Bankless - The 2023 Recession with Coinbase's David Duong

Episode Date: October 3, 2023

Joining us today is the Head of Research at Coinbase, David Duong, and macro is on the menu.  We’re talking yield curves, election fears, US equities, and if macro economics is even real.  And finally, David walks us through the recession. Is it delayed, is it cancelled, is it already here? ----- 🏹 Airdrop Hunter is HERE, join your first HUNT today https://bankless.cc/JoinYourFirstHUNT  ------ 📣 LayerZero | Accelerating Web3 Interoperability via GoogleCloud https://bankless.cc/layer-zero  ------ BANKLESS SPONSOR TOOLS: 🐙KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE ⁠https://k.xyz/bankless-pod-q2  ⁠ 🦊METAMASK PORTFOLIO | MANAGE YOUR WEB3 EVERYTHING ⁠https://bankless.cc/MetaMask  ⚖️ ARBITRUM | SCALING ETHEREUM ⁠https://bankless.cc/Arbitrum ⁠ 🗣️TOKU | CRYPTO EMPLOYMENT SOLUTION https://bankless.cc/Toku  🦄UNISWAP | ON-CHAIN MARKETPLACE ⁠https://bankless.cc/uniswap  🔗 CELO | CEL2 COMING SOON https://bankless.cc/Celo  ----- RESOURCES David Duong https://www.linkedin.com/in/david-duong-cfa/  Quarterly Outlook: Crypto Markets in 10 Charts https://www.coinbase.com/institutional/research-insights  ----- Chapters: 0:00 Intro 9:38 Is Everything Going Alright? 13:09 Is Macro Economics even Real? 16:43 Government Fiscal Spending 21:44 Election Impact 24:11 US Exceptionalism? 29:14 The Impact of Fiscal Stimulus 38:30 How important is Cash? 45:29 US Equities 52:23 Student Loans 56:39 Recession Talk ----- Not financial or tax advice. See our investment disclosures here: https://www.bankless.com/disclosures⁠ 

Bankless Nation macro is on the menu for the special live stream that we are doing. Whatever happened to the recession, that's the question on my mind and on David's mind. We're going to ask that of our next guest. Was it delayed? Was it canceled? Or maybe it's already here and we just don't know it yet? David, we have the head of research on from Coinbase. And our guest's name is also David.

So I am between two Davids on today's episode. You are. Introduce this topic for us. I don't know yet. I can't wait to experience the David effect. But why are we talking about macro and who do we have on today? The time for macro for 2020 was the year of macro. Macro has you all flustered.

Yeah, it has me all flustered, right? For a while, it was the theme that we wanted to talk about. It's macro, macro, macro. The last time I think we talked about macro was the Silicon Valley banking crisis. I don't even know if that's considered macro, but all of a sudden, macro seems to have been gone. from the limelight. And so the question is, like, why are things so quiet? Are things, are we in the all clear? Did we get the soft landing? Is that what this looks like? Or are things a

little too quiet? Why are things quiet? Like, there's many different things to talk about that are going on in the macro land, the state of inflation. Why are equity so high? Is what's the Fed going to do when they meet in a few weeks here at the end of this month? And what's to deal with the correlation between crypto and stocks, yield and dollar at all-time highs. Can we start to pattern match some of these things? And what can it tell us about Q4, 2023, and 2024 and beyond? Yeah, I feel like this is, things are quiet, a little too quiet. I mean, I feel like this is the part of the horror movie, where everything is quiet. And you're just in the suspense, you're just waiting for the next shoot of drops. So maybe that's part of it. David, before we get in, though, we got a quick PSA.

And this PSA is for ourselves. This is all about becoming. becoming a bankless citizen. So you're listening to this episode of bankless, which means you are an enjoyer of the podcast, at least we hope you are. You're not just listening to this out of pure hate. There is the potential for you to become a bankless citizen. We don't often talk about this on the podcast, but there are a slew of tools that you unlock by becoming a bankless citizen, one of which is the premium feed, the citizen premium feed, we call it. This is a dedicated RSS feed with bonus episodes and it's completely ad-free as well. And you get that as a result of becoming a citizen. There's also some really cool features that we've added here lately, including

the token hub, which is our bearable neutral rating on our website for various tokens. We've just rolled out an air drop hunter is an opportunity to see which air drops, which potential quests you can go on and potential protocols you can test out for air drop eligibility. And I think this is probably my favorite new feature. This is bankless claimables. You put in your eth addresses. Basically, it tells you what you can claim on chain. I didn't know this actually, but I just recently looked at this.

I have apparently $103 in one of my eth addresses here that I can go claim. Better go claim it. Yeah. What else would you say about citizenship, David? What are the benefits of a bankless citizenship? Yeah, I bet a lot of people are listening to this podcast. on their podcast player. That premium RSS feed, the ad-free RSS feed, also goes there.

So Ryan's showing it on his screen, but most people just listen to the ad-free RSS feed natively in their podcast player. That is a link that you get only as a citizen. And just all of these perks and things in the bankless app that we've put together is really just meant to be the toolkit to help you live a bankless life, to help you navigate the world of crypto, navigate away from the traps, and just do it in a much easier way. So it's supposed to be a much more fluid way to live in the world of crypto. I was muted there, but absolutely.

Yeah. And one of my favorite parts, too, is the bankless community that you get to join when you become a citizen and meet everybody on Discord. Participate in our live events, all of these things. I've got my own channel inside of Discord. It's called Ask David Anything, where you are allowed to ask me anything. I will answer them. Really? Anything.

Anything. Anything from a menu, my friend. Yeah, I actually prefer the non-crypto questions. Yeah. There's a link in the show notes if you guys want to check that out. David, going to this episode, I have just one overarching question for you before we bring on David here and introduce him to the bankless nation, which is why does macro matter?

