We’re not sure why Federal Reserve member Neel Kashkari feels that he’s qualified to speak about investments. What he lacks in knowledge, he more than makes up for with contempt.
If you wish to speak about investments, it’s a good idea to at least be familiar with the basics. While the Federal Reserve does important work, their field of expertise is not in investments, as they instead formulate and design monetary policy to manage our economy.
When it comes to investments, everyone seems to have an opinion, whether it is based upon the facts or sound judgement or not, and we can even say that the great majority of opinion in the field is not. When it comes to an investment like Bitcoin, all bets are off here as there are a great many who remain totally confused about what goes on in this market, even though it should be so simple to understand.
Minneapolis Fed President Neel Kashkari certainly has a pretty strong resume, starting out as an aerospace engineer, getting a business degree, and then helping guide us through one of the most difficult times in history as an aide to Treasury Secretary Hank Paulsen during the financial crisis of 2009, helping administer the bailout that saved us.
After a 4-year stint at bond king Pimco, and an unsuccessful bid to become governor of California, Kashkari became named president of the Minneapolis Federal Reserve in 2015, and is part of what we could call the New Fed, which is doing a great job at what they do these days.
Kashkari has plenty of ambition, but sometimes ambition can get the best of us, as his comments about Bitcoin clearly attest to. Somewhere along the way, whether that be in business school or during his career, he surely would have been exposed to how financial markets work, although his dim view of Bitcoin tells us otherwise, in a striking way.
The errors that Kashkari is making in his evaluation of Bitcoin are so elementary and obvious as to throw himself into much disrepute, although we may want to see this as his being angry at Bitcoin for some reason and then allowing this anger to dominate his thinking to the point where even the obvious gets set aside in favor of just ranting for its own sake.
It turns out that Kashkari’s real beef is that Bitcoin just isn’t anywhere near as good of a currency as the U.S. dollar or other major currencies, although that would be an understatement, as it is a terrible currency that is simply way too volatile to be of much use. This would still be the case even if they could get transaction processing times down to that of Visa and Mastercard, because as long as people are speculating on it, it will be far too wild to be a good currency, because this will always keep it far too volatile.
We have little doubt that Kashkari has at least a good understanding of how currencies work, and being up on this is part of his job at the Fed. His understanding of investing is so lacking though that he doesn’t even realize that the real purpose of Bitcoin isn’t for it to function as a currency, but as an investment. It is not like the dollar, it is like gold, even though it may be gold on steroids.
We might think that no one could make such a big mistake, but to hear Kashkari speak, there is no doubt that he is making it. Whether or not Bitcoin is all that useful or even useful at all as a currency has no bearing on its investment value, just like the fact that no one buys and sells anything with gold coins anymore has nothing to do with investing in gold.
Because Bitcoin does not make much sense as a currency, he feels entitled to call it “burning garbage.” He is not alone in this view of course, as there are plenty of others that consider investing in Bitcoin investing in nothing, but he shares with them a fundamental misunderstanding of investing itself.
Investing in financial assets just requires us to have a positive expectation with the value of the assets we invest in, and this is what we are out for when we invest in Bitcoin as well, nothing more and nothing less. The value of an investment is always derived from the market, what you can sell it for, and this is where it gets all of its value in fact.
As basic of an idea as this may be, there are many whose understanding does not even extend this far. They even think that other assets such as stocks and bonds do not work this way as well, which casts their entire investment thinking into disrepute, placing limitations on asset prices that do not correspond to the real world such as using fundamentals such as book value to price stocks.
The next step in our figuring this out is that assets do not require underlying value at all to have market value, and this is where Bitcoin provides us with the perfect lesson here, since there is nothing that would stop it in theory from going down all the way to nothing. There is no floor, but we don’t ever hit the floor with anything really, as it is at best an illusion, and the market will always decide the value of something based upon what it wishes to pay for something at a given time.
There is also no real ceiling, with Bitcoin, gold, stocks, or just about anything else, and if the market wants to bid any of these up to the sky, they could and nothing would get in its way. Financial markets are all about supply and demand, period, and while external factors can affect this supply and demand, they never in themselves determine it, or even need to exist at all, as they do not with Bitcoin and other cybercurrencies.
Speculation Is What Drives Financial Asset Prices, Bitcoin or Otherwise
We tend to think that it is the business results that drive stock prices for instance, without realizing that it is only the interpretation of them by the market that moves prices. There are therefore two components to this, which we could call the fundamental and the speculative side, and the speculative side is the one that ultimately decides, especially when there is nothing else to go on like with cybercurrencies, or gold for that matter.
We pay a lot more for gold due to speculating on it than if its use were confined to using it as a business input, and if all of the speculation we do with gold was suddenly withdrawn, the thing that some fear will happen with Bitcoin, the price would drop to practically zero, with only companies that use it left to fight it out. Still though, we invest in gold with a very high degree of confidence about this not happening, and with good reason, because speculation will keep the price way above this floor even in the worst of times.
If we derive significant comfort in the fact that gold won’t go all the way down to zero or a stock won’t dip to quite zero, where we now are happy that we’re only losing almost all of the money we have in these things, that sure doesn’t amount to much solace. The risk with Bitcoin was with the first fall, and we now have a floor, and this floor is just as real as any other because that’s when demand takes over again and puts the price back up.
