Buffett on Inflation and Stocks (Part 1)

[tradevestor]

Munger,

 

Thanks for your reply.  While I somewhat understand (and share) most of your concerns, I don't understand a few things specifically:

 

"no one knows the actual tipping point for hyperinflation.  So I chose to have a fairly large holding of cash ".

 

This makes no sense to me, can you please explain your reasoning ?  If hyperinflation hits, cash will be worthless. Why would you hold cash in a hyperinflationary scenario ?  It makes sense to hold real assets during hyperinflation - commodities, real estate, stocks (part ownership of real assets in companies). 

 

"...if the currency gets meaningfully debased and the price of everything goes up while salaries remain unchanged "

 

This is a huge assumption.  With high unemployment, there's a good chance that salaries won't match inflation rates.  However, if currency gets debased 10x, I don't think salary would remain unchanged, it will be more like 8x.  Consumer prices would go up 10x, but salary rises only 8x.  Result ? Less discretionary spending, lower asset prices, lower standard of living. Earnings and hence, share prices will drop in absolute terms,  but measured against currency (which was devalued 10x), it will still be much higher. Wouldn't it ?

[Munger]

This makes no sense to me, can you please explain your reasoning ?  If hyperinflation hits, cash will be worthless. Why would you hold cash in a hyperinflationary scenario ?  It makes sense to hold real assets during hyperinflation - commodities, real estate, stocks (part ownership of real assets in companies).

 

While clearly a risk, I chose not to speculate on a hyperinflationary scenario.  I believe the Fed policy is creating deeper structural problems that could have grave consequences down the road but I'm not convinced hyperinflation is the definite result -- see Japan.  

 

And if true hyperinflation takes hold, all will be screwed -- those believing that buying commodities (especially ETFs), real estate, and stocks will protect them from the adverse consequences of hyperinflation are living in the land of wishful thinking...make no mistake -- society, rule of law, property rights will all crumble for some period...see Weimar Germany.  So I see it as pointless to hedge against hyperinflation as an investment strategy.  If you believe hyperinflation is certain, go buy productive farmland with its own water supply (as Michael Burry as done) so you can feed/protect yourself and possibly use the surplus as barter -- something I've considered but not from the perspecitive of an investment in which I expect to get an economic return in the tradtional sense.

 

This is a huge assumption.  With high unemployment, there's a good chance that salaries won't match inflation rates.  However, if currency gets debased 10x, I don't think salary would remain unchanged, it will be more like 8x.  Consumer prices would go up 10x, but salary rises only 8x.  Result ? Less discretionary spending, lower asset prices, lower standard of living. Earnings and hence, share prices will drop in absolute terms,  but measured against currency (which was devalued 10x), it will still be much higher. Wouldn't it ?

 

In the scenario of a currency debasement (caused by a run on the dollar), it is most definitely not a huge assumption that wages would remain unchanged.  Under a 10x currency debasement, chaos will unfold...unemployment will spike, wages will stay flat at best...

 

Earnings and hence, share prices will drop in absolute terms,  but measured against currency (which was devalued 10x), it will still be much higher. Wouldn't it ?

 

No

 

 

 

 

I agree with others -- we've exhausted this topic for the time being...let's move on

 

 

 

 

 

 

 

 

 

[Cardboard]

Myth,

 

"I think sitting on his hands hoping it all works out looks just as bad from where im sitting, and doesnt work well economically or politically. Buffett is man enough to realize that and avoids throwing stones. You seem to be bitching and thats about it. All options look bad."

 

Why is it that almost everyone thinks that low interest rates is a good thing for the people?

 

Who has that helped really, to keep rates close to 0% for so long?

 

The homeowners? Nope. Those who could not afford a home in the first place are still denied now. Those who have seen their rate reset, still pay a high rate. Those who could refinance at a lower rate are a little better off, but these were well off individuals in the first place. And these individuals are so worried now about what is going on (remember they are mostly savers) that they are not spending a dime more.

 

The alternative is to raise rates. This is the way IMO to induce confidence in the system, this is normalcy after all. 0% isn't. If savers were receiving their normal 4 or 5% a year on their savings, they would spend. It is additional cash you know. It would create jobs. The deficit would get reduced. Pension plans would be honoured. Stimulating IMO, is going from say 6% down to 4%. Going to 0% is creating an unhealthy situation.

 

Now you will tell me that this would push up the dollar and hurt export. This is BS. The U.S. economy never did better than during the 90's and look what was happening with the buck. A stronger currency attracts capital, it also forces a country to be productive. The Chinese currency is also pegged to the dollar, so they would have to follow.

 

The only people benefiting from a 0% policy are the banks and hedge funds. They can borrow at ultra low rates, leverage to the hilt and invest at higher rates. They also play carry trade with the dollar since Bernanke has almost promised them to kill it.

 

I just see a grand game of manipulation with very little impact for Main Street.

 

Instead of creating unsustainable debts for future generations with QE and massive deficits, just raise rates a little and let the real people take charge.

