Finance is other people

I’m not a fan of bitcoin, but I want to defend it against the accusation that it’s obviously worthless. In 2022, Warren Buffett unfavorably compared bitcoin to farmland and apartment buildings, saying that:[1]

If you ... owned all of the bitcoin in the world and you offered it to me for $25, I wouldn’t take it. Because what would I do with it? I’ll have to sell it back to you one way or another …. It isn’t going to do anything. The apartments are going to produce rent and the farms are going to produce food.

Buffett is articulating a common belief: since the value of an asset is the discounted future expected cash flows it generates, an asset with zero cash flow must be worth zero.

I think he’s wrong for two reasons. First, as an empirical matter, there are many assets that are valuable but do not generate observable cash flows. For example, consider silver, gold, or physical currency. Not only do they pay zero dividends, but they also are costly to store. Yet I would gladly pay more than $25 to buy the entire world supply of these things (indeed, the Hunt brothers in 1980 went to considerable trouble to corner the silver market).

Second, as a philosophical matter, Buffett’s thought experiment misses the big picture. Let’s take the apartment buildings. Okay, so they generate rent. This rent comes in the form of little pieces of green paper. What am I supposed to do with green paper, eat it? Wear it? No. With both U.S. dollars and bitcoin, I eventually have to “sell it back to you one way or another,” that is, I must exchange the green paper for goods and services that I actually want to consume. In modern economies, we don’t get paid in chickens or hogs, we get paid in money, an inherently useless object that is (like bitcoin) only valuable due to the shared social convention that it is valuable.

Investing vs. trading

There’s an old-fashioned and misguided view that investing is good but trading is bad, where “investing” means multi-year holding periods while “trading” means shorter holding periods. Investing is a high-class activity pursued by respectable citizens, while trading is a sleazy activity pursued by street peddlers and two-bit hucksters, looking for a quick buck. This view harkens back to pre-modern conceptions of aristocratic landowners vs. money-grubbing commoners engaged in dishonorable commerce. In an odd twist, this traditional view is shared by the crypto community, who celebrate those who hold (“diamond hands”) as opposed to weaklings who sell.

Here’s Buffett describing his ideal investor:[2]

… investors who trust Berkshire with their savings without any expectation of resale (resembling in attitude people who save in order to buy a farm or rental property rather than people who prefer using their excess funds to purchase lottery tickets or “hot” stocks). Over the years, Berkshire has attracted an unusual number of such “lifetime” shareholders and their heirs.

Buffett wants Berkshire shares to be something that you pass on to your children, like a country estate or a genetic disease. And that’s why Buffett is unwilling to pay $25 for all of bitcoin: because holding an asset is virtuous but reselling it is a sin.

It’s an absurd view. The whole point of any asset market is that you can buy and sell. Buffett has similarly misguided views about gold. Here he is in 2012:[3]

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future … if you own one ounce of gold for an eternity, you will still own one ounce at its end.

I’ve previously discussed Adam Smith’s explanation of the seeming paradox that diamonds are worth more than water. Smith’s explanation is that diamonds have higher “value in exchange,” in other words, diamonds have resale value.

For thousands of years, humans have adhered to the shared social contrivance that gold is valuable, and this practice was a useful financial technology prior to the invention of paper money. One can imagine an Iron Age Warren Buffett, dismissing gold:

I wouldn’t trade 25 goats for all the gold in Thrace. Gold does not generate goat milk, therefore gold must be worthless.

If you’re still uneasy about assigning a positive value to something that pays no dividends, the academic literature has a hack. Consider a hundred-dollar bill. Why hold it? It generates no dividends, no interest. Economists say that physical currency is worth holding because it generates liquidity services, which are valuable even if not directly measurable.

A more nebulous concept is convenience yield. What is convenience yield, you ask? Good question! It’s basically a made-up concept that economists use to justify prices we don’t fully understand.

Cochrane (2022) discusses the dichotomy between long-term investing and short-term trading, and the idea that trading-based convenience yield can explain many puzzles in asset pricing. In the specific case of bitcoin, the convenience yield may reflect its value in facilitating gambling, tax evasion, or various criminal activities.

