Three times this week I was asked the following question:
“Why are the prices still low when the fundamentals seem so strong?”
Fortunately, there’s a two-worded answer: Animal Spirits
It’s not a simple answer – not by a long shot. But it is, indeed, a short answer that encompasses the intricacies of greed, fear and human behaviour.
To understand this, let’s first question if prices are really low? Or are we simply benchmarking prices at their all time high – prices that were guided by the animal spirits of crypto investors.
John Maynard Keynes, a famous economist, used the term “Animal Spirits” to describe the irrational decisions investors make in an uncertain environment.
But today the phrase “Animal Spirits” seems to be used primarily in environments of high confidence. Confidence & optimism, however, aren’t the only byproducts of Animal Spirits. Fear & pessimism play an equal share in the phenomenon.
Irrational Exuberrance. Irrational Anxiety
Should it not then make sense that irrational confidence be followed by equally irrational fear? Optimism that drove prices to exuberant highs should follow with a similar anxiety that would drive prices to irrational lows. For if it does not follow, eventually at least, then perhaps the optimism was not irrational after all. In a way, this explains the driving mechanism of “bubbles” (and also why it’s claimed impossible to forecast)
Nobel Laureate winner Robert Shiller defines a ‘speculative bubble’ in his book ‘Irrational Exuberance’ as follows:
I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase…”
Shiller akins a bubble to that of an epidemic virus – something that can “catch” and get out of control very easily. Similar to their virus counterparts, speculative epidemics can result in massive losses when culminated with doubt, fear and anxiety.
But the key question here is: Are we already past the irrational anxiety? Or is it yet to play out?
Recurrence of Epidemics . Reflating of Bubbles.
Interestingly, Robert Shiller makes sure to emphasise that “speculative bubbles” don’t simply burst and disappear. Rather, they tend to inflate and deflate in accordance to the accepted narrative.
A viral epidemic can reappear if a new environmental factor reignites the contagion rate.
Similarly, a deflated speculative bubble can “re-inflate” if a new narrative is strong enough to ignite the animal spirits of investors.
Ah, but this poses yet another tricky question for the crypto space. Have we already “re-inflated”? After all, prices did surge to an all-time-high of $1000 before deflating to $200.
Have we already re-inflated?!
Is it possible that we see another epidemic spark the animal spirits to a point irrational confidence?
A Great Time To Be Alive
A strong argument can be made in favour of another speculative bubble – a larger one. In his definition of a “speculative bubble”, Shiller goes on to explain what follows the price increase in a speculative bubble:
...The price increase brings in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement”
The crypto market allowed for a new class of investors to be first entrants. They consisted mostly of people who were young & technologically sophisticated. But they were by no means the “large class of investors”. Those are yet to come in mass.
Already we hear reports of new & larger entrants into the market. Will their success draw the envy of other institutions? And will that, in turn, lead to an environment of overconfident gambling and exuberance that we have seen in the past?
Only time will tell. But one thing is certain, never before have we seen events play out at this rapid of a pace. Ahh, what a time to be alive.
The Myth Of The Rational Market - A history of risk, reward & delusion by Justin Fox
Irrational Exuberance by Robert J Shiller
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