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An insightful interview with Warren Buffett

Great interview, especially his insider account of the crisis, helping out GE and Goldman and about cash as oxygen…

“After this, American industry literally stopped. George Bush said, “If money doesn’t loosen up, this sucker will go down” – I believe this was the greatest economic statement of all time. This is why he backed up Paulson and Bernanke. Companies were counting on the commercial paper market. In September 2008, we came right to the abyss. If Paulson and Bernanke had not intervened, in two more days it would have been all over. BRK always has $20 billion or more in cash. It sounds crazy, never need anything like it, but some day in the next 100 years when the world stops again, we will be ready. There will be some incident, it could be tomorrow. At that time, you need cash. Cash at that time is like oxygen. When you don’t need it, you don’t notice it. When you do need it, it’s the only thing you need. We operate from a level of liquidity that no one else does. We don’t want to operate on bank lines.”

Warren Buffett’s Meeting with University of Maryland MBA Students – November 15, 2013.

Charlie Munger on the Psychology of Human Misjudgements

This is an audio recording of the often referred to speech by Charlie Munger on the psychology of human misjudgement given to an audience at Harvard University circa Jun 1995.

Mr. Munger speaks about the framework for decision making and the
factors contributing to misjudgements. c. Jun 1, 1995

Enjoy this nestor of succesful investing thanks to Buffett Munger Wisdom. Go here to find the full transcript.

Also see the very readable Poor Charlie’s Almanack



Macro Scenario: The Demise of Manufacturing Is the Real Problem of the World Economy

Enjoy and learn from this discussion between Prof. Bruce Greenwald and Richard Koo at the CIGI conference: The Great Recession: Structural and Cyclical Causes

While Richard Koo is sure weak balance sheets are the issue, Greenwald disagrees and further elaborates on his thesis, the underlying problem is the demise of manufacturing.

I am always interested in comprehensive macro scenarios which I can use to test the business model of my investments or clients.

Manufacturers Suffered More from the Crisis Than Debtors

Greenwald, says that balance sheets are the problem in any recession, however now balance sheets are repaired (US, UK) the recession still continues. Evidence shows the countries that suffered most from the worldwide crisis were not the countries with a large bubble (UK, US), but countries with relatively sounds balance sheets.

He mentions:

  • Japan suffered a 7% drop in GDP while Japanese companies had very healthy Balance Sheets (significant negative debt)
  • and Finland (a 13% drop in GDP from 2008-2010, my add.)
  • Natural Resources countries also suffered, like Canada (My add. GDP drop -13%)
  • US (-2%) and the UK (-6%)

Is Manufacturing the new Agriculture?

Greenwald draws the parallel with agriculture. This industry suffered enormous productivity gains and limited increase in worldwide demand.

This same development is now happening in manufacturing.

And growing in a dying industry is an extremely difficult thing to do…

Screen shot 2013-01-06 at 11.19.33 AM

Agriculture as % of GDP development since 1960. I’ve included the countries mentioned. Source: Google, Worldbank. 

Greenwald says: productivity increases annually with 5-7%, however worldwide demand merely grows at best 2-3%. Capital expenditures (robots, technology, software) have come down dramatically the last decade, and so productivity improvements become less capital intensive…

Screen shot 2013-01-06 at 11.25.28 AM Manufacturing as % of GDP development since 1980. I’ve included the countries mentioned. Source: Google, Worldbank. 

Ok, ok what’s new you might ask…manufacturing usually declines as a % of GDP as a country moves up the income ladder and more and more countries move up this ladder…

Well there is something new, remember the earlier post on Greenwald’s thesis? The way out of the crisis and sustaining/increasing employment for manufacturing economies like Germany is selling the production surplus through exports.

However exports are a zero sum game between surplus and deficit countries…

Especially countries with a strong manufacturing base (read: labor unions, industry lobbies) are resisting the decline in jobs and revenues as hard as they can through exports, helped by politicians that aim to keep unemployments at bay.

The Spender of Last Resort Ran Out of Cash!

