The Wolf Of All Streets - Fed’s Mistakes Could Spark Recession | What’s Next for Bitcoin & Economy? | Campbell R. Harvey

Starting point is 00:00:00 The story is very simple. It slows economic growth. The Fed is playing with fire, and this makes no sense whatsoever. I can see your book behind you, DeFi and the Future of Finance. And that yield curve has un-inverted or dis-inverted. I'm not even sure what the right word is.

Starting point is 00:00:21 Bitcoin is going to be even more unreliable. The history is very short. This was the perfect timing for another conversation with legendary economist Campbell Harvey. You may remember from previous podcasts that Campbell Harvey is the person who originally realized the relationship between the yield curve inversion, specifically the 10-year and three-month, and recessions. It's been eight for eight since he wrote the paper in 1986. Well, right now we have the 10-year and the two-year finally normalizing, which means coming out of inversion, but not yet the 10-year and three-month. Cam and I had a very deep discussion on what he thinks is coming Fed policy,

Starting point is 00:01:01 how they've reacted to lagging data and are far behind what they need to be doing. And of course, about Bitcoin and DeFi and where all these assets fit in your portfolio. So we finally have a normalizing yield curve after a few years here. This has been a historically long period of yield curve inversion. What do you make of it in context of yield curve inversions of the past? Let me back up a little bit. So my dissertation at the University of Chicago detailed this relationship between the slope of the yield curve, which is kind of the difference between a long rate and a short rate, and future economic activity. So it was a leading indicator and an accurate leading indicator.

Starting point is 00:02:08 And after I published that dissertation in 1986, the indicator continued to do well. So over the entire sample from 1960s to today, there have been eight recessions. The yield curve inverted before each of the eight, and there was no false signal. So the yield curve that I actually use in my dissertation is a long-term rate minus a short-term rate, and long-term is 10 years, and short-term is three months. So the yield curve that you refer to, and there's many different pieces of the yield curve. So the yield curve that you refer to is the 10-year minus the two-year. So instead of using a three-month, some people use kind of a medium maturity, which is two years. And that yield curve has un-inverted or dis-inverted. I'm not even sure what the right word is.

Starting point is 00:03:12 So let me comment on the two different yield curves. So first, my yield curve, the 10-year minus three-month, I chose three months because that is short term, it's highly liquid, and it kind of matches the frequency of GDP, which is quarterly. The 10 minus two was introduced later. And usually if you go to a different indicator, you need to have a good reason for it. So for example, if my original indicator was giving many false signals, then maybe you'd change. But that wasn't the case. There was no false signal given from my indicator. And the other thing that gives me pause is that the 10-year minus 2-year has actually had a false signal. In 1998, it forecasted a recession that never

Starting point is 00:04:07 occurred. So I think that we need to be careful here. And I do think that in this particular case, and we know that the 10 minus two year, 10 minus three month are highly correlated, but the 10 minus two might be actually giving us a leading indication of what's going to happen to the 10 minus 3. So let me discuss that. The reason that the 10 minus 2 has uninverted is mainly the expectations that the Fed will start to move. And the 10-year minus three-month is still inverted because the three-month rate is high

Starting point is 00:04:50 because the current Fed funds rate is high. So when the Fed begins to cut, and that will begin in September, then the 10-year minus the three-month will start to flatten and eventually uninvert. So that's point number one. Point number two is, and this is very important, some people say, oh, well, the yield curve is uninverted. That means the, and we don't have a recession, so therefore it must be a false signal. And that's not the way it works.

Starting point is 00:05:27 So over the last four recessions, the yield curve is uninverted before the recession actually began. So this is just a natural property of a leading indicator. So you get the signal, and it goes for a while, and then the signal turns off, and the signal is forecasting slower economic growth. So that's kind of where we are. You're also correct about the very long time the yield curve has been inverted. So for my indicator, it's like 22 months, which is not the longest historically, but pretty close. So once we get to the end of October and it's still inverted, that would tie for the longest inversion within my sample.

