There are few people whose views on macro-economic issues carry any sort of authority. Economists tend to get things wrong more often than not, academics are rarely able to transfer theoretical knowledge into real life, while executives spend more time talking their own book and worrying about their remuneration to proffer any valuable insights.
One exception to this rule is Warren Buffett, CEO of Berkshire Hathaway, the world’s third richest person and arguably, greatest ever investor. In an op-ed piece that ran in the New York Times yesterday, Buffett warned of the dangers of excessive fiscal stimulus and the dire effects of an ever-increasing public debt.
Buffett noted that:
Enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.
To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 per cent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 per cent of GDP, more than twice the non-wartime record.
In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.
Buffett then followed with the question conveniently ignored by politicians in the United States (and also, by our local, big-spending Government). That is: What are the real implications of maintaining massive deficits funded by borrowing, mostly from overseas (and in particular, China)? In this regard, Buffett stated:
An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money.
Borrowing from citizens is the only real way to fund a sustainable expansion (or in this case, recovery). It occurs by an increase in the savings rate (this is already happening in the US but as Buffett noted, the $US500 billion saved by Americans last year fell well short of the $US1.8 billion that has been borrowed to finance all sorts of stimulus spending and financial bail-outs.)
The other alternatives are more incendiary — borrowing from foreign investors (again, this is already happening with China’s huge holding of US treasuries). The problem with using foreign monies is that eventually, foreign investors will perceive the risk of holding US dollars or bonds to be too great — were China to start selling its holdings, this would have dire ramifications for the US dollar. There are also serous geo-political problems with relying on a totalitarian, planned government with a questionable human rights record to maintain an economy.
The final choice is even less palatable, but possibly, most essential for politicians — turning on the printing press. As Buffett explains, printing money, or purchasing one’s own bonds (quantitative easing) is a political solution that leads to an economic nightmare (as the residents of Zimbabwe or Germany in the 1920s could readily attest).
Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election.
To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes.
In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens … The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
It would take a brave government to curb the flow of stimulus cash going to voting constituents, and an equally courageous central banker to turn off the tap of easy money greasing the economy.
But sadly, when an economy is managed by self-interested politicians, bravery is a rare gift.
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