As each year ends, I try to pause and reflect on some of the year’s themes and how poorly I predicted them. The goal of this exercise is to relearn some of the lessons we relearn every year: Mainly that nobody, including myself, has any idea how macroeconomic and sociopolitical events will play out, nor how they will affect the markets. The best we can do is predict that past inertia will continue into the future – e.g. the stock market will return about 7.0%. We know this is an illusion since, within any chaotic, complex system, inertia is ephemeral at best, but it’s a nice illusion.
This isn’t to say making predictions and planning ahead is pointless, but rather to say that even the best-made predictions and best-laid plans will often go awry. Adaptation is what matters. For example, on November 29th, 2017, Voyager 1 became the first human-made object to enter interstellar space. Such a multi-decade feat required a level of long-term prediction and planning that luckily space travel is uniquely amenable to. And yet it still went awry:
Since 2014, engineers have noticed that the thrusters Voyager 1 has been using to orient the spacecraft, called “attitude control thrusters,” have been degrading. Over time, the thrusters require more puffs to give off the same amount of energy. At 13 billion miles from Earth, there’s no mechanic shop nearby to get a tune-up.
The Voyager team assembled a group of propulsion experts at NASA’s Jet Propulsion Laboratory, Pasadena, California, to study the problem. Chris Jones, Robert Shotwell, Carl Guernsey and Todd Barber analyzed options and predicted how the spacecraft would respond in different scenarios. They agreed on an unusual solution: Try giving the job of orientation to a set of thrusters that had been asleep for 37 years.
It worked, and in 2017, after 40 years of flight, and with the help of planning, adapting, and patience, humanity entered the space between the stars for the first time. This analogy was a reach, but space is cool so whatever. Now, let’s get into the year.
A Year of Economic Expansion
In 2017, markets boomed around the world – stocks were up, bonds were up, real estate was up, tech was up, bitcoin was up, pretty much everything was up (energy was down). The S&P 500 closed positive for each of the 12 months of the year – something that has never happened before – and Emerging Markets were up about 45% after doing nothing for most of the past decade. Things went well.
This market performance was matched by the underlying economic performance. According to the IMF, GDP growth accelerated in three-quarters of countries around the world – the highest share in about a decade. Europe was a clear winner; after entering the year with the weight of brexit, failing banks, and political uncertainty on its shoulders, Europe exited the year with a 2.2% growth rate, falling unemployment, a strengthening currency, a labor reforming French president, and a Greek economy that was able to return to the bond markets. Laggards this year included fuel exporting countries and countries suffering from civil strife.
Global trade increased despite heightened rhetoric about protectionism, volatility decreased despite heightened rhetoric about geopolitical conflicts, and inflation decreased despite heightened rhetoric about central bankers overheating the economy. On the downside, productivity and wages have been stagnant. Also, depending on how you look at it, the US dollar had it’s worse year in more than a decade.
A Year of Political Recession
In case you missed it, Donald Trump took office this year and accordingly or not, people freaked out. This election night piece by Paul Krugman captures the sentiment well (Krugman would later retract this prediction as an emotional lapse in judgment):
If the question is when markets will recover, a first-pass answer is never.
Under any circumstances, putting an irresponsible, ignorant man who takes his advice from all the wrong people in charge of the nation with the world’s most important economy would be very bad news. What makes it especially bad right now, however, is the fundamentally fragile state much of the world is still in, eight years after the great financial crisis.
During the year, the tone from the two parties has ranged between “everything is going to blow up tomorrow” and “everything is going to be great forever”. As usual, the truth was somewhere in between.
Trump didn’t start a trade war, markets are soaring, mass deportations haven’t occurred, GDP is growing at over 3%, there is no border wall, the Iran deal hasn’t been torn up, Putin hasn’t annexed Eastern Europe, Obamacare is still around, and there hasn’t been a constitutional crisis… yet. Of course, the bar has fallen pretty low when we are handing out points for not starting a nuclear war.
There has also been some real damage. Trump’s foreign policy appears to have left a void that China is happy to fill. Trump has actively gone after political and social norms in what appears to be a misguided attempt to further his policy agenda. The country is pacing Trump’s rhetoric and the level of political discourse has deteriorated to a point where tribalism is making it difficult to separate policy from party. Just look at Alabama, where an alleged pedophile, and incontrovertibly labeled asshole, almost won a Senate seat by appealing to this division.
Why does it feel like every day the hammer has fallen on this Presidency? For one, this administration does dumb things every day. For two, the 24-hour news cycle amplifies these dumb things. The media seems to feel that they played a complicit role in Trump’s rise to office (hours of free publicity, focusing on Clinton’s flaws while downplaying his, etc), and are now overcompensating in the other direction. Most of these news outlets are operating in good faith, but they seem to have fallen into a confirmation bias trap that led to expanded coverage of every possible left-leaning fever dream. The news on the right hasn’t been any better – often operating on click-bait rather than in good faith.
