Crypto – Currencies
Quantity Theory Revisited
The price of gold fell another ten bucks and that of silver another 28 cents last week. Perspective: if you are waiting for the right moment to buy, the market is offering you a better deal than it did last week (literally, the market price of gold is at a 7.2% discount to the fundamental price vs. 4.6% last week). If you wanted to sell, this wasn’t a good week to wait. Which is your intention, and why?
Gold vs. TMS excl. memorandum items (the latter add several 100 billion dollars to the recent total, but currency & deposit money represent the bulk of TMS-2 – we chose this version because it allowed us to make a longer-term chart). It is obvious that there is no 1:1, instantaneous correlation between the quantity of money and prices – in this case, the gold price – far from it. However, no-one is saying that anyway, as far as we are aware. The purchasing power of money depends on four factors: the supply of and the demand for money, and the supply of and demand for goods and services. Nevertheless, it is undeniable that prices are not independent of the money supply. With respect to the gold price, the chart above simply shows that there are leads and lags between the quantity of outstanding dollars and the gold price – these can certainly be lengthy, but that is what the periods when the two drift apart represent. The gold price (and all other nominal prices in the economy for that matter) would not have experienced such a large long term increase if the money supply had remained stable. Most of the time, changes in the money supply growth are not very useful for forecasting short term trends in the gold price, but the size of the money stock and the price of gold do correlate over the long term. Mises described the effect of inflation (inflation = an increase in the money supply) on prices as follows:
“The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent. This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services.”
Elsewhere Mises remarks that economic productivity has often matched or even outpaced monetary inflation, and in those periods nominal price increases were occasionally suppressed altogether:
“A sharp rise in commodity prices is not always an attending phenomenon of the boom. The increase of the quantity of fiduciary media certainly always has the potential effect of making prices rise. But it may happen that at the same time forces operating in the opposite direction are strong enough to keep the rise in prices within narrow limits or even to remove it entirely. […] As an actual historical event credit expansion was always embedded in an environment in which powerful factors were counteracting its tendency to raise prices. As a rule the resultant of the clash of opposite forces was a preponderance of those producing a rise in prices. But there were some exceptional instances too in which the upward movement of prices was only slight.” [emphasis added]
Gold is a monetary asset, i.e., the market-chosen money commodity. As such, it behaves like a currency and its long term correlation with USD money supply growth is actually quite pronounced. The supply of gold grows at a very slow pace, and as long as the market treats it like money, its price will tend to rise in the long term relative to currencies with a faster growing supply. In the short to medium term other macroeconomic factors are most of the time more important gold price drivers. It should be noted though that in today’s central bank-administered fiat money system, these other factors also tend to have a lead-lag relationship with money supply growth rates. After all, the latter are driven by central bank policy, which in turn is generally formulated in response to macroeconomic developments. [PT]
A Purely Technical Market
Long time readers may recall that we regard Bitcoin and other liquid big cap cryptocurrencies as secondary media of exchange from a monetary theory perspective for the time being. The wave of speculative demand that has propelled them to astonishing heights was triggered by market participants realizing that they have the potential to become money. The process of achieving more widespread adoption of these currencies as a means of payment and establishing appropriate (and potentially more stable) exchange rates relative to state-managed fiat currencies is still underway.
A snapshot of cryptocurrency market caps as of June 12 – they made local lows two trading days later. After the small rebound since then, market caps are now slightly higher than those shown on this map, but it is still roughly in the right ballpark. Note: XRP has the third highest market cap, but we do not regard it as a true “cryptocurrency”. It is not a decentralized currency at all, it is a token under control of the company that issued it (it can be traded though and for a while there was a big burst of speculative demand for it, oddly enough mainly from South Korea). Bitcoin Cash (BCH) is the most important fork from the original BTC blockchain and in our opinion the better Bitcoin. It has a much larger block size, avoiding the scaling problems BTC encountered late last year (which were associated with long waiting times for transactions and soaring fees). BTC still enjoys a first mover advantage and trades at a far higher level as a result. There is no logical reason why it should, but that is a topic for another occasion.
