What caught my eye this week.

People are increasingly reluctant to call bitcoin’s parabolic rise a bubble. With the price hitting $11,000 this week, those who dismissed it as a fad or a fraud at $100 look like idiots.

Those who own bitcoin get it. Those who don’t are antediluvian relics.

There’s nothing like a profit to turn people into prophets.

For what it’s worth (not much) I think bitcoin is in a bubble. Probably.

I’ve spent some time this year trying to understand bitcoin, cryptocurrencies, and blockchain – the distributed ledger technology that drives them – better.

I think I’ve succeeded. This summer I had a eureka moment when I finally got that bitcoin was a financial architecture as much as it was a currency or a store of value, and that owning some meant investing in that platform.

I even thought about buying a little. Alas, bitcoin had just hit $2,500 and I’m cheap.

So I didn’t.

Oops!

Having nerdy friends from my university days means bitcoin bubbled into my consciousness years ago. I even have the archetypal friend who mined them when you could do so without a liquid nitrogen cooled garage full of Chinese programmers.

My friend used his self-mined bitcoins to buy an Apple iPad.

Oops!

Eleven reasons why the price of bitcoin may be a bubble

I’ll spare you a primer on the technology (plenty exist – see the links below). Instead here are some random thoughts as to why I think it’s probably a bubble.

1. This graph

Source: WSJ

There might be another widely traded security that has gone up like that and not come down. But I can’t think of it.

2. It’s too volatile to be a currency

A useful currency can’t go up and down 20% against the dollar in 24 hours. If it’s not (at least partly) a currency, then what (partly) is it? If it is a currency then it will have to stabilize. Have we happened upon the right price, right now? Seems unlikely. Are prices going up because they can? Seems likelier.

3. Its ascent is being talked about everywhere

Everywhere! Great sign of a bubble.

4. Seriously, even my girlfriend told me about her bitcoin

I’ve yet to see a woman quoted in an article about bitcoin, which does weaken the bubble case (it might suggest there are still huge demographics to be pulled in). Perhaps it’s begun, though. Plenty of women are into investing. Many are even readers of this blog. My girlfriend is neither. Yet this week she – well – boasted about the value of a fractional bit of bitcoin she picked up along the way. She’s never talked about shares, ISAs, bonds, interest rates, pensions – not even property prices.

5. The overnight wealth creation seems to defy common sense

At $11,000, bitcoin has a market cap of $185bn. Is it reasonable that $185bn has been magicked out of nowhere just because sufficient people believe their bitcoins are worth $11,000 a pop? Perhaps it’s not so ridiculous. Fractional reserve banking means High Street banks add to the money supply all the time. Or is it so different from a stock market being worth 1% more today than yesterday? While $185bn is a big number, it’s a tiny fraction of the world’s wealth. On the other hand, surely that valuation should be tethered to, well, something? States and fiat currencies at least have armies and taxes. And gold has rappers’ teeth. If bitcoin really is on its way to becoming a hybrid of gold and the US dollar, then I can just about accept its rapidly created market cap, except…

6. Governments will want a piece of the action

The bitcoin market is unregulated, and the bitcoin network is creating a store of wealth without governments getting any. Until governments are fully involved, I think the price can’t be trusted. What’s to stop them banning it? Fine, they’d fail, but is the average citizen going to risk breaking the law for an illicit floating world currency – let alone the average billionaire?

7. The price is self-limiting

The higher the price of bitcoin climbs, the less likely people will want to spend their bitcoins. Can it function as a currency then? Hmm, I say. It could still be a store of value though.

8. There are questions about the technology

Initially touted as incorrigible, the cryptocurrency has been splitting. Just keeping the show on the road already consumes as much energy as Ireland. Then there are the hacks that shake faith in a digital currency much more than a bank heist. (Although really stealing bitcoins from a digital wallet or store is just the same. The integrity of the blockchain is the important thing.) Questions about technology don’t mean it’s necessarily a bubble – and they don’t mean it (or blockchain) won’t succeed. Rather, this could be the equivalent of a video-on-demand Internet service in 1999 – right idea, wrong time. But for me these issues do make it harder to trust the price action.

