»The Daily Reckoning by Bill Borner

Buffett and Munger warn Bernanke
9 MAY 2013

Baltimore, Maryland

Stocks up 48 on the Dow yesterday. Gold up $24.

Nothing remarkable. Nothing very illuminating either.

The newspapers and TV channels all reported the Dow 15,000 story as though it was just a stepping stone...a milestone on the way to 16,000...or 20,000...or 30,000.

Heck, the sky's the limit.

Investors have reached a new level of bullishness. They're borrowing again to buy stocks, confident that prices go in only one direction. Advisors, too, seemed sure that this was not the end of a trend, but the beginning of one. Just what you'd expect at a market top.

There's also a swift current of economic analysis telling us that the commodities boom is over...the Fed has the situation under control...and the bull market in gold is finished.

All of which is amazing...and often breathtaking.

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Stock market investors don't seem to know or care that the only thing holding up their investments is something that will ultimately destroy them.

And that the longer it continues, the bigger the mess when it finally blows up.

We're talking, of course, about the Fed's monetary policy. It is 'experimental.' It is 'bold.' It is also reckless and potentially catastrophic.

Lending money at negative interest rates creates grotesque distortions. Savers get nothing for their trouble - thanks to zero interest rate policy. So they shift to speculating on stocks. The stock market goes higher...but it is not a market you can trust. It is not driven by genuine values...it is driven up by amateur speculators desperate for profit. This won't go on forever.

It is also unnatural for a central bank to print up new money and use it, indirectly, to pay for government operations. If you could do that without penalty - that is, if you could pay for real things with fake money - you would do it all day long. Normally, central banks don't do even try. They know the penalties make it not worth the fleeting enjoyment.

Do you see any penalties, dear reader? We don't. But the fact that the penalties have not yet been assessed doesn't mean they don't exist. And the longer we go without paying them, the greater they will eventually be.

At present, the feds get only rewards.

First, lower interest rates make it easier to finance federal debt.

Second, low debt interest payments reduce federal deficits...so the feds actually borrow less.

Third, while the feds borrow less the Fed continues to buy $85 billion worth of bonds per month. This lowers interest rates even further.

Fourth, low interest rates...and new money from the Fed...boost stock prices as well as bond prices; rich bankers and rich campaign contributors get richer.

What's not to like?

For the moment, nothing. But the markets won't stay in this sweet spot for long. The time will come when the Fed will have to reverse its policies or face substantially higher inflation. But how? Instead of buying bonds, the Fed will have to sell them. But to whom?

Fortune Magazine reports:
    Warren Buffett has a piece of advice for Ben Bernanke: It's easier to buy than it is to sell.

    Buffett, speaking on Saturday at Berkshire Hathaway's (BRKA) annual meeting in Omaha, said he is worried about what will happen when the Federal Reserve tries to wind down its recent efforts to stimulate the economy. Via a program nicknamed QE, short for quantitative easing, the Fed in recent years has bought up over $2 trillion in bonds in order to lower interest rates and promote borrowing and investment.

    Some have warned that when the Fed decides to sell its trove of bonds, or even just stops adding to it, stock markets could tank. Rising interest rates could cause banks to lose billions, perhaps igniting another financial crisis. Buffett says we don't know what will happen, but he is concerned.

    "QE is like watching a good movie, because I don't know how it will end," says Buffett. "Anyone who owns stocks will reevaluate his hand when it happens, and that will happen very quickly."

    "People make different decisions when they can borrow for practically nothing," says Buffett. "It's a huge experiment."

    Charlie Munger, Buffett's long-term chief lieutenant, who was also talking at the meeting, says he worries about more than just inflation.

    "What has happened in macroeconomics has surprised pretty much everyone," says Munger. "Given that history, economists should be more cautious when they print money in massive amounts."

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