Warren Buffett and the Imaginary Economy

Warren Buffett is back as the nation’s financial conscience, publishing an op-ed in yesterday’s NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that’s a message with which I wholeheartedly agree. My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion:

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

This have-your-cake-and-eat-it-too approach is typically what we get from Paul Krugman: Yeah, debt is a problem and has to be dealt with long-term, but in the meantime we should jack up deficit spending in order to boost growth. To paraphrase St. Augustine, make us fiscally and monetarily prudent, just not yet. Ben Bernanke said something of that sort in a speech. He was trying to be funny.

The problem, it seems to me, is that rising GDP and employment — i.e. “recovery” — is not compatible with de-leveraging, which is what Buffett is talking about.

When consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.*

Consumers de-lever, government re-levers.

Private consumption and government spending now drive something like 80% of GDP. It can’t keep rising unless consumers, the government or both continue borrowing huge sums.

The Goldilocks economy Buffett describes, in which we can have “recovery” without increasing debt, is a fantasy.

My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.

What Buffett should have said? 'Suck it up folks, we’ve no choice but to learn to live with less.'

——

P.s.: I think Buffett actually knows this, but being asset-rich, he’s boxed in. Deflation hammers the value of all non-cash assets, so he has to support monetary/fiscal stimulus in order to preserve his own and his shareholders’ wealth. Hence the opening of the piece, which lauds the “wisdom, courage and decisiveness” of the Bush and Obama administrations in the face of collapse, and the end of the piece, which says their emergency measures continue to be necessary. He maligns the effects of stimulus, but he’s stuck supporting it.

*The “Paradox of Thrift” this is called, a particularly problematic economic theory used to justify heavy government borrowing.

Comments

[PenName Dave:]

u again? I think your going to lose your feud with Buffet

Aug 21 03:29 PM

[HunterGVL:]

The debt to GDP ratio is imaginary, just like this 'Bull?' market. I wouldn't even call this rally a bear market rally. It is exactly the same rally I watched from the sidelines in late '07. The difference this time is that I am shorting this one heavily. As soon as I hear pundits touting, 'DOW at 15,000 soon,' I will know I am about to get paid.

But, back to the debt to GDP ration that everyone is so concerned with. During the depression of the 30s, GDP fell off a cliff to nearly 1/2 of it's pre-'29 levels. The 2009 GDP is also falling significantly and I am not in the camp of the recovery fools. Our GDP is recovering? Call me crazy, but I am concerned over the $600 Trillion of Derivatives held by the largest banks that are held 'OFF' balance sheets, and are NOT marked to market. The GDP numbers are about as accurate as the new methodology unemployment calculations, government's inflation numbers, and failure by everyone to recognize the hundreds of local and regional banks set to fail because CRE valuations have fallen an estimated 27%. Furthermore the Option Arms and Alt-As failures are steadily coming down the pipeline.

This is a "no volume" market swell casting a siren spell on daytraders and short sighted speculators. With the economy in free fall and the QE reaching unprecedented levels, our GDP is a complete scam. Therefore the calculation of the Debt/GDP ration should immediately be viewed as outside the safe zone and veering with tremendous velocity towards the japanese ratio. It is already too late to be prudent with our debt to GDP. In fact it's too late for this entire american system of finance. Mr. Buffett would be better served designing a new financial system for our country. If the markets are not allowed to crash and the toxic debt wiped out during this correction, then quite frankly, I can't imagine what the next 'correction' will be. Maybe just utter and complete collapse, riots, murder, starvation, disease, you know -that whole biblical armageddon kind of a thingy.

Aug 21 04:34 PM

[chap08:]

"My point is that in order to reduce debt we have to endure some sort of deflationary recession"

No we don't.

1. You seem to think that it would be a good idea to reduce the debt to GDP ratio immediately, rather than after recovery, as Buffett favors. Well, a deflationary recession will just make the ratio worse. The real value of the debt will be increased by deflation and the real value of GDP will be reduced by recession. Result: you're even deeper in the s**t.

2. If you can reduce the value of the debt while holding GDP steady, then you can reduce the ratio and the size of your problem. How can you do this? Well, one option is to inflate. Inflation reduces the real value of your debt. At the same time, the policy mixture you use to achieve this (weak dollar, low real rates etc) is likely to result in an improvement in the trade deficit and GDP. The key is to create inflation without increasing leverage. There are ways and means of achieving this. If necessary, this could be done by the Fed printing money and the government giving it to us to spend.

