Window Dressing

October 27, 2003 – Because financial statements provide a snap-shot of a company’s balance sheet for just one day, the opportunity exists for corporations to take steps before their fiscal year-end to ‘window dress’ their financial accounts. In other words, they take those actions that they believe will present the financial statements sent in the annual report to their shareholders in the best possible light, for example, by paying or not paying bills before its year-end date. It seems that the federal government has also been ‘window dressing’.

The feds reported a $374 billion budget deficit for the September 30^th fiscal year just ended. Let’s ignore from this analysis the $555 billion actual growth in the federal debt during the year. This discrepancy between the reported ‘deficit’ and the increase in the total debt arises from tomfoolery, not window dressing. This deception of the size of the federal government’s annual deficit is obvious, but the window dressing is less so.

It seems clear that the feds are window dressing, presumably to make last year’s deficit – by far an all-time record – look smaller than it would otherwise have been if the window dressing were not used. In other words, it appears that some expenses that should have been paid in September were instead deferred to October. We’ve seen this trick used before.

For example, earlier this year the federal debt was knocking against the $6,400 billion debt limit then in place. For a while, Congress was deadlocked about increasing the ceiling, but rather than cut expenses, the feds continued to operate at full speed. To keep the government afloat, they dipped into some of the various piles of cash to which they have access. Once the new $7,384 billion debt ceiling was passed, there was an orgy of borrowing to get funds to replace those ‘borrowed’ from temporary sources.

The net affect was to keep the federal debt under the debt ceiling until eventually some compromise was reached about increasing

Anyway, here are the numbers that lead me to the conclusion that the feds are window dressing again.

In the first 22 days of October, the federal debt has grown by $51.6 billion from $ 6,783.2 to $6,834.8. That’s about $2½ billion per day, which equates to an annual growth rate in the federal debt of $856.1 billion, which is more than 2-times last year’s all-time record increase in the federal debt. At this rate of spending, the newly approved ‘limit’ for the federal debt will be reached in June 2004, several months before it was supposed to be reached.

This reckless rate of growth in the federal debt is alarming. The federal deficit has to be funded, which means that the Federal Reserve is no doubt going to pump up the money supply further. Clearly, the federal deficit is to some extent going to be funded by dollars ‘created out of thin air’.

As a result, look for the dollar to continue to fall on the foreign exchange markets as this ongoing debasement of the dollar picks up speed in the weeks and months ahead. And of course, stay away from US Treasuries. But this conclusion is not just my opinion.

Here’s an important statement in the current issue of Barron’s about Warren Buffett’s thinking:

“Berkshire’s cash position grew to over $24 billion on June 30 from $10 billion at the end of 2002, largely reflecting first-half operating profits of $2.7 billion and the sale of about $9 billion of long-term Treasury bonds held in actively managed portfolios. Berkshire sold the bonds as long-term rates fell to their lowest levels in 40 years — a smart move given the rate rise since midyear. Buffett, who has spent a lifetime successfully playing the percentages, says that buying Treasury bonds at current levels probably isn’t a smart move. He noted that Berkshire could be earning $1 billion more annually on its investment portfolio if it shifted its cash holdings into longer-term Treasuries, but Buffett doesn’t believe the risk is worth the added income.” [emphasis added]

Buffett is walking away from $1 billion a year because he says the risk of US Treasuries isn’t worth it. Therefore, US Treasuries are to be avoided. In fact, in my view, avoid all US dollar denominated debt instruments.

Back in the 1960’s as dollar inflation began rearing its ugly head, the legendary Franz Pick mockingly called US Treasuries “guaranteed certificates of confiscation”. His point was that you were guaranteed to lose purchasing power from inflation and other types of dollar debasement if you owned US Treasuries.

One would have done well to listen to Pick back then. And I expect that looking forward from here, one will do well by listening to Warren Buffett.