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Bitcoin is a bubble, but manias can have economic benefits

The UK's railway mania, the tulip bubble, the dot com boom and other collective economic madness – such as bitcoin – might lose people a lot of money, but they often lay down important foundations

Bitcoin is, of course, a mania – a delusion of the sort that human societies are prone to. This is fighting talk from someone who declared in 2011 that bitcoin was all over. Being wrong is not interesting – it is rare things which are interesting, not common ones – but the psychology and economics here are important.

The classic text on this topic is Charles McKay’s Extraordinary popular delusions and the madness of crowds. Human societies are prone to manias which seem to defy any sense or reasonableness. Certainly markets can be so overcome, although the witch burnings show that it’s not purely an economic phenomenon.

The South Sea Bubble, Tulip mania, railway shares, the dotcom boom and now bitcoin are all part of that same psychological failing of not recognising that prices can and will fall as well as rise. That is the classical interpretation of the McKay book and observation, but modern studies take a more nuanced view.

South Sea and the Mississippi Company bubble were simply speculative frenzies, but the tulip story – while appearing very similar – can be read another way.

It is still true, for example, that a few sheds near Schipol, just outside Amsterdam, are the centre of the world’s trade in cut flowers – the result of that historical episode where a single tulip bulb became worth more than a year’s wages.

We can, and some do, take tourist trips to see the fields of those very tulips today. Modern researchers point out that the tulip was near unknown in Europe, the first examples only just having arrived from Turkey.

The art of cross-pollinating tulips to gain desirable characteristics was only just becoming generally known, and Europe was reaching a stage of wealth where the purely ornamental was becoming valuable.

Yes, the speculation in prices was ludicrous – although the weird stuff was in futures and options markets, not the physical trade, and the absurd prices never actually happened – but the end result of the frenzy was still that the tulip and flower market became and is centred in The Netherlands.

Other manias

We can trip through other manias using the same optics. 1840s Britain most certainly had Railway Mania, where companies were floated to build lines of whatever level of economic ludicrosity. Huge sums were lost as well – and yet the country did end up with the basics of a railway network.

The dot com boom is perhaps closer to our own hearts, and the plan for losing money on every transaction but making it up with volume business was shown to have its little errors.

Yet we as an economy did end up with value from the frenzy. Amazon and Google got financed, and the gigamiles of fibre-optic cable that was laid in this bout of optimism aided in continuing the internet revolution as the costs of using that surplus capacity fell to near zero. The shareholders of Global Crossing might not be all that happy about this, but the rest of us have done well.

There’s a school of thought which insists that the madness and investment delusion is necessary to get grand economic changes funded
Tim Worstall

As for Bitcoin, despite reality proving me wrong, I’m not sure my 2011 view was in error. I just can’t see the new coinage, the new money, retaining value. I, along with many others, can see great value in the concept of the underlying technology, blockchain, even if it’s not entirely obvious what use is going to produce that value.

However, the economic point here isn’t that we’re desperately looking for a silver lining in that maniacal cloud. Rather, there’s a school of thought which insists that the madness and investment delusion is necessary to get grand economic changes funded.

This is akin to how the tech venture capital funds operate, at least how we’re told they do. Seven out of 10 investments are going to fail, two might rumble along as nice little businesses, but the hope is that the tenth will become much bigger, which pays for everything else.

Investment frenzies are a great deal less directed, but can be viewed as the societal equivalent. If it weren’t for the general shouting about climate change and green energy, who thinks that Tesla would have been funded to the extent that it has? Or the rather wilder shores of lithium mining?

If it weren’t for tulips having those excessive values, who would have planted vast fields of them? Without share prices of anything railway or dot com soaring, how would those basic infrastructures have been funded?

Exploring the space

This brings us back to Bitcoin and cryptocurrencies and blockchain. A good guess as to total market size is some $300bn currently, most of which is not real in any sense. It’s not that this sum has been spent on anything and the cash sum is likely to be ephemeral, it’s the supposed value of all those coins currently in existence.

But that mania is what is leading to a thorough exploration of the technological and economic space, in which we might in fact find something useful.

For example, blockchain sounds like – and experiments, serious ones, are being carried out – a useful way to run an asset ledger.

Shared ownership these days is just an entry in a database, such as the Depository Trust Company in the US. Running that as a permanent listing of all previous ownership, each and every transfer, might be a good idea.

Well, maybe, which is the point that is being made. We don’t know, despite my waters telling me that the currency itself isn’t it, what Bitcoin and the like might be useful for – thus, we’ve got to explore.

People throwing money around to see if it sticks is the way to finance such exploration. Obviously, not necessarily a sensible, certainly not planned, manner, but one that does work.  

Thus the sneaking suspicion among some economists that investment manias and delusions are just those things, yet are useful all the same. For that’s how the truly “out there” ideas get financed, and enough of those work to make near everyone losing their money systemically useful even if more than somewhat a collective madness.   

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This was last published in January 2018

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