Greath Wealth -Investment Information & Services

What Happens if the U.S. Government Goes Broke?

What happens to investors if the U.S. government goes broke? With the condition of Greece, Spain, Portugal, Italy, Great Britain and yes, the U.S., this is a question any prudent investor must ask. No, I don’t have a crystal ball, but we can look at the broad picture and analyze the situation.

Unfortunately, if you’re crazy enough to loan the U.S. government money; i.e., to purchase U.S. government bonds at this point, you’re out of luck. If the government goes broke, they’ll default on their bonds and you’ll be paid less than a dollar on the dollar.

What’s perhaps more likely is that the U.S. government will inflate its way out of debt by simply printing more money and thus devaluing everyone’s cash. This will, in all likelihood, create rampant inflation, thus devaluing all bonds and creating the same effect as the U.S. government defaulting on their debt. The only difference is that they take all bonds down with them in this case.

But what about stock investors? Fortunately, even if the U.S. government goes broke, I believe people will continue to drink Coke, go to McDonald’s, purchase gas, buy Proctor & Gamble toothpaste, wear out their tires and do most of the “normal” things they do in their daily lives. Hence, corporations will continue to retain monetary value.

Yes, I believe that inflation will hurt the stock market and yes, I believe there will be riots in the streets if the U.S. government goes broke. However, I also believe that people around the world (remember that most of our companies are global) will continue to go about their daily lives as best they can.

Ultimately, the U.S. will go the way of the Roman Empire. We don’t know when or how fast, but one constant in world history is that nations rise and fall. But I believe that mankind, and thus the global economy, will continue to march forward. We don’t sail around the world in wood ships anymore. And likewise, with or without the U.S. government, I believe the global economy will continue to march forward.

What do you think?

Thanks,

Rod

An Interesting Fact

By any conventional measure, bonds are a lower risk investment than equities (stocks), particularly government bonds.  However, although I continue to design portfolios using bonds as an instrument to dampen volatility, I continue to wonder, “are government bonds really safer than stocks”?

You may remember a post a while back about a recommendation to a client to make an investment in the S&P 100 not long after the market bottomed out and began to rise.  Although the move was particularly well timed and the money had come from bonds that had been called, I’m not about to say I saw the rapid rise in stocks coming.  Yes, it has been a rapid rise, as I just read, a day or two ago, that the last six months have represented one of the six strongest six month periods for stocks in the history of the market.

What was I thinking when I made the S&P 100 recommendation?  First and foremost was the discipline of sticking to rebalancing a portfolio.  One needs to pay attention to the basics.  It doesn’t mean you have to follow them 100 percent, but like blocking and tackling, you have to pay attention to the basics.

The second thing that was running through my mind was the rising risk of loaning money to the U.S. government, which, traditionally, is a big part of nearly any bond portfolio.

Yes, everyone in the world who can understand a standard news source knows about the rising U.S. government debt.  But today, in a Washington Times article by Richard Rahn, a senior fellow at the Cato Institute and the Chairman of the Institute for Global Economic Growth, I read the following super-interesting fact:

“The U.S. entitlement programs (Social Security, Medicare, Medicaid, etc.)…will take more than 100 percent of all federal tax revenue this year, requiring that virtually all of the other government programs, including defense and interest payments on the debt, be funded by more borrowing.”

That’s staggering, truly staggering.  Would you consider a loan to such an entity to be a low-risk investment?

I can explain and lecture on bell curves and standard deviations all day long, but everyone, including myself, has to be concerned about loaning money to such an entity, no matter what the historical profile looks like.

What to do? I’m glad, really, really glad, that none of my clients have an excessively large exposure to U.S. government bonds.  Yes, many, especially my older clients, have a significant bond position, but they’re all in highly diversified bond positions.

Also, ironically, stocks may be lower risk than loans to the U.S. government.  Will they be completely immune from U.S. government and currency issues?  No.  But even if the U.S. government can’t meet debt payments or inflates its way down the road by simply printing more dollars, millions of people around the world will continue to drink Coke, fill their cars with ExxonMobil gasoline and use a computer powered by Windows (although I’m an Apple guy).  Capitalism will march onward.

What about gold?  It’s still just an inanimate commodity.

What else to do? If you’re depending much on an entitlement program, you may wish to give your dependency some serious thought.  Do I really think the U.S. would eliminate or seriously scale back its entitlement programs?  In all honesty, none of our politicians on either side of the isle have the political backbone to take on the issue.  However, time and again over the centuries, markets and balance sheets have proven to be stronger than political will or desire.  Ironically, the 60s generation that wanted peace and sex with everyone may run begging to the churches they have despised all their lives for handouts of basic life sustaining elements like bread and water.