Starting point is 00:06:18 Yeah, for the last 25 years, looking at the 10-year, 2-year inversion, we've had the inverted yield curve. To your point. It normalizes. That's the term I'm using, normalizing. I'm not sure if it's correct either. Then the Fed pivots. Then we get a stock market correction. And usually that lines up with a recession, presumably. But there's this sentiment that liquidity will come in, the Fed will cut, we get a soft landing, everything goes up. That's not what we've seen over the past quarter of a decade, at least looking at the 10 and 2, un-inversion, then pivot, then stock correction. Yeah. So this is really important that the Fed's actions don't have an immediate impact.

Starting point is 00:07:06 So their job is a difficult job. So they need to manage inflation. They need to manage growth. But both of them operate with the lag based upon Fed policy. So I've been of the strong opinion that the Fed has kept rates too high for too long. And let me explain that logic. And it also explains why the yield curve has been inverted so long. So obviously, the Fed was embarrassed that they missed the inflation surge. So they were talking transitory

Starting point is 00:07:46 when if you're looking in kind of the real-time data, it was obvious that we were going to get a surge in inflation. And the main driver of that was shelter inflation. So looking at real-time shelter inflation, this is back in 21, it's running in double digits. And we know that shelter is the largest component of the CPI. And that will work its way into the CPI allowed for this concept called owner's equivalent rent. And effectively, that means that shelter operates with a lag in the CPI. Now, today, we had a CPI print. And the CPI was 2.5% year over year. And there's a headline in the Wall Street Journal

Starting point is 00:08:49 saying that the shelter inflation that was reported will give the Fed pause in terms of cutting rates. And this makes no sense whatsoever. So let me kind of dive into today's number. So shelter represents just the weight of shelter in the CPI. It's the largest component, as I mentioned, and it's 36%. So if you look at the shelter inflation that was reported year over year is 5.2%. So you can just do the math in your head, like a third of that is the main driver of that 2.5% inflation print. So the question is, well, how reasonable is it that inflation would be 5.2% for shelter? So let's go to some real-time data. So if you go to apartmentlist.com and look at their year-over-year or shelter for rental, it is negative 0.8%.

Starting point is 00:10:05 It's negative. So another provider, Zillow, if you look at their most recent numbers, year over year, it's 3%. Not 5.2%, 3%. And then if we actually look at housing prices, if you look at medium housing price reported by the Federal Reserve, it's negative year over year. If you go to Zillow or their medium housing price, it's negative year over year. So you put all these numbers together and none of them are close to the 5.2%.

Starting point is 00:10:45 And this, again, is because of the way that the CPI is constructed. And by the way, the way the U.S. does the CPI is different from Europe. So if we had the European calculation of CPI, CPI would be with a one handle. So I think that this is really important, that because of this change in the construction of the CPI in 1982 with the shelter inflation and the owner's equivalent rent. This means that the inflation that is being reported today, that 5.2%, really represents what happened like a year ago. And for the Fed, they need to make decisions based upon real-time data. They claim to be data-driven, and I'm fine with that. But you should be data-driven by data today, not data that happened a year or 18 months ago. So what does this mean? It means that what will happen to the inflation rate, we will continue to see it go down.

Starting point is 00:12:00 It will go below 2%, below the target. And it's obvious. And it has been obvious for quite a while. So the Fed kept on increasing rates at a time when inflation was decreasing. They increased rates and kept rates high in a time where if you calculated CPI based upon real-time data, inflation was at their target of 2%. So this means the rate has been kept too high, too long. And what does that do? Well, it slows economic growth.

Starting point is 00:12:39 And we've seen slower economic growth. So 2023, the annual growth rate, 2.5%. We have seen lethargic growth overall. And it's kind of obvious why. So if rates are higher, it makes investment more expensive. So a company is thinking of spending money on a new plant or even hiring additional people, it will think twice because the cost of capital is so high. And indeed, we see this even with things like mortgage rates.

