WBD713 Audio Transcription
The Breaking of the Global Economy with Nik Bhatia
Release date: Friday 22nd September
Note: the following is a transcription of my interview with Nik Bhatia. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.
Nik Bhatia is the founder of ‘The Bitcoin Layer’ & author of ‘Layered Money’. This interview delves into Nik's work in the Bitcoin industry and his background in trading interest rates. We discuss the impact of low-interest rates on the economy, the relationship between inflation and interest rates, and the impact of central bank actions on markets. The conversation expands to include global recessions, the Chinese economy, and the future of Bitcoin.
“You can imagine a world in which people actually have more power than institutions and governments...Bitcoin has the ultimate power in making the world a better place for people.”
— Nik Bhatia
Interview Transcription
Peter McCormack: We are live with Nik Bhatia in Sydney. Hello, man.
Nik Bhatia: What's up, Pete, good to see you, man.
Peter McCormack: Good to see you. I didn't think the next time we would record would be on the other side of the planet in Australia.
Nik Bhatia: Well, I appreciate you having me as your West Coast representative here on this side of the world.
Peter McCormack: Well listen, man, it's great to have you here. We love these live events and we were umming and ahing of various people to get. We drew up a list, reached out to a couple and you said yes and we appreciate you coming in. Have you been here before; have you been to Australia before?
Nik Bhatia: I have. In 2016, I visited Melbourne, Sydney and Cairns.
Peter McCormack: So, you did it as a proper holiday then?
Nik Bhatia: I did.
Peter McCormack: Well, this is my first time and I think it's very cool. It's Danny's shortest ever journey for a recording sprint.
Danny Knowles: Yeah, love it! I'm feeling fresh!
Peter McCormack: What was it, an hour?
Danny Knowles: An hour in a plane, yeah.
Peter McCormack: Hour in a plane. How long was your flight?
Nik Bhatia: 15 hours.
Peter McCormack: That's a long flight. Mine was two flights, 23 hours. But look, great to see you, man. It's been a long time now, about five years, four years; I can't even remember?
Nik Bhatia: Since we last recorded?
Peter McCormack: No, since when I first met you, that time I rocked up in LA.
Nik Bhatia: That was in LA.
Peter McCormack: The Time, Value, Money series.
Nik Bhatia: That's right.
Peter McCormack: God, man, so much has happened. And congratulations on all your success. You're claiming to be a competitor now. You're not a competitor, you're a friend. But congratulations, man, it's been great to see.
Nik Bhatia: Thank you. I am having a blast building The Bitcoin Layer. We came to see you in Miami to talk about some of the work we're doing. We're very proud of the content that we're producing, both written, video, and trying to cover Bitcoin, the transition toward a more Bitcoin-centric monetary system, but you can't do that without covering rates and what's happening with the global economy. So we try to balance both of those things.
Peter McCormack: I think it's a good, sweet spot for you and Joe.
Nik Bhatia: Well, for me, I come from a background of trading interest rates. And so, when I wake up in the morning, my day starts with the same sort of routine, looking at markets, reading the financial news, looking at the economic data. That's how I start my day every day. So, that's how we approach the publication. We come with an interest rates' mindset and framework, global macro framework as well. And then, oh, by the way, there's this thing called Bitcoin, which we do believe is going to be here for another 100 years. And if that's the case, there needs to be some explanation along the way for why Bitcoin, on a daily basis, and you know that I'm trying to do content that's why Bitcoin on a more decade-to-decade basis, and that comes with books.
Peter McCormack: Okay, lots to get into there. Firstly, just interest rates. Why are interest rates the starting point for you?
Nik Bhatia: So, when I was studying finance as a college student, master's student, I had to basically decide. I knew I loved markets, right? I knew I loved following the global economy, geopolitics. What really was interesting to me as a young person studying economics for the first time in high school were foreign exchange relationships. Why does a currency strengthen or weaken versus another? And that really is global macro. And when you dive deeper into it, you understand that interest rate parity, or the differences in interest rates around the world oftentimes, is the main driver of currency relationships. So, I got deeper into studying and then basically the first couple of job interviews, the people were asking me questions. I was applying for equity research positions, fixed income positions. The people on the equity side, there were way more equity jobs available. They asked me, "What is it that you want to do?" And I said, "I love global macro, foreign exchange, interest rates, the Fed". And they said, "What are you doing in an equity research interview? You shouldn't be here. And actually, if you go equities, you'll never get to the rates world".
So, at that point I said, "Then this needs to be my focus". I went all in on the study of interest rates and ended up getting my first job in the industry at a fixed income hedge fund. From that point, then I became a member of the fixed income industry from the institutional side. So, then I adopted the methods of rates professionals, and that just means starting your day with what is happening in interest rates and what are the drivers, that's really what it comes down to. Why rates go up or down is anybody's guess, but what drives it is what we can study and try to project, and then maybe you can understand a little bit why rates are going up or down.
Peter McCormack: And when you get up in the morning and you have another look, what are the key signals you're looking for?
Nik Bhatia: So, I start always with prices. So, what we're doing is looking at the way that interest rates or other asset classes move up and down through time. You're looking at prices. And I like the expression that, "Technical analysis is horoscopes for men". I think that that's a funny way to describe it. But what I do is not technical analysis, meaning that I'm not looking at statistical patterns and trying to figure out the next trade. What I'm actually looking and I'm doing is what I call price study, which you're studying the time series of prices over a long time horizon, and through that picture, which is a chart, you don't even need any lines or indicators on it. All you need is the image, and with the image you can see buyers and sellers are doing this. You can just see it. If a price is going up over a ten-year time horizon, what are buyers doing? They're overwhelming the sellers, and vice versa.
So, when I look at prices in the morning, interest rates up, down, stocks up, down, I'm looking at it, of course today, but then I'm zooming out to what has it done this week, what has it done this month, and what are the prices telling us about supply and demand in these specific markets. And through that I extract information about the global economy, what's happening, the demand for liquidity, the demand for risk, and the demand for safety. All of these factors are in play at all moments when financial markets are open. So, when I get up in the morning I'm looking at prices, that's the first place I look to see, is there any immediate information that I can extract if something is up a lot or down a lot? Then I will go to the news and I will read maybe what caused some of those movements. And then I'll turn my attention to the economic data set. So, that comes out in the morning, in the first few hours in the morning. And I'm able to take each one of those data points and determine that this is important, this is not, filter it in and then add it to the framework.