The Global Community is Unhappy With the Monetary System, Change is Coming
Our friend Claudio Grass of Precious Metal Advisory Switzerland was recently interviewed by the X22 Report on cryptocurrencies and gold. He offers interesting perspectives on cryptocurrencies, bringing them into context with Hayek’s idea of the denationalization of money. The connection is that they have originated in the market and exist in a framework of free competition, with users determining which of them will be winners and losers.
Claudio Grass
Another Highly Useful Report
As we noted on occasion of the release of the first Incrementum Crypto Research Report, the report would become a regular feature. Our friends at Incrementum have just recently released the second edition, which you can download further below (if you missed the first report, see Cryptonite 2; scroll to the end of the article for the download link).
BTC hourly (at the Bitstamp exchange). Although BTC has been in a bear market since peaking in December, it still offers numerous short term trading opportunities due to its high volatility. We took the above snapshot of the hourly chart at around 8:00 am EST to illustrate this. After declining sharply amid an onslaught of negative news (including an announcement by Google that it would no longer accept cryptocurrency-related ads, which strikes us as an utterly absurd decision), bitcoin made a short term low in March 18 at $7,325; from there it rose to a short term peak at $9,188 on March 21. This is certainly what one would consider a “playable move” as a trader. Note the strong trading volume right at the low – this is a recurring characteristic of short term lows in BTC (sometimes the low of the heavy volume candle is retested at lower volume before the trend actually turns – the same phenomenon can often be observed at short term highs as well).
Relative Scarcity and Bubble Dynamics
There is widespread awareness about the relative scarcity of BTC compared to the ever-expanding fiat money supply, but it seems to us that the dynamics underlying their relationship are largely ignored. The scarcity argument underpins a lot of speculative activity in BTC and other cryptocurrencies – hence ignoring the related dynamics is probably not a very good idea.
One of the features of bitcoin people find enticing – by no means the only one to be sure – is the fact that its supply is strictly limited (well, sort of – see our comment on “forks” further below). We have highlighted the currently circulating and the eventual total supply above. Keep in mind that the “free float” of BTC is even smaller: there are a number of very large wallets which apparently never trade, and quite few BTC have been lost forever – we are pretty sure that the UK resident who famously threw away an old hard disk drive that held his BTC wallet is not the only person who has disposed of his bitcoin in such a decidedly painful and unprofessional manner.
The Wingsuit Test of 1912
Late last year press reports informed us that by October, the number of active accounts at US cryptocurrency exchange Coinbase* had exceeded the number of accounts at Charles Schwab, one of the oldest US discount brokers, by 1.1 million. The report was dated November 27, by which time the number of accounts had just soared by another 1.6 million. We felt reminded of the final few weeks of China’s stock market bubble, which saw similarly stunning growth in retail brokerage accounts. We felt that these Johnnie-come-latelies would soon experience the financial equivalent of the infamous wingsuit test of 1912. Witness the sacrifice of a man ahead of his time:
Wingsuit pioneer Franz Reichelt fails to get past the proof of concept stage.
Style Over Substance
There are many things that could be said about the GOP tax bill. But one thing is certain. It has been a great show.
Obviously, the time for real solutions to the debt problem that’s ailing the United States came and went many decades ago. Instead of addressing the Country’s mounting insolvency, lawmakers chose expediency without exception. They kicked the can from yesterday to today.
The empty chairs meeting – this is slightly reminiscent of the Clint Eastwood skit in which he addressed an empty chair that was supposed to represent Barack Obama. No-one can accuse the current tax reform plan of making a lot of sense, but the problem is that any comprehensive sensible reform package would never make it past the lobbies interested in maintaining the status quo. Given that elections are advance auctions of stolen goods (h/t HL Mencken), any perceived interference with the stealing will tend to be strongly resisted. [PT]
Photo credit: Kevin Dietsch-Pool/Getty Images
A Useful Infographic
When we last wrote more extensively about Bitcoin (see Parabolic Coin – evidently, it has become a lot more “parabolic” since then), we said we would soon return to the subject of Bitcoin and monetary theory in these pages. This long planned article was delayed for a number of reasons, one of which was that we realized that Keith Weiner’s series on the topic would give us a good opportunity to address some of the objections to Bitcoin’s fitness as a medium of exchange voiced by critics (we have kept the final three parts of Keith’s discussion in abeyance as well, we intend to publish these concurrently).
