Warren Buffett Tackles The Deficit

In 1984, the Berkshire Hathaway CEO took to the pages of the Washington Post to decry America's ballooning deficit — and its worrying ramifications on bonds, interest rates, and inflation

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At times, it can feel like everything that Warren Buffett has ever said or written has already been picked apart and examined from every conceivable angle. Buffett’s annual letters — nearly seventy years’ worth — remain must-reads for investors of all skill levels, while his old interviews and Q&A sessions rack up mind-boggling engagement numbers on YouTube.

But, every once in a while, we’re lucky enough to stumble upon something that slipped through the cracks. I’ve covered a few of these “discoveries” in the past, like…

• Rediscovering Berkshire Hathaway’s 1985 Annual Meeting

• Warren Buffett’s 1969 Annual Letter — Yes, It Actually Exists

• Warren Buffett’s Second Appearance on Adam Smith’s Money World

(And I still haven’t given up hope of tracking down Buffett’s missing partnership letter from 1956, though that trail has admittedly grown quite cold.)

While digging around in the Omaha World-Herald’s digital archives over the weekend, I came across an op-ed that Buffett penned in 1984 about America’s ballooning deficit — and its worrying ramifications on bonds, interest rates, and inflation. This plea for congressional action (and responsibility) originally appeared in the pages of the Washington Post, but was later syndicated to newspapers all across the country.

Up until a few days ago, I didn’t even know this Buffett op-ed existed. (And, after some unsuccessful Googling, I’m guessing that’s the case for most people.) So, in the Thanksgiving spirit of sharing, I’ve reprinted the article down below to give everyone a chance to read Buffett’s warning.

(I particularly enjoy how he pokes fun at some of the popular explanations and financing “solutions” for the nation’s deficit. Agree or disagree with his diagnosis of the problem, Buffett has always known how to use humor to drive home his points.)

What makes this op-ed especially timeless, though, is that its underlying theme — that nothing will really get fixed until Congress stops whistling past the graveyard and confronts the problem directly — remains as true today as it did thirty years ago.

It seems like the thorny issues of inflation, interest rates, and soaring deficits — not to mention congressional dereliction — never truly go out of style.

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Financing The Deficit “Congress Must Find Will” (July 1, 1984)

The writer, of Omaha, is chairman of Berkshire Hathaway Inc. and is on the board of directors of The World-Herald. This article was written for The Washington Post, which distributed it to its clients across the country.

By Warren E. Buffett

The United States will spend about $850 billion this year and finance only 80% of that with taxes. The deficit of around $170 billion will be met by the sale of government bonds. That’s a big number.

But many legislators, as well as President Reagan and Treasury Secretary Donald Regan (in their 1984 economic incarnations), are suggesting that it is not a very important number.

Certainly, they say, it is not important enough to justify the current 13% interest rate on long-term government bonds.

Supporting their position, they note that in the face of extraordinary deficits, the economy has improved and inflation has subsided. They also lean on a theory.

The theory holds that it is the method of financing deficits — not their size — that counts. The trick, this proposition says, is to avoid monetization. That is, the creation of money through purchase by the Federal Reserve system of those deficit-financing bonds.

Instead, so the argument goes, the buying must come from savings — and, in that case, the deficits will be rendered harmless.

If that proposition were truly valid, a shift in national fiscal policy would seem compelling. This new policy would seem particularly desirable because it also would instantly cure two other problems that many think impede our economic progress: the burden of excessive taxation and our lamentable national tendency to under-save.

Let’s step through the looking glass and examine this remarkable cure-all.

The plan would be simplicity itself. First, abolish all federal taxes. Second, substitute for them a requirement that all present taxpayers buy a new variety of government bonds in amounts 25% higher than the taxes they now pay. Third, make it illegal for banks or the Fed to own these bonds. In that way, the bonds could not be transformed into printing press money.

Under this system, the government would still raise its $850 billion, so spending could continue without missing a beat. Relieved of taxes, the citizenry would accumulate “the best investment you can make” — U.S. government bonds — at the staggering rate of $850 billion per year.

And, happily, the whole process would be non-inflationary since every bond purchase would be financed by savings.

Of course, a few statistical oddities would materialize. For instance, the national debt would rise at a historically fast rate. So, of course, would interest on the debt.

No problem about the interest. It would simply be paid in more bonds. (That’s actually the way our government currently handles bond interest, except that we disguise things by using a borrow-from-Peter-to-pay-Paul approach. In fiscal 1983, the government’s net interest payments of $90 billion were far exceeded by net sales of bonds to the public of $212 billion.)

At 10% interest rates, for example, an additional $85 billion of bonds would be issued in the second year to pay the coupons attached to bonds sold during the first year. By this procedure, the entire nation would learn the joys of pure compounding.

