Buffett on Inflation

We talked earlier this week about Warren Buffett, and also about the possibility of inflation returning. Then lo and behold, what should show up in yesterday's New York Times but an op-ed by Warren Buffett warning about the return of inflation. Like a lot of people, Buffett is worried about the enormous deficits the federal government is running, and lays out the scenario for various ways of financing that debt.

Buffett makes it clear that his concerns are still some years in the future, and that there's time to avert the kind of monetary policy that can bring about crushing inflation. But he's doubtful that Congress will do the right thing: "Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election," Buffett writes. "To avoid this fate, they can opt for high rates of inflation."

"Our immediate problem is to get our country back on its feet and flourishing - 'whatever it takes' still makes sense," he writes. "Once recovery is gained, however, Congress must end the rise in the debt-to-GDP ratio and keep our growth in obligations in line with our growth in resources."

One of Buffett's most famous lines is "Someone's sitting in the shade today because someone planted a tree a long time ago." It's good to have people looking out for our long-term future - someday soon, we will be into a full recovery, and it's important to not forget about other problems that may arise down the road.

The Latest on Inflation

We've been keeping an eye on the possibility of inflation returning, and we've had some good news this week. Wholesale inflation, measured by the Producer Price Index as kept by the Bureau of Labor Statistics, dropped 0.9 percent in July. Over the past year, the PPI has now fallen 6.8 percent, the largest drop since the BLS began tracking the index.

Interestingly enough, prices have fallen more the further back you go on the production line. The PPI measures prices for finished goods, and as I said, it's fallen 6.8 percent in the last year. Meanwhile, what's known as intermediate goods have fallen 15.1 percent and the price of crude goods - raw commodities that have yet to be processed - has fallen 44 percent.

The federal government's massive deficit spending has led to increased inflation fears, so these reports are very welcome. Not only can inflation be a nasty shock to the paycheck, but a low inflation rate will allow the Federal Reserve to keep its Fed Funds rate low. That will be critical in funding the recovery.

Buffett's Moves

Yesterday, we talked about where venture capitalists have been investing lately. At the end of last week, Warren Buffett's Berkshire Hathaway also announced some stock purchases and sales. Here's what the Oracle of Omaha has been up to:

Bought shares of Becton Dickinson & Co., a syringe and laboratory equipment maker based right here in Franklin Lakes, New Jersey.

Bought shares in Johnson & Johnson, the world’s largest maker of health-care products, also located close by in New Brunswick, New Jersey.

Sold shares in Eaton Corp., a manufacturer of of circuit-breakers and fuel pumps based in Cleveland.

Sold shares in Carmax Inc., the nation's largest used-car dealer, based in Richmond, Virginia.

Sold shares in Home Depot Inc., based in Atlanta.

Sold shares in WellPoint Inc., a health insurance company based in Indianapolis.

Sold shares in UnitedHealth Group Inc., another health insurance company, this one based in Minnetonka, Minnesota.

Sold shares in ConocoPhillips, the oil company based in Houston, although Berkshire Hathaway remains the company's second-largest shareholder.

The Smart Money

One of the best ways to address the status of the economy is to see where the smart people are putting their money. The business school at Pepperdine University in California surveyed 185 VC firms to see where they're been investing lately. The biggest winner in recent months has been, not suprisingly, software, a common favorite for venture capitalists. Software firms have collected 23.7 percent of all VC money lately.

Here's the top five:

Software: 23.7 percent
Medical devices: 13.4 percent
Biotech: 10.3 percent
Clean technology: 9.3 percent
Internet specific: 9.1 percent

It's interesting to see clean technology, which the Obama administration has made such a big show of supporting, garnering so much venture capital. Near the bottom of the list is pharmaceuticals, at 3.5 percent, financial services, at 3.1 percent, and consumer products, at 2.9 percent.

Pepperdine also asked the firms how many investments they were planning to make in upcoming months. More than half, 54 percent, said they planned to make three or more investments over the course of the next year. That's a lot of money that could be coming into the economy.

Pretty Money

There's an email going around suggesting that our paper money has been redesigned, and that the new five will look something like this:



It's not true; the design above is simply something produced by an artist named Michael Tyznik for a contest called the Dollar Rede$ign Project. Notice that in redesigning the dollar, he moved George Washington to the five-dollar bill. Tyznik's plan calls for the dollar to be replaced by a coin.

So Washington moves up to the five, Lincoln goes to the ten, Jefferson to the twenty and Jackson to the fifty. Tyznik also proposes doing away with the penny and including a new $200 bill. You can see more here.

Hooray

According to the Federal Reserve, the worst of the recession is over. The Fed emerged from its two-day meeting yesterday optimistic about the economy and the recovery, although it also said "economic activity is likely to be weak for a while."

You probably saw that the Wall Street Journal went even further: It polled a panel of economists and came away declaring that the recession is over - not just the worst of it, but the whole shebang.

So where does this leave us? It's good news; it's always a plus when the most qualified observers think the economy is doing well. But it certainly doesn't change anything fundamentally. The same companies still woke up this morning and tried to find new customers so they could make more money and grow. An assessment of the larger economy means very little for individual stocks. Not to mention for individuals looking for work; indeed, the WSJ panel of economists still expects unemployment to rise near ten percent by year's end.

I don't mean to be too negative; this is very good news. And it may be reaping dividends already - the dollar rose against the yen, apparently because of the Fed's report. But we still have a lot of work to do.

The Fear Index

Despite the gains the markets have put up in recent weeks, are investors still nervous? The Chicago Board Options Exchange compiles a Volatility Index - also known as the market's fear index - and it rose 4.1 percent to 26.01, its highest level in a month. Historically, the average is more like 18-20. After peaking at a record 89.5 last October, in the midst of the banking meltdown, it's down 35 percent in 2009 but now it appears to be moving back up.

But volatility doesn't necessarily equate to a bear market; volatility can mean violent upward price movements, too. The Volatility Index looks at options based on the entire S&P 500 to see how much volatility investors are expecting over the next 30 days. Call options, those expecting an increase in stock prices, raise the Volatility Index just as much as put options, which expect downward price movements.

So the fear index isn't always aptly named. Investors suspect there are extreme times to come in the market, but it may well be extremely good.