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  • Tesla As By-Product Bubble Of NIRP

    "History, which has a painful way of repeating itself, has taught mankind that speculative overexpansion invariably ends in overcontraction and distress"
    - Paul M. Warburg

    Tesla Motors, Inc. (NASDAQ: TSLA)
    $14.04 billion market capitalization
    115.55 million shares
    @ $122.43

    Tesla Motors, Inc., is an electric vehicle (NYSE:EV) company based out of Silicon Valley in Palo Alto, California. Tesla went public on June 29th, 2010, at a price of $19 per share. Since the IPO roughly 3 years ago, Tesla is up 544.36%. The news and euphoria surrounding the company would have one believe that this is perfectly sustainable and that the best is yet to come. For one, the company finally turned a profit in Q1 2013. Furthermore, Tesla is expanding into Europe and China, where they expect to generate most of their revenues. Moreover, the Model X is on the horizon, which is promised to be a cutting-edge all-wheel drive EV that provides the handling of a sports car and more functionality than a minivan. Yet, looking at the valuations of the company, one cannot help but notice it is grossly overvalued.

    Price ÷ Book (P/B)

    The P/B ratio of Tesla is 83.29. Typically, stocks are considered cheap when the P/B is less than 1.0. For example, Hewlett-Packard (NYSE:HPQ) was considered cheap last year when it was trading below book value at roughly $12. By this metric, Tesla would have to decline by over 98% in order to be considered cheap, which would place it under $2 per share. The P/B of Toyota (NYSE:TM) is 1.70, Ford (NYSE:F) is 3.80, and General Motors (NYSE:GM) is 1.85. While none of these automakers are trading at a discount today, it would be more than safe to assert that Tesla is the relatively overvalued one.

    Price ÷ Sale (P/S)

    The P/S ratio of Tesla is 14.86. As is the case with P/B, stocks are typically considered cheap when the P/S is less than 1.0. Toyota has a present P/S of 0.94, while that of Ford is 0.49, and GM is at 0.33. In terms of P/S, there is but one grossly overvalued stock amongst the automakers.

    There are numerous other valuation metrics that one can use to try and get an idea of whether a stock is on sale or whether it is overvalued. By virtually any standard measure, Tesla is grossly overvalued. What's more, an important thing to keep in mind is that the peers to whom Tesla has been compared to are all up significantly this year. Toyota is up 80.87% from its 52 week low, Ford is up 97.84%, GM is up 96.37%, and Tesla is up 379.74%. One cannot help but wonder what happens when the industry as a whole takes a dive. Will Tesla fall the least in a downtrend? Will automakers continue to rise ad infinitum? Not likely.

    Technically Overbought

    Technical Analysis is a deeply rich art form that can dissect a given asset, be it a commodity, bond, currency, stock, ETF, or virtually any other asset with a price history attached to it from a nearly infinite amount of angles and cross-angles. Yet, when it comes to a stock like Tesla, one does not have to dig very far in order to see that the stock is overbought. A simple glance at the Full Stochastic indicator reveals Tesla to be as overbought as is technically possible.

    (click to enlarge)

    "The intelligence of the creature known as a crowd is the square root of the number of people in it"
    - Terry Pratchett

    Every asset has an upper limit to which it could possibly be bid up. Every mania eventually runs out of steam because at a certain point there cease to be buyers at the given hyperinflated price, if for no other reason than that the participants do not have any more of their own or other people's money to spend. There is something worth observing from the Tesla Motors, Inc. 2013 annual shareholder meeting. During the Q&A portion of the meeting, Elon Musk was able to answer the various questions of 26 individuals before having to depart. One cannot help but notice that the crowd there, most of which were shareholders but not Tesla EV owners, were a very diverse bunch. There was a lady who was easily upwards of 60 that was inquiring about whether the EV's will make more noise going forward so that children playing on the streets could hear them coming as they would internal combustion engine (NYSE:ICE) cars. There was also a teenager that was wondering about the shape of the future EV's to come after the Model X.

    While diversity is typically considered a good thing, this isn't always the case, including in the realm of investment. Had the room been full of the stereotypical middle aged investor with a clean cut and a suit on, the implication would have been that there were plenty more potential investors out there that could boost the market cap for Tesla. The fact that the crowd there was diverse in nearly every possible sense goes to show that not only is the smart money already in the stock, but so are the novice and emotional investors who were sucked in due to a combination of the cult of personality that Elon Musk presents and rising prices which they extrapolate going forward.

    One cannot expect the likes of Warren Buffett, George Soros, or Jim Simons to start piling into Tesla at this point. This is not only the case because the stock is already overvalued, but also because it simply isn't how markets work. You don't see grown-ups dressing like Justin Bieber. You do, however, see young people eventually putting on a suit. When it comes to fads like magic the gathering cards, stock, bitcoins, or Tesla stock, the market can get saturated pretty quickly. The reason is that adults typically have a more sober mindset, a lower time-preference during business hours, and are therefore unlikely to enter a faddy market, especially not after those who are lower on the economic food chain have done so first. Typically, a market is full of professional traders who are agnostic to the underlying asset which they trade. It is once the laypersons, the housewives, the teenagers, and the beggars giving hot tips enter the market that we may deem it to be fully saturated. Unless one expects the E*TRADE Baby to bring in a new demographic of baby traders on margin accounts, TSLA is very close reaching an inflection point.

    No Moore's law when it comes to Batteries

    In 1965, Intel co-founder Gordon E. Moore wrote a paper titled Cramming More Components onto Integrated Circuits. His basic observation was that the number of components in integrated circuits had roughly doubled every year from 1958. Moore went on to extrapolate that exponential trend for at least another decade. The term Moore's law was later coined by Carver Mead, and the basic idea behind the term is that of exponential improvement.

