Bitcoin, the Supernova of Deflation

Wherein we discuss the confluence of quants, computers, macroeconomics, and SQL.

Herbalife is a ponzi scheme, although it remains legal. So is bitcoin. Whether either will survive 2014 is up for debate. For this piece, bitcoin is discussed.

For those who're lazy (or don't like my prose), here's the punch line: should bitcoin's promoters get their way, i.e. bitcoin becomes the reserve currency of record, the world will fall into a permanent deflationary spiral. The sole winners will be the early buyers (Winklevii, I'm talking to you). Just as they are in a Ponzi scheme. There is historic precedent, for those who bother to look. 19th century USofA was a morass of falling prices and wealth concentration, and for the obvious reason; gold standard currency is dependent on native lodes of the metal and appeared only a very few times. The entire amount of gold extracted from the planet for all time has been described as about enough to fill an olympic swimming pool. The Wiki says a 21 meter cube. Near enough.

Here's an academic-ish review. On balance, the 19th century was volatile to a degree no one alive today, or their grandparents, have experienced first hand. But there was more deflation and depression than the 20th by a long shot.

By now, the Mt. Gox fiasco is well known. What isn't known, as I type, is whether the entirety of deposits (said to be 750,000 bitcoin) has vanished. The metaphor for bitcoin, mining, to gold was intentional. The difference is that the amount of recoverable gold is unknown, while with bitcoin it is fixed and published: 21 million of the little boogers, 2.5/minute and soon even less. There are reported to be 12 million already mined. 9 million to go, and a long way to get there: 2140. Unlike gold, which submits to standard mining techniques (pretty much) once located and whose total is unknown, bitcoin mining is intentionally non-linear with time, number of miners, and of a single source. The notion that such a snail's pace of currency generation can support expanding global commerce is somewhere between silly and evil. Making value independent of governments, sovereignty, geology, and place of residence (e.g., external factors which individuals can't easily change) sounds like an egalitarian motive. But the implementation is decidedly autocratic. The gating factor is bitcoins/unit time; this is fixed, until it gets smaller. The reason mining has become so compute intensive is that the gating factor is a constant, irregardless of the amount of mining attempted (the machine increases difficulty as the number of attempts increases to hold static the number of bitcoins released, a pure positive feedback loop); not the move from 50 to 25 per unit time. Moreover, by making the game one of rewarding timeliness rather than actual effort, the game is perverse. Kind of like being born 7 feet tall with a deadly 18 footer; pure chance to get massive reward.

As with the archetype Ponzi, the later you join the harder it is to succeed. Herbalife, but with a much larger cost of entry.

Which all reminds me of the taunt from grad school (voiced by MBA wannabes to the rest of us): "if you're so smart, why ain't ya rich?" Well, here's the other side:

At the Tokyo office building housing Mt. Gox, bitcoin trader Kolin Burges said he had picketed outside since Feb. 14 after traveling from London in an effort to get back $320,000 he has tied up in bitcoins with Mt. Gox.

Bitcoin is a ponzi scheme, and makes little effort to hide this fact. They've just used veiled language. At the beginning, mining was easy with few computers involved, so the originators could make all they wanted. Soon enough, godzilla sized computers are needed. In short order, mining them becomes nearly impossible, on a cost/benefit basis. It's already reached the point that the cost of the electricity alone to run the required computing power exceeds the value of mined coins. The system, by design, adjusts to the amount of mining by making the mining process more difficult. Thus, early miners who were few in number got lots of bitcoin with minimal effort. Since the release rate is what's fixed, more or less, at a point in time, then the effort/reward metric skyrockets as more mining is attempted. It's as if God goes about hiding the gold as more miners enter the lode. How Darwin of him. And so Ponzi. Today's serious miners are betting that bitcoin's value will move inversely to national currency (mostly, the US buck). That deflation will occur globally, and raise the purchasing power of bitcoin. Gold bugs have the same point of view.

The SQL part? MtGox has been hacked with sql injection before. And current reporting says that the missing bitcoins dribbled out over the years, not as a single event robbery. No Ocean's 666. I certainly wouldn't bet against the possibility that the sql injection vector has been ongoing since first admitted.

