Charlie Munger Wants to Scare You Straight

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The second in command at Berkshire Hathaway (NYSE: BRK-B  ) has never confined himself to the large shadow cast by Warren Buffett's iconic persona, but Charlie Munger's scathing account of this country's economic outlook in my opinion marks a new level of unbridled frankness from this well-known fixture in the financial world.

Munger has penned a sobering parable that appeared at over the weekend, and I expect that in time this piece will be viewed as a classic and timely attempt to instruct a nation in the basic foundations of fiscal solvency and the potential perils of our current trajectory.

He tells of a place called "Basicland," which, like the U.S., was rooted in principles of sound money and a tradition of conservative fiscal economics. In Basicland, Munger describes what started out as a sort of economic Utopia that was eaten away by higher taxes, increased government spending, and most importantly "casino gambling." He correctly characterizes our banks as casinos and derivatives as their bet of choice. This, over time, led to a system that was susceptible to economic shocks, like higher energy prices and diminishing exports due to low-cost foreign competition.

Every parable has a moral to its story, and Munger's appears to be a plea to heed former Fed Chairman Paul Volcker's approach that would aggressively rein in the gambling activities of the financial sector. Munger takes it a step further by having his Volcker-inspired character proposing an outright ban on trading in financial derivatives altogether. Suffice to say, such a measure would inexorably alter the financial landscape by limiting access to leverage through securitization. How one would set about dismantling a $600 trillion marketplace in an orderly fashion I cannot guess, but Munger seems to present the death of derivatives as the only sustainable way forward. I agree 100%.

What does it all mean?
This article is important not only because of what it says, but also because of whom is saying it. Berkshire recently completed an epic acquisition of railroad Burlington Northern Santa Fe (NYSE: BNI  ) , which Buffett hailed as his "all-in wager on the economic future of the United States." If that future looks anything like the one portrayed in Munger's parable -- where the once-solid credit of Basicland was reduced to tatters by persistently "extreme financial leverage" and "counterproductive governmental action" -- then Buffett's wager begins to look like something of a crapshoot.

Although the tone of Munger's tale is inescapably morose, and the mere idea that the United States could be driving down a path toward a place that Munger calls "Sorrowland" is a tough pill to swallow, Fools can take solace by safeguarding some portion of their assets from such a scenario. I have been encouraging Fools to limit their exposure to the U.S. dollar for some time now, and regardless of what debt-borne illness may befall the euro, I believe that the deep-seated fiscal imbalance underlying the greenback will make its presence known with equal or greater vigor.

For the past nine years, gold has offered a safe haven amid a precipitous decline in the purchasing power of the dollar. Fund managers like George Soros have gone for the gold with holdings of the SPDR Gold Trust (NYSE: GLD  ) exchange-traded fund, and China's sovereign wealth fund has ventured into stakes in miners like Freeport-McMoRan Copper & Gold (NYSE: FCX  ) and Gold Fields (NYSE: GFI  ) . China's central bank has made no secret of its desire to diversify its holdings away from U.S. dollars. I will say it again: I believe that any notion of gold being a bubble is patently false under the circumstances.

I take no delight in saying so because of the implications for the dollar, but I believe gold's likelihood of striking the $2,000 mark has never looked stronger. I believe that silver will surprise many with a run to $50 per ounce or higher before this precious-metals bull market eventually runs its course, which formed part of my rationale for selecting Silver Wheaton (NYSE: SLW  ) as my top equity pick for 2010. Moreover, I believe that equities relating to a broad swath of commodities from agriculture to iron ore will continue to fare better than most over the coming years, and I see potential bright spots for investors from diversified suppliers like BHP Billiton (NYSE: BHP  ) .

How would you characterize the significance of Charlie Munger's article? Is Munger dead-wrong with the economic recovery well under way and with risk abating? Sound off in the comments section below.

Fool contributor Christopher Barker carries a silver coin that reads, "Honest value never fails." He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of BHP Billiton, Freeport-McMoRan Copper & Gold, and Silver Wheaton.

Berkshire Hathaway is a Motley Fool Inside Value pick, a Motley Fool Stock Advisor selection, and the Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days.

