2010: How is Berkshire preparing for potential currency failures?

AUDIENCE MEMBER: Good morning to all of you. Switching topics, Charlie and Warren, I’m Norman Rentrop from Bonn, Germany. I want to first give you a big thank you and then a question.

“Come by train,” you wrote in the shareholder letter, and that is how I came to Omaha for the first time back in 1997.

I deliberately took the train from Denver to experience Omaha as a railroad city, and I immediately liked Omaha a lot. But the train ride, I saw room for improvement. So thank you very much for taking the future of American railroads into your gifted hands. (Applause)

WARREN BUFFETT: That’s one of the best questions I’ve ever heard. (Laughter)

AUDIENCE MEMBER: Oh, here a question.

WARREN BUFFETT: Oh, OK. (Laughter)

AUDIENCE MEMBER: It’s about Greece, the future of the euro, and the fiscal discipline all over the world, and what we have to prepare for as investors.

In the past, you have been warning us about structural weaknesses of the U.S. dollar. Now we see Greece, and potentially other European countries, in crisis.

Berkshire has significant investments in the eurozone, the big ones like Cologne Re, Munich Re, and even small ones like ISCAR’s (inaudible) in Hamburg.

How are you preparing Berkshire Hathaway for potential currency failures? And what are your thoughts on the sustainability of the euro? And what is your advice for us as investors?

WARREN BUFFETT: Yeah. I’m going to — Charlie and I have not talked about Greece, actually, recently, so I’m going to be very interested in hearing his views on that. I will — I’ll answer the last part of your question first.

We have a lot of exposure in various countries on both the asset and liability side. In other words, we do own stock in Munich Re, and they’ve got lots of assets, majority, probably, in the euro.

We have Cologne Re, a subsidiary of General Re, which has a substantial net worth that is basically tied to the euro.

On the other hand, we have very substantial liabilities that are denominated in other currencies, including fairly big time in the euro around the world.

For example, when we reinsured three or four years ago, three years ago maybe, Equitas, we took on many, many, many billions of liabilities around the world. And we were paid by, in effect, Lloyd’s. And we took that money and invested it in dollars.

So we keep those liabilities for all kinds of old insurance claims arising from Equitas in foreign currencies.

And if the euro depreciates against the dollar, we benefit on that side, but we lose, as you point out, on other sides.

I can’t tell you, and it’s something I’m not concerned about, whether our net balance in euros or sterling or yen or whatever, I can’t tell you what it is on any given day. Some of it enters into our equity put options and things of that sort.

But we have no dramatic exposures in any other currency. That doesn’t mean that other currencies are unimportant to us, because what happens with the Greek situation and what may fall out from that can be quite important, in terms of the world’s economy.

And Charlie’s going to explain to you exactly what that might be. (Laughter)

CHARLIE MUNGER: Yeah. Well, generally speaking and with rare exceptions, of course, we’re agnostic about currencies. We simply do our business and we take those fluctuations as they fall, wouldn’t you agree with that?

WARREN BUFFETT: Yeah. We’re agnostic in terms of the relative values, of —

CHARLIE MUNGER: Yes. Yes.

WARREN BUFFETT: — course. Yeah, we’re not agnostic about where we think all currencies are headed, generally.

CHARLIE MUNGER: No, no.

WARREN BUFFETT: But the relative value —

CHARLIE MUNGER: But —

WARREN BUFFETT: — agnostic.

CHARLIE MUNGER: — Greece presents an interesting problem, of course. What’s happened is that the past conservatism of a place like the United States gave it wonderful credit, a combination of success and conservatism.

And we used that credit to win World War II, and help revive Germany and Japan in one of the most constructive and intelligent foreign policy decisions ever made in the history of the world.

And we used that credit to help assure prosperity for all these decades in which Berkshire has flourished.

And now, of course, the government does not have quite as good a credit as it had before it started using it so heavily. And that’s happened pretty much all over the world.

And so Greece is just the start of a very interesting period, and of course, it’s more dangerous to civilization when governments push their credit so hard.

Because if you need credit to help civilization function, and you’ve blown it by your own aggression in using it in the past, that’s not a good thing.

And I think in this country, and in other countries too, responsible voices are now realizing that we’re nearer trouble from lack of government credit than we’ve been, well, in my lifetime.

WARREN BUFFETT: Everything you read about country credits, currency, you always want to make a — you always want to distinguish between countries that are borrowing in their own currency pretty much exclusively, like Japan has or the United States, and countries that are being forced for one reason or another, because the world doesn’t trust them, to borrow in other countries’ currencies.

I mean, in the past, you know, if you were some South American country and you were borrowing in your own currency, you never default, you just buy a new printing press or work it a little harder.

But the world doesn’t like that sort of thing. So with weaker credits, and countries with poorer reputations, they force those countries to borrow in other currencies, frequently the United States currency.

And that can really put you out of business very quickly because, you can’t — if you’re some South American country, you can’t print U.S. dollars, although you can print your own currency. And that’s what’s caused failures among countries.

The European Monetary Union, it’s a really interesting situation, because Greece, they are a sovereign country, in terms of their own budget. But they can’t print their own currency, you know, they’ve got the euro.

And this is — you know, the euro was regarded as quite an experiment 20 years or whenever it was ago, or less than that. But you may be seeing sort of a test case play out here of a country that is not using its own currency, in effect, or using a common currency, and yet is sovereign, in terms of making its own promises to its citizens.

And I don’t know how this movie ends. That doesn’t mean I’m forecasting disaster or anything, I really just don’t know how this movie ends. And I try not to go to movies like that, if I can. (Laughter)

But I’ll be watching. Really, this will be high drama, in my view, what happens here.

The one thing, Charlie says we’re agnostic on currencies, and we don’t make big currency plays. We did make one a few years ago and we did all right on it. But we very seldom will develop a strong view on one currency versus another.

I would say this though, that events in the world of the last few years would make me more bearish on all currencies, in terms of their future — holding their value over time — than previously. But it’s not unique to the United States, it’s not unique to the United Kingdom.

If you really could run budget deficits of 10 percent of your GDP and do it for a long period of time, believe me, the world would have been doing it a long before this. I mean, that is — that’s a lot of fun if you can keep it up.

And the reason it hasn’t been done in the past, I think, is probably that most people understand that it can’t be kept up.

And how the world weans itself off huge deficit financing by country after country after country — it’s going to be easy — I mean, it’s going to be interesting — to watch.

You do not need to worry; as long as the United States government borrows in U.S. dollars, there is no possibility, none, of default. If the world won’t take our obligations denominated in dollars then we — then you have a real problem.

But you don’t default when you can print your own currency.

CHARLIE MUNGER: Well, yes. And of course, the published statistics are quite misleading because the debts of the currencies — of the countries — are normally stated in terms of the government bonds outstanding, and the unfunded promises of the various governments are much greater than the government bonds outstanding.

So whatever you think this problem is when you read the statistics, it’s miles bigger.

And those unfunded promises don’t bind if you keep growing GDP at 2 or 3 percent per annum, per person, or something like that. You can afford the unfunded promises.

But if you get to where the growth stops, then you’re going to have enormous social strains. And God knows what the effect will be on government policy and on currencies.