Buffett’s imaginary economy

August 20, 2009

Warren Buffett is back as the nation’s financial conscience, publishing an op-ed in yesterday’s NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that’s a message with which I wholeheartedly agree. My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion:

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

This have-your-cake-and-eat-it-too approach is typically what we get from Paul Krugman: Yeah, debt is a problem and has to be dealt with long-term, but in the meantime we should jack up deficit spending in order to boost growth. To paraphrase St. Augustine, make us fiscally and monetarily prudent, just not yet. Ben Bernanke said something of that sort in a speech. He was trying to be funny.

The problem, it seems to me, is that rising GDP and employment—i.e. “recovery”—is not compatible with de-leveraging, which is what Buffett is talking about.

When consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.*

Consumers de-lever, government re-levers.

Private consumption and government spending now drive something like 80% of GDP. It can’t keep rising unless consumers, the government or both continue borrowing huge sums.

The goldilocks economy Buffett describes, in which we can have “recovery” without increasing debt, is a fantasy.

My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.

What Buffett should have said? Suck it up folks, we’ve no choice but to learn to live with less.

——

P.s.: I think Buffett actually knows this, but being asset-rich, he’s boxed in. Deflation hammers the value of all non-cash assets, so he has to support monetary/fiscal stimulus in order to preserve his own and his shareholders’ wealth.  Hence the opening of the piece, which lauds the “wisdom, courage and decisiveness” of the Bush and Obama administrations in the face of collapse, and the end of the piece, which says their emergency measures continue to be necessary. He maligns the effects of stimulus, but he’s stuck supporting it.

*The “Paradox of Thrift” this is called, a particularly problematic economic theory used to justify heavy government borrowing.

28 comments

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great piece! I was having the same discussion with a coworker today. he’s maligning the stimulus yet will align his shareholders interests because he knows congress will destroy the dollar.

hasn’t he been buying the Brazilian Real?

Are you referring to Warren Buffet…or King Farouk?

Rolfe. You say the following:

“The minute consumers try to cut debt and boost savings, the economy goes into a deflationary spiral that Keynesians argue must be counteracted with fiscal and monetary stimulus.”

This statement is complete nonsense. Your argument taken to the extreme implies that GDP growth can only come from borrowing. This couldn’t be further from the truth. GDP growth in the long run is driven by porductivity enhancements and population growth. The US economy has grown healthily in the past, and in will in the future, with a savings rate above 0. GDP is a flow figure – debt is a stock figure. It is entirely realistic to have positive GDP *growth* (a change in flow) whilst at the same time decreasing debt (a change in stock) – what matters is the rate of change of the rate of change of debt for GDP growth. An easier way to think about it is that the change from a low to a high savings rate is painful for an economy, but sustaining a high savings rate is growth neutral. The fact that the savings rate has already risen sharply suggests that the worst is behind us.

Posted by Geoff B | Report as abusive

Tom Brokaw wrote about the greatest generation, our parents who saved us from tyranny in WWll with their courage and sacrifice. Their parents, who suffered the Great Depression, were also stoic heros.

Many like me, who are the oldest of “boomers” are just old enough to remember both generations and the self sacrifice they exhibited when faced with horrific challenges.

I see no such class in our selfish, whiney, greedy, “me first” generation. Thankfully, most of those true heros aren’t around any more or they would be disgusted to see that their legacy was for naught.

Posted by al coholic | Report as abusive

You are correct, in a warren when 2-Towers were buffeted.

Interesting how individual and collective economics always restores balance…

Posted by Trader Duke | Report as abusive

[...] Buffett’s false promise Rolfe Winkler [...]

[...] Rolfe takes issue with the Buffett op-ed from this week.  (Reuters) [...]

Bravo!

Posted by fresno dan | Report as abusive

Geoff B….great point, but what about the demographic realities facing us? Not only is population growth slowing, the share of the population that is working (i.e. productive) is declining rapidly as the baby boomers hit retirement. This greatly reduces our “growth” potential. Productivity gains won’t offset this demographic time bomb.

As for savings, if the government/Fed weren’t borrowing/printing heavily to replace the decline in private consumption, we’d be facing dramatic deflation, wouldn’t you agree?

Take a look at total debt over GDP, which now stands at an astounding 376% according to the Fed’s flow of funds report. It keeps growing year after year as we finance “growth” with more borrowed money. But debt can’t grow forever. Eventually it will fall, either because we decide to pay down it down or because the bond market will cut us off. When that happens, we’ll have a deflationary recession.

Posted by Rolfe Winkler | Report as abusive

@Geoff
” The fact that the savings rate has already risen sharply suggests that the worst is behind us.”
Unfortunately, it is the HOUSEHOLDS savings rate that went up sharply. At the same time, government deficit exploded : the government is just borrowing in households’ name ! Nothing has changed.

