Berkshire Ruminations

Saturday, April 25, 2009

Buffett was wrong about this one. (Unfortunately it is the most important one of all.)

This is an issue that has become very important to me lately, and I hope readers will be patient and read through my thoughts. It is not a pleasant topic and most people would prefer to pretend the problem doesn’t exist. But it needs attention soon.

One evening last spring I took my wife to a local movie theater to see the premiere of the documentary I.O.U.S.A., the movie designed to increase awareness of the “inconvenient fiscal truth” that our nation faces. It was a great event, and was followed by a live Q&A with some of the stars, including Dave Walker and Warren Buffett.

Walker was the doomsayer, and expanded on the already strong case made by the movie that due to the national debt and other liabilities of the federal government, our children are destined to end up worse off than we are today. Buffett was the counterpoint, arguing that although it is a serious problem, America will be fine in the long run.

Buffett was wrong.

I wanted to believe the guy, my hero, the Oracle of Omaha. But the facts just didn’t support his Alfred E. Newman-esque stance. Here we are a year later, and things not only look bleaker than ever, it almost seems as if the sky has started its fall.

When Bush 43 took office in 2001, our nation had $5.6 trillion in outstanding debt. In the eight years since then, through a combination of tax cuts, wars and expensive Medicare supplements, the amount has mushroomed to nearly $11 trillion. Think about that: the balance of our national debt is climbing at an annual compound rate of 9%. And this doesn’t even include the unfunded liabilities of Medicare and Social Security, which will come due at ever increasing rates in the coming years and by most accounts dwarf our current $11 trillion in debt.

The Peter G. Peterson Foundation estimates that our “real” national debt, after accounting for all these unfunded liabilities that will presumably have to be financed by taking on additional debt, is now $56.4 trillion – four times our current GDP. Comfortably paying this off is simply an impossibility.

Now, in a misguided Keynesian approach to solving the financial crisis(which is not unrelated to the problem of government overspending in the first place), Obama and the others are spending a trillion dollars MORE of money WE DON’T HAVE. Of course, this is not a Democrat or a Republican issue. Democrats like to spend money, Republicans like to cut taxes. BOTH are equally dangerous. No one will want to do it, but what this country needs is higher taxes, lower spending and a higher personal savings rate. How the hell are we gonna pull that one off??

I don’t think we will. And that is why I think Buffett was wrong. Washington, now more than ever, lacks the political will to correct this problem. And that is why we are doomed. Sadly, what will eventually happen is the government will have to print enormous sums of new money, causing hyperinflation and prohibitively high interest rates. What it cannot do, ironically, is choose to simply default on its mountain of debt as the Russians did in the 90s. This is because the vast majority of our debt is actually owed to ourselves, via Social Security and Medicare entitlements. What a fricking trainwreck.

What I am saying is nothing new. People throw these kinds of numbers around all the time. At some level, this may even be counterproductive – people get desensitized to the enormity of problem. What we don’t hear enough about is what life will actually be like when this hits the fan some twenty years down the road. How will we be living when 75% of our GDP is committed to simply servicing our national debt? Where will jobs come from when reinvestment ceases because corporations are forced to forfeit their earnings to the government? How will the citizenship react the government is forced to confiscate nearly all the earnings of the public while simultaneously eliminating the programs upon which everyone has become so accustomed to relying? From a sociological perspective, this is terrifying. Chaos could ensue. Good thing the second amendment hasn’t been completely repealed.

Perhaps most frustrating to me is that the root of the problem seems to be something that is all but impossible to change. It is a societal attitude towards debt – the entitlement philosophy that WAY to many (though not all) Americans adhere to. I DESERVE that 52” plasma tv, because I work ten hours a day flipping burgers, and burger flipping is hard work. That kind of attitude will kill a society fiscally, because the truth is that simple hard work does not entitle you to anything more than someone else is willing to pay you for that work. If they don’t pay you enough, you need to find a way to become more economically productive so as to boost your wages so that you can afford that Cadillac Escalade only AFTER having saved for it.

It’s a chicken-or-egg situation to determine whether it is the government setting a bad example for individuals or if it’s an infiltration of the government by entitlement-minded individuals, but clearly both segments of our society have the same attitude towards debt. This MUST change.

