The Big Picture
The Big Picture
What do you believe are the greatest successes of capitalism?
Of the clear successes of capitalism, a greater abundance of things we want and need, and considerable improvements in the standard of living are good candidates. The standard of living in the U.S. has increased almost seven fold in the last century. One century is a speck on the greater timeline, and such an increase in productivity in the standard of living is surely unprecedented. Another noteworthy success of capitalism is that it is surely better than any alternative system at allocating resources and getting the best people to their most appropriate places. Consider this: in 1790, the first global census was conducted; there were 290m people in China, 100m in Europe, and 4m in what is now the U.S. Now the U.S. holds 4.5% of the world's population but is responsible for 30% of global GDP. I believe the great American book is yet to be written and will be the one that manages to capture how spectacular this growth has been; again 214 years is just an instant. When we think about such growth, I don't believe the causal factors are the people; it must be the system. The smartest people in Guam are as smart as the smartest people in Iceland are as smart as the smartest people in the U.S. Being born in the U.S. is more important to my success than anything that has happened since.
What do you see as the shortcomings of capitalism?
Capitalism, like any system, is imperfect, but it's getting better and we're getting closer to goals such as equality of opportunity and learning how to deal with those that are hurt by the system. But capitalism is surely a free marketplace, a dog-eat-dog marketplace in many ways. And a marketplace implies losers. Early in my career, I bought a textile mill in New Bedford and the vast majority of the mill workers were Portuguese and could not speak any English. Over time, textile mills in other parts of the world were able to operate more efficiently and we simply could not compete. I had to shut the plant down and fire everyone; the workers were casualties of the system. You can't retrain or save those people; they'd had it. So the real challenge with capitalism is that you can't throw sand in the gears of greater output but you also want to care for the casualties. If you look around, it's clear that most people are burdened with real fear; fear is terrible and people shouldn't have to live with it. We should want to reduce societal fear of the things that they should never have to worry about - fear of going hungry, fear of going without medical care. These are the problems you should be thinking about solving.
How should we take care of those who are harmed by the system, like your former textile mill workers?
I would start with the tax system. It would not be easy to implement, but some form of a steeply progressive consumption tax for the wealthy makes a lot of sense to me. For instance, when I fly my private jet I use hundreds of gallons of jet fuel but I'm not taxed at a higher rate. Flying in a private jet is usually unnecessary, excessive consumption and I should be taxed appropriately via a higher consumption tax. Here's another example: I could easily hire 20,000 people and pay them $50,000 per year to sit here and paint portraits of me all day in search of the perfect one. Not only would that be ridiculous, but it would pull 20,000 productive contributors out of system and I should pay highly for that. Other than figuring out ways of reallocating money to the 'bottom 20%,' we need to focus on finding ways to help people be useful and feel useful. This means finding people jobs, keeping them involved in society, and the like.
With the recent changes in the global political economy and surges in terrorist activity, some would argue that uncertainty is increasing for all types of global markets. Where do you think things are heading and how should we deal with this heightened uncertainty?
Human beings don't change very much over time. But until recently, most dangerous people had limited ability to harm others in scale…. I think the terrorism issue is one problem to which there is clearly no solution. I'm confident that we'll solve everything else out - we making progress on cures for major diseases and all that - but terrorism, it seems to me, is impossible to solve because there will always be troubled people seeking to do harm to large masses of people. The intent is surely there. And knowledge of how to inflict terror is spreading. If you have intent and knowledge, the third aspect of terrorism is 'materials and deliverability.' This is harder to come by for the terrorists and what we should be working to prevent. If I knew we could devise a solution to terrorism, I would dedicate 100% of my foundation's funds to this effort; but I'm just not sure there's a solution.
What kind of impact will the demographic shift (i.e. baby boomers) have on the United States?
We aren't big on demographic trends. It's difficult to translate that information into profitable decisions. It is hard to figure out what businesses will prosper in the future, based on macro trends. See's candy is for anyone and Fruit of the Loom is for people who need underwear today. We want to be right on something that will work right now, not something that might work in the future. I doubt that Wal-Mart spends a lot of time on demographics. They instead focus on where to put the store and what to put on the shelves. I've never found those kinds of stats useful. People were all excited to go into stocks 6 years ago, but it wasn't because of demographic trends.
[Warren then referred to a recent WSJ article written by Jeremy Siegel that discussed funds flowing out of investments because baby boomers will need to cash in their investments during retirement. He said he respected Siegel, but he doesn't find fund flows data useful.]
Do you believe that the Federal Reserve is fostering moral hazard thereby leading to the misallocation of capital and subsequent asset bubbles? If so, what are the long term risks?
There is always some introduction of moral hazard when government decides to act in favor of the common good versus letting someone fail. There was moral hazard with the bailout of LTCM and there is some aspect of that with the current situation. But it’s hard to measure because the consequences are 15-20 years out. During the 1987 market crash, Greenspan was new to the job and unsure of what would happen. The specialist system got hit, most of them operated on very little capital and were broke. The Fed provided them with more capital. Will that change future behavior? Maybe, but at the time it was the right call. It’s also resulted in the “Too Big to Fail” doctrine. The big banks, Freddie Mac, and Fannie Mae figured the US Government wouldn’t allow them to fail and the managements of those companies knew that. I would be disinclined to second guess the Fed, they have more information and are trying to do what’s right.
Could you comment on the current rise of sovereign wealth funds from theMiddle East and Asia and how they are playing an increasing role in how corporations raise capital. Is competition from these sources for the cash flows of corporations affecting your investment strategies or opportunities?
Any competition is competition. The situation of sovereign wealth funds is interesting. A lot of it is China bashing, OPEC bashing and plays right into politician’s hands. Today, the US will buy $2 billion more from the world than they buy from us. In exchange we give them little pieces of paper and they have to buy assets. As long as we consume more than we produce we have to let the rest of the world invest in us. We created sovereign wealth funds and that $2 billion gains interest. US funds feel they can get the best terms from these foreign investors and lately, enticed them into buying equity. China wanted to buy Unocal, a 3rd rate oil producer with production overseas in places like India. US Congress went ape and 395 representatives signed an anti-Chinese resolution to block the deal. For 100 years the US companies went around buying the world’s assets and bribing officials, but told China they couldn’t buy Unocal. The Chinese took it, but they didn’t like it. It doesn’t make sense that we are buying foreign assets, and giving them pieces of paper and then telling them what they can’t do with that money. We have created them and I have no objection to them. I recommend an index fund for these sovereign wealth funds. It gives them exposure to the US market, but they won’t get taken by salespeople with bad deals. In economics you always want to say “And then what?”
It seems that the worldwide trend is towards lower corporate tax rates. Do you think that the US risks becoming less competitive if it maintains its current corporate tax rate?
Relative to GDP, government taxation is 18.5% and spending is 20%, so we borrow the balance. The national debt should not be a scary topic and the fact that it’s gone up is fine as long as it’s proportional to GDP. Where do we get that 18.5%? There’s 2.7 trillion in government revenues. 2.2 trillion comes from individuals, and less than 1% of that comes from the estate tax. 1.1 trillion comes from income taxes, with payroll taxes consisting of 900 billion, but it’s capped at the first $100,000 of salary. We want a tax system that encourages greater prosperity, but it needs to take care of the family.
We did an informal office survey by looking at the total tax footprint versus the total income. I earned 46 million and paid a tax rate of 17.5%. My rate was the lowest, the average was 33%, and my cleaning lady paid 40%. The system is tilted towards the rich. The Forbes 400 total net worth has gone from 220 billion to 1.54 trillion, an increase of 7-to-1. You see in legislature that there is lobbying carried on by the powerful over issues such as the estate tax and carried interest for private equity investments. We need to flatten income and payroll taxes, and those making under $30,000 shouldn’t be bothered.