So the worst is still in front of us…

Posted by Charles M | Report as abusive

I think you were far too lenient on Mr. Buffett. Don’t forget last Fall he was bailed out by the government. He owned Moody’s, Bunk of America, Wells Fargo, SunTrust, and Goldman Suchs. He also had very very large bets on stock markets via derivatives, essentially betting on inflation of commodities (like stock indices) vs the dollar. So in effect, Buffett bet everything he had in 2007 on the US government printing their way out of crisis. So his criticizing the government is in fact preposterous, as he himself was saved by it, and continues to be saved by it (given he still owns all these bets and banks).

Is it possible Mr. Buffett is simply entering this into a national newspaper so he can defend himself at a later date? As in, “see, I recommended we not print all this money back in summer 2009″ even though it benefitted me to do so. So I’m not greedy. But in fact, he just months ago cheerleaded the gov’t printing all that money/stimulus. Perhaps what Buffett meant when he approved these measures based on the premise of avoiding catastrophe, was simply avoiding HIS catastrophe. Taxpayers who actually saved money and had positive net worth would probably have lost less money in the bank runs; if they continue to hold cash and save like responsible human beings (something Buffett supposedly supports), they will likely lose everything to a destroyed dollar whilst Mr. Buffett profits from hyperinflation with his big derivative bets on markets (dollar based) and banking stocks (highly leveraged dollar bets). So Mr. Buffett, are responsible people supposed to start becoming less responsible this summer, kinda like you were in Fall 2007 before you got your greedy hand caught in the cookie jar? No wonder he loves Bernanke. It’s time to no listen to anything he says, he’s got massive conflicts of interest. Why the newfound love of the spotlight (TV interviews, newspaper op-eds) Warren? You didn’t use to crave it; necessity or daliance?

Posted by B.M. | Report as abusive

[...] Comentario sobre el articulo de Buffett en el NYT By marianomendezc Buffett’s imaginary economy [...]

Berkshire Hathaway and Warren Buffett have been the single largest beneficary of the banking bailout.

http://proudtoliveinamerica.com/forms/ma in/default.aspx?l=en-us&p=editorials13

His carefully crafted image as the grandfatherly sage to the average investor is a mirage. The FED and Treasurey Dept needed his image to sell the banking bailout and AIG rescue and he was been well rewarded.

Posted by strawdog | Report as abusive

nice article….

by the way, it is…..”eat your cake and have it too”.

Posted by hotei | Report as abusive

I am an avid follower of Buffett and consider him a mentor. With that said I have come out in critique of his last piece. You articulated what I have been thinking better than I was plus I think his piece lacked a lot of substance from someone we are used to learning from when he opens his mouth. Oh well, can’t win ‘em all.

Posted by MLF | Report as abusive

B.M: loved your post. is there anyway you can get that in a comment section or get some other exposure on NY times. you’re spot on on Buffett.
also consider that he owns interest in home builders, private jets, jewelry, furniture,
he more than most depended on the printing to keep consumption going..

Posted by tt | Report as abusive

BM….I haven’t forgotten:

http://blogs.reuters.com/rolfe-winkler/2 009/08/04/buffetts-betrayal/

Posted by Rolfe Winkler | Report as abusive

What Buffett should have said? “Let Them drink Diet Coke! Except me.”

But his mouth was full of taxpayer Angel Food, so it came out wrong.

Posted by The Bell | Report as abusive

[...] Buffett’s Imaginary economy – Reuters [...]

Lots of good comments. I hear the argument for consumption which to me is foolish. On one hand we a trying to conserve energy in buildings and vehicles and on the other we are trying to get people to buy more vehicles and junk. I still have not heard of a plan to get us out of this instability. I suspect a third party will arise with some answers. If the press allows it to be heard it will come out openly, if not then it will show up anyway.

Posted by f belz | Report as abusive

i wonder at the timing of this op-ed. hmm, what’s on the national agenda these days, healthcare? oh, and that just happens to be one of buffet’s main holdings you say? he couldn’t be using his celebrity and renown to talk his book. could he???

Posted by dennis | Report as abusive

He’s a crook. He’ll say anything that could sway peoples opinions in a way he’ll benefit. I wouldn’t listen to WB for anything except how he buys Congressmen to line his own greedy, dirty pockets.

Posted by s | Report as abusive

There is no contradiction in what Buffet said, nor is it purely selfishness that drives the remark. He doesn’t own anything different to any other investor, he merely owns more of it. Berkshire is so diversified now it is naturally Indexed; the only difference in the performance of Berkshire and and any Index in the wider market is the free leverage Berkshire gains from low cost loans, and float from the insurance companies it owns. I own Berkshire stock and it has reflected every movement in the S&P 500 perfectly allowing for the gearing. ‘Whatever it takes’ doesn’t necessarily mean only financial stimulus.

Posted by Buffetreader | Report as abusive

So, Rolf, you know more than Warren Buffet does about business? Good luck selling that, son. Buffet is saying that the stimulus is good, but don’t keep it up longer than necessary. That isn’t self-contradictory, that’s common sense. I can’t believe that someone is paying for you to write nonsense like this.

