Warren Buffett Says Sell to Me, Not `Porn Shop,' as Growth Dips

une 25 (Bloomberg) -- Warren Buffett is in Toronto, fielding questions from a crowd of 300 executives. One asks what makes people want to sell their companies to him.

The Berkshire Hathaway Inc. chief executive officer replies that he tells a prospective seller to think of the company as a work of art.

``You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever,'' he says at the February meeting. ``Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''

Buffett, 77, can afford to throw a little mud on his competitors in the private equity industry. Wall Street's acquisition machine has seized up, while Buffett, in the valedictory chapter of a career stretching back more than 60 years, is on a buying spree.

He has $35.6 billion in cash to spend, and he's looking for companies that he can buy at a reasonable price, that have experienced managers he trusts, products with strong market positions or other competitive advantages.

Buffett's biggest catch so far in 2008 was Marmon Holdings Inc., a conglomerate owned by Chicago's Pritzker family. On March 18, Berkshire announced it had bought 60 percent of Marmon from the Pritzkers for $4.5 billion. Buffett is buying the rest in increments during the next five to six years.

Needle-Moving Events

In April, he agreed to pay $2.1 billion for an undisclosed stake in Chicago's Wm. Wrigley Jr. Co. as part of McLean, Virginia-based Mars Inc.'s $23 billion purchase of the gum maker. Buffett, who already owns See's Candies, is helping to fund the deal with $4.4 billion in subordinated debt.

``This is the kind of market where you would expect the pace of Berkshire acquisitions to pick up,'' says Keith Trauner, senior analyst of Fairholme Capital Management LLC in Short Hills, New Jersey. ``In a weaker business environment, sellers moderate their expectations.''

At the same time, Berkshire is now so big that Buffett is having a hard time turning acquisitions into growth. Most of Berkshire's more than two dozen purchases since 2000 are too small to have much impact. ``The larger the company becomes, the harder it is to find needle-moving events,'' Citigroup Inc. analyst Joshua Shanker says.

Buffett agrees. ``Anyone who thinks we will come close to repeating our past performance should sell their stock,'' Buffett told investors at Berkshire Hathaway's annual meeting in May. He declined to comment for this story.

Affinity for Insurance

The Sage of Omaha, by his own count, now owns 76 companies outright, a number that rises to about 200 if Marmon's 125 subsidiaries, which make everything from water treatment gear to brake drums, are taken into account. Among the Buffett companies are names familiar to most Americans: Geico car insurance, best known for the Cockney-accented gecko in its television commercials; Dairy Queen restaurants; Benjamin Moore paints; and Fruit of the Loom underwear.

Berkshire also owns 8.6 percent of Coca-Cola Co., 13.1 percent of American Express Co. and 8.8 percent of Wells Fargo & Co. Those three investments alone amounted nearly $25 billion on June 24.

Insurance firms dominate the list of Berkshire-owned companies. Buffett controls a dozen of them -- Berkshire Hathaway Reinsurance, General Re Corp. and Geico Corp. are the biggest -- accounting for 31 percent of Berkshire's 2007 revenue.

``I would say we have a special affinity for insurance,'' Buffett said at the 2007 annual meeting's news conference.

Competitive Advantage

One reason is that Buffett loves float -- the premiums collected from policy holders that can be invested at a profit until claims need to be paid. As of the end of December, Berkshire had $58.7 billion of float.

In May, an acquisition-minded Buffett took a tour of Europe -- stopping in Germany, Italy, Spain and Switzerland -- where the media and business establishment treated him like a rock star. ``I'm not looking for Pet Rock or Hula Hoop businesses,'' he said at a Frankfurt news conference. ``I'm hoping to make big deals, whether it's in the United States or Germany or Italy or Denmark.''

In Europe, Buffett repeatedly praised the company headed by the man who sat beside him during his European tour, Eitan Wertheimer, chairman of Tefen, Israel-based Iscar Metalworking Cos. Buffett bought an 80 percent stake in Iscar, a maker of metal-cutting tools, in 2006 for $4 billion, his first big overseas acquisition.

Loyal Customers

A close look at Iscar's main factory complex in northern Israel shows why Buffett took an immediate interest when Wertheimer faxed him a letter declaring that Berkshire would be an ideal home for Iscar. The company has the ``durable competitive advantage'' Buffett told the Europeans he always looks for. It's a market leader in the design and production of a variety of metal-cutting tools.

And Iscar has loyal customers. A disposable tungsten carbide insert used to slice steel can wear out in 20 minutes or less, meaning that Iscar must deliver a steady supply of new blades to every customer that uses them.

Buffett's purchase of Iscar made the Wertheimers celebrated billionaires, so it's no surprise that he receives hundreds of letters from other entrepreneurs offering to be bought out.

Among those that have made the grade in the past 10 years are: MidAmerican Energy Holdings Co., which can generate a set return on equity of 10-11 percent from its regulated utilities; electronic parts distributor TTI Inc., which has never posted an annual loss nor laid off an employee; and Business Wire, one of two companies that dominate the niche of sending news and financial releases around the world.

Quick Dividends

Becoming a Berkshire company can pay quick dividends. On June 30, 2005, Berkshire purchased Medical Protective Corp., a Fort Wayne, Indiana-based malpractice insurer, from General Electric Co. for $825 million. The next day, Standard & Poor's raised the firm's A financial rating to AAA. ``It's hard to imagine how MedPro could have done any better than being owned by Berkshire,'' CEO Tim Kenesey, 41, says.

Sometimes the benefit is more subtle. ``There's definitely a halo effect,'' says Steve McKenzie, CEO of Norcross, Georgia- based Larson-Juhl Inc., a custom picture frame maker Buffett acquired in 2002 for $223 million. ``It's realized in the higher- quality recruits we hire and in potential acquisitions' readiness to talk to us,'' says McKenzie, 46.

Buying on Faith

Buffett often decides to buy a company after what looks like a cursory examination of its operations. He agreed to purchase Larson-Juhl after a 90-minute talk with its founder, Craig Ponzio. During his European tour, Buffett told questioners that he had bought Iscar without any due diligence and after just a few days of talks with its top executives, who traveled to the U.S. three times to meet with Buffett and his investing partner, Charles Munger.

No one from Berkshire ever stepped inside an Iscar factory before the deal was done, Buffett says.

``He's buying on faith, and especially with larger acquisitions, that's certainly perilous,'' says analyst Chuck Hamilton, who follows insurance at FTN Midwest Securities Corp. ``If he were to spend $20 billion-$30 billion on a major company, without due diligence, that would really be cause for heartburn.''

With a staff of only 19 at Berkshire headquarters in Omaha, Nebraska's Kiewit Plaza, Buffett says he won't buy a company without management in place that he's sure of.

Modest Backgrounds

``We have to see it in their eyes,'' he said at the May 3 annual meeting, where 31,000 investors converged on Omaha's Qwest convention center to hear Buffett and Munger, 84, answer shareholder questions between mouthfuls of See's candies.

In the case of Victor Mancinelli, CEO of CTB Inc., a maker of poultry feeding systems and other agricultural equipment in Milford, Indiana, Buffett could see it on the balance sheet. Mancinelli had paid off nearly $80 million in leveraged buyout and other debt in just three years. Berkshire bought CTB in 2002 for about $180 million.

