Saturday, May 10, 2008

Justification-Deterioration Model?

From Buffett's speech to the Tuck Investment Club:
Q: What is your view on the leverage in the economy?

A: We are currently an enormous debtor to the rest of the world. The danger is that our children and their children will not want to pay this debt, or said another way, will reject the costs that servicing this debt will impose on society. Let's say that during the Revolutionary War, the colonists were offered a choice: instead of fighting a bloody war that will cost thousands of lives, you can simply agree to pay King George 5% of total national income for perpetuity in exchange for full independence and political freedom. Now to the colonists this would have been a great deal, potentially having their lives spared and gaining freedom for only 5%/year. Decades later their children may not think it's as good a deal but will still have heard stories from their parents and will probably pay the fee. But eventually, three or four generations down the line, enough Americans will forget the original rationale for the deal and will in some way demand a change in terms - possibly go to war with England again to halt the payments. The danger today is that future generations of Americans will be unwilling to continue paying for today's spending and force political action with potentially negative consequences.
I think this example itself deserves its own mental model (although I'm having trouble giving it a proper name). But as I was reading this, I thought of another similar case. Let's say a foreign company offered to make a large factory investment in a developing country. Now at first, the country would praise the opportunity for bringing more production and job opportunities into their country. But as time goes on, children will start to wonder why some of the value of their labor is going to these companies abroad. Eventually, tensions build and the original rationale is lost, leading the people to demand nationalization of the factory.

I don't know what the call this tendency, but I experienced it for myself through my investment in Harvest. It appears destined to keep coming up in the future.


Al said...

I think the formal name for that phenomenon is Argentina.

tariq said...

I think that you have to separate the Harvest case from others though. Natural Resources are seen from a very different perspective than just any ordinary company, and so they're more likely to be nationalized than others.

Nnejad said...

I include it in there just because at one point, the country wanted/needed foreign companies to come to their country and they were willing to give them reasonable terms. But it's no longer that they are investing in their countries and "expanding production/increasing jobs". Now, the foriegn oil companies are trying to "exploit" the people and their country of their natural wealth.

But I will admit that something is inherently different with natural resources.

los said...

Very tactful verbal maneuvering by Buffett...

The comments remind me of a business week article by Jack Welch i read a while back. A large multi-national invested several billion dollars in a large (and getting larger at a fast rate) developing country and built a lot of infrastructure to get it going. If I remember correctly, while they were working within the local beaureaucracy things feel apart and it looks like they are going to lose control of the factory. The article was from 06 or 07 so I could be wrong about the details...but the larger point is that I suspect that there is a large cultural and political element that many don't see when they consider the globalization hype in any given moment. You can't just create a democracy or meritocracy or free markets overnight. It takes time,planning, resources and visionary ingenuinity--not just throwing resources money and analysts at the problem.

Nnejad said...

al, I dont know if you saw this from Leucadia's annual meeting notes:

"How do you protect against political risk in Argentina (referring to recent export taxes)?

IC: They’ve had a successful run in Argentina. A long time ago, we privatized the national insurance company, successfully got out before the dip. It’s never ending. It’s not politically correct, but the old joke is that Argentina is a country with wonderful natural resources, the problem is that it is full of Argentines. We don’t have a great answer, just pray. We paid a cheap enough price, think we will do just fine."

tariq said...

heh, that is an interesting read.

I think though that two of the ideas really conflict with each other - the export tax and LUK's belief that the argentine peso will appreciate.

i believe that Argentina operates a narrow currency band to keep it in check from exceeding, and the export taxes were IMO a method for controlling the peso in an environment where agricultural commodities are rapidly appreciating and pushing currencies upwards.