So there are many people in crypto who I know just don't pay attention to macro at all. That's a superfluous thing. It's not relevant to crypto markets. Would you make that argument? Why are we even doing a show on macro? in general. Like, we must think it's important. Why? Yeah, certainly. Well, what finance is, is a big, gigantic mesh network of interconnected variables. And so crypto is, a story of crypto growing up is becoming a relevant macro player. Bond yields, as we've known in 2022 and 2023,

does impact the valuation of our assets. The macro conversation is the regulatory conversation, which is the Bitcoin ETF conversation. And so all these variables are worth considering when We make informed investments about the future because macro is about predicting the future. Yeah, I agree. I also think that understanding macro helps you understand crypto better in the same way that understanding crypto helps you understand macro better. We are, of course, creating a new financial system. And we should learn lessons from the old one if we're going to move past it and build

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You can reach out to Toku at Toku.com slash bankless or click the link in the show notes. Bankless Nation, I would love to introduce you to David Duwong, head of research at Coinbase, leading Coinbase's institutional research efforts for their institutional clients. David both speaks macro and crypto, which is why we're having him on the show today. We haven't done a macro show in a while. It's been a little quiet out there. Is no news good news or is it a little bit too quiet?

David is going to help us answer that question. David, welcome to bankless. Hey, thanks a lot, David. Thanks, Brian. So I want to start with that question. We haven't done a macro show in a while. Why? Why not?

Everything kind of seems to be going all right. The economy's not falling apart. We don't seem to be having that recession that we were so worried about at the start of the year. How does the whole idea that everything seems to be going all right check out? out with you. How to, just five check on that statement. Everything's going fine and that's my segment. So, no, I think the expectations at the beginning of the year were that we were going to get recession because there was this recency bias in people's minds, right? The big signal that people kind of look at, at least in the finance world for whether recession is coming or not, is this idea

of the inversion in the yield curve and the curve inverted. And so we said, well, recession is coming. Let's all panic. The problem with that is that doesn't tell us anything about the timing of when these recessions occur. Like the timing for when you see the curve actually invert and when a recession happens can be anywhere from 120 days. It could be 400 days. So we are still well within that window of possibly seeing it. But a lot of us kind of look at indicators like, well, the labor market seems to be doing fine. Like we just got some joltz numbers that say we have 9.

million job openings available in the United States. So compared to 2001 when we had four, 2008, when we had four, the previous kind of recessionary periods, like that seems like a lot. And it is. The problem is that the changes in these things, like the Delta, are actually already peaking, or if they've already peaked in many of these cases, and we're actually moving down. And the other big problem is that the relationships that we're familiar with, traditionally in macro, they're not working.

And I think this is actually the biggest challenge because generally things happen like the Fed hikes rates and then the economy weakens, right? And of course, there's long and variable lags, which the Fed talks about. But this time around, the Fed's hiking rates and the economy's doing pretty well. Like the housing market, like housing prices are rising. You don't see that when mortgage rates are at 7%, for example. Or in the last few months, the dollar's been very strong. But oil prices keep rising. That is not a traditional relationship.

Generally, when the dollar is strong, you don't see oil prices or energy prices like this. Right now, you know, you mentioned yields. Yields have been the biggest concern for a lot of investors. They've been rising, but up until Q3, for example, gold prices have actually been stronger, which is, again, that's not something. So, like, you have all these historical relationships that just don't work right now, and I think that's more concerning more than anything else. One question, David, here about this yield curve inversion.

you seem to maybe be preparing us for some sort of discussion on like a recession is only a matter of time. I feel like that's maybe part of what you're implying. So the yield curve inverted. And historically, that has been a sign that we're going to get a recession, right? And you said that doesn't necessarily tell us when we'll get the recession. Could be 100 days out, could be many hundreds of days out. We just don't know. But does it actually guarantee that we will get a recession?

How about the case where yield curve inverts and we don't get a recession? Is that a possible forecast? Or do you think a recession is pretty much a guarantee? It just is the only dependency is on the timing and the when. So I will say this, and this is probably going to hurt all the macro analysts, whoever will come after me. We don't know anything. I'll be completely like frank about that. We really have no clue.

You know, like the best part about inflation is that like, you know, oftentimes the fed's like, well, you do this and then inflation's going to come down or go up depending on what we wanted to do. Like a lot of, there's actually papers written by former Fed officials who basically say what I just said, who basically, we have no clue how inflation works. By the way, like we said all these things. We have no clue how it works. Can I ask, yeah, can I ask a higher level, though? Like, if we have no idea, you know, how any of this works or what's going to happen,

then why do a macro show? Why are you in, you know, macro at all? Like, doesn't this go back to the intro of like, why talk about macro? Why can't we just put the blinders on? Invest in kind of what we know and just ignore the chaos that's going on outside because no one knows anything about anything. A big part of that has to do with it's a social science. You know, it's one where we testing because a lot of depends on human behavior and a lot of these variables I was talking about in terms of why don't these historical relationships work. Well, all of them have an answer to it.

all of them, it could be geopolitical. It could be that, you know, for example, the economy is doing very well right now because I believe that the government is spending significantly. Like, we are seeing a lot of fiscal stimulus inside of this economy that's propping it up. And this is different from what we've seen in previous cycles. Like right now, the U.S. government is acting pro-cyclically, which is to say it's working, actively working against the Fed in terms of the Fed's attempts at cutting rates and trying to you know, get the economy weaker so that inflation actually comes down. Like the reason we've had

these odd dynamics can be explained and we have to try to explain them. But the problem with it is that a lot of times we don't know what their final answer is like with the reality until ex post, until after the fact. Like until we actually see it happen, we're like, we're just kind of guessing. So David, we can't necessarily use history in order to kind of predict the future. But you are saying, you are saying it is possible to kind of gather all of this data and look at what's going on and actually read the tea leaves and and actually create some predictions, predictive model on what might happen next. That's right. You know, like I think that the, you know, and this is, I'm not an economist.

You know, I've trained as an economist and I've had these things, but like I'm actually a strategist, which is a little bit different because I generally use what I understand in terms of the economic variables and what's going on in the macro. economic environment to kind of inform my decision making as far as investments are concerned. But I will say that, you know, oftentimes what we kind of get with these kinds of variables, like we have to understand like where does it, where could it work out of sample and where are the changes from what we're used to in history that is making this situation possibly different from all the others? That's kind of what we're always trying to analyze and we're to kind and get a better understanding of what kind of trading environment are we in to trade crypto or any asset? I think the answer to Ryan's question is like why do we do macro shows?

