Lyn Alden’s 2024 Investment Thesis: “Nothing Stops This Train”

Summary

The video script discusses the concept of 'fiscal dominance' in financial markets, contrasting it with the 'monetary dominance' that has characterized trading for the past 40 years. Monetary dominance refers to the central bank's control over economic growth and inflation through interest rate adjustments, which influence bank lending and credit creation. In contrast, fiscal dominance occurs when large public debts and fiscal deficits become the primary drivers of economic indicators, constraining the central bank's options and pushing it to a secondary role. The script uses a meme to illustrate this shift, likening it to a train that cannot be stopped. It suggests that the era of declining interest rates, which has benefited certain asset classes, is ending, and a new environment characterized by fiscal dominance is emerging. This transition, which has been gradual and began around 2019, is expected to lead to a more inflationary environment where stocks and bonds may become more correlated and capital controls could rise, affecting investment strategies and the financial industry.

Takeaways

• 🚌 The meme illustrates the transition from a market environment dominated by monetary policy (the bus) to one dominated by fiscal policy (the train).
• 📈 Over the past 40 years, markets have operated under monetary dominance, where central bank policies like interest rate adjustments were key drivers of economic activity.
• 🚂 The concept of fiscal dominance suggests that large public debts and fiscal deficits become the primary drivers of economic factors like inflation and growth, reducing the impact of monetary policy.
• 💵 In a fiscal dominance scenario, central banks like the Federal Reserve have fewer options as their actions may not significantly influence fiscal policy.
• 🔄 The inverse correlation between stocks and bonds, which was prevalent during monetary dominance, may become less relevant as fiscal dominance takes hold.
• ⏳ The era of declining interest rates, which has benefited various asset classes, is ending, and this shift could lead to a new market structure unfamiliar to many investors.
• 🌐 The developed world has not experienced fiscal dominance since the 1940s, making this a significant transition with potential implications for investment strategies.
• 📉 The rise of fiscal dominance often coincides with increased capital controls and potential restrictions on financial privacy and self-custody in the crypto industry.
• 🚨 The meme serves as a warning that the long-standing investment strategies based on monetary dominance may no longer be effective in a fiscally dominated market.
• ⛓ The transfer of private debt to public entities, as seen in responses to crises like the pandemic, contributes to the rise of fiscal dominance and potential currency debasement.
• 📊 The shift from monetary to fiscal dominance is not a sudden event but a gradual process, with the U.S. having experienced periods of fiscal dominance since 2019.

Q & A

What is the main theme of the meme discussed in the transcript?

The meme illustrates the concept of 'fiscal dominance', which is a shift from the 'monetary dominance' that has characterized market trading for the past 40 years. It suggests an impending change in economic paradigms, where fiscal policies and government actions will have a more significant impact on the economy than monetary policy.

What is 'monetary dominance'?

Monetary dominance refers to a period where monetary policy, primarily controlled by the central bank, is the dominant force influencing economic growth, inflation, and interest rates. It involves the central bank's actions, such as adjusting interest rates and influencing credit creation through the banking system.

What is 'fiscal dominance'?

Fiscal dominance is a situation where large public debts and fiscal deficits become the primary drivers of economic outcomes, such as inflation or disinflation, and nominal economic growth rates. In this scenario, the central bank's power is constrained by fiscal policies, and its ability to influence the economy through interest rates is diminished.

How does the concept of 'fiscal dominance' relate to the current economic environment?

The concept of 'fiscal dominance' suggests that we are moving into an era where government spending and fiscal policies will play a more significant role in the economy. This is due to factors such as high public debt and persistent fiscal deficits, which are becoming more influential than monetary policy in shaping economic outcomes.

What are the implications of 'fiscal dominance' for investors?

In a fiscal dominance scenario, traditional investment strategies that worked well during monetary dominance may no longer be as effective. Investors may need to adjust their strategies to account for the new economic dynamics, which could include higher inflation, different asset correlations, and potential capital controls.

How does the speaker describe the transition from 'monetary dominance' to 'fiscal dominance'?

The speaker describes the transition as a multi-year process rather than a sudden shift. Since around 2019, the U.S. has been moving towards fiscal dominance, with periods where it briefly moves away before returning. The transition has been more persistent since early 2023.

