Topic: The Dichotomy Of a Bubble - Why Bitcoin Will Endure - page 3. (Read 17509 times)

I recommend a work by a bubble-expert: BUBBLES AND HOW TO SURVIVE THEM by JOHN P. CALVERLEY

Available here.

According to his checklist, I would rate Bitcoin about 6/9. You can recognize many of the mantras of the Bitcoin community in his write-up.


RAPIDLY RISING PRICES
First of all, a bubble obviously involves a period of rapidly rising prices. However, a strong rise in prices in itself does not necessarily imply a bubble, because prices may start from undervalued levels. So we should only start to suspect a bubble if valuations have moved well above historical averages, on indicators such as the price–earnings ratio for stocks or the house price–salaries ratio for housing. The extent of this overvaluation probably gives us the best clue as to the exact probability of a bubble. For example, the US stock bubble in the 1990s took the price–earnings ratio on operating earnings (which excludes one-off factors) to over 30 times, well above the long-term average of about 14–16 times.

OVERVALUATION
The issue of valuation is contentious, with many people arguing that we can never be sure that a market is really overvalued. I disagree and believe that we can identify ranges for valuations that are more or less reasonable, such that if a market goes above them, we can say that there is at least a high probability that it is a bubble. Further evidence can then be sought in other characteristics.

ECONOMIC UPSWING
Typically bubbles develop after several years of solid, encouraging economic growth and rising confidence. The traumas of past recessions and bubble crises (at least in the same market) have faded away. For example, the US 1990s stock market bubble came in the last three years of a nine-year economic expansion and following fifteen years of a relatively strong stock market. And the Asian property and stock market bubbles that burst in 1997–8 came after over a decade of breakneck expansion, which had become known as the Asian Miracle.
The current housing bubbles are a little different in that they have inflated at the same time as the collapse of the stock bubble. However, they come 10 years or more after the last housing bubble burst in the early 1990s and they are partly the result of the low interest rates put in place to fight the effects of the bursting of the stock bubble. Moreover, the most intense housing bubbles currently are in Australia, the UK, and Spain, three of only a handful of major countries that avoided a recession during 2000–3.

NEW ELEMENT
As noted earlier, another typical characteristic of a bubble is a new development or change in the economy that can reasonably justify higher prices. In the 1990s it was computers and networking technology and, more broadly, the apparent sharp acceleration in US productivity growth that led to much talk of a “new economy.” In the 1980s in Japan it was the perception that the Japanese economic model, with all its panoply of “just-in-time” inventory management, worker involvement, and “total quality control,” was going to dominate the world. Current housing bubbles in the UK and Australia are often linked to increased immigration.


PARADIGM SHIFT
There is often the perception of a “paradigm shift” and this is usually argued energetically by some leading opinion formers. We shall see later that people seem to have an innate tendency to believe (or want to believe) that current events are entirely different from any episodes in the past. This is a natural characteristic of younger people especially and certainly the 1990s internet boom was very much led by young people. But of course, some people have a vested interest in arguing that “it is different this time”—especially brokers, fund managers, and real estate agents.
I do not for one moment want to sound like someone who has seen it all before and believes that nothing is new under the sun. Economic performance and market behavior do change over time and periods of strong performance and weak performance can persist for a long time, often decades or more. Nevertheless, it is dangerous to extrapolate this into justifying very high valuations, at least without serious caveats.
Even if higher valuations in a market can be justified by fundamental changes in performance, we should expect this to be a one-off move, not a shift to permanently faster price increases. For example, faster growth of profits would justify higher valuations, but once valuations have moved a step higher, stock price gains should then slow down to the rate of growth of profits. It is unrealistic to expect valuation multiples to expand further. The same goes for house prices. If a higher house price–earnings ratio really is justified now, as many people argue, once the step higher has been made house price growth should return to the growth rate of earnings.
The US 1990s experience is interesting in this regard. The acceleration in productivity growth in the 1990s, part of the paradigm shift that accompanied the bubble, continues to be reaffirmed. US productivity growth since 2000—that is, after the bubble—has averaged 4 percent a year, a very high rate. Similarly, the new technologies continue to permeate the economy in ways that many of the new economy enthusiasts correctly predicted. But during the bubble a crucial point was forgotten: Faster productivity growth does not mean higher profitability in the long run. At first it brings higher profits, but this then brings more investment, more competition, and, eventually, lower prices so that the gains flow through to increased real incomes. Profits fall back to normal levels because in a market economy companies cannot hold onto them in the long run.

