Warren Buffett Is Wrong On U.S. Debt Problem Solution

by: Disruptive Investor

There is no doubt in my mind that Warren Buffett is one of the greatest investors of all time. I have also observed that Mr. Buffett is an optimistic individual and it is great to be optimistic. At the same time though, one needs to be realistic. This article discusses the reasons why the debt problem in the United States is almost impossible to solve, contrary to Warren Buffett's belief.

According to Mr. Buffett:

The United States is richer than it's ever been. We have $50,000 or so of GDP per person. But we've overpromised and we've also undertaxed to some extent, so we find ourselves with this great fiscal imbalance. But it was manmade. We're a rich country. It can be solved. ... We'll be able to overcome this problem. America has faced a lot tougher problems than this one. We'll get it solved.

First, I would differ in the opinion that the United States is richer than ever. It is very important to understand that the amount of money does not matter as much as the purchasing power of money. However, this is a different issue and I would primarily focus on the debt problem.

The government debt to GDP in the United States is currently at 102% and has the potential to trend much higher over the next decade. I would really like to know from Warren Buffett or anyone else how the U.S. can solve the debt problem considering the facts I will be listing below.

According to the CBO, the projected budget deficit in the United States for the next ten years is in the tune of USD10 trillion. This is with the assumption that the tax increases are not exercised along with the budget cuts. I can say with some conviction that there will be no substantial budget cut over the next few years considering the fragile state of the economy. Also, the tax increases might just be for the wealthy and will not meaningfully impact the deficits. Therefore, the U.S. will be well on course for USD10 trillion or more of deficits over the next ten years. How can the debt problem be solved with over USD1 trillion annual deficits expected in the coming decade?

The problem for the U.S. does not end there. The present value of the Social Insurance programs (Social Security and Medicare) for the next 75 years is estimated at $34 trillion, according to the 2011 annual financial report from the U.S. Department of the Treasury. Certainly, the entire amount is not due over the next few years. However, being an off-balance sheet item, the funding has to be arranged. It will be most likely through more debt and more specifically through debt monetization. Does this help in solving the debt problem?

I am also sure that there is no political will to cut on the spending and politicians and policymakers will keep deferring the budget cuts or significant tax increase program till the point of no return. I am referring to the inescapable debt trap, which the U.S. might find itself in a couple of years from now.

Amidst all this, equities, precious metals and commodities stand to benefit as money printing (debt monetization) leads to inflated asset classes. Individual investors need to preserve their purchasing power and invest in diversified asset classes and sectors in order to prevent losses arising from the coming inflation and devaluation of paper money. My recommendation would be the following -

SPDR Gold Shares ETF (NYSEARCA:GLD) - The ETF seeks to replicate the performance, net of expenses, of the price of gold bullion. The ETF has an expense ratio of 0.4%, with net asset holdings for the fund at $65.26 billion

iShares Silver Trust ETF (NYSEARCA:SLV) - The ETF seeks to reflect the price of silver owned by the trust, less the trust's expenses and liabilities. The ETF has an expense ratio of 0.5%, with net asset holdings for the fund at $8.78 billion

SPDR S&P 500 ETF (NYSEARCA:SPY): It has been proven that beating the index is not an easy task. Therefore, the strategy should be simple -- beat the index or invest in the index. From this perspective, SPY looks interesting on any meaningful correction. Further, the markets should trend higher on continued expansionary monetary policies. The ETF provides investment results that, before expenses, generally correspond to the price and yield performance of the S&P 500 Index

Seadrill Limited (NYSE:SDRL): I like Seadrill, as it caters to the oil and gas sector, which I am bullish on for the long term. Also, the company offers a high dividend yield. SDRL provides offshore drilling services to the oil and gas industry worldwide, and is also an excellent long-term buy, in my opinion. The company has a diverse asset base of 24 drillships & semi-submersibles, 21 jack-up rigs and 21 tender rigs. Further, 18 newbuilds would serve as long-term revenue drivers once they come into operation in 2013 and 2014. SDRL currently has an order backlog of USD19.7 billion, which gives revenue visibility in the foreseeable future. Being the second largest ultra-deepwater player also serves as an advantage for SDRL in the long term. Investors can consider the gradual accumulation of this exceptionally high dividend yield (9.2%) stock

Vanguard Energy ETF (NYSEARCA:VDE) - The ETF seeks to track the performance of a benchmark index that measures the investment return of stocks in the energy sector. With a low expense ratio of 0.19%, the ETF is a good investment option in a sector, which has good upside potential in the long term.

iShares MSCI Emerging Markets (NYSEARCA:EEM) ETF: Global diversification is necessary, and exposure to emerging markets is critical. Over the long term, emerging markets will outperform developed markets in terms of equity price appreciation. The cumulative mutual fund inflow into emerging markets has been higher in the last five years compared to developed markets. The iShares ETF corresponds generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.