Following is a guest post by Roy Sebag, the founder of BitGold. The post originally appeared on GoldMoney Insights.
Buffett’s Math Trumped by Gold
“The first principle is that you must not fool yourself and you are the easiest person to fool.” Richard P. Feynman
Introduction
Every year, I patiently await the release of Warren Buffett’s Annual Letter written to shareholders of Berkshire Hathaway. Though I have “evolved” when it comes to macroeconomics and my understanding of monetary history, I still consider myself first and foremost a bottom-up deep value investor and view this methodology as the only logical method to analyze, invest, or short securities traded by market participants in a free market. As far as value investors go, Buffett and his mentor Benjamin Graham are not only the best practitioners of the craft but have basically re-invented it and evangelized it. For that, every investor should have and maintain great respect for Warren Buffett, Benjamin Graham and others including Charlie Munger, Irving Khan, Walter Schloss, and David Gottesman.
View the entire Research Piece as a PDF here…
Value investing is what led Buffett to become the greatest investor of all time. He has, through his initial understanding of value investing, accumulated a collection of nearly 300 businesses spanning the globe. He has also amassed a significant fortune and more importantly, power. The same goes for Charlie Munger. With that power also comes an undoubted level of hubris, patriotism, and dare I say, statism.
Anyone that has followed the two as closely as I have can point to the specific moment when both realized their position of power was far more important to their interests than their ability to deduce market and political behaviour based on logic. It was 2008 when the financial crisis hit. That was when I believe Buffett and Munger realized they had become so successful and so big while the rest of the financial sector was so indebted and insolvent that, unless they started cheerleading, everything they had built would also be lost. It was ultimately fear which led Buffett to support Hank Paulson and even the big banks in stark contrast to his public positions in the prior decade.
I wrote about this in depth in an essay from 2012 which is entitled: “Respectfully Disagreeing with Buffett’s Recent Views on Gold“. I found it difficult to reconcile Buffett’s unsolicited comments about gold with the empirical historical data relating to his investment in silver, his public comments about inflation, and his father’s deep comprehension and support of the gold-standard as a congressman. Later this year, I will also dismantle Buffet’s comment to Becky Quick on CNBC by demonstrating that gold has actually outperformed the Dow. That piece will show that there has not been any investment vehicle that would have enabled an investor to mirror the performance of the Dow index.
In short, reaching this stage has required a deep understanding of value investing, Berkshire Hathaway’s history, and gold to disprove these arguments, and I am grateful to possess this multidisciplinary approach.
Buffett’s Latest Rhetoric
In Buffett’s 2015 Annual Letter, sandwiched between a logical review of the company’s achievements, is Buffett’s latest attempt to cheerlead and obfuscate. Unfortunately for Buffett, I had nothing to do this weekend and decided to put together a point by point rebuttal to his latest rhetoric and sophistry.
On page 7 of the annual letter, Buffett writes the following:
It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do.
That view is dead wrong: The babies being born in America today are the luckiest crop in history. American GDP per capita is now about $56,000. As I mentioned last year that – in real terms – is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well. [emphasis added]
Here Buffett is obviously taking a jab at politicians and other market participants that state the obvious: The US and other western economies are slowing, labor participation rates are at an all-time low, fertility rates are declining, household formation rates are declining, inflation is rising in the things we need, deflation is creeping in the things we own and most importantly, the gap in wealth inequality keeps growing to unprecedented levels.
These statements are not hypotheses; they are empirical and point toward a deviation from the historical path which made western democracies such as the US the most impressive prosperity machines in history. Buffett is once again fearful as he was in 2008 because he knows very well that the solution to recalibrating the path is the aggressive revaluation of the ratio of global assets to global debt.
Buffet’s creative solution is to leverage his deep understanding of real-inflation which forms the crux of his insurance float business model to obfuscate US data and convince readers that Americans are better off today than they were in 1930 (the year Buffett was born). He elects US GDP per Capita as the metric to convey this view and authoritatively declares that everyone else is “dead wrong”.
“Real” GDP per Capita – Many ways to Skin the Cat
Buffett arrives at a $56,000 2016 “Real” GDP per Capita for the US. He does so by saying “about $56,000”. Now, I could not reconcile this figure, the closest I came was via the St. Louis Fed’s “Real Gross Domestic Product per Capita” figure published here which comes in at $50,993 for Q4 2015. Nevertheless, let us take Buffett’s $56,000 figure at face value.
