Third Time’s a Charm?

By Joseph Calhoun

I find the article laughable. I should point out I am a millennial male though, so I would think that. We invest in bitcoin because we are BROKE, and you cannot earn any significant amount by working. And honestly, this entire market proves what we all suspected. Working is for suckers, it will not get you ahead, and money makes money. I have said on here before I made several times my salary in bitcoin last year, and I have a small group of friends who have all made $200,000+ in this market…for doing NOTHING…..Risks are socialized and gains are privatized, act accordingly. The attraction here is the lack of regulation.  No one is under any illusion that these are risky markets and that you can lose your whole investment, but at least I can get in on the market early. All I remember about the .com bubble is that Mark Cuban unloaded a bunch of companies I have never heard of and became a billionaire. Bubbles create winners and losers. (Emphasis added)

From the comments section of the Financial Times article, A bitcoin bubble made in Millenial Heaven 

There is a very serious debate underway at the Fed these days concerning how to conduct monetary policy. You see, the Fed set an inflation target a few years back of 2% and despite their heroic efforts, they just can’t seem to hit it. It’s almost like they don’t know what they are doing, inflation seemingly oblivious to their ministrations. So the latest debate is whether the inflation targeting regime should be replaced with price level targeting. If price level targeting sounds a lot like inflation targeting that’s because it is. But it is inflation targeting with a memory. It says that if your long term goal is 2% and you have a year that comes in at 1%, you should aim for 3% the following year to get back on the preferred track. So, obvious question I suppose but apparently it needs to be asked: how is the Fed going to hit 3% when it can’t hit 2%?

I don’t know exactly the origin of the epistemological question of how many angels can dance on the head of a pin but if ever that phrase applied to a debate it is this one. (Anders Sandberg “calculated” the upper limit as 8.6766×1049  angels by the way.) While the Fed is busy debating the merits of adopting a slightly modified inflation targeting system, we are in the midst of our third asset bubble in the last twenty years. It is as if the Fed is trapped in one of its own models unable to see what is plain to anyone with even a smidgen of historical awareness. Bubbles do not develop out of thin air. They are now and have always been monetary phenomena, a clear case of too much money chasing too few assets. Asset bubbles are monetary and denying it by ignoring the prices that are inconvenient doesn’t change that.

How do I know we are in a bubble? Heck, for that matter how do I know the two previous widely acknowledged bubbles were bubbles? Was the late nineties run up in dot com stocks a bubble? Was the run up in real estate prices in the middle of the last decade a bubble? The economic conditions that prevailed during those two episodes were very different so it is easy to dismiss the idea that they have a common cause. The earlier period featured a strong dollar, rapid productivity growth and falling commodity prices. The second time featured a falling dollar, lousy productivity growth and booming commodities. But both featured what we have all come to realize were pretty obvious asset bubbles in technology stocks and real estate (and some might add commodities). How could monetary policy be the cause if the economic conditions and bubble assets were so much different? But those economic conditions and the two very different bubble assets do point to a common cause and the answer is actually revealed, in some ways, by the current bubble in bitcoin (and other assets).

The Fed’s position on bubbles is that you never know one existed until after it has burst and caused widespread financial and economic damage. And since you can’t know when one is forming, the Fed can’t do anything about them except try to clean up the aftermath. That’s just a little too convenient, a rationalization wrapped in a veneer of efficient markets faith. True, there are no agreed upon parameters that define a “bubble” and the concept is foreign to economists who believe in homo economicus. The rational actor of economists’ models always acts in his own best interest. Economic man is the market and he has the wisdom of crowds, a basic and gross misunderstanding of human behavior in my estimation. I have a career of evidence that says the crowd is usually right except at the most important times when it turns out they can be spectacularly wrong. Economists may not know how to define a bubble but, like Justice Potter Stewart observed about obscenity, I know it when I see it.

