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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: porcupine --''''> who wrote (350)	5/22/1998 3:24:00 AM
From: porcupine --''''>	Respond to of 1722

Wayne on Budget Surplus, Trade Deficit, and Real Interest Rates From: WCrimi <WCrimi@aol.com> Date: Fri, 22 May 1998 01:50:49 EDT To: gadr@nyct.net Subject: Comments on GADR >1. Now that the Federal budget is in balance (at least >according to GAFF: Generally Accepted Fudge Factors), there is >more, not less, room for cutting taxes. Considering that the government is likely to run a surplus due to more receipts than they thought or GDP growth suggests (according to them, I have no idea and don't care because it is not relevant to how I invest) there must be incredible capital gains receipts. I have seen various estimates about this, even from Greespan. This is another bubble like phenomenon. Higher stock prices cause higher tax receipts, cause surpluses, cause lower interest rates and greater liquidity, cause higher stock prices etc..... Another virtuous circle. If these stock prices prove to be significantly overpriced as most value investors believe, it becomes a vicious circle and is a bubble like condition. >2. Real interest rates (stated rate minus inflation) remain >very high by historical standards. There remains plenty of room >for them to fall further. Real rates are not much higher than they have been since we started running trade deficits in the 80's. I have read a few studies that indicate that real rates are always higher for debtor nations with a current account deficit like the U.S. than for the opposite. That is the penalty for low savings and loose money over the long term. You get trade deficits and higher real rates. Real rates may fall some, but probably not as much as the longer term historical record would indicate. At the very least, its no sure bet. >6. Foreign willingness to cover the U.S. trade deficit by >buying Treasury Bonds is primarily based, in our view, upon 2 >factors: a) If they don't, the dollar will lose value, and they >lose their trade surplus; and b) the U.S. economy has >fundamentals that make it appear that the debt can be repaid >with money that has real buying power, instead of with >inflation. You still misunderstand the "real" issue here. What you say is true of course. But the issue is that the U.S. economy and its inflation rate have both benefited significantly as a result. Foreign purchases actually keep the inflation rate lower by keeping the dollar strong. We need to save less and can consume more because they are providing the savings. So part 'b' is not completely accurate. WE ONLY LOOK GOOD IF THEY THEY KEEP BUYING. NOT WE LOOK GOOD SO THEY KEEP BUYING. Otherwise inflation would be higher, rates would be higher and we would have to save more. All of which would impact the economy and profits negatively. Even this is not the key issue. It makes sense for them to keep buying for right now. I agree with you. They need to sell us stuff. We need their savings. It is another virtuous circle. Unfortunately, it is not sustainable over the long haul in its present form. That's the issue. The rate of accumulation over the last few years was far greater than the growth rate of nominal GDP. So compound interest payments + the new accumulations via the continued deficit means that eventually the current account deficit will blow us out due to ever rising interest costs. This may be a bit down the road, but we were on the fast track during 95, 96, and most of 97. So from a long term perspective, it is a bad situation causing good results that are not sustainable. If one values businesses the way I do, it becomes something to consider. I am trying to estimate the normalized level of inflation and profitability in order to estimate the proper discount rate and terminal income stream to use. So It is a long term factor without being a current one. I realize your method is more short term anticipation oriented, but most value investors are making longer term estimates. Hence, I view the present snapshot as better than the average future snapshot and believe that stocks aren't as valuable as present interest rates and profits indicate. As least as it relates to this issue. How much ... I don't really know. But the present situation will end in either disaster (unlikely but possible) or in us getting our act together and saving more and tightening money (likely). The benefit of a temporary and illusionary free lunch will then disappear at least to some degree.