Peter McCormack: And how important is the actual rate itself versus the movement in rates?
Nik Bhatia: It's a good question. The absolute level of rates is definitely important, right? Because if you think just from a basic corporate finance perspective, if you have a $100 million note, it's floating rate. Your rate is 2% a few years ago. Your annual interest rate expense there is $2 million, right? So, you know that on a monthly basis, you're going to need about $200,000 going towards this debt payment. And if you're bringing in $400,000 a month, you have a positive margin. But if rates go to 6% on that loan, now you have $6 million a year, divided by 12, that's $500,000. So, you have half a million in interest rate expense, but I just told you that your revenue was $400,000. So, the level of rates does matter a lot, but so does the direction and the movement itself.
But when I think about today and interest rates being at 5% to 8% for basically most of the borrowing economy, right, the government's borrowing at about 4% to 5%, the private sector somewhere in 5% to 8% in the investment grade or the good credit realm. That's expensive relative to the last 15 years.
Peter McCormack: Relative to the last 15 years, but is it more healthy to have, I don't know how to put it, like a decent cost of capital because we know 0% interest rates have kind of skewy effects; so, is it more like a tough adjustment going up to these rates? Because I remember as a kid, you used to get the TV adverts, you know, Yorkshire banks, savings account was 7% to 8% interest and my dad knew if he wanted to borrow money it was expensive, but if he wanted to save there was a good incentive, there were good interest rates. We got to a place where I remember, like Revolut, I was told my interest rate in my savings account was going up to 0.25%, like absolute garbage, no incentive to save when the interest rate is so low and inflation so high. So, are we adjusting back to a more healthy place?
Nik Bhatia: So, instead of arguing healthy versus unhealthy and the absolute level of interest rates, think of it as a lagging indicator to current situations. So, what's the current situation? High inflation relative to the last 40 years, right? So, we're in a high inflation environment right now. And in a high inflation environment, those with capital are going to demand more money to deploy that capital in the form of higher interest rates. So, it's actually a market lagging indicator to the current dynamics that we face in the global economy, which is predominantly inflation right now. And so, instead of thinking that yes, it's healthy, and I would argue that yes, generally a 5% cost of capital is more healthy than 0%, because a 0% cost of capital will give rise to silly and nonsensical investments, because the annual interest expense is nil, or effectively nil; so, if you don't have any profit, there's no punishment for it, right? But now with interest rates at 5% to 8%, if you don't clear the profit, you're going to either be going bankrupt, you're not going to get your loan rolled, and you're not going to be able to fund your projects, which generate the cash flow in the first place.
So, yes I would argue that 5% is better than 0% in that it prevents some malinvestment, but it's actually just a function of higher inflation, that you have to demand more interest from borrowers if you are a lender, and in that way you effectively are slowing down investment and increasing savings or the propensity to save with that type of activity.
Peter McCormack: Okay, so which parts of the economy are the interest rates set by the market, by the private sector, and which are set by the central banks? Because central banks set rates, but what you just said to me there is something that I've never even crossed my mind. It's like, yeah, if I'm going to deploy capital and inflation is at 8%, well, I kind of want 10%. It just hadn't crossed my mind that I, as a deployer of capital, would want to do that. For me, I just always thought interest rates were set by the central bank and everything rolled on from that.
Nik Bhatia: So, maybe Danny can pull it up, if he can find a chart from one of the recent Bitcoin Layers. I can't point to any one specifically, but we've published charts, the two-year yield, Treasury two-year yield versus Fed funds, and we overlay them. And this is a chart we've been tracking, basically since we started The Bitcoin Layer in 2021. What we show you is that rates lead the Fed. The Fed is simply lagging. So, when the Fed increases interest rates from 0% to 5%, if you look at it on a chart, it's simply 3- to 6- to 12-month lag of the two-year Treasury yield that was sold, meaning the bonds were sold, yields went up, right? When bond prices go down, yields go up. So, those that owned two-year Treasuries yielding 1%, looked at either their grocery bill or the CPI data, doesn't matter, you understand that? It doesn't matter if they looked at CPI or they looked at their grocery bill or they looked at their rent. It was going up.
So, they said, "I've got this instrument paying me 1%, it's not going to cover my increase in prices for the next two years because I see that as 5% in the market. So, I'm going to sell this instrument". And the selling of each person, each investor that sells their two-year note at 1%, then it goes to 1.5%, then 2%, then 2.5%. Who is stepping in to buy the two-year note at 2.5% a year-and-a-half ago? The answer's basically nobody because the yield went to 5%. And when did the Fed get to 2.5% or 5%? If you look at the chart, it's months after the market had already gotten there. So, yes, the central banks set their policy rate, but it is basically a lagging indicator to where the market puts them. And that is something that we can empirically prove, and we have, with the visuals of market interest rates versus central bank policy rates.
Peter McCormack: Okay, so when central banks set their rates and claim they're raising the hiking because they want to reduce inflation, it's kind of sold as strategically the same, "We're raising rates, we've got to get inflation under control". But really is the market pre-empting them and seeing the inflation? If there was no central bank, you would still have these interest rates and cost of capital, which would ultimately lead to a reduction in inflation. So, are they a passive player in this?
Nik Bhatia: They are a passive player, they are a lagging player, but the answer actually goes to the very technicals of interest rate maths and bond maths. I'll try to break it down as simple as I can. A two-year Treasury security, called two-year note; a two-year note mathematically should equal -- the return that you get on that two-year note should equal what the market expects you to get on a one-day instrument for two years. So, if you think about 250 business days a year, so 500 times compounding an overnight rate is what should equal the two-year yield.
