Continuity and Confidence: Greenspan and Buffett

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You
may have read that Fitch, a firm that rates the credit-worthiness
of the debt of publicly traded corporations, has downgraded Berkshire-Hathaway,
the investment holding company run by Warren Buffett.

Berkshire-Hathaway
has exceeded the return of the Standard & Poor’s 500 index in
34 of the last 40 years. This success is understandably attributed
by the public to Buffett’s skill in picking companies whose shares
his holding company buys. So phenomenal is Buffett’s success that
economists, who are committed to the premise that nobody can consistently
outperform the stock market, either ignore Buffett or else invent
a new category of performance: a five-sigma man. This is someone
who beats the odds by millions to one, for no known reason —
just pure blind luck. Warren Buffett is living proof that the economists
are wrong. This upsets them, especially when the Nobel
Prize-winners are such poor investors personally
. As an
article in The Economist put it recently
:

Mr
Buffett — an investor who famously thinks of a stock as "part
of a business rather than a thing that moves around on a chart" — has
always stuck in the craws of those theorists who concluded that
in efficient markets stock-picking was a waste of time. He has
had far more successes than failures. As a result, the per-share
book value of Berkshire has gained 286,865% since 1965, while
the S&P 500, with dividends included, has risen by 5,318%.

Buffett’s
success is in part due to his partner, Charles Munger. The problem
is, Munger is seven years older than Buffett ("the kid").
Buffett is 74. At this year’s annual meeting of investors — paid attendance
was 19,000 — Buffett began with this repartee:

I’m
Warren. He’s Charlie. We work together. We really don’t have any
choice, because he can hear and I can see.

But
then they fielded questions for six hours. This is not just stamina.
This is bladder control.

The
Economist sent an anonymous reporter to cover the event.
Anonymity is normal. There are never any by-lines in the Economist.
Even the editor’s name is published only twice in his career: in
the issue after he becomes editor and the issue after he is replaced.

Mr.
Buffett used to have more ideas than capital, he says. "Unfortunately,
in recent years my capital has outrun my ideas." As long
as what ideas he has are good ones, that may not matter, and the
octogenarian Mr Munger is no slouch either. But it is beginning
to affect public perceptions. Last month, Fitch, a credit-rating
agency, downgraded the outlook for the triple-A rated firm to
"negative", citing Mr Buffett’s age as the main reason.
"They discovered that I was mortal — though I hope to
prove them wrong," he says. The emphasis at this year’s AGM
was on continuity, and on fireproofing Berkshire so that, come
what may, it will continue to embody the culture and characteristics
that it has today. But can that be guaranteed?

Obviously,
if the economists are right, it cannot be guaranteed. A five-sigma
man is hard to replace.

Investors
obviously retain their confidence in Buffett and Munger. They think
that there is more where that came from, despite losses recently
sustained by Berkshire-Hathaway’s portfolio of AIG shares. They
are confident in both the man and his system of investing. Otherwise,
they would sell their shares, which are in the range of $83,000
per share. This is down from $92,000 in February. (Mr. Buffett never
splits shares.)

But
this raises a key conceptual problem. Are the economists correct?
Is he a five-sigma man? In other words, is his investment strategy
a function of his own five-sigma abilities? Or is his system as
such the primary source of all these gains? If it is his system,
then why hasn’t anyone else matched his performance? Why is he all
alone?

BETTING
ON THE MAN

If
investors are betting on the man, then the mortality problem raises
its ugly head. How much longer can he go on?

Because
the American stock market is remarkably short-run oriented, the
share price today reflects mainly short-term expectations. This
short-run outlook is so common that the market applies low discounts
to long-run problems. This, after all, is the American way. Americans
have confidence that all problems can be overcome by good, old-fashioned
American know-how. This outlook, coupled with a short-run time horizon,
has reduced the personal savings rate to the low single-digits.

If
Buffett were to drop dead, that would be bad for the company. If
he were to falter mentally, that would be much worse. He would stay
in power much longer. The thought of a corporate raid on Berkshire-Hathaway
is ludicrous. Who would be nutty enough to position himself as a
man wiser in investing than Buffett? Who would trust someone who
would claim this?

So,
Buffett is here for the duration . . . his duration. But when he
departs from the scene, what happens to liquidity? At $83,000 per
share, there could be liquidity problems down the road. Sell orders
at this price in the wake of the wake might create problems.