9. Initial coin offerings

Do you know about ICOs? They are unregulated funding rounds for would-be the next bitcoins that have raised more than $3bn globally. Pretty much on the back of napkins. There’s now an estimated 1,200 new digital crypto-currencies out there. On the one hand they might seem to validate the concept – even the failure of all but a couple to gain traction might support the rising price of bitcoin, because it has gained traction. But on the other hand… really? Doesn’t this seem a little, well, nutty? Just a bit?

10. Company name changes

Companies are changing their names to mention bitcoin and seeing their valuations soar. (Here’s a British example, and a US one). Again, not slam dunk proof, but we’ve seen this movie before. Famously, adding ‘dotcom’ to a company name in the late 1990s spiked the price. More recently, I recall a tiny UK music technology firm that changed its name to something to do with rare earth mining at the top of the commodity cycle. At least, it suggests a speculative aspect at play.

11. I’m writing about it

I’ve mostly tried to keep cryptocurrency off this site because it just seemed too iffy. But here I am, adding my two pence worth. When the last blogger turns, you know a bubble is upon us.

True, some telltale signs are missing. For example I haven’t yet heard of babies named Bitcoin or Ethereum. [Update: Reader E. wrote to let us know that baby Bitcoin was recently born and named in the Crimea.]

Football managers are also getting in on the action.

A bubble does not mean a permanent bust

To end on a hypocritical ass-covering note, I’m not really sure bitcoin is a bubble.

It looks like one, smells the same, and has a letter from its mum. But occasionally the world does change. Perhaps this is one of those times.

I’m also not calling a top. Bubbles can keep climbing for years, and it’s easy to see more catalysts for bitcoin.

Think back to how the first exchange traded gold funds seemed to stoke that boom. Bitcoin futures will arrive in a couple of weeks, and I suspect ETFs will follow.

If bitcoin ETFs track the price by investing in bitcoins (rather than synthetically) then they’ll surely boost the price, at least initially. It’s still a hassle to buy bitcoin, compared to adding some alongside your trackers and bond ETFs on Hargreaves Lansdown.

Millions more punters could flood in and send the price skyrocketing! Or the ETF-afication of bitcoin could strip it of its mystique and the price could crash. Who knows?

A price collapse wouldn’t necessarily mean the end of bitcoin or blockchain, any more than the bursting of the dotcom boom halted the Internet.

Bitcoin could go on to be a household name for the rest of our lives, something we all might use. Perhaps it is the future of currencies? Maybe it is a new store of value?

It seems unlikely that blockchain technology will go away anytime soon – it’s too easy to think of applications. (As a would-be home buyer I’d love all the information pertaining to my potential purchase to have been recorded and distributed for everyone to see. It would save hundreds of emails, dozens of letters, and a wodge of money).

But bitcoin right now?

If it walks like a duck and talks like a duck, it’s a duck.

And Bitcoin is probably a duck.

I mean a bubble.

• Good Bitcoin primer (with more at the bottom) by Bloomberg Business
• This Motley Fool podcast is another excellent introduction [Podcast]
• Patrick O’Shaughnessy’s superb Hash Power series goes deep [Podcast]
• Smart take on the mania aspect – The Reformed Broker

[continue reading…]

One of the most easily spotted and ever-repeated psychological errors we make is recency bias. This is the tendency to believe that what has happened lately will continue forever.

You see it all the time in comments on Monevator.

To give just three examples:

• In 2008 and 2009, loud commentators called me irresponsible. I said it was a good time to invest while the markets were cheap and fearful. They urged other readers to keep their money in gold and/or under the mattress.

• Remember when emerging markets were doing well a few years ago but developed world shares were in the doldrums? Putting any money to work in the US or (god forbid) Europe was considered the mad folly of an old has-been who’d never heard of Nintendo.

• American friends told me to steer clear of US house builders. They said the upcoming millennial generation all liked renting and living in their parents’ basements. I wanted to invest with a US friend directly into US property as that economy began to recover. But he was gun shy. Now the US housing market is booming, and millennials want their own homes. (A similar story can be written in the UK – see my post on UK home builders from late 2011).

Of course, I can be as prone to recency bias as much as anyone. But by definition it’s easier to see it in other people.

Onwards, downwards, and upwards

Recessions are a great time for students of recency bias to pull up a stool, crack out a soda, and start taking notes.

