Posted 9:41 AM by Robert

Legendary II

For the past month (here and here and here), the Man Without Qualities has been intrigued by the likelihood that Warren Buffett, now largely a forex speculator posing as a value investor, may steer his Berkshire-Hathaway corporation into gigantic short-term losses in the currency markets (known as the "casinos of the very rich" on Wall Street). Now, even TIME magazine is waking up to this likelihood:

The buy-and-hold billionaire is up to his ears in ... derivatives... Buffett once called derivatives "financial weapons of mass destruction," so you'd think he would steer clear. But his company, Berkshire Hathaway, has acknowledged a $307 million pretax loss in the first three months of this year that's due to a $21.4 billion position in "currency contracts," which are derivatives that hit pay dirt when the dollar falls. Problem is, the dollar is rallying. The greenback--up 4% against the euro in the first quarter and an additional 8% since then--shows no signs of stalling, and Jim Bianco of Bianco Research estimates that Buffett's losses this year have surpassed $1 billion.

The $1 billion-plus losses to which Mr. Bianco refers are only Berkshire-Hathaway's direct currency derivatives losses. Berkshire-Hathaway also holds lots of euro-denominated securities, which carry indirect exposure. Mr. Buffett has made clear in interviews that Berkshire-Hathaway has additional huge embedded currency exposure in its portfolio companies:

Now some of those [Berkshire-Hathaway] assets are antidollar assets. Example: In 2002 he bought bonds of Level 3, a telecom company, that were denominated in euros. In 2000 Berkshire picked up MidAmerican Energy, a gas pipeline company. By doing so, Berkshire indirectly acquired the assets of Northern Electric, a utility in England, at a time when the pound was worth $1.58. Now it's worth $1.94, so Berkshire has a paper gain irrespective of any appreciation in the electric company's pound-denominated earning power.

None of this is intended to disparage the long term negative effects of the United States trade deficit on the dollar. But currency markets move on the basis of much more than trade deficits. Political risks - of which Mr. Buffett can claim no particular history of perspicacity - are very big factors. Relatedly, unpredictable international events - the intervention of a George Soros, a decision of some obscure Chinese politicians or some persnickety actions of French voters - can have dramatic consequences in the currency markets that don't figure so large in the domestic equities markets with which Mr. Buffett established his very considerable, even legendary, reputation.

What would be the effect of a huge currency market loss on the now quite aged Mr. Buffett's reputation and, concomitantly, on Berkshire-Hathaway's stock price? It would not be pretty. In fact, it might help investors to bring into perspective many other troubling developments in Mr. Buffett's world: His grossly inconsistent stance on derivatives is just one of many hypocrisies that litter his path these days. I have already mentioned his mutation into uber-forex speculator while maintaining the garb of a value investor. Then there are his pretensions to good corporate governance policies, juxtaposed with his failure to maintain systems to control the rampant fraud facilitation at General Re as well as his failure to designate and groom his own successor (in part a consequence of his refusal to pay his people well enough to attract and hold a good potential successor). Then there is that huge quantity of Berkshire-Hathaway cash (about $40 billion) that seems to be creating mischievous desires on Mr. Buffett's part to make big, problematic buys in the energy sector (some of which are inconsistent with the Public Utilities Holding Company Act). The list could be made much longer.

UPDATE: In terms of unexpected international developments and their possible effects on the euro (say), consider the recent actions of the clown troupe posing as the current French government, as detailed here:

A French charm offensive aimed at driving a wedge between Britain and new EU member states ran into early trouble yesterday after bullying from top French ministers.

First, the French interior minister, Nicolas Sarkozy, demanded that the European Union's future enlargement be "suspended" to allay the fears of French voters.

Then Philippe Douste-Blazy, the French foreign minister, provoked a row between Paris and Warsaw by hectoring his Polish counterpart over his warm links with London. ... In a clear warning to aspiring EU members such as Turkey, Croatia and Ukraine, Mr Sarkozy said France needed to "clearly ask questions about the borders of Europe".

The foreign ministers of Germany and Poland, as well as Britain's Europe minister, Douglas Alexander, distanced themselves from Mr Sarkozy's comments, made shortly before a crucial summit involving France, Germany and Poland.

So that's what the French government thinks of as a "charm offensive" in connection with a "crucial summit?" Clearly, emphasis was put on the "offensive" bit. Maybe the French were trying to provoke a re-enactment of the Defenestration of Prague?

Does reading this article make the reader just want to jump up, run to the phone and put in an order to buy and hold euros long term? - just like Mr. Buffett says Berkshire-Hathaway is doing?