Warren Buffett Says American Economy is a Shambles

Yesterday didn't turn out so bad after all on the ASX. Stocks finished slightly up, as did the Aussie dollar and oil. Today might be a different story, though.

For starters, billionaire investor/guru/jovial-grandfatherly-figure Warren Buffett has said the American economy is a "shambles." Buffett told CNBC that the worst of the financial crisis peaked late last year (we're not so sure). But the economic crisis? That's still in full flight.

"I get figures on 70-odd businesses, a lot of them daily," said Buffett. "Everything that I see about the economy is that we've had no bounce. The financial system was really where the crisis was last September and October, and that's been surmounted and that's enormously important. But in terms of the economy coming back, it takes a while."

"A while," is not a precise unit of time. But Buffett is probably right. "There were a lot of excesses to be wrung out and that process is still underway and it looks to me like it will be underway for quite a while. In the (Berkshire Hathaway) annual report I said the economy would be in a shambles this year and probably well beyond. I'm afraid that's true."

Buffett remains optimistic that eventually we'll grow our way out of this recession. He said the same thing, by the way, after the U.S. debut of "I.O.U.S.A." But that was before the U.S. stacked on several trillion more in debt to "deal" with the financial crisis.

Speaking of "I.O.U.S.A," we're hoping to bring it to Melbourne in late July for its first official Australian screening. A plan is being made. You will be alerted to this plan once it's down. We're organising what we hope will be Australia's first real frank discussion about household debt, government borrowing, and the banking sector. No holds will be barred. Stay tuned.

One more comment from Buffett. "I don't worry about deflation at all," he said. We haven't seen the entire interview. But we are presuming that means he's more worried about inflation-unless he's worried about neither, which we suppose is possible. But Buffett did say he thought the stock market was attractive over the next ten years, compared to other alternatives.

If, by other alternatives, he means cash, then maybe he IS worried about inflation and thinks that stocks are a better asset class to own than cash during inflation. He certainly can't mean that government bonds are a better bet than stocks for inflation, can he?

Enough of trying to read Warren's mind. Let's take a quick look at what the Federal Open Market Committee said today regarding U.S. interest rates. Remember yesterday we said to watch for language which tipped the Fed's intentions regarding the bond market. It all begins with the bond vigilantes these days. So what did the Fed say?

It made clear low rates-at least the Fed's target rate-are here to stay. "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Whether the Fed can talk down or manipulate long-term rates into staying dormant is another matter. But it had more to say on the subject. "As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year."

The important part here is "as previously announced." This sounds a bit like, "I really mean it. I'll do it. I'm dead serious. Don't make me buy those mortgage bonds. I'll do it if I have to. Don't push me."

In other words, the Fed is merely repeating what it said it would do earlier. It did not announce a new policy or its intention to expand quantitative easing to keep bond yields down. We imagine it would not want to advertise its willingness to keep buying bonds. That might induce a lot of selling and have the perverse effect of pushing U.S. yields up and investors into other assets.

But just for good measure the Fed repeated itself one more time. "In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

So it's a waiting game now. The Fed hopes the economy recovers this year and that it can withdraw its massive liquidity measures before they leak through into the economy to cause inflation. So far, its credit facilities have not translated into an expansion in the money supply. That's what the bond market fears (which is also why ten-year Treasury yields were up on the day).

Here in Australia, yesterday's bleak global forecast by the World Bank was immediately countered by a ray of sunshine from the Organisation for Economic Cooperation and Development (OECD). The OECD says Australia's economy will only shrink by about 0.3% this year. That's less than any other economy in the OECD. It also says the economy will grow by 2.4% next year, more than any other OECD economy.

Just how it reached that conclusion we don't know. Will unemployment peak out this year? Will housing roar ahead? Are exports to China about to soar again? What will be the engine of the Aussie economy in this recovery? It probably won't be bank lending.

Today's Australian reports that, "The Commonwealth Bank has flagged a sharp decline in its business lending portfolio as the bank admitted there would be future increases in provision charges due to the slowing domestic economy. The bank's chief financial officer, David Craig, told an investors conference in Sydney yesterday the operating environment for the bank remained difficult, but the economy was well-placed compared with its global peers."

Commonwealth Bank said it had total impaired assets of $3.9 billion at the end of the March quarter. That was up $785 million in three months. But it said the rate of growth in asset impairment slowed down. Hmm. We'll have a think on that and get back to you tomorrow.

Dan Denning

for The Daily Reckoning Australia

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