Warren Buffett And The G20

The G20 Finance Ministers and Central Bank governors are meeting today in St. Andrews, talking about the data they will need to look at in order to monitor each other’s economic performance and sustain growth (seriously).

The underlying idea is that if you talk long enough about the US current account deficit and the Chinese surplus, stuff happens and the imbalances will take care of themselves – or move on to take another form.

Warren Buffett seems to agree.

Buffett’s big investment in railroads looks like a shrewd way to bet on growth in emerging markets – which is where most incremental demand for US raw materials and grain comes from.  It’s also a polite way to bet against the dollar or, even more politely, on an appreciation of the renminbi. 

When China finally gives way to market pressure and appreciates 20-30 percent, their commodity purchases will go through the roof.   You can add more land, improve yields, or change the crop mix of choice (as relative prices move), but it all has to run through Mr. Buffett’s railroad.

Of course, Buffett is nicely hedged against dollar inflation – this would likely feed into higher inflation around the world, and commodities will also become more appealing. 

And Mr. Buffett is really betting against the more technology intensive, labor intensive, and industrial based part of our economy.  If that were to do well, the dollar would strengthen and resources would be pulled out of the commodity sector – the more “modern” part of our production is not now commodity-intensive.

The G20 will stand pat, waiting for the recovery and hoping for the best; “peer review” will turn out to be meaningless.  But this raises three dangers.

  1. China will overheat, with capital inflows fuelling a giant credit boom.  Books with titles like “China as Number One” and “The China That Can Say No” will appear.  The boom-bust cycle will resemble that of Japan in the 1980s – you don’t need a current account deficit in order to experience a costly asset price bubble.  Other emerging markets may follow a similar pattern (think India, Brazil, Russia.)
  2. US and European banks will be drawn into lending to China and other emerging markets, directly or indirectly.  In a sense this would be a re-run of the build-up of debt in Latin America and Eastern Europe in the 1970s, leading to the debt crisis of 1982 (remember Poland, Chile, Mexico).  Banks with implicit government guarantees will lead the way.
  3. We hollow out the middle of the global economy – with a few people doing ever better and most people struggling to raise their living standards.  Increasing commodity prices hit hard at poorer people everywhere (recall the effects of the relatively mild run-up in food and energy prices in the first half of 2008).  Global volatility of this nature helps big business but at the cost of undermining the middle class.

By betting on commodities, Mr. Buffett is essentially taking an “oligarch-proof” stance.  Powerful groups may rise to greater power around the world, fighting for control of raw materials and driving up their prices further.  As long as there is growth somewhere in emerging markets, on some basis, Mr. Buffett will do fine.

As for the G20, they are already a long way behind the curve.

By Simon Johnson

50 thoughts on “Warren Buffett And The G20

  1. “likely feed into ” LIKELY = WILL

    “Powerful groups may rise to greater power ” MAY=WILL.

    Other than that — super read as always.

  2. I think it has more to do with the efficiencies of the Railroad vs. the Truck. The only advantage trucks have ever had over railroads is basically they can deliver it door to door. J.B. Hunt and Schneider dominate the trucking industry largely because of their “intermodal” operations (and the fact the basturds at Schneider killed the Union around 1984). When the price of oil rises trains become much cheaper to transport goods. Also Buffet already owned a large percentage of Burlington Northern so he knows the books aren’t cooked.

    I think connecting Buffet to emerging markets is a sad attempt to make the topic of G-20 sexy. Nice try though.

  3. I understand grain, but US raw materials like what? Coal? Timber? China has all the raw materials anybody needs. This isn’t the Eighties and China isn’t Japan. Today the action is in derivative bets and the action is all one way. Moreover, the asset bubble is likely to explode before the China as Number One books even come back in proof from the printer.

    As for Warren, he has all that money and has to buy something. At least the farmers his railroad will be gouging are now all owned by corporations. I think his real bet was on Goldman and Obama.

