ERICOPOLY

The BLS CPI predicts nothing! it is not a predictive tool for anything other than future Social Security premiums and payments! ... It is a HISTORIC measure of price of a basket of specific consumer goods and services for a specific purpose. It is probably not a good tool to use for any other purpose or comparison! I was looking at it from the point of view of, if we were in 1991, which would be a better predictor of the future cost of living. Other people might call this "backtesting", I called it "predict" and you are probably correct that I wasn't semantically accurate. Regardless, after backtesting it has been a more accurate measure of price increases than pre-Clinton -- unless you have a basket of important prices that suggests otherwise?

Agree with that. It's purpose is to track what it really costs to live as compared to when they paid their premiums. But suppose you paid your premiums in 1991. Where is the 4x inflation? What exactly do you buy outside of eating at restaurants, drinking beer, buying soda, filling your car with gas, buying a car, buying your house. What is up 4x? What???? I tried to include the major purchases like houses and cars, and that only made prices seem low relative to 4x. Fine, let's talk merely of services, not assets. Pizza is not an asset, neither is beer, neither is soda, neither is toilet paper. In 1991 a haircut at Supercuts was $8. Is it $32 today? Not even close, it's about $13-$15, depending on location. The BLS CPI predicts it would cost $14.75, while the pre-Clinton CPI says about $32. There was a popular gameshow with a buzzline "You could be the next contestant on The Price is Right!". Who is winning this game so far? The pre-Clinton CPI or the new CPI?

ShadowStats suggests 4x rise in prices since 1991. (I can't tell the exact number because they only supply a bar chart, not a number). A baseline 4wd Chevrolet Suburban cost about $20k ($18,540 MSRP) in 1991 and I paid $34k for a brand new 2008 Chevrolet Suburban LT2 from a local dealership in 2008. The MSRP was $48k but this was not the baseline model. The LT2 is practically fully loaded. It did not come close to the $80k or $100k that ShadowStats CPI would suggest. The quality today is much higher than in 1991. This is a luxury car now, compared to the trim and features of the 1991 car. The baseline MSRP of the 2009 4wd model is $43,215 (133% price increase but higher quality, more features). BMW: 1991 535i $42,900 MSRP 2009 535i $47,010 MSRP (it is a better car too) I worked at Round Table Pizza in High School. In 1991 it cost about $18-$20 for an extra-large King Arthur Supreme pizza. Today it's $27.50 for the same pizza. Not even double. Same pizza. Beer is not double. Pizza is not double. Cars might have doubled. I paid $380 for a Sage 490LL fly rod in 1994. Today they are about $700 for the similar top line of rods, and they are still manufactured at the same plant right here in Bainbridge Island, WA. The quality is better on the new rods too. Median house prices have certainly not quadrupled since 1991. The median price for a new house in 1991 was $117,900. Today, it is about $200,000. Not even double! http://www.census.gov/const/uspricemon.pdf There are a lot of prices that are nowhere near 4x that ShadowStats suggests. Mostly, I see these 50%-100% price increases. But I can't find anything that's gone up 4x. Not even gasoline! Gas today is roughly twice what it was in 1991 -- maybe up 150% (despite rising global demand, peak oil, and other explanations for a long term trend up even without monetary inflation): http://www.randomuseless.info/gasprice/gasprice.html So what the hell is he measuring? I can't find things that cost 4x as much, so there might be some things that John Williams is counting that are up at least 10x or 20x in order to bring up the average to 4x.

There was a thread about Polish Re getting a negative ratings outlook earlier and it had something to do with the high equities concentration in the portfolio and the risk of potentially being in a compromised position regarding claims due to a global equities crash. So the investment mix scares the ratings agency, which in turn may scare the customers (lower credit rating). My understanding is that Berkshire can invest it's insurance subsidiaries into equities without that kind of a problem due to the wide and diverse number of cash generating operating subsidiaries within Berkshire. I'm suggesting that keeping the operating subs intact within Berkshire allows the insurance subsidiaries to rake in more cash. So it would seem that splitting it apart weakens the value of the insurance subs. And keeping it together allows Berkshire to occasionally add an insurance sub that can make more money as a part of Berkshire than it could standing on it's own (it picks up the stronger credit rating and clients like that).

All their beer is cheap though. I think the price of a six pack Coors is also roughly unchanged after 18 years. Newer "specialty" beers are pretty much the same price too, if not cheaper. That website ShadowStats.scom suggests that a $5 sixpack of Budweiser ought to be about $25 bucks right now. http://www.shadowstats.com/inflation_calculator?amount1=5&y1=1991&m1=8&y2=2009&m2=8&calc=Find+Out There must be something special about the beer market that is holding inflation down. $25! Come on, not even close.

