I was wrong about Bitcoin: it is an asset class not money…

These curious capabilities make Bitcoins a combination of a commodity and a fiat currency (creating the coins is referred to as “mining” and they have value only because people accept them). But boosters inflated a Bitcoin bubble. Shortly after the currency launched, articles spread around the internet arguing that Bitcoins would protect wealth from hyperinflation and that early adopters would make a fortune. The dollar price of a Bitcoin currency unit climbed from a few cents in 2010 to a peak of nearly $30 in June 2011 (see chart), according to data compiled by Mt Gox, a popular online Bitcoin exchange. Inevitably, the currency then crashed back down, bottoming out at $2 in November 2011.

The Economist on Bitcoin in 2012 when the price was USD 12 per coin

 

This commodity [gold] is a material to be almost indestructible, and one of which therefore the accumulated stocks are very large in proportion to the annual fresh supply. Gold tends, therefore, to have a remarkably steady value.

R.G. Hawtrey, The Gold Standard

The Economic Journal, Vol 29, 1919

I have been prety vocal in the past about Bitcoin as a bubble. Stories like this seem to reinforce that image in me:

Eugene Mutai’s Nairobi apartment is filled with the sound of money: That would be the hum of a phalanx of fans cooling the computers he’s programmed to mine cryptocurrencies around the clock…

“The entire ecosystem could be the biggest wealth-distribution system ever,” Mutai said as his 2-year old daughter, Xena, named after the warrior princess, played with a tablet, swiping from app to app. In the world of internet-based currencies traded without interference from banks or regulators, “big players can’t deny anyone from participating in the financial system.”

And sure enough the CEO of Credit Suisse also explained that:

[f]rom what we can identify, the only reason today to buy or sell bitcoin is to make money, which is the very definition of speculation and the very definition of a bubble

I am not sure I believe that big players are excluding people from the financial system… but it is certainly part of the marketing of Bitcoin. The FT also has a great article on a how people are being marketed the dream of riches via bitcoin (read the whole thing the promoters are “interesting” to say the least:

“Ninety-five per cent of people you’re going to talk to about cryptocurrency, they say to you it’s a bubble. Correct?” he said as the 30 or so men and women packed into a small, hot room on the fourth floor nodded in agreement. In fact, he declared, “the bubble will never burst…

Pro FX Options launched in 2016 and says it can turn people with “zero trading knowledge” into skilled traders. It claims its software can detect short-term trading trends and help ordinary people make consistent profits from binary options, where a bet is placed on whether a stock or currency pair will be higher or lower at a predetermined time in the future. “What we’ve done is really made it simple, simple for anybody from any walk of life to take advantage of it”

But I am erring more now to the fact that while the top prices may be “bubble like” in that they deviate from the mean significantly over time, that some cryptocurrencies, and Bitcoin in particular, look likely to be a permanent asset class. I don’t think the CEO of Credit Suisse is right, buying and selling for profit only is speculation, but that doesn’t make it a bubble.

Bitcoin isn’t a currency as defined by monetary economists in the classical sense, but it appears to have become an asset class, which seems likely to give it some enduring value. It just needs enough people to believe it worth something at it will have a floor of demand that should give it some value, even if intrinsically it generates no income. There are enough reports now that people are starting to treat it like gold, risk small stakes and hoping to profit wildly. All it needs is this number to keep growing faster than the Bitcoin system mines coins and the price will go up. Last week CME announced they would start a futures service for Bitcoin. It seems almost inconceivable that a global market this big will simply vanish, the price may go down as some buyers lose confidence, but there is surely enough market depth now that this is simply becoming a recognised asset class, albeit one with likely extreme volatility in demand/pricing.

The mistake I made was treating it as currency and as money. I am not the only one this attempt to value Bitcoin on a rational basis was :

based on the presumption that bitcoin’s core utility value is serving as a currency for the dark economy.

Bitcoin is clearly neither money nor a currency but it is becoming an asset class.

The reason I missed 9 of the last 0 housing recessions in NZ is simply because I was too rational in my analysis on the overall return not the capital gain: Asian buyers and peoples innate desire for a secure house has increased faster than the stock of housing and ergo the prices have boomed.

newzealand-house-prices-gdp-per-cap

Its all about the capital gain in NZ but that doesn’t make the gain any less real if you cash it in.

I’m not pretending Bitcoin is perfect: there are security issues, and the price will be volatile, to name just two. But there is a longevity in the prposition that simply didn’t exist with Dutch Tulips (a fashionable perishable item amongst a small domestic population) or the South Sea Company (effectively a financial engineering that overreached combined with fraud).  Some of the Initial Coin Offerings are clearly fraud and a bubble but the more I read the more I can see a case for investing in Bitcoin: the rate of supply will grow less slowly than the rate of demand.