I worry about my one-year old son, David, and what type of world he will face as an adult. For his birthday earlier this month, a good friend of mine gave him a $50 Series EE “Patriot” savings bond. I loved the message of savings and responsibility in such a gift, I only wondered if it would be in default when David goes to cash it in 2039. I tell you, I would do anything possible for my son but ensuring he lives in a prosperous economy seems beyond my control. That worries the hell out of me.

I am sure many folks will think I am wacko for this outlook, but I hope those that do take an honest look at the situation before concluding I am wrong. At a minimum we need to put ourselves on track to reverse the current trend.

*** Clarification, 28 Apr 2009***
In this post, I did not mean to imply that I think Buffett was wrong just because of what has happened over the past year. Buffett said last spring that "America will be fine in the long run" and by long-run I assume he means 30, 50 years. I just happen to disagree becuase as long as we continue this trend of enormous deficit spending ($1.7 trillion this year alone) we will not be fine in the long run.

9 Comments:

  • I've been thinking about this same issue all year, but nobody seems to comprehend the magnitude and urgency of interest working against you. No matter how many zeros that you tell them that we are in debt, it just does not sink in.

    I think the reason is that people do not comprehend the consequences of an action unless you make it clear how they will personally be affected.

    Cialdini said you have to drive home the consequences, ie tell them they will ruin their reputation, their career, etc, in order to influence their decisions. In this case however, the people that will be most affected are those people my age (22) and younger who will have to do the work to pay off this debt. And it will be very difficult to influence the president and congress when they are short sited, based on their short term incentives. And unfortunately, people my age are more concerned with other matters than to take the time to understand and act on the issue.

    Most generations have some kind of monumental undertaking. This will likely be ours.

    By Blogger David Meehan, at 26 April, 2009 18:52  

  • Since you can't owe yourself money you can default on yourself.

    By Blogger viadave, at 26 April, 2009 20:38  

  • Your post puts to words my thoughts. What we are going through is bad, and the only way to get out of this mess and stay away from similar situations is to increase saving and begin a prudent lifestyle. Buying things that we can afford is a forgotten mantra that should be brought back. Unfortunately, I don't think that will happen.

    By Blogger Pedda, at 27 April, 2009 06:07  

  • You sound like Thomas Malthus did. And we know how that ended up. But here are a few things that I find disturbing about your writing:

    1) Your overuse of emotional expressions makes me doubt the legitimacy of your thesis. It reads like something that will be debriefed on esnopes.com.

    2) For someone of your background, I would expect you to know the difference between one year and long term. So Mr. Buffett says in the long term the country will be OK and you say that he was wrong because things have not improved in one year? Does that make sense to you because it does not to me.

    3) Just like Malthus' theory that got proven wrong because of technology, your theory can also be easily proven wrong by future events. If the standard of living in the U.S. increases enough, the tax base increases, tax revenue increases and the deficit could be reduced not just because tax revenue increases but also because people will need less government programs.

    4) Social security is a future problem that can be easily fixed by increasing the retirement age and by encouraging people to save for retirement.

    5) Growing health care costs are one of the main reasons why people need to save so much for retirement. Considering the eating and living habits of Americans, a lot could be done without the intervention of the government just by people taking better care of themselves.

    6) Finally, why are you in grad school "wasting" money? Because you know that the money you spend now will more than pay itself later. And so it should be with government spending--it is justifiable if it creates more value for society than not spending it. Unfortunately, most people do not think like that when they swipe their credit cards...

    By Blogger Alfred the Pug, at 27 April, 2009 11:14  

  • While I agree it is a very important concern I also think that you are missing some important off balance sheet assets that America has.

    In particular the united states owns 30% of your wages (per year) for the rest of your life. In fact, you actually work from January 1st until April 1st of each year for the government(might as well be a govt. employee). Your son will when he gets his first job as a lifeguard(or whatever else) up until past the time he retires will do the same. The government also owns 30% of each American corporation. The Goldman Sachs, Ibms, Microsofts, the Cokes and yes even the Berkshire Hathaways.

    We have a solvent government.

    We have country that people want to live in.

    We have rule of law.

    The list goes on forever.

