Why Buffet is a dollar bear

published 31 October 2005

Until last year, "I had lived nearly 72 years without purchasing a foreign currency", Warren Buffett told Fortune. Since then, however, Buffet has been loading up in anticipation of "a significant decline in the value of the dollar" due to America's unsustainable trade deficit. This now stands at more than 4% of GDP, meaning that the US consumes over 4% more than it produces. Equally "ominous", thanks to the foreign funds required to finance this shortfall, net foreign ownership of US assets has reached a staggering $2.5trn. The deficit is "selling the nation out from under us".

On current trends, with $1.5bn a day needed to plug the gap, the US will owe foreigners about 47% of its GDP within five years, says John Paul Rathbone on Breakingviews.com. No wonder the European Central Bank's chief economist says that a current account adjustment must eventually occur. This is "a potentially scary prospect", as it could happen suddenly. As the debt pile grows, foreign investors are likely to begin demanding higher interest rates for funding it. However, a major event that pushes up rates could cause "the whole edifice" to topple over, causing investors to flee the US en masse. With the US already having passed the stage when foreign investors typically lose interest in funding a current account deficit, an adjustment is in the offing, implying more downward pressure on the dollar.