Thursday, July 24, 2008

The Investment Zoo: Chapter 3: The Perils of Debt and Over Consumption

The author starts this chapter by claiming that the major problem in the world is excessive consumption and debt. He suggests that governments have not exercised enough restraint when it comes to spending and that this is a global phenomenom. The problem with overspending is that it leads to overcapacity which in turn leads to deflation. One of the problems with deflation is that it causes more debt since lower prices increase the weight of debts as things get cheaper. A country's problems are no longer just domestic issues as the world banking system is becoming increasingly interlinked.

Jarislowsky feels that worldwide debt is so high that a major increase in the money supply is inevitable. Increasing the money supply would have the effect of higher inflation and increased inflation would lessen the burden of debt (contrary to deflation). He is not optimistic about standards of living being maintained into the future which are largely fueled today from debt or from redeemed capital holdings.

Excessive taxation is a problem in many countries. Since taxation reduces the savings rate, there is less money remaining for savers to reinvest into the economy. Since investments precedes jobs, increased taxation lowers employment rates. He is strongly against high taxes on investment income since it reduces capital allocated to investment, thereby reducing employment and leading to a waste of human capital. He blames the politicians for killing jobs and the economy and that we are letting it happen.

The high taxation in Canada is a contributing factor to having many of our brightest minds leaving for lower taxed countries. So Canada uses tax dollars employed through our education system to train young people, only to see many of them become tax payers in other countries.

Since Jarislowsky feels we are headed for higher inflation in Canada he poses the question what should we do for financial protection? He thinks people should live within their means and not overconsume. Additionally he feels that it will be much better to invest wisely in stocks than hold monetary assets. The reason is that historically real assets have always outperformed monetary assets.

He makes reference to real assets that have increased tremendously in value such as a can of coke that used to cost 5 cents when he was a boy that now costs around $2. Paintings that he purchased for $300 are years later now worth $100,000. His house that he paid $20,000 for in Montreal is now probably worth around $500,000. He states that monetary assets would not have kept up with the price increases of these real assets.

He claims that stocks over any 25 year period for the last century, stocks have outperformed bonds. This makes sense to him since because without the incentive of extra earnings, who would start a business if you could make more with a government bond?

Jarislowsky believes that a diversified portfolio of stocks is the answer to protect yourself against purchasing power loss in the future. He also suggests that with investing its the downside you need to be cognizant of because the risks are what you need to protected against. Stick with investing in good quality stocks and you will be better off regardless of the world situation.

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