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The long-awted letter to his Berkshire Hathaway Shareholders was released yesterday by billionaire Warren Buffet and he admits to having had a very bad 2008 with record losses and share value drops.

He is also convinced that 2009 is out the window given the disastrous state of the US and global economies but beyond that he is hesitant to predict the future - at least the immediate future.

Let us take a look at what his investor letter contained and where Mr Buffet sees it all heading.

MarketWatch quotes  Buffet from his letter with regards to future predictions :

We’re certain, for example, that the economy will be in shambles throughout 2009 — and, for that matter, probably well beyond — but that conclusion does not tell us whether the stock market will rise or fall,” Buffett wrote.

The article goes on to quote a brutally honest Buffett on his 2008 mistakes and bad investment choices and timings :

Buffett, known as the “Oracle of Omaha,” admitted to mistakes last year. “During 2008 I did some dumb things in investments,” he said. One such error, he said, was the purchase of a large amount of Conoco Phillips Inc. stock when oil and gas prices were nearing peak levels.

“I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year,” he said. “I still believe the odds are good that oil sells far higher in the future than the current $40-to-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.”

Buffett also said his acquisition of shares in two Irish banks have turned out badly — with losses of more than 89%.

On the positive side, the investor is pleased with buys totaling $14.5 million in fixed-income securities issued by General Electric Co.  and William Wrigley Co. “We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three purchases, we also acquired a substantial equity participation as a bonus.”

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Traditionally economists and policy makers as well as the man on the street worry about inflation and not so much deflation (which to many just mean cheaper prices) but lately the talk has swung around to deflation being the bigger of the two evils as the world economies shrink and people lose their jobs as a result.

This post looks into which of these two monsters are likely to prevail in the short-medium and long term and also what the experts have to say about each as governments right now ready themselves to fight the deflation monster.

A Reuters article  has this quote on the issue :

“Deflation is as dangerous as inflation, and we will take every step to counteract it,” Richard Fisher, president of the Federal Reserve Bank of Dallas, told reporters after a speech at Bryant University in Smithfield, Rhode Island.

So while deflation seems to be the present evil Mr Fisher is very aware of the fact that soon he could be figthing inflation again :

As companies across the country cut jobs and consumers spend less, many economists are worried about the potential for a sustained decline in prices.

 

The Dallas Fed calculates price pressures based on personal consumption expenditures, or PCE, and in the bank’s December report, the bank found that more than 50 percent of the market basket was going down in price, Fisher said.

 

But Fisher cautioned it was far from certain whether this decline will continue in coming months.

 

“There are price pressures on the downside, but we will make sure that deflation does not take hold,” Fisher said.

 

At the same time, Fisher said U.S. central bankers are keeping a watchful eye on inflation. Some economists have voiced concern about the potential for inflation down the road as the Fed has cut interest rates to near zero and pumped hundreds of billions of dollars into the financial system to unfreeze key credit markets.

Mark Crosby of TheAge.com.au has these comments to make on the subject :

Two questions that arise are what is the purpose of an inflation target, and why adopt an inflation target now, when there is no sign of inflation?

Inflation targeting started in the late 1970s and 1980s, when the Bundesbank in Germany, and the Swiss central bank used targets for inflation to guide their decisions about growth in the money supply.

At this time, many central banks were targeting the money supply, with the view that reducing money growth would reduce inflation from then high levels. But the Bundesbank was much more successful than other central banks in keeping inflation low, and tended to follow the strategy of using an inflation rate of about 2 per cent to guide its money growth targets.

And the article continues to explain :

Since being given inflation targets, and the independence to pursue these targets, central banks have been very successful in maintaining low inflation.

The main purpose of explicit targets is to anchor expectations of businesses and unions: if businesses believe that inflation will stay at around 2 per cent they will tend to increase prices by around that amount. Similarly unions will know that to increase wages significantly above 2 per cent plus a margin for productivity will put jobs at risk. These expectations of businesses and unions will then help sustain the low inflation target.

