Bitcoin is in a bubble phase; the bubble will burst – Twin Cities

With its market price recently crossing the psychological milestone of $100,000, bitcoin is making history.

Enthusiasts, many in the Donald Trump camp, are clamoring for the US government to buy cryptocurrencies, until we hold 5% of the world’s supply.

The reason given is that these coins would “act as a hedge against inflation”. Trump, once sworn in, could introduce legislation along these lines. The Republican majorities, joined by some Democrats, could well adopt a bill. Individual states could be expected to jump on the same bandwagon.

Should we, as a nation or as states, do this? For a cautious conclusion, start by considering the wisdom of the ancient past:

The preacher in the Old Testament book of Ecclesiastes tells us that “there is nothing new under the sun.” An ancient Greek, perhaps the playwright Aeschylus, recognized that “those whom the gods want to destroy, they first make mad.”

American promoter PT Barnum said: “There is a sucker born every minute. » Thomas Tusser, a British poet-farmer from the 1500s, warned: “A fool and his money are soon parted. »

These wisdoms are not born from a vacuum; these are the conclusions of the experiment.

In other words, the current Bitcoin frenzy is just that: madness. Cryptocurrencies are in a classic financial bubble. All bubbles eventually burst. Enthusiasm always peaks before disaster. And a sad, “what was I thinking?” still permeates survivors while real damage is done to real people.

Those who say “this time is different” must understand that this statement has been common in all bubbles of history. It’s never different. Those who argue that “bitcoins are doing great so far” need to remember that the I-35 bridge across Minneapolis worked wonderfully for 39 years – until it suddenly didn’t.

The economics of all this are simple. First-year university students encounter him a few weeks into their introductory macroeconomics classes when they learn about “money.” Some academic crypto enthusiasts might need a refresher. So here it is:

To be money, something must serve:

• “A standard of value” to indicate the relative value of different things;

• “A store of value” to save value produced in one period for spending in another.

• “A medium of exchange” for buying and selling goods and services.

Many things can be very valuable: Bugatti Royale cars, diamonds, Judy Garland’s ruby ​​slippers, Nobles County farmland, Stradivarius violins. This does not define them as money.

Objects that people value can serve as standards of value for a while, until they are no longer rare. Lucky Strikes or Spam bought goods and services in many places in 1945. But how many cigarettes or cans of salted meat can buy you a new F-150, pajamas or a semester at Carleton in 2025?

The means of exchange were very varied: salt in the pay of Roman soldiers, cigarettes in the prisoner of war camps of the Second World War, bread in Joseph Stalin’s gulags. But all of them disappeared because they were imperfect in this use.

So, unless something can perform all three functions reliably over time, it cannot function as “money.”

Gold and silver are, although their values ​​have fluctuated more over time relative to a standard basket of goods than many realize. The same is true, despite temporal inflationary surges, of fiat currencies such as the British pound, the US dollar and the Swiss franc. Bitcoin, certainly, has also achieved this goal, notably by guaranteeing the anonymity of the buyer and recipient, allowing online payments for drug or ransomware shipments to be processed without consequences.

But the key to a cryptocurrency must be available and reliable over time. Successful fiat currencies have their values ​​supported by prudent monetary policies of the central bank, the fiscal powers of the government, and confidence in the stability of that government. Corporate shares are backed by the profits and capital of the companies that issue them. Corporate bonds are backed by guarantees given by the issuer and often by cash flows from the expansion of activities financed by the bond issuance.

In contrast, Bitcoin does not enjoy such support, either in terms of assets or cash flow. As with the causes of other bubbles, its value is determined solely by the demand for bitcoin. The bubble bursts when people stop buying it.

So how did this crypto mania start?

The high inflations that hit all major currencies between the mid-1960s and the 1980s harmed hundreds of millions of people. This particularly hit owners of long-term bonds paid at low, pre-inflation interest rates. People, especially libertarians, distrustful of all government, were looking for solutions.

Many economists advocated “rules, not discretion” in monetary policy. Objective criteria should be used to manage the money supply and interest rates, not committees sitting around tables in Washington, DC, Tokyo or Frankfurt. The “monetarist” and “rational expectations” schools of thought within the economics discipline have particularly emphasized this.

Some have argued that “private currencies” could provide discipline and stability. If the government monopoly on currency were revoked and private suppliers were allowed to issue currencies, then people would come to prefer any currency that seemed resistant to inflation. They would flock there. Government money would be avoided.

Computers, the Internet and mathematical “blockchain” technologies have presented a way to implement such private currencies. Real dollar payments have long been made electronically between financial institutions and individuals. So who says these payments can’t be made with something of consensual value that isn’t a dollar – something “mined” via a computer?

Thus, as these private, non-governmental transactions became feasible, blockchains could then strictly limit the issuance of new units of any “cryptocurrency”. These were transparent and impervious to counterfeiting. They could be transferred between “wallets” belonging to different people or companies. Creating new parts could only be done by solving complex mathematical problems with hours of computer time.

If control of the quantity of money were no longer in the hands of government, even those of supposedly autonomous central banks like the Federal Reserve, crypto would provide a strong safeguard against government irresponsibility. The most trusted and popular cryptocurrency would become an international standard of value and a trusted store of value. Fluctuating, government-manipulated exchange rates would be a relic of the past. A utopia indeed!

But demand for new cryptocurrencies, particularly Bitcoin, grew faster than they could be produced. Their value in fiat currency has increased, albeit very intermittently. And then, as with tulips in Amsterdam in the 1630s, shares of the South Sea Company in London around 1711 or real estate in downtown Tokyo 40 years ago, the desire to buy something simply because many others had the same desire took over. The fluctuations were drowned out by a bullish surge.

The vast majority of cryptocurrencies purchased are now not used as the best method for buying gas or ordering shampoo online. They are treated more like a financial guarantee, but without any assets or cash flow, or even the “going concern” status of a company or the full faith and credit of a state or city. Additionally, with bitcoin prices varying from nearly $65,000 this time in 2021, to less than $17,000 two years ago, and over $100,000 today, this particular crypto has only little use as a stable store of value. Nor is it even a standard of value. What would give a more reliable indication of the value of a section of cropland near Fairmont, Minnesota, or a truckload of ½” rebar or No. 2 yellow corn? , US dollars or bitcoins?

Other dangers are numerous.

Bitcoins can only be produced by solving mathematical problems with vast networks of computers wasting enormous amounts of electricity. But, just like the hopscotch race between impenetrable tank armor and overpowered tank guns, how can we know when a new computer chip or algorithm will enable faster bitcoin mining? The discovery of gold at Sutter’s Mill in California drove up prices in the United States in the 1850s, as did the Alaska Gold Rush and even the use of cyanide rather than mercury to separate gold ore. But as with all commodities, as supply increased relative to demand, prices fell.

All fads end. The end of Bitcoin may not be near. But cryptomania will hit a wall sooner than many think, even though the underlying blockchain technology will be of great use.

Don’t waste time emailing me or the more famous sane crypto-skeptic Warren Buffett to explain our blind stupidity. Instead, seek out a copy of Charles Kindelberger’s classic “Manias, Panics, and Crashes” to learn more about how these events will unfold.