    Although Moore's so-called law has applied fairly well to things such as processing speed, memory capacity, sensors, and the amount of pixels in digital cameras; it does not apply to thermodynamics. In fact, Moore himself acknowledged this in his famous paper alluded to above, in having written, "There is no fundamental obstacle to achieving device yields of 100%. At present, packaging costs so far exceed the cost of the semiconductor structure itself that there is no incentive to improve yields, but they can be raised as high as is economically justified. No barrier exists comparable to the thermodynamic equilibrium considerations that often limit yields in chemical reactions; it is not even necessary to do any fundamental research or to replace present processes. Only the engineering effort is needed" [Emphasis added]

    Moore's law was never meant to be used for making predictions regarding all sorts of technologies. Rather, it was originally an observation and extrapolation regarding the increasing amount of transistors and other components contained on an integrated circuit. Neither the average internal combustion engine nor the average battery is exponentially better today than it was a decade ago. The reason why Moore's law applies to processors is because electrons do not take up space in a processor. The constraints that revolve around processors are regarding lithography, and not space. On the other hand, ions do take up space in a battery.

    When push comes to shove, Elon Musk is selling an inferior product. Batteries can never have the sort of energy density as can gasoline or diesel fuel because they are thermodynamically inferior to oil. Unlike processing speed, power density is inelastic and does not exponentially improve over time. The single biggest component cost of the Model S is the lithium-ion battery. At over $100K per Model S with all the bells and whistles, Tesla is trapped in the luxury market, which by definition limits the number of its potential customers. Mr. Market seems to think that the cost of the underlying battery will drastically decline and that the range which the given battery provides will either stay the same or drastically improve within just a few years. Sooner or later the walls will give in and the bears will prove Mr. Market wrong.

    No EV Infrastructure

    There are roughly 120,000 gasoline stations in the US*. Elon Musk has stated that the cost of an EV station, dubbed the Supercharger, is about $150,000, and $300,000 with solar. Musk has stated that he would like the majority of Superchargers to have solar. However, let us assume the bare minimum figure of $150,000 as the standard. In order for the EV market to match the ICE market of 120,000 stations, the minimum cost would come to a cool $18 billion. This figure of $18 billion excludes all other expenditures, such as property and maintenance costs. Moreover, over 80% of gasoline stations have convenience stores. This is because gasoline stations make most of their money on selling convenience goods such as food or beverages at a premium. The Superchargers are not designed to have convenience stores, and if they did the cap ex costs would be significantly higher than $150,000 per station.

    The 120,000 gasoline stations that are in place today did not spring into existence overnight. Rather, there was a built-in incentive to bring them about. Companies like Standard Oil figured out that the dominant source of demand for their product would come from trucks and cars. They had an enormous incentive to rapidly build out an infrastructure of gasoline stations throughout the country. As a result, ICE cars offer an anywhere to anywhere experience throughout the lower 48 states. Neither coal, natural gas, solar, nor electricity utilities are racing to build out an infrastructure for EV's, due to in large part because they have other sources of demand.

    Broken Promises

    In an effort to ease the reasonable and prudent fears of many potential Tesla owners that the EV will depreciate significantly over time, Tesla has offered a resale value guarantee. The company speculates that the resale value of the Model S will be higher than that of any comparable luxury sedan, including those made by BMW, Audi, Mercedes, Lexus, or Jaguar models. In essence, the guarantee is that the Model S will be worth at least 50% of its original purchase price 36-39 months after the purchase. If not, Tesla will fill the gap. Elon Musk himself has stated that he will personally back the resale value of the Model S*.

    While there isn't a long history of EV depreciation rates from which one can get an idea of how this will turn out, the idea that EV's will depreciate faster than ICE cars certainly isn't out of the question. For one, the lithium-ion battery, which happens to be the most expensive component of the EV, loses its capability and thus value even with proper use over time. Batteries of all sorts are notorious for providing less and less charge over time, not to mention they can be easily abused.

    A glance at what price Tesla Roadsters are selling for shows a potential red flag. The base price of a new Tesla Roadster was $109,000. One can find a 2011 Roadster selling for $82,980 with a mileage of 6,427*, which is a 23% decline in value. Yet, the interesting thing about the Roadsters is that their price is not so much a matter of year-make as it is a matter of mileage. For example, a 2010 Roadster is selling for $89,000 with a mileage of 1,400*, which is a decline of 18%. At a first glance, the Tesla Roadster market depreciation rates seem to be well above the resale value safety-net that Elon Musk is promising. However, one thing that has to be taken into consideration is that the average annual miles per driver in the US comes out to 13,476. If the Model S is driven more like a normal car as opposed to a novelty car like the Roadster, then Tesla is in trouble. Even if the typical Model S gets only half the mileage of an average ICE car, we are looking at 6,738 miles, or 20,214 miles in 3 years. Moreover, the unintended consequence of the resale value guarantee may very well end up being that drivers end up doing more miles and will take less care of the battery than would otherwise be the case.

    Creative Destruction or Cantillon Effect?
    "Nothing should be more obvious than that the business organism cannot function according to design when its most important "parameters of action" - wages, prices, interest - are transferred to the political sphere and there dealt with according to the requirements of the political game or, which sometimes is more serious still, according to the ideals of some planners"
    - Joseph A. Schumpeter

    While the cheerleaders of Tesla would have one believe that Tesla is redefining and innovatively disrupting transportation, it may in fact be a malinvestment. The reason why Tesla EV's are gaining any traction at all is because the Bernanke Fed has proactively reflated asset prices, namely bonds, stocks, and real estate. This has had the consequence of generating so-called wealth effects. Some of the winners of this asset price reflation have decided to order what is perceived as the newest and coolest toy, a Tesla Model S. Yet more have bought the stock in hopes of further capital appreciation.