One quality Buffett firms usually have in common: CEOs from modest backgrounds, often without Ivy League degrees on their resumes. Mancinelli's father was a truck driver, and his mother was an autoworker.

MidAmerican Chairman David Sokol worked his way through the University of Nebraska at Omaha as a night manager at a grocery chain. TTI's Paul Andrews is a former oil rig roughneck who once sold Bibles door-to-door. Business Wire's Cathy Baron Tamraz is a former taxi driver.

Wagering Billions

Buffett is famous for his lack of pretension. He has honed the fine art of ukulele playing. He still lives in the Dutch colonial home he bought for $31,500 with his late first wife, Susan, in 1958, according to ``Of Permanent Value: The Warren Buffett Story'' by Andrew Kilpatrick (self-published, 2008).

When he eats out, it's often at Gorat's Steak House on Center Street in Omaha, where a luncheon steak will set you back $8.25 -- including soup and a side of mostaccioli pasta. Buffett personally drives visitors to and from the airport. He prefers Cherry Coke to fine wine and saves money buying it by the case.

Buffett's just-plain-folks posture is a bit of a feint. His father, Howard, was an investment banker and a Republican U.S. congressman. Warren attended the Wharton School of the University of Pennsylvania and got a master's degree in economics from Columbia University.

In terms of the businesses he buys, Buffett never tires of telling questioners that he invests only in simple, straightforward industries whose operations he can grasp. Yet he wagers billions on everything from hedge funds to junk bonds. Through December, Buffett had made $2.3 billion in pretax earnings during the past five years on foreign-exchange bets.

Put Options

And as of March, he had tens of billions of dollars riding on two kinds of derivatives -- instruments he dubbed ``financial weapons of mass destruction'' in his 2002 letter to shareholders. The first is a variety of credit-default swap guaranteeing payment on certain high-yield bonds. Credit-default swaps, which are contracts to protect against or speculate on default, pay the buyer face value if a company fails to adhere to its debt agreements.

Buffett also has sold put options -- contracts that provide the right, but not the obligation, to sell a security, currency or commodity at a set price within a set period -- on four stock indexes. In his 2007 shareholder letter, Buffett wrote that because Berkshire holds the cash connected to the derivatives, there is no risk the parties on the other side of the transaction won't pay.

Slow to Sell

Buffett's investment choices have yielded a conglomerate that's profitable in all kinds of weather. Through May, Berkshire's Class A stock, which traded on June 24 for $122,700 a share, has returned an average of 19.3 percent annualized in the past 20 years, nearly double the 11.2 percent return of the S&P 500 Index. From June 30, 2007, through June 24, Berkshire stock rose 12.1 percent, while the S&P 500 Index returned a negative 10.8 percent.

As of Feb. 29, Buffett himself owned 28.1 percent of the combined value of Berkshire's Class A and B shares, worth $53.44 billion on June 24. Class B shares have 1/30th of the value of Class A shares' value and 1/200th of their voting rights.

Buffett could be even richer if he had bent some of his own rules. For instance, he prides himself on buying and holding companies forever -- and is slow to sell his stocks. That has cost him and his shareholders' money. Berkshire's 8.6 percent stake in Coca-Cola was worth $17.6 billion when it hit its high in July 1998. Nearly a decade later, it's valued at just $10.67 billion -- and Buffett hasn't sold a share.

Underwriting Losses

Buffett has stumbled, most notably in 1998, when he spent $22 billion in Berkshire stock to buy Stamford, Connecticut-based General Re, one of the world's biggest reinsurance companies.

``General Re's name has stood for quality, integrity and professionalism in reinsurance,'' Buffett wrote in that year's shareholder letter. He lauded CEO Ronald Ferguson for his leadership.

Yet, as Buffett has pointed out in several annual reports since, the company was selling insurance way too cheaply. From 1999 through 2005, Gen Re ran up a total of $7.69 billion in underwriting losses. FTN Midwest's Hamilton estimates that those losses have been largely offset by investment income.

In 2001, Ferguson stepped down, replaced by executive vice president Joe Brandon. In that year's letter, Buffett compared Brandon to former General Electric CEO Jack Welch. ``He is smart, energetic, hands-on,'' Buffett wrote.

`A Sinkhole'

In 2006, prosecutors accused Ferguson, former CFO Elizabeth Monrad and two other former General Re executives of helping American International Group Inc. inflate reserves by writing sham, no-risk reinsurance contracts beginning in late 2000.

Jurors convicted all four of fraud in February, along with one former AIG executive. They are still awaiting sentencing. Two other former Gen Re executives pleaded guilty to their role in the fraud in 2005.

Buffett was interviewed by prosecutors in connection with the case. He wasn't charged with any crime. Brandon, named by prosecutors as an unindicted co-conspirator, resigned on April 14, and was replaced by Gen Re President Tad Montross.

``It's been a sinkhole,'' Hamilton says. ``Buffett's lost more than a shred of reputation.''

General Re isn't Berkshire's only regulatory entanglement. Connecticut Attorney General Richard Blumenthal said in May that he's investigating whether Moody's Investors Service, which was 19.6 percent owned by Buffett as of March 31, was guilty of a conflict of interest when it gave a AAA rating to Berkshire's new municipal bond insurance firm.

`Purse Strings'

``It is one symptom of a system rife with possible conflicts of interest and problematic relationships,'' Blumenthal said in a May 1 interview with Bloomberg News.

Buffett says his company deserves its rating. ``If Berkshire isn't AAA, I'm not sure what company would be,'' he told Bloomberg Television.

As pressure has grown for Berkshire to spend its cash, Buffett has been willing to travel farther afield in search of companies to buy, says David Carr, chief investment officer of Oak Value Capital Management Inc.

``I think in the past five years, he's loosened his purse strings,'' Carr says. ``There's nothing off limits as long as he understands the model.''

Analyst Hamilton says Buffett is finding it hard to replicate his previous returns. ``The returns on equity and capital are not what they were in years past,'' he says.

Intrinsic Value

Berkshire's growth is slowing. The annual median increase in per share book value, or net worth, averaged 10.3 percent in the eight years ended on Dec. 31, 2007, compared with 26.1 percent in the 1990s and 28.8 percent in the '80s, according to Citigroup's Shanker. He says Buffett is turning Berkshire into a conservative capital preservation vehicle.

``If you're interested in capital appreciation, you have to ask yourself whether Berkshire Hathaway is the right investment,'' Shanker says.

Buffett says there's only a limited number of good, big companies for sale at reasonable prices. As he put it in a May 2007 interview with TV host Charlie Rose, ``The real goal at Berkshire is just to keep building more and more earning power from operating companies.''

What makes Buffett want to buy? He himself says there's no secret formula, because each company's dynamic is unique. Berkshire is most active when markets go awry and companies' market capitalizations dip below their true worth -- their ``intrinsic value'' in Buffett-speak.

`Deal Velocity'

MidAmerican Energy's Sokol turned to Buffett during the stock market bubble of 1999. Investors, infatuated with Internet and technology stocks, were undervaluing the shares of relatively staid utilities such as Des Moines, Iowa-based MidAmerican, which looked especially pallid next to booming energy trader Enron Corp.

``You do two to three deals a year,'' Sokol recalls one analyst telling him. ``Your competitors are doing two to three a month; they have deal velocity.''

