Portfolio manager’s Letter November 2007
Toward the end of “The Age of Turbulence” Alan Greenspan’s new book about his 17 years as chairman of the Federal Reserve, there are a couple of chapters were the Ex Chairman looks ahead and attempts to predict economic trends between now and the year 2030. Throughout the book he claims to be optimistic about the future of the American economy, but his view of the future course of inflation in this country and the rest of the world is anything but rosy.
He begins the section on inflation by reviewing the economic history of the last 200 years … Prior to World War I the United States and the rest of world were pretty much on the gold standard. Inflation was not a problem in periods that did not include major wars (The war time periods do not count because paper currency was often introduced to finance the cost of the war). In the United States from 1870 and for the next 44 years to the beginning of the First World War the cost of living increased at an annual rate of just two tenths on one percent per year.
In contrast from 1939 to 1989 after the US went off the gold standard the cost of living in this country increased by an average of 4.5% per year. The lack of inflation under the gold standard left interest rates throughout the world flat from 1840 until the start of WW I. Interest rates in Great Britain remained close to a constant 3% for 74 years from 1840 until 1914.
The Gold Standard is long gone and will never return. Probably it would not work in today’s economy anyway. In a world of paper currencies were a countries money supply is always a political issue, the politicians always want easy money. Greenspan notes that in his 17 years at the head of the FED he did not receive one phone call from a President or congressman requesting that he raise interest rates. Whereas there was constant pressure from politicians of all shapes and sizes to lower rates.
As you would expect this drumbeat became particularly overwhelming during election years. Greenspan is still mad at George Bush I because after he left office Bush was quoted as blaming his defeat in the 1992 election on Greenspan’s failure to lower interest rates in the year leading up to the election.
The Chairman feels the current period of low inflation is an anomaly, and that the period of low inflation will pass. The reason for the lack of inflation is a temporary rapid expansion of the world labor pool and productivity gains brought on by a revolution in information technology. He feels that both of these trends will soon peak, or have already peaked, that political pressure will soon return inflation world wide to a rate close to what we have experienced since the end of World War II, or about 4.5% per year.
This is not what I would call a rosy view of the future. True we have lived with this level of inflation in the past, and done pretty well over the long run. But there was the 16 year stagflation in the nineteen seventies, and if Greenspan is correct long term bonds no matter whether they are issued by the US Treasury, investment grade corporations; or municipalities are a very poor investment at today’s yields.
So far in the second half of 2007 BRK is working for us as the best possible kind Berkshire Hathaway hedge fund investment. It goes up when the market is going up and stays either up or down a little in down markets. Last month was a good month both on an absolute and on a relative basis, with most all of Losch Management Company’s accounts up more than 7 1/2%. On a relative basis we beat the S&P 500 by at least 6%.
Since 6/30/2007 when the current liquidity crisis first appeared Losch Management Company’s accounts have out performed the S&P by 12% or an average of 3% per month. This has brought our Three year record compared to the S&P 500 back into positive territory.
The main reason for this result has been Berkshire Hathaway. My feeling for the last two years has been that Berkshire Hathaway was not only cheap, but that it offered a good hedge fund in the case of an economic melt down. So far our large position in Berkshire Hathaway has worked to help us out outperform the S&P 500 while holding a large cash position and a low risk portfolio. To date this strategy has not been tested by a serious bear market, but sooner or later it will be.