Warren Buffett's Inflation WARNING for 2021

From raw material purchases by Berkshire subsidiaries, are you seeing signs of inflation beginning to increase?

We're seeing very substantial inflation. It's very interesting. I mean, we're raising prices, people are raising prices to us, and it's being accepted. I mean, it's not—you know, take home building. I mean, you know the cost of—we've got nine home builders in addition to our manufactured housing. And then, operation, which is the largest in the country, so we really do a lot of housing. The costs are just up, up, up. There’s more inflation going on—quite a bit more inflation going on—than people would have anticipated.

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Inflation—it’s a word that a lot of economists have been throwing around recently. It's been plastered all over the news, and at times it can seem tricky to understand with all that's going on right now. But really, the Brandon definition of inflation is just the prices of stuff going up. That's what inflation is. But how does it happen? This is another question that seems complicated, but at a basic level it isn’t.

Inflation works simply by a supply and demand equation. If there's a higher demand for stuff and a lower supply, you get inflation. If there is plentiful supply but not much demand, you get deflation.

Now, a lot of people have been concerned that we'll see inflation ramping up very, very soon. The reason for that—well, one reason is the actions of the government and the Federal Reserve. The Federal Reserve has been lowering interest rates to make it easier for businesses and consumers to borrow money. This borrowed money then gets spent on stuff, adding to the demand.

Now, the government is also announcing lots of stimulus payments and infrastructure initiatives which further gets cash in the hands of consumers and businesses and also helps fund the building of new stuff. This adds even more force to the demand side of the equation.

But then, on the supply side, there is still serious disruption to the global supply chain, and shortages in many raw materials are still being seen. So it's a bit of a recipe for inflation.

But here's the issue that's on the minds of all the economists and all of the investors out there—that's it. If inflation were to run, the way you stop it is by raising interest rates. Now, this is a problem for investors because raising interest rates will bring down stock prices.

Let's hear Warren Buffett explain it.

"I know you eventually bought Apple in 2016 because of the quality of their businesses and their management. How do you assess if these high flyers are worthy of your investment given these crazy high valuations that muddy the waters?"

Well, we don't think they're crazy. Well, it gets back to something fundamental in investments. I mean, uh, interest rates, you know, basically are to the value of assets what gravity is to matter, you know, essentially.

And, ah, on the way out here, uh, I tried a little clipping from the Wall Street Journal yesterday. Here it is—the results of the treasury auction.

A little tiny thing, ah, they sold for—they had applications on the four-week treasury bill for a hundred and some billion. They accepted bids for 40, 43 billion worth. And it says average price, one hundred point zero zero zero zero zero, six zeros, and essentially people were giving 40 some billion dollars to the registry. And they offered to give 130 billion or something, whatever the amount entered, and the treasury received the money at zero.

There are a few things to unpack here. Firstly, Buffett says interest rates are to the value of assets what gravity is to matter. So the stronger the gravity, the harder it is to jump up. Whereas, the lower the gravity, it’s very easy to jump very high.

Well, when interest rates are high, it is harder for the value of stocks to rise. But when interest rates are low, it's very easy for stock prices to inflate. Why? Well, when interest rates are high, people put money into bonds; they get a great return, and in many cases it's considered risk-free because T-bills are backed by the U.S. Treasury.

But when interest rates fall, bonds are less and less enticing. And that's what Warren Buffett discusses there. The little newspaper clipping he referred to has the U.S. Treasury selling a four-week bond for a zero return for investors. So bonds aren't the place to be in a low interest rate environment.

So the money gets taken out of bonds and shoveled into stocks instead, as investors look for better returns. And that's what's happened, and it inflates stock prices. And that's why, currently, stocks are really high.

"If I could reduce gravity, it's Paul, by about 80 percent, I mean, I'd be in the Tokyo Olympics jumping."

And essentially, if interest rates were ten percent, valuations are much lower. So you’ve had this incredible change in the valuation of everything that produces money because the risk-free rate produces really short enough, right now nothing.

Those companies that develop mentioned in this question—they’re bargaining. They have the ability to deliver cash at a rate that’s—if you discount it back—and you’re discounting at present interest rates, stocks are very, very cheap.

Now, the question is what interest rates do over time. It's a fascinating time. We've never really seen what shoveling money in on the basis that we're doing it on a fiscal basis while following a monetary policy of something close to zero interest rates. And it is enormously pleasant.

But in economics, there's one thing always to remember: You cannot—you can never do one thing. You always have to say, "And then what?"

And we're sending out huge sums. I mean, the president said it on Wednesday: 85 percent of the people are going to get a $1,400 check. And so far, we've had no unpleasant consequences from it.

I mean, people feel better; the people who get the money feel better. And people who are lending money don't feel very good, but it causes stocks to go up. It causes business to flourish; it causes an electorate to be happy. And we'll see if it causes anything else.

And of course, that anything else he refers to is inflation. So interest rates are low, people aren't getting a return from bonds, money is shoveled into stocks, and stocks are inflated.

But, as I said before, our dilemma is that if we see inflation, then the Fed will raise rates in order to control it. And that will cause gravity to get stronger, and stocks will likely pull back down to earth.

So, the question is, will we see inflation? Well, here's Warren Buffett's take from raw material purchases by Berkshire subsidiaries: "Are you seeing signs of inflation beginning to increase?"