Now, what changed? Greenwald tells us US households have been eating the world surpluses up to 2008. Unfortunately they cannot finance a net deficit any longer through rising house prices and a zero savings rate. And if there is nobody in the world to eat the net export surpluses of manufacturing countries, the world economy will continue to have problems to grow until manufacturing countries make the explicit choice to change into a more service based economy.

This development has a chronic deflationary pressure on manufactured goods…

So the Remedy is a Focus on Services?

The remedy according to Greenwald is changing the economic structure of manufacturing surplus economies like Germany, China and Japan to focused (non-financial) service sectors like medical care, education. However this takes focus from government and bold decision making (read: confronting labor unions and industry lobbies).

Corroborative Inquiry: McKinsey on Manufacturing

Now all this sounds like a solid storyline from a highly respected (also by me) professor. But can we check some facts?

Very conveniently McKinsey’s Global Institute recently published a report named: Manufacturing the future: The next era of global growth and innovation, full of interesting statistics actually supporting Greenwald’s thesis.

Where McKinsey and Greenwald grow apart is the storyline on the future… So even though McKinsey draws similar conclusions as Greenwald from economic data, their overall conclusion (and productivity growth estimate) sounds less dramatic.

McKinsey explicitly mentions: Manufacturing is entering a dynamic new phase. As a new global consuming class emerges in developing nations, and innovations spark additional demand, global manufacturers will have substantial new opportunities—but in a much more uncertain environment.

Actually this conclusion sounds like manufacturing is set for a new growth spurt….not decline! Well let’s just use their facts.

Screen shot 2012-12-30 at 8.40.35 PM

Source: McKinsey Global Institute

So how does McKinsey’s data support Greenwald’s thesis?

McKinsey: “Manufacturing contributes disproportionally to exports, innovation and productivity growth.” Which is supported by Exhibit E2 and 13 as per above and below.

Per above we can see only 14% of employment (in advanced economies) is in manufacturing, whereas 37% of productivity growth comes from manufacturing (EU-15).

Per below we see most exports are still manufactured goods. According to Greenwald high productivity and high exports have a negative impact on manufacturers and jobs in manufacturing.

Manufacturing drives two third of exprts

Source: McKinsey Global Institute

So How Does the Future Look?

According to McKinsey, up to 2025 about 1.8 bln. people will enter the consumer class, which is about 140 mln new consumers per year or a CAGR of 3.8%. Not bad! However this is similar to the last 20 years.

Furthermore McKinsey estimates consumption will rise 3.54% so consumption per capita will actually fall from 16k to 15k per capita. Did they forget inflation? Or does inflation offset a decrease in overall income due to growth coming mainly from low income countries? Let’s assume the latter…

As the 3.54% is slightly above Greenwald’s 3% estimate, but far below the 7% productivity gain in manufacturing, the deflationary pressure still makes sense…or am I missing something?

Demand Shift

Source: McKinsey Global Institute

Now for the Productivity Gains? Are they Supported by Historical Evidence?

McKinsey mentions productivity gains have been at an average of 2.7% p.a. which does not tie in with Greenwald’s 5-7%.

However from the graph we can see a spread between US productivity growth and real value added of 1 – 4%. If this spread persists, this will probably impact pricing of manufactured goods.

Screen shot 2013-01-16 at 12.15.47 AM

Source: McKinsey Global Institute

This conclusion could be supported by exhibit 15: productivity gains were passed on to consumers through lower prices of consumer durables (refrigerators, cars etc.).

Screen shot 2013-01-16 at 12.25.49 AM

Source: McKinsey Global Institute

So could Greenwald be right? I don’t know. It sounds like a logical explanation. More important is to me…What can I learn from this?

I will have to think about the consequences for employees, companies and investors. Next to job losses of the lower skilled due to productivity gains, the multiplier effect of manufacturing could turn into a serious negative force following manufacturing decline, which will impact also service sector jobs and revenues.

As an investor I will have to look more critical at service sector companies and try to find out, whether the companies aren’t built too much around manufacturing clients. Who are the key clients? What is their competitive position? Will they still be clients in different manufacturing landscape? Why? Why not?

