What’s up, everyone, my name is Jackson, and
today I am super excited to announce that I will be talking to Campbell Harvey. If we go into a recession next year,
it’s not going to be a surprise. He is a professor of finance
at Duke University and is very well-known throughout economics for linking the yield
curve to oncoming recessions. In the past week, we saw an escalation of tension between
the U.S. and Iran. Trump ordered a drone strike on Iranian General Qasem Soleimani. And Iran
retaliated by firing missiles at U.S. bases in Iraq. Since this exchange, both Trump and
Iran have for the moment seemed content not to pursue violence further. The threat of international conflict coincided
with a spike in Bitcoin’s price and reignited the narrative of Bitcoin as a safe haven asset.
Do you think this international tussle told us anything significant about Bitcoin? So this story’s been told many times that
Bitcoin or cryptocurrencies in general could be like a new version of gold, a digital gold.
And the idea here is that gold has got a very long history, thousands of years. And often
it’s the case that when there is a crisis or political risk or heightened risk, the
price of gold goes up. So we actually see something analogous to that, where we see
these political risk events unfold and the price of Bitcoin or some other cryptocurrencies
actually goes up. So it’s a reasonable story to tell that this is a potential safe haven
that is not directly controlled by a central bank. It’s a reasonable story. The problem
is the very short sample that we’ve got. So over the five years of high quality data that
we have with cryptocurrencies, we really don’t have a lot of big risk events. We don’t even
have a U.S. recession in that five year span. So the story is a credible story, but we just
don’t have the data to safely say, well, this is a safe haven asset for sure. So along that line, Peter Schiff said something
really interesting on Twitter a few days ago. He said that gold is being bought by investors
as a safe haven, but Bitcoin is being bought by speculators betting that investors will
buy it as a safe haven. What are your thoughts on that? So, again, the story of a safe haven asset
is a credible story, and you could use that to potentially speculate. So you buy before
or during a risk event, hoping that people will flock to the safe haven and you make
some money in the meantime. So that definitely as part of it, I must also say that I use
safe haven and it should be in quotations for two reasons. One of already mentioned
that is that the history is very short and we don’t really have a lot of evidence that
Bitcoin or other cryptocurrencies will be a reliable safe haven. And number two, you need to take into account
what the volatility actually is. So the volatility of gold is about 15% on an annualized basis.
The volatility of the U.S. dollar is maybe 3 or 4%. The volatility of the U.S. stock
market maybe 15% also. The volatility of Bitcoin is more than 80%. So you need to be very careful
here. I’ve done research on gold in particular. So I’ve looked at gold prices over the last
two thousand years. And even gold is an unreliable safe haven. You never know what’s going to
happen. Four years since 1933 to 1971, the U.S. government banned citizens from holding
gold. So again, we need to be careful in terms of what a safe haven actually is. So now that this like safe haven narrative
actually exists, what do you think the chances are of it becoming a self-fulfilling prophecy? Well, the narrative exists. And again, we
need to be careful of the narrative because it’s being spun potentially by speculators
that want to talk their trade essentially. So we need to be skeptical of the narrative.
There is another reason to give this narrative credibility, and that is that there’s no fundamental
reason that cryptocurrency prices, and I’m talking about cryptocurrencies like Bitcoin,
are correlated with anything. So there’s no underlying fundamental with Bitcoin, for instance.
So given that lack of link to a fundamental suggest that they should be relatively uncorrelated
with macroeconomic events. So let’s be clear here what we mean by safe haven. So there
is a safe haven that effectively retains its value, even though there could be a catastrophe
in the economy. So that’s one type of safe haven. Another
type of safe haven actually goes up in value when there is a crisis. And that’s more like a hedge. And I think
that that’s the latter is the story that people are telling that as the risk increases. So
if there is war in the Middle East, that that actually will lead to appreciation. And they
draw inference from, as you introduced the price recently, going up of Bitcoin exactly
at the time of heightened risk in Iran. How do you think cryptocurrencies as a whole
would function hypothetically if there is a war, if it does escalate that far? So again, Bitcoin has got a very attractive
property and that is not controlled by anybody. It’s attractive because it’s not linked to
any particular fundamental. So that’s so different than other assets. So if you think of the
stock market, well, that’s going to be affected in two ways if there’s a crisis. Number one,
the cash flows and profits of the firms go down. And number two, the risk goes up. You
put those together and the stock market could easily lose more than 50% like it did 12 years
ago in the global financial crisis. Or you look at a currency, well, the dollar versus
the euro, we kind of figure out what the value is. We look at the strength of the U.S. economy.
