AS 2017 draws to a close, breaking out the champagne to celebrate the US tax cuts and record stock market prices suggest that bubbles will continue into 2018.
In hindsight, 2017 was one of the most exciting years because of very bipolar situations. Anyone who has lived with bipolar personalities would recognise that a high could feel that you are walking on clouds, but the lows certain feel very down.
There was hardly a dull moment with US President Trump’s tweets literally changing long-standing policies by the minute. From withdrawing from TPP and Paris Climate Accord to calling the North Korean leader a Rocket Man, nothing could be more divisive than making Jerusalem the location for the US Embassy for Israel. This crossed a red line for the Islamic community, since the US shifted from an arbiter of Middle East peace to a partisan player.
Brexit ended the year looking like the leaving wife has to pay up to US$50bil for the divorce privilege, keeping a back door (common Irish border) open for sneaking to the family house. The European Union took a tough line because if Britain could leave cheaply, it would encourage more leavers. But there is no doubt that when the far right won 13% of the votes in the German elections, polarisation within Europe on how to handle the rising tide of immigration will be its primary existential threat.
Through all the geopolitical stresses and strains, the global financial markets sailed through 2017 by creating record highs, ignoring any fear that the central banks would reverse their unconventional monetary policies. Indeed, the biggest surprise winner in terms of returns is bitcoin, which started the year at US$1,000 or so, and last traded at US$18,000. According to Investopedia, if you bought US$100 worth of bitcoin on Jan 1, 2011, you would be worth more than US$3.7mil at a price of US$11,321 at end-Nov 2017. At US$18,000 that would be worth more than US$5.8mil.
This is a bubble far worse than the South Sea Bubble of 1720. I am amazed at how sanguine central bankers and financial regulators are on how easily innocent investors in cyber currencies can be taken to the cleaners in this bubble. Most retail investors do not realise that cyber currency has no intrinsic value, it is not anyone’s liability with no custodian or central register. So when someone tells you that your cyber currency has “disappeared” due to hacking or fraud, the cyber currency investor has no legal protection at all.
According to Bloomberg, roughly 1,000 key players own up to 40% of bitcoin, so no one can check whether the prices and liquidity are subject to manipulation. After all, if you cannot crack Blockchain and trace who is doing what, how can any regulator find out who is responsible for what?
Since the market value of all cyber currencies already exceed US$200bil, and regulators are allowing both futures and initial coin offerings (ICOs) to open and trade, if and when institutional investors also get into the game, any collapse of the bubble will be very widespread and catastrophic in impact.
There are two ways to explain the authorities’ complacency. One is that they are playing bureaucratic legalism, claiming that since the cyber currency is neither currency nor commodity, regulation is outside each agencies’ narrow jurisdiction and therefore someone else is responsible for the mess when it collapses.
The other is that they feel that the market will sort this out, and that after the crash, investors will be taught a lesson better than any regulatory action.
Such behavior smacks of the “monumental collective intellectual failure” that did not foresee the 2008 global financial crisis. If the reversal of the cyber currency bubble causes widespread systemic failure like CDOs in 2007/08, then be assured that the regulators will ask for more laws, powers and blame it all on “shadow players”, where no one needs go to jail, no regulator is negligent and we can solve all this through more investor and consumer education.
A severe reversal of cyber currency bubble seems almost unavoidable, taking down some smaller players. Of course, since algorithm or computerised trading accounts for up to half the total trading in some markets, it would not be surprising that every drop will be an opportunity to buy the market higher. Hence it is quite possible that the market will continue to trade higher for a while, but it cannot defy gravity too long.
Basically, the financial markets are riding on expectations that economic growth is recovering everywhere. But any unknown trigger event could send it crashing. We live in a simultaneous knife edge of massive greed and bottomless fear – including the fear that we will miss the upside.
On the bright side, the Fed has finally made its interest rate adjustment, followed quickly by the People’s Bank of China. This means that interest rate normalisation is on its way. Traditionally the UK is a wind vane in taking interest rate action ahead of the US. But this time around Brexit worries may temper any aggressive rate increases by the Bank of England.
The real question on the economy is whether a flat US Treasury yield curve, which historically signalled a slowing economy, will come true or not. Optimists think that the US tax cuts will continue to boost the market, whereas Trump opponents vehemently argue the reverse.
Unbounded human optimism happens when there is what Charles Kindleberger calls a displacement – a phenomenal event that disorients rational thinking. The 18th century South Sea Bubble happened because great fortunes were made in colonies from growing cotton using slave trade.
Even the great scientist Isaac Newton lost a fortune playing stocks. As he famously said, he could calculate the movement of motion of heavenly bodies, but not the madness of the people.
This time around, we are living in an age of wondrous technology, at a time of great change that brings hope as well as despair of the unknown. This explains our euphoria and our worries. 2018 will be a year of great hope for optimists and devastating despair for pessimists.
Enjoy the bubble while it lasts. Happy New Year to all.
Andrew Sheng writes on global issues from an Asian perspective.