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Tulips, Bubbles, and Bitcoin

It is tulip season in Mt. Vernon, and for me that brings to mind a book.

One of the classic investment books is Extraordinary Popular Delusions and Other Madness of the Crowd by Charles Mackay. Despite being first published in 1841, it is one of those books that I think has not only withstood the test of time, but is also, and unfortunately, relevant to modern investing every few years. The book begins in the 1600s and works its way through famous bubbles, such as the South Sea Bubble from 1719, John Law’s French Mississippi Scheme, and, perhaps most famously, Tulip Mania.

Tulip Mania swept through Europe in the 1630s. Tulips were a highly-desired luxury item from the Ottoman Empire and with so few making their way into Europe, the prices began to rise to the point where in 1634, speculators were investing in them – a perishable good! By 1635, 40 tulip bulbs were worth 100,000 florins, while the average yearly wage was only 150 florins. In 1636, with a booming futures market, two tulip bulbs could have purchased 12 acres of land. Many investors made very rich.

By February of 1637, the market dried up and prices crashed.

It’s not hard for the modern investor to jump from Tulips to the Dot Com bubble of the late 1990s/early 2000s. Hindsight being 20/20, we like to think we wouldn’t fall into another bubble so quickly, but as Mackay’s book proves, we all love the idea of a get-rich-quick scheme, and it is difficult not to imagine that the next is somehow going to be different.

I overheard a conversation in the grocery store back at the beginning of 1999; I overheard two twenty-something women talking and one said, “You’ve got to buy stocks! You know, you can borrow money on your Visa card, and you’ll only have to pay 18% interest!” To me, as an investor, that was another signal that the Dot Com bubble, that those good times, were coming to an end.

Something similar occurred a couple of months ago; I had a former sales associate call, and after some brief small-talk, she asked me for a loan of $10,000 to purchase Bitcoin. She has no investing experience and I wasn’t swayed to invest, but I got the same feeling I had the grocery store almost 20 years ago.

My concerns with Bitcoin stem from the same place as Tulip Mania. When I invest, my evaluations are based on measured value. I believe that if you cannot measure the value, it isn’t a good deal. I am also devoted to doing my own research because I know that TV personalities, the media, and so-called “experts” all have their own agendas. When I can’t rule out any of those concerns, there are too many red flags for me to invest in the product.

I’ve heard some people discussing the idea that Bitcoin could become a world currency, and perhaps it’s on that basis that the virtual currency has skyrocketed 1600%. The problem with that idea is that there are some very strict requirements for a currency to become the primary exchange currency. The reason the US dollar is so far-reaching – is, in fact, used in 85% of all foreign currency transactions and greater than 60% of all foreign countries hold their reserves in the US dollar – is because it is uniquely stable, large, and backed unconditionally by the United States government.

Prior to 1914, there were three primary currencies – the English Pound, French Franc, and the German Marc. Following WWII and the Great Depression, a number of countries met together and from that meeting came the rules that still define a world currency. At the time, the United States was the largest nation with both world-wide reach and the least damage following the war. The US had an enormous trade surplus, and other countries such as the UK found themselves deep in debt following the war. Any other currencies that were potentially stable enough were too small – specifically Switzerland’s Franc. In the end, the United States dominated and the dollar cemented its place as the world-wide industry.

Bitcoin is neither large nor stable enough to take the place of the dollar as a world currency. In fact, the dollar was considered a safe-haven even during the Great Recession.

In the end, much of the market is about perception – if the market believes 2+2=5, they’ll buy for 4 ¾ all day long. While the perception of Bitcoin is bringing speculators flocking, I don’t trust that the perception will hold, and like the Tulips, eventually someone will realize we’ve been paying more than they’re worth.

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