SHI 11.30.22 — What The Heck is ‘Value’ Anyway?

SHI 11.23.22 – They Need Me In the Kitchen!
November 23, 2022
SHI 12.7.22 – The Most Boring Book Ever Written
December 7, 2022

 

Is crypto an ‘existential threat’ or a ‘valuable asset?’ 

 

As is often the case, it depends on who you ask.  Here’s an idea:  Let’s ask Senator Elizabeth Warren.

In a Wall Street Journal ‘op-ed’ run just days before Thanksgiving, Senator Warren offered her definitive opinion on crpyto.   Below are her words, from an article titled, “Regulate Crypto or It’ll Take Down the Economy”: 

 

“History is littered with financial schemes promoted by criminals and charlatans who claimed that the latest and greatest tools had evolved beyond the need for regulation or a cop on the beat. During the 2008 collapse and every financial crisis before that, these claims have proved dangerously delusional. Crypto is no exception.”

 

Damn.   ‘Criminals’ and ‘charlatans’?   That’s harsh, Liz.  Seriously. 

Look, say what you want about Senator Warren’s politics, you have to appreciate her skill with rhetoric!    She sure can turn a phrase!   OK, sure, that Bankman-Fried guy over at FTX is probably a criminal.  That seems increasingly likely — his comments today from an interview on “DealBook/Summit” notwithstanding. 

But can an un-regulated crypto market take down the US economy, as Liz seems to fear?  

 

 

From FOMO … to UHOH … to OHNO …” 

 

… in about 1 year.   Amazing.   Lots has happened during 2022 — it’s been one  C R A Z Y  year, economically speaking, but I suspect almost everyone would agree the crypto-world has been upended.   Once “valued” at over $3 trillion, the ‘value’ of crypto and NTFs, collectively, is down to about $820 billion.    About 70%.  Damn. 

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI10, or its objective and methodology, I suggest you open and read the original BLOG: https://www.steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/


Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.  

But is the US economy expanding or contracting?

Expanding.    At the end of Q3, 2022, in ‘current-dollar’ terms, US annual economic output rose to $25.66 trillion.   So far this year, America’s current-dollar GDP has increased at an annualized rate exceeding 7.1%.   The world’s annual GDP rose to about $95 trillion at the end of 2021.   America’s GDP remains around 25% of all global GDP.  Collectively, the US, the euro zone, and China still generate about 70% of the global economic output.  These are the 3 big, global players.

 

The objective of this blog is singular.

 

It attempts to predict the direction of our GDP ahead of official economic releases. Historically, ‘personal consumption expenditures,’ or PCE, has been the largest component of US GDP growth — typically about 2/3 of all GDP growth.  In fact, the majority of all GDP increases (or declines) usually results from (increases or decreases in) consumer spending.  Consumer spending is clearly a critical financial metric.  In all likelihood, the most important financial metric. The Steak House Index focuses right here … on the “consumer spending” metric.  I intend the SHI10 is to be predictive, anticipating where the economy is going – not where it’s been.


Taking action:  Keep up with this weekly BLOG update.  Not only will we cover the SHI and SHI10, but we’ll explore “fun” items of economic importance.   Hopefully you find the discussion fun, too.

If the SHI10 index moves appreciably -– either showing massive improvement or significant declines –- indicating growing economic strength or a potential recession, we’ll discuss possible actions at that time.


 

The Blog:

 

Ironically, as 2022 began, a friend  asked if I had any serious personal fears about our financial system.   Did I have any “black swan” fears – you know, those exceptionally infrequent financial ‘tail risks’ that can strike and potentially cripple or take down financial systems when you least expect expect them? 

I answered yes, in fact, I do.   Two.  Two ‘worries’ kept me up at night.   Both, I commented, reflected powerful ‘bubble momentum’ — in my opinion — and if either collapsed, the contagion could cause widespread economic damage.  These two financial manias, I shared, had the potential to create serious problems for the globe’s financial systems.

First, I told him I was worried about crypto.  Very quickly, this “asset class” market cap had grown to more than $3 trillion – equaling about 5% of the value of the public stock and bond markets.  I felt the growth rate was unsustainable and dangerous.   I felt it had become a bubble … a new financial mania. 

Secondly, I worried about a general collapse in the Chinese housing market.  In my opinion, the “see-thru” high-rise condo projects were a bubble ready to pop.   And depending on how it happened, that event could potentially take-down the Chinese economy and spread contagion around the world. 

My ‘mania crystal ball’ must have been working well back in January.   Because both bubbles have now burst.   The bloom is definitely off the rose in crypto.   And China’s condo market is in a world of hurt right now.   The crypto-bubble has burst — sort of.   At the minimum, a whole lot of air has whooooosed out.  Worthless tokens and NFTs can now be found littering most NYC subway stations and the lobbies of popular yacht clubs, those with bored apes as members, are silent today.   The Chinese see-thru high-rise condo market has become just a shell of what it once was – which, of course, was a bunch of empty shells.   The air has rushed out of both balloons … and I’m pleased to report I’m now sleeping better.   Not soundly, mind you.  But better. 