One thing that bitcoin, gold, and currency all have in common is that they are portable and sometimes hedge disaster. Suppose you lived in Shanghai in 1948 and you owned gold, farmland, and apartment buildings. When the revolution came in 1949, you might have been able to escape with the gold, but the farmland and apartment buildings would have been a total loss. That’s the convenience yield that perhaps justifies holding gold and bitcoin. However, I don’t see this characteristic as especially appealing to pension funds or other institutions that are not planning to flee across the border.

No man is an island

Finance is about other people. Finance is not about Robinson Crusoe alone on an island. We don’t buy farms because we plan to grow our own food, we buy farms to generate cash. Similarly, Buffett owns shares in Coca-Cola, not because the shares pay dividends in the forms of cans of Coca-Cola, but because they pay dividends in cash, which can then be traded for goods and services. It’s absurd for him to complain that he doesn’t know what to do with bitcoin; trade it for goods and services, obviously. Duh.

Let me compare gold and bitcoin with something else that doesn’t pay dividends: Berkshire Hathaway shares.[4] Since 1967, Berkshire has not paid a dividend. Does that mean that Berkshire is worthless? Nonsense. Berkshire shares are valuable, because if we wanted to, we could sell our shares to someone else.

Now, I don’t mean to imply that all prices are completely arbitrary and have no connection to economic reality. Berkshire is valuable, for example, because it generates profits from meaningful economic activity, and even if it retains these profits instead of distributing them, the underlying assets are worth owning. My point is that ultimately value comes from the willingness of other people to trade goods and services for financial assets, and in this sense, bitcoin is no different from Berkshire shares.

Money, the financial system, the economy – they are all based on belief, trust, and other people’s valuation, just like bitcoin. It is just not true that farmland is somehow pure and immune from unseemly trading activity. Farmland, like bitcoin, has value that depends on other people’s beliefs and actions in the future. Let’s say my farm produces eggplant. I sell the eggplant to other people for cash, so I depend on other people’s desire for eggplant.

I myself do not care for eggplant. I think it is slimy and repellent. However, as long as there exist others who love eggplant, an eggplant farm is valuable. I like bitcoin less than I like eggplant, but as long as there are other individuals out there who love bitcoin, bitcoin is valuable.

Bitcoin as digital gold

I agree with Buffett that neither bitcoin nor gold are attractive investments. It’s not because they pay zero dividends, but because I suspect their current price is high relative to their future price. Let me explain.

Suppose you think that bitcoin will, like gold, have enduring appeal. During the reign of the Babylonian king Nebuchadnezzar, an ounce of gold purchased 350 loaves of bread according to Erb and Harvey (2013). Here we are 2,700 years later, and an ounce of gold will still get you around 350 loaves of bread. On the one hand, that’s an amazing record of retaining value. On the other, that’s a zero percent real return! If gold had merely beaten inflation by 30 basis points a year, an ounce of gold would get you a million loaves of bread today, instead of 350.

Gold is a pretty safe asset over the horizon of thousands of years, but it does not deliver high returns. If the bull case for bitcoin is that it’s as good as gold, that’s not a great bull case in a world of positive real interest rates.

Jean-Paul Sartre’s 1944 existentialist play No Exit features three unpleasant people who die, and their punishment is to be locked in a room with each other for eternity: “Hell is other people.” Well, finance is other people, too. Whether we are buying gold, bitcoin, or Berkshire shares, we are hoping to eventually sell to other people. We cannot escape the complex web of economic interdependencies that bind us all together. Unless you are a hermit living off the grid, you cannot hold yourself in magnificent isolation away from the hurly-burly of the marketplace.

We’re all trapped in a room with a bunch of bitcoin enthusiasts. Finance is other people, and we can’t avoid the necessity of trying to predict their future beliefs and actions, no matter how wrong we think they are.

Endnotes

[1] “Warren Buffett wouldn’t buy ‘all of the bitcoin in the world’ for $25: ‘It doesn’t produce anything’,” CNBC, May 2, 2022.

[2] Berkshire Hathaway shareholder letter, February 2024.

[3] Berkshire Hathaway shareholder letter, February 2012.

[4] References to this and other companies should not be interpreted as recommendations to buy or sell specific securities. Acadian and/or the author of this post may hold positions in one or more securities associated with these companies.

References

Cochrane, John H. "Portfolios for long-term investors." Review of Finance 26, no. 1 (2022): 1-42.

Erb, Claude B., and Campbell R. Harvey. "The golden dilemma." Financial Analysts Journal 69, no. 4 (2013): 10-42.