Now, do we know the two-year yield today? Yes, it's on the screen, that's the price. Do we know the overnight rate for the next 500 business days? No, because the overnight rate for the next 500 business days depends on who? The Fed, because the Fed sets the overnight rate, the Fed sets the policy rate. So, when the Fed says, "We're raising rates 25 basis points", they're not actually raising the Fed funds rate by 25 basis points, they're raising the window of money market rates, the floor by 25, the ceiling by 25, and they're moving what they want the overnight rate to be out in the market, overnight repo for Treasury, which is collateralised borrowing; federal funds, which is the market for one bank in America lending to another bank in America for the reserve account that they hold at the Fed.
Also adjacent to this, not necessarily directly related, but the rate at which London banks lend to each other, the artist formerly known as Libor. All of these rates are in the target of what the Fed is doing. So, they raise the target rate, they lower the target rate, that's what they do. So, the two-year yield is an expectation of what the Fed is going to do for the next 500 business days. So, when the two-year yield goes up, what the two-year yield is saying is that, "Hey, we've read between the lines. Either the Fed has explicitly said it or the economic data just shows us what they're going to do". In mid-2021 when inflation was starting to pick up, the yield of the two-year yield was still close to 0%, it was basically nothing. Then at the end of 2021, inflation started to go, so did the two-year yield. The Fed was still saying transitory, but investors knew better, right? So, investors knew they're going to hike, sell, sell, sell. And what happened? The two-year yield started to rise. And it rose, I don't know, four or six months before the first hike in March 2022.
So, the yield is just this, the word we use is discounting, but it's basically just an average of what they expect that overnight rate to be. Because if you're an investor, institutional investor with no appetite for risk and $1 billion, what are you going to do with that $1 billion? There's only a few options if you're not willing to take any market risk or what we think about as risk, like stocks or corporate bonds. You have a few options. You can park it at a money market fund which owns Treasury bills; you can own the Treasury bills themselves; or you can go out to a two-year note and buy that and lock in whatever yield that is. So, the institutional investor is coming to the market and saying, "Hey, we can either invest overnight 500 times or buy this instrument once and not do anything for two-years". And they have to make that decision every single minute of the day. You understand? It's not like a one-time decision. It's a continuous market decision.
So, in 2021, at the end of 2021, those investors said, "Hell no, I'm not going to lock in my two-year yield at 0.5%. I'm going to go to overnight, because they're going to start raising it". And guess what, when they raise the rate 25 basis points, or they raise the window 25 basis points, and you're that investor that didn't buy the two-year note, you're just rolling every night, guess what? Tomorrow night, you get 25 basis points more, right, divided by 360, it's just one night, but still, the annualised yield that you're getting is 25 basis points more than it was. But if you owned the two-year note, you're losing money every day as the rate goes up, because you locked in 0.5%. So, your investment gets worth less and less and less each passing day as it's obvious to everyone and their mother, inflation is here, it's not going away any time soon. Fed is clearly going to have to raise rates a lot and keep them higher for longer, which is what's happening right now.
When June/July of 2022 passed, that would be about a year-plus ago now, inflation hit 9.1% CPI on the reading and then started to go down pretty sharply. By October, we had seen four or five months of consecutive declines in the inflation readings and I believed at that point, "Hey, CPI's coming down sharp enough, the Fed can slow down its aggressive, hawkish rhetoric", meaning the Fed doesn't have to say, "We are we're going to be relentless in our rate hikes". They can ease up a little bit because inflation is clearly coming down, and it has, it's down to 3%, so it's come down a lot. But the Fed is not willing to do that and I was definitely too early or wrong about how quickly I thought that the Fed would level off their interest rate increases, or at least their hawkish rhetoric.
Peter McCormack: So, why do you think they're doing that? Could they overshoot the other way?
Nik Bhatia: Yes, and they will. I mean, I absolutely believe that they will.
Peter McCormack: And go deflationary?
Nik Bhatia: So, right now, we are in late cycle, right? So, the business cycle cycles, and when you're in late cycle, you're in the time when the Fed is raising rates or has raised rates a lot, and then that starts to feed into the economy, right? So, from a general cycle theory, we'll go from a tightening cycle into a recession. Generally speaking, that's what an inverted yield curve often signals about two years in advance. So, we had that signal last year, so we should be getting a recession sometime soon in the next year. I don't think that that would surprise anybody, right? It wouldn't even surprise the Fed. The Fed has admitted this year that we believe a recession is probably coming sometime next year. They said that mid-year, they've eased off that a little bit, but they are fully aware of all the lagged effects of their tightening and what that can do and how it can cause a recession.
The reason that they are going too far right now, I believe, is deeply rooted in some vanity issues and some ego issues that stem from, this is at an institutional level, the transitory word that they used, but also from the QE infinity that they've basically employed since 2009. They have to show that they have the other side, right? They're hawks and they're doves. So, they went dove, they went dove, then they went dove, then they went dove. So, does it make sense that we might get 15 years of too much hawkishness as an effort to repair the reputation of the institution? Maybe yes.
Peter McCormack: We shouldn't have a place for egos in these decisions.
Nik Bhatia: I agree with you, but I believe that there's very little reason to have kept hiking after March. We had Silicon Valley go under, we had Credit Suisse, we started to see bank lending seize up, then we had another regional banking crisis in May, where a couple of banks went under. And there's so many signs that you don't have to go further, or you don't have to keep going this far. You can say we're stuck here, but they can't give that signal to the market too early because what is the market going to do? They're going to price the cuts in. They're going to start buying all the fixed income instruments and driving them down like we talked about, and then actually force the Fed's hand to start cutting rates. So, it's all a mind game.
Peter McCormack: Yeah, I was just about to say, it sounds like a game. It's incredibly psychological what the Fed does. Jeff Snyder talks a lot about this. It is so psychological what they're doing, it's all behavioural economics. They write about this all the time, the wealth effect is a behavioural premise. Everything in the economics field of study really is a lot of behavioural, "Hey, this is how we can influence behaviour". So, it is in the science of what they do. And I mean, that's just what they do.
Peter McCormack: But it's a game, it's like a game of chess between the Fed, which is a small group of people, and the market, which is a large group of people.
