Charlie Munger on US economy - "Basically It's Over"

Feb 22, 2010

In this issue:
» Indian equities among best in Asia, affirms Chris Wood
» Taxpayers must not expect much from the Budget
» India's appetite for gold remains insatiable
» "India giving us stiff competition," Obama warns Americans
» ...and more!!

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Charlie Munger, Warren Buffett's aide and Vice Chairman of Berkshire Hathaway is at it again! He, as many would know, has a long history of using parables to educate the public regarding business, economic, and political issues. In his latest parable titled - Basically, It's Over - Munger describes the ascent and descent of the US using the analogy of an hypothetical nation called 'Basicland'.

This parable shows how Basicland, once a flourishing country, came to financial ruin as casino mentality took hold. It led to speculative activity and high levels of debt. An elder statesman known as 'Benfranklin Leekwanyou Vokker' (read Paul Volker, the former US central bank chief) attempted to talk some sense into Basicland's leaders, but to no avail. Eventually, as Munger ends his parable, Basicland came to be known as 'Sorrowland' as the economic and political system collapsed.

Now, that is quite a contrast to Buffett's unflaggingly optimistic view of America's long-term economic future! But then this is Munger, always witty but worldly wise.

 Chart of the day
Today's chart of the day traces the historical performance of Indian companies on the parameter of operating profitability. As the chart shows, while operating margins have improved over the last two quarters as compared to the previous two, these are still below the highs achieved in the middle of 2007. As for the improvement in margins during the past two quarters, it has largely been a result of lower raw material costs.

Note: Data is for 368 of BSE-500 companies, excluding banking and finance companies;
Data Source: CMIE Prowess

So, you missed the 81% rally that the Sensex witnessed in 2009. And are now waiting to make amends for it. But is this the right level to enter? Perhaps not. A 15%-20% correction from the current levels would do just fine, isn't it?

If these are the thoughts entering your mind right now, then you may not be alone. You have CLSA's famous strategist and an acknowledged India bull Chris Wood for company. Writing in his report titled Greed and Fear, Chris has mentioned that one of the economies which has displayed resilience is India and investors want to buy more in Indian shares but are expecting and hoping for more of a pullback as most of the shares are commanding a hefty premium even now. He further observes that India remains complementary to China in an Asian equity portfolio because the two investment stories are, in almost every respect, so completely different to each other.

Talking about valuations, Chris argues that premium given to India vis-a-vis other Asian and world markets is perhaps justified as over time, demand for Indian shares will grow whereas supply will remain limited in view of the low levels of free float.

Taxpayers must not have many expectations from Mr. Pranab Mukherjee as he presents his budget later this week. This is given that the government is expected to raise taxes as a way to partially withdraw its economic stimulus. With fiscal deficit staring at the 7% mark, there is no other way for the government to fulfill its spending program than to raise taxes. So there's disappointment in store for taxpayers!

As for investors, a disappointing budget can serve as a good omen! This is because good quality stocks, which have become expensive after last year's bull-run, can again provide some value if they fall. As the Finance Minister had said last year - "A single Budget speech cannot solve all our problems nor is the Union Budget the only instrument to do so." It will be good for investors to lower their expectations from the budget. Investing carefully and with discipline will rather serve their purpose better.

Anyways, if the advice of Planning Commission's deputy Montek Singh Ahluwalia is to be heeded by the government, the pace of stimulus withdrawal will have to be gradual. He suggests in an interview with The Economic Times - "Any decision on stimulus withdrawal has to be taken by considering both the state of prices and growth...we can consider withdrawal but the pace at which this is done has to be determined very carefully."

Indian stock market had a good outing today. The BSE-Sensex was trading with gains of around 140 points (0.9%) at the time of writing this. Metal and IT stocks were leading the gains on the broader markets. Among other Asian markets, Hong Kong (up 2.4%) and Japan (up 2.7%) closed amidst strength.

The structural change in the Indian economy is now more real than ever before. Ever since liberalization we have been reading and hearing about the Indian middle class saving and investing more. The statistics of more Indians entering the billionaire club make headlines every other day. But of late there has been a tangible prosperity at the broader level. The result on this has been seen in the food price index. Indians falling in the lowest income bracket are now having more spending power. Thanks to schemes like the NREGS, more Indians can afford to pay better prices for food.

More importantly, going by the recent trend in savings and investment growth, India is soon set to surpass China's records. From 38% of GDP in FY09, Indians are soon expected to invest more than 41% of GDP trumping their oriental neighbours. These indicators are surely more reliable when it comes to future economic visibility than trillion dollars of bank lending and multi storey tower constructions.

India's appetite for gold remains insatiable. Otherwise what would explain the fact that the country ended 2009 as the leading gold purchaser. We bought a total of 480 tonnes during the year. While the start to the year was poor, strong demand in the last three quarters is what propelled India to the top slot. However, consumption in 2009 still paled in comparison to that of 2008 as it declined by 33%. One reason that propelled the demand for gold especially during the last quarter was the festive and wedding season.

However, gold also garnered interest as a hedge against inflation. Inflation has been rising due to higher food prices. To add to that the developed world is still not seeing visible signs of sustainable recovery. Little wonder then that the propensity to hold gold has increased. What is more, the RBI's announcement of purchasing 200 tonnes of gold also played a key role in reinforcing sentiment that gold is reliable and safe. In fact, we believe that gold will continue to grab the headlines till such time ill effects of the financial crisis wear off.

There is an increasingly popular view about the emergence of a new world order, where developing nations will outshine the developed ones. One person who certainly believes in it is Barack Obama. For the second time in the last few days he has highlighted how the US is being outdone in several fields. China is building more capital goods. India and South Korea are producing more engineers and scientists. As a result, the US economic supremacy, which stems from superior physical and intellectual infrastructure will face a big challenge in the days to come.

Obama believes this will sentence young Americans to a lifetime of low earnings. In our view, he is right. After all, the developing world including India has been caught in this trap for decades if not centuries now. And history shows that economic supremacy reshuffles periodically.

 Today's investing mantra
"It's in the nature of stock markets to go way down from time to time. There's no system to avoid bad markets. You can't do it unless you try to time the market, which is a seriously dumb thing to do. Conservative investing with steady savings without expecting miracles is the way to go." - Charlie Munger

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5 Responses to "Charlie Munger on US economy - "Basically It's Over""

anil mohindra

Feb 22, 2010

well timed tip & writing on the subject



Feb 22, 2010

Brevity is the soul of wit



Feb 22, 2010

"This parable shows how Basicland, once a flourishing country, came to financial ruin as casino mentality took hold. It led to speculative activity and high levels of debt".

Casinos lead ro speculation and speculation leads to borrowing and debt and indebtedness to other nations. The laid back attitude has been responsible and the nation as a whole wanted to enjoy at other nations' labour and savings! time has proved that this cannot be on for ever!!! Long live free market economy!



Feb 22, 2010

One thing I have noticed about the titles of Five minute wrapups. Its almost always negative about life. Only talks about impending doomsday. Looks like this editor is is serious depression.



Feb 22, 2010

You are right in noting that there US is being outdone in several fields by China and India, Obama's speech to supports this view, however, is it that Obama is fearing India or Indian's. It is true that we have been producing more engineers, doctors and scientists than any other country, but how many of them are we able to retain in India? How much do we spend on R&D? How many inventions do we boast of in the past few years? How many youngsters dream of a career in India?? Although Indians will keep making strides in the field of knowledge India will still require a lot of time and political will to catch up. Till the time our politicians and public at large wakes up and provide adequate infrastructure and support Obama doesn't have much to worry, he can keep importing knowledge from other countries like India.

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