Let’s imagine that 24 hours before you are born, a genie comes to you and tells you devise a social and economic system. The only catch is that after you designed the system, you would choose a paper from a barrel which would determine your demographics. What objectives would you want? You need to devise a system that creates prosperity. It needs to be a meritocracy, to put the right people in the right place. It needs to have a strong education system, and throw off lots of goods and services. It also needs to not discriminate against women or minorities. Even though the per capita GDP is $47,000, 20% of the population makes less than $20,000. We need to eliminate that fear of sickness or old age. A tax code is the codification of a country’s values. But you can’t kill the golden goose of prosperity.
Do you feel that the might of America has changed?
You can bet against the dollar, but I would never bet against America. The system in the U.S. has allowed the country to unleash more for the world than any other country. Since 1776, the U.S. had a different system than the rest of the world and that system unleashed the human potential. We were not the smartest nor did we have the best resources. This is the same system we have in place today with people of similar intelligence. I have and would bet against the U.S. currency, stocks, etc. but the United States prevails over time. There are all kinds of rocky roads but we have rule of law, equality of opportunity, and a meritocracy. We have a market system and people apply energies and imagination to come up with things someone would want. Everyone in this room is working far below his/her potential.
Overall, I’m an enormous bull on the United States. In 1790, we had a population of 3.9 million people vs. 290 million in China and 190 million in Europe. We’ve all had roughly the same conditions since then, yet 215 years later, we have 30% of the world’s GDP. This is one of the great all-time success stories.
[Charlie Munger: I believe that we are at or near the apex of a great civilization.]
I don’t feel that way. You’ll know who’s right in 20 or 30 years.
What we do is no secret. The relative importance of America will diminish. The rest of the world is catching on and adopting our best practices. But our castle will grow. It’s good for us if the rest of the world does well, and they’re growing from a lower base. I don’t think their success comes out of our hide.
[Charlie Munger: In 50-100 years, if we’re a poor third to some countries in Asia, I wouldn’t be surprised. If I had to bet, the part of the world that will do best will be Asia.]
What are the biggest challenges that this country faces?
The biggest problem is probably weapons of mass destruction. We have always had people who were ill-fitted to society and wished harm on others. In 1945 we unlocked the atom, and that changed everything. The human animal hasn’t changed, you still have the same percentage that are maladjusted. The problem is knowledge, materials, and deliverability. What you could do with the wrong kind of infectious disease is incredible. You can transmit things much faster today. Governments, individuals and organizations can’t control security. It’s what I would spend all of my money on if I could fix it. Everyone here in this room won what I call the ovarian lottery. You were born at the right time and we were all very, very lucky. We are in the luckiest 1% of humanity.
What do you think about the U.S. trade deficit?
I talked to Barack back in August, and said: “I have good news and bad news. The good news is that the economy will be terrible, so you’ll definitely get elected. The bad news is that the economy will be even worse at inauguration.” He asked, “Do you think it’s too late to throw the election?” The trade situation is there and it causes problem and could exacerbate the situation. However, all issues go on the back burner until we solve the big problem. We create sovereign wealth funds, buying more goods and services than everyone else in the world. The decline in the oil price has helped the trade deficit but nothing will get better until everyone feels better. Every day, we buy $2 billion of goods and service more than we produce and export. We give the exporting nations USD. The trade deficit creates claims on the United States. Sometimes we’re a little hypocritical. For example, three years ago, the Chinese wanted to buy Unocal (a small oil company in California) and Congress wanted to condemn China for wanting to buy the oil company with the money we gave them (through U.S. imports). That’s a little disingenuous. The trade deficit creates a situation because we give people claim checks, then we get upset when they want to use them. The Japanese bought Rockefeller Center in the 80’s. Did we think they were going to move it? It’s not useful to fan those flames in a nuclear world, and that’s what’s wrong with “Buy America.” The trade deficit will come up big time when we get past the current problems.
What level of taxation on capital gains is most conducive to the long-term economic health of this society, and is that also the fair and just rate?
[Charlie Munger: I think there's an easy answer to your capital gains issue, and one is what makes an economy work best in some abstract mathematical sense, and the other is the consideration that you allude to that gets into issues of fairness. Aristotle felt that systems worked better when they were generally perceived as fair, and civilization worked better if people saw the differences in rewards as being reasonably fair, anyway. I think that if you have a civilization where you work 90 hours a week driving a taxicab, with no money and no medical insurance and so forth, and somebody else does nothing but own Berkshire Hathaway shares and sit on the country club porch and peel off a few every year to pay the bills, that would be regarded as so unfair, that even if it had some theoretical economic efficiency that it would be counterproductive for our particular civilization to have that kind of a tax code. I'm all for having some taxation of capital gains. Once you reach that conclusion, you get into the question of what is the fair rate. I think the fair rate might be a little lower than it is now, but not much lower.
Sounds to me like he's a seller of Berkshire. (laughter) Patrick [the questioner, who Buffett knew previously--ed.] gave me a system of mental construct to attack questions like this. He said just imagine that you were going to be born 24 hours from now, and you had been granted this extraordinary power: You were given the right to determine the economic rules of the society that you were going to enter. Those rules were going to prevail for your lifetime, and your children's lifetime, and your grandchildren's lifetime. But as in most of these types of questions, there's one hooker: You don't know whether you're going to be born black or white, male or female, bright or retarded, infirm or able-bodied, in the United States or Afghanistan--in other words you're going to participate in 24 hours in what I call the ovarian lottery. (laughter) It's the most important event in which you'll ever participate. It's going to determine way more than what school you go to, how hard you work, all kinds of things. You're going to get one ball drawn out of a barrel that probably contains 5.7 billion balls now. And that's you. Now what kind of society are you going to construct with that in prospect?
Well I suspect you would focus on two issues that Patrick mentioned in his question. You would try to figure out a system that is going to produce an abundant amount of goods, and where that abundance is going to increase at a rapid rate during your lifetime and your children's and your grandchildren's. You'd want some system that turned out what people wanted and needed, and you'd want something that would turn them out in increasing quantities for as far as the eye could see. But you'd also want a system that, while it did that, treated the people that did not win the ovarian lottery in a way that you would want to be treated if you were in their position, because a lot of people don't win the lottery. I mean, Charlie--when we born the odds were over 30 to 1 against being born in the United States. Just winning that portion of the lottery is an enormous plus. We wouldn't be worth a damn in Afghanistan. We'd be giving talks and nobody would be listening. (laughter) It would be the worst of all worlds. So we won in that way--we won partially in the era in which we were born by being born male. When I was growing up, women could be teachers and secretaries and nurses and that was about it. 50% of the count of the country was excluded from a very large part of the occupations. We won it by being white. No tribute to us, it just happened that way. And we won it in another way by being wired in a certain way which we had nothing to do with, that happens to enable us to be good at valuing businesses. Is that the greatest talent in the world? No, it just happens to be something that pays off like crazy in this system. (laughter)
When you get through with that, you still want to have a system where the people that are born like Bill Gates or Andy Grove or something get to turn those talents to work in a way that really maximizes those talents. It would be a crime to have people like that or Tom Murphy working in some pedestrian occupation just because you have this great egalitarian instinct. The trick, it seems to me, is to have some balance that causes the people who have the talents that can produce goods that people want in a market society to turn them out in great quantity, and to keep wanting to do it all their lives, and at the same time, takes the people that lost the lottery, and makes sure that just because they got the wrong ticket, they don't live a life that's dramatically worse than people that were luckier.