We look at the strength of the European economy. And we can kind of get a valuation of that
exchange rate. But if you go to cryptocurrency, it’s not
so straightforward to do that. There’s no underlying fundamental. So that means that
hypothetically and theoretically that these cryptocurrencies should be relatively uncorrelated
with events. So in that respect, it potentially allows you to hold value or perhaps even appreciation,
given the volatility during a crisis. But what I said in terms of volatility is important
here. Just because of the volatility, it might be that in the crisis, you lose value. And
the question is, how much do you lose relative to other assets? That’s the key. So theoretically,
there is a credible story to be told that given the lack of linked to fundamentals,
that this particular new asset class could be valuable as a crisis hedge or at least
safe haven in quotations. Great. Thank you. So now I would like to switch
gears a little bit. Could you please just quickly take a moment to explain what the
yield curve is and why it’s so important, especially right now? My dissertation at the University of Chicago
linked the yield curve to economic activity. So let me first explain what the yield curve
is. So the yield curve is a concept that longer term interest rates usually have a higher
yield than a short term interest rate. And the intuition is very straightforward that
if you lock your money up for a longer period of time, then you should be paid extra. So
it’s a premium, a term premium for actually doing that versus a very short term deposit.
And we see this all the time. So a normal yield curve, the long term interest rate is
higher than a short term interest rate. So my dissertation at the University of Chicago
noticed that in certain times we get the reverse, so that the short term interest rate is higher
than the long term interest rate. And that’s unusual, and it’s called an inverted yield
curve. And the economic model in my dissertation linked that inverted yield curve or the slope
of the yield curve to future economic activity. And you can think of it in a very simple way,
that in a time of expectations of economic weakness, people often go to the safest asset
they perceive in the world that has a lot of liquidity, and that’s the U.S. 10-year
Treasury Bond. So currently that is essentially the safest asset in the world. When people
go to that bond, when they start buying the bond, the price goes up. As the price goes
up, the yield is pushed down. And what we saw in 2019 was an extended period of six
months where the 10- year bond yield was below the 3-month U.S. Treasury yield. So we had
a full inversion for six months. My dissertation showed that those inversions are associated
with future recessions. So we’ve had since the 1960s 8 yield curve inversions, 7 of them
have led to recessions and the number 8 we had in 2019. And usually the lead time to
a recession is 9 to 22 months. So this is an indicator that gives you a lot of advance
warning to a recession. The yield curve is now back to normal, so the long rate is above
the short rate. But in the last three recessions, it went back to normal before the recession
actually began. So that is the beauty of this indicator. It actually gives you advance warning.
It gives you not just like a one quarter warning, but a year or more warning before a recession. And I saw over the summer you went on Bloomberg
and you called it a code red, as I recall. So that’s important. 7 per 7, no false signals.
And now we’re code red. We have an inversion effectively for two quarters. It’s really
hard to ignore. And do you still believe that this is an accurate
indicator that we will see a recession in the near future? I mean, is this time any
different than any past times? Significant enough to make it a different outcome? So I guess maybe I’m a bit biased because
it’s something I invented. So, you know, your viewers need to take that into account. But
I’m also an empiricist. This is a very simple model. Let’s look at its track record over
the last 50 years. We’ve had 7 inversions. Each one followed by a recession. So that’s
100% accuracy. But actually, if you think about it, it’s pretty easy to get 100% accuracy,
because you get a model that every quarter says there’s gonna be a recession. Every single
quarter says a recession. So it’s 100% accurate also. But it’s a huge number of false signals.
So this particular indicator historically over the last 50 years, it’s got zero false
signals. So 7 inversions, 7 recessions, and we just
had the number 8 inversion. So that track record is a pretty considerable track record.
So you asked what is different this time? And there is something that’s different this
time, and that is that you’re asking me questions about the yield curve inversion. If we were
doing this in 2006, you would not be asking me, the question was not in the news. People
didn’t really care about it. So now that it’s a topic of conversation, you’ve got an indicator
that’s reliable, that has got a track record of 7 out of 7, given that we’ve had that inversion.