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Read/Post Comments (8) | Recommend This Article (48)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 23, 2010, at 5:19 PM, TheDumbMoney wrote:

    The only good reason to buy gold is if one believes China and other developing nations will massively up their gold holdings in the coming decade. I'm guessing that's Paulson's bet. Otherwise, gold is in the middle of a spike. In any event, it is but a chemically stable yellow metal that does little and inherently generates no profits. In my humble opinion, if you're worried about devaluation of the dollar, people, a less risky hedge is to buy companies like PM, available now at a P/E of around 15. PM gets 100% of its revenue outside of the US and converts it to dollars for its profits. Try THAT on for purchasing-power size if the dollar tanks relative to other currencies.... In the meantime you get a great company at a nice value, a 5% dividend, and peace of mind. Or you can follow this genius into SLW at a 145 P/E. Disclosure: I own shares of PM. Do your own research.

  • Report this Comment On February 23, 2010, at 8:30 PM, XMFSinchiruna wrote:

    Please be sure to join the discussion at my blog:

    Track all of my articles via Twitter:

  • Report this Comment On February 23, 2010, at 10:31 PM, CMFStan8331 wrote:

    Articles like this only help exacerbate the ongoing gold bubble. Yes, we've done a lot of dumb things and have a mess to work through, but betting the farm on a complete economic meltdown is a REALLY dangerous strategy - even more dangerous than our government's financial misdeeds.

  • Report this Comment On February 24, 2010, at 12:10 AM, Ruhaan wrote:

    PM may be good but p/e of 145 will not get you anywhere with SLW. P/E is just one metric, besides commodity companies are generally traded on what they hold in reserves.

    Anyways, now back to the orginal article by Mr. Charles Munger. Anyone who know Munger a little, knows that he has pessimistic outlook in general. So this is no surprise to read this article. Infact, Mr. Buffett had written a similar piece a few years back where he has shown concern about our trade deficit with China (foreign countries).

    Its not at all a surprise that these two are the best buddies. Buffett grew up as republican, his father being Congressman from Omaha. His father had similar pessimistic view about US Dollar and encouraged others to buy gold. There is nothing wrong with that. Infact, everyone should try and allocate their assets in order to balance out the risks. I am not a gold bug but I listen to what people are saying and look at what other sovereign nations are doing. So it would not hurt if one hedges about 10% of his portfolio by investing in metals/commodities. If worse come to pass, at least some part of your portfolio with procide it a ballast.

    Depending on which camp you are in, you can adjust your allocation but make sure that you dont go overboard in one class of investment.

    my 2 cents

  • Report this Comment On February 24, 2010, at 10:03 AM, TheDumbMoney wrote:

    I agree with allocation. Also, I realize P/E alone is simplistic; but this is a blog comment and not a report for S&P. It's just that Barker is telling us "it's different" for gold. It was also "different" for tech stocks in the late nineties. It was then "different" for housing prices. Now, it may be that this time it really is different. But it may also be that gold and to a lesser extent silver are simply the latest mania. I'm the kind of guy that was buying MO in the late nineties, and who chose to rent rather than buy in 2005/06, so I'm a bit sensitive to this stuff. On the other hand, allocating some to gold is fine. It's just that now would not be a good time to establish one's full position. Average in over a couple of years and see what happens, in my view. In the meantime, there are other ways to protect against what the gold bugs think they are protecting against.

  • Report this Comment On February 24, 2010, at 11:35 AM, langco1 wrote:

    as fast as realization that there is no recovery sets in the larger the bubble in stock prices grows!

  • Report this Comment On February 24, 2010, at 1:51 PM, justin4j wrote:

    Here is the problem with Charlie Munger's commentary about derivatives - Berkshire has huge derivative positions and has done a lot of the very "gambling" that Charlie believes needs to be reined in. In addition to over-the-counter derivatives, Berkshire has a boat-load of reinsurance contracts which also are derivative contracts, albeit in a less conventional sense, but they still are derivative contracts where the economic result of each contract is indexed to external events and the economic effect for Berkshire is highly leveraged, exposing Berkshire to huge potential losses, relative to the consideration ("premium") charged. If Charlie truly believes derivatives are financial weapons of mass destruction, as he has said repeatedly, then why doesn't he convince Buffett to curb them within Berkshire and lead by example?

  • Report this Comment On February 24, 2010, at 4:27 PM, silverminer wrote:

    Actually, I believe it was Buffett who called them "financial weapons of mass destruction".

    But yes, you're right, BRK is exposed to them just as nearly every major corporation has accrued derivatives exposure of one form or another. The insurance industry as we know it would barely exist without them.

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