When I get through that long speech, I probably come out with the idea that the capital gains tax as it is today is just about right. I've been around a lot of people with money and talent over time, they don't always go together but I've been around both classes (laughter) and I see very few of them that are turned off from using their talents by a 28% capital gains tax--it just doesn't happen. They do what they like to do. I've just never seen it happen. I see a lot of people that pay taxes that are higher than 28% that are contributing more to society by some judgment other than a pure market system. I just don't think it's inappropriate in a country like this to tax me at 28% for selling some of my Berkshire shares whereas somebody who makes even relatively modest amounts of money can get up to 39% while they're trying to figure out a cure for cancer. That's where I come out on that. (applause)
What's your opinion of oil? peak oil?
Oil is finite. It will eventually run out for practical purposes. America found oil early, and there isn’t much left here. We will see a plug‐in electric car. BYD is very smart. Doesn’t know if change to alternatives will be evolutionary or revolutionary. But oil will be higher and solar/electric will be more abundant. (A side note: Buffett went from average oil out of the ground down the value chain and into a personal consumption calculation in his head in about ten seconds.)
[Q - Oil will run out this century. Considering US policy is to do nothing until the last second, will we face World War III? Will oil companies go to zero?]
Warren Buffett: Oil won’t run out - it doesn’t work that way. At some point the daily productive capacity will level off and then start declining gradually. There is the depletion aspect and the decline curves. We are producing 86 million barrels per day or so, more than ever produced. We are closer, by my calculations, to almost our productive capacity, than we have ever been. I think our surplus capacity is less, and quite a bit less, than in the past. Whatever that peak is, whether it’s 5 years, 10 years, etc., the world will adjust, and we will think about it. Adjustments will cause demand to taper off. I don’t know how much oil is there, but there are lots of barrels of oil in place. We never recover total potential. We may have better engineering recovery in the future. It is nothing like an on and off switch. You may still have enormous political considerations to get access to available oil since it is so important. There is nothing you can do over a short period of time to wean the world off oil.
Charlie Munger: If we get another 200 years of growth dispersed over the world while the population goes up, all oil, coal and uranium will run out, so we will have to use the sun. I think there will be some pain in this process. I think it is stupid to use up the hydrocarbons of the world so quickly. It’s stupid when there are so few, and limited, alternatives. What should we have done? We should have brought all the oil over from the Middle East in the 1930s and put it in our ground. Are we doing it now? No. Government policy is behind in rationality. If we are to have a prosperous civilization, we must use the sun.
Warren Buffett: Charlie, what is your over/under for oil production in 25 years?
Charlie Munger: Oil in 25 years? Down.
Warren Buffett: If that is true, that is a big number. China is doing about 10 million cars this year, so down in 25 years is significant.
[Q - You speak frequently about future prosperity. How about oil – when it runs out. Isn’ t it like trying to satisfy a drug addict with Coca-Cola?]
Warren Buffett: Titusville 1853 changed the world. There are 500k producing wells in the US. It contributed to the prosperity of the world. The world will not be dependent on that windfall for next 100 yrs. There will be other free lunches available, whether it be solar or other. Don’t give up on humans’ ability to innovate to face problems that seemed insoluble. We haven’t really started. If you could a point in time to be born, I would pick today. CM will give you something more dire.
Charlie Munger: 150 yrs ago they needed the oil to get ahead. We can get ahead without the oil if we have to, we are advanced civilization. We need gas, coal and oil for chemical feedstock, not warmth or motor vehicles. Freeman Dyson has pointed out that we could go off oil. It doesn’t mean because we couldn’t do it before that we can’t do it in future. If it doesn’t bother Freeman Dyson, it shouldn’t bother you too much.
Warren Buffett: He’s always pulling that one on me too. [laughter]
The current tenuous economic situation and interest rates? Where are we going?
I don’t think about the macro stuff. What you really want to in investments is figure out what is important and knowable. If it is unimportant and unknowable, you forget about it. What you talk about is important but, in my view, it is not knowable. Understanding Coca-Cola is knowable or Wrigley’s or Eastman Kodak. You can understand those businesses that are knowable. Whether it turns out to be important depends where your valuation leads you and the firm’s price and all that. But we have never not bought or bought a business because of any Macro feeling of any kind because it doesn’t make any difference. Let’s say in 1972 when we bought See’s Candy, I think Nixon put on the price controls a little bit later, but so what! We would have missed a chance to buy something for $25 million that is producing $60 million pre-tax now. We don’t want to pass up the chance to do something intelligent because of some prediction about something we are no good on anyway. So we don’t read or listen to in relation to macro factors at all. The typical investment counselor organization goes out and they bring out their economist and they trot him out and he gives you this big macro picture. And they start working from there on down. In our view that is nonsense.
If Alan Greenspan was on the one side of me and Robert Rubin on the other side and they both were whispering in my ear exactly what they were going to do the next twelve months, it wouldn’t make any difference to me what I would pay for Executive Jet or General Re or anything else I do.
[Q - your opinion on low interest rates?]
Warren Buffett: Very difficult for many with such low rates. People talk about easy money, but it’s not easy on the people who have money. If you invested at these rates when Columbus landed, and didn’t pay taxes, you’d have doubled your money by now! It won’t go on forever, but I’m very sympathetic with people living on a fixed income. Purchasing power is getting eaten away. This will end at some point. I would not want to be Chairman of the Fed. It won’t work forever to run big budget deficits and have easy monetary policy. When we run into trouble the blame doesn’t go to the Fed, it goes to Congress.
Charlie Munger: In some sense, the reality of our situation is depressing, stocks are up because running fixed income returns are so lousy. But if it does last, we won’t like it – just like Japanese. We will be mired in stagnation. This is a very easy message. [laughter]
Warren Buffett: The pressure of extremely low rates can’t be underestimated. Afraid of everything else, pressure to put other prices back up will be enormous as fear gets resolved. You shouldn’t underestimate the degree to which the last year of stock prices is result of agony of very low interest rates. We have seen a lot of that, and we’ll see what happens when rates go up.
What was the impact of September 11th?
It made everyone realize that human haven't progressed in how they behave, but have progressed in terms of their ability to hurt someone they hate. 9/11 brought that home. It used to be that if you hated someone, you could only throw a rock at them.
There are millions of people who hate us, but most can't do anything about it. But a few can, and there's incredibly more ability for a deranged person to do harm to us today.
Before 9/11, we weren't being paid for insuring the risk of terrorist attacks. Since then, the insurance industry has recognized that it has exposures that it had to exclude or charge for.
For new policies, we've sold quite a bit of terrorism polities, but almost all exclude NCB -- nuclear (and fires afterward), chemical and biological. The World Trade Center attack was about as extreme as you can get without NCB.
As an industry, we can pay claims of tens of billions of dollars, but not hundreds of billions.
We write a few policies that cover NCB because we can take a loss of a few billion.
Most people don't realize that the World Trade Center attack was, by a huge margin, the largest workman's comp loss in history. Had the attack been on, say, Yankee Stadium, there would have been few workman's comp claims, but people were at work in the World Trade Centers. Imagine if someone developed a deadly biological agent and released it into the ventilation systems of a number of large buildings simultaneously. It would make the workman's comp claims for the World Trade Center look like nothing.
[Charlie Munger: "To the extent that 9/11 causes us to be less weak, foolish and sloppy, it's a plus. We regret what happened, of course, but it's good that people become more realistic. For example, we should have tightened our immigration policies years ago." [I didn't interpret this as opposition to immigration in general -- simply that it should be monitored more carefully so that people like the 9/11 attackers couldn't enter the country and operate freely.]]