And given other data that’s out there. So Duke University does a survey of CFOs and
our CFOs over 50% believe that a recession will begin in late 2020 and the proportion
goes even higher if we include 2021. So we’ve been in a recovery for a face in the U.S.
for over 10 years. This business cycle is the longest on record since the 1850s. So
as it gets longer and longer and longer, the probability of a downturn gets higher and
higher and higher unless you believe that the business cycle has gone away. I don’t
believe that. So this is actually the time to be thinking about, okay, we’ve got these
signals that are suggesting that there’s increased risk of an economic downturn. It is also the
case a little confusing that the economy seems to be doing well and climate is very high,
unemployment very low. But that’s exactly what happens before a recession. Things look
good before it. That’s the definition of a recession. So given you’ve got these signals,
now is the time to kind of reexamine the positioning of your portfolio and and think about some
of the things that we talked about earlier in terms of, well, if there is an economic
crisis, is my portfolio position correctly? Am I in the right assets to basically lessen
the blow of a recession? So given that there is a good chance that
we see a recession in the near future, how do you think a recession would impact the
cryptocurrency and Bitcoin markets? I’ve got, I guess, two views of this. One view is similar to the earlier discussion
that given the cryptocurrencies aren’t directly linked to the economics. So the stock market
is directly linked to the economics. So the profitability of firms decrease in a recession
and that drives stock prices down. So given that you don’t have that fundamental
link, then economic theory would suggest that a shock to the economy wouldn’t necessarily
impact the prices of, say, Bitcoin. So that’s kind of one view of this. Another view is
this the safe haven sort of view that people will want to abandon the traditional currencies. People see that they need to somehow crisis
proof their portfolio and will invest in assets that are perceived as very low risk, which
could be U.S. Treasuries, which traditionally do well in recessions. That could be gold. That has a checkered record,
but nevertheless, it is also relatively uncorrelated. And it could be this new asset class – cryptocurrency.
So it is possible that we see flows into cryptocurrencies and this causes some price appreciation. Again,
I say it’s possible we don’t have the track record, so we don’t have the global financial
crisis to take a look at the cryptocurrency complex and to see how they do. We’ve got
these small observations that are suggestive that there could be some hedging ability. But on the other hand, we’ve got a huge amount
of volatility. So, again, we need to be careful. But I do think any time where risk increases,
assets that are safe or relatively uncorrelated potentially will attract investors. In a research paper you published in 2014
titled “Bitcoin Myths and Facts”, you said that as of that moment, Bitcoin was too small
to be an important economic force. Has anything happened since then to change your opinion? So I’ve taught a course on cryptocurrencies
and blockchain at Duke University. I’m just about to start my seventh version of the course.
So seven years. And when I began teaching, and this is, you know, seven years ago, what
I’m talking about the cryptocurrencies, you’re talking about Bitcoin. That was it. So I wrote
that paper in 2014. And essentially, Bitcoin was the cryptocurrency. And at the time, it
was interesting and very promising, but it was small. And the sort of stories that we’re
being told at the time that it would be essentially the new payment mechanism. So it was a currency
that has many different uses or attributes of a currency. And one is the exchange motive
and the other is a store of value motive. And then there’s others. But it was fairly
clear to me back then that it was going to be challenging for Bitcoin to be a payments
mechanism. And what we’ve seen over the last seven years is that it’s essentially morphed
into a store of value and for speculation. So what is different, when I wrote this paper
in 2014, in my opinion, is the rise of the cryptocurrency complex. So it’s not just Bitcoin,
it’s many other types of coins. So there’s in my course, I list seven different categories
of cryptocurrencies. So Bitcoin is one. You’ve got distributed
computational tokens, utility tokens, you’ve got stablecoins. So stablecoin complex is
very, very interesting in that they’re effectively challenging the central banks. So it’s a much
different landscape today. And actually, when I look at the cryptocurrencies as a whole,
I’m much more optimistic about the future of crypto, I see the possibility that almost
all assets are going to be tokenized. It is a completely different world where I’ve got
a wallet, I’ve got some Bitcoin in my wallet, I’ve got some Ethereum in my wallet, I’ve
got some stablecoins, I have some gold, I’ve got some securities like a piece of IBM stock
that’s tokenized. I go and I pay for my groceries and I can choose from my wallet, say, well,
I want to pay in gold so I can actually do that. The grocery store doesn’t accept gold,
but I can instantly transfer my gold to somebody else on a distributed exchange and transfer
it into something that the grocery store actually wants. So I can easily do this. And it allows
essentially if you really think about this, and I had no idea in 2014. This tokenization
of everything potentially leads to a situation where actually we don’t need the fiat currency.
