For Tuesday December 10, 2013, We Recommend Against Investing


Investment Recommendations:

Avoid US markets and watch closely to see what trend develops.  Cash positions (including some currency outside of bank accounts) and price inflation hedges are still recommended.  There is too much uncertainty in US markets right now to make an investment recommendation, although it is probably safe to hold any currently owned equities for a few weeks.

Technical Comments:

The S&P 500 advanced 0.18% Monday with volume below last Friday and lighter than the 30-day moving average.  It is not usual for Monday volume to be lighter than the preceding Friday.  The continuation of up-days on light volume and down-days on strong volume could still produce a predictive pattern in the daily market data.  If the S&P 500 declines about 37 points on Tuesday (-2.1%) our automated market forecast could change to an uncertain trend.

Subjective Comments:

At the request of some readers, here are our thoughts on Bitcoin.  We have decided to comment on it not only because we were asked, but because we accept Bitcoin as donations from satisfied customers.

If you’re unfamiliar with Bitcoin, here is an introduction to what it is.  You can also watch a short video about Bitcoin here.  Bitcoin was created to be a digital currency and decentralized global payment network.  It is not issued by any government but instead it is being created by the payment processing network.  The network is not owned by a single company or a single entity.  Anyone who wants to participate can connect a specialized computer to the network via the internet and process transactions.  This is called “mining” and the incentive to become a Bitcoin miner is payment in Bitcoin currency units.  When the network has produced about 21 million Bitcoins no more will be produced and miners will then earn donated transaction fees.  Individuals can purchase Bitcoin without participating in Bitcoin mining, and Bitcoin can be used as a currency to purchase some goods and services.

There is a raging debate about Bitcoin as awareness of it has been increasing.  The current debates seek to answer this question; is Bitcoin money?  It’s also being asked if Bitcoin is an investment.  Bitcoin can be considered an investment with risks and opportunities.  Since it was designed to be a currency and transactions can be conducted in Bitcoin, it is a currency but it is not a stable currency and is not yet fully functioning as “money”.  We have high hopes for Bitcoin and are aware many promoters want it to become fully functioning money, but if we are to be fair about Bitcoin we feel compelled to point out this current deficiency;  Bitcoin is not yet functional as a “unit of account” for economic calculations.  Bitcoin could mature, become more stable in its purchasing power, and become money, but it’s not there yet.  The “unit of account” for economic calculations is best described by an example.  If you’re considering opening a new business or expanding a current business, you would evaluate the profit potential by looking at gross revenues, costs, etc.  This would include labor costs, capital expenditures and the like.  If you could use Bitcoin to evaluate all of these costs and revenues, then Bitcoin would be functioning as a “unit of account”.  The really critical test would be the willingness of people to accept wages in a set amount of Bitcoin, for example 10 Bitcoins per month, regardless of its fluctuating value in terms of other currencies.

Bitcoin as an investment is possible because people are expecting its purchasing power to increase over time.  If Bitcoin had become stable in its purchasing power then as an investment it would prevent the loss of purchasing power via inflation, and this is one of the major advantages of Bitcoin.  Yes, Bitcoin is currently “inflating” to 21 Million Bitcoin, but it is doing so on a published and known rate and will eventually end.  There are drawbacks to Bitcoin that will eventually be overcome.  Some examples are the recent thefts of Bitcoin and the technological sophistication required to protect against theft.  As the market provides solutions for these issues Bitcoin will likely become more popular.  There are two drawbacks that Bitcoin will never overcome, but these drawbacks might or might not prevent it from becoming fully functioning money.  The permanent limitations of Bitcoin are these:

  1. As a virtual currency, it depends on the internet and electricity.  Power outages will create problems in conducting transactions in Bitcoin.
  2. Bitcoin is not anonymous.  Despite anything you have read to the contrary, all Bitcoin transactions are publicly available and not difficult for governments to trace to specific persons.

The first drawback is self-evident, but the second requires a little explanation.  A major problem with computer files as currency is the ability to replicate the files.  File replication is easy and allows everyone to print money of digital currencies.  Bitcoin solves this problem by making public every single transaction in a register called the “blockchain”.  This enables everyone to see how much Bitcoin is in each “wallet” at any point in time.  It prevents people from trying to replicate their Bitcoin units.  This is a great feature, but it also creates the traceability.  We think this will eventually prevent thieves from stealing Bitcoin as the network will undoubtedly create a mechanism to identify the wallet addresses that contain stolen Bitcoin.  Like antivirus software, there will be services that the Bitcoin network and user community can use so honest people refuse to accept stolen Bitcoin.  This feature is also fantastic since it will prevent money printing.  New wallet addresses can be created, and some people mistakenly believe moving Bitcoin into new wallet addresses can preserve anonymity.  Sophisticated programs can identify these types of transactions, and this activity will likely be labeled as “money laundering” and outlawed.  The markets where physical currencies can be exchanged for Bitcoin will have to capture identifiable data about account owners to comply with various financial laws, and this will enable governments to connect bank accounts to Bitcoin transactions and wallets.  This will likely not prevent Bitcoin from being used, but users must be aware and assume all their Bitcoin transactions are tracked.  These two drawbacks will, in our opinion, prevent Bitcoin from becoming the only currency used.  The need for other currencies will remain.

This brings us to our opinion of Bitcoin as an investment.  At present Bitcoin is not traded by a lot of people.  The Bitcoin market is not very liquid, and as such the price swings have been tremendous and are likely to be so for quite a while.  If you purchase a lot of Bitcoin and the price increases, you might find it difficult to sell and lock in your gains.  Your selling could cause the price to drop.  Until Bitcoin becomes much more liquid, the investment is similar to thinly traded penny stocks and subject to “pump and dump” scams.  Bitcoin is NOT a Ponzi scheme, although fraudsters could invent Ponzi schemes using Bitcoin.  If you choose to invest in Bitcoin on the hope its purchasing power will increase, go ahead.  We recommend considering it a highly speculative and thus highly risky investment.  For this reason only invest an amount you could afford to completely lose.  Limiting your investment to a relatively small amount protects your overall portfolio.  If you’re right, the payoff could be very large.  We do own Bitcoin, but at present we use it to purchase internet advertising and pay for our webhosting services.  We are not accumulating or holding Bitcoin as a speculative investment.

Among economists there is a definition of “money”, and there is a lot of interesting debate about calling Bitcoin “money”.  Austrian economists have the best monetary theory of any economic school.  Considering the origin of money as explained by Carl Menger and the regression theorem provided by Ludwig von Mises, we think Bitcoin is becoming money.  At present Bitcoin is being purchased using other currencies.  Bitcoin is gaining value from people’s subjective valuations and could become money by replacing other currencies.  We think this would all be consistent with economic theory.  Bottom line, Bitcoin was designed as a currency and could become money.  At present it is not fully money and only time will settle the debate about Bitcoin’s future.