Unit 3 Lecture Notes

Like it has done to many things in this world, the emergence of Bitcoin shakes up foundations of Exter's pyramid, both the credit structure and the pedagogical concept. After the massive reflation of Exter's pyramid in 2008, governments have gone on with their eternal song and dance of creating credit and debasing money, while individuals try to maximize their wealth by searching for the best combination of liquidity and risk to achieve their ends. The easier the credit conditions, the easier money is, the more risk people will be willing to take, and the more reckless investments they finance. Whereas in the 1970's the top of the pyramid contained third world debt, in the 1980's it had penny stocks and junk bonds, while the 1990's and 2000's saw stocks, real estate, and collateralized debt obligations take the dubious crown of silliest money at top of the pyramid.

It is not easy to estimate with any certainty what assets are at the top of Exter's pyramid today, particularly as there are many, many competitors for the crown. Stock markets' unstoppable rise looks like a prime candidate, but when one looks at the ridiculous amounts flowing into the bonds of incompetent governments, that appears like another worthy candidate. Various industries surviving thanks to government subsidies and access to cheap credit are other prime candidates for this. The number of industries reliant on low interest rates and continued credit expansion is so overwhelming that it is not even clear what would be the first major sector of the economy that would collapse.

Suffice it to say that this entire charade would never be possible without the insane amounts of easy money creation taking place in the major central banks. As individuals can borrow to finance the most hare-brained business idea or even personal consumption, and failed and unproductive businesses are provided the lifeline of low interest rate lending, they can continue to pay salaries to people who are not productive, and dividends to investors who are not good at picking investments. This means a lot of unearned easy money in the hands of people who overestimate their own competence. As these people start putting their money in various new fields, one particular sector is likely to offer particularly high returns, due to technological, political, or regulatory reasons. For instance, in the 1990's this was mainly internet-related stocks as the internet's explosion created large profits. In the 2000's it was housing because various US government regulations made investment in housing more profitable, such as the removal of capital gains tax on housing.

I would propose that a strong candidate for being the top of the pyramid is the massive bubble that is "the cryptocurrency industry" - an entire industry of cargo cult investors throwing money at cargo cult engineers in the vain attempt that one of them will one day produce anything worthy of being compared to bitcoin. The Bitcoin Standard, and my twitter feed, contain enough material on why exactly I find this entire industry pointless, and I will not rehash these points here, but explain how I see the rise of the Shitcoin Industrial Complex through the lens of Exter's pyramid. Bitcoin was created in 2008, and began trading in 2009, right at the beginning of this current episode of credit expansion. As it rose in value through its early years, it attracted a lot of the easy money people have floating around and ready to invest in mostly-stupid high risk ideas. The rise in value continued to attract more people to invest in Bitcoin, and like with anything in Exter's triangle, the rise in value will cause a rising demand for creation of more.

But as readers of The Bitcoin Standard will note, Bitcoin is unique among all monetary assets to have ever existed in being absolutely scarce. No matter how much time and money goes into producing more bitcoin, there seem to be no way to produce any more than the 21 millions Satoshi gave us. But it is very easy to produce knock-offs! As these altcoins were being produced during the credit expansion phase, they were also there ready to benefit from the large amounts of stupid money looking for something with a return. The musical chairs dance could continue for as long as the music of credit expansion went on.

So what happens next assuming the preceding analysis on Bitcoin and altcoins is applicable? Two very important questions emerge with respect to a potential financial crisis: first, how will bitcoin behave in a financial crisis? Will it witness a collapse like a top-of-the-pyramid high risk asset, or will it witness a rise in value as a bottom-of-the-pyramid safe haven asset? Second, will Bitcoin differentiate itself from shitcoins during the next financial crisis, or will they behave similarly?