Is Bitcoin a Safe Haven for Your Money? | Inventor of Yield Curve Signal Explains

What's up, everyone? My name is Jackson and today I am super excited to announce that I will be talking to Campbell Harvey.

If we go into a recession next year, it's not going to be a surprise.

He is a professor of finance at Duke University and is very well known throughout economics for linking the yield curve to oncoming recessions. In the past week, we saw an escalation of tension between the US And Iran. Trump ordered a drone strike on Iranian General Qasem Soleimani, and Iran retaliated by firing missiles at US Bases in Iraq. Since this exchange, both Trump and Iran have, for the moment, seemed content not to pursue violence. Further, the threat of international conflict coincided with a spike in Bitcoin's price and reignited the narrative of Bitcoin as a safe haven asset. Do you think this international tussle told us anything significant about Bitcoin?

So this story's been told many times that bitcoin or cryptocurrencies in general could be like a new version of gold, a digital gold. And the idea here is that gold has got a very long history, thousands of years, and often it's the case that when there is a crisis or political risk or heightened world risk, the price of gold goes up. So we actually see something analogous to that where we see these political risk events unfold and the price of bitcoin or some other cryptocurrencies actually goes up. So it's a reasonable story to tell that this is a potential safe haven that is not directly controlled by a central bank. It's a reasonable story. The problem is the very short sample that we've got over the five years of high quality data that we have with cryptocurrencies. We really don't have a lot of big risk events. We don't even have a U.S. recession in that five year span. So the story is a credible story, but we just don't have the data to safely say, well, this is a safe haven asset for sure.

So along that line, Peter Schiff said something really interesting on Twitter a few days ago. He said that gold is being bought by investors as a safe haven, but bitcoin is being bought by speculators betting that investors will buy it as a safe haven. What are your thoughts on that?

So again, the story of a safe haven asset is a credible story, and you could use that to potentially speculate. So you buy before or during a risk event, hoping that people will flock to the safe haven and you make some money in the meantime. So that definitely is part of It I must also say that I use safe haven and it should be in quotations for two reasons. One I've already mentioned that is that the history is very short and we don't really have a lot of evidence that Bitcoin or other cryptocurrencies will be a reliable safe haven. And number two, you need to take into account what the volatility actually is. So the volatility of gold is about 15% on an annualized basis. The volatility of the US dollar is maybe 3 or 4%. The volatility of the US stock market maybe 15%. Also the volatility of Bitcoin is more than 80%. So you need to be very careful here. I've done research on gold in particular, so I've looked at gold prices over the last 2,000 years. And even gold is an unreliable safe haven. You never know what's going to happen. For years since 1933 to 1971, the US government banned citizens from holding gold. So again, we need to be careful in terms of what a safe haven actually is.

So now that this safe haven narrative actually exists, what do you think the chances are of it becoming a self fulfilling prophecy?

Well, the narrative exists and again, we need to be careful of the narrative because it's being spun potentially by speculators that want to talk their trade, essentially. So we need to be skeptical of the narrative. There is another reason to give this narrative of credibility, and that is that there's no fundamental reason that cryptocurrency prices, and I'm talking about cryptocurrencies like Bitcoin, are correlated with anything. So there's no underlying fundamental with Bitcoin, for instance. So that given that lack of link to a fundamental suggests that they should be relatively uncorrelated with macroeconomic events. Let's be clear here what we mean by safe haven. There is a safe haven that effectively retains its value even though there could be a catastrophe in the economy. That's one type of safe haven. Another type of safe haven actually goes up in value when there is a crisis. And that's more like a hedge. I think that the latter is the story that people are telling that as the risk increases, so if there is war in the Middle east, that that actually will lead to appreciation. And they draw inference from, as you introduced the price recently going up of Bitcoin exactly at the time of heightened risk in Iran, how do you think.

Cryptocurrencies as a whole would function? Hypothetically, if there is a war, if it does, escalate that far.