Starting point is 00:13:17 So rates go up, mortgage rate goes up. That means housing is more expensive and it's less likely that people move. It's less likely that people move. It's less likely that people buy a house because the cost has increased. So all of this slows economic growth. And indeed, if we look at key indicators like it's very kind of likely that we go into a sort of soft landing. So you believe in the soft landing. I want to dig more into the CPI calculation because most people probably know the history of the 70s. Arthur Burns famously dealing with inflation,

Starting point is 00:14:06 removed food and energy from CPI, or at least pushed for that. And as you said, then in the 80s, I guess that would have been under Volcker, owner equivalent rents. Seems like there's a constantly moving target as to what constitutes CPI, and that causes maybe this lag. But some would also say maybe that's a way of them somewhat manipulating the data. You talked about the job numbers. We saw recently that they were revised down by hundreds of thousands of jobs for the last year, basically, meaning that the strong job job numbers that the markets have been reacting to effectively monthly were all wrong. Right. And so when you have a Fed that's dealing with lagging data and everybody

Starting point is 00:14:45 seems to know it when you can point to superior data as you did, and you have revised numbers for jobs, how can we trust that the Fed is looking really at data at all when they're making these decisions? Yeah. So that, again, we do have revisions, and that employment revision was very substantial. It was 800,000 jobs. So this is a big deal. So let me talk about the inflation calculation in a little more detail because it's confusing. And I'll give you an example. Suppose in December 2023, your landlord sends out a notice by email saying everybody's rent is going to go up by 10%. So if your lease expires at the end of December of 2023, your rent goes up by 10%. But if your lease expires at the end of September 2024, then from January to September, you don't feel that 10%.

Starting point is 00:15:58 It's zero. But then when it hits in September, then you take the 10% hit. So in this way, the 5.2% actually reflects the inflation that's happening in the economy. My point is more subtle. My point is that that inflation happened in December of 2023. And the Fed should be focused on September 2024 and looking at new leases that are happening in the market. Whatever they do, they cannot affect that landlord's letter that went out in December of 2023. It's very unlikely. The landlord sends out another email

Starting point is 00:16:53 saying, oh, well, I've changed my mind. The Fed has persuaded me that we're not going to do the 10% and I'll refund all of the increases. No, that inflation is done. So again, the Fed, what they need to do is to use a different way of calculating the CPI for their policy decisions. So the CPI as it is, and I'm not a fan of pulling certain things out. There's so many different CPIs. Oh, we'll pull out food and energy. Well, why? That doesn't make any sense that people need to eat and drive their car, heat their house. Or some people pull out the most extreme numbers, the so-called trim CPI. No, just use the CPI, the weights that we've got right now.

Starting point is 00:17:47 But for policy decisions, for certain inputs, and shelter is the obvious one, then use real-time data. So what I've done is, for example, I've just recalculated the CPI. So all the numbers are identical except for that 5.2%. So let's substitute something else in. So, for example, if I substitute, let's say, shelter instead of 5.2%, substitute, let's say, 2% or 3%, all of a sudden we're below 2% year over year. It's obvious, right? So that's what the Fed should be doing. They should be saying, okay, we've decided we're going to use this CPI,

Starting point is 00:18:35 but we need to be careful that there's at least one of the inputs that is backward-looking. We want to be forward-looking. And it completely changes the narrative. It's very frustrating for me because this is not rocket science. This is really straightforward stuff. And indeed, this idea of kind of real-time numbers, again, that's what's used in Europe. That was used, you know, pre-1982 in the U.S. Why not have like an alternative sort of indicator to help the decision making? But the result of this mistake, and again, it is very frustrating for me because the story is very simple.

Starting point is 00:19:21 Base your decisions upon real-time data. Like, come on. That's really simple. Base your decisions upon real-time data. Come on. That's really simple. And there's no shortage of economists at the Fed. So there's over 400 PhD economists at the Fed. So surely they can figure this out. And the result of this is the Fed continued to hike rates unnecessarily. So this is not new. I talk about today's inflation. This is a year and a half old. So this mistake has been ongoing. They took the rate to a level that was unnecessary and held it there too long. And I certainly hope that they move with decisiveness in the September meeting and reduce the Fed funds rate by at least 50 basis points.

