28 March 2023

Preston Pysh hosts financial expert, Alfonso Peccatiello, to discuss the crumbling legacy financial system and explore critical insights into the global economy, in this riveting episode of the podcast.

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  • Global perspectives and insights.
  • Twitter debates: QE returns or not?
  • Predicting the 10YR-2YR inversion’s future.
  • Dispelling Bitcoiners’ mistrust in the banking system.
  • The impact of immediate withdrawals on banks’ cash reserves.
  • Shadow banking and insurance companies under the microscope.
  • Piecing together the European inflation & bond yield puzzle.
  • Debating the debt spiral scenario.
  • From problem talk to finding solutions.
  • Forecasting the oil market: 6 months & 1 year outlooks.
  • Real estate and REITs in times of high debt and interest rates.
  • Unexplored insights: What’s being overlooked?
  • Examining inflation stickiness in today’s economy.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:00] Preston Pysh: Hey everyone. Welcome to this Wednesday’s release of the Bitcoin Fundamentals Podcast. On this week’s episode, I have back Mr. Alfonso Peccatiello, better known as Macro Alf. During the show, we talk about all the excitement happening around the world with banking and the unprecedented actions happening by all central bankers.

[00:00:16] Preston Pysh: Alf is a former bond trader at a large cap bank and understands the plumbing and implications extremely well. We get into how the banking system works and what might come next with the spreading global impairment and what it might mean for Bitcoin and other asset classes. So without further delay, here’s my chat with Macro Alf.

[00:00:39] Intro: You are listening to Bitcoin Fundamentals by The Investor’s Podcast Network. Now for your host, Preston Pysh.

[00:00:58] Preston Pysh: Hey everyone, welcome to the show. I’m pumped to have Alf back here. You’re such a thoughtful thinker in how the legacy financial system works and fixed income, and I love those types of conversations. So welcome to the show, Alf.

[00:01:10] Alf Peccatiello: Preston, my pleasure to be here. And I guess a lot of people will be wanting to know what’s going on in the banking sector, what’s causing all this trouble, and so let’s see if my experience can help the audience understand a bit further what’s going.

[00:01:25] Preston Pysh: That’s exactly where I want to start is because you have such a depth of understanding of, of the legacy system. I guess my first question is just like, what’s your one over the world of everything that’s happening and prioritize, like this is one of the most important things that people really need to be focusing in on and and understanding because it has like all these other compounding effects beneath it.

[00:01:46] Preston Pysh: So where would you start?

[00:01:48] Alf Peccatiello: So look, I think money’s misunderstood at the higher level of management, even in the financial industry. Look, money in the traditional banking system, or in the traditional finance economy works as follows. There are different layers, and the safest form of money you can have in traditional finance is the liability of the government.

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[00:02:09] Alf Peccatiello: So your money is very often a liability of somebody else in the traditional finance system. So please understand that. And there are different kind of risk that you can run by owning money in the traditional finance space, mainly to risks. Your money can be the liability of the government or it can be the liability of a bank.

[00:02:32] Alf Peccatiello: Let’s first talk about the liability of a bank, a bank deposit, especially above a hundred thousand Euro in Europe or above $250,000. In the US It’s nothing else that an unsecured loan to a bank. As we are seeing if the bank has any stress, any mismanagement has mismanaged, the risk has run a certain amount of interest rate risk, which was not hedge.

[00:02:57] Alf Peccatiello: Your money can be at some point even just wiped away. So that means you are effectively lending, unsecured your money to the bank above the $250,000. That’s always been the case, Preston, by design. If your money at the bank is below $250,000, you have the implicit guarantee of the government of the United States.

[00:03:18] Alf Peccatiello: So you fall into the second bucket, which is your money is the liability of the government in this case, rather than the liability of a. But it’s always the liability of something in the tra in the traditional finance space. Now the liability of the government of the United States is a better proposition than being a senior lender unsecured to a bank, simply because the government of the United States issues the very currency issues, the very money that we use in the.

[00:03:48] Alf Peccatiello: So effectively the government of the United States can always try to blow a hole in their balance sheet through deficits and print more of this money that we use in the system. So effectively, you are somehow a bit more protected in nominal terms by having money as a liability of the government than as a liability of a bank.

[00:04:09] Alf Peccatiello: People are now finding that. Because depositors of SVB have been wiped out effectively. The FDIC came in and said, no, no, no. We’re going to make an exception. We’re going to guarantee your deposits even above the $250,000. Basically, the government in saying you were an unsecured lender to SVB will make you now whole by transforming your money from the liability of a bank to the liability of the government.

[00:04:36] Alf Peccatiello: So we will make you whole basically through that. People are finding that out, but this is the first big picture observation I have in the traditional finance system. Your money is always a liability of somebody else, Preston, so choose wisely which liability you want it to be. An unsecured liability of a bank, that’s pretty risky because you’re often not even rewarded for that risk in the first place.

[00:04:59] Alf Peccatiello: This bank deposits don’t yield much in the first place, or do you want it to. Liability of the government of the United States through many of its forms. It can be a bank deposits below $250,000. It’s implicitly guaranteed. It can be a tbi, it can be a money market fund deposit, which is basically guaranteed by the government.

[00:05:19] Alf Peccatiello: But pick your fighter. You always, your money is always an unsecured liability of somebody else in the traditional finance.

[00:05:28] Preston Pysh: So, you know, people were looking at that action with the Silicon Valley Bank and they’re saying, okay, well FDIC was supposed to be anything above the 250 k that those depositors are now at risk of, of the actions of that bank.