    (click to enlarge)
    The above chart shows the nominal federal funds rate in black, which is the interest rate at which depository institutions actively lend balances amongst one another overnight. The name of the game since the financial crisis has been ZIRP, or zero interest-rate policy. However, if we adjust the federal funds rate for inflation, we find out that the real policy has been one of NIRP, or negative interest-rate policy, which is represented by the red line.

    In the early 1980's, the Volcker Fed raised the nominal fed funds rate to nearly 20%, or close to 10% above the rate of inflation, in order to break the inflationary spiral. While we do not currently have high and rising consumer price inflation largely in part due to high unemployment, we are certainly getting lots of temporary asset inflation in bonds, stocks, and real estate. This sort of inflation of asset prices via interest rate manipulation isn't all that new. It has been observed and elaborated upon by Richard Cantillon*. In short, governments whom are typically debtors can't help but fight deflation at all costs. They along with mainstream economists have what is known as apoplithorismosphobia i.e., the fear that an economy would suffer from falling prices, or a general decline in the prices of goods and services.

    This process of asset boom (and subsequent bust) has been named the Cantillon effect. As put by economist Mark Thornton, "The resulting alternations in the structure of production (buildings, technology, and the pattern of industrial organization) are called Cantillon effects. This is the boom - a phase when resources are misallocated, both to malinvestments and misdirected labor. As relative prices correct themselves in the bust, resources are reallocated via such mechanisms such as bankruptcy and unemployment"* Ludwig von Mises went on to further describe this process, in having written, "The increased productive activity that sets in when the banks start the policy of granting loans at less than the natural rate of interest at first causes the price of production goods [asset prices] to rise while the prices of consumption goods, although they rise also, do so only in a moderate degree, viz., only in so far as they are raised by the rise in wages"*

    "Recent history - and a mountain of financial research - have shown that the market is unkindest to rapidly growing companies that suddenly report a fall in earnings"
    - Jason Zweig

    The fact that Tesla went after the higher end of the market is being praised as a stroke of genius. Yet, this is how markets in general work when it comes to new products and services. As stated Ludwig von Mises, "Every advance first comes into being as the luxury of a few rich people, only to become, after a time, the indispensable necessity taken for granted by everyone. Luxury consumption provides industry with the stimulus to discover and introduce new things"*. While Elon Musk may not appreciate the naysayers who claim that the value of his stock is grossly overvalued, much as the Guggenheims resented Baruch when he told them their stock was overvalued, the reality of the situation must be acknowledged. Elon Musk has no other choice at this point but to feed the ducks while they're still quacking. However, the point at which the bubble will burst is soon approaching.

    Forecast #1: The price of TSLA will trade at below $20 within 12 months.
    Forecast #2: The Google trends for the keyword tesla will peak out shortly after the peak in the Tesla stock price.
    Forecast #3: EV's are not a game changer at all. Instead of creative destruction, they represent an ephemeral micro-economic Cantillon effect where the market has been temporarily deluded into believing that batteries can be thermodynamically superior to gasoline.

    Den Letzten beißen die Hunde

    * This article was inspired by Eric Janszen, President of iTulip and one of the best macro-economists on the planet. -

    * Statistic Brain, US Census Bureau, verified 6.13.2012 -




    * Richard Cantillon (1680s - 1734) was a successful banker, merchant, and one of the very first economists. He is mostly known for his foresight during the Mississippi bubble.

    * Mark Thornton, Who Predicted the Bubble? Who Predicted the Crash? -

    * Ludwig von Mises, The Theory of Money & Credit

    * Ludwig von Mises, Liberalism

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: TSLA, TM, F, GM, HPQ
    Jul 23 9:35 AM | Link | 24 Comments
  • Tulips On Asteroids

    Planetary Resources, Inc., (NYSE:PRI) is a pioneering company in the potentially ground-breaking industry of asteroid mining. PRI was originally formed in November 2010, known then as Arkyd Astronautics*. The company was reorganized, renamed, and formally introduced on April 24th 2012 at a launch press event held at the Museum of Flight's Charles Simonyi Space Gallery*. In a nutshell, PRI seeks to identify, prospect, and mine near-Earth asteroids for hydrogen and precious metals.

    Asteroids & Asteroid mining

    Within our solar system, there are roughly 620,000 asteroids that have been discovered, most of which are in the asteroid belt between Mars and Jupiter. Of these 620,000 asteroids, about 10,000 are near-Earth asteroids, meaning they are within 1.3 astronomical units* from the sun. Furthermore, about 1,800 of these near-Earth asteroids are energetically easier to get to than the moon.

    (click to enlarge)

    There are two main types of asteroids that are potentially valuable for their resources. First, there are LL chondrite asteroids, which contain vast amounts of platinum, palladium, rhodium, iridium, ruthenium, and osmium. Second, there are carbonaceous chondrite asteroids, which contain hydrogen, carbon, nitrogen, and oxygen. The reason why hydrogen is potentially valuable is because it costs over $10,000 to take a liter of water into space. Moreover, hydrogen can potentially serve as a fuel in space. The idea is to develop lasers or microwaves which are getting exponentially more efficient as far as the cost to produce a gigawatt is concerned. Thus, the process that the folks at PRI seem to want to bring about is called beam-powered propulsion. In a nutshell, microwaves are beamed onto a rocket, which in turn convert that energy into heat that ignites a working fluid like hydrogen. This could in effect allow a spaceship to roam around the asteroids, refueling itself on every carbonaceous chondrite asteroid on which it lands. While all of this may sound a bit far-fetched, there are a number of reasons why this company has the potential to gain some major attention.

