Bitcoin Lessons for the Fed

I recently read (up until fairly recently) several newsletters that had been negative about how overvalued the stock market is and predicting that the Fed’s policies would lead to inflation, had been losing subscribers. We’re all subject to the psychology of the herd mentality and don’t enjoy hearing how our neighbor’s wealth advisor outperformed the market again.

But now that the world has quickly turned darker, with the grim news of Russia’s invasion of Ukraine, the markets off to a poor 2022, China becoming more aggressive and inflation all offsetting the good news that the pandemic appears to have finally become an endemic, let’s chat about a seemingly minor topic, Bitcoin.

Niall Ferguson and Manny Rincon-Cruise in?Sick Stablecoins Can’t Infect Financial Markets (WSJ 06/12/22) tell us that Treasury Secretary Janet Yellen’s blanket statement that stablecoins?“run risks, which could threaten financial stability, risks associated with the payment system and its integrity” was incorrect; as was the SEC’s Gary Gensler and Sen. Elizabeth Warren, who call stablecoins “wildcat banks,” susceptible to runs.?

Not all bitcoin are the same and they don’t present “a systemic risk to financial stability,” the authors instruct us, since “a true stablecoin is a dollar-like token collateralized by at least $1 worth of assets,” and two of the most well-known “can delay or suspend redemptions at any time—history’s time-tested solution to runs. This keeps their balance sheets intact and makes it impossible to “short” either by attacking its dollar peg.” Just make sure to monitor the quality of their bond holdings.

“Stablecoins” shouldn’t be confused with “coupon coins,”?which rely on minting “new coins when their price is above their peg and sell interest-bearing “coupons” when the price is below the peg. The logic is that investors will buy coins to acquire the coupons, raising the price back up to the peg. But once speculative demand for the coins declines, issuing more and higher-interest coupons only hastens the final collapse of their peg.”

Bitcoin investors have lost over $2 trillion dollars recently in panic selling, but still retain another $1 trillion in value. Interestingly, like the Dutch tulip mania in 1637, only a handful of investors have taken the majority of the losses. The founder of one coupon coin, Terra, got into trouble by launching a separate platform that offered 18% annual interest on deposits of the underlying stablecoin. But while these distinctions are important, here’s the lesson to take, “roulette games for rich speculators pose no systemic risk:

?“Seventeenth-century Amsterdam was awash in new wealth, fueling a bubble in tulip-bulb prices and futures. Yet, contrary to the popular myth, tulip mania wasn’t an extraordinary popular delusion but rather a game for a small group of wealthy merchants, the end of which had minimal economic consequences for Amsterdam. Similarly, despite the pain to retail investors, Terra was a game of musical chairs for a relatively small group of big investors,” Ferguson and Rincon-Cruise instruct us.

Yes, a lot of sports fans watching the Super Bowl ads were duped by celebrities like Larry David, Tom Brady and Matt Damon, who should know better than to be shilling about something they don’t know much about. The size of the endorsement deals that were paid, along with naming rights to stadiums, should have raised red flags. That’s bad enough.?

But when our government experts don’t learn from history and overstate the severity of the problem, that affects all of us.

One explanation of Bitcoin that I like: it’s an email delivering money between two private individuals, with no middle man. Early advocates claim that the fiat currency of the U.S. government is in trouble. With our Debt to GDP ratio going from something like 35% in 1980 to 125% today, they may have a point. But as poorly managed as our government is, it’s still the go-to currency in times of crisis since the economies of Europe, Japan and China have even bigger problems than we do at the moment.?

In academic terms, the Bitcoin should have been seen as a store of value—it has been called digital gold by some—that you would expect to perform well in precisely uncertain times such as these. But that has not been the reality.

Bottom line: the best time to buy is when the last owner has surrendered, willing to sell at any price, when all of Wall Street hates the investment—but comes with the caveat that the investment still has a very, very strong financial sheet. Remember how daring it seemed when Warren Buffet bought Goldman Sachs in the middle of the 2008 Financial meltdown??

But with Bitcoin, the jury is still out. Probably best to let others take a dive. There are plenty of other ways to diversify a portfolio. As the authors warn us, “The U.S. Treasury and Federal Reserve have better things to do—like bringing under control the inflation that currently threatens the stability of the dollar itself.”?