To me, like people that look at the macro landscape, it's they're all looking, everyone's looking for a story to be told. Here's what oil is telling us. Here's what yields are telling us. Here's how this part of the story fits to that part of the story. And ultimately, it's a prediction of the future, which means that to some degree, all the stories will be wrong in some sense. some will be more wrong than others, some will be on target. And so I guess, David, we're bringing you on

here as a storyteller to see the story that you are seeing in all of these different variables. And one of them that you painted that I think is a place to start this story is all of the government fiscal spending that has happened since the Silicon Valley banking crisis, but maybe also even earlier than that. If we accept that as the beginning of this story, can you walk us through that story? Why is this an important part of the story of the economy? Yeah. So, you know, and to your kind of point, I would say, like, the only guarantee we have at the end of all these things is that half of us will be happy and half of us will not be happy. Like someone's going to get a right based on our call and some of us will not. So, I mean, there are really two reasons why I think the U.S. economy has been doing so well. And I say that because, like a lot of the other places in the world, things are not going well. Like Europe, you know, they're suffering from some countries suffering from stagnation. For example, China. economy is not doing very well. They're going through a period of deflation. So the U.S. has been exceptional. In fact, that's what we say. This is a period of U.S. exceptionalism,

which in part explains why the dollar has been doing so well, for example. I think there are basically two main reasons why that has happened over the course of 2003. Number one is a lot of spending. So currently, we have the Eflation Reduction Act, we have the Jips Act, we have the Infrastructure All these things have amounted to trillions of dollars that we are going to be spending. I think over the next few years, we're going to have about $2.1 trillion more in terms of outlays that we need to pay for because we needed to have these things, right? But it's a bit different than what we're used to. So I think that's number one.

The other big thing is we've seen a very large labor productivity move. And what that basically means is during the pension, we actually had huge declines in labor productivity. I mean, like, we all suffered because not a lot of people, like, I don't know who was going to the office, maybe like the, you know, the people who were who were needed, like nurses and doctors and things like that. But for the most part, a lot of us weren't there. So there was a very large productivity spike over the course of 2020 and into 2023. And this has kind of propped up the U.S. economy. And that did exist in other places. but only certain countries have the ability to actually fiscally spend their way and kind of boost the U.S. economy.

We were one, or rather boost their economies. The U.S. is one of them. Okay. So if we take the idea that there's a United States government is doing a lot of spending. You named a few of the acts, the bills, the Inflation Reduction Act. There's billions and billions of dollars being pumped by the government into the economy and it circulates around the economy. and it's being like kind of forced in, right? It's not happening of its own causes.

It is an exogenous force on the economy by the government that could potentially stop or not. I don't know. But that's the question to you is like, are we concerned about the ceasing of the government doing this artificial pumping of blood through the economy? Like, what's the state of that? So that is part of my thesis behind why I would expect, recession and materialized probably in the first half, maybe in the first quarter of 2024.

It's purely, I guess, on my part, but I would expect that that stimulus is coming to an end. I mean, there are going to be lingering kind of latent aspects of this. For example, like, you know, certain states are going to be receiving apportionments of government, of federal funds in the beginning of 2004, and I think that they have until 2025 to use that. So some of those things will probably keep the conditions for, you know, the, you know, economic situation, probably easier in terms of having some liquidity available and things like that. But ultimately, a lot of that is starting to lapse already. So I would guess by, you know, first quarter of 2024, that's going to end. And if that, if the story is correct, if that is one of those things

that it's propping up the U.S. economy right now, then I would think that that's where we're going to start to see things turn. Well, that's really interesting. And I want to come back to that prediction. But so you're saying one of the ways to interpret this, this data that, you know, the strategic interpretation is that a recession is still coming. Yeah, we did see the yield curve inversion. Fiscal spending has really propped this up in the U.S. to the U.S. to the recession. point we've been outspending you know other countries but that could start to turn in uh 2024 maybe the first part of 2024 the first quarter the first half of 2024 which is very interesting because 2024 is an election year for the u.s does that factor at all in in your

analysis here david yeah that's what's a bit unusual about this because typically you don't want to time, you know, if all things being equal, you would love to have that spending during an election year, right? And there's a lot of conspiracy theories about also how the central banks operate. And this isn't just in the U.S., of course, this happens in a lot of countries. I don't necessarily subscribe to those views in all cases. And I certainly think that, you know, in the U.S., the Fed's independence is pretty impeachable, unimpeachable, rather. But, you know, a lot of the spending was approved at a time before the midterm elections when the Democrats had control of both houses. And that's why, like trying to extend that beyond this period of time is much more difficult.

But the way some of the spending has been characterized in terms of federal funding that goes states, for example, the fact that that carries over into 2024 and 2025, I don't think that was an accident. But it is the case that the U.S. is outspending, say, Europe, where maybe some of the economy has been less bright and we're outspending China as well. Are you seeing that in the data? Is that the case that we're outspending these other jurisdictions, these other countries? It's different for each place, you know, like Germany's going through a stiflation kind of environment right now, or at least I believe they are. You know, China has been unwilling to kind of provide the levels of stimulus. that a lot of investors would have liked them to, in part because they're kind of stuck because in the past, a lot of that spending has been around infrastructure, for example, and now they have a lot of ghost towns and other places. Like, they've kind of already overspent, and their big problem right now is private debt,

which has been redistributed among, like, kind of local governments and other places. So it's become a mix of public and private debt in some ways. Like, the problems kind of exist elsewhere. But the U.S. has been one place where they've definitely had the firepower available to them, while many other countries have not. Can we talk about that, David? Why? Why does the U.S. have the firepower available to it to spend more? This idea of this period of time has been a period of U.S. exceptionalism with respect to kind of the economy and also with respect to the amount of money we're able to find and pump back into the economy. Why is that? Where are we getting this money? Is it simply a matter of the U.S. having the world's reserve currency status? And we kind of eroding that. Are we like people are just willing to buy U.S. bonds or have been thus far, our treasuries and that kind of thing? Is that what, you know, why the U.S. has been exceptional with respect to its level of firepower, it's able to inject? Like, what are the reasons here? I think that's a big part of it. But I would kind of separate it two things. Number one is the mindset.

