November 1996
Vol 20 No 3
The dictionary defines money as: ‘anything that serves as a common medium of exchange, a store of value, or as a means for the payment of debts or services rendered’. Try to imagine a world in which money had not been invented. How would trade or businesses be able to operate? What would be the common measure of value and method of accounting between people with different needs? Without money, we’d be back in the dark ages bartering for survival.
Before there was money, mankind existed in nomadic tribes as primitive hunters and gatherers subsisting on what could be caught, killed, grown or found; with a lifespan of less than 30 years. That too would be our fate without a universally accepted medium of exchange. A system of commerce based upon barter without a common measure of value couldn’t exist on the global scale we need. Nor credit. Nor charity. Nor trade or business. Nor any practical way to accumulate and to preserve wealth. Without money, commerce would be too cumbersome.
Bills of Sale, Deeds, Assignments of Contracts would have to take the place of checks. Savings would have to take the form of products held in warehouses. It would be physically impossible to store up capital and to protect it from theft and deterioration. There would be no great financial centers. How could a commodity market operate when all contracts had to be delivered? How effectively would stock and bond markets operate when they had to transfer actual possession of goods and services? How could capital be amassed? How could international trade take place? It couldn’t. Money exists simply because society depends upon it.
Less than 1% of what we call civilization would exist without money. Political and cultural institutions would have never progressed beyond those of barbarian tribes. The strongest would rule, taking what they wanted and sharing it with henchmen. The weakest, recognizing the futility of effort, would stop trying to prosper. Labor would be performed by slaves. There would have been no writings. No education. No medicine. No science. No trade. No exploration. No America.
From its earliest days, what set American apart was the concept of economic opportunity, individual property rights and capitalism. Despite what you may have heard, most of the exploration and colonization of North America was done for profit. Early corporations and Trusts raised money from speculators in the quest for riches from the new world. Investors’ quest for riches financed the industrial revolution, the railroads, and the opening of the Western frontier.
Some people think that gold could serve as money, but where would sufficient quantities of it come from? All the gold that has ever been mined in the world would easily fit into two double garages. When the economy consumes over a trillion dollars in this country alone, who could afford even minute amounts of gold to use as money? How would people be able to transact business with profits measured in milligrams? If gold were the only means by which business and trade could be conducted, commerce – and our form of government – couldn’t exist as we know it. There’s a direct link between the invention of money and of politics.
It’s a chicken and egg situation. Without tax money there would have been no political system. Without a political system, there could be no uniform rule of law or legal system to secure contracts and profits – or savings. Without savings, there would be no banks or credit! Money and credit are the foundations of capital. Capital gives birth to economic opportunity, jobs, profits – and the tax base. Taxes pay for the political system that creates and guarantees money. And freedom.
INVESTMENT IS A CAPITAL IDEA . . .
In the old days, a trader could accept money as payment in lieu of trade goods, fully expecting it to hold its value until it could be used to buy other goods and services. That’s no longer true. For over 30 years, credit card balances, reflecting electronically stored credits and debits held by private banks, have been replacing traditional money backed by the government. Today we can pay our bills by using a laptop computer and a cellular modem to instruct a central computer to issue unsigned checks which will be honored by banks. We can hold international assets deep in the memories of computers in the form of cyber-cash.
The definition of money is undergoing a dramatic mutation that promises to radically change our political institutions and investments. Rather than being a ‘store’ of value, money is becoming a ‘measure’ of value. As governments conspire to ‘fix prices’ of their currencies, they risk losing control over their own monetary systems. Internationally, currencies are being computer-traded around the clock. Government guarantees are a decreasing, and currency markets an increasing, factor in determining the value of a country’s money.
The changing character of money is probably a bigger threat to a political system than war. How does a government collect taxes when debits and credits are adjusted electronically? Or seize the assets of a company when they are held in cyber space? As government counterfeits its currency to fund pork barrel projects and to buy votes, the value of its currency adjusts automatically, instantaneously, internationally. You can see this by watching CNBC anytime a U.S. Treasury debt auction is taking place, or when the FED changes interest rates. We might say that money needs to be redefined as an instantaneous measurement of value of any transaction. In that context, it’s become a medium of information as much as of exchange. The public is learning to deal with government’s currency manipulation.