I have no doubt that monetary policy is the source of our serial bubble economy. I also know I can’t prove that with certainty and that there are those who disagree. There are plenty of people who, for whatever reason, are perfectly happy blaming the real estate bubble on the Democrats or Republicans for various misdeeds that allowed Wall Street to fleece Main Street. They are happy to blame, again and not without cause, Wall Street for selling a bunch of worthless securities with dot com in their name. And yet, we see stocks rising today for no other reason than a name change to include the word blockchain. And we see a metaphorical line around the block wanting in on the latest ICO, the right to purchase a token which may or may not entitle the holder to something of value. If there is a difference between today’s bubbles and the late 90s version it is only in terminology. The likelihood of these bubbles being driven by disparate forces or just the malevolent nature of Wall Street is approaching nil I think. We’ve had plenty of bubbles in history and during each of them existed both Wall Street (or some other marketplace) and political shenanigans. That doesn’t mean the bubbles were caused by them. Indeed, either we are just a gullible lot that keeps getting fleeced by an amoral Wall Street or, as I certainly believe, the causation runs the other way.

The appeal of bitcoin tells us quite a lot about the origins of our bubble economy. Bitcoin didn’t just spring from nowhere; it rose from the smoking ruins of the global economy after the great financial crisis of 2008. A message embedded in the genesis block, the first block of bitcoin, says:

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks

One of bitcoin’s most attractive attributes, the one I hear cited most often, is its finite quantity. There will only ever be 21 million bitcoins and that amount is far in the future. In the meantime, adding to the supply is difficult and expensive. It seems the designer of bitcoin, the ever elusive Satoshi, had some ideas about the origins of the financial crisis and set out to correct them. Bitcoin is designed to act as a hard currency – finite quantity – and a means of payment that bypasses the traditional banking system. Regardless of whether you believe bitcoin can function in the real world, its design specifically addresses what its designer(s) and owners see as the root problems plaguing the global financial system. Bitcoin’s success proves one thing I think beyond a shadow of doubt – people want an honest monetary system, one that can’t be manipulated for the benefit of the few at the expense of the many.

Imagine for a moment an economy with bitcoin as its national currency. The currency is an asset whose available supply grows slowly from year to year until all of it has been mined. It is hard and expensive to mine and so it will take a long time to mine it all. In the meantime the quantity available for transactions grows by a diminishing amount each year as mining of new supply gets more difficult. If the demand grows faster than the supply its value will rise and the economy will experience deflation. If the supply grows faster than demand the value will fall and the economy will experience inflation. That, if you haven’t figured it out yet, is a pretty good description of a country operating on a gold standard. Ironic isn’t it, that millenials have used technology to create a monetary system that approximates one that requires no technology at all. Millenials, thinking they have designed something new for the 21st century have actually copied a monetary system from the far past.

Bitcoin is the most obvious bubble today but I don’t think it is the only one. It is very, very hard to justify the level of the US stock market unless one assumes a very rapid acceleration in US economic growth and earnings. Certainly, the reduction in the corporate tax rate will positively impact some companies and those are the ones we’re hearing from now. But some companies will pay more and that will only be revealed in time as earnings are reported. Even many of the companies that will benefit ultimately will pay a price up front. Apple made headlines yesterday with a vague promise of US investments and jobs but the headline everyone is ignoring was their $38 billion tax bill. The promised investments may or may not happen but the tax bill definitely will be paid and that is real money. I’ve never seen so many Republicans cheer for companies sending billions to the US Treasury. The total tax bill on those foreign earnings, just for the S&P 500, is going to be well in excess of $200 billion.

There are plenty of other examples of bubbles around the world. The behavior in today’s credit markets – standards reminiscent of the last bubble – will likely look absurd in retrospect. The relative pricing of European bonds – corporate especially but also some sovereigns – make no sense. In what world does Greece pay a lower rate to borrow for two years than the US? How can it possibly make sense for a low investment grade company to be able to issue bonds with a negative yield as happened recently? Is it a rational market that oversubscribes a 100 year bond from Argentina? That would be the same Argentina that has defaulted on its international obligations seven times in its history and twice since the turn of this century (2001 & 2014). I’ve written previously about the unicorn bubble of still private, unprofitable companies like WeWork as well as the silliness of the art market where a “da Vinci” of dubious provenance goes for nearly a half billion dollars.