Social media hasn’t helped either. A former Facebook executive, commenting on Facebook’s role in the election, argued that “the short-term, dopamine-driven feedback loops we’ve created are destroying how society works.” This may be hyperbolic, but there’s certainly some truth to it. Social media companies have figured out that there is something about car crashes and fights that make people naturally stop and watch. The same is true for fights on social media. If so and so is getting into a political fight with their uncle on Facebook, chances are an algorithm will serve that thread up to us. If so and so is exchanging pleasantries with their uncle, chances are the algorithm will ignore it. Fights are good for business, anger equals engagement.
Look at the coverage of the Tax bill. Depending on which echo chamber we are in, it is either a complete handout to the rich or the greatest middle-class tax cut in history. Again, the truth is neither. According to the Joint Committee on Taxation – a committee set up by both sides of Congress to evaluate tax policy – the distributional effects of the bill remain the same. Actually, millionaires play slightly more – now 19.8% up from 19.3%. Over time, this falls back down, but that is mainly due to the expiration of middle-class tax cuts that aren’t likely to expire. There is a real debate to be had about whether this distribution was ever even optimal in the first place (it probably wasn’t), but that debate isn’t happening.
There are things in the bill I agree with: lowering the corporate tax rate, increasing the standard deduction, increasing the child tax credit, reducing the mortgage interest deduction, reducing the business interest deduction, using chained CPI, expanding 529 college savings plans, and adding a territorial taxing system. There are things in the bill I don’t agree with: lowering the estate tax, removing the ability to choose your tax basis for stock sales, temporarily adding full expensing of physical business investment while removing full expensing of R&D, removing the individual mandate, exploding the deficit, and adding complexity for anyone not claiming the standard deduction.
So what can be done in a time of political recession? One thing is for sure, there is no shortage of people trying end Trump’s Presidency. In fact, Trump has started a fight with everyone in a position to do so: the Media, the FBI the CIA, the DOJ, the IRS, both parties in Congress, his own cabinet, and his own staff. If it turns out there is nothing impeachable going on, it won’t be because of a lack of trying. A better strategy is to just remember that our institutions are strong and the 25th Amendment is a powerful check on Presidential irresponsibility.
If that doesn’t give you any comfort, take a look at some of the good stuff going on around the world this year.
A Year of Bitcoin Mania
To get a sense of why Bitcoin deserves its own section this year, look at the Urban Dictionary entry for nocoiner:
A Nocoiner is a person who has no Bitcoin. Nocoiners (usually Socialists, Lawyers or MBA Economists ) are people who missed their opportunity to buy Bitcoin at a low price because they thought it was a scam, and who is now bitter at having missed out. The nocoiner takes out his or her bitterness on Bitcoin Hodlers, by constantly claiming that Bitcoin will crash, is a scam, is a bubble, or other types of easily refuted FUD. Nocoiners have little to no computer skills or imagination; even when they see the price of Bitcoin go up and its adoption spread they consider all Bitcoin users to be in a collective delusion, with only themselves as the ones who can see what is happening. This attitude comes from being steeped in the elitist priest cultures found at Harvard, Yale and Columbia, where anyone who is not part of their clique is treated with suspicion by default. The worst nocoiners are tenured academics and goldbugs. Nocoiners believe that the world owes them everything they want because they are part of an elite; they are hysterical liars, brats, prostitutes and losers.
I’m pretty sure Emin is a Nocoiner. Yesterday he made a Tweet about how Bitcoin going up was just a fad, and that a crash was inevitable. He’s always talking Bitcoin down; if he had Bitcoin, he would never trash his own stash.
Like gold, tulip bulbs, 1980s Tokyo real estate, baseball cards, beanie babies, dotcom companies, 2000s Florida real estate, and 2010s Toronto real estate, Bitcoin is the latest incarnation of the “limited supply equals profit” trope.
In 2017, Bitcoin’s value grew by more than 1,000%. Compare that to the relatively tame 20%-ish move in the S&P 500 and there’s plenty of reason to get excited. But of course, if you find yourself getting rich quickly, it is usually a sign of luck. Let’s take a closer look at the craze.
For an asset whose main selling point is restricted supply, there is certainly no dearth of cryptocurrencies to invest in. Sure, Bitcoin returned 1,000%, but that didn’t even make the top 10 of cryptocurrency performers in the year. Ripple was up ~36,000%, NEM ~30,000%, Stellar ~14,000%, Dash ~9,000%, Ethereum ~9,000%, Litecoin ~5,000%, you get the point. It is no coincidence the largest cryptocurrencies by market cap are the ones that people have the easiest access to on Coinbase. Imagine that if that during the dotcom bubble only three tech stocks were allowed to list on the exchanges and you’ll get some sense of what is going on here. It follows that as more people gain access to different cryptocurrencies, the price of each will be diluted.
The second selling point is the underlying technology of the blockchain. The blockchain is basically a computer protocol that allows people to transact with each other even when they don’t trust each other. It also happens to be a free and open source technology. A useful analogy is the internet itself. Back in the 1990s, it was very clear that there was a ton of value on the internet. Certain companies jumped on that internet wave and were handsomely rewarded for doing so, but there was nothing stopping competitors from jumping on that same wave. Some of these competitors innovated and built upon the work of those that came before them, and some of these competitors just added dotcom to their name and ran away with the money. Like the internet, the blockchain is open to innovators and scammers alike.
