it does have the lighting Network for for uh fast move exchange as well but I think that a lot of a lot of this is under the hood for most people and we'll still have a variety of different ledgers that we can pay with”
Interest expense on U.S. debt is nearly $1 trillion currently (about one-third of tax revenue) and is trending toward $1.6 trillion as more existing debt refinances at current interest rate levels above 5 percent, representing a structural increase that will continue to flow into the economy as income to bond holders and investors.
“when you run the numbers even at the current interest rates so just over five percent as more and more existing debt refinances towards the current interest rate level we would Trend towards about 1.6 trillion in interest expense so even this current one trillion level is only the it's only in the current environment where some of the debt has rolled over in this new industry environment basically we just maintain it for a period of time this is going to Trend structurally upward”
More credit for recent inflation reduction should go to fiscal contraction (spending winddown), energy supply improvements (SPR drawdown, China/Iran sales), and geopolitical factors (Russia/Ukraine normalization) rather than Federal Reserve tightening, though Fed tightening has slowed the economy and provided some brake on inflation.
“I would give more credit to the fiscal environment as you've seen a fiscal contraction uh like I said last year we had a significant physical contraction and so the lag we've seen a partial inflation contraction and of course energy is always a big component a lot of that was driven by Europe's policies and by Russia's war in Ukraine and so as some of that has subsided and normalized your varying degree um you know the inflation has taken a break but I would I would assign more to that to the spr being drawn down so the Strategic petroleum Reserve uh being significantly reduced China helped Iran bring their oil to Market more than they've historically been able to in recent years”
The structural unsustainability of U.S. fiscal policy stems from 40 years of rising debt-to-GDP ratio offset by structurally falling interest rates; going forward, even if rates merely stay flat rather than continue falling, that offset disappears and deficits can no longer be absorbed without creating larger problems.
“the past 40 years you've had Rising debt as a percentage of GDP in the public level but that was offset by structurally Falling interest rates and the challenge going forward is that you know even if interest rates aren't going up structural anymore if they're just going Sideways from here or they're chopping at a big range now you don't have that interest rates going down offset for the larger and larger structural deficits”
Fitch's downgrade of U.S. sovereign credit will not materially raise short-term borrowing costs because bond traders do not significantly change behavior based on rating agency downgrades, but it reflects a broader trend of market participants increasingly recognizing fiscal unsustainability.
“most likely not I mean there are very few Bond Traders today that will change their opinion on U.S treasuries based on Fitch uh their and their rating right so they're very like not a lot of entities to say oh now there's double A plus uh we're gonna treat them differently uh so mechanic like uh mechanicalistically it shouldn't be a big deal”
The services sector remains strong in the U.S. economy and is partially supported by higher deficits and higher interest rates that benefit wealthy retirees and certain service businesses like healthcare, travel, and restaurants.
“the services sector is still going decently strong and I think part of it is actually ironically fueled by some of these higher deficits and higher interest rates we're seeing so you know most most um economic impacts hurt someone help someone else and so there are parts of the economy today that are being helped by some of the policies that we're seeing um you can look at the health care sector you can look at the travel sector you can look at the you know the restaurants things like that there are a bunch of areas that are working well in the economy”
The market is deeply bifurcated: outside the top 7 stocks, valuations are reasonable and the market is not overpriced, but the top 7 large-cap tech stocks have experienced significant valuation expansion without earnings expansion, creating concentrated downside risk if the market re-rates those equities to match higher interest rates.
“I think we see a very bifurcated Market I mean outside of the the top seven stocks um a lot of them are actually pretty inexpensive and not on performing this year and so I don't have a lot of concern about the necessarily the broader Market but certainly the areas that have been over uh bought and that are mostly well not with we haven't really seen earns expansion for to a significant degree instead we mostly saw valuation expansion”
The next 6-9 months remain uncertain due to lingering recession risks, but the key inflation risk to watch is energy: without a significant energy capex cycle creating new hydrocarbon supply, energy inflation remains a risk alongside large fiscal deficits.