[00:05:42] Preston Pysh: So the government steps in totally backstops everybody, all the deposits at the bank. And they’ve set up this new precedence of, well, the government might step in and maybe the limit really isn’t 250 K if you’re banked with a large enough bank, which created this incentive of, Hey, I need to get outta my community bank and I need to put my deposits at Bank of America or whatever.

[00:06:05] Preston Pysh: First of all, is there something similar happening in Europe to what happened in the us And if so, kind of describe that to. And then more just your general thoughts on this incentive that’s now popping out of these actions and what it means moving forward.

[00:06:21] Alf Peccatiello: Look Preston, it all boils down to the incentive schemes that regulators have given banks in the US and in Europe because, you know, obviously banks are there to try and make money and they have to try and not take too many risks because they are so important to the traditional finance space.

[00:06:39] Alf Peccatiello: Their stability is so important that they’re heavily regulat. The US has failed pretty miserably, I should say, in regulating small banks. So let me, let me tell you what I mean. In the US if you’re a bank below 250 billion in assets, and mind me, Preston, this is a pretty large bank. I mean 200 billion in assets.

[00:07:01] Alf Peccatiello: It’s not peanuts. It can be a pretty large bank anyway, but that was a threshold below 250 billion in assets. You are basically exempt. From the main stringent regulation that regulators have applied to large banks after the great financial crisis. So namely, you don’t have to stick to something called the net stable funding ratio.

[00:07:23] Alf Peccatiello: It’s a lot of words, but in reality, it’s just a ratio that tries to make sure that the funding of a bank is not concentrated, it’s not volatile. Basically, all depositors cannot flee away at the same time. Exactly like it happened with SvB was a bank below 150 billion in assets, which meant as SVB didn’t need to stick to this net stable funding ratio could have a very concentrated funding base, which was one of the problems.

[00:07:50] Alf Peccatiello: The more concentrated your funding base, the higher the risk. They flee away very rapidly, and that’s what happened. The other thing is, If you are a bank below to hundred 50 billion, you don’t need to stick to something called liquidity coverage ratio, LCR. So this is another rule that the regulators put up to say, Hey banks, you need to have a lot of liquid assets on your balance sheet because if Preston Alf and everybody else at the same time goes to the bank wants their money back, you need to be able to service these deposit outflows.

[00:08:20] Alf Peccatiello: Now, this liquidity coverage ratio does something very interesting, Preston, which basically. I mean, if I ask you what’s the most liquid asset you can have in the traditional finance space, you would say cash or any form of cash i’s just liquid there. If Preston comes and withdraws money, I can just give him the cash and I’m done.

[00:08:40] Alf Peccatiello: But banks also want to make money, so they ask the regulators, is there something else I can own on my balance sheet? I don’t want to stock of cash there. I want to own some liquid assets that you will consider to be liquid. I can make some money in the meantime, but they can also be used to service these deposits.

[00:08:57] Alf Peccatiello: Guess what the regulator said. Well, we’ll treat treasury bonds, mortgage backed securities as well. Basically ask cash from a regulatory perspective. Listen to this. If you’re a bank in the US after the great financial crisis, Presson, you were told that you must own a bunch of liquid assets. To meet this regulatory requirement, and it could be cash at the Fed, reserves at the Fed, or treasury bonds and mortgage backed securities and some corporate bonds because effectively you had no liquidity haircut on treasuries.

[00:09:30] Alf Peccatiello: So they will, they will treat it as cash by the regulator, and also you needed to own zero capital, and I repeat zero capital against any potential losses that these tr, these treasuries would inc. This mortgage back securities would occur very, very little. Capital required, basically the regular set to banks.

[00:09:50] Alf Peccatiello: Go ahead and buy bonds will treat it as if they were cash. Now, there are some proportions for large banks. They cannot own a bunch of corporate bonds, a bunch of risky credit. They need to own a lot more treasuries or svb. That wasn’t the case. Remember, they were not subject to this liquidity coverage ratio, which meant they went ahead and.

[00:10:11] Alf Peccatiello: 90 billion of mortgage backed securities on a 200 billion balance sheet. And guys, I’ve been in the business, it’s just a gigantic amount of mortgage back securities. Basically, the regulators have in the US made one big mistake, which is under regulate small banks. So give them basically incentive schemes to act as cowboys and the moral hazard.

[00:10:33] Alf Peccatiello: At the SVB case was also very high because these guys didn’t hedge their interest rate risk properly. They didn’t apply basic risk management techniques, so they basically used the loophole that wasn’t regulation to take an extremely large amount of risk. They had a concentrated funding base and they were wiped away because of that.

[00:10:53] Alf Peccatiello: But Europe, on the other hand, to answer your question, I mean in Europe we do a lot of things. Suboptimally, let’s say when it comes to finance or banking, but regulation is much, much tighter. So for instance, in Europe, Preston, there is no small bank that can be under-regulated that easily. Regulation is tighter in the first place and it just looks after also what’s called a small bank.

[00:11:18] Alf Peccatiello: Also, again, guys, Small banks, 250 billion in assets. That’s not a small bank. Let me give you a European parallel. The third largest bank in Germany is 180 billion balance sheet, so that’s the size we’re talking about. That in the US was deemed to be small enough not to be sufficiently regulated. So this was a pretty miserable regulatory failure, I would say in the US.

[00:11:49] Preston Pysh: I’m a hardcore Bitcoin. Our show has tons of Bitcoiners that are listening in. And just to put it simply, I just don’t trust the banking system because of everything that you’ve just described. This. Ever expanding manipulation in markets to control fixed income and never allow creative destruction to actually occur is what we’re really talking about.

