The following is excerpted from an article by Warren Buffett, Fortune, 10/10/2003
To understand why (America’s Growing Trade Deficit is Selling the Nation), 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 Squander-bonds (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 for- bid, 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 (or Ports!) 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.
So what does all this island hopping have to do with the US? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. … Since then, however, it’s been all downhill, with the pace of decline rapidly accelerating in the past five (seven) years.
In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4% (now 6%) more than we produce – that’s the trade deficit – we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.
To put the $2.5 trillion (now $3 trillion) of net foreign ownership in perspective, contrast it with the $12 trillion value (now $13 trillion) of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what’s already been transferred abroad is meaningful – in the area, for example, of 5% of our national wealth.
More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level (now almost $800 billion per year), which means that the deficit will be adding about one percentage point annually (now 1 _ points) to foreigners’ net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding – goodbye pleasure, hello pain.
The U.S. … can behave today as we wish because our past financial behavior was so exemplary – and because we are so rich. Neither our capacity nor our intention to pay is questioned and we continue to have a mountain of desirable assets to trade for consumables. In other words, our national credit card allows us to charge truly breathtaking amounts. But that card’s credit line is not limitless. … The time to halt this trading of assets for consumables is now.
Framers of our trade policy should heed this caution – and steer clear of Squanderville. Excerpted from an article by Warren Buffett, Fortune, 10/10/2003
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Originally Posted by Dawg in Dallas
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