by Calculated Risk on 6/24/2005 09:17:00 PM

Kash covered the political reaction to the announcement that China National Offshore Oil Corporation, or CNOOC, is bidding for Unocal. MaxSpeak and Dr. Setser work the numbers.

This event reminds me of the following cautionary tale from Warren Buffett (Oct, 2003).

[T]ake a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo-but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks). Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off-or simply service - the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of squanderville are in no mood to listen to such doom saying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville. At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat - they have nothing left to trade - but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest. It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are - in economist talk - some pretty dramatic "intergenerational inequities."

UPDATE: Buffett was on CNBC Thursday June 23rd. Here are his comments on China:

Buffett said he doesn't subscribe to the view that China is engaging in a trade war with the U.S. He said Chinese corporate takeovers, such as CNOOC Ltd's (CEO) recent bid for Unocal Corp. (UCL) were an "inevitable" consequence of the U.S. trade deficit. He noted that the U.S. imported far more goods from China than it sold to the nation.

"If we're going to consume more than we produce, we have to expect to give away a little bit of the country," said the "Oracle of Omaha."