Gold has no value beyond what someone is willing to pay and and 37% of its demand come from people who just hold for “investment purposes”. A fraction of those people worldwide who decided to invest in Bitcoin would likely make it a great investment.

Gold-Demand-by-Source

But I still would pay someone £1100 for a three day couse to learn how to trade the stuff. I may regret that later but that is a bubble.

My Uber rant and the Gold Standard…

If a man has good corn or wood, or boards, or pigs, to sell, or can make better chairs or knives, crucibles or church organs, than anybody else, you will find a broad hard-beaten road to his house, though it be in the woods.

– Ralph Waldo Emerson
“I landed in this country with $2.50 in cash and $1 million in hopes, and those hopes never left me”
Charles Ponzi

As someone who has predicted 9 of the last 0 housing crashes in NZ I like to think I know an investment bubble when I see one… and nothing gets me more confused than the valuation of Uber at a cheeky USD 69bn. I should point out a clear conflict of interest here: I own a taxi license: Auckland Coop 466 is mine, a legacy and one I am reluctant to give up mainly for historical reasons (my father left it to me rather than economic reasons).

But Uber does my head in… I don’t think I am a Luddite, but it’s just so transparently not what it says it is: namely I don’t see any innovation just regulatory arbitrage and the collision of money and politics. The main thing they seemed to have achieved is to avoid the classification of a smartphone as a taxi meter, and therefore any of the regulatory costs that come with that. Taxis have always been defined by the meter, which enabled them fairly and transparently to show people how they were charging, combined with a host of regulations (including safety) they pushed the costs up far above what anyone with a private license and car could offer their services at. It was seen as collectively better for society to ensure that you knew a safe and regulated car was turning up, that was insured etc. Uber drivers also don’t get the same levels of insurance as licensed hire cars, nor undergo the same sort of licensing checks.

In other words, Uber’s costs are cheaper not because they have invented a better mousetrap but because they operate in an environment where the smartphone that catches the mouse is not called a mousetrap (with apologies to Emerson) even though it catches mice. I am not sure any of the reductions in regulations and insurance are in the long-term interests of consumers, but I may be biased, but then again I also know someone who lost their private hire license after a stroke and considered driving for Uber instead as he only needed a normal drivers license without a health check.

The constant need of Uber to fight it out in court, where they seem to be losing a number of battles such as Denmark, Brazil, and cities like Prague, show this isn’t minority view. And maybe that is what grates the most, the whole corporate mien of Uber. I read this today from INET (please read the whole thing):

In one of these countries live members of what Temin calls the “FTE sector” (named for finance, technology, and electronics, the industries which largely support its growth). These are the 20 percent of Americans who enjoy college educations, have good jobs, and sleep soundly knowing that they have not only enough money to meet life’s challenges, but also social networks to bolster their success…

Politicians increasingly influenced by the FTE sector turned from public-spirited universalism to free-market individualism. As money-driven politics accelerated (a phenomenon explained by the Investment Theory of Politics, as Temin explains), leaders of the FTE sector became increasingly emboldened to ignore the needs of members of the low-wage sector, or even to actively work against them.

When David Cameron was Prime Minister he claimed to be looking after the little guy. But the little guy was a tax paying guy from Essex who had done three years training to get “the knowledge” who then found his income dramatically cut by a fleet unregulated and unregistered drivers. Coincidentally his head of strategy, Steve Hilton, was married to Rachel Whetstone, who headed up Uber’s PR department in London… and behind closed doors… Which explains why a traditional group of self-employed business, traditional Tory voters were hung out to dry. It’s why Travis Kalnick can yell at an Uber driver… I could go on…

I get it: Uber is cheap, and in the new gig economy we all like cheap. But is it economic? For a thorough demolition of the business model read Naked Capitalism. I really like this part:

By contrast, in the hundred years since the first motorized taxi, there has been no evidence of significant scale economies in the urban car service industry. That explains why successful operators never expanded to other cities and why there was no natural tendency towards concentration in individual markets. Drivers, vehicles and fuel account for 85% of urban car service costs. None of these costs decline significantly as companies grow. As the P&L data above demonstrates, Uber has not discovered a magical new way to drive down unit costs.

The whole thing is worthy of a read. Nothing beats a good bit of iconoclasm when it’s grounded in fact.

I especially like the revelation that two investment banks passed on marketing the private company to their high-net-worth customers after reviewing a prospectus with no revenue or profitability data (at 290 pages!). Not all did: caveat emptor!

