Charlie Munger's SCARY Inflation Warning (2022)

What makes life interesting is we don't know how it's going to work out. I think we do know we're flirting with serious trouble. Inflation is at such high levels right now that those of us under the age of 40 have never even lived through a period of such high inflation before. In fact, the most recent inflation data in the United States showed inflation hit a staggering 7.5 percent.

We are all seeing higher prices for everything from groceries, rent, home prices, energy prices, and even the cost to purchase a vehicle. While this may be the first time most of us have lived through substantial inflation, at almost 100 years, old Charlie Munger knows a thing or two about inflation because, well, he's lived through it before.

So that's why I got my attention when I heard Charlie speak on the topic of inflation in a recent interview. Make sure to hang around till the end of the video to hear Charlie's advice about how you can avoid the damage inflation causes. Whether you are a new investor or a professional investor like myself, we can all learn a thing or two from Charlie. Now let's listen to what he has to say.

Conventional economic theory argues that excessive monetary and fiscal stimulus over the last two years has triggered the highest inflation in 40 years. Do you broadly agree with this thesis? And more importantly, do you think there will be a high economic price to pay as the Fed attempts to bring inflation back under control?

I guess, um, the reasons for it, um, I agree with it. We've done something pretty extreme, and we don't know how bad the troubles will be. Whether we're going to be like Japan, or something a lot worse. When you print money on the scale what modern nations are printing it—Japan, the United States, Europe, etc.—we're getting into new territory in terms of size.

The Japanese bought back not only a lot of their own debt but a lot of the common stocks. So the Federal Reserve system, you can't imagine how much money printing Japan has done, and they haven't had all that much inflation. And it’s still a very admirable civilization. In fact, you could argue that Japan is one of the more admirable civilizations in the whole world, and in spite of all this very extreme government money printing they've done, and they haven't had terrible consequences.

Now they've had 25 years of stasis, with living standards not improving very much. I don't think that came from their macroeconomic policies; I think that came from the rise of tough competition for their export powerhouse from China and Korea. But at any rate, it's weird what's happening, and nobody knows for sure how it's going to work out.

I think it's encouraging that Japan can spread as much money as it has and remain as civilized, calm, and admirable as it has. So I hope to God the United States has a similar happy outcome. If you didn't know or couldn't tell by the clip, Charlie is a student of history. He studies history in order to shape his thinking about how to better understand what's happening in the world currently.

I think it's extremely interesting here how, when Munger is asked about his thoughts on inflation, particularly in the United States, he brought up Japan as an example. Now, for those of us that aren't familiar with Japan and its history, it's worth noting that there is a period of time where many smart people thought Japan would become the world's dominant economy and pass the United States.

In fact, Japan's recovery from the devastation of World War II was so impressive that it is referred to as the Japanese economic miracle. Hang in there with me; we are getting to why this is relevant. Japan's overheated economy, money printing, and large amounts of debt led to one of the greatest stock market bubbles of all time—not just in Japan but in the history of capitalism.

In late 1989, the Nikkei 225, think of it as the Japanese version of the S&P 500, hit a high of 38,911.6. Now, over 30 years later, the Nikkei 225 is just under 27,000. The burst of this bubble led to a stagnant Japanese economy for years. Obviously, Japan's money printing led to problems, but notably, one problem that the money printing didn't lead to was inflation.

Japan's money supply has increased significantly over the years. Logically, economic theory would suggest that this would lead to inflation and pretty significant inflation at that. However, that has not been the case. Take a look at this chart of Japan's inflation rate over the past 25 years; it has almost always been below 2%, and in many years has actually been negative.

Very different from the high rates of inflation one would think would have been a result of Japan's economic policies. The reason Charlie Munger brings up Japan is that when it comes to economics, no one truly knows what's going to happen. I like to think of Charlie's business partner, Warren Buffett, to further explain this.