  4. The railroads of the USA are way obsolete, but they own the tracks. Developing high speed rail will bust airlines on a lot of US travel (anything below 5 hours flying cannot compete against very high speed 250 mph trains). europe is developing rail-road system, where trailers get put on rail (cargo rail go at a standard 100 mph in France). Very high speed cargo is under study in Europe.

    Even Russia is developing high speed rail like crazy, buying French and German systems, trainsets, and technologies. Need I say more?

    Patrice Ayme

  5. Something else: France has started the crackdown on bankers (it’s already implemnented in the Netherlands). The French gov say that, to make a level playing field, the entire G20 needs to follow, and decide and implement similar measures. So the G20 will be behind the curve, if, and ONLY IF, the wall Street-Bama contraption pursue in its mighty wobbling way, same as before: no unemployment is high enough, apparently.

    What does China have to do with it? It’s Wa-Bama who decides whatever happens in the American garden.

  6. Simon: “As long as there is growth somewhere in emerging markets, on some basis, Mr. Buffett will do fine.”

    If you mean commodities will go up as long as there is growth anywhere, you could turn out to be horribly wrong. There was plenty of world-wide growth from 1983-2000 and commodities fell throughout the period.

    What if there is another leg down for the world economy, mainly due to the unresolved over-capacity you allude to? Protectionism and falling consumption lead to a further decline in trade, and natural gas prices stay so low coal prices keep falling as China begins importing gas from Russia, and LNG becomes cheaper… Buffett’s bet might not be so prescient.

  7. Mr. Buffett is essentially taking an “oligarch-proof” stance..?

    I am confident we could now call Mr. Buffet the ‘Oligarch from Omaha’ not the ‘Oracle Of Omaha’… He’s a market creator, maker and mover; not some type of Sion.

  8. China? Aren’t trains an obviously more economic way of transporting things and people than highways and air?
    Generally rising oil prices and generally declining American wastefullness in the face of a downward adjusting economy should hasten and amplify rail usage.
    Rail transport is also less carbon poluting to the atmosphere.

  9. As I read, “Powerful groups may rise to greater power around the world, fighting for control of raw materials and driving up their prices further,” I hear the not too distant drums of war.

    As I read these posts, I appreciate the depth of economic insight but sometimes feel a lack of social-historical context.

  10. What about the emerging markets within China — a large population of people known to save, and that currency about to inflate.

    Investing in railroads also has the function of clustering industrial development close to rail lines, preserving space for other functions including food production and natural-resource extraction.

  11. Warren will next need a bridge building company to create BN routes from Omaha to Beijing….

    The trains will be made up of luxury cars carrying “financial instrument” sales persons.

  12. “US and European banks will be drawn into lending to China and other emerging markets, directly or indirectly….. Banks with implicit government guarantees will lead the way. “

    So, regulatory changes that would make our big banks “too big to exist”, or the reintroduction of Glass-Steagall, would reduce our bank’s international competitiveness?

    Perhaps, this in conjunction with the WTO restrictions on re regulation of financial institutions, is the “elephant in the room” that politicians do not wish to address, and perhaps explains the following statements:

    Barney Frank .House Financial Services Committee Chairman Barney Frank (D., Mass.)
    “.. it would be impossible to legislate a repeal of the Gramm-Leach-Bliley Act.” WSJ, November 3, 2009.

    Diana Farrell ,Larry Summer’s deputy on the National Economic Council and the former director of McKinsey Global Institute: “..the genie’s out of the bottle ..and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that were unlikely to ever come back to or want to come back to.” Diana Farrell And The White House Theory Of Bank Size,The Baseline Scenario October 13, 2009.

  13. This is the most intriguing part of the post:

    “And Mr. Buffett is really betting against the more technology intensive, labor intensive, and industrial based part of our economy.”

    But I don’t understand it. I usually think of this as a continuation of our entire economy (or most of it) being shipped off to China, India, etc. which may be a good thing, I don’t know.
    In this post, do you mean that if Buffett wanted to invest in technology he would have bought more Intel, or something like that? I don’t know of an example for industry, does America have any industry left?