    Reason #1 - Names & Money

    "Prestige is the mainspring of all authority. Neither gods, kings, nor women have ever reigned without it"
    - Gustave Le Bon

    PRI consists of some of the brightest minds on the planet. It includes a number of people who previously worked for the Jet Propulsion Laboratory (JPL), which helped put rovers on Mars for NASA. These include the likes of Chris Lewicki, Chris Voorhees, Peter Illsley, Sean Haggart, Hannah Goldberg, and Spencer Anunsen. It also includes a number of people from Space X, the space transport company founded by Elon Musk. Moreover, there are numerous other people coming from all sorts of top-notch companies, such as Ray Ramadorai, who was an architect of the Intel core i7 series, which drastically improved processing efficiency and lowered the power requirements. In short, the company is a powerhouse of accomplished intelligence and is bound to receive attention ex cathedra.

    The investors and advisors backing PRI are no slouches either. Amongst them are Google CEO Lawrence Page, Google Executive Chairman Eric Schmidt, film director James Cameron (known for blockbusters such as Titanic and Avatar), software architect best known for developing Microsoft Office Charles Simonyi, and billionaire H. Ross Perot, Jr. Furthermore, the company has a partnership with Bechtel Corporation, which acts as a strategic partner and core investor. It would be safe to say that even at this state the company has plenty of capital behind it.

    The founders of PRI are Eric Anderson and Peter Diamandis. Eric Anderson helped forge the commercial market for space travel. Having co-founded Space Adventures in 1997, he reached an agreement with the Russian space agency to purchase seats on the Soyuz space vehicle that would go on to transport private citizens to the International Space Station. The first seat was sold to Dennis Tito for $20 million. Anderson is also President & CEO of International Software Corporation and has worked with Peter Diamandis going as far back as 1994 with the X Prize Foundation.

    At the helm of PRI is Peter Diamandis, who holds a B.S. in molecular biology and a M.S. in aeronautics and astronomics from MIT. In addition, Diamandis also holds a M.D. from Harvard Medical School. While this academic record is impressive, it pales in comparison to the achievements he has already made throughout his career. Diamandis founded Constellation Communications (1991), X Prize Foundation (1994), and Space Adventures, Ltd. (1998). Moreover, he co-founded the International Space University (1987), International Microspace, Inc. (1989), Zero Gravity Corporation* (1994), Rocket Racing League (2005), Singularity University (2008), and most recently PRI. Diamandis also co-authored Abundance: The Future Is Better Than You Think along with Steven Kotler. While some may be good champions of a cause and others great catalysts, it can be safe to say that Peter Diamandis is amazing at being both. It should be of no surprise that he received the 2010 Innovation Award from The Economist*.

    Reason #2 - Backing up the Biosphere

    "The Earth is the cradle of humanity, but mankind cannot stay in the cradle forever"
    - Konstantin E. Tsiolkovsky

    The ancient library of Alexandria, located in Alexandria, Egypt, was burned down in 48BC* during the Alexandrian War. Along in the fire was consumed not only the papyrus paper and the various commodities from which the books and the library itself were made, but also the vast amount of knowledge that had been accumulated there. Thus, the reason for expanding onto asteroids, other planets, and potentially to other galaxies is not only to acquire resources and bring them back to Earth. Were a meaningfully sized asteroid to hit the Earth, humankind will go the way of the dinosaurs, despite all of our accomplishments. Thus, mining asteroids would allow us to not only expand our resource base, but will bring us one step closer to becoming a multiplanetary species.

    Reason #3 - Something New

    "where do we allow crazy ideas to bubble up?"

    Mining is an old affair that goes back tens of thousands of years. On the other hand, asteroid mining is bound to spark extraordinary interest, especially by those who are not professionals in the field i.e., potential investors. Like the railroad, clipper ship, radio, or the internet in the days gone by, the perception of something new has an incredible ability to generate interest. Space exploration, cutting-edge technology, some of the brightest minds, and the potential to open up a brand new world to humankind; PRI has all the ingredients necessary in order to attract lots of attention. Who cares about drinking bottled water from the rainforest or the Alps; it's all about asteroid water.

    Reason #4 - Commodity Bull Market

    "The Earth is a crumb in a supermarket filled with resources"

    Hardly anyone would have cared about platinum group metals (PGMs) at the turn of the century. Commodities in general were at all-time lows adjusted for inflation. Platinum was as low as $350/oz in 1999. Currently, platinum trades at $1,500/oz, which is a nominal increase of 329%. Commodities were in a bear market from 1980 all the way to the turn of the century, declining in both nominal terms and especially in real-terms. Since then, however, commodities have gone up while equities have gone down.

    (click to enlarge)
    This is the S&P 500 ÷ USD price of West Texas Intermediate per barrel. From 1980 the ratio kept rising in favor of the S&P 500 until it reached a peak in late 1998, when it took over 100 barrels of WTI to purchase the S&P 500. Since then, the ratio has persistently fallen in favor of WTI as the S&P 500 has declined adjusted for inflation. On the other hand, commodities in general have gone up since 2000.

    The promise of vast riches to be had from the New World was very enticing during the Mississippi bubble of the early 18th century. No longer did one have to be a king or a colonizer to enjoy resources from distant places, or so people thought. One simply bought shares in the Mississippi Company and waited to get rich as an abundance of resources came flowing in from the virgin lands. Likewise, if commodity prices continue to rise despite relatively low output (high unemployment), then it will become quite alluring to think that abundant supplies of space fuel and precious metals await us in the new New World. What was once only an industry that government could touch will be brought to mankind. One only has to wait for the IPO to purchase a slice of the future. Hope springs eternal.

