E-piphany

Last night, over drinks – a detail that will gain more salience when I describe the discussion – several friends and I were talking about lots of market-related items (as well as, of course, many non-market items).

The topics were as diverse as bitcoin, New Jersey Transit, and Tesla. However…and here’s where the drinks may have played a role…we also explored intersections of the elements of this set. For example, one of our party pointed out that fifteen Teslas would produce about the same power as a diesel locomotive, but at a fraction of the price. Given the recent record of New Jersey Transit’s locomotive fleet (among other problems), perhaps this is worth considering. Not only that, going to work in a train pulled by 15 Teslas would be much more stylish.[1]

A more interesting connection is between Bitcoin and Tesla.

In my book, I reflect at length about the significance of having money which is backed by something concrete (no matter what that is) compared to something backed only by faith – faith that other people will accept our money as a medium of exchange, in exchange for goods or services at rates reasonably predictable and not terribly volatile. Inflation is caused by too much money in the system; hyperinflation is what happens when a currency loses its anchor of confidence and people lose faith that these things will be true in the future. I talk a bit about how high rates of inflation, by eroding confidence, can lead to hyperinflation – but that’s only true of fiat currencies. If money is backed by something tangible, whether it is a precious metal or a bushel of rice, there are limits to how much it can depreciate in real terms and hyperinflation is difficult to come by in these circumstances.

In this context, consider Bitcoin or any of its crypto-currency brethren. Bitcoin is not backed by anything; indeed, it is backed by even less than the “classic” fiat currencies that issuing governments at least promise to accept in payment of citizen obligations to the government. This is not a critique – it simply is. Evidently, the inflation issue is not currently a problem with Bitcoin…as the chart below (source: Bloomberg) suggests, everything in the world is deflating in Bitcoin-equivalents.

But the fact remains that if something were to happen – such as the MtGox scandal a few years ago, at the left side of that chart – that affected people’s confidence that someone else would take Bitcoin in payment, then the value of Bitcoin could (and did) drop precipitously. At the extreme, Bitcoin could go to zero if no one was willing to accept it in exchange – for example, if for some reason it became impossible to confirm that the contents of your Bitcoin wallet was really yours.[2] There is no one you can turn to who is guaranteed to give you something real in exchange.

Now, no one thinks of Tesla as a currency. But, actually, equity securities representing ownership in Tesla could be considered a form of currency – you can exchange them for other items of value, although the usual way is to exchange them for dollars which can then be used to buy other items of value. I am not sure I would call  its price in exchange reasonably stable…but it’s certainly more stable than Bitcoin. Here’s the salient commonality, however: at the current price, representing a 11x price-to-book ratio, 6x price to sales ratio, and undefinable price to free cash flow (-$9.74/share free cash flow) or earnings, on a stock with negative net margins, ROA, ROE, and ROC, the price of Tesla is almost entirely faith-based. It is based on a quasi-religious belief by the equity owners that the CEO will manage to produce cars at a positive margin and maintain a large market share, which it will be able to maintain even once large auto manufacturers start to compete.

Far be it from me to question whether investors’ faith will prove well- or ill-founded. I will leave that to my friend @markbspiegel. I don’t own Tesla and have no plans to be long it or short it. My point, though, is that it is remarkably like Bitcoin in that it is backed primarily by faith and, as with any faith-based currency, is entirely based on that faith remaining unshaken. For the implications of having that faith shaken, see Enron in 2001 (chart below, source Bloomberg).

Interestingly, in the battle of Bitcoin versus Tesla it is the former that is winning. A share of Tesla in 2015 was worth 1 Bitcoin. Today, that share is only worth 0.14 Bitcoins (see chart, showing the ratio of Tesla to Bitcoin).[3]

All of which goes mainly to show – be careful when you go out for drinks with quant finance friends!

[1] We thought perhaps Elon Musk is just being coy, playing the long game before he springs this brilliant idea on the public. But today another friend of mine pointed out that it isn’t just the power you’re paying for but the sustainability of that power, and he estimated that 15 Teslas could only pull the train for about 8 miles. Oh well.

[2] “Preposterous!” shout the supporters of Bitcoin. Relax, I’m not saying this is something that will or could happen. It’s not a prediction. It’s merely a thought experiment.

[3] This is a ridiculous chart and it means nothing. But it’s fun. You should see what it looks like if you go back farther. In 2010, one share of Tesla was worth 300 Bitcoins!