The key point is that we don't have to endure a deflationary recession. Obviously there's no free lunch, but there are different options on the lunch menu.

Aug 21 04:39 PM

[Dave Wrixon:]

Your confusing GDP growth with economic growth.

If GDP simply gets better because the government is spending more then that does not makes improve its overall debt situation. It makes it worse.

You cannot spend your way out of debt, however appealing it may sound. Keynes advocated deficit spending. He never ever advocated getting the country into so much debt it could never ever get out of it without defaulting. He would turn in his grave.

Aug 21 05:58 PM

[The Geoffster:]

I'm just not convinced we'll see real prolonged deflation. I'm more in the stagflation camp. It looks like the Fed is prepared to backstop the big banks until the economy recovers enough to unwind. The 64T question is how much can the Fed's balance sheet expand before it loses its bet? Right now we are seeing new bubbles in the stock market and treasuries as a result of the Fed's actions. If the economy does not rebound, both bubbles will burst, the dollar will collapse and treasury yields will soar to attract foreign buyers. Monetization of the debt will be inevitable because tax revenues will be anemic and Congress will be passing all sorts of programs to keep the lid on social unrest.

Aug 21 08:15 PM

[chap08:]

Dave, you are wrong to say that "You cannot spend your way out of debt". If you are an individual or a company, then you are right. But if you are a country with your own currency, and debts in your own currency, then you are wrong. The process is simple. It is:

1. Calculate real value of debt denominated in local currency
2. Turn on printing press
3. Print x trillion of local currency
4. Distribute crisp new notes to joyful local population
5. Sit back and watch currency devalue as new notes are spent
6. Recalculate real value of debt

The only new debt that has been created is your debt to the suppliers of paper and ink.


On Aug 21 05:58 PM Dave Wrixon wrote:

> Your confusing GDP growth with economic growth.
>
> If GDP simply gets better because the government is spending more
> then that does not makes improve its overall debt situation. It makes
> it worse.
>
> You cannot spend your way out of debt, however appealing it may sound.
> Keynes advocated deficit spending. He never ever advocated getting
> the country into so much debt it could never ever get out of it without
> defaulting. He would turn in his grave.

Aug 21 08:49 PM

[Leftfield:]

Every commentator has his/her own recipe here. To those who agree with massive government spending to ward off deflation as the least of the evils, I add that there is no sign of the government aiding strapped ordinary people in a meaningful way and no sign the oncoming steamroller of defaults and bankruptcies can be averted short of true Zimbabwe-style results.
Buffet is folksy but as a normal rich-and-powerful individual, his self-identity is to be rich and powerful above all else. So, he tantalizes with folksy, often misleading crumbs from his table but has no interest in rocking the boat. The founders of this country were uniquely inspired in their concern for a better society but it looks like the common people are on their own this time.

Aug 21 11:36 PM

[Asbytec:]

Leftfield is right...field? :) Why do folks pay attention to Warren Buffet, some hang on his every word. It's beyond scary.

On the founding of our nation, that remark goes deeper than you might imagine.

In any case, we might try to get back to business as usual, drive up personal debt, but I think, "the fairy is dead," as one contributor said.

Look for less personal debt and a slower rate of growth in the coming decades. I hope we can de leverage and deflate a lot more and get back to an economy based on science, engineering, and production...and back to our founding father's concepts where the common man can flourish.

Aug 22 08:43 AM

[perceptions...:]

Warren has has lost some of his old touch, he has been wrong a few times lately and he was wrong again, when he said "we were justified in using any means necessary to stave off another Great Depression".

Why? Because in "using any means necessary", they became part of the problem, in fact they increased the problem.

In short, they (the US government & the FED), are part of the problem and a large part, at that!

For the slightly longer version, see my post at -
seekingalpha.com/artic...

Aug 22 09:03 AM

[W.E. Heasley:]

Good article.

Warren's two sided take on the issue may well be that he tries to explain the economics then goes onto explain he's a Democrat/Obama-bot in his closing statement.