Starting point is 00:20:18 To me, what the rate should be today is about 3.5%. So we're talking about a very substantial distortion. So if the rate should be 3.5%, yet it is 5.25%, that is a significant distortion. The Fed is playing with fire. And that fire is increasing the probability of a recession. And any recession, whether it be a hard landing or soft landing, is a self-inflicted wound. So how do we get a soft landing if the Fed just cuts 25 bps and then waits a couple months and cuts 25 bps again? They historically overshoot in both directions, right? They stayed with ZERP for far too long as well. So this is, like you said,

Starting point is 00:21:11 I mean, tale as old as time, obvious what's happening here. If there's 400 economists there, it's got to be intentional. They can't be dumb. So I just don't understand what the plan is here. If now the market is effectively pricing in 0.25, if they cut 0.5, people are going to panic and say they must know that something is broken, which is not the narrative that you're obviously sharing. But the sentiment that if they cut too much is going to spook markets, and that could also be a self-fulfilling prophecy that leads to market crash or poor economic health. So it seems like they're between a rock and a hard place to some degree here. Yeah, and their fault. Always.

Starting point is 00:21:49 Look, it shouldn't be a blaming game. It should be how do we move forward to minimize the damage of these mistakes? So I think that if they did something drastic, like slash by 100 basis points or 75, that would definitely rattle the market where people would say they know something that we don't. So that would probably be a mistake. And a lot of the Fed's game is just managing expectations. But 25 to 50, that's within kind of market expectations. So to do 50, that's not going to rattle the market. And it is really a choice between the 25 and the 50. So I do think that, again, there's just no good reason that we are above 5% in terms of the Fed funds rate. And to take it, to give a forehandle to start with, that would be great.

Starting point is 00:22:56 Indeed, the last meeting of the Open Market Committee, the timing was extraordinary. It was like three days before the unemployment announcement. So why not consider the fact that that employment report is one of the most consequential pieces of data. Indeed, I think the most consequential because the inflation report is highly predictable. So inflation you can observe in real time, gasoline prices, and we know shelter operates with the leg. It's highly predictable what is going to happen, at least on a year-over-year basis.

Starting point is 00:23:47 But employment is much more difficult to forecast. So to me, why not wait a couple of days? So why not have your meeting on the Friday rather than the Wednesday, Tuesday and Wednesday? Make it Thursday and Friday. And then wait for this announcement, and then make your decision, which... So you think they would have cut? They would have cut 25 business

Starting point is 00:24:11 points. So now, what are they going to do? And we have another jobs report, and it's unimpressive. It was below expectations, and the vector is negative. So that would be like another 25.

Starting point is 00:24:30 So we would be at 50. So I think going 50 is quite reasonable. You know, again, we need to think about, well, what should rates be? So given that inflation in real time is operating less than 2%, so this is really important that we are below the Fed's target. And you couple that with the declining employment situation.

Starting point is 00:24:57 So if we look at unemployment, we look at, I prefer to look at non-farm payrolls year over year. If we look at that, the outlook is negative. So, and this is the other important point, that the Fed needs to get ahead of things. So just because they cut by 50 basis points, that impact will take a while. So the story I told you about the company making an investment, and they're saying, oh, we're not going to do any investment because the cost of capital is too high.

Starting point is 00:25:32 So let's say the rates are cut by 50. They might say, okay, well, maybe we will rekindle that investment. But it doesn't happen instantly. So it happens with the lag. So that's why the Fed needs to be out ahead of the curve. And that's not its history, as you mentioned. Its history is to wait, wait, wait, and then drip, drip, drip.