Specifically, when he compared the economy to a math equation, most people want to view the economy like a simple equation with only a couple of variables. They think that if x happens, then y must happen. However, in reality, making economic predictions is not that simple. Instead of a simple equation with only a few variables, the economy should be viewed as a complex equation with hundreds or even thousands of variables, and these variables are always changing and evolving.

So it is extremely difficult to see how the economy will be impacted by one single action. While we don't know exactly what's going to happen in the future, as Charlie will go on to explain, printing money is like playing with fire, and there's a chance it won't end well.

What makes life interesting is we don't know how it's going to work out. I think we do know we're flirting with serious trouble. I think we also know that some of our earlier fears were overblown. Japan is still existing as a civilized nation in spite of unbelievable excess by all former standards in terms of money printing.

There's never been anything quite like what we're doing now, and we do know from what's happened in other nations, if you try to print too much money, it eventually causes terrible trouble. And we are closer to terrible trouble than an example Munger frequently cites in his interviews and lectures is Germany during the 1920s.

Long story short, Germany was in large amounts of debt due to World War I. In order to pay back this debt and its other government obligations, the government simply printed more money. Believe it or not, inflation got so bad that workers were paid twice each day because prices rose so fast that the workers' wages were virtually worthless by lunchtime.

As you can probably imagine, this led to significant instability and social unrest within the country. Many historians actually look back at this hyperinflationary period as one of the root causes of the Second World War. I think the best way to think about what will happen to the United States due to this money printing is to view it on a spectrum, with Japan on one end and 1920s Germany on the other end.

Now, as Munger mentioned earlier in this video, it's really hard to say what exactly will be the result of all this money printing. On the one end, you have Japan, which, relatively speaking, was rather unimpacted by the amount of excessive money printing on the quality of life of its citizens. But on the other hand, you have Germany during the 1920s, where the results of money printing were absolutely disastrous.

Charlie and, frankly, all of us are hoping the ultimate impact on the United States will look a lot more like Japan. Ultimately, though, only time will tell. But something that we probably don't want to see a repeat of is the 1970s and early 1980s, where inflation was routinely at or around 10% annually, even topping out at around 14% in 1980.

When Volcker, after the seventies, took the prime rate to twenty percent and the government was paying fifteen percent on its government bonds, that was a horrible recession that lasted a long time and caused a lot of agony, and I certainly hope we're never—we're not going there again. I think the conditions that allowed Volcker to do that without interference from politicians were very unusual, and I think that, in hindsight, it was a good thing that he did it.

I would not predict that our modern politicians will be as willing to permit a new Volcker to get that tough with the economy and bring on that kind of a recession. So I think the new troubles are likely to be different from the old troubles. This is related. These are all—you may wish you had a Volcker. You may wish you had a Volcker-style recession instead of what you're going to get.

The troubles that come to us could be worse than what Volcker was dealing with and harder to fix. Paul Volcker was the chair of the Federal Reserve from 1979 to 1987 and is widely credited with helping end the high levels of inflation seen in the United States during the 1970s and early 1980s. You see, during this time period, America was suffering from what is referred to as stagflation.

Stagflation is the combination of three things that no economy wants: high inflation, but also slow economic growth and high unemployment. Inflation is tough by itself, but when you add on a stagnant economy and a large number of people who are unemployed, it gets even worse. In order to combat this very nasty inflation, Paul Volcker raised rates pretty dramatically, and as a result, that did not make him a very popular person at the time as it led to the serious recession that Charlie referred to.

In fact, it led to not only one recession but two recessions in a relatively short period of time, which economists refer to as a double-dip recession. In order to quote "break the back of inflation," Volcker dramatically slowed the rate of growth in the U.S. money supply to bring price inflation to heel. This provoked an immediate but relatively short recession through the first half of 1980.

Through the second half of 1980 and into 1981, the economy began to recover. Real GDP rose, but unemployment and inflation both remained stubbornly high at around 7.5 percent and 10 percent, respectively, through this period, with inflation again accelerating in late 1981. Volcker maintained its tight money/high-interest rate policy, and the economy re-entered recession. Unemployment rose to 10.8 percent by the end of 1982.

