The Warren Buffett Paradox

The Warren Buffett Paradox

May 14, 2020 0 By aure

Tl;dr: Warren Buffett is a version of capitalism that worsens social-economic inequality while adding zero value to society.

I have plenty of respect for Warren Buffett, even though I believe he is (one of) the cause(s) of social inequality and that he cheated his way into wealth.

Buffett managed to become (for a short time) the richest man in the world without ever having invented anything or contributed to the world in any meaningful and significant way.

To understand that, we need first to understand that wealth = value.

Very rich people are people that are actually “helping” to a great extent a lot of people.

We can take the classic example of Bill Gates, which designed a program to make computer use easy and accessible to the entire planet.

If you provide value to the entire planet, you’ll be rich, no matter what you provide.

Jeff Bezos invented Amazon so that people could buy cheap books and wouldn’t have to go to a bookstore (or, for that matter, to any shops) anymore.

Massive value providing, massive net worth!

The Al-Saud family owns the biggest oil company producer in the world (and next to that, a country): massive value providing, massive net worth.

These three examples show the good part of capitalism: it allows people that are a bit smarter than the average and a bit more hardworking to change the life of everyone else.

Everything you see around, everything you use, has been invented by someone in the past.

My take on this is that we shouldn’t go after rich people just because they’re rich.

Most of the time, their net worth reflects their contribution to society.

Except for Warren Buffett.

How Has Warren Buffett Become Rich?

He didn’t invent anything, he never created any company, he wasn’t born rich either.

But he was smart, and after having noticed that rich people had companies, he simply decided to buy some with money that wasn’t his.

Wait, what? That’s it? Yeah. Let me explain.

As a child, young Buffett didn’t know many things, but he knew he wanted to be rich.

Apparently, by age 11, he had read every book of the library on how to become rich, until he stumbled across the bible of investment: the intelligent investor, by Ben Graham.

The book is a guide to buying undervalued stocks (companies), wait until everyone realizes they are undervalued and see your initial sum invested double, or more.

You see, Buffett understood that rich people own means of production called “assets”.

Assets are possessions that make you money: it can be a company, or a stock, or bitcoin, or gold. The more assets you own, the more money goes into your pocket.

Why bothering to start a company when you can buy one for cheap, and transform it and make it grow to make more money?

So Warren, after having studied how to invest in undervalued companies, started offering his services to rich people.

He told them “pay me so I invest your money, and your money will grow”, and this worked quite well, so well, in fact, that he made a lot of money for himself with which he bought a company called Berkshire Hathaway.

Originally a clothes factory, it is today one of the biggest companies in the world.

They do…well, about everything.

When Buffett bought Berkshire, he first got rid of the clothing activities and transformed the company into an investment company, that is, a company that buys other companies (do you see any value in that? Don’t look, because there is none).

He understood that among all businesses, the insurance business was particularly suited to his skills because he could invest the money he’d receive as a premium until eventually giving it back to pay what he was ensuring (if need be).

Sometimes, that period could be dozens of years, and a year for Warren represented on average 20% of gains on capital through his investments.

So Buffett bought an insurance company, then another one, then another one.

With all that money that these companies were making, he started buying other companies, always undervalued to make a maximum amount of money when their stock price would reach fair value.

Sometimes, he’d sell these companies and cash in on a monstrous premium…and invest that sum in other undervalued companies.

Then he’d patiently sit in his Omaha office, sipping on his daily 5 Coca-Cola bottles, and wait to cash in on the dividends.

As such, Apple, Coca-Cola, Duracell, Net Jets…are Berkshire Hathaway companies.

Berkshire eventually grew so huge that it almost became a danger to itself.

In 2019, a factory from a company belonging to Berkshire exploded in France.

Luckily, the factory was insured…but insured by a company also belonging to Berkshire.

So what Aurélien, where is the problem with all of that? Let me finish. There are two things you need to know about Warren: first, he doesn’t spend his billions.

He owns a normal house, drives a normal car, eats breakfast at McDonald’s.

The only expense he has is his private jet.