Starting point is 00:26:00 I think the time is for, you know, some decisive action, some leadership. I think we deserve that. They are absolutely atrocious. What if I told you there was a way to solve both of these problems? Well, there is. And it's with a self-directed IRA from iTrust Capital. Guys, not only can you open a new self-directed IRA and fund it with the limits each year, but you can actually convert over from your 401k, your Roth IRA, any other IRA that you already have. And you can do that tax-free, just transferring over the balance and then you can go to cash, buy as much Bitcoin than you want and not pay taxes when you sell it. You absolutely have to try this if you are in the United States. Use the link down below. It's

Starting point is 00:26:55 bit.ly slash itrust-scott. That's B-I-T dot L-Y slash I-T-R-U-S-T dash S-C-O-T-T. You have to try this now. Feels like Powell is just trying to have his Volcker movement and disappear gracefully into the sunset before the next person has to actually make the meaningful decision at this point. It could be. So as I said before, at least in recent memory, we tend to see a stock market correction after this Fed pivot, even though there's an expectation that it's going to increase liquidity and that

Starting point is 00:27:28 markets are going to go up. What is your expectation this time, not necessarily for the economy itself, but for the stock market, for risk assets? And this is my segue into also talking about Bitcoin and DeFi. Yeah, so I'm not going to give investment advice. I don't do that on air, and I certainly don't do that in my classroom. But let me just make some general remarks. So number one, there's only eight observations. So think of it that way. We've had eight recessions. And to do sort of statistical analysis based upon what happens to the stock market after yield curve disinversions is like fraught with danger because it's only eight. And we also know that there's many different ways that the yield curve could

Starting point is 00:28:31 uninvert. So it could uninvert because long-term rates shoot up and that would be really bad, right? Because you talk about the cost of capital, it's often a long-term cost of capital. Or it can un-invert with the short-term rate just going down, and maybe the long-term rate going down also. And that would be maybe a better scenario. So there's so many different ways that the yield curve could un-invert, and they kind of lead to different conclusions in terms of the stock market. So we need to be very careful about that.

Starting point is 00:29:09 So certain things are kind of obvious. For example, certain stocks, often growth stocks, where they're not paying dividends and are not expected to for a long time, those are very sensitive to changes in interest rates. So these are so-called very long-duration stocks, kind of like long-duration bonds are very sensitive to interest rates, whereas short-duration bonds are not. So this needs to be taken into account too. So again, I would be careful in doing this analysis because there are many things at play. So lower rates are generally good news for stocks, but a recession is not necessarily good news for stocks. But even looking at recessions, and I've got a paper that looks at different economic episodes and different types of risk

Starting point is 00:30:15 assets. So even in recessions, it doesn't necessarily mean the stock market goes down. There have been recessions where the market goes up. So again, you need to be very careful here in terms of your portfolio positioning. If there is like a negative shock that leads to anything that's more serious than a soft landing, and let me define a soft landing. A soft landing is either a mild recession, like the 2001 recession, or the 1990 to 91 recession, or just slower growth, where we go into like less than 2% growth, and that's sustained for a while, that would be consistent also. The yield curve gives a forecast of growth.

Starting point is 00:31:11 And obviously, a recession is associated with negative growth, but it doesn't have to be negative growth. So a soft landing could be a mild recession, or it could be like no official NBER recession designation, but much slower growth. Now, the usual idea here is that stocks are negatively affected by slower growth. You think about stocks as the present value of the cash flows that the firm is generating. So that's tied to earnings. Slower economic growth means slower earnings growth or negative earnings.

Starting point is 00:31:56 And that potentially would damage stock prices. So again, you need to be careful, and my paper actually details this also, that different sectors have different sensitivities to economic slowdowns. And it's very intuitive that, for example, like healthcare, people get sick no matter what. It doesn't matter whether it's a recession or a recovery, good times or bad times. So that's relatively immune. There's safer industries like utilities. So again, the sensitivity to a slowdown depends on the sector. So as portfolio managers, we need to take that into account and have a plan for positioning our

Starting point is 00:32:45 portfolio in a time of economic slowdown. And actually, that is my forecast. I actually believe the yield curve is providing an accurate signal of an economic slowdown, and it probably will manifest itself in a soft landing. And that soft landing, if it is a recession or if it's slower growth, is a self-inflicted wound. So the yield curve inversion was engineered by the Fed jacking rates up because they were late to the game for inflation. And that has caused an economic distortion. You talked about portfolio construction in advance of a recession, not asking for financial advice, obviously. But how do you frame Bitcoin in September of 2024, now that it's been largely institutionalized, gotten the stamp of approval from BlackRock. We have ETFs.