People are invariably gloomy during recessions, and they’ve often lost money. Many are scared. Jobs are lost among family and friends, if not your own.

Commentators lament we’ll never again see a glorious time of easy access 0% credit cards and people day trading shares from their bedrooms, nor young women carrying five or six brightly-coloured bags of cheap clothes down Oxford Street.

Yet things do bounce back. The economy does recover. Stock markets sniff it out sooner, and begin to climb 6-12 months in advance.

In the long-run (short of rare catastrophes) things aren’t so bad.

Here’s one we did earlier

These highs and lows are well-illustrated by this pair of graphs highlighted this week by The Value Perspective:

Source: The Value Perspective/Bloomberg.

Ready to have your mind blown? The two charts show the same thing:

One may look deeply volatile and scary and the other smooth and reassuring but they actually both represent the same information.

The chart at the top shows how US gross domestic product (GDP) numbers have bounced around since the end of the second world war while the chart on the bottom shows the cumulative effect of that – the actual nominal growth of the US economy in that time.

I keep trying to explain this to people about Brexit. I expect volatility short-term – we’re already seeing that – and with respect to the second chart I expect our slope to be less steep than it would have been.

But we’ll still grow, eventually, over the long-term. It’s just we’ll probably have slower growth, lower total output, and hence a lower standard of living. There will be less money to spend on the NHS and so forth than we would have. And all for very little gain.

To tie this back to investing, here’s one of my all-time favourite graphics from Portfolio Charts.

Look at the following graph. Which of the scenarios – the three colored lines – would you have rather invested through?

Source: Portfolio Charts / Peter Martin.

Ready to have your mind blown, again? They all show the same returns!

To quote Portfolio Charts:

If you’re like me, the yellow portfolio intuitively seems to have the lowest volatility and the magenta option seems downright terrifying.

Well guess what — they all have the identical average return and standard deviation!

The blue series is taken from a real fund. The magenta series takes the exact same returns numbers and simply reorders them from worst to best while the yellow series juggles them to stay as flat as possible.

While the order of returns has a massive effect on the personal experience of the investor, it has no impact at all on the standard deviation calculations.

Ponder the first two graphs of US GDP and this third graph showing how sorting returns changes our perception of risk.

This is brain food for investors.

Rearranging the deckchairs on the Titanic. Fiddling while Rome burns. Or even – if you’re still somehow giddy with the possibilities – gilding the lily.

To say Brexit was the elephant in the room overshadowing the 2017 Budget is a bit like saying Harvey Weinstein has a weight problem.

As we continue to careen towards the cliff edge / sunny uplands, whatever is agreed in the Brexit trade talks – or lack of them – over the next 18 months will dwarf any tweaks Phillip Hammond made to the nation’s steering.

Long-suffering readers know I am not positive. Nor we now learn is the Independent Office of Budget Responsibility – Hammond informed us it has slashed growth expectations for the next five years.

As the BBC reports:

[The OBR] warned that public spending cuts and Brexit-related uncertainty would “weigh on the economy” while the “remarkable” struggle that the UK economy has endured in bouncing back from the 2008 financial crisis, in terms of lost productivity, would also have major dampening effect.

To put the figures into perspective, while there have been three recessions since the early 1980s there has not been a period since then when growth has been forecast to dip below 2% for more than three years in a row.

While Jeremy Corbyn promises a return to the 1970s, Brexit is already set to take us back to the 1980s.

Brexiteers will say these forecasts have been hopelessly wrong for so long, why take any notice of them now? Also, Britain had a productivity problem long before Brexit. And there’s some truth to that.

But you’d have to be very blinkered not to notice that Britain has gone from the top of the G7 table for economic growth to the near the bottom entirely in the wake of the Referendum result.

On theoretical grounds, short of ‘doing a Singapore’ I can’t see how Brexit can boost growth in the next decade. The question is to what extent any deal we get with the EU ameliorates the downsides.

I’m often reminded that it’s futile to hark on about what might have been. Still, imagine what might have been!

This could have been a Budget where our economy had been ticking higher at around near-2% GDP for years, trade was surging as Europe recovered, the national debt started falling, austerity was lessened, and the Government could turn its attention to dealing with some genuine problems.

