This article appears in the July/August issue
of The American Spectator. To subscribe, please click
here.
WARREN BUFFET IS BEARISH on the United States, and he’s bullish on
Europe. For the first time in his life, starting in 2002, Mr.
Buffett entered the foreign exchange markets and shorted the
dollar. This rare macro-economic bet was based on a belief that
U.S. consumers and the U.S. government were spending beyond their
means, and that the trade deficit was a sign of economic
weakness.
While his short position was profitable in 2004, he has lost
more than half a billion dollars so far in 2005. Some Wall Street
sources suggest that his breakeven exchange rate is $1.22/euro, so
with the euro trading near $1.21 in mid-June, his short position
was seriously in the red.
Buffett’s anti-American investment sentiment has cost Berkshire
Hathaway shareholders dearly. During the 12 months ending in
mid-June, his stock price was down roughly 7 percent, while the
S&P 500 was up 5 percent. The stock market voted “non” on this
Berkshire investment strategy, just like the French and Dutch voted
against the European constitution.
And, of course, these two developments are inextricably linked.
The French voted against the constitution because they are afraid
it will force them to give up their 35-hour workweek and generous
social welfare system. This system forces French taxpayers to
support an unemployed contingent that has reached 10 percent of the
labor force.
It’s hard to figure out why Warren Buffett is so down on the
U.S. economy and so enthusiastic about Europe’s. But gloom and doom
forecasts about the U.S. economy are a dime-a-dozen these days.
It’s as if we rolled back the clock 20 years and it’s the early
1980s all over again.
Then, it was President Reagan’s tough stance against Communism,
large budget deficits, growing trade deficits, Germany, and Japan
that were bothering so many pundits. Today, it is President Bush’s
tough stance against terrorism, trade and budget deficits, China,
and India that stir fear in the hearts of the doomsters.
The gloom and doom of the early 1980s proved to be nonsense,
just as the current pessimism will prove wrong as well. Corporate
profits have climbed to an all-time record high, the U.S. stock
market is more undervalued than it has ever been, and the
unemployment rate has fallen back to 5.1 percent.
Despite all this good news, pessimists took refuge in the belief
that U.S. consumers were spending beyond their means. The data
supported this view. Personal consumption in the U.S. climbed 6.3
percent during the year ending in March, while wages and salaries
only climbed 5.7 percent. This divergence was enough to test even
the most bullish forecaster.
BUT SOMETHING INTERESTING happened in May. The Bureau of Labor
Statistics revised income statistics over the past year. New data
show that wages and salaries actually climbed 7.5 percent, not 5.7
percent. This is a massive revision. It changes the entire picture.
With the flick of a statistician’s pen, a big part of the
doom-and-gloom story evaporated. Incomes have grown faster than
spending, not the other way around.
These revisions have become commonplace as the U.S. economy
becomes more difficult to measure. The government’s statistical
machinery was designed in an industrial era of large enterprises,
time clocks, and paternalistic corporations. Today’s economy has
more small companies and self-employed entrepreneurs.
Decentralization makes it harder to gather accurate
measurements.
As a result, it is not for months (and sometimes years) after
the fact that full information is available. In order to accurately
gauge incomes, the statisticians in Washington must wait for data
from the state unemployment insurance systems. New small business
start-ups eventually show up on state records even if they are
missed by federal statistics. And when they are finally counted,
the revisions are usually positive.
The upwardly revised income statistics solve another riddle.
Individual income tax revenues have grown much faster than incomes.
Through May 2005 total tax revenue rose 14 percent from the same
time period in 2004. Because people do not pay taxes on incomes
they do not earn, the surge in tax revenues suggests that the
underlying U.S. economy is much stronger than the pessimists
believe.
This cannot be said for “Old Europe.” Average GDP growth has
been less than half that of the U.S., while unemployment is almost
double. As a percentage of GDP, budget deficits in Old Europe are
larger than those in the U.S. It is these countries, not the U.S.,
that are profligate with spending and stingy with investment. Old
Europe is slowly decaying as global competition undermines the
ability of insular social welfare states to maintain the status
quo.
New Europe, especially the former Soviet bloc and Ireland, are
fierce competitors, willing to embrace the entrepreneurial spirit
of capitalism. It is the French who want to cling to the
centralized social welfare system rather than adopt the more
uncertain, but certainly more successful, decentralized free-market
system.
This is not what many had hoped. Conventional wisdom argued that
a single European currency would force countries to move toward
lower tax rates and freer capital markets. Now, some are suggesting
that the failure of the constitutional votes will lead to a
collapse of the euro system, and with it the pressures on the
whining socialists in Europe to reform. I am not willing to go so
far. Eventually, even Old Europe will be forced to change, but it
won’t happen fast. I suspect the euro will survive and that New
Europe will continue to lead the way.
ALL OF THIS BEGS A QUESTION: Why was the dollar so weak in the
early 2000s? Because the U.S. economy was weak, or somehow
unstable? Or was it that consumers and government were spending
beyond their means? None of the above is the answer.
The U.S. dollar was weak as a result of an excessively
accommodative monetary policy. The Fed cut the federal funds rate
eleven times in 2001 and pushed it down to 1 percent by 2003. And
despite a series of rate hikes, the federal funds rate has been
below inflation for over two years — the longest period since the
mid-1970s.
In order to hold interest rates below inflation, the Fed has
forced liquidity into the economy to such an extent that it caused
a drop in the value of the dollar. As in any other market, supply
and demand are the dominant forces affecting the value of the
dollar. The Fed has supplied more dollars than the world demanded,
and the dollar dropped.
Now that the Fed is boosting interest rates, monetary policy is
slowly moving back toward neutral. As this occurs the dollar will
strengthen. A strong U.S. economy will help this adjustment process
as well.
Being short, the dollar in this environment is not a great
investment strategy. Warren Buffett should just say “non.” The
French already have.