This
is the problem of continuity. Fitch decided that the issue should
no longer be deferred. The other credit rating services have not
followed Fitch.

There
are two issues here: continuity of performance and continuity of
investors’ confidence. Performance depends more on Buffett than
his system of stock-picking. That is Fitch’s assessment. Then there
is the question of investors’ confidence. Will shareholders retain
their confidence in the performance of his successor? No successor
is ever publicly mentioned by Buffett. This is also an aspect of
continuity. It points to discontinuity.

The
advantage we have as non-investors in Berkshire-Hathaway is that
the outcome of investors’ sentiment regarding the firm will not
affect us directly. Others have borne the risk of his death and
the uncertainty of the aftermath.

We
cannot say the same about Greenspan.

O
CAPTAIN, MY CAPTAIN

Greenspan’s
tour of duty is up early in 2006. If he retires at that time, he
will not break the all-time record set by William McChesney Martin,
who was Chairman from Truman through Nixon. He will get close —
within months. But unless there is a delay in finding a replacement,
he will depart from the FED without the record.

Again,
the issue is continuity. Greenspan has been Chairman ever since
October, 1987 — days before the world’s stock markets fell in one
day by over 20%. He was there during Bush I’s recession. He was
there during the 1995 Mexican currency crisis, the 1997-98 Asian
currency crisis, and the near-gridlock effect of the near-default
by Long-term Capital Management. He was there during Bush II’s recession.
He was there during 9/11 and the aftermath.

The
public has seen his face on TV for a long time. He seems so calm.
He speaks that peculiar dialect of central bankers’ Esperanto. Congress
treats him with kid gloves. (Congress treats all FED Chairmen with
kid gloves.)

He
is the only central banker known throughout the investment world.
He is perceived as the leader of the band, the maestro. As in the
case of Buffett, he is perceived as the possessor of an analytical
system that is beyond the capabilities of one-sigma fellows, however
bright they may be.

This
raises the question of continuity. The dollar has been turbulent
in recent years. The United States is at war. The trade deficit
is astronomical, and the U.S. government’s deficit is in the same
league. While the public still trusts the President on military
matters, it has never trusted him on the economy.

The
public is asked to place great trust in the day-to-day operations
of both the economy and the political order that oversees it. People
personify any system through its leaders. They may trust the system,
but this implies trust in the ability of the system to recruit future
leaders, identify their abilities, and elevate them to decision-making
power. The degree of trust in the political system does not match
Catholics’ degree of trust in the cardinals at the conclave.

Investors
have trusted Greenspan as they have trusted no previous FED Chairman.
Prior to Paul Volcker, hardly anyone even knew who was the FED Chairman.
Volcker’s cigars made a much greater impression than Arthur Burns’
pipe. So did his elevation. He was a steamroller of a man.

Greenspan
has a different style — enigmatic, reserved. Call him the Federal
reserved Chairman. But there is no doubt in my mind that the public
trusts him. Investors have confidence that he is somehow on top
of things, that he can crunch the numbers mentally and come up with
policy prescriptions that will prevent chaos during a crisis.

It
goes deeper than this. He has been Chairman for so long that other
central bankers have looked up to him. Long before the chairmen
of other central banks became chairmen, Greenspan was holding forth.

The
problem is, he holds out when he holds forth. Like a skilled poker
player, he never shows his cards after a successful bluff. He does
not articulate his formulas, if any. He does not go into detail
regarding his decision-making process.

POOR
TIMING

We
are now facing a transition in FED leadership at a time of uncertainty.
This is not just economic uncertainty. It is the insecurity of public
safety. What would be the effect on the fractional reserve banking
system of a terrorist attack on New York City that used anthrax
as a weapon of mass destruction? What if it was followed the next
day by a similar attack on the City of London — the banking district
at the center of the city?

These
are not idle speculations of a madman. On May 10, the U.S. Senate
voted 100 to zero to impose a national identity card system on this
country. You and I are going into the Federal government’s soon-to-be-universal
data base. The House had already voted for it 388 to 44. The President
will sign the bill soon. This was done in the name of fighting terrorism.
If there is no such threat, then why did Congress pass such a law?

