The dollar will probably go up. Still, we’d stay away…
Here is Warren Buffett’s view:
“Last fall, our financial system stood on the brink of a collapse
that threatened a depression. The crisis required our government to
display wisdom, courage and decisiveness. Fortunately, the Federal
Reserve and key economic officials in both the Bush and Obama
administrations responded more than ably to the need.
“They made mistakes, of course. How could it have been otherwise
when supposedly indestructible pillars of our economic structure were
tumbling all around them? A meltdown, though, was avoided, with a
gusher of federal money playing an essential role in the rescue.
“The United States economy is now out of the emergency room and appears to be on a slow path to recovery.”
This is probably the view shared by most economists and most
investors. It is not our view. From where we sit there is no recovery
underway…and there never will be one. You can recover from a hangover.
You can recover from a nasty divorce. You can even recover from an
earthquake. But once a depression begins, you can only endure it. Get
on with it. Get it over. And then, you can begin rebuilding again. You
will never recover the economy you had before the crisis. You must find
a new economic model.
A headline from yesterday: “Reluctant shoppers hold back recovery.”
That’s one way to put it. Shoppers don’t have any money. They need to cut back.
Most likely, they will cut back until their savings rates reach 10% of
disposable income. That will take $1 trillion out of consumer spending.
The economy cannot possibly recover under those conditions; it can’t
return to its same old, consumer-led, credit-fuel self. Instead, it
must go through a period of transition – in which output is depressed –
until it finds a new personality, better suited to the new economic
But Buffett is not worried about the depression. He’s worried about how the recovery is financed:
“…enormous dosages of monetary medicine continue to be administered
and, before long, we will need to deal with their side effects. For
now, most of those effects are invisible and could indeed remain latent
for a long time. Still, their threat may be as ominous as that posed by
the financial crisis itself.”
Buffett does the math. This year, the US deficit will total $1.8 trillion.
Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of
GDP. The magnitude of it alone should be cause for alarm. But there’s
more. Where does this money come from? Even if you could direct 100% of
the net US trade deficit (about $400 billion, the money that ends up in
foreigners’ hands as a result of American spending) and 100% of
American’s savings (estimated to be about $500 billion), you’d still be
$900 billion short.
Desperate borrowers should expect to pay high rates of interest. A
borrower who doesn’t need the money can shop for the best rates and
hold out for a good deal. But when a person needs to borrow, he takes
what the market gives him.
Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note.
It has fallen to under 3.5%. Despite record borrowing by the feds,
lenders content themselves with the lowest yields in nearly half a
century. Go figure.
The market seems to be anticipating a depression. Why else would
bond yields be so low? If the economy sours…and the stock market
sinks…the safe yields on Treasury bonds will seem like a good
alternative. But Buffett believes the Treasury yields are not as safe as they appear.
That other $900 billion has to come from somewhere. And the feds can’t
allow interest rates to rise significantly; that would undermine all
their stimulus efforts. High real interest rates depress economic
activity. So, what can the feds do?
“Washington’s printing presses will need to work overtime,” says
Buffett prophetically. Of the two ways of financing the deficit, one is
a flimflam; the other is robbery. In the great credit expansion
consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles.
No matter who does it, borrowing for consumption is merely taking
from the future. Then, when the future comes…the account has to be
settled. Result: no net gain. What was consumed in one year is not
consumed in the next.
Of course, the feds don’t spend money the same way consumers did.
Consumers wasted their money on frou-frou and watchamacallits of their
own choosing. The government wastes money on different things – like
turtle crossings and billion-dollar bailouts.
Not that we’re complaining about government spending. We’re just
pointing out that it’s not the same as private spending. What makes
goods good is that people choose them and buy them with their own
money. They get what they’ve got coming. But the feds are spending
other peoples’ money. If they get any goods at all it is practically an
But what we’re talking about this morning is the dollar. According to Buffett, the dollar is in danger.
He’s worried about the larceny, not the flim-flam. Printing up
additional dollars robs savers. Each new dollar created to buy US debt
makes each one already in existence – say, in a vault in the Bank of
China – worth less than it was before. If that isn’t true, the whole
body of economic thinking from Adam Smith to Irving Fisher is nothing
but a fantasy. And the only way to protect the value of the dollars
held by savers, theoretically, is to withdraw the stimulus money before
inflation sends prices soaring.
Buffett is an optimistic fellow. He believes that responsible
authorities will turn off their dollar-printing machines in order to
protect the greenback. Here at The Daily Reckoning, we’re not so sure.
First, the depression is likely to be worse than people think. This
will mask the effects of dollar printing. Plus, it will make the need
for more dollars – more federal spending, more US debt – seem more
urgent than ever. Instead of pulling the plug, they’ll turn up the speed.
Second, the feds are not really interested in the health of the real
economy anyway. This is an insight, which while it may seem obvious, it
only came to us recently. When the feds put in place absurd policies to
delay and restrain the inevitable correction, they are making things
worse, generally, for everyone. But the politicians are responding to
their constituents’ demands. One campaign donor wants to keep his
business alive. Another wants to keep his job. Still another promises
the feds high paying jobs on Wall Street, after their term in
Washington is over. Millions of others – more than enough to turn an
election – want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They’re not going to stop doing their jobs – especially in a depression – just to protect foreign dollar-holders.
The Daily Reckoning