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The Great Recession Is Over! Now You Get to Pay for the Recovery, with High Inflation and High Interest Rates
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The Great Recession Is Over! Now You Get to Pay for the Recovery, with High Inflation and High Interest Rates

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here is one individual whose words about the economy carry a lot of weight. He is Warren Buffett and he has amassed an estimated fortune of $37 billion managing Berkshire Hathaway Company. He is the …

here is one individual whose words about the economy carry a lot of weight. He is Warren Buffett and he has amassed an estimated fortune of $37 billion managing Berkshire Hathaway Company. He is the world's second-richest man, according to the Forbes Richlist 2009.


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  • 1. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved. The Great Recession IsOver! Now You Get to Pay for the Recovery, with High Inflation and High Interest Rates There is one individual whose words about the economy carry a lot of weight. He is Warren Buffett and he has amassed an estimated fortune of $37 billion managing Berkshire Hathaway Company. He is the world's second-richest man, according to the Forbes Richlist 2009. As the global financial crisis erupted Buffett praised the government’s actions of infusing enormous amounts of cash into the economy to avoid a total collapse beyond the level of the Great Depression some 75 years ago. Federal spending soared to avert a total collapse to the tune of a $787 billion economic stimulus package enacted in February of 2009, plus a $700 billion bailout of the financial industry, and takeovers of mortgage financiers Fannie Mae and Freddie Mac. The government, for instance, set aside $3 billion on its 'cash for clunkers' program, which paid up to $4,500 if owners trade in older gas guzzlers for new, fuel-efficient cars. The public purse also faces lower tax receipts and higher social security costs as unemployment rises to what is now 16.5% to 16.8% depending on the index used. The worst of the crisis was in fact averted by the stimulus but the reality of the cost of shoring up the economy is beginning to sink in. Warrant Buffet said in a NY Times interview last year, Enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself. In his New York Times column, Buffett cited the 20th Century economist John Maynard Keynes, whose borrow and spend theories were used by President Roosevelt to tackle the GreatDepression of the 1930s, just as they are today. Keynes also noted the problem of unbridled use of his plan when he stated, By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.... The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
  • 2. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved. Buffett's concerns now center on America's $1.8 trillion budget deficit, which represents 13% of the size of the total economy. The previous peacetime record, Buffett says, was 6% in 1920. The interest cost alone is $500 million a day! The fear is that under-fire political leaders facing midterm elections this fall will be tempted to continue to use spending and quantitative easing - a form of printing money - to create inflation that would help to wipe out the debt. Buffett said that the use of spending and quantitative easing is like global warming, and warns of the side-effect of 'dollar emissions' from the 'Greenback effect'. Buffett wrote, Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. Buffett further stated, “Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.” Printing money has a cost. It creates inflation and with it higher interest rates. An economist at an influential think tank has warned that LIBOR may spiral “rapidly” as the Bank of England will need to curb runaway inflation. Andrew Lilico, of the Policy Exchange think-tank, said, “To keep inflation (as measured by the Retail Prices Index) down to only 10% for one year, the economy will have to be able to tolerate interest rates of perhaps 8%.” The situation in the United Kingdom is no different than the situation we face in the United States. Each of the actions currently being taken or contemplated by the Federal Reserve Board of Governors, US Treasury, Comptroller of the Currency, etc., to rescue or stabilize financial institutions will create more money. In the absence of proportionally-higher real output from our workforce, we face more money chasing the same amount of goods. It is very hard to increase output when unemployment remains 16.5%. This is a text book recipe for inflation and the expectation of inflation, both of which raise interest rates. What is an interest rate, really? Interest rates are the sum of real-economic growth and inflation. Very-high interest rates are mostly a product of inflation. In August 1981, the 18.79% 3-month Libor was associated with negative real growth and in the neighborhood of 20% inflation. Consumption is reduced proportionally by inflation, e.g., 20% inflation reduces consumption by 1/5 per year.
  • 3. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved. Worse yet, at some point in as inflation takes off, there will come two psychological tipping points:  Foreigners, think China, will stop wanting to hold US dollar-denominated (noncash) assets. They will start selling their debt instruments (think Treasuries), and thus debt-instrument prices will fall, which means interest rates will rise; and  foreigners will not want to use US dollars as a medium of exchange and the US economy will therefore suffer "Seigniorage Shrinkage" Seigniorage is economic term which defines the profit a government makes on the money it creates, i.e., the value of the things it buys with money that it prints (most is created electronically) minus the cost of creating the money. Up until now, foreigners have produced real things, which we consumed and paid for partly with electronic dollars. It cost the United States nothing to create money as it is all done electronically with no real costs. This part of our foreign purchases was until now a gift from them to us, as we consumed their products and sent them none of our products in return. We only sent them electronic dollars. China has supported this relationship in order to maintain its own economy. My Grandfather once told me, “If you are going to borrow then borrow as much as you can. When you owe the bank a little they own you but when you owe the bank a lot, you own them.” Well, we owe China more than we can pay back and if we fail they fail with us so who owns who? However, if China were to switch all transactions to the Yuan and the rest of the world were to follow and use a currency other than the Dollar then they would be buying our output by returning our electronic money. More dollars coming home than we can consume in our economy reverses the relationship with China. Thus, we will suffer the reverse in our standard of living that we enjoyed with Seigniorage in the past. Economics seems so complicated but the effect on you is easy to understand. The effects of much higher interest rates on the order of 16 times what they are now will have catastrophic effects. Let’s list the obvious one:  Reduced Purchasing Power: each unit of currency buys fewer goods and services.  