Shares of MidAmerican slumped to less than $27 in late 1999 from $42 in '97. ``The irrational behavior was driving me crazy,'' Sokol says.

What Buffett saw in MidAmerican was a company positioned to take advantage of utility deregulation and grow through a string of acquisitions. It now operates regulated utilities in 10 states, plus the U.K. It also owns plants in Australia and the Philippines. State regulatory commissions typically allow returns on equity of 10-11 percent.

`A Fool's Game'

``Warren thinks of our business as a good place to invest money on a long-term basis,'' Sokol says.

Sokol didn't need to join a long line of company owners trying to get Buffett's attention. One investor in MidAmerican was Walter Scott Jr., a Berkshire director and Buffett friend. He is chairman emeritus of Omaha-based construction contractor Peter Kiewit Sons' Inc.

Scott suggested the meetings that resulted in the sale. Berkshire paid $1.7 billion for 85 percent of MidAmerican. Sokol, Scott, now 77, and MidAmerican President Gregory Abel paid some $310 million for the rest.

Midamerican dips into Berkshire's till for acquisitions, while keeping true to Buffett's reputation for thrift by scooping up companies on the cheap.

``With regulated assets, overpaying is a fool's game,'' Sokol says.

Deep Pockets

In 2002, the company paid $450 million for Salt Lake City- based Kern River Gas Transmission Co. Also in 2002, it bought Northern Natural Gas Co. from Dynegy Inc. for $928 million. Dynegy had purchased the pipeline company, now based in Omaha, less than nine months earlier from a collapsing Enron for $1.5 billion.

``It was a brilliant acquisition,'' says Gordon Howald of Calyon Securities (USA) Inc. ``Using standard industry multiples, we could see these assets worth more than $2 billion in today's market.''

Sokol has kept up his buying. He paid $5.1 billion for PacifiCorp, a Portland, Oregon-based utility, in March 2006. That month, Berkshire also agreed to give him up to $3.5 billion in cash for new purchases or other purposes, in exchange for MidAmerican stock.

NetJets Inc.'s Richard Santulli also had Buffett's deep pockets in mind when he made a call to Omaha. The year was 1998, and his partner, Goldman Sachs Group Inc., which owned 20 percent of the company, was pushing for a public offering. In 1986, Santulli had invented the notion of ``fractional'' jet ownership, in which individuals and companies buy shares of a private plane's flying time in lieu of buying the entire jet.

`25-Year-Old Kids'

By 1998, several other companies, including Montreal-based Bombardier Inc. and Waltham, Massachusetts-based Raytheon Co., had crowded into the field. To keep his dominant market share, Santulli expanded both the number and variety of aircraft in his fleet.

Santulli balked at the idea of an IPO for Woodbridge, New Jersey-based NetJets because going public would subject his company to the scrutiny of Wall Street analysts. ``I wasn't going to answer to 25-year-old kids telling me how to run my business,'' he says in his thick Brooklyn accent.

Like Sokol, Santulli had ready access to Buffett, who was a customer and had told him in the past to give Berkshire a call if he ever wanted to sell. Less than a week after he made the call, Buffett picked Santulli up at Omaha's Eppley Airfield in his Town Car and took him to his office. ``The deal was done in 5 minutes, maybe 10 minutes,'' he says. Berkshire paid about $725 million in cash and stock.

Expanding to Europe

Berkshire not only bankrolled NetJets' fleet of Boeings, Citations and Gulfstreams, it also underwrote the company's expansion to Europe. From 2000 to '05, NetJets lost $212 million building up a European fractional jet ownership program. ``If I were public, I would have had to close the European business down,'' Santulli says, adding that today the unit is profitable.

``If I were to sell that business -- which of course we're not -- I would start at more than a billion and go from there,'' he says. According to Jetnet LLC, a Utica, New York-based research firm, NetJets now has more than 50 percent of the U.S. fractional jet market and virtually no competition in Europe.

Business Wire's Tamraz, 54, had no special entree to Buffett's office when she faxed him a letter, along with financial data, in November 2005. Eight days later, her receptionist buzzed her.

``Warren Buffett's on line 2,'' she said.

``Hello, Mr. Buffett,'' Tamraz said, as she scrambled to find her copy of the letter.

``Call me Warren,'' he responded.

Job Security

Tamraz says Buffett asked for more financial information on New York- and San Francisco-based Business Wire and for an idea of the price she was asking for the enterprise.

What appealed to Buffett about Business Wire was its business model, Tamraz says. The firm, founded in 1961, delivers 250,000 news releases a year for 25,000 corporate clients around the world. In 2007, it had more than $125 million in sales, which have been growing about 8 percent a year for the past three years, according to Tamraz.

One reason: Regulation Fair Disclosure, a U.S. Securities and Exchange Commission rule implemented in October 2000 that requires companies to disclose market-moving information to all investors simultaneously.

Tamraz is thrifty. She has no secretary and decorates her office with posters. She's been known to pitch in to format press releases when earnings season picks up. Another feature Buffett liked is that Business Wire has only one significant rival, London-based United Business Media Plc's PR Newswire, which had an operating margin of 35 percent in 2007.

`Cheap Parts'

Tamraz had spent four years trying to sell her business. No private equity or media firm would agree to her roster of demands, including job security for her 500 employees and a free hand to run the company. Two weeks after she talked to him, Buffett agreed to all of her conditions. The price he paid was ``more than several hundred million dollars,'' Tamraz says.

Fort Worth, Texas-based TTI, which Buffett bought in 2007, is also in the distribution business. It buys components that are used in an array of electronic devices and sells them to manufacturers around the world. ``We sell cheap parts better than anyone,'' CEO Andrews declares in his Texas drawl, before correcting himself: ``We sell inexpensive parts better than anyone.''

No Losses

TTI has carved out a niche in so-called passive components -- connectors, capacitors and resistors. They sell for an average of less than 4 cents each. With 2007 revenue of $1.4 billion, TTI operates in an industry with thin margins. Everything about TTI is low cost: Its Spartan headquarters is tucked inside a 276,000- square-foot (25,600-square-meter) warehouse.

Andrews, 65, started TTI in his living room in 1971 after being laid off from a purchasing job at General Dynamics Corp. Over the years, he plowed profits back into inventory and rode out the cycles of the electronics industry that forced many rivals to sell or fold. Andrews says TTI has never posted an annual loss and has never laid off an employee.

Today, TTI's inventory is enormous. An Apple iPod may have about 500 components, and TTI says it stocks 450 of them. All told, the company sells more than a million different kinds of parts. TTI buys them from manufacturers such as Malvern, Pennsylvania-based Vishay Intertechnology Inc. and Greenville, South Carolina-based Kemet Corp. ``When you come down to it, they are an extension of our sales force,'' Kemet CEO Per-Olof Loof says.

Hamburgers and Cokes

Receiving, ``picking'' and packaging orders at TTI is largely automated. For high-volume items, automatic lifts pluck the appropriate bar-coded part -- say, a reel of capacitors -- from a revolving carousel and send it off on a conveyor to be combined with the balance of the order. Given the company's low- priced goods, any error in the process will eat up TTI's profits.

