More Like the 'Ostrich of Omaha'by
To be frank, I'm getting a bit tired of Warren Buffett's pessimism about the U.S. economy. The so-called Oracle of Omaha, the second-richest man in the world, was anti-New Economy in the 1990s. Now he's downbeat on the U.S. dollar (see BW Online, 5/8/06, "Under Warren Buffett's Big Top").
In his latest letter to the shareholders of Berkshire Hathaway (BERK.B), Buffett wrote: "The underlying factors affecting the U.S. current-account deficit continue to worsen, and no letup is in sight.... Either Americans address the problem soon in a way we select, or at some point the problem will likely address us in an unpleasant way of its own."
We don't need this "voice of prudence" from someone worth more than $40 billion. But in the same letter, Buffett says something else I find interesting:
"...calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base."
Let's think about the U.S. as a business: How would we value it, if we were a long-term investor like Buffett? The fundamental market value of a corporation is based on the expected flow of future profits minus the current total of its debt and other obligations. The fundamental market value of IBM (IBM), for example, is the sum of all of the company's expected profits, appropriately discounted so that future earnings count less, minus its debt. This is the sort of calculation that any first-year business student knows how to do, using the concept of net present value.
Similarly, the fundamental market value of the U.S. economy depends on the expected flow of future output minus the debt that Americans -- individuals, corporations, and government -- owe to the rest of the world (debt that Americans owe to each other doesn't get subtracted). So the first thing that we need is a long-term forecast for gross domestic product.
Lucky for us, the Social Security Administration publishes a range of long-term forecasts going out to 2080, which take into account a variety of assumptions about demographics and productivity. Their most pessimistic forecast calls for a long-term growth rate of 1%, while their optimistic forecast projects that long-term growth will average 2.8%.
IT'S THE OUTPUT.
Depending on whether we take the pessimistic or optimistic estimate for future growth, the fundamental market value of the U.S. economy today could be as low as $225 trillion or as high as $255 trillion, in 2005 dollars. This takes into account the $4 trillion in debt that the U.S. currently owes the rest of world. (This number is based on looking at the next 20 years of growth only, but the conclusions don't change if we take a longer time horizon.)
Why is this number for the fundamental market value of the U.S. economy so much higher than the roughly $50 trillion net worth of U.S. households? Household net worth is based only on the value of financial and physical capital owned by Americans, such as residential real estate and corporate stocks. The fundamental market value of the U.S. economy also includes the output generated by future labor -- that is, all the skilled labor and hard work that Americans will put out in the years to come.
It turns out that the market value of the U.S. economy is increasing by anywhere between $4 trillion to $7 trillion per year. To put it in financial terms, this is the annual capital gains for the whole American enterprise. By comparison, our trade deficit means that the U.S. is adding roughly $1 trillion in external debt each year. That's a big number, but far less than the increase in the market value of the economy. From this perspective, we can keep this up forever.
Other industrialized countries are not so fortunate. It's expected that the prime-age working populations of Japan, Germany, and France will start shrinking soon. As a result, most current forecasts call for these countries to have very slow economic growth 20 years from now. That means the fundamental market values of these countries is rising very slowly, if at all.
My advice to Buffett is to apply the same sort of fundamental analysis to countries as he does to the stocks he owns. He might find that it's the U.S. that is the better deal.