Removing the gold peg only means that it is now mechanically possible for the Swiss Franc to fall in price vs gold. It does not explain why it is happening. Why is it happening to the AUD? Why is it happening to the CDN? Neither of those two countries have recently moved from the gold standard. They are not undergoing monetary inflation on the scale of the US. An explanation for the scale of the price movement in gold vs a basket of important world currencies needs to be more sophisticated than merely "US Fed action". I think the problems with the US management of the dollar and deficits explains why it is depreciating vs a basket of world currencies. That makes perfect sense. But it's a different conversation entirely when discussing why gold is blowing away that same basket of world currencies. You mention that gold is trading at a premium, and that is part of the explanation. The other part of the explanation is probably that (along with many commodities) gold was likely trading at a severe discount earlier in the decade. So rather than "monetary inflation" as the answer, it is more likely that it isn't even the biggest factor behind the gold movement -- a huge part of the swing is likely going from a position of discount to a position of premium. After all, the other world currencies have seen nowhere near the rise that gold has seen. Similarly, Fairfax stock might rise 80% from some low point earlier this year. Somebody could say, "it's because they made a lot of money", which is true, however it's significantly due to the discount vs premium factor.

I went to Walmart yesterday. A six pack of Heineken was $6.99. I don't think it has changed in price since I was graduating high school in 1991. In fact, I think it is cheaper now than it was then. When consumer prices are calculated, where do they go to shop for prices? Do they go to Walmart or do they go to the mall?

I wouldn't credit the goldbugs for recognizing that the dollar ought to slide against relatively stronger currencies. The goldbugs are simply the ones that only see one way to go: gold at any price. They don't focus on what is happening to gold vs Swiss Francs, they are satisfied it seems only that the USD is depreciating and gold is going up. That's why I think they are wackos. If they instead saw merely that gold is but one of many options, they could be deemed to be reasonable people. Ask a goldbug why gold has skyrocketed in USD terms and they say "monetary inflation". Ask them why it has skyrocketed in Swiss Francs and they say " ", they dodge the question actually. Warren Buffett for example has been expecting a USD decline for years, but we get more intelligence from him than simply "buy gold". He sees the problems in the USD, but he is not a goldbug.

As for supply... At $1,004 per ounce, there is only enough gold in the world to support one billion people, each with an individual net worth of $5,000. The total amount of gold is only worth $5 trillion ($5,000 evenly distributed across one billion people). So there are easily one billion people on this planet with that much money. What will the rest of the people do? On a gold standard, how could redemptions be met if everyone demanded payment in gold? That was the problem with the US under Nixon, the gold standard failed because there was not enough gold to meet redemptions. If we put the world on the gold standard, will things be any better?

Cows breed. Yes, the supply of cows is elastic, putting downward pressure on price as the new supply of cows come on line (cow inflation). This is a problem with using most biological commodities as a store of value... supply is not constant. The supply of gold is static, it is practically indestructable (supply can not be decreased and is finite and relatively small.. ) From what I have read (which may be wrong), silver is being consumed and thus has an edge over gold if that is what you find valuable.

Cows breed.