Aug 22 09:57 AM

[JCCIII:]

Buffet has achieved immortality as a great investor; notice the past tense. Could he do it again; who knows? Now, however, he thinks we should all pay more taxes; his argument would be a little more credible if he (and Bill Gates) were not engaged in an attempt to "cheat" the government out of the 50% of their wealth that the gov't claims (via the death tax) to be rightfully theirs. If Buffet and Gates really believed that the gov't can best spend money, why would Gates establish a foundation, the primary result of which will be to push away the tax man, and why would Buffet bestow a large percentage of his money to it? Seems to me, if they really meant what they say (we should all pay more taxes), they would do away with the tax-avoiding foundation and give 90%+ of their wealth to the US gov't today, or at least not establish a tax loop-hole to "cheat" the US gov't out of its share upon their deaths.

Aug 22 01:14 PM

[AuGod!:]

To quote Rolfe,

"My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion: ..."

and:

*The “Paradox of Thrift” this is called, a particularly problematic economic theory used to justify heavy government borrowing."

Since Keynes was referred to above by Rolfe: <incidentally ..> "..the paradox of thrift holds that collective thrift may be bad for the economy." (wiki), Karl Marx also had some interesting ideas about the inherent contradictions within a capitalist system. He was generally wrong as much or more than he was right (EG: Arguably, the only successful class revolutions took place not in industrial but in largely agrarian societies like China) but a reading of "Das Kapital" might be instructive. Could Warren be alluding to his closet Marxist leanings when he offers up such thoughts, susceptible as they are to paradoxical interpretation?

Fun to think about but I doubt it. The plain truth is probably closer to the realization that nobody nohow including Warren, knows the length width and breadth of the grave issues we face except that contradictions/paradoxes are going off like cherry bombs in the global financial toilet and nobody can stop it.

Aug 22 02:47 PM

[MarkitWacha:]

The government cannot be, and will never truly be, benevolent.


On Aug 22 01:14 PM JCCIII wrote:

> Buffet has achieved immortality as a great investor; notice the past
> tense. Could he do it again; who knows? Now, however, he thinks
> we should all pay more taxes; his argument would be a little more
> credible if he (and Bill Gates) were not engaged in an attempt to
> "cheat" the government out of the 50% of their wealth that the gov't
> claims (via the death tax) to be rightfully theirs. If Buffet and
> Gates really believed that the gov't can best spend money, why would
> Gates establish a foundation, the primary result of which will be
> to push away the tax man, and why would Buffet bestow a large percentage
> of his money to it? Seems to me, if they really meant what they
> say (we should all pay more taxes), they would do away with the tax-avoiding
> foundation and give 90%+ of their wealth to the US gov't today, or
> at least not establish a tax loop-hole to "cheat" the US gov't out
> of its share upon their deaths.

Aug 22 03:06 PM

[Commies are...:]

Sorry for sounding daft, but how does step 4 work?

4. Distribute crisp new notes to joyful local population

I never understood the concept of printing money. Who prints it? The fed? and who do they 'give' it to? I sure having received my check yet.

Aug 22 08:52 PM

[Rong:]

The best reason that I think of, to give funds to a charitable foundation rather than our government is that the foundation might get more bang for the buck. Also; it may be spent for something more to my liking.

Aug 23 12:42 PM

[chap08:]

If you want to find out how this applies to the US, you need to read about "monetizing debt". Imagine a simplified process of: the Treasury creates a bunch of debt, the Fed creates the money and buys the debt, the government spends the proceeds. Who do they give it to? Well, maybe they like stimulus schemes like cash 4 clunkers or road building. If things get bad, you may see it come directly to you as a tax cut.


On Aug 22 08:52 PM Commies are people too wrote:

> Sorry for sounding daft, but how does step 4 work?
>
> 4. Distribute crisp new notes to joyful local population
>
> I never understood the concept of printing money. Who prints it?
> The fed? and who do they 'give' it to? I sure having received my
> check yet.

Aug 24 06:58 AM

[Hephasteus:]

There is no paradox of thrift. There's a paradox of fractional reserve systems where too many dollars they get are loaned out and if there's a run on banks they are screwed. If there's a run on debt settlement then they are also screwed. Massive deflation is just that. It's a run on converting hard assets to cash to settle debts. It works against an ever shrinking money pool. Until either all the hard assets are gone or all the cash to convert them is gone. Or all the debt settlement is gone. It's sort of a reverse bank run. The problem is the big flush hits the stock market it plummets the prices of stocks. The holders of common stock are really nothing more than flushable co-signers of debt that the companies may incur. Once that buffer to chew through before you go to bankruptcy is eaten up it makes every company need more cash or easily convertible inventories which doesn't happen in a flush. Since the banking systems have done a good job of raping every company and making them dependant on loans to make payroll buy pencils invest in super rare super valuable ink cartdriges etc. Their revolving loans roll over rapidly and interest rates skyrocket and long term debts become unstable.