Starting point is 00:33:45 It's much more in the mainstream than it was previously. But people still have trouble deciding where it fits in a portfolio. If it's another risk asset, if it's digital gold, if it's idiosyncratic. A lot of confusion still as to what Bitcoin is and where it fits, even though it's matured, at least from public perception? Yes. So you'll have to link another one of my papers on your website called An Investor's Guide

Starting point is 00:34:13 to Crypto. Those are the questions that we actually address. So you're correct that this has gone mainstream, where this technology is complicated. You could invest in crypto, you know, for the last, like fairly easily for the last 12 years. But there's some risk because a cryptocurrency is defined by its private key, which is a long code. And if you lose that, there's no recovery.

Starting point is 00:34:47 There's no password recovery. It's gone. It's gone forever. So that has been unattractive for a lot of people. And I'm not talking just about retail investors that are afraid of losing their private key. I'm talking about institutional investors that are worried that something catastrophic could happen and they lose their keys, potentially linked to hundreds of millions of dollars of crypto investment. So this has been a major impediment. So these investors, these institutional investors don't want to hold the so-called physical, which means holding the codes. They want somebody else to do that. And it's only recently that we've got companies entering the institutional space that will provide custody for these assets.

Starting point is 00:35:46 And the alternative, of course, is the ETF. So you invest in the ETF. You don't need to worry about losing your private keys. That is the worry of the person or people running the ETF. So this has opened up this space to a broader group of investors. This is still a very risky investment. So if you look at sort of annualized volatilities for Bitcoin or Ether, it's around 75% volatility. And that compares to, what, 15% on average for the S&P 500. So this is a highly risky asset. And people are attracted to it for various reasons. And there's some reasons that I think are false reasons.

Starting point is 00:36:51 So one reason is there is some ability to provide like an inflation hedge, somewhat like gold. So they say, well, this is digital gold. So it provides like an inflation hedge. That logic is problematic in a big way. Indeed, that logic doesn't even work for gold. And the reason is that gold is volatile. So gold prices are about as volatile as the S&P 500. Yet inflation is not that volatile. So if you do the analysis like I have in my papers on gold, that's the number three paper we'll have to link to, gold is incredibly unreliable over 10-year horizons. Over extremely long horizons, gold holds its value.

Starting point is 00:38:01 So I've got an example where I calculate the wage in gold of a Roman centurion and then look at the dollar value of that gold today. So we calculate the number of ounces, then look at the dollar value. And the wage looks like a US Army captain, which is about right. So what does that mean? It means gold holds its value over the long term. But that is super long term. That's millennia. So most investors' horizons are shorter. And gold is unreliable over, let's say, 10 or even 20 year horizons. So if gold is unreliable at 15% volatility, Bitcoin is going to be even more unreliable.

Starting point is 00:38:46 So that's the number one point that you cannot rely upon this cryptocurrencies today to be kind of an inflation hedge. So the number two point is that, well, these are diversifying assets. So there's a theoretical reason that Bitcoin, for example, shouldn't be linked to any economic fundamentals. Because the money supply for Bitcoin is increasing at a decreasing rate, and it's algorithmic. So it is not impacted whatsoever by whatever economic policies of a government or the Federal Reserve. It's just an algorithm. The decision was made by Satoshi Nakamoto in 2008, and we see this algorithmic inflation.

Starting point is 00:39:47 And then inflation is very low, by the way, like about 0.5% annually in terms of new Bitcoin production. Indeed, that doesn't count the number of Bitcoin that have been lost. So it's probably deflationary overall. So theoretically, it seems like, well, this should be like a zero correlation asset. Wrong. This is a speculative asset today. And when we get into a situation where people go risk off, so they dump risky assets, think of March 2020. Yeah. It's liquid 24-7, 365. So when

Starting point is 00:40:28 you need to sell something on Saturday or Sunday, we always see it. Yeah. And so what happens? So the market tanks, gold loses value and Bitcoin drops 55%. Okay, so to think that this has zero correlation is incorrect. So this, you know, technically, theoretically, yes. But in the actual practice, this is an asset that is largely used for trading right now. And this is not the purpose of the Satoshi Nakamoto's vision in 2008. Prepare cash. Yeah, this was a transactional mechanism. Now it's kind of more a risky store of value.

