Update: The following post was written back in 2008, but I think it’s still equally valid. Towards the bottom of the post, I made some suggestions of buying housing, financials, discretionary consumer companies. In retrospect, this turned out to have been the right call (as long as you bought the strongest companies) for the first two, which is also where I put my money. Knowing what kind of consumer discretionaries is popular is not really within my field of competence.

Economically speaking, the government is a zero-sum game that takes money from one group and distributes it to another group with the intention to somehow improve the world. For instance, when the government engages in war, it gets money from taxpayers (through the IRS) and savers (by issuing and selling bonds) and gives it to defense companies and soldiers which through a multiplier effect recycles the money back into the economy (while causing destruction somewhere else). In the current case of the economic stimulus package, the government gets money from savers (by issuing bonds and going further into debt) and distributes it taxpayers or consumers. Here the intention is to stimulate the economy to prevent the official declaration of a recession which would certainly look bad in a voting year.
The thinking behind the stimulus plan comes from the Keynesian idea of economic central planning. Keynensian economics was developed during the world wide depression of the 1930s where people where saving everything they had. The understanding was that people were unemployed and were saving too much. Keynes therefore proposed that the government should dislodge this inconvenient tendency by borrowing money (from the savers) and increase spending (to employ the unemployed). This was done by engaging in large scale public projects such as increased military expenses and building highways and autobahns. This project was very successful. An unintended consequence might have been World War II though but it is hard to attach blame with the world being as complicated as the world is.

Even though one might get the impression from reading pf blogs that many people have been overcome with a sudden desire to save, this is not the problem facing the economy now. Rather the problem is that thanks to Greenspan (and certain other central bankers) overly cheap credit has fueled a housing boom for several years. This resulted in a massive overproduction of housing. Furthermore it allowed the selling of real estate at increasing prices and leverage to buyers with an ever decreasing understanding of how to handle money (e.g. people with subprime credit). This money (now in the hands of the sellers) was spent and used to fuel the economy.

Now we have a problem!

The understanding of the government is that borrowing more money from savers and giving it back to tax payers will solve the problem. However, since the problem was one of excess credit, it makes little sense for the government to borrow more money on our behalf and dole it out to every person in the country. This is like drinking tequila to cure a hangover. Most likely the money will not be spent but rather used to pay off debt. This might reduce the monthly payments for some people. However, for other people the money will not even cover one mortgage payment and thus not prevent foreclosure and the resulting drop in housing prices. Overall this will only delay the inevitable a little bit longer (but perhaps long enough to get past the election).

The main problem here is that the majority of voters do not seem to understand this and thus they will react accordingly e.g. pay off debt or buy a new TV. So what can investors do to save themselves when nobody wants to listen? (In case anyone is listening – please stop this folly!) In a country where the government has a lot of control with the economy it is wise to get as close to government spending as possible (both in terms of investments and career wise). In terms of investments, note that this time around the government is giving money back specifically to taxpayers. Now what are the taxpayers going to spend it on? My guess is TVs and credit/mortgage bills. That means financials, consumer discretionary and maybe even housing. However these are also exactly the sectors that are currently ailing, so this is a rational yet quite risky bet (due to the timing issue). An alternative strategy is to opt out of this crazy scheme. Convert the refund to foreign currency and invest in other countries that don’t believe so strongly in free lunches.

As always, this is just my personal opinion and none of this should be construed as investment advice. If you are not ready and prepared to take full responsibility for your own investment decisions I urge you to please consult with a certified professional.

Originally posted 2008-02-02 07:07:28.