    Reason #5 - Mitigating War

    "WWIII will most certainly be fought over oil, but for economic survival not for economic advantage"
    - Eric Janszen

    We live in a world filled with scarcity. As such, it is perfectly understandable that wars have been fought over resources. An MIT working paper entitled A Dynamic Theory of Resource Wars came to the conclusion that, "In the empirically relevant case where the demand for the resource is inelastic and the resource-poor country can capture most of the remaining endowment in a war, war becomes inevitable"*. It is important for mankind to secure more and more resources over time, especially those which are relatively scarce and vital. Ecclesiastes 5:11 states that "As goods increase, so do those who consume them". That logic also works in reverse.

    Reason #6 - Inflation

    "An abundance of fictitious and imaginary money causes the same disadvantages as an increase of real money in circulation, by raising the price of land and labor, or by changing the value of money and goods only to cause subsequent losses. This furtive or unnatural abundance vanishes at the first gust of scandal and precipitates economic chaos"
    - Richard Cantillon

    Bubbles and euphoria are almost always associated with periods of vast money and debt supply increases. Inflation is the sine qua non for speculative manias. The result is that the period of provision is stretched to an unsustainable point. The tulipmania coincided with massive inflows of silver and gold from the New World. The Mississippi bubble occurred in an era of John Law, who greatly increased the quantity of money and actively pumped up the stock market in part by making debt more available. The South Sea Bubble, also fueled by monetary inflation, displayed some peculiarities. Bubble companies sprung into existence, such as the London Umbrella Company, which planned to rent out umbrellas at numerous stations throughout the city, being sort of akin to zipcar today. There was even a company in the works which planned to drain the red sea in order to search for gold and jewels left by the Egyptians in their passage after the Israelites. One has to wonder if anyone entertained the idea that the costs might outweigh the benefits. Moreover, rampant speculation in insurance, land, building development, mining, and metals was present during the South Sea Bubble. A company called General Insurance went up by 6,300%, while another called London Assurance Co. by 3,100%*. Perhaps we can expect Elon Musk to insure the endeavors of PRI, that is, if he doesn't run into problems regarding the guarantees that he has already made towards Tesla (NASDAQ:TSLA) thus far*. Inflation of money and debt has a way of distorting the behavior of market participants. It is the fuel that is necessary in order to ignite the flames of speculation.

    (click to enlarge)
    The left-hand side shows MZM (red) which is one of the broadest and perhaps the most useful measures of money supply. MZM is approaching the $12 trillion mark. The right-hand side shows the total amount of credit market instruments (blue), also known as debt, which is approaching the $60 trillion mark.

    Gravity is a Bear

    "I had learned my first lesson in moneymaking - that people who try to get rich from mining often put more into the ground than they take out of it"
    - Bernard Baruch

    It is hard not to like Peter Diamandis, who describes himself as a libertarian capitalist. His accomplishments thus far are surpassed only by his passion for exploring the cosmos. Not only that, he has some of the brightest minds working for PRI and already the company is well capitalized while still private. That being said, all that glitters is not necessarily platinum. Diamandis was CEO of BlastOff! Corporation from 2000 until its failure in early 2001. BlastOff! was meant to get the first private mission to land on the moon. The company incorporated, or was meant to, a mix of entertainment, internet, and space exploration. Like PRI, BlastOff! consisted of some of the brightest minds from NASA, JPL, and Hollywood. BlastOff! was eventually spun off into, which sought to provide a global peer-to-peer television network for broadcasting unique content. Although very much unrelated to the initial purpose of BlastOff!, Diamandis also served as CEO for the now defunct

    Gold mining on Earth isn't a terribly profitable business, so one cannot help but wonder how profitable it is to (1) fly a whole bunch of mining equipment onto an asteroid, (2) successfully mine the ore, and (3) fly the stuff back to Earth. One cannot help but think that this whole affair is equivalent to draining the red sea for gold. Whether or not PRI turns out to be a raging success that expands our resource base and turns humankind into an interplanetary species, it certainly has the potential to become a bubble company. Much like a mirage, in times of easy money and tight commodity supplies, the idea of abundance just around the stratosphere has some verisimilitude to it.

    pecunia pecuniam parere non potest

    * Arkyd Astronautics was the name of PRI while the company was still in stealth mode. The name was inspired by a company which supplied exploration droids in the Star Wars universe called Arakyd Industries


    * An astronomical unit is equivalent to 149,597,871 kilometers. Thus, 1.3 astronomical units would be equivalent to 194,477,232 kilometers, or 120,842,550 miles

    * Zero Gravity would go on to take physicist Stephen Hawking into the upper atmosphere


    * Some suggest that the library of Alexandria was burned down in the attack of Aurelian in 270AD, or by the decree of Coptic Pope Theophilus in 391AD, while others suggest that it was during the Muslim conquest of 642AD

    * A Dynamic Theory of Resources Wars was written by Daron Acemoglu, Michael Golosov, Aleh Tsyvinski, and Pierre Yared

    * New Evidence on the First Financial Bubble was written by Rik G.P. Frehen, William N. Goetzmann, and K. Geert Rouwenhorst


    Jun 05 9:40 AM | Link | 3 Comments
  • Bitcoin Bubble 2.0

    'It is also important to make certain that our efforts are directed at the decisive core of the problem and not on distracting side issues. The more complex the difficulties we face, the more important it becomes to bear this in mind, for it is human nature to try to evade what we cannot cope with'
    - Bernard Baruch, My Own Story

    A conversation with a typical bitcoiner usually leads into a whole series of ignoratio elenchi after ignoratio elenchi revolving around technological jargon. Thus, I think it would be useful to start this article off with a parable set in the past. Suppose that during the 1970's, when consumer price inflation was an actual problem, someone went ahead and developed an alternative currency. Of course, there were no computers in the average household, no internet, and no peer-to-peer during that stagflation.