    Would you be willing to take the 1 in 45 shot at being born somewhere other than America?

    I agree that this has the possibility of being the defining thing of our (<30yr ) generation but imagine if the Allies decide to quit because they had a rough spring and summer in 1942. Make no mistake about it, there is a lot more hard work needs to be done.

    America right now is a turn around.
    As a value investor, I wouldn't invest in anything else.


    ps....on a side note I think you are way out of line saying buffett is wrong...weather or not he is wrong now or right wont be determined for many years. To think that one year will make a difference is foolish at best. And as a follower of Buffett (and i assume value investor) you know very well that you can see material drops of 90% on your investments.

    We will be stronger in 10 years. I'd bet on that.

    -Ryan McP. (yes, dave. Hows school treatin' ya?)

    By Blogger rwmcpar, at 27 April, 2009 21:38  

  • I completely agree with your comment about the 52" Plasma and the Escalade. Americans is WAY overspending. It seems like we are a nation of comsumption.

    I just picked up "Snowball"...Liked it so far. Have you get a chance to read it yet?

    By Blogger David Pham, at 29 April, 2009 20:54  

  • Good heartfelt post, Andy. I agree with you... all will not be ok just by saying "all will be ok", as Buffett has for years now. It's somewhat akin to saying "house prices always go up". It might be true for many many years, until it isn't.
    While the last year has forced some of the 'entitled' public to rethink their personal finances (emphasis on "FORCED"), there is so little political will to do the same as a government.

    By Blogger Samir, at 01 June, 2009 22:16  

  • The government would he was Most of these problems have been because high spending, low saving and as a result low investment. Today people need to save much more for retirement because the health care costs are growing. People need to understand the need for investing just to make sure a better life in future.
    stock investments

    By Blogger john, at 05 August, 2009 07:57  

  • 1) Your overuse of emotional expressions makes me doubt the legitimacy of your thesis. It reads like something that will be debriefed on esnopes.com.

    I'll disagree, he presented a well layed-out thesis.

    2) For someone of your background, I would expect you to know the difference between one year and long term. So Mr. Buffett says in the long term the country will be OK and you say that he was wrong because things have not improved in one year? Does that make sense to you because it does not to me.

    Actually, the situation hasn't failed to improve in one year. Things have gotten catastrophically worse in one year, and we've seen to what point will "leaders" in congress attempt to inflate their way out of the problem, just so this mess doesn't blow up during their watch. Future 10-year deficits of 9 trillion? What the hell...

    3) Just like Malthus' theory that got proven wrong because of technology, your theory can also be easily proven wrong by future events. If the standard of living in the U.S. increases enough, the tax base increases, tax revenue increases and the deficit could be reduced not just because tax revenue increases but also because people will need less government programs.

    This is, IMO, the one thing that will prevent the scenario the blog author speaks of from unfolding. Technology. Something has to change for sure. Keep walking down this path will NOT solve anything.

    4) Social security is a future problem that can be easily fixed by increasing the retirement age and by encouraging people to save for retirement.

    Easily increasing retirement age? Right, people will have no objections to that. "Ouch, sorry, you'll have to give up more of your last years to keep on working, don't worry about it". Yeah right. Not to mention, someone who currently contributes to social security does so on the terms that they'll be entitled to retirement at 65. You can't "easily" change the rules like that, it's slightly more complicated.

    5) Growing health care costs are one of the main reasons why people need to save so much for retirement. Considering the eating and living habits of Americans, a lot could be done without the intervention of the government just by people taking better care of themselves.

    I agree on this, people really do have to take care of themselves and stop eating so much sh*t. Doubt they will on their own though.

    Finally, why are you in grad school "wasting" money? Because you know that the money you spend now will more than pay itself later. And so it should be with government spending--it is justifiable if it creates more value for society than not spending it. Unfortunately, most people do not think like that when they swipe their credit cards...

    Actually, while you are in grad school, you are investing your money since, like you say, you know that money will more than pay itself later. Government spending is just that, spending. It is not being used (on the most part) to INVEST in the future, but rather to satisfy the whims of the voters, who want all the perks but none of the sacrifices needed.

    By Blogger Rosita, at 03 September, 2009 19:52  

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