Buffett on the Dollar and Trade Deficits

A number of commentators (see here and here) have taken note Warren Buffett’s favorable remarks in his much-anticipated annual letter to Berkshire Hathaway shareholders on sovereign wealth fund investment in the US.

What I found far more significant was his somewhat-longer-form observations about how we had gotten ourselves in the situation where SWF-type capital inflows were necessary. Buffett stresses that letting the dollar depreciate has been an insufficient remedy for our large trade deficit and urges Congress to take more concerted measures.

Note that this is not tantamount to advocating protectionism. Our international system is far from “free” trade; it’s more accurately described as managed trade. We have tended to play the game to favor corporate rather than national interests, It’s time to rearrange our priorities. As Buffett tells us, we can’t afford not to.

From Buffett:

The U.S. dollar weakened further in 2007 against major currencies, and it’s no mystery why: Americans like buying products made elsewhere more than the rest of the world likes buying products made in the U.S. Inevitably, that causes America to ship about $2 billion of IOUs and assets daily to the rest of the world. And over time, that puts pressure on the dollar.

When the dollar falls, it both makes our products cheaper for foreigners to buy and their products more expensive for U.S. citizens. That’s why a falling currency is supposed to cure a trade deficit. Indeed, the U.S. deficit has undoubtedly been tempered by the large drop in the dollar. But ponder this: In 2002 when the Euro averaged 94.6¢, our trade deficit with Germany (the fifth largest of our trading partners) was $36 billion, whereas in 2007, with the Euro averaging $1.37, our deficit with Germany was up to $45 billion. Similarly, the Canadian dollar averaged 64¢ in 2002 and 93¢ in 2007. Yet our trade deficit with Canada rose as well, from $50 billion in 2002 to $64 billion in 2007. So far, at least, a plunging dollar has not done much to bring our trade activity into balance.

There’s been much talk recently of sovereign wealth funds and how they are buying large pieces of American businesses. This is our doing, not some nefarious plot by foreign governments. Our trade equation guarantees massive foreign investment in the U.S. When we force-feed $2 billion daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds?

Our country’s weakening currency is not the fault of OPEC, China, etc. Other developed countries rely on imported oil and compete against Chinese imports just as we do. In developing a sensible trade policy, the U.S. should not single out countries to punish or industries to protect. Nor should we take actions likely to evoke retaliatory behavior that will reduce America’s exports, true trade that benefits both our country and the rest of the world.

Our legislators should recognize, however, that the current imbalances are unsustainable and should therefore adopt policies that will materially reduce them sooner rather than later. Otherwise our $2 billion daily of force-fed dollars to the rest of the world may produce global indigestion of an unpleasant sort..

Buffett also tells his shareholders he took a large and successful bet on the Brazilian real, which doubled 2002-year end 2007.

Update 5:00 AM: Floyd Norris provides some good commentary.

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One comment

  1. foesskewered

    When the oracle speaks…
    but frankly, Mr Buffett is always entertaining if nothing else. He did kinda contradict himself since he mentioned that his position on the real was small and in decrease mode. Considering it’s a backdoor bet on the risinmg (and ever rising ) world of commodities and resource demand, the real should have made a tidy profit for him

    Not too surprised about the pharmaceutical investment. The sanofi-aventis tie-up has always been bit of an oddball couple but heard their research is pretty top-notch, besides, as he mentioned, people are living longer and health care costs/profits are bound to rise…

    nice reading on a sunday morning…

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