While almost everyone worries about money, most people don’t like talking about it. Money triggers emotion, the topic is shrouded in lingo and some of the underlying concepts are indeed tricky. In a sense, money is a bit like sex, central to human existence, yet viewed as something private, best discussed, if discussed at all, behind closed doors with a specialist or a life partner.
As a kid, I couldn’t figure money out. I stared uncomprehending at the Business Section of The Washington Post. Who was Dow and Jones and what was an “industrial average”? I observed my Russian-born grandfather—gray hair, gray mustache, high-school education—listen with the utmost seriousness to the daily stock market report on, as I recall, AM radio. He’d lived through the Great Depression and it felt like he might be scanning for the next one. Some families were richer, others were poorer and I didn’t know why.
A new chapter in the never-ending money story is bitcoin. My exploration of bitcoin both involved talking to an expert, Michael Casey, on my podcast (please rate it on Apple podcasts if you are enjoying these shows!) and also doing some digging myself. This combo ultimately ended up in a piece in The South China Morning Post, which ran today and I excerpt below:
There are two perspectives useful to think about bitcoin: within the sweep of history and as a part of a portfolio.
Bitcoin is a currency, like the dollar or euro or renmimbi. The question of a) how much currency to create and b) who should be allowed to make that determination is a fundamental question that has over time never been fully resolved.
While most people find talking about the money supply boring, the question of how much currency to create is critical for social stability. If either too little or too much money is created, the economy and society become unstable. If the money supply grows at the appropriate rate, the consequent stability creates the requisite conditions for innovation, boosting the standard of living and many other things we associate with good times.
Throughout history, currencies come in two forms, those whose supply is flexible and determined by committee, and those whose supply is constricted and determined by some non-human force, like nature for gold or an algorithm for bitcoin. A flexible system can reduce economic volatility by expanding and contracting the money supply as needed. A fixed system eliminates the risk of inflationary money printing.
The inability to adjust the supply of money can be catastrophic. While it seems like distant history now, some of the worst periods of economic growth occurred in the 1930s when central bankers tried to maintain a gold peg during an economic crisis. A terrible depression followed. My grandfather and father lived through this.
Freeing masses of people from being tied to the gold standard consumed years of economic debate before central banks finally abandoned this policy. To end the depression, the authorities had to print, as the chart below provided to me by Alex Campbell at Rose shows. This happens again and again.
On the other hand, Zimbabwe and Weimar Germany are examples of how much damage a flexible money supply can create. Intuitively, I am much more attracted to flexible systems that can evolve.
The draw of bitcoin today is due both to its novelty and because developed world central banks are pursuing novel policies that might translate into inflation. In addition, unlike gold, which is difficult to use in transactions, bitcoin can be used to conduct commerce.
The central bankers doing the printing believe economic circumstances––high unemployment, millions hungry––justify their policy and don’t believe what they are doing will translate into high inflation. I agree. The enthusiasm for bitcoin is a hedge on central bankers making a mistake.
In a portfolio, currencies play a specific role. Unlike a stock, bond or real estate, currencies have no claim on an underlying cash flow and zero expected return. Currencies rise and fall against each other, but they can not in aggregate rise.
Adding a return stream to a portfolio that does not produce a return makes sense if it reduces risk. For bitcoin, that could occur in two ways. First, if the domestic currency is likely to rapidly lose value. Second, if this asset reliably rises in value when other assets fall in value, meaning that bitcoin is diversifying.
Certainly, if major investors were to decide to make an allocation to bitcoin, more demand would meet with limited supply and the price would rise. In this sense, owning bitcoin is a bit like owning a lottery ticket; low odds but potentially immense pay off. That is one scenario and probably argues for a small allocation. There are however other scenarios.
As Covid recedes, the printing will likely decline. This has already occurred in China. Moreover, I don’t understand the technology that limits how much bitcoin can be produced and, as far as I can tell, most people don’t. Bitcoin is less than 20 years old. Perhaps something better comes along or technology shifts and the price plummets?
The correlation benefits of bitcoin are also uncertain. A good portfolio contains assets that rise in value over time, but rise at different points in time, thus dispersing the risk. With bitcoin, these relationships are less clear because the history is so short.
If global printing produces global inflation, it seems logical that bitcoin would go up in value. Yet the big rise in bitcoin has come at period of falling inflation. If inflation does come, would investors choose other assets instead, such as inflation linked bonds, gold, other commodities or real estate? It’s also true that ascertaining the correlation of any currency is fraught.
Finally, there is the regulatory risk. Given that bitcoin isn’t centrally managed, it is attractive for criminals as well as investors. How will regulatory entities respond to bitcoin, particularly if its popularity grows? I don’t know. If the regulation shifts, bitcoin could fall significantly.
I welcome the evolution of financial systems and find bitcoin an interesting step in that process. However, when it comes to saving and investing, I am attracted to assets that are simple and whose characteristics are understandable. For me, bitcoin doesn’t meet that test or meets it in such a murky way that at best I could hold a very small allocation as a sort of experiment. Right now, I don’t hold any.