    Ed Beaugard

  14. Yes, this failure to re-regulate is very worrying, and you’re probably right that for now the outlook for anything like bringing back Glass-Steagall looks bleak. Maybe this has to do with Simon Johnson’s idea about ‘regulatory capture’.
    Perhaps a true global collapse of the economy and not a near-miss like we had a year ago, will finally convince governments about regulation.

    Ed Beaugard

  15. We’re still making a lot of weapons. My son’s a machinist, laid off last fall. He made blades for the inside of jet turbines.

    Now, the only jobs are cranking out machine gun parts. He did that for a while, and didn’t like the feeling that his work could blow up in someone’s ear, let alone that it was intended to take someone’s life.

  16. With all the printing that China has done, the RMB will be depreciating. You can’t print 2 trillion of your own currency and then think you can buy up foreign assets with it. The only thing holding them up is the multinationals attempting to “invest” in their consumers.

  17. Once again there is practically no chance that this economy will be run for the benefit of the people in it.

  18. “When the price of oil rises trains become much cheaper to transport goods.”

    Yep! That’s exactly right Ted.

    So what happens to the price of oil when China’s currency appreciates and ours weakens? Conversely, what happens to the price of oil if Simon is wrong, the dollar strengthens, and commodities go bust?

    I think you accidentally provided more proof that Simon is right.

  19. Explain #2. China has a trillion $US and “U.S. and European banks will be drawn into lending to China”?!

  20. Point. Hard to argue with Simon’s analysis of our near economic future and the general ineptitude of the G20 but I can’t see that Buffet’s move on BNSF either supports or refutes it per se.

    If you want to see how BNSF brought in their money in 2008, check out this Reuters backgrounder and the 2009 investor report.

    Click to access 2009bbt.pdf

    If I’m breaking it down right, it looks like about 15% port container, 16% domestic container, 23% industrial products, (building and construction materials, petroleum products, chemicals and plastics, food and beverages), 23% domestic coal shipping, 13% domestic agricultural, 7% agricultural exports, 3% cars and car parts, 2% other stuff.

    A major caveat here would be the relative profitability of each sector. But if you want to try to link all this to a hot topic, try “Buffet bets on no climate change bill” based on that whopping 23% revenue from coal shipping, which almost exclusively feed domestic power plants. Taken as a whole, 75% of BNSF’s revenue derives from domestic economic activity. (You can quibble over a point or two on industrial products, but it’s overwhelmingly domestic traffic. To the extent that the US exports building materials, these tend to originate in the Pacific Northwest and BNSF handles them very little or not at all.) This is indeed a big “bet on America” to the extent that three quarters of BNSF’s revenues depend on a domestic recovery.

    As for the dollar hedge, it consists in the potential growth in the 7% agricultural export piece offsetting the falloff in the 15% port container piece (or even, hope against hope, a modest shift within the port container sector from import to export traffic: I know, I know, but it theoretically should take place, if only to a microscopic degree). But that hedge represents less than a quarter of the total operation. If overall domestic activity continues to be flat, BNSF’s screwed along with the rest of us.

  21. Buffet tends to invest only in things that he feels he understands. In the past, that has largely kept him out of computers, software etc., and in more mundane things.
    Maybe SJ has something in mind that has gone over the heads of a number of us, but I suspect Buffet is simply making a domestically oriented investment based on the idea that rail use is going to see a revival.
    Personally, I think he’s right, and with the US auto industry on the ropes, they may not be in as good a postion to pay off politicians who in the past did Detroit’s bidding, at the expense of rails and mass transit.

  22. According to The Economist, Buffet’s mega-purchase is also motivated by the widening of the Panama Canal.

  23. I just read on Bloomberg he made money trading derivatives this year (and lost money on derivatives last year). Unless preferred shares count as derivatives (and it’s news to me if they do) I’m pretty surprised. I never thought I would see Buffet trade derivatives.