What is the significance of the declining interest rate environment in the context of 'monetary dominance'?

The declining interest rate environment has been a key feature of monetary dominance, providing a tailwind for various asset classes. Lower interest rates have allowed for more debt accumulation, which has fed into itself and pushed interest rates down further, creating a cycle that has defined the investment landscape for the past several decades.

How does the speaker characterize the investment strategy of the past 40 years?

The speaker characterizes the investment strategy of the past 40 years as primarily focused on the debasement of currency, particularly the U.S. dollar. This has involved investing in assets that benefit from inflation and currency devaluation, with all other investments being downstream of this primary trade.

What are the potential challenges of operating in a 'fiscal dominance' environment?

In a fiscal dominance environment, there may be challenges such as rising inflation, changes in the correlation between stocks and bonds, potential capital controls, and attacks on privacy tools and self-custody. These factors can make the investment environment more complex and less predictable.

How does the speaker suggest that the era of declining interest rates and structural disinflation is ending?

The speaker suggests that the era of declining interest rates and structural disinflation is ending due to the rise of public debt levels, which are not being offset by declining interest rates as they have been in the past. This shift is leading to a new economic environment characterized by fiscal dominance.

What does the speaker mean when they say that fiscal dominance can lead to 'currency debasement'?

Currency debasement refers to the decline in the value of currency, often due to the increase in the money supply without a corresponding increase in goods or services. In the context of fiscal dominance, high public debt and persistent deficits can lead to currency debasement as governments may resort to printing money to finance their debts, thereby reducing the currency's value.

How does the speaker view the role of central banks in a 'fiscal dominance' environment?

In a fiscal dominance environment, the role of central banks becomes more constrained. Their ability to influence the economy through interest rate adjustments is limited by the fiscal policies of the government. The central bank takes a backseat as fiscal policies become the primary drivers of economic outcomes.

Outlines

00:00

🚂 Introduction to Fiscal Dominance

The first paragraph introduces the concept of 'fiscal dominance' through a meme that Lynn posted on Twitter. The meme illustrates a bus going over a train track with a train about to hit it, symbolizing the unstoppable force of fiscal dominance. The discussion explains that for the past 40 years, markets have been under 'monetary dominance', where central bank policies have been the primary drivers of economic growth and inflation. However, the conversation suggests that we are transitioning to an era of 'fiscal dominance', where public debt and fiscal deficits become the main influences on inflation and economic growth. This shift means that the Federal Reserve's ability to impact the economy is reduced, as its actions on interest rates have less effect on the fiscal side. The meme and discussion imply a significant change in market dynamics, with past strategies becoming less relevant in this new environment.

05:00

📉 The End of Monetary Dominance and the Rise of Fiscal Dominance

The second paragraph delves deeper into the transition from monetary to fiscal dominance. It discusses how the past 40 years have been characterized by the debasement of currency and declining interest rates, which have influenced investment strategies. The speaker suggests that this era is coming to a close, with fiscal dominance taking over. This new era is marked by higher public debts and deficits, which will lead to different economic dynamics. The speaker notes that during fiscal dominance, there is often an increase in capital controls and potential challenges to privacy and self-custody in financial markets. The paragraph also touches on the historical context of debt cycles and how the current situation is reminiscent of post-World War II economic conditions, which are not familiar to many current market participants. The speaker asserts that since 2019, the U.S. has been experiencing fiscal dominance, and this trend has become more pronounced since early 2023.

10:00

📧 Sign Up for the Bankless Newsletter

The third paragraph is a call to action for viewers to sign up for the Bankless newsletter, which is described as the world's most popular crypto email. The paragraph is a promotional break from the discussion on fiscal and monetary dominance, offering viewers a free resource to continue leveling up their understanding and involvement in the cryptocurrency space.

Keywords

💡Monetary Dominance

Monetary dominance refers to the period where central bank policies, particularly interest rate adjustments, are the primary drivers of economic activity. It is characterized by the effectiveness of monetary policy in influencing inflation and economic growth. In the video, it is contrasted with fiscal dominance, where the focus shifts from central bank actions to government fiscal policies as the key determinants of economic conditions.