If I am investing in a manufacturer…I will not expect productivity gains to be passed on to me, the shareholder, but most probably to the clients. Overcapacity will also lead to a landscape for high end and low costs producers (e.g. think fashion and furniture): will my producers be stuck in the middle or are they already well positioned? Will capital expenditures be also lower in the future (deflation will also impact capital goods) or will companies have to spend more frequently to keep up with the productivity race.

Please let me know if I made mistakes, whether you disagree, or want to add to the scenario. Also read: Worse Than the Great Depression:  What Experts Are Missing About American Manufacturing Decline by ATKINSON, STEWART, ANDES, AND EZELL

Screen shot 2013-01-16 at 1.00.16 AMSource: McKinsey Global Institute

Interview with Jean-Marie Eveillard, Senior Adviser, First Eagle Funds

According to Jean-Marie Eveillard, Senior Adviser, First Eagle Fund, after 2008 Value Investors should ask themselves if their bottom-up approach should be complemented with a top-down analysis of the macro environment.

This interview gives you a fresh insight on current macro environment and how investors should deal with it. I have made a limited (incomplete) summary of the topics he discusses.

Austrian School Best Analytical Tool to Perceive Current Environment

  • For top-down analysis, according to JME, the best analytical tool is the Austrian School to see through the neo- Keynesian measures taken by governments.
    • JME expects these measures to be discredited in the future
    • Inflation to the Austrians is not the increase of the CPI or asset prices it is the creation of too much money and too much credit.
    • Money is not supposed to be free and this situation will cause significant distortions.

Gold is the Currency of Last Reserve

  • Gold is a protection against extreme outcomes. It is the currency of last resort. Warren Buffett does not seem to get this. We see it as a substitute currency to hold cash in. We don’t see any of the printed currencies as reliable.

Graham vs. Buffett

  • He discusses the difference between Graham’s quantitative and Buffett’s qualitative intrinsic value measurement and describes the struggle of value investors on determining the right moment to sell their investments. At the static quantitative intrinsic value of Graham or the qualitative moat based intrinsic value of Buffett.
  • He describes he was twice illuminated by Graham’s Intelligent Investor and Buffett’s Shareholder Letters

Fund Performance Management

  • About his performance targets when was fund manager of first eagle funds.
    • His absolute target: perform better over time than money market funds.
      • In hindsight he would’ve set the absolute performance target in real terms
    • His relative objective: perform better over time than an adequate benchmark.
  • He mentions the reasons for having so little value investors around are psychological. As Grantham recently spelled out, it is career risk. Nobody wants to diverge too much from the benchmark. Job safety is too important.
  • He notices, now an advisor, value investing on personal account is much easier than doing it on behalve of clients
  • Successful value investing is highly depending on the clients chosen (he mentions Klarman has chosen his clients well)

Bonds are riskier than perceived

  • JME calls the run on bonds a big mistake
    • People working in the bond markets under 55 have never seen a bear market, so are overconfident in safety of bonds.
    • He thinks this is one of the reasons so many institutions move from equities to bonds these days.


  • Europe has a real problem, the Euro is created for political reasons not for economic reasons
    • Full integration of Germany into Europe requires the Euro
    • National governments kept fiscal power
    • The flaw became obvious from by the
    • Correct the mistake and have a European government
    • Giving up sovereignity is unpalatable
    • Everybody is buying time
    • Most European companies do business beyond Europe
    • Some of these companies are worth looking at right now


  • JME’s take on Japan
    • JME sees parallels with investing in French undervalued Small Caps in the 80s, patience is key.
    • On bicycle producer Shimano
    • Cultural issues


  • Accounting issues between countries – conservatism vs. aggressiveness
  • Political Risk Premia

The interviewers (brothers Mihaljevic) have made a great compilation of investing wisdom and other investors in the Manual of Ideas.

Bruce Greenwald: Germany and the Netherlands should leave the Euro; The Global Demise of Manufacturing is the Real Economic Problem

Professor of Bruce C. Greenwald, Robert Heilbrunn Professor of Finance and Asset Management at Columbia Business School gave some very interesting interviews recently.