If we cannot appreciate the role that speculation plays in other investments, we’re certainly going to be confused with what goes on with Bitcoin, because none of this will make sense to us. Just because we cannot make sense of something due to a lack of understanding does not mean that it does not make sense period, no matter how strong our views may be.
Kashkari tells us that Bitcoin investing is limited to “toy collectors.” Bitcoin gets called this by him because it has so little use as a currency, and he completely misses the fact that all investing is toy collecting in the sense he means it, or to put it more accurately, bets on something going up in value over time. If this is to be understood as playing with toys, these toys are pretty important as they decide how well-off or not our futures will be.
He offers up treasuries as an example of a non-toy to invest in, although it is not made clear at all why, other than the fact that he has thought about the matter so superficially that he doesn’t get that these two types of investments both involve placing bets on the future direction of markets. The only real difference here is of magnitude, where the treasury toy is just a little top that travels very little on our floor, where Bitcoin is a remote-controlled monster truck toy that has the potential to crush this top or anything else that gets in its way.
This does not mean that the monster truck is necessarily preferable, as that will come down to analysis, and we’re still at the stage of characterizing what it is, and it is far from the thin air that so many think it is. It is a very powerful investment entity in fact, far more powerful than traditional investments, and so much so that it needs to be approached with much more caution.
This is not nothingness and as far from it as we could get in fact. It might be seen as garbage from the perspective of those who have been taken down by this beast, or by those who have been too afraid to take it on and are just looking to rationalize to cope, but there are many who have made a lot of money from this and their returns have been as far from garbage as you can get.
Kashkari hasn’t even made it this far to make that mistake though, even though many have. He tells us that “the idea that these virtual currencies are ever going to compete with the dollar is hard to fathom,” which is why it is garbage. The fact that people can make a lot of money off of this independent of its use as a currency is somehow lost on him.
Bitcoin is Indeed New, Which Means We Need to Think About it More
He sees holding Bitcoin as “a novelty,” which is pretty curious given that this means that all investments are novelties. People do invest in novelties of various types, but it’s not to just own the monster toy truck, it’s to have it make money for us. With Bitcoin, since it is a novel investment, there may be an element of novelty here but this is completely drowned out by the much bigger ambition of profiting.
Kashkari ends up admitting that Bitcoin does function like gold, which is in itself an admission that whether or not it serves as a good currency doesn’t matter, as gold doesn’t function as a currency either, but he tries to quash that idea by saying that the barrier for creating such assets is now virtually zero.
We only have to look upon how many cryptocurrencies we have created so far to see how low the threshold has become, and this is certainly a new thing that has been created completely within the digital realm now that we have one. Not that this would matter, but there are limitations to this, real ones, which are the limits of how much money people are willing to put into these investments at any given point in time.
This is another way of saying that the market will ultimately decide the extent of our investments into these digital assets, and the same limitation applies to all assets in the same way. We only want to drive the price of anything so far, and we’ve seen that happen with Bitcoin already, where we went too far and saw a big correction due to profit taking.
Kashkari also ended up admitting that Bitcoin can play a role in stabilizing economies that have had their currency bashed, such as Venezuela, but in order to really get what Bitcoin does, he needs to be thinking about its value as an investment separately, its speculative value in other words.
Trading any financial security, even treasuries, does not add or subtract anything from the real world, it just involves these securities changing hands, held by one person instead of another. This is all that Bitcoin involves, but is essentially all that other securities involve as well.
After a wild ride, Bitcoin is becoming more stable as an investment, and while trading it does require quite a bit more skill than treasuries or stocks do, in the right hands, this provides us a truck that is just so much bigger than the rest and can deliver much better returns as a result. Sure, it is a lot more volatile as well, but this volatility is becoming more tamed as we get more confident with it, seeing that the sky did not fall as Chicken Little had predicted and it has made a nice nest for itself since that is growing in size.
Those who were impressed with things like making 12% with bonds in a banner year for them, or 30% with stocks in a banner year for stocks, will be much more impressed with the 82% that Bitcoin returned in 2019, and this involved ignoring the fact that it was up 182% year to date in August before it gave a lot of this back. It still had us up that much even if we weren’t paying attention and insisted on being still in it while it gave back 100% of this return.
Bitcoin is also up 33% so far in 2020, and may be set to go even higher as investors anticipate the effects of what Bitcoin pays to miners for new coins to be halved again. This hasn’t happened since 2016, but each time this happened, the value of Bitcoin has risen considerably, and not surprisingly since this reduces supply. Less supply means higher prices and although this is still dependent upon vagaries with demand, the effect of this halving getting investors even more excited about it should help both sides bring the price up more.
The only thing standing in the way of Bitcoin going up a lot more is the effect of profit taking, as without anything in the real world to dim it’s view, the market itself decides everything and this is why markets sell off by themselves, by more people getting out than getting in. This will remain a real threat, although all we have to do is look at the charts to get a sense of this and act upon the information to improve our standing considerably by stepping aside during these major selloffs and missing most of them at least, as we saw in the last 5 months of 2019 for instance.
Calling Bitcoin a toy, a novelty, or garbage won’t really matter much, as this is just foolish talk from the peanut gallery, although we would hope for more from a Fed president. He’s obviously well out of his league with this though, and people who lack even the most basic knowledge of something and are in a position to influence people should refrain from adding so much garbage to the discussion.