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Problems with Holding Cash

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By thelegendoftomvu
March 26, 2008

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I appreciate you taking the time post your thoughts here to what amounts to a pretty amateur question.

Your question is not amateur at all. It is a very serious question. We are rocking in a small boat ever so gently over 70,000 fathoms... the derivatives market and the shadow banking system. How about that for a scare quote? Comes from my favorite profligate writer, Soren Kierkegaard, who was talking about the loss of a sense of self, rather than financial markets.

I think holding near cash investments is pretty scary right now, all things considered. Lowering short term rates has many effects on the economy, but it also effects the investment decision of where to park money while safe short term returns are well below the rate of inflation (defined as the loss of purchasing power of MY money on what I spend MY money, not what the government tells me I have lost in terms of CPI or core CPI, which are preposterously distorted versions of reality for most consumers).

I have thought a lot about this problem of holding cash and eventually forced myself to buy foreign currencies (particularly the Yuan), as well as place money in certain closed ended municipal bond funds after they sold off when the hedge funds recently got squeezed on one of their levered "sure things".

One benefit of buying munis this way was that they traded to a discount to NAV in certain funds. The Saudis and the Chinese don't really bid them up because they don't reap the tax benefits. Moreover, there has been a lot of panicked selling with the roiled credit markets, and the controversy surrounding bond insurers. Even without insurance, munis in general have an extremely low historical default rate, even in hard economic times, meaning the bonds are mostly money good if you buy them broadly (don't bother trying to figure out if Houston power is better than Indiana school system...).

The other cool thing about the levered aspect of a some of the closed ended funds (many have 30% leverage or more) is that they actually benefit from the decline in short term interest rates, as their cost of borrowing goes down. Anyway, I think it is a reasonably safe way to get 5.5% income tax free with an add price pop over the medium term, that is, if you can stand the price volatility (which I can) while the stuff hits the fan in USA.

The other thing I am doing is buying shares of some businesses that yield as much as near cash safely yields, but only in businesses that have no real exposure to a down turn in the economy. I bought Bud recently with this idea in mind. People drink more bad beer, not less, when times get hard. That doesn't mean the share price of Bud will go up tomorrow or even this year, but it does mean that I can count on the intrinsic value of the business to be fine while I receive a yield (2.9%) . . . more than just sitting on cash. It also can't hurt that I got in there for an average cost basis below that of Warren Buffett years back. . .

As the debasement of the dollar and depth of the recession and financial panic become apparent, more and more people will start to look for these types of things and I believe they will be bid up. I obviously could be wrong, but I don't think I am. Berkshire itself, anywhere near 125K a share is a good safe haven, albeit without a yield. You'll benefit from panic there.

You might protest that I have basically advocated buying (in some cases with leverage) certain bonds, certain types of stocks, and foreign currencies in a response to a question, about what to do with cash. That's right. Part of debasing the US currency and bailing out Wall Street is deep rate cuts...and that flushes people out of cash and into other asset classes, because the relative reward to risks starts to tip in favor of the other asset classes.

Anyway, this gets much, much worse before it gets better. I truly think that, and there will likely be plenty of opportunities to get into safe havens along the way with further dislocations.

We have yet to have the Fed outright purchase mortgage backed securities, and I am reasonably sure that will come to pass, as we further our market based decline into a form socialism for the rich. Just make sure you're rich, son, because over the long haul we are in for a higher cost of borrowing, a lower standard of living, and an emergence of both militarism and protectionism as the population tries to figure out what happened during one of the greatest periods of profligacy in history. Some politician will come along with a line of BS about how it is not our fault and how we need to attack so and so and put up trade barriers here and there...It'll just be awful, but that is some years away. For now we have a re-inflation of asset classes on the menu.

We elected a leader who can't form a complete sentence, twice, because he told us to spend, spend, spend while he lowered our taxes. It is definitely our fault, but in a republic it is hard to not choose instant gratification, especially when we are so used to it.