THE VIRTUS VIEW

Good afternoon to all.

This communication is intended to add value to your life by helping you separate the real news from the white noise, understand the critical economic events that you read about every day and outlining  alternative investments which might be advantageous to you in these times.  We send this weekly e-mail to both clients as well as individuals we hope become future clients.  Thus, to my valued clients, since we use many alternative investments in your portfolio currently, some of the e-mails might discuss assets that you already understand.  It never hurts to review your knowledge of those investments.

Please feel free to forward these e-mails to any friends you have who you believe will benefit from learning more about finances and investments.

I am a football fan and I watch my fair share of games.  I get amused sometimes when it feels like I have a certain team’s playbook right in front of me and I can tell which play is going to be called next.

Well, we have the government’s playbook right in front of us and we know what is coming next.  Over the past month, many of you have asked me what I thought of our leadership’s bail out plans.  Let me assure you, they are not trying anything new.  The efforts of our President, his staff, Congress, and the Fed are straight out of John Maynard Keynes playbook.  Keynes was the controversial but highly successful economist who many credit for getting the U.S.A. out of the great depression.

Since the depression of the 1930s there have been many economic crises across the world.  Asia, Australia, Germany, Russia, Mexico, etc. who have all faced major recessions after the 1930s that almost crippled their respective economies.  Many used Keynes tenets to help them recover from these major economic crises.  One only has to look at the Japan economy in the 1990s to see Keynes philosophies at work.

Japan, stuck in a deep and painful recession throughout the 1990s, tried many different solutions to spur their economy.  Like the situation we find ourselves in right now, interest rates were already at historical lows.  The first play out of the playbook in a recession is to lower rates, however, what do you do if rates are already low?  In the early 1990s Japan tried many different strategies to jump start their economy.  Those strategies didn’t work.  In the mid 1990s they incorporated some of Keynes economic policies.  Keynes’ philosophy was that if the private sector will not spend their way out of a recession (to get full employment), the public sector must.

In the mid 1990s, Japan did just that.  They passed a public works bill that spent billions on improving highways, school systems, etc. and it actually worked for a couple years.  For 2 years after the bill was passed, Japan witnessed growth and the economy was improving, albeit very slowly.  However, Japan had an additional problem that compounded the crises, aging demographics.  After a couple years they slid back into their slump, only to stay there for another 7 years.  

I know people are concerned with the deficit, but please understand, doing nothing is a much worse scenario.  We have two major issues; liquidity crises and an employment/spending crises.  We could survive the housing crises if we were just looking at a housing crisis.  Even though the housing crisis started the liquidity issues, it isn’t even our biggest issue at this time.

Regarding the deficit, there is no doubt it will be a problem; however, the deficit must be looked at as a percent of GDP (Gross Domestic Product or what our nation is worth), not as a stand alone number.  As of September 2008, our deficit, as a % of GDP, was lower than the early 1990s.  We are currently running a deficit of around 70% of GDP.  We should expect that to reach around 100% due to the current spending, which for comparables, was about where we were right after WW II.  The point that must be understood is our deficit is going much higher either way.  If we spend our way out of this, the deficit goes up due to expenses.  If we do nothing, the deficit goes up due to a lack of revenues (taxes).  I know what some of you are thinking; just cut spending also.  However, a cut in public spending means additional layoffs.  It is a sand trap that quickly leads nowhere.

Interesting enough, Japan’s crisis started with banking issues just like our current mess (as a side note, most of our world’s economic problems started with banking issues, more specifically moral hazard).  Just like Japan in the 1990s, Thailand in the late 1990s and the U.S. in the 1930s, we have a liquidity crisis.  We must get banks lending again.  Not necessarily at the care free days of just a couple years ago, but to normal credit standards.   Thus, our leadership has to throw all available funds to stabilize the banking system and get liquidity flowing again.  Then the government has to stop the ever increasing unemployment rate.   Not only must the public sector spend our way out of this crisis, the private sector must start spending again.  With unemployment going the wrong direction and doing it very quickly, spending will not improve until unemployment slows.  Spending on public works does create jobs. (A real fear should be what if we have a complete shift in spending habits of consumers like after the great depression).

I know we want quick fixes.  But there isn’t a quick fix.  It will take time to work our way out of these problems, and as I said above, we must spend our way out of this crisis.

Bottom line, we have seen by past crises that doing nothing leads to depressions.  Spending is a policy that has worked to jump start countries in crises like the one we find ourselves in today.  Will our current policies work?  Only time will tell.   For all of our sakes, we all should hope (pray) that Keynes is correct once again.

The next play in the playbook: inflation.  The Fed will target an inflation percentage going forward, and we need to be sure our investment strategy is ready for it.  The government wants inflation going forward.

Finally, the term moral hazard (used mostly in the insurance business) is the root of most all economic evils.  It has caused most of the major economic problems seen world wide over the last century.  It is at the core of the problems we are facing today.  If you have an interest in discussion this further, please give me a call.  As you know I have a passion for discussions regarding economics.

Best Regards,


Brian Tillotson
Wealth Manager
 
Virtus Wealth Management
2435 E. Southlake Blvd
Suite 120
Southlake, TX 76092
817-717-3812
866-407-4320
Fax: 817-416-6585
www.virtuswealth.com

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