Andrews got his foot in Berkshire's door through John Roach, a friend of Andrews's who had sold Justin Industries Inc., a Fort Worth building supply maker, to Berkshire in 2000 for $600 million. Roach overnighted TTI's 3-inch (7.6-centimeter) thick book of financial information to Buffett and set up a meeting.

Andrews arrived with Roach at Buffett's offices at 10 a.m. on Nov. 15, 2006, for a scheduled two-hour meeting. It lasted twice as long, with Buffett peppering Andrews with questions about his business and family. Buffett treated his visitors to hamburgers and Cokes at a country club, and then they returned to his office.

``Warren made an offer, and Paul made a quick response,'' says Roach.

``OK, let's do it,'' Buffett said and called in CFO Marc Hamburg to work out the details. The price wasn't disclosed.

Katyusha Rockets

Andrews agreed to stay at TTI for at least three years. ``There's nothing in writing, except a handshake and a gentleman's agreement that I'm going to be here to do what I said I was going to do,'' he says.

One reason Andrews says he sold to Buffett was he had no desire to see his company loaded with debt by a private equity firm or gutted by a cost-cutting rival. Iscar's Wertheimer, 56, had the same notion. ``We are very proud of what we've built,'' he says. ``We want it to continue.''

In buying an Israeli company, Buffett took on the kind of geopolitical risk he's accustomed to as an insurer. Within days after the deal closed in July 2006, fighting broke out between Israel and the Shiite Hezbollah group that dominates southern Lebanon.

Wertheimer called Buffett to tell him that Katyusha rockets were slamming into the sun-baked hills around his plants and there was a chance his machinery would be damaged and that his employees would lose workdays.

20-Year Perspective

``I'm not interested in what happens next quarter,'' Wertheimer says Buffett told him. ``I'm interested in the next 20 years.'' Some of Wertheimer's staff did move south while the rockets were falling. Iscar didn't miss a shipment.

Wertheimer says that in the eight months and three face-to- face visits leading up to the Iscar deal, he and the Omaha investor had wide-ranging discussions about everything from philanthropy to ``how to look on life,'' in Wertheimer's words. At one point, Buffett sent him a biography of the Jewish-American educator Abraham Flexner, who helped found the Institute for Advanced Study in Princeton, New Jersey. Both Buffett and Wertheimer have a longstanding interest in education.

``I love talking to him,'' Wertheimer says. ``For me, he's a teacher.''

Wertheimer took over as CEO of Iscar in 1984, when his father, Stef, now 81, who founded the company after fleeing Nazi Germany, was injured in a car accident.

Jews, Arabs and Druse

He transformed it from a local exporter of metal-cutting tools into an international enterprise with 7,500 employees, plants from Barcelona to Bangkok and more than $1 billion in 2007 sales. In 1995, he turned over the CEO position to his colleague, Jacob Harpaz, 57.

``I was just getting in Jacob's way, so I fired myself,'' says Wertheimer, who remains chairman.

On a rainy day in March, Wertheimer leads a tour through some of the 20 buildings that comprise the company's hillside campus. The company's Israeli workers are a combination of Jews, Arabs and Druse, many of whom Wertheimer greets by name.

Iscar's tools are used by makers of cars, appliances and other durable goods to cut metal to exacting specifications. The inserts, as they're called, sell for anywhere from a few dollars to more than $100 each. Teams of Iscar designers are at work every day looking for ways to make them cut faster and more efficiently.

Sharper Tools

One customer is Bolton, Ontario-based Husky Injection Molding Systems Ltd. In April, manufacturing engineer Noel Pinto was looking for a way to improve the milling of the steel plates Husky makes at its Milton, Vermont plant. They are used in plastic bottle manufacturing, among other processes. Iscar's Thomas Raun devised a new tooling process, improving the speed of the operation by 40 percent.

``They find ways to implement new technology,'' says Pinto.

Wertheimer says he's very comfortable linking up with Buffett. ``Warren has a message to the world,'' he says. ``It's balance.'' He points with his index finger to his head, to his heart and finally to his wallet. ``And he does it in a fair, clean and nice way,'' he says.

One of the companies Buffett owns is expected to yield a new Berkshire top executive if the Omaha investor passes from the scene anytime soon. Buffett updates shareholders regularly on the subject of succession and did again at the annual meeting in May. Berkshire's board, he said, has identified three candidates with the qualifications to succeed him as CEO, and one has been selected.

`Nobody Replaces Warren'

Analysts, including Citigroup's Shanker, say based on their ages and accomplishments, the most likely candidates are NetJets' Santulli, 63; MidAmerican's Sokol, 51; Berkshire Re head Ajit Jain, 56; and Geico CEO Tony Nicely, 65.

Four money managers have also been selected as candidates to replace Buffett in his role as chief investor. The board and new CEO will decide which of those candidates he will work with.

These plans could change if Buffett remains in place for an extended period, and men like Santulli and Nicely are seen as too old to don his mantle. The new CEO could end up being the head of a Berkshire company that has yet to be acquired.

Sokol doesn't let the issue trouble him. ``There is more than adequate talent to keep the Berkshire Hathaway way of doing things going forward,'' he says. ``But nobody replaces Warren Buffett.''

Buffett treats the issue of his mortality with characteristic wisecracking humor. One Saturday morning several months ago, CTB's Mancinelli says he called Buffett, as he occasionally does. Buffett asked to call him back, saying he had an appointment with his barber.

``The way I figure it, I have just so many haircuts left in my life,'' Buffett said. ``I don't want to miss any of them.''

-- Editors: Michael Serrill, Frederic Wiegold. With reporting by Josh P. Hamilton in New York.

To contact the reporter on this story: Richard Teitelbaum in New York at rteitelbaum1@bloomberg.net.

Bernanke's Inflation Cure Wanes as Import Costs Rise

June 23 (Bloomberg) -- What's good news for U.S. businesses may turn out to be bad news for Federal Reserve Chairman Ben S. Bernanke's fight against inflation.

The surging oil prices that are raising exporters' costs to ship everything from steel to sofas to America are encouraging customers to buy more domestically made goods -- and giving the producers of those goods more room to raise their prices.

The result: As Bernanke and fellow policy makers meet in Washington this week, they may find themselves starting to lose the benefit of the flow of inexpensive imports the chairman cited in a June 3 speech as a key force holding down living costs.

``It's changing global costs,'' says Jeffrey Rubin, chief economist at CIBC World Markets in Toronto. ``It's a huge inflationary threat.''

If competition from abroad wanes, Fed policy makers may in the future have to rely more on higher interest rates and less on trade to contain inflation. Traders in the federal funds futures market are betting the Fed will keep rates unchanged this week, then raise them in August or September to keep price pressures in check.

For importers, the rising cost of shipping is ``like an increase in tariffs,'' says San Francisco Fed economist Reuven Glick.

Just as duties on imported goods give domestic industries cover to raise their own prices, higher shipping costs have the same inflationary effect, Rubin says. He reckons that transport costs are currently the equivalent of slapping a tariff of more than 9 percent on imports into the U.S.

Made in America

Fuel costs have made it so expensive to ship low-priced bookshelves to the U.S. that Ikea is starting to make them in America. Asian steel exporters, saddled with higher freight rates, are losing U.S. market share, allowing domestic producers to boost their prices.

According to Rubin, who's written several reports on the subject, the expense of shipping a standard 40-foot container from East Asia to the East Coast of the U.S. has nearly tripled since 2000. Freight costs would almost double again, he says, if oil prices head toward $200 per barrel from about $137 today.