Neither bursting bubble crushed or gutted global finance.   So far. I’m no longer concerned about crypto-contagion … but China-fears still loom large in my mind.  I’m watching this one closely.  

The crypto-bubble-burst has proven quite interesting.   Of course, that’s only if you’re on the sidelines – as I have been – thru the entire episode.   I’m a spectator.  

As I mentioned above, at the peak, “crypto assets” were valued at over $3 trillion.   Today, their collective market cap is down to about $820 billion – only 30% of their prior value peak.  And Elizabeth Warren’s admonitions aside, the crypto-collapse did not take down our economy.   In fact, I’m pleased to report, the general economy machinery really didn’t seem to notice.   The stock markets chugged on.   The bond markets chugged on.    E-commerce continued to work.   Grocery store shelves continued to be stocked.  Burgers were still sold.  Good. 

 

Could the ‘value’ of ‘crypto’ go to zero?  

 

That was the precise question from a recent Economist magazine article, “How crypto goes to zero.” 

It’ a well-written article … worth a glance if you have time.   Google it.   But the title notwithstanding, the author concludes “it’s hard to imagine” it’s ‘value’ can go to zero.   He suggests the cryptocurrency internal plumping makes that outcome unlikely: 

 

“An answer requires a sense of how the industry works. At crypto’s base are blockchains, like Bitcoin and Ethereum, which record transactions verified by computers, a process incentivised by the issuance of new tokens.

The Ethereum blockchain validates lines of code, which has made it possible for people to issue their own tokens or build applications. These include stablecoins, which are pegged to real-world currencies, and tokens like Uniswap, which manage decentralised-finance (DeFi) protocols. Major chains and a handful of Ethereum-based tokens, like stablecoins, account for about 90% of cryptocurrency value.  Big businesses have been built on top of this world, including exchanges, investment funds and lending platforms.”

 

But what, precisely, is “value” – the word the author used in the article, and I underlined above?   Why does a cryptocurrency have ‘value?’   Why does an NFT have ‘value’?   Why does a US dollar have ‘value’?   

In the case of ether and bitcoin, the author suggests the underlying blockchain system has value because …

 

“… Knocking the stool out is extraordinarily hard, and the current high value of bitcoin and ether makes it even harder. To attack a blockchain and shut it down requires gaining 51% control of the computational power or value of tokens staked to verify transactions. The more valuable the tokens, the more energy it takes to attack a proof-of-work chain, like Bitcoin, and the more money to attack a proof-of-stake chain, like Ethereum. The security of these chains—as measured by the amount someone would have to spend to attack them—is now in the region of $10bn to $15bn.”

 

So the ‘security of the chain’ – another word for ‘value?’ – can be measured by the underlying creation cost, or the cost to destroy the system?   Interesting. 

‘Value’ is a fascinating word … and I’ll return to this a bit later in the blog. 

The US Treasury ‘Financial Stability Oversight Council’ has ‘weighted in’ a bit on the crypto-discussion.   In a 124-page paper entitled “Report on Digital Asset Financial Stability Risks and Regulation 2022,” they actually do a fairly deep dive into the crypto-world and even make some recommendations!    Maybe the US Treasury’s thoughts will calm Liz down a bit?   Take a look … it’s quite interesting (right click, open in new tab):

 

https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf

 

Existential threat or not, the crypto-world is quite complex.   Ignoring “how it works” for the time being, consider this diagram from the Treasury’s report of the relationships on just one (now failed) platform:

 

 

Owner ……. investor …… lender …. I get vertigo trying to follow the relationships.  Sorry, folks, but to me this image screams ‘PONZI SCHEME!!!!!!  But maybe that’s just me … and Senator Warren.  🙂

OK, let’s circle back to the earlier question:   What makes an asset valuable?    What is ‘value?’

Assessing the value of the US dollar is easy, right?  It is the most readily accepted mode-of-payment on the planet.   The vast majority of international transactions and transfers occur with dollars.   Daily, trillions upon trillions of US dollars are used by the vast majority of the 190+ countries in the world.  Yet, in his book “HOMO DEUS:  A Brief History of Tomorrow,”  Yuval Noah Harari suggests that money is simply a “fictional belief based on a submissive reality.”   Harari claims,

 

“The government makes worthless pieces of paper, declares them to be valuable and then uses them to compute the value of everything else.   The government has the power to force citizens to pay taxes using these pieces of paper, so the citizens have no choice but to get therein hands on at least some of them.  Consequently, these bills really do become valuable, the government officials are vindicated in their beliefs, and since the government controls the issuing of paper money, its power grows.”

