5 March 2018

Boon or Bubble? Is Bitcoin a bubble, a scam, a Ponzi scheme? Or a transformational innovation which will change forever the functioning of the global economy? Begin by defining a bubble. People often use the term bubble to describe assets which they think are overvalued. But I find it more useful to define a bubble more narrowly. An asset can be held by someone who prizes its fundamental value – the use they will obtain from it, the income which it will yield over the years, or the pleasure they derive from owning it. Or it may be held for essentially speculative reasons by someone who hopes it to sell it on to someone else. A bubble exists when the asset is mainly held by the latter group, who hope to sell it on, rather than by people who are interested in its intrinsic value. The bubble bursts when there is no longer ‘someone else’, when the last guests arrive at the party and discover that the punch bowl is empty – and perhaps always was. Then price reverts to fundamental value – or perhaps below, as participants in the bubble are forced to realise their positions regardless of price. The Dutch tulip mania remains the most widely-quoted example of a bubble, but the Japanese property and securities boom of the late 1980s, and the dot-com boom a decade later, were recent clear examples. So what is the fundamental value of bitcoin? Some people suggest that since the future supply of bitcoin is limited, by design, the crypto-currency must not only have value, but increasing value. This is nonsense. I still have, or I may have lost, a sheet of World Cup stamps of 4d, overprinted “England Winners“. As a boy I queued to buy them in 1966. The Post Office had announced that the supply was strictly limited; but so, it proved, was the demand. The price rose, for a few days, as buyers who had been disappointed in the queue arrived late at the party; but the bubble lasted only a week or two. The best use of the stamps was to recover their fundamental value by sticking them on a letter.  Last week, I was quoted the price of such a stamp at 15p offer, nothing bid. It was my first lesson in economics, although I had yet to begin formal study of the subject. And when I did, Professor Youngson began the lecture course by drawing on the board those familiar curves that demonstrate that price is determined by the intersection of supply and demand. Can a bubble persist indefinitely? Can an asset price that permanently exceeds its fundamental value be sustained forever by speculative purchasers? There are three assets for which this might plausibly be, or  have been, true – gold, old master paintings, and paper currency. But look more carefully at each of these. Gold The World Gold Council estimates that the total amount of gold which has been mined is about 200,000 tonnes, of which around half is incorporated in jewellery. Private investment holdings amount to 40,000 tonnes, official stocks of gold comprise a similar quantity – the US government’s pile at Fort Knox is by far the largest hoard – and the balance of mined gold has gone for industrial and other uses.(1) Gold is a very good – and indestructible – conductor of electricity. But more importantly, it is lustrous, malleable and beautiful and for thousands of years rulers have adorned their monuments with it, devout believers have adorned their shrines with it, and wealthy men have hung it around the necks of their women. And, for a few centuries, gold and silver coins were used as medium of exchange. In Britain, gold coins were  effectively withdrawn from circulation at the outbreak of war in 1914. And the US made private ownership of gold illegal in 1933. But this history casts its shadow. The price of platinum today (around $1000 per ounce) is not much less than the price of gold (around $1300 per ounce). The earth’s crust is thought to contain almost as much platinum as gold (silver is much more common than either).(2) But a much smaller proportion of these deposits have ever been mined, since uses for platinum are mainly industrial, and both speculative and cosmetic applications are relatively modest. It is rarely possible to escape from supply and demand. Old Masters The price of some major paintings seems to defy any measure of fundamental value. Damien Hirst’s diamond studded skull was supposedly sold to an unnamed investment purchaser for $100 million dollars.(3) The market for old master paintings whose merits have stood the test of time – those which were painted before 1900 – looks a lot less like a bubble. Most of the old masters which have been sold in recent years have been purchased by, or for, public galleries. From which they will never re-emerge. Leonardo’s Salvator Mundi, Cezanne’s Card Players, and Gauguin’s When Will You Marry? went to Gulf museums. The most recent Rembrandts to come to market were purchased for the Louvre and the Rijksmuseum; the most valuable van Gogh to be sold recently is in New York’s MOMA, Rubens’ Massacre of the Innocents was purchased by by a Canadian philanthropist for the the National Gallery of Ontario, and Titian’s Diana and Callisto is in the National Gallery of Scotland. (The painting alternates between Edinburgh and London.) The Australian fraudster Alan Bond bought van Gogh’s Irises, but could not pay for it; and the work is now in the Getty Museum. The disgraced Japanese magnate who within a few days bought both van Gogh’s Portrait of Dr Gachet and Renoir’s Moulin de la Galette (a smaller version of the one in the Musee d’Orsay) probably couldn’t pay for them either, and these paintings have disappeared from view. The recent example of a purchase of an old master by a private individual is the acquisition by the American financier Leon Black of one of