A new paper reports that the Bitcoin bubble of 2017-18, when the price of that cryptocurrency reached $20,000, was fueled by “funny money” creation in its sister coin Tether. That is hardly surprising, the cryptocurrency universe, where all values are artificial, is bound to be subject to scams and bubbles. However, it throws a lurid light on the supposedly “real” stock markets of the world: since the world’s monetary authorities are through perpetual quantitative easing equally creating money from nowhere, then surely today’s stock markets must be in equally fictitious bubbles.
The paper “Is Bitcoin really Un-Tethered” by John M. Griffin and Amin Shams, reviewed in the Wall Street Journal, found that Bitcoin prices were manipulated in 2017-18 using a “stablecoin” Tether, whose value was pegged to the dollar, with the transaction mostly taking place through the Bitfinex exchange. According to the study, additional supplies of Tether were created and then used to purchase Bitcoin, which in a fairly illiquid market forced up its price.
Since at the peak the total value of all cryptocurrencies exceeded $800 billion, with Bitcoin representing around half of that, the scope for profits from this manipulation was very substantial. Today the outstanding value of Tether is only $4.1 billion, while the outstanding value of Bitcoin, priced at $9,300 is $168 billion, so the leverage of this technique is highly attractive.
The SEC is even now doubtless sucking its teeth at this disclosure, and wondering whether to prosecute somebody, possibly the proprietors of Bitfinex. Yet surely this is the same technique used in the last decade by central banks worldwide, when they have created liquidity through “quantitative easing,” while holding interest rates close to zero or even below zero, thereby allowing market participants to bid up the price of big city real estate, stocks and other assets to unheard-of levels.
If Bitcoin at $20,000 was an artificially created bubble, why is not the Dow at 27,000 an equivalent bubble, equally artificially created? Yes, Bitcoin is a wholly artificial currency, the product of a clever computer program, controlled only by the magic of “blockchain,” yet how much less artificial today are the dollar, yen, euro or pound, whose value is equally detached from anything real? Yes, central banks are careful not to allow the value of the world’s currencies to fluctuate too much, or to create excessive inflation, but they are no more successful in stabilizing the value of those currencies than are the managers of Tether, whose price has tracked the dollar quite closely.
Using moderate amounts of a stable “store of value” like Tether, clever well-connected people can cause a gigantic boom in quite major assets like Bitcoin. Exactly the same is being done by the world’s central banks, using their own stable “stores of value” to inflate gigantic booms in much larger assets such as stocks, urban real estate and private equity participations. Since all the central banks’ playthings are fiat currencies, the “stores of value” are equally imaginary; in today’s market, so are the ever-booming assets.
More than 200 years ago, Britain’s prime minister Lord Liverpool forecast this, saying to the House of Lords in May 1818: “the tendency of an inconvertible paper money is to create fictitious wealth, bubbles, which by their bursting, produce inconvenience.” Liverpool was a remarkably sophisticated economic thinker, anticipating much of the Austrian economic analysis that was to be developed a century later. In this case he saw a problem with an inconvertible paper money that had only occurred once before, in the 1720 French Mississippi crash, rather than simply the problem of hyperinflation that had more recently bedevilled the American Revolutionary “Continentals” and the French Revolutionary “Assignats.”
If paper money creates “fictitious wealth,” then presumably the various different kinds of inflated asset represent different kinds of fiction. Cryptocurrencies such as Bitcoin are clearly science fiction; they rely on a barely believable, barely comprehensible premise that goes beyond the limits of what we had previously thought possible and expands our thought horizon thereby.
Private equity on the other hand is a Game of Thrones-type fantasy, in which noble Unicorns battle with unspeakable dangers, while melodramatic and unlikely plot lines extinguish major characters suddenly and keep the viewer guessing what may come next.
City centre real estate is an overpriced investment made because of the social pressures involved, like the compulsory “classics” that schools make you read – not the real Shakespeare/Dickens classics, but the ephemeral “classics” like Bertolt Brecht’s “The Caucasian Chalk Circle” in my generation or Paulo Coelho’s “The Alchemist” for the younger set. Like those ephemeral “masterpieces,” city centre real estate is an appallingly unsatisfying investment, requiring great effort in leverage and foregone consumption to make, that can yet become utterly worthless if the neighbourhood goes out of fashion.
Global stock markets, on the other hand, are clearly rom-coms, in which obstacles to love are overcome, the couple move through valleys of tribulation and in the end live happily ever after. Most people in Western societies have their savings for old age invested in the stock market either directly or through money-purchase pension funds. Such investors are betting the success or even the solvency of their retirement on the stock market’s ability to continue its long-term uptrend forever, with only temporary plot twists, thereby achieving eternal happiness.
If you think of the stock market as rom-com capital, you will see on what uncertain foundations most of your net worth is built. The decline of 2.8% in third quarter S&P500 earnings suggests that rom-com investors in the U.S. stock market at least are about to be subjected to the costs and traumas of an unpleasant divorce from their savings.
The move to fiction in economics in general and capital markets in particular can be laid squarely at the door of John Maynard Keynes. Keynes never really understood either interest rates or stock markets; his reputation as an investment genius was due to a lifelong commitment to insider trading – not then illegal – and was severely dented in 1931-37, when Neville Chamberlain as Chancellor of the Exchequer barred him from access to confidential government information.
Keynes believed that interest rates had little effect on capital investment and that the “animal spirits” of businessmen were more important. He also regarded the Gold Standard as an “outdated relic” and sought a monetary system that could be controlled by government, thus allowing that government to set interest rates wherever it thought appropriate. As for the stock market, Keynes believed it existed only to reward rentiers, a parasitic element in society whose “euthanasia” was devoutly to be wished for. His disciple Harold Macmillan even wrote a book “The Middle Way” in 1938 advocating abolishing the stock market altogether and replacing it with a National Investment Board.
After the 1936 publication of Keynes’ “General Theory” governments’ use of Keynesian tools was initially fairly cautious. They ran budget deficits, but attempted to keep them within bounds, and debt to manageable levels. The British government discovered the delights of inflation in the 1950s and 1960s, when it was able to pursue a delightfully Keynesian policy of negative real interest rates, that wiped out the savings of the British middle class, but brought the government debt down to manageable levels without the budgetary “heavy lifting” spending reductions that Liverpool and his Chancellor of the Exchequer Nicholas Vansittart had undertaken in 1815-27. Then in the 1970s British inflation began to get out of hand and the economy declined further, until Margaret Thatcher restored a modicum of reality, the lesson from which persisted for the next two decades, with governments of both parties.
Policymakers today believe that with a decade of negative real interest rates and budget deficits at unprecedented levels they have finally achieved the Keynesian nirvana. That is not quite the Nirvana set out by Harry Hopkins in 1938, at the Empire Race Track in Yonkers N.Y., of “spend and spend, and tax and tax, and elect and elect,” because modern Keynesians want to avoid taxes – they upset the voters – and have discovered that printing money appears to work just as well.
Brexit and President Trump dislodged the third of that modified triad, at least temporarily, but the other two – spend and spend, and print and print — remain firmly in place, apparently as attractive to Trump and British prime minister Boris Johnson as to their predecessors.
Bitcoin is a fictitious currency, easily manipulated. But so, today is the dollar – and the pound, the yen and the euro. As Liverpool said in 1818, this universal taste for fiction is likely to “produce inconvenience” at some point. It is only to be hoped that, when it does, policymakers sweep away fictional currencies of all kinds, fictional budgets and fictional economics, and return to the reality-tested principles that Liverpool understood so well.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)