💡Fiscal Dominance

Fiscal dominance is a situation where government fiscal policies, including public debt and deficits, become the main drivers of inflation and economic growth. This often occurs when there are very large fiscal deficits and high public debt levels, which constrain the central bank's ability to influence the economy through interest rate changes. The video discusses how fiscal dominance could be replacing monetary dominance as the dominant economic paradigm.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. In the context of the video, it is discussed in relation to how it is influenced by monetary and fiscal dominance. Under monetary dominance, inflation is more affected by central bank policies, while under fiscal dominance, it is more influenced by government spending and debt levels.

💡Interest Rates

Interest rates are the cost of borrowing money and are a key tool used by central banks to manage economic activity. In the video, it is mentioned that during monetary dominance, changes in interest rates have a significant impact on the economy. However, in fiscal dominance, the central bank's ability to influence the economy through interest rates is diminished.

💡Debt to GDP Ratio

The debt to GDP ratio is a metric that compares a country's national debt to its gross domestic product (GDP). It is used to assess a nation's ability to pay back its debt. The video discusses how high levels of public debt, where the debt to GDP ratio is over 100%, can lead to fiscal dominance and have significant economic implications.

💡Central Bank

A central bank is an institution that manages a country's monetary policy, including controlling the money supply and interest rates. In the video, the central bank's role changes from being a key player in monetary dominance to having a more constrained role in fiscal dominance, where its options are limited by government fiscal policies.

💡Credit Creation

Credit creation refers to the process by which banks lend money and thereby create new money in the form of bank deposits. It is a critical component of monetary dominance, where the central bank's policies influence the rate of credit creation and contraction. The video explains that in fiscal dominance, the focus shifts away from credit creation as a primary driver of economic activity.

💡Asset Correlation

Asset correlation describes the degree to which two assets move in relation to each other. In the video, it is mentioned that during monetary dominance, stocks and bonds often have an inverse correlation, meaning they tend to move in opposite directions. However, in a fiscal dominance environment, stocks and bonds may become more positively correlated due to changes in economic dynamics.

💡Currency Debasement

Currency debasement occurs when a country's currency loses value, often due to increased money supply without a corresponding increase in the goods and services that the money can buy. The video discusses how currency debasement can be a consequence of fiscal dominance, where large-scale government spending and debt can lead to inflation and a decrease in the currency's value.

💡Investment Strategy

An investment strategy is a plan or approach for managing investments with the goal of maximizing returns while managing risk. The video talks about how the investment strategies that have been successful during the era of monetary dominance may not be as effective in a fiscal dominance environment, where different economic forces are at play.

💡Capital Controls

Capital controls are measures implemented by governments to regulate the flow of international capital into and out of a country. The video suggests that during periods of fiscal dominance, there may be an increased likelihood of capital controls and restrictions on financial privacy and self-custody, which can impact investment strategies and the movement of capital.

Highlights

The meme illustrates a shift from 'monetary dominance' to 'fiscal dominance' in market trading.

Monetary dominance is characterized by effective monetary policy influencing the economy and inflation.

Fiscal dominance is marked by large public debts and fiscal deficits driving inflation or disinflation.

Central banks like the FED take a backseat during fiscal dominance, with options constrained by fiscal policies.

Stocks and bonds have been inversely correlated during monetary dominance eras.

The meme suggests that the era of monetary dominance is ending, and fiscal dominance is taking over.

Monetary dominance involves the central bank and commercial banks' lending activities.

Fiscal dominance involves government actions, including tax cuts and subsidies.

The past 40 years of investment strategy has been influenced by currency debasement and the dilution of the US dollar.

Fiscal dominance may lead to a rise in capital controls and potential attacks on privacy tools and self-custody.

The shift from monetary to fiscal dominance is not a sudden change but a gradual transition.

Since 2019, the US has been experiencing more fiscal dominance, especially since early 2023.

In fiscal dominance, stocks and bonds tend to be more correlated rather than inversely correlated.

The developed world has not seen an environment like the one described since the 1940s.

The era of declining interest rates and rising debt levels is coming to a close.

The new environment will be more inflationary, and the relationship between different asset classes will change.