The
government is telling us that such a threat exists. It is spending
tax money like mad to solve it. Result? A stack of paid bills and
equipment that does not work. On May 8, this
story appeared in the New York Times and was picked up by
other newspapers
.

After
spending more than $4.5 billion on screening devices to monitor
the nation’s ports, borders, airports, mail and air, the federal
government is moving to replace or alter much of the antiterrorism
equipment, concluding that it is ineffective, unreliable or too
expensive to operate.

Many
of the monitoring tools — intended to detect guns, explosives
and nuclear and biological weapons — were bought during the
blitz of spending after the attacks of Sept. 11, 2001.

In
its effort to create a virtual shield around America, the Department
of Homeland Security now plans to spend billions of dollars more.
Although some changes are being made because of technology that
has emerged in the last couple of years, many of them are planned
because devices currently in use have done little to improve the
nation’s security, according to a review of agency documents and
interviews with federal officials and outside experts.

"Everyone
was standing in line with their silver bullets to make us more
secure after September 11," said Randall Larsen, a retired
Air Force colonel and former government adviser on scientific
issues. "We bought a lot of stuff off the shelf that wasn’t
effective."

Greenspan’s
timing poses problems. If Warren Buffett loses his five-sigma magic
touch, this will harm investors in Berkshire-Hathaway. I am not
convinced that Greenspan has a five-sigma magic touch, except in
his ability to deal with Congress, which I think a one-sigma man
could do just fine. But whether five sigmas or fewer, he will be
departing soon. We have no idea who will replace him. We do know
this: he will not be perceived as a five-sigma man.

THE
ILLUSION OF BEING IN CONTROL

Warren
Buffett is in control. He has been in control for five decades.
He has the track record and the net worth to prove it.

Alan
Greenspan may not be in control of anything other than Congress.
He influences the Board of Governors, but he cannot outvote them.
The Board, through the Federal Open Market Committee (FOMC), is
in control of the monetary base. As to what the financial system
will do in response to changes in the monetary base is anyone’s
guess, as testified to by M-1, M-2, M-3, MZM, and the credit system
generally.

Voters
believe that governments are capable of balancing and protecting
their respective national economies. Two groups adamantly deny this:
Austrian School economists, who do not trust politicians as economic
planners, and central bankers, who also do not trust politicians,
and who have kept free of control by the very political order that
grants them their legal monopoly over the monetary base.

This
confidence in government spills over into confidence regarding the
Federal Reserve System. But this means confidence in Greenspan.

Greenspan
will soon depart. What will happen to public confidence? What will
happen to continuity? No one in authority is asking these questions
publicly, despite the fact that his departure is only a few months
away.

CONCLUSION

I
think that the next FED Chairman will have a much harder time of
it than Greenspan had. For one thing, Greenspan will be a tough
act to follow.

Over
30 years ago, the head basketball coach at Louisville, Denny Crum,
was asked if he wanted to replace John Wooden after Wooden’s retirement.
Crum had served under Wooden. Crum remarked: "I would prefer
to replace the man who replaces Coach Wooden." (Anyway, I think
it was Crum. My memory has faded.)

The
crucial economic issue today is the continuity of the dollar as
the world’s reserve currency. The world’s economy is pegged to the
dollar. What if the market forces an unpegging?

This
issue can be deferred for a while longer. It cannot be deferred
for as long as Greenspan has served as Chairman, let alone for as
long as Buffett has beaten the S&P 500.

Faith
in Buffett has paid off hugely for long-term investors in his company.
Faith in Greenspan has paid off hugely for speculators who could
predict the next bubble — something that Greenspan says central bankers
cannot do.

Buffett
has a system: value investing — the Graham-Dodd system. Greenspan
has a system: inflate the money supply whenever equity markets plummet.
Buffett’s system is good for the economy. It moves capital to its
highest known uses — and no one in history has been able to identify
highest uses with the skill of Buffett. Greenspan’s system keeps
capital invested in lower uses than the free market would otherwise
determine.

I
hope Buffett stays. I am happy to see Greenspan depart. The man
who replaces him may be incompetent, but that’s not all bad. This
would reduce men’s faith in that which should not be trusted: a
government-created monopoly over money.

May
14, 2005

Gary
North [send him mail] is the
author of Mises
on Money
. Visit http://www.freebooks.com.
He is also the author of a free multi-volume series, An
Economic Commentary on the Bible
.

Gary
North Archives

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