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Buffet predicts massive inflation

May 10th, 2009 · 4 Comments

Does he have a point? Yes and no, it’s all a matter of timing as we will explain after Buffet (great men go first, even on Shareholdersunite.com)

We’ll try to give you some points at the end of the article, first, here’s the article:

Buffett Sees Massive Inflation to Handle Staggering Debt
By: Dan Weil

The explosive rise of the U.S. budget deficit and debt burden will lead to serious inflation down the road, says billionaire and Obama supporter Warren Buffett.

The Congressional Budget Office predicts that government debt will peak around 54 percent of GDP in 2011. But Buffett told CNBC Monday morning that the ratio could surpass 80 percent — unless there are significant spending cuts or tax increases.

After a testy exchange with Sen. Judd Gregg, who suggested that President Obama’s plans to hike federal spending would only increase the nation’s staggering national debt, Buffett relented by stating that, in the end, the U.S. government simply will do what every other government has done in such circumstances.

“A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it’s going to inflate its way out of the burden of that debt,” Buffett said. Experience proves that, he points out.

“Every country that has denominated its debt in its own currency and has found itself with uncomfortable amounts of debt relative to the rest of the world, in the end they inflate,” Buffett explains. “That becomes a tax on everybody that has fixed dollar investments.”

Of course, it’s likely that these trends also will mean a serious swoon for the U.S. dollar. Buffett also suggested that dollar denominated investments like T-bills won’t be a wise investment, in the long run.

Elsewhere in the economy, Buffett sees unemployment rising further. “Who knows where it tops out,” he says. But, “it will top out eventually.” Buffett remains bullish long-term for the economy. “We have a wonderful economy over time,” he says. We do come out of recessions, Buffett says.

“The biggest thing that brings us out of them is the fact that we have a system that works very well over time, even though it gets gummed up periodically.” Buffett’s Berkshire Hathaway has $20 billion in cash and is “perfectly willing to make a deal that’s compelling,” he told reporters at the end of the company’s annual meeting Sunday.

The Oracle of Omaha doesn’t have anything specific in mind, and neither he nor Berkshire’s Vice Chairman Charlie Munger would reveal which sectors of the economy or regions of the country interest them most. Berkshire is holding its annual meeting over the next few days, an event to which thousands travel just to hear Buffett and Munger hold forth on the economy and Berkshire’s prospects.

Buffett did say that, of the three banks whose stock he already holds — Wells Fargo, US Bancorp and M&T Bank — that Berkshire “would buy stock in any of the three banks at present prices.” Last year, Buffett invested in troubled blue chips Goldman Sachs and General Electric.

Buffett and Munger say the company isn’t currently planning to issue new shares or bonds to pay for a big acquisition. They defended the company’s performance, despite a 31 percent slump in share price from a year ago.

Munger says it’s foolish to judge the firm’s fate by short-term movements in its share price. “If you think we’re in trouble because the stock price went down, you don’t understand what’s going on,” Munger says.

Munger says Berkshire is following “Andrew Carnegie’s playbook.” The steel mogul made himself famous by snapping up market share from struggling competitors during recessions. Many experts view Berkshire’s purchases of shares in Goldman Sachs and GE in the same terms.

——–[End of article——–

Now, a few observations:

  1. The budget deficit was already quite bad before this crisis, and the massive public spending as a reaction to the crisis is absolutely necessary, as deflation is way more dangerous than inflation in a time where balance sheets in the private sector carry large amounts of debts, deflation will only increase the debt, lead to more bankruptcies and less spending
  2. The government can borrow at rather low interest rates these days
  3. Even a debt to GDP ratio of 80% is not that bad, countries like Japan and Italy are facing much worse
  4. Buffet is right though, the public finance situation and historical precedents of countries which could issue debt denominated in their own currency do have a tendency to repair matters by inflating their way out of trouble, that’s what the UK did after WOII, for instance.
  5. Technically, when the economy recovers the Fed has the instruments to “mop up” the excess liquidity (that is, the excess money created by buying all these debt papers to save the financial system)
  6. But some mild inflation would actually be just what the doctor ordered. It allows for the debt on balance sheets left, right, and center to slowly melt away, this would be a good thing.
  7. The risk is in inflation getting out of hand, but we think the Fed won’t let that happen, and fortunately real wage resistance, and therefore the chance of a wage-price spiral is particularly weak in the US (compared to continental Europe, for instance).

So, Buffet is right, but as long as inflation stays mild, we actually think that would be beneficial, apart for bondholders, that is.

There are some signs this is already starting to play out. Long-interest rates are rising a bit, the last Treasury sales didn’t go all too well. The dollar is creeping down.

And that is a bit of an other worry. If it happens too soon, that is, if it happens when the economy is not recovering yet, it will put the Fed between a rock and a hard place. They will be forced to chose between fighting the recession and terrible balance sheets, and fighting inflation.

Tags: Public Policy

4 responses so far ↓

  • 1 Darcy Patten // May 11, 2009 at 10:54 pm

    Assuming that the government does the right thing. Numerous times over the past 6 months you have pointed out government action or timing that is less than desired.

    I am not confident they will hit this one out of the park.

  • 2 admin // May 11, 2009 at 11:08 pm

    True, but two things:
    1) There really wasn’t any alternative to stimulus, deflation is by far the bigger risk at present, especially in the circumstances we’re in (balance sheets ballooned by debt)
    2) The nature of central banks is to be wary of inflation, so I think we’ll see the Fed move when the time is ripe. Long-term interest rate might very well rise in response to higher inflationary expectations and lack of buyers for government bonds anyway, as a sort of automatic inflation fighter of sorts (as it cools of the economy).

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