The artificial currency, Bitcoin, won’t trigger the next crash, but its mere existence is a sign of the problems facing financial markets.
When the value of something has fallen to zero it only has one way to go.
While that may be a statement of the obvious, it’s keeping some of the world’s smartest money managers awake at night because of concern that the first sign of rising interest rates could trigger the next phase of the GFC.
No-one in Australia is talking much, yet, about the prospect of higher interest rates, largely because there is a belief that they could slip a little lower as the economy rotates away from the mining boom into a more conventional phase.
It’s different in Europe and the US, where professional fund managers with long memories are on full alert for signs that the great bond crash of 1994 might be repeated.
Back then, in conditions similar to now but not quite so bad, interest rates were low thanks to central banks releasing large amounts of liquidity to stimulate growth.
The result was a few good years of economic recovery, rising property prices, record car sales and good employment growth; until the Federal Reserve – the US central bank – decided that it was too much of a good thing and could lead to an outbreak of inflation.
On February 4 1994 the ‘Fed’ struck without notice, raising interest rates in a pre-emptive strike against inflation. It was the surprise nature of the move, combined with a realisation in the market that more rises would follow, that triggered a stampede out of corporate and government bonds which had been, until then, a favoured investment class.
The result of a switch in the direction of interest rates from down to up was catastrophic. Big-name investment banks failed, and even one of the biggest local government authorities in the US, California’s Orange County, declared itself bankrupt when an investment in interest rate derivatives turned sour.
Today, a similar set of conditions appears to be developing, though with a difference. This time around there is a much-improved level of communication, and the Fed is aware of the damage it can cause by a sudden shift in policy.
But even with a better-informed market there are signs of global markets becoming seriously distorted by the current period of ultra-low interest rates, which are causing investors to make odd decisions – none stranger than the boom in the artificial currency, bitcoin.
Too small to act as the trigger for a market crash, the rise of bitcoin is an indication of what people will do to add a bit of speculative excitement to their investment portfolios, which have been in zero-yield mode for several years.
What bitcoin has done for early ‘investors’ is deliver the same sort of sky-high profits that early investors in tulip bulbs enjoyed in Holland in the 1600s, or that sub-prime investors enjoyed earlier this century – until the game was exposed as a nonsense
With bitcoin, a currency designed for trading website services, logic has again flown out the window. There is no central control of the system, which has been likened to Monopoly money, especially in the way the value of a bitcoin has risen from $US1 two years ago to about $US110 this week, valuing the whole crazy business at well over $US1 billion.
No-one can actually explain rationally how bitcoin works, who owns it, who invented it or how the system works; a situation that can only have one result – a crash.
Because it is so obviously doomed to fail, bitcoin will not be the catalyst of the next big market downturn; but it is a useful yardstick on the road to the next major event, which could occur on the day the US central bank decides that it’s time to start raising interest rates.
Euro crisis
A more serious situation than the eventual crash of Bitcoin could be the crash of the European common currency, the euro, which suffered a severe blow during the banking crisis in Cyprus but which was already being dumped by investors worldwide.
The Cyprus crisis exposed the severity of the European financial situation and the failure of austerity measures to restore confidence in the region, or its currency.
Long before the brutal raid on Cypriot bank deposits, which undercut confidence in all European banks, the rest of the world was voting with its feet and shifting deposits away from European governments desperate for cash.
Last year, according to a study by the International Monetary Fund, developing countries dumped €45 billion of their euro deposits, an 8 per cent cut in their combined holdings.
What that really means is that some of the poorest countries in the world are taking steps to protect their precious savings from a region that was once the richest, but which is now on track for a full-blown economic and political crisis.
Keeping up
Anyone who doubts the direction of the shale-gas revolution and whether it is safe, or not, ought to look at how what started in the US has spread to the world’s two biggest oil producers, Saudi Arabia and Russia, which have accepted that they cannot avoid joining the rush, or risk losing their market leader status.