As to the macroeconomic effect of bitcoin uber alles? The main two are that wealth would concentrate to a degree not seen since the pharaohs, and deflation becomes the norm. Why, one might ask? Well, for the same reason as in the 19th century: with a fixed amount of legal tender, any expansion in output has to be accommodated within that currency store. Price * output == money supply. Price, in the aggregate, has to fall. Falling prices are an incentive to hoard, and thus a disincentive to produce. Death spiral. Of course it can be argued that if output *does* increase (the necessary motive for deflation), then no harm no foul as it's just a wash. History says it's never been a wash. The Fortune X00 are hoarding trillions of $$$ as we speak, CPI/PPI flip-flop around the 0 mark, and we've not yet entered the bitcoin spiral. The issue is that deflation must, necessarily, reduce output increases due to hoarding and wealth concentration.

Since the bitcoin mining supply rule is intentionally asymptotic to 0, and is well into its declining stage due to the release criteria: every 10 minutes 25 bitcoins appear. Since this is not a reward for effort, but for timeliness, the proportional return on effort is inverse to the total amount of mining computer power employed. And, as we know, that has skyrocketed. Just as in real world gold rushes, the more the sadder; all but a handful waste not only time and energy, but funds which could have been put to productive use. One might as well spend the moolah on Powerball. Odds might even be better. In real gold rushes, those that made money were the ones who sold eggs and beer to the miners. All that gold, and only so many eggs and kegs of beer. One might see the correlation in the move from cpu to gpu to asic processing in mining: the ones making the money are the egg and beer guys.

Tulips, anyone?

Catch Me, If You Can

Yesterday, I tossed in a metaphor to the growing realization that there just might be limits to making "new" tech. Specifically, that:

May be vendors should include a phone life's supply of Prozac?

You know, with the stasis of tech, we enter a Dark Age, where little ever changes, the archetype of economic and social depression? A sarcastic metaphor?

So, what should show up in my inbox today, you may ask? This (I use Thunderbird, and only directly download headers. Cuts down on nonsense, so I'd advise you don't actually follow any links. I munged it just in case.)

Get Help for Depression SignsofDepression.z@jn.newmailonline.XXXXX

Look under the bed!!! Look under the bed!!!

Boris Godunov

A recent itch, motivated in large part by the carping from the smartphone gallery, is that Moore's Law nears repeal. Unless some new physics becomes evident.

Announcements for the latest Samsung Galaxy phone abound. This is from AnandTech. Pay special attention to the comments. It's beginning to dawn on folks that limits exist. May be vendors should include a phone life's supply of Prozac?

The first comment to get it.

We're entering the era of "good enough" in the smartphone space. If you've been happy so far you'll be happy for plenty of time ahead.
-- Mondozai

Then we have, pithy the poor man.

How fast the market was moving from 2007 to 2009 led me to believe we would be seeing some true innovation and mind blowing things by now. Even Apple is doing incremental upgrades every year. Better cameras and a faster soc's, this has turned into the PC industry.
-- agent2099

Sounds like a financial sector quant. Just because one thinks today looks mostly better than yesterday doesn't mean tomorrow will look mostly better than today. Well, until stasis has won, so the days run into each other like a pea soup fog. Of course.

Baksheesh

(Another comment, elsewhere, that gets elevated to essay. Kind of a selfie, I guess. The context: whether any of the other semiconductor companies can, or even should try to, match Intel. From the quant's point of view: what should be the measure of RoI, and how should it be measured? If tech is close to, even reached, stasis, then justification for buying more of existing producer goods rest solely on fulfilling unmet demand. With global wealth/income continuing to concentrate, is there meaningfully growing unmet demand? Has a black swan touched down in Wall Street?)