The reason for targeting inflation above zero is that there is a feeling among economists that a small amount of inflation “greases the wheels” of the economy. Furthermore, deflation can be very damaging to an economy, and so it is best to keep clear of a zero inflation rate or lower.

John Lonski, who is chief economist of of Moody’s Investors Service, is also more worried about the deflationary economy and explains why :

I’m still more worried about price deflation looking ahead than I am about inflation. We still have a ways to go yet as far as forming a top for the unemployment rate. And I wouldn’t be surprised if to an unprecedented extent, many employers both in the public and private sector decided to freeze wages, if not cut wages.

Senior Economist Milton Ezrati  sees the issue somewhat differently :

Well for the short term, for the intermediate term the next six or 12 or even 18 months, I don’t think we have to fear very much either from inflation or deflation. For the longer term, however, inflation is the threat largely because of the tremendous liquidity the Federal Reserve has poured on our markets.

Andy Serwer provides this brilliant overview of the inflation vs deflation issue at hand at The Captain’s Blog from CNN Money :

High inflation is bad of course, but a little bit of inflation is a good thing and actually optimal. A moderate rate of inflation seems to make it easier for businesses to raise prices (which is good for growth) and allows employees to ask for raises. A little bit of inflation also encourages folks to invest their money instead of leaving it in their mattress. On the other hand, deflation, or falling prices, is a bad thing since it causes people to freeze up and delay purchases until prices are lower. This can induce a death spiral of deflation and economic contraction, which is what happened in Japan. Right now economists are much more concerned about deflation than inflation. No question, we are pulling in our spending horn right now, which seems to have eradicated inflation, now the question is, will prices fall?

And he has these words when it comes to what we can expect on price developments in 2009 :

So if you were a betting person, would you wager that prices overall will fall this year? Well, the wild card is energy, but other than that, it’s tough to see prices going up. Just how badly this hurts the economy is a huge unknown. Hey, we made it through 1955, we will most likely make it through 2009.

Christopher Grey of TheStreet.com explains why the US Government is dead scared about the looming deflation :

In just a few months, the Fed has effectively printed trillions of dollars and the Treasury has spent more than a trillion dollars trying to increase the supply of money. That should demonstrate their seriousness about preventing deflation.

According to Grey there is also an even bigger agenda as to why the US Government has a strong incentive to create a strong inflationary economy and hence fight deflation tooth and nail :

Second, it is in the national interest of the U.S. and the personal interest of most American consumers to create inflation. The U.S. government owes trillions of dollars to foreigners. It has a strong financial incentive to destroy the value of the dollar in order to repay that foreign debt with cheaper currency. Similarly, most Americans are deeply in debt and would benefit from inflation that would effectively reduce that debt burden on their households.

Grey finishes off his insight into the inflation vs. deflation issue with some sound reasoning why the consumer should look at inflation as a positive thing and also what can be done now to ensure financial success assuming of course that Grey is right and that inflation will soon prevail :

Another way to benefit from future inflation is to take advantage of low-interest rates and lock in long-term financing to buy income property such as apartments in supply-constrained markets that will benefit from future inflation through increased rental rates and higher cash flow to the owner.

Do not believe the hype about deflation. It could be dangerous to your financial health. Right now is the best time to start hedging against future inflation because most people don’t believe it’s going to happen. Now is the classic time to buy a straw hat in winter, because people are just giving them away.

So let battle commence between these two giants ! It does, however, seem that major economies such as the US, Japan and China have more to lose by allowing deflation to take over from the traditional inflationary economies and hence we should expect strong efforts by Obama and Co to fight deflation on all fronts which hence is likely to be major theme for 2009 and probably also 2010.

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With a very troubled 2008 soon behind us and many private as well as institutional investors breathing a short sigh of relief, the big question facing the world is of course: will 2009 be a year of recovery or will the crisis worsen and prolong the Recession or even, as some fear, slide further into a full blown Recession ?

This post looks into what some of the analysts have to say about 2009 and whether to world economies and all its dependants are in for a recovery or if indeed we shall have another very tough year to face up to.