Number two is the ability, right? And the mindset, I think previously, like for, you know, a very, very, very long time, like the whole mindset around fiscal spending was tax and spend. And this is fairly prominent. I mean, it was not unquestioned globally. Like, this is how you do things. If I want to spend, I need to actually have the capital raised in order to spend that money. Pretty obvious. Or at least you think so. Because a lot of times we make these parallels of like, well, you run a government the way you run a household, right? I'm not going to spend. this stuff unless I'm able to get credit for it, i.e. I can borrow in the market and be able to borrow that money to buy a house, for example. Well, similarly, if the U.S. government wants to spend on whatever, let's say it wants to increase defense spending, well, I'm going to pass that on and try to like tax people more or find other ways to actually raise those funds. But something changed, right? What really kind of changed in thinking? Well, we had a modern monetary theory kind of positioned as an idea and it came prior to the pandemic but when the pandemic actually happened all of us were like well this is a this is a catastrophe like we like this is a world health

crisis like just get us out of it and to be fair all of us were kind of culpable in this all of us just saying like rescue us we don't care what you have to do spend this money and just get us out of it and so we printed money effectively we're saying like forget about tax and spend that's not going to be like, we'll just spend whatever we have to and we'll figure it out later. And that was the kind of thinking. And part of what's embedded in that thought process, at least in the U.S., is that, yes, we can issue, like we can issue whatever bond that we need to kind of pay for this because we control the reserve currency of the world to some extent, meaning we can print ourselves out of it if we need to. Like, functionally, this is known as monetizing the debt in

some way, shape, or form. We are seeing the remnants of that happening right now and possibly, like, it may continue into the future because effectively we're saying, if we need to, you know, get more money, we will borrow more. But I think we're creating problems for ourselves because while the U.S. remains the reserve currency of the world, and I'm not a conspiracy theorist, I do believe that, you know, the de-dollarization story that a lot of people pause it, I think that it is not. something that's going to just happen suddenly nor in the short term. It's not binary. No, it's it is a

process and it's going to be a, you know, it's probably going to happen sooner rather than later, but it's a decades long process. It is not a like within the next five years kind of process. Well, regardless of that, I think the, you know, the, the, the U.S. government kind of perceives, well, we can issue this debt. The problem becomes who's going to be buying all this debt? Because right now U.S. Treasury bonds are used as collateral globally, and we need it. Like people, people have the dollar in their reserves, central banks in other countries, primarily because, well, when they buy goods or move goods, the dollar often acts as an intermediary within the balance of payments. Like, you need the dollar somewhere in order to kind of pay for

goods that you're either buying or selling or whatever, you know, like often to buy, but, you know, you need it for some purpose used inside of trade. You don't want to just carry dollars, so you often carry treasuries because it's a yield-bearing asset rather than just having dollars. So that's kind of where the function it plays in the world. And that's still the function of plays. Even though I think you're not seeing the dollar having as strong a place in country's reserves, it's still very moderate.

Like for the most part, people are carrying dollars there. But it's not going to last forever and the world is changing. There's yield curve control that's being removed in Japan, for example. So Japanese buyers who are the largest buyer of treasury bonds in the world, you know, that's not going to be there like probably in the near future, for example, who's going to replace that? So there's a concern that they might need to be filled possibly with the Fed needing to step in and actually buy that again. Currently we're in a period of quantitative tightening, but will we need to flip the quantitative easing probably fairly soon.

The way I understand this is that the fact that the United States dollars, the global reserve currency, produces this very large reservoir of power that money printing can tap into, right? If everyone else is using our currency base, well, then that gives us more affordances to actually be able to do the fiscal interventions that we've seen in 2022 and 2023, like the ones that we were talking about. I want to ask about your perceived equilibrium. that the economy would actually be in if it weren't for the fiscal intervention.

Like if you took out the variable of fiscal intervention, like what would the economy be looking like? Because over a year ago, everyone was worried about the recession, but then the recession never came. And so like one perception might be is that, well, we just kick the can down the road using fiscal intervention. But then another angle might be like, yeah, we did kick the can down the road. And we also kind of spread out the recession over a wider period of time, which is what you kind of call a soft landing. Where do you stand between these two things? We just, we just, the recession is going to be just as bad and we just kick the can down the road. And as soon as we stop fiscal intervention, we're going to be hit with a full weight of a recession. Or the kicking

of the can down the road is the spreading out of the recession. And that's what you call a soft landing. So had it not been for the fiscal stimulus that we got, I still think that we would have been in a fairly slow moving train because it takes time for a lot of what, the Fed's doing to actually percolate into the broader real economy, as they call it. Just take housing, for example. You know, like housing has done pretty well all things considered, whereas if you saw the 30-year mortgage rates were somewhere around 7 to 8%, you would have said, well, things should have slowed to a crawl at this point.

But there are other mitigating circumstances that have stopped that from happening, right? Because one thing is supplied, like 82% of... of homeowners, for example, have a current mortgage, an existing mortgage that's somewhere below 5%. So if you have that and you see that current mortgage rates are 7% or 8%, you're going to say, well, I don't want to, I'm not able to go out and buy another home to replace the one I currently have because I'm not going to switch my 5% mortgage for an 8% mortgage, for example. So you're just sitting on that. Now, typically speaking, that would still create negative flows in the economy because people still aren't moving things.

Demand, of course, has been constrained on that side, but then supply kind of gets constrained, so that's so far balancing it out. But real kind of money sloshing around the system, you know, it's not great. It's not a good feeling. The pandemic also changed that a little bit. And so that's a factor that we've never had to consider before as well because one of the things that we saw during the pandemic that's extended beyond that is, well, if I'm not going anywhere and I'm sitting in this house anyway, I might as well make this house that I'm living in as nice as possible, right? So, hey, let me like redo my living room.

Let me like, you know, upgrade my kitchen, for example. And so we are seeing spending on that side, which is kind of offset the inability for people to kind of buy and sell homes. So, you know, like these things have definitely kind of eased things such that, like, higher rates hasn't necessarily impacted immediately. So all things considered, I would have said that we would have already seen a bigger slowdown at this point in the U.S. economy. But I wouldn't have expected us to necessarily be in a recession at this point.

