Even Newton could not see what goes up must come down

Even Newton could not see what goes up must come down

Fri 23 Feb

“I can calculate the movement of the stars, but not the madness of men.” So said Sir Isaac Newton in the spring of 1720. Doubtful of the stock market’s volatility he sold his shares in the South Sea Company and trousered his gains. He’d doubled his money by jumping ship when the stock was trading at £200 a share. Had the price stabilised or dropped, there would be little more to say about Newton’s involvement with the markets. However, it did not end there, not even for one of the greatest minds of his time.

For the gambler, particularly the gambler who considers him or herself objective, and without a compulsive edge, it’s not the losing that’s intolerable. It’s not the winning either. It’s the feeling of being left out or left behind that is unacceptable. Having sold his stock, Newton watched his peers grow rich as the South Sea Company’s share price continued to climb. It hit just shy of £1,000, making the joint stock company’s worth one quarter of Britain’s GDP. It was at this price and at this point in August 1720 that the inventor of calculus bet everything he had and quite a bit that he didn’t have. Shortly afterwards, the price collapsed and he lost everything. By the end of the year, the whole company had been exposed as a sham.

It was a complex fraud involving hype, lies, “pump and dump”, and insider dealing, all of which was then exposed. The price of the shares and of many other unconnected businesses tumbled. The whole county, labourers to lords, the willing and less willing were involved in the mania. By January of 1721 the truth was out and the only real heroes were the short-sellers: those who’d seen through the mirage, consolidated their advantage and bet against the stock by borrowing shares, selling at £1,000 and buying them back after they had tumbled.

The South Sea Company had been created nine years earlier, not as a trading enterprise in the traditional sense but as means of consolidating, buying and selling debt: government debt. There was a lot of it to buy. The public, as now, and with good reason, struggled to comprehend the notion of a debt market. As a result, the business was awarded an effective monopoly to trade with the Spanish-controlled South Americas.

At the same time, the East India Company was over a century old. It had made many rich and with presumed ease. The fortunes of the East India Company were real, based on real business, bloody and immoral by today’s standards but real nonetheless. So the East India Company was not a get-rich-quick scheme in the way the South Sea company was presented. For all but the most enlightened specialists – Sir Isaac was not one – these were pre-information times and the South Sea Company presented itself as a very good bet indeed. 

In early 1720 EIC’s market valuation was about £200 per share. Earnings per share (EPS), the previous year’s performance and probable upcoming successes drove demand. On the other hand, South Sea’s valuation was a real valuation but a valuation based on tall stories; or lies – a word we’re  frightened to use now.

South Sea’s manic episode involved the market in its entirety: consequently almost all stocks were overvalued and by Summer 1720 EIC was trading at £420. Had Sir Issac bet more traditionally and bought East India Company instead of becoming reacquainted with the South Sea Company, his predicament would have been woeful if not calamitous: likely losses would have been 65%. When speculations are exposed we all suffer. Even if you rent your home and the value of property plummets, you will still be affected. Similarly, if 25% of the United Kingdom’s GDP is bet on Total Recall to win this year’s Grand National, we’re all in trouble – win, or lose our place.

By December 1720, repossessions and suicides were commonplace as poverty and depression took hold of the public’s hearts and minds. The game was up. Insider dealing, a powerful and dishonest PR machine, corruption of those institutions that should have protected the people, and avarice were now the only truths apparent. The South Sea Company had never been a real business.

God and money have much in common; at least once they are bought and sold they do. More accurately the God business and the money business have many parallels. It’s not the rewards that are dogmatic, it’s those individuals offering methods and means to be rewarded who are dogmatic. Cults, some religions and their leaders target those most in need of spiritual nourishment. Those seeking answers with open minds are easy pickings especially when disillusioned. We all seek solutions and answers even those of us who come to believe that no belief is belief. As near as all of us need money or at the very least a means of exchange to live. Some of us are gluttonous: some of us just want better lives. We’re all believers and we all need a religion, cult or ideology when it comes to wealth. Unfortunately, emancipation can be as ugly as indoctrination.

Bitcoin is real. It’s alternative, sounds safe and feels like a breath of fresh air. It is seen as alternative, not in an angry Leninist or Robespierre-esque way, not in a grungy “Occupy!” way, not in a blind-faith Scientology way: it’s a bit like New Labour but on Mars. A new type of greed that’s not state-sponsored.

The thinking behind it is good. Some of our leading thinkers are exposing institutions such as central banks and post-Smithsonian economics as flawed and self-serving. Steve Keen, Professor of Economics, History and Politics at Kingston University separates the facts from the fiction in his book, Debunking Economics. Unstable and corrupted central banks, the idiocy of fractional-reserve banking and a “science” predicated on whims and desires are all covered. The Emperors Keen debunks are indeed down to their undies.