During this time, Volcker faced increasingly sharp criticism and even threats of impeachment from the U.S. Congress and the Treasury Secretary at the time. The reason why this is relevant today is because, as I'm sure you can imagine, recessions are not good for politicians that want to get re-elected. However, many economists would argue that recessions are part of a normal economy.

It took a lot of political willpower in order for Volcker to take these necessary steps without political interference. Charlie questions the ability of the Federal Reserve to be able to take similar steps, if necessary, in today's political climate. Now with that background, I want to address the most important question of this video: given this inflationary environment, how should we as investors be investing in order to build wealth?

It may be that you have to choose the least bad of your bunch of options—that frequently happens in human decision making—and the Mungers have Berkshire stock, Costco stock, Chinese stock, Sioux Lilu, a little bit of Daily Journal stock, and a bunch of apartment houses. Do I think that's perfect? No. Do I think it's okay? Yes. I think the great lesson from the Mungers is you don't need all this damn diversification.

That's plenty. You're lucky if you've got four good assets. I think the finance professors sell the idea that perfect diversification is professional investment. If you're trying to do better than average, you're lucky if you have four things to buy, and to ask for 20 is really asking for egg in your beer. Very few people can have enough brains to get 20 good investments.

Us as investors right now have to pick between the least bad alternatives. This current investment environment is not made any easier by the fact that stock prices, well, not at all-time highs due to the recent sell-off, are still relatively close to all-time highs. Additionally, asset values for real estate, small businesses, and other investments have also skyrocketed.

Given that everything is so darn expensive, people may be tempted to sell out of everything and wait for the crash they believe is coming to bring down stock prices and then jump back in and take advantage of the crash to buy at the low prices. However, I think it's worth pointing out a few issues with that strategy.

The first is what is referred to as friction costs associated with selling. An example of this would be the taxes you would have to pay when you sell an investment. Let's say you bought a stock years ago, and now you have made one hundred thousand dollars on that investment. If you sell that stock, you have to pay taxes on that one hundred thousand dollar profit you made. That means that the stock would have to fall by more in value than the amount of taxes you paid just to break even on trying to time the market.

Additionally, if the asset you're looking to sell is less liquid, like an investment property, not only will you have to pay taxes on your profits, but you also have to pay commissions and fees such as real estate agent commissions. The next issue with trying to time the market—and this is especially relevant given what's happening now—is that when you're holding large amounts of cash that's not invested, inflation is eating away at the value of the money you are holding each year.

Every dollar that you are holding becomes worth less and less due to inflation. And then finally, maybe that crash never even comes. Maybe the stock market and other asset values just hover at these high levels for years while you pay taxes and other frictional costs associated with selling out of your investments and are being negatively impacted by inflation due to all the cash we're holding.

Now, in Charlie's opinion, we should take the least bad alternative. That means investing in a few high-quality businesses that you understand and hold that concentrated portfolio for the long term. This is what Charlie is doing with his family's investment in Berkshire Hathaway and Costco, as well as owning some apartment buildings.

Personally, I am employing a similar strategy as Charlie. My stock portfolio is relatively concentrated with seven to eight holdings. Additionally, I am investing in rental properties both in the New York City suburbs where I live, but I'm really focusing my real estate portfolio on rental properties in the Midwest United States.

If you want to see what stocks I personally hold in my portfolio, as well as access to the tools I use to analyze stocks, you can access that through my Patreon through the link in my description. Feel free to check it out, because the tools are focused on helping improve your investing skills.

So there you have it. Let me know what you guys think about what Charlie has to say on inflation in the comments below. I always love hearing what you guys have to say. As always, thank you so much for watching. Make sure to give this video a like and subscribe to the Investor Center because it is my goal to make you a better investor by studying the world's greatest investors. Talk to you next time.