The key to both investing and insurance underwriting is to be realistic and disciplined. 9/11 drove home these lessons.
Could you use your clout to advocate for tort reform?
I'm sympathetic to what you're saying, but our clout is nothing compared to that of trial lawyers. It's appalling the friction costs to our society of tort insurance. People pay off rather than go through the nuisance of a suit. The people that pursue that activity pursue it not because it's right, but profitable.
But when I look at what's happened in Corporate America, I don't think they should get off scot-free. I just wish the people who engaged in the wrong-doing would pay, not the D&O insurance.
[Charlie Munger: If you say the tort system includes Workman's Comp, which I would, I'd agree [that the system has serious problems]. In California, Costco has 1/3 of its employees but pays 2/3 of its total Workman's Comp [bill]. It's institutionalized fraud -- chiropractors, etc. all working together. It'll cost jobs. I had a friend who moved his plant from Texas, where his Workman's Comp was 30% [of wages] to Utah, where it was 2%. In California, it's gotten so bad that I think there will be reform, even though the legislature is controlled by Democrats.
Most of the time they [the plaintiffs' lawyers] are suing someone who has done something terrible. A lot of defendants who are screaming about plaintiffs bar have done some terrible things. The present system is crazy, but I don't know how to fix it.]
Would you make people who did wrong things pay a portion themselves?
[Charlie Munger: I think it would be a great improvement if there were no D&O insurance . The counter-argument is that no-one with any money would serve on a board. But I think net net you'd be better off.]
Views on growing income inequality?
The American consumer overall is better off, but not dramatically better than 10 years ago. You're right that there's been increasing inequality. We don't make decisions on what business we buy based on some sweeping projections about what American consumers will do. We're very certain that Americans will do better over time. Average income per capita rose 7x in the 20th century. A simple phone call across the country used to cost a great deal relative to income. People will be better off decade after decade. We're not big on being futurologists.
Our consumer businesses -- candy, furniture, etc. -- are very very soft. They were down in Q1. I think we've been in a recession -- although not huge or violent one -- for two years. When government talks about GDP growing 2%, keep in mind that the population grows 1%. It's GDP per capita that counts. And GDP counts people who make you take off your shoes before you get on a plane. It counts good and services that we wish we didn't want. When you get into a war, if you drop planes into the ocean, it [building replacement planes] is part of GDP. Desirable GDP, my guess, has gone no place in the past three years. The quality of GDP isn't talked about very much.
[Charlie Munger: Figures you gave on inequality obscure an important fact: if the same family were always on the bottom, then you'd have big resentments. But if DuPonts go down and Pampered Chef up, [that's good]. That much churn makes people think the system is fairer. Buffett: We don't like churn now, but we liked it more 30-40 years ago. [Laughter.]]
[BRK2004 - I don’t see how corporate profits will move up as percentage of GDP.]
Buffett: Corporate profits today are close to their highs, except for a few years after World War II. Incidentally, corporate taxes are nowhere near their highs, so there’s a disconnect there.
It is certainly true that in the last 5 to 10 years, the disparity in income has widened significantly and the tax breaks for the wealthy have been extraordinary. I’ve said in the past that most of the members of the Forbes 400, myself included, pay a lower percentage of their income in taxes than their receptionist. This wasn’t true decades ago and it’s wrong in a rich society.
In 2004, my tax rate was the lowest of the 15 people in my office – and I’m not taking advantage of any tax shelters – and it’s even lower in 2005. That’s crazy. I don’t think the American people understand that, and if they did, they wouldn’t be very happy about it.
Munger: GDP per capita figures have been very good. I wouldn’t get too wild about the median income. There are huge fluctuations up and down. What’s really important is that the pie keeps growing.
That being said, I don’t disagree that Warren’s right about too many tax cuts for the wealthy, but I don’t think it’s as important.
Thoughts about the odds of a nuclear attack?
You are quite correct that people tend to underestimate low probability events when they haven’t happened recently, and overestimate them when they have.
On the nuclear question, you can do the math easily – the question is whether your assumptions are right. If there’s a 10% chance each year [of an attack], then there’s only a 0.5% chance it doesn’t happen sometime in the next 50 years. But if the odds are only 1% each year, then there’s a 60% chance you get through the next 50 years.
Buffett: I couldn’t agree more that the ultimate problem of mankind is a state- sponsored use of a nuclear weapon. It will happen someday.
Thousands of years ago, if you wished evil upon your neighbor, you threw a rock, but since 1945, the potential for inflicting enormous harm on a large number of people has increased geometrically.
To those who believe the idea that if we solve poverty it will take care of the problem, I’d remind you that the only country to use nuclear weapons on another is us.
What holds the danger in check is a lack of knowledge, materials and deliverability. But knowledge is getting more widespread, and materials are too.
I don’t know how money attacks this, but I think this should be a top priority, at least for my foundation.
There are six billion people and a few percent are really crazy and they would like to do great harm to a lot of people. And only one has to succeed. I don’t know how many we’ve stopped. It could be state-sponsored or by a terrorist.
As for how our company and stock would do, Berkshire is better positioned than anyone else, but that won’t make much difference.
Munger: I think chances that we won’t have any nuclear attacks over the next 50-60 years is probably zero. But I don’t think there’s anything we can do about it.
Buffett: You can elect leaders who are very aware of the problem and devote efforts to mitigate it. The genie’s out of the bottle, but you’d like to have leaders who focus on this. Both candidates in the 2004 Presidential race agreed that it was the biggest problem we faced.
[Q - How can further nuclear proliferation be prevented?]
Warren Buffett: The great problem of mankind is that the genie is out of the bottle on nuclear weapons. More and more people will know how to do damage. Psychotics will wish ill will. Materials and deliverability is the choke point. People generally associate this risk with terrorists and rogue states. But I regard it as a big threat to the future of mankind. We haven’t made much progress and we should be doing everything to reduce access to materials. We have a proposal to reduce the rationale to have big weapons. The world has 6.5 billion people, and it is very likely that twice the number of people wish ill than when the world had 3 billion. We used to just pick up a stone and throw it at our neighbor, so massive damage was limited. Since 1945, everything in the world has changed except how men think. There’s been exponential growth, and we haven’t gotten rid of the nuts. We live in a dangerous world, and it’s getting more dangerous as we go along. In the Cuban Missile Crisis, the odds were probably 50/50. We were lucky. It won’t go away. You would hope we have an administration which will try to figure out how to minimize the risk. It should be paramount to eliminate deaths on a large scale.
Charlie Munger: Well, you can talk about death on a large scale. The population of Mexico probably had a population decline of 95% as result of European pathogens. It won’t wipe out the species. I hope that cheers you up.
Warren Buffett: The cockroaches will survive.
Opinion on immigration?
[Charlie Munger: I’m very pleased when the smartest people come [to the U.S.] and almost never pleased when the very bottom of the mental barrel comes in.]
Over the past 200 years, we started with four million people and we now have over 30% of the GDP of the world. We’ve been characterized by lots of immigration. Whether that’s responsible for our success, I don’t know, but I suspect so. I don’t think we’ve been hurt by immigration.
I think Charlie would like to be the admitting officer. It would work pretty well, but it’s not very practical.
Buffett: I think illegal immigration is a problem and should be addressed quickly. I don’t think 11 million people should be shipped home. I also think more liberal rules going forward should be enforced.
I don’t think it would have a dramatic effect on the economy if the people here illegally became legal. [I missed this, but I think he said something like costs at businesses that employ illegal immigrants would go up and would be passed along, but the impact would be minor.]
Who’s to say if Charlie and I were born elsewhere that we wouldn’t try to get in, so I’m sympathetic [to the illegal immigrants].