The larger issue, and certainly not imminent for the momo or day trading types, is what becomes the $$$ sink for The Giant Pool of Money? It's still out there. And now we've got more in the form of giant cash balances in the Fortune X00. The right wing Americans (mostly, financial sector with a dog in this fight) demand that we're spending too much on consumption, and not investing enough (they want those fees). Fact is, except for healthcare and semis, most "investment" is things like housing and finance and share buybacks. None of which produce anything. The Fortune X00 and the existing Giant Pool of Money are still sitting out there, looking for baksheesh. But without an avenue to buy "better" producer goods into, return on investment falls. As it has been, and without any help from the Fed. That's why the housing market was targeted by the Giant Pool of Money: seen as low risk, high payoff (relative to what real physical investment was providing); iow, low return on real investment had already happened by 2003, and is still here.

The return on physical investment is a function of technological progress; iow, there's no reason to add an open hearth steel furnace, only a better one. If there isn't....? You see where this is going? For much of the last 60 years, that's been semis. If semis also reaches a place of tech stasis, how to earn from investment? Housing pays off only if owners can earn more, since housing doesn't produce anything. Since they weren't the house of cards collapsed. If industry, too, hits a wall of stasis, what do we then?

[Looked at another way: the owners of the Giant Pool of Money seek to extort high return from Treasuries, i.e. taxpayers, rather than actually building out infrastructure. As the captains of industry seek to avoid making real investment due to perceived low real returns, then Treasuries' return must fall, too. Demanding X% from the Government when industry only returns Y% (less than X%, of course) with real investment perverts the system. Kind of moral hazard. Without expanding technology, and unmet demand, i.e. moolah in the hands of the many, capital loses value. And, no, rate of time preference is not the gating element, tech is.]

Have a nice day.

Hair Brained

The 2008 FOMC transcripts are released. As you can see, they're extensive. More text than my single set of eyeballs really want to endure. Fortunately, the NYT has plenty of eyeballs, and have gone through them. And published a number of pieces.

What's missing from the writeups is any reference by those within the Fed to the disconnect between house prices and incomes as impetus to the crisis. If I survive chopping yet more ice from the driveway, I'll have a go at the transcripts and update. For now, here are my takeaways.

- Yellen is smarter than Bernanke and Paulson
- Quants are dumb as a sack of hair
- Fed members from fascist states are as fascist as one might expect

Here's the list of articles, in descending order of interest. Although I find them all interesting.

The Fed's Actions in 2008: What the Transcripts Reveal (The online version is much more extensive than the dead trees I read this AM.)

Fed Misread Crisis in 2008, Records Show

As Crisis Loomed, Yellen Made Wry and Forceful Calls for Action

Fed Fretted Over Reaction to Demise of Lehman

Reporter's short notes


Transcripts timeline:

Yellen: For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter] Reservations are no longer necessary at many high-end restaurants. And the Silicon Valley Country Club, with a $250,000 entrance fee and seven-to-eight-year waiting list, has seen the number of would-be new members shrink to a mere thirteen. [Laughter]

Which simply means that she looked out the window to discover that it really was raining, despite what the weathermen were saying. Anecdotal evidence is still evidence.


Yellen piece:

What the transcripts show is a woman who was constantly pushing her peers -- and also cleverly cajoling them -- to do more to help ordinary households, not just financial institutions. At the same time, she urged her colleagues to look at the flaws in the banks that caused the crisis in the first place. "I don't believe in gradualism in circumstances like these," Ms. Yellen said in March 2008, months before the situation came to a boil.

Fed Misread article:

The Fed's understanding of the crisis, however, was clouded by its reliance on indicators that tend to miss sharp changes in conditions. The government initially estimated, for example, that the economy expanded in the first half of 2008 because it basically assumed that some economic trends, like the pace of business creation, had continued apace.
...
The transcript for that meeting contains 129 mentions of "inflation" and five of "recession."
...
Some Fed officials have argued that the Fed was blind in 2008 because it relied, like everyone else, on a standard set of economic indicators.

Lehman piece:

Today, critics of the Treasury and the Fed say that the our-hands-were-tied argument may be an excuse, used after the fact, as a shield from criticism that they were negligent and miscalculated badly.

"It was a post-incident rationalization," Harvey R. Miller, a partner at Weil, Gotshal & Manges, said in an interview on Friday.
...
"Although Fed officials discussed and dismissed many ideas in the chaotic days leading up to the bankruptcy, the Fed did not furnish to the F.C.I.C. any written analysis to illustrate that Lehman lacked sufficient collateral to secure a loan," the [FCIC] report noted.

