On Friday, the Commodity Futures Trading Commission (CFTC) approved bitcoin futures trading on the Chicago Mercantile Exchange (CME) and the CBOE Futures Exchange (CFE). Bitcoin has risen by a factor of ten since the start of the year. Was the market for the crypto-currency not frothy enough? If, as many suspect, bitcoin is a bubble, its collapse would not be a systemic risk to the financial system. But what about the stock market?
Bitcoin is a digital currency or crypto-currency (the first, in fact). Based on blockchain technology, it is technically elegant. It facilitates secure peer-to-peer transactions. Bitcoin is neither a real currency nor a commodity, but it has similar properties. It serves as a medium of exchange, a store of value, and a unit of exchange, just like regular money. Like gold and other precious metals, bitcoin is an alternative asset for those distrusting government and central banks in general. Bitcoin has also had a role in illegal activity (such as drug deals, money laundering, and other crimes). However, while the tech folks love bitcoin, economists are generally not big fans. There is no central bank backing it up. It’s only valuable because people believe it’s valuable. Yet, just because it’s a bubble doesn’t mean that it can’t go a lot higher. Fed Chair-Nominee Jerome Powell testified that the central bank was watching bitcoin and other crypto-currencies, but “they are just not big enough to matter.”
Meanwhile, stock market valuations have been elevated. Some of that reflects increased optimism since last year’s election, but the market was already well off the 2009 lows last November. Does the more rapid pace of increase over the last several months indicate a bubble? Or is it justified? Corporate profits, from the National Income and Product Accounts, were reported to have risen 5.4% in the year ending 3Q17 (+4.5% for domestic nonfinancial corporations). The S&P 500 is up about 21% from a year ago. With most companies in the index having reported, 3Q earnings for the S&P 500 were up 9.8% y/y.
Ok, so it seems that either the stock market was significantly undervalued a year ago or it has gotten a little ahead of itself in recent months. However, one could make the argument that corporate tax cuts will lift after-tax profits. Lowering the rate from 35% to 20% would boost after-tax profits by 23% (all else equal). However, few firms currently pay 35% and some pay a lot less. So, the savings may not be as great.