Reduced Value of Assets: Higher interest rates will reduce the present value of many assets, as their future cash stream will be discounted in the market by these higher rates. If you try and sell the assets you have to take less; your net worth is reduced drastically.  Increased Borrowing Costs: Interest payments on credit cards and loans are more expensive. Therefore this discourages people from borrowing and saving. People who already have loans will have less disposable income because they spend more on interest payments. Therefore other areas of consumption will fall.
  • 4. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved.  Higher interest rates increase the value of the Dollar: (due to hot money flows. Investors are more likely to save in US Banks our rates are higher than other countries) A stronger Dollar makes US exports less competitive - reducing exports and increasing imports. This has the effect of reducing Aggregate demand in the economy.  Rising interest rates affect both consumers and firms. Therefore the economy is likely to experience falls in consumption and investment.  Government debt interest payments increase. Higher interest rates increase the cost of government interest payments. This leads to higher taxes in the future.  Reduced Confidence. Interest rates have an effect on consumer and business confidence. A rise in interest rates discourages investment; it makes firms and consumers less willing to take out risky investments and purchases. Affected assets include those which provide services or cash in the future, like real estate, life insurance, health insurance, equity stocks, and most long-term bonds. For many investors and some consumers (those purchasing long-term services like owning rental real estate is like buying a stream of rental services), much higher interest rates will greatly reduce their wealth. That is, for many assets higher interest rates will discount future cash streams more than it will increase the size of those streams. This effect is exacerbated by the reduced effective demand for such assets caused by more- expensive and less-available lending. It is moderated a little by people fleeing financial assets for tangible assets. Apart from such adverse wealth effects, the object of many people's wealth is consumption (including gifts to charity), which will be separately affected by high interest rates. So what are we to do? If inflation is coming and higher interest are coming is there anything you can do to prepare yourself or even profit from the change? Investors and consumers can now access the fixed-income market, to hedge the above- mentioned dangers, very inexpensively. This low cost is due to several factors that have depressed the price of fixed-income volatility compared to historic levels. If rates rise substantially, then it will, in a sense, be too late and such protection will be far more expensive so the time to act is now while prices for these investments are low. However, few retail financial services firms are well equipped to offer this service. I am aware of only a few real-estate businesses that have approached financial-service firms for such interest- rate insurance. They were quoted and/or charged excessive fees. To buy such protection efficiently requires access to more mathematical-finance expertise and relationships with fixed-income trading
  • 5. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved. desks, than most such firm can readily provide. So where can you go to shield yourself from the negative effects of inflation and higher interest rates? The frustration over the accessibility of such interest investments for our clients led me to form Aegis Risk Management Group, LLC (See AegisRMG.com) to assemble the expertise to assess your exposure to higher interest rates, quantify the risk of loss in real dollars and cents, implement an efficient interest investment that will protect you when inflation comes and interest rates rise, do it with tax efficiency and coordinate the interest protection within the Aegis Council plan for your wealth creation and preservation goals . Contact Kingsley Charles at kc@aegiccompanies.comfor more information. ___________________________________________________________ More information on Thomas Agresti can be found here: http://aegiscompanies.com T.J. Agresti, J.D., LL.M, CEO Founder and Chairman of the Board, Aegis Holdings, Denver, Colorado Thomas Agresti (JD LLM) from Denver, Colorado began a successful career as a tax attorney after finishing an extensive and well-planned education that included the University of Maryland, Seton Hall University School of Law, University of Parma School of Law in Italy, and University of Denver School of Law. He is currently registered with the Bar of Colorado. In law school he focused on taxation and transactional law. He also went to Italy to understand the intricacies of international law and finance, again with a focus on taxation and transactions. He then took his taxation skills to the ultimate level receiving a Masters in Taxation from the University of Denver School of Law. He immediately became a highly sought after professional with a rare educational background. He chose to work with a large multinational public accounting firm, due to the extensive tax and transactional experience he could gain in a condensed time period. While a taxation specialist for a "Big Six" international accountancy firm, he specialized in domestic and international strategic tax planning or, quite simply, how to reduce a client's overall tax burden. His responsibilities also included financial and estate planning, income, gift, and estate tax reduction, compliance for individuals, trusts, and estates, partnerships, corporations, and tax-exempt entities. After leaving public accounting he practiced tax law with a boutique law firm before forming his own firm. He has lived and worked overseas representing a
  • 6. Aegis Group Holdings, Inc a Colorado Company 8400 East Prentice Avenue, Suite 660 Denver, CO 80111 T: 303-770-3664 info@aegiscompanies.com Copyright © 2009-2010. All rights reserved. broad range of clients. He has practical experience planning and implementing multi-national transactions, sophisticated wealth transfer planning, sophisticated life insurance structures, captive insurance, private equity and structured debt instruments.