[00:12:09] Preston Pysh: And in my humble opinion, we aren’t operating in a free and open market these days. And when you look at at the size and the quantity of like some of these decisions that are being made by a couple people in the room, it’s just, it’s kind of mind blowing and I just see trust breaking down as a person that really understands the legacy banking system.

[00:12:29] Preston Pysh: Do you empathize with Bitcoiners and why they’re turning to other alternate solutions to. Storing their hard-earned capital. And just kind of, what are some of your thoughts on like what this looks like from a systemic standpoint moving forward with this keyword trust?

[00:12:46] Alf Peccatiello: Look, the entire system banking system is effectively based on the assumption that collateral must be, must hold its value.

[00:12:56] Alf Peccatiello: And the collateral of the traditional finance financial system is treasuries. Everything runs around treasuries. It’s very simple to understand as well, Preston, because if you go to a bank and ask for a mortgage and ask for credit, they will price your interest rate on that mortgage, on that credit, on that loan, effectively based on where treasury rates are, plus a credit spread on top of it, right?

[00:13:21] Alf Peccatiello: So imagine also treasuries are the foundation of the repo market, where banks effectively exchange money with each other in a secured, collateralized way, and that collateral is again, treasuries, basical. You have to think of treasuries as the foundation, really, of the entire machine. And you can also see the reaction of the failure, Preston, because what was about to happen was that some banks that were under-regulated were effectively mismanaging their risk and they were facing a deposit outflow, which was very large to services deposit outflows.

[00:13:58] Alf Peccatiello: They were forced to sell their tr. The treasuries that the very regulators told them they could own because there were as liquidous cash. But of course because of the interest rate hike, these treasury values were much lower. So they needed to take a massive capital, air cut, capital loss to sell these treasuries, and at some point they found themselves insolent.

[00:14:19] Alf Peccatiello: So what happens then is if you leave this uncheck. It will generate a fire sale on treasuries because more banks will find more losses on their balance sheet. More depositors will get nervous, they will withdraw deposits, and it’ll force a self-fulfilling mechanism where everybody has to sell treasuries to service this deposit outflows.

[00:14:40] Alf Peccatiello: The fed cannot allow this to happen, right? And it’s basically, again, a system which is based on trust on the value of this collateral. And if that goes away, the whole system implode. So what the Federal Reserve does in this case is comes to the rescue and it says, ladies and gentlemen, this collateral is worth a hundred.

[00:15:02] Alf Peccatiello: You bought it for a hundred. , it’s a hundred. Just give it to me. I don’t care whether the price is 60, 70, 50, or 80. I’ll take that a hundred and I’ll lend you money against that at par against its nominal value at a hundred. That’s yield curve. I mean, we’ll, we’ll talk about the difference between this QE and control.

[00:15:24] Alf Peccatiello: There’s a lot of mechanics to explain, but my first reaction is, wow. This goes to show how much the system is built on the stability of this collateral. Because think about it, in 2008, the main collateral behind the banking system was house price. In 2007, we were lending against the value of the houses like there was no tomorrow, and we were over-leveraging the system with more complicated structures.

[00:15:52] Alf Peccatiello: And it w, it was all based on one predicament. House prices in the US cannot go down. Preston, this was the predict. As soon as the collateral value started going down because house prices started collapsing, then you were the massive problem because it generates a deleveraging of the system that cannot rely on the value of the collateral strengthening anymore.

[00:16:12] Alf Peccatiello: And you saw what happens, what kind of creative destruction, as you called it before. . unfolds. But what unfolds from it is also political challenges. It’s unemployment rate much higher it’s misery. It’s nothing that a politician would want to see because nobody gets reelected if he’s the one to pinpoint for the, the great financial crisis.

[00:16:32] Alf Peccatiello: Right. So this incentive scheme you’re describing effectively make it so that the policymaker’s incentive scheme is to keep the value of the collateral stable or rising. And that’s what the Fed has done. The Fed has basically said, give me the treasuries, I’ll fund you at a hundred. So what happens then is a couple of banks go in and they’re like, yeah, yeah, please, I’ll do that because I’m in trouble.

[00:16:54] Alf Peccatiello: I mismanaged my risk. I used the treasuries. I didn’t hedge the interest rate risk. You guys hiked the interest rates, the value of the treasuries went down. I’m in trouble while you’re telling me I can ignore this reduction in value. I’ll use the facility. So I’ll land you the treasuries and you’ll fund me What this means.

[00:17:13] Alf Peccatiello: The Federal Reserve is expanding its balance sheet again, which is something that we didn’t see for a while as they were engaged in fighting inflation, trying Tori keep interest rates higher, shrink their balance sheet. This has now changed again and there are some differences between these and quantity easing and yield curve control that we can discuss.

[00:17:34] Alf Peccatiello: My main point is, as I told you before, the tagline is, remember that your money is the liability of somebody else in the system. Choose whose liability do you want it to be? Now the tagline is the Fed and the system is predicated around the stability of collateral, and it is that important that the Fed has chosen to ignore the market value, ignore what is the market assigned value to these treasuries, and give them a value of a hundred, an artificial value of a hundred, just to make sure the system doesn’t implode on.

[00:18:10] Preston Pysh: So, like me personally, I’m just, I’m looking at that and I’m saying, okay, so you’re going to, you government are going to pick the winners and the losers, even though these people mismanaged risk and they should pay a consequence for that mismanagement in this system. They’re not, they’re getting an advantage.

[00:18:27] Preston Pysh: People from up on high or are saying, no, this person’s going to get a bailout. They don’t actually have to deal with the consequences of their poor decision making. And therefore other, someone else is paying that price. And I think that the someone else is the general population through just terrible policy making.