So again, Bitcoin has got a very attractive property in that it's not controlled by anybody. It's attractive because it's not linked to any particular fundamental. So that's so different than other assets. So if you think of the stock market, well, that's going to be affected in two ways if there's a crisis. Number one, the cash flows and profits of the firms go down. And number two, the risk goes up. You put those together and the stock market could easily lose more than 50% like it did 12 years ago in the global financial crisis. Or you look at a currency, well, the dollar versus the euro, we can kind of figure out what the value is. We look at the strength of the US economy, we look at the strength of the European economy, and we can kind of get a valuation of that exchange rate. But if you go to cryptocurrency, it's not so straightforward to do that. There's no underlying fundamental. So that means that hypothetically and theoretically that these cryptocurrencies should be relatively uncorrelated with events. So in that respect, it potentially allows you to hold value or perhaps even appreciation, given the volatility during a crisis. But what I said in terms of volatility is important here. Just because of the volatility, it might be that in the crisis you lose value. And the question is, how much do you lose relative to other assets? That's the key. So theoretically there is a credible story to be told that given the lack of link to fundamentals, that this particular new asset class could be valuable as a crisis hedge, or at least safe haven in quotations.

Great, thank you. So now I would like to switch gears a little bit. Could you please just quickly take a moment to explain what the yield curve is and why it's so important, especially right now.

My dissertation at the University of Chicago linked the the yield curve to economic activity. So let me first explain what the yield curve is. The yield curve is a concept that longer term interest rates usually have a higher yield than a short term interest rate. And the intuition is very straightforward that if you lock your money up for a longer period of time, then you should be paid extra. So it's a premium, a term premium for actually doing that versus a very short term deposit. And we see this all the time. So a normal yield curve, the long term interest rate, is higher than a short term interest rate. So my dissertation at the University of Chicago noticed that in certain times we get the reverse. So that the short term interest rate is, is higher than the long term interest rate. And that's unusual. And it's called an inverted yield curve. The economic model in my dissertation linked that inverted yield curve or the slope of the yield curve to future economic activity. And you can think of it in a very simple way that in a time of expectations, of economic weakness, people often go to the safest asset they perceive in the world that has a lot of liquidity, and that's the US 10 year treasury bond. So currently that is essentially the safest asset in the world. When people go to that bond, when they start buying the bond, the price goes up. As the price goes up, the yield is pushed down. And what we saw in 2019 was an extended period of six months where the 10 year bond yield was below the three month US treasury yield. So we had a full inversion for six months. My dissertation showed that those inversions are associated with future recessions. So we've had since the 1960s, eight yield curve inversions. Seven of them have led to recessions. And the number eight we had in 2019. And usually the lead time to a recession is nine to 22 months. So this is an indicator that gives you a lot of advance warning to a recession. The yield curve is now back to normal. So the long rate is above the short rate. But in the last three recessions it went back to normal before the recession actually began. So that is the beauty of this indicator. It actually gives you advance warning. It gives you not just like a 1/4 warning, but a year or more warning before a recession.

And I saw over the summer you went on Bloomberg and you called it a code red as I recall.

So that's important. Seven for seven, no false signals. And now we're code red. We have an inversion effectively for two quarters. It's really hard to ignore.

And do you still believe that this is an accurate indicator that we will see a recession in the near future? I mean, is this time any different than any past times significant enough to make it a different outcome?