I want to drill into the rates conversation because that is more or less a focal point for the entire world, like the rates of the bond market, the treasury yields. So high treasury yields plus actual like dollar strength, kind of, dictates everything. It's kind of the epicenter of the global economy. Why are these things so high? And what is your kind of like just take on the state of these things? So if my narrative around government spending is true and basically we are pro cyclically keeping the U.S. economy afloat, for example, among other things, right? Like I can explain some of the other stuff around like labor markets and other things later. But, but. But let's just assume that first thing is true. Well, then that means the Fed themselves have to keep rates somewhat higher than they would have had otherwise, right? Because like we said, if we expected the economy would have been slowing down at this point because of what the Fed's doing,

well, now they've got to work extra hard in order to keep the economy down so inflation stays or at least goes down in the traditional. that they wanted to, which is the 2% target. That means rates are on the higher side and the yield is there on for on the higher side. And that's probably the biggest component to it. Like, it's always kind of the Fed decision that kind of factors into it. But then there's other stuff as well. The supply. Supply is definitely a very big aspect of, well, if the government's borrowing more, typically in a normal situation, added supply doesn't necessarily negative. affect the yields too much. But in this case, we can see the trajectory already is going towards them borrowing more.

Like, for example, they changed, like last quarter. They said they were originally going to have something like $700 billion worth of bonds that they need to either roll over or issue in terms of new debt. And they borrowed a trillion dollars. So, I mean, these things are starting to really kind of eat at that as well. And then probably, like, there's going to be these other smaller elements that are pushing, like, yields higher like, you know, there's convexity hedging that a lot of investors do, which means that they're basically looking at the curve and saying, like, I want to be in the less,

the stuff that's less sensitive to higher interest rates. So let me do that and that, you know, create some lumpiness in terms of what they're buying and selling in the curve itself. Okay. So just to be clear that I understand your answer, you think that bond yields are going higher? So there's been a lot of conversations around this recently, you know, like Larry Fink was on the tape very recently saying that he thinks 10 year yields are going to be a 5%. Jamie Diamond said they were going to be in the 7% kind of range. I would expect that probably very short term, which would probably last through like Q4, for example, we will see that bond yields are going to continue higher because we are still

in this environment of, you know, fiscal spending kind of propping the economy, the economy doing well. And I don't think it's a goldilocks scenario, but it's fine. I think then you're going to start seeing things really moderate beginning in probably first quarter of 2004. And keep in mind, I'm talking about nominal interest rates. It's a very different thing to be talking about nominal versus real interest rates. Real interest rates just subtracts the impact of inflation. And I think that is what people are missing because what could happen.

And this is just one potential stay of the world that I think is perhaps most likely. if inflation increases, and I'm talking about headline inflation, because right now energy prices are on the way up. And a lot of that, it's not artificial, but it's kind of manufactured by the market dynamics more so than actual forces of supply and demand. So I don't think it's going to last forever. But let's say, like short term inflation goes up because energy prices go up. Well, that's cyclical, right? I mean, a big part of that is just cyclical inflation. you know, the Fed has no control over energy prices, not really.

Like the Fed's whole shtick is that they need to get demand down. They don't have controls for supply, which is really what's impacting the energy market, the oil market right now. Well, your real rate, if that headline number is higher, is going to still either remain stable or, you know, maybe possibly go a little bit higher, but not much higher. Like, we're right now, we're looking at a 10-year real rate. it's somewhere around 2.3%. And I'm using like the, you know, break even 10, 10 year, which, you know, it assumes investors have a very long horizon or are able to predict the future over 10 years,

which we can't. But anyway, that's the best measure we have. So let's say it's around that. That could remain stable, all things being equal because if inflation, headline inflation, keeps going up and the 10 year keeps going up, you just kind of balance those two things out. But by the time we get into the beginning of 2024 into the first quarter, 2024, assuming the economy starts to kind of soften, assuming energy prices like I, like I believe, do not last. And I think we are already on a disinflationary trend. Then very likely, the Fed actually doesn't have to do anything here because they can just be like, oh, our job's done. Economy is going pretty well.

Like the core inflation hasn't moved. It's just headlines moving higher, but we don't control for that anyway. So like, we're a fine. So, David, I know in the back half this episode, we're going to ask you about some other asset classes. And we covered bonds, but we want to talk about kind of stocks, you know, equities, of course. And we want to talk about crypto, obviously, because, you know, that's what bankless listeners really care about coming to this episode and how macro might affect that. But one question I had for you is about this asset class that we often disparage, I think, in crypto circles. Fiat, cash. And I recently read a Ray Dalio piece called just extolling the virtues of cash right now.

Cash is no longer trash. You know, cash is back again. And his case for this is basically like, you know, when you compare the valuations of stocks, when you look at kind of the bond market and then you look at sort of cash and the liquidity and all of the options you get on top of cash. And then, of course, if you're able to generate some kind of a yield on top of that cash, ideally a real return, say a five to five and a half percent, well, cash seems like a fairly attractive asset to hold. And that's the posture he took, which is he said is much different than how he felt about cash in 2020 when rates were very low.

What's your take on cash? Do you think cash is back? Cash is now king. it's no longer trash. You think maybe in crypto, we underestimate the value of cold, hard U.S. dollars. Yeah. I like what Ray Dalio said because basically he was disparaging of bonds, but very optimistic about holding cash.

And that's your opportunity cost, right? Around 5%, 5.5% and 1⁄2% like holding cash, that's your opportunity cost that you have to beat right now if you want me to take any greater risk. And that goes for any risk asset. but it's really important for people on crypto to understand because, you know, if I believe that holding a long-duration asset isn't going to pay me as much as 5%, then why am I doing it? I need to kind of get that plus probably some premium because you're telling me I got to

hold something for a while in order to see the benefits of that thing to materialize. I do. I think that holding cash is a pretty good prospect, you know, like it's very different from what we're used to over the last, you know, decade at least in terms of, well, you know, like, I might as well get into anything else because just holding cash, I'm losing money. Because the problem generally arises that if I'm just holding dollars, I'm losing money because of inflation. Like if we say that inflation is typically moving around like 2%, well, then I'm losing 2% every year if I'm not invested in something. I got to make above that.

Now we're saying like, well, for the most part, you know, like inflation is down to around like the three handle. For example, if we're talking about five, I'm making two percent real return or two percentage points in return. Like it's pretty good. You know, all things considered. Like, why do I need to do it? Take, for example, equity risk premium, for example, the extra return that you get from equities over that interest rate, over the risk free rate, for example. right now it's about one percentage point above that, which is probably one of the lows we've seen in a very long time.