Do I think the day of reckoning will happen within the next one to three years, as Mr. Rahn does?  You probably know by now that I’m not about to make a specific time dependent prediction like Mr. Rahn.

However, I do think it’s safe to say that it’s highly risky to loan money to an entity going the direction of the U.S. government or to depend on such an entity for an “entitled” payment.  Thus, informed investors may want to consider making their decisions accordingly.

Have a super day.

Thanks,

Rod

Risk and the Weather

Recently, while meeting with a married couple who are prospective new clients, I asked them a question I always ask prospective new clients:  ”How would you define risk?”  Her first answer was driving on the freeway, which is a very good answer, which was followed up by another answer, which is the weather.  What’s even better about the answers is that she had no background or experience with investments.

Weather.  That’s good.  People are always talking about the unpredictability, or uncertainty, of the weather.  That’s how I hope investors think.  Risk is uncertainty, and we can quantify uncertainty.  Yes, not wanting to disappoint anyone, we did briefly discuss bell curves and standard deviation.  Risk = uncertainty = standard deviation.  No, it’s not a perfect analogy, but it’s the best industry and academics have found.

Living in Houston, I also liked the “driving on the freeway” description of risk.  Driving on a Houston freeway, especially during rush hour, is an uncertain experience.  It’s uncertain from both a safety standpoint and from a time required standpoint.

Although I often refer to Nobel Prize level tools and tactics, I do like to keep things, especially investment concepts, simple.  We’re all more likely to remember and understand simple explanations.  Besides, simple solutions usually work the best.  That’s what we want:  things that work the best.

Stay tuned.

Thanks,

Rod

What is Money?

What exactly is money?  Is it paper?  Is it coins?  Is it something you can exchange for a certain amount of gold?  What exactly is it?  We talk about and use money constantly, but have you ever stopped to ask yourrself:  ”What exactly is money?”

I remember grappling with this question in a class when I was a graduate student at Duke many, many years ago.  But I got a better angle on it, as you might guess, when I went to a round-the-fireplace discussion with J.B. Fuqua, the businessman who donated $14 million in the mid-1980s to Duke’s graduate school of business and thus had his name placed on it.

J.B. grew up on a Virginia tobacco farm and didn’t have any formal education beyond 7th or 8th grade.  However, he developed a kind spot in his heart for Duke University when the school loaned him books through the mail.  And boy, did it ever pay off for Duke.  But on to J.B. and the question about money.

One of the things I remember J.B. asking us in front of the fireplace if we had read The Wealth of Nations and going on to say that he read the book every five years.  Almost immediately, I went to the bookstore and purchased my copy of The Wealth of Nations and began reading it.

As you might imagine, it’s dry and confusing.  What exactly is it?  Adam Smith’s The Wealth of Nations is to capitalism what Lenin’s Capital is to communism.  Basically, from what I remember, The Wealth of Nations is Adam Smith’s observations about what he was seeing in the British economy in the 18th century.  In short, it’s sometimes referred to as the foundation of modern economics.

Of the things I remember from the book, one thing stands out:  Money is a representation of labor. A true Adam Smith scholar would likely grill me for the inexactness of this, but to me it makes a lot of sense.

$100 will buy you a certain amount of a gardener’s time, another amount of a physicians time and still another amount of third world labor time.  Money is labor.

But what about manufacturing?  When you boil it down, manufacturing is really a service, too.  That $100 buys you a given amount of factory time to transform raw materials, which came to the factory via someone’s…..labor.  Yes, even gold comes from someone’s labor at digging up enough dirt in a given location to extract a certain amount of gold.

What do you think of all this?  Does it make any sense?  I look forward to hearing your thoughts.

Thanks,

Rod

Today is a Good Day for Capitalism

Because of what’s happening in Chicago, today is a good day for capitalism.  What’s happening in Chicago today?  Based on what I’ve seen in the media, all Chicago city workers, with the exception of the police, firemen and paramedics, are having to take a day off without pay.  Why?  The city is out of money.

Am I wishing bad things on Chicago city workers or anarchy in the Windy City?  No, absolutely not.  I had a college roommate from Chicago and I love the city.  However, every person and every organization must learn to live within their means.  Unfortunately, Chicago’s leadership didn’t learn to live within its means, so the city, which put them in power, is paying the price.

What will happen now?  My guess is that days like today (and there’s another two or three furlough days scheduled for 2009) will force the city’s leadership to start realizing they have limited means.

They can keep raising taxes, but it won’t likely raise any revenue as people and businesses will just move away.  Hence, they, or someone who ultimately rises to power in Chicago, will ultimately learn that hard decisions have to be made.  Money ultimately represents labor (more on this tomorrow) and they have to learn that they have a limited amount of labor.

