Buffett sees economy in ‘shambles’ but holds out hope

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Master investor Warren E. Buffett warns today in his annual letter to shareholders that the economy ‘will be in shambles throughout 2009 -- and, for that matter, probably well beyond.’

But as he has done several times in recent months, Buffett tries to rally hope, insisting that ‘America’s best days lie ahead’ despite the current economic crisis.

As usual, the billionaire’s letter to his Berkshire Hathaway Inc. investors mostly reviews the company’s operations and investments. Berkshire’s businesses include insurance, utilities, manufactured housing and retailing, and the company also is a major shareholder of firms including Coca-Cola, Wells Fargo & Co. and Kraft Foods.

Buffett also gives his views on the broader economy, and on the government’s attempts to fix the mess we’re in.

The ‘debilitating spiral’ in the financial system and economy ‘has spurred our government to take massive action,’ Buffett notes. ‘In poker terms, the Treasury and the Federal Reserve have gone ‘all in.’ Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel.’

Buffett, a Democrat, says the government’s moves were necessary to avoid a ‘total breakdown.’ But he predicts that ‘these once unthinkable dosages [of financial help] will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.’ . . .

‘Moreover, major industries have become dependent on federal assistance, and they will be followed by cities and states bearing mind-boggling requests,’ he says. ‘Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.’

Still, Buffett writes, ‘Amid this bad news, never forget that our country has faced far worse travails in the past,’ citing the two World Wars, the Great Depression, and the wild inflation of the 1970s.

‘Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.’

He makes no short-term prediction about the stock market, which is off to a horrendous start this year, with the Standard & Poor’s 500 index down 18.6% since Dec. 31. But he notes that in 75% of the past 44 years, the S&P index has risen. ‘I would guess that a roughly similar percentage of years will be positive in the next 44 years,’ he says.

Buffett, who publicly recommended buying stocks amid the meltdown in October, reiterates his view that investors who are hiding out in short-term cash accounts or long-term Treasury bonds will come to regret it. He suggests that the fear-driven rally in Treasury securities that pushed yields to record lows late last year is a massive bubble on par with the dot-com bubble and the housing bubble.

‘Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long,’ Buffett writes. ‘Beware the investment activity that produces applause; the great moves are usually greeted by yawns.’

-- Tom Petruno