Munger: If you don’t like the results, get used to it. We have never had the will to enforce the immigration laws. What you see is what you’ll continue to get.
Opinion on social security?
I don’t want to do anything to hurt the bottom 10-20% of the population. I’ve seen people who fear for the last years of their lives [that they won’t have enough money].
We’re worrying about a problem in 25 years, that’s a fraction of our current $500 billion trade deficit. We’re spending 4.5% of our GDP on Social Security now; if we have to increase it to 6% in 50 years, this is not a worry.
There are some things we should do, however: means test it, lift the $90,000 cut-off [there are no Social Security taxes above this amount each year] or eliminate it, and increase the retirement age. 2005 is a lot different from 1935 [in terms on longevity].
[Charlie Munger: That’s the perspective of the Democrat up here, so you might be surprised to hear from the Republican that I think the Republicans are out of their cotton-pickin’ minds to be taking on this issue at this time. The thought that more of our GDP will be going to the elderly over time is not anathema to me.
Social Security is very successful. Apart from disability – a small part – there’s almost no fraud; it’s hard to fake being dead. (Laughter) It rewards work, it’s low cost. It’s one of the most successful government programs ever.
For the current administration, which needs to face down North Korea and Iran, deal with Iraq, etc., to waste political capital on this twaddle.]
Buffett: Every society has to decide how to allocate wealth. Starting in 1935, we formally took the idea that the government should provide for the elderly. The government has always been there for young, via schools. Perhaps the idea that 65 isn’t the right age for retirement anymore is correct and more change is needed.
This country has output of nearly $40,000 of GDP per capita. Some people like Charlie and me are wired to earn a lot in our society, but many people aren’t [and they need to be taken care of in their retirement]. Our country can easily handle the Social Security issue. It astounds me that a government running a $300-400 billion deficit now is worried about a $100 billion deficit decades from now. We produce more every year as we go along. There’s always a debate over how to split the pie, but it’s a huge and growing pie so we can take care of older people.
Munger: Of course if we don’t change anything, Social Security will run low on funds. But if we grow, then it’s child’s play to [deal with this problem]. And it’s crazy to think we’d freeze the amount we’d pay to the elderly. Social Security is a low-overhead, efficient program. I wish my own party would wise up on this issue.
Buffett: This is what happens when you ask a couple of old guys about how much to give to the elderly. [Laughter]
Politicians are very happy to talk about the Social Security surplus and trumpet that, but when there’s a deficit decades out, they panic. There’s a lot of hypocrisy.
Opinion on public education?
A good public school system is a lot like virginity: easy to preserve, but not to restore. To succeed, well-to-do people need to be involved. I admire the fact that people like John Walton, Bill Gates and Ted Forstmann have gotten involved with this issue.
Next to the nuclear/chemical/biological weapon problem, the #1 problem we face is making sure our educational system is providing a good education to all children – and it’s not. Dealing with the problem is complicated, as there are thousands of school districts and many unions as well.
A big problem is that in many places, the rich have opted out. I imagine that if I used the local golf courses, I’d care a lot about how they were managed and maintained – it’s the same with schools. There’s a two-tiered system right now.
I’m a big believer in public schools.
[Charlie Munger: I met a guy whose wife teaches 8th grade in the local schools. He told me that, due to requirements of No Child Left Behind, for the numerous students who can’t read, she records the books herself so that these students can listen to the books and follow along in class. This is [the best of] No Child Left Behind in a sense, but it’s also a failure. It’s very hard for a civilization to fix failure when 8th graders can’t read.
It’s a very serious failure that we’ve allowed this to happen.]
Bill Ruane [of Ruane, Cunniff, managers of the Sequoia Fund] has an extraordinary program that teaches kids to read. It’s been going on for 10 years and the kids are enthusiastic.
A major reason for the success of the United States is the equality of opportunities compared to the rest of the world. It’s a bad situation when some kids have great families, caring teachers, good schools, etc., but less advantaged kids have teachers that just push their students through the system, in schools where other students are doing bad things...
This [failure of the educational system] shouldn’t be allowed in a country with almost $40,000 of GDP per capita.
Views on the U.S. Current Account Deficit?
We have earned more on American assets owned by people outside this country than the reverse. The net balance flipped in the most recent quarter and I expect this to continue. One reason is that the foreigners owning our Treasury bonds were getting only a little over 1% not long ago, so this was leading to a favorable balance. Now, that’s turning as our interest rates are up. And, over time, it’s going against us.
Now if you consider the magnitude and consequences of our $3 trillion net debtor position, that depends on what the dollar does. Over the past few weeks, the dollar has weakened, which reduces our debt, but could lead to inflation. Overall, [these trends] will not be favorable.
Munger: This is not a field to which I’ve devoted the same attention as Warren, but I do share his general pessimism that there will be a price to pay for the course we’re on. I’ve always thought we could get away with more ruinous behavior than Warren has. We started from such a strong position. It’s not as if the alternatives are all so great. I can understand why people would rather invest in the U.S.
Buffett: Yeah, if you landed from Mars, you’d still rather land in the U.S. than anywhere else.
Munger: Do you want to be in Europe, where 12-13% of people are unemployed and most 28-year-olds are living at home and being paid by state to do it? Or be in Brazil or Venezuela with the political instability that you fear? It’s not totally irrational that people still like the U.S., despite its faults. Whatever misbehavior there is could go on quite a long time without a price being paid.
Buffett: I agree. This is the country that could sustain fiscally irresponsible policies for a long time. We still think this is the best place to be. But I also think there’s a chance for something to suddenly go wrong.
What do you think the likelihood is of a major credit contraction?
It occurred during the junk bond crisis in 2002 and for equities in 1974. I don’t think you’ll necessarily see a contraction of credit or the Fed stepping on the brakes. I think you might see an exogenous event, a shock to the system, that causes a huge widening of credit spreads and a cheapening of equities. This would be good for Berkshire because we have money to take advantage of this.
In the past, when credit contracted, there was no money around. We tried to buy a bank in Chicago 30 or 40 years ago and couldn’t borrow at all. The only people willing to lend to us were in Kuwait, and would only lend in dinars. That was real credit contraction. The reason the Fed was established was in response to this. We really needed a system where that would not happen. I think the Fed will not by design produce any credit contraction.
Munger: The last time we had a credit contraction [in the junk bond crisis in late 2002], we made a quick $3-4 billion. The whole investing world is getting more and more competitive. If we had a big credit contraction, it would really gum up the world. If we had this, especially after a period of excess like we’ve had, we’d get legislation that most of us wouldn’t like.
Buffett: Jon Alter, in his book about the Great Depression [The Defining Moment: FDR’s Hundred Days and the Triumph of Hope], describes how this country was close to the brink and FDR got any law passed he wanted, as soon as he could write them. It was a good thing in this case – banks were closing and people were dealing in scrip.
In 1998, Long Term Capital Management blew up and you had a seize-up of the credit markets that was not orchestrated by the Fed. People panicked about even the safest instruments. This happened not 100 years ago but less than 10 years ago. There were plenty of smart people with a lot of money, but people panicked in part because they saw others panicking.
History doesn’t repeat itself, but it rhymes. We’ll have something that rhymes.
The state of Florida getting into the insurance business?
It’s easy to understand both sides. The average homeowner will not read line by line of an insurance policy and the agent often won’t explain it. So when something goes wrong, the homeowner wants to be paid. It’s worse when tens of thousands of homeowners are affected at the same time. It’s natural for government to step in and expand what an insurance company thought they were covering, which leads insurance companies to pull out.