BTC was easily the best investment asset of 2017 (we may have overlooked some other “alt coins”, but in terms of market cap only the 6 – 10 largest cryptocurrencies look like serious contenders in this market). We should probably write more often about it, then you would e.g. have learned that we thought BCH (the post-fork younger brother of BTC) was likely to play catch-up at some point. We actually believe this particular valuation gap is likely to narrow further, and the same may well happen with DASH, another cryptocurrency with quite similar features (both BCH and DASH are lacking some of the legacy technical drawbacks of BTC). As an aside, we always had a certain minimum target for the coming gold bubble in mind which we never mentioned in public, because we felt it sounded silly. Usually we just recommend that people use their imagination, in the hope that their imagination is big enough. By now it probably sounds a lot less silly – we will revisit this topic once gold has overcome certain technical hurdles – click to enlarge.
The Instability Problem
Bitcoin is often promoted as the antidote to the madness of fiat irredeemable currencies. It is also promoted as their replacement. Bitcoin is promoted not only as money, but the future money, and our monetary future.
In fact, it is not.
A tragedy… get the hankies out! :) [PT]
Crypto-Statistics
In the last issue of Seasonal Insights I have discussed how the S&P 500 Index performs on individual days of the week. In this issue I will show an analysis of the average cumulative annual returns of bitcoin on individual days of the week.
Bitcoin, daily. While this is beside the point, we note the crypto-currency (and other “alt coins” as well) has minor performance issues lately. The white line indicates important lateral support, but this looks to us like it could be the beginning of a higher degree correction, mainly because it so far proceeds with greater verve than previous corrections over the past year. Besides, the recent rally in this trading sardine seems rather stretched, and the term stretched by itself actually sounds a bit inadequate as a descriptor. It needs an adverb… insanely might do. [PT] – click to enlarge.
Forking Incentives
A month ago, we wrote about the bitcoin fork. We described the fork:
Picture a bank, the old-fashioned kind. Call it Acme (sorry, we watched too much Coyote and Road Runner growing up). A group of disgruntled employees leave. They take a copy of the book of accounts. They set up a new bank across the street, Wile E Bank. To win customers, they say if you had an account at Acme Bank, you now have an account at Wile, with the same balance!
BCH, son of Bitcoin, born by forking – down quite a bit from its highs, but still up 130% in the past month, and sporting the third-largest market cap in crypto-currency land. [PT] – click to enlarge.
How We Got Used to Fiat Money
Most false or irrational ideas about money are not new. For example, take the idea that government can just fix the price of one monetary asset against another. Some people think that we can have a gold standard by such a decree today. This idea goes back at least as far as the Coinage Act of 1792, when the government fixed 371.25 grains of silver to the same value as 24.75 grains of gold, or a ratio of 15 to 1. This caused problems because the market valued silver a bit lower than that.
The gold-silver ratio from 1800 to 1915. In the 1870s, numerous nations around the world dropped bimetallism in favor of a gold standard (France was a noteworthy exception). Thereafter it quickly became obvious that silver had been vastly overvalued at the official exchange ratio. It was essentially a subsidy for silver miners. Once a pure gold standard was adopted, mild consumer price deflation became the norm, as economic productivity grew faster than the supply of gold. Contrary to what virtually all central bankers nowadays assert, this had no negative effects on the economy whatsoever. On the contrary, the four decades following the adoption of the gold standard produced the biggest and most equitable real per capita growth the US has ever seen – such growth rates were never again recaptured. Of course, at the time government spending represented between 3% to 4% of total economic output, i.e., government was but a footnote in most people’s lives. The reason why governments subsequently sabotaged the gold standard was precisely that they wanted to grow without limit. [PT]
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