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The US Ponzi Economy and Bernanke leading the masses right off a cliff


Munger
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Those in the camp of just put your head down and buy quality stocks at 10-15x FCF should first see if they can refute this analysis.  Othwerise, your FCF will certainly disappear in large quantities. 

 

This is not rocket science but rather basic math.  Anyone asserting the "macro is too complex and too uncertain to factor into investment decisions" is quite frankly proclaiming their ignorance in the current environment.

 

The truly scary part is that Bernanke is such an ideologue (brainwashed by having "theory" pounded into his head during years in the classroom), he doesn't get it and the ultimate reckoning will only be more horrific if he continues down the current path -- quite simply, you don't and can't solve a debt problem by encouraging more borrowing.  QE will ultimately fail.

 

http://www.businessspectator.com.au/bs.nsf/Article/Bernankes-blind-spot-pd20100830-8T8HE?OpenDocument&src=sph

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Now let's tie that analysis into some basic facts to add further clarity:

 

 

In 1929, household debt as a % of GDP reached app 100%.

During the period btw the Great Depression and WWII, declined to approximately 20% of GDP.

Further, household debt did not again pass 50% of GDP until 1985!

 

Now let's see where we are today:

Household debt as a % of GDP reached 100% again in 1Q09.

At the end of 1Q10, household debt as a % of GDP totaled app 93%.

 

And we enter this period with far more government debt than we did with the Great Depression.

Gov't debt at start of the Depression = 16% of GDP

Peak govt debt during the Depression = 44% of GDP

 

Gov't debt at start of "Great Recession" = 65% of GDP

Current gov't debt = 90% of GDP

 

 

This is not fear mongering.  These are simple mathematical facts.

 

Ain't no way around it folks -- we have a day reckoning ahead of us, with the only questions being when and how bad.  Remember, only WWII and the consequent destruction of the manufacturing capacity in the developed world (with the exception of the US) pulled us out the Great Depression.

 

And Bernanke as well as politicians encourage more borrowing -- this is INSANE.  And yet the owners of capital as well as the general American public gleefully allow this continue.  

 

 

 

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Ain't no way around it folks -- we have a day reckoning ahead of us, with the only questions being when and how bad.  Remember, only WWII and the consequent destruction of the manufacturing capacity in the developed world (with the exception of the US) pulled us out the Great Depression.

 

And Bernanke as well as politicians encourage more borrowing -- this is INSANE.  And yet the owners of capital as well as the general American public gleefully allow this continue.  

 

 

A few observations:

1) A moralizing tone ("reckoning," debt aversion, etc.) plays well in today's environment (a la Mr. Beck), but draws upon an emotional appeal that may shortcut detailed analysis.

2) Concentrating on debt outstanding without always and at the same time considering interest rate, duration, and earnings power is a mistake.

3) You seem to imply an unstated and CRUCIAL set of premises something along the lines of: GDP will decline (at some point in the next 3-5 years), corporate earnings will decline, the earnings multiple that equity buyers are willing to pay will decline, ergo the prices of business will be lower, so the optimal strategy is to hold cash today until the better prices arrive, and... then buy?

 

That last chain of argumentation is heard from many, it sounds plausible, and I do not deny could happen.  Frankly I cannot handicap that outcome with a fine degree of precision, at least relative to the wide array of other future paths.

 

What I do see are companies with enduring competitive advantages at prices that I find attractive.  Might they become more attractive?  Sure.  Is it more likely than not that prices will be more attractive?  In the next six months, I say about a 50% chance.  Three years from now, probably less than 20%.

 

I have bought and sold in the last week, selling cheap to buy businesses whose quality strikes me as preferable.  There are innumerable reasons why today's prices might be cheaper tomorrow, and the more scary ones are a nuclear terrorist attack, world war, and a rampant worldwide infectious disease.  Whether aggregate GDP is lower two years out is a lesser concern than those. 

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A few observations:

1) A moralizing tone ("reckoning," debt aversion, etc.) plays well in today's environment (a la Mr. Beck), but draws upon an emotional appeal that may shortcut detailed analysis.

