Bubble, Bubble, Toil and Trouble

Like most men, I suppose, I have a puerile streak. It partly manifests itself through a love of James Bond movies.

I do think that Bond Super Villains are amongst the most interesting characters in cinema, and direct descendants of the classic Shakespearean villains from the golden age of Elizabethan Theatre.

Twenty five or so years ago, in Tomorrow Never Dies, Terence Stamp played a super villain who controlled both a software empire and a media empire. It does not take much insight to realise that Bill Gates and Rupert Murdoch were being used for the inspiration for that Bond Super Villain.

With Elon Musk’s recent activities on twitter, both building up and then knocking down cryptocurrency, I think a lot of Bitcoin enthusiasts are currently seeing him as a Bond level super villain right now. And I suppose that the Eon company might slyly look at scripting a villain in a future Bond film based on him.

I somehow doubt that Elon Musk would mind terribly much.

But as more and more people around me talk about getting onto the cryptocurrency band wagon, I have been revisiting the generally available commentary on asset bubbles.

The Wikipedia page on economic bubbles cites the economist Charles P. Kindleberger as dividing the stages of a bubble into 5 phases:

  1. Substitution: increase in the value of an asset

2. Takeoff: speculative purchases (buy now to sell in the future at a higher price and obtain a profit)

3. Exuberance: a state of unsustainable euphoria.

4. Critical stage: begin to shorten the buyers, some begin to sell.

5. Pop (crash): prices plummet

Of course, we are still mostly in the third stage, Exuberance, where some people are saying that Bitcoin is going to replace gold as the preferred store of value.

Yes, go ahead and keep on believing that.

But I really think we are, like when a roller coaster reaches the height of the track, about to reach stage four, when people start selling.

That same Wikipedia article I have quoted from also talks about a concept known as moral hazard:

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. A person’s belief that they are responsible for the consequences of their own actions is an essential aspect of rational behavior. An investor must balance the possibility of making a return on their investment with the risk of making a loss – the risk-return relationship. A moral hazard can occur when this relationship is interfered with, often via government policy.

A recent example is the Troubled Asset Relief Program (TARP), signed into law by U.S. President George W. Bush on 3 October 2008 to provide a Government bailout for many financial and non-financial institutions who speculated in high-risk financial instruments during the housing boom condemned by a 2005 story in The Economist titled “The worldwide rise in house prices is the biggest bubble in history”.[26] A historical example was intervention by the Dutch Parliament during the great Tulip Mania of 1637.

Other causes of perceived insulation from risk may derive from a given entity’s predominance in a market relative to other players, and not from state intervention or market regulation. A firm – or several large firms acting in concert (see carteloligopoly and collusion) – with very large holdings and capital reserves could instigate a market bubble by investing heavily in a given asset, creating a relative scarcity which drives up that asset’s price. Because of the signaling power of the large firm or group of colluding firms, the firm’s smaller competitors will follow suit, similarly investing in the asset due to its price gains.

However, in relation to the party instigating the bubble, these smaller competitors are insufficiently leveraged to withstand a similarly rapid decline in the asset’s price. When the large firm, cartel or de facto collusive body perceives a maximal peak has been reached in the traded asset’s price, it can then proceed to rapidly sell or “dump” its holdings of this asset on the market, precipitating a price decline that forces its competitors into insolvency, bankruptcy or foreclosure.

The large firm or cartel – which has intentionally leveraged itself to withstand the price decline it engineered – can then acquire the capital of its failing or devalued competitors at a low price as well as capture a greater market share (e.g., via a merger or acquisition which expands the dominant firm’s distribution chain). If the bubble-instigating party is itself a lending institution, it can combine its knowledge of its borrowers’ leveraging positions with publicly available information on their stock holdings, and strategically shield or expose them to default.

When you look at the last three of the above paragraphs, you can perhaps see some parallels with what Elon Musk has been doing. He tweeted that he was going to allow people to use Bitcoin to pay for Tesla cars. This caused the Bitcoin price to go up considerably, at little actual risk to himself and his business. He has now suddenly discovered (I am being ironic here) that Bitcoin is bad for the environment and therefore has decided to not allow Bitcoin as a currency for purchasing Teslas. That has caused Bitcoin to go down considerably in price.

I think, if someone was to look at the relation between his and Tesla’s investment in, and potential divestment, in Bitcoin, and his tweets on the same subject, you could map the Bitcoin price fluctuations in direct proportion to those tweets.

And remember that whilst Elon Musk runs a rocket company these days, he is not a rocket scientist – he is a financial services guru, one of the creators of PayPal. He did not get to be so rich and successful without being extremely smart about money, and understanding better than all but a few thousand people on the planet how the financial system works. And he understands people and the way they behave in crowds very very well.

He can play social media in a very hip way, and everyone will follow his tweets and react to them (do I dare call them ‘sheeple’?). But he is the only one who can actually act, as he is the only one who knows what he is going to tweet.

So go ahead and pump your hard earned savings into Bitcoin, or Dogecoin, or Poseidon Nickel NL shares (no, you can’t do that as that bubble was 52 years ago), or tulips. At least with tulips you will have something pretty to admire.

Published by Ernest Zanatta

Narrow minded Italian Catholic Conservative Peasant from Footscray.

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