Sunday, December 8, 2013

If Something Doesn't Make Any Sense to You.....

If something doesn't make any sense to you, maybe that is because it is nonsense.

When I was younger, and someone tried to explain some financial transaction to me that made no sense to me, I figured that maybe I was just dense and didn't "get it."   After all, smarter people than I had investigated these things and must have found them sound.  I was just too young and naive to understand the complexities of finance.

Or so I thought.

As I got older, I started to see a pattern in these things.   People would try to sell me (often literally) on financial concepts that made no sense to me.   Later on, we discovered that they were flawed concepts - and a lot of people would lose their shirts in the process.

It began to dawn on me that perhaps I wasn't such an idiot after all, but rather my "gut instincts" were telling me that a snow job is a snow job.

For example, in 1989, I bought a house in Fairfax County, Virginia.   My boss told me at the time that property values in Fairfax County would always go up!   And everyone was buying and selling houses, which were appreciating, in some instances, by as much as 30% in a year.   I kept scratching my head about this, and thought, "This makes no sense!"

But "smarter" people than me explained, condescendingly, that I was just too dumb to understand.  "But," I said, "if housing prices keep going up this fast, who will be able to afford to buy them?   And if it costs far less to rent than to own, why bother owning?"

"Tut, tut," they replied, "You just don't see the bigger picture!"

Well, turns out, I was right and they were wrong.  The housing market in Fairfax County crashed and crashed hard, in the 1990's, with waves of foreclosures and short sales.  I bought some nice properties at that point - in foreclosure sales.

Twenty years later - nearly to the day - the exact same thing happened again - and the same people were telling me I was "dumb" to get out of the Real Estate market when so many people were "cleaning up".  This time around, I listened to my gut instincts, and not the "experts."  I made a million dollars, literally.

In retrospect, we all saw what happened.   Financial instruments that, on their face, made no sense, were being bought and sold, with no one bothering to ask whether they were sound or not.  Small investors were buying and flipping houses, and prices were climbing into the stratosphere.

This second time around, I was not so intimidated by the "experts" and sold out before the crash.  I began to realize that "experts" are just jerks like you and me.   And I realized this after taking the stand and testifying as an "expert witness" in a couple of cases.   Being "expert" in this country doesn't take a whole heck of a lot.  And experts are wrong - a lot of the time.

So I stopped listening to experts and listened to my gut instincts instead.   And when I was told some story that made no sense, I stopped thinking that maybe I was dumb and "didn't get it" but rather than people were trying to sell me horseshit.

And horseshit sales are booming.

Young people are still told these wild stories - and young people still believe them and not their own instincts.   Many a young person has tried to extoll the virtues of leasing to me, or explain why spending $100 a month on a smart phone is a "good deal".   Deep down, they know they are lying to themselves and these deals make no sense.  But they bought into "cash-flow" arguments or "opportunity cost" arguments that were peddled by retailers, and believed them, even if they made no sense.

The other day, I read this stupid story online about Bitcoin.   The tag line was "Man buys $100,000 Tesla with Bitcoins!" which sounds so trendy and cool, as it ties the trendy Tesla to the trendy Bitcoin.   But the reality is that this fellow cashed in his Bitcoins and then bought the Tesla with dollars. But that is not a very interesting story, is it?

I had heard about Bitcoins as some kind of online currency, but never really gave it much thought.    After all, if you want to shop online, everyone already takes credit cards or PayPal or whatever.   Why screw around with something else?

But the more I looked into Bitcoins, the more I felt I was being fed one of those "you're-too-dumb-to-understand-it" kind of deals.

How do you get Bitcoins?  What is the currency based on?    Well you can buy a Bitcoin, at current exchange rates - which vary wildly and have gone up dramatically over time.  Or you can "mine" them - which is what the currency is based on.

Mining?  How?  

Well, basically, they give away the bitcoins to people who can program their computers to solve algorithms - puzzles, if you will.   Solving these puzzles benefits nobody and creates no wealth.   We are not talking about decrypting documents or decoding DNA.   No, the bitcoin miners merely solve arbitrary puzzles and are awarded this imaginary currency as a result.  Over time, the puzzles get harder, and eventually, they will cease entirely when 21 million bitcoins are "minted".    So the currency has a fixed size, in terms of big "M" or the money supply.  This means that if an economy were based on bitcoins, it would have a hard time growing, as the currency would become more and more valuable over time.

It almost sounds like a practical joke being played on us by an Econ major.  Or the Mother of all pyramid schemes.   Think about it.  Each "puzzle" that these computers solve is harder than the last.  As a result, today, to "mine" a bitcoin, you need banks of computers solving these problems - the power needed to run them is staggering.   But the first guy who started it, mined the first Bitcoin in a few minutes, if that.  The first 100 in an hour.   The first million in a day.   He's sitting on a pile of dough and you ain't.   Sounds like a pyramid scheme to me!   And I suspect it will collapse when the last Bitcoin is "mined".

Well, who set up this deal?   That's where it gets really weird.  No one really knows.  The founder of bitcoin won't disclose his real name, and the enforcement and management of bitcoin depends on a distributed network of public keys and encryption.

