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| Issue 28 26 April 2002 |
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Berkshire Hathaway’s 2001 Annual Report was released over the Internet on 9 March. Its centrepiece, the Chairman’s Letter, is a rarity. It is written personally by Berkshire’s Chairman, Mr Warren Buffett, and not by a committee of lawyers, PR and media specialists, intermediaries or dissimulators. Berkshire’s headquarters, whose number of employees has mushroomed in the past year to 14.8 (Berkshire’s subsidiaries have a workforce of more than 100,000), employs no PR, media or marketing people and appears to be a committee-free zone. Equally unusually, admirably and surely not co-incidentally, the most prominent attributes of Mr Buffett’s annual communications to shareholders and the general public include clarity, candour, acuity and sheer readability. Given these attributes, to say nothing of his track record since the 1950s, the moral leadership of Mr Buffett and his Vice-Chairman, Mr Charles Munger, repays careful study and emulation (see also Letter 3 and Letter 15).
It is well known that since the 1960s Berkshire has generated outstanding results for its shareholders. Less recognised, and seemingly alien to many analysts, advisors, funds managers, financial journalists and commentators, is the primary criterion (i.e., percentage change in per-share book value) that Berkshire uses to gauge its results. A tabulation of these figures for each year since 1965 precedes Mr Buffett’s Letter; and the Letter’s first sentence invariably draws attention to the most recent year’s figure. Although it has been static since the beginning of 1999, during Mr Buffett’s tenure at the helm per-share book value has increased at an average rate of almost 23% per annum. Berkshire’s steadfast resistance to academic, institutional and other imperatives – of which its use of a “business-based” rather than “market-based” criterion to measure its progress is but one example – helps to explain why its results have been so remarkable. Conceptions of risk proposed during the 1950s and 1960s by academics, and adopted uncritically and almost universally by practitioners in succeeding decades, have bastardised not just the criteria by which most market participants measure the results of investment operations; they have also deranged the principles underlying many of these operations. The vast majority obsess about “the market” and its short-term (i.e., quarterly, monthly, even daily) “performance.” They define the market in terms of a price index, i.e., a weighted average of the current prices of the securities (equities, bonds, etc.) comprising it. They also think about a given portfolio of securities as an index and equate the performance of the portfolio with the weighted average of changes in the prices of its assets. Accordingly, the greater an index’s percentage increase from one point in time to another the more favourable the evaluation of its performance; conversely, the smaller the rise or the greater the decrease the more negative the interpretation. Accordingly, if Index A (say, Jack’s portfolio) increases relative to Index B (Jill’s portfolio or some market index), then A has “outperformed” B. This obsession about overall markets and their indices allows the vast majority of market participants surprisingly little time to analyse individual businesses. According to Michael Santoli (Barron’s 18 June 2001), “too often analysts lack broad and deep understanding of industries and fail to undertake the rigorous independent legwork to divine the true prospects of the companies they follow. Just as crucial, many don’t employ real discipline in valuing companies, the very thing investors most sorely crave.” In The Warren Buffett Portfolio, (John Wiley & Sons, ISBN 0471247669, 1999) Robert Hagstrom asks “if you owned a business and there was no daily quote to measure its performance, how would you determine your progress? Likely you would measure the growth in earnings, or perhaps the improvement in operating margins, or a reduction in capital expenditures. You would simply let the economics of the business dictate whether you are increasing or decreasing the value of your business.” In order to buy or sell a financial asset, in other words, one requires a price. In order to evaluate its quality, on the other hand, one does not: one requires valid and reliable information about the business, its operations and prospects (see also the circular to shareholders entitled Value Investing and the (Mis)Measurement of Results). Mr Buffett’s operations and results over the decades remind us again and again of this fundamental and irreducible truth. So too, but in a way they surely cannot intend, do the irrational operations and comparatively mediocre results of the majority obsessed with “the market” and short-term “performance.”
Sins of Omission and Commission If they are freed from the strictures of institutional, academic and other imperatives, justifiable investment operations will be not be based upon what others think about macro-level phenomena (i.e., “the market.” “the economy,” etc.). Nor will they depend upon others’ views about a particular business and its prospects. Hence a central tenet of successful business and investment operations: in Benjamin Graham’s words, “you are neither right nor wrong because the crowd disagrees with you.” Rather, “you are right because your data and reasoning are right.” Indeed, and as Mr Graham also emphasised, “the right kind of investor [takes] added satisfaction from the thought that his operations are exactly opposite to those of the crowd.” This tenet has a corollary: as Mr Buffett wrote in this year’s Letter, one produces “outstanding long-term results primarily by avoiding dumb decisions, rather than by making brilliant ones.” One should strive not to slay dragons spectacularly but unobtrusively to avoid them; and one should address simple and solvable problems and evade complicated and intractable ones. To use some sporting analogies, it is preferable to step slowly over one-foot hurdles than to risk injury sprinting over one metre ones; to stick to the fare way, reach the green in three and two-putt rather than attempt to reach the green in two and risk driving into the rough, hitting a bunker and scoring a triple bogey; and to wait for high-percentage lay-ups rather than indulge in entertaining but very low percentage throws from half-court. It is easier, then, to stay out of trouble than it is to extricate oneself from it. Time after time I have been struck by the realisation that, whatever one’s talents and shortcomings, considerable long-run advantage can accrue by the simple method of avoiding egregious short-term stupidity. (Interestingly, it is the strongest and most confident swimmers who are disproportionately likely to drown in Queensland’s surf.) The implication of this approach to business and the allocation of capital is that one should strive to reduce the likelihood of committing “sins of commission” (i.e., making what turn out to be bad decisions). In so doing, one must necessarily increase the likelihood of committing “sins of omission” (i.e., foregoing what turn out to be good investment decisions). For full details, see the series of Circulars to Shareholders entitled Irrational Exuberance in Australia, Reasoned Scepticism Versus Irrational Exuberance and Value Investing, Risk and Risk Management.