MarketWatchpoints out that whilst the downturn is gathering pace in Europe and The US, the same crisis has now also spread in full to The Far East and Asia with the pace of the economic downturn in China being the most surprising factor to economists and experts.

Quoting experts on the development of the economic downturn in Asia, the article says:

Experts painted a grim picture for the Asian region in 2009.

“Asia is not doing well at all,” said Son Won Sohn, an economist at the Martin Smith School of Business at California State University, Channel Islands.

“Decoupling, which looked for a while like it was going to work — turned out to be a myth.”

Japan is mired in a recession, South Korea will be lucky to reach 2% growth this year and Chinese growth could fall below 6%.

The downturn in global trade has just begun to have a negative impact on China’s economy, but it is pressure that will last for most of 2009, according to Brad Setser, an expert on China at the Council of Foreign Relations in New York.

“The latest data for November was off-the-charts bad,” Setser said.

In addition, China’s own domestic cycle looks to have turned, he said.

“The pace of the downturn has been a little bit of a surprise,” he said.

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Yesterday The Federal Reserve cut the main U.S. interest rate to as low as zero for the first time ever in an attempt to boost credit and try to end the financial crisis, causing the bond market to collapse and the stock markets to soar.

While this may be a blessing for those consumers looking to buy a house or a car, and hence a boost to the deflationary and slumping US economy, analysts are divided as to the long-term effect of this drastic move will have on consumer spending and the economy overall.

This post looks into some of the prevailing arguments surrounding the historic Fed cut.

MarketWatch quotes an economic team at Wells Fargo for being very optimistic about the cut:

This latest change in monetary policy strategy by the Fed has the potential to be highly effective in our view, and will better reduce the cost of borrowing for a vast majority of consumers and businesses,”

The same article also quotes Stephen Gallagher, Chief Economist of SocGen:

Bank confidence in its ability to finance itself today and in the future is an essential for making loans,”

Bloomberg quotes The Federal Open Market Committee for saying that:

“The focus of the committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level,” the FOMC said.

The Fed “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability,” the Federal Open Market Committee said today in a statement in Washington. “Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

According to Wlliam Poole, former president of the St. Louis Fed:

The Fed is sending a message that it will print money to an unlimited extent until it starts to see the economy expanding,”

Associated Press quotes  an impressed Mark Zandi who feels that The Fed is ahead of the game this time:

The Fed has taken some very historic steps and for the first time since this crisis began, they have gotten ahead of expectations instead of trailing behind them,” said Mark Zandi, chief economist at Moody’s Economy.com.

The article, however, suggests that the crisis is not over and may go on for some time due to the depth of same:

Economists cautioned that even with the Fed’s bold moves it will take months for the economy to stabilize given that it is confronting the worst financial crisis since the Great Depression and a year-long recession that is already the longest in a quarter century.

The news on the economy is expected to get worse before it gets better. Businesses, which have already cut nearly 2 million jobs since January, keep laying off workers in the face of slumping demand.

And AP’s article concludes that at least when it comes to the US Government’s inflationary fears things are on the up:

The weak economy is helping to keep a lid on prices. The government reported Tuesday that consumer prices fell by a record 1.7 percent in November as gasoline and other energy prices continued to plunge. The Fed noted that “inflation pressures have diminished appreciably,” a development that gives the central bank maneuvering room to focus on boosting growth.

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On the day that U.S. auto executives appealed to Congress for a $25 billion bailout, General Motors Corp. reported that its U.S. sales plummeted 41 percent in November compared with a year ago. Ford Motor Co. announced its sales dropped 31 percent, and Chrysler said its sales plunged 47 percent.

As credit remained tight, retirement accounts continued to be decimated, unemployment jumped and the recession deepened last month, the plunging price of gasoline was not enough to generate a rebound in auto sales.

The U.S. sales of Toyota Motor Corp., which may surpass General Motors as the world’s largest auto company this year, declined by 34 percent.

Dire times for the US Auto industry - check out the full story and insights here

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