Reporters' Notes:

"While there are tales of woe, none of the 30 C.E.O.'s to whom I talked, outside of housing, see the economy trending into negative territory," said Richard Fisher of the Dallas Fed in January. "They see slower growth. Some of them see much slower growth. None of them at this juncture -- the cover of Newsweek notwithstanding, a great contra-indicator, which by the way shows 'the road to recession' on the issue that is about to come out -- see us going into recession."
...
And while the stock market might drop in the short term, [Jeffrey M. Lacker, then and now the Richmond Fed president] added, there was a "silver lining" to Lehman's collapse. "I don't want to be sanguine about it, but the silver lining to all the disruption that's ahead of us is that it will enhance the credibility of any commitment that we make in the future to be willing to let an institution fail and to risk such disruption again."

Life is so much more comfortable in that 1% bubble.


In sum then, no understanding that mortgages had and were outstripping incomes. Utter subservience to quants, who didn't have a clue. And, save Yellen, little concern except for their clients on Wall Street. Not a banner year. So far as cure, no indication that the Fed folks, as a whole, understood they were the last, but wrong, bastion against complete collapse. The correct approach, of course, was/is fiscal policy to restore demand, but the Republicans were and are steadfast against "giveaways" to the unworthy. That left the Fed, but recovery monetary policy is never any more than pushing a string, as we have seen. Generating a contraction, to kill dat ole debbel inflation, is yanking the gallows' rope. Works like a charm; Volker was a blessed savior for killing inflation caused by OPEC oil price hikes (not domestic profligacy). Even now, corporate America considers the Fed as constraining. Total ingrates.

Sup?

Ok, I know I should enter some blogging, commenting twelve step program, but may be tomorrow.

Anyway, one of the many postings, many places, chewing on the WhatsApp buying led me to post the following comment (it starts with a snip from a previous comment):

-- younger users will move from them extremely fast if something better comes along.

The point, of course, is that Zuck (and all the other advert shifting folks) is simply chasing the fungible whims of hormone overloaded kiddies. They don't even comprehend good, better, best; only different. And, if 55 coders could make something different that filled a whim, some other bunch of 55 coders will shortly do so, again. Flush $19 billion down the crapper. Again.

Someone(s), possibly Carr, voiced the current situation with "high tech" and "innovation" as computerized putting-out or cottage industry, which was based on a, relatively, cheap bit of technology (most often that new fangled sewing machine) dispersed in homes. The workers often got just subsistence wages, if that. All those HuffPo scribes and Seeking Alpha pundits, for example. The difference being that if fickle finger of fate dubs you, you're very rich. For creating a bit of software infotoyment. An economy and society built on sand.

Viva la Difference [update]

Here's an interesting quote (from here):

Does that ring a bell? That kind of trade is similar to transactions in derivative products known as credit default swaps that played a key role in the financial crisis. Credit default swaps allowed investors to bet on the health of housing-related securities; with Bitcoin, they're betting on the health of Mt.Gox.

That's almost correct. And, of course, it was the quants that went hog wild ("But I was just following orders!") with CDSs. There is a difference: with CDSs, there's no limit on how many can bet on the underlying entity's failure. Kind of like the craps table: one shooter, but lots of bettors. The Mt. Gox situation is simply discounting the instrument, much as a stock will crater on bad news. Unless, of course, these Mt. Gox-ians are emulating "The Producers" by selling more than 100% of what they hold. Wouldn't that be fun?

"It took me less than 12 hours of programming to do this, and I didn't have to get approval from anyone," Jones said. "It's an uncertain time, and I think there's money to be made and lost."

If that sounds like financial anarchy, I'd bet you're quite correct. I wonder how many survivalists have BitCoins next to their Rands and M-16s?

[update]

Mt. Gox is officially dead: here

And in the same Top Stories box, we find that gold is (allegedly) manipulated by some London banks. "We make money the old fashioned way, we cheat."