2) Concentrating on debt outstanding without always and at the same time considering interest rate, duration, and earnings power is a mistake.

3) You seem to imply an unstated and CRUCIAL set of premises something along the lines of: GDP will decline (at some point in the next 3-5 years), corporate earnings will decline, the earnings multiple that equity buyers are willing to pay will decline, ergo the prices of business will be lower, so the optimal strategy is to hold cash today until the better prices arrive, and... then buy?

 

How and why should I respond to someone who clearly didn't read the analysis/facts and yet firmly offers a subjective opinion, with no relation to the analysis/facts?   Part of the problem -- everyone wants to believe...no one wants to do the work.

 

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How and why should I respond to someone who clearly didn't read the analysis/facts and yet firmly offers a subjective opinion, with no relation to the analysis/facts?  Part of the problem -- everyone wants to believe...no one wants to do the work.

 

I think the articles premise is correct and there is nothing I disagree with.  But you are anchored to your position, thus no one will be able to convince you otherwise, facts be damned. 

 

http://ir.thecoca-colacompany.com/phoenix.zhtml?c=94566&p=irol-stocksplit

 

Cheers!

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I did read the article.  So, when private debt is repaid, what will the creditors do with the proceeds?  The article conveniently ignores the fact that creditors must either re-invest the cash, spend it, or stuff it under their mattress.  Since #3 is an unlikely outcome, the reduced aggregate demand argument does not really hold water....unless the author is of the view that the private debt repayments will be issued uniquely to foreign creditors (which would seem implausible).

 

I do not deny for a minute that there remains a great deal of pain coming down the pipe as businesses, households and governments deleverage.  However, I am having some difficulty arriving at an apocalyptic conclusion.  My larger concern is that markets still look to be 10-35% overvalued in a historical context (even in the absence of a drawdown in GDP), and careful shopping is therefore my preferred strategy.

 

SJ

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I think the articles premise is correct and there is nothing I disagree with.  But you are anchored to your position, thus no one will be able to convince you otherwise, facts be damned. 

 

How could I be anchored in my opinion if you agree with the analysis/facts?   

 

And if Coca Cola trades (or a company the equivalent) trades down to 5x earnings, I will be buying hand over fist. 

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So, when private debt is repaid, what will the creditors do with the proceeds?

 

 

When private debt is repaid (of the magnitude that must occur), the economy slows and asset values decline, rendering much debt on the banks balance sheets BAD.  So the debt banks are actually fortunate to get repaid provides much needed reserves.

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Debt reduction (i.e. Debt Deflation) is an issue to be worried about via the Great Depression and the Japan experience.  However, one must not only anchor on the Debt-to-GDP number, but also take into account the Asset-to-GDP number.  True, assets have fallen the past few years, but more assets are available and more 'options' are available to the average Joe these days than in the '30s.

 

Pessimism is abundant these days and even if we only grow at 0-2% over the next few years, it will most surely feel like a depression in comparative terms as we have been conditioned to more.  Irrespective, I am in agreement with the debt reduction argument, but still open to and placing capital into the 'compounders' as I believe them to be.  

 

One can say I am anchoring on financial history and Graham, but if folks are offering 50¢ dollars, I am committed to buying them knowing the could turn into 25¢ dollars over the short-term.

 

 

Cheers

JEast

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There is another interesting facet about the QE programs that I haven't yet heard on this forum.  It's an interesting perspective to consider: one of the goals of QE is to stimulate the economy by blah blah (we all know the drill).  What's interesting to me is there seems to be a dilemma here.  As a gov't bondholder, why would I want to spend when I know the gov't will be trying to lower interest rates?  I should just keep my bonds.  This policy seems to favor the "rich", or folks who are savvy enough to buy bonds.  

 

If you believe that the gov't is in a liquidity trap, then it's apparent to me that there is no bubble in Treasuries.

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How could I be anchored in my opinion if you agree with the analysis/facts?