Recently, Long Island Iced Tea’s stock rallied 500% after it changed its name to Long Blockchain. The company was doing the exact same thing that it was doing before, but now it had blockchain in its name. Or look at Dogecoin − specifically created as a cryptocurrency parody − which now has a market cap of more than $1 billion. You could buy all of J.C. Penny and its 306 or so stores for that amount – though, like Dogecoin, I don’t know why you would. There are also competitors in the space innovating and improving on the work of Bitcoin. What the winning technology will look like is anyone’s guess. For example, Etherium is working on smart contracts and IOTA is working on scalability.
Speaking of scalability, current implementations on the blockchain aren’t exactly efficient. The cost of maintaining the Bitcoin blockchain is insane when compared to the cost of say storing a government bond. According to Wired:
Back in 2009, you could mine competitively with your desktop computer, but now you’ll need specialist hardware, such as the Antminer S9 – a dedicated mining rig that weighs six kilos and costs well over £1000 before you even start thinking about the electricity bill.
To put these figures in some context, Digiconomist suggests Visa’s payment systems uses the energy equivalent of 50,000 US households to run 350 million transactions, while bitcoin uses the energy equivalent of 2.8 million US households to run 350,000 transactions on a good day — in short, Visa does more with less. As the site’s rationale explains, bitcoin is increasingly becoming a tool for the rich but we’re all paying the price for a system that uses 20,000 times (give or take) more energy than traditional systems per transaction.
These numbers have been challenged, but even if they are only half right, it would still call into question the sustainability of the Bitcoin network. Those rising transaction fees we’ve been reading about aren’t just miners trying to milk more money out of the system, they’re a byproduct of the rising cost of maintaining the network.
The third selling point revolves around a libertarian fever dream of a decentralized, fixed-supply currency that can’t be devalued. It goes something like this, “Government is bad, banks are bad, and they work together to expand the money supply so the Government can go deeper into debt, which is bad.” This idea is the result of a fundamental misunderstanding of what money is. Money isn’t something we have, productivity is something we have, money is something we can get. Money is credit.
David Graeber has argued convincingly that the origins of exchange systems were based on credit. Borrow a plow from your neighbor today, pay them back when the crops come in tomorrow. Borrow food today, repay with food later. Borrow a house from the bank today, repay through productive employment 30 years later. Have a good business idea? A bank will create a deposit asset for you out of thin air that you can use for building up that idea. If it works, pay them back and the economy now has an enterprise that wouldn’t otherwise exist. There is no reason that any of these transactions should be artificially fixed to how much currency or metal is available in a given system. Instead, the money supply should expand or contract with the supply of productive endeavors in an economy. A fixed currency just leads to deflation and hoarding.
But what does any of this matter if everyone is still getting rich off of Bitcoin? There will always be something returning 100x. There will always be someone winning the lotto. The hardest part of any cycle is when everyone else seems like they are getting rich. This is when we need take to step back and compare the narrative to the reality. As Buffett likes to say, “the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”
Bitcoin is a beautiful mishmash of FOMO, storytelling, wishful thinking, speculation, confirmation bias, and technology. Enjoy the ride.
A Year of Other Stories
This post is already going longer than I wanted it to be so I’ll do a quick shout out to some other stories that stood out to me this year. In no particular order:
- Amazon ate everyone’s lunch.
- The Weinstein effect.
- The Equifax Hack.
- AlphaZero beating stockfish.
- Marcon winning the French election.
- Erdogan consolidating power in Turkey.
- Xi consolidating power in China.
- North Korea launching some missiles.
- Central banks tightening around the world.
- ISIS suffering losses in Iraq and Syria.
- Madrid suspending Catalonia’s autonomy.
- Venezuela falling apart.
- Mass shootings.
Predictions For 2018
Since this post opened talking about the folly of making predictions, let’s make some predictions.
High conviction predictions (~50% – 90%):
- Donald Trump won’t be impeached, but people connected to him will be convicted of various crimes and perjuries.
- There is no progress on border wall.
- Obamacare remains intact for the most part.
- The US remains in NAFTA.
- The quality of discourse continues to decline.
- Democrats take the House.
- No progress is made on the Isreali-Palestinian conflict.
- No country leaves the European Union.
- Tesla isn’t able to hit production targets.
- Half-Life 3 isn’t released.
Low conviction predictions (~10% – 50%):
- North Korea returns to the negotiating table as sanctions tighten.
- Iran becomes a secular republic.
- Democrats take the Senate.
- A Bipartisan infrastructure bill is passed.
- A Bipartisan immigration bill is passed.
- The stock market ends the year up.
- Bitcoin ends the year down.
- The yield curve steepens.
- Brexit is reversed.
- An AI system is able to beat humans at Starcraft 2.
- That UFO story from this year gains some traction.
- People agree that on second thought, The Last Jedi was actually pretty good.
We’ll revisit some of these predictions next year to see how wrong they were.