Bitcoin Falls Further

Friday was part two of the destruction in bitcoin prices as it fell nearly 11%. The price opened above $1,000 and fell to below $900. As I mentioned, before bitcoin started this volatile two-day period of trading, the price was overbought. It was common sense that the price couldn’t continue at that pace of increases. With about a 25% correction, the momentum has ended and buying it becomes more reasonable. I don’t advise trying to time your purchases for a short-term trade because the volatility is so high. However, if you buy at a time of extreme enthusiasm, you will feel snake bitten having it fall quickly right after you bought it. It makes more sense to buy on dips.

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In my last article on bitcoin, I mentioned that China would be unlikely to ban bitcoin because it wants to embrace free markets. It also would have a tough time banning bitcoin considering how widespread its usage is now. The majority of bitcoin trading is in China. The worst-case scenario would be what some other countries have done which is provide confusing regulations which limit its use and make it more expensive to do so.

While China won’t ban bitcoin, this doesn’t limit its ability to talk the price lower. This is why bitcoin fell almost 11% on Friday. The People’s Bank of China met with representatives of the bitcoin exchanges BTCC, OKCoin, and Huobi to encourage them to comply with regulations and laws. That’s a politically correct way of saying the government was trying to appear to pressure these groups. It’s theater to get speculators worried about government action without the government doing anything. Both the PBOC’s office and the Shanghai regional office issued a statement about the recent price movements of bitcoin.

The two statements had similar tones. They say the government spoke with the bitcoin firms to discuss the legal, policy, and technical risks. There certainly is heightened risk with the price of bitcoin rising so fast as the amount of Chinese speculators grows. They reiterated that bitcoin doesn’t have legal status to be used as a currency and shouldn’t be used as one. I consider bitcoin being a commodity to be better than a currency because governments may be able to regulate it tighter as a currency. However, governments may not want to call bitcoin a currency because it gives it more credibility. There will likely never be a government which supports bitcoin because it undermines governments’ power over their respective money supplies. While any action by China would be a negative, it wouldn’t be a shocker that a communist government doesn’t want to lose power. I do think that an outright ban is still unlikely.

Government movement on bitcoin and the yuan had great effect on their respective valuations because traders were all positioned in one direction and the government moved the price in the opposite way. The yuan had the biggest gain ever in two days in offshore markets as the price versus the dollar went up 2.5%. As expected, the short covering rally ended and it fell back down to earth on Friday as it was down 1.1% versus the dollar in offshore markets. This would have been good news for bitcoin if it wasn’t for this latest announcement.

According to Goldman Sachs, the best time to short the yuan is after an intervention like we just had. This makes logical sense as nothing fundamental changed and the oversold nature of the yuan has been alleviated. The median expectation for the yuan is for it to fall to 7.16 versus the dollar by the end of the year and to 7.3 by the end of next year. As you can see from the chart below, this has been a trend which has been going on for a while. The reason for the decline is the $50-$60 billion in monthly outflow from the country as the economy continues to weaken. As I said before, it’s a catch 22 because if China tries to end capital outflows, it hurts the goal to have a freer market. Having a free market is what would cause the currency to rise in the future. The worst decision would be to continue these half-measured approaches which don’t halt capital outflows and continue the narrative that China doesn’t support free markets.

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China’s SOE debt bubble is what is causing such uncertainty as these firms bleed capital. It takes a lot of pain to transform into a capitalist system. The question is if China is ready to take the pain to get the gain. I personally do not think it will be able to because when the Chinese debt bubble bursts, it will use the government to try to save itself, thus perpetrating the problem.

The question of whether bitcoin prices will move higher in 2017 depends on how much of the price increase was caused by using it as a way to get capital out of China versus how much was pure speculation. If it was mostly speculation, the price increases may not return, but if it was because it was medium to get capital out of the country, it will rally again. The trend of the yuan weakening and capital leaving China is going to continue, but as we are seeing today that hasn’t helped stop this correction. Unlike other currencies there is not central power which can stop the declines in bitcoin. The price can fall as far as fear is willing to take it. I talk about China facing the potential pain the free market can bring, but bitcoin is now feeling that pain. Once this correction ends, the Chinese natural demand should get it going up again.

For long term buyers looking to store their wealth in bitcoin in order to diversify away from commodities and fiat currencies, now is a great time to start purchasing some bitcoin again. If you exercised prudence and didn’t buy into the hype of the past few weeks, you should have cash to put to work. It can go lower, so I wouldn’t make a big splash in the $800s, but it’s a good place to start buying.  It’s tough to visualize storing your wealth in such a volatile instrument. You have to believe the $20 trillion debt level and increasing entitlements will hurt the dollar at some point in the future in order to justify owning bitcoin. I think it’s a reasonable justification, so I’ll be buying some this year.

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