Nik Bhatia: I honestly don't think the Fed makes -- the market always leads. So, right now, why isn't the market pricing in extreme cuts to the point where the Fed is forced to cut, right? The market still has cuts and has had cuts in a 6- to 12-month forward looking basis since Silicon Valley, right? So, cuts were priced into the market as of March. The initial drawdown actually said, "By September, we'll be cutting", in March. So, "In six months we'll be cutting". That was wrong, because they're not cutting yet, that's not where we are. So, the market has priced in those cuts, but why hasn't the extreme happened? Because the US is not in recession. The economy grew in Q1, it grew in Q2, it's going to grow again in Q3.
Peter McCormack: So, it needs the recession to drive it.
Nik Bhatia: It needs the recession to actually get the cuts. Where's unemployment? 3.9%. It's up a little bit but it's still low. Where is ISM services?
Danny Knowles: So, what is it you would see? This is the ten-year Treasury.
Nik Bhatia: Yeah.
Danny Knowles: Where is it you'd see the pricing going to cut; is that this drop?
Nik Bhatia: So, the ten-year yield is not the best.
Danny Knowles: Okay, what's better?
Nik Bhatia: The two-year, but you can keep it here for a second. You see the drawdown from March to April in the yield?
Danny Knowles: Yeah.
Nik Bhatia: That is investors seeking the safety of long-term Treasuries yielding 4% and buying, buying, buying, all the way down to 3.5%. That is a flight to safety. That move that you see from March to April, 4% to 3%, it went to 3.3%, I believe.
Danny Knowles: So, that's because they think that long-term Treasuries will likely drop, so get them while they're good.
Nik Bhatia: Get them while they're good. Get them at 4%.
Danny Knowles: So, here's the two-year.
Nik Bhatia: Yeah, you see that drop from March? It went actually from a five handle to a three handle. So, it moved 120 basis points, if my memory serves me correctly, from top to bottom, in March, in one swift move. And I always tell Joe, rates reprice super-fast, because the market picks up on the shift really, really fast, especially in the treasury part of the curve. And look, they were bought and then a slow sell-off as, oh wait, it's not a crisis, it's not a recession either.
Danny Knowles: So, now we're back at nearly 5%, so the market's basically saying, "Okay, nothing's going to change for now"?
Nik Bhatia: Yeah, because where's the policy rate? 5.25%. So, the market is saying, "Hey, we actually think the policy rate's going to stay around here".
Peter McCormack: Recession is an interesting word, because if you don't understand financial markets, you don't have a podcast where you get to speak to Nik Bhatia and have him explain to you, if it's something you're just aware of, you see the news headlines, you hear your parents talk about it when you're growing up, you think of it as this thing that there's an absolute disaster. We're going into recession, everyone's going to be struggling, life's going to be terrible. But really, recession to me now is just a period of market correction and it's a necessary part of a market correction, of a market cycle. Is that right?
Nik Bhatia: So, I would argue that, let's just say the stock market, to be more specific in this realm, the stock market is a lagging indicator to what is actually happening in the economy specifically with corporate profits, because that's what drives, in part, share prices. Share prices are driven by two things, earnings and valuation. So, earnings is how much money they're making and clearing, and valuation is how expensive are those earnings. So, that's the psychological or behavioural aspect to markets. We know what they earn, but there's always a multiple to that earning. When recessions happen, stocks go down, absolutely, that is empirical. But why do stocks go down? Because the companies are selling less and therefore making less money, so earnings are declining. So, stocks go down because earnings decline. Earnings decline because in a recession, consumers stop purchasing or slow down their purchasing. So, it is economic in nature and the stock market is a symptom of slowing sales.
When a stock investor looks at the channel checks or the same store sales and they comp on earnings calls, the companies are the first ones to say, like Intel, "Hey, we're selling less chips". Then you start to see, okay, we're going into a recession because the companies are starting to sell. The recession is simply the diagnosis that sales have slowed. And why do sales slow in a recession? Because an economy cycles, right? Interest rates go down, investment goes up, then inflation goes up, interest rates rise, profit margins decline, and people get fired, and then they stop buying things, and then profits decline, and then interest rates decline because inflation is gone, and it cycles. And so when you talk about recession means a drawdown in stocks, that's correct, but that's not the only thing happening there. There's a chain of events that is cycle-based, and it starts basically with profit margins going down.
Peter McCormack: I think what I'm getting at is, I think the word recession was a scary word when I was growing up, a young man, like in my late teens, early 20s. And now, it's less of a scary term. I think of it more as just an indicator of where the market cycle is. But it's treated in the news like panic, "We're going into recession!" and it just feels like it's you've just explained the market cycle, it's just part of a cycle; we will go into a recession and we will come out of a recession. Is that fair?
Nik Bhatia: Yes, and I would also add that we actually haven't seen a recession since 2009.
Peter McCormack: Yeah, why? Should we have?
Nik Bhatia: Yes. The COVID recession was coming. If you look at like where the market was, we were going into rate cuts. That had already been priced in before the pandemic.
Danny Knowles: Travis Kling was talking about this before COVID; this was like the repo crisis, right?
Nik Bhatia: That's right. That was September 2019, and the Fed had to pivot policy and start basically easing.
Peter McCormack: But Danny, can you explain the repo to me; can you explain the repo?
Danny Knowles: Well, Nick's here!
Peter McCormack: No, explain, what is reverse repo, Danny?!
Danny Knowles: I'll defer to you here, Nick!
Peter McCormack: Every time it comes up, we can never explain what it is again. Lyn Alden has explained it to us 170,000 times.
Nik Bhatia: Okay, Pete, I'm going to try.
Peter McCormack: Do it in a way so you never forget.
Nik Bhatia: The pawn shop for bonds is the repo market. It's a pawn shop for bonds.
Peter McCormack: People need to get rid of them quick.
Nik Bhatia: What do you do with gold jewellery when you go to a pawn shop? You give them the jewellery, they give you some cash, but the jewellery is still yours as long as you pay back the loan.
Peter McCormack: Yeah.
Nik Bhatia: That's the repo market, except instead of a gold jewellery, it's a treasury bond.
Peter McCormack: That's brilliant. I'm never going to forget that now.
Danny Knowles: Yeah, right.
Nik Bhatia: It's a pawn shop for bonds.
Peter McCormack: And what's the duration on those usually? When they say overnight repo, it's overnight?
Nik Bhatia: Overnight.
Peter McCormack: All right, so I need some capital, take my bonds, I'll come back and get them tomorrow.
