You probably know that Warren Buffett (Trades, Portfolio) is a great believer in the idea that stocks are destined to go up. But do you know that he has historically been down on bonds? In the recent past, he has said, “Between stock and bonds for the next 10 years I would choose the S&P 500 in a second." In his 2013 investor letter, Buffett wrote that the trustee of his wife’s inheritance is to put it in a portfolio that is weighted 90% low-fee index funds and 10% short-duration government paper.
The kindness of strangers
Buffett’s main gripe with long-duration bonds was that they are “no better than the currency they are denominated in," and he had very little confidence in the ability of the U.S. dollar to retain its value over the long term. Indeed, the dollar had seen extremely high periods of inflation in the 10 years prior to the writing of the letter, so it is easy to see why Buffett was skeptical. He believed that significant inflation was inevitable due to the size of the U.S.'s external debt:
“Our enormous trade deficit is causing various forms of 'claim checks' -- U.S. government and corporate bonds, bank deposits, etc. -- to pile up in the hands of foreigners at a distressing rate. By default, our government has adopted an approach to its finances patterned on that of Blanche DuBois, of A Streetcar Named Desire, who said, 'I have always depended on the kindness of strangers.' In this case, of course, the 'strangers' are relying on the integrity of our claim checks although the plunging dollar has already made that proposition expensive for them.”
In other words, the ability to take on debt denominated in a currency controlled by the debtor creates a strong incentive for the debtor to print more of the currency. This is why it is historically rare for so much of global debt to be issued by a single country:
“For the debtor government, the weapon of inflation is the economic equivalent of the 'H' bomb, and that is why very few countries have been allowed to swamp the world with debt denominated in their own currency. Our past, relatively good record for fiscal integrity has let us break this rule, but the generosity accorded us is likely to intensify, rather than relieve, the eventual pressure on us to inflate. If we do succumb to that pressure, it won't be just the foreign holders of our claim checks who will suffer. It will be all of us as well.”
Buffett opined that inflation was inevitable due to the government’s short-term outlook. Of course, as we know, the next 30 years were to be a period of persistent decline in inflation, even as external U.S. debt swelled to truly gargantuan levels. So, was Buffett wrong? Well, it depends on how you look at it.
On the one hand, inflation as conventionally measured by the Consumer Price Index has been low since the early 2000s. On the other hand, asset price inflation over the same period has taken off, with the prices of equities, property and almost any other asset out there rising significantly. The exact causes of this are disputed, but central bank policy is certainly near the top of the list. So in that sense, investing in the S&P 500 over the last few decades has been more profitable than holding government debt, so perhaps Buffett was correct in his 1987 prescription, if not in his diagnosis of the core problem.
Disclosure: The author owns no stocks mentioned.
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