Two Big Bets Against The Buck

Why Warren Buffett and Pimco's William Gross say a slide is inevitable

International markets are in free fall. But that doesn't scare two of the most savvy U.S. investors. Warren E. Buffett, who runs a $140 billion empire as CEO of Berkshire Hathaway Inc., and William H. Gross, managing director of Pimco, which operates the world's largest bond fund, are making big long-term bets on global currencies and stocks. The market gurus are going against the flow because they think the U.S. dollar will tumble. "You can believe in fairy tales and Peter Pan, which is what the strong dollar represents," says Gross. "But there comes a point when people stop believing in Tinkerbell."

It certainly looks like a risky gamble. Investors worldwide are spooked about rising interest rates and fears of higher oil prices and weaker corporate profits. None are more worried than investors in foreign markets, which have been top performers in recent years. Since May, Morgan Stanley's MSCI EAFE index, which tracks European, Asian, and other international stocks in developed nations, is down 12%, while the MSCI emerging-markets index is off 20%. The Standard & Poor's 500-stock index, by comparison, is down 6%. At the same time, many investors have been fleeing to the dollar as a safe haven.

Not Buffett and Gross. When it comes to the dollar, they're big bears. Buffett has argued for some years that the U.S. current account deficit, which hit a record $805 billion in 2005, would hurt the dollar. Gross agrees and adds that the U.S. economy is in for a rough patch as the housing market "cracks" and foreign investors lose their appetite for dollars. Although the Fed is still in rate-hiking mode, Gross says it will be forced to reverse track and cut interest rates when a federal funds rate of 5.5% or higher crimps economic growth too much. Central bankers worldwide, on the other hand, will still be raising rates, and foreign investors in U.S. Treasuries will start to bail out in search of higher returns. Gross also thinks Fed Chairman Ben S. Bernanke and incoming Treasury Chief Henry M. Paulson Jr. will allow the dollar to soften in order to rouse exports. "I think few would quarrel with the inevitability [of a weaker dollar], though some would suggest it will take several years," says Gross.

COSTLY PLAN

Until recently, Buffett had been playing a weaker dollar by owning foreign currency contracts. Last year that bet cost Berkshire $955 million, and it's a pricier strategy as U.S. interest rates rise. Today, according to Berkshire's latest annual report, he is largely betting against the dollar by "purchasing equities whose prices are denominated in a variety of foreign currencies and that earn a large part of their profits internationally." Earlier this year, Berkshire put roughly $330 million into Britain's Tesco PLC, a retailer with stores in Europe and Asia, and bought shares of London-based Diageo PLC (DEO ), seller of Guinness beer and Captain Morgan rum. Buffett also scooped up stakes in United Parcel Service (UPS ) and ConocoPhillips (COP ), U.S. companies with a huge global presence.

For his part, Gross has invested $20 billion in foreign currencies. That can be costly: When the dollar rises, the firm can lose as much as $1 billion in a week, but Gross is sticking to his guns. "We can't gauge the imminent weakness in the economy any more than Bernanke can. For us this is a several-year bet, and we're willing to suffer...if we have to."

By Adrienne Carter and Mara Der Hovanesian

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