The Crypto Crash

The American economy has already slid into a recession, I think. It’s never clear at first; the statistics come in later. Officially, a recession requires two quarters of down output. We’ve had one already.

It doesn’t feel good: too much bad news. Labor shortages everywhere. The inflation rate, above 8%, is up; the stock market is down. What economists are likely to remember, though, is the collapse in the cryptocurrency market.

James Surowiecki has written a piece in the Atlantic called “How Crypto Disappeared into Thin Air.” This could happen, he writes, because cryptocurrencies have no intrinsic value — “value that’s independent of what other people will pay for them.” Unlike a stock, which has dividends, earnings per share, and a company behind it, a cryptocurrency’s value “depends on what other people think it’s worth” and only on that. He quotes a crypto investor: “If the collective group of people on the internet believes something has value, it has value. We are in a world where belief equals value.”

Too much bad news. Labor shortages everywhere. The inflation rate is up. The stock market is down.

In a deeper sense, all value is subjective, as the Austrians say, but that’s not what Surowiecki means. Ordinary values, though ultimately subjective, have ties to real things. A share of stock is an abstraction, but it generally reflects the earnings per share of the company behind it (though the stockholder doesn’t get those) and the dividend, if there is one. The value of a house generally reflects what it could rent for, and if it is in good repair and in a desirable location, the cost of building another one like it. Few things are in a pure belief-equals-value market. Surowiecki mentions collectibles. Megan McArdle, writing in the Washington Post a year and a half ago, compared cryptocurrencies to Hummels, the German figurines.

But crypto is not a rare book, a ’37 Cord, or a ceramic boy. Yet it has risen, like the genie from the lamp, to “more than $1 trillion of value out of thin air (or, more accurately, out of code) in less than a decade,” Surowiecki writes. And now the structure has collapsed.

But what is cryptocurrency, to begin with? I have asked several tech people to explain it. They tell me how it works, but I want to know what it is.

On the internet, “Investopedia” defines a cryptocurrency as “a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology — a distributed ledger enforced by a disparate network of computers.”

You haven’t actually killed anything, and your reward is an image and sound made of ones and zeroes. Make-believe.

Blockchain is a setup to make sure the Bitcoins, and their imitators, cannot be counterfeited or double-spent. Investopedia goes on: “The decentralized structure allows [cryptocurrencies] to exist outside the control of governments and central authorities.” Fine. We’re libertarians, so that’s OK with us. But this is a description of how the cryptocurrency works. We want to know what it is.

Surowiecki never says. A Bitcoin is a — what?

Consider how you get one. You can buy one with dollars, in the market, or you can “mine” one by solving a puzzle in base-16 numbers using a graphics processing unit or an application-specific integrated circuit (ASIC). This is expensive (in dollars, for the computers and electricity). But if you solve the puzzle, you get a Bitcoin.

They call this “mining,” but really it’s pretend mining. It’s more like playing a shoot-em-up video game and getting to the tenth level. You haven’t actually killed anything, and your reward is an image and sound made of ones and zeroes. Make-believe. What cryptocurrency has done, it seems to me, is to put an outlandish label on make-believe, and declare it real.

I can hear the objection. “What is a dollar? It’s not a unit of anything, either.” A dollar used to be an IOU-gold, but for 90 years it has been an IOU-nothing. Fine. But everyone accepts dollars. You accept them. Americans do their business in dollars and keep their assets in dollars. We think in dollars. The cryptocurrency market is priced in dollars and the collapse has been measured in dollars.

Why not a private currency? OK, fine. But crypto is not widely accepted in trade and it has not been a reliable store of value. What makes it a currency, other than that you say it is?

Biden has been spending and borrowing on a trillion-dollar scale. Trump did it, and before Trump, Obama did it, but Biden has outdone them.

For more than a decade, a huge number of people didn’t worry about this. I know a young man who was paid in crypto, watched it go up (in dollars), sold it and bought a house. Good for him! I know another who has been making his living in the crypto market. I imagine it’s not so good for him right now. The whole episode of crypto, it seems to me, has been the closest thing in my lifetime to the tulipmania in the Netherlands 400 years ago.

Historically, the peak of an economic boom is the classic time for the rise of belief-based assets, from the tulip bulbs in the 1640s to the dotcoms of the 1990s to the rotten-mortgage bonds of 2008. The crypto crash is a sign that down-to-earth stocks, real estate, and commodities are probably in for a rough ride, that people’s assets are going to shrink (in dollars). Some of them are going to lose their jobs.

I could be wrong, but it doesn’t look good.

It’s particularly not good for President Biden and the Democrats. When recessions hit, the party in power takes a hit. This is not always fair, because the president is not a businessman and the economy is not run by the government, but here there is some fairness in it. Biden has been spending and borrowing on a trillion-dollar scale. Trump did it, and before Trump, Obama did it, but Biden has outdone them. COVID-19 has provided the grand excuse for chugging economic medicine. Stimulus! If the Democrats know anything, it’s how to provide stimulus. Spend! And now they have stimulated America into 8% inflation.

Nothing like this had been done since the Truman administration, when the nation was carrying the debt from World War II.

Plenty of people warned them not to do this, including, in 2021, Harvard Professor Larry Summers, who was the treasury secretary for Bill Clinton. The naysayers, including Summers, were brushed aside. When inflation reared up, the Bidenites said not to worry, it was a blip, a one-off caused by problems in the supply chain. But inflation didn’t go away. It’s climbed steadily to 8%. Once you get that high you don’t get back to the 1-to-2% range without a hard landing.

Another thing: interest rates. They go down after everyone realizes there is a recession. The drop stimulates borrowing and investing. Once the recovery is under way, interest rates begin creeping up. After the 2008 recession, Obama’s Federal Reserve never let short-term rates go up. They kept T-bill rates and money-market rates at nearly zero for Obama’s whole eight years in office. Nothing like this had been done since the Truman administration, when the nation was carrying the debt from World War II. The problem with this is that at the next recession, the Fed can’t lower rates if they’re already at zero.

And that’s where they have been. The only weapon the Biden people have for fighting a recession is spending. They know how to do that. They call it “investing.”

Probably the Republicans will take Congress in November, but they “invest” other people’s money, too.

Tighten your seatbelt.