- Is Bitcoin a momentum trade, a value trade, or both?
- Digitized Money – Dystopian or Utopian to individual liberty?
- Gold takes a short recovery break like an athlete, only to grow stronger going forward
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Bitcoin, Marcus Aurelius & The “Essence of the Thing”
December 2, 2020
“It takes independent thinking, and it takes rigorous research to figure out what has value, what warrants value, what will have value, but does not today. Bitcoin – it may sprout wings and fly. That is appropriate in the category of a speculation. I still prefer value firmly planted on terra firma. Hard assets, please. And hard assets, thank you.”
Kevin: I always enjoy our time on Monday nights, Dave, when we talk. We were talking a little bit about what is the essence of a thing. Marcus Aurelius – that’s sort of a summary of what he was saying. What is the essence of a thing when we invest in it? I’ve worked with you all for 33 years because I know what gold is. It’s not really hard for me to describe in a sentence what gold is.
But, man, some of the investments out there are far more complicated. I’ve asked my clients when they asked me about Bitcoin, what is the essence of it? Can you explain to me what Bitcoin is in a single sentence? And so I’d like to talk about that a little bit today, Dave, because I thought it was an interesting conversation.
But why don’t we talk about gold, since that’s something I do know what it is? Gold has been in a correction. We had a very, very nice rise on gold this year. Still, it’s a nice rise, but we’ve had a correction. Can you comment on the correction to give us a little bit of perspective as to how we move forward?
David: Yes. And as for Marcus Aurelius, I think you’re right, it gets to something that is very important. You have to understand before you commit and that certainly is Buffett’s notion of, if it doesn’t make sense to me, if I can’t wrap my mind around it, I shouldn’t be playing with it. One of your favorite scientists used to take a similar approach which is to understand something he actually had to recreate it, and only when it was recreated did he feel that he properly understood it.
Kevin: The physicist, Richard Feynman, said that he had to rediscover everything that he really learned.
David: So what is the nature of the whole? What is my nature? How is this thing related to that thing? That’s what Aurelius is getting at, understanding relationships and understanding essence, being able to articulate that.
Gold, as you say, is a much more basic thing to understand, and, as a store of value, as a medium of exchange, this is its history for 5,000 years. We’ve had it in a normal cyclical bear market pattern. This is short-term, the last several months – August, September, October – correcting a very healthy up-cycle, and silver as well is digesting a better than 100% move off the March lows.
Corrections, in some sense, can be thought of like a recovery. You expend energy if you run a certain distance. So for the athlete you run a certain distance and then you have to recover, and you allow the energy that you have expended to be absorbed. In the case of your muscles, it’s the recovery period, which is critical to progress. Recovery is rest before more energy can be spent again. So you can view the market from an exercise enthusiast vantage point. Exhaustion is temporary, necessitating rest, and rest opens the way for more healthy activity in the future.
Kevin: One of the things about that Marcus Aurelius quote is also how to relate things to other things, real things to other things. I think about the man that we met in the Bahamas, Dave, for a conference. He had sailed his boat around, through, I think, the Panama Canal from the northwest where he lived and he was over in the Bahamas. But he ran a website called PricedinGold.com. And it’s a beautiful site because basically he weighs everything out in gold, from grand pianos to chocolate, and you can actually see the chart. It’s quite different than if you’re weighing out or you’re charting relative to a fiat currency like the dollar.
David: Frankly, for the long-term holder of hard assets, there’s more than price, and this is where relative value matters. So if you’re like me and you own some percentage of your net worth in precious metals, come rain or shine, perhaps even considering that portion of your wealth has an intergenerational sort of network stabilizer legacy asset.
The question then becomes how to manage increases and decreases in value. And really, the important aspect is relative to other assets, not just in currency terms. By relative value, I mean the price of one asset compared to another. Gold relative to financial assets, oil relative to gold, silver relative to an Airstream. I actually have a story there.
Kevin: And you have an Airstream. You have a story and an Airstream.
David: Yes, because some of our relative value trades are not done with optimal timing, but you look at other trade-offs and you say, perhaps there’s a way to invest in family memories and what not, so bags of junk silver for a 2008 Airstream, maybe that does make sense in terms of a relative value trade and the trade-offs that come with it.
But even if you’re thinking about Bitcoin, Bitcoin relative to real estate, and I think unfortunately we think of price only. We think of price of any particular asset, which really, when we do that, it’s just an asset relative to a particular currency value or cash. But if you extend your thinking to relationships between things and change your attitude towards volatility, all of a sudden the changes between things signify valuable information, not merely a gain or loss or a risk of loss, I think that decision-making through time changes dramatically. So to me the true value investor is looking for more than a cheap price. They’re looking for the right exchange rate between assets.
Kevin: Dave, I predate you by about 12 years. I can remember when my wife and I first got married. The question was what to buy as far as recording equipment, both camera and player. There was the VHS versus the beta debates. Then that moved later to DVD. That was the popular thing, and VHS just became anathema. And now we’ve moved away from DVD. Hardly anybody has DVD anymore, they’ve moved to the cloud and streaming. So you know, things move from popularity to obscurity pretty quick, and it seems like that’s increasing in speed the older I get.
David: Well, assets do the same thing. They are on a continuum, and they move from obscurity or unpopularity to eventually garnering a following, gaining market attention and rising in popularity. And they can also move in the opposite direction where they go from popularity to obscurity. In August we had Exxon Mobil, which was removed from the Dow Jones industrial average, taken out, and it was replaced by salesforce.com. And frankly, it’s not the first sort of company, an enterprise software company, that comes to mind as an industrial index component, but Exxon being yanked out of the Dow-Jones industrial average tells a very interesting story about power and might, which it once had, and now about growing obscurity. I think this is really well reflected if you look back over the last 30 to 40 years where the energy sector in 1980 was 30% of the S&P 500 as a weighting. Today that number is under 2.5%. So last March we had the gold-to-oil ratio, which, due to Covid, reached an all-time high ratio, 80-to-1.
