Why Warren Buffet’s “theory” behind his non-investment choice in Bitcoin is wrong, Part 1

Recently 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”.

In Part 2 we will begin exploring the nature of those topics.

=> Click here to read Part 2: https://medium.com/@melis.io/why-warren-buffets-theory-behind-his-non-investment-choice-in-bitcoin-is-wrong-part-2-4fb20bc17025

=> Click here to read Part 3: https://medium.com/@melis.io/why-warren-buffets-theory-behind-his-non-investment-choice-in-bitcoin-is-wrong-part-3-final-ccc335d2f622