Reckoning today from Rancho Santana, Nicaragua…
Where we part company with Warren Buffet…
Here’s the Sage of Omaha, explaining, in Fortune Magazine, why bonds are dangerous:
Investments that are denominated in a given currency include money- market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.
Even in the US, where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”
For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of US Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.
High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments – and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.
Under today’s conditions, therefore, I do not like currency-based investments.
Buffet goes on to explain why he doesn’t like gold either. He points out that since 1965 the total return on gold (not adjusted for inflation) was 4,455%. But the total return on stocks was higher, at 6,072%.
The difference between the two is that gold is a ‘sterile’ investment, says Buffet. Stocks are not.
Gold is only useful at protecting purchasing power when the monetary system is in danger. At almost all other times, you’re better off with stocks…businesses…farmland or another productive asset.
That’s why Buffet now prefers stocks. And it is why we now prefer gold.
Buffet willingly gives up the protection of gold in order to the get the upside from stocks. We willingly give up the upside from stocks in order to get the protection from gold.
Only time will tell. Our guess is that time will tell us that Buffet is right…in the near term. But we’re still not going to switch to stocks. Because the risk is too high that time will be on our side.
In other words, the most likely outcome…as far as we can tell…is that the financial world will stumble along more or less in the same direction it is going now. Perhaps for many years. Gold, already expensive in terms of purchasing power, may go nowhere…or even down. After all, we’re still in a Great Correction. As long as we follow in Japan’s footsteps there’s no particular reason for gold to rise.
But we do not bet on the most likely outcome. We bet on the outcome that is underpriced. The outcome that is most likely to pay off…or blow us up. In our view, investors do not yet fully appreciate the risks of a financial catastrophe, a war or a revolution.
In [the] news, we learned that 100,000s of Greeks had taken to the streets. “Rioters burn buildings…” reports Bloomberg:
Rioters set fire to buildings and battled police in downtown Athens as the Greek Parliament prepared to vote on Prime Minister Lucas Papademos’s austerity package to avert the nation’s collapse.
Ten fires were burning in central Athens including buildings housing a Starbucks Corp. cafe, a bank and a movie theater, a fire department spokesman said, speaking on the condition of anonymity in line with official policy. The blazes were near a bank that was set on fire in May 2010, killing three bank employees, during a general strike against Greece’s first bailout package.
“Today at midnight, before markets open, the Greek Parliament must send a message,” Finance Minister Evangelos Venizelos told lawmakers in Athens today as the final debate on the accord to secure a 130 billion-euro ($171 billion) second aid package got under way. “We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst.”
“We are seeing Athens go up in flames again,” Mayor George Kaminis, said in an interview on ANT1 television. “This must stop. What they are trying to do to Athens is what they are trying to do to the entire country.”
Meanwhile, hardly a day passes that we don’t hear of an impending attack on Iran.
The developed economies are borrowing money at 2 to 5 times the rate of GDP growth.
And the world’s major central banks eagerly print money.
Maybe Buffet will be right. Maybe the next 47 years will be like the last. But it seems like a bad bet to us. All the key circumstances are completely different – even opposite.
You remember the years from ’65 to 2012. They weren’t perfect. But they weren’t bad. The US was on top of the world…and headed higher. It was owed more money by more people than any nation ever had been. It was the leading energy exporter. It was the world’s leading capital investor. Its people were earning more and more money – in real terms. Total consumer and government debt, as a percentage of GDP, was barely a fifth of today’s level.
Of course, it wasn’t all good. The US was getting deeper and deeper into a costly and losing war. This would lead to some big bills to pay in the ’70s…and to some tough times. But, overall, America’s best days were still ahead.
Now, the emerging markets are growing much faster…taking more and more market share from the US. America is deep in debt…and adding more debt every day. Major industries have been zombified. More than half the voters depend on money from the government. America’s degenerate capitalism…and its geriatric democracy cannot adapt to the challenges it faces. And the typical working man hasn’t had a real increase in wages since the Johnson administration.
In ’65, the US was heady for glory. In ’12, it may be going to Hell.
But who knows? Maybe Buffet will be right.
Still…we’ll stick to our formula.
Buy gold on dips. Sell stocks on rallies.
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