Kevin: That’s 80 barrels of oil to one ounce of gold.
David: That’s right.
Kevin: That’s amazing, wasn’t it?
David: And that ratio generally flirts with 35 on the high side, so 80 is incredible, it’s only happened once. And so 35 is generally where it’s flirting on the high side, and that would represent oil as undervalue, where the opposite, extreme oil overvaluation is when that ratio dips below 10.
Again, an ounce of gold doesn’t buy too many barrels. We saw that 1979 where you could by 8.6 barrels with an ounce of gold, or 2008 when an ounce of gold would buy you 6.8 barrels per ounce. So 80-to-1 was a record, with oil being extremely undervalued, and it’s not unlike the silver-to-gold ratio at 125-to-1. Again, we saw that on paper this year, 2020. Covid exaggerated relative pricing and provided some of the most intriguing entry points into a variety of markets here in 2020.
Kevin: The thing that has always fascinated me, talking to just the public, and I’m including myself in this, rarely do people actually look at those ratios and buy when they should. Most of the time what they’re doing is they’re looking at the news or they’re looking at a neighbor or the guys that they golf with, or if people are talking to each other about investments, they usually buy what’s already popular, which means it’s usually not valued.
Like that oil trade. Who would have thought to buy oil when it was 80-to-1 relative to an ounce of gold – 80 barrels of oil for an ounce of gold? What an entry point. 125 ounces of silver for an ounce of gold – what an entry point. I’m going to use Bitcoin as an example. Bitcoin is near 20,000 and there probably have never been more investors in Bitcoin than right now.
David: Yes, the line is growing for Bitcoin. Now, we think of silver in March of this year, oil in April of this year, representing once in a lifetime entry points. McAlvany Wealth Management owns both. You might think that investors are, in fact, lining up for those kinds of assets. And you’re right, the answer is no.
And we might like the idea, but my guess is that the game plan, someone who is thinking about oil, who is thinking about metals in that respect, is playing a long game and their engagement with the markets is really a long game. It’s not a trade, it’s not something they’re looking to buy and flip. It’s not something that they’re going to hold from now until this afternoon. But for the vast majority of investors, the questions most often on their minds are, what’s going to put fast cash in my pocket?
So momentum is the game, and just like a multi-level marketing scheme, there are people who benefit really handsomely if you’re in very, very early on and there are people who get in later, and maybe there’s some benefit. But again, it’s the late-comer who is not going to be compounding returns the way the early adopter would be.
You’re not only dealing with a much higher cost basis, but your risks are considerably higher coming into a market later in the game, buying any asset that has had its run and may be exhausted and in need of recovery is higher risk. So to be early is actually to be on the opposite end of the spectrum. You may benefit from momentum as time goes on, but to be early to any kind of investment is to askew momentum.
Kevin: Speaking of momentum, everyone in our offices has read the book, Extraordinary Popular Delusions and the Madness of Crowds. That was a book by Charles McKay written in the middle 1800s. He went back and looked at some of the extraordinary delusions. You and I talked about what is the essence of a thing? You had mentioned that Warren Buffett said, “You’ve got to get your head around it. If you can’t explain the investment or why it’s priced at what it is, you probably shouldn’t own it.”
Sometimes I just imagine myself going back 500 years, Dave. Let’s say we had telephones and clients at that time, and we started getting calls about these tulip bulbs that started rising at rapid pace. And sometimes these tulip bulbs back 500 years ago in the Netherlands got up to the point where you could buy a house with a tulip bulb.
I’m wondering what that conversation would sound like, if it would be. “Well, what is the essence of the thing? Tell me why a scarce tulip bulb is worth a house. Well, of course, that whole thing came tumbling down, and I know you’d recommend this, every listener should read that book, Extraordinary Popular Delusions and the Madness of Crowds, at least the first three chapters.
David: Can you put a price on beauty? This is where, depending on what bulb you have, it has such significant value. And the arguments build and build over time to the point where you know that you do understand the essence of the thing because you’re getting closer and closer to the essence of beauty, right? These are the arguments we build and we construct and these ramparts buttress the decisions we make.
That brings me to Bitcoin. I am officially an owner, but not a convert. If Bitcoin went to a million dollars, I don’t own enough. I do not own enough for it to materially change my life. I’ve read books on it. I’ve talked to people who have owned a lot of it and still do, with a cost basis of less than $1.50 per Bitcoin. And I can tell you more easily what people want it to be than I can tell you what it is.
And of course we can have a conversation about what it may be in the future in terms of adoption and usage and whatever. But simply put, it’s a database with a limited number of tradable units. And so that scarcity aspect is why there is a crossover comparison to gold because of scarcity, 21 million when all are mined out at some point in the future.
But before you jump down the rabbit hole, immediately agreeing with the scarcity proposition, it is important for you to know that those units can be valued to the 8th decimal point, which to some degree takes away that sort of inflation hedge characteristic as it’s being presented, how the argument is being buttressed today to own it – alternative to gold, 21st century version thereof, very scarce, but again, valued to the 8th decimal point.
It’s worth a walk down memory lane for anyone that remembers the shift from fractions to decimals on Wall Street back in the year 2000. It ended a tradition of pricing that had roots in the Spanish Empire silver coins, divisible into 1/8th pieces.
