Legend has it that Joe Kennedy, father of former President John F Kennedy, avoided the stock market crash of 1929 by selling his entire portfolio just days before prices collapsed. He did this, the story goes, after receiving a share tip from a shoeshine boy. When taxi drivers, lift attendants and young lads on the sidewalk are speculating in stocks, he concluded, “the market is too popular for its own good”.

The stock market is riding high today but I’d be amazed if your next cab ride results in a share recommendation. This unloved bull market has failed to generate much excitement. It’s quite unlike the explosion of interest in shares in the late 1990s when everyone knew someone who had made a killing in some obscure internet stock and fear of missing out was intense.

So, if Joe Kennedy were having his shoes polished today he would not be talking equities. What he might well be steered towards, however, is an investment in bitcoin, the crypto- currency which is tracing the classic parabola of every bubble in history, from tulips to internet incubators.

Two years ago, you could have bought a bitcoin for $300; today, it would set you back $7,000. Its price has doubled in six weeks. It’s not just the price of bitcoin that is increasing but the speed of the gains is accelerating. The chart is turning left and heading straight up the page as asset prices always do in the final stages of an irrational mania.

Perhaps unsurprisingly, the exponential rise in the price of bitcoin is setting alarm bells ringing. Tidjane Thiam, the chief executive of Credit Suisse, said this week that the speculation around the alternative currency is ‘the very definition of a bubble’. As he observes, the only reason to buy or sell bitcoin is to make money, ‘which is the very definition of speculation and has rarely led to a happy end’.

His comments echo those of JP Morgan boss Jamie Dimon who recently described bitcoin as a ‘fraud’. He said that anyone ‘stupid enough to buy it’ will pay the price for it in future.

I don’t know whether Thiam and Dimon are right. In fact I don’t really know much for sure about bitcoin and it’s this lack of clarity that makes me think they are both right. I’ve been trying to get my head around bitcoin for a while and I’m frankly none the wiser.

I’m not even terribly sure what bitcoin is: a currency or a commodity? It sounds like the former but it fails to exhibit the essential characteristics of money.

It can hardly be viewed as a store of value. That requires at least a modicum of stability. Unlike the pound in my pocket, however, I can have no idea what a bitcoin will be worth tomorrow or in a year’s time. That, in turn, reduces its value as a unit of account. Why would another individual be prepared to accept my bitcoin for a good or service when its future value is so uncertain; for the same reason, why would I want to spend my volatile bitcoin rather than hoard it in the hope of further appreciation.

So bitcoin is a poor currency. But neither is it really like gold or any other physical commodity. Gold may not generate an income – it’s value is only what someone else is prepared to pay me – but it does at least have some decorative and industrial uses.

When it comes to bitcoin, people really are buying it solely because they expect other people to take it off them later for an even higher price. There is no better definition of the ‘greater fool theory’ than this.

As with every asset price bubble, of course, it is not wholly groundless. Ever since President Nixon broke the link between paper currencies and gold in 1971, dollars, pounds and euros have been little more than an act of faith. The value of a bitcoin is no more illusory really than a currency that depends on our collective trust in political leaders and central banks. Like gold, crypto-currencies are free from political interference, regulation, confiscation, inflation or debasement.

It may be that, as electronic commerce becomes the norm, cryptocurrencies will become viable mediums of exchange. The blockchain technology that underpins them may well be the future.

But I’m prepared to wait and see. I will not be risking my savings on what looks remarkably like the tulip mania of the 1630s. By the peak of the madness in 1637, the price of a single bulb was worth ten times a craftsman’s annual income. In three years, bulbs had soared in value sixty-fold.

Like all bubbles, Dutch tulips ended badly. A default on a bulb by a buyer in Haarlem was the bubble-popping catalyst and the implosion was savage. Within a matter of days, prices had fallen to a hundredth of their previous levels.

Peter Lynch said he would only invest in companies if he could ‘draw their business models with a crayon.’. Warren Buffett also famously warned against investing in businesses you cannot understand. If ever there were an investment that fits this description, bitcoin is surely it.

While bitcoin is soaring, the greater fools look like those of us refusing to follow the siren calls of the latter-day shoe-shine boys. Like Joe Kennedy, however, I’m pretty relaxed about who will have the last laugh. What goes up like a rocket comes down like a stick.


Article Source: Fidelity Australia – Tom Stevenson, Investment Director

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