2005: How could America's current account deficit close?

AUDIENCE MEMBER: My name is Ola Larson (PH), from Salt Lake City, originally from Sweden.

I read your annual report where you mentioned how the current account deficit, or a trade deficit, has to eventually come to an end.

And in the report, you were reluctant to give views, a forecast of how this would come down from $2 billion a day.

Would you, nevertheless, be willing to share some thought on what — how it might come down, if you have any views on this?

WARREN BUFFETT: Well, that really is the $64 question, because, we are, in my view — and Charlie doesn’t — he’s not as on board on this as I am, so it’s important that you listen to him on this, too.

The — it does seem to me that a $618 billion trade deficit and a larger current account deficit, rich as we are, strong as this country is, that something will happen that will change that in a major way at some point, and that the longer that it goes before changing, the more likely it is that something fairly significant happens.

But most economists — most observers — would still say that some kind of a soft landing is possible. Or they would say it’s likely. They never, to my mind, they never quite explain, you know, what the soft landing is.

They just say it’s, you know, it’s likely to be a soft landing but it could be something different but we still think it will be a soft landing.

But I don’t know what a soft landing is, exactly, in the sense of how the numbers come down quite significantly, and if they don’t come down, the current account surplus — or deficit — means that we are transferring more and more wealth abroad and that we will, in addition to our trade deficit, we will, at some point, have a very significant deficit in terms of the net investment position that the rest of the world holds on us. So it becomes a compounding effect.

I do recommend — there was an op-ed piece in The Washington Post on April 10 by [former Federal Reserve Chairman] Paul Volcker, and he has expressed himself some on this, and he gets into the question of whether it can be a soft landing or not. But I think he certainly expresses some real apprehension about whether a soft landing will be the likely result.

In the kind of world we live in, with so much of the assets of the world, whether they be foreign exchange or whether contracts or whether they be stocks or bonds or junk bonds or whatever, I think as high a percentage is on what I would call a hair trigger now as has ever existed.

In other words, I think there are more people that go to bed at night with a position in foreign exchange, or bonds, or a carry trade, or stocks, or whatever, that some event that could happen overnight would cause them to want to change that position in the next 24 hours. I think that’s the highest, perhaps in history.

Somebody [economist Thomas Friedman] has referred to it as the “electronic herd,” that it’s out there.

I mean people can with — they can give vent to decisions involving billions and billions and billions of dollars, you know, with the press of a key, virtually. And that electric — I think that electronic herd is at an all-time high.

I think that some exogenous event — it was almost Long-Term Capital Management in 1998 — but some exogenous event — and we will have them — will cause it — I think it could very well cause some kind of stampede by that herd.

You can’t get rid — if you’re the rest of the world — you can’t get rid of dollars.

I mean, if you’re sitting in Japan, China, or someplace, and you own a lot of U.S. government bonds, if you sell them to somebody in the United States you get U.S. dollars. So you still have U.S. assets. If you sell them to somebody in France, you’ve now got euros but they’ve got the [debt.]

You can’t you can’t get rid of those assets. But you can have people trying to head for the door very quickly with them, under certain circumstances.

Volcker said, in this thing, he said in the second paragraph, “Yet, under the placid surface there are disturbing trends: huge imbalances, disequilibria, risks — call them what you will. Altogether the circumstances seem to me as dangerous and intractable,” and I emphasize intractable, “as any I can remember, and I can remember quite a lot.”

Well, Paul Volcker can remember quite a lot.

And I agree with that. I don’t — I have no idea — I have no idea on timing, whatsoever. In economics, it’s far easier to tell what will happen than when it will happen.

I mean, you can see bubbles develop and things, but you do not know how big the bubble will get. For example, you know, this happened five years ago in the market.

So you — predicting timing is — I’ve just never been successful at it nor do I try to do it.

Predicting what will happen, I think, is a much easier sort of thing. And I would say that what is going on, in terms of trade policy, is going to have very important consequences.

It was not addressed in the last presidential campaign by either candidate in any meaningful way at all.

Now, I’m not sure if, you know, you were standing up in front of the American people, and somebody is giving you three minutes to explain this whole situation, when 90 percent of your audience couldn’t define current account, you know, it’s not an easy game. But it’s an important one.

Now, Charlie is less enthusiastic about our foreign exchange position, somewhat, than I am, so I want to yield the floor here for a significant period of time while he gives you the other view.