There is a big difference between cows and gold. Cows have more intrinsic value or utility to them than gold. You can milk them, you can slaughter them for meat and leather goods, and you can use them for labor (e.g., pulling plows). Gold has some utility, but not as much as cows or most other traded commodities. Gold, however, does function very well as an alternative currency, which is driven by the fact that it is a precious metal and has a hold on human imagination that goes back since time immemorial. Furthermore, the absolute supply of gold cannot be influenced/manipulated by central banks, though central banks can affect the dynamics between the supply and demand for gold in the market, as they control most of the gold that exists in the world. This monetary function in the minds of most people in the world makes holding gold a nice insurance policy to have in case of sudden currency devaluations or systemic crisis. I’m not sure that I would ever make the claim that gold has a "stable" value as it is in the end just a currency to be used in exchange for goods and services. The ratio of exchange between gold and useful goods and services can easily fluctuate based on animal spirits and short term supply/demand fundamentals. ----- Here's my theory about what has happened to gold over the last few years and what will happen going forward: -In the late 90s and early 2000s, many central banks -- and the Fed in particular -- came up with an easy money policy where they would inject liquidity into the system to soften every little recession. One of the things that the central banks did when they lowered rates was to lend gold out at very low interest rates, promoting what has been called the "gold carry trade." Gold was leased at these low rates to bullion banks, who subsequently dumped the gold into the market in order to lend out the money or buy fixed income securities such as MBS. This caused the price of gold to be very depressed during this period and the price reached a bottom in the early 2000s. -Between the early 2000s up until the financial crisis happened, the supply and demand in the market for gold began to normalize and so the price of gold began to revert to a more normalized level. On top of this, many smart people began to realize that we were getting to the point where we would finally see the dollar be devalued at a rapid pace and where we could have global systemic crisis due to the casino-like, too big to fail, derivatives-laced financial system that was reaching its apex. These people saw that if a global panic were to ensue, you might want to be in gold because of its insurance value. Reversion to normalized prices plus realization of the potential systemic crisis caused the price of gold to appreciate relative to many sound country currencies over the last five years. -Then the panic happened. It became clear to everyone that the dollar was going to be worth much less going forward, including the Chinese and Japanese central banks who had continued to hold dollar reserves and lend money to us in order to sustain their export sectors. Fearing a sudden devaluation of the dollar and systemic collapse, these central banks, institutional investors, and even retail investors began to pile into gold and useful commodities (such as oil) in order to preserve the wealth they had accumulated. They did this because it was the easiest and quickest way to do so. Gold and commodities spiked versus the dollar and versus other currencies. Gold continues to remain high because supply cannot be ramped up as with useful commodities such as oil, nat gas, and copper, and because demand for gold is not as tied to the real economy as demand for these useful commodities. -Now we see China and Japan, which still have lots of dollars and dollar-denominated fixed income securities in their coffers, chomping at the bit to get rid of their dollars in an orderly manner, i.e. in a manner that won’t destroy their export sectors overnight and cause unrest. Instead of dumping dollars into the currency markets, they are planning on investing in U.S. commercial real estate in the next few years and will probably buy more stakes in U.S. business so that they have claims to real/productive assets instead of dollars in their hands. They will likely also slowly diversify into other currencies such as the Canadian dollar and Australian dollar, which will push these currencies up relative to the dollar over time. Buying gold will no longer be the best way to combat dollar devaluation, and the price of gold will stagnate versus other currencies that are backed by useful commodities, fiscally sound government policies, and strong industrial concerns. The time to buy gold was between 2001 and the financial crisis. Not now. That makes a lot of sense and at least provides a satisfying narrative as to gold vs CDN and AUD, and what I suspect will be their relative outcomes in the future.

I would use gold as a hedge if I could understand the price movements. I don't understand why it makes the Swiss Franc look like it is hyperinflating over the past 5 years. Ditto for gold vs CDN and AUD. I do understand why the USD is falling in value against Swiss Franc, CDN, and AUD. That's pretty clear. It makes sense that it is losing value to gold too. But what doesn't make sense to me is why the CDN/AUD/CHF are quite literally collapsing relative to gold (the past 5 years). There is no theme of rapid devaluation of those currencies, except when held up to gold. So it is a conundrum. Julian Robertson is staying away from gold because he thinks gold is driven by psychology, and he isn't a psychologist. He does believe in the possibility of a USD collapse so he is hedging via derivatives that effectively short US Govt bond market (the curve steepener).

I have been seeing sandwich boards out on the highway near my house recently, advertising gold and silver coins. Has anyone else seen these with more frequency as of late?

Viking mentioned the 6.9% book value growth over the past 10 years and law of large numbers in the same post. I was really referring to that. In an parallel world, where KO and similar stocks were dirt cheap 10 years ago and expensive today, then book value growth over past 10 years would have possibly been 15%, but we would not be able to draw any conclusions from that regarding the size of Berkshire and how it impacted performance, only that the market P/E expanded. Lastly, suppose we were talking about KO in isolation and not mentioning Berkshire. Would we even be impressed with measuring KO's book value growth? Doubt it. That's because KO is an operating company and we would be more interested in rate of profit growth. Likewise, Berkshire is increasingly more so every year just a consolidated balance sheet of operating companies and the right way to measure it is earnings growth, not book growth. Fairfax is different because it's operating companies are just shells that hold publicly priced securities, so book value is far more relevant. For example, you don't amortize the cost at which you hold JNJ stock, but if you bought the company outright you would amortize the goodwill. The value of JNJ within Fairfax grows as the earnings at the company grow, this grows book value for Fairfax. Now, if Berkshire took JNJ private the value of JNJ on Berkshire's balance sheet would not grow along with the profits -- you would have instead the amortizing goodwill. Lastly, Fairfax trades them to generate profit in excess of the look-through earnings of those underlying stocks. Berkshire trades to a far lesser extent, largely because of size, but of heavy importance due also to culture (won't trade privately held subsidiaries). On a relative basis Berkshire's results are driven much less by trading. I forgot the year but you don't amortize goodwill anymore, you perform a goodwill impairment test each year but only do a write down if the test is failed. That's an improvement. I should have known this, and I probably read it before and forgot it. This leaves only the problem of a goodwill item that doesn't grow along with the prospects of the company. Oh well, I suppose the Goodwill item serves a purpose as a placeholder so companies like Fairfax don't have a huge immediate drop in book value if they pay a large P/B premium for an acquisition.