Nik Bhatia: That's right.
Peter McCormack: Okay, and you pay like a little amount on it.
Nik Bhatia: Yeah, whatever Fed funds that window that we talk about right now, around 5.25%, that's going to translate to the overnight repo rate just because of how money markets work.
Peter McCormack: And the repo crisis was, there were too many people with gold jewellery and not enough cash behind the till.
Nik Bhatia: There were a couple market players because of a certain type of trading strategy that had gone wrong. There were a couple market players that were unable to find a pawn shop that was open.
Peter McCormack: Right, okay. And so, had you expected us to be in recession right now? Are we in recession in Europe?
Nik Bhatia: Oh yes. Germany is in recession, the eurozone is in recession.
Peter McCormack: Is the UK in?
Nik Bhatia: The UK just went into recession.
Peter McCormack: When was that announced, because I've not even heard it?
Nik Bhatia: That was in the last month or so. And Germany's been in recession for most of the year to be honest now.
Peter McCormack: Do all markets classify recessions the same, like is it two quarters of negative GDP?
Nik Bhatia: That's the general accepted term. When you look at economic activity in Germany, it is -- so, I don't use GDP in my framework, right? At The Bitcoin Layer, we use PMIs, which are the surveys of companies in these countries that are hiring people and that have input prices and things of that nature. So, we look at PMIs and in Europe, the PMIs are all in contractionary. Danny can even pull up a global PMI tracker on Bloomberg and it's a map and it visualises, you can just see Europe, the whole continent is red. It actually has the United States in negative territory at the moment, because using this survey, the US PMI is below 50, using this particular survey.
Peter McCormack: So, it's deteriorating. Okay, so the measure on this map is the trajectory, not the position, because it says, "Deteriorating and improving"?
Nik Bhatia: No, deteriorating and improving --
Peter McCormack: But could you be in recession but improving, and therefore be green even in a recession?
Nik Bhatia: The metric of PMI measures whether the economy is deteriorating or improving. But the colour that you see is the status of each one of those countries, like it's in the number.
Peter McCormack: Okay.
Nik Bhatia: The number, if it's below 50, it means the economy is deteriorating, month over month, and that's the key, Pete. It's a month-over-month change. So, the lower the number is, it means the worse that this month was to last month.
Peter McCormack: So, this chart is indicating to us that the UK and central Europe is deteriorating.
Nik Bhatia: You can see Taiwan in recession, you can see India's a strong point in the global economy.
Peter McCormack: India's crushing.
Nik Bhatia: And again, the US is not in recession. It just so happens that the PMI of using the S&P PMI here is showing a little bit below 50. So, the US Economy is struggling by some metrics, but the US GDP is still positive. In Europe, the GDP is actually negative and confirming the PMIs that it's in recession.
Peter McCormack: Okay, so yeah, so Europe is pretty fucked and America's indicating it's heading that way.
Nik Bhatia: Right, but Europe is a symptom of the global economy. This is what needs to be understood. It is a symptom. The economy is global. So, when Europe is in recession, it means the world is not buying their shit. It's the global economy that sends Europe into recession. It's nothing to do with Europe. Europe makes things that everyone wants.
Peter McCormack: Yeah, it's funny how small Europe really is, I mean if you don't include Russia; a tiny, little, pathetic continent!
Nik Bhatia: You like those mems where they fit all the countries into Texas?
Danny Knowles: Yeah, I love that. Well, you know Australia's about the same size as the United States?
Nik Bhatia: Large country.
Peter McCormack: I think the UK fits in something like Idaho.
Danny Knowles: It fits into just Queensland like four --
Peter McCormack: I feel like they've overstated the size of the UK here. I think we're smaller and more pathetic than that!
Nik Bhatia: It's pixelated quite large.
Peter McCormack: Yeah. And the recession we're in in Europe, how deep a recession is this; how deep is it expected to go; what do we know about it?
Nik Bhatia: Right now, it's not that deep. And how deep is it expected to go? I can't, I mean that's what I love about The Bitcoin Layer. We're not a trading service, we're not even trying to project the economy going 12 months forward. Just trying to analyse the fixed income markets to give people some signal to what is happening. Because honestly, people that try to project too much, you're just making shit up.
Peter McCormack: Horoscopes for men!
Nik Bhatia: I mean, who is to say what's going to happen? Where is the European Economy right now? It's in recession, it is not looking good in Germany. I'm going to tell you that. I looked at some of the year-over-year numbers in Germany in terms of some of their exports. If Danny can just look for --
Peter McCormack: And why is that?
Nik Bhatia: Global demand.
Peter McCormack: Okay, but global demand specifically for German products?
Nik Bhatia: Chinese demand for German products, I mean if you want to be very specific about it.
Peter McCormack: Which is cars.
Nik Bhatia: Right. And you know, I was reading about how China is really going internal with their car purchases. They're favouring Chinese brands over German brands. So, that might not be that the global economy is crashing, it might be something more specific to Chinese consumer patterns.
Peter McCormack: And could it also be part of a shift in the types of cars people want? Could Germany be behind on electric vehicles compared to Tesla?
Nik Bhatia: They're not. They're not behind, they're a leader. Volkswagen is a global leader in the technology, so is Mercedes.
Peter McCormack: But is there a demand for those cars? Because if I was going to buy an electric car, my starting point would be Tesla. I wouldn't be thinking, "I'll get an electric Volkswagen".
Nik Bhatia: But in China, they're making domestic EV purchases.
Peter McCormack: Right, okay.
Nik Bhatia: And in Europe, they're buying Volkswagen EV products, I mean for sure. But it's not just cars, right? But my point is that, yes, it could be a little bit of this pattern that Chinese consumers are going to Chinese EVs over German vehicles, but it's probably not. It's probably systemic, global demand for German manufacturing, whether it's cars, medical equipment, Germany makes a lot of stuff, right? Siemens is one of the largest, there are just so many important products that come out. BYD is absolutely crushing it.
Peter McCormack: Who the fuck is BYD?
Nik Bhatia: It stands for Build Your Dreams, and it's a very popular car.
Peter McCormack: How have I not heard of it?
Danny Knowles: I've not heard of it either.