The words Ponzi scheme are used, and the Uber valuation clearly is one. Not because there is any fraud involved, but because the last people in depend on more people coming into ever show a profit. With a 2bn operating loss those people will get harder to find… eventually… The cynic would argue the investment banks have gone through the institutional money making small portfolio bets, then moved on to individuals who are much less astute…

I prefer the arbitrage comparison. Charles Ponzi’s original scheme  had the basis of sound economics (more so than Uber after reading the Naked Capitalism posts), if it worked; but it was also based on regulatory arbitrage and the slow adaptation of international systems to economic change. In 1906, in the classical Gold Standard era , by agreement at the Universal Postal Congress (held in Italy) , world postal organisations agreed to a system of International Reply Coupons to make it easy to send funds abroad: as exchange rates were fixed to a pre-agreed formula the prices for the coupons were pre-agreed and locked in as well. When in 1919, under the interwar gold standard (where there was some exchange rate flexibility), someone sent Ponzi an IRC from Spain that cost 30 centavos that could be exchanged for US 5c and Charles Ponzi realised there was a riskless profit to be made as the Spanish currency had recently devalued.

And Ponzi was right, but like Uber part of the economic problem rested with scale, and Ponzi simply couldn’t organise to purchase enough of these coupons to make the profits he had promised investors. The mistake, the fraud,  he then made was to claim he had a network of agents buying IRCs in various countries and that there was a viable business underpinning this that could go on indefinitely; he then hired a network of agents in the US, paid them more than the arbitrage profit levels to collect “investments”, and collected the money coming in paying out those who wanted to be cashed out with the money coming in. (One could also add the stupidity of investors was not realising that riskless profits would be traded away).

Uber does appear to be a business that takes advantage of regulatory arbitrage on a global scale and it obviously, based on five years of operating performance and financial results, requires massive scale if it is ever going to work at all.   I buy the argument that actually the industry structure and economics don’t work that Naked Capitalism make so eloquently so I won’t bother doing anything other than quoting some more of it:

If rapid growth could not drive major margin improvements between 2012 and 2016, there is no reason to believe that Uber will suddenly find billions in scale economies going forward. Fundamentally digital companies like Amazon, EBay, Google and Facebook had massive operating scale economies because the marginal cost of expanded operations was close to zero. Aggressive pricing fueled the growth that drove major margin improvements and also created major consumer welfare benefits.

What all the other big names like Google, Facebook and Amazon achieved were increasing returns to scale where fixed costs remain virtually unchanged even as revenue grew massively and hence dramatically lowered unit costs. Unless Uber could find some way of changing this equation they simply cannot trade forever on at the same price level as a company that does this as they require dramatically more cash (mainly in subsidies by the look of it). The next pricing round promises to be extremely interesting because if Naked Capitalism is right it’s not simply that it should be done at a lower number it’s clearly that there is no inherent economic value in the business at all… which is also like Ponzi…

Macro, gold, and private credit

Like most economic historians I get the gold standard was a bad idea and we shouldn’t go back to it. But I think the hankerings for it really reflect a deeper desire for some sort of control on the monetary base. As Bordo et al ., note:

We find that [financial and banking] crisis frequency since 1973 has been double that of the Bretton Woods and classical gold standard periods and is rivaled only by the crisis-ridden 1920s and 1930s. History thus confirms that there is something different and disturbing about our age.

The problem is credit. Specifically privately created credit and frankly clearly linked to housing and commercial property lending.

bank-lending-1870-2013

The Bretton Woods agreement controlled the capital account and acted as a brake on the pro-cyclicality of asset price inflation (unintentionally) by making it harder to fund these transactions from offshore borrowing. In some ways it linked the domestic asset base to a trading value of the currency. Now land values have gone crazy because capital is international and property has simply become an international asset class.

And as part of this change tThe banking system has been transformed:

The share of mortgage loans in banks’ total lending portfolios has roughly doubled over the course of the past century—from about 30% in 1900 to about 60% today. To a large extent the core business model of banks in advanced economies today resembles that of real estate funds: banks are borrowing (short) from the public and capital markets to invest (long) into assets linked to real estate.

The driving force in this has been lending to households as the article makes clear.

In the modern economy fractional reserve banking is a myth although it may have functioned like that under the gold standard. But now we understand that banks create money via deposits and there is no theoretical limit on money supply creation other than the monetary policy of the central bank, and there are questions as to the effectiveness of this given the openness of the modern international monetary system and banks ability to fund themselves in the wholesale market. In a modern economy, where home ownership is exalted above almost all other policy goals, combined with open bank funding on a international scale,  I struggle to see a limit on the creation of private credit to property and thus it is a system with a self-induced propensity to pro-cyclicality with a put option on the state. Anything less would imperil the banking system itself.

To me, the question isn’t whether we should be going back to the Gold Standard but really could the Bretton Woods agreement be improved and tried with Bancors? Like the Chicago Plan for domestic money, I am too cynical to believe an institutional mechanism that requires so much change is likely to occur, but it is clear that the link between credit and the macroeconomy is the crucial variable that needs to be understood better and be the driver of economic models. A fundamental model of understanding the modern macroeconomy needs to be the driver of credit, something Minsky well understood.