Kevin: The pieces of eight.
David: Pieces of eight. So prior to the switch, 25 cents was divisible by three. It was actually 16th increments. So 25 cents was divisible by three into 6¼ cent increments. After the switch, 25 cents was divisible by 25, or 25 increments. And really, it was a significant shift. It was the beginning of the end for market makers on Wall Street. It was the beginning of the beginning for high frequency traders, and it has forever changed the kinds of volumes that we see traded on the New York Stock Exchange in the American exchange, and with it, it’s changed the importance of the flows. It’s changed the importance of proximity to the capital flows.
Kevin: It’s interesting that you say Bitcoin can be broken out to eight decimals. That’s a similar conversation that we’ve had with going back to a gold standard, actually. If indeed the country wanted to go to a gold standard, you could do it with one ounce of gold, you would just have to break the price of gold down into a number of decimals, or dollars down into a number of decimals relative to gold.
But the question with Bitcoin, too, today isn’t just breaking it down into decimals. There are a number of cryptocurrencies out there other than Bitcoin. And so the question would be, looking forward, and I asked you this last night, Dave again. This is not an anti-Bitcoin discussion, this is just purely a discussion. What is it?
And the other question that I would have is, how do you determine future movement of price with something that really doesn’t have any history? We go back to 2008 with Bitcoin. That’s 12 years. How in the world do you sit down and chart the potential outcome of a value which, when you listen to mainstream media right now there’s a number of people who are making price predictions to ridiculous highs.
David: Yes, and I think a part of this does deal with the scarcity issue. If there’s more demand and you only have 21 million units, surely the price has to go to 100,000, a million, some significantly larger number. And again, it strikes me that if you can create more units and subunits through decimalization, you really do have an issue in terms of scarcity, and that’s just not really the case.
Bitcoin today can be taken out eight decimals, but the protocol can be changed with software modifications allowing for even smaller units, which again, theoretically, starts to feel like the infinite money machine we already have. And you mentioned the other cryptocurrencies that we have, but just looking at Bitcoin, it’s a little bit like taking two points on a line and bisecting. Theoretically, how many times can you bisect? And it’s really an infinite process, in theory.
So today you could, if you wanted to you, switch your greenbacks for Bitcoins. I just think you should also recognize that it’s not necessary to do so to navigate a digital landscape. In fact, digital transactions are already occurring and they don’t require the block chain or any other type of cryptocurrency. It’s not like we have to go there in order to see continued development of the digital landscape. It’s in vogue for everyone to create their own medium of exchange and so we do see a proliferation of digital currencies.
But digital transactions using debit and credit already exist. If you think first about MasterCard and Visa, that’s the given, we are all familiar with that. But then there are the newer iterations, and they’re already usable as a medium of exchange. Think about PayPal or Vinmo or Alipay or Wechat pay. The last two combined already handle more than $40 trillion of transactions each year, double the volumes of Visa and MasterCard combined. That’s digital transactions in the digital ether and a digital platform doesn’t require digital currency.
So the proliferation of cryptocurrencies reminds me, if you go back to when every bank in the country issued their own currency, and it wasn’t a very effective way of managing a monetary system. So we end up with a centralized system with one issuer of currency. So that that idea of having many non-state issuers, non-bank issuers, one centralized – that’s where we have gravitated. It would be interesting to see us somehow justify moving back to the chaos of a multi-bank digital issuance kind of a structure.
But again, it’s popular. Even Facebook and a variety of other companies have said, “Well, we’re going to have our own version of Cryptocurrency.” Libra will be out next year, a new version of it rebranded as Diem. This is this is the landscape we live in.
Kevin: Looking forward, Dave, I think we have to also look at what makes us feel so independent with a cryptocurrency? It’s the distributed ledger. It’s very, very hard to counterfeit the number that’s represented by a Bitcoin. So the number itself is what has value, and I think a lot of people look at that and they say, “Well, that’s like an ounce of gold. An ounce of gold gives me value wherever I take it.” Well, the argument is that number that would represent your particular Bitcoin is something that is almost impossible to counterfeit, and it represents a way of capturing every transaction.
Here’s my question to you, though, Dave. Anything that can guarantee freedom can also be used against your own freedom. I’ll use guns as an example. The patriots talk about the right to bear arms. Well, independence is guaranteed if everyone owns an arm. There have been other countries that have done things like that. But you can just as easily take independence away if all the guns are in the hands of the particular government. How is it that our government would give up its own monopoly of currency and let everybody have this “independence” of currency, including Facebook, everybody creating their own currency. Can you look at that a little bit?
David: Yes, because it’s really the question of control, and where that resides, amongst the many or amongst the few? Or even amongst the one? Centralized versus distributed power. And so that whole notion of a distributed ledger, there’s a play on words and something of a natural appeal to the distributed ledger because it is decentralized in one sense. So the advantage of Bitcoin is the distributed ledger. It’s safer. The disadvantage of Bitcoin is also the distributed ledger. It represents a fundamentally transformed world where there is an immutable record of every activity associated with the technology. And so I think it’s ironic, or will prove to be ironic, that block chain has been billed as an insurance policy against an Orwellian future because I think it’s the guarantor of an Orwellian future.
Kevin: That’s what I’m getting at, Dave. I think one of the ways that we might be deceived here a little bit is to think that this is something that puts the government in check. It’s like, “By golly, if you guys keep printing fiat currency, we’re going to move to Bitcoin.” Yes, gold does that. Gold is a discipline. But Bitcoin, it’s interesting how it’s looked at at this point because I’ve talked to people who see it as our cry for freedom for a hard currency, and I’m just wondering if that couldn’t be turned on its head.
