Charlie Munger Warns of High Inflation Consequences

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. I think we do know we're flirting with serious trouble.

Just yesterday, the Daily Journal Corporation held their 2022 annual shareholder meeting. For those that don't know, this is just essentially a two-hour Q&A session with Charlie Munger. This time around, Charlie gave us his thoughts on a very wide range of topics, from the new Activision buy to investing in China, to the greed we see in the current stock markets, to climate change, Costco, Alibaba, and, interestingly, he also took a bit of time to explain his thoughts on the current money printing and inflation the U.S. is currently experiencing. That's what we're going to focus on in this video.

As a quick refresher, inflation is, of course, the prices of goods and services going up, but that's actually only half of the definition. Inflation can also be defined as the value of your money going down. Now, what we're seeing at the moment is high demand generally for goods and services and low supply due to supply chain problems, and that's causing prices to rise. But at the same time, we've also seen the Federal Reserve increasing the money supply, aka printing fresh new dollars, albeit electronically. In fact, the Fed has effectively printed 4.72 trillion dollars since February 2020.

So, the combination of the dollar becoming a lot more abundant, as well as general demand for goods outweighing the supply, has led to a fair amount of inflation. Just a week ago, we got inflation data for January 2022, and it showed an annual inflation rate of 7.5% in the U.S. Now, the Fed's target for inflation is 2% per year, so obviously, we've blown past that. It’s now getting to the state where the Fed needs to step in and raise interest rates to put the brakes on the economy to cool inflation down.

So, that's the story so far, and now with that background in mind, let's now turn over to Charlie Munger and hear his thoughts on the current situation. Simon Jacobs asks, "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? More importantly, do you think there will be a high economic price to pay as the Fed attempts to bring inflation back under control?"

Charlie responds, "I guess the reasons for 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, 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. 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, 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 and calm and admirable as it has, and so I hope to God the United States is similar in happy outcome."

I find that response really interesting from Charlie because I feel the main message we've been hearing from basically everybody so far is, you know, we're screwed. Run for cover! The world is going to end. And don't get me wrong, Charlie is certainly of the opinion that we've gotten ourselves into a bit of a pickle here, but it's interesting that he brings up the example of Japan that has been printing money consistently across decades but has never run into a big inflationary crisis. In fact, the highest inflation has gotten in Japan across the last 25 years is around four percent.

The reason he brings up Japan is to demonstrate that nobody truly knows what's going to happen. We could be in for a tough time, or the doom and gloom narrative may be overblown. We just don't know. But one thing Charlie will go on to explain is that even though we don't know exactly what will happen, the game of printing money in very large quantities is a dangerous one to play.

He continues, "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 access 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 that if you try to print too much money, it eventually causes terrible trouble. We are closer to terrible trouble than we've been in the past, but it may still be a long way off."

So, I think these clips really clarify Charlie Munger's thinking. The practice of printing a lot of money is no doubt dangerous. It's a pretty scary experiment to print 4 trillion U.S. dollars and say, "Well, let's just see what it does." It's kind of like seeing a big red button—you know you don't know what that button is going to do but you know it's probably a dangerous button to press.

Well, Jerome Powell and the Federal Reserve have certainly pressed that button, and of course, the early indications—and yes, we are in the early stages of this—the early indication is that it didn't work out quite as consequence-free as we would have liked. But the question is, what happens next? You know, if the supply chain issues improve over the next few years and that does pull inflation down, then maybe we will have largely dodged a bullet. The one thing we don't want to see is the inflation continuing to spike to plunge us into an inflationary crisis similar to what was seen in the 1970s when inflation hit 15 percent.

What are your current thoughts on the inflationary environment? Please compare and contrast it to the 1970s.

Charlie responds, "Well, when we, when Volcker, after the 70s, took the primary to 20 percent and the government was paying 15% on its government bonds, that was a horrible recession. It lasted a long time, caught with a lot of agony, and I certainly hope we're never—not going there again. I think the conditions that allowed Volcker to do that without interference from politicians were very unusual, and I think it—in 2020 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. These are related. 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."

For those that don't know, Paul Volcker was the chair of the Federal Reserve at the time when inflation spiked up to 15%. He very decisively raised interest rates to 20%, which, of course, didn't make him very popular as it plunged the U.S. into a nasty recession, as Charlie described, but it did stop the inflation. But it's interesting to hear Charlie's opinion that he doesn't believe the current political landscape would allow for such decisive action today. If this were the case, what it tells me is that the Federal Reserve better step up to the plate now and raise rates by a good chunk so that we don't end up needing that sort of action if inflation continues to worsen.

So that's Charlie's opinion on the inflation situation as a whole, but what do we as investors need to do about it? You know, being heavily invested might see us inflicted with some stock market pain as rates rise and businesses slow down, etc. But staying in cash during an inflationary period is just downright painful. So, what do we do? How will this all play out? What's the best advice you have for individual investors to optimally deal with the negative impact of inflation?

Other than owning quality equities, it may be that you have to choose the least bad of a bunch of options. That frequently happens in human decision-making. The Mungers have Berkshire stock, Costco stock, Chinese stocks, 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.

I think that's a really insightful answer from Charlie. We know that as long-term investors, there are going to be bad times. Looking at a situation like this, where interest rates are about to rise and inflation is very high, there may be a period of time where there are not a lot of good options to take. So we may need to take the least bad option. In Charlie's opinion, the least bad option is to just be invested in a few businesses that you know are really high-quality assets. You look at that business and you're proud to say, "Yeah, I own that." For Charlie, he has Berkshire, Costco, Daily Journal Corp, some investments made by Li Lu in China, and he has a few apartments.

If you look back in time, there would have been better stocks to buy, there would have been better real estate assets, etc. But at the end of the day, he knew he had a few really high-quality assets, and that approach treated him very well despite all the booms and busts over his investing career. So I think we can all learn something from that. You don't have to pick the absolute best performing asset class or stock for what's happening right now. Really, you just need to own high-quality cash-producing assets for a long period of time and keep calm and just ride out all the bumps in the road that you inevitably experience along the way.

So, anyway, guys, they are Charlie's thoughts and opinions on the current inflationary environment. Definitely, let me know your take in the comment section below. I'd love to hear it. Let me know what do you think. Do you think Charlie's on the mark or do you think he's missed something? Let me know down in the comment section below. Leave a like on the video if you did enjoy it. Subscribe to the channel if you want to learn more about value investing. Of course, I keep up to date with all of the great value investors of the world. If you're interested in how I go about my investing and you want a step-by-step approach, you can check out Profitful. Links down in the description below.

"Introduction to Stock Analysis" is an eight-hour course that teaches you how to go through the classic Warren Buffett, Charlie Munger approach. New Money Clips is also linked down in the description below. Thanks always to the New Money Patreon supporters for helping fund the channel. But with that said, thank you guys very much for watching and I'll see you all in the next video.

This video is brought to you by ShareSight. Sick of tracking your performance manually? Track capital gains, dividends, and currency fluctuations easily, and when it comes to tax time, have everything you need ready to go with just a click of a button. Try ShareSight for free or use the referral link in the description to get four months free when you sign up for an annual plan.