Long Bitcoin short term; short Bitcoin long term...
Wisdom on monetary economics from John Cochrane, Milton Friedman, Keynes. Unlimited Bitcoin derivatives & substitutes could destroy its value in the long run, but price can still go up for decades.
Yet another email on Bitcoin… It hit an all-time-high of $60k last week after coming out of the very recent dip to $45k. Here are some short-term and long-term price predictions by me and Stanford economist John Cochrane, along with some hardcore economic theory about the “Quantity Theory of Money” and “Fiscal Theory of the Price Level.”
Will Bitcoin drop to $30k by this summer? Likely not.
Some of you have texted me about “waiting for Bitcoin to drop to $30k by this summer and then buying the dip.” The new record high makes that seems more unlikely. Bitcoin is currently in this weird self-correcting mechanism: if it drops by 10%+, a lot of people will immediately buy in because they feel like they’re buying the dip, so that ensures that Bitcoin’s price wouldn’t fall too much anytime soon. It will continue to be volatile day-to-day, but I just don’t see it dropping 50% in value down to $30k anytime soon.
Trading Bitcoin is a risky endeavor; you should only invest in it if you believe in the long-term thesis – whether it’s the investment thesis or the grander vision for decentralization. That means holding it for a long time before cashing out and riding out any extreme short-term volatility.
Bitcoin will eventually go to zero in the very long term?
Hoping to be as unbiased as possible, I have and will continue to seek out good arguments against Bitcoin and cryptocurrency. Here’s one that I’d like to share with you today, made by John Cochrane, a Stanford economist who is quite renowned for his various contributions to financial & macroeconomics. Cochrane appeared on economist Tyler Cowen’s podcast and briefly touched on Bitcoin around 21 minutes in.
Cochrane believes that Bitcoin will eventually die, and here are his words (slightly edited for clarity):
It is a pure fiat unbacked money. It doesn’t have a government raising taxes to soak up the extra money if needed. It’s not anything real; it’s just in limited supply. In order to short it, you’d have to use up a lot of computer power. I’m very interested to see the crypto community to re-learn centuries of monetary economics.
Bitcoin is classic “MV=PY” fiat money. It has value because it has liquidity use, and it’s in limited supply because it takes money to make it. But there’s nothing preventing you from making substitutes and derivative claims that trade just like Bitcoin. For any asset that doesn’t prevent you to do so, the value of that asset will eventually go to zero.
That can take a long time. Markets can be very slightly inefficient in rate of return, while being highly inefficient in terms of prices.
Shorting Bitcoin wouldn’t work because it can go up for a long time before coming back down again. So if it costs you even 0.1% per year to short Bitcoin, and if you don’t have the money to stand the mark-to-market losses on the way, that price can be very far out of line. So 1% of inefficiency in rate of return can have 2% or 3% of ineffiency in terms of prices, and I think we see that all over the places.
What Cochrane is saying here is that even though Bitcoin theoretically has limited supply (21 million coins), the amount of financial products, substitutes, and derivatives generated by the Bitcoin ecosystem can be unlimited.
Fiat currency like dollar can also unlimited supply in theory, but the government can use taxation to soak up the amount of money circulating in the economy if needed, thus controlling the quantity of money. Bitcoin can’t really do this. (I later explain why quantity of money matters.)
But how long is long term? Probably longer than you think.
The title of this email “Long Bitcoin short term; short Bitcoin long term...” seems quite counter-intuitive to what most people believe in. If anything, most people would say that Bitcoin price would fall in the short term, but in the long term it will eventually play a much more dominant role in the global financial system because this trend of decentralized finance is inevitable.
It is interesting that despite believing that Bitcoin will eventually be worthless, Cochrane did also say that the price of Bitcoin could “go up for a long time.” This begs the question: what do “long time” and “eventually” mean in Cochrane’s time frame? Are we talking Bitcoin going up for the next 10 years before collapsing, or 100 years? I am once again reminded by the wisdom of John Maynard Keynes:
But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
Keynes has also said:
The markets can remain irrational longer than you can remain solvent.
In the context of my title, I consider “short run” as the next 5-10 years, at least, and even possibly the next couple decades. To really expect Bitcoin to completely die out, or to expect any market inefficiency to be fundamentally corrected, it may take decades if not even longer.