David: It comes back to the word control. Is there difference between what can be controlled in the gold market versus in a market like Bitcoin? Nassim Taleb was saying this a few years ago about Bitcoin. He said, “Bitcoin is a currency without a government. In its present state it may not be convenient for transactions, not good enough to buy your decaffeinated espresso macchiato at your local virtue-signaling coffee chain. It may be too volatile be a currency for now, but its mere existence is an insurance policy that will remind governments that the last object the establishment could control, namely the currency, is no longer their monopoly.
“This gives us, the crowd, an insurance policy against an Orwellian future.” That’s the end of his quote. And true, it is a currency without a government and the point at which it is generally adopted or modified by the monetary authorities as a tool for more effective monetary policy implementation, it’s no longer an expression of freedom. It’s a manifestation of control.
So that really is the question. How long is it tolerated in its current form? Because today it is not centrally controlled, but you think about the venue in which it exists, again, like the question we discussed years ago with Nazli Choucri from M.I.T. Who controls the Internet? The decentralized nature of Bitcoin has front edge appeal, but the question remains, who controls the venue of exchange? Who controls the marketplace? Not just the medium of exchange but the marketplace?
Kevin: It reminds me of laws that are made during what you would consider a benevolent administration in any country, let’s say our own, and you love the president, or you love Congress at the time. I’m just using an imaginary period of time. But those laws that are given to a benevolent leader can also be misused by a malevolent leader or leadership. We talked last week a little bit about how even the Cares Act could either be used as a help or a hammer. You were talking about money that should have been going to small businesses was actually going toward mask enforcement and pulling licenses of small businesses, which seems more like the hammer.
So the question that I would have is if you’ve got something that captures every transaction and it can never be erased, and everything about the movement of currency can be recorded and analyzed by big data, does that always stay a help? When does it become a hammer?
David: Yes, I think that’s one of the things that’s fascinating. I’ve read most of the books that Niall Ferguson has written, and The Ascent of Money was a really good read. I highly recommend it. He modified the 2018 version and updated it. It has a bit in there on cryptocurrencies, and Bitcoin in particular. So as a more recent Bitcoin convert, I think he picks up on some of that irony, Bitcoin as an expression of sovereignty, or maybe not, saying this: “It will be a fundamentally different world when all our payments are recorded, centrally stored, scrutinized by artificial intelligence, regardless of whether it is Amazon’s Jeff Bezos or China’s Xi Jinping who can access our data.”
He also commented, and this is actually from a recent Financial Times article, “Blockchain is an indelible record of all Bitcoin transactions, complete with senders’ and receivers’ addresses.” Of course, this was what came out in the 2013 busting up of the illicit transactions on the Silk Road. They knew exactly who was doing what because they just traced it back to addresses. Even if the messages were bounced off of and redirected off of various servers, they figured out who was doing what on the Dark Web and all this notion of privacy tied to Bitcoin – not so.
Ferguson’s conclusion is that if you’re a law abiding citizen, then your transactions are safer with Bitcoin and seeing as you have nothing to hide, government access to data is not a big deal. Again, it goes back to your point, as long as authority is benign in the application of law, and on that basis I would agree.
Kevin: Dave, that brings me to another book that was written about the same time as Extraordinary Popular Delusions and the Madness of Crowds. It’s a book we bring up often, and of course you know where I’m going with this, Frederic Bastiat’s The Law. The law can either be used to help a citizen or with malevolence, it can be used as a hammer. And I’m just wondering if Ferguson is taking into account Bastiat’s The Law when he says, “For a law abiding citizen, it’s perfectly fine for them to see everything. Hmm.
David: Well, and I think this comes back to context. If you look at Bitcoin out of context, this is a brilliant innovation. It’s something we should all be very enthusiastic about it. You put it in context and there’s some nuance there that I think is important. And a part of that is the nature of government and the nature of law. I do think Ferguson should read or re-read Bastiat’s The Law. I’m sure he’s read it. The good or bad citizen is defined by those that wield the power and use the law as either a protection for its citizenry or as a blunt instrument to abuse them.
From my vantage point, I do not assume the best of any politician or corporatist seeking as much power as possible. That’s the trend today. Whether you are in a monopoly oriented business or a politician, power is what people are after. And I don’t assume that the law is the same through time because the people who write it and the people who interpret it are not the same through time. This is where all of a sudden a political philosophy, which is driven by ideals and assumptions, and the ideals and assumptions of what a fair and free society look like change with the leadership.
And I’ll be honest. As I listen to the far left – the far, far left today – explore ideas of retributive justice, you listen, and it’s vengeful and it’s hateful in not only the tone but the content. And I’m not sure that I hold out faith in the protective nature of the law. Maybe this is a digression.
Kevin: I’ve gotten the question recently, Dave, is Bitcoin a replacement for gold? I’m not quite sure what they’re meaning by that, to be honest with you, because we don’t have gold as a backing for any currency in the world right now. But the rumor is Bitcoin could be a replacement for gold, and it’s going to change transactions completely. I’d like your thoughts on both the first point and the second point.
David: On the second point, it’s not changing transactions completely because we already have digital alternatives that are driving far more volume. And so it’s simply not necessary for us to go toward a digital cashless society and have something like Bitcoin as the vehicle. The vehicles already exist. The question would then be, do you want the immutable tracks associated with Bitcoin, and what are the upsides or downsides to those things? What are the pros and cons, the trade-offs for having that attached to the transactional side of things?
