 Ostrich of
Omaha
Mike "Mish" Shedlock
May 23, 2006
Michael Mandel, chief economist
for BusinessWeek, is writing about the 'Ostrich
of Omaha.'
Buffett's bearishness on the
U.S. economy ignores how Americans' hard work adds value at a
steadily higher rate than trade adds debt. To be frank, I'm getting
a bit tired of Warren Buffett's pessimism about the U.S. economy.
The so-called Oracle of Omaha, the second-richest man in the
world, was anti-New Economy in the 1990s. Now he's Now
he's downbeat on the U.S. dollar.
In his latest letter to the shareholders of Berkshire Hathaway,
Buffett wrote: "The underlying factors affecting the U.S.
current-account deficit continue to worsen, and no letup is in
sight.... Either Americans address the problem soon in a way
we select, or at some point the problem will likely address us
in an unpleasant way of its own."
We don't need this "voice of prudence" from someone
worth more than $40 billion.
Mandel writes "We don't
need this voice of prudence from someone worth more than $40
billion." Somehow that does not seem exactly right.
Here, let's try this version: What we don't need is someone who
is totally clueless about factors affecting the current account
deficit giving Buffett a lecture about "fundamental market
values" based on the nebulous idea of "hard work".
Mandel continues with:
"Lucky for us, the Social
Security Administration publishes a range of long-term forecasts
going out to 2080, which take into account a variety of assumptions
about demographics and productivity. Their most pessimistic forecast
calls for a long-term growth rate of 1%, while their optimistic
forecast projects that long-term growth will average 2.8%.
The fundamental market value of the U.S. economy also includes
the output generated by future labor -- that is, all the skilled
labor and hard work that Americans will put out in the years
to come.
It turns out that the market value of the U.S. economy is increasing
by anywhere between $4 trillion to $7 trillion per year. To put
it in financial terms, this is the annual capital gains for the
whole American enterprise. By comparison, our trade deficit means
that the U.S. is adding roughly $1 trillion in external debt
each year. That's a big number, but far less than the increase
in the market value of the economy. From this perspective, we
can keep this up forever."
USA! USA!
Other industrialized countries are not so fortunate. It's expected
that the prime-age working populations of Japan, Germany, and
France will start shrinking soon. As a result, most current forecasts
call for these countries to have very slow economic growth 20
years from now. That means the fundamental market values of these
countries is rising very slowly, if at all.
My advice to Buffett is to apply the same sort of fundamental
analysis to countries as he does to the stocks he owns. He might
find that it's the U.S. that is the better deal.
Lucky For Us
Gee, "lucky for us"
the Social Security Administration publishes a range of long-term
forecasts. That is indeed lucky, or do I mean useless? Since
when has any long term government forecast been any good? I also
have to wonder if Mandel thinks Buffett is supposed to feel "lucky"
that Mandel is so generous with his advice.
"It turns out that the market value of the U.S. economy
is increasing by anywhere between $4 trillion to $7 trillion
per year."
This is a lot like looking at the stock market in 2000 and projecting
future earnings growth as far as one can see forever into the
future without considering whether or not the result is sustainable.
Other than "hard work" Mandel does not explain where
this "market value" comes from. He does not look at
production of goods or manufacturing and perhaps presumes we
can keep borrowing forever while flipping each other houses at
ever increasing prices, living happily ever after. One can work
hard at digging holes then filling them up again but that work
simply is not productive. Working hard at flipping homes or working
hard at passing the trash (risky loans) to Fannie Mae is not
exactly productive either, and certainly bombing Iraq to smithereens
is not what anyone should call productive.
Just as people were offering Buffett advice on "The New
Economy" in 2000 we now have economists like Mandel explaining
to Buffett how the US can "can keep this up forever".
To any thinking person that is just another version of "It's
Different This Time". I have no doubt this proclamation
from Mandel will prove to be as foresightful as the June 2005
cover of Time Magazine "Why we're going gaga over real estate"
or the 1999 Economist cover story predicting $5 Oil with a cover
touting "awash in oil".
The Richebächer Letter
Actually the best rebuttal
to Mandel's "It's Different This Time" argument come
from the May issue of the Richebächer Letter. Let's take
a look at a few highlights. Richebächer writes:
It Is Far Worse Than In
2000
THE NEW U.S. ECONOMY
The policy dilemma currently facing the United States can be
simply stated. Economic growth has become completely dependent
on consumer spending, and this, in turn, has become completely
dependent on rising house prices providing the collateral for
the most profligate consumer borrowing.
This borrowing has become a necessity because income growth has
abruptly caved in. Rock-bottom short-term interest rates and
utter monetary looseness were the key conditions fostering altogether
four bubbles: bonds, house prices, residential building and mortgage
refinancing.
What developed is an economic recovery with an unprecedented
array of escalating imbalances: ever-declining personal savings;
an ever-widening current deficit; exploding government and consumer
debts; and, on the other hand, a protracted shortfall in business
fixed investment, employment and available incomes.
We must admit that the staying power of this extremely ill-structured
and debt-laden recovery and the stubborn buoyancy of the financial
markets have rather surprised us.
But this only lengthens the rope with which to hang oneself.
What American policymakers and most economists studiously keep
overlooking is that the credit bubbles are doing tremendous structural
damage to their economy. The longer the bubbles last, the greater
the damage.