    Coinstamp Parable

    An entrepreneur named Wei Boyang sets up to take advantage of the situation. His proposal is to print a total of 1,000,000 units of what he calls coinstamps. He goes through great measures to insure that there would be no coinstamp counterfeits in the future, using various methods such as signing each stamp, classified materials, codes, et cetera. For the sake of argument, the coinstamp truly is counterfeit-proof. The only entity that could create more coinstamps is Wei Boyang. However, Boyang just happens to be a really nice guy, and having read Lord Acton, he even goes so far as to cut off his hand in order to make sure he cannot make more coinstamps.

    Some may cry aloud that coinstamps have no intrinsic value or that they are not backed by anything. Wei Boyang, having also read his Carl Menger, points out that there is no such thing as intrinsic value. Value, explains Boyang, is a subjective phenomenon. Moreover, Boyang argues that it is actually a good thing that coinstamps are not backed by any commodity. If they were backed by something, such as platinum, then the underlying asset could easily be seized. Moreover, since there is no underlying asset to coinstamps, there are no storage fees and transfers are far cheaper than they would otherwise have been.

    With inflation approaching double-digits, people who are worried about gold or silver confiscation start to pile into coinstamps. Similarly, investors who are worried about holding the least bad fiat currencies such as the Swiss Franc or the Deutsche Mark due to potential inflation in order to help exporters, also start to pile in. Coinstamps truly seem to be a stroke of genius. People start using them as a means of payment worldwide, even for long-distance transactions. The Federal government is unable to do anything meaningful about coinstamps because it does not have the resources to check every envelope that happens to be mailed. Moreover, since the stamps are so light and thin, lots of people mail them discreetly inside of other items, just to be on the safe side.

    By all measures, coinstamp seems to be a hit. Through various ingenious methods, Wei Boyang helps prevent counterfeiting of the stamps. Moreover, Boyang ends up being labeled a domestic terrorist and arrested, which has the unintended consequence of increasing the popularity and awareness of coinstamps, leading people start piling in big time. There is but one problem, other fellows such as Jean de Meung, Johann Georg Faust, and Tycho Brahe also get in the game. While they are unsuccessful at counterfeiting coinstamps, they are successful at copying the protocol and making their own version. Although different in name, the knockoffs are virtually the same in substance. Jean de Meung makes meungstamps, making only 1,000 units, with his own fingerprints on every meungstamp as one of the security measures. Subsequently, he burns off his fingertips as part of a rigorous public relations campaign. With coinstamps trading at $750/cs, the new protocols start to gain traction. Since Wei Boyang wants nothing to do with the government, he has no patents on his invention. The fact that he was first to develop the alternative currency makes no difference to those flocking into the more affordable protocols. The lack of a moat on the scheme eventually sends the entire house of cards collapsing.

    Back to Reality

    While bitcoins cannot be hyperinflated in name, they certainly can be hyperinflated in substance. Already, there are numerous knockoffs such as namecoin*, freicoin*, and litecoin* in place. This is a particularly valid point because bitcoin is a starfish i.e., it is fully decentralized. As put by Ori Brafman and Rod A. Beckstrom, 'The starfish doesn't have a head. Its central body isn't even in charge. In fact, the major organs are replicated throughout each and every arm. If you cut the starfish in half, you'll be in for a surprise: the animal won't die, and pretty soon you'll have two starfish to deal with'*. After Napster went under, Niklas Zennström (the creator of Skype) stepped in with his creation called Kazaa, which had no central server that could be shut down. Eventually, the peer-to-peer programs got more and more numerous, including Kazaa Lite, eDonkey, eMule, BitTorrent, et cetera. While this may be good news for people who like to download and share content for free, it certainly is not for people who are under the impression that bitcoin is a hedge against inflation.


    Does bitcoin jive with the Austrian stand on money? The only way to find out is to read what the Austrians had to say. Let's start with Carl Menger. In Principles of Economics, Carl Menger made the point that money, a medium of exchange, has always tended to be the most saleable commodity of the time. Menger wrote, 'In the earliest periods of economic development, cattle seem to have been the most saleable commodity among most peoples of the ancient world'. This is perfectly understandable in a world where barebone subsistence is a reality for most people and the structure of production is virtually nonexistent. As society progressed, however, cattle became less and less marketable. Menger goes on to write, 'With the progress of civilization, therefore, cattle lost to a great extent the broad range of marketability they had previously had with respect to the number of persons to whom, and with respect to the time period within which, they could be sold economically…They ceased to be the most saleable of commodities, the economic form of money, and finally ceased to be money at all'

    As civilization progressed, Menger states that 'peoples who were led to adopt a copper standard as a result of the material circumstances under which their economy developed, passed on from the less precious metals to the more precious ones, from copper and iron to silver and gold, with the further development of civilization, and especially with the geographical extension of commerce' Gold won out due to a variety of reasons, such as being durable, amalgamable, malleable, divisible, homogeneous, and rare. Yet, the primary reason that gold won out is because it was the most saleable of commodities. As Menger goes on to write, 'Gold nuggets extracted from the sands of the Aranyos River by a dirty Transylvanian gypsy are just as saleable in his hands as in the hands of the owner of gold mine, provided the gypsy knows where to find the right market for his commodity. Gold nuggets can pass through any number of hands without any decrease whatsoever in marketability. But articles of clothing, bedding, prepared foods, etc., would be suspect and almost unsaleable, or at any rate of greatly depreciated value, in the hands of the gypsy, even if they had not been used by him, and even if he had, from the beginning, acquired them only with the intention of passing them on in exchange'