CHARLIE MUNGER: Well, I’m, if anything, a little more repelled than you are by the lack of virtue in the way our nation uses consumer credit and the way we run the public finances.

And I have a feeling that eventually a lack of virtue is going to hurt one.

Where we differ is that I agree with [18th century Scottish economist] Adam Smith that a great civilization has a lot of ruin in that, meaning it will bear a lot of abuse.

And so I think there are dangers in the current situation that make it unwise for anybody to swing for the fences. But I don’t think that we have a certainty that the system won’t stand a lot more of the kind of abuse it’s getting now.

WARREN BUFFETT: What do you think the end will be?

CHARLIE MUNGER: Bad. (Laughter)

WARREN BUFFETT: I knew I could count on him. (Laughs)

No, we are truly, in this country, like an incredibly, I mean incredibly, rich family that owns, we’ll say metaphorically, millions of acres of land. They can’t see, they can’t travel to the outer reaches of their domain.

But, nevertheless, they sit on the front porch and wait for the produce to come in from this vast holding, and when they get it all they still want to consume about 6 percent more than everything that’s been produced on the farm.

And they have the ability to do that by simply selling off a little piece of the farm every day, and every year, that they can’t even see. So they don’t feel any poorer at the end of the day or the end of the year, because it’s still, as far as their eyesight can see, they own everything that God ever created.

And they can sell that little piece or they can mortgage it. They can send IOUs to these people that are giving them the extra goods to consume.

And we are very, very, very rich family. And we produce a whole lot and we consume a little bit more than we produce.

And we trade away a little bit of the farm or put a little bit of a mortgage on every day and the rest of the world is happy to take a little piece of our farm or take a mortgage on it because it’s such a terrific asset and we’ve behaved so well over the years.

And so they’re willing to work a little harder to send us something so that we can consume a little bit more than we produce.

It’s been going on a while. It’s accelerated a lot in the last few years. And more and more the rest of the world is owning part of us and we’re going to have to service that ownership, either through interest if they took it in IOUs, or in some other way.

And it can go on a long time. But if it goes on a long time, the world will own a good bit of us and our children will be paying, one way or another, for the fact that we got to consume more than we produced.

It could happen — you could have — you’ve obviously had some less interest in the rest of the world accepting dollars by the fact that the dollar has declined somewhat in value in the last few years.

In other words, the investment in us is always going to be equal to the overconsumption. I mean, it’s an equation.

But if people get a little less excited about one — enthused about one side of the equation — it reflects itself in the pricing mechanism.

And the world has demonstrated a diminishing enthusiasm for dollars in the last few years as they get flooded with them. We send $2 billion out every day, whether we like it or not and whether they like it or not.

Now, the question is, does that reach some tipping point at some point or does some exogenous event come about that causes people to want to rush for exits? Who knows?

I have a hard time thinking of any outcome from this that involves an appreciating dollar, but, as Charlie will point out in just a second, there have been times when we’ve been surprised.

Charlie?

CHARLIE MUNGER: Yeah, the counter-argument is that, what does it matter if the foreigners own 10 percent more of the United States, if, at that time, the total wealth of the United States is 30 percent higher than it is now.

And so, people who have that point of view just roll with it.

And some of them think that if we didn’t manufacture anything in the United States and just sat here running hedge funds, we would have a wonderful economy because it comports with Republican principles.

WARREN BUFFETT: We could cut each other’s hair, too, actually, I mean —

But back in the late 18th century, obviously, the idea of taxation without representation caused a certain amount of trouble, and ownership of the rest of the world — by the rest of the world of this country would be seen as a form of taxation, I think, 20 years from now, by the people who resided here.

If we — if, instead of fighting the Revolutionary War, we’d simply made a deal with England and said we’ll give you three percent or five percent of our national product forever and you let us be free and we’ll just mail it — send the royalty over every day — that might have looked like a good alternative to war in, you know, in 1776.

But I don’t think that subsequent generations would have reacted well. I mean, something would have happened over time.

And I have a feeling that the idea of America paying tribute to the rest of the world because of the overconsumption patterns of a previous generation seems to be — I don’t think that’s a particularly stable scenario.

But that’s why we have only 21 billion in foreign exchange contracts.

Charlie might have a little less, or maybe none, if he were running it entirely, and I might have somewhat more, if I didn’t know I’d have him sitting up here next to me next year. (Laughs)