    I think Buffet is a typical of the super-rich, we only get to see the parts of him he wants us to see. When I found out he was having an extra-marital affair many years ago (I’m not sure I think it was in Money magazine in the late 1980s, but I’m not certain) my little naive balloon got popped. I don’t think you can get as far in life as he has without a few icy veins running through you. I bet we would be surprised.

  24. Rail will help reverse global warming, so maybe his investment side is one with his philanthropic side.Plus there aren’t too many easy picks in a down economy.

  25. I have to completely disagree with the author’s views on why Warren Buffett purchased BNSF. This is a very-long-term purchase, which is how Berkhire Hathaway operates. If you buy a company outright and hold on to it, as Berkshire Hathaway always does, it is a purchase until termination. It is essentially the purchase for the life of the asset (in this case, possibly 50 to 70 years, or until railroads become obsolete.)

    If you think of the long-term, what happens in China or elsewhere is almost meaningless. What happens to commodity prices or trade in the next 10 or 15 years only has a small impact on the value of the purchase, compared to what happens in the subsequent 50 years. Commodity shipments could boom for the next 20 years; or world trade may do well for 10 years; or the US$ could decline for 15 years; but can you be sure that will continue, not just for 10 or 15 years but 50 years? If trade collapses or if China grows very slowly, or the US$ stabilizes for the subsequent 50 years, this isn’t a good purchase.

    Furthermore, if the purchase was largely to capitalize on the elements the author has suggested, there may be better ways to do so. Buffett is more familiar with consumer goods and financials–both of whom generally earn higher returns on equity than rails–and can probably find better assets to achieve the suggested goals. Instead of spending $40 billion on a railroad, he could invest in multinationals like Coca-Cola, P&G, Diageo, HSBC, Emerson, or whatever, with good results. I’m sure he could find 2 or 3 medium-sized export-oriented American companies that can capitalize better on the author’s thesis.

    So, I do not believe this is a bet on foreign macro scenarios. Instead, I believe this is, as is usually the case with Buffett, a bet on a changing trend. In this case, it appears that railroads have become far more productive in the last 10 years. Add to this the fact that chance of a new entrant is zero, and you are looking at a decent business. What used to be a high capex, low return, business, seems to have changed about 10 years ago. I’m pretty sure Buffett is investing with an eye to making a profit even if world trade doesn’t boom.

  26. SJ is basically correct, but Buffett’s investment has a few other perks:

    – It’s capital intensive, so a major cost of business is financing – which could continue to be cheap if we settle into Bill Gross’ “new normal”. Low interest rates shift the competitive edge from truck to rail.

    – Rail has significant oligopolistic power, and “wide moats” – one of Buffett’s key focal areas for value investing. It isn’t easy to build new rails, and it often is not profitable (think of a Hotelling line model and natural monopolies).

    – If the dollar devalues, US labor will get cheaper

    – World population will increase; if wealth in developing countries increases, meat consumption will increase

    – Agricultural patterns due to global warming are projected to INCREASE crop yields in north america (and especially northern north america), while decreasing crop yields in southern population intensive locations (e.g. India)

    I don’t know that it’s a bet on China or the US… it seems like a bet on some key underlying dynamics.

  27. “I’m pretty sure Buffett is investing with an eye to making a profit even if world trade doesn’t boom.”

    Good point.

  28. –Rail has significant oligopolistic power, and “wide moats” – one of Buffett’s key focal areas for value investing.–

    Bingo. Buffet’s ‘bet’ is going to be a winning one no matter what. He has too much sway in the government at this point. BH is a fortress surrounded by a moat.

  29. I think that it can also be bet on some kind of Obama climate change bill which would favor the rail transport.

  30. As someone noted, Buffett’s purchase is a bet on continued environmental degradation: carrying coal within the US, and exporting grains to China where the environment is deteriorating more rapidly than anywhere on Earth and self-sufficiency in food will quickly become an historical relic.

