Buffett is the Bubble, Not Bitcoin

I know, I hear you.

Who the heck am I to disagree with arguably the greatest investor who ever lived? The great Oracle of Omaha himself, Warren Buffett?

You are of course right. I don’t even deserve to put myself in the same article, never mind the same sentence.

But — deep breath — I’m convinced he’s wrong about bitcoin.

Dead wrong.

It’s not what he’s saying that is wrong per se. Bitcoin may or may not be in a short-term bubble.

No one knows for sure.

But it’s how he justified the bubble statement that irks me. It shows a complete misunderstanding of what bitcoin even is.

And if you don’t understand what it is, then how can you say whether it is — or isn’t — in a bubble?

In fact, he admitted as much, before then weirdly declaring it a bubble.

You can’t value bitcoin because it’s not a value producing asset.

I’ll come back with the obvious flaws in this argument shortly…

First I’ll note Buffett first called out bitcoin in 2014, calling it ‘a mirage’.

The price has risen since then from lows of US$300 to its current price of US$6,135. But it’s a common refrain I’ve heard from — I’ll be honest here — older, richer, whiter folks.

Not all for sure.

But mostly…

And it’s easy to understand why.

You see, this group has been largely successful in the current system. They own property, they have superannuation, they’ve worked hard and they’re now generally pretty well off.

And there’s nothing wrong with that.

It’s natural that someone in that position — or someone like Buffett — doesn’t need to delve deeply into the mechanics of a supposedly ‘revolutionary’ technology.

Who needs a revolution when you’re already at the top of the tree?

Therefore, it’s easy to dismiss bitcoin out of hand.

I’d put fellow ‘establishment’ crypto critics such as JP Morgan’s CEO, Jamie Dimon, and Saudi Prince Al-Waheed bin Talal in the same boat.

These people have no motivation to want bitcoin to succeed. Oil-backed financial capitalism has made these people rich and powerful.

But that doesn’t mean it has to stay that way.

As populist revolts have shown — mainly in the Brexit and Trump elections — discontent with the way things are is a growing trend in western society.

A lot of people do want change.

And Buffett might even be part of the problem…

OK, fair warning, I’m about to go from respectively disagreeing with Buffett to all out chutzpah… 

Buffett is the real bubble

What if instead it’s Buffett that’s the bubble?

What do I mean here?

Well, what if it’s ‘Buffett style’ capitalism that’s actually the real value trap for investors?

And bitcoin is actually the essence of free markets, as envisioned by 18th century economist Adam Smith?

In the book, How Warren Buffet Broke American Capitalism author Robin Harding argues the dark side of Buffet is to avoid competition and minimise capital investment in the real economy.

From the book:

Kraft now makes a 23 per cent operating margin and an enormous return on tangible capital. In a competitive market, those high margins ought to present an opportunity for rivals to invest and steal market share.

Instead, Kraft competitors such as Unilever and Nestlé are under pressure from their owners — a mixture of index funds and Buffett-like activists — to match those sky-high margins.

If rivals also cut, rather than invest and compete, Kraft can cut even more. A kind of Buffett equilibrium is taking hold.

Large institutional investors who own shares in multiple companies in the same industry will lead to just this sort of equilibrium.

Management are under pressure from their owners (big shareholders) to cut costs and maintain high margins, rather than compete with each other by lowering prices and investing in more capacity.

It’s basically collusion. Though as a consequence of the system design, rather than an explicit cartel.

Both Buffett and the indexers, allegedly, reduce competition by lazily defending margins rather than aggressively pushing expansion.

If this critique is true, then that suggests that it reflects something deeper in modern business culture, something rotten about the way big business operates in practice.

Cryptocurrencies are the opposite of this.

The flurry of new alt coins represents a perfect free market system. A case of ‘may the best coin win.’ And the losing coins will fail.

There will be no bailouts here.

But at the end of it all will be a system that fosters innovation, criticism, continual improvements, failures and a dynamic marketplace of competition.

How Adam Smith envisioned free markets in the first place.

Which brings me back full circle to Buffett’s comments on bitcoin being a bubble.

A multi-decade boom is just beginning

Trying to value bitcoin on a traditional basis is like trying to value the internet in 1993.

You just can’t.

That’s why Buffett’s comments on it not being a ‘value creating asset’ didn’t make sense.

The crucial thing is to spot the sea-change enabled by the technology. These changes are what will create value. And bitcoin will derive value as the base layer (or one of the base layers) in this new financial ecosystem.

Decentralised cryptocurrencies will play a big part. As will companies in the fields of artificial intelligence, machine learning, big data and blockchain technology.

But beyond that low hanging fruit, the real disruption will be in centuries old models of trust. It will destroy the ‘moats’ of companies that don’t adapt. And even a lot of those that try to.

Did you see the advent of social media when the internet came along? No, no one did. And certainly not the selfie!

Those like Buffett, clinging to the status quo, will be left wondering what hit them in the next decade.

Make sure that’s not you.

Good investing,

Ryan Dinse,
Editor, Money Morning


Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.

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