Bitcoin appeals to the “Brave New World” that fuels our dreams. It captivates with a promise of truth and a once-in-a-lifetime opportunity. Bitcoin gets some added kudos for excluding some of our most hated institutions. Many of these are rightly accused of abetting the 2008 crash and subsequent depression. But availability to the masses, simplicity and democratic ideology don’t mean it’s a good thing. At best Bitcoin will become a long forgotten speculative bubble, at worst another form of tyranny. 

The collective delusion that gathers around schemes like the bitcoin is not the same as that engendered by the Ponzi scheme. Like Charles Ponzi’s original idea, Bitcoin looks both legal and plausible. A Ponzi scheme works by paying investor’ returns on their investments with the investments of new investors. If not stopped, it works until either the supply of money, victims or both run out. It’s fraud. But the mechanics leading up to the act of fraud are fascinating. Ponzi knew what he was doing was illegal but there was a time when he had a real idea that he believed was both possible and legal. Only when he realised that it was not possible did he become a criminal.

Satoshi Nakamoto (nobody knows who he or she is) is heralded as the creator of both Bitcoin and the network used for transactions in bitcoin called the “blockchain”. The blockchain is public, secure and allows these transactions to take place without the interference or protection of a banking system. As more transactions are processed, more Bitcoin are created. This process is called mining. Anyone with a computer can mine but powerful processors are required to do this efficiently. Thus mining has become an industry in itself. Industry is the appropriate word – mining Bitcoin consumes more power than Ireland's electricity grid in an entire year.

Now we’re getting a sense of the bubble. Those on the inside of the Bitcoin cult will argue that the currency and the technology are one, and that the blockchain holds the future of all financial transactions. If you believe in the technology, buy some stock in the corporations refining it; the usual suspects, the large corporations, are all believers. Invest in IBM and hope they've got no skeletons ready to pounce from their filling cabinets. 

“What the internet did for communications, blockchain will do for trusted transactions.” – Ginni Rometti, CEO, IBM.

If you’re one of the enlightened few – I’m not – and you can predict the next rise or fall of Bitcoin, by all means capitalise. My day job is that of “turf accountant”. Sometimes, I can predict that odds of a particular selection in a particular event will move up or down – with some certainty. Often, I have no opinion on the outcome of the event but there is a pound note to be had from the fluctuation. Guessing right isn’t the same as being right.

The writing is already on the wall for Bitcoin and in big letters. Whether or not the hype has been planned by those likely to profit from the cryptocurrency or whether the relentless optimism of the Brave New Worlders is responsible for almost all positive coverage of Bitcoin is unclear. Bloomberg, I hear, offers financial incentives to their writers for writing articles about Bitcoin. Perhaps readers clicking on these articles makes it financially worthwhile for the company.

Another worry is Mt. Gox. This is the Japanese Bitcoin exchange that allegedly closed down due to theft, fraud and mismanagement. It is an almost forgotten story, difficult to research, but it’s an important piece of the jigsaw. Once the largest bitcoin intermediary and the world’s leading bitcoin exchange, Mt. Gox handled nearly three quarters of all Bitcoin transactions. In 2014 it inexplicably closed with a half billion dollars’ worth of Bitcoin missing. 

I speak to investors and traders a lot, and many of them don’t remember these losses and if they do they’re sketchy on detail; they’re alarmingly unalarmed. The volatility of Bitcoin is usually explained  by citing the fact that it is still in its infancy with very few users and that as popularity increases so will stability.

This was not the case in 1720 and neither was it the case in 1637 when the craze for tulip bulbs was recognised as a mania. One tulip bulb could never sustain a price of £150,000 in today’s money. As in England in 1720, it took a whole nation state, in this case, the Netherlands, to invest before the bubble burst.

Andreas Antonopolous is a pioneer of the digital currency. Antonopolous lectures on the subject and has written a book on it (https://antonopoulos.com/). Researching this piece I was captivated by a speech he gave on Argentina. He said he had watched Argentina’s economy shattered by hyperinflation twice in two decades. He went on to explain how the Argentines grasped Bitcoin and its importance immediately. In the US and Britain we’ve not had to deal with our currency’s value dropping to zero so we are harder to impress. I would argue that Argentina is simply hungry for alternatives and that any alternative to the institutions that govern our fiat currencies are more attractive than the institutions that govern our fiat currencies.

En fin, there are only two certainties: the rise, which has only just started, and the fall. But it doesn’t matter how much history, science or psychology we have at our fingertips. Around love and money we are predisposed to repeat history and those who want to become rich quick will always act inappropriately and with little regard for the inevitable.

Article by Long Shot, a turf accountant.

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