“I think the next six to nine months are still very uncertain because like I said we're not out of the woods yet for potentially happening a recession and that obviously can put down pressure on prices but I think the key thing to look at is what happens with energy so we've still not had a significant energy capex cycle um in this in this kind of um you know this current market cycle and so I think it's still until we have a significant Supply jump of available hydrocarbons I think energy inflation is one of the key risks to watch”
Bitcoin is already among the top 10 globally-saleable forms of money (like international dollars or gold coins) despite having no geographic center of density, because it can be transferred and accepted across borders more easily than most national currencies.
“and the way I put it now is that in any one country obviously the local currency is by far the dominant medium exchange but if you think of assets that you can bring globally that are money like I think Bitcoin is already in one of the top ten so for example you know I have Egyptian currency I have Norwegian currency in in the drawer next to me and if I were to go around in a 10 mile radius trying to find someone that will accept those uh it'd be pretty challenging whereas I could actually buy something in Bitcoin easier than I could with those monies”
The end result of structural fiscal unsustainability is likely to be inflation rather than default, because the U.S. government can finance its debts in its own currency indefinitely and the Fed can monetize deficits, so the political path of least resistance is to allow above-target inflation rather than cut spending or raise taxes.
“the end result is likely inflation uh so generally when a country um you know has debts now in its own currency uh it's able to finance things with its own Central Bank as much as it wants it's not that the fault's the issue unless it has again some sort of like policy you know unless it kind of does it to itself do its own conflictedness so default's not really the issue it's more about structural inflation or period like waves of future inflation”
The U.S. is currently running a deeply negative net international investment position (owing more on sovereign credit to other countries than other countries owe to the U.S.), and reversing this requires either: sustained structural trade surpluses and current account surpluses, or alternatively a long multi-decade process where U.S. assets perform poorly while international assets perform well, similar to the United Kingdom's decline over recent decades.
“the U.S is currently still a net detonation meaning that the U.S owes in terms of sovereign credit more to other countries than other countries owe to the US”
The United States differs from Japan in lacking offsetting factors: the U.S. is running equal or larger deficits, spends 2-2.5 times more per capita on health care despite being younger, and lacks the private sector deleveraging Japan experienced, making the U.S. more likely to experience inflation.
“the United States is not quite in that same situation one is we're running equal or larger deficits um two is that we fend we spend far more per capita on health care than Japan does something like two two or two and a half times as much per capita even though we're a younger society and so they have a number of like a they have a number of efficiencies or offsets that I think the United States does not have”
The biggest challenge for most of the world's population in developing countries is managing two currencies simultaneously: their local currency and the dollar (since their debts, inputs, and trade are often dollar-denominated), creating unique vulnerability to currency devaluation; in developed countries, currency erosion is only experienced at the margins.
“those of us in developed countries uh you know we see these kind of mild upticks in inflation so high single digit inflation you know that that's kind of our biggest worry I think that the the biggest challenges for you know the majority of the world that lives in developing countries um because they have the situation where their their political leaders have to effectively manage two currencies right so they're managing their own local currency and then they're also managing their relationship with a dollar”
Commodity money (particularly gold) is the most immutable and reliable natural ledger because of gold's physical properties, making it the most durable natural form of money across history.
“and so as we've kind of iterated through the different Commodities gold is the most immutable or reliable natural Ledger that we can you know work with”
The Federal Reserve will likely continue to be a structural buyer of Treasury securities over the next 5-10-15 years because one of its shadow mandates is maintaining financial stability in the system; even though it may not explicitly monetize deficits in normal times, Treasury malfunction or insufficient market liquidity would trigger Fed intervention to restore stability.
“while we're in this current window where the FED has room to tighten and to reduce its balance sheet I think the issue is that when you look out forward the amount of Treasury instance that's coming to Market one of the feds kind of Shadow mandates is to maintain some degree of financial stability in the system and so should you get some sort of Treasury malfunction you know not insufficient buyers insufficient liquidity that kind of thing I think eventually you would see the FED step back in”
Gresham's Law—'bad money drives out good'—applies specifically to situations where there is artificial fixed exchange rate between two forms of money; Bitcoin avoids this problem because there is no fixed exchange rate, but instead faces 'Gresham's friction' from taxation on Bitcoin transactions, which discourages spending and keeps it in store-of-value phase.
