ARCHIVED COMMENTARY
Will Buffett Be Early
Victim of Deflation?
For edition of June 15, 2005
Monday’s edition featured the thoughts of fellow deflationist Mike "Mish" Shedlock, who believes as I do that this world is far too deeply in hock to avoid a debt deflation. Mish covered a lot of ground in explaining why this is so, but I’d like to add my two-cents’ worth, since he left a few things unsaid that could affect all investors – even financial geniuses like George Soros and Warren Buffett. Speaking of whom, both supposedly have been positioned to profit from a weak dollar -- a strategy that has not worked out very well this year, to put it mildly. In the last quarter, Buffett took a reported $310 million hit on a $21 billion short-dollar position. That’s chump change by his standards, but to paraphrase the late Sen. Everett Dirksen, a hundred million here, a hundred million there, and pretty soon you’re talking real money.
Even worse for Buffett, the dollar’s rise has steepened considerably since. Given his propensity to take the long view, we shouldn’t be surprised to learn at some point that he increased the size of his bet since it was last estimated. But what do we make of the fact that world's second richest man, known mainly as an equities investor, has gone outside of his bailiwick to mix it up in the currency game? And how do we regard this legendary contrarian’s aggressive shorting of the dollar at a time when nearly everyone else hates it as much as he does?
False Bottoms
Well, I’ve always said that when deflation finally arrived it would be tough for investors merely to survive, much less prosper. But I had assumed all along that the big fortunes would be lost on the way down because bargain hunters were unable to imagine how much lower prices were yet to fall. We saw this happen during the tech-stock bust, as bottom-fishers moved in to plunder the likes of JDS Uniphase as it fell from a high of $153 to $77 in a little more than a month. But how many who bought the stock at huge markdowns could have imagined it was on its way down to…$1.32? What is so remarkable about this bear is that deflation hasn’t even kicked in yet and the Sage already looks all too vulnerable. Granted, he’s about $50 billion further from insolvency than you and I. But when the size of one's bet exceeds $20 billion, it doesn’t take much leverage, or much mistakenness, to blow through a stack of hundred-million-dollar chips. (Yeah, we should all have such worries.)
Now, for my two cents’ worth concerning the coming deflation:
It will not be dot-com mania in reverse, since there is no practical way to leverage a real estate bust.
2. Holding onto a substantial fraction of one's current net worth will be quite a trick.
Unbelievable opportunities will surely arise when a bottom is reached in perhaps eight to ten years, but probably not before.
4. Interest rates needn’t rise at all to turn existing debt into a crushing burden; it would suffice merely for the underlying collateral (i.e. homes) to
fall just slightly in value.
Murphy’s Law simply will not allow tens of millions of debtors in over their heads to skip free via inflation or hyperinflation -- and neither would creditors and savers go along with a dollar blowout, since it would be ruinous for them.
6. The bear’s biggest surprise will be a dollar that continues to strengthen, much to the increasing discomfort of all who owe.
With interest rates still trending lower, deflation’s day is not immediately imminent. Act while you still can, trusting unattactively low yields to point the way to safety.