The multi-year transition towards fiscal dominance has implications for investment strategies and market participants.

Transcripts

[Music]

so so Lynn I think D and I want to

explore this topic by way of meme if

that works for you so this is a a meme

I'm showing it on screen right now that

um you posted on Twitter I don't know if

you created this meme or you sort of

seated around and really popularized it

and so if people haven't seen this

before it's kind of the classic um

there's a bus it's a like going over a

train track and there's a train so the

the top frame is the bus uh like going

over the train track and there's a train

sort of like in the like just about to

hit it and the second of course is where

the train just plows right into it and

the first frame with the bus going over

the train track says how markets trade

for the past 40 years uh and the second

the train is called fiscal dominance and

Nothing Stops this train so this is like

the imagery of we are about to get hit

by a train and we have to get out of the

way so Lynn can you explain this meme

because I think the the framing of this

entire conversation is is based on a

train that's about to hit us this train

of fiscal dominance so what is this

train what is fiscal dominance sure so

you know Market regimes go through these

long periods of time where they trade a

certain way and there's certain forces

that impact them and so over the past 40

years um the United States and much of

the rest of the developed world has been

in monetary dominance and the kind of

the simple way to put that is that a

monetary policy is is very effective at

either kind of re accelerating or

slowing down an economy uh and impacting

inflation and most of the money creation

is coming from Bank lending basically

credit creation or credit contraction

which is why those monetary levels

levers are are powerful but in fiscal

dominance um that situation becomes

reversed which is that very large debts

and and and fiscal deficits uh

specifically public debts and then and

then fiscal deficits those are bigger

drivers of inflation or disinflation or

rate of rate of nominal economic growth

and those sort of things and the Central

Bank in this case the FED in the United

States starts taking a backseat their

options become constrained by what's

going on on the fiscal side because when

they raise or lower interest rates it

doesn't impact the fiscal side in the

same way that it impacts Bank lending

credit creation that kind of thing and

so you know a lot of people they have

these back tests they have you know

here's what happened over the past 20 30

40 years for example that stocks and

bonds are often inversely correlated for

example um but going forward people that

were looking at those metrics that were

super important during a monetary

dominant era are less likely to be um

those metrics are less relevant is is

what that kind of that Meme means that

basically all these kind of ways of

doing things all these expectations that

people developed they made sense over a

period of time but if it's true that we

are entering a different type of Market

environment and developed countries have

been in this in the past just not in

anyone's current trading Lifetime and

Emerging Markets go through this on a

more regular basis you know kind of more

frequently but developed countries have

not been in this for a long time and so

a lot of people's Mentor mental models

are kind of tuned around monetary

dominance and not around fiscal

dominance so that's what the meme means

and that's and we we can unpack what

some of that means to put it in its most

simple terms is it accurate to say that

monetary dominance is simply the fed the

Federal Reserve uh interest rates

whether we're cutting or increasing them

just like what whatever the FED is doing

and then fiscal dominance is whatever

the government is doing whatever like

more top down control about like who

should get what who should get tax cuts

who should get uh subsidies and so like

one is one is the Fed one is the central

bank that's monetary dominance and the

other is the government is that like a

simple way of understanding this yeah

pretty much and I guess the one thing I

would add is that monetary dominance is

the combination of the central bank and

then the broader banking system the

commercial Banks um their rate of

lending or or not lending as well as

different things the central bank is

doing to try to accelerate the amount of

lending that's happening or trying to

slow down the rate of of lending that's

happening that's all monetary dominance

and then as you said basically all the

fiscal side all those different things

um that's fiscal dominance and fiscal uh

you know when deficits are lower when

public debts are smaller monetary

dominance tends to be occurring that

basically all those monetary forces are

bigger whereas when you build up 100% or

more Deb of GDP uh on the on the

specifically on The Sovereign level um

and you're running above Target deficits

that are not really onetime things

they're more structural um that starts

to override the power of that whole

monetary side both the central banks and

then even the broader banking system so

that that bus that Ryan described in the

meme how markets trade for the past 40

years I've heard this take from a number

of different people that really the

whole entire investment strategy over

the last 40 Years or or so has just

really been one trade which is uh the