So, yes I think it is safe to say that we have bubbles right now and they aren’t confined to bitcoin or the borders of the US. Indeed, this bubble may be the worst of the three in that it encompasses a much wider array of assets. The technology bubble was confined primarily to NASDAQ stocks. The real estate bubble was confined primarily to the finance sector (although the bust certainly had a wider impact). This bubble is worldwide and covers assets from across the spectrum. I think the fact that it is widespread points to the common cause too. It isn’t just US monetary policy that is causing this global problem. And while they certainly deserve some of the blame I don’t think it is strictly caused by the world’s other central banks either. The problem is the one that bitcoin attempts, in a very clumsy way, to address. The problem is our global currency system.

I do not come to this conclusion via an elegant economic theory but rather through several decades now of trading markets. I’ve seen how capital flows impact national economies and markets by observing Latin America from my perch here in Miami for nearly 30 years. It wasn’t monetary policy by itself that caused the dot com bubble. It was a strong dollar policy taken too far by the Clinton administration. My Latin American clients in the 90s didn’t care much how their money was invested as long as it was in dollars. A strong dollar attracted capital inflows that further strengthened the dollar attracting more capital until it was so plentiful that it was being thrown at anything with a business plan and a domain name.

And it wasn’t just Greenspan’s too low for too long policies that blew the real estate and commodity bubble in the ’00s. It was the sotto voce weak dollar policy of the Bush administration that forced capital into real assets in an effort to protect purchasing power. And the weak dollar also powered the emerging market boom as those same Latin American clients took their capital back home to protect it from devaluation, something with which they have a plethora of experience. And all that reversed again sometime after the 2008 crisis, capital again abandoning the emerging world in favor of a US economy seen as the cleanest shirt in a very dirty laundry. And that episode of dollar strength in turn reduced the price of oil nearly to the point of causing a US recession as the shale boom deflated.

And so it is today that we find ourselves with bubbles built in a world of maximum liquidity, minimum volatility and unpredictable changes in currency values. A year ago everyone knew the dollar had to go up and it has done nothing but go down since. Shale companies on the verge of bankruptcy a couple of years ago now thrive with $60 oil. Emerging markets are again the darlings, the favorites of strategists everywhere until the next time the dollar goes on an extended rally, driven by a change in ECB, BOJ, PBOC or Fed policy. Success isn’t driven by hard work and intelligence but is rather a function of currency fluctuations over which a businessman in Rio has no more control than the oil man in West Texas.

Who wants to make long term commitments to actual on the ground investments in an environment where capital can move from Paris to London to Buenos Aries to NYC with the click of a mouse over the course of a trading day?  How does one invest in a world where your investment can be diminished by a change in monetary policy half way around the world? Why work when a little capital and a dash of luck can provide you with a lifetime’s income in a few years – or months maybe in the case of bitcoin? This floating rate, rotating global bubble economy we’ve built since the early ’70s is one where speculation and luck are rewarded while work is scorned as a sucker’s bet. It is this system, more than anything, that is the source of our inequality issues and political turmoil. Most people have no problem celebrating someone who has gained success through hard work and intelligence. But when success is seen as purely a function of luck or political connections, it rends the social fabric, politics driven by anger and envy.

I don’t pretend to know what system should replace the current one that is, more than anything, a complete lack of one. But we need to find a solution so we can create an economy, a nation, a world where success is once again available to anyone with the drive to achieve it. The bitcoin mania offers a clue though that I think we should consider. To paraphrase Churchill, the gold standard is the worst form of monetary system except for all those others that have been tried from time to time. We could do a lot worse….and have. Maybe the third time is the charm and when this bubble is finally deflated we will come together to create a new monetary system. Or maybe return to an old one.

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