 

Cardboard

 

[alertmeipp]

>>Who has that helped really, to keep rates close to 0% for so long?

 

The banks.

 

[vinod1]

 

Who has that helped really, to keep rates close to 0% for so long?

 

The only people benefiting from a 0% policy are the banks and hedge funds.

 

I just see a grand game of manipulation with very little impact for Main Street.

 

Cardboard

 

 

At the end of the day 0% rates are like shuffling money from the left hand pocket to the right had pocket as each $ saved by a borrower is offset by an equivalent $ that is not earned by a saver. So it is a form of redistribution.

 

The only benefit seems to be to induce some sort of bubble and pray that it fuels economic growth (at least in the short term) and hope that the bubble pops out when the economy is in a much better shape to handle the aftermath.

 

 

Vinod

[alpha231616967560]

As evidenced by the origination of this thread, Buffet does pay attention to macro risk -- he wrote a lengthy and incredibly insightful essay on the impact of inflation (a macro factor) on equity returns.  Macro risks are among the many that must be considered when determining the required margin of safety.

 

I came across the snip of an interview with Warren Buffett that precipitated my initial comment in this discussion:

 

"...When Charlie Munger and I talk about buying something, we don't spend 10 seconds on macro factors..."

 

- From Buffett's recent interview with Carol Loomis (at about 37 minutes) (http://money.cnn.com/video/news/2010/10/05/n_buffett_MPW.fortune/)

 

 

[Myth465]

Myth,

 

"I think sitting on his hands hoping it all works out looks just as bad from where im sitting, and doesnt work well economically or politically. Buffett is man enough to realize that and avoids throwing stones. You seem to be bitching and thats about it. All options look bad."

 

Why is it that almost everyone thinks that low interest rates is a good thing for the people?  

 

I am a firm believer in 2 things. 1, I have no idea how this will all turn out, and niether does anyone else. 2, there is no free lunch.

 

I never said that zero interest rates, were good. They obviously are good for some and bad for others. I think lowering rates is something just about all economist agree on though because - They help deal with upcoming maturities (it helps debtors) and it helps bailout the banks (via a backdoor). If you think the recover is weak at 1%, I think it would be extremely weak with 6% just based on housing.

 

Like I said inmo there are really no good easy answers. Generally you just pick who you want to screw / help.

 

Possible but here is a question -- with real unemployment around 20%, there is zero evidence that inflation triggered by a currency debasement will lead to a rise in wages.  Let's think this through but note that this is complete speculation on my part -- nevertheless, here goes...if the currency gets meaningfully debased and the price of everything goes up while salaries remain unchanged -- the cost of living will then consume more than the average wage.  In this scenario, consumers and companies would be trying to sell hard assets to cover the cost of living (cost of business), which begs the question of who will buy these assets at inflated prices...there is a reasonable scenario that hard asset prices fall not increase when inflation is triggered by currency debasement.  

 

Separately -- remember that virtually all entitlement obligations (pensions, SS, medicare, medicaid etc) are currently indexed to inflation -- so Fed stoked inflation doesn't remove the vast majority of the debt burden overhanging the US economy.  The one obvious benefit of currency debasement -- the US gov't could theoretically more easily pay off foreign debt, which assumes China doesn't dump the debt when they realize the Fed is trying to debase the currency.

 

These are 2 big risks with money printing. Thanks for posting them. Especially the one related to pensions. Bernanke has been hinting that these need to be addressed and can be basically cancelled, and you may be on to something as to why. The salary one is also interesting. I am not sure why they havent fallen for professionals. It seems to be tougher to get a job, but the salary is at a similar pre crash level if you can obtain the position. I believe you are correct, that they wont rise with crazy unemployment. They may go up but wont likely keep pass.

 

It will be interesting watching it all play out.

 

 

Myth, my man -- honestly appreciate the thoughtful response, some of which I agree with but most of which I don't. We both want to do well -- just seem to have different perspectives/thoughts on the issues.  As you noted, we could go round and round...  So, let's respectfully move on and see how all of this plays out.  If I get any great ideas, I'll certainly post on the board.

 

Agreed, and I enjoy reading your thoughts and predict that your ideas when posted will be quite popular given the Margin of safety you desire. I know I will be picking them over.

 

Thanks again for the article. I really enjoyed his take on tax claims. Class A, B, and C stock. Buffett is extremely good at breaking things down.

 

[zippy1]

 

No. 

 

The macro certainly affects individual companies and stocks.  With that said, I am not trying to time the macro.  If great companies were valued at 5-7x earnings, I would buy hand over fist today, regardless of the macro.  And don't be so naive, Buffett understands the macro risks probably better than anyone on the planet.  Buffett looks for a margin of safety that allows him to ignore any macro risks -- important distinction.

 

 

I guess this above quote may be the reason why some have the wrong impression that the suggestion is to wait for coke to go to ~5X cashflow to buy.