“gresham's law applies in a circumstance we have some sort of artificial exchange rate so if you for example have a gold and silver Peg um and if the international exchange rate is 15 and a half to one whereas you're trying to do it at 15 to 1 or 16 to 1 then one of them is overvalued in your country relative to the other and so the one that ends up being undervalued either leaves the country because Global Arbiters come in and basically make make use of that exchange rate differential or people hoard it they don't want to they want to spend the the overvalued money into circulation and they want to hoard the undervalued money and so Bitcoin doesn't have that exchange rate fixation issue”
Money can be conceptualized as a ledger—a set of liquid units that society agrees upon—and the key question is who maintains that ledger; commodity money (gold) uses nature, fiat uses centralized government/central banks, and Bitcoin uses decentralized users/nodes, each with different trade-offs for reliability and immutability.
“I generally view Bitcoin the most favorably um basically what I what I do in the book is I characterize basically the money is a ledger it's basically this this set of you know kind of liquid units that we agree on and then of course the question becomes who maintains that ledger and so commodity monies use nature to maintain The Ledger and so as we've kind of iterated through the different Commodities gold is the most immutable or reliable natural Ledger”
Example from Egypt: currency was cut in half relative to the dollar over two years, devaluing all savings and ongoing wages for Egyptian citizens, demonstrating real-world impact of money system problems.
“for example if you were living in Egypt over the past say two years you just got your currency cut in half relative to dollar and so all of your savings and your ongoing wages are devalued”
The U.S. is now ranked behind two U.S. corporations (Microsoft and Johnson & Johnson) in terms of likelihood of defaulting on debt over the next five years, which is reasonable because congressional gridlock presents a material technical default risk even if the U.S. could always print money to pay nominal amounts.
“it's still the case today that the US government is now ranked behind two U.S companies in terms of their their likelihood of defaulting on you with their bonds and I think that's actually somewhat reasonable if we imagine the next five years or so the chance that Microsoft or Johnson Johnson misses a an interest payment is actually probably lower than then if there's some sort of like you know process hiccup in Congress and they they end up missing a payment or you know principal something like that at least temporarily”
The solution to inflation-eroded wealth at an individual level requires finding and owning assets that are not being devalued, rather than fixing the monetary system itself, which historically works itself out organically but over multi-decade timeframes.
“the solution comes down to individuals you have to find assets that are not being devalued and so I think that over time the history of money especially you know when I when I went kind of hold the whole background of the book to see how money evolved over time generally it's a problem that works itself out somewhat organically so as as money start breaking down people gravitate towards other types of monies”
In countries that print their own currency, real default (reduction in purchasing power through inflation) is more likely than nominal default (missing payments), and current-form bonds will not be paid back over 10-20-30 years in terms of full purchasing power—holders will experience real losses.
“I think basically going forward there's both an impairment to the you know the balance sheet basically I think that you know Bonds in their current form or knocked me paid back over 10 20 30 years in terms of full purchasing power so you know you're in in countries that print their own currency you're more likely to have a real default rather than a nominal default”
The solution to broken money systems likely involves either central bank digital currencies (which solve backend inefficiencies but introduce privacy and control risks) or open-source money solutions like Bitcoin (which reduce friction but face adoption challenges and are still small-market alternatives).
“one is obviously Central Bank digital currencies so as they try to modernize their back end of their system they can potentially fix some of these inefficiencies the obviously the challenge there is that there's obviously privacy issues control issues and other risks around that so instead I generally have a more favorable view towards open source type of solutions so things like Bitcoin”
Large energy companies are pricing in indefinitely low oil prices, so even if oil drops to $60-70, large-cap energy stocks remain relatively valued for that pessimistic scenario, providing moderate downside but significant 5-year upside potential.