Like 2% or 1 percentage point, you know, like which one would I rather be in? To do nothing, I get paid more. Like I think that that is the big, like this is the big draw with cash right now. Yeah, that's funny. My two favorite assets right now are crypto and cash. And I feel like there's not a lot of space in at least my own personal portfolio for anything in between those two things. they're just crushing it right now.

But David, we have a lot more to cover in the back half of this episode. What are we going to talk about? Yeah, ultimately, why do we do macro shows? It's because we want to understand what's going to happen to risk assets, since that is the punchline that we will inevitably get to on this episode. But there are some conversations that we need to meander through to get there. The October 31st, November 1st, Fed meeting is on the table. We're going to have to talk about that.

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There is a link in the show notes. Bankless Nation, and we're back zeroing in on the ultimate punchline, which is what is going to happen to risk assets. But we still have a couple more points on this story to get through. I want to start, David, the second half of the show with equities. Equities are very high. they have come down recently. I think there are 7% off of their recent highs,

but their recent highs are almost their all-time highs. I would sure love it if my crypto portfolio was 7% off of its all-time highs. That would be nice. There's a disconnect there between the crypto markets and the equities markets. So there's two questions here. Why are equity so high? And why is the correlation between crypto and equities so low? And what does that tell us?

So right now, I think there, are a lot of people who are worried about the equity markets more than, you know, worried about it going weaker, rather than it continuing its current strengthening trend. It's been doing well primarily because of growth, right? Like U.S. stocks, well, any stock really likes growth, but U.S. equities in particular have done very well because if you look around the world, then things haven't been doing so well. Even other countries want to get access to our U.S. stock market because they're like, well, that's one place where I'm actually getting. some kind of attraction. And that kind of goes against a thesis I was saying earlier before the break about, well, if equity risk premium is so low and these things look expensive, why am I still in it? You're still in it because maybe you expect that that growth is going to actually materialize

and higher activity above and beyond what you're expecting from the earnings of a particular stock or a particular company, for example. But the challenge right now is, well, we have this higher yield. And oftentimes, what really matters when we're trying to, kind of look at the performance of a stock is we look at the discount rate because you have to discount whatever you're looking at. Like if there's a dividend, for example, I discount it over the period of time over which is expected and I bring it back to PV, like the present value. And then I say, like, is that sufficient for what I would like? If that tenure rate is going higher, does that mean that equity prices need to come down? And I think this is the big, you know,

problem people are wrestling with right now because people are looking at the spike in the tenure yield and saying, well, like, this is very bad for equities. And historically, we don't know whether that's true. Like, it hasn't always happened that way where just because tenure rates are higher, we've seen that, you know, the equities necessarily needs to perform worse. And by the way, this is just also the last 17 years where we've seen rates not being somewhere in that range of 1% to 4% like before that like rates like the median kind of like a performance of rates 10 year was somewhere around like 4 to 8%. So like I think a lot of people are scared right now or nervous about rates creeping up 4.7% will it go to 5% all this kind of you know like but we this is just

the last 17 years where we haven't seen this since 2007 or so like it's been it's been clear. So I think that's something you got to keep in mind too that like it's, This is a newer development, but this has happened before in the world. The second part of your question was correlations. Well, then why have correlations been so low? And actually, more recently, I will say that on a risk-adjusted basis, crypto has outperformed equities. So we've seen this.

This has only really been the last like two, three weeks or so. But like Bitcoin, E, those things are actually doing much better than the NASDAQ and stocks. And I'm talking when I say risk adjusted, I mean that I look at it on a standard deviation basis, right? Like I look at it relative to where it's been over the last, like the average of the last, say, three months or so. And this is kind of where we're at. A big part of that has to do with idiosyncratic elements inside a crypto. Like earlier this year, for example, you guys mentioned the top of the hour the banking crisis.

Well, Bitcoin did very well for various reasons during that period of time. Obviously, this is an alternative to the traditional financial system, but also a lot of those guys, that were in Silicon Valley Bank, for example, as depositors have to be in tech and we're very amenable to buying something like Bitcoin, for example. So that was a big factor. Later on, in June, we got the applications for Bitcoin spot ETFs. So that's been a big factor and that's helped put a floor under the performance of Bitcoin in particular. As a result, you know, like you aren't seeing that anyone who wants to sell their Bitcoin because even though liquidity has been fairly poor, and that's not just in, you know, crypto.

It's also been true in TradFi as well. Well, how many people do you see saying, man, like, I really need to sell my Bitcoin right now because I think that the stock market is weakening. Not many because all of us are probably kind of looking at the same thing and saying, if there is a, you know, ETF spot Bitcoin ETF that gets approved, well, like, you know, Bitcoin could do multiples higher than where it currently is. Certainly certain percentages. I'm not saying that I have a number in mind, but if it's going to perform higher,

I don't necessarily want to sell my Bitcoin right now. So I think elements of that are keeping the correlation pretty subdued at the moment. Okay. So the idea that crypto prices have just like lost in comparison to equity prices, you are kind of saying, well, that's been true up until recently. And now there is a case to be made for that inverting. Is that true? Well, insofar as the relationship, I think that this is the challenge.

Because the correlations low, people are assumed that that means there's no directional impact. That means that like it's the magnitude of the impact as well as the direction that really matters. Directionally speaking, crypto still does tend to follow like stocks to some extent. And it hasn't always through the course of this year. Like certainly there's meaningful kind of. change between what we saw in 2022 when the correlation was at like upwards of 70 to 80% compared

to where we are now, which is coefficient of around 20. Well, you know, that does suggest that there are periods where it's not even moving in tandem, but it doesn't need to reverse necessarily. It could still kind of move directionally the same. And I think that could be true, particularly once we see the Fed pivot and move to an, you know, an easy monetary view. And And that will happen. I think that could be beneficial for both crypto and stocks. But I think we have seen that crypto prices have been so washed out as well. It just doesn't really take a lot to actually move prices higher from here.