Air-freight costs are rising too, up almost 16 percent in the last year for cargo going to the U.S., according to the Bureau of Labor Statistics.

Imports are already getting more expensive. The cost of foreign goods excluding petroleum climbed at an annual rate of 6.6 percent in May, the fastest increase since 1988, the BLS says.

Iron and Steel

Iron and steel import prices were up 46.4 percent in May from a year earlier, government figures show. That allowed U.S. producers to increase their prices 32.6 percent in the same period without having to worry about losing market share.

U.S. steel production has risen nearly 3 percent this year as imports have declined 12 percent, according to the American Iron and Steel Institute in Washington.

``Higher freight rates were the final straw in tipping the balance to domestic producers,'' coming, as they did, on top of a weaker dollar, says John Anton, director of steel service at Lexington, Massachusetts-based Global Insight Inc.

`` A weak dollar means that domestic producers are better sheltered from competition by foreign suppliers,'' Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said in a June 18 interview on Bloomberg Radio. ``So the domestic producers here in the United States will have every incentive, therefore, to take advantage of that greater protection from competition by raising their markups.''

Chinese Firms' Disadvantage

Chinese steelmakers are doubly disadvantaged by higher oil prices. Not only do they face the added cost of shipping products to the U.S., they also must pay more to transport iron ore to their mills from Brazil and Australia.

Baosteel Group Corp., China's biggest steelmaker, agreed today to pay Rio Tinto Group at least 80 percent more for contracted iron ore this year. The Australian miner had been demanding a premium for its material because it costs China less to ship it than it does iron ore from Rio Tinto competitor, Cia. Vale do Rio Doce of Brazil.

Vale, the world's largest exporter of iron ore, said in February it won an increase of between 65 percent and 71 percent for annual contracts.

Pittsburgh-based U.S. Steel Corp. in contrast, is able to meet the majority of its iron-ore needs in North America from its two mines in Minnesota, company spokesman John Armstrong says.

Allen Sinai, chief economist at Decision Economics in New York, says many companies will have to reassess their shipping and sourcing strategies if fuel prices stay up. The result may be higher business costs and inflation, he adds.

Redoing the Sums

Furniture companies are among those redoing the sums. Prices for imported furniture and related products rose 6.3 percent in May compared with the year-ago month. That's the biggest increase since at least 1993, the earliest year such BLS statistics are available.

Rising freight costs were a major reason why Ikea, the world's largest home-furnishings retailer, decided in late 2006 to build its first factory in the U.S. The 930,000 square-foot plant, which opened last month in Danville, Virginia, will produce a variety of products Ikea had been importing from Europe, including bookshelves, coffee tables and entertainment systems.

``Transporting some products can cost as much as manufacturing them,'' says Joseph Roth, a U.S.-based spokesman for the Swedish company.

Other retailers and consumer companies may follow Ikea's lead and start to source more goods locally. San Francisco-based jeans maker Levi Strauss & Co. is among those forging partnerships with domestic producers to reduce shipping expenses, ease environmental concerns and improve quality, according to a survey released by PricewaterhouseCoopers on June 11.

No `Screeching Halt'

``I wouldn't expect global trade to come to a screeching halt, but higher fuel prices will have an impact,'' says David Hummels, a professor at Purdue University in West Lafayette, Indiana, who has done research on trade and transport costs.

He says the most-affected goods are those shipped by air -- where fuel accounts for a bigger share of freight rates than with ocean transport -- as well as cargo such as steel or cheap furniture with high weight relative to its value, and merchandise produced through complex global supply chains.

Any of these factors could provide U.S. businesses with an opportunity to boost prices in the coming months.

``The rise in transport costs will relieve some pressure on domestic firms to compete with foreign companies,'' says Menzie David Chinn, a professor at the University of Wisconsin at Madison, who worked at the White House Council of Economic Advisers in 2000 and 2001. ``There will be less restraint on inflation.''

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net.

Ten Signs Yang Made The Right Move

Burlingame, Calif. -

Jerry Yang has a lot to prove. Turning down Microsoft's $33 a share bid and jumping in bed with Google means that he's betting the future of his company--and his career--that doing a deal with his Silicon Valley "frenemy" will pay off.

Jittery investors, of course, will be looking for Yang's deal with Google (nasdaq: GOOG - news - people )--to run ads supplied by the Internet giant that will be placed alongside Yahoo! (nasdaq: YHOO - news - people ) search results--to generate a ton of money.

Here are 10 signs that the Yahoo! co-founder and chief executive's gamble is panning out--or not.

1. Stock Soars

Before Microsoft (nasdaq: MSFT - news - people ) launched its initial $31 per share offer for Yahoo! on Jan. 31, the Web portal's stock had been in freefall since late October, dropping from $33.63 to $19.18. The software giant's bid gave it an immediate boost to $28.38--but it has yet to top Microsoft's last offer of $33 a share. In the next six months, Yahoo's stock needs to show a lot of upward direction. The goal: getting above that $33 water mark.

2. Yahoo! Piles Up $2.47 Billion In New Revenues

Yahoo! needs to make like Whole Foods (nasdaq: WFMI - news - people ) and start showing us the organic green stuff. It's called sales growth, and for Yahoo! to succeed it will have to show that, excluding the effect of any acquisitions, it can do this. The magic number: $2.47 billion. That's how much Microsoft's online services business made for the fiscal year ended June 2007. Asking Yahoo! to hit that number isn't fair. It means Yahoo! would have to boost its annual run rate by roughly a third. Then again, that's the kind of sales growth Google posts, and proving Yahoo! can keep up with Google--and add new online business comparable to that of the company that tried to acquire it--would silence it critics.

3. Deal Makes Yahoo! Faster And Tougher

With Microsoft breathing down its throat for months, Yahoo! started picking up the pace and launched many more products and services than usual in recent months. Now, it will surely benefit from Google's killer instincts and crafty strategies. Google Chief Eric Schmidt is said to have mentored Yang on the Microsoft deal. Now Yang and Schmidt can be open about their talks. Riiiight.

4. Monetizes Its 500 Million Visitors--Finally

Yahoo! has been sitting on an unexploited goldmine for far too long. The company's combined sites get the most traffic of any portal around the world, yet Yahoo! earns so little from it. But it can't look to Google for help on this one: the Internet giant is so far a one-trick pony, making all its money from search advertising. Yang really should ask Microsoft chief and salesman extraordinaire Steve Ballmer for guidance here, but that would be a tad awkward now.

5. Becomes A Magnet For Techies Again

Remember when Yahoo! was the "it girl" of the tech world a decade ago? Everyone and their mother wanted to work there. Great holiday parties and pricey Christmas gifts, such as MP3 players, for every employee. If revenues soar and the stock jumps appreciably, the world's best engineers will be knocking on its doors again.

6. Yang Buys A Zeppelin

People need leaders they can believe in, and Silicon Valley's greatest do their best to acquire symbols of excess. Nvidia (nasdaq: NVDA - news - people ) Chief Executive Jen Hsen Huang parks his hand-built Swedish road rocket in the company parking lot between his employees' Honda Accords and Toyota Camrys. Google's Sergey Brin and Larry Page ride in a 767 emblazoned with the company logo. Apple (nasdaq: AAPL - news - people ) Chief Executive Steve Jobs cares for 413 cats. If Yang is to succeed, he'll need to show he's the new big tabby in town. Our suggestion: a gigantic gray and purple zeppelin. Hey, Hangar One at nearby Moffett Field is just a short drive from Yahoo's Sunnyvale headquarters. And yes, we lied about the cats.