The Real GDP per Capita is calculated by taking the nominal GDP in US Dollars (which we have a history of dating back to 1790) and dividing that figure each year by the population figures. The result is a nominal GDP per capita figure one can trace back to 1790. A good website for perusing this type of data is: www.measuringworth.com. Here is where the monkey magic begins. Economists and now Buffett take this nominal data which is empirical and deflate it with some type of a formula to arrive at what they consider the “real” GDP per Capita figure. This, they claim provides an accurate measurement of historical GDP per Capita figures in today’s unit of account and helps to measure productivity over time.
Of course, any intelligent market participant knows the formula used by most economists (the consumer price index) is severely flawed and doesn’t reconcile with reality. Recently, I published a short piece on ZeroHedge showing how the Economist magazine uses the CPI and other useless formulas to manipulate gold’s true performance.
GDP per Capita Priced in Gold
When it comes to financial analysis, I try and focus on what I consider to be “universal truths”: wisdom or knowledge that is as close to foundational as possible. Mathematics for example, is universally true. Gravitational forces in the universe are also universally true. Buffett’s analysis and conclusion lacks rigor as it relies on a subjective variable (deflating a historical nominal GDP by a CPI index to measure productivity and quality of life) and then disregards the most important one: That 20.67 US Dollars in 1930 was equivalent to 1 Troy Ounce of .9999 or better elemental Gold (Au).
Buffett makes the argument that his $56,000 today is six times better (even after his adjustment for inflation) than the $858 of GDP per Capita each US Citizen earned in 1929 but forgets to mention that $858 in 1929 was equivalent to 41.5 Troy Ounces of Gold in 1929. Here is the math:
1929 Nominal GDP | $104,600,000,000 |
1929 Population | 121,878,000 |
1929 Nominal GDP per Capita | $858 |
1929 Gold Price | $20.67/Troy Ounce |
1929 GDP per Capita in Gold | 41.5 Troy Ounces |
February 2015 Gold Price | $1,224/Troy Ounce |
1929 GDP per Capita Today’s Gold Price | 41.5 oz * $1,224 = $50,796 |
St. Louis Feds 2015 GDP per Capita | $50,993 |
The result is unequivocal: When measuring on an apple to apples comparison, there has been little to no gain in GDP per capita over the last 86 years in the United States. There is most certainly not a six times increase in productivity nor is there an increase in the quality of life per capita as measured using the same unit of account that was used in 1929. Buffet’s manipulating of the figures without reconciling under the apple to apples gold method is trumped by math.
I have built a graph of US GDP per Capita priced in Gold from 1929 to 2015. On first glance, this graph appears to show that there were in fact times where, as measured on an apple to apples basis, the US was gaining in both productivity and quality of life on a per capita basis.
A part of me agrees with the graph and ascribes the first cycle from 1942 to 1971 as a classic post-war expansion fueled by healthy demographics, sound economic policies, normalized interest rates and the discovery and proliferation of conventional oil as a primary energy source. The second period from 1987 to 2001, in my view reflects the Greenspan era of targeting the gold price with the fed funds rate as he explains in his book “Age of Turbulence”. Though there were many unintended consequences brewing, market observers should agree that interest rates from the early 1980’s to 2001 incentivized savings and productive usage of capital.
Today, we have neither. We don’t have a market rate that incentivizes savings, nor do we have healthy demographics or sound economic policies. Most millennials prefer to remain single and defer household formation. When they do form households, their fertility rates are far lower than their parents.
GDP per Capita Priced in Gold Excluding Government Spending
There is an even more distressing analysis of the GDP per capita figures. In searching through the data, I noticed that government spending as a percentage of nominal GDP has been creeping up from 1930’s through today. If one is to extrapolate productivity or quality of life from GDP per capita as Buffett has done, shouldn’t the government component be excluded? Even the most ardent Keynesian would agree that government spending is not the arbiter of the free market but there to smoothen out the business cycle.
