In a recent blog post, Bob Murphy succinctly asks a question that seems to get at the heart of the disagreements between Bitcoin proponents, and Bitcoin haters like me:
There are people claiming that Bitcoin’s non-monetary price is zero, and hence if it’s trading for anything at all, it is in a bubble. But by that logic, gold’s non-monetary price might be (say) $250, and so if it’s trading right now for $1,250, then $1,000 of that is clearly just due to a self-fulfilling prophecy, where people are willing to pay $1,250 for gold because they think that’s how much (at least) it will be worth in the future. If something were to shatter that expectation, then the price of gold would plummet back down to its fundamental value of $250
He similarly quotes a hypothetical proponent’s position, which I believe captures my point of view quite fairly. I would recommend reading his whole post, it’s not very long. I’ve touched on this particular argument before, but I think I should expound on it, given the opportunity to respond directly to Dr. Murphy’s careful layout of the proponent’s position. Murphy, at least for the purposes of this article, accepts the premise that bitcoin has no value as a consumer good, whereas gold has some. I will counter-argue with that premise as well. He also makes some of the same distinctions in categories of valuation that I like to make: consumption, store of value, and speculation. However, I think that Greater Fool speculation is a separate entity. But let’s start with the beginning.
He gives $250 as a hypothetical market value for gold in a pure consumer market today, and of course $0 for bitcoin. For simplicity, let’s suppose that this hypothetical $250 market price is absent any major lapses in knowledge on the part of vendors, so we can safely take as a given that there is no bubble in this market. In reality, a price of $250 doesn’t mean that all consumers are willing to buy at exactly $250, there will be a range of prices at which potential consumers are willing to buy. Suppose this range is between $100 and $1000. We arrive at the price of $250 because anybody only willing to spend $249 is out-bid by people willing to spend $250 or more. The number of people willing to pay $250 or more roughly matches the amount vendors are willing to sell at the same price (basic supply and demand).
Supposing then, that people start deciding to buy gold as a store of value. Many of them are willing to spend more than $250 an ounce, thus they outbid many of the potential consumers in the market, bringing the price up to, say, $300. In buying for a store of value, they expect the price to stay roughly the same, at worst. As such they are speculating on price stability (as Mises said, all action is speculative). Is this a bubble? Not necessarily, because we said that there are potential consumers going up all the way to the $1000 range. It might be a bubble, since these holders may be overestimating the demand at those higher prices, but not necessarily, because they might be right. In contrast, if the same is done with bitcoin (again, taking the $0 pure-consumer market assumption) they can’t possibly be right, so it must be a bubble.
Okay, so what brings gold all the way to $1200 today? It is probably the result of speculation, but the sort of longer-term speculation on effects of inflation of the dollar, in which the gold is priced. Is this a bubble? Again, not necessarily. If the feared outcome of inflation comes to fruition, consumer goods will skyrocket in price, and gold is a consumer good. The hypothetical pure-consumer market, may rise, say, to $1100. If we then account for the store-of-value speculators of that future date, those who speculate on price stability, perhaps the stable price post-inflation will be $1500. Now, the long-term speculators could be wrong that impending inflationary effects will increase the consumer + store-of-value price of gold to that degree, in which case this mentality and the resulting price would be a bubble. But in doing the same with bitcoin, taking the opening assumptions of no consumer market, they are surely wrong.
I’d like to note here that store-of-value speculation on price stability, alone, can increase the price of gold, but it cannot (without being a bubble) rise above the hypothetical price that the highest bidding consumer is willing to pay. That is, this cannot raise it above $1000 in the initial example. But speculating on price increase, as in the case of inflation speculators, the price can be well above today’s entire consumer market, without (necessarily) being a bubble. That said, this is not even the case today; gold-tipped RCA cables are still on the market. I like to point to this example because even jewelry can be a convenient store of value, whereas it seems implausible for RCA cables.
Finally, none of what I’ve described thus far is actually what I would consider “Greater Fool” speculation. All of the above forms of speculation, as I have described them, are based on the expectation, correct or not, of certain consumer prices at a certain point in the future. Greater Fool speculation, on the other hand, is speculation based on the assumption that another trader will always be around to keep the price afloat, in spite of the fact that there is no expectation of consumers. I don’t believe that it is correct to describe every price above the consumer price of gold to be a Greater Fool price. I’d gladly concede that some of gold’s price is due to it, maybe a whole lot of it, like in any market. But to say that everything holding gold so high above the hypothetical pure consumer market price is Greater Fool pricing is incorrect. A lot of speculation is quite legitimate, and as such, it is not necessarily a bubble (again, there could still be bad data). However if we assume that bitcoin has no potential for a consumer market, we must conclude that it is purely a bubble, either via bad data by those who believe bitcoin does have a consumer market, or of the Greater Fool variety for those who do not.
Original content by Dan, CC0 (attribution appreciated), tips welcome