Why Warren Buffet’s “theory” behind his non-investment choice in Bitcoin is wrong

Warren Buffet continues to say inaccuracies about Bitcoin. In fact, two days ago he repeated another time how is non-investment choice in Bitcoin should be an example for others. At the core of his theory there is the completely self-confidence about the righteousness of what he understood Bitcoin is. He’s wrong. In this regard, we propose again our op-ed in which we explained why and where he is mistaken.

Warren Buffett, probably the most successful financial investor in the world, has been asked why he doesn’t invest in gold or Bitcoin. The answer given, in a nutshell, is that “Bitcoin and gold are assets that produce nothing. Their value only grows because people keep investing money on them. They are therefore […] ‘bubbles’”.

If these are the reasons why Buffett doesn’t invest in Bitcoin, then the “theory” behind these particular non-investment choices is wrong.

Before explaining why, it is useful to underline that a critique of the “theory” that underlies particular non-investment choices is not a criticism of these choices: everyone can make the choices he/she wants, of course, and for unquestionable reasons.

Moreover, it is useful (even obvious) to underline that a critique of the “theory” on which particular choices of non-investment in non-productive assets are based on, is not a critique of the method behind particular investment choices in productive assets. The “Buffett method”, in particular, is based on a solid statistical and qualitative analysis of productive assets long-term performance. This analysis has shown that it is able to identify productive assets that are undervalued by the market, and/or with good and constant growth opportunities over the long term. For those who had seen Bennett Miller’s beautiful movie Money Ball (based on a true story), the “Buffett method” is analogous, mutatis mutandis, to what brought Billy Beane and Peter Brand’s Oakland A baseball team to victory in 2001. In other words, it’s a great method. However, while Buffett’s investment choices in productive assets are based on this good method, his non-investment choices in non-productive assets such as Bitcoin are based on an economic (and monetary) “theory” that is fallacious.

Gold has both hands tied behind the back

As a reference to the market value of Buffett’s investment choices in productive assets, we can take the price of its Berkshire Hathaway fund (BRK-A). Setting as an arbitrary time horizon the last five years, we can say that — based on bare data — the choice of Buffett not to invest in gold was correct and that not to invest in Bitcoin was wrong. In this period, in fact, the price in dollars of the BRK-A fund has increased by 100%, the one of gold has decreased by 17% and the one of Bitcoin has increased by 106,828%. In other words, those who had invested $1,000 in the BRK-A fund on January 7, 2013 after five years would have gained $1,004, ending up with $2,004; who had invested that sum in gold would have lost $171, ending up with $829; and whoever invested that sum in Bitcoin would have gained $1,068,285, ending up with $1,069,285.

Bare data say little relevant from the point of view of economic theory. Above all, they cannot confirm it or deny it. In fact, economic theory is developed logically from self-evident and therefore a priori axioms. Furthermore, these results, which could change drastically with a different time horizon, should be read in the light of a fact: by the law of supply and demand, much of the price of gold comes from its demand as a medium of exchange. However, this function spontaneously selected by the market over millennia has been forcibly severed by government mandate since 1971. This means that, unlike the price of the BRK-A fund and the one of Bitcoin, and beyond specific manipulations, the price trend of gold is not very significant for our analysis. In fact, gold had to fight with both hands tied behind his back. And this is precisely one of the reasons why Bitcoin was born: a currency not arbitrarily inflatable as gold but, unlike gold, is not censurable.

What would have been the price of gold in dollars if its use as a means of exchange had not been prevented by government mandate? What would have been the price of gold in dollars in light of last ten years artificial balance sheet expansion of global central banks? The very existence of those questions is enough to keep the price of gold out of our analysis.

Criticism of the “theory” behind Buffett’s decision not to invest in Bitcoin

Regardless of the results (those we observe today and those we will observe in the future), Buffett’s “theoretical” analysis which is the basis of his non-investment choices in particular non-productive assets (and specifically in Bitcoin) is fundamentally wrong. And it is wrong for three reasons:

• confusion about the concept of production and utility;
• confusion about the concept of value (which is the starting point of economic theory);
• confusion about the concept of “bubble”.