It would be interesting to visit Chicago today to see if everyone in the city is taking the day off and going hungry.  My guess is that everyone but the government employees is going about finding a way to do business as usual, without the thousands of bureaucrats.  Maybe, just maybe, someone in Chicago will ask:  ”Do we really need all these city employees?”

A couple of decades ago corporate America went through a gut wrenching “reengineering” period as corporations learned they couldn’t have 20 layers of management where 5 layers would do.  Yes, it was painful for everyone involved, but corporations, shareholders and ultimately consumers benefitted.

Corporations had to look around and ask:  ”What are our customers really willing to pay for?”  At some point, the many layers of government will have to do the same.  It’s unfortunate the government entities didn’t learn by watching; however, it’s near certain that they’ll have to learn at some point.

Capitalism thrives on efficiency improvements, which ultimately raises everyone’s standard of living.  Now it’s time for the government entities to step up to the efficiency plate.  And as they do, ever so slowly, you can bet that consumers, and ultimately the economy, will benefit.  Yes, today will go down as a good day for capitalism.

Kids, Money and TV

I’m a finance and engineering guy, not a child psychologist.  Also, I like to blog about investing, and I realize that’s what you expect to read about from me.  Nevertheless, the above three topics converged at the Schulz home earlier this summer.  And because we found something that has worked very well with our situation, I thought I’d diverge from my usual blog and share our situation and solution with you.

Our children, two girls ages 5 and 7, would watch TV 12 hours a day if we let them. No, we don’t let them do that, but it’s a draw that we were constantly fighting and I didn’t like the amount of time they were spending in front of the TV. Do you ever deal with this situation?

Then, after returning from a week at family camp in June I had a major clash with my 7 year old about watching TV instead of doing what I had asked (helping unload the SUV).  As a result, I banned both children from the TV for a week, both as punishment and to give me time to think about the situation.

While I thought about the situation I considered four things:

1) Modifying our approach to TV management
2) Banning the TV for the summer
3) Banning the TV period, except for family DVDs
4) Dropping our TV satellite subscription

Pam strongly disliked 2-4, as she uses the TV to sometimes keep their attention while fixing dinner or doing other household chores. If it were up to me, I would have pursued option number 4. I don’t like the TV and I really don’t like writing a check to the satellite company every month. No, we’re not going broke, but I have no value for 99% of what’s on TV.

In addition to thinking about it personally, I consulted several of the elder members of our church for their thoughts on the situation. What did we come up with, and more importantly, how well has it worked? Bottom line: it’s worked beautifully, better than both Pam and I would have expected. It’s very simple, cheap and everyone is happy.  Yes, I realize that the same thing doesn’t work for everyone and every situation, but since this has worked so well and since it concerns money, I thought I’d share it with you.

What did we do? We told our girls that if they made their beds and picked up their room by 10:00 a.m. in the morning we’d pay them 50 cents. Additionally, they could earn 50 cents, and possibly a bit more, every day of the summer by applying themselves at the daily learning time. For example, Megan, our 7 year old, generally gets a penny for every math problem she does.

However, if they want to watch TV, they pay me 50 cents for a half hour program, with a limit of two programs a day.  Wow, did it ever create the behavior we wanted.

Almost every day now they’re quick in the morning for me to inspect their room.  (Yes, although we have a four bedroom house, we’re making them share a room at this point in their lives to encourage sharing and getting along skills.)  After the inspection I pay them each 50 cents, assuming they’ve done their job.

Then, later in the day, when they want to watch TV, they get me or Pam and dutifully pay us 50 cents for a half hour slot.  And since they know they’re limited to two 30 minute slots a day, they’re careful about how and when they spend their limited resources.  Hence, they’re also learning about limited resources and sacrifices.

Of course, I was hoping they’d forego TV and keep their ~$1 a day.  I’ve got the 7 year old to think about this and the number of dollars she could save in a month makes her head spin.  However, she can’t yet resist the daily temptation to watch her two programs.  But she occasionally gives serious thought to the saving idea.

It has also been neat to see how truthful they are about the 30 minutes and not trying to bend or argue with the rules.  We’re far from perfect parents, but Pam has done a yeoman’s work here.

As we move through parenthood I’m finding that parenting is like investing in equities:  two steps forward and one step back, while also being fun, rewarding and work.  Hence, I just thought I’d share this with you since it does concern the topic of  money.

What do you think of our situation and solution?  I’m interested to hear what you think.  I’m also interested to hear your thoughts about this occasional divergence from the normal investing topic.

Thank you for your comments, and please have a super weekend!

Rod