Peter McCormack: It's the largest electric car maker in the world? I mean, they're selling what, 25% more than Tesla?
Danny Knowles: I don't know what BEV and PHEV means.
Peter McCormack: It's funny, because Tesla has less of the market than I thought they had, so everybody else has been catching up pretty well.
Danny Knowles: Maybe it's something to do with being like full electric, because Tesla's fully green.
Peter McCormack: Okay yeah, Hybrid Electric Vehicle, Blatant Electric Vehicle! Okay that's interesting.
Nik Bhatia: So, this confirms what I was telling you about Chinese demand for German cars, but I cannot -- I mean, look at the map, and look at the UK in recession. It has nothing to do with this. It's a global recession and it's slow moving. Your first question was, "Does the level of interest rate matter or just the direction?" The level matters a lot right now.
Peter McCormack: So, what is The Bitcoin Layer to all of this? When you think of all of this, you look at it all, what is Bitcoin's role; what's its position in all of this?
Nik Bhatia: When we put it in the context of the global economy cycling into recession, where Bitcoin stands or where it comes into play is that, when you cycle into the easing part, policymakers are able to demonstrate just how diluted the currency can be. And that flood of capital liquidity, it's not capital, the flood of liquidity that comes from policymakers, either fiscal monetary or both, in the last it was both, in the Great Financial Crisis it was both but largely monetary only, it shows you an apolitical, policymaker-free currency algorithm has value. And so, when you see Bitcoin rise, and everyone wants to talk about, "Does the halving matter or not?" and that actually, Bitcoin's rallies have lined up with global easing, and has nothing to do with the halving, I don't want to come down on either side there. But the truth is that Bitcoin performs really well when central banks go into easing mode. And we don't have --
Peter McCormack: There was a good chart on Twitter this week. Somebody said, "Everyone thinks the halvings drive price", but he'd layered on the periods of currency expansion, and they actually just seem to line up with the halvings.
Nik Bhatia: Yeah, we do a global liquidity versus Bitcoin price graph as well on The Bitcoin Layer. It is basically an overlay of the major central banks.
Peter McCormack: And do you feel like we are, in the next six or eight months, potentially heading into another period of…?
Nik Bhatia: Well, what did we just talk about earlier, that they could be heading for 15 years of hawkishness? I'm not saying that's my base case, but you have to think what might happen, what could happen. Bitcoin might not be able to extract value from central bank easing for the next couple of years. Now what is my base case? They'll be easing next year, because we're heading into a recession.
Peter McCormack: During the halving!
Nik Bhatia: Yeah, during the halving again!
Peter McCormack: So, has Satoshi lined up the four-year halving cycle with business cycles?
Nik Bhatia: The correct question is, is the global economy falling onto the Bitcoin calendar and block time?
Peter McCormack: There you go. What do you think?
Nik Bhatia: I mean, I think it's at the moment fantastical and even far-fetched, but very cool to consider that in maybe 12 years, we could have a definitive answer. That would be really amazing. And I'm patient, I'm patient to wait to see if that's actually a thing. But I can't go out on a limb and say that right now.
Peter McCormack: Okay. Talk to me more specifically about China. And the reason I have an interest in what's happening in China is more because the conversation regarding BRICS keeps coming up. What will they do? Will they come up with their own currency? Will people increasingly start settling in the yuan? But people I trust and respect keep coming back to it like, "Yeah, maybe they want to push for this, but realistically, you really want to settle in the dollar, it is still the most trusted reserve currency globally. Don't expect massive settlements in the yuan just yet". If the Chinese Economy is in trouble, the yuan could be in trouble, therefore that kind of puts the kibosh in that.
Nik Bhatia: Yeah, I think you have it absolutely correct.
Danny Knowles: Completed it!
Peter McCormack: All right, okay. Thanks, Nik!
Nik Bhatia: So, let me ask you then --
Peter McCormack: Yeah, go on!
Nik Bhatia: I think you've summarised that perfectly, and take it one step further.
Peter McCormack: Yeah.
Nik Bhatia: What type of BRICS block currency would we ever see? It just so -- do you want to talk about far-fetched?
Peter McCormack: I mean, the only one I think is a gold-backed currency.
Nik Bhatia: Yeah, that itself is very far-fetched. Any BRICS-united currency, whether gold-backed or not, is not even in the realm. By the way, in their recent summit held in South Africa, they removed or didn't include any united currency. It's not even part of their communique or their list of topics that they discussed. Okay, so that whole thing is imaginary, the BRICS currency is imaginary. Going to the Chinese Yuan as a settler --
Peter McCormack: Sorry, just before that, so is BRICS really more just an economic union? Is it like another G7, really?
Nik Bhatia: Do you know that Xi Jinping is not going to New Delhi for the next G20 meeting?
Peter McCormack: No, I did not know that. Okay.
Nik Bhatia: He's not even going to India, because China and India aren't allies.
Peter McCormack: I know.
Nik Bhatia: They're not allies. And the BRICS, you're right, the BRICS is basically --
Peter McCormack: It's a rogue G7.
Nik Bhatia: Yeah, it's, "Let's trade more with each other", and I'm not going to deny that that's happening, "and let's even use our own currencies in cross-border settlement". That'll happen too, and it is, it's been happening and I'm not denying any of that. But they're not really a block. They're not united in any effort to dethrone the dollar. That's kind of the thing. If they were united in an effort to dethrone the dollar, they would actually come together and start a currency and actually try to challenge it with a bond market and financial plumbing and a repo market. You understand none of that stuff is -- it's imaginary for a BRICS united currency, it doesn't really exist in any internationalised sense for the Chinese Yuan whatsoever. The Chinese Yuan isn't a convertible currency around the world either, so there's just nothing. It's a bunch of nothing.
Peter McCormack: A bunch of signal.
Nik Bhatia: On the currency front. But on a geopolitical and a trading front, there's no denying that we are in a multipolar world. It just doesn't apply to the monetary system. And more importantly, I don't think that it will apply to the monetary system in the coming years, right? I always caution against making projections too far out, but there's nothing that shows us that, "Oh yeah, in five years we'll have a BRICS currency". No, I would fade that argument.
