WARREN BUFFETT RAISES THE DRAWBRIDGE
Source: ShutterstockWarren Buffett is the co-founder, chairman and CEO of Berkshire Hathaway. He is a legendary and revered investor who draws massive crowds to Berkshire's annual meetings. Buffett is noted for his investment mantra: "Be greedy when others are fearful and fearful when others are greedy". His investment strategy has been to focus on established companies that come with large "moats" that make it difficult for others to compete with them. A former holding of his was Norfolk Southern Railroad. No one was going to build another transcontinental railroad any time soon. He has become very conservative in his investing. Hence, our reference to him raising the drawbridge over his moated investments.
He recently sold 116M shares of Apple stock raising Berkshire's cash hoard to an astonishing $189B. When asked why he was not reinvesting those funds he said that he cannot find anything fairly valued that interests him. While he publicly praised Apple, that was to protect his remaining $135B investment in the company. He added,
I don't think anyone sitting at this table has any idea how to use [the cash] and therefore we don't use it. We’d love to spend it, but we won’t spend it unless we think we’re doing something that has very little risk and can make us a lot of money. We only swing at pitches we like. And right now, they’re not liking anything other than T-bills.
It is noteworthy that Berkshire's income from short-term U.S. Treasuries has exceeded the dividend income from its stock holdings for three straight quarters.Buffett's trepidation about the market is based on his view that most stocks are substantially overvalued. One widely-followed metric reporting this is the Case-Schiller CAPE (Cyclically Adjusted P/E) Ratio. It recently stood at 34.57. It is calculated by dividing the S&P index's current price by the 10-year moving average of inflation adjusted earnings. Its historic average is around 17. Buying stocks at higher ratios historically produces lower returns over the longer term.
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Here is another chart showing the S&P's elevated P/E ratio over its "mean" level (the black horizontal line).
Buffett was asked if anything was worrying him. He unhesitatingly said,
I worry about the [US] fiscal deficit... I don't sit and work myself into a stew about it, but I can't help thinking about it... The fiscal deficit is what should be focused on.
That deficit is set to rise at least another $1.7T this fiscal year. There is no reason to believe it will do anything but continue to soar as the President and both political parties (the Uni-party) are intent on trying to buy votes for the impending presidential election by promising more subsidies, give-aways, foreign aid, student loan debt forgiveness, and military spending. Therefore, one can count on the US continuing to run large deficits, grow the $34.5 trillion national debt (up 50% since just before Covid) and face ever-larger national, state, corporate and personal debt levels. This warrants taking action today to avoid the inevitable spending and debt consequences to come tomorrow: continuing currency devaluation, soaring interest payments and higher direct and indirect taxes to pay those costs - all of which will throttle corporate and infrastructure investments and debt reduction.
Many investors will react by reducing their equity holdings and pouring the proceeds into US Treasuries, as Buffett has done. The problem with that is your interest income will be negative in real terms. If you buy a 10-year Treasury that pays 4.5% you will lose money - month after month - because the real rate of inflation is far higher than that reported by the government. The Fed reported that the Personal Consumption Expenditures Index was 3.4% in Q1 2024 and "Core CPI" (omitting pesky food and energy costs) was 3.7%. Your personal buying experiences undoubtedly reveal these inflation figures to be pure fantasy. The reason is the data included in the government CPI calculations have been "hedonically adjusted" (manipulated) in order to produce a lower, less-alarming but fictitious, rate of inflation.
The government removes items from its CPI calculation when their prices are rising dramatically. For example in 1983 the CPI eliminated the interest expense paid on mortgage and other loans because interest rates were high and that was pushing up the CPI. If you ignore high interest rates the reported inflation rate miraculously falls. The National Bureau of Economic Research just reported that if personal interest payments and the cost of homeownership were honestly accounted for, the year-over-year inflation rate would increase from the reported 3% to 9% (as of last November). Another example of tinkering with the inputs was the government's decision to eliminate coffee from the calculation because its price was rising.
The largest monthly cost for most people is housing (30-40%+ of take-home pay) which has been rising relentlessly. The government's solution for obscuring this cost was to create a fictional housing cost it calls "Owner's Equivalent Rent". It dramatically understates the price actually paid by renters. If one adds real rent, coffee, interest costs and other omitted items back into the mix, the inflation rate equals that suffered by Americans during President Carter's days in office (9.9%).