Starting point is 00:41:22 So beware. So number three point, the history is very short. So for the stock market, we've got a very long history that we can work with. And even with that history, it's challenging. I already mentioned there's only been eight recessions since the 1960s. So it's hard to make inference about, let's say, the relationship between yield curve inversions and the stock market. Well, we really only have high quality data for cryptocurrencies since 2012. Okay, so 2012 or maybe 2013. We're talking a little over 10 years. So you need to be really careful because any statistical analysis will not have power,

Starting point is 00:42:12 meaning that it's really hard to draw conclusions, especially with something so volatile. So I guess investors need to be careful, in my opinion, and I've said this many times, that investors should hold diversified portfolios. It's kind of one of the most obvious things in finance. So that means that crypto should be in your portfolio. And it should have a weight that is commensurate with its capitalization relative to the capitalization of other assets. So if you have gold, you should have one-tenth of the amount of Bitcoin. Yeah, sure. And we need to be careful on the gold because much of the gold is

Starting point is 00:43:03 not really tradable, right? So it's jewelry or whatever. So again, we need to be careful with that. Much like lost Bitcoin. But to have some in your portfolio, that's really important. and it is important that we think of crypto in terms of what we call in the space layer one currencies. So layer one is Bitcoin, it's Ether and currencies that have their own blockchain. But this space is way more diverse. So I do this in my teaching where I go through 20 different categories, so subsectors within the crypto space. And it's really eye-opening to my students

Starting point is 00:44:00 because these are really active spaces with companies you've never heard of. So I also advise investors to look beyond the layer ones and to consider other types of investments within this space. That's the number two point. The number three point is something that's different this year versus 2023 and before. And that is the interest of traditional companies in this space. So many traditional companies have realized that they can leverage what they're doing. They can offer something better to their clients in using this particular space. Blackrock, you already mentioned, well, they've got a mission where they will be a leader in ETF product when it comes to crypto, but their mission goes beyond that. So they are also tokenizing assets and they've got a tokenized bond fund. And they see

Starting point is 00:45:17 this as very important for their future of business model. So there are a number of firms that have realized that they need to embrace this space because it provides opportunities for them to provide better product for their customers and obviously profit opportunities that go along with that. And they don't want to be Blockbuster or Kodak, right? Disrupt yourself before somebody disrupts you. Exactly. There are other firms that are at great risk with this space. So it's really the sort of exposure that you've got to this space really depends upon

Starting point is 00:46:02 what you're doing. And let me give you a couple of simple examples in terms of kind of what we call web three. So think of your computer. Like how much CPU do you actually use? How much GPU, which are in demand with AI, how much do you use during the day? What about a situation where you can rent out your CPU or GPU overnight and get paid in a crypto? Render, Lumarin. There's a lot of projects that are doing this. It's incredible. Exactly.

Starting point is 00:46:36 So you've already made the investment in the computer. So you're able to harvest some extra rents effectively. And so you get paid in some token, and that token's obviously got value because those that want to buy the computing, they need to buy that token. So you've got both sides of the market. Indeed, there's comparable. You just look at the cloud computing providers and you can figure out what they're charging. So this is like low-hanging fruit, and

Starting point is 00:47:11 we could go on, but storage, the same thing. Oh, I've got an extra terabyte of storage I'm not using, so I'll rent it out. Like, why not? And so this will provide a lot of opportunity.

Starting point is 00:47:28 And there's many things that have been kind of centralized and oligopolized that will suffer definitely. There's simple

Starting point is 00:47:43 examples here. Think of ride-sharing. So. So ride sharing is just an algorithm. So it's matching like the customer and the driver. Yet these main companies, they take at least 40% of the fare for an algorithm. So again, that will all be decentralized. There's companies in this space already. So that 40% can largely be shared. I should make the point here that this doesn't mean that there's no role for centralized players. In the ride-sharing example, you need to have the driver certified. You need to have the driver certified. You need to have the car certified.

