Charlie Munger Commentary Warren Buffett

Commentary: Warren Buffett is Right About Cryptocurrencies

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“Bitcoin is like rat poison squared,” Warren Buffett said during the 2018 Berkshire Hathaway annual meeting. The comment got a positive response from the tens of thousands that packed the CenturyLink Center’s arena.

That Buffett, and Berkshire’s vice-chairman Charlie Munger, are down on cryptocurrencies is no surprise. As the world’s leading value investors, speculative assets are exactly the things they avoid.

While the “rat poison,” comment did not come with a detailed explanation, it easily ties in with a major point that Buffett hammered home at the beginning of the meeting.

After showing the audience the front page of a newspaper from 1942, Buffett talked about the first three shares of stock that he ever bought when he was age 12, which was a company called Cities Service. He showed how his impatience and quickness to denied the far greater amount he would have made if he had been patient and held the shares long term.

Buffett again returned to the 1942 date to make a completely different point.

Buffett detailed what would have happened to an investment of $10,000 in gold on that date, as compared to $10,000 in what would have been an index of the S&P 500, if it had existed at that date. While 300 ounces of gold would have grown to a worth of $400,000 today, the shares of the S&P 500 stocks would have grown to a vastly greater sum of $51 million.

That’s the difference been a nonproductive asset and a productive asset, Buffett explained. Even after all the decades went by, the gold would still be only 300 ounces. It wouldn’t have grown. But the productive assets of the S&P 500 stocks have the capacity to grow because they represent businesses that produce goods and provide services.

“For every dollar you could have made in American business, you’d have less than a penny of gain by buying into a store of value which people tell you to run to every time you get scared by the headlines,” Buffett explained.

It’s all about nonproductive assets versus productive assets.

“While the businesses were reinvesting in more plants and new inventions came along, you would look into your safety deposit box, and you’ve have your 300 ounces of gold,” Buffett mused, “And you would look at it, and you could fondle it, I mean, whatever you wanted to do with it. But it didn’t produce anything. It was never going to produce anything. And what would you have today? You would have 300 ounces of gold just like you had in March of 1942, and it would be worth approximately $400,000.”

In the end, gold versus stocks, over a great length of time, is not even close.

“In other words, for every dollar you could have made in American business, you’d have less than a penny of gain by buying into a store of value which people tell you to run to every time you get scared by the headlines,” Buffett said.

While Buffett’s nonproductive asset versus productive asset lecture was using gold as the example, it could have just as easily been about Bitcoin and other cryptocurrencies.

Here’s where you get my commentary

People that tout Bitcoin and other cryptocurrencies are really believers in the rise of a nonproductive asset that is no different than gold, silver, or the alligator infested swamp land offered during the Florida land speculation of the 1920s. Cryptocurrencies are an asset that is moving up or down daily based on what Benjamin Graham would have called speculation, and what can also be called gambling.

Naysayers will talk about the unique properties of blockchain, supposed anonymity of cryptocurrencies, and other virtues of virtual currencies that show its utility, but to do that is to ignore that these assets are not being bought and used as currency, which after all is a medium of exchange between two parties.

Let’s pretend that a significant number of people were converting their dollars or euros, or other currencies into Bitcoin and then going out and buying houses, or cars, or diamonds with it. The last thing a recipient of a Bitcoin transaction would want to do is sell their house today and find that the value of the medium of exchange had dropped 5%, 10%, or more the day after their real estate transaction.

Let’s look at another key aspect of Bitcoin. It’s inflated in value at an astronomical rate. This is what has everyone so excited about it. You can become a cryptocurrency millionaire or billionaire overnight without doing anything.

This extreme bidding upward in the marketplace is not a feature of currencies. It is a feature of speculative fevers reminiscent of the Dutch Tulip Mania of the 1500s.

While historically currencies have periodically plunged in value due to hyper-inflation. We need just look at Weimar Republic Germany, 1980s Argentina, or Venezuela today to see that phenomenon, the same process does not happen in reverse.

There’s a simple explanation for that. Plunging values for currencies reflect a lack of faith in a currency as a method of exchange. The more extreme that pessimism, the more currency it takes to overcome it.

But, currencies of the more sound variety, which in essence have more faith placed in them by creditors, do not get bouts of extreme faith that shoot them up astronomically. They increase or decrease in a much narrower range.

Accepting Bitcoin as a currency is no different than asking to get paid in casino chips or lottery tickets. You are hoping for a second transaction to determine its value. At the casino it’s spinning the roulette wheel, and with cryptocurrencies it is betting that in the marketplace someone will pay you more for your Bitcoins than the valuation you got them at.

All speculative bubbles are full of enablers. They are so-called experts that tell you why this time is different, hucksters telling the masses not to be left out, and true believers that have adopted the asset as a religion.

It’s best to remember that speculative fevers are not just a remnant of the distant past. In the late-1990s, a plush toy called a Beanie Baby became the focal point of a speculative fever. Suddenly, an asset that’s main utility was as an occupant of a child’s toy box, was being hoarded by everyone and their brother. Prices soared, certain $5 Beanie Babies were going for $5,000, and one obsessed man planned to pay his children’s college education based on the anticipated rise in value of his plush portfolio. The strategy did not work out well.

As for Bitcoin, while players such as Goldman Sachs are actively looking to make money off of people trading cryptocurrencies, Warren Buffet rightly expressed his skepticism that such a move represented any kind of endorsement of the soundness of the strategy.

“I would be very surprised if the top partners of Goldman are selling their Goldman stock and putting it into Bitcoin,” Buffett said on CNBC’s Squawk Box.

It’s a familiar tale that always has a sad ending for all but a few. Just ask the man who lost $100,000 hoarding Beanie Babies.

Buffett’s rat poison comment is true. However, rat poison kills rats. Speculative fevers kill the hopes, dreams, and lives of investors.

© 2018 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.