As such, at the end of 2019, Buffett was sitting on a pile of cash equivalent to 140$ billion at Berkshire, money that his companies were making, and that he didn’t want to invest (nor spend of course) because he thought all other companies were too expensive.

And that wasn’t a bad thing in itself.

Having Warren keeping his cash is not as bad as having him invest it.

Let’s take a look at how the economy works.

How the Economy Works

If you know how the economy works, Warren Buffett is someone that should worry you.

You see there are two types of spendings: expenses, and assets.

Expenses take money out of your wallet. Assets put money into your wallet. Buying a car to go on holiday is an expense.

The car is going to cost you and won’t make any money for you.

Buying a share of a company is an asset. The share will make money for you in the form of a dividend, and you will have more money.

The way the economy works is that your spending is the salary of someone else.

When you buy a car, that money will serve to pay the carmaker, which will then pay the engine maker, which will pay the iron provider, which will pay, etc.

The economy works because people spend money.

If no one goes to buy a car, the carmaker will go bankrupt.

His employees won’t have money to spend on food, and so the supermarket will go bankrupt, etc etc.

The economy works when people spend.

When people don’t spend, whether because they don’t have money, or because they spare their money, the economy is in trouble.

It is a bit what happened during the pandemic.

People that still made their salary ended up at the end of the month with a lot of money they couldn’t spend because bars and restaurants closed while these bars and restaurants went bankrupt because they couldn’t conduct business as usual.

Your spending is someone else’s income, and if you don’t spend your money, people are getting less income.

Warren Buffett understood this.

Since he wanted to make as much money as possible, he vowed to spend as less on expenses as possible, and as more on asset as possible.

The more assets (companies), the more money, the more money, the more assets.

It is an ever-ending cycle.

So while Warren keeping his money is not doing the economy any favor, having Warren buying companies to make even more money may simply be worse.

Yet, that’s how Warren built Berkshire.

From a social standpoint, it is negative for two reasons.

Firstly, one of the roots of social-economic inequalities is inequality of means of production (thank you, Marx, for this lesson).

Inequality of Production 

Let’s imagine a society made out of a hundred farmers. Let’s say that they are debt-free and own 100% of their means of production (the field, the farm, etc).

Their salary is directly equal to the value they provide the economy with, let’s say 100€ per month.

Society is as we speak, very equal.

No one is richer than anyone else, all farmers are making more or less 100€.

No poor people, no rich people.

Now, if one farmer decides to buy a second farmer’s farm, and hires him as an employee, that farmer will make money off his original farm + his new farm. (In order not to complicate things, we’ll leave the loan problem out of the equation.)

He will therefore earn 100€ from his original farm + 25€ from his second farm, as he will pay a salary of 75€ to his new farmer-employee.

If we look now at the social-economic situation, 98 farmers make 100€/month, 1 is making 125€ (the one that bought the farm) and one is making 75€ (the one that sold the farm and became an employee, 75€ being his salary).

Let’s say that this farmer keeps on buying farms, and eventually buys all of them.

Society will then be composed of one farmer making 2 575€ (100€ from his farm + 25€ x 99 other farms) while all of his farmer-employees will be making 75€.

That one farmer is now worth in terms of salary, 34 farmers-employees.

What Does This Mean?

When you acquire assets, in that case, farms, you’re creating social-economic inequality.

Indeed, while farmers were making equal pay in our initial example (providing they were equally productive), the fact that one farmer bought the remaining 99 farms catapulted his income at the expense of the other farmers (because the status of employee is reinforcing social-economic inequality).

Now, let’s imagine that the rich farmer spent all of his 2575€ each month in the economy along with the 75€ of each of the other 99 farmers. Would that be a problem? No, because in economic terms, the results would be the same.

Whether you have 100 farmers spending 100 € or 99 farmers spending 75€ and one farmer spending 2575€, you arrive at 10 000€ of total euros spent in the economy, and these 10 000€ will be the salary of other people in the city.

But this is not what Warren does: not only does he not spend his money (which is, therefore, a loss for the rest of the people in the city/country, even world, at this point), but he reinvests that money to acquire more assets (farms) and make even more money!

