Wednesday, September 6, 2017

Nobel Prize Economist: Bitcoin is in a Bubble

In a new interview with Quartz, Nobel Prize-winning Yale economist Robert Shiller was asked to name the best example of irrational exuberance or speculative bubble he can think of right now.

He did not hesitate in his response.

"The best example right now is bitcoin," he said. "And I think that has to do with the motivating quality of the bitcoin story. And I’ve seen it in my students at Yale. You start talking about bitcoin and they’re excited! And I think, what’s so exciting? You have to think like humanities people. What is this bitcoin story?"

It is, of course, a bubble but when will it bust? I have discussed Bitcoin and other crypto-currencies several times this year in the EPJ Daily Alert. This is what I wrote in the ALERT yesterday:
Crypto Currency Madness
An EPJ Daily Alert reader emails:

I have been reflecting on the cryptocurrency speculative frenzy and suspect it is absorbing a lot of the speculative activity that would normally be going into commodities, stocks and property. What are your thoughts?
There is no question that we are seeing a massive digital version of the tulip bubble price explosion.

Back in June I wrote in the ALERT

My view continues to be that these electronic currencies are a type of mad money advance. There is a group of people that buy them driving up the price, then others buy and so on and so on. Eventually, the price of the currencies collapse when peak demand occurs.

Given that the Fed and other central banks are printing money at aggressive rates, the price climbs in these currencies can go on for a very long time as the money available to buy them continues to expand.

It is basically a modern day Tulip Bubble craze.

I also wrote earlier in June:

Bitcoin is having another spectacular run. But it is a wild ride. Swings in price have occurred of more than $300 a day.

Long-term ALERT readers will  recall that we traded Bitcoin here during what I call its "American run."  We got in at around $40 and out at $700 before it collapsed.

The current run I refer to as the "China run." Almost 90% of the trading is coming out of China.

During the American 
run, it was fairly easy to understand the breadth of the buying and when it would get exhausted. Thus, exiting,before the collapse. But it is very difficult for a non-reader of Chinese-language newspapers to understand the depth of the buying and when it might be exhausted, this time around.

As Henry Blodget of Business Insider recently commented, the price of a Bitcoin could go to zero or a million dollars.

Thus, it is a wild speculative gamble that has no place in a serious portfolio. On the other hand, just as there is 
dramatic downside, there is dramatic, and open-ended upside. I am not recommending the purchase because even if it does  go higher unless there is a way to judge the amount of Chinese buying ahead, the chances you will get out in time will be very slim. In order to make this trade, you would need to be able to read Chinese-language news (not just the limited English translations) and also understand the depth and culture and thinking of the Chinese traders who are trading Bitcoin. A very tall task.

Thus, except for a wild insane American trader, Bitcoin is not a sound trade because it is impossible to understand the Chinese trading dynamics.
Things have changed a bit since then. The buying intensity (and madness) has intensified in the U.S.

It is no longer just a China run.

Paris Hilton on Sunday tweeted about a coin offering! Boxer Floyd Mayweather has promoted two separate offerings. Tim Draper, a founder of the Silicon Valley venture-capital firm Draper Fisher Jurvetson, has said two of his coin holdings could bring about a “sea change as big as the internet."

On an anecdotal basis, I am hearing that some Silicon Valley millennials, who are earning decent money, have sold all their stocks and put the cash all into Bitcoin.

I have heard convoluted arguments on why there should be a ratio between bitcoin and litecoin that is similar to that between gold and silver.

I am told college students are borrowing the $200 limit on their credit cards and putting it in Bitcoin.

This will not end well.

On a short-term basis, the crypto-currencies were hit over the weekend when China announced a ban on digital coin offers.

My guess is that the crypto-currencies will continue to climb as long as the Fed is printing money aggressively---but with very wild swings.

As for it draining money from the stock market, it is important to remember that a crypto-currency transaction is only a shift in a cash balance from the crypto-coin buyer to the crypto-coin seller. That money is then available to enter the stock market,

What really happens when stocks, bonds (and crypto-currencies) are traded is a very complex thing. Fritz Machlup discussed it in relation to stocks and bonds in his very academic but important book, The Stock Market, Credit, and Capital Formation 

That said, the cash flow and profits behind corporations and their stocks will keep them climbing during a boom phase. It is a much more substantial backing of the advance than the crypto-currency advance which is completely a momentum advance with nothing to back it up.

The same goes for commodities and property.There is a sound use value for them that cryptocurrencies don't have. You can always fill teeth or make jewelry out of gold. There is no such base support for a crypto currency. Most commodities and property, outside of gold, trade based on their base use value. As long as there is more money in the system there will be upward pressure on these prices.

But also, as long as the Fed prints money aggressively, the crypto-currency advance could continue and be spectacular but it is a very dangerous side show, that has no fundamental support at any price.

Bottom line: Tulip bulbs have bottomed. These are what crypto-currency prices will probably eventually look like.  But, hey, if you are into high wire acts, crypto-currencies are the current place for you. Just remember the old Wall Street adage, "They don't ring a bell at the top."


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