 

Interesting.  Ironically, this argument bears eerie similarity to the beliefs of the bitcoin-ers.   And ‘they’ would add that unlike the dubious pieces of paper issued by the government in ever-increasing amounts, bitcoin has a fixed and limited supply.   Once that ceiling is reached, no further bitcoin can ever be created.  Unlike the US dollar.  

So, is ‘value’ a ‘scarcity’ thing?     Does a limited supply of a ‘thing’ imply that thing has ‘value’? 

Clearly, by her own words Senator Warren doesn’t distinguish between bitcoin, ether and the other tens-of-thousands of tokens.    She lumps all ‘crypto’ into the same basket as subprime mortgages of 2008 (ironically, in 2008 almost no subprime mortgages were actually made … they were made years before and came crashing down in 2008), and ‘penny stocks of a century earlier.’  Again, you have to love her hyperbole, whether you agree or not:

 

“Crypto has created new opportunities for money laundering. Terrorists, drug dealers, ransomware criminals, tax cheats and outlaw nations can hide their illegal activities by trading billions of dollars of cryptocurrencies with complete anonymity.”

 

Ouch. 

The Economist article disagrees.   It suggests a “base” or value foundation has been built in blockchain during the past decade or so.  And, by extension, the time, effort and money required to build that base essentially confer ‘value’ on the system. 

Perhaps in the same way that a commercial real estate developer builds, say, a new hotel.   The construction process has a complex set of rules and standards the developer must meet and follow.   The time and materials required to create the hotel are substantial.  Construction lenders will appraise the “to-be-built” commercial property and lend against it.  And when complete, the asset has ‘value.’ 

 

But how do we know a piece of commercial real estate, like our mythical hotel above, has ‘value’ once completed?

 

Because most people agree that is does?   Or is there something else ….

Let’s ask Wikipedia.   There we see the formal definition of ‘asset’ comes from the International Financial Reporting Standards (IFRS) which says:

 

“An asset is a present economic resource controlled by the entity as a result of past events.  An economic resource is a right that has the potential to produce economic benefits.”

 

OK, right.   An asset is a ‘right’ that might product ‘economic benefit.’    This works for me.   Because I ultimately come back to my personal foundational belief when defining ‘value’:  “The value of an asset is some function of the income that asset can generate or produce over time.”    Note that income can be both quantitative (money) and qualitative (utility).   This is my lens thru which I assess value. 

But I fear I can offer no end-all definition here.   I apologize.  The US dollar has value because billions of people believe it does.  Belief.   Perhaps it’s that simple. 

So maybe this concept helps … maybe “when enough people believe that some object – tangible or otherwise – has value, it does.”   It’s not a concept I like much because I find it impossible to determine that proverbial ‘tipping point’ inherent in the definition – “enough people.”   How many people is enough?  I have no idea.   But it does seem to hold water. 

The author’s argument in the Economist article seems to rest on this foundation:  Apparently “enough people” – as evidenced by the investment of time and money – today believe that bitcoin and ether have ‘value.’  Some part of ‘value’ — the author would argue — is ensconced in the amount of human ‘capital’ that was expended to create the asset or system over time.    Like pyramids, globalization, or bitcoin. 

Or a bottle of fine wine!

Some sell for thousands of dollars – which according to Harari are “worthless pieces of paper” – and the marketplace is robust.   And while a fine bottle of wine cannot inherently generate income, drinking one can create a feeling – perhaps of satisfaction or enjoyment – for the drinker.    And the right wine tastes fantastic with a perfectly grilled New York steak!

So, perhaps, in the final analysis, ‘value’ – much like ‘beauty’ – is in the eyes of the beholder.    If enough people believe a particular asset is valuable, perhaps it is.  

Don’t get me wrong:   I still have no plans to “invest” in crypto.   Senator Liz and I agree on that one.   Our opinions notwithstanding, the crypto ‘system’ has taken some serious hits lately, and while the contagion is spreading, so far the system seems to have withstood the onslaught.  The damage is obvious, but the system stands.   Permanently?  Who knows.   But as this very human drama plays out, I suggest you grab a comfortable chair and some popcorn and watch it unfold.  

But first, can I suggest a trip to the steak houses?

 

 

Well, perhaps the fact that we’re rolling into “the holiday season” has added some season cheer into reservation demand!   Demand is up about 20% this week!   Boom!  Is this surge an economic vitality… or simply a seasonal adjustment?    Time will tell.   But it’s worth noting that the GDP report issued earlier today by the Bureau of Economic Analysis (BEA) reflected a robust 2.9% GDP growth in Q3 of this year.   Current-dollar GDP was up at the annualized rate of 7.3%!    These are strong growth numbers … and the SHI and the GDP are very much aligned here.   🙂

Here’s the longer-term trend report:

 

 

The trend is strong and very positive.  

Next week I’ll talk about the contrarian view — one stark and clear from the current “yield curve” and the Case-Shiller index.   Until then, I thank you for reading, and I hope you found ‘value’ in today’s blog.   🙂

<:> Terry Liebman

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