[00:18:47] Preston Pysh: And so like people like me that are Bitcoiners, we’re just saying, you know what, no, my money is not somebody else’s obligation because I have stuffed it into Bitcoin and it doesn’t have any counterparty risk. I just can’t understand how people will continue to trust this system that continues to compound and spiral outta control with larger and larger bailouts, which clearly is the trend in not going away.

[00:19:14] Preston Pysh: When you have this other thing over here that doesn’t require any trust that people can buy and continue to hold and it doesn’t have any counterparty risk, and if I want to move all of it to some other account right now, I can do that. and I don’t have to ask for permission from anybody. I just don’t know how, I don’t know how the legacy system can compete with something like that, I guess is where I’m going.

[00:19:36] Alf Peccatiello: Look, Preston the system is based on trust, as you said before, so it’s, well, from a technical perspective, trust on the value of collateral being treasuries in most cases. . , from a user perspective is the trust. That the unsecured loan that you have made to the bank, basically by having money more than $250,000 in a bank doesn’t get blown away because at the first signs of stress, obviously your incentive scheme as a user of the system is to say, whoa, I’m actually running counterparty risk with my money.

[00:20:08] Alf Peccatiello: Yeah, I didn’t know that because Preston, most people don’t know that Exactly. That they’re, that they’re running unsecured risk from a bank. They get a reminder. And then there are signs of stress. So the system only works. Any credit-based system actually only works if there is trust in its stability, and if the collateral holds its value stable or increases its value over time.

[00:20:35] Alf Peccatiello: Those are the two really major foundations behind the credit. From time to time, we challenge those, right? Because the system in itself, if it works, leads to something very interesting, more and more and more leverage. Because look, what’s your incentive scheme, Preston? If in a credit based system, if everything is smooth, what your incentivized to do is to make use of leverage.

[00:20:58] Alf Peccatiello: Because there is no volatility, there is no signs of stress. So how you gen, how you amplify your returns is by making use of credit, by making use of leverage. If everything is stable and you are sure that your job will be there for the next 20 years, you have a set of cash flows ahead of you right in in.

[00:21:16] Alf Peccatiello: It’s your salary. Your salary will be there, will actually grow a little bit year by year. So your incentive scheme is to make use of credit to go to a bank and ask for a mortgage. A mortgage is nothing else. Then money being created now against the your future cash flows coming from salary. So what you’re doing is you’re relying on the stability of the system, which means you will have a stable job over time as well, and you’re now getting credit for it.

[00:21:44] Alf Peccatiello: You get the credit creation, your mortgage, you go ahead with money that you didn’t have, and now you do have, that’s the credit, being credit by a bank and you buy a house that otherwise you couldn’t afford, and you push asset prices. And so banks have collateral values that low, higher. So you see what the incentive scheme is here, right?

[00:22:01] Alf Peccatiello: If everything is stable, the system will create and rely on more and more and more credit. And you know, the other side of credit is that because you now have a mortgage, it means it sits on your balance sheet. Preston, it’s, it’s a liability. You are indebted. So for the system to keep working, you need to have more stability, and it just reverberates further and further.

[00:22:24] Alf Peccatiello: What happens at the first sign of stress is that in a system like that, the deleveraging is also very, very rapid and very painful. Japan has experienced something like that. In the nineties, Japan has basically told us what’s the way to go? What are the pros and the cons of bringing the system to the extreme?

[00:22:42] Alf Peccatiello: It has already shown us that about 20, 30 years ago in Japan in 1989, the Imperial Palace of Tokyo was supposed to be worth more than the entire state of California . I mean, when I say this, this is pretty fun, but this was the result of excessive credit creation. Credit was ample and available to everybody in Japan.

[00:23:06] Alf Peccatiello: There was basically an overreliance on stability of the system and more and more credit. What happened the moment that there was a sign of stress is that the system went into deleveraging and look at the Japanese growth for the next 20 years, Preston, that negative consequences for the productivity of the system and it basically, Effectively everybody poorer.

[00:23:29] Alf Peccatiello: In real terms, growth went nowhere for 20 years in Japan, and this is the risk you run when you deliver such a leverage system. So it’s a very inherently unstable system that we keep artificially stable because that’s the incentive scheme. Kick the can down the road, lever up more, keep the system stable so we can create more credit, generate more asset returns now.

[00:23:53] Alf Peccatiello: Amplify our returns today. And by the very virtue of it, we’re also increasing the instability of the system. So I do agree on that assessment.

[00:24:03] Preston Pysh: Yeah, it seems like we’re at the, coming up on the N roads from a global collective. You know, all of this is intertwined when I look at the European banks, the US banks, the Japanese banks, all of ’em, versus what I would describe as non NATO .

[00:24:17] Preston Pysh: That are net producers and extracting raw materials, and they’re saying, we don’t want these digital units, that the NATO based countries keep expanding and debasing at a breakneck pace. We’re, we’re done with it. You can either pay us in our currency or you can pay us with gold or, or bitcoin. That’s pretty much their stance, and that’s what I think the whole war in the Ukraine and everything that’s happening from an energy standpoint over in Europe, I think really kind of comes down to that fundamental aspect.

[00:24:43] Preston Pysh: So I’m curious if you would agree with that. And I’m also curious kind of your thoughts on how Europe is going to be able to get any of their energy in high inflation rates down in the face of all of these banking decisions that just continue to compound on themselves, creating this more and more unstable.

[00:25:03] Alf Peccatiello: So Preston, so far, we talked about the sources of leverage and instability within a closed economy, right? We discussed basically as if there is no external influence when you talk about an economy, but the reality is that global economies are, are interconnected and most importantly, the dollar plays a central role when it comes to the global economy nowadays, and it has been the same basically since the seventies.