“you know even if even if oil would have dropped to 70 or 60 and and places like that the large caps are still relatively priced for that scenario so I think the downside risk is somewhat moderate whereas the upside potential over say a five-year period is pretty significant”
Lynn is bullish on energy sector, healthcare sector (with attention to regulatory risks), T-bills, gold, and Bitcoin at current levels, suggesting these represent attractive opportunities in the current macro environment.
“I'm so recently constructive on energy um uh when I look at the full health care sector um you have to be careful with certain regulatory risks but overall that's a reasonably priced uh value-oriented sector at the moment as well as I think I think things like t-bills are attractive in this environment um you don't have to be fully invested in the equity market and I'm still bullish long term on gold and Bitcoin at these levels”
Social Security could be means-tested in the future, which would reduce benefits for wealthier retirees and address some of the program's structural fiscal challenge before it becomes fully problematic in 2030.
“one is that Social Security could be means tested in the future and so some people that think they're getting Social Security benefits might not get them because otherwise the whole program where it might become more structurally problematic in 2030”
Lynn's book 'Broken Money' examines how monetary technology evolves as technology changes, covering commodity money systems, banking and central banking services, and digital assets like Bitcoin, and argues that current monetary systems are troubled, using examples from emerging and developed markets to show how money systems break down.
“I have broken money coming out and what I do is I look at Monetary technology over time so as technology changes what we use as money uh changes and how we interact with money so I cover commodity money I cover the evolution of bank and banking services then I touch into things like Bitcoin and digital assets and so it's not any specific region it's more about why our current money system is troubled”
Equity market risk is more significant in real terms (purchasing power) than in nominal terms, meaning a 10-20% drawdown is not abnormal and investors should prepare for moderate corrections.
“I think it'll be it'll be somewhat sector specific and I think that much of the negative kind of risk to the market is more in real terms than in necessarily nominal terms but you can still have easily a 10 20 drawdown those are those are normal”
Japan's investors have experienced mild-to-negative real yields for an extended period but the outcomes have been less negative than many predicted, suggesting that high-debt environments don't always lead to severe currency/bond devaluation if the underlying structural conditions support it.
“I mean you know investors have been sitting there with with mild and negative real yields for for a period of time but it's certainly not been as negative as people thought”
The interviewer notes that the U.S. dollar is still widely accepted internationally (unlike other currencies like Canadian or Egyptian dollars), reflecting its position as a global medium of exchange and illustrating why individuals and merchants don't yet need Bitcoin despite its theoretical advantages.
“I have one final question on bitcoin I'll let you go then it's very fascinating talk thank you I'll give you a personal anecdote on the dollar being International medium of exchange so I came back from a trip to the U.S not too long ago I landed in Canada I only had U.S cash in my wallet at the time so I paid the cash driver in USD I asked him hey man like do you do you accept this otherwise I'll just give you my credit card he said no I'll take the US cash it's fine didn't even hesitate no problem there”
Bank of America recently shifted to a soft landing forecast from a more negative outlook, and now expects 2% real GDP growth on average, up from 1.5% prior forecast, but Lynn still expects eventual mild recession, suggesting the market and BofA may be underestimating downside risks.
“Bank of America recently switched their stance their Outlook to a soft Landing forecast previously they had a more negative outlook this is from Reuters of Brokers no longer expects a model recession in 2024 and sees Real gross domestic product growing two percent on average this year up from a previous forecast of 1.5 percent”
Unemployment has been hovering around 3.6% since December 2022 and was 3.5% as of August 4 (the Friday when the interview occurred), indicating stable historically-low unemployment, which raises the question of whether the Philips Curve applies.
“we have the latest unemployment data come out this morning as a Friday August 4th it's a 3.5 slightly down from the previous months 2.6 but it's been Lynn it's been hovering around 3.6 for quite some time now actually going back to December it was 3.9”
Alden's book 'Broken Money' will be released later in August and will be available on Amazon initially, then spread to other bookstores.
“and when does your book broken money come out later this month later in August all right well uh good luck with the book launch where can we find an Amazon uh with Kindle yeah start by Amazon and it'll it'll spread to other bookstores as well most likely”