I can understand the insurance company not wanting to write policies if the words won’t be adhered to, and I can understand the upset homeowner. If I were writing policies, I’d put exclusions in big type, but even so, I’d expect courts and legislatures to extend or even abrogate the terms of the contracts, figuring a guy like me or insurance companies can better afford it vs. the people affected.
When you have people around the country subsidize people who suffer from hurricanes in Florida, that gets very tough. It might become so expensive that they want to socialize it, but the guy in Nebraska says “Why should I subsidize you living in a hurricane path?”
It will really become an issue if you have a $100 or $150 billion loss in Florida. This would lead to a huge increase in taxation in Florida, so the state might call on Washington [the federal government] to pay for it. How much should people who are not exposed to risk send to people who choose to have this risk? I think you’ll see a big struggle over this in the next 10 years.
I can’t tell you with precision what the Florida legislation says, but the state of Florida has gotten more into the business of insuring citizens than it was before.
[Buffett asked Joe Brandon, CEO of Gen Re, to take the microphone and answer the question.]
Brandon: Back in mid-January, the Florida legislature met in a special session and passed legislation that is moving a lot of risk in personal lines. It is having a depressing effect on the insurance industry. There is no free lunch. The state and citizens of Florida are taking a lot of risk. It will work out well if the wind doesn’t blow, but odds are that it will. [According to this summary of the legislation, the state has taken on a $12 billion increase in exposure from $16 billion to $28 billion, with the possibility of an additional $4 billion more.]
Buffett: The real problem will be with a $100 billion insured loss. The state might have to issue $60 billion in bonds and might go to the federal government and say, “It’s not our fault and the entire country should pay.” $100 billion isn’t likely – Hurricane Andrew, inflation adjusted, was $30 billion – but if that storm had come through 20 miles north, it could have been. If this happens, we’ll find out if the whole country has, in effect, been insuring Florida. If the federal government throws it back to Florida, they’d have to issue a lot of bonds and raise taxes.
What's your opinion on global warming? climate change?
Buffett: I believe the odds are good that global warming is serious. There’s enough evidence that it would be foolish to say there’s a 99% chance it isn’t a problem. In this case, you have to build the ark before the rains come. If you have to make a mistake, err on the side of the planet. Build a margin of safety to take care of the only planet we have.
Gen Re writes way less business subject to the effects of global warming than does National Indemnity, which writes super-cat policies. We think much more about whether global warming will produce atmospheric changes that will change the frequency and intensity of major storms. We think the exposure goes up every year, even though we don’t know exactly what goes on in the atmosphere.
The relationship is explosive – global warming could increase expected losses by two, three, four or five times. It’s not something that keeps me up in terms of the financial prospects of Berkshire, but [it’s worth thinking about].
Munger: Carbon dioxide is what plants eat. Generally speaking, it would be more comfortable if the world were a little warmer. It’s not as if a vast flood of people are moving to South Dakota from southern California. [Laughter] It’s not clear that it would be a disaster for all humans, but the dislocations would be hard.
Buffett: You don’t think it would be a problem is the sea level were 15-20 feet higher?
Munger: With enough time, these things can be adjusted to. I don’t think this is likely to be an utter calamity for mankind. You’d have to be a pot-smoking journalism student to think so.
Buffett: We do know that in 2004 and 2005, hurricanes hit with a frequency and intensity that would not be expected looking at the past century. We were spared a far worse scenario by a couple of category 5 hurricanes that didn’t hit the coastline.
I don’t think Katrina is the worst that we’ll see. I don’t know all of the factors that go into hurricanes – there could be 50 variables, but all I know is that it’s likely to get worse. And it would be crazy to write insurance at prices from a few years ago, so it’s a factor for us.
What's your opinion on politics, elections, and the political system?
Politics is difficult. Famous line from Bill Buckley about what would you do if elected? ‘I would demand a recount.’ The truth is that you get lots of pandering in the policies that are proposed. The candidates are pretty smart about economics. The political process is something that doesn’t lend itself to Douglas-Lincoln debates on the fine points. I think the current candidates will be better in office than on a soap box. We have a country that works well regardless of who is in office. You want to buy stock in a business that is so good because sooner or later an idiot will run it. I think we have three very good candidates. The motivations of people running are better than their proclamations. You may win a badge for courage, but you won’t win the presidency in Iowa if you’re against ethanol.
Charlie Munger: When Enron shocked the nation, our politicians passed Sarbanes-Oxley. We are currently shooting at an elephant with a peashooter. I confidently predict we will have changes in regulation, and they won’t work for everybody. Human nature always has incentives to rationalize and misbehave. For this reason, we will have turmoil for as far ahead as you can see. [There will always be something.]
Warren Buffett: I would gladly pay to have this job. Let’s assume I was campaigning for this job, and if so, my answers might be different. It is a corrupting process, naturally. There is a boom in oil and also in soybeans. Because of increases in food prices, would anyone expect to propose an excess profits tax on farmers? But what about an excess profits tax on Exxon? Situational ethics and policymaking depend a lot on voters. I’m not sure I’d be able to do better, but if I wanted to be President, I’m not sure my behavior wouldn’t be bad too. Any one of the three candidates will do well in the White House. I think they will do what is best for the country.
Maybe there should be a Buffett/Munger Presidential ticket. Please name three difficult policy decisions and three perfect solutions to better the country.
Warren Buffett: Charlie will serve the first term, so he’ll answer first.
Charlie Munger: That takes us so far afield. Three perfect solutions to the problems of mankind, we are not up to it.
Warren Buffett: I would do something about the tax system. The super rich should pay more. The middle class should pay a little less.
Can volunteering help the economy? If so, then why aren't people doing it? I stick to my motto if you see something that needs doing, do it.
Volunteering can definitely help the economy. Value is created in many ways and public service is definitely an important one. It is an investment in our society and country. Your attitude will bring positive dividends to not only yourself, but to others around you.
Should the U.S., and U.S. companies such as Coca-Cola, withdraw sponsorship of the Beijing Olympics because of humanitarian values?
Warren Buffett: I think the Olympics should be allowed to continue forever with everyone participating. It is hard to grade a couple hundred countries. It is a terrible mistake to try to start grading. The more that participate, the better. I would not start getting punitive. I think it’s a terrible mistake to ban countries from the Olympics. The United States only started allowing women to vote in the 1920s, and I consider that a huge violation of human rights, but we wouldn’t want to be banned from the Olympics for the years prior. I think that over time, China is contributing and getting better.
Charlie Munger: Warren understates my position. Many are distressed by imperfections in China, so I ask - has China gotten more or less imperfect as the decades have gone by? It is moving in the right direction. That is a good thing, and it is not good to pick the worst thing about a person you don’t like and obsess about it.
Warren Buffett: You will do better with people you are working with if you nudge them a bit.
Why is it that Americans do not save, and what can we do?
Warren Buffett: The savings rate has fallen. It may be negative. But the value of the country in real terms increases decade to decade. It’s worth more now than 20 years ago—something good has happened. The propensity to save seems innate in some places. If you own Berkshire, you are saving because we retain earnings and therefore you are net saving—and I have been doing it in Berkshire for 43 years. I don’t know that the savings rate—based on calculations on consumption and imports—is accurate. We are importing $700 billion more of services than we are exporting [per year]. We are exporting claims against America. But we are so rich, it may not be really apparent. Average standards are likely to improve, but it may be disproportionate. In net real terms, the value on a per capita basis will very likely increase decade to decade. But it is nothing compared to China or Korea where the savings rate is very high. We may not save very much because we don’t need to. We are a very rich country, and we may not need to save as much as other countries trying to reach their potential.
What is the future of mass transit?