So it’s efficient, efficient barter. We’ve never had the possibility of that before.
It used to be that you had to carry the two goats to trade for the cow. So now you’ve
got these digital tokens. And I think that the challenge to the financial landscape is
very, very significant. So this is a really bigger deal than I thought in 2014. Those
follow quite closely to my thoughts as well, actually. And that leads very nicely into my next question,
which is: can digital currencies or tokens like Bitcoin, Libra, China’s central bank
digital currency or some other tokenized security undermine the global hedge money of the U.S.
dollar? Yes. So I think that we need to be careful
here, because if it’s just like a US dollar coin or a JPM coin or Libra, that’s essentially
linked to the US dollar. So Libra is supposedly going to be a diversified portfolio of currencies.
But my guess it’ll be probably 75% U.S. dollar. So when you just essentially create a stablecoin,
you’re still linked to the central bank. And indeed the central bank, well, come up with
its own stablecoin. That’s kind of obvious to me. That one risk in terms of the current
set of coins out there is that there is a euro coin. There’s a Fed coin. It’s kind of
obvious to me that in the future we’re not gonna be using paper for currency. It just
doesn’t make any sense. And just like we’re not going to be using credit cards or driver’s
licenses or passports. Blockchain that provides a way to solve all of these problems. So I
think that the central banks will jump in with their own versions of cryptos. And one
country that’s kind of low-hanging fruit is Sweden, where only 1% of transactions are
done in cash, in physical cash. So that’s a country that probably be one of the first
ones to go. So the landscape is going to be very interesting where now you’ve got the
central banks actually competing with the stablecoins. So that’s going to be very interesting
to see how that plays out. Again, this is a situation where the central bank still has
control and the central bank is only realizing that, oh, well, if we have a digital currency,
then we can efficiently collect, for example, a VAT. Like right now, the VATs in Europe are really
high because people use cash. So you can get whatever big discount if you pay somebody
in cash rather than doing like electronic transaction that could be traced, so you avoid
the VAT. With a digital currency that’s basically hardwired into the system with a national
crypto fiat. So I think that these central banks are realizing, oh, well, there’s so
many advantages here. So number one advantage, we can efficiently collect tax. Number two
advantage, we can discourage illegal transactions because we know what’s actually going on.
Number three advantage, you make transactions more efficient. That’s good for the economy.
And that’s something that a hundred percent of economists would agree on. And it’s very
few things that economists are unanimous on, so efficient transfers of money, that’s a
good thing for an economy in general. Number four, you can instantly execute monetary policy.
So you want to a helicopter drop? No problem. It’s a line of code. So there’s all of these
very attractive characteristics that once the central bankers kind of figure it out,
it’s kind of obvious that they should be in the space. And of course, every major central
bank has got a team actually working on it. So your question is originally about the dominance
of the U.S. dollar. So I don’t think that’s going to go away any time soon. And soon,
I mean, five years. However, this idea that I’m pitching that
once we tokenized all of these digital assets is just less important to actually have dollars
that I can hold a portfolio of whatever. So I’ve got a token that represents a piece of
a self-driving Uber and I get income from that. I can use that for spending. So there’s
not the same need to actually have U.S. dollars. In the past, it’s really hard to save if let’s
say you don’t have dollars in your agriculture. How do you save? Well, you have an extra cow
or you’ve got some gold that you put under the mattress. Today, it’s all digital and
actually can save in other types of assets. So I think that’s a really big ideas. Very
disruptive for finance and the current landscape will look a lot different. We’ll have to give
it five years. We will see some small changes and then all of sudden we’ll go off the cliff,
and I do think that the central bank currencies as we know them today are at risk. Thank you, everyone, for watching. That was
Campbell Harvey, professor of finance at Duke University. My name is Jackson and always
remember to like, subscribe and hodl.