Buffett Sees Inflation Ahead, But It’s Needed Now.

Warren Buffett, 78, and Charles Munger, 84, Omaha’s finest, regaled their Berkshire Hathaway shareholders this weekend. The news about Berkshire, of course, was downbeat. It’s share price has fallen 39 percent since December 2007, but Buffett said no stock buybacks are planned because Berkshire’s share price is not “demonstrably below” the company’s intrinsic value, and that’s interesting. Additionally, profit fell 62 percent last year, which explains Buffett’s previous statement.

We Do NOT Want To Hear That Word. Or Do We? Guardian reports Buffett also expects inflation, the usual bugaboo of all healthy economies, “It may be much harder to tame inflation a few years down the road because of the things we’re doing now to combat the present severe recession so it’ll look different but overall it will look better down the road.” Not exactly overly concerned, but still he’s likely right that the extraordinary actions of the government, now basically printing money, has the earmarks of the actions that cause inflation. Therefore, Buffett believes US government bonds are one of the poorest choices for investors today, especially non-Americans, “Anybody who holds (US) Dollar obligations from outside this country is going to get back less in purchasing power in future.” Don’t let the Chinese or Japanese hear this . . .

Delightfully, though, Buffett sees the absurd “high tax” meme of the GOP, and its hilarious tea bag parties, as the b.s. that it is, “It’s wrong for politicians and others to keep saying they’re using taxpayers money. My taxes haven’t gone up and neither have yours. What we are doing is borrowing from the rest of the world and building up government debt. The classic way of reducing the impact and cost of foreign debt is by reducing the value of the dollars you’re going to repay them with.” Again, let’s hope Chinese and Japanese central bankers are on holiday and sunbathing . . .

Hear Inflation Now. Have Inflation Later. Actually, with interest rates basically at zero (measured by the fed funds rate), the U.S. is caught in what’s called a “liquidity trap.” This results in little incentive for investment, and encourages hoarding of cash. The Federal Reserve cannot push rates lower, although in principle it could produce negative rates, but that would increase hoarding and further suppress lending – who would lend when they’d be repaid in depreciated dollars?

Though controversy exists about the effect of this, we’re also caught in the “paradox of thrift/saving.” Saving, in a family of four, for example, is a good idea; however, when an entire country of families of four (or any number) simultaneously save money and repay debt, the money supply and its “velocity” declines, spending collapses, and a consumer-led economy like ours sputters to a halt. This is where we find ourselves, despite some better news lately, which I believe is simply a manifestation of the inventory cycle, representing nothing more than inventories being restored at much lower levels than previously. This cycle shows up as economic progress, but it’s actually a symptom of more pain to come, despite the massive federal fiscal stimulus. We suffered through the same up and down cycles in the Great Depression. While, because of Obama’s quick fiscal stimulus plan, I don’t believe we’re in that kind of collapse, we certainly still are in decline. We’re in a “decession“(TM), my term for something less destructive than the Great Depression but more destructive than the worst U.S. recession.

In a way, what the U.S. needs, but cannot get because of the previously mentioned problems is a little inflation. Furthermore, we’re in a deflation, and that leads to more hoarding. Deflation signifies that “cash is king,” and a dollar just held in one’s pocket gains value just by sitting there. Prices are falling, that’s part of the reason why. It’s also a bad thing, however, since that works both ways: the holder of your fixed rate mortgage is now being repaid in “fatter” dollars as well . . .

So, yes, Buffett is correct that the seeds of future inflation are being thrown far and wide, kind of like Johnny Appleseed. Have a look at the Fed’s balance sheet for the past 18 months sometime. Yet, the ground is not hospitable, and the weather indicates little rain, so those seeds cannot germinate. They’ll lay dormant, however, and what Buffett sees is that when the next economic upturn arrives, then the rain will pour, and inflation will perhaps then become embedded.

With job losses still at a high rate and the effects of the stimulus plan as yet unmeasured, the depth of this decession is unknown, and forecasts as credible as forecasts of the weather four years from today. Without banks willing to lend, however, and assuming the government just doesn’t nationalize them and start lending directly, it’s hard to see how the economy can revive. And, as I’ll write here soon, will consumers (1) who are already over-leveraged at historically high levels, and (2) who have learned that over-leveraging is indeed a “bad” thing, be interested or willing to borrow . . .? That’s the real question as to how deep the decession will go, and it’s as yet untessted.

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