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 circumstances.
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 accident.
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 Markets and Money, 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.
Until next time,
for Markets and Money