Berkshire Hathaway 2013 Annual Meeting Audience Question # 12

The long term risks of the Fed stimulus

Warren Buffett:

Station 4?

Audience Member:

Thank you. Scott Moore, Overland Park, Kansas.

With the Fed buying 85 billion per month of mortgage securities and Treasuries, what do you think are the long-run risks to this process, and how does the Fed stop this without negative implications? Thank you.

Warren Buffett:

Charlie, you answered that yesterday in an interview, so I’ll let you lead off.

Charlie Munger:

My basic answer is I don’t know.

Warren Buffett:

Yeah.

I might say I have nothing to add.

But Scott, you came from Overland, so we’ll do our best.

Charlie Munger:

I think you’re… the questioner… is right to suspect that it’s going to be difficult.

Warren Buffett:

It’s going to be… yeah, it is really uncharted territory.

And as many people have found out, whether it was the Hunt Brothers buying silver or whatever it might be, it’s a lot easier to buy things, sometimes, than it is to sell them.

And the Fed’s balance sheet is up around 3.4 trillion now, and that’s a lot… those are a lot of securities.

And the bank reserve positions are incredible. I mean, Wells Fargo is sitting with $175 billion at the Fed earning a quarter of a percent, and really earning nothing, after attendant expenses.

So, there’s all this liquidity that’s been created. It hasn’t really hit the market because the banks have let it sit there.

You know, in classical economics, you know, that’s how you juice the economy, and you pushed it out by having the Fed buy securities and create reserves for the banks and all of those things.

But, believe me, the banks want loans. I mean, they are not happy… Wells is not happy… having 175 billion at the Fed, and they’re looking every place they can to get it out, with the proviso that they hope to get it back from whoever they get it out to, which can slow down a bank at times.

But it— we really are in uncharted territory. I’ve got a lot of faith in Bernanke. I mean, he… if he’s running a risk, he’s running a risk he knows and understands.

I don’t know whether he’s affected by the fact that his term expires pretty soon, so he just hands the baton off to the next guy and said, “Here. Here’s this wonderful balance sheet. And all you have to do is bring it down a few trillion dollars,” you know.

And I gave a few lectures at George Washington University last year, if you care to read them, and maybe it’ll help you.

The… this is something we haven’t seen. It certainly has the potential for being very inflationary.

It hasn’t been so far. In fact, my guess is that the Fed wishes it had been a little more inflationary.

If you’re running up a lot of debt, it gets measured in relation to nominal GDP, and the best way to run up… easiest way to run up, not the best way… the easiest way to run up nominal GDP is to inflate, and my guess is that they never would admit it but that the… that at least some Fed members… are probably disappointed that they haven’t seen more inflation.

It won’t be when they start selling. It’ll be… when the market gets a… any kind of a signal… that maybe just the buying ends, maybe that selling will take place, you know, it’s likely to be the shot heard around the world.

Now, that doesn’t mean the world will come to an end, but it will certainly mean that everybody that owns securities and who’s felt that they’ve been driven into them by extremely low rates or that the assets have to go up in price because interest rates are so low, will start re-evaluating their hand, and people re-evaluate very fast in markets.

So, while I’ve been talking, Charlie, have you got any new insights?

Charlie Munger:

Well, generally speaking, I think that what’s happened in the realm of macroeconomics has surprised all the people who thought they knew the answers, namely the economists.

Who would have guessed that interest rates could go so low and stay so low for so long? Or that Japan, a mighty, powerful nation, could have 20 years of stasis after using all the tricks in the economist’s bag?

So I think given this history, the economists ought to be a little more cautious in believing they know exactly how to stay out of trouble when they print money in massive amounts.

Warren Buffett:

It is a huge experiment.

Charlie Munger:

Yeah.

Warren Buffett:

What do you think the probabilities are that within ten years you see inflation at a rate of 5 percent or higher a year?

Charlie Munger:

Well, I worry about even more than inflation.

If we could get through the next century with the same results we had in the last century, which involved a lot of inflation over that long period, I think we’d all be quite satisfied.

I suspect it’s going to be harder, not easier, in this next century. And it wouldn’t surprise me…

I’m not going to be here to see it… but I would predict that we may have more trouble than we think… than we now think.

Warren Buffett:

Charlie says he won’t be here to see it, but I reject such defeatism.

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