Warren Buffett: Passenger traffic? [Yes.] The American public generally doesn’t like mass transit. Americans have a love affair with their car, which translates into an aversion to mass transit. One person to a car seems to be a popular method for moving around. We are unlikely to see expansion in mass transit. The American public is genetically averse to mass transit. It seems to be human nature that people want to drive even if they have to pay $4 a gallon on gas and double on parking. I wouldn’t be optimistic about something that has a long trend in human nature to reverse all of the sudden.
Charlie Munger: You have a more optimistic view of it than I have.
Is there a chance the CDS [Credit Default Swap] market may eclipse subprime?
Warren Buffett: The CDS notional value is about $60 trillion. There is lots of double counting, etc, but no doubt it is a lot of money. They are swaps, or insurance against companies going bankrupt. We have written two types of derivatives, and we have insured a swap that pays to someone else in the event of a default on high yield indices. I think we will make significant money. I think there is no question that the corporate default rate will rise. That has been included in the price in writing this insurance. Will the CDS market lead to chaos? Probably not, but if Bear [Stearns] had failed, you would have had chaotic conditions. A CDS is a payment by one party to another. When someone loses money on a loan, they’ve lost real money, but there is not a swap of dollars immediately when the loan goes bad. In a CDS, there is an exchange of cash. Whether the counterparties fail [on a massive scale]—I don’t think it will happen. We’ve had enormous collateral payments from one firm to another in this recent crisis. Fairfax Financial made $1 billion in CDS’s. This means another guy lost $1 billion. They have been the most volatile of instruments and it really hasn’t created a problem in the system. If the Fed must step in, I don’t think it will be due to CDS’s. It may cause big losses, but it will be matched by big gains by others. There is a problem of an overnight disruption in the system [i.e. Bear, nuclear bomb]—where discontinuity and collateral posings are inadequate. At that time, large CDS exposure could exacerbate chaos to a considerable degree.
Charlie Munger: Could we have a mess in CDS’s? Yes, but the stupidity is not as bad as sweeping bums off skid row to give them houses. There is an issue of insuring against the outcome of losing money on a $100 million bond issue when you have $3 billion worth of contracts on that $100 million bond issue—there are incentives to manipulate the smaller loss to make a big collection on the larger position. It used to be illegal to buy life insurance on people you didn’t know, with big payoffs in the event of their death. Why did we want enormous bets to be made in unregulated markets? We have a major nutcase bunch of regulators and proprietors in this field.
Warren Buffett: Charlie 1 point, Invisible Hand 0 points.
How do you envision a nationalized healthcare system, and how it would affect Berkshire’s portfolio?
Munger: Something more like Europe, supplemented by a private system, like private schools [compete with public schools], will probably come to the U.S. in due course. I’m a Republican, but I’m not personally horrified by that. I wish they’d put it off for a year to solve other economic problems.
Buffett: Berkshire will adjust. It would pose no specific problems and specific opportunities.
Would the government’s stimulus spending be better spent acquiring national infrastructure, as during the Great Depression, in order to put people to work?
Munger: Let me answer that one: Yes. [laughter]
Buffett: I certainly agree. A lot of wonderful things were done in the Great Depression. The 1930s should be the goal and model. Obviously, we want to use it intelligently. The intent is to get it into action quickly. Any time the federal government does something on a massive scale, there’s going to be a lot of slop. We have a [political] system that doesn’t detach the interest of individual legislators [leading to pork-barrel spending]. I am distressed when I look at what is attached to the bill. When the American public pulls back, government has to step in. There will be consequences [of the stimulus program].
Munger: One no brainer: Nationwide, we need a hugely improved electrical grid. That will help Berkshire subsidiaries, but we don’t depend on it. The chance that it won’t help us is zero.
Will retail, manufacturing and service businesses still be below their 2007 levels three years from now, given how they have been affected by the recession?
Buffett: I don’t know. If housing starts [remain] at 500,000, we’ll get [housing market] equilibrium in two years or less. The government is now unhappy that people are saving. Retailing has been hit very hard. The higher end has been the hardest hit — it will last quite a bit longer. The experience of the last couple of years will not go away [be forgotten]. Retail real estate will be a tough area for quite a while. Shopping centers will be tough for years. Cap rates of 5% will look pretty silly. Service businesses are generally the better ones, because they require less capital and can be more specialized. I would not look for a quick rebound. South Florida will be a problem for a long, long time.
Munger: I have nothing to add.
[Comment: A “cap rate” is essentially the reciprocal of a price/earnings ratio, so a cap rate of 5% corresponds to a P/E of 20, which would be a rich valuation for the stock market.]
What problems do you see in the world economy?
Buffett: There’s always a lot of things wrong in the world; unfortunately, it’s the only world we’ve got. We have a great system that works very well. Over time, people will live better and better. Our system unleashes human potential like no other—we haven’t reached the end of that road by a long shot. We have these interruptions in the progress of society, but we have moved ahead pretty fast. We’ve wasted human potential in fits and starts. There will be bad years in capitalism, but in the 20th century there’s been a seven-to-one improvement in the standard of living. There is enormous human potential, and the opportunities will win in the end. Every year we meet you can name a bunch of problems. Your children and grandchildren will live better than you do.
Munger: Interestingly, now as I get closer to death, I grow more cheerful economically. I especially like that we are about to harness the direct energy of the sun and [to get drinkable water from] seawater. It’s probably a mistake to think only about your probable misfortunes. You should think about your blessings as well. The main technical problem of man is about to be fixed — energy.
[Q - A shareholder from Dayton, Ohio referred to Buffett’s op-ed piece in The New York Times, wherein Buffett said he was moving toward a 100% investment in U.S. stocks, and asked him to comment on the relative severity of the current downturn.]
Buffett: Stocks got much cheaper in 1974, about four times earnings, than now, but interest rates were far higher, so maybe they were not really cheaper. It’s not as dramatic as in 1974 in terms of buying opportunities—that was the best period I’ve seen. I bought some equities and bonds, too. I like when things get cheap, as long as the value’s in the business. I’d much rather pay half of X than X.
Munger: It’s nothing like 1973 – 74. I knew at the time that was my time [to invest], but I had no money—but that’s part of the way it happens. 1974 was obvious. If I were you, I wouldn’t try to wait for 1973 – 74 [conditions].
Buffett: What I paid yesterday doesn’t matter. Picking bottoms is not our game— that’s impossible. I spend 99% of my time thinking about Berkshire [not my separate money]. We had the chance to buy great corporate bonds. Our idea is not to tiptoe into anything.
Munger: Sometimes opportunities are under shell A when [you’re] looking under shell B.
Financial reform - what are the good ideas, and what are the bad ideas?
Warren Buffett: The bill in Congress is 1550 pages. Charlie you take first 1500 pages... I’ll take the last 50.
Charlie Munger: My guess is most of the Senators have not read the bill and everyone is in doubt about what is going to happen. One thing is perfectly clear, our governmental system which regulates banks and investment banks, was too permissive. Every big bank was going to go blooey. A system so important with this risk should be changed. People are thinking about that. Banks hate losing investment flexibility. JP Morgan would hate to give up the biggest derivative book in the world. However, so much derivative exposure may not be good for the country.
If he were the benevolent despot of the country he would make Volcker look like a “sissy.” He would reduce the activities of banks that are permitted. We need a new version of the Glass-Steagall Act that limits what commercial and investment banks are allowed to do. They need to be much safer businesses. Then Charlie gave an example of an S&L he was familiar with. As long as the repertoire was limited, the S&Ls were ok. But when people have unlimited credit like under the repo system, they are bound to go “plum crazy.”
Warren Buffett: What would you vote today?
