Don't Be 'That' Fool: The Bitcoin Mania Will End Badly

Don't Be 'That' Fool: The Bitcoin Mania Will End Badly
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The acceptance of money as a medium of exchange has been central to our economic evolution. No longer do people need to be self-sufficient, growing their own food, making their own clothes, building their own furniture. No longer must people barter, trading fruit for fish and chairs for canoes. People can specialize in what they do well and use the money they are paid to buy the things they want.

 It hardly matters what is accepted as money—seashells, whale teeth, woodpecker scalps have all been used. The people of Yap used stones canoed in from hundreds of miles away, even a large stone that had fallen to the bottom of the ocean generations earlier. As long as people are confident that they can use shells, scalps, or stones to buy things, they accept them as payment.

In our computer age, money need not be a physical object. Electronically maintained records of transactions and balances are sufficient—as long as we trust the system. We don’t need to pay cash in order to buy dinner or hold stock certificates in order to know we own Apple stock.

Which brings us to bitcoins. There is no reason why something bitcoin-like could not be a useful medium of exchange if it were widely accepted as money and, especially, if it were sanctioned as legal tender.

But, as an investment, a bitcoin is no better than a woodpecker scalp or a Yap stone at the bottom of the ocean. A bitcoin generates no income whatsoever. Yes, the price people are willing to pay for bitcoins has soared, as did the prices of baseball cards, beanie babies, and, need I say, tulip bulbs.

Today, we laugh at the Dutch who paid the price of a house to get a tulip bulb. Future generations will laugh at us for paying the price of a car for literally nothing.

The value of a dollar is anchored to the prices of goods and services. If a cup of coffee costs $3.00 and a gallon of gasoline costs $4.00, we know what we are getting when someone pays us ten dollars—enough money to buy two cups of coffee and a gallon of gas. Dollars can gain or lose purchasing power if all merchants raise or lower prices, but individuals cannot unilaterally declare that their $1 bills are now $10 bills. Bitcoins are different. Bitcoins have no anchor because they are not dollars, but something that is traded for dollars. A bit coin can be valued at $1 or $10,000 or $100,000–whatever people are willing to pay, since bitcoin speculators are not buying bitcoins to buy coffee or gasoline, but to sell to others.

Bitcoin prices will keep going up as long as there is a line of Greater Fools thinking that they can sell for higher prices than they paid. But, inevitably, that faith will wane and, then, there will be no reason to hoard bitcoins. When the price of Apple stock drops, the price is stabilized by the fact that, as long as Apple is a profitable company, its stock is worth owning, When bitcoin prices drop, there will be no reason to hoard bitcoins and no reason for the price to stabilize. In the rush for the exits, few will make it out the door unscathed

Think about it. From the perspective of a value investor, it doesn’t matter what Ben Graham’s Mr. Market says something is worth. An investment’s true value is what you would pay to hold it forever. Apple stock is worth owning forever because it is a profitable company that pays dividends and buys back its stock. How much would you pay to own a woodpecker scalp forever? To own a stone at the bottom of the ocean forever? To own a bitcoin forever? That amount is its intrinsic value, not the current price quoted on some exchange. Woodpecker scalps, sunk stones, and bit coins are worth a few pennies at most—no matter what some fool pays for them.

Don’t be that Fool. This is a bubble and it will end badly.

Gary Smith is a professor of economics at Pomona College, and the author of Money Machine: The Surprisingly Simple Power of Value Investing (AMACOM, 2017).  

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