    This point about marketability bears elaboration. One may have a Picasso at home, which will fetch quite a sum at a Sotheby's auction during a boom, but a Picasso, like a poem by Friedrich Shiller, a work of Sanskrit, or a multi-decade old bottle of red wine can never be the most saleable good. As Menger put it, 'Compare only the number of persons to whom bread and meat can be sold with the number to whom astronomical instruments can be sold'. This leads us to another criticism of bitcoin: It can never be the most saleable good. The reasoning for this is quite simple, until the majority of the 7 billion or so people that inhabit this planet have either a smartphone or frequent access to the internet, a digital currency is out of the question. Gold, on the other hand, is easily recognizable, as opposed to silver that may be mistaken for other metals such as nickel. Moreover, it melts at a relatively low temperature and is a relatively soft metal, which provides superior amalgamation and explains partly why it historically won out to metals such as platinum. If one questions the role of gold in the present monetary system, one only has to walk down the street and see a 'We Buy Gold' sign. Moreover, central banks hold gold and lots of it, they do not hold cattle, wheat, soybeans, copper, silver, or bitcoins.

    Menger also went on to write, 'I am ready to admit that, under highly developed conditions of trade, money is regarded by many economizing men only as a token. But it is quite certain that this illusion would immediately be dispelled if the character of coins as quantities of industrial raw materials were lost'*. This, of course, leads us to that pesky thing called the regression theorem. In an article entitled 'Bitcoins, the regression theorem, and that curious but unthreatening empirical world' author Konrad S. Graf* attempts to reconcile the regression theorem with bitcoins. He states,

    'First, one element to consider for intangible objects such as bitcoins are various "inherent" direct-consumption values that may be primarily psychological or sociological in character. Consider, for example, the geek value hackers find in creating and attempting to crack encryption codes of any kind: "Dude, look at this code; I bet you can't crack it," may indeed be more highly valued to some people in some contexts than certain "real" economic objects or specific quantities of fiat money. Regardless of any potential future indirect-exchange value, one can imagine such persons expending hundreds of hours of effort in creating and breaking encryption codes, just because they like to. This may be true, separate from any degree of dependence on any particular expectations of future exchange values of code objects'

    While it may very well be true that some early adopters valued bitcoins with what Menger described as imaginary value, the point of the most saleable good bears repeating. Gold is and has been seen as an object of beauty since the dawn of civilization. Thus, the argument that bitcoins are in accord with the regression theorem because a handful of people consume them as they would a Picasso is like saying paper money has value because John Law or Ben Bernanke really enjoy playing monopoly. In fact, we might as well say that Alchemy works, considering a significant amount of human history and energy was spent in attempting to find the philosopher's stone. Some people may enjoy work just for the sake of working. Unfortunately, this is not a sufficient justification for slavery nor the labor theory of value.

    So where does bitcoin stand when it comes to the Austrian framework of money? For this we have to turn to The Theory of Money and Credit by Ludwig von Mises. Mises never claimed that only gold or silver are money. On the contrary, he stated that 'the market enables any commodity to be turned into money and money into any commodity'. Furthermore, Mises went so far as to say that silver was no longer a monetary metal, which explains why the gold/silver price ratio has tilted significantly towards gold from the late 19th century onwards, in having written 'If any kind of money is deprived of its monetary characteristics, then naturally it also loses the special value that depends on its use as a common medium of exchange, and only retains that value which depends upon its other employment. In the course of history this has always occurred when a good has been excluded from the constantly narrowing circle of common media of exchange. Generally speaking, we do not know much about this process, which to a large extent took place in times about which our information is scanty. But recent times have provided an outstanding example: the almost complete demonetization of silver. Silver, which previously was widely used as money, has been almost entirely expelled from this position, and there can be no doubt that at a time not very far off, perhaps even in a few years only, it will have played out its part as money altogether'. He further went on to crystallize this point by classifying silver as fiduciary media, having written, 'Of no greater relevance is the circumstance that the fiduciary media were in the one case predominantly bank notes and cheques and are in the other case predominantly silver coins. The silver rupee is in truth nothing but a metallic note, for the conversion of which its issuer, the State, is responsible'. Those who rushed into silver in 2011 would have been well advised to have read the TMC, and so would bitcoiners.

    Ludwig von Mises claimed that there were three main types of money: (1) commodity money, (2) fiat money, and (3) credit money. What is important when it comes to commodity money are the technological aspects. With fiat money, the important aspect is the stamp that (initially at least) represented a fixed weight of commodity money. Credit money, on the other hand, is a claim falling due in the future (IOU) used as a medium of exchange. We can safely assert that bitcoin is not a credit money. Nor is bitcoin a fiat money since there is not a sovereign proclaiming it to be a fixed amount of anything. So is bitcoin a commodity money? The answer is no.

    Bitcoiners would have one believe that bitcoin is a digital manifestation of the gold standard, and thus should be considered a commodity money since it is technologically similar. The problem with this reasoning has already been touched upon: bitcoins can be hyperinflated in substance. In the real world, a Niklas Zennström cannot come along and create underground reserves ex nihilo of what in substance would be the equivalent of gold, except that it be blue and called jold. On the other hand, the amount of potential flavors of bitcoin on the cloud is theoretically restricted to the amount of aggregate geobytes available on the various smartphones, tablets, notebooks, and all other electronics capable of using peer-to-peer.