"Let me answer that thing, Greg. Can give Morgan. We're seeing very substantial inflation. It's very interesting. I mean, we're raising prices. People are raising prices to us, and it's being accepted. I mean, it’s not—you know, take home building. I mean, you know the cost of—we’ve got nine home builders and in addition to our manufactured housing thing and then operation, which is the largest in the country. So we really do a lot of housing. The costs are just up, up, up. Steel costs? You know, just every day, they're going up.

And that—it hasn’t yet been because the wage—the wage stuff follows. I mean, if the UAW writes a three-year contract, we got a three-year contract. But if you're buying steel at General Motors, or someplace, you're paying more every day.

So it's an economy, really. It's red hot. I mean, and we weren't expecting it. I mean, all our companies, when they thought when they were allowed to go back to work—what for various operations? They would—we closed the furniture store, as I mentioned. You know, if they were closed for six weeks or so, on average, they didn't know what was going to happen when they—when they opened up.

And, you know, they can’t stop people from buying things, and we can't deliver them. And they say, 'Well, that's okay, because nobody else can deliver me either, and we'll wait for three months or something to sort.'

But the backlog grows and then we thought it would end when the $600 payments ended. And I think, you know, around August of last year, it just kept going. And it keeps going, and it keeps going, and it keeps going.

And I get the figures every week. I call her; Bumpkin calls me, and we go over day by day what happened at three different stores in Chicago and Kansas City and Dallas. And it just won't stop.

People have money in their pocket, and they pay the higher prices. And when carpet prices go up in a month or two, you know—we announced the price increase for April for our costs are going up; supply chains all screwed up; you know, for all kinds of people—but it's a buy—it's almost a buying frenzy. Except certain areas you can't buy it.

You know, you really can't buy international air travel. And there's—so the money is being diverted from a little, some—a piece of the economy into the rest, and everybody's got more cash in their pocket than—there’s more inflation going on—than quite a bit more inflation going on than people would have anticipated of just six months ago, or thereabouts."

Wow, this is one of the most interesting clips literally in the whole three to four hour shareholders meeting because the chair of the Federal Reserve, Jerome Powell, said not too long ago he doesn't expect much inflation.

The stuff we're seeing, it's short-term only—nothing to worry about—and the Federal Reserve doesn't plan on raising interest rates until 2023. So that reassures people. But their hand can be forced if inflation ramps up.

And then, you see this clip that shows you when you turn to a business like Berkshire Hathaway that has boots on the ground and is operating in many different industries, they are already seeing a lot of inflation in their day-to-day activities—in the raw materials.

So petroleum, lumber, steel, copper, etc. And this causes prices to rise in the end product. For example, new home prices are more expensive because lumber is more expensive. Cars and trucks become more expensive because steel is more expensive.

And this is called cost-push inflation. The raw materials get more expensive, so the companies raise their prices on their finished products to maintain their margins and maintain their profits.

And if this inflation continues, no doubt it will put pressure on stock prices. So Buffett says he's already seeing a lot of inflation.

But what's interesting is that right now, people and businesses are simply accepting it because they're so cashed up right now—cashed up through stimulus or just borrowing money at very cheap rates.

So now, let's recap and go back to the inflation equation: supply and demand. So firstly, what Warren was saying: we're seeing the demand stay strong because people and businesses have the money. So that side of the equation is pushing inflation.

But then listen to what Greg Abel says for the supply side of the equation:

"Great, you probably are in a good position."

"Yeah, well, when I think you touched on it—when we look at steel prices, timber prices, any petroleum input—you know, fundamentally, there's pressure on those raw materials.

I do think something you've touched on—one, and it goes really back to the raw materials—there's a scarcity of product right now—of certain raw materials. It's impacting price and the ability to deliver the end product.

But, you know, that scarcity factor is also real out there right now as our businesses address that challenge. And it may be that some of that's contributed or arisen from the storm we previously discussed in Texas. When you take down that many petrochemical plants in one state that the rest of the country is very dependent upon it, we're seeing it flow through both on price but overall in scarcity of product, which obviously go together.

But, uh, there are challenges—that's for sure."

So not only is the demand side of the equation strong, but the supply side is weak. As Greg said, there are raw materials shortages, there are supply chain constraints, so we're seeing inflationary forces on both sides of the equation.

So it sounds like Buffett is already resigned to the fact that we're definitely going to see inflation in the future, and I think that is a key takeaway from the Berkshire Hathaway shareholder meeting.

And yes, it is a warning that we could see pressure on interest rates in the future, which wouldn't be good for inflated stocks.

And it's kind of scary because a lot of people have been talking about this lately, like big names from Ray Dalio to Michael Burry. So, I think it's something that we should definitely be paying attention to.

You don't want to let it stop you from pulling the trigger on a great investment or anything like that, but it's something to definitely be aware of. We need to be aware that this is the direction that we seem to be heading.

So overall, that’s it for this video, and I'd love to hear your take.

Do you think we will see big inflation? I mean, I'm certainly no macroeconomic expert, so I'd love to hear your opinion. Obviously, Warren Buffett thinks it's already happening, and he's seeing it in his business.

But I'd love to hear—do you think we will see inflation really ramp up, putting pressure on the Federal Reserve to raise interest rates to control the inflation, but thus putting big-time pressure on the inflated stock market?

So I'd love to hear from you guys. Let me know what you think down in the comments section below.

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