Instead we have shot ourselves in the foot fighting largely imagined – or at least misidentified – ones, and the bleeding looks set to continue for years.

Budget 2017 roundup

The dramatic downgrade to our growth prospects aside, what else did the Budget have in it for you and me?

Bigger sites have covered the detail. Below I’ll link to those Budget tidbits with the most relevance to Monevator, and then give my super-quick personal verdict.

• £44bn package to boost house building to 300,000 homes a year – I think Hammond picked the right hot button problem, and using existing channels to get the money into the market makes sense. But given the distraction of Brexit, it’s a nuanced attack on a bunch of intractable problems that I doubt they’ll be able to deliver to the level required to reach 300,000 homes. Building homes via a new state homebuilder may ultimately be required (with all the downsides that entails).

• Stamp duty cut to zero for first-time buyers on the first £300,000 of homes costing up to £500,000 – Bad news for me; I’m a first-time buyer who has saved and invested his way to above the £500,000 cut-off point, and my imminent purchase will attract nearly £30,000 of stamp duty! (That gets me a two bedroom flat in a nice but not swanky part of London). Stamp duty is a hard tax to like, as it just clogs up transactions, so a cut is good. But Hammond’s targeted move will probably simply push up the price of first-time buyer properties, introduce new artificial boundaries around the £300K and £500K points, and it does nothing to get those higher up the chain moving.

• Driver-less cars on the roads by 2021 – Seems ambitious, but I am all for it. I think you’ll probably need some exemption to be driving a vehicle in 20 years time.

• Higher taxes on diesel cars and fuel duty freeze – After trumpeting his push towards self-driving cars and clean energy, Hammond flipped and went on to brag he was freezing the fuel duty escalator yet again. This has cumulatively cost the exchequer tens of billions in lost revenues, and is made dirty carbon-rich transport more affordable than it would have been, reducing the incentive to cutback or switch towards cleaner fuels. Past support for diesel cars looks like a mistake given what we now know about pollution, so I welcome that reversal.

• VCT and EIS tweaks – I’d like to see the costs of VCTs come down somehow, perhaps through mergers that enabled more expense saving. As things stand it’s hard to recommend them to the average person. But I am increasingly chancing my arm with small EIS investments into start-ups, where the tax incentives are very real. Increasing the limits for both individuals and certain kinds of companies raising money will fly over 99.9% of most people’s radars. But if it gets more money into innovative new companies that would otherwise have been gummed up in State spending, that’s good.

• National Living Wage rising from April 2018 by 4.4% to £7.83 – All for it. The lesson that minimum wages do not suppress job growth has been one of the least discussed economic discoveries of the past few years. I want to see the lower-paid earn more, and I think the best-paid can take standing still for a while to narrow the gap.

• Winners and losers from the personal allowance rising to £11,850 and the 40% income tax threhold rising from £45,000 to £46,500 – While in nominal terms this wasn’t a new austerity Budget, the winners are definitely more higher earners than those relying on benefits. While I wouldn’t dispute some of the latter face real hardship, the boom in employment since the Conservatives went on the attack against the excess largesse of the welfare state does seem to support this recent direction of travel. We must make sure the truly vulnerable get the support they need, of course.

Update: Analysis from think tanks

The Institute for Fiscal Studies has now released a multi-part response to the Budget, and it underlines my gloom about the years of low growth ahead:

“[Forecasts] now suggest that GDP per capita will be 3.5% smaller in 2021 than forecast less than two years ago in March 2016. That’s a loss of £65 billion to the economy. Average earnings look like they will be nearly £1,400 a year lower than forecast back then, still below their 2008 level.

We are in danger of losing not just one but getting on for two decades of earnings growth.”

The Resolution Foundation focuses on the impact of the downgrade on the low paid:

“Productivity isn’t the only determinant of pay growth. But it is a key one. In the OBR’s model, there’s a direct feed-through from today’s grimmer picture to pay. And if typical wages are rising more slowly than previously forecast, then so to will the National Living Wage.

Putting those figures into pounds and pence, our analysis using today’s figures show that the pre-tax pay of a National Living Wage earner working full-time will be over £1,400 a year lower in 2020 than originally forecast when it was announced in 2015.”

What did you think about the Budget and the economy? Let us know – politely please – in the comments below!