Is Bitcoin a safe haven? It’s tough to say that it’s a safe haven when you see, the week of Thanksgiving it was down 27% in a day, actually two days in the context of being up maybe 160% for the year. That’s interesting if you’re talking about a speculative moneymaking vehicle, but it doesn’t really sound like insurance. It doesn’t really have the same qualities of safe haven or vehicle for preservation of value through time.
I mentioned Bitcoin because over the last decade I’ve had friends, frankly, that have never bought a single ounce of gold or silver, and they’ll call me and ask me what I think of cryptocurrencies. And typically before I can answer them they’re suggesting that Bitcoin, just as you mentioned, Kevin, Bitcoin specifically and cryptocurrencies in general, these are a replacement for gold. And in the 21st century the distributed ledger will change everything.
Again, these were not people who understand gold and silver, but they are borrowing an argument, and the legitimacy, and applying it to something new and shiny. It’s a fascinating thing to see occur. I disagree with the first thing they generally present to me, which is that it’s a replacement for gold. But I tend to agree with the latter that there is value to the distributed ledger, and there’s going to be many things in commerce that change as a result of not just Bitcoin but other versions of cryptocurrencies, whether it’s Ethereum or Ripple, or what have you, there are a variety of applications that are disruptive, not any of them being used as currencies, but just some functional aspects that are very intriguing.
Kevin: We’ve been talking for years about a move toward a cashless society and moving people away from an old style of transactions or what we’re told are old style of transactions to purely digital. 2020 has been a strange year, Dave. Even you and I have had to figure out ways of working remotely and recording remotely and talking to clients remotely. But it’s also accelerated. I learned how to use Zoom. I gave a presentation this morning to a group of people on Zoom. I wouldn’t have done that a year ago.
But don’t you think what we’re seeing, even for people who are maybe of an older generation who would have probably shied away from digital-type transactions, don’t you feel like 2020, like a chemical reaction? It’s like an accelerant has been added and Covid-19 is being used to basically excuse the direction that they wanted to go, the proverbial they, for years, which is completely digital.
David: Yes, digital commerce and the broad adoption of digital commerce has been accelerated by at least a decade, due specifically to Covid-19 and the adaptations which consumers have been forced to make, whether it’s lockdowns continuing to capture this sort of crisis dynamic, it has compressed time. So, like it or not, we are going cashless. The question remains whether the monetary authorities sort of adapt and organize a centrally planned alternative or merely co-opt under the guise of some sort of a joint venture. In either case, there is data created, there is data stored, there is data used, however it is used.
Kevin: Last week I brought up a movie, Jurassic Park, and the question that my favorite character in there continues to ask is, “What are the unintended consequences? Is this something that should be done?” So my question would be, what type of unseen risks are the information age generating that really didn’t exist in the past, something that we can’t really look back to the past and say, “Well, we’ve learned from that,” because this seems to be a new era, especially as machines start doing the thinking for us? I’m referencing big data.
David: Yes, the use of big data to predict behavior and in turn, to guide our choices is, to me, an unseen risk in the information age. If you think about something like a stampede, or the global financial crisis, these are examples of emergent phenomena. We had a long conversation with Richard Bookstaber about what it looked like to understand the difference between an individual making a choice which is in their best self-interest, and a whole group of people making the same decision, which takes on herd-like characteristics and may in fact damage the entire system.
So the argument being, if it’s one person making the decision, it’s rational. If it’s a group of people making the decision, it’s panic and irrational, and we can’t afford for it to happen. So again, the reasonable actions of one person, if done by a group, are characterized very differently.
And when we last spoke with Bookstaber, this was the goal, to curtail emergent phenomena and to guide social or economic outcomes. So the end of economic theorizing, to borrow from the title of his book, The End of Theory, the end of economic theorizing about human behavior and its measurable effects – that’s the goal. The end of theory is the end of trying to predict economic outcomes because instead of theorizing on human action and behavioral response, you’re guiding it. But to guide it well, you need as much data as possible.
So here we are. Marry all the transactional data, the immutable record of who does what, when and why. And now you have the tools for limiting emergent phenomenon. Again, like a market crash or a stampede. And in those terms, isn’t it favorable, isn’t it desirable, to be able to avoid or curtail those kinds of disasters?
Kevin: I keep using Jurassic Park references, but that same question came up on the island where they were bringing back dinosaurs. And the idea is, “Well, how do you keep these under control?” And they said, “Oh, well, we just take away their lysine and they can’t reproduce. Of course, most people have seen the movie and they realize that really did not work. So the arrogance or the hubris of the thought that man can control natural outcomes is really the message of that movie.
You brought up creative destruction last week, and some of the adaptations that will occur, partially because of this Covid-19 crisis and the excuse that it brings. But then partially also because of this rapid transfer from individual decisions to group decisions. What do you think from an adaptation point of view, Dave, we’re looking forward to?
David: Yes, just because you can doesn’t mean you should. And that’s the point from Jurassic Park. You can modify the cycle of boom and bust, and there’s one perspective on that which is very healthy. We avoid a lot of pain. But you may inadvertently modify the long-term trajectory of a market economy as well. So the appeal is obvious for those who are in the present moment. What we don’t know is the long-term costs. They’re not obvious. And the future heir, the future recipient of this, downstream from us, may look back with regret.
So today we ask the question of, what price for peace and prosperity? And yet we have a hard time putting a dollar figure to it. And of course, now, all of a sudden we’re hearing more and more that that’s even asking the wrong question. Price is irrelevant. Peace and prosperity are available. All we do is print as we go. Again, modern monetary theory says we run the deficits we need, we print the money we want. We get exactly what we want in terms of a social construct. We can deliver the sun, moon and stars.