Posted by Benjamin Franklin | Report as abusive

DEar Sir,
Can you imagine what the cost would be if we (US) would become “fiscally and monetarily prudent” tomorrow??????
By all your arguments, ‘we have to endure some sort of deflationary recession’…. If we engaged your ideas tomorrow morning, can you imagine the social costs, the economic cost and the human cost of this thesis? Can you?
I don’t think you can…..
Respectfully,
EdgyInChina

Dear EdgyinChina … Ironic that someone with your particular screen name is more concerned about too little spending than too much! ;) My concern is that the pain will be much GREATER when the bond market cuts us off. That won’t happen soon, I grant you. But the more debt we rack up now, the more painful it will be when it does.

Posted by Rolfe Winkler | Report as abusive

[...] Buffet’s Imaginary Economy – Thanks for killing Santa, Rolfe. Seriously though, this is important stuff. How can we take Buffet seriously when he says we need to be fiscally responsible and slash deficits drastically, yet he supports bank bailouts and the ridiculous intervention taking place? [...]

The consumer must continue to save and reduce debt, so the government can tax the accumulated wealth. It will be necessary to steal the money from taxpayers to pay for bailing out the banks, excuse me, criminals that created this mess. Two of the biggest beneficiaries of the bail outs was, Hank- who bailed himself and friends at Goldman out to the tune of billions, and Buffet- remember his investments is banks. Buffet is a self serving piece of garbage, where was all this talk of fiscal responsibility when he needed the bailouts for his investments.

Posted by Ted | Report as abusive

Buffett is talking his own book just like he did when he said we must rescue the big banks. Recall, he hold big position in Wells Fargo and American Express and HE go bailed out. I assume you know he is short the dollar.

Posted by peter | Report as abusive

I can’t imagine what American can do to boost growth without consumption. If the Americans’ real productivity can offset the consumption, that would be ok and without borrowing. But please face the reality, where do our productivities come from? The great American have now become a great wealth redistribution machine, no more wealth creation.

Posted by Rose Eli | Report as abusive

The world’s “economy” is nothing much more than a giant house of cards and at the base, it is dependent on a never ending supply of tangible raw resources and ever increasing consumption of those resources. In the end, abstract layered monetary theories, policies and newly invented financial instruments will not cut it and as the world’s population continues to grow while resources continue to dwindle, there is only one course for the world economy – down the swirling drain. We are running out of tomorrows.

Posted by Ray | Report as abusive

“My point is that in order to reduce debt we have to endure some sort of deflationary recession. The alternative is to spend and print perpetually, which Buffett points out is the worse option.”

What pre-Victorian nonsense. Deflation increases the value of debts. The best way to reduce debt-RATIOS is to grow – to work on the denominator. The Keynesian insight still works: if you all “save”, you bring income down, and no-one gets less leveraged.

It is elementary economics – take 30 minutes out to read the comments at the bottom of this piece by DeLong to work out where you went wrong:

http://delong.typepad.com/sdj/2009/01/ti me-to-bang-my-head-against-the-wall-some -more-pre-elementary-monetary-economics- department.html

But Giles, the “growth” you’re talking about is financed with more debt!

All of you Keynesians are in love with the Paradox of Thrift, but you’ve never considered the Paradox of Gluttony. To wit:

“Keynes worked out that the escape route from the “paradox of thrift” was to get some agent (the government) to spend more money, thereby boosting profits, encouraging more borrowing, generating more profits, leading to a virtuous cycle of economic expansion. Keynes was concerned with finding a policy to help economies escape the Great Depression leading him to emphasise the “paradox of thrift” element of the story. Minsky, however, took Keynes’ theory to the logical conclusion, arguing that borrowing can lead to a self-reinforcing positive spiral. This positive spiral could be though of as a “paradox of gluttony” whereby higher borrowing producers higher profits, thereby ratifying the decision to borrow and spend more.

The paradox of thrift and gluttony are important because they are linked to the same credit creation process that drives asset market instability…The additional borrowing associated with an asset price boom will likely flow back into additional asset purchases, but part will also be converted into higher levels of debt-financed spending…”

Every time we hit a recession, Keynesians argue to borrow and print more. Credit never stops expanding. That is, until the bond market makes it stop.

DeLong pretends the bond market doesn’t exist, or, Krugman-like, he dismisses it as a concern since we should have no trouble borrowing more.

But at some point we CAN’T borrow more.

DeLong thinks he’s really clever because he’s got a cute theory. But it doesn’t trump common sense — we can’t borrow forever.

Posted by Rolfe Winkler | Report as abusive

[...] 这位对老巴还是客气的 … Warren Buffett is back as the nation’s financial conscience, publishing an op-ed in yesterday’s NYT lamenting the dangers of too much monetary and fiscal stimulus. As regular readers of this blog are aware, that’s a message with which I wholeheartedly agree. My problem with Buffett’s piece is that he makes a good argument and then totally undercuts it in his conclusion: [...]