The effect is therefore double: he earns money that he doesn’t spend which creates inequality, and when he does spend it, it is to acquire more means of production which creates…more inequality.

We now understand how poverty is also attached to inefficient spending in society since one man’s salary is another man’s income.

By (1) acquiring a lot of companies and (2) not spending any of the money in the economy, Warren Buffett directly contributes to social-economic inequalities.

In many interviews with the financial media Yahoo Finance, Warren Buffett declared that capitalism widens social-economic inequality, that it is a huge problem that the government should take care of.

Can you see the irony?

Why the Rich Care About the Poor

But…why does Buffett care about inequalities?

As we saw, the economy is based on people spending and the fewer money people have, the less money they can spend.

Who do you think is at the other end of poor people’s spending?

You got it: Warren Buffett.

People that work for Warren Buffett earn a salary they spend in companies belonging to…Warren Buffett.

The fewer money people spend, the less money Warren makes.

Social-economic inequalities are therefore neither good for the poor nor the rich.

If the poor can’t buy anything anymore, the rich will see their income crashing.

How Do You Fix This?

So how do you fix this? I’ll write another article about it, but there are some very basic approaches you can take to avoid social-economic inequality altogether, and no, vegan communism is not the answer (thinking about it now, I’m not surprised vegans are often communists: these are both self-destructive practices).

The first problem is the competition.

If you have two big companies in a market, there will be two very rich founders/CEOs and a smaller total number of employees (one manager, for example, instead of supervising 5 employees, will supervise 20) which means fewer people making a good salary that can be spent in the economy.

If you have 20 companies in a market though, there will be 20 founders/CEOs, a higher number of employees, and more money that can be spent in the economy.

We can therefore assume that we should put higher limits on mergers and acquisitions because they capitalize means of productions (money-makers) into the hands of a restrictive number of people, which creates more inequality.

At the moment, the minimum number of companies within the same market is fixed at…2, to avoid monopolies.

Needless to say that 2 is not enough, 4 or 5 would be better.

An example of this is the US movie studios.

In 2010, you still had 6 big Hollywood studios: Columbia, Disney, Paramount, Universal, 20th Century Fox, and Warner Bros.

In 2020, you have Warner Bros, Disney…and the rest is almost dead, Disney has bought 20th Century Fox.

Has the quality of movies improved, stagnated, or decreased?

I won’t get into this debate now.

But in terms of box office income, one company is a clear winner: Disney.

A second option to decrease social-economic inequality would be to better allocate means of production.

Should we make mandatory for companies to distribute a fair share of their stocks to their employees, the employees would earn the money they are making due to their productivity on top of their salary: they would be shareholders of the company they work for.

I believe it would as well make companies and employees more productive because they’d have other financial incentives to work harder to earn a higher dividend on their stocks.

But more on that later.

The Bottom Line

In an ideal world, there would be as many companies as there are people and the employee status wouldn’t exist.

Your boss would become your client and your colleagues, your competitors.

You could charge what you would deem fair for your services but would take the risk to lose your clients suddenly, should you provide low quality work.

CEOs wouldn’t exist and companies would be actually made out of several companies equal to the number of people working for different contractors.

Utopian, but sound.

What should you retain from this article?

First, acquiring assets makes money.

You do so when you create companies (giving society value), or buy companies (cheating your way into giving society value. It remains perfectly legal though) or any other assets.

The more value you provide, the more money you make, unless you cheat and do like Warren.

Through little spending and constant reinvesting into asset acquisition, Warren Buffett’s behavior has created social inequality across society.

His behavior is permitted by capitalism rules, and solving inequality demands a change of these rules.

Practically, nothing prevents you from doing exactly what Warren did, and to become as rich, if not richer.

You just won’t be making anyone any money.

Rather, you’ll sit and wait for others to make it for you.

Elon Musk actually said during his second passage on Rogan that he is not a fan of Buffett, because he made money by reading company reports which provides zero value to society, and that the world needs makers and builders, not boring readers.

I’m not a fan of Musk, but I can’t deny I agree with him on this one.

Photo credits: Image by chiplanay from Pixabay