Charlie Munger Wants to Scare You Straight

A new level of straight talk from a very familiar source.

Christopher Barker
Christopher Barker
Feb 23, 2010 at 12:00AM

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.

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