Shadowstats.com produces consumer price data using the same formula the Fed employed before it began manipulating its results. The red line below is the Fed's reported inflation rate and the blue line is what it would be but for these manipulations. Consequently, you would be losing over 3% of your investment a year if you invest in Treasuries. To add insult to injury, you will have to pay income taxes on that phantom 3% interest income. Such a result might be acceptable in the short term if you are concerned that the stock market could suffer an imminent 40-50% loss - but bonds are not a viable long-term strategy at current rates.
Should you be hesitant to accept ShadowStats' computations, economist, former US Secretary of the Treasury, Director of the National Economic Council, and president of Harvard University, Lawrence Summers co-authored a paper stating that if inflation was measured today in the same way it was during the last bout of high inflation in the 1970's, it would have peaked at 18% in November 2022, rather than the 9.1% reported by government officials. Thus, the cost (loss) to you of owning government bonds is even higher. The manipulated data produced by the government are designed to comfort (mislead) the public rather than inform them.
A question that should come to mind is whether the Fed is really trying to reduce the rate of inflation to 2% as it claims. The reason it might not be is that the US government benefits from inflation. It is the world's biggest debtor. It has no ability to repay its debts in honest money. Inflation allows it to repay its creditors with ever cheaper dollars - i.e., it borrows in dollars and repays in quarters. Inflation always benefits debtors at the expense of lenders, savers and wage earners.
Higher interest rates are typically used by central banks to fight price inflation. The downside is that high rates cause the Treasury to incur much larger interest expense. High inflation and low rates have long benefited the deeply indebted Treasury and allowed it to amass its current staggering debt by keeping its borrowing costs low. The lesson is that the government's economic interests are not aligned with your interests - they are in conflict with it. Inflation continuously shifts wealth from the tax payers to the government in a non-transparent way.
What About The Promised "Fed Pivot"?
Banks, brokers and investors are praying that the Fed will cut interest rates hoping that will trigger a new stock market rally and bigger profits. We make no predictions about what the Fed will do or when it will do it. In a better world, rates would stay higher for longer to continue the fight against inflation. But there is enormous incumbent political pressure on the Fed to lower rates to aid Biden's re-election hopes. The problem is that lower rates come with the likely side effect of reigniting inflation. If that were to happen before the election, it would sink Biden's ship.
Both political parties stridently argue that the election of their candidate is crucial for the future well-being of the nation. Bill Bonner puts this in a more realistic light,
The fantasy of American democracy is that the election process weeds out the dopes, jackasses and frauds. A single visit to the Capitol when Congress is in session is enough to dispel that myth. Instead of raising up the best and brightest, [US elections] do the very opposite. [They] elevate the big mouths and mountebanks... those most willing to peddle influence in exchange for campaign money.
Based on their presidential histories, both Biden and Trump would continue the growth of government, the national debt, and foreign military adventures and therefore either one of them would be a disaster for the economy. Under Trump the national debt rose by $8 trillion and under Biden it has risen another $7 trillion - so far. In that the debt is now increasing $1 trillion every 100 days, Biden is poised to win the prize for fiscal profligacy. What about third party candidate Robert F. Kennedy, Jr?
Biden calls Kennedy a "Trump plant" intended to swing Democratic votes away from him; Trump fears that Kennedy will attract Democrats who are sour on Biden who might otherwise vote for Trump. Both major candidates know that a respectable Kennedy vote tally might keep them from garnering enough electoral votes to win. That would throw the election into Congress for resolution with an unpredictable outcome.
We have no interest in politics but cannot ignore it because politics directly impact the economy - almost always in a negative way. One of the most obvious ways it does so is the ongoing and alarmingly large budget deficits. This chart shows the Congressional Budget Office's calculation of recent deficits and its guesstimate of future deficits. Note that it has consistently underestimated Congress' proclivity for spending money it does not have, so future deficits may be well higher. These deficits rapidly grow the national debt. Founding Father Thomas Jefferson presciently wrote, "The principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale." The US Congress excels at this swindle.
The direct effect of these deficits, funded by Treasury borrowing and Fed money creation, is continuing price inflation. Jerome Powell recently seconded Buffett's deficit concerns but no one is listening.We’re running big structural deficits, and we’re going to have to deal with this sooner or later, and sooner is a lot more attractive than later.