In theory the system is secure, but there have been some thefts reported.   The "money" resides in your hard drive, unless you print out the code numbers representing your wealth.  As reported recently, one unlucky chap lost a fortune when he threw out his hard drive and lost a thousand bitcoins, reportedly worth a million bucks or so.  Back then, they were worth pennies apiece, so he didn't think much of throwing the hard drive away...

Which brings up an interesting point.   Bitcoins, like any currency, can be lost, stolen, or mutilated.  So, over time, the number of Bitcoins in circulation will decrease, since the maximum number is limited to 21 million.   If you take this to its logical conclusion, eventually, we will run out of Bitcoins.

The currency is not stable.  It has gone from 32 cents to 32 dollars, just in 2011 and then back down to two dollars.  It soared to nearly $1100 dollars and then back down to $600.  Some claim that this extreme volatility is irrelevant - as the bitcoin is just an exchange medium, and not a currency that one holds.  Yet the limited number of bitcoins encourages hoarding of the coins.   And if it is just an exchange medium, then it really isn't a currency, is it?

But taking all that aside, what is the real value of this money?   It is a perception-based currency,  and when people perceive it to be valuable then it has a value.   And today, people are perceiving it to be valuable, just as people perceive gold to be valuable.   And some would argue - again with the "you're-too-dumb-to-understand" argument, that all currencies are based on perception of value.

And while there is a nugget of truth to this, it reminds me of these relativists who argue that all truth and perception is relative, based on the person observing - and that "reality" is a myth.   But while that sounds find in the lecture hall on campus, in the real world (and there is one) it falls flat.   You may think you can fly if you jump off the Empire State Building - but mean old reality will tell you otherwise, in about 30 seconds.

And, oddly enough, the same has happened to Bitcoin, in fact, last week.   The value of bitcoins dropped by nearly half.  Far from being a stable currency, bitcoin has turned out to be, well, something else entirely.  It is hard to understand why someone would put "full faith and credit" in a currency based on the ability to solve meaningless and unproductive puzzles by computer.  No real work is being done - just make-work.   Nothing is being created.  No wealth is being created.   It is just a lot of people deciding that this arbitrary currency has value.

Now, you could say the same about the dollar - and indeed, all currencies, even gold (especially gold) are based on consumer perception of their value.  A currency is little more than a placeholder of wealth - an means of measuring the relative values of disparate items.  And in that regard, as I noted, money is the greatest invention of mankind.

But what makes the U.S. Dollar different from Bitcoin is that we know who controls the dollar and how.  It's value is not only determined by consumer perception, but by our interest rates, the amount in circulation, and the monetary policy of the Fed.   You may agree and disagree with the actions of the Fed, but the bottom line is, we know who is running the show, and they are answerable to the President, Congress, and by extension to the American people.

Yes, the dollar could also crash, but I am not so sure it will.  The economy is growing, inflation is down, and interest rates are low.   The rest of the world still cherishes U.S. Dollars and while China may hold a ton of our debt, we are paying them very little in interest for these loans (and despite what tea-baggers say, China cannot "call" this loan.  If you own a T-bill, you know how powerless you are as a creditor to the USA).

So, no, I don't buy the arguments that bitcoins are just like dollars and based on perception alone.  And no, it  is not because I'm too dumb to get it, but because the argument is bullshit.  And I'm old enough to detect bullshit when I see it.

Maybe down the road bitcoin will succeed.  I doubt it though.  For any "virtual currency" to succeed, it would have to be more widely used than bitcoin.  Only 1000 retailers worldwide accept it, only only a pitiful 10,000 online.  This is not enough to sustain a real currency for real trading.

It would also have to be controlled or monitored by some government agency or body of governments (like the Euro).   It would have to be backed by more than the ability to solve puzzles on your computer.   And we'd have to know who is actually running the show, too.

And I am not sure why people would bother with Bitcoins.   Granted, transaction fees for moving currency overseas are a pain in the ass, as I have noted before.   The banks, it seems, want a piece of every dollar you move from country to country, in wire transfer fees, credit card fees, or whatever.   Bitcoin promises to eliminate or reduce that - but you still have to find someone to convert Bitcoins to and from local currencies, and that is going to involve fees, as well as currency conversion rates.   Leaving money in bitcoin form runs the risk of sudden devaluation - as happened the other day when the value of bitcoins dropped in half.

In other words, I am not sure Bitcoins really have much of a use - or are a "cure" for anything in our existing system.   They may incur less banking fees, but they have far greater risks in valuation and liquidity.   And no, I'm not dumb for "not getting it" - it simply doesn't make any sense.   And certainly, the average citizen of any country will have little use for Bitcoins in their daily lives.

But the point is, never feel like an idiot when someone tries to explain some concept to you that sounds like a come-on.   In fact, if you feel "dumb" because you don't understand a lease agreement, or reverse interest-rate default swaps, or buying gold as an investment, you should take this as a warning sign that you are being fed a wagon-load of horseshit, and you are about to get ripped off.

Clever people always want to make you feel dumb - so they can take advantage of you.   When you feel this happening, treat it as an alarm going off - police tape roping off a bad deal - and just walk toward the door.

In the long run, you will be better off.    And no, you won't miss out on a "good deal".   There are plenty of other good deals out there, that are easy to understand for the simple reason that they make sense.