Does the Fed Keep Warren Buffett Up at Night?

Since the beginning of the financial crisis, central banks around the world have been trying desperately to avoid a comatose economy. An unprecedented amount of liquidity has improved credit conditions and kept the stock market alive, but Warren Buffett warns about the “huge experiment” ending.

The Oracle of Omaha spoke to more than 30,000 fans at Berkshire Hathaway’s (NYSE:BRKA) (NYSE:BRKB) annual meeting this past weekend. During the Q&A session, he was asked about the Federal Reserve’s massive bond-buying programs, which have pushed interest rates to historic lows.

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Buffett explained, “Interest rates power everything in the economic universe and they have some effect” on Berkshire. “We have benefited significantly and the country has benefited significantly from what the Fed has done. It has been a very smart policy, but the unwind of it has got to be more difficult than buying.”

At this point, buying bonds is second nature to central banks. When converted to U.S. dollars, the four major central banks have expanded their balance sheets to more than $13 trillion, compared to $3 trillion only ten years ago, according to Hayman Capital. Central banks now account for at least a quarter of all global gross domestic product, a sharp increase from 10 percent in 2002.

Central banks are also buying stocks. According to a recent annual survey of 60 central bankers conducted by Central Banking Publications and Royal Bank of Scotland, nearly a quarter of reserve managers already own equities or plan to buy them within five years. The Bank of Japan, which committed to nearly doubling the nation’s monetary base by the end of 2014, will more than double investments in equity exchange-traded funds.

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When central banks manipulate interest rates, it distorts the true cost of money and often causes capital misallocations. This is one major reason for the current boom/bust economy. “People make different decisions when they can borrow for practically nothing,” says Buffett. He claims to have complete “faith” in Fed Chairman Ben Bernanke, but when Mr. Market receives any signal that the Fed may end its bond-buying programs, “it’s likely to be the shot heard around the world.”

On the positive side, Buffett also noted, “that doesn’t mean the world will end.” Investors will re-evaluate their positions quickly, but the market will live to see another day. In fact, the billionaire considers quantitative easing to be “like watching a good movie, because I don’t know how it will end.”

The Federal Reserve’s balance sheet has ballooned to more than $3.3 trillion. While the movie will eventually end, the credits are not ready to roll just yet. Last week, the central bank reaffirmed its commitment to buying $85 billion of bonds each month. Furthermore, it noted for the first time that it could increase the level of monthly purchases based on incoming economic data.

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