Mr Graham noted during the 1930s, and he and his followers amply demonstrated thereafter, that value investors possess a distinct temperament. A strong respect for logic and evidence, a healthy appreciation of the imperfect nature of evidence and inference, a recognition of the ubiquity of human error and a sensitivity to sins of omission and commission – all are hallmarks of their mental apparatus. More generally, and whatever their logical mathematical, accounting and other abilities, Mr Graham emphasised that individuals who can neither master their emotions nor appreciate the long-term implications of their actions seldom make rational and successful decisions. Similarly, and as Henry Hazlitt noted in Economics in One Lesson (Laissez Faire Books Fiftieth Anniversary Edition, 1996, ISBN 0930073207), “... there is a second main factor that spawns [fallacies]. This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences....” If only politicians were guided by such fixed stars; if only those few politicians guided by sound principles were better remembered; and if only the principles of one such politician, who has been largely forgotten by Americans (and is utterly unknown to Australians), were restored to their former prominence. Robert A. Taft was Senator for Ohio (“for” as well as “from” – check the U.S. Constitution) from 1939 until his death in 1953. Sen. Taft was the second generation of one of the American Midwest’s most prominent political families. He was the son of William Howard Taft (27th President, 1909-1913; Chief Justice of the Supreme Court, 1921-1930), the father of Robert Taft Jr. (U.S. Senator, 1971-1976) and the grandfather of Bob Taft (Governor of Ohio since 1999). Known during the 1940s as “Mr Republican”, by 1952 he was the man whom the Old Right, which harboured grave suspicions about General Eisenhower’s proposed foreign policies, supported for the presidency. As an unabashed classical liberal in the American mould, Sen. Taft was a spirited critic of the New Deal’s centralisation, socialisation and supposition that élite bureaucrats in Washington know better than average producers and consumers in the real world. In foreign affairs, he stood squarely in the non-interventionist tradition of George Washington, Thomas Jefferson and John Quincy Adams. Perhaps more than any politician of his day, he set out the moral basis of non-interventionism in matters foreign as well as domestic. Despite the rapidly waxing clout of the executive, he also reminded Americans about the critical role assigned by the Constitution to Congress in the conduct of America’s external relations. Fused to Sen. Taft’s reverence of American institutions and free-market capitalist ideals was his innate anti-militarism and profound hatred of war. He therefore condemned FDR’s drive, overt and covert, to secure America’s participation in what became known as the Second World War, and opposed Lend-Lease aid to Britain. He evinced great scepticism towards Bretton Woods financial arrangements and the nascent United Nations Organisation, and at the end of hostilities he criticised the use of export-enhancement loans to foreigners. He greatly feared that the U.S. might follow the British example and embark upon a quest for Empire.
