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Thursday, November 24, 2011

Warren Buffett's simple wisdoms...

Warren Buffett once described the role of current account surpluses/deficits in his wonderfully simple way. Think of Germany when you read 'Thriftville' and think of Greece when you read 'Squanderville". Here it is.

"Take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo -- but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off -- or simply service -- the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat -- they have nothing left to trade -- but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are -- in economist talk -- some pretty dramatic "intergenerational inequities."

Let's think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies -- that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island's fiscal pain.

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island's government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force". 

Warren Buffett told this tale having the USA in mind. The corresponding formular would be:
Greece = USA2


  1. Comparing Greece to the US shows the person doing the comparison has little knowledge of both. Greece has the lowest rate of tax collection in the industrialized world and a high tax rate. The US on the other hand has a low tax rate and the highest rate of tax collection.

    Saying that Buffet was comparing the US to Greece is also nonsense.

    “The United States is not going to have a debt crisis as long as we keep issuing our debts in our own currency. The only thing we have to worry about is the printing press and inflation.” - Warren Buffet 2012

    1. My view is that one can compare anything, even apples and oranges. It all depends what conclusions one draws from the comparisons. If I said anywhere that Warren Buffett was comparing the US with Greece, please point out where I said so. In fact, I specifically said that Warren Buffett had ONLY the US in mind (I myself added the conclusion that "Greece is the US high 2" figuratively speaking. In actual fact it might be 'high infinite'). And the Buffett statement from 2012 is exactly what I once wrote in the below piece when I actually did compare the US with Greece.

      Thus, I completely agree with your statement that 'saying Buffett was comparing the US to Greece, as though they were the same or similar, is also nonsense'. Please help me out who said that so I can criticize him.

      I am afraid you misunderstood what Buffett meant by his tale. He was referring to current accounts. Yes, the US will have no debt crisis as long as it can print the currency in which its debt is denominated. But if the US continued the high current account deficits it once had (over 7% of GDP; now much lower), ownership of US assets would continue to be transferred abroad in significant ways. That is mathematics and not economics. Ross Perot had referred to this phenomenon 20 years earlier as the 'giant sucking sound' of jobs being transferred from the US abroad.