From the fact that “Bitcoin and gold are assets that don’t produce anything”, for Buffet is a consequence that their price increase would be unjustified: a “bubble” destined to burst. Although the premise is correct, the conclusion is wrong.

Money is a “non-productive” asset in the sense that, if one would find himself/herself on a desert island, he/she wouldn’t know what to do with it. If you could choose between a wallet with 100 bitcoins and a peach, you would definitely choose the second one. This is due to the fact that the situation of a desert island is an economy of pure subsistence, primitive and above all without exchange. In this type of “economy”, money (the medium of exchange) has no use as an email account would have no use without networks and computers.

However, once introduced networks and computers, that email account acquires utility, is demanded and therefore is priced (a price that today, in many apparently free email services, is paid, instead of money, in personal data and lack of privacy; but this is another matter). Once the exchange is introduced and once, thanks to it (and given the subjectivity of the value, on which we will return later), the economy moves away from mere subsistence and approaches to a complex market economy, money, despite being a non-productive asset, acquires utility.

More specifically, although it may not please Keynesians (which by definition are not economists), the amount of money that in a complex market economy is not spent or not invested in productive assets (hoarding), has an utility. The greater this utility, the greater the demand for money. The greater the demand for money, the greater is its price, that is, its purchasing power. Back in New York, our aforementioned castaway would prefer a wallet with 100 bitcoins.

The utility of “reserve money” (the one not spent on consumption nor invested in productive assets) derives from some of its functions (See Rothbard M., 2001 [1962], Man, Economy and State, Ludwig von Mises Institute, Alabama, Chapter 11). One of these is the ability to cope with uncertainty; for example, the capacity to bear unexpected expenses. Another of those functions is speculative; for example, if a person who has a low temporal preference (i.e. who saves a lot and consumes little) perceives a bubble in financial assets, he/she will disinvest and thus increase his demand for money.

The current economic, monetary and political situation maximizes the usefulness of a “reserve money” with the characteristics of Bitcoin.

In this situation:

• people are forced by the government with the threat of violence to use an arbitrarily inflatable form of money and thus lose purchasing power over time;
• by depositing their money in a bank, people formally lose ownership of it;
• because of the progressive limitations on the use of cash, people are increasingly forced to deposit their money in a bank; however, given that banks resort to the fractional reserve (and resort to it in an extreme way thanks to the protection of central banks and the government), they are always intrinsically bankrupt: in the event of a bank run, they should close;
• governments have approved measures that, in the event of a bank run, authorize the “rescue” of the banks with the money of account holders (i.e. bail in), which, we remind you, are in fact increasingly forced to deposit their money in a bank;
• by depositing their money in a bank, account holders are also exposed to forced withdrawals aimed at financing a parasitic machine in continuous and inevitable expansion;
• people are easily and increasingly monitored in their expenses, in their donations and in their earnings;
• people don’t have “escape routes” from cyclical crises like the one in 2008, which are the direct product of the artificial expansion of money and credit by central banks and that have been “cured” with even greater doses of the same poison that produced them;
• and more.

In this situation, a currency like Bitcoin makes it possible to use “reserve money” much more than in normal market conditions. As a result, its price has good reasons to continue growing in the long run. Bitcoin in fact:

• offers a choice in the money sector;
• it is not arbitrarily inflatable and this contributes to increase its purchasing power over time;
• allows the transfer of money from A to B without passing through C and without the possibility of censorship/surveillance by D;
• is a non-censurable form of money;
• allows you to keep ownership of money;
• doesn’t allow the fractional reserve: a bitcoin can be in the wallet of A or in that of B, not in both at the same time;
• doesn’t expose who holds it to risks of forced withdrawals, bail ins, etc;
• it is a form of money which, being decorrelated from the monetary, banking and financial system, offers an escape from the systemic cyclical crises produced by central banks/fiat money system;
• and more;

So even if Bitcoin is a non-productive asset (and moreover immaterial), it doesn’t follow that its extraordinary price increase is unjustified. Among other things, if it were unjustified, governments and central banks wouldn’t hurry to “ban it” and “regulate it” as they are doing (i.e. to prohibit and regulate exchanges and centralized custody services between bitcoins and cryptocurrencies, which, unlike Bitcoin, can be banned and regulated). On the contrary, if everything goes well, we are only at the beginning. To be unjustified (in the sense that in the absence of government coercion aimed at their support things would be very different) are, among other things:

• the current purchasing power of fiat money;
• the artificially low level of current interest rates;
• stock and bond prices that have been affected by artificially low interest rates.