Starting point is 00:48:26 These are things that will be centralized, but it doesn't cost 40% of your fare to do that. So there's a lot of stuff that will happen in this space that's outside of like Bitcoin and Ether in particular, the sort of investment case. This is a bigger, broader sort of context. I can see your book behind you, DeFi and the Future of Finance. Another thing that we'll link in the description. So obviously, even beyond these other use cases, where we effectively disrupt the third parties that are toll collectors in very obvious ways. You still clearly believe in DeFi, which is the biggest disruption, in my opinion, because it's disrupting the global financial system. And you talked about the fact that Larry Fink certainly recognizes that,

Starting point is 00:49:18 right? Everybody focused on the ETFs last year, but they didn't read the annual report in March before they applied for the ETF that said they were going to tokenize everything. Yeah, exactly. So that's what he believes the next big thing is. And there's different ways to do tokenization. So think of a stable coin. So I send a dollar to somebody and then they issue a token. And then I can use that token and I can send it anywhere in the world within 12 seconds. And then I can send the token back and get my dollar. So somebody has to warehouse effectively that dollar. And we can have a gold token also. So I could buy a token that's backed by gold. Again, you need to warehouse the gold. We could have a token based upon a

Starting point is 00:50:13 stock. So let's say tokenized Apple stock. Well, you need to warehouse the actual physical stock. So this is called the tokenization of real world assets. And it is only a stage in the process because the next stage in that process is to eliminate the warehouse for assets that are easily digitized. So, for example, instead of taking a physical share or even a digital share of Apple stock and putting it in the same place, instead of doing that, Apple issues its own token, which represents a share of their stock. That is the next stage. And that is the most efficient thing to do. So I say assets that are easily digitized, like stocks and bonds. There are some assets that are not easily digitized, and we will have to warehouse even

Starting point is 00:51:25 in the future. And gold is a good example of that. So you have to have a warehouse. So the ETFs have warehouses, and the tokenized gold, they have warehouses. I wish we had a lot more time, because now we're talking about disrupting really the largest institutions on the planet. It comes to payments, you're disrupting, obviously, the credit cards and anyone who's the third party intermediary, the banks, right?

Starting point is 00:51:49 We know that. When you start talking about settling directly peer-to-peer and not having to do T plus one or T plus two, and you're really talking about a lot of people that are going to have a very firm and aggressive grip on their business that are not going to want to let it go. Of course, this is the way it always happens, that there will be companies that oppose these ideas and they're just buying time because this is inevitable. So the number four paper you'll link is my new paper on decentralized exchange. So decentralized exchange is essentially trading with an algorithm.

Starting point is 00:52:33 You can do this 24-7. The liquidity is relatively constant at all times during the day. You see the liquidity is transparent. You see the algorithm, it's transparent. The algorithm doesn't care if you're a buyer or a seller. You see the price that you're going to get. Like this is just a great idea.

Starting point is 00:52:56 And when we move into this next stage where stocks and bonds are fully tokenized, this is the way the trading will happen. And you're right. stocks and bonds are fully tokenized. This is the way the trading will happen. And you're right. This is not a T plus one, which makes no sense to me. We just switched from T plus two to T plus one in the digital age.

Starting point is 00:53:20 Do we have to wait 24 hours? No. In this space, the, the, the, the trade and the settlement, the execution and the settlement are near identical. Not quite, but near. Well, I wish we had a lot more time because I wanted to dig into your three points on Bitcoin a bit more that I tend to agree with, but I think have

Starting point is 00:53:40 some nuance and maybe we can have another conversation about it in the future because we really just started getting into the good stuff here. Yes, that sounds good. I appreciate your time. Thank you so much. Where can everybody follow you and find all of those papers beyond us linking them here and all the other work? So LinkedIn, the best place. All right. Thank you so much. I look forward to speaking to you again in the near future. Thank you.

The Wolf Of All Streets - Fed’s Mistakes Could Spark Recession | What’s Next for Bitcoin & Economy? | Campbell R. Harvey

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.