Buffett Is Having Sleepless Nights. Here's Why. - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Buffett Is Having Sleepless Nights. Here's Why. 

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In this issue:
» Compare your salary to your counterparts in other nations
» Poor monsoons in India give shivers to the world
» RBI's novel strategy
» Demand for gold falls to six year low
» ...and more!!

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Warren Buffett, in his traditional simple and homespun style, wrote recently an article in The New York Times explaining how the policies the US government is currently using to tackle the crisis can affect the country over the long run. Call it a u-turn from the world's second richest individual to what he had believed in October 2008 when he said, "Buy American. I am," the fact is that US government's and central bank's policies are now seemingly giving sleepless nights to this legendary investor.

Despite the fact that the US economy appears to be on a slow path to recovery, the cause for Buffett's concern is the enormous dosages of 'monetary medicine' that continues to be administered, which is creating an annual deficit in the US of alarming high levels. While most of the effects of these actions are still invisible, their threat can be as disastrous as that posed by the financial crisis itself.

Buffett suggests that to avert such a disaster, the US government must end the rise in the debt-to-GDP ratio and bring the country's growth in debt back in line with the growth in its resources. If not, Buffett warns that the US runs the risk of becoming a 'banana republic', a term that is used to describe a country that is politically unstable and whose economy is dominated by foreign companies and depends completely on one export (such as bananas) for its livelihood.

Buffett's last article - Buy American. I Am written during the peak of the credit crisis last year where he advised that buying stocks was the best bet at the time, rested on this very faith - that the US government will show the restraint and wisdom necessary to exit this monetary and fiscal extravagance at the appropriate time. But it didn't. And now that is making Buffett scared.

01:16  Chart of the day
Today's chart(s) is a clear indication of why companies in the Western world will continue to look towards India for cheaper outsourcing options. As the left hand chart shows, an employed employee in Mumbai earns gross wages of around US$ 1.3 an hour, just around 5% of an average guy working in New York. And if it assumed that New York won't be the right comparison considering that most employees out there work for high paying financial firms, let's compare Mumbai with Rio de Janeiro (Brazil) and Beijing (China). Wage levels there are still 4.3 times and 2.5 times respectively of what an employee in Mumbai earns per hour.

Data Source: Prices and Earnings 2009, UBS

To look at these data points in a more interesting way, see the chart on the right. While an employee in Beijing has to work 73 hours to earn enough to buy an iPod Nano, the amount of work for the same product to be put by an employee in Mumbai is 177 hours!

Fear of a spike in food prices has been palpable in India ever since rains have played truant in the country this year. We are well into August and monsoons have already been 29% below normal with almost 50% of the total districts in India reeling under a drought. The government has assured that it would use its reserves to put a cap on rising food prices and also increase ration supplies, especially in the case of wheat, rice and sugar which have been badly hit by the drought. Thus, the government will have to do all in its power to ensure that there is a smooth operation of the food distribution system and the national markets in the country.

Globally, the International Food Policy Research Institute has warned that even if global reserves are relied upon to curb hunger and price rises, rebuilding stocks from the low levels will be difficult. Food prices had spiked internationally in 2008 as high fuel prices and the subsequent interest in biofuels impacted production of other crops. Therefore, a lot of issues will need to be addressed if a food crisis in the future has to be prevented.

People living in big towns may have taken banking services for granted. But the fact remains that an overwhelming 70% of our population does not even have a banking account. Thankfully though, the importance of bringing such a huge swathe of our population under financial inclusion has not lost on our banking regulator, the RBI. And this has led to the germination of a brand new idea. A report by the RBI working group has come out with a recommendation that in order to have a speedy and cost effective financial inclusion, people such as kiranawalas, petrol pump owners and retired teachers be allowed to function as business correspondents (BCs) for banks in areas where there are no bank branches.

Ideally, these BCs should be allowed to undertake activities such as disbursal of small value credit, recovery of dues, collection of small value deposits, sale of micro insurance, pension products and other such activities. The report has even gone to the extent of discussing the remuneration for BCs stating that as they may take away high volume but low value work from banks, the resultant cost savings could be transferred to BCs as their compensation. While the RBI is still contemplating the same, we hope that such novel ideas do see the light of the day as it will help in bringing about a structural change in our banking system and add to the long term well being of the economy.

Be it equities or gold, investors seem to have a logic which is often at odds with the real economy. Stock markets have rallied despite worries over the economy and investors in gold are buying when actual consumers are not. As per the World Gold Council, the demand for gold has fallen to a six-year low in the second quarter and stands at 719.5 tons. Apparently, the recession is affecting demand from the two main consumers - jewelry (down 22%) and electronics (down 26%). The demand for gold fell by 38 % in India, the largest buyer.

However, investors in the yellow metal bought 46% more than last year. Interestingly, the central banks around the world are among those investing. In fact, they have turned net purchasers this quarter for the first time since 2000.

The Indian indices managed to hold on to their gains today after yesterday's dismal performance. At the time of writing, BSE-Sensex was trading higher by 300 points (2%). Other major Asian indices also ended in the green today.

According to a survey carried out by us, we found that almost 60% of our women readers did not take financial decisions on their own and instead, took help from their husbands. A majority of them confessed that heavy financial jargon and its equally complicated explanations left them all the more confused! In an endeavour to address this growing need among our women readers, Equitymaster has launched an exclusive investment guide for women, Rendezvous With Money. Download the free copy now!

04:43  Today's investing mantra
"People who habitually purchase common stocks at more than about 20 times their average earnings are likely to lose considerable money in the long run." - Benjamin Graham & David Dodd
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2 Responses to "Buffett Is Having Sleepless Nights. Here's Why."

Vikas P

Aug 21, 2009

What we are seeing at play are two phenomena
1) Momentum of events - In a large economy like the US everything gets magnified in geometric proportion. So the corrective actions as well as the side effects get magnified.
2) The belief that the consensus must be right - In a capitalistic environment strongly governed by targets and incentives, contrarian opinions get easily drowned. Most people and agencies find it easy to play along with the consensus irrespective of whether it is taking things on an improvement path or deterioration. Same has been seen in the creation of the Credit crisis and also in the Japanese banking crisis earlier. The same kind of behaviour is being seen in the response to the credit crisis. America will do good to keep aside its tendency for rapid action under check and do proper evaluation of the contrarian voices.
Vikas P



Aug 20, 2009

I do not think, the interpretation of Buffett's recent article is right(Buffett taking U turn). Buffett would still bet on American corporations. For a US citizen, he gets 0.25% per annum Bank FD and long term US Govt. bond rate is around 4% where some of the great companies like P&G, JNJ, Kraft's dividend yield itself is around 4% who can pass on inflationary input cost to customers easily(and they earn more than 50% outside USA). Instead of keeping the money in low yielding govt.bonds/FD, it makes sense to buy part ownership of these companies - I dont think, there is anything he has written in this Op-Ed to revert that stand.

This is more of a macro comment that USD may loose its sheen and govt. need to act prudent in their expenditure and all.

With regards,

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