I guess maybe I'm a bit biased because it's something I invented. Your viewers need to take that into account. But I'm also an empiricist. This is a very simple model. Let's look at its track record. Over the last 50 years, we've had seven inversions, each one followed by a recession. That's 100% accuracy. But actually, if you think about it, it's pretty easy to get 100% accuracy because you could have a model that every quarter says there's going to be a Recession. Every single quarter says a recession. It's 100% accurate also. But it's a huge number of false signals. This particular indicator, historically, over the last 50 years, it's got zero false signals. So seven inversions, seven recessions, and we just had the number eight inversion. So that track record is a pretty considerable track record. So you asked what is different this time? And there is something that's different this time. That is that you're asking me questions about the yield curve inversion. If we were doing this in 2006, you would not be asking me the question. It was not in the news. People didn't really care about it. So now that it's a topic of conversation, you've got an indicator that's reliable that has got a track record of seven out of seven. Given that we've had that inversion, given other data that's out there, Duke University does a survey of CFOs, and our CFOs, over 50% believe that a recession will begin in late 2020. And the proportion goes even higher if we include 2021. So we've been in a recovery phase in the US for over 10 years. This business cycle is the longest on record since the 1850s. So as they get longer and longer and longer, the probability of a downturn gets higher and higher and higher. Unless you believe that the business cycle has gone away. I don't believe that. So this is actually the time to be thinking about, okay, we've got these signals that are suggesting that there's increased risk of an economic downturn. It is also the case, a little confusing, that the economy seems to be doing well, employment is very high, unemployment very low. But that's exactly what happens before a recession. Things look good before. That's the definition of a recession. So given you've got these signals, now is the time to kind of reexamine the positioning of your portfolio and think about some of the things that we talked about earlier in terms of, well, if there is an economic crisis, is my portfolio position correctly, am I in the right assets to basically lessen the blow of a recession?

So given that there is a good chance that we see a recession in the nearest future, how do you think a recession would impact the cryptocurrency and bitcoin markets?

I've got, I guess, two views of this. One view is similar to the earlier discussion that given the cryptocurrencies aren't directly linked to the economics, so the stock market is directly linked to the economics, so the profitability of firms decrease in, in a recession, and that drives stock prices down. So given that you don't have that fundamental link, then economic theory would suggest that a shock to the economy wouldn't necessarily impact the prices of, say, Bitcoin. So that's kind of one view of this. Another view is this safe haven sort of view that people will want to abandon the traditional currencies. People see that they need to somehow crisis proof their portfolio and will invest in assets that are perceived as very low risk, which could be US Treasuries, which traditionally do well in recessions. It could be gold that has a checkered record. But nevertheless it is also relatively uncorrel and it could be this new asset class, cryptocurrency. So it is possible that we see flows into cryptocurrencies and this causes some price appreciation. Again, I say it's possible. We don't have the track record, so we don't have the global financial crisis. To take a look at the cryptocurrency complex and to see how they do, we've got these small observ that are suggestive that there could be some hedging ability. But on the other hand, we've got a huge amount of volatility. So again, we need to be careful. But I do think anytime where risk increases, assets that are safe or relatively uncorrelated potentially will attract investors.

In a research paper you published in 2014 titled Bitcoin Myths and Facts, you said that as of that moment, Bitcoin was too small to be an important economic force. Has anything happened since then to change your opinion?

So I've taught a course on cryptocurrencies and blockchain at Duke University. I'm just about to start my seventh version of the course. So seven years. And when I began teaching, and this is seven years ago, when we're talking about the cryptocurrencies, you're talking about Bitcoin. That was it. So I wrote that paper in 2014 and essentially Bitcoin was the cryptocurrency and at the time it was interesting and very promising, but it was small. The sort of stories that were being told at the time that it would be essentially the new payment mechanism, it was a currency, as many different uses or attributes of a currency. One is the exchange motive and the other is a store of value motive, and then there's others. But it was fairly clear to me back then that it was going to be challenging for Bitcoin to, to be a payments mechanism. And what we've seen over the last seven years is that it's essentially morphed into a store of value for speculation. So what is different when I wrote this paper in 2014, in my opinion, is the rise of the cryptocurrency complex. So it's not just bitcoin. There's many other types of coins. So there's. In my course, I list seven different categories of cryptocurrencies. So bitcoin is one. You've got distributed computational tokens, got utility tokens, you've got stablecoins. So the stablecoin complex is very, very interesting in that they're effectively challenging the central banks. So it's a much different landscape today. And actually, when I look at the cryptocurrencies as a whole, I'm much more optimistic about the future of crypto. I see the possibility that almost all assets are going to be tokenized. It is a completely different world where I've got a wallet, I've got some bitcoin in my wallet. I've got some Ethereum in my wallet. I got some stablecoins, I got some gold, I've got some securities, like a piece of IBM stock that's tokenized. I go and I pay for my groceries, and I can choose from my wallet, say, well, I want to pay in gold. So I can actually do that. The grocery store doesn't accept gold, but I can instantly transfer my gold to somebody else on a distributed exchange and transfer it into something that the grocery store actually wants. I can easily do this. And it allows essentially, if you really think about this, and I had no idea in 2014, this tokenization of everything potentially leads to a situation where actually we don't need the fiat currency. So it's efficient, efficient barter. We've never had the possibility of that before. It used to be that you had to carry the two goats to trade for the cow. So, no, you've got these digital tokens. And I think that the challenge to the financial landscape is very, very significant. So this is a really bigger deal than I thought in 2014.