Peter McCormack: Okay, so back to China.
Nik Bhatia: Yeah. China is really struggling in their economy right now. But my focus is that -- data out of China is harder to get or harder to assess what's going on there.
Peter McCormack: Because they don't want to tell us?
Nik Bhatia: Yeah, exactly!
Peter McCormack: Because they're fucked!
Nik Bhatia: So, the best thing that we have, and this is my approach to it, is the price of the currency. So, we look at the Chinese Yuan versus the dollar as the number one signal to what's happening in China.
Peter McCormack: But the dollar itself has been performing well, right? There's like seven consecutive months of growth.
Nik Bhatia: Versus the Chinese Yuan, or on like a global currency?
Peter McCormack: I think on a global basis. I think that's what Dylan LeClair posts, seven consecutive months of growth.
Nik Bhatia: So, I don't know if it's gone up for seven straight months. The dollar has had a nice rise recently and it is rising against all currencies, and we can go down that rabbit hole as well.
Peter McCormack: Let's stick with the Chinese Yuan for now.
Nik Bhatia: Yeah. But in the specifics of the Chinese Yuan, when the Chinese Yuan is weakening, it means that the Chinese Government policymakers are guiding the currency to a point that allows them to access the market. So, when they cheapen their currency, it makes their exports cheaper, right? We were talking about how, in the Xi Jinping era, he has tried to say that, "We are going to consumerise the Chinese Economy. We are going to try to shift from export-driven to more domestic consumption-based. And in that way, we will be more self-sufficient and less reliant on the global economy cycle and demand for our widgets and manufacturing sector".
Danny Knowles: How has he tried to make it a more consumer economy? How do you actually do that; what steps do you take?
Peter McCormack: Freedom!
Danny Knowles: He's definitely not tried that one!
Peter McCormack: No. That looks like it's lost 10% this year, which in currency terms is massive.
Nik Bhatia: Yeah. So, there are government programmes to try to incentivise consumerism and in that way, they are making the policy effort, right? But what we know from the past few years is that the Chinese consumer is behaviourally just different than a Western one. And it's actually almost nothing to do with China itself. This is something you find in emerging markets. Countries with weak currency regimes historically or unstable governments, why would you spend money on stuff when you can hoard savings for a rainy day? And I'm not an expert on Chinese consumer behaviour.
Peter McCormack: So, this is cultural?
Nik Bhatia: My understanding is that that shift is not happening in China. I would recommend Bill Bishop, he does a great Substack. He's one of my main sources on China. Jacob Shapiro is another geopolitical analyst that I follow. I'm reading people that are following -- and also Michael Pettis. People know him. He's one of the more famous financial journalists that's stationed in China and gives fantastic information. So, I'm reading all of this stuff and my understanding is that that shift isn't happening. So, China has to fall back on what? Exports. And the global economy is weak, so exports are weak, so they say we have to make it cheaper. And so when you see this number go up, that's dollar strength. The dollar strength is yuan weakness. The yuan weakness is again a symptom of global demand, that's the common theme here. The symptom of global demand is the Chinese has to weaken their currency and if you zoom way out, it looks really bad.
Peter McCormack: Can you zoom right out, Danny, so we can see it?
Danny Knowles: Yeah. So, where does the housing crisis fit into this, because I know Evergrande's blown up.
Nik Bhatia: So, the property sector in China has experienced overinvestment, right? So, there are defaults looming everywhere you look. Now, the policy responses in China have been basically, "Let's come up with programmes that don't force people to write down these investments, either the banks or that defaults trigger write downs. That way we paper over the losses in the property sector". So, China can do a lot of things on the policy side. What we know, overinvestment. What else do we know? Defaults are looming. What we don't know is how large the bazooka is in terms of stimulus or bailouts or extend-and-pretend measures that basically give the sector time to absorb the losses.
So, one of the things that we're asking ourselves right now about China is the important question, "Hey, what will the property sector default due to the global financial system, what impact will that have?" I actually think that's the wrong question. The correct question is, "Is this weakening a symptom of a terrible global economy; and if that's the case, that's going to matter way more than whatever localised property bubble is in China", which on the grand scheme of things, on the global economy, I don't think it matters, I don't think it moves the needle. This is the more important thing.
Peter McCormack: What do you think it is; do you think this is all a symptom of a terrible global economy?
Nik Bhatia: Yes.
Peter McCormack: Okay, great. How bad?
Nik Bhatia: So, if you look up Chinese exports as well, it does look like it's very bad. What is my worry here is, if you combine one plus one here, one meaning where are Chinese -- yeah, down 8% year over year. The nominal amount is maybe not the best, but if you read the top line here, it's down 8.8% year over year. It was down 14.5% year over year in July.
Peter McCormack: Go back to that five-year though, Danny.
Danny Knowles: Yeah.
Peter McCormack: So, we're not far off where we were, and we're still above 2020.
Nik Bhatia: So, this definitely has a seasonal pattern here. But Pete, the point is here that it's not just the numbers that are already red in China and Germany that are two massive red flags. The euro is in a mini crash formation. I wouldn't call it in full crash formation yet, but the euro is in a mini crash formation right now, adding to dollar strength. The yuan is also in a crash formation, adding to dollar strength. It's that plus the lagged effects of higher rates, which are a lagged effect to the inflation, right? People demand more money for their money, and so higher interest rates are going to filter into reduced profit margins, people getting fired, those people not spending, that contracting corporate earnings, then stocks going down, stocks going down affecting behaviour of US consumer, because of the wealth effect we know, when stocks go down, US consumer stops spending.
None of that has happened yet. That's why I'm worried, because it's already not great, even though the US Economy is above water.
Peter McCormack: And do you think this could be a worse situation than 2008 we're heading towards?
Nik Bhatia: I'm not making that sort of call.
Peter McCormack: Okay. But is this why you think there may be a liquidity event next year, because of this situation?
Nik Bhatia: I don't even -- liquidity events drive the Fed to do instant easing, and that has not been my base case really since the hiking cycle began. I really remember that when the Fed started hiking, the going narrative, and even Arthur Hayes wrote a piece, he said, "By summer, the Fed is going to pivot after everything crashes". That was 2022. And I remember writing that, "Hey, a couple percent rate hikes is not going to crash the stock market", and I still feel that that is my base-case scenario that stocks are not, and we're not heading for some grand liquidity event. That's just my base case.
