CINCINNATI BUSINESS COURIER
September 17-23, 1990
Investments
By Charles D. Vaughan
Shifting the decade of debt to the decade of reckoning
WANTED: ALCHEMIST.
Job Description: By use of the philosopher’s stone or other devices not known to the unenlightened, transmute mountains of uncollectible debt obligations into their original gold state.
Our economy has been more than amply endowed with modern day chemists. many whose faces have appeared on a myriad of magazine covers, who have magically transformed money into waste matter. Now our wounded economy cries out for yet another sorcerer who can reverse the process. Some things never change.
For thousands of years learned young men sought to create wealth by transmuting common matter into gold. They, of course. had little success. But many of them lived quite well by soliciting subscriptions in their ventures. Their contemporary counterparts found a practical substitute for the philosopher’s stone OPM. Throughout the decade of the 1980s the acknowledged secret of success was Other People’s Money, otherwise known as leverage.
The use of debt which carried a social stigma in the 1940s and 1950s became quite the fashion in the 1980s. Easy profit in financial markets created an aura of invincibility. The federal government began to use deficit financing not to right a war or overcome recession, but to avoid making hard spending decisions. State and local governments likewise lost their sense of fiscal direction. Not to be outdone. consumers went on an unprecedented spending spree via universal credit cards and home equity credit lines.
The business of making money in financial markets shifted from compounded results of the tried and true to get rich quick. Monthly performance became the standard of measurement. Corporate management became a numbers game. The easy road to riches was to take over a stodgy old company (using Other People’s Money) and turn it into a money machine. The formula was simple. Replace all the stupid people who had run it for years with brilliant MBAs who could “manage anything.” Raid the pension funds, fire the “expendable” employees and run a tight ship. Aggressive lenders were only too glad to work with those who had a “track record.”
Now the term leveraged buyout and its offspring the junk bond leave the same nasty taste in our mouths as Third World Debt, Oil Patch Loan and Savings and Loan Crisis. In retrospect the 1980s may become known as the Decade of Debt. If so, the 1990s may become the Day of Reckoning.
Historically the consequences of overextending an economy have taken two forms. In hard currency economics precious metals acted as ballast. The lack of available currency caused a contraction known as a recession or depression. Since the dollar lost its last vestige of gold backing in the 1970s this is not applicable. In other economies the pattern was to merely print more currency to accommodate the expansion of trade. Since there was more currency chasing finite amounts of goods, prices rose. This is known as inflation. In instances where governments have attempted to borrow their way out of debt, the result has been a rapid rise known as hyperinflation. There are more countries in the world undergoing a hyperinflation right now than at any other time in history.
It is becoming increasingly unlikely that our economy can persist on its present course. We need to make a tough decision soon. Are we willing to reduce federal spending and accept an economic slowdown? Or are we willing to risk a rampant inflation by continuing to spend while we are monetizing the banking system’s bad debts? Postponing the decision means choosing the latter.
This doesn’t necessarily mean gloom and doom. but it does suggest change. The individual investor needs to take steps to prepare for changes. More than anything else the 1990s are likely to be a time for “back to basics” investing. Risk aversion is apt to be more important than reward. Safety will no longer be a whimsy word. Short term performance will cease to become the focal point. Long term strategy will require more attention to multiple “whatif” scenarios. Diversification and asset allocation will become more important.
Uncertainty frequently creates opportunities. Those who position themselves for change can see tremendous results in the long run. But it takes courage to forsake the short term. It seems appropriate now to position along three lines. First, avoid leveraged ventures that could be vulnerable to a weak economy. Two, allocate a reasonable percentage (15 percent to 25 percent) of portfolio assets to solid investments that provide direct inflation hedge. Three, diversify broadly among asset classes in both domestic and international investments.
With excessive debt there are two possible solutions. Pay it off or repudiate it. On the off chance that our national leaders won’t be able to find another magic answer, let’s be prepared for either.