As old bonds annually gave birth to new bonds, the buildup in wealth would be monumental. All of this would be achieved with no reduction in consumption; after all, the $850 billion to be devoted to mandatory bond purchases — and, thus, not available for consumption — would merely equal today’s sum of taxes and voluntary bond purchases (also not available for consumption).

It’s interesting to contemplate the potential value of these new government bonds. If they should trade at 100 cents on the dollar, any individual could sell them off, recoup his investment, and truly feel that taxes had been eliminated.

And why shouldn’t they sell at 100 cents? They would be tax-free and issued in an environment that we are told need not be inflationary. If, however, a 10% rate will not keep the bonds at par, the plan can provide that interest will be adjusted annually to reflect current rates. This would guarantee a market price of approximately face value.

The adjustable-rate provision would cause no financial strain for the government, since — whatever the rate — it must be paid in more bonds.

Skeptics may say this scheme won’t work: it’s too brazen, too transparent, too good to be true. Those with a mathematical bent may contend that a cascading quantity of claims on a slowly increasing quantity of goods and services must lead to accelerating debasement of the claims.

To pacify these skeptics without leaving behind all the joys of fantasy land, let’s try Plan B — a variation incorporating several “improvements”:

(1) Raise only part of the needed funds by sale of bonds — let’s use 20% bonds, 80% taxation; (2) complicate the process by inserting pension funds and other financial intermediaries to blur who is doing what to whom; and (3) have political leaders assure the populace that large bond sales are only a one-shot proposition. That is, unending amounts of bonds are not to be forthcoming.

Prolonged usage of such assurances requires that leaders be replaced frequently. (A truly great communicator may prove an exception.)

Plan B, of course, would “work” for a much longer period than Plan A. Particularly if the country involved, like the United States, has an extended history of not materially abusing its fiscal prerogatives.

However, even the dim-witted and most trusting realize that Plan B is simply Plan A with a longer fuse. Fantasy land is still fantasy land, even when camouflaged.

And that’s why financial markets, from the standpoint of policy-makers, have behaved so perversely in the last few years. It’s not that we’ve adopted Plan B. Indeed, by our words, we generally have rejected it.

But there is a pervasive apprehension in financial markets that our political system is developing a dependence on something akin to Plan B — and that, like other addictions, it will prove far easier to continue than to cure.

The market now fears the consequences of unlimited bond issuances in much the same manner as it always has feared unlimited issuances of currency.

People need no econometric models to understand that a U.S. economy with present physical output but, say, $10 trillion of government debt would be an economic world far different from the current one — even if all that debt were financed by the savings of little old ladies in Dubuque.

At a 10% rate, interest on that much debt would be $1 trillion — or 30% of today’s GNP. But, of course, such a massive transfer of current output from producers to bondholders would not be allowed. The mechanism for disallowance wouldn’t be repudiation.

That’s not needed by governments dealing with debt denominated in their own currency. Inflation is the genteel method of diluting, or even virtually eliminating, such claims.

Given debt of $10 trillion — and real output only moderately greater than its present size — the nominal level of GNP would be enormously higher than it now is. It might be $20 trillion or $30 trillion or $15 trillion. No precision is really possible in this area.

But, in any case, a vastly increased GNP in nominal terms would have been created — in major part — by a mammoth rise in the price level. Perhaps 200%, perhaps 500%, perhaps 1,000%.

The very lack of precision about future economic relationships, once fiscal behavior gets into uncharted territory, contributes to the increased fragility and volatility of today’s bond market. Of course, a mathematical case can be made that an annual combination of 8% inflation, 2% growth, and a roughly 10% increase in the national debt will produce equilibrium in the Debt-GNP ratio.

The market rejects this case: it does not believe that stability can exist in any economic equation containing a high inflation component.

That’s the major reason supposedly high “real” interest rates fail to entice investors.

Calculations of real rates lose all meaning in Plan B situations. What, after all, would have turned out to be the real interest rates on a long-term taxable bond issued ten years ago by Mexico, Israel, or Argentina at 5 percentage points above the inflation rate then existing?

At some point, financial markets decide that interest rate bets made with governments in fiscal disarray are a losing game — no matter how attractive the odds look on a historical basis.

The bond market does not know at what speed the bond-issuing snowball will build. It does know that, by peacetime standards, the snowball is extraordinarily large and fast-moving.

It also knows that only Congress can slow the snowball — and that the act would require great political will. The market has seen little evidence that such a will exists.

Talk by Congress about “down payments” and “out-year projections” won’t work. Only action to bring down the deficit dramatically — now — will suffice. Were that to occur — and to be combined with a continuation of Chairman Paul Volcker’s leadership at the Fed — long-term interest rates would drop sharply.

Such a drop will not guarantee a brighter national economic picture, but its absence will preclude that future. Unless Congress moves decisively, rates will stay up. Lots of talk and little action will leave the market scrambling to get out of the snowball’s path.