Kind of hopping around here just to get some loose ends out of the way. Student loans have started payments again. This is a new thing as of just, I think, like last week or the week before. So like for the first time since COVID, since student loans, payments were paused during COVID due to COVID, students have started to have to pay their debts, pay the interest on their debts. How will this impact the economy? Yeah. I mean, already we are seeing that like defaults are rising. Loan delinquencies are rising. And I think student loan repayments are just another aspect of that. I think in and of itself, it probably wouldn't have been like a

hugely negative detriment to the economy, but in conjunction with everything else that we're seeing, I think that it's pretty meaningful. And that kind of goes back to what we were saying before about mortgage rates and housing and just credit in general. I think that the situation has so far been able to be okay for the most part. You know, like for example, if you roll back to March, a lot of us were looking at the regional banks and saying, oh crap, these guys are all sitting on like commercial real estate loans and other things like that portfolio. could be problematic. It's still problematic. Nothing has changed about it. It's just that we've been able to kind of ignore it because we put a Band-Aid on the situation. Now that Band-Aid is starting to come

off. And I think that all these things, like in conjunction with the whole like situation, like in the credit situation at writ large, I think that's where we could see a problem for the banks materializing. Like we aren't done with that situation yet. I think that there's still another leg of this, we just have taken a pause on this. So does this maybe student loans starting up again, maybe contribute to your recession case in, you know, the early 2024? Yeah. Yeah.

I definitely think that this factors into what I'm seeing with the Fed, what I'm seeing in with the U.S. economy, for example, you know, I think that come November, the Fed is very unlikely to move because we will at that point have seen the completion of like the writer's strike in Hollywood, the United Auto Worker. strike, you have student loan repayments. I mean, all these things are factoring into Q3, and they had just revised their estimates for GDP growth higher. So I think these, these factors are going to undercut that view. And, you know, keep in mind, too, that like their whole approach, and I think a lot of people, like the pushback, I get, you know, because I don't have the consensus

view. I think a lot of people kind of push back and say, like, are we doing okay, though? Like I said, like, yeah, when you say, it's consensus view that we have. actually have achieved a soft landing, that recession is probably not going to happen? Would you say that's the consensus view right now? The consensus view is definitely that we haven't achieved it, not past tense, but we will achieve. That is the expectation right now. The expectation is that come Q4, like the Fed will have done everything in its power to basically land this plane safely, which is to say it's slow the economy enough to keep inflation down, but it has averted recession. That would be like their definition of what a soft landing kind of looks like. And a lot of

people believe we are in fact in that Goldie Locke scenario. And they point to a lot of things. Housing is okay. Labor market's okay. Except that when you kind of dig into the data, like and you go on a micro level piece by piece, it doesn't really look that great. You kind of brought up the stuff already with student loan repayments, for example, labor market data. Like people aren't getting paid what they were getting paid six months ago. You know, you see new entrance to the market. You know, there were headlines from Walmart, even on the white color side of like people coming into like Goldman Sachs or whoever, like those jobs like for new entrance into those

companies, they're not getting paid what they were getting paid a year ago. And that's a big part because even though we are seeing that number tick up slightly in terms of the job openings, like the quits rate has actually stabilized. And that suggests that people have far less ability to negotiate the salary they want. Like being underpaid, being like, you know, like underemployment is very different from unemployment. And that is still a problem that actually is rising in the U.S. We might still have a lot of underemployment. So that's why you, David, have the non-consensus view right now of, hey, this landing is going to be a lot bumpier than we thought.

And they'll probably, we'll start to feel the bumps in Q1 of next year in the form of a recession. So let me ask you, let's walk through your. your concept all the way to conclusion. Okay, so let's say we get some form of a recession in the first half of 2024. Okay, what does this mean? So what does this mean for, well, first of all, how deep of a recession are we talking about

and how long? And then also, what would this mean for Fed rates in this scenario? Yeah. So I would say quarter to quarter to quarter, this is kind of broadly where like, this is broadly how I'm thinking about things. And I have higher conviction, you know, in what I expect for Q4 versus like first quarter of 2024 and second quarter of 2024. Makes sense, right? Like the farther, the future kind of goes out, the less of a crystal ball I have. And I don't think I have a great crystal ball in the first place. But like I do think that probably I'm very constructive for Q4 and I still think that's going to materialize. And I think like crypto and maybe stocks, but mainly crypto is going to do well in the back half of Q4. But the first. quarter is very, very murky for next year because I think that's the point in which we're actually

going to see these things really hit, right? Whether it's going to be like temporary or not, the energy prices are still going to be a constraint on just spending on in the manufacturing side. And, you know, like we're all going to be moving further and further away from all the production that people just kind of put in place because, you know, those fiscal stimulus that I was kind of talking about, well, a big part of that had to do with if I was a manufacturer, right now, for example, I was getting subsidized by the U.S. government. Like, you know, like maybe they were, let's say they were going to give me like a million bucks. They'd say, hey, put in two million dollars of your own money and we'll talk. And that's what they did. And then like we had this

support coming from manufacturing. Well, that's all going to end. And that ends in the first quarter, for example, we'll get some residual spending like I was kind of talking about, but it's not, in my mind, going to be a good quarter. But then I think the second quarter of 2004, it becomes, a little bit more clear again. And it's still uncertain. I think that it's still kind of hard to predict. But my guess is the Fed will probably need to start cutting rates or at least move themselves on the path of cutting rates probably by May or June of next year. Because the economy won't be looking so hot because it'll feel very much more like we're headed towards a recession or are in a recession already. Yes. Yes. I mean, there's two things. Number one, of course,

like the main objective of the Fed is to target inflation. So all of this like is irrelevant insofar as it gets inflation down. But also, you know, it cares about full employment. And there's also other concerns. And this is where kind of the fiscal situation becomes difficult to kind of get a handle on because a lot of there's a lot of theory that goes into, well, the government spending more inflation kind of goes in more, which is, of course, why rates are higher and why the Fed needs to maintain a hawkish tone.

but once that kind of comes off, you allow for that to happen. But what did things were already disinflationary? Like one thing that I think people don't realize is like, you know, and I'm not trying to be a crackpot about this. You can actually look at the data. Like San Francisco Fed actually published data that looks at the breakdown between cyclical inflation and a cyclical inflation. And cyclical inflation is aligned with the business cycle. A cyclical inflation is everything else.

A cyclical inflation peaked back in January of 2000. The Fed started hiking rates in March 2022. So already that component of inflation was already on the way down well before the Fed started hiking rates. So really what the Fed has been trying to get down is cyclical inflation. And that just peaked about two months ago. So already, like this is moving the trajectory that the Fed wants it to be. So it's really not a crazy idea to think that the Fed already could be in a place where it's thinking about cutting rates or wants to cut rates, but it won't say that and it won't move to that.