    If bitcoins are not commodity, fiat, nor credit money, then what are they? Has Ludwig von Mises missed something? The answer, once again, is no. The aforementioned types of money are a narrow subset of the broad money scheme that Ludwig von Mises had formulated. There were, aside from the three types of money already mentioned, so-called money-substitutes. Within money-substitutes are two categories, (1) money-certificates, and (2) fiduciary media. Money-certificates are self-explanatory, examples of which include countless paper notes that promise to pay the bearer x amount of gold on demand. The relevant thing to bear in mind as far as this article is concerned is that bitcoins are not money-certificates.

    Thus, we are left with only one remaining option: fiduciary media. Within fiduciary media, there are (1) uncovered bank deposits and notes, or (2) token money. The former stuff is what has periodically led to booms and busts as well as countless bank runs. However, bitcoins are definitely not uncovered bank deposits or notes. Thus, we have an answer before us: bitcoins are fiduciary media, or more specifically token money. From a monetary standpoint, as devised and formulated by Ludwig von Mises, they are on a par with the stuff you find at Chuck E. Cheese's.

    (click to enlarge)


    With the imminent hyperinflation meme fading away and no longer holding much water, the new reason to hold bitcoins is the anonymity, nay, the freedom that it provides. Want to gamble online or buy something illegal? Bitcoins are the solution. It is a way of circumventing the Kremlin and uplifting free and voluntary trade, or so goes the story. Unfortunately for many of the misinformed, the reality is toto caelo. This article is too short and not intended to get into the details. Thus, it would be best to take it from bitcoin developer Jeff Garzik himself.

    The fun starts at 3:20

    The ironic part about this is that anyone and everyone who has participated in illegal activity using bitcoins, presumably because they thought it was anonymous, now has a permanent record of every single one of their transactions contained on the public ledger. Imagine if bitcoins existed 50 years ago. Chances are, none of the last three Presidents (including Barack Obama) would have ran for office.

    Bubble Time?

    The question left to be answered is whether or not bitcoin is once again taking the shape of a bubble. The answer is yes. There is present a reflexive pattern of people buying because prices are rising, and prices rising because people are buying. The myopic are extrapolating the price trend of the past three months, which they deem is normal, and in so doing they exacerbate it to the upside, thus attracting even greater fools. The inflection point will come when the continuity of bullish thought is broken, which could be anywhere between $49/bc to $69/bc. One thing is for sure, the amount of suckers left who are willing to jump on the moving and ever accelerating train is drawing thin, and so are their pockets.

    When prices for any asset go parabolic, it does technical damage to a chart. It is sort of like someone deciding to go full speed in the middle of a marathon. Surely, one would look good for a few minutes. However, at a certain point one would inevitably collapse, with the possibilities of finishing the race being greatly diminished, let alone doing as well as they would have otherwise. Like Icarus, who had soared too high and melted the wax on his wings, parabolic moves always end in a crash. Ironically, the best thing that can happen for bitcoin naysayers is if bitcoin skyrockets to $100/bc within a week.

    There is nothing anti-Austrian about acknowledging that there exist in the market place a lot of naïve, irrational, and misinformed players. During the dotcom bubble, for example, a maintenance and building company called Temco Services almost tripled in a matter of minutes in 1998. The reason is because by 1998 every other layperson was involved in the market. Thus, the level of competence significantly dropped. The ticker symbol for Temco is TMCO, which was fairly close to that of Ticketmaster Online, which was TMCS. Ticketmaster Online (then TMCS) just happened to trade publicly for the first time on the day that Temco Services (OTCPK:TMCO) tripled. Rising asset prices create euphoria, and euphoria significantly drops the IQ of the participants.

    So why is it that people are attracted by rising prices and shy away from falling prices, when in fact the rational thing to do would be to buy low and sell high? The answer is that we are wired that way. As put by Jason Zweig, 'Groundbreaking new research in neuroscience shows that our brains are designed to perceive trends even where they might not exist. After an event occurs just two or three times in a row, regions of the human brain called the anterior cingulate and nucleus accumbens automatically anticipate that it will happen again. If it does repeat, a natural chemical called dopamine is released, flooding your brain with a soft euphoria'*. The process also works in reverse, which explains why most people are turned off by falling prices. A loss fires up the amygdala, which is the part of the brain that processes fear and anxiety. If one were to look at the Google Trends chart* of bitcoin and the USD price chart at mtgox* (formerly magic the gathering online exchange), the data is nearly identical with the google trend following the price. The bottom line is that people are attracted to bitcoin because the price is rising.

    Another reason why bitcoin is so susceptible to becoming a bubble is because it is perceived as being something new. New Era thinking always attracts lots of attention. The tulip was introduced to Europe by way of Turkey in the middle of the sixteenth century. In fact, the word tulip came from the Turkish tulipan, which means turban. Aside from being something new to Amsterdam, a country which at the time possessed an abundance of newly discovered gold and silver from the New World, the tulip also had an intriguing element to it. The plain tulip may turn into a precious Semper Augustus, the most precious tulip of them all. The reason is that the various color schemes of tulips were caused by a virus that attacked the bulb. Likewise, the Mississippi bubble, which was perpetrated by John Law, promised vast richest to be had from the New World. The manias in railways, the radio, the internet, you name it, most of them involved something new or something perceived to be new.

    » Bitcoins can be hyperinflated in substance
    » Bitcoins can never be the most saleable good
    » Bitcoins cannot account for the regression theorem
    » Bitcoins are the equivalent of token money
    » Bitcoins are the opposite of anonymous
    » The USD price of a bitcoin has been rising in an unsustainable fashion, the only thing missing being a blow-off top




    * The Starfish and the Spider was originally published in 2006

    * Underline added by the present writer


    * The Intelligent Investor by Benjamin Graham, Commentaries by Jason Zweig



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I am short bitcoins via

    Mar 05 11:23 AM | Link | 45 Comments
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