DEBT EXPLOSION VS. INCOME IMPLOSION
This time, we want to focus on the dramatic shortfall of employment
and income growth that radically distinguishes this recovery
from all its precedents in the postwar period. It must have a
particular cause, but where is it? In search of its causes, we
contrast, first of all, credit and debt growth with income growth.
Over the five years from 2000-2005, total debt, nonfinancial
and financial, has increased $12.7 trillion in the United States.
This compares with a simultaneous rise in national income by
$2.1 trillion. For each dollar added to income, there were $6
added to indebtedness.
In real terms, national income increased little more than $1
trillion. Last year, U.S. private households added $374.4
billion to their disposable income and $1,204.7 billion to their
outstanding debts. Inflation-adjusted disposable income grew
$115.7 billion. It is a growth pattern with exploding debts and
imploding income growth.
To make our point perfectly clear: The present U.S. economic
recovery has never gained the traction that it needs for self-sustaining
economic growth with commensurate employment and income growth.
As to its main cause, all considerations lead to the conclusion
that it must reside in the protracted, appalling shortfall in
business fixed investment. Investment spending is, really, the
essence of economic growth.
Our own considerations begin with the recognition that the U.S.
economy is, in every single respect, in far worse shape today
than it was in 2000, and also that there is no other bubble in
sight to replace the housing bubble. Everything depends on the
housing bubble to rapidly reflate once the Fed eases again.
Our strongly held assumption that the U.S. economy is in a most
precarious condition basically has two reasons. One is the extravagant
size of the housing bubble, involving the whole financial system
to an unprecedented extent. The other is the grossly ill-structured
economy, replete with imbalances inhibiting sustained economic
growth.
CONCLUSIONS:
Forecasts for the world economy are generally optimistic in the
expectation that the U.S. economy will continue its global pull
with continuous strong growth. We think the anemic and extremely
unbalanced U.S. economic recovery is in its last gasp.
Our key consideration is that the U.S. economy has become perilously
addicted to asset inflation in general and the housing bubble
in particular. Both rising asset pricesand the rising dollar
had their foundation in carry trade of astronomic scale. While
interest rates may still appear rather low compared with the
inflation rates, the Fed's rate hikes have pulled the rug from
under the dollar-based carry trade.
Mandel practically taunts Buffett
without considering the effects of globalization and what that
has done to real wages, he ignores a credit bubble, a housing
bubble and instead focuses on a cyclical recovery of stocks while
making huge assumptions about "hard work".
Somehow the busting of the housing bubble is of little importance
to Mandel. Then again, perhaps he does not see that trainwreck
coming. Nor does Mandel look at earnings, book values or dividends.
In The
Big Chair John P. Hussman of Hussman Funds addresses some
of those issues.
It's interesting that the current
P/E is about double its "normal" level based on the
current position of earnings. If you look at the price/book ratio
on the S&P 500, at 3.1, it's also about double the historical
norm of about 1.5. The price/dividend ratio on the S&P 500,
at 54, is about double the historical norm of about 26. The price/revenue
ratio on the S&P 500, at 1.5, is nearly double the historical
norm of 0.8. This market isn't cheap.
From an economic perspective, corporate profits as a share of
GDP are near an all-time high. Historically, a high profit share
relative to GDP has generally been followed by disappointing
earnings growth over the following 5-year period.
What's worse, nearly all the growth in U.S. domestic investment
since the mid-1990's has been financed by imported capital which
we observe as a current account deficit so that the observed
"productivity boom" has gone hand in hand with an expansion
in imports. To the extent that we now have an intolerably deep
current account deficit, the U.S. is likely to observe restricted
growth in capital investment in the coming years, which will
tend to be a drag on productivity even while real wages increase.
The resulting squeeze on profit margins may be acute within a
few years.
In short, the S&P 500 is richly valued on the basis of nearly
every fundamental measure, including earnings when those figures
are properly considered. The point is not to predict a near-term
decline in stocks, but rather to emphasize that the long-term
returns priced into stocks here are likely to be disappointing.
So what did Buffett miss if
anything? Perhaps he missed predicting that the Fed would panic
by slashing interest rates to 1%, or perhaps he did not foresee
panic home buying where 40% of the homes bought over the last
two years were for "investment purposes" or perhaps
he failed to account for the effects of credit standards lowered
to the point that if one could breathe one could get a mortgage.
Please consider the MarketWatch bulletin Banks'
mortgage demand weakens. Published quarterly, the Fed's
senior loan officer survey polls 57 domestic banks and 19 foreign
banks about lending trends. Of the respondents, 11.3% said they'd
eased home mortgage lending standards, while only 1.9% said they'd
tightened them somewhat.
The interesting thing is that even in the face of rising foreclosures
and rising bankruptcies companies are still lowering credit standards.
The fact that companies are acting reckless by taking on more
and more risk in the face of deteriorating fundamentals is something
that anyone but an ostrich should clearly be able to see.
More than likely Buffett did not miss much if any of that and
chose to be relatively bearish on a market driven by such forces.
The question now is who would you rather believe?
- John Hussman, Warren Buffett,
Dr. Kurt Richebächer
- Michael Mandel
Will the "Real Ostrich"
please come up for some fresh air?
Having your head in the sand clearly affects one's thinking.
May 21, 2006
Mike Shedlock "Mish"
email: Mish
http://globaleconomicanalysis.blogspot.com/
321gold Inc
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