Warren Buffett’s Thoughts on Trade in 2003
In 2003, Warren Buffett wrote an article with a proposal to address the trade deficit. It deserves more attention in the current tariff debate.
Financial markets have been in convulsions due to President Trump’s rollout of sweeping changes to America’s trade policy on April 2.
This is hardly news to the vast majority of readers of this article. I have my own views, but I would like to focus on the thoughts of someone far more qualified to opine on business and trade. Although Warren Buffett has been very cautious not to enter into political debates in recent years, he was far more willing to do so decades ago. We are fortunate to have an interesting article written by Mr. Buffett in 2003 that has not received the attention that it deserves in light of current events.
Before proceeding, I should note that Mr. Buffett’s article was written over two decades ago and we cannot be certain whether he still supports the same policies. In addition, there have been some false reports of Mr. Buffett “endorsing” the recent tariffs which Berkshire Hathaway had to repudiate in a brief press release last week. All I am trying to do in this article is to discuss what Mr. Buffett actually wrote in 2003, and in no way am I suggesting that he currently supports tariffs in general or President Trump’s tariffs in particular. I would encourage everyone to read Mr. Buffett’s article in full for themselves. It is quite brief.
Mr. Buffett begins by admitting that his record as a forecaster of macroeconomics is “far from inspiring.” He points to his “excessive” fear of inflation and his prior concerns about the trade deficit. I don’t think that this is false humility. As I wrote in a series of articles two years ago, Mr. Buffett underestimated the severity of the inflation of the 1970s when he wrote his final letter to investors in the Buffett Partnership in 1970. Perhaps his “excessive” fear of inflation in the 1980s and 1990s was due to the terrible impact on fixed maturity investments of the sort he recommended to his partners in 1970. Mr. Buffett’s great skill is as a businessman and investor, not as a macroeconomic forecaster.
Caveats aside, Mr. Buffett felt a need to speak out in 2003 regarding what he believed were unsustainable trade deficits that he thought would negatively impact the value of the dollar in the long run, leading to his decision to begin investing in foreign currencies. As he wrote at the time, “to hold other currencies is to believe that the dollar will decline.” He thought that the dollar might not merely decline but “plunge” and that Berkshire’s foreign currency investments would only offer a partial offset to the harm done to shareholders.
Thriftville and Squanderville
Taking a step back, why are trade deficits a problem to begin with? The first part of the article attempts to simplify the situation by describing the actions of two primitive economies: Thriftville and Squanderville. Initially, both are “closed economies” and citizens produce what they consume which makes them entirely self-sufficient. However, citizens of Thriftville eventually decide to work harder. They start to produce more goods than they consume so they can export their surplus to Squanderville. In exchange, Squanderville issues Squanderbucks, representing debt, to citizens of Thriftville. Over time, citizens of Thriftville end up owning a greater stock of “claim checks” against Squanderville’s future production.
Since Thriftville citizens are smart, they eventually come to doubt that Squanderville will make good on their debt, so they start buying up land in Squanderville. Eventually, citizens of Squanderville no longer own their land and they must work harder and harder to sustain themselves while servicing debt and paying rent on the land they need to produce food. The situation ends in impoverishment of Squanderville, although the process might take a long time and the people who ultimately pay might be future generations of Squanderville citizens rather than those who enjoyed the initial party of debt-fueled overconsumption.
The government of Squanderville eventually finds itself in an untenable position. They cannot simply inflate their way out of the problem since Thriftville owns not only their bonds but also owns the land. To confiscate land would be a step too far for most governments. As Mr. Buffett writes, “theft by stealth [inflation] is preferred to theft by force [outright confiscation].”
Import Certificates
Following the story of Thriftville and Squanderville, Mr. Buffett briefly turns his attention to the trade deficit as it stood in 2003, making the case that foreign ownership of U.S. assets would increase in the coming years if the trade deficit was allowed to persist at recent levels. This is regrettable because annual net investment income would be flowing out of the country at ever-increasing rates which Mr. Buffett compares to negative compounding. The same rationale seems to hold today, although readers should review the article for themselves and I will not go into the specific figures he cites from 2003.
Rather than propose explicit tariffs, either globally or on a country-by-country basis, Mr. Buffett proposed the idea of issuing “import certificates” to U.S. exporters. An exporter sending $1 million of products abroad would be issued $1 million worth of import certificates by the government. These import certificates could be sold to an importer bringing $1 million of products into the United States from abroad. The result would be an overall trade balance since, by definition, every dollar worth of imports would require a certificate that could only be earned by another company exporting goods of equivalent value.
Mr. Buffett acknowledged that this idea amounts to a tariff in terms of its effect. The importer of goods would face higher costs because of the need to purchase import certificates and, depending on competitive factors, would either have to pass along some or all of the impact of that cost to consumers or accept lower profits. However, the exporter of goods would face lower costs due to the sale of import certificates which could lead to price cuts for consumers or higher profits for the exporter.
Under Mr. Buffett’s proposal, the overall plan would not raise revenue for the government because the import certificates would be given to exporters without charge. However, it would be easy enough to adapt the plan to generate government revenue if the import certificates were auctioned off to importers, albeit at the cost of potentially higher inflation because exporters would not enjoy the lower costs made possible by selling the import certificates they would have been issued. In other words, adapting the import certificate plan to raise revenue for the government would increase the impact of the tax.
Benefits of the Plan
In my opinion, the benefit of Mr. Buffett’s proposal is that it sets an overall policy objective of balanced trade without being overly prescriptive regarding how balance is to be accomplished or appearing punitive against any particular trading partner. Importantly, there is no reason for trade to be precisely balanced on a country-by-country basis under his plan. The United States could run trade deficits with certain countries provided that offsetting trade surpluses are run with other countries. Who decides? Market forces would dictate exactly how it all plays out rather than being decided by government officials.
Insisting on balanced trade with every country seems unwise because there are lower income countries in the world that can provide the United States with affordable low value-added products but cannot afford commensurate imports of our products on a dollar-for-dollar basis. If we insist on balanced trade with poorer countries, the result could very well be a large reduction in trading volume benefitting no one.
Mr. Buffett also allows for a transition period in which we deliberately accept a smaller trade deficit to avoid shocks to the system. This could be accomplished by issuing “bonus” import certificates or giving them away to less developed countries which, admittedly, would be a form of foreign aid. When fully implemented, perhaps over period of a few years, the plan would assure balanced trade in aggregate.
Conclusion
The principle of government setting goals and frameworks without being overly prescriptive or punitive has a great deal of appeal. In a free market economy, decisions regarding how to best achieve an objective are best left to market participants, not government bureaucrats. No one individual or even a group of individuals in Washington D.C. has the wisdom to micromanage the economy, no matter how good their intentions might be, and in our sad reality, we cannot assume good intentions among politicians.
I wrote at the outset that the point of this article is to highlight Warren Buffett’s ideas rather than my own, but I will say that I generally agree with his concerns expressed in 2003 and find his plan to be interesting and at least worthy of discussion. I have no idea whether Mr. Buffett still believes that his proposal makes sense and it is unfortunate that we are unlikely to find out. Due to the poisonous political environment of recent years, he has all but completely withdrawn from policy debates. The country is poorer as a result.
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Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.
