Expert View: Don't believe the tale of Buffett and the dollar bears

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The Independent Online

The dollar bears have this week wheeled out the world's greatest investor, Warren Buffett, in support of their cause. In his latest Berkshire Hathaway commentary he repeats his concerns about the dollar in general, and America borrowing too much from foreigners in particular.

The dollar bears have this week wheeled out the world's greatest investor, Warren Buffett, in support of their cause. In his latest Berkshire Hathaway commentary he repeats his concerns about the dollar in general, and America borrowing too much from foreigners in particular.

While wary of taking on the Sage of Omaha, the fact that he is a company investor, not a macro player, gives me some encouragement (and courage). Indeed, he himself said he spends about one hour a year listening to economics and that is probably an hour wasted.

I'm confused. If one of Mr Buffett's companies were borrowing money at 4 per cent and investing it in areas delivering something approaching twice that, he would be very happy. More important, he would not concern himself with looking only at the liability side and ignoring the potential growth in the assets. And yet this is in effect what his comments on the dollar are doing.

To explain: Americans are selling debt at high levels (borrowing at low rates) and yet they are also investing heavily overseas (also domestically, but for the purpose of the dollar discussion this is less relevant). On the 10-year view Mr Buffett is taking, the existing US liabilities to the rest of the world are fixed - they are, after all, fixed income - and yet with only a 7 per cent compound growth rate, the value of existing assets would double over that period.

In a simple example, if you can borrow $100 at 4 per cent and invest half to return 7 per cent compound, set aside interest payments and spend the rest on toys, then after 10 years you have assets equal to liabilities and a decade of toys for free. Is that dumb?

Overseas investors buy US fixed income at prices Americans consider too rich because they have no choice. Their own bond markets are unable to provide the yields needed to match their liabilities. And this is a key point. They are no longer managing their assets; they are managing their liabilities.

The asset allocation has already been decided by an unholy alliance of trustees, actuaries and government. Removed of the responsibility for maximising risk-adjusted returns, the fund manager will simply buy any amount of the thing he has been told to buy.

Some market timing may come into play to make sure they don't miss the benchmark, but that's about it. And of course, the same governments making these rules are also the ones borrowing cheaply by selling bonds to forced buyers. Or is that too cynical?

One small aside that should reduce concerns about the multi-billion public sector pension deficit we heard about recently. These deficits arise from the assumptions about the value of the pension fund being invested in low-return bonds. Except, of course, the government sector is the one area that doesn't have to fund its pensions in bonds. It doesn't fund it at all - in fact, it self-insures - and its income is not only perpetual but grows in line with nominal GDP.

In effect, it is able to do the same as the US household - borrow cheap and make a long-term investment in growth. Of course, our amusement at this irony should not distract from the fact that around 90 per cent of the increase in employment since 1997 has been in the state sector. That is where the risk actually lies.

Mr Buffett is undoubtedly a wise man, but to suggest the market is foolish is extremely dangerous. On this analysis, it is being entirely rational. America is providing the savers of the world with relatively high-yielding, low-risk assets to match their liabilities, and recycling that capital into higher-risk investments to allow the world to grow.

Mark Tinker is a director of Execution Stockbrokers. Mark.Tinker@execution-limited.com

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