[00:25:28] Alf Peccatiello: This has led to something very interesting. The birth of the Euro dollar system, which is nothing else than a machine that allows entities not residing in the United States to get access to newly created dollars. So it’s basically a dollar funding machine for entities sitting outside the United States.

[00:25:50] Alf Peccatiello: If you run the global reserve currency in our system, you have one job and one job only. To keep your eja you have to make sure that dollars flow freely outside or otherwise For other people, that cannot create dollars. going to be very hard in periods of stress to cope with the system. That depends on the resource.

[00:26:10] Alf Peccatiello: The dollar that you are in charge of your job is to keep this flow of dollars free and smooth for the the outside. So now what has happened is something very interesting because if the system keeps growing like it did the Euro dollar system over the last 20 years, what happens is that take a corporation in Brazil that sells soybeans or whatever, they sell some commodities, right?

[00:26:36] Alf Peccatiello: If most of your invoicing is in dollars, most of your trades are denominated in dollars. What you have done to enhance your business model over the last 20 years is also leverage in dollars. Issue dollar bonds. Get some dollar loans from a bank. This is a very interesting system because the Brazilian company now in the Euro dollar system ingrained in the global dollar system, needs two things to be able to sell their soybeans.

[00:27:03] Alf Peccatiello: They nominated in dollars as much as they can. That brings in earnings, right? But it also needs these earnings to service their leverage on dollars. So what happens at the moment then the global trade? That the growth global growth comes down is that the company will scramble for dollars because it still has dollar liabilities to service dollar leverage, but it doesn’t see new dollars coming in because global growth is coming down.

[00:27:30] Alf Peccatiello: Very interestingly, what happens in that case is that even if the very, very problem is this dollar centric system, the dollar gets some benefit out of it because these companies are scrambling to try and. The dollars they need to pay their debt. So the system deflates the leverages and it leads to a stronger dollar, which creates more problems to other companies in net in dollars because their debt become worth more while their earnings are coming down.

[00:27:59] Alf Peccatiello: So it’s a dollar racking bowl. The irony is that we have built a system where the problem in itself, the structure problem, is the over-reliance on the dollar and to destroy the system. To change it. Basically you first need to see a, a rush to the dollar, such a destructive rush to the dollar that it de leverages the entire system until we say, maybe this wasn’t the best idea after all, we should look for another system that makes more sense.

[00:28:28] Alf Peccatiello: But you see the irony, right? Because a lot of people are saying, look, dollar dominance will fade away. And it’s hard to say when Preston, I mean, these are very long cycles. They take decades to unfold. I do agree it will in the end. We have seen Global Reserve currencies change every 80, 90 years on average.

[00:28:48] Alf Peccatiello: We don’t know if it’s going to be 80 or a hundred years. My most important point, To destroy the system from within, for the system to implode, you finally need first the dollar to appreciate so much that it basically kills everything else around it. And only then you will realize that the system doesn’t work anymore.

[00:29:07] Alf Peccatiello: And I think people instead expect a dollar to steadily depreciate in a destructive mode. But I think the path of Bly resistance is that you see one of these incredible rushes. In the dollar that just leverages everything else around it. And then people will realize that that wasn’t the right system in the first place.

[00:29:28] Preston Pysh: As an American, as you’re talking about the dollar and the advantage of it expanding, I, I think of a chess scenario where it’s like the queen is such a powerful piece, and when you ask amateurs like what their favorite piece is, they almost always say, oh, the. But you also have to understand that the Queen has a huge disadvantage in that you have to protect it at all costs.

[00:29:48] Preston Pysh: Because if you lose it in the game, your chances of winning are slim the nun. And so you’re almost become a, a prisoner of its power in that you have to respond when somebody checks it with a, or that they could take it out with a pawn. And so I see a very similar scenario with the dollar where it’s become so, That the United States is now having to make decisions that are sometimes decisions that it doesn’t want to make, but it has to make because they can’t allow for the instability in the dollar because some other country or some other thing has forced it to provide liquidity or swap lines or, or whatever the case might be.

[00:30:29] Preston Pysh: And so I see it in a very similar light and your your point about it becoming so strong and so powerful. Is basically akin to it holding the same power as the king itself, where if that piece goes out, the whole game is lost, is kind of where we’re going with dollar dominance. We’re seeing the, the issues of the balance sheet showing up with banks that are actually connected to the fed rails.

[00:30:52] Preston Pysh: How do you see the risk kind of maturing from here with respect to shadow banks? And insurance companies that have this massive float that often denominate that float into treasuries that might have long duration treasuries sitting on their balance sheet as where maybe disaster strikes next here in the coming months.

[00:31:15] Alf Peccatiello: Look, Preston, this is the right question because if we have now defined. That the Federal Reserve will try. Their incentive scheme is to do their best to keep the collateral value stable, the treasury value as a collateral value, as as stable as possible, and they have the tools for it. For instance, their new bank term funding program that we discussed before, giving par value to treasuries, even if their market value is way below par, they have the tools to ensure that what you need to look for next.

[00:31:48] Alf Peccatiello: Okay. If the Fed wants to keep the system artificially stable, they can. What is that? The Fed cannot control. To a certain extent. That’s where normally you find the release valves historically, and you pointed to the shadow banking system and in general, other actors in the financial market that are less close to the Fed.

[00:32:09] Alf Peccatiello: And I think that is a very smart thing to do. And I see one big issue overall. Which is credit markets. So look, credit stress is something that is very hard to fix for the Federal Reserve. We’re talking about companies having a weaker balance sheet. We’re talking about the real estate market, taking a a deep dive.