All over the world, securities markets are exploding as tens of millions of people, more than at any time in history, are trading in their government-backed currencies for stocks, bonds, REITs, and mutual funds. Money’s principal value lies in measuring the relative values of these instruments in the various worldwide securities market than as a store of value per se. Without using values of money set by the international currency markets to compare prices, how would anyone compare the value of shares of Toyota or Telemex to shares of Exxon or Nestle?
The ebb and flow of capital into and out of global bond and currency markets influence would politics today as never before. In the future, nations may come to resemble large voluntary national associations. They will compete against other similar national associations for ‘members’ and capital with an array of benefits which can be purchased with their particular currency. Investors may elect not to join a particular country’s ‘association’ and currency block, holding their assets elsewhere. We can see this happening in the breakup of Czechoslovakia.
The turmoil in Russia today illustrates what happens when citizens lose confidence in a political system. Despite the so called political reforms that have taken place, it is an economic basket case today because of the lack of investment. In contrast, China’s economy, in spite of its repressive government, is growing by leaps and bounds. In India, the world’s largest democracy, millions of people would die of starvation each year if left to government alone. Capitalism is taking over.
Investors today have to preserve and maintain purchasing power. We also must find a way to create a margin of safety in what could be a rapidly changing world. Start by thinking of invested dollars as unpaid servants who go to work each day, then bring their wages home to you each night. It’s up to you to help you dollar-servants work as efficiently as possible every day; ensuring that they return to you with their wages, denominated in the most valuable currency. We’re all going to have to learn to invest in new ways we may have never tried before, and in products with which we aren’t very familiar. This isn’t going to be easy.
THERE’S SAFETY IN NUMBERS . . .
Constantly changing tax laws, government regulations; political, social and economic policies that shift with the wind are going to make investment a lot more challenging. Despite what some soothsayers proclaim, nobody can truly see the future. Just look back 20 short years to the Carter Administration. In 1976, housing was in a slump. New home buyers were given a 5% tax credit. The Dow was around $1000. Bonds were yielding 8%. Things didn’t remain that way long.
Within a few years, in many markets, housing prices were exploding as much as 2%-3% per month. Mortgage rates were soaring past 17%. The DOW was nearing 700 as gold topped $850 an ounce. Fortunes were made and lost again and again. Hardly any of the so-called experts foresaw the economic gyrations that occurred. Nor did they foresee the USA go from being the largest creditor nation to being the largest debtor nation within a 5 year period. The future just wasn’t what it used to be.
Maybe a historical peek into the past would be useful. Suppose over the past 20 years, after establishing a reasonable cash reserve held in 91-day Treasury Bills, you had divided $100,000 into 5 equal investments to hold for retirement. These would include (1) Two 80% leveraged $50,000 rental houses, (2) Two $10,000 seasoned mortgages yielding 12%, (3) $20,000 in a 500 S&P stock index fund, (4) 4 free and clear mobile homes, and (5) $20,000 invested in an International Stock Fund. Let’s see what would have happened to you over 20 years, financially.
(1) Since 1976, two houses costing $100,000 wholesale would have just about tripled in retail value to around $300,000. Moreover, they’d almost be free and clear today. For most of that time they’d have produced a positive after-tax income.
(2) Despite Carter’s inflation, if you continued to hold them, your mortgages would have produced a solid pre-tax income stream of over $200 per month for 240 months. Today, they would be just about paid off with little residual value.
(3) Despite the crash of 1987 and 1990, and three wars, the 500 S&P stock index fund would have increased by 900% or so to about $180,000 without any thought or effort on your part at all, and with little long term risk.
(4) Your mobile homes might now be ready for the scrap heap, but, over the past 20 years they could have been producing as much as $1000 per month for 20 years in net income with which to supplement your income and lifestyle.
