Depends on what you mean by 'inflation'

I was drawn to this article by its headline reporting that Warren Buffett, the billionaire investor and world's richest man, does not agree with Ben Bernanke's views on inflation and its medium to long-term impact on the U.S. economy. What I'll comment about, however, is the apparent distinction that the Fed makes between relative-price changes and what we would otherwise call inflation. Did you know that they made a distinction? I didn't!

Relative changes in prices are considered to be the result of the demand and supply forces that underly any market for a good or service. Inflation, more generally, is the resulting affect of a general change in price levels that causes our purchasing power to be reduced (assuming positive inflation, of course). What's interesting about this distinction, beyond the fact that such a distinction is even made, is that the Fed (and by the Fed, I'm really referring to Mr. Bernanke) believes that relative price changes are otherwise transitory and will not necessarily lead to inflation. The argument is one that I've written on before, simply that wages are sticky upward and that will mean subdued inflationary pressure. There is a problem with this argument though...

I do agree that wages are sticky and that will mean that inflationary pressures are somewhat tethered. That said, it would be difficult for anyone to argue that purchasing power has not been affected. Beyond the cost of fuel and the rising cost of food, consumer wealth is falling rapidly and this has a very real affect on consumption. As consumer wealth falls, they have less collateral and a generally lower willingness to spend. This, of course, must necessarily result reduced demand which will then result in slower sales, layoffs, even more bankruptcies, and ultimately even slower economic growth. So, my question, then, why does the Fed make such a distinction between relative-price changes and what we plebes call inflation if they both lead to the same thing?

Auction-rate bonds & Sub-prime loans; Deja-Vu anyone?

I have to admit that I wasn't familiar with auction-rate securities shortly before writing this post. From the news reports now filling the pages of many online financial news sites, it would seem that I wasn't alone. Of course, as with the sub-prime loans, the lack of understanding didn't seem to stop many from buying into these products.

One can't help but recite Mr. Warren Buffett's mantra: invest in what you know.

Auction-rate securities offer borrowers seeking long-term capital the opportunity to pay only short-term rates. Sounds ideal, right? You get money for as long as 40-years, but don't have to pay the premiums that would generally go along with such a maturity. This is possible because of the 'auction' in auction-rate. Specifically, as often as every 7-days, the interest rate cost on these securities are reset in a dutch auction. So, for those buying the securities, it's very much like buying short-term debt. Of course, as you might have guessed, there is a catch.

Unlike Treasury bills or investing in short-term money market funds, investors who purchase these auction-rate securities are essentially buying long-term debt (yes, like 40-years), but with the expectation that they'll be able to hand-them-off at the next auction. You have to ask yourself, then, what happens no other buyers show-up at the next auction? You guessed it, you get to keep those bonds. For individuals and institutions that purchased these securities because they were short-term, this could spell disaster if the funds were expected to be liquid to satisfy some other obligations.

It's not all bad news, if you have some other flexibility in your portfolio. There are penalties when the auctions fail; if you happen to be one of the owners of these little-understood securities and can manage to make-do when the auction fails, your return can shoot-up to as much as 20% on an annualized basis. That ain't bad when the banks are offering you less than 1% for short-term, liquid, savings accounts.

Of course, it's hard to think about the other side of the table - the institutions that sold these securities and are now forced to pay those double-digit rates.

At the end of the day, Mr. Buffett's wisdom certainly does shine-through. It's so simple. Invest in what you know and in what you understand. As an investor you have to appreciate that your broker is a salesman; he or she makes their money by selling securities to you. When they offer you a product that is unknown to you, then take the time to quiz them on the details. If they aren't able to answer your questions, then that should tell you something. If they aren't willing to explain them, then just get a new broker.

Buffett Chastises Wall Street for Financial Mess

Yes, I know, it's another Buffett post, but can you really blame me?

Did you know that Berkshire Hathaway Inc. and Mr. Buffett were approached as a possible white knight for Bear Stearns? Neither did I. Apparently Berkshire turned-down the offer because they didn't have enough capital or enough time to properly evaluate the situation. When you consider that Mr. Buffett is just about to leave on a European buying with about $35 billion in spare change.

In what has now become known as Woodstock for Capitalists, Mr. Buffett and his Berkshire investing partner, Charlie Munger, chastised Wall Street and financial institutions in general for letting the financial system slip into this kind of disarray. Mr. Buffett has said before that he doesn't trust the financial statements of most financial institutions and he said it again: banks can get away with too many big secrets for too long.

I, for one, will certainly be keeping an ear open to hear about what comes from Mr. Buffett's Eurotrip. I'll be sure to keep you all in the loop.

Buffett: "I invest in what I know and in what I understand"

Warren Buffett, the world's richest man, is someone to whom all investors should listen and from whom they should at least attempt to learn. In an interview on CNBC this morning, Mr. Buffett spoke about his latest deal to partner with Mars in a purchase of Wrigley at $80 per share (I wrote a blog about that here). When asked about why he was interested in the company, his comment was quite refreshing. Well, he said, when compared to the balance sheets of Wall Street's banks, this is a company whose value I understand.

Coming from one of the world's most respected, and successful, investors, this should cause many investors to truly question what is going-on in today's marketplace. When a savvy investor like Mr. Buffett can't make heads-or-tails of what financial institutions are reporting in their reports, how can a retail investor hope to do so? Instead, invest in what you understand.

Mr. Buffett's joke about doing a 70-year taste test of Wrigley's products speaks volumes about how investors should make their own investment decisions. Just like you shouldn't buy foods whose ingredients you can't pronounce, don't buy stocks who's underlying business you can't describe in a single sentence (or paragraph). Simple.

Buffett, Mars & the 70-year Wrigley Taste Test

CNBC had a great interview this morning with Warren Buffett following the announcement that his firm, Birkshire Hathaway and Mars are teaming-up to buy Wrigley (yes, the chewing-gum company) for $$80 per share. It continues to amaze me how easy-spoken Mr. Buffett is given his success. No pretentiousness; no stuffiness; just a regular businessman doing  his thing.

They started the interview by asking Mr. Buffett why he wanted to buy $6 Billion (his firm's share) worth of Wrigley. His answer was fabulous: well, I've been doing a 70-year taste test of Wrigley's products and like their products. He goes on to make a very powerful statement: when you have the opportunity to buy a great company, take it. He couldn't help buy quoting Yogi Bear: "when you come to a fork in the road, take it!"

Mr. Buffett compared this deal with Lays' (the potato chip company) offer to sell to Coca Cola year ago. Coke passed on the deal and Lays ultimately sold to Pepsi Co., largely considered their best acquisition. Coke, Mr. Buffett says, made a big mistake. Wrigley is a geat company according to Mr. Buffett and the best time to buy it is when you can afford to do so. Period.

One more thing...

Mr. Buffett also made the following statement regarding the state of the economy: I think that we are in a recession and that it will be deeper and longer than people think. I don't think that he could have been more blunt, do you?