Tag Archives: inflation

Buffet: "I don’t see how the dollar avoids going down"

Forbes reports on Warren Buffet’s currency perspective:

Heed the Sage of Omaha. Warren Buffett, whose investment acumen seems unerring, had a caveat for America: Barring “a major change” in policies, the trade deficit will further undermine the U.S. dollar.

The billionaire spoke in a Wednesday interview with CNBC, the cable TV news channel owned by General Electric (nyse: GEnewspeople).

Without shifting current trade policy, “I don’t see how the dollar avoids going down,” he mused, warning of inflation risks posed by an anemic Yankee currency.

The prairie-born genius also confessed he’s having a “hard time” identifying stocks to buy, and isn’t purchasing commodities. His cash swelled to $43 billion in the third quarter, by one account, because he couldn’t find many investment opportunities.

Buffett, 74, is chairman of Berkshire Hathaway (nyse: BRKa
people), the immensely successful investment vehicle that acquired a new–and immensely successful–board member in December: Microsoft (nasdaq: MSFTnewspeople) Chairman Bill Gates.

The latter also enjoys a personal friendship with Buffett, and takes part in his bridge games. (see: “Gates: Buffett’s Pal Bill Elected To Berkshire’s Board“)

Renminbi Valuation

The renminbi is pegged to the US Dollar, and has been for a long time, so what would a revaluation of the Chinese currency mean? Without an exchange rate determined by the marketplace, how can we anticipate the magnitude of the difference between the pegged rate and the appropriate market rate?

It is clear that the yuan is cheap relative to the dollar, but by how much? Our economies are different, and these differences lead to different relative pricing, but looking at a variety of prices can give us some sense of purchasing price parity.

Unskilled Labor:

Textile workers in China are paid about 1/30 of the amount paid for equivalent work in the United States. If this ratio were to equalize through currency revaluation, the yuan would increase by 3000%. However this is almost certainly too high, as China has an oversupply of unskilled labor. This number provides the high-end boundary on the scope of the question.


Gold can be purchased in yuan At the time of this writing, $442 worth of gold costs 3670 yuan, implying an exchange rate of about 8.303 Yuan/$. If this ratio were reflected in the currency echange rate, the yuan would increase a negligible amount (Because the exchange rate peg is currently 8.27 Yuan/$). However this is almost certainly too low, as it is illegal for chinese citizens to invest in Gold. This number provides an low-end boundary on the scope of the question.

Basket of goods:

Depending on the basket you select, purchasing price parity implies different undervaluation of Yuan. I estimate approximately 40% undervaluation, clearly with different classes of goods and services.


Under a fair and open market, I envision a 40% inflation on Cinese imports would greatly imporove the stature of US companies that have been drowning under Chinese import competition. Similarly, Chinese companies that earn their revenues from Chinese will see a US Dollar denominated revenue increase of 40%.

[UPDATE 1/25/2005]

Senator Lindsey Graham, (R) Judiary Committee and

Senator Charles (Chuck) Schumer, (D) Finance Committee

are announcing bill to impose a 27.5% tarif on Chinese imports, implying their view that the Renminbi is near 27.5% discounted against the Dollar.


Let’s speculate that Chinese currency will reflect market forces within 2 years. In this speculative possible environment, investors might benefit from:

underweight Chinese companies with revenues largely based on exports

overweight Chinese companies with revenues largely based in China

underweight US companies who import from China

overweight US companies who compete with Chinese imports

Now let’s speculate that Chinese currency will remain pegged to the US Dollar. In this speculative possible environment, investors might benefit from exactly the opposite positions.

How can the US exploit a currency peg that is clearly an unfair trade practice?

Cut taxes and issue more debt.

This increases the Federal deficit, diminishing the value of the US Dollar, and also increases the after-tax pay rates for US workers.

Historic Debt will lead to Inflation

I’ve talked about the debt and inflation before, but the following might scare you:

Although the level of deficit is the largest in history, it is not the largest when measured as a percentage of GDP. The current deficit is about 4.3% of GDP. This is high by historic standards, but has been exceeded in 6 of the fiscal years since 1962. BUT the private sector is larger than it has ever been, and issuing more debt than ever before. Total $US debt when combining private and public debt is about $35 trillion, or 300% of GDP.

Don’t think that inflation is soley a function of public debt. No, foreign investment is a competition among all capital securities, and it is net US debt interest owed as a percentage of GDP (as well as US GDP as a percentage of global production, and other factors) that underly inflation.

Do Deficits Matter? Does Inflation Matter?

Yes. Deficits cause inflation.

National debt is one of the most important factors that determines the value of the US dollar and international confidence in American investments. With extensive history and other nations as examples, we clearly see that as the debt gets bigger, we will risk higher inflation, not be able to buy as many foreign goods, and see less international interest in our stock markets.

This fiscal year’s $477 billion deficit (Oct 1, 2003 – Oct 1, 2004) is the largest in US history.

Federal Budget Surplus or Deficit

Although the level of deficit is the largest in history, it is not the largest when measured as a percentage of GDP. The current deficit is about 4.3% of GDP. This is high by historic standards, but has been exceeded in 6 of the fiscal years since 1962.

Data source: http://www.cbo.gov/showdoc.cfm?index=1821&sequence=0

If you are wealthy

We all like tax cuts that put money into our pockets today, but these tax cuts impact income, not wealth. Inflation, on the other hand, is a tax on wealth. If you are wealthy, then inflation will cost you a great deal in terms of spending power. You will be pushed into equity investments because fixed income and cash are hurt by inflation and rising interest rates. If you would be hurt by inflation, then deficits are your enemy.

If you are in debt

Inflation decreases the value of wealth and debt. Those who have money can buy less with it, and those who are in debt find it easier to pay off. This discounting of old wealth makes the “real” distribution of wealth less concentrated. It brings us all closer to each other by bringing us all closer to zero. If you are in debt, then inflation will reduce the burden, making it easier to pay off. If you are in debt, then inflation and deficits are your friend.

Productivity and Deflation

What happens when productivity grows faster than production?

We produce more with less work and that means unemployment, right? Initially, the answer is yes, but looking at history we can see that the answer is more encouraging than that. Productivity growth eventually transitions into falling prices. And these days, it should happen even faster. Here’s why:

Competition and consumer choice, especially now that information flows so freely, has led to much more efficient markets in terms of pricing. Improving productivity is rarely unique to a particular company… in other words, if one company benefits from a new technology, then others follow, competition drives prices down, and consumers ultimately benefit.

Are falling prices always good?

Falling prices is called deflation, and deflation is an ugly beast; it exaggerates the disparity in the distribution of wealth and creates an artificial investment hurdle. Deflation increases the buying power of wealth. It makes money more powerful. Those who have money can buy more with it, and people in debt fall deeper in debt. This makes the “real” distribution of wealth even more concentrated. Similarly, deflation means that your cash grows in value; if your cash grows in value, then your investments will have to appear very strong before you will be willing to make them.

The solution to these problems is a low stable inflation rate. Low stable inflation helps to maintain investment by discouraging holding cash, slowly eroding stagnant concentrations of old wealth unless it is invested.

In order to achieve a low stable inflation rate, the deflationary pressure of productivity growth should be balanced by growth in the money supply and a low FED Funds rate. The faster productivity grows (and it appears to be accelerating over the decades), the more aggressive the Federal Reserve may have to be in order to avoid deflation.