 

Your assumption is that some of us are saying to buy any large-cap stock or that the markets cannot go down from here.  That's not what we are saying, or at least I'm not saying.  You're basing your investment philsophy around macroeconomic circumstances, and I think for the average investor, that is pure folly.  There are industries that will do very well going forward, depression or not.  Some of those companies are undervalued in present circumstances.  Can they go cheaper?  Sure!  And they can go a hell of a lot higher as well.  And that was why I provided the page showing the growth in Coca-cola when both stock and reinvested dividends are included.

 

In a case like Fairfax, they have huge insurance reserve liabilities, and their ability to meet those responsibilities could be severely undermined if markets moved down.  Thus, they are protecting their portfolio due to the leverage they operate with.  This is not the same circumstance for the average, unleveraged investor.  Too many people are assuming that they need to do what Prem is doing, but that would only be true if you shared the same risks.  Even Francis, one of the right-hand men at Hamblin-Watsa for many years, is saying that some things are undervalued.  Can they go cheaper...let me reiterate, yes they can!  But if you can tell me when and how certain that is, then you should be running Fairfax Financial and not Prem Watsa.  Cheers!

 

 

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Guest broxburnboy

Debt reduction (i.e. Debt Deflation) is an issue to be worried about via the Great Depression and the Japan experience.  However, one must not only anchor on the Debt-to-GDP number, but also take into account the Asset-to-GDP number.  True, assets have fallen the past few years, but more assets are available and more 'options' are available to the average Joe these days than in the '30s.

 

Pessimism is abundant these days and even if we only grow at 0-2% over the next few years, it will most surely feel like a depression in comparative terms as we have been conditioned to more.  Irrespective, I am in agreement with the debt reduction argument, but still open to and placing capital into the 'compounders' as I believe them to be.  

 

One can say I am anchoring on financial history and Graham, but if folks are offering 50¢ dollars, I am committed to buying them knowing the could turn into 25¢ dollars over the short-term.

Cheers

JEast

 

There has been a lot of confusion over the past few years as to what constitutes a financial asset, indeed yesterday's no-brainer compounders have often been revealed as the ongoing liabilities they always were.. personal levered real estate for example. It is apparent that the losses on these no-brainers have been transferred from their rightful owners - the creditors- to the designated victims- the taxpayers/borrowers.

Other losses remain unrealized on a massive scale in the balance sheets of government, government financial entities, banks, the fed and the treasury through the miracle of accounting practises previously considered fraudulent. These losses are gradually being absorbed by dilluting the currency with fresh money supply. The losses are continuing to pile up through deficit spending and malinvestment and the subsequent devaluation of the currency is assured.

It may be that folks are offering to sell today's dollars for .99 and repay you with a .90 cent dollar next year.

 

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You've got to wonder what makes people so thick as to think they understand a better formula for understanding the economy then hundreds of years of economic thought.

 

Anyways, the argument is asinine for numerous reasons,number 1 being, he's double counting by adding changes in private debt.  If I compare two of the exact same scenarios, except in the second one i borrow 150 from my neighbor that would of spent it, and I spend it myself, GDP is the same in each, aggregate demand is the same in each.  Adding an additional 150 by adding the change in private debt makes no sense.  

 

If my neighbor wouldn't have spent it in example 1, but i borrow and spend it in example 2, then I actually have boosted GDP by 150 in example 2 versus example 1.  BUT AGAIN, there's no reason to add private debt.

 

Someone mentioned above something about it all being foreign debt.  That is correct.

 

Anyways, what is important about changes in private debt (and the author of that article deserves no credit whatsoever in seeing this) is that if i borrow 150 that my neighbor wouldn't have spent, and i do this year after year, we can have quite a conundrum to deal with.  Why isn't my neighbor spending it at all?  Why am I borrowing it?  And can I afford to borrow it?  A large change in private debt like the one that has occurred lately in the US shows that a subset of the population with money isnt spending or investing, and then another subset of the population is. And it just so turns out that they couldn't afford to spend as much as they did.  So if it unwinds, eventually subset A has to either learn to invest or spend or, or do nothing.  Subset B has to cut back and live within its means.  And if subset A actually does nothing with it, it will hurt GDP from the inflated levels.  Yes, that is a real risk.