After the war, Sen. Taft sought to reduce the scope and cost to American taxpayers of the Marshall Plan; in 1949, asserting that it made another war more likely, he voted against the creation of NATO; and shortly thereafter (whilst later conceding a tendency to equivocate) he generally opposed American military intervention in Korea and America’s Cold War policies more generally. In debate about President Truman’s authority to deploy troops overseas, Taft declared “if the President has unlimited power to involve us in war, war is more likely.” Sen. Taft and the Old Right he led were vanquished during the early 1950s. Not until the 1970s, when some Americans became disillusioned by the results of Wilsonian foreign policy, particularly but not exclusively in Vietnam, did Taftian principles begin to receive serious re-evaluation and belated appreciation (see Ronald Radosh, Prophets on the Right: Profiles of Conservative Critics of American Globalism, Simon and Schuster, ISBN 0671219014, 1975; and Justin Raimondo, Reclaiming the American Right: The Lost Legacy of the Conservative Movement, Center for Libertarian Studies, ISBN 1883959004, 1993). Sen. Taft’s book, A Foreign Policy for Americans (Doubleday, 1951), described and justified his conviction that foreign and domestic policies must not only be inextricably linked; they must also be constitutional and therefore limited in scope. The imperative that policy be logically coherent, e.g., that limited government at home implies non-interventionism abroad, led Taft and his supporters to conclusions that many Americans would today find odd, unsettling and perhaps even (to use the terms favoured by the present Republican leadership) “thoughtless”, “ill-timed,” “divisive” and “disgusting.” His book begins “the ultimate purpose of our foreign policy must be to protect the liberty of the people of the United States.” It expressly rejected “national purpose,” development of impoverished and liberation of oppressed foreigners, a New World Order and other inspirations of Wilsonian foreign adventurism as bases for America’s relations with other lands. Sen. Taft continued: “only second to liberty is the maintenance of peace.” He was deeply aware of the costs of war. His experiences in Europe after the Great War demonstrated forcefully that that conflict wasted countless lives, produced untold economic suffering and, in Germany and Russia, unleashed Leviathan states inimical to individual liberty. After the attack on Pearl Harbour and America’s entry into the War, Republicans faced pressures similar to those faced today by Democrats. There were admonitions that the administration not be criticised and declarations that politics stop at the water’s edge. Undaunted, Sen. Taft delivered a speech to the Executive Club of Chicago that argued that particularly in wartime it was the duty of legislators to hold the executive accountable for its deeds and misdeeds. He did not remain silent five and a half months after the attack (the time taken by Sen. Daschle to mention in passing that Democrats would begin “to ask the tough questions” about President Bush’s war strategy). He did not hold his tongue for five weeks after the commencement of hostilities (the grace period allowed by Sen. DeLay before lambasting President Clinton’s war in Kosovo). Sen. Taft delivered his speech on 19 December 1941 – less than a fortnight after the attack on Pearl Harbour. Wreckage and bodies still lay in the water, and American servicemen were already headed towards theatres of war. Yet at that time, unlike today, partisan debate raged. Towards what end was the war directed? How would private industry convert to its demands? What was the best way to expand conscription? Taft spoke about each of these topics and systematically opposed President Roosevelt’s plans (“I see no use in sending boys of nineteen or twenty to war.”) Sen. Taft’s speech tied the war to domestic politics and demanded that Congress investigate recent events (“Perhaps the fault at Hawaii was not entirely on the admirals and generals.”) Invoking the views of Oliver Wendell Holmes and Francis Biddle (FDR’s attorney general), according to Taft “the duties imposed by the Constitution on Senators and Congressmen certainly require that they exercise their own judgment on questions relating to the war.” Indeed, “as a matter of general principle, I believe there can be no doubt that criticism in time of war is essential to the maintenance of any kind of democratic government ... too many people desire to suppress criticism simply because they think that it will give some comfort to the enemy to know that there is such criticism. If that comfort makes the enemy feel better for a few moments, they are welcome to it as far as I am concerned, because the maintenance of the right of criticism in the long run will do the country maintaining it a great deal more good than it will do the enemy, and will prevent mistakes which might otherwise occur.” Observing events from a distance of half a world and more than sixty years, it is more than interesting that Sen. Taft’s speech was not a cause célèbre; indeed, it generated little comment of any description. The New York Times did not cover it; The Washington Post only briefly mentioned it at the end of a larger story mostly about Secretary of State Cordell Hull; and The Chicago Tribune, at that time the standard bearer of the Old Right, gave it favourable but not detailed scrutiny. Significantly, however, in the U.S. in 1941 a prominent Senator’s right to speak critically on a matter of national importance was not questioned.It is difficult to imagine that an American politician could today deliver a similar speech – including a full Congressional investigation of the attacks on New York and Washington on 11 September – without generating vituperation and accusations of treason. The First Amendment notwithstanding, nothing but staunch support appears to be acceptable; and major media outlets have seemingly accepted the principle that criticism is tantamount to collaboration. The contrast with Sen. Taft’s time is thus stark. America’s historical record tells us much about the appropriate parameters of loyal opposition in a free society during wartime. Obviously, no historical analogy is exact, some things apparent now were not so then and other things acceptable then are apparently not so now. And that is the point. It is disconcerting that, in the first and probably only country founded upon an enlightened scepticism about and fear of government, more and more activist government within the U.S. during and since the New Deal has, just as Sen. Taft and his Old Right colleagues (such as Congressman Howard H. Buffett of Nebraska) feared, generated a commensurate amount of interventionist foreign policy. It is even more disconcerting that the invidious consequences of this interventionism, for both American taxpayers and foreign civilians, registers only dimly or not at all within the Beltway. And it is dispiriting that prominent Americans have either forgotten or disavowed the noble non-interventionist principles of their country’s Founders. As a people who have long and rightly served as a moral beacon to others around the world, Americans might reflect that there was a time not too long ago when a doughty few of their leading lights – enthusiastically pro-capitalist, staunchly anti-Communist and conservative Midwesterners to their bootstraps – thought and acted diametrically differently about their Constitution, foreign relations, war and dissent. All best wishes for a pleasant and thoughtful ANZAC Day holiday, Chris Leithner
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