Think of it as a phase change problem. For every ounce of liquid theres 10 ounces of solid. When the system demands a phase change from solid to liquid it's fail because that phase change is only balanced on a time line and can't occur rapidly.

Aug 25 02:45 AM

[A. Chi:]

The "primary result" of a charitable foundation is not necessarily to cheat taxes, but to provide charity.

Your anti tax view, though not necessarily wrong, causes you to miss the point of the donations. Buffett's support of the death tax and of the charitable foundations is not contradictory because both mitigate dynastic wealth.

The wealthiest Americans can place their money in the hands of Seth Klarman, Eric Sprott, Steve Mandel, etc... In doing so, heirs can circumvent a meritocracy by hiring poorer, smarter fellows. Consider a wealthy family like the Rothschilds in the absence of a death tax. At a mere 6% CAGR, by the 2209 every $1.00 they own now would have a nominal value of $115,126.00. Historically, a Rothschilds lost money due to global instability and to varying abilities of the heirs. But if the world going forward proves more stable than the past, the effects of weak heirs will be smoothed out by the enormous talent they can purchase. The danger is that a virtuous circle develops, wherein money buys the best money producers, resulting in a concentration of wealth. Can meritocracies thrive in that condition?


On Aug 22 01:14 PM JCCIII wrote:

> Buffet has achieved immortality as a great investor; notice the past
> tense. Could he do it again; who knows? Now, however, he thinks
> we should all pay more taxes; his argument would be a little more
> credible if he (and Bill Gates) were not engaged in an attempt to
> "cheat" the government out of the 50% of their wealth that the gov't
> claims (via the death tax) to be rightfully theirs. If Buffet and
> Gates really believed that the gov't can best spend money, why would
> Gates establish a foundation, the primary result of which will be
> to push away the tax man, and why would Buffet bestow a large percentage
> of his money to it? Seems to me, if they really meant what they
> say (we should all pay more taxes), they would do away with the tax-avoiding
> foundation and give 90%+ of their wealth to the US gov't today, or
> at least not establish a tax loop-hole to "cheat" the US gov't out
> of its share upon their deaths.

Aug 25 09:39 AM

[A. Chi:]

The "primary result" of a charitable foundation is not necessarily to cheat taxes, but to provide charity.

Your anti tax view, though not necessarily wrong, causes you to miss the point of the donations. Buffett's support of the death tax and of the charitable foundations is not contradictory because both mitigate dynastic wealth.

The wealthiest Americans can place their money in the hands of Seth Klarman, Eric Sprott, Steve Mandel, etc... In doing so, heirs can circumvent a meritocracy by hiring poorer, smarter fellows. Consider a wealthy family like the Rothschilds in the absence of a death tax. At a mere 6% CAGR, by the 2209 every $1.00 they own now would have a nominal value of $115,126.00. Historically, a Rothschilds lost money due to global instability and to varying abilities of the heirs. But if the world going forward proves more stable than the past, the effects of weak heirs will be smoothed out by the enormous talent they can purchase. The danger is that a virtuous circle develops, wherein money buys the best money producers, resulting in a concentration of wealth. Can meritocracies thrive in that condition?


On Aug 22 01:14 PM JCCIII wrote:

> Buffet has achieved immortality as a great investor; notice the past
> tense. Could he do it again; who knows? Now, however, he thinks
> we should all pay more taxes; his argument would be a little more
> credible if he (and Bill Gates) were not engaged in an attempt to
> "cheat" the government out of the 50% of their wealth that the gov't
> claims (via the death tax) to be rightfully theirs. If Buffet and
> Gates really believed that the gov't can best spend money, why would
> Gates establish a foundation, the primary result of which will be
> to push away the tax man, and why would Buffet bestow a large percentage
> of his money to it? Seems to me, if they really meant what they
> say (we should all pay more taxes), they would do away with the tax-avoiding
> foundation and give 90%+ of their wealth to the US gov't today, or
> at least not establish a tax loop-hole to "cheat" the US gov't out
> of its share upon their deaths.

Aug 25 09:39 AM