[00:32:32] Alf Peccatiello: The Fed has a much harder task in controlling those because they’re further, further away from the epicenter of the system, the repo market and treasuries that they can so much influence. Now let’s look at the housing market, for instance, and I want to talk about real estate for a second because it’s interconnected between shadow banks, banks, pension funds, insurance companies, et cetera.

[00:32:52] Alf Peccatiello: Between 2014 and 2021, Preston interest rates were basically zero in the US the whole time. They were negative in Europe, by the way. Now let take a European bank. It has deposits and it has assets, and if interest rates are at negative levels for European banks not to lose money, they need to charge their depositors as well, right?

[00:33:17] Alf Peccatiello: Because if their assets are making negative returns, the only way not to lose money is to charge your depositors as well. By law, European banks couldn’t apply a negative interest rates on deposits in most cases for years. Which meant that they were basically destined to lose money unless they did something on the asset side, Preston, and they did.

[00:33:37] Alf Peccatiello: So they took more risks. How do you take risks? Well, you either take more interest rate risk, but European banks are very well regulated, so it’s very hard for a European bank to take a huge amount of interest rate risk. They need to hedge it very closely. Which means you take other risks, credit risks, so you buy securities that offer credit spreads on top of the risk-free rate.

[00:34:01] Alf Peccatiello: The housing market is a hive for such securities. I mean, during the great financial crisis, we learned about all sort of securities you can create on top of a loan on top of a mortgage, c d, CDOs, CLOs, et cetera. The regulation had made it more complicated to make it, you know, debt leverage. But there were many securities leverage loans, CLOs.

[00:34:21] Alf Peccatiello: Commercial mortgage backed securities that offered higher yields, so banks in a low interest rate environment went ahead and bought a lot of them. The same happened to insurance companies and pension funds for the same reason. Preston, if you need to generate returns to meet future obligations, being your pension contributions to be paid out, for example, and your bonds are yielding nothing, you’re going to look for yields somewhere else.

[00:34:47] Alf Peccatiello: So what I’m saying is when the system was too much artificially compressed and stable, this bread instability by giving incentive scheme to shadow banks, asset manager, pension funds, banks, insurances to go and buy high yielding assets mostly in the real estate market. Fast forward to today, mortgage rates in the US have gone up from three to 7%.

[00:35:14] Alf Peccatiello: And we are seeing housing sales down 40% on a year on year basis. The market is basically frozen. Buyers are cut out. They can’t afford, sellers are trying not to sell because why would you sell if you’re not forced to? You locked in a mortgage rate at 3%, which basically means the market is frozen. Now I think the stress is coming to surface.

[00:35:35] Alf Peccatiello: Now. We have had the first default of a commercial mortgage backed security of over 500 million by black. Blackstone and KKR are effectively the largest real estate investment trusts in the world. And before the default of this commercial market, mortgage backed securities, both companies had gated to redemptions on the two largest real estate investment funds they had.

[00:36:00] Alf Peccatiello: Which in plain English means that if you were an investor that invested into this real estate investment trust and you want your money back, Preston, you can’t have it back. You can only have a little bit each. And why? Because if press enough and everybody withdraws money from these funds, they’re forced to sell the assets, which means they need to sell offices, stores, multi houses, et cetera.

[00:36:24] Alf Peccatiello: In this market where there is no buyer, this will lead prices to go down and this will lead probably to fire sale coming up next. When I hear all of this and I look at the first default on the commercial mortgage back security, and I think of the amount. Leveraged real estate securities that have been bought by Shadow banks, pension funds and insurance companies and banks to try and generate some yield over the last seven to eight years.

[00:36:50] Alf Peccatiello: And I look at the state of the commercial and residential housing market today. I tend to think that while people are focusing on liquidity risks, that the Fed can back stop if they really want to. They can and they are trying hard to that. . , they’re missing the big picture, which is the credit stress, which is growing under the surface.

[00:37:09] Preston Pysh: How long do you think that this is going to take to kind of percolate out? I, are we talking three months, six months window?

[00:37:16] Alf Peccatiello: Look, the amount of credit creation going through the system was already pretty negative before this banking stress. Now you have banking stress. In that case, money flows to the safest form of collateral.

[00:37:29] Alf Peccatiello: You can have credit dries up further. . , nobody wants to land very aggressively in an environment where there is banking stress. So this will compound the credit flow weakness that was already existing before this stress. . , which means Preston. I think policymakers have the tools to try and backstop this liquidity crisis that we saw.

[00:37:52] Alf Peccatiello: There are going to be a couple of casualties, but overall they, they have the tools to backstop this because it’s coming from an epicenter very close to their control. It’s the treasury market and they have almost a duty from a maker perspective to backstop the value of the collateral. And as we have seen, they have some very creative tools to make sure that artificially, the system can be kept stable for a bit longer.

[00:38:15] Alf Peccatiello: On the credit side, they don’t have these tools and it’s not even their job to have these tools, to be honest. So the answer is, look, my out of consensus call on the Macro Compass, which is the research firm that I run, was the recession in the US would start in late second quarter this year. So there will be like May or.

[00:38:36] Alf Peccatiello: I think this cold is now vindicated even further because what you are seeing is a credit crunch basically. So further deterioration in credit conditions for the real economy, which will probably accelerate the downturn and especially when it comes to the real estate products and the real estate market.

[00:38:54] Alf Peccatiello: I see things going pretty much sour over the next few quarters.

[00:38:58] Preston Pysh: Alf, these numbers that we’re talking about, Trillions and trillions. I think that when we saw the amount of, I would call it all these PPP loans that went, that happened during covid and how it basically just turned into basically free money for banks that that took out the loan and they just, yeah, dissolved the loan part of it.

