Crazy speculation time, again.

We don't know when speculative excess will end, but we have a good guess how it will end.

We run out of greater fools.

A young speculator told me about his great good fortune.  He made 2300% in ten days.

He bought a five-second video image of a little-known NBA player dunking a basketball for $14. He was one of only 50 people who had that image, he told me. It was a NFT, he explained, a Non Fungible Token, a numbered, limited-edition copy of that bit of video of NBA action, secured by blockchain. After a week he sold it for $320. He told me he sold it too soon because the person he sold it to promptly re-sold it for $420.

He is looking right now for more bargain NFTs to buy and re-sell.

NFTs are non-fungible because they are unique, like an hand-numbered art print. There is only one number 27. It it a token because it is a digital asset that exists on blockchain. Anything with the word "blockchain" in it is hot.

A version of the image here, except that the real one bobs up and down, sold for $1,546,000 in February. It had sold for $3,025 in June 2018, and for $1,100 in July 2017. The image does not do anything special. It looks exactly like the one here. It is singular and therefore "valuable" only because the piece of code that created it is identifiable. One can copy it--I just did--but I don't have the original, and neither do readers, but we all know what we don't have because the original is similar. 

I consider this to be a moment of maximum crazy speculation. I am not offering financial stock market timing advice, beyond noting that my fellow countrymen have entered a time of extraordinary risk seeking, and that my observation and experience is that this doesn't last. The appetite for an investable asset with the potential for growth is extreme, and credit is easily available to finance marginal investments. The result is that traditional assets are priced high in relation to their potential returns. Price has disconnected from value, and when that happens on one set of items--NFTs--it happens on others, too, e.g. real estate and stocks.

The late 1990s in the U.S. was a boom era. Bill Clinton was president and the budget was in surplus. The stock market was growing every year. As we can observe now with the benefit of hindsight, there was a gigantic mis-pricing of technology stocks. The business world and investors understood that the internet was a transformative technology. What no one knew was who would be the winners and how fast the changes would come. (They were right that the internet was huge. They were just a decade early.) The result in the late 1990s was that technology stocks were bid up in price. 

Then the music stopped. Buyers became cautious. The NASDAQ stocks fell 83% in value. Why didn't investors see that the prices were crazy? I think it was because they were caught up in a zeitgeist of enthusiasm, built on a foundation of reality. Investors understood, correctly, there was value. What they could not easily measure was the sentiment, because they were part of it.

Beanie Babies. 

There were cues at the time, a Beanie Baby boomlet. Small, cheap plush toys were given a bit of artificial scarcity by having short production runs, which were announced in advance. The toys were nothing special from the point of view of a child having a toy. Similar ones were readily available if one wanted the functional equivalent. But the Beanie Baby toys were not for function. They needed to stay pristine because they were bought to be resold.  After all, any one series--a yellow duck, a brown monkey--was limited edition, therefore rare. Click for more on the Beanie Baby craze

Speculation happens most easily when money is cheap and lenders are happy to lend. Federal Reserve policy in the aftermath of the collapse of the internet bubble created the foundation for the mortgage bond bubble of the mid-2000s. Interest rates were near zero and people with money sought yield. Investment banks created an instrument with yield: Bundled mortgages. Banks ran ads offering loans of 110% of the value of a house. What could go wrong?

Again, today we have a very low cost of money. Some people with time on their hands are getting "free" money to speculate with. We saw the stock of GameStop become thoroughly disconnected from enterprise value. Each buyer was hoping someone else would buy it from them for more than they paid. 

Lehman Brothers, creator of mortgage bonds

We are getting a warning signal from GameStop and NFTs. I could be wrong, It is possible that housing prices and stock prices will climb forever, and it is possible that owning one's own numbered bit of video showing the same thing anyone can readily see for free--but not with your number!--will prove to have enduring value.  After all, there is no particular reason that gold is perceived as better than silver. It is just a shiny metal, but one that is more difficult to find and mine profitably, and therefore rarer than is silver. Most of the gold mined is pulled from where it is buried in the earth, counted and weighed, and then hidden back in vaults, often underground once again. It is perceived as having enduring value. People can be serious and irrational both.

But I don't think I am wrong.  I think we are seeing crazy speculative excess in pricing and it signals a public mood disconnected from value. This is dangerous and unsustainable. Beanie Babies had only nominal value, once people lost their belief they could re-sell them. Readers of this blog got the image of the "Crypto-Punk" for free. What value does a numbered image have that an unnumbered image does not? The fact that people think it does, is an indication of speculative appetite, not value. Speculative appetite is real; I grant that. But it comes and goes.

If I am right, then Biden's luck will run out, perhaps soon. We are overdue for a big correction as greed turns to fear.