Macro-economics is not my forte, but I don’t have to be an expert on the mechanics of a train to appreciate that it’s big, heavy and will hurt like hell if I get in front of it.
My investment focus in Baobab Global Fund is on individual companies. I believe that if I invest in solid companies, run by owner-orientated management, and I get this at a reasonable price, my investors will do fine.
A tenet I follow is to invest only in countries whose currency maintains its value over the long term. If, like me, you invest in the United States, you have to ask yourself: Can I expect the US dollar to maintain its long-term value?
When I listen to salesmen like Alan Greenspan, John Snow and George W Bush discussing the state of the American economy I juxtapose them with humble geniuses like Sir John Templeton, Charlie Munger, Warren Buffett and Francis Chou.
I also think of a scene in the movie Falling Down where Michael Douglas holds up a shoddy hamburger, points to the mouth-watering picture of the burger above the serving counter, and asks: “Can somebody please tell me what’s wrong with this picture?”
The first shoddy hamburger in this case is US external debt. My father taught me to stay away from debt, pointing to people who started to live the high life, funded by debt, and finished up a number of years down the line flat on their arses.
The US went into a net external debt position in 1986. It is astonishing if one looks at the US’s net external debt of $2,6-trillion at the end of 2002 to find that it averaged less than $300-billion for most of the early 1990s. Then from 1995 to 2002 that debt compounded by 33% a year.
As far as I know the 2003 numbers are not out yet, but it looks like there is going to be yet another significant increase.
Net external debt is also reaching significant proportions in relation to gross domestic product (GDP). At the end of 2002 it made up 26% of GDP, and it is hard to believe that the 2003 numbers will not raise this to 30%.
The second shoddy hamburger is the US’s social and medicare deficits, which are increasing as the number of taxpayers servicing these obligations falls. According to the International Monetary Fund (IMF), the ratio of retirees to working age population is set to increase from 20% to 40% between now and 2050. IMF estimates put the fiscal imbalance at a mind-boggling $47-trillion. That is $47-trillion the US doesn’t have.
The third shoddy hamburger is derivatives. The majority of companies go bankrupt owing to cash flow or liquidity issues, and derivatives threaten liquidity in the system.
Derivatives have been a thorn in my side for a number of years. I don’t like them because I cannot get a handle on the risk they pose.
In his 2003 annual report Warren Buffett wrote: “No matter how financially sophisticated you are, you can’t possibly learn from reading the disclosure documents of derivatives-intensive companies what risks lurk in their positions. Indeed, the more you know about derivatives, the less you will feel you can learn from the disclosures normally proffered you. In Darwin’s words: ‘Ignorance more frequently begets confidence than does knowledge.’ ”
If you look at the Comptroller of the Currency’s fourth quarter derivatives report, you will find that the total credit exposure of derivatives in the US at the end of 2003 was $755-billion. What is most worrying is that $646-billion, or 85%, of that credit exposure, sits with only three banks — JP Morgan Chase, Bank of America and Citibank.
What happens if one of them fails? JP Morgan’s total credit exposure to capital ratio is 844%! Can somebody please tell me what’s wrong with this picture?
Shoddy hamburger number four is the increase in the money supply. President Bush knows that if the economy falters in an election year, he is out of the race. All the buttons have been pushed to flush liquidity into the system.
Under Richard Nixon the M3 money supply was increased by 14% in 1971 and 1972. This time it is only in the region of 10%, but it goes hand-in-hand with tax cuts, ridiculously low interest rates and things like “pension contribution changes”.
As Jim Rogers says: “We’re like the untrustworthy brother-in-law who keeps borrowing money, promising to pay it back, but can never seem to get out of debt. Eventually, people cut that guy off.”
If you want to see what a healthy balance sheet looks like, take a look at Botswana. As international rating agency Moody’s puts it: “Public sector net external assets, at about 170% of current account receipts, are among the highest of rated sovereigns, bolstering the government’s capacity to absorb potential shocks.” How many shocks can the US bear?
The increase in US debt is unlikely to stop in the near term. Long-term though, to quote Herb Stein, “If something cannot go on forever, it will stop.” The liabilities are building, and despite the shenanigans it is still easy enough to figure out that the US’s intrinsic value is sliding.
I will continue to allocate the majority of our capital elsewhere, unless my margin of safety is big enough to discount the dollar’s devaluation.
Martin van Blerk is a Botswana-based fund manager