NEW INVESTORS AND ENTREPRENEURS
Returning to the checklist, a regular feature of bubbles is that new investors are typically drawn in, people who had not invested at all before or had been only very passive players. They are persuaded by the bulls’ arguments and also by the continuing rise in the market. Often they are assisted by the emergence of new entrepreneurs, for example those offering new investment vehicles, like the internet offerings in the late 1990s or the buy-to-let funds in Britain and Australia in recent years

POPULAR AND MEDIA INTEREST
Popular interest in the market becomes intense and this is reflected in greatly increased media coverage. Some stories emphasize the “wow” factor, as big rises in markets make people rich overnight. During stock bubbles, media stories may be tinged with envy for the lucky few, or even hostility toward “speculators.” In the case of housing markets, where often a majority of readers will be gainers, the emotional hook may be glee at the good news. A subtext may be that the reader too can get rich and some coverage will put the emphasis on how to join the party, for example providing information on stock funds or on mortgages and property investment.
Another type of media story will focus on the risk that the market is in a bubble, warning of trouble and usually critical of speculators and, sometimes, of the authorities for allowing it. There are nearly always some commentators who forecast the demise of the bubble. For example, in the late 1990s The Economist and the Financial Times regularly returned to the bubble theme in US stocks. In recent years they have been justifiably pleased with themselves, although too polite to gloat. And they have turned their attention to warning about housing bubbles.

MAJOR RISE IN LENDING
Typically bubbles also involve a significant rise in lending by banks or other lenders. Sometimes this reflects regulatory or structural changes in lending practices and often it involves new entrants to the market.
The housing bubbles in the UK and Scandinavia in the 1980s followed the liberalization of banking systems, which allowed banks to lend far more freely than in the past. Debt tends to rise and the household savings rate tends to fall. Behind all this is often what I would characterize as a relaxed monetary policy. Sometimes this is evident from a rapid rise in money growth. Probably more important, though, is the rate of credit growth; that is, the increase in debt (related to but not identical to the rate of money growth). Sometimes too it can be seen in the level of real interest rates in the economy, which may look unusually low.

STRONG EXCHANGE RATE
A final characteristic of most bubbles is a strong exchange rate or, if the currency is fixed, an inflow of resources. During the bubble money flows into the country, either attracted by the booming asset or drawn in by the strength of the accompanying economic boom. The strong currencythen leads to trade and current account deficits. Indeed, that is the “purpose” in a sense, so that there can be a net capital inflow, by definition equal to the current account deficit.

Not all of the items on the checklist are present in every bubble. Ultimately, deciding whether a particular market boom is really a bubble is a matter of judgment, based on the number of characteristics present and how extreme they have become. If we think back to the internet bubble of the late 1990s, it should have been clear to all at the end of 1999 and the beginning of 2000 that this was a bubble. But by then the bubble was nearing the peak, with the US NASDAQ index rising from about 2,800 at the beginning of October 1999 to its peak of just over 5,000 six months later. It dropped back through the 2,800 level in December 2000 and went to a low of about 1,200 in 2002, the same level as 1996; see Chart 1.2. Ideally we would have identified a high degree of bubble risk
as early as the middle of 1998 and some degree of risk also in 1997.

Every movement upward or down, there is the same question that is reverberated in these forums and elsewhere. "Is Bitcoin a Bubble?". Rather than type a cursory sentence or two refuting the whole concept, I took it upon myself to gather the 'evidence' from prior bubbles to see if we were in fact repeating history. Many sensational claims have been made, and I believe that the emotion involved has allowed the facts to be obscured to the point that no one really has a good definition of what a bubble is.

Allow me to provide some examples, gathered from some graphs that have been helpfully posted on the web. As a general rule, a bubble can be defined as part psychological, where people become so rapt with the promise of future gains they throw all caution to the wind; To the literal interpretation of charts, a peak of such-and-such value is what infers the later collapse of speculative frenzy.

For instance, take a look at this chart of the South Sea Trading Company.



Here we see the issuance of new shares or 'subscriptions' that take the speculation to new heights before crashing back to prior values.

As a rule of thumb, a bubble can be defined as a surge in price that takes an equal amount of time to subside, sometimes shorter - but never longer than the original buildup in price.

Looking at the chart prior, and to the latest chart at: http://bitcoincharts.com/charts/mtgoxUSD

I can make the following assertions: If we align the rise in price from the south sea chart to the bitcoin one, I'd start comparing bitcoin from April to present day. IF... and I do mean "IF" bitcoin is a bubble, this means that the runup from April to the mid-June high of 30+ will subside to previous levels by the last day in August.

That is -- IF it is a bubble at all, which I personally think it isn't.

Take a look at this chart:



Ah yes, the oft-quoted tulip-mania. When a man's servant ate what he mistook to be an onion for his supper, putting out his master to a great degree (thousands upon thousands of gilders) he barely escaped with his life. Such a meal! I hope it was worth it

Here we see a rather exponential curve that culminates in a nasty crash, not following the symmetrical pattern we discussed before. If we were to equate this with the same starting point of April in the bitcoin chart, that would mean a nearly exponential rise for the next two years (2013), followed by a crash to the starting point of this year.

Another example is the classic "Dot-Com" bubble. As shown by the chart here:


Six years up, only four years down from the peak before it hit the same level. So - you must be asking yourself, "Is bitcoin a bubble?". Well, here's the answer - I don't personally think so, but let's go with the charts. If bitcoin is a bubble, then it will follow the same pattern as other bubbles, more or less. That means a minimum growth period of two years (possibly longer) to the same amount of decline after.

In support of this theory, a few projections and examples:






So, there you have it. I'd like this thread to be the focal point of any further 'bubble' accusations and discussion. What the hell - at least the worst case is you have two years to get your bids in and run with it. Again, personally, I don't think we will mirror this example.

I'm interested to hear what you think.