You only learn who has been swimming naked when the tide goes out

[Warren] Buffett’s annual letter to shareholders, which was released Friday, has become something of a business institution, with the certainty that he will offer caustic comments and the hope that he will shed light on his investments.

This year, his scorn was aimed at the “financial folly” of lenders who financed the housing boom, since vanished, and at companies that use rosy assumptions of investment success to raise reported profits.

The comments, which were released after the market closed, came as Berkshire reported that fourth-quarter profit fell 18 percent, in part because of falling insurance rates. Net income decreased to $2.95 billion, or $1,904 a share, from $3.58 billion, or $2,323, a year earlier.

Mr. Buffett offered no commentary on Berkshire’s foray into the municipal bond insurance business, and no explanation of why he spent $1.5 billion to buy a 1.3 percent stake in Sanofi-Aventis.

But he was willing to say, in effect, “I told you so,” in recalling his warning a year ago about “weakened lending practices” in the mortgage market.

“Just about all Americans came to believe that house prices would forever rise,” he wrote. “That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that H.P.A. — house price appreciation — would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight.”

Buffett's State of the World: There's Folly in Wonderland (New York Times, 1 March 2008)

Related: Warren Buffett's 2007 Letter to Shareholders (BerkshireHathaway.com)

The $1.4 Trillion Question

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. But because of political tensions in both countries, and because of the huge and growing size of the imbalance, the arrangement now shows signs of cracking apart.

The $1.4 Trillion Question (James Fallows, The Atlantic)

The dollar, in free fall

The financial press reported last week that the value of the U.S. dollar plummeted to a 14-year low against the British pound, and weakened against the Euro and Yen. Many financial analysts predict continued rough times for the dollar in 2007, given reduced expectations for economic growth at home and less enthusiasm among foreign central banks for holding U.S. debt.

This decline in the value of the dollar is simple to explain. The dollar loses value as the direct result of the Federal Reserve and U.S. Treasury increasing the money supply. Inflation, as the late Milton Friedman explained, is always a monetary phenomenon. The federal government consistently wants to spend more than it can tax and borrow, so Congress turns to the Fed for help in covering the difference. The result is more dollars, both real and electronic-- which means the value of every existing dollar goes down.

Congressman Ron Paul (R-TX): Monetary Inflation Is The Problem (December 4, 2006)