As I write, “Fartcoin” is worth more than HALF A BILLION USD, and many observers are shocked by the meteoric rise of this crypto meme coin. Why are people willing to pay to buy Fartcoin? The answer is very simple: there is so much excess liquidity sloshing around in the financial system that holding Fartcoin is perceived to be of greater value than holding cash in the bank.
I know what I just said is a strong statement, but what many observers are overlooking here is the concept of “opportunity cost”.
First of all, what is the definition of “opportunity cost”? It is the value of the next best alternative that is foregone when a decision is made. It represents the benefits you miss out on when choosing one option over another. For example, if you spend time studying instead of working, the opportunity cost is the money you could have earned during that time.
Secondly, what do you think is the opportunity cost for a gambler sitting at the roulette table when he knows that if he loses everything, a “magic hand” will place freshly printed cash in his pocket in case he goes bust? Logically, he will have an absolute incentive to continue betting since there are no downsides to his behavior, right?
Third, if there are virtually no downsides in taking a certain choice, the next logical step the subject will take will be to maximize his potential upside since the difference in upside between two alternatives will effectively be his opportunity cost.
At this point, the “rational” decision to invest in something like Fartcoin, sadly, starts to make sense:
- Central Banks are actively removing any downside risk from markets. As soon as stocks have a small correction, more liquidity will be promptly injected into the system. If a bank goes bust, a bailout is guaranteed. If governments run out of money, more will be printed out of thin air to fill the hole.
- The “new liquidity” injected into the system always has a greater marginal impact, on a like-for-like basis, on assets of lower nominal value. Imagine stock A and B have 100 shares each, but stock A price is $10 per share while stock B is $1 per share. If $20 of new liquidity is injected in this simplified financial system made of stocks A and B, what’s going to be the impact of allocating $10 on each stock? In the first case, you will buy one share and hardly impact the price. In the second case, you will start bidding for the shares available, and after the first is bought for $1, the demand for the second will be $1.50, for the third $2, for the fourth $2.50, for the fifth $3, so with $10 you will be able to scoop up 5 shares and the nominal increase in the price of stock B will be 300%.
Now, with stocks at all-time highs, broadly speaking, crypto led by Bitcoin at all-time highs (again broadly speaking), and no fear whatsoever of any sustained correction in asset values, investors are incentivized to act more and more irrationally, seeking more risk (that they fail to perceive as such) to maximize their upside. The ultimate result is that the likes of Fartcoin become “great bets” where if all goes well, you expect to make a killing because it will be the next “dogecoin” worth tens of billions and that many investors regret having missed. And if there won’t be greater fools to keep bidding Fartcoin higher and higher because no free money materializes in their pockets? All the investor will lose is going to be the free money he got himself materialized out of thin air in his own pocket (in the form of gains made possible by central banks’ continued effort to inflate asset values).
Considering all I have explained so far, what would you expect to be the opportunity cost to borrow money at cheaper rates (as per central banks’ intentions), invest these in the economy for a return far from granted, and that in any case will require years to materialize? What about selling stocks, and materializing the profits, instead of financing your daily expenses via consumer debt keeping the upside value of remaining invested? As a matter of fact, all the options that Central Banks claim to be willing to incentivize with their policies that are making financial conditions looser and looser are instead becoming less and less attractive in the environment they created, in an ultimate demonstration that they are diametrically wrong. What central banks should instead be doing in the interest of the real economy and restoring healthy financial markets and investor behavior should be tightening financial conditions dramatically, but don’t worry they will never do this intentionally and this will ultimately happen only when the current system becomes unsustainable on its own.
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