Wednesday, August 19, 2009 2 comments ++[ CLICK TO COMMENT ]++

Warren Buffett warns policymakers about inflation

Thanks to 24/7 Wall St for bringing Warren Buffett's latest opinion piece in The New York Times. Dated, August 18, 2009, Warren Buffett's piece is directed at policymakers and others with influence in the US government. Cementing his inflationist stance, he warns about the risk of inflation due to the deficit—unprecedented outside wars.

I think Buffett is correct in suggesting that the FedRes will take orders from the government and start printing money if bond buyers stay away from the government debt. Although the FedRes is thought to be an independent institution, it hasn't been always like that. Some claim that it was basically taking orders from the government from the 1930's to 1950's.

The question for investors is what the outcome will be, if Buffett's scenario unfolds. Buffett implies that inflation will be high and he has bet on that. I lean more towards deflation (but I don't have much conviction.) The FedRes was monetizing debt in the 30's and 40's and inflation wasn't high. Japan also has not seen much inflation (but I'm not sure how much of the Japan government debt is purchased by the JCB i.e. purchased with printed money.)


2 Response to Warren Buffett warns policymakers about inflation

August 19, 2009 at 12:40 PM

Inflationis a dynamic process; we don't know if, when and how newly-created bank reserves held with the Fed will be transmitted into the "general economy" (whatever that means).

For instance, such reserves might find themselves funnelling into commodities ('70s and this decade); wages ('70s); consumer prices ('70s and, briefly, this decade); technology stocks ('90s); or real estate ('70s and this decade).

However, a fe points about the '30s, '40s and Japan.  First, as we know, US monetary aggregates plummeted in the late 20s.  Consumer prices followed.  It took several years after the monetary spigot was turned back on for consumer prices to reverse the trend.  But they did, if not to the extreme:  conumer price increases reached ~5% in '34 and '37.  When the fed then tightened, they dropped.

But then, in '42, consumer price increases touched 13%.  Somewhere around this time the government imposed price controls and rationing, and only then did consumer price increases plummet again.  When price controls and rationing were finally lifted after the way in '46, consumer price increases reached 14%.  And then, in the 50s to early '60s, when the government greatly scaled down, the US enjoyed a long, low and stable pricing environment.

In other words:  price controls and rationing counteracted monetary growth and kept consumer prices contained.

As for Japan, the Bank of Japan didn't start Quantitative easing until 2001 -- a full 11 years after their credit bubble began imploding.  Moreover, Japanese monetary aggregate growth -- from M0 all along the line of Ms -- never approached what we've seen here in the US since this past Fall/Winter.  And, remember, Japan is a creditor nation vis-a-vis the rest of the world and is a net exporter.  They haven't had to seek funding elsewhere, regardless of their government's massive defecits.

Still we can't know how all the dollars the Fed prints will make their way through the system.  And we can't know exactly what will ultimately happen to all the dollars we export and when it will happen.

Sivaram Velauthapillai
August 19, 2009 at 3:55 PM

Let me see if I can poke some holes in your thinking... Let's ignore the definition of inflation and what is "high inflation" versus normal inflation, and so on...

I think your first argument (price controls) seems wrong; the second one (how Japan was quite different) is a more powerful argument...


I'm not an economist but doesn't economics say that price controls and rationing should not impact prices in the long run? After all, didn't we have high price increases in the 70's precisely because of price controls, wage controls, and so forth? So, I think the price controls did not cause the inflation to be low in the 40's. If anything it should cause prices (perhaps of the goods not controlled by the government) to rise because of shortages.

Overall, the period in the 30's and even 40's consisted of low inflation and even deflation. I don't think price controls will lower inflation. For instance, if the government decided that oil price should be set at $50, I'm pretty sure that it will not lead to lower prices.


I have to do more research on Japan. You are right in saying that quantitative easing did not occur until almost a decade afterwards. However, the government did spend huge sums to revive the economy. This isn't money created out of thin air but it should still have been inflationary. Yet it wasn't. Yes, a lot of it came from Japanese citizens but, in this discussion, I don't really think it matters where the money is coming. The key point is whether it is causing prices to go up or not.

I think only the base money supply in present USA is much higher than Japan. Broad money supply measures are not high in USA (here is M2 yoy change; M1 yoy)

In any case, if we go back to Warren Buffett's criticism, he isn't criticizing the money printing of the Federal Reserve; instead, he is criticizing the deficits of the government. In terms of deficits, the current situation is similar to Japanese govt spending (but as you point out, the JCB didn't undertake radical policies as quickly or to the same degree.)

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