Of course, in the fixed income world, they teach you, you have to do your probability distributions. So, I think 25% probability that we're going to have a liquidity event, 50%, and then 75% that we're not and we're just going to be in a run of the mill recession. And that is probably where I am, right? 25%. And so, you adjust your language, your use of adverbs when you're writing and how confident or not confident you are about what's happening. And you just adjust your approach, and for investors as well, because that's the background I come from, you're a fiduciary, you have to actually express your probability distribution, "Hey, I have 25% chance that we're going to have a grand liquidity event, 75% that we're going to have a general recession, and for this reason, we're going to go long Treasuries and XYZ part of the curve, and this is how we're expressing that probability".
So, I feel blessed that I don't have to sit in that chair any more, because it's a very stressful job, to be honest with you. I commend fiduciaries, left and right. I mean, it's tough to have other people's money on the line. And I don't know what that's like for VCs. You have a lot of VCs on, but I know what it's like in a rates chair or a fixed-income chair. And that's big, it's big money. The clients that I had on my sheet were top-10 companies in the NASDAQ and top-10 emerging markets, like the entire sovereign wealth fund, big, big money that they have. And when they have the money on the line, you have the money on the line for them, it is very stressful.
Peter McCormack: So, how are you preparing?
Nik Bhatia: For me, I'm focusing on my career.
Peter McCormack: Just build resilient business?
Nik Bhatia: That's right, yeah, because I'm not in that seat any more. I have my own business, Bitcoin Layer. I help people read and watch and listen.
Peter McCormack: And subscribe.
Nik Bhatia: Subscribe. And I'm writing my second book, because I know that books can have real lasting power. And on a daily and weekly basis, I'm giving my intellectual capacity to The Bitcoin Layer, and on an annual basis, I'm giving my intellectual capacity to write books.
Peter McCormack: Yeah, let's talk about this book because you told us a little bit about it. Your last book, Bitcoin Layer, fantastic, did very well and it was very popular. But you're going to sit down again and write another book. What can you tell us?
Nik Bhatia: The book is about Bitcoin and it is another story about Bitcoin. So, with Layered Money, I tried to tell a story about money that explained why Bitcoin is basically a bearer asset. It's not much fancier than that, right? You guys know if you've read the book, what I'm basically trying to explain is that, "Hey, Bitcoin is not a liability of a financial institution". And liabilities of financial institutions are basically infinite in their theoretical limit, and have approached levels that make people uncomfortable to hold them. Nobody holds bank deposits as a long-term instrument. And why don't you do it? Behaviourally, it's unsound. So, I wanted to tell a very detailed history of why banking liabilities and Bitcoin are qualitatively opposite from each other, and taking offense to people comparing Bitcoin to PayPal as well. So, Layered Money addresses that.
But if you step back and you really want to explain Bitcoin to the world, I feel like I have much more to say. There is a deeper history, societal impact, and promise within Bitcoin that you feel in your soul, I feel it in mine, and a lot of our friends and colleagues in this industry feel. When we meet with each other and we talk to each other over the years, we know that we all feel this. I believe that I can articulate it in a way that hasn't been done in a very broad, human, and contextualised way. And I'm in my quest right now to tell that story and I'm deep in the research. I've started writing the book. I do have the title. For self-publishing reasons, I can't actually share it in advance; just the way that it works when you're publishing your own book, because I can't possibly protect it until it comes out. But I promise you that it is a Bitcoin book and it really has me fired up, dude.
Peter McCormack: Well, I look forward to that. Just finally before we close out, you've done a lot of work studying global markets, you understand global markets very well. It's always a real pleasure to sit with you. You explain things amazingly well. You are a bitcoiner, a proponent of Bitcoin. I'd be really interested to know, what is the purpose of Bitcoin in the world as we are; and if Bitcoin fulfils its potential, what will it offer us? Nice big question to finish on.
Nik Bhatia: Yes, and I think this is where you can let your imagination go, and you can imagine a world in which people actually have more power than institutions and governments and countries. And in the way that the internet has allowed people to join the global community, whether through business or other means, and it has levelled the playing field, Bitcoin does that again in a way that also brings property rights to people that may have never had it. And I do believe that it has the ultimate power in making the world a better place for people. And I do think that I'm not alone in that dream and that vision. That's another thing that's so exciting about Bitcoin. It's why I started a company called The Bitcoin Layer. The company was going to have Bitcoin in the name; that much I knew because this is how I feel. I appreciate you having me out in Australia, man!
Peter McCormack: Dude, it's a lot of pleasure, man, honestly. I don't know how many interviews we've done; it's about six now?
Danny Knowles: Six, yeah.
Peter McCormack: About six now, every time such a pleasure. And it's just so cool to see you've built this business and you're crushing it. I don't consider you a competitor, I consider you a colleague, someone we work with, I think this rising tide will lift both our ships.
Nik Bhatia: You know, it is a teammate feel. I think a lot of people in Bitcoin feel that way, that it is a teammate sort of feel. From a mathematical perspective, there are only a certain amount of views and listens to go around.
Peter McCormack: We can grow that pie together.
Nik Bhatia: None of that, honestly, none of it matters because we're all trying to add value. I mean, I'm trying to add value and you're trying to add value. When you extract information out of the people that you interview, I always learn a lot. And when I write, teach, speak, and do interviews and all that, I'm also hoping to add value. People, Bitcoin education, that's what my mission is.
Peter McCormack: Yeah, well, let's build a bigger pie, that's what I want to do. But no, look, all the best, I wish you all the success. It has been very cool to see you grow a team and I just want nothing but success for you. And if you're listening, check out The Bitcoin Layer, subscribe, support, go check out Nik's work, Joe's work as well, Joe's great. Yeah, I think we're going to go have some dinner, go and have a couple of beers. We're going to watch some AFL, and then tomorrow we have a live event. So, yeah, thanks for coming over because it's a big journey, so I appreciate you coming over to be our guest of honour.
Nik Bhatia: Peace and love.
Peter McCormack: All right, man.
