TREES INVESTMENT COUNSEL VIEWPOINT (Q2 2005)

 A slightly different explanation, Mr. Greenspan

Everyone seems in agreement that there is lots of money around the world, despite generally modest increases in the rate of growth of the world's supply of money.

Historically, inflation has been the result of too much money, as consumers exercised their seemingly inexhaustible demand for more goods.  Not this time.  Why?

          1.  A large percentage of the world's consumers have all the "stuff" they need.

          2.  New "stuff" can be had at low prices as the third world industrializes.

The supply of money, or savings comes from three sources.

          1.  The developed world is aging with low population growth and high earnings, and excess flow is 

               saved for the future.

          2.  The third world has high savings due to rapid growth.

          3.  Borrowing throughout the world is increasing faster than real growth, partly due to low

               interest rates, thus increasing leverage around the world.

As many have pointed out, if the excess savings doesn't go toward goods, it will be invested in assets.  The stock market bubble and the real estate bubble represent manifestations of this phenomenon.

The natural outcome of an excess of investment funds seeking a return is a reduction in the rate of return in the aggregate that will be achieved by investors.  More leverage is used to try to maintain overall rates of return, thus increasing the riskiness of investments and decreasing the financial stability of the world's economies.

What are the possible end games given the above conditions?

          1.  The supply of "stuff" from the third world could begin to rise in price, due to greater friction in

               converting subsistence farmers to industrial workers.  There is some evidence of this in China

               already.

          2.  The dollar could fall in value if foreign investors reduce their US commitments.

          3.  Overleverage could bring the world economic system into crisis as it unwinds.

          4.  Slower growth or recession in both the developed and the third world could significantly reduce

               the savings supply.

Now the hard part.  What should investors do to earn a real rate of return on their funds while protecting themselves from the fallout which might occur from the end games mentioned above?

          1.  No one knows the timing of any of this.  Maximum safety, i.e. US Treasury Bills, will probably

               be a loser, but some liquidity makes sense.

          2.  Diversify by currency so, if the dollar or the US economy is weak, you can achieve a somewhat

              higher relative return in foreign assets.

          3.  Emphasize higher quality assets with lower leverage and relatively stable revenue streams to

              ride through difficult periods.

M. Jay Trees
Jackie E. Moss
July 22, 2005