7. Yahoo! Buys Facebook

Would such a deal be safe? Is it even sane? Hell no! But the ability to make a crazy, game-changing move, such as buying Facebook, would seal Yang's status as one of the greatest CEOs of all time. In contrast, passing up on the opportunity to buy Google, and then losing DoubleClick to Google are two of the reason's Yang's predecessor, Terry Semel, has been nominated for a spot in the Chief Executive Hall of Lame. A bold deal shows that Yang isn't afraid of losing Yahoo's independence, rather, he's eager to use it.

8. Larry Ellison Comes To Yang For Advice

Oracle (nasdaq: ORCL - news - people ) Chief Executive Larry Ellison is the Sith Master of Silicon Valley: cool, calculating and quite stylish. Yang, by contrast, seems to be the very opposite. But what if it's all a trick? What if getting the 218-pound monkey who runs Microsoft known as Steve Ballmer off his back was just the first phase in some kind of darkly brilliant master plan? If so, Ellison will sniff it out, first, and pay his respects.

9. Steve Ballmer Loses His Job

The Yahoo-Microsoft negotiation was a mess. Someone's head needs to roll, and if you are Jerry Yang, you're first in line for a little of the old high-level chop-chop. However, if Yahoo! starts to perform (see items 1 and 2), then it will prove that, despite all his bluster, Ballmer didn't have the nerve to pay what Yahoo! was worth, after all. One way or another, this story won't end until we have a loser.

10. Poach Someone, Anyone , From Google

All we need is one, Jerry, just one. It doesn't have to be a star, such as Google Vice President of Search Product and User Experience Marissa Meyer. Convince one promising Google employee to step away from the all-you-can-eat-buffet at the Googleplex and maybe we'll start to believe in you, too.

After the Slowdown

As winter turned to spring the price of a U.S. recession on the Irish betting Web site, Intrade, had gotten as high as 75. By mid-May the price was less than 28. Mere months ago such sages as George Soros and Alan Greenspan were shouting from yacht decks that the 2008 global financial mess was the worst since World War II. The debate was whether the U.S. economy would stop at a recession or tip into a 1930s-style depression.

Very few economists and pundits challenged the recession presumption. Now, if your definition of a recession is the traditional standard—two consecutive quarters of negative growth— rest assured, this isn’t going to happen. There’s no possibility now that the U.S. will suffer two consecutive quarters of negative growth in 2008, as there’s too much liquidity sloshing around. Also expect America’s small businesses to go on a second-half buying spree to take advantage of accelerated tax depreciation.

If you prefer the National Bureau of Economic Research’s fuzzy-math recession definition of a “significant decline in economic activity,” then the jury’s still out. It’s possible that on some day in August the NBER will say the U.S. entered a recession in December 2007 and emerged from it in March 2008. Whatever the definition, the recession dog at most whimpered. It never barked.

The questions now are twofold: What will be the strength of the recovery? Have stocks begun a two-year bull run, or is the recent pop a bear trap? The best guesses are:

--A decent recovery with 2%-to-2.5% growth will occur in the second half of 2008 through 2009. I’m skeptical there will be a 3%-plus recovery, because the Fed’s going to have to start sucking up liquidity soon to avoid the risk of more inflation.

A so-called W recession (thusly named because of its second slump) depends on how much further house prices sink. Another 15% drop could trigger the W. But I don’t think this will happen. As Cyril Moulle-Berteaux of hedge fund Traxis Partners recently wrote in the Wall Street Journal, “[Since 2005] house prices have fallen 10% to 15%, while incomes have kept growing (albeit more slowly recently) and mortgage rates have come down 70 basis points.… Homes on average are back to being as affordable as during the best of times in the 1990s.”

--Yes, U.S. stocks have begun a two-year bull run that could give us 20%-to-30% further gains over this period. The ride will be bumpy.

Valuations are somewhere between cheap and fair. Stocks are ridiculously cheap compared with long-term Treasury rates. Stocks are still decently priced even if you think earnings are headed down—which could well be the case.

From 1980 to 2007 the aftertax profit margins of U.S. stocks averaged 8.6%. More recently profit margins have averaged more than 11%. Either American companies have jumped onto a higher earnings plateau—New Economy, anyone?—or earnings will revert to the mean. Probably the latter: Higher earnings will be competed away and revert to the mean. Then today’s 15 P/Es will go to 20 P/Es in a heartbeat. A P/E of 20 is not so cheap. But it’s not rich, either, as long as Treasury yields stay below 5%.

Born-Again Value Investor

Last month I was reminded of one of my more spectacularly boneheaded investments. The painful memory intruded as my wife and I were driving to San Francisco on a lovely afternoon to shop at a Room & Board furniture store. On the way, we drove past a building on which there was the logo for a company called MobShop.

Ah, MobShop. Pain flooded my brain. I was an early private investor in MobShop, one of those late-1990s dot-coms. MobShop's core idea had some merit to it: Mobs of people, connected by the Internet, carry more clout in buying power as groups than as individuals. What if 10,000 buyers shopping for a Toyota (nyse: TM - news - people ) Camry got together and negotiated a fleet price? The idea was intriguing and seemed possible.

I wrote a FORBES column in 1998 about this idea, demand aggregation. Soon enough an entrepreneur e-mailed me and said he was doing exactly what I'd written about. I visited the founder, liked what I saw and heard, and then wrote a $50,000 check for MobShop's Series A stock. But I didn't stop with that; I helped the founder raise another $5 million from Netscape cofounder Marc Andreessen and the Mayfield Fund, a top-drawer venture capital firm.

Alas, MobShop didn't work out, and the founder switched careers to selling surfboards. I lost all my money. Bigger investors lost bigger pots. Of some small consolation was the fact that Microsoft (nasdaq: MSFT - news - people )'s cofounder, Paul Allen, lost money pursuing the same idea of demand aggregation. His company was called Mercata; it lost even more money than MobShop did.

This is why I'm a born-again value investor. When my bets are wrong, I want to have that margin of safety Benjamin Graham often wrote about.

Speaking of value investing, the new Benjamin Graham is Vitaliy N. Katsenelson. I highly recommend Katsenelson's book, Active Value Investing: Making Money in Range-Bound Markets (Wiley, 2007). I like to think the old Ben Graham would have recommended it, too

Soros Explains The Credit Crisis

The New Paradigm for Financial Markets: The Credit Crisis of 2008 And What It Means by George Soros ($23, Public Affairs, 2008).

With his near real-time critique of the credit crisis, George Soros has saved financial historians a lot of work. If he's right, the summer of 2007 and all of 2008 will be the topic of many an academic paper, much like how Ben Bernanke made a career out of studying the Great Depression. Soros sees this as a monumental time. It's not just a bursting housing bubble, he says. It's the end of a quarter-century of credit-driven economic expansion. We're in a whole new world.

