Easy Money

CINCINNATI BUSINESS COURIER
January 21-27, 1991
How to profit by not losing your perspective

Investments
By Charles D Vaughan

EASY   MONEY  music to any ear. At least it should be. But right now nobody is too sure what to make of it. The Federal Reserve is ever so carefully casing back on interest rates attempting to engineer a “soft landing” for the economy. The business press is beginning to suspect that it may land softly in the quicksand. The same writers who formerly were afraid to use the word “recession” are now tentatively trying out the word “depression.”

While greed may be moderately contagious, fear is prone to instant epidemic. There is great profit in keeping your perspective when others lose theirs. Here is an oversimplified analysis that may help you avoid losing money through mistaken overreactions to the news:

Theory: The goal in managing a national economy is to keep it growing at a consistent moderate rate that will not cause inflation. That means, of course, avoid any downturn or recession. There are two major forces that can be used to keep an economy within acceptable bounds: fiscal and monetary.

Fiscal measures include the management of government finances through taxation and spending policies. When the economy is soggy, the government coin reduce taxes to stimulate business and can increase spending. This could create a deficit, but would be justified as good for the economy. The only other justification for deficit spending is the financing of a war. During prosperous times, taxes should be increased and government spending reduced. This would tend to slow the economy and reduce inflationary forces.

Monetary measures are controlled by the Federal Reserve. By using a series of sophisticated techniques, the Fed can make money more or less available through the banking system. This in turn tends to cause interest rates to rise or fall. Lower rates stimulate and higher rates slow the economy.
When used in combination, fiscal and monetary measures have tremendous potential to manage the economy.
Fact: We will never know if the theory works. Both fiscal weapons, tax policy and government spending, are determined by politicians, not economists. The golden road to reelection is to never raise taxes and to never cut spending in one’s own district. Therefore, tax policy has only been used to stimulate the economy, not to restrain it. Spending likewise has been unidirectional.

The result has been that the less directly political Federal Reserve has been expected to manage the economy alone. Most commentators tend to give the Fed more credit than is deserved for maintaining the longest prosperity in history. A casual glance at the growing federal deficit will show that it was actually bought by using more credit than needed.

The federal government policy of overspending set the tone for the whole economy. The well publicized problems of the real estate, savings and loan and banking industries are a direct result of that approach.

Implications: As the 1980s were the wild party, the 1990s will be the hang over. Guilty consciences, blame passing, headaches and queasy stomachs may be the order of the day. But do not be tricked into believing that it will be fatal.

There is little doubt that we will see a recession (it’s probably already here). It is extremely doubtful that we will see a depression. Bad economies produce good managers. The fittest will survive and prosper. The weak and undercapitalized may not. Longterm opportunities for investors will be myriad.

Interest rates will come down. However, many borrowers may find themselves in the same predicament as the lady in the butcher shop. She complained to the butcher that his pork chops were 50 cents higher than the shop across the street. When he asked why she didn’t buy across the street, she told him that they were sold out. Even as rates fall, lenders are likely to be more selective. Money may be cheaper but unavailable.

Falling rates for mortgages and bonds should provide capital gains opportunities for fixed income investors. But holders of quality high coupon bonds can expect to have them called away. Those who have been happily parked in money market mutual funds are already seeing their yields drop sharply. Certificates of deposit buyers are likely to see the double whammy from lower rates and higher bank costs for FDIC insurance. Insurance policy and annuity investors will suffer from lower renewal rates because of tax increases on insurers.

Stock market and real estate investors who concentrate on quality operations with proven managers should do well in the long run. As always, a wellplanned, balanced and diversified approach should provide the best return and the most acceptable risk level. That’s the easiest money most of us will ever see.

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