In 1929, government spending as a percentage of GDP was 11.16%. In 2015, it was 36%. Unsurprisingly, the adjustment of nominal GDP each year to exclude government and the subsequent adjustment of the resultant figure to Gold from 1929 to 2015 shows a completely different picture:
Though this graph resembles the prior graph, it’s important to observe carefully. The Gold adjusted Ex Gov Spending GDP per Capita figure shows less pronounced cycles than before. This is crucial as it indicates a longer-term asymptotic decline in peaks achieved by the US economy when excluding government spending. For market participants familiar with technical analysis, this resembles a “lower high” chart pattern. More importantly, the 2015 Gold adjusted Ex-Gov Spending GDP per Capita figure is $35,690 down 17.3% over 86 years vs. $43,157 which was the same figure for 1929.
Conclusion
We cannot prosper as a society unless we are using the right measurement tools. In this piece I showed how Warren Buffett was able to fool most people into believing they are six times better off today than their ancestors. It’s easy to convince anyone of anything if the author is both brilliant, powerful, and has an artifice through which they can distort the past. By using a measurement tool that is totally arbitrary such as the CPI to deflate nominal GDP per Capita, Buffett attempts to show empirical and logical analysis.
In reality, he diverted the public’s attention from a critical factor: that the historical dollars were redeemable in gold.
If you understand basic science and elementary physics, you will quickly grasp why only gold should be used as a measuring system for our productivity and prosperity. Most people who own gold don’t fully understand why they do. In my encounters with leading gold investors and market participants, the smartest own it because they understand it to be antithetical to everything else in financial markets. Another popular axiom is: It’s an “asset” without counterparty risk or an “insurance policy”. These are reasons for owning gold that miss the critical reason for why gold ascended as money in the first place. For those interested, I recommend these two pieces. The answer has little to do with economics and lots to do with physics:
Why Gold – BitGold.com by Roy Sebag and Josh Crumb
Gold Price Framework Vol. 1: Price Model by Stefan Wieler and Josh Crumb
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View the entire Research Piece as a PDF here…
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“American GDP per capita is now about $56,000. As I mentioned last year that – in real terms – is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries.”
What is America’s debt per capita then and now? I am sure even that is a leap far beyond the wildest dreams of his parents or their contemporaries
For those that are not blinded by gold “buggism” the obvious conclusion is that gold was ridiculously overpriced in the late 70’s and is ridiculously overpriced now.
There is no way in hell we are not better off now than in 1930.
“There is no way in hell we are not better off now than in 1930.”
The post is not about whether we are better off. It is about GDP per capita and how to measure it.
Buffett not Buffet.
In the last 244 years this country was practically debt free compared to today. Govt debt was from nonexistent to a very tiny fraction of GDP, except briefly during WWII. Today compound interest threatens to blow up Buffett’s book, because more debt is just not stimulating economic growth. Last year, the US total debt jumped another $3.4 trillion—and GDP increased something over $400 Billion. So the economic cost was an increase in debt of $10.00 to grow the economy by $1.00—
We may be approaching the straw that breaks the camel’s back. People aren’t stupid, and this math is pretty elementary….thus gold looks pretty attractive as a way to avoid getting swept into the abyss of bad debt…..i agree.
“1923 De Croes’ French Restaurant, Indianapolis: “Delicious tee-bone steak. French fried potatoes, salad, hot biscuits and syrup, tea or coffee, all for 40 cents.”
Restaurant prices through history
http://restaurant-ingthroughhistory.com/restaurant-prices/
C’mon , Mish. you must realize that Bitcoin’s are the only true measurement for our productivity and prosperity.
And after that my extensive Beanie Baby collection.
Gold runs a poor third at best .
I get the desire to come up with an apples to apples comparison and I’ve used this exact same approach myself in older posts that I’ve written. But for a while I’ve been questioning the validity behind such an approach.
The author doesn’t delve much into why we’re supposed to use gold to measure GDP.What if an ounce of gold in 1930 bought you less than it does today? It’s not like people actively use gold on a day to day basis so to those purely in the fiat economy its price is rather meaningless.
Nor does it necessarily give you a safe indication of inflation and purchasing power. in the 1930s as well as 2008 gold went up quite a bit while the Dollar’s purchasing power also went up significantly.
How does this approach capture productivity gains? For example I can buy a high end flat screen TV that’s larger than 70″ today for $1200, roughly an ounce of gold. How many of those did an ounce of gold buy in 1930. Oh wait, we were unable to produce even one of those back then because the productivity for it wasn’t there …
gold is equally floored as a metric – why not use televisions,radios cars……
you should look at your chart closely.