The growing concern is: who will step forward to buy the flood of Treasuries that continuously come on offer? Foreign central banks used to be big buyers but they are stepping back after the US froze Russia's US Treasury and Agency debt following its invasion of Ukraine. Foreigners quickly learned that they could be next in line for such a freeze and are taking action to avoid that possibility. The chart below shows China's shrinking holdings of US bonds (blue line) and purchases of gold (red line). Its gold holdings are immune from future US government freezes, forfeitures, and other efforts at control.
Russian, Indian and other central banks have also been big buyers of gold - hundreds of tonnes of it. In Q1 Chinese private gold imports amounted to 543 tonnes and the People's Bank of China added another 189 tonnes. All together, central banks (not the US, EU or UK) bought 1,100 tonnes in 2022 and another 1,000 tonnes in 2023. (Note: each tonne is over 35,000 oz. of gold so they acquired over 35 million ounces of gold in 2023 alone.) Much of the money they used to buy that gold would otherwise have bought US Treasuries.
Central banks are not the only ones buying gold. Costco is selling $200M of one-ounce gold bars - every month. Chinese workers are willingly paying $85/oz. over the spot price of gold to acquire it. They learned the hard way that Chinese stocks and real estate are not assets that can be counted on to hold their value. Chinese workers, discount mall shoppers, and foreign central banks are loading up on an asset that governments are unable to print at will. Buyers see the handwriting on the wall regarding fiscal deficits, money printing and the continued devaluation of their currencies and are taking action to protect their savings and reserves. US government officials routinely denounce gold as a "financial relic" to be avoided, hoping to dissuade Americans from buying it to protect themselves from the dollar's ongoing devaluation. Should you be sitting on the fence about what to do, recall that financier J.P.Morgan famously said, "Gold is money. Everything else is credit." In this era of rapid world-wide monetary debasement, which of the two would a prudent person want to own?
The Looming Debt Crisis
Looking at the big picture, Porter Stansberry writes,
We are running right now in peacetime a 8% of GDP fiscal deficit. There is no way you're going to bring inflation under control, not unless you have interest rates that are double digits. And of course, we all want to kick the can down the road and pretend that these things aren't problems. We want to pretend that we haven't promised hundreds of trillions of benefits to Americans. What's going to happen when those benefits don't materialize? There is no way those benefits can materialize in real terms. Everybody knows that.
Well, "everybody knows that" except the President, members of Congress, voters and most economists - all of whom think that everything will work out. All it will take is a little more tinkering by the Fed to bring about the promised "soft landing." But Uncle Sam's debt continues to grow at the rate of $9 billion a day and is on pace to add $2 trillion to the national debt this fiscal year. Congress' rampant spending acts as a counterweight to the Fed's higher interest rates. They negate each other. Thus, no progress is being made on the national debt or the real inflation rate. What happens when buyers fail to line up to buy the flood of Treasuries on offer? Life will get very "interesting" very quickly.
Social Security On the Brink
The US Social Security act was signed by President Franklin D. Roosevelt in 1935. It was designed as a social insurance plan for retirement age Americans, to protect them “against the hazards and vicissitudes of life". It provides the states with money to be given out to older, poor Americans, and a monthly payment to retired workers in return for their years of work and their taxes paid into the fund.
Problems with the system started to show up in the 1970s. Presidents Reagan, Bush, and Obama put together commissions to find ways to save the quickly depleting Social Security fund as benefit payments kept growing while withholding inflows remained stagnant. A fact lawmakers failed to account for was rising life expectancies. When the act was signed into law, the average life expectancy was 60 for men and 64 for women. Many Americans did not live to collect Social Security benefits, so the fund was able to stumble along. Now the average life expectancy is nearly 80 years old. While the retirement age has been pushed to 67 years old for full benefits (62 for reduced benefits and 70 for extra benefits) - the fund is rapidly dwindling. The blue line in the chart shows benefit outlays and the green line shows social security tax revenues.
Another problem is the country's changing age demographics. Post-World War II saw a decades-long baby boom; today there is a marked decline in the number of children born per household. There are now more older Americans receiving Social Security benefits than young people in the workforce contributing to the fund. The Social Security trustees have predicted the fund will fail to fully meet its obligations by 2035 (causing recipients to receive only 83% of their benefits). What is Congress doing to ward off this crisis so both today's retirees and younger workers can be assured of receiving their benefits? Absolutely nothing.