But if you view Bitcoin as an asset class in the historical cycles of finance and humanity, then sure it probably won’t last forever and will eventually die out in the long run. But the “long run” in this context (50+ years or even centuries) will certainly take much longer than the common “long-term investment horizon” that we commonly perceive to be (10-20 years).
So in my view, Bitcoin may have some volatility in the short-short term (next few months), but it will likely keep going up for the foreseeable short-term future (next few years), and it might only die out in the long-long term (decades or centuries later) if it ever does.
Bitcoin and the cryptocurrency vision are surely a long game. To some, “long game” means months; to others it means decades if not centuries. It’s easy to hear someone saying phrases like “long run” and simply interpret that to whatever we want to believe in. That’s very dangerous, especially in the context of crypto investing.
It goes back to my earlier point that Bitcoin may take years before dropping down to $30k again and decades to be worthless (or hitting $100k for that matter), but you hear people say Bitcoin will be “worthless (or to the moon) eventually” and immediately interpret that as in the next couple years – that might not have been what others meant, and you would lose money.
Everyone should determine for themselves how long they want to commit their capital and how patient they can be when things inevitably go bad for a period of time.
Now turning to some more hardcore economics in case you’re interested in learning more about Cochrane’s work, Milton Friedman, and monetary economics:
Quantity Theory of Money
Why does the quantity of money matter? This is where the “Quantity Theory of Money” and the MV=PY equation that Cochrane cited above come in, where:
M = Money supply
V= Velocity of money’s circulation in the economy
P= Price level (of goods and services)
Y = Real GDP
As explained by this simple post, the above equation must hold, meaning that the value of expenditure on goods and services must equal the value of output.
Monetarists (like Milton Friedman) believe that in the short-term velocity (V) is fixed, since the rate at which money circulates is determined by institutional factors, e.g. how often workers are paid does not change very much.
Monetarists also believe output Y is fixed. They state it may vary in the short run but not in the long run (because long-run aggregate supply is inelastic and determined by supply-side factors) – we don’t have to get into the details here.
Therefore an increase in the Money Supply M will lead to an increase in Price Level P, which is essentially inflation. This is the foundation for Friedman’s famous saying “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”
If you have too much money (either for dollar or for Bitcoin), that will certainly lead to a decline in the value of that asset, and eventually it will probably worth nothing…
Fiscal Theory of the Price Level
What stand on the opposite side of Milton Friedman and the Quantity Theory of Money are John Cochrane and the Fiscal Theory of the Price Level (FTPL), along with many other economists who developed the framework like Princeton Nobel Laureate Chris Sims. According to Wikipedia:
FTPL is the idea that government fiscal policy, including debt and taxes present and future, is the primary determinant of the price level or inflation as opposed to monetary theory. FTPL requires confidence the government will not default on its debts, but rather “inflate away” debts. FTPL suggests that currency is like a stock in a government and if the government has structural deficit then the “stock” losses value.
The intuitive logic is: The government needs to pay back its debt and cannot just run a Ponzi scheme. When it struggles to pay back its debt, it can refinance it by issuing new debt or simply engineer inflation so that the existing debt is worth less overtime. But if the people see the government as fundamentally incapable of ever paying back its debt, they will start dumping the debt they hold, and hyperinflation will happen.
FTPL assumes a fiscal-dominant regime in which the government determines its budget first, and the central bank then adjusts its policies accordingly. Price level according to the fiscal theory thus shows up through a very different mechanism from the Quantity Theory of Money (the monetarist view) – price level is now an endogenous variable, adjusting itself to bring about equilibrium after taking future surpluses, debt, and money supply as given.
I’m personally still not too sure how exactly we should apply FTPL to Bitcoin, and Cochrane didn’t say more about cryptocurrency beyond the quotes above. He is currently working on a comprehensive book about FTPL that has already exceeded 600 pages. As a staunch critic of Modern Monetary Theory, Cochrane believes that FTPL could do much more in guiding us through the coming years of economic uncertainty. I suppose in that case it also means the volatility of Bitcoin price!
The saga of Bitcoin is to be continued…
Disclaimer: Needless to say, my emails are just casual commentaries. I try my best to write them thoughtfully and with care to provide some alternative perspectives on various issues, but please do not treat them in any way as financial advice for your own investment.
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