(5) International stock funds would have enjoyed a terrific run over the past 20 years. Turkey, Japan, Brazil, Argentina, Mexico, Chile, Indonesia, Spain, India, Malaysia, Taiwan, Korea, Peru, the Philippines, Portugal have made millionaires of those who stuck it out. You could have realized as much as $300,000 if your $20,000 had been spread over the right markets. Fortunes were made by investments denominated in Swiss Francs as American money lost half of its global purchasing power in the intervening years. We’ll hedge next time.
The rental dwellings did just fine, but would have required a lot of work. Thus, they were less of an investment and more of a business. The stocks did well too, maintaining liquidity without much effort or risk. All those tempting forays into the precious metal markets, tax-shelters, limited partnerships, etc. had their flurries, but didn’t make their investors much money over the years.
Fundamental changes in markets can be unsettling. When all those about you are losing their heads, diversifying your investments seems the only sane alternative. It’s not as exciting, but much safer, to try to ride both ends of the economic seesaw, and also have a firm grasp on the center as well. No matter which investments go down, others will be going up, and some won’t be moving at all. This way, you’ll more or less be insuring a reasonable future income at the risk of missing explosive opportunities. You won’t eat better, but you’ll sleep better.
WHERE DO WE GO FROM HERE?
Ideally, an investment portfolio should be like a Range Rover; a little pricey, but comfortable, flexible, able to cruise all day long at super highway speeds, but also capable of negotiating twisting, rough trails over any kind of terrain, domestic or foreign, with ease. In this Presidential election year, Clinton might lose his job, so might a lot of those eager freshman Republican Congressmen. The Senate could once more become ruled by the Democrats. Either party could wind up with total control over the country.
Bear in mind, this will be happening against the backdrop of the continuing war in Bosnia, instability in Saudi Arabia, militancy in Iraq, Israel, Korea and China, political unrest in South Africa, and a labor party’s resumption of power in Britain. In the ebb and flow of international politics and economics, your investment portfolio could be in for a bumpy ride. The need for an all-terrain investment vehicle with an experienced driver is going to become more acute.
In the turbulent economic times ahead, speculators who have the skills to jump in and out of the market will have a field day. Slower moving investors with diversified portfolios consisting of a variety of investments may be able to wait out events and still emerge in good shape. Cash will continue to be king. With long term real estate holdings, the road is going to be a little rocky. You can count on local property taxes to increase as the feds pass on the costs of programs to the States. And the EPA will continue to loom as a threat to property values.
The new Lead Paint laws are going to probably depress prices on pre-1978 residential properties and increase demand for those built after 1978. EPA threats are going to make holding raw land more risky, and use restrictions are going to increase the costs of new construction. That means, existing, post 1978 residential values should rise, possibly even in the absence of general price inflation.
Fixer-uppers, landlords and private mortgage lenders should continue to do well as their markets expand. Sooner or later, the stock market is going to reverse course. This will probably be triggered by inflation and higher interest rates when it happens, but not necessarily in that order. The overseas markets are going to start catching up with ours, and the dollar will start sliding again if our deficit spending continues unabated. Here’s how you might deal with all this:
Continue the process of selling off older properties to pay off debt. Use tax-deferred exchanging to upgrade your house portfolio whenever possible. Hold liquid cash in money market mutual funds as well as international stock and bond index funds. You might hold a few gold mutual fund shares, but don’t expect much to happen to them anytime soon. If they go up, so will your house equities. If you’re going to buy mortgage notes, make sure that they are secured by something you wouldn’t mind investing in. You could wind up owning it!
Landlords! Focus on selecting quality tenants who have the ability to support their families. I have waning confidence in government’s ability to continue to subsidize rents. You don’t want to face the turmoil that awaits landlords if those subsidy checks ever fail to come in. If you can’t find solvent tenants in today’s economy, it may be time to sell and get out while you can. If you’ve got the capital and know-how, you might begin building a few smaller new houses or start rehabilitating existing houses for all cash sales to the public when financing is available. Until we can see who wins the election, sitting on the sideline isn’t all that bad place to wait and watch for the time being.
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