Charlie Munger: I don’t think anybody knows what’s going to happen. I don’t know enough about it. If I was the benevolent despot of America, I would make Paul Volcker look like a sissy. I would reduce the activities permitted if you used the government guarantee. If you are defacto using government money to make a business run, then you should not have a structure so complex that even the partners in the business don’t understand the balance sheet. The complexity in the system is ridiculous and counterproductive. We need a new version of Glass-Steagall that drastically limits what both commercial and investment banks are allowed to do. When we owned a savings and loan, we had a restricted repertoire. We had government [deposits], and we were limited. If you give human beings too much freedom, especially in the repo system, they will go plumb crazy, and of course they did.
The leading cause of death among young people is car crashes. BRK insures many of these crashes. New technology is helping give people feedback on their driving. How are GEICO and the Gates Foundation positioned to help save lives and improve this technology?
Buffett: The Gates Foundation has a large initiative on cigarette smoking, which is probably a lot more serious that car crashes. The Gates Foundation can’t solve all the problems in the world. Deaths/mile have diminished over the years as cars have become safer (not due to cell phones and Blackberries of course, technologies that are leading to more deaths). Everyone has an interest in bringing down deaths and GEICO has a large safety program. Auto companies are working to make cars safer as well.
Munger: Nothing to add
What is biggest challenge facing the US economy – what are implications of that for investing globally over next decade?
Warren Buffett: Charlie? [laughter]
Charlie Munger: Thank you for that easy problem. We haven’t made our way in life with great global allocation systems. Berkshire’s attitude is to concentrate on what we know, find things that seem sensible to us and let everything else fluctuate as they will. We do prefer to do more in responsible countries. More responsible countries make us more comfortable. We don’t have global allocation system at Berkshire unless WB is hiding it from me.
Warren Buffett: Not that one. [laughter]
Warren Buffett: We aren’t moving BNSF to China... A nuclear or biological event is pretty high probability over next 50 yrs. We have made remarkable progress in USA – it is a system that unleashes human potential. This crowd is not smarter than 200 yrs ago, and don’t work harder, but boy do they live differently. System allows ordinary people to do extraordinary things over time. We don’t know our own potential -- just like guys in 1790 hoping for better farm tools. We hope rest of world does well, it is not zero sum. If China and India do better, we don’t necessarily do worse. I would be perfectly content to limit investments to US alone. But I’d rather have the whole world. Opportunities will be ample. I would not run from the United States.
We need hope and jobs. Can you help?
Warren Buffett: We will hire people when we have something for them to do. When BNSF carrying 173,000 loads per week (vs 150k before), we need more people. In our carpet business we are still down 6,000 from peak, but there is no reason to hire people if you have nothing for them to do. Get someone in textile mill who is 55 yrs old, they speak Portuguese – it is hard to retrain them. If you believe in creative destruction, you better have a social safety net. We have a pretty good one in this country, a lot better than 30 yrs ago. It isn’t going to go away. Society owes some minimal living standard to people looking for work. But I don’t think Berkshire Hathaway should be the social safety net.
Charlie Munger: If Berkshire tried to hire make-work jobs to raise hope, the net effect over time would be to reduce hope.
Warren Buffett: I believe the same, but rather Charlie say it.
This was an opportunity, but in thick of the action, I was too scared. Given that we are not out of the woods yet in terms of the economy and the financial system, how would you assess the current buying opportunity for stocks?
Buffett: He has seen some times when undervaluation screamed at him and when overvaluation screamed at him. For the most part he believes that we have been somewhere in between. Right now we are somewhere in between and it is not the best time he has seen.
In terms of being scared during the depths of the market lows, if you can’t handle the ups and downs and have the right temperament then you won’t make much money in the investing business. People are focused on the pricing and quotes for stocks on a daily basis. But you wouldn’t buy a farm and think about what it was worth on a day to day business. Ben Graham wrote about the importance of temperament years ago and everything he said still applies. Most people don’t have the temperament to handle the ups and downs in the market. People who own a farm don’t think that the market and the price is “telling” them something. What counts is buying a business at a great price and forgetting about it for a long time.
Munger: Said he developed more courage when he learned he could handle hardship. Maybe people should get their feet wet with more failure.
Buffett: How liquid is my farm? I’m not expecting prices to tell me what to do. There is a lot of interest in investing. What counts is buying a good business at a decent price and forgetting about it for a long, long time.
Is there a way to create synergies between BRK companies to promote solar solutions?
Charlie Munger: Solar solutions are coming because they are so obviously needed. I never pass on an opportunity to not put them in, because they will get cheaper.
Warren Buffett: That’s long term thinking!
Charlie Munger: I have to think of long term. And I am going to miss you terribly when you’re gone. It reminds me of the old quote, Husband: “Will you still love me if I lost all my money?” Wife: “I will always love you but I will miss you terribly.” What would modern civilization do if we had no alternative to fossil fuels? Cities are choking on themselves. More renewable energy is the answer. It is a stunningly stupid idea to grow corn with fossil water and fossil fuel. I am enormously optimistic about the new energy grid, and we will be way better for it. It is not all that important if solar power costs twice as much as we are used to – it is a blip in the economic future. Immediate business decisions, frequently the right answer is counterintuitive. Wait, they will get cheaper.
Warren Buffett: I have nothing to add. [laughter]
Rail business – does our country need high speed passenger rail? Private or public?
Warren Buffett: By its nature, it is non-economic when competing with auto and air. We don’t have point to point density to produce economic return. If it gets done, unless heavily subsidized, it won’t meet test for private economics.
Charlie Munger: I know little, but I am at least as dubious as you are. It would be competing with a system that works. The cost of a high speed rail in a densely populated place is enormous – a bottomless pit of cost and trouble in LA.
Warren Buffett: If it is high speed, it can’t stop very often. It can’t spoke easily. They are considering a trolley system in Omaha – it will cost several hundred million dollars, and revenues are something like $400k, not including operating expenses. The math gets to be staggering. Money is from federal government so costs are shared, and it was done in Buffalo – and costs are huge – it would be cheaper for society as a whole to give everyone a cab ride. It is tough in a country of 3mil square miles. It is hard to make math work. If it becomes a huge project of government, then maybe it will work. But it won’t happen with money that wants a return.
What would be impact on portfolio of a Chilean size earthquake in LA or SFO?
Warren Buffett: Fire following SFO quake was major cause of damage. In the industry they call it shake and bake – how much shake and how much bake? We think hard to get over $100bil. Big quakes in Pacific Northwest – possibility of high quake, new Madrid Missouri was well over 8 scale. I tend to think, when I think about quake exposure, I think $100bil. Northbridge caused more damage than San Francisco. Berkshire is totally prepared. I think in terms of $250bil worst case. And my guess is that Berkshire would still have positive earnings of some substantial amount in that case.
Charlie Munger: A lot of fire in SFO in 1906 caused the damage, a lot of damage in an earthquake is uninsured. Earthquake insurance is not universal like fire insurance. Recent quakes didn’t cause much fire. Fire or wind catch people worse than earthquakes. Chile I think 40% of cost was tsunami, and 60% quake.
Warren Buffett: We have so much earning power outside insurance business. We have 3-4% of all earthquake insurance on $250bil, or $10bil dollars, and our pretax earnings are more than that. Everyone else gasping, and we’ll be okay.
How do you hope to tackle administrative costs when it comes to Aids treatment in Africa?
Bill and Melinda Gates can tackle these issues better then I can. I work on giving them more money so they can have more to work with. I am better suited to raising the capital, letting others do the work they are good at. We can do a lot more with private charities than the government can. We judge our success on how intelligently we attack a problem rather than on success or failure. Bill Gates regards every human life as valuable; we in the US need the help much less then other countries do.
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