Sunday, February 15, 2015

Warren Buffett and Hugo Stinnes

Hugo Stinnes is practically unknown today, but this was not always so. In the early 1920s he was the wealthiest man in Germany, at a time when Germany was the third largest economy in the world. He was a prominent industrialist and investor with diverse holdings in Germany and abroad. He was also a close associate of the leading politicians of the time. Chancellors and cabinet ministers of the newly formed Weimar Republic routinely sought his advice on economic and political problems.

In many ways, Stinnes played a role in Germany similar to the role Warren Buffett plays in the U.S. today – an ultra-wealthy investor whose opinion is eagerly sought on important political matters, who exercises powerful behind-the-scenes influence, and who seems to make all the right moves when it comes to playing markets.

Students of economic history know that the period 1922 to 1923 in Germany was the worst period of hyperinflation experienced by a major industrial economy in modern times. The exchange rate between the German paper currency, the Reichsmark, and the dollar went from 208 to 1 in early 1921 to 4.2 trillion to 1 in late 1923, at which point the Reichsmark became worthless and was swept down sewers as litter. Why was Stinnes not wiped out during this hyperinflation?

Stinnes was born in 1870 into a prosperous German family that had interests in coal mining. He worked in mines to obtain a practical working knowledge of the industry and took courses in Berlin at the Academy of Mining. Later he inherited his family’s business and expanded it by buying his own mines.

He then diversified into shipping, buying cargo lines. Stinnes used his own vessels to transport his coal within Germany along the Rhine River, and from his mines abroad. His vessels also carried lumber and grains. His diversification included ownership of a leading newspaper, which he used to exert political influence. Prior to the Weimar hyperinflation, Stinnes borrowed vast sums of money in Reichsmarks.

When the hyperinflation hit Stinnes was perfectly positioned. His hard assets in coal, steel, and shipping retained their value. It didn’t matter what happened to the Germany currency, a hard asset is still a hard asset and does not go away even if the currency goes to zero. Stinnes’s international holdings also served him well because they produced profits in hard currencies, not worthless Reichsmarks. Stinnes kept some of these profits offshore in the form of gold held in Swiss vaults so he could escape both hyperinflation and German taxation. Finally he repaid his debts in worthless Reichsmarks, making them disappear.

Not only was Stinnes not harmed by the Weimar hyperinflation, his empire prospered and he made more money than ever. He expanded his holdings and bought out bankrupt competitors. Stinnes made so much money during the Weimar hyperinflation that his German nickname was Inflationskönig, which means Inflation King. When the dust settled and Germany returned to a new gold backed currency, Stinnes was one of the richest men in the world, while the German middle classes were destroyed.

Interestingly, we see Warren Buffett using the same techniques today. It appears that Buffett has studied Stinnes carefully and is preparing for the same kind of financial calamity that Stinnes saw coming.

Buffett recently purchased major transportation assets in the form of the Burlington Northern Santa Fe Railroad. This railroad consists of hard assets in the form of rights of way, adjacent mining rights, rail, and rolling stock. The railroad makes money moving hard assets such as ore and grains.

Buffett next purchased huge oil and natural gas assets in Canada. Buffett can now move his Canadian oil on his Burlington Northern railroad in exactly the same way that Stinnes moved his coal on his own ships in 1923. Buffett is also a major holder in ExxonMobil, the largest energy company in the world.

For decades, Buffett owned one of the most powerful newspapers in the U.S., the Washington Post. He sold that stake recently to Jeff Bezos of Amazon, but still retains communications assets. Buffett has also purchased large offshore assets in China and elsewhere that produce non-dollar profits that can be retained offshore tax-free.

A huge part of Buffett’s portfolio is in financial stocks in banks and insurance companies that are highly leveraged borrowers. Like Stinnes in the 1920s, Buffett can profit when the liabilities of these financial giants are wiped out by inflation, while they nimbly redeploy assets to hedge their own exposures.

In short, Buffett is borrowing from the Stinnes playbook. He’s using leverage to diversify into hard assets in energy, transportation and foreign currencies. He’s using his communications assets and prestige to stay informed on behind-the-scenes developments on the political landscape. Buffett is now positioned in much the same way that Stinnes was positioned in 1922. If hyperinflation were to hit the U.S. today, the result would be the same for Buffett as for Stinnes. His hard assets would explode in value, his debts would be eliminated, and he would be in a position to buy out bankrupt competitors. Of course, the middle classes in the U.S. would be wiped out as they were in Germany.

Stinnes saw the German hyperinflation coming and positioned accordingly. Buffett is following the Stinnes playbook. Perhaps Buffett sees the same hyperinflation in our future.

It’s not too late for investors to take some of the same precautions as Stinnes and Buffett. In the short run, deflation has the upper hand. But, it’s just a matter of time before central banks slay the deflation monster and open the door to much higher inflation. Do not rely on your fixed dollar assets like savings, insurance and pensions. Diversification into energy, mining, transportation, gold, land and fine art will serve you well. Also don’t be afraid to build up a cash position. Critics will say that cash has “no yield” these days. But cash in a portfolio helps to reduce volatility and gives you the ability to pick up bargains when the inevitable financial traumas emerge.

- Source, Jim Rickards via Darien Times