Viking mentioned the 6.9% book value growth over the past 10 years and law of large numbers in the same post. I was really referring to that. In an parallel world, where KO and similar stocks were dirt cheap 10 years ago and expensive today, then book value growth over past 10 years would have possibly been 15%, but we would not be able to draw any conclusions from that regarding the size of Berkshire and how it impacted performance, only that the market P/E expanded. Lastly, suppose we were talking about KO in isolation and not mentioning Berkshire. Would we even be impressed with measuring KO's book value growth? Doubt it. That's because KO is an operating company and we would be more interested in rate of profit growth. Likewise, Berkshire is increasingly more so every year just a consolidated balance sheet of operating companies and the right way to measure it is earnings growth, not book growth. Fairfax is different because it's operating companies are just shells that hold publicly priced securities, so book value is far more relevant. For example, you don't amortize the cost at which you hold JNJ stock, but if you bought the company outright you would amortize the goodwill. The value of JNJ within Fairfax grows as the earnings at the company grow, this grows book value for Fairfax. Now, if Berkshire took JNJ private the value of JNJ on Berkshire's balance sheet would not grow along with the profits -- you would have instead the amortizing goodwill. Lastly, Fairfax trades them to generate profit in excess of the look-through earnings of those underlying stocks. Berkshire trades to a far lesser extent, largely because of size, but of heavy importance due also to culture (won't trade privately held subsidiaries). On a relative basis Berkshire's results are driven much less by trading.

I spent quite a while on ShadowStats.com today. I take it the feeling is that the government can hold down CPI calculations to fix budget issues by limiting payments to Social Security. Why then have they rigged it so that FICA taxable income also is pegged to the CPI? I mean, if they keep CPI down sure it limits payouts, but it also limits revenue at the same time. Probably wasn't wise to link taxable income to CPI if they are rigging it. I couldn't find anywhere on ShadowStats where he admits the government is also deliberately holding down their revenue -- not that he would say that given that he is selling his data. My grandmother (Australia) doesn't trust the CPI either. She too thinks the CPI numbers are bunk. I think the CPI has understated inflation, but I think the real rate of inflation is somewhere in between the two. For instance, I don't think a median house is going to be as low as the $112,000 or so that the CPI suggests it would be if houses followed the general trend of consumer prices. Yet I don't think $300k sounds right either.

I hear you, it sucks to say steak one day and hamburger the next. But once the switch is made, it no longer upsets the differential in CPI for subsequent years. For example, I will have a higher degree of confidence next year when I get the 2010 BLS numbers because I'll at least be satisfied that they are measuring the right thing. If I pay this guy for his shadowstats.com numbers I will get a less useful view of consumer inflation because I will be seeing the price of steak which is a luxury, vs the price of a more widely consumed item. I don't want to continue on the wrong path forever simply for consistency -- consistently inaccurate is not a good thing. If we're supposed to be measuring the most broadly consumed items, then lets do it and quit fucking around with steak which doesn't allow us to arrive at what we're trying to measure in the first place which is the cost of living, not the cost of luxury. The sin as I see it was that they didn't correct the index soon enough, not that they should never correct it at all. I don't care if seniors can't afford steak with their Social Security income -- let them eat hamburger! (that was a joke). Nevertheless, past (hamburger for steak) substitutions in the CPI do not explain why ShadowStats.com suggests that the rate of inflation was approximately 3% higher per annum every single year this decade. You might get a distortion in the very year that a substitution is made (as you describe, $2 steak for $1 hamburger), but this is ridiculous. Every single year! True, homes are not components of the basket, and Shiller knows this. However he argues that homes cannot increase faster than inflation, and he uses the CPI as his measure of inflation. The price to rent ratio was adequate in 1970, rent is a component of CPI, and it's widely accepted that in the long run prices should rise in line with rents. Therefore, although housing prices are not directly a component of the CPI it does actually make a good deal of sense to use rents as a proxy for house prices given that only a bubble should be responsible for a large distortion in the price/rent ratio.