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There are industries that will do very well going forward, depression or not.  Some of those companies are undervalued in present circumstances

 

While I certainly would agree with that, I am wondering which industry will do very well as compared to the last decade or two if the depression is particularly intense and what kind of margin of safety I have to get.

Munger is absolutely right about the debt levels and this is not only in the US: this is almost common to the entire western world! The japanese situation is even more gloomy but for some reason it is almost ignored by everyone today. The pool of savings that the japanese used to borrow and stimulate has shrunk dramatically with the aging population...

It makes it particularly difficult to estimate earning power in many many instances. Always ignoring the macro factor is a mistake: it is all a matter of proportions. We may be at a moment in history where big changes will happen.

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Parsad great response! RE: Coca Cola

 

What Munger refuses to understand is that mathematics lead to an unequivocal situation where every year there is more money in the system. Call it inflation, Call it whatever you want. Buffet realized this early on, hell his father invented the TIPS!!!

 

And for Long-Term investors with permanent capital buying KO @ 5x or buying say BP today at 5X makes no difference we just look at different rocks.

 

But what will surely happen to investors like Munger, UNLESS THEY ARE PLACING A HUGE BET TO THE DOWNSIDE, is they will NEVER and I repeat NEVER catch the perfect bottom, and they will walk away from the bottom and subsequent reversal feeling dissatisfied as though they didn't buy enough or didn't make enough.

 

Its a young investor mistake to think that there is really a point where society comes to a screeching halt!!! I have a wonderful book, its the New York Times Front Pages from 1800's until today. I love flipping towards the 1929-1935 pages. Its great to see things in real context on a daily basis reported by local newspapers. Parties, Sales, Entertainment reports, Top Salary Earners (Edsel Ford $5m+) life still goes on. We are all human wake up the next day and charge. And we have an ability to be extremely flexible.

 

The value of money can disappear but not the value of top enterprises earning decent rates of return on capital deployed.

 

Bottom line, you can't be a long investor wasting anytime in the thought process that Munger has. You can be a short investor, or you can say pull back your long positions in anticipation of the day of reckoning. But it's a pipe dream to sit and wait for years until valuations reach the golden margin of safety that is stuck so far up in your head!

 

Give me a short Idea or something, own up to an investment thesis not Macro Dreams!

 

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Your historical statistics are spot on. Likewise, I can produce balance sheet, income statement, ratio analysis, and provide historical data on a company I  might invest in (the US - or the entire world for that matter may be considered a giant company with many subsidiaries, but unlike a company it has different economic dynamics).

 

However, I think the chain of logic to your conclusion has some weaknesses in it. The primary weakness is that the argument hinges on a comparison of a past historical state with the current historical state and an extrapolation of future consequences unravelling exactly like in the past historical state. However, much about the world in 2010 is very different than the world in 1929. I'm not talking about economic ratios alone, if the world is a machine with trillions of variables, the state of those variables today is a very different configuration. To wit: even if GDP were to suddenly drop 20% today in the US, why is it a foregone conclusion that the consequence must be the same as in the Great Depression?

 

 

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Steve Keen projects about a 4% drag on GDP as debt is repaid. He is one of thefew people who correctly model the effect of credit creation or destruction. Instead of an average of a nominal 6% GDP growth perhaps we should predict a nominal 2% GDP growth. The implication of the shrinking balloon of credit must be that assets which were inflated by the expansion of credit must now decrease in value. The debt repayment process will be slow, perhaps 5 to 20 years depending on government policies. So far the policies have been to expand the debt and attempt to keep the asset prices falsely inflated without doing much to improve the "plumbing" of the economy. Further, as government debt obligations climb it is vital to keep interest rates low to prevent shocks to confidence which could create a debt death spiral. Unfortunately Bernanke seems wedded to failed theories which call for QE so risks precipitating the loss of confidence.

 

Investors who fail to grasp the macroeconomic environment risk violating Buffett's rule 1 and 2. Munger earlier suggests increasing margin of safety. It is also more important to target investments more carefully. The days of most stocks doing well are over. Instead we should expect more bankruptcy and industry consolidations. Companies with little debt, good moats and lots of free cash flow will likely enjoy relatively better opportunities. Volatility will likely increase. Fluctuating exchange rates will favour companies who are flexible. Value investors can look forward to lots of excitement.

