BITCOIN MUST BE THE “NEXT BIG THING”, RIGHT?
Financial headlines are trumpeting the “money” that is being made by owners of Bitcoin, the revolutionary cryptocurrency. As this is written, Bitcoin traded for over $4,000/unit which is many times the value of just a couple of years ago, and a quadruple in 2017 alone. Something is clearly going on here, so the question naturally becomes what to do about it. Should you buy it and, if you buy it, how long should you hold it?
A Currency is most often defined as a form of money, circulated through the economy and used as a medium of exchange for goods and services. There are privately “branded” currencies such as airline miles and credit card points that can be used for a limited number of purposes, but most broadly used currencies have been issued by governments, who have a number of ways of potentially “backing” the value of that currency by offering to exchange the currency for a broadly accepted “package” of goods or services. Most notably, from 1863 to 1933, paper “gold notes” were exchangeable into a fixed weight of gold, so the quantity of notes (currencies) was limited by the amount of gold that the government owned. The amount of notes (currency) that was issued by a government could grow as the economy grew, and the amount of gold mined, and then owned by the government, could grow proportionately. The universal acceptance of gold, for literally thousands of years, provided credibility for the currencies that were backed by gold. The fixed weight of gold exchangeable into the U.S. Dollar, for example, allowed the notes (currency) to be used as a “store of wealth”. Governments, as opposed to the creators of cryptocurrencies today, can at least “back” their currency, in ways to be determined by the crisis of the day, by taxing their citizens. Over thousands of years, the longest lasting currencies were those convertible into a proven store of value, most often gold and/or silver, therefore controlling the amount issued, and providing predictable purchasing power of those units of value. Several years ago I created a three minute youtube video, on this subject, that discusses why “Warren Buffet (who dislikes Gold) is Wrong” which you can watch at https://www.youtube.com/watch?v=ah7Y2rHuhCs . Of course, in the history of the planet, there has never been an unbacked “fiat” currency that has lasted. It is just a question of time until the politicians of the day dilute the currency into oblivion as they try to satisfy their constituents.
The best known cryptocurrencies currently are Bitcoin and Ethereum. You should know, though, that (per James Grant’s Interest Rate Observer) “there are now 840 cryptocurrencies, worth $123.4 billion. Two weeks ago, there were 828 cryptobrands, worth less than $90 billion”.
One of the requirements of a desirable currency is the knowledge an owner has as to what quantity of goods of services that “unit of exchange” will be worth. Look at it simplistically. Let’s say we have a closed “society”, call it a “residential community” with 100 homes for sale, and the total amount of currency that is circulating within that society is $100M. Depending upon how many residents want a new home, there will be transactions at an average price, perhaps at an average of $1M per home. Let’s say then, that the government, or some other issuing agency, puts $1 billion more value (in cryptocurrencies or oil or bananas or whatever) into that community and distributes it among the residents. It’s obvious that those homes are going to be worth a lot more “money”, therefore the previously existing currency (U.S.Dollars, in the US, these days) will have been severely depreciated. It is ridiculous to assume that new currencies, issued by governmental agencies or the “quant” creators of Bitcoin and the others will not inflate the assets of existing goods and services over time, at the same time depreciation the previously issued currency. It is just a question of degree, and time before the newly issued currency circulates within the society.
The proliferation of individual competing cryptocurrencies, as well as the enormous volatility in price of such currencies, by their very nature, invalidate these cryptocurrencies as predictable stores of value or units of exchange. Nobody can know from one day to the next, let alone over months or years, what the purchasing power of Bitcoins or the others will be. Speculators might want to “roll the dice” in terms of what Bitcoin might sell for tomorrow, or next week, but I suggest that nobody in their right financial mind would put a “serious” amount of money into Bitcoin as more than a speculation for a short timeframe. Of course, a “serious” amount of money or time will vary among investors. Some vendors such as Spirit Airlines have accepted Bitcoin as payment, but you can bet that they have converted that Bitcoin into a more “stable” currency ASAP.
WHY BITCOIN NOW?
The proliferation in recent years of cryptocurrencies is a commentary on (1) an unfortunate human inclination to try to make “a quick buck” through speculation (2) a search for an alternative to governmentally issued cryptocurrencies which have had no backing since Richard Nixon closed “the gold window” in 1971 (3) a “reach” for a return by investors frustrated by federally suppressed interest rates on their savings accounts.
THE ESSENCE OF THE PROBLEM
The essence of my conviction that Bitcoin (and the others) will fade from existence over team, and speculators will lose their “investment” in these “tulips” of the 21st century, is that there is no limit to the number of these types of currencies that can be issued. While the amount of governmental Central Bank digitally created currencies also have no limitation, at least the taxing capability allows the government to provide some sort of value to the currency after the ……… hits the fan.
BITCOIN VS. GOLD
This discussion very much also relates to my conviction regarding the long term ownership of gold related assets as a store of wealth and potential medium of exchange. It is likely that the cryptocurrencies have siphoned off a certain amount of capital that is looking for a safe haven away from government’s prying eyes. It is possible that the gold price will “go parabolic” just amount the time that the Bitcoin frenzy winds down.
LARRY KUDLOW HAD IT RIGHT
I remember a CNBC TV segment a few years ago, when Larry Kudlow, the well regarded financial commentator, had his nightly show, he invariably talked about his intense disapproval of the ownership of gold, which had started to slip from its all time high at $1900/oz. Gold, he said, had no “utility”, it was a psychological game and therefore very dangerous. (See my youtube video, referred to above, @ https://www.youtube.com/watch?v=ah7Y2rHuhCs. So one night in 2012 or 2013, he was doing a segment on Bitcoin, which had just started to emerge, and he said: “Bitcoin is ridiculous, it has no backing, now if you backed it with Gold, you would really have something”. I sent him an email, saying “Larry, I’m confused, help me out”. He never responded.
AND SO IT WILL BE WRITTEN
I believe that when the books are written (possibly after my lifetime) and the fiscal/monetary follies of the early 21st century are described, Bitcoin and the other cryptocurrencies, including those issued by worldwide Central Banks, will be described as “ringing the alarm bell” at the beginning of the financial revolution to follow.
My advice to readers, which you have no doubt already concluded, is to avoid the cryptocurrency “asset class”, except perhaps as the rankest of speculation. It’s hard to know whether your capital will last longer in Bitcoin or in a Las Vegas casino, but the result will be the same. Those casinos weren’t built by customers walking away with much in the way of winnings.