    The “China as Number 1” books might not even get as far as the typesetter. At the current rate of money printing (25% M3 growth), wild speculation, and the impossible-to-achieve need for 8% plus GDP growth just to meet the expectations of the 800,000,000 peasants still hoping for the good life, the China melt down is only months away. Every one of those hundreds of empty condominium towers littering every major Chinese city is a bad debt waiting to happen, and a population full of dashed expectations is a disaster waiting to happen.

    If any of those China books do make the store, they’ll be on the “Steal Me” table outside within weeks of arrival.

    What bubble has ever ended well?

  31. Simon’s analysis of the Buffett railroad purchase is most distrurbing! Remember that it was Mr. Buffett back in 2003 who warned the nation of the dangers of our huge trade deficits and that we needed to start pruducing and saving more rather than spending on imports and borrowing from abroad. Has he really given up on our industries ever recovering? That’s a devastating forecast for continuing job losses and unemployment.Say it’s not so, Mr. Buffett!
    Ken Davis,
    Former US Ass’t Sec’t’y of Commerce/International

  32. It is only impossible because they choose not to repeal the legislation. They have forgotten how to legislate.

    The EU is currently requiring some of the big banks to divest their insurance business… ie ING without new legislation.

  33. Let’s hope it doesn’t get that bad before they wake up to the dangers of this deregulated predatory financial services sector of the economy.

  34. I don’t think it’s a prediction of disaster. I think Buffet just likes to go with safe bets, this is a safe bet with increased profit streams in the future.

    We don’t need Buffet to tell us our manufacturing sector is in disaster. Hopefully we can use our own eyes and mind to realize that. We had economists like Milton Friedman telling us for years it’s great to have your nation’s manufacturing base moved overseas if you can get cheaper goods from it.

    Of course the fact that business executives (vast majority Republicans) were pocketing all those profit margins from cheap labor into their bank account while illegal immigrants and Chinese prison laborers took our jobs was a COINCIDENTAL result of that….. thank you Reagonomics

  35. Ted,

    Don’t you think that the decline in manufacturing employment in the US has more to do with increases in productivity than Ronald Reagan? Manufacturing productivity increases 2-3% a year and will ultimately lead to very few people being employed in making things. A similar process clearly happened in agriculture.

  36. IIRC the last time China had a trade surplus it lead to the Opium wars. It goes without saying, a solution entirely befit of morality. As a non-expert, sometimes I wonder if the legalized opium trade was the first chapter in global drug-trafficking; if the “karmic consequences” of the opium trade include the social harm caused by the drug trade in inner-city ghettos and the American war on drugs.

  37. Is China really the culprit in its trade relationship with North America?

    What happened is millions of poor peasants in China found work producing consumer goods for Europe and North America. These factories in China have labour conditions (to put it mildly) that are no longer acceptable in the developed world. While in the United States the purchase of these consumer goods was financed by the credit card companies. Noting here companies like WalMart successfully opposed the development of labour unions in factories that they contract with.

  38. I agree with Patrice – that’s been my hunch too. This is less to do with China or commodities or shipping but an expectation of where future ‘stimulous funding’ will be going.
    I’d expect to see a similar purchase or ‘strategic agreement’ with an additional company that operates North-South along the East coast

  39. This was my original point above, but it seems Mister Sivaram did a much better job stating it.

  40. Productivity rises=jobs move overseas???

    Interesting theory. If you can make a graph that proves that and simultaneously proves it’s the civic duty of American workers to be paid less than the minimum wage you could be the next Academic celebrity/star of the Republican party.

  41. Buffett bought BNI because he didn’t get the Choo-choo set he wanted when he was a kid (read “The Snowball”)

  42. Let me break it down for you: BRK has sold billions of dollars of long-term put options on US stock indices — in effect, a huge bullish bet on the USA. Stock markets went up. Puts go down in value when stock markets go up. BRK was short these options contracts. Options are derivatives. Thus, there were gains on derivatives trades.

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