We went through a period where Berkshire held huge positions in stocks like KO that are worth less in price today than they were 10 years ago, even though the earnings power of KO has grown significantly. I think if you look at their look through earnings of today vs 10 years ago it will show that Berkshire's intrinsic value has grown much faster than book value. This law of large numbers isn't what happened to Berkshire the past 10 yrs. Instead, it was the law of compressing equity portfolio valuations.

Book value growth at Berkshire does not matter. What does matter is this: From the 1999 AR Reported operating earnings of Berkshire 1,318 Total look-through earnings of Berkshire $ 1,926

Shadowstats.com has an inflation calculator that give us the "real" rate of inflation (although their data is secret unless you pay them a fee). So I plugged in $17,000 for the median priced home in 1970 to see what it is "really" worth today: http://www.shadowstats.com/inflation_calculator?amount1=17000&y1=1970&m1=1&y2=2009&m2=8&calc=Find+Out CPI is a measure of the cost of a basket of consumer goods and services... and originally used to indicate the impact of price inflation on an "average" consumer. During the Clinton era, the basket of goods and services was changed , like substituting hamburger for steak, which had the effect of understating the rate of CPI inflation. Shadowstat's calculation of CPI uses the prices of the original basket components in order to track the inflation of an unchanged basket, and hence gives a different, higher number. For rates of inflation in USD of housing assets you should refer to the Case Schiller index and for rates of inflation of stocks or other assets, check the appropriate industry price index. Robert J. Shiller is the author of a book titled Irrational Exuberance Second Edition. I have a copy of this book sitting here next to me. He makes a case that house price outpaced their "real" values, as measured by the CPI (as measured by the BLS). Now, if Shiller had instead used the data provided by ShadowStats.com then he would have been forced to conclude that housing was getting cheaper in real terms, as opposed to more expensive. Perhaps then the title would have been Rational Exuberance. Yes, the CPI has been altered. But why do you feel that steak a more reliable measure of inflation than hamburger? Supposing for a minute that there is a real conspiracy by the government to underreport CPI, how would they know ahead of time that hamburger would rise in price at a slower pace than steak? Once the CPI adjustment is made, on a going forward basis the price of hamburger should still increase with inflation right? So shouldn't the price of hamburger be perfectly reasonable to use as a price measure for say, 2005 vs 2004 CPI calculations? Hamburger is consumed in much greater quantity, and steak is really a luxury item. I would say steak is to hamburger as first class seating is to economy seating, and if they CPI were based on first class seating I would think it reasonable to correct the mistake and base it on economy pricing given that it's what's purchased most broadly.

Shadowstats.com has an inflation calculator that give us the "real" rate of inflation (although their data is secret unless you pay them a fee). So I plugged in $17,000 for the median priced home in 1970 to see what it is "really" worth today: http://www.shadowstats.com/inflation_calculator?amount1=17000&y1=1970&m1=1&y2=2009&m2=8&calc=Find+Out It turns out that the official BLS data suggests it is worth $113,258, and (while they won't give out the exact number for free), the ShadowStats data suggests that home is worth nearly $300,000 today. The height of their block 2.5x to 3x the height of the CPI-U block (suggesting at least 2.5x to 3x the price of $113,258). Hmmm.... is that really the inflation adjusted price? It feels to me like the BLS number is closer, but that's because I doubt the real price of the median 1970 house is anywhere close to $300k.

Those returns don't look cheery, and can you imagine how bad it looks on an after tax basis? Especially if you were in the top marginal tax rate (as high as 94%): http://www.truthandpolitics.org/top-rates.php It's hard to belive that in my lifetime, tax rates were as high as 70%. Everyone should convert their IRAs to RothIRAs next year when there are no income limits. Get out while you can. (that's my fear mongering for the day)

The bond market looked similar in the 1940s, but I don't think it was a good time to buy long term bonds.

A quarter of them are $125 and $140 strike Jan 2010. Then I have 2011 calls with strikes of $200 and $210. There are no 2012 available. My 25% cash position is there for taking delivery, or buying more calls if I need to (I will need to if it gets really cheap again). I don't want to bet against inflation, don't want to bet against a market pullback. So I have 50% hedged for inflation and 50% hedged for a market pullback. At $23 WFC is only 1.27x book -- that's quite silly if we can put the $7.80 market bottom out of our minds.