Up until August 2007, Soros had mostly farmed out management of his hedge fund to outsiders so that he could devote his time to philanthropy, philosophy and politics. The first troubles in subprime spurred Soros back into the markets. This time his goal wasn't so much to find the next billion-dollar trade but to preserve the wealth of his foundations.

This market has been so tough that it's vexed even Soros. His book offers a broad trading diary from January 2008 through the end of March, when The New Paradigm went to the printer. Soros' investment plan was to "short U.S. and European stocks, U.S. 10-year government bonds and the U.S. dollar; long Chinese, Indian and Gulf States stocks and non-U.S. currencies."

On March 10, he noted that commodities were stronger than he thought they'd be, that the Federal Reserve acted more aggressively than he'd anticipated and that the Indian and Chinese stock markets, not quite decoupled from the U.S. economy, took major hits. On March 16, he observed that "The panic is palpable," and bought into ailing Bear Stearns (nyse: BSC - news - people ), expecting some return on a Federal Reserve brokered auction of the company. He got burned admitting that, "We forgot to take into account that Bear is disliked by the establishment, and the Fed would use the occasion to deal with a moral hazard by punishing shareholders."

For those who might be confused by Soros' analysis there, Bill Miller, manager of the Legg Mason Value Trust explains: "Bear had been very aggressive in seizing the capital of Askin Capital in 1994 and precipitating its failure. In 1998 it opted out of rescuing Long Term Capital Management. That's the kind of thing where, if you're Merrill, Citigroup or the Fed, you remember." Miller also bought shares in Bear, for the same reasons Soros did.

The trading diary ends with Soros losing money. While he wishes he could have reached a more triumphant ending, he notes that the result "may be more appropriate for the purposes of the book."

Indeed, it is. While Soros is investing actively again, he's really using the market as a laboratory where he can test his philosophical ideas, especially the notion of reflexivity--that no market participant can ever have perfect knowledge because their beliefs, and the beliefs of others, effect and distort the markets. Because investors tend to herd--they buy things that are going up and sell things that are going down--markets are constantly beset by bubbles. Irrationality reigns supreme.

Soros was once a student of the philosopher Karl Popper, who spent most of his time studying science. Popper came to the conclusion that all scientific statements must be falsifiable and that no scientific theory is ever absolutely true. They are just able to withstand people's attempts to prove them wrong. So long as a theory isn't falsified, it's as good as true. But we're 100% certain about nothing.

The turmoils we see in the markets reflect the turmoils of human thought. The implications of this go far beyond investing. It means that market fundamentalism, the idea that markets are always self-correcting and don't need regulation, is just wrong. Markets are flawed because they reflect human delusions of certainty. Banks make money by issuing loans. If they want to make more money, they need to issue more loans. Absent regulation to stop them, the banks will issue new loans in new ways. They rationalize the risk away by building models based on past experience. The risk models say that the loans are safe. The flaw? All of these new loans fuel an unprecedented housing bubble that the risk models, which are backward looking, can't account for. All of these new loans also create new levels of debt, also unprecedented in history. So the risk models, once again, miss them.

It's time, says Soros, to bring back some of the regulations that were put in place after the Great Depression and then eroded in the decades that followed. Leverage and credit creation, he says, need to be reigned in. Regulators need to start looking to control asset bubbles as they manage the economy for the more usual goals of full employment and price stability.

Soros sees a new economy, indeed a new world order emerging. If the U.S. leaves its fate to the whims of flawed markets, it will lose much of its worldwide influence. Without the dollar as the reserve currency of first choice, the U.S. really has nothing but military supremacy in order to defend its position in the world, and even that, says Soros, has been undermined by the debacle in Iraq.

Soros' message for citizens, investors, politicians and regulators is to approach this new economy and new political order with humility. Be flexible and never dogmatic. Strive to find truth while realizing it's unattainable. It's false certainty that trips us up, in both investing and life.

Soros Says Record Oil Prices Result of `Bubble'

June 3 (Bloomberg) -- Billionaire investor George Soros said the record oil prices weighing on the economy are the result of a ``bubble'' caused by speculation from index funds and a tight balance between supply and demand.

``The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality,'' Soros said in testimony before the Senate Committee on Commerce, Science and Transportation. ``The rise in oil prices aggravates the prospects for a recession.''

The committee is holding hearings on potential energy price manipulation. Congressional leaders are pushing the Commodity Futures Trading Commission and other agencies to step up efforts at overseeing the markets for fuels such as gasoline as retail prices are forcing consumers to drive less. The hearings come as oil has retreated from a record $135.09 a barrel on May 22.

The average nationwide pump price for regular gasoline rose to a record $3.978 a gallon yesterday, AAA said. The price was above $4 in 12 states and the District of Columbia.

Gasoline demand in America fell 4.7 percent last week, which included Memorial Day weekend, from a year earlier, according to MasterCard Inc.'s SpendingPulse report. Sales have declined in 16 of the past 19 reports.

Soros laid some of the blame on recent oil price rises on commodity index funds, which only buy oil contracts, helping to push prices higher.

Not `Legitimate'

``Commodity indexes are not a legitimate asset class,'' he said. He added that raising margin requirements would not affect index trading but could function to limit speculation.

Soros attracted renewed controversy with his 10th book warning that an exploding ``superbubble'' threatens the global financial system, the New York Times reported on April 11. The book bases its conclusions on the idea that individual inclinations and actions generate market fluctuations, rather than the conventional view that markets move toward some kind of equilibrium, the newspaper said.

The current oil market price ``is a textbook illustration of my theory'' on bubbles, Soros said in an interview after his testimony today. ``The buying is based on a misconception'' as well as a fundamental driver of higher prices, he said.

Soros said he does not consider himself an expert in oil markets and is not investing in them now. ``I stay away from the oil market because it is a very tricky market.'' He added ``I don't find it an attractive market.''

Failing Americans

The Senate committee also heard testimony from a consumer advocate who said U.S. regulators are failing Americans by not properly regulating energy markets.

Minnesota Senator Amy Klobuchar said the U.S. spends $600,000 per minute on foreign oil. ``I want to follow the money and figure out how American consumers are getting ripped off,'' she said. ``We need a cop on the beat. We also need a prosecutor on the beat.''

Mark Cooper, director of research for the Consumer Federation of America, said the current commissioners of the CFTC and Federal Energy Regulatory Commission are to blame for allowing energy prices to rise to records.

``Just fire the commissioners and clean the problem up,'' Cooper told the committee. He compared the federal regulators' reaction to recent price spikes to ``the regulatory equivalent of the FEMA's response to Hurricane Katrina,'' referring to the Federal Emergency Management Agency.

``Americans are suffering needlessly due to the financial bubble'' in energy prices, he said.

Soros disagreed with Cooper's analysis that $40 of the current oil price is related to the cost to get it out of the ground, $40 is added by the ``OPEC cartel,'' and $40 is due to speculators in the market.

`Underlying Factors'

``I think that is an exaggeration,'' Soros said. ``There are serious underlying factors for the rise of oil.''

Soros said too much regulation of oil markets could drive trading into unregulated areas such as the over-the-counter market.

Oil has gained 91 percent in a year. The CFTC said last week it's been investigating the transportation, storage and trading of U.S. crude since December. The commission took the unusual step of announcing an on-going investigation due to ``unprecedented market conditions,'' it said May 29.

