Bubbles in Bitcoin and Elsewhere


Global MoneySupplyGrowth

Michael Pollaro has recently updated his moneyTMS data. As of October, US monetary inflation shows signs of re-acceleration. Earlier in the year a slowdown could be observed in spite of ‘QE-to-infinity’. This was probably attributable to a combination of commercial bank credit inflation slowing down and dollars that moved into the US banking system during the height of the euro area debt crisis slowly leaking back out (only money that is on deposit in the US banking system is counted in the US money supply data).

As of October, broad US money TMS-2 is increasing at 8.4% year-on-year, at a 10.2% quarterly annualized rate and a 17.6% monthly annualized rate. Narrow money TMS-1, which is the more volatile measure, exhibits slower year-on-year growth (6.5%) as well as slower quarterly annualized growth (5.9%), but its monthly annualized growth rate has risen to 25.4%, so it is catching up.

In the rest of the world, a slowdown in money supply growth rates can be observed in the euro area. There is an ongoing decline in outstanding ECB credit as LTRO funds are repaid and bank credit expansion is sluggish. Even so, year-on-year money supply growth still clocks in at 6.5%, but that is down noticeably from the 8.8% high recorded in March and bound to slow down further (with quarterly annualized growth at 2.6% and monthly annualized growth at 4.7%).

In Japan, BoJ credit and hence excess bank reserves are surging at an unprecedented pace, but the response in terms of money supply growth has been very subdued so far. Year-on-year growth of money TMS has been at 4.6% recently, which is down from this year’s peak of 5%. The problem the BoJ is facing in its attempt to print Japan back to prosperity is that commercial bank credit continues to shrink, and with it the amount of uncovered money substitutes in the system (these are down 5.6% year-on-year, and the decline is accelerating, with the most recent monthly reading at a negative 15% annualized). That said, Japanese money supply growth seems set to increase anyway, as covered money substitutes grew at an astonishing 302% annualized pace last month.

There can also be little doubt that both the ECB and BoJ are planning to increase their pumping and/or its effectiveness. It seems also possible that similar to what has happened in the UK, the banking system will react with a lag to central bank largesse. In the UK, money TMS recently grew at 9.6% year-on-year, down slightly from this year’s peak readings above 10%. However, in spite of BoE credit growth turning slightly negative lately (‘QE’ hasn’t been increased further in the UK), commercial bank credit expansion has begun to take off.

In order to put all of this into perspective, the annual growth in the supply of gold amounts to approximately 1.4% (note also that non-monetary demand amounts to about half of the gold mined every year).

One thing is clear, the major central banks are all either actively inflating or aiding and abetting bank credit expansion. The main brake on their efforts is provided by the reluctance of commercial banks to expand inflationary credit, but as we can see in the UK this year, this can be overcome.

Bubbles Galore

All this monetary pumping is creating bubble conditions in numerous markets. The stock market’s relentless ascent (supported by a large increase in margin debt) is one of the better known bubbles, but we can also observe the effects elsewhere. One market that has recently begun to exhibit bubble conditions is bitcoin. Below is a one year chart of the crypto-currency. Over the past three weeks it has gone ‘parabolic’ for the second time this year:

Bitcoin over the past year. On Monday alone the currency rose by about $200 to a new high of $742 – click to enlarge.

One of the reasons cited for the recent acceleration of the uptrend is increased participation by Chinese speculators, who reportedly inter alia see bitcoin as a means to evade currency controls. It is interesting that the bitcoin chart looks like a compressed version of the 10-year chart of gold from 1970 to 1980. The major difference between these charts is that what happened in gold over the span of a decade has happened in bitcoin in just one year. Note that even the corrections and consolidations occurred at roughly the same levels and were of almost similar extent.

Gold 1970-1980 – the fractal shape of the chart is the same as that of the bitcoin bubble over the past year – click to enlarge.

NYSE margin debt as a percentage of US GDP – close to eclipsing the 2007 record high – click to enlarge.

However, bitcoin, stocks and junk bonds are not the only ‘bubbly’ markets. Last week the art world has also set a new record. A painting by Francis Bacon, a triptych depicting his friend Lucian Freud, was sold for $142.4 million at a Christie’s auction. This has made it the most expensive work of art ever sold at auction, eclipsing even the $119.9 million that were paid for Edvard Munch’s famous painting ‘The Scream’ in 2012 at Sotheby’s by a sizable margin.

The Francis Bacon triptych ‘Three Studies of Lucian Freud’ changed ownership for the princely sum of $142.4 million last week.

Meanwhile, One WTC (also known as ‘Freedom Tower’), the new skyscraper that is under construction in New York, will be the tallest building in the US with a height of 1776 feet. While not the tallest building in the world, it is still a noteworthy record. Extremely tall skyscrapers (often of record height) tend to by built at the tail end of business cycles and are so to speak monuments to the cluster of business errors that is usually close to being revealed. Very often the buildings concerned are only finished during the bust phase, but this is not always the case.

As Mark Thornton explains in his 2005 study on the skyscraper curse and the business cycle (pdf), there are several Cantillon effects at work (changes in relative prices actuated by an artificial suppression of interest rates below the natural rate) that lead to the construction of ever taller buildings close to the end of a business cycle. As land gets more expensive and the cost of credit decreases, it appears profitable to stack as many floors as possible on top of each other. Moreover, the expansion of business activities usually increases demand for office space at the same time. A major investment in a tall office building that might not be undertaken otherwise can look perfectly reasonable when interest rates are artificially low. Construction of the ‘tallest building’ is not always warning of an imminent bust, but it does so very often.

We can also observe the effect of changes in relative prices via the chart that shows the ratio of capital goods vs. consumer goods production. It has incidentally just reached a new all time high as well.

The ratio of capital goods (business equipment) to consumer goods production- click to enlarge.

The problem is that the effect of artificially suppressed interest rates on relative prices must eventually be reversed, in tandem with a rise in market interest rates (the gross market interest rate reflects more than just time preferences, but it is this component specifically that cannot be suppressed forever).

In terms of production ratios such as the one depicted above, one must consider that in order to invest in capital goods and lengthen the production structure, the pool of saved consumer goods must be large enough to sustain all these investment activities until they bear fruit. What the chart above tells us essentially is that the economy ties up more and more consumer goods relative to the amount it releases. It follows that the distortion in relative prices that has led to this situation must eventually reverse again. At that point the boom will turn to bust, which will inter alia impact the profitability of the latest tallest building.

And while we don’t know when exactly that will happen – the possibility that all or most of these bubbles will expand further cannot be ruled out – there are clearly more and more warning signs in evidence. They are largely ignored at the moment, but when the post mortem of the current echo bubble era is undertaken at some point in the future, we expect that all these signals will be identified as warning signs in hindsight.

Addendum: Litecoin Alarm

Bitcoin’s ‘little brother’ Litecoin has also joined the bubble lately. The recent strong move in this secondary crypto-currency can probably be compared to the rallies in four and five letter o-t-c and pink sheet stocks that tend to be seen in the latter stages of a stock market bubble.

Litecoin has suddenly taken off as well – the same thing happened close to the end of the first bitcoin blow-off move earlier this year – click to enlarge.

Charts by: Mt. Gox, Ltc-charts, St. Louis Fed, Bloomberg

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