The solution is not a mystery. Either wage withholdings must be increased, the retirement age raised, benefits reduced, benefits converted to "needs" based (disenfranchising all contributors who prudently saved for their retirement) or some combination of them. The problem is that no politician will propose any of these changes fearing voter outrage, being voted out of office and having to get a real job.
Inflation Is Government Theft Of The People's Wealth
We have often written about the immorality of price inflation. Daniel Lacalle at Mises adds,
Monetary inflation is the equivalent of a default. It is a manifestation of the lack of solvency and credibility of the currency issuer. Governments know that they can disguise their fiscal imbalances through the gradual reduction of the purchasing power of the currency and with this policy, they achieve two things: Inflation is a hidden transfer of wealth from deposit savers and real wages to the government; it is a disguised tax. Additionally, the government expropriates wealth from the private sector, making the productive part of the economy assume the default of the currency issuer by imposing the [use] of its currency by law [on its people] as well as forcing economic agents [banks] to purchase its bonds via regulation. The entire financial system’s regulation is built on the false premise that the lowest-risk asset is the sovereign bond. The estimated unfunded Social Security and Medicare liability is $175.3 trillion (Financial Report of the United States Government, February 2024). Yes, that is 6.4 times the GDP of the United States. If you think that will be financed with taxes “on the rich,” you have a problem with mathematics.The situation in the United States is not an exception. In countries like Spain, unfunded public pension liabilities exceed 500% of GDP. In the European Union, according to Eurostat, the average is close to 200% of GDP. And that is only unfunded pension liabilities. Eurostat does not analyze unfunded entitlement program liabilities.This means that governments will continue to use the “tax the rich” false narrative to increase taxation on the middle class by imposing the most regressive tax of all [inflation].
Soaring Municipal Debt and Decay
Chicago is typical of the fiscal problems facing most major cities. Judge Glock at the Wall Street Journal recently wrote, "Chicago Will Need a Miracle to Escape Its Debt Burden." In it he recites that the city owes $40 billion to bond holders and other creditors. According to the Manhattan Institute, that amounts to almost $43,000 per taxpayer in the city. Chicago lags only New York City in the size of its debt. There are many factors that have contributed to the city's economic decline.
First, it has some of the highest real estate taxes of all major US cities. It taxes industrial property at nearly double the rate of other large cities, and almost triple the rate on office buildings in the central business district known as The Loop. Office building taxes are a large component of the revenues taken in by the city. Many businesses have grown tired of the high taxes, high rents, urban decay and the grossly mismanaged government. They have fled to the suburbs and other cities with lower taxes.Second, Chicago (and the state of Illinois) both are losing population because of their withering tax rates. The remaining taxpayers will be forced to shoulder an ever-increasing tax burden. That will force more to leave resulting in a "tax doom loop" where rates continue to go up but tax collections go down. The Loop suffers a 16.3% office vacancy rate (compared to a US average of 13.8%). This has led to buildings being sold for less than half of their former purchase prices. This impacts lenders (banks, pension funds, real estate ETFs and hedge funds) who wrote mortgages on the properties. The city hopes to counter this crisis by converting office buildings into rental and condo space at great cost and with the restriction that one-third of the units be affordable housing. (Nation-wide, there is 1.2 billion square feet of vacant office space.) During the pandemic the Biden administration lavished Democratic controlled Chicago with some $2 billion in aid in 2022. By the next year the money was gone and the city was again facing a huge fiscal deficit.
Third, the mayor and State's Attorney decided that it would be a good (progressive) idea to cease arresting shoplifters, drug dealers and eliminate bail for arrestees on the premise that giving career criminals a "hug" instead of a jail sentence would lead to less crime. To their great astonishment, it led to higher crime and resident flight.
Fourth, the city boasts of being a "Sanctuary City" and has drawn many thousands of immigrants, all of whom need to be fed, housed, provided medical care and their children schooled. The city lacks affordable housing and is ill-equipped to deal with migrant surge. Large cities across America have comparable issues and are also staggering under large debt burdens: New York City- $127.4 billion; Miami- $2.3 billion; Los Angeles- $2 billion; Dallas- $6.9 billion; San Francisco- $7.5 billion. These cities - and their state governments - lack the financial ability to address, much less solve, these problems. It is reasonable to assume that these debts will eventually land in the lap of the nation's taxpayers and/or be paid with newly printed money further debasing the currency. In the meantime, these cities are becoming ever more unlivable. There is a day of reckoning for governments that irresponsibly take on debt and endlessly raise taxes.
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