The agency said today that it will tighten rules for investors and index funds, including increased disclosure about holdings in agricultural markets, after farmers and lawmakers alleged speculators had inflated food prices. It also said it's investigating possible manipulation of the cotton market.

Incomplete Data

Senator Jeff Bingaman, chairman of the Senate Energy and Natural Resources Committee, said last week that acting CFTC Chairman Walter Lukken may have used incomplete data in discounting speculators' impact on soaring oil prices.

Speculators are not driving oil prices higher, according to energy exchange executives.

``We don't see that from our data, but I think it's important the CFTC assure everyone about what's driving prices,'' Nymex Chief Executive James Newsome said in a May 30 interview. ``Our data indicate the prices are moving by fundamentals.''

Intercontinental Exchange's Chief Executive Officer Jeff Sprecher agreed. ``In fact, it looks like the amount of speculators in energy markets has been decreasing as a percentage. What's been increasing is hedgers,'' he said in an interview the same day.

Commercial Users

``We've seen this rapid influx of commercial users,'' Sprecher said. ``That's why we want to get data in the hands of regulators so they can provide assurance it's not speculators'' causing prices to rise.

A U.S. probe into whether speculators manipulated oil prices up to more than $135 a barrel is a ``waste of time,'' billionaire hedge-fund manager Boone Pickens said yesterday.

``What you're trying to do is trying to find a scapegoat and place blame for it when what you have is demand that is greater than supply,'' Pickens said in an interview. ``We're using 400,000 barrels of oil less today than we did a year ago, but the Chinese are now using 500,000 barrels greater than they did last year.''

Pickens himself was criticized for his comments on the investigation.

``To say that investigation and, by implication, regulation, are useless is an indication that what he wants is a Wild West, not an orderly market that has some reaction to supply and demand,'' Judy Dugan, research director of Consumer Watchdog, a nonprofit based in Santa Monica, California, said in a telephone interview.

Airline Industry

Record oil prices are hurting industries such as airlines. Higher fuel prices may push some carriers into bankruptcy by next year, Soleil Securities Corp. said in a note to clients on May 21.

AMR Corp., parent of American Airlines, and UAL Corp., owner of United Airlines, are more likely to be forced into Chapter 11 in 2009 if fuel prices don't fall to ``sustained lower levels,'' analyst James M. Higgins said in the report.

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net.

Bernanke Says Rate `Well Positioned,' Watching Dollar

June 3 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke signaled he's done cutting interest rates for now and raised his biggest concerns yet about the inflationary effects of the dollar's 16 percent drop in the past year against the euro.

The Fed is working with the Treasury to ``carefully monitor developments in foreign exchange markets'' and is aware of the effect of the dollar's decline on inflation and price expectations, Bernanke said today in his first speech on the economic outlook in two months. In addition, interest rates are ``well positioned'' to promote growth and stable prices, he said.

Bernanke's comments are a shift from past remarks by Fed officials that have highlighted both the spur to exports from a cheaper dollar and the pressure it puts on import prices. The dollar climbed after the speech indicated exchange rates will be a consideration in setting rates.

``I can't recall such a strong defense of the dollar from a Fed chairman,'' said Sophia Drossos, a currency strategist at Morgan Stanley in New York who used to work at the New York Fed, where she helped manage the central bank's foreign-exchange holdings. ``The Fed is putting its marker down in letting the market know that a weaker dollar would be detrimental.''

Investors anticipate the central bank will keep its benchmark rate at 2 percent this month after 3.25 percentage points of cuts since September, futures prices show.

ECB's Trichet

Bernanke, 54, spoke via satellite to the International Monetary Conference in Barcelona, Spain. European Central Bank President Jean-Claude Trichet also spoke at the event, where he reiterated that ``monetary policy stays firmly focused on delivering price stability.''

``For now, policy seems well positioned to promote moderate growth and price stability over time,'' Bernanke said. ``We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate.''

The remarks come as the central bank's optimism that inflation is abating and growth will start to pick up has been dashed by the unexpected surge in oil prices, which is eroding the potential benefit to the economy from more than $100 billion in federal tax rebates. The resulting increase in inflation expectations is also getting the attention of Fed officials.

The dollar strengthened to $1.5450 per euro from $1.5537 earlier today. Gold dropped 1.3 percent to $879.69 an ounce. Crude oil fell 2.8 percent to $124.15 a barrel.

Fed `Attentive'

``We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations,'' Bernanke said. The Fed's commitment to price stability and maximum employment ``will be key factors ensuring that the dollar remains a strong and stable currency.''

During the dollar's decline over the past six years, some Fed officials have said foreign demand for U.S. assets may fade. Bernanke's predecessor, Alan Greenspan, told a European audience on Nov. 19, 2004, that ``given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point.''

Bernanke and other Fed officials, when asked for their opinion on the dollar, tend to defer to the U.S. Treasury Department, which is responsible for currency policy. The Fed chief meets weekly with Treasury Secretary Henry Paulson, who yesterday repeated his backing for a ``strong dollar.''

``I believe the long-term economic fundamentals will be reflected in our currency,'' Paulson said in Abu Dhabi.

`Financial Stability'

David McCormick, Treasury's undersecretary for international affairs, said in a Bloomberg Television interview today that Bernanke's and Paulson's remarks this week ``are consistent in that they are advocating policies that will strengthen the U.S. economy and ultimately ensure ongoing financial stability within the global markets.''

Asked about the dollar at a congressional hearing Feb. 27, Bernanke at the time noted that its decline ``does increase U.S. competitiveness.'' He also noted its impact on inflation.

Robert Eisenbeis, former head of research at the Atlanta Fed, said the comments indicate ``more rate cuts would hurt the dollar and that would have negative feedback effects to our inflation situation.''

``I don't read it as saying that intervention is on the horizon,'' said Eisenbeis, who is now chief monetary economist at Cumberland Advisors Inc. U.S. officials haven't intervened in foreign-exchange markets to buy or sell the dollar since President George W. Bush took office in January 2001.

`Significant Headwinds'

Today, Bernanke said financial-market conditions ``remain strained,'' and consumers face ``significant headwinds'' from declining home prices, a weaker labor market, stricter lending standards and higher energy costs.

The U.S. economy grew at an annualized 0.9 percent pace in the first quarter, capping the weakest six-month performance in five years, government figures showed last week.

The second quarter is ``likely to be relatively weak,'' Bernanke said, leaving out his mention in an April speech of a possible contraction. The second half may have ``somewhat better economic conditions,'' and growth may pick up further in 2009, he said.

``Until the housing market, and particularly house prices, shows clearer signs of stabilization, growth risks will remain to the downside,'' Bernanke said. ``Recent increases in oil prices pose additional downside risks to growth.''

Supply and Demand

Bernanke, in a question-and-answer period, said soaring oil costs are more the result of supply and demand than the weaker dollar. ``The effect of the dollar on commodity prices is relatively modest,'' he said. Supply and demand conditions are ``by far the strongest and most important factor.''

Crude oil has climbed 93 percent in the past year. Gasoline prices have also hit a record, impairing spending by consumers who are already buffeted by a slump in home values.

``The possibility that commodity prices will continue to rise is an important risk to the inflation forecast,'' Bernanke said. Higher public inflation expectations are also a ``significant upside risk'' to prices and may ``ultimately become self-confirming,'' he said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net