That’s the nature of what is coming together, control of emergent phenomena, being able to smooth all of the natural bumps in the road. And one argument would say, “Well, if you can, why wouldn’t you? You’re avoiding so much pain and suffering.”
Kevin, I can’t help but think of a conversation I had with a client 10 years ago. They sat in our office, husband and wife. Husband got up to leave for an appointment, and the wife lingered and said, “You know, we’ve tried to do everything we can for our kids, everything we could. And as a parent, I have some regret that we made their life so easy, they have no idea what hardship is. They have no idea what suffering looks like. They have no idea how to deal with a lot of things that they’re going to encounter in life. We did not prepare them for life. We actually prepared them for the easiest of circumstances. And that’s not life. It was out of love that we did all these things. It was a vision of a better life that we had for them. But in fact, I fear we have impaired them. We have hobbled them.”
It was a fascinating conversation because if you ask the essence of parenting, don’t we want what’s best for our children? And wouldn’t that include the elimination of all pain and suffering? And for the central planner, you might ask the same question. Is it too small a vision, peace and prosperity? And yet there’s a price that comes with that. It’s not that those things are bad, but it does create, it does introduce a certain frailty into the equation, which I think, in the end, has a deleterious effect on the entire system.
So this whole notion of anti-fragile is a really important thing to keep in mind. And what the central planners want to move us towards is in fact, something that is incredibly fragile, where we end up being the most frail. It may be unrelated, the connecting of dots between the digital currency dot and the narrowing of the range of human action. Call that a dot.
And all I can say is that sometimes people do something for a particular reason, not knowing that it fits into a bigger picture and in the end accomplishes something that they never imagined. Sometimes it’s an accidental success, and sometimes it’s an accidental disaster. So as individuals, we can do this subconsciously. As societies we can do this by focusing on a narrow aspect without enough contextualization.
Kevin: Sometimes I look at things, the way they move forward, and I might say, “Well, I’m not going to do it that way,” like what you were talking about. But then a need comes up. You had brought up Covid being an accelerant. But sometimes the need comes up and you say, “All right, I’m going to yield just this once. And I wonder, as we see this thing accelerating, how much the need begins to accelerate the submission. And the consequences that come from that – it’s like what you say. We all would prefer a comfortable life, but we know that that’s not realistic.
I’ll tell you a quick little story, David. When my daughter was very young, we moved to Durango here. There was an Arby’s I remember in town, and the way we distinguished the difference between going and getting a burger with an Arby sandwich was we called it a cow meat sandwich. That’s when my son and my daughter were little.
And so I remember we were sitting there at the Arby’s and my daughter was halfway through her sandwich and she just started crying. I said, “What’s the matter? Why are you crying?” What had happened was that she realized at that moment, for the first time in her life, that she was eating a dead cow.
I know it sounds like a cute story, but I think we all come to that realization at some point. “Wait a second. Something had to be sacrificed for this.” Last week you had said, “I think we’re going to have to come to the end of the age of excess before we actually start to see the truth of the situation.” To me, in a way, that’s a little bit like us realizing that a cow meat sandwich really doesn’t come for free. There was a sacrifice.
David: That’s why I mentioned the appeal of digital currencies on the front edge of things, and the usefulness, the convenience, of moving toward an all-digital cashless system. To see the end from the beginning requires some imagination, not sort of a flight of fantasy, but an imagination that ties events together in a logical progression. And if we do that, I think the digital world of tomorrow and the dystopian world of tomorrow are one and the same. And to be fair, it’s not entirely good, and it’s not entirely bad. We’re locked onto a track that takes us there, whether we like it or not. So if cashless is the wave of the future, it’s where we want to go, maybe without adequately contextualizing the choice.
Kevin: Going back to an accelerant to do things you normally wouldn’t do, we just came through the Thanksgiving holiday, and what they call Black Friday. I hate that terminology. But this Black Friday and this weekend, we saw foot traffic to mom and pop stores and brick and mortar stores reduced by half. But we saw digital transactions go through the roof, and of course, you know people are on lockdown, but you’ve got to figure there are a number of people who probably would have never purchased online that for the first time this last weekend began doing that.
David: Yes, that’s the resistance point which has flat disappeared. People who would never have done online transactions, would never have put their credit card details on their computer, the last 11 months they’ve been forced to. Covid has redefined what we now see as a normal part of life in the 21st century. And again, it’s probably accelerated 10 years in this short period of time. And the cost is obvious. Retail brick and mortar are shrinking. Our transactions this Black Friday confirmed that trend. And for some people it’s just destruction. They don’t see the creative side of it. Mom and pop businesses depend on foot traffic. They’re the ones suffering. It’s not loss altogether, it is a shift in capital flows.
Kevin: But Innovation, Dave, adaptation, like we talked about last week, this country and worldwide, but especially this country, as long as we have our freedoms, there are some amazing innovations that come from distressed situations and I’m just wondering if that is factoring into this as well. It’s dystopian, it’s digital, but you wonder where the opportunity lies, as well, as you look forward.
David: Yes, and it is a shift in capital flows. I’m confident that innovation and change can occur in the marketplace. But just as cost structures on Wall Street were radically altered by decimalization 20 years ago, and they ended up reshaping the players who were involved, market makers, many of whom have just disappeared, transforming profit structures and ultimately the capital flows. And the same is happening on Main Street today as we go digital. I think digital currencies will complete that trend in the transition, so the biggest winners will be closest to the volumes. They will be closest to those flows. We’ve already seen the squeezing of margins. That’s already occurring. High volume is what’s required to prosper. That’s the model that Amazon has adopted. One of the things that introduces other aspects of risk that Covid reveals, inventory management is a big deal. Supply chain vulnerabilities are a very big deal. And you now have more concentrated risk when it comes to supplies coming through limited bottlenecks.
