If Warren Buffett is not making money, there may be little chance for the rest of us. His annual letter to shareholders earlier this month reported unfavourably on his performance in 2004. But what is underperformance for him would be regarded as satisfactory performance by many investors.
Last year Berkshire Hathaway's book value gain was 10.5 per cent against the return of 10.9 per cent on the S&P 500 index. For Warren Buffett that is slightly worse than standing still. What is really interesting is that he says he could not find attractive securities to buy. He has plenty of cash, waiting for any opportunity. In fact, he ended 2004 with $43 billion in cash equivalents.
When I was a Director of the British G.E.C., the Board was criticised for having a cash mountain of $3 billion. That was all invested by our successors in telecom shares at the top of the dot.com bubble. The shareholders lost almost all their money.
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I do not mind any business having a cash pile, since opportunities to invest cannot be predicted to fit the graph of cash flow. Nevertheless, the best long-term investor in the world, who has been in the business for sixty years, does not keep a cashpile of over $40 billion if there are investments available which meet his standards of value.
We must assume that Buffett has got it right; he usually has in the past. That would mean that all the major markets, and real estate, are fully valued by traditional standards. When markets are fully valued, that does not mean that they are about to fall. It does mean that they have entered the stage of speculation. The historic returns on investment will obviously be higher at this stage, and investors may get false confidence from the historic record.
In the dot.com bubble the historic returns on high tech investment were, at one point, incredibly high. The high tech market did eventually collapse, but it went up by about 200 per cent after it had reached what could be called the full value level.
Warren Buffett's greatest anxiety is the US trade deficit about which we have, over the years, written in the Fleet Street Letter. To quote Warren Buffett himself: "A 318-page Congressional study of the consequences of unremitting trade deficits was published in November 2000 and has been gathering dust every since. The study was ordered after the deficit hit $268 billion in 1999. By last year it had risen to $618 billion."
Total US exports of goods and services in 2004 came to $1,723 trillion. That means that a $618 billion deficit amounts to 34 per cent of US foreign earnings. It amounts to about 6 per cent of US Gross Domestic Product. Like the rest of us, Warren Buffett worries that this is unsustainable.
He points out that if the United States "continues to run current account deficits comparable to those now prevailing, the net ownership of the US by other countries and their citizens a decade from now will amount to roughly $11 trillion."
Does all this matter? In the first place, all experience is that the unsustainable is not sustained. The best metaphor is from flying. If you push up the nose of an aircraft and let the speed fall, there comes a stalling point. In the early days, the pilot was usually killed. In the 1920s, the US stock market crashed so badly that the world suffered the slump of the 1930s. At some point the US trade deficit has to be brought under control.
In 1914, at the start of the First World War, Britain was the wealthiest empire on earth, with colonies and self-governing Commonwealth counties all round the globe and huge investments, including investments in the United States. Britain's economy was past its peak of performance, which had come earlier in the industrial revolution, but was still very powerful.
By the time I was born, a year or two earlier than Warren Buffett, most of Britain's investments had been sold to pay for the war, but London was still the great international financial centre. The decline continued, Britain went heavily into debt in the Second World War, and the sterling area started to disintegrate. Now I cannot help feeling that the United States is following the financial track of Britain in the twentieth century. No country can afford the trade deficits that the United States is currently running
What could be done to correct the imbalance? If the United States allows the dollar to slide to a competitive level, there is bound to be some inflationary effect. If the United States raises interest rates to a level which reduces consumption, world trade will fall...unemployment in the US will rise...stock markets will fall. In any case, an American Government which followed deflationary policies would be voted out of office. Paul Volcker achieved a major deflation in the early 1980s, but that was in the face of a raging global inflation. Everyone felt the pain of the inflation of the 1970s.
The United States seems to be in a situation in which there is no easy answer. The dollar is still overvalued; the trade deficit is far too high; the Budget deficit is also too high. The President is not a man who thinks in economic or financial terms. He will not sacrifice the prosperity of the present, or the victory he foresees in the mid-term elections, in order to reduce the external deficit.
He will not do that because of any warnings, from Warren Buffett or anyone else. The US is therefore going to continue with the trade deficits. There will be a tendency for interest rates to rise, but not to a deflationary level. Chinese competition will continue to keep price inflation in manufactured goods at a low level. The underlying weakness of the US trade deficit will not be corrected, and world trade would be damaged if it were.
Everyone is hoping that the unsustainable will go on a little longer. But it cannot last forever.
Leading political commentator William Rees-Mogg is the former editor-in-chief of The Times and a member of the House of Lords. His perceptive, informed, and often controversial insights can be found in Times every Monday. But his investment analysis and ideas are published only in The Fleet Street Letter.
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