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But it's a pipe dream to sit and wait for years until valuations reach the golden margin of safety that is stuck so far up in your head!

 

Buffett and Graham would most certainly disagree.  Never waver on demanding a very high margin of safety.  

 

 

Macro Dreams!

 

No this is macro reality.

 

And they can go a hell of a lot higher as well.

 

You may get a trading bounce but a "hell of a lot higher" -- not happening.

 

 

But if you can tell me when and how certain that is, then you should be running Fairfax Financial and not Prem Watsa.

 

I can't.  But I can certainly discern a good margin of safety from a poor one.  And if you think you are getting a good margin of safety on any large cap equities today, I can only say good luck

 

 

Overall -- a lot of rhetoric disagreeing but NO ONE can refute the analysis/facts/basic math.  Moreover, most don't want to accept the inevitable consequences of the math.  

 

Best.

 

 

 

 

 

 

 

 

 

 

 

 

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And so many abuse Buffett's "ignore the macro" comments.

 

When Buffett ran his partnership and even during the early years of Berkshire, Buffett would only invest if the margin of safety was so high that he could ignore the macro.

 

If the margin of safety was not high enough, Buffett would then have to accurately predict the macro -- he never wanted to be dependent upon a prediction of a robust macro economy in order to earn a reasonable profit over a reasonable time frame on an investment. 

 

The key is to get a margin of safety that allows to you ignore the macro.

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Munger it seems as though everyone is in agreement in principle on everything with the exception that you all have a different idea of margin of safety. Some want 10x FCF with a large cap that is fairly immune to macro and you want the same or a lesser quality company but with a 5x FCF.

 

It seems as though everyone is repeating the same thing, thread after thread.

 

 

You are saying the world will end and then recover so batten down the hatches, they are saying it will be painful but we will get through buy quality when its priced right.

My basic thesis is things are never as good as they say or as bad as they say. Everyone is so doom and gloom, so I dont think its that bad.

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Some want 10x FCF with a large cap that is fairly immune to macro and you want the same or a lesser quality company but with a 5x FCF.

 

What I am saying is that paying 10-15x does not compensate for the very high risk that FCF will be much lower (on average) in the future -- in effect, you are paying higher than 10-15x FCF today.  Hell, FCF would be much lower TODAY if the gov't weren't running a 11-14% budget deficit and artificially depressing interest rates, both of which are completely unsustainable.

 

Layering more debt onto an already over-levered system is insane.

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I think you are missing a very important point.  If the QE and all the other loose monetary policy was not followed, the stock market would be toast.  This money has caused inflation in stock market and other productive and natural resource assets.  The end game may be to inflate our way out of it over a long period of time to offset the deflation that is in the system.  The interesting point brought up by the data is that real demand has declined by 25% already and profitibility of most firms is doing very well.  The Great Depression had a decline of 50%.  In think that data provides an interesting bullish signal given the amount of demand destruction.

 

Packer    

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This money has caused inflation in stock market and other productive and natural resource assets.

 

True -- this should be well understood.  The problem is that the fiscal and monetary stimulus are unsustainable...what happens when it ends -- pop goes the bubble.

 

The end game may be to inflate our way out of it over a long period of time to offset the deflation that is in the system.

 

This requires more debt in an already over-levered system -- not sustainable and not a solution.  Further SS, medicare, medicaid, and all state/local entitlements are indexed to inflation -- inflation would never solve the problem.

 

The interesting point brought up by the data is that real demand has declined by 25% already and profitibility of most firms is doing very well.

 

Firms are only doing well because of cost cuts, which are finite and the gov't artificially propping up the economy with 11-14% budget deficits and depressed interest rates, both of which are unsustainable.

 

And the data shows real demand declined by app 69% during the Depression.  And remember the only way we got out of the Depression was WWII and the subsequent demand created by the destruction of virtually all productive capacity in the developed world outside of the US.

 

 

 

 

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