Surely living standards did not increase 6 fold then collapse and rise again 5 fold and collapse.
Common sense is in short supply
By the charts the Johnson/Nixon and GWB presidencies were the most disastrous economically in the post war era. And a couple of turnarounds with Carter and Obama. Hmmm… something just feels wrong with this analysis.
Mish. Just who is Roy Sebag? It seems strange a young Israeli would come out of nowhere and invests tens of millions of dollars all of a sudden
You can find his bio on Wikipedia and other places.
He is a smart guy with a good vision and idea on gold.
I have spoken with him several times
Mish
GDP ex total government spending doesn’t make sense – you’d need more detail on what is being spent to decide whether or not to include it – I would include some spending on military procurement, for example, but exclude spending on IT services to administer welfare payments etc. Not all government spending is created equal.
Good point on the Au output per head though.
It seems that Buffet is first and foremost an opportunist. The 2008 financial crisis was a revealing look into the soul of the elitists who were desperate to protect their wealth, much of which was obtained via fraud, looting and back-room deals with a bought-and-paid for government.
They parade the tenets of free market capitalism while they reap the benefits of very socialist policies which are referred to by other names. It’s pretty easy to be a successful investor when you have inside information or you can actually steer policy to your benefit.
Thank you
I was hoping for at least ONE poster to call out Buffet. Certainly not going to be Sebag considering his infatuation with WB.
Buffet most certainly started out as a great value investor, but over time morphed into a reservoir of bailouts/insider information. In fall 2008 the government desperately needed a private investor to step up to plate for Wall Street. His multi billion dollar investment in Goldman Sachs was a home run when Federal Reserve granted them access to Discount Window shortly afterward. Coincidence? His large position in Wells Fargo …. and its large portfolio of second lien mortgages (which should have been worthless) … was bailed out by various fedgov machinations. Obama has regularly met with WB to discuss economy. You don’t think WB doesn’t get heads up on which way fedgov will move and front run it?
Buffet’s folksiness is nothing other than tool to fool the masses.
All I did was go to a calculator see that inflation has gone up 13.75x in the time wages went up 6x from 1930. Add the disintegration of families, productivity, wage growth (lately), education cost spikes along with inability to do anything productive in Congress and it is easy to see why the American Dream is slipping away for all but the top 3%. Taking more from the rich or them middleclass to try to add a buck or two or free college or cars for the poor isn’t a solution. There needs to be a repatriation of jobs and profits from multinationals. If you want to sell your products to US citizens, the profit has to stay here and create jobs…end of story.
I don’t think there can be an overall definitive answer to if people are better off, there are so many variables that affect that, all the way down to liberties or social mood etc. etc. These two articles offer some common comparisons for basics, and to my view they are what counts:
http://www.mybudget360.com/cost-of-living-1938-to-2015-inflation-history-cost-of-goods-inflation/
http://www.thepeoplehistory.com/70yearsofpricechange.html
Being no expert on price history of common goods, I would welcome debate on the above.
How to sell stocks: Devise non-gaap analysis that makes a loss look like income and an eps beat.
How to sell a basic bet on something: package it as a derivative and make it look like innovative finance
How to sell gold: Devise a conspiracy and graph something that makes no sense, but make it all appear official and use a long term time series in the graph
I don’t think there can be an overall definitive answer to if people are better off, there are so many variables that affect that, all the way down to liberties or social mood etc. etc. These two articles offer some common comparisons for basics, and to my view they are what counts:
http://www.mybudget360.com/cost-of-living-1938-to-2015-inflation-history-cost-of-goods-inflation/
http://www.thepeoplehistory.com/70yearsofpricechange.html
Being no expert on price history of common goods, I would welcome debate on the above.
Interesting perspective on the 1998 run up. Say Mish, how about removing the effects of ending defined benefits plans and pushing everyone’s retirement into the stock market.
Certainly the wrong time to be throwing everyone into stocks
But I am always in favor of killing public sponsored defined benefit plans
Mish
I don’t think it’s right to subtract govt spending from the last chart. During this period the vast bulk of govt. spending has been social security and defense. Both highly desired by the voters. Because we got ripped off by our defense purchases is that any reason to subtract since purchases of lemon vehicles or other faulty products would be included.in GDP no matter how defective.