[00:39:20] Preston Pysh: It just became money into the system. It almost seems like we’re going to see that times two, times three, as they try to resolve a lot of these risks that I agree with you are coming in three to six months from the time we’re recording this. And I think it’s going to be way bigger than what people can even begin to wrap their head around.

[00:39:41] Preston Pysh: Would you agree?

[00:39:43] Alf Peccatiello: Yes. I think there is a, a risk because of the size of the market, the housing, the real estate market is by far the biggest asset class in the world. . , if I would ask you, is it the bond market or the equity market, people would say, ah, I think the equity market. You need to combine the bond and the equity market together, and you still are not at the size of the global real estate market.

[00:40:07] Alf Peccatiello: This is how big it is. Yeah. Okay. It’s a very leveraged system because of the mortgage market underlying it. Right. It’s a very credit raven system. We have just discussed incentive schemes over the last seven to eight years for institutional investors to move and pile up on leveraged products in the space to try and generate some yield.

[00:40:24] Alf Peccatiello: So I think there are quite some, quite a confluence of negative factors that could make this pretty bad. The fourth one is the following. This always surprises in me, Preston, but in 2020, we printed the ridiculous amount of. And I mean like real economy money. I mean like money for Preston enough directly in our pockets, which was just bank loans giving away like there’s no tomorrow.

[00:40:49] Alf Peccatiello: Yeah. Checks reaching our inbox straight away with no direct liability attached to it. Like literally new money that you can spend, no liability attached to it right now. We did so much and if you wait, if you pulled all that money into the system and you wait 12 months, You are undoubtedly going to see stronger growth, stronger inflation.

[00:41:11] Alf Peccatiello: People have more spending power. They literally have more spendable money that you have created. And so we saw this temporary growth and inflation, right? That was the end of 21. The beginning of 2022. But guys in 2022, we have abruptly stopped doing that. No new stimulus. Bank landing came down slowly but surely as the economy started deteriorating.

[00:41:32] Alf Peccatiello: So you are seeing basically a disinflationary impulse from a credit creation perspective that is at least as bad as the credit creation on the way up. So for what reason, you shouldn’t expect now the same magnet or even a bigger marketing person as you just discussed. As you had a strong growth and a strong inflationary impulse on the way up, you should expect quite some deterioration in economic conditions as the result of the opposite effect that we had in 2022.

[00:42:02] Alf Peccatiello: It just works with a lag, so you need to wait for another three to six months. But I think that we are getting pretty close to the point where the tightening in conditions, both in credit and in financial condition that we saw in 2022, the system can’t handle. Together with the natural embedded leverage that we have built in the system, in the products behind it, and all that we have discussed so far.

[00:42:26] Alf Peccatiello: I would say making the case for a relatively bad recession is not something you should discard.

[00:42:32] Preston Pysh: We often talk about all the issues and kind of where it’s going and, and whenever I think about central banking and this legacy system that we all operate within, it just seems like it’s a crescendo that’s just growing in systemic stability.

[00:42:47] Preston Pysh: As we’re moving right on the timeline, how do you see this resolving itself? You know, my opinion, my opinion is I think Bitcoin has a major role in how this all gets resolved and actually brings stability to the system in the long run. I’m curious if you agree with that or if you see some other way in which they can actually right the ship and actually bring stability back to the world without ever growing systemic risk.

[00:43:14] Alf Peccatiello: No, I don’t. I don’t think that’s possible. Preston, it’s if you want the world to grow organically without having to engineer leverage and credit, that happens via more people actively contributing to economic growth. So a growth in the labor force, and by more productivity, if you have those two, then the world can grow organic.

[00:43:40] Alf Peccatiello: It makes sense, right? You’re growing the pie by having more people contributing to growth and having them more productively. So contributing to economic growth. So then you don’t need any artificially created environments or credit creation or leverage to boost growth. But you know, look at the two things I just discussed, labor force growth, where.

[00:44:00] Alf Peccatiello: Like if you look at Europe, Korea, China, Japan, most developed economies, they will have a negative labor force growth over the next 20 to 30 years. Preston and negative labor force growth, which means you don’t even have enough new young people to replace the Rees. You’ll have a shrinking labor force, so you have less people contributing to economic.

[00:44:24] Alf Peccatiello: When it comes to productivity, we already made most of the ban. Most of the, we already saw most of the benefits of technology permeating many sectors of the economy so that productivity growths is behind us. We keep growing year by year in terms of productivity, but it’s too little. So then you have to use these tricks, you have to create more credit, you have to get more leverage year after year after year.

[00:44:48] Alf Peccatiello: And again, the policymaker incentive scheme will be to try and keep the system as stable as. Will manage probably for a bit longer. This will increase the inherent instability of the system in the first place. So where does it end? It’s actually a good question. Look, I think this is rather a death by a thousand cuts than anything else.

[00:45:12] Alf Peccatiello: The pandemic was the perfect excuse to try and restore the system. Preston, because it’s an exogenous event, it’s something that you can’t control and you can’t predict. Right. Policymakers could have said, well, the system is deleveraging. We need a new form of money within a new credit system if you want to make the credit system.

[00:45:32] Alf Peccatiello: Otherwise, we need a new sound money system. Let’s work to it together. This could have been an option. The reality has been the opposite, where they have doubled triple quintuple, the normal reaction they have, right? Gigante QI programs, ante fiscal deficits program, artificial stability being brought back to the system.

