Trying To Beat The System Is A Fatally Flawed Investment Strategy

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Bill Cara writes:  This week’s article will begin with a parable. Soon, however, this piece of fiction might become source material for a Harvard Business School case study.

So, recently there was a private members club with 99 men and women who had each paid $1,000 to join. At the first monthly meeting, somebody suggested it would be a good idea to top off membership at 100, so the call went out to their friends. Lo and behold, one person stepped up with an offer of $1,500 and the capital account grew to $100,500. The next month however another individual offered $2,000 to join and the members were elated to grow their numbers to 101 with the capital account now up to $102,500. Nobody complained the following month when another individual came forward with $2,500 to join, bringing membership to 102 and the capital account to $105,000. As the months flew by, there was always one more person who wanted to join, and the offers were up to $3,000, $4,000, and $5,000 in months 4, 5 and 6. The original members became giddy and decided to set the price higher by $1,000 each month, and each month a new member joined at the posted price. After a year, the membership was up to 111 and the members actually believed their memberships were worth $11,000 and so they valued their club at $1,221,000, putting it up for sale.

Nobody seemed to care that their capital account had grown to a much smaller $168,000, which averaged just $1,513.51 per member. Arguments soon ensued from twenty of the members who did not want to sell the club, which after they were out-voted decided instead to sell their memberships back to the club for $11,000 each in order to start their own club. Being short the $220,000 required to buy back 20 memberships, the first club depleted their capital account and went to the bank and borrowed the necessary $52,000 shortfall. Not wanting to have a deficit capital account, another 20 members decided to sell, which cost an additional $220,000 for which their bank willingly secured the full $272,000 debt with personal guarantees from the remaining 71 members. But later when this club went to the market offering their full 71 shares at $11,000 each, they were surprised there were no bids, which happened because the second club, now up to 40 members, had been offering founding memberships at just $1,000. After the first club had failed to sell any memberships at any amount to repay the bank and get off their personal guarantees, the bank called the loan and put them out of business. With no competition, the second club now started selling memberships at $2,000 each. This was an expensive lesson in economics, particularly to those members who had paid up to $11,000. The final insult came when the tax department refused their claim for losses, ruling these individuals to be gamblers, not investors.

What we see happening with Bitcoin is purely and simply a gamble. Just because CME Group will be offering futures on Bitcoin starting this month does not legitimize the instrument as money just as weather contracts and many other futures products do not make the basis of those instruments money. Bitcoin only becomes money when governments legalize it as money and central banks give it their financial support.

Despite the rapidly growing numbers of individuals now buying Bitcoin at prices close to $16,000, up from about $1,000 at the start of the year, we agree with Nobel prize-winning economist Joseph Stiglitz that all cryptocurrencies ought to be outlawed in the public interest because there is no intrinsic value to what is essentially a pyramid scheme. At the very least the owners should be taxed quarterly on unrealized gains, which would soon cool the mania.



What is most likely to happen is that the G-20 central banks and governments will soon decide that cryptocurrency products are in fact vehicles for money laundering and tax evasion. Should that happen, it’s doubtful that many people, including crooks, will be sending their money to a banana republic to acquire these items. As the deputy governor of the People’s Bank of China opined this week, cryptocurrencies will soon be dead, and one could sit on a river bank and watch the corpse float by.

Buyers of cryptocurrency ought to look at the chart of First Bitcoin Capital Corp (BITCF) to see what happened when the SEC stepped in. First Bitcoin is a Vancouver BC stock promotion that applied for a US listing without having ever made a filing to the SEC. Following regulatory action, the stock price collapsed as will happen with all the others.



What Bitcoin buyers are ignoring is that the product is not a medium of exchange in the taxable world; it’s a technology, one that will be replaced by newer technologies as increasingly sophisticated hacks steal coins from today’s market. In fact, NiceHash, a digital currency exchange, reported this week that bitcoin worth nearly $64 million was hacked. The technology is not perfect.

At some point, we believe there will be acceptance by central banks and G-20 governments to adopt a single standard technology that will serve as a global medium of exchange. All others will be outlawed. However, before we get to that point, Humongous Bank & Broker will have funded and control the latest, greatest, cryptocurrency product that will become the global standard, backed by the International Monetary Fund and Bank for International Settlements.

We understand the blow-back that may follow from comments like ours; but ours is an important message of investor prudence. A point we want to make is that in their desire for independence from government and central bank policies, which as most of us know have put the world in a bad place, people should not be so quick to ignore prudent advice from registered investment advisers and bankers.

The bitcoin world is making our work extremely difficult, but is going to be found later to have been just a distraction. In time, the technology behind cryptocurrency will be found to be extremely useful to governments and central bankers and will be brought into the mainstream; but the winners at that point will be the bankers who presently manage the global financial system.

Traders who have the notion they collectively will defeat the G-20 governments and their international banking system are going to suffer big losses. We strongly advise against trying to beat the system.

Bill Cara is a widely read financial blogger and free market patriot.

© 2017 Copyright Bill Cara / Williams Market Analytics - All Rights Reserved

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