Bitcoin, the Virtual Currency That Could Cause You Real Pain

Bitcoin's value has been swinging madly, but who are we to complain, given that out leaders have been behaving like speculators on speed.

Bitcoin, Bitcoin, Bitcoin. Last week the virtual currency created by unknown programmers was the only story in town.

After soaring last week to record levels of $250 and plummeting to less than $100, Bitcoin rallied a tad to about $114 per bitcoin on Friday. But the question plaguing investor minds is less the wild swings in its value and more whether it is a revolutionary financial concept, or a figment.

Well, what is it? Is this a fundamental change in the world of finance, as some Bitcoin devotees and investors claim? Or is this just another stupid bubble, in which financial history is so rich?

Everybody has the right to their opinion. I belong to the growing camp of people who claim that the whole Bitcoin thing is nothing but another step in the march of financial folly that seizes the world from time to time, from Dutch tulips in the 17th century to the subprime craze.

The only difference is that this time, the folly is taking place online.

If I'm right, Bitcoin will end up like previous finance fads. Speculation will attract innocent gamblers and profit-starved people to “invest” in it. Its price could skyrocket to unimaginable levels, as happened last week. Then one fine day, suddenly buyers will vanish as if by magic (that very thing seemed to be happening over the weekend, but sellers discovered there was no other side to the deal).

As always there will be a few lucky ones who cashed out their in investment in time. They will make a lot of money. Since this is a zero-sum game, their gains are identical to the losses of losers, people trapped on the day of reckoning with positive balances in their Bitcoin accounts.

We can only hope that the bubble will not continue to swell and that the craze will hurt only a few. We can only hope it doesn't burgeon into a full-blow economic crisis.

When pyramid schemes go viral and lock in a lot of players, and then collapse, the financial fallout is horrendous. Money is transferred from the many to the few, thus increasing inequality.

If the past has any lessons, it’s that when the big bubbles burst, the result is economic slowdown. That is because money belonging to many has been diminished, while the capital of only a few has grown, even if by a lot.

That was true in The Netherlands in the 17th century, when the demise of the tulip bubble caused severe recession. It happened again in the United States of 2001–2002 after the dot.com bubble burst.

If the Bitcoin froth stays at its current dimensions, it will be nothing more than an anecdote, one more curiosity brought to us by Internet along with piano-playing cats and talking goats.

But if Bitcoin recovers from its weekend drop and becomes a mass phenomenon — and we are still far from that — it could be a problem.

A global spirit of financial folly

But the Bitcoin craze has another aspect. While it may be no more than a financial anecdote in and of itself, it symbolizes the spirit of the times.

If countries and their governments, and their central banks, may do as they please without thinking of the long-term ramifications of their actions, who are we to complain about the antics of a virtual currency traded among computers by a relatively small group of hard-core fans?

After all, if we adopt the spirit of Bitcoin, we could say that the whole financial world today is nothing more than one big Bitcoin — a financial system gripped by a spirit of folly and unable to extricate itself.

In the U.S., we could change the name of the dollar to the Bernankecoin, since Ben Bernanke, the chairman of the Federal Reserve, is printing them without reservation.

In Europe, we could change the name of the Euro to the drachma-markcoin, since the euro is nothing but a mutation, an interesting genetic combination of the currencies that, if they were separate, would have sunk like the Greek drachma or gained strength like the German mark. Meanwhile, they are in a kind of unstable balance that Mario Draghi, the president of the European Central Bank, is trying to maintain.

In the United Kingdom, whose economy has been based on financial services for a long time, the name of the currency could be changed to the tuppencecoin. The strength of this currency is based on attracting the magnates of the world who, like the old song says, know that London has great TV programs, and the taxes are more convenient there as well.

Sergeant Pepper’s Lonely Currencies Club Band

Japan is the latest member of Sergeant Pepper’s Lonely Currencies Club Band (having replaced the legendary Sergeant Pepper with a paper currency that hasn’t got much to back it up). Having decided that anything the U.S. can do, it can do better, Japan has begun printing yens with Japanese intensity and efficiency. And now we have the yen-coin, too.

So what will the financial historians write about our times in another ten or twenty years?

It’s clear to everyone that much of what is happening in the global financial arena is extraordinary, and we have no known historical precedent for it.

Everyone also understands that the decision-makers and shapers of policy aren’t really in control of events, and they are holding onto the future of this financial experiment mainly out of fear of being seen as those who stopped the music and took away the drinks in the middle of the party.

If it should turn out that the only fiasco remembered from these days is the story of Bitcoin’s antics and the headlines it never made, that will be a miracle. The big fear is that the real fiasco of the financial world — both monetarily and fiscally — will be much larger, and not virtual at all.

The writer is an independent financial consultant.

AP