debasement of currency the the um

dilution of the US dollar and really

it's a matter of like how fast or slow

the FED is doing that all all other

Investments have really been Downstream

of that and this is what you're saying

is actually coming to a close this is

like the market structure that has

defined the last era of anyone's like

trading memory uh and you're saying that

this this era is is likely coming to a

close soonish because fiscal dominance

is coming to replace it because

something about fiscal dominance is not

stopping this train that train is not

stopping this is kind of like the

summation of this meme uh yeah po last I

think the thing I would add is that it's

not just de basement per se because de

basement happens under fiscal dominance

as well um it it's really about that

kind of 40 Years of of declining

interest rates uh and and then the

Tailwinds that that provides to a number

of different asset classes so uh we kind

of started from this high point in this

in this current ERA of very high

interest rates and then you go through

40 years of every time there's a

recession you can cut rates um generally

inflation is is on you know even though

it's it's still positive it's it's

declining from what used to be a high

level to eventually by the 2010 you got

to a pretty low level at least for

Consumer Price inflation there's

obviously different ways to measure

inflation but declining inflation rates

declining interest rates and basically

all that was offset by Rising debt to

GDP so you know over time more and more

debt piled up on households more and

more debt piled up on the public Ledger

and that was offset by the fact that

indust rates were declining and it kind

of fed on itself because lower indust

rates allow more debt to accumulate um

and then higher debt levels tend to slow

down economic growth and kind of put

pressure in a lot of things which which

ends up kind of pushing interest rates

down uh that that's kind of one of those

tools that they use to kind of Kickstart

the next um expansion out recession and

the problem is when you run into zero

and then you kind of start going

sideways to up in terms of interest

rates um you no longer have offset for

all those debt levels and private debt

levels peaked around or shortly after

the global financial crisis um whereas

public debt levels are still going up

and when you look at history of how

these kind of really long-term debt

Cycles play out so not just the cyclical

debt Cycles but these kind of more

generational debt Cycles when they play

out it does tend to happen in that onew

punch where first you kind of hit some

private sector maximum and then you

start rotating that onto the public

sector uh the debt starts getting

transferred so for example you know you

bail out the banks you kind of

recapitalize them and and push a lot of

the debt more on The Sovereign level and

then same thing with with the response

during during and after the the pandemic

and lockdowns a lot of the more private

debt was kind of indirectly transferred

to the public level so you have a little

bit of deleveraging on the private side

but that gets pushed up to the public

level and that eventually comes out in

currency debasement and fiscal dominance

issues and so basically I think what the

era that's behind us is that ever lower

rate environment the structural

disinflation uh from a high level

environment and now we kind of go

forward in an environment that really

hasn't been seen in the in the developed

world since the 1940s um Japan's been in

it kind of first in this cycle among the

developed world you see it occasionally

or or pretty frequently actually in the

emerging world but it's it's not

something that a lot of developed Market

um participants have a lot of experience

with at the you know in kind of their

their current careers because it's all

it's all been one trade which is indust

rates keep going down valuations of both

bonds and stocks keep going up and they

tend to be counter cyclical you know

they tend to be inversely correlated

with each other um but that environment

is is Messier going forward in in more

inflationary environments stocks and

bonds tend to be more correlated um and

also you start to get generally during

fiscal dominance you get a rise of

capital controls and other issues like

that um which can manifest for example

in this industry it can manifest in in

attacks on privacy tools rules or self-

custody or basically the ways to move

around Capital so there's there's

overlap there um and that's just a it's

a it's a environment to be aware of and

I would argue that there's not a a

moment in time per se where you go from

monetary dominance to fiscal dominance

like you're not in 100% of one and zero

and the other it's this kind of change

over that happens and I would say

there's there's different ways to

analyze it but I would say at least

since

2019 the US has been in uh fiscal

dominance more or less and when starts

to you know go over there's like you

know a year or two where you're kind of

in fiscal dominance and maybe you're

briefly out of it again then you're back

in it until until it gets so strong that

you're more persistently in it so ever

since early 2023 we we've been in it

probably more persistently but kind of

this whole covid era and and even just a

little bit before it um this was kind of

this is has been a multi-year kind of

transition toward fiscal dominance to

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[Music]