Bitcoin, despite its name, isn’t money. Its price volatility significantly diminishes its usefulness as a reliable unit of account or an effective means of payment. Bitcoin might, however, serve as a sustainable store of value, like gold. Even if you’re not buying crypto assets, bitcoin’s boom-and-bust cycle is worth watching. It may foretell of heightened market volatility to come and significant imbalances across a broad swath of financial assets. The underlying technology, the blockchain, is a significant breakthrough. Bitcoin’s computer code was unveiled on Jan. 3, 2009, by the pseudonymous Satoshi Nakamoto. It deftly allows participants, who may not know or trust one another, to complete transactions without having to rely on any centralised governance regime. Most of us can’t read the code, but in bitcoin’s “genesis block” its creator inserted a curious bit of text, a headline from a U.K. newspaper that day: “Chancellor on the brink of the second bailout for banks.” Bitcoin’s founding spirit is evident, too, in what its founder wrote shortly after that: “The root problem with conventional currency is all the trust that’s required to make it work.”
Bitcoin’s earliest disciples included technologists and libertarians, along with a few doomsayers who feared catastrophe and currency debasement in the aftermath of the financial crisis. Still, the breadth of interest in cryptocurrencies—and bitcoin’s price—increased smartly. By Election Day 2016, one bitcoin was worth about $700. Then last year, buyer interest in bitcoin exploded. As the price kept climbing—past $2,000, then $5,000, then $10,000—the innovators were followed by imitators. Everyone from Uber drivers to grandmothers wanted in on the action. So did Wall Street pros, in pursuit of new assets under management. The price finally peaked at nearly $20,000 in December.
What caused the bitcoin fever of 2017? Euphoria is a part of the human condition, but also important were the changing contours of the global economy and economic policy. First, the election of President Trump reinvigorated animal spirits. Investors and CEOs began to expect pro-growth changes in regulatory and tax policy. The outlook for economic growth, both in the U.S. and abroad, improved markedly. The Fed raised short-term interest rates four times between Election Day and the end of 2017. But broader financial conditions—including the all-in cost and availability of credit across financial markets—were looser nonetheless. This economic backdrop made bitcoin and other alt-currencies look like a one-way bet. If loose financial conditions continued, risk assets like stocks and new-fangled cryptocurrencies would be bid up. If stronger growth brought higher inflation, causing the Fed to raise rates faster than expected, then bitcoin would be a haven from the volatility affecting other financial assets.
Second, investors, while decidedly upbeat overall, worried that the Trump administration’s trade policy might include a sustained bout of mercantilism, including dollar devaluation aimed at bolstering American exports in the short term. Administration authorities suggested a preference for a weaker dollar. And markets obeyed: The dollar lost 12% of its value against a trade-weighted basket of foreign currencies during 2017. Investors looking for another store of value found bitcoin and other cryptocurrencies, whose prices escalated accordingly. Third, trust in institutions plummeted amid the 2016 election. The Edelman Trust Barometer, a survey conducted in October and November, reported that in the U.S. “trust has suffered the largest-ever-recorded drop in the survey’s history.” The trend was driven “by a staggering lack of faith in government, which fell 14 points to 33 percent among the general population.” Another boost to cryptocurrencies.
The euphoria dissipated somewhat earlier this year. Two-way volatility jumped. Bitcoin dropped more than half from its December peak, before recovering somewhat in the past month to about $10,000. The other largest alt-currencies traded similarly. Investors are now recalibrating their expectations of government policy. Mr Trump’s mercantilist rhetoric may prove more than a negotiating tactic, auguring new tariffs and trade restrictions the world over. Economic isolationism would do great harm to our economic growth prospects. The Treasury should understand, too, that denigrating the world’s reserve currency is particularly ill-advised.
Jerome Powell, the new Fed chairman, might cause the institution to think anew about how best to conduct monetary policy. The Fed might also prudently consider introducing its digital currency to gain the benefits of innovation without sanctioning the illicit behaviour that bitcoin and its brethren have attracted. Most cryptocurrencies on the market today will turn out to be worthless. But a new generation of cryptocurrencies is on the horizon, some of which might possess more of the attributes of money, better satisfying bitcoin’s founding purpose. Bitcoin is particularly sensitive to new uncertainties in the conduct of economic policy. Bitcoin’s surge in volatility in December and January thus presaged the past month’s volatility in more traditional and consequential financial assets, including stocks, bonds and credit. When the tide goes out, the excesses in other financial asset classes will be more apparent. And bitcoin may well have shown the way.
Credit: Kevin Walsh for The Wall Street Journal, 7 March 2018.
Mr Warsh, a former member of the Federal Reserve Board, is a distinguished visiting fellow in economics at Stanford University’s Hoover Institution.