Buffett: Wrong on Treasuries?

In Berkshire Hathaway's (BRK.A) 2008 Shareholder Letter, Warren Buffett makes mention of the US Treasury bond bubble of late 2008. Mr. Buffett writes:

When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.

Concern that demand for US Treasuries will dry-up are likely overdone as investors will continue to seek a return of principal rather than Mr. Buffett's return on principal argument. Hyperinflation is not around the corner. Let's review my prior post, Gold - No Liabilities Attached:

Inflation is not right around the corner. Demand for all goods and services continues to decline and consumers across the country remain concerned, and rightly so, about the job market. The monetary printing to come from the Obama administration's stimulus package and the bank and auto bailouts will not cause runaway inflation. Credit is the key driver to inflation and both demand for and supply of credit are shrinking. Until the growth of credit recovers hyperinflation concerns are overdone.

Is the drop in the 10 year treasury yield another bubble waiting to burst or do the low yields represent deflation and real interest rates near normal levels? As fear retreats treasury investors will require higher yields but not in a bubble bursting manner as many are predicting.

The move into treasuries is not speculative, it represents the ongoing problems in the financial system, the eroding economy, and the lack of a real solution to the problem. Until the clear downtrend in yields since their peak in the early 1980's is broken US treasury bonds remain a place to preserve capital.

Stock position: None.

Comments

[John Polomny]

Around 50% of next years Federal Budget needs to be financed. Who is going to buy all of these bonds? Long rates are up substantially since the panic lows of Nov/Dec. Will the FED have to monetize some of this debt? I think the risk of a move higher in rates and inflation far outways the "rush to safety" trade.

2009 Mar 03 09:24 AM

[Jason Rines (iThinkBig)]

Thank you. And just because your blog states your opinion that there will not be runaway inflation, you should simply claim it is your opinion. Which I happen to vehemently disagree with. In my forecast of creating $3T in money, barely weighted to any asset, you will have runaway inflation in energy and trickle downs beginning in 2010 and culmulating in 2012. Oil $175, gasoline $5.00 a gallon just as consumers begin seeing ray of sunlight they will be crushed again. Add in higher interest and the whole event is 1870's depression followed by 1980-1983 deep recession. I will be around. I have my own blog too. We'll compare notes and here's to hoping I am wrong. Better to finish deflation, clear the debt decks then the scenerio I just presented.


On Mar 03 09:24 AM John Polomny wrote:

> Around 50% of next years Federal Budget needs to be financed. Who
> is going to buy all of these bonds? Long rates are up substantially
> since the panic lows of Nov/Dec. Will the FED have to monetize some
> of this debt? I think the risk of a move higher in rates and inflation
> far outways the "rush to safety" trade.

2009 Mar 03 03:36 PM

[Paul Fekula]

You seem to miss one key aspect of the bond markets: the supply and demand of currency. The United States is not becoming any less leveraged, the leverage is merely moving from the private sector to the public sector. We are tremendously increasing the money supply and the supply of government bonds. It won't be long before we've flooded the market with dollars, making the dollar cheaper relative to all other asset classes i.e. inflation. While the dollar may be a refuge right now, the dollar's strength and low yields have nothing to do with the fundamentals of money supply. Additionally, we are still running a huge current account deficit, resulting in a continued increase in debt levels. The recent moves of the dollar and US government bonds seem to ignore the fundamentals of the economy and are purely based on emotion, and we all know how well of a guide emotion is when making investment decisions.

2009 Mar 03 06:56 PM

[goodenuf]

The problem I see is this:

We're certain to be left with a massive public debt as a result of all this. What's uncertain is that we'll recover this economy to anything like what it was. We could very well be left with a much more intractable situation than we're expecting, requiring higher taxes, higher interest offered on treasuries, or both.

We run the very serious risk that beyond this intermediate period (when the world is rushing to the dollar because they think our institutions are going to prove better-able to handle things than anyone else's) we'll be left with a world that's both unable and unwilling to continue financing our artificlally-supported national lifestyle.

ALL we've done is shift our debt onto the government's rolls. This seems more a last, desperate measure to postpone our collective day of reckoning awhile longer and less a considered effort to stimulate our way back to economic and financial health.

This isn't a hangover we're recovering from; it's a coma, and to the extent we have hope it's because we persist in dreaming.

We dream alot. We dream too much.

My most optimistic assessment is that the Dow and S&P will be cut in half again before beginning their recovery. Schiller has done some excellent work in this area. My least optimistic assessment is that it's going to become quite a struggle to maintain one's real net worth amidst all the chaos we'll continue to see coming.

Things can always get worse ...

2009 Mar 04 01:38 PM