Like all things being equal, like Jay Powell is actually fairly doveish. And another point is like he controls this board. And I think this is something that well understood, especially from people who aren't fed watchers on a day to day basis. Like I care what other people are saying on that board. Don't get me wrong. It's important. But like he controls that board.

He controls what that board is going to do. And that is a power of this central bank in particular. I mean, that happens for a lot of central banks out in the world. I just cover merger markets. You can kind of see which ones do and which ones don't. But in the U.S., like a lot of them will fall in line with what he wants. And I do believe that he is dupish and that is his bias. So that, like, rationale.

He's dupish, but with a tough guy, Clint Eastwood, Paul Volcker type of front. But he's dupish in the back? I think that like his bias is to be dutch. but the rhetoric is hawkish because that's where they need to be right now. And so fascinating how this game works, right? Business in front, party in the back. Yeah, well, doveish in the back, I guess.

Oh, there's something called verbal intervention too, which is fantastic, which is the idea that sometimes it's not even what they have to do in terms of actually cutting or hiking rates is what they say in order to move the markets. It's a lot of, a lot of chess that goes on. So verbal intervention is that just what we call bluff. Yeah. That's one way to phrase it. Yeah.

So what happens in this scenario, David walk us through? We talked about kind of fed rates and we talked about kind of, you know, the economy and recession. What happens to our risk on assets? Maybe more specific because I'm actually not sure what crypto is. I guess I'd more call it a risk on asset. We talked a little bit about equities. But what happens to crypto in this environment when we're looking at 2024, Q1 and Q2? Because let me tell you.

David. 2024 was supposed to be the year of the bull, okay, for crypto. At least, you know, the start of an epic bull run. What do you see in the cards? Can you bring us back down to Earth in the signals that you're looking at with Macra? If this story comes true, then how does it bode for our crypto assets in 2024? Yeah. One thing I didn't really address was the timeline in terms of how long the stuff will last

and how deep it's going to be. And the truth that I don't know. I don't think anyone really does, you know, like my best guess would be that it's going to be a moment of recession. That's not going to last too long. And if that's going to be the case and we start seeing the Fed cut rates, then actually that could still be a fairly decent time for crypto in particular. You know, I think that we could still see that, you know, assuming that the regulatory situation

kind of manifests in a way that's amenable to this, you know, like crypto could actually still do fairly well. I think that some of those things are going to be put into Q4. For example, you know, expectations surrounding a Bitcoin spot ETF, for example, or the things surrounding the halving for Bitcoin, perhaps, but maybe not inclusive of what's going on with a Dankoon fork. But like, I think that those things will probably be placed better for a lot of people into like November or December of this year, rather than being played in the first quarter of next year, for example. So next year, I think, will still be a fairly volatile period, which is to say, like, probably uncertain. Like, I really don't know. Like, I think, like, for me, like,

first quarter in 2024 is still very much a black box. But I think we'll come out of it into a better, more constructive world in the second quarter of next year. Okay. David, I feel like I've gotten a lot of questions in my mind answered. I want to maybe turn back to kind of where David Hoffman, the other David, the David on my left, uh, began. this episode with how weird this macro environment is. And you also said the same, David, on my right. And this, this was a tweet that we pulled out for our weekly roll-up last week from a Kobe-S-E letter, the Kobesi letter. Current situation, one, stocks are falling like a recession is coming. Two, oil prices are rising like there's no recession in sight. Three,

interest rates are rising like we have 10% inflation. Four, gold is falling like inflation is gone. Five, housing prices are rising like rates are falling. Six, commercial real estate is falling like it's 2008. Nothing adds up here. And I think, David, I want to make sure I understood you as we kind of close out this episode. I think your theory of everything is the reason why all of this stuff is weird is we have had some pretty unprecedented circumstances on the back of COVID, particularly with respect to the U.S. anyway, fiscal stimulus. And that will, that has artificially distorted a lot of things and has led to a lot of, you know, the results that I just read out. And that will start to kind of dry up in the beginning

of 2024. And we will get back to a situation that is more in line with, with kind of reality once that that drying up actually happens. Is that sort of your theory of everything, your theory of why things are so weird, is it basically like, yeah, COVID fiscal policy spending. That's why it's been so weird in the U.S. That explains one through six of the things that I just mentioned. Yeah, how would you sum this up? The pandemic definitely created some unanticipated outcomes. You know, fiscal spending was a big product of that.

But also, like, the way the labor market kind of works changed significantly as a result as well, because what we saw was a lot of baby boomers, for example, leave the job market. And as a result, you know, like we are left with higher job openings than they would be previously, at least anything that we've encountered in very recent economic history. So there are elements of that that are creating kind of strange effects that make it difficult to kind of interpret the data, you know. I think that we're interpreting the data or finding new ways to interpret the data in the context of how the pandemic has kind of affected our lives. And we haven't really fully kind of materialized it.

But there's other elements, too, that we haven't even talked about. And, you know, like, AI is a big one. Like, like, the way artificial intelligence is probably contributing to the disinflationary trend isn't being well discussed. Like, when I talk to people in economic circles, for example, they want to talk to me about demographics. And they're right to because they're saying, like, hey, we don't. really have as many young workers in the economy anymore. Like the birth rates are declining, and this isn't just in the U.S. It's declining globally outside of a few pockets in maybe some developing countries.

But, you know, like when I look at it, AI is also going to be a very big effect that's going to displace workers and probably lead to greater efficiency and lower input costs. So, you know, like that's something that isn't well understood in terms of how that's also going to impact us and therefore what's going to impact the Fed and therefore how we're going to be impacted in terms of the like asset classes and investing. Yeah, that makes sense. Well, I'm coming out of this episode bullish on the two assets that I was bullish on coming into it, which is crypto and cash, you know, for me, for my portfolio. But of course, none of this has been financial advice. And David, you've been so kind to lend us your macro brain on today's episode. I want to thank

you very much for that. No, thank you for having me. Bankless Nation, got to end with this. Of course, I'll re-articulate. None of this has been financial advice. Crypto is risky. You could definitely lose what you put in. But we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.