According to Buffett, the price of Bitcoin is growing “just because people keep investing money in it” and that would be a “bubble”. Now, let us put aside for a moment the distortions in stock prices produced by artificially low interest rates. If the price of Buffett’s investment fund grows, it is thanks to the fact that people (and companies) invest money in it. And they do it because the profits of the companies on which the fund has invested (let’s say Starbucks) grow. But these profits grow “just because” some people decide to spend money in a cake instead of in a book. And if they make this choice, it means that for them, at that time and place, the benefit they get from eating a cake is greater than what they get from reading the book.

That is to say, in the long run the price of Bitcoin increases for the same reason the share prices of the investment fund BRK-A increase: the scientific law of the subjectivity of economic value. This law states that the value lies in people: in the importance they give (on the basis of their preferences, their individual priorities, their knowledge, their being in a certain place at a certain moment) to certain goods, and not in goods themselves.

The fact that money is a commodity “different from others” does not change the validity and universality of the subjective theory of value. One of the main differences between a cake and a quantity of money is that, if the price of the first was zero, people would elbow to grab it. On the other hand, if the price of money (that is, its purchasing power in terms of other goods) was zero, no one would be concerned with obtaining it because, since it could not act as a means of exchange, it would not be money. This difference between money and “normal” goods doesn’t change the subjective theory of value, which applies to a fraction of Bitcoin and a cake in exactly the same way.

In a free market, the subjectivity of value is the basis of every exchange and helps to define the trend of each price. Consequently, to say that the price of Bitcoin grows “just because” people continue to invest money in it is like saying that a particular stone falls to the ground “just because” it is subject, unlike other stones, to gravity force.

Is Bitcoin a bubble?

According to Buffett, Bitcoin is a “bubble” because it is a non-productive good on which people “continue to invest money”. As we have seen above, the fact that people “continue to invest money” in a non-productive asset, increasing its price, doesn’t constitute a “bubble”, but is a fact that underlies the subjective theory of value and therefore the price formation process.

Given this, the term “bubble” can be used to indicate different things.

On the one hand, it can be used to indicate an economically unsustainable increase in the price of an asset due to people’s choices. This is for example the case of the current “bubble” of many ICOs (Initial Coin Offerings) and probably of different Altcoins.

On the other hand, the same term “bubble” can be used to indicate an economically unsustainable increase in the price of an asset due to the coercive activity of governments. This is, for example, the case of the financial bubbles inflated by the artificial expansion of money and credit by central banks.

In both cases, the increase of the asset price sooner or later must necessarily face a correction.

A difference between the two cases, however, is that while in the first case the system tends to self-correct itself quickly enough, in the second the “bubbles” tend to occur systemically and don’t self-correct; and this leads them to last much longer (as in the case of the bubble of the purchasing power of fiat money).

To distinguish the two cases, we find it more appropriate to call the first “fad investments” and the second “bubbles”.

Bitcoin clearly cannot be a bubble (in fact, there is no government coercion and it is born in antithesis to the latter). Those who believe that Bitcoin is a “fad investment” don’t understand what is Bitcoin and above all don’t understand what are the problems that solve at the level of monetary and political structure.

Conclusions

The Buffett’s “theory” at the heart of his choice of non-investment in Bitcoin is a superstition, not a theory. In particular, it is a reasoning that is in contrast with economic and monetary theory. A theory, the economic one, is logically deduced from self-evident axioms and therefore scientific, objective, incontrovertible.

Buffet’s reasons would remain wrong even if in the future Bitcoin would fail and its price would definitely go to zero. In other words, if Bitcoin should continue to be successful, this would not be a proof that Buffett’s reasons are wrong. We already have this proof ex ante (and we can only have it ex ante) on the basis of economic theory, that is, the logic applied to human action.