Those follow quite closely to my thoughts as well, actually. And that leads very nicely into my next question, which is, can digital currencies or tokens like Bitcoin, Libra, China Central bank, digital currency, or some other tokenized security undermine the global hegemony of the US Dollar?

Yes. So I think that we need to be careful here, because if it's just like a US dollar coin or a JPM coin or a Libra that's essentially linked to the US dollar. So Libra is supposedly going to be a diversified portfolio of currencies, but my guess it'll be probably 75% US dollar. When you just essentially create a stablecoin, you're still linked to the central bank. Indeed, the central bank will come up with its own stablecoin. That's kind of obvious to me that one risk in terms of the current set of coins out there is that there's a Euro coin, there's a Fed coin. It's kind of obvious to me that in the future we're not going to be using paper for currency. It just doesn't make any sense. Just like we're not going to be using credit cards or driver's licenses or passports. Blockchain that provides a way to solve all of these problems. I think that the central banks will jump in with their own versions of cryptos. One country that's low hanging fruit is Sweden where only 1% of transactions are done in cash, in physical cash. That's a country that probably be one of the first ones to go. The landscape is going to be very interesting where now you've got the central banks actually competing with the stablecoins. That's going to be very interesting to see how that plays out. Again, this is a situation where the central bank still has control. The central bank is only realizing that, oh well, if we have a digital currency then we can efficiently collect, for example, a VAT. Like right now the VATs in Europe are really high because people use cash. So you can get whatever big discount if you pay somebody in cash rather than doing an electronic transaction that could be traced. So you avoid the VAT with the digital currency. It's basically hardwired into the system with a national crypto fiat. So I think that these central banks are realizing, oh well, there's so many advantages here. So number one advantage, we can efficiently collect tax. Number two advantage, we can discourage illegal transactions because we know what's actually going on. Number three advantage, you make transactions more efficient, that's good for the economy. And that's something that 100% of economists would agree on. And there's very few things that economists are unanimous on. So efficient transfers of money, that's a good thing for an economy in general. Number four, you can instantly execute monetary policy. So you want to do a helicopter drop, no problem. It's a line of code. There's all of these very attractive characteristics that once the central bankers figure it out, it's obvious that they should be in the space. Of course, every major central bank has got a team actually working on this. Your question is originally about the dominance of the US dollar. I don't think that's going to go away anytime soon and soon, I mean, five years. However, this idea that I'm pitching that once we tokenize all of these digital assets is just less important to actually have dollars that I can hold a portfolio of, whatever. So I've got a token that represents a piece of a self driving Uber and I get income from that. I can use that for spending. So there's not the same need to actually have US Dollars. In the past. It's really hard to save if, let's say you don't have dollars in your agriculture. How do you save? Well, you have an extra cow or you've got some gold that you put under the mattress. Today it's all digital and actually can save in other types of assets. So I think that's a really big idea. It's very disruptive for finance and the current landscape will look a lot different. We'll have to give it five years, but we'll see some small changes and then all of a sudden we'll go off the cliff. And I do think that the central bank currencies as we know them today are at risk.

Thank you everyone for watching. That was Campbell Harvey, a professor of finance at Duke University. My name is Jackson and always remember to like subscribe and HODL Cointelegraph.

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