Prof. Greenwald is generally known for his value investing expertise, however in these interviews he offers us an different macro view on the euro-zone and the causes for the continuing world economy’s crises. I have made a limited transcript of the interviews.

International Trade Imbalances Are a Bigger Problem

Today there are some real problems in the world economy that have nothing to do with the financial crisis or unhealthy balance sheets.

The trade imbalances are at the heart of the economic decline and this is not a new phenomenon:

  • Japan: for 50 years a net exporter, managing their currency
  • China: grows through exports by keeping the Yuan at bay
  • Germany: stays in the euro-zone keeping its exports too cheap
  • Indonesia, Thailand, Malaysia and South Korea are since the Asian currency crisis (’97) running surpluses through a currency reduction of 50%

Adding up the surpluses of the oil exporters, there should be also various countries running deficits as all global trade accounts balance to 0.

A Short History of Deficits

Who runs these deficits then? Well after ’97 when Indonesia, Thailand, Malaysia and South Korea went from deficit to surplus, the deficits went to Mexico, Argentina, Brazil, Russia and we remember what happened to them around the turn of the century. They collapsed! Since then, they have all run surpluses.

During the 2000s the deficit running countries became the US and to a lesser extent the UK and the euro-zone. Financed by households living beyond their means, saving 0% and eating away household equity produced by the housing bubbles. Now the housing bubbles have deflated or stabilized and households are saving again, while demand has collapsed and everybody is adjusting.

The Difficulty in The Euro-Zone

Competitive Germany and the Netherlands are tied into the euro area with less competitive countries (Portugal, Spain, Italy, France etc.)

  1. When countries have significant deficits, it is extremely difficult to sustain full employment.
  2. Germany is in effect exporting any job problem it might have to less competitive countries in the euro area.
  3. These countries cannot protect themselves, because they cannot depreciate their currency

As long as Germany keeps running account surpluses, less competitive countries won’t have healthy demand growth. And as they cannot depreciate their currency they will have to make another fundamental change: lower real wages.

And Germany is not going to give away its economic power so easily. It has a very powerful manufacturing sector growing productivity at 5-7%. As domestic demand just grows 1% and globally it grows just 2-3%, they have to export. Otherwise manufacturing dies.

The Underlying Problem is The Decline of Manufacturing

The same goes for China, Japan, South-Korea etc. transmitting deflationary pressures overseas.

The underlying problem of global imbalances is the demise of manufacturing and the enormous vested interests in this economic sector. Governments try their best to protect manufacturing jobs by stimulating exports similar to the protection of agriculture in the depression years. However manufacturers are increasing productivity at a higher speed than global demand, leading to a significant deflationary pressure.

As long as the net exporters don’t find jobs in the service sector for their displaced manufacturing workers, there will be no solution for this crisis.

The other part of the problem is the dependency of deficit countries on external financing, where these countries are at the mercy of their external creditors. Living beyond their means becomes virtually impossible as long as they run a deficit and they have to become surplus countries without being able to depreciate their currencies.

So essentially, what is required from countries like Italy and Spain, is becoming more competitive than Germany through productivity gains. This is extremely difficult and probably not going to happen. The other painful way out is a decline in real wage rates which is a very difficult path, because households will feel real pain, losing their purchasing power.

The only way out is currency depreciation. This can be done the easy way or the hard way:

The easy way out:

  • Germany, the Netherlands and Denmark (maybe France) leave the euro and appreciate their currency.
  • The euro will fall, which will fix the problem for the uncompetitive countries.
  • As the debt of these countries is denominated in euros, the burden becomes more bearable.
  • Of course this scenario leads economic shocks for the leavers as exports will fall and their investments in euro will decline.

However prof. Greenwald sees this solution as the least painful and more orderly way to solve the problem as exits by the weaker countries will lead to defaults, serious recessions and even larger problems for German manufacturing.

Greenwald on Italy in Specific

Greenwald on the future of the US economy (But this could easily apply to Europe’s economy as well)

Interview with Jim Chanos

In an earlier post (Why Should We Pay Attention to Short Sellers?) I discussed short sellers and mentioned Jim Chanos. See this interesting recent interview with him on short selling, his success story, China, Europe and the US.