[00:45:51] Alf Peccatiello: And this tells you where the incentive scheme lies. Preston, it lies into bringing the system. To a higher and higher and higher level of inherent instability by trying to make it more stable. And I think that’s where we are going to go. What’s the end game? Look, I’m a bit, this is a very interesting question and the reality is there is one asset which is already sitting on the balance sheet of most of these decision makers, policymaker Simon, and that’s.

[00:46:21] Alf Peccatiello: It’s already sitting on the balance sheet of central banks of governments, and it’s been already this hard asset that we have tried to pin credit creation against during the gold standard until the seventies. Gold though has a lot of problems with it, right? I mean, it’s not fit for a new system. In a new technological environment, gold is not optimal to serve that role.

[00:46:46] Alf Peccatiello: So digital assets can play a role into it, but then you need something that is reliable, trustable scars that cannot be increased in supply. So when I say digital assets, obviously you need to shrink your field. If you want to try and refer to that asset, then probably Bitcoin gets the closest to it. And look, this is a very long-term process, Preston, and I don’t think it’s going to be disruptive in a way that a major external event accelerates it.

[00:47:13] Alf Peccatiello: Otherwise, the pandemic would’ve been the perfect candidate, ex, right? It’s an exogenous event, still didn’t serve the purpose. So I think it’s rather going to be a death by a thousand cuts trying to make the system more stable, but in reality, making it more unstable as we go. And then at some point the system will have to move to something different.

[00:47:33] Preston Pysh: This is my last question for you, Alf, is there’s a lot of people writing and talking about the US and many other countries being in a death spiral with respect to, as they look at their tax receipts and they look at these higher interest rates that they have to roll their debt over to the interest expense is exceeding what they’re bringing through the door.

[00:47:54] Preston Pysh: So are we in a debt spiral? You talked a little bit about this potential for deflationary forces and call it six months to a year from now, hopefully dropping rates back down and, and not realizing that death spiral, but in the long term are, is this the start of the death spiral that eventually kind of percolates out or do you not see that being where we’re at right now?

[00:48:17] Alf Peccatiello: Nah, look, there are two things to be said there, Preston. The first. What really matters in our traditional finance system is real returns and real interest rates. Most, a lot of government liabilities are actually indexed to inflation, so that means that if nominal interest rates are going up because inflation is going up, then you have kind of natural offset because these liabilities are indexed to inflation in the first place.

[00:48:43] Alf Peccatiello: That’s the first comment, which makes the problem a. Less problematic, but still makes the problem exist. If you have much higher nominal interest rate on your debt, even if some of your liabilities are indexed to inflation, you’re going to have a problem over time. Well, the answer again is policy makers can fix problems artificially so that are very close to the core of the system.

[00:49:08] Alf Peccatiello: And in this case, this could be fixable artificially via yield curve control. For example, we have done it already. During the second World War and post the Second World War to make sure that we could fund the war, we could fund the rebuilding post-war. So we have said, look, these are the costs of borrowing.

[00:49:24] Alf Peccatiello: Even if inflation was higher or lower, we’re going to keep it there fixed. And this is the earth growth control, right? So we’ve seen Japan doing that now for many years. Again, those are not sustainable solutions to structural problems. We have discussed, Preston, that people need to be realistic and understand that the closer you are to the core of the system, treasuries, repo market, the value of collateral interest rate on that, this system can be made artificially stable.

[00:49:55] Alf Peccatiello: This increases long-term the instability of the system. It breeds further instability, which often pops up somewhere else, and in this case can be the housing market, the credit market, the shadow banking system as we discussed. So frustration can run very high for a long period of time because this can take a lot to play out towards the end game.

[00:50:16] Alf Peccatiello: And I invite people to follow the. Study macro, be informed and also respect the cycles and the timelines that we are discussing while keeping an eye on the big picture. I know it can be difficult, but it also can be done and it helps people, I think, investing their money in a more risk adjust, generating better risk adjusted returns for their investment portfolios.

[00:50:40] Alf Peccatiello: Always keeping the big picture in mind, but respecting these macro cycles and policy makers incentive schemes that we discuss. Alf.

[00:50:48] Preston Pysh: I love having you on. I love having these conversations. I always learn something new whenever you come on, but give people a handoff to your Twitter feed or anything else that you want to highlight.

[00:50:59] Alf Peccatiello: Well, if they want to follow my work, the best way to do that is on themacro So The Macro Compass is my macro research and portfolio strategy firm. What I do there is I try to break down these complex macro topics in plain English and also keep people informed about macro developments and market developments by giving them actionable investment strategy so they can better manage the risks around the macro cycle.

[00:51:29] Alf Peccatiello: While keeping in mind what’s the big picture ahead. All of that. It’s on, and obviously I have a Twitter feed as well. That’s @MacroAlf, where you’ll find snippets of all these macro analysis and occasionally some pizza pictures because I am Italian after all.

[00:51:48] Preston Pysh: All right, Alf. Thank you so much for making time and coming on the show.

[00:51:52] Alf Peccatiello: Thanks, Preston. Always a pleasure.

[00:51:54] Preston Pysh: If you guys enjoyed this conversation, be sure to follow the show on whatever podcast application you use. Just search for, We Study Billionaires. The Bitcoin specific shows come out every Wednesday, and I’d love to have you as a regular listener if you enjoyed the show or you learned something new or you found it valuable.

[00:52:15] Preston Pysh: If you can leave a review, we would really appreciate that. And it’s something that helps others find the interview in the search algorithm. So anything you can do to help out with a review, we would just greatly appreciate. And with that, thanks for listening and I’ll catch you again next week.

[00:52:27] Outro: Thank you for listening to TIP. To access our show notes, courses, or forums, go to This show is for entertainment purposes only.

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