More Buffett gems: on tariffs, tax and boardroom excess

In the first two articles in this series to mark the announcement of Warren Buffett’s retirement we looked at his advice for investors who wanted to keep things simple and then at his more detailed suggestions about how to select winning stocks. But his annual letters to shareholders in his company, Berkshire Hathaway, are peppered with observations about a variety of aspects of investment, business and the economy, not least his views on tariffs.

We have not edited the quotes, other than (where shown) to shorten them, so be prepared for American spelling and punctuation.

Trade and tariffs

Donald Trump has made a determined effort to cut America’s trade deficit via attempts to persuade manufacturers to build more factories in the US – attempts backed by his increased tariffs. But Buffett has long called attention to the dangers of America’s persistent trade deficit with the rest of the world – how it regularly buys more from other countries than it sells to them. This imbalance, he says, can be maintained only by America borrowing from foreigners or by selling them its assets. This is what he said in 2005:

‘Charlie [Munger, Buffett’s late business partner] and I … believe that true trade – that is, the exchange of goods and services with other countries – is enormously beneficial for both us and them. Last year we had $1.15 trillion of such honest-to-God trade and the more of this, the better. But … our country also purchased an additional $618 billion in goods and services from the rest of the world that was unreciprocated. That is a staggering figure and one that has important consequences. The balancing item to this one-way pseudo-trade – in economics there is always an offset – is a transfer of wealth from the US to the rest of the world. As time passes, and as claims against us grow, we own less and less of what we produce. In effect, the rest of the world enjoys an ever-growing royalty on American output. Here, we are like a family that consistently overspends its income.’

But although he wanted America to address this trade imbalance, he did not think targeting specific countries or protecting certain industries – the Trump approach, more or less – was the way to go about it. He said this in 2008:

‘In developing a sensible trade policy, the U.S. should not single out countries to punish or industries to protect. Nor should we take actions likely to evoke retaliatory behavior that will reduce America’s exports, true trade that benefits both our country and the rest of the world.’

In an article for Fortune magazine in 2003, he warned of the dangers of the trade deficit and proposed a novel way to address it:

‘We would achieve this balance [of trade] by issuing what I will call Import Certificates (ICs) to all U.S. exporters in an amount equal to the dollar value of their exports. Each exporter would, in turn, sell the ICs to parties – either exporters abroad or importers here – wanting to get goods into the U.S. To import $1 million of goods, for example, an importer would need ICs that were the byproduct of $1 million of exports. The inevitable result: trade balance.’

Tax

Buffett says he has no argument with paying taxes:

‘Last year [Berkshire Hathaway paid] $860 million in income taxes to the US Treasury … Charlie and I believe that large tax payments by Berkshire are entirely fitting. The contribution we thus make to society’s well-being is at most only proportional to its contribution to ours. Berkshire prospers in America as it would nowhere else.’ (1997)

Inflation

Buffett’s investing career stretches back to the 1970s and 1980s, when inflation was far higher than it has been in recent decades. He made frequent references to it in his letters and emphasised how hard it was for investors to make returns that kept pace with the rising cost of living. This is from 1981:

‘Unfortunately, earnings reported in corporate financial statements are no longer the dominant variable that determines whether there are any real earnings for you, the owner [shareholder]. For only gains in purchasing power represent real earnings on investment. If you (a) forego ten hamburgers to purchase an investment; (b) receive dividends which, after tax, buy two hamburgers; and (c) receive, upon sale of your holdings, after-tax proceeds that will buy eight hamburgers, then (d) you have had no real income from your investment, no matter how much it appreciated in dollars. You may feel richer, but you won’t eat richer.’

High inflation has a huge impact on bonds, especially if they are many years or decades from maturity. Buffett summed up the problem in a characteristically homespun way in 1980:

‘The very long-term bond contract has been the last major fixed price contract of extended duration still regularly initiated in an inflation-ridden world. The buyer of money to be used between 1980 and 2020 [in other words the issuer of a 20-year bond] has been able to obtain a firm price now for each year of its use while the buyer of auto insurance, medical services, newsprint, office space – or just about any other product or service – would be greeted with laughter if he were to request a firm price now to apply through 1985. For in virtually all other areas of commerce, parties to long-term contracts now either index prices in some manner, or insist on the right to review the situation every year or so … Overall, we opt for Polonius (slightly restated): “Neither a short-term borrower nor a long-term lender be.” ’

Buffett himself believed in modest and carefully structured use of debt for Berkshire:

‘We rarely use much debt and, when we do, we attempt to structure it on a long-term fixed rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable.’ (1984)

He also pointed out the consequences for asset prices of the wide availability of cheap debt:

‘Really good businesses usually don’t need to borrow … However, we are not phobic about borrowing … [But] unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it … Tight money conditions [high interest rates], which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side [borrowing money] should sometimes be taken independent of any action on the asset side [making acquisitions] … Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.’ (1988)

Executive behaviour

Buffett has expressed firm views about boardroom malpractice and business ethics. This is from 1989:

‘Over the years, Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished; many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun.’

‘Earnings can be as pliable as putty when a charlatan heads the company reporting them. Eventually truth will surface, but in the meantime a lot of money can change hands. Indeed, some important American fortunes have been created by the monetization of accounting mirages.’ (1991)

He is sceptical of boards’ willingness to hold bosses to account:

‘Relations between the Board and the CEO are expected to be congenial. At board meetings, criticism of the CEO’s performance is often viewed as the social equivalent of belching. No such inhibitions restrain the office manager from critically evaluating the substandard typist.’ (1989)

‘Sometimes … CEOs clearly do not belong in their jobs; their positions, nevertheless, are usually secure. The supreme irony of business management is that it is far easier for an inadequate CEO to keep his job than it is for an inadequate subordinate.’ (1989)

‘It’s difficult to overpay the truly extraordinary CEO of a giant enterprise. But this species is rare.’ (2006)

Share buybacks

Buffett has always been an advocate of share repurchases, although he stresses the overriding importance of the price at which they are conducted:

‘One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares. The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price?’ (1981)

‘When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended.’ (1985)

‘But never forget: In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value.’ (2013)

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• Read: The Warren Buffett gems you haven’t heard before
• Read: Warren Buffett’s advice for serious stock-pickers
• Read: Warren Buffett’s greatest lessons for ordinary investors

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