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Has Charlie Munger Gone Senile on U.S. Energy Independence?

A puzzling picture of an oil play for 1930

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Charlie Munger is the long-term business partner of Warren Buffett, the legendary chairman and CEO of Berkshire Hathaway (BRK.A) (BRK.B). Munger is the deep thinker who has managed an impressive record with his investment partnership, at Wesco Financial (WSC) and Daily Journal (DJCO).

Munger overcame huge obstacles in his life, including the death of his son and a divorce to make billions of dollars. Munger is the one who changed Buffett’s perspective on business and investing from cigar butt type investments to buying quality companies trading at fair prices. Munger is a genius and has achieved a lot of wealth in the process.

However, sometimes even accomplished people such as Charlie Munger venture outside their level of expertise, and start making statements that sound weird.

I am referring to his comments on energy independence (source: Morgan Housel & this video)

Oil is absolutely certain to become incredibly short in supply and very high priced .. The imported oil is not your enemy, it’s your friend. Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you’re going to need to feed your people and maintain your civilization. And what responsible people do with a Confucian ethos is suffer now to benefit themselves and their families and their countrymen later. The way to do that is to go very slow in producing domestic oil and not mind at all if we pay prices that look ruinous for foreign oil. It’s going to get way worse later …

The oil in the ground that you’re not producing is a national treasure … It’s not at all clear that there’s any substitute [for hydrocarbons]. When the hydrocarbons are gone, I don’t think the chemists are going to be able to just mix up a vat and create more hydrocarbons. It’s conceivable that they could, I suppose, but it’s not the way to bet. We should spend no attention to these silly economists and these silly politicians that tell us to become energy independent.

Let me pose a question for you. It’s 1930. Oil in the United States is in glut. We have cartels to get the price up to $0.50 a barrel. Everywhere we drill we find more oil in our own country; everywhere we drill in Arabia we find even more.

What would the correct policy of the United States have been in that time? Well, the correct policy would have been to issue $150 billion of very long-term bonds and cart 150 billion barrels of Middle Eastern oil into the United States and throw it into our salt caverns and leave it there untouched until the current age.
It’s easy to see that in retrospect, but who do you see who ever points this out? Zero. We have a brain-block on this issue. We should behave now to do on purpose what we did on accident then.”

I read this statement, and I understand his idea in theory. In reality, it seems very stupid. Of course the risk is that maybe I am so simple minded, that I do not understand the wisdom of those words.

First, the size of the U.S. economy was about $100 billion in 1930. So it would have been tough to borrow $150 billion, which would have been 1.5 times the size of economy. I am sure that if this were done in 1930, many people would have been unhappy about this debt deal. It would have also been difficult for a country to sell a debt issue of that size, without shaking the markets and raising its interest rates. The backlash from voters would have been ever worse, as it would have been seen that this is effectively enslaving future generations with interest payments on oil that won’t be used for years. Remember when everyone proclaimed the end of the U.S. as we know it in 2008, when we had the $700 billion in TARP funds? How would you like it if the U.S. government decided to borrow 15 trillion today and buy oil to be used in 100 years?

Second, this idea is nonsense because it introduces the concept of leverage. Leverage is a dangerous tool, that can lead to total destruction of capital even if you are 100% right. A country that instantly leverages itself by borrowing an amount that is 1.50 times the size of its economy is levering itself, and thus leaving it highly susceptible to short term fluctuations in macroeconomic factors. To put it in simple words, things don’t go up or down in a straight fashion.

For example, if you were smart enough to recognize the genius of Buffett in 1972, and bought Berkshire Hathaway on margin that very same year, you might have little to show for your forecast. This is because the price of Berkshire stock fell by more than 50% between its 1972 high and 1975 low. An investor on margin would have been forced to sell at the depths of the market crash of 1974, in order to cover margin loans. Munger should have known better, because his friend Rick Guerin did exactly that leveraged experiment, and sold Berkshire at $40 per share in 1974.

Article printed from InvestorPlace Media,

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