Kevin: You were talking about having a record, a transactional record of everything. It seems to me that as we go forward, we’re moving more into a technocracy, Dave, where if you have the faster data transfer or you have the better artificial intelligence, or the larger block of data on what’s occurred in the past, it seems like that’s a great advantage. So I, as an individual, or you, we really don’t stand a chance on our own with this technocracy. It is who controls the speed and who controls the data.
David: That’s right. So we’re moving toward speed and efficiency and that speed and efficiency is driven by data. You could see the shift happen on Wall Street, where, again, real estate has always been expensive around Wall and Broad. But it got more expensive the closer you got to the exchange because if you could pick up a fraction of a second just in terms of the data transfer, because your lines were closer to the exchange, you picked up the advantage. As a high frequency trader you win the bet.
That speed and efficiency driven by data, if you apply it to Main Street, not just Wall Street, bring in quantum computing. So the things happen almost, in a sense, in real time. Number one, you’re destroying the value proposition of something like Bitcoin and what it takes to create Bitcoin, the costs involved. That is a vulnerability that we’ve talked about before, quantum computing in the value of Bitcoin.
But one of the things that you’re doing is, again, you go back to Bookstaber’s view of being able to take that data and use it. Control the data and you control the world because you control a perspective on the actors which no one else has, particularly if you’re moving faster than anyone else. So according to Bookstaber’s agent-based theorizing, you can influence choice. It’s a little bit like a cowboy driving cattle through a series of gates. You open this gate, that’s where they’re going. You open that gate, that’s where they’re going. They look at it as the only alternative, or one of two alternatives, or one of three alternatives.
But it’s kind of a fallacy of false alternatives in a world of infinite choice. Now, all of a sudden choices are being limited because we can’t afford, again, going back to agent-based modeling, for individuals to choose and drive the bus. We have to control and limit emergent phenomena.
Kevin: So I wonder if we’ve got a showdown coming between the digital giants and the governments because up to this point I think governments would prefer to be the ones controlling. The gate analogy that you used, they prefer to control the gate. But it’s the digital giants that actually control the speed and the big data at this point.
So how did those two merge, Dave, when you see control of the people? I already know when I get on Amazon that they know more about me than I probably know about myself, a least my buying habits, because they remind me, and then they show me things, and a lot of times it’s things that I want.
David: When we talked with Nazli Choucri a few years ago, the conversation was about who controls the medium, who controls the gates, who controls the kill switches for the Internet. It was less about who controls the content and the media. So now, with the conversation we had with Professor McBrayer a few weeks ago, you start to see how powerful, not only the medium and control of the medium is, but also the media and the content. And if you can store an infinite amount of data, gather it, process it, figure it, you are in a very, very powerful position. As a non-state actor you may have more power than a state.
So yes, the digital giants and governments have a showdown coming, and the conflict is in real time in Europe. It’s happening now. Digital currency giants and monetary authorities, they’ll have a showdown, too. I think the difference between what we see in Europe today with the digital data giants and government, and the U.S. government, by contrast, is the Atlantic divide provides enough distance from the tech powerhouses for politicians in Europe to engage in that conflict.
And that hasn’t happened here in the US, in part due to how close politicians in the U.S. are to the tech giants. And by close I mean, do you live in their pockets? Who pays for the elections these days? The modern day digital robber barons do, of course,
Kevin: Dave, a couple of years ago, remember Ken Rogoff wrote the book with Carmen Reinhart, This Time Is Different. He threw down on who is going to win, basically, the war on Bitcoin. Remember that quote?
David: Yes, he’s clearly a proponent for a cashless society, and he’s clearly a proponent for digital currencies. But he is a realist, through and through, when it comes to power and control. And specifically related to Bitcoin he said, “What the private sector may innovate in due time the government regulates and appropriates.” For anyone who is looking at Bitcoin and cryptocurrencies as a freewheeling free market, the great expression of liberty, as Nassim Taleb would say, an insurance policy against an Orwellian future, this is the guy saying, “Yeah, until we are your Orwellian future. You walked in thinking that it was an embrace of freedom. We saw it coming and knew that you would pay for the innovation and all we had to do is close the gate and we’ve got you.”
Kevin: I’m going to play the listener who’s listening right now who’s thinking, “You know, these guys, they’re a little bit down on cryptocurrency because I’m way up on mine.” So here’s my question, Dave. We’re looking further into the future. Is there time for the person who wants to speculate and play the momentum?
Here’s what I think of. Whenever there’s an investment, and Bitcoin is not the first, I mentioned tulip bulbs 500 years ago, but all the years that I’ve been here, there’s always some hot topic where people are wanting to buy. It may be the dot coms back in the late 1990s. They want to buy it, not because they understand it, but they want to buy it because it’s making money.
So you call that a momentum trade, or, if you were to walk into a casino in Vegas, that would be a hot table. The table is very lively and you’ve got the lady spinning the dice and it just doesn’t look like it’s going to stop. How long will Bitcoin be the hot table?
David: Yes, this is where it’s difficult to argue against price action. Absolutely, there’s enough time to be a cryptocurrency speculator and ride the momentum trade to wealth and profits. But here are the things I’m certain of. I’m certain that you’re talking about speculation, and I’m certain you’re talking about momentum investing. Those are the best descriptions of the cryptocurrency phenomenon.
Like I said at the start, I’m not a convert, maybe with the exception of lunch money, right? We’re not talking game changing [unclear]. If I owned less than 1-2% of the total net worth, it’s nothing, because here’s what happens with momentum. It works until it doesn’t. In this case, it’s not just exhaustion that ends the uptrend like you’d see in a normal market pattern, but you’ve got the risk of regulation. Rogoff described it, “appropriation,” to quote Ken, which seems to me to be a momentum killer. Bitcoin is a different animal in the hands of government, and that’s the only place it can end up. You’ve got monopolists and central planners who won’t allow an alternative outcome.
So between now and then, because there is time, you have a momentum trade. And I think this is one of the key things to keep in mind. You got a momentum trade in the context of easy money, and it’s just one of many radical expressions of speculation. It’s an expression of the current zeitgeist. You can buttress it and say, “This is what it is, it’s the new gold, it’s a hedge against inflation, it’s the new hedge against market volatility, it’s non correlated to market assets.” It’s not a hedge against anything. It is a current expression of the current zeitgeist, and it says that anything goes in the context of money printing and gross monetary excess. This is capital misallocation when all the dust settles. But between now and the time the dust settles, you know what it is?
Kevin: It’s fun, Dave. Dave, it’s fun. Most people want to have something to talk about where they’re sharing in an experience. And so oftentimes I know you’re asked about Bitcoin, but my guess is they’re asking you after buying it. They’re asking the question, “What did I just buy? Why is it going up? And should I buy more?”
David: Well, at least my friends are that way. No one asked me questions on Bitcoin prior to investing. They asked questions as a means of confirming a choice already made. And so the calls from friends only come, frankly, after a major move higher. They are the late entrants. They are the ones with a very high cost basis. They’re not the early adopters because they frankly don’t know enough to recognize value in obscure places.
That idea of obscurity and non-popularity just doesn’t fly with most investors. It takes independent thinking, and it takes rigorous research to figure out what has value, what warrants value, what will have value, but does not today. Everyone else is snookered and brought into the game because it’s on the move, and it’s obvious. So a $15,000-20,000 price for Bitcoin. Guess what I get? The calls flood in, and that just happened a few years ago, and they’re flooding in again.
There’s only one friend of mine who called to discuss Bitcoin when it was between $3500 and $4000 per Bitcoin. And at that point, I was interested in buying it. But you know what? It took me three hours to try to set up a wallet, and in the end, I couldn’t figure it out. So I left it alone. I said, “To hell with it. I’m not doing this. It’s a waste of time.”
Could I have made more money? Yes. You know what? With my lunch money guess what I can do now? I can buy dinner. (laughs) But now that it’s easier to purchase, that’s what I did. I put in my lunch money. And in that time frame now I can buy dinner.
Kevin: I remember the same experience, how I felt violated. I kept having to send pictures of my driver’s license and all that. I thought, “If this is the most private way to transact, this is certainly not the most private way to open up a wallet.” And, of course, every transaction there’s a 1099 on. This is not as private as people would say.
But let’s go back. We were talking a little bit about comparing things to other things. Marcus Aurelius. What is the essence of a thing? For years we have instructed clients and helped clients. I’ll give you an example. Farmers, when they plan on buying acreage around their own family farm. We’ll look at it and I’ll say, “Well, how many ounces of gold is an acre worth right now?” And they’ll say, “Well, maybe 5, 6, 7 ounces of gold. This is some of the rich farmland up in Illinois. But the goal was, “If it’s six ounces of gold today, why don’t you set a goal to buy farmland around you when it gets to three ounces of gold? Don’t worry about the price in dollars. Let’s look at it in gold.” So looking at things relative to other things is a little better than just chasing the latest fad trend or tulip bulb, I think, don’t you?
David: Absolutely. You know, one of the things that came to mind in our conversation last night as we were sipping on a Talisker and talking about today’s show was the importance of mythology. And I realized that some of what I do in terms of taking the long view, thinking about legacy and the things that I want to do for my family, they are essentially my own crafted family mythology.
And so, thinking about what my relationship with my wife is going to look like 20 years from now and deciding what I’m going to do daily, weekly, monthly, the patterns of life over those periods of time, feeds into a particular mythology.
And I’m not saying mythology is bad, but take the long view to investing and decide what you want your legacy to be. Maybe substitute the word mythology, I don’t know. But this is where you take the long view, and I’d say this is an alternative to chasing the latest, shiniest, shiny object, or the freshest technological innovation. I think the strategy of extending your thinking to relationships between things, changing your attitude toward inter-market volatility holds merit.
The changes between things signify valuable information, not merely gain or loss or a risk of loss, but the opportunity to identify value and future gain. And I think decision-making through time changes dramatically when you’re not chasing a momentum trade and you are instead looking for patterned relationships.
So the true value investor is looking for more than a cheap price. They’re looking for the right exchange rate between assets. To me, again, if you shift your thinking from: How can I make a quick buck? What brings me this moment’s daily hit of pleasure? Instead, start extending your timeframe out. Take the long view. Develop a family mythology. Develop an investment mythology.
What was the method to all of this madness, the major shift that we discussed in recent weeks, Kevin, between asset classes? It’s fast approaching. This is the asset class shift from emphasis on financial assets, stocks and bonds, to tangibles. It’s between whatever the current favorite is, again, high-flying stocks along with radically mispriced bonds toward hard assets.
Yes Bitcoin may sprout wings and fly. That is appropriate in the category of a speculation. I still prefer value firmly planted on terra firma. Hard assets, please. And hard assets, thank you.