After he has protected his old age and his dependents by adequate insurance, the investor according to the scheme that has been sketched out for him proceeds to accumulate a holding of securities that will give him an income if he happens to be afflicted by loss of earning power, by ill-health or any other cause.
In England we generally prefer to deal in stocks and shares that are registered or inscribed, while securities to bearer are usually preferred abroad. Under the English system the buyer of a security has his name enrolled by the debtor (or by the company in which he is part proprietor in the case of ownership securities) and his interest or dividends are sent by post either to him or to his bank, as he may direct. If the security is "registered" he receives a certificate stating that he is the registered owner, but this certificate has no value as title to ownership, which is transferred by means of a deed of transfer signed by the seller and the purchaser. In the case of "inscribed" stock there is no certificate and ownership is transferred by the attendance, in person or by attorney, of the seller. Bearer securities, as their name implies, are represented by a document which is in itself evidence of ownership—a bond or share certificate—and interest or dividends are paid against the delivery of coupons—pieces of the bond or share—that are cut off it and presented. Safe custody of bearer securities is thus essential and they are generally left by their owners in the charge of their bankers, who cut off and present the coupons. Victory Bonds are an example of bearer securities issued by the British Government, but the greater part of the British debt is in the form of inscribed and registered stocks.
It was agreed that in laying his foundations he is to consider safety first, second, third and last with no thought of increase in income except by addition to his investments and little hankering after a rise in the prices of his securities. Naturally he will not want to see them fall, and he may endeavour to secure himself against this contingency by selecting obligations that are redeemable at a definite date ahead. But steadiness of income is the first and last consideration, and to the continuous investor who is saving and investing periodically, a fall in the prices of well-secured stocks enables him to invest to greater advantage. If the stocks that he has chosen fall for some special reason that has made them less safe, that will be a reason for getting out of them, but if the fall only reflects a rise in the general rate of interest and affects all high-class investments alike and is not significant of any weakening in real security, it is an accident that may be ignored by the genuine investor who is first concerned to provide himself with an income that he may feel sure of receiving.
There is, however, a school of investment doctrine which tells us that we ought to watch the fluctuations in the rate of interest and anticipate them, and make a profit from them by changing over from long-dated or perpetual securities to those which are due for redemption at an early date, and back again; and the possibility of engaging in this interesting system may appeal to some investors.
The idea, as far as I understand it, is something like this. Changes in the rate of interest on investments—that is in their yield to the investor at current prices—are due in normal times chiefly to the quickening or slackening of the tide of trade. When trade is active and prices of goods are rising, money is wanted by manufacturers for financing enterprise, and there is thus less available for investment and for financing speculation in securities. When Manchester, Huddersfield, Sheffield, Glasgow, and the other great centres of industry and commerce are so busy that they want every penny that they can raise to pay for materials and other current expenses, they are then likely in the first place to sell securities and so depress their prices and, further, by their clamorous demands on their banks for assistance, to reduce the amount that the banks can lend to the financial firms which use it in carrying the floating mass of securities which is the stock-in-trade of the investment market; and so some of it has to be sold and prices are further depressed. As they say on the Stock Exchange, trade and securities cannot boom together.
When money thus becomes scarce and dear, the securities that are most severely affected in price are the fixed rate creditor securities that are perpetual, or are not redeemable until a remote date. Those that have to be redeemed comparatively soon are naturally kept steady by that fact. Evidently a stock representing the obligation of a solvent debtor to pay 5 per cent. interest and £100 per cent. in capital in two years' time is less likely to fall far below par than the obligation of the same debtor to pay 5 per cent. interest with no obligation to pay the principal ever, or before, say, 1965.
And vice versa, when money is plentiful and cheap because trade is slack and commodities are low in price, and consequently need less money to finance those that have not yet found their final purchaser, then securities rise because the spare money is invested in them; and the long-dated or perpetual variety will rise faster than those which must, or may, be redeemed shortly.
Consequently, those who can make accurate forecasts concerning the future movements of trade, which expands and contracts, or has hitherto done so, in more or less regular cycles, can make profits by jobbing in and out of fixed-rate investments, from the long-debts to the short ones; or from fixed-rate investments which rise in time of slack trade, to industrial shares and other owner-securities which rise in time of active trade owing to the larger profits that their holders then expect to earn.
For the ordinary investor it is very doubtful whether it is advisable to take part in this form of speculation, for it is nothing else. It is simply backing one's view concerning the probable course of trade, a matter which requires an amount of study and information that the average citizen can rarely bring to bear on it. The expense of changing from one investment to another is considerable by the time that brokers, jobbers and tax-gatherers have all taken their toll of the process. If you work out the commissions, transfer stamps and fees, contract stamps and jobbers' "turns" on a sale and repurchase of registered stocks or shares, you will find that they may come to something like a half year's income on the securities. In this way a large part of the profit, if any, is gone before it is garnered; and the loss is pro tanto increased, if calculations concerning the course of the trade cycle should happen to be upset by some prank of Nature's in the shape of good or bad harvests, earthquakes or pestilence, or by some human aberration, such as war or revolution or widespread industrial unrest.
This being so it seems much better for the ordinary investor to choose for the foundation of his holding good creditor securities that can be relied on not to fall because of any special deterioration affecting the probability of the interest on them being paid; and, having got them, to keep them as long as they remain within that class, unless some special reason arises for changing them.
As long as he has a sufficient holding of such securities he is sure of an income payable in the legal tender money of his own country, or in some other country's which can be relied on (a point which will have to be discussed more fully later) not to vary widely in value when it is converted into sterling. But so much has been said lately—and with good reason—concerning the violent changes that have taken place in the last twelve years in the power of English and other monies to give their holders command over the goods that they want to buy and the need for a careful investor to protect himself against depreciation of the money in which his interest is paid, that this subject cannot be left out of any manual of investment. We have to ask ourselves, is it enough to secure an income in money, or ought we to remember the case quoted in Chapter I of the holder of gilt-edged German securities whose money income was secure, but was worthless, having been divided by a thousand millions or so by depreciation due to the pace at which the marks in which it was paid were multiplied?
The same thing happened, on a much smaller scale, in England and everywhere else. According to the calculations on which the Economist "Index Number" is based—an Index Number is an attempt to arrive at the aggregate wholesale price of important representative commodities—prices in July 1925 were just double their average level in the first five years of the present century, having been in the meantime, in March 1920 when the zenith of the after-war rise was reached, nearly four times as high.[1] So that anyone who bought Consols in the early years of the century and hoped to receive a steady income from them, got the income but found that when he turned it into goods its power to purchase them was not much more than a quarter, in March 1920, of what it had been when he bought; and finds now that it is only about half as potent in supplying him with the good things of life.
He feels, probably, that he has been somehow infernally swindled, but that it was all owing to the war and could not be helped, as to which he may or may not be right. But we are not concerned with his feelings, but only with the fact that the same depreciation of money by over-issue, which has applied those "abhorred shears" to the real value of his income, has had the same effect on all fixed incomes from securities, annuities, pensions, or any other source; and we have to grope our way to a decision as to whether the investor is bound, for his own safety, to consider the risk of further depreciation on anything like the scale that has lately been witnessed.
If he is, then he should eschew creditor securities altogether, because they are only promises to pay so much in money, and confine himself, in so far as he invests at all on the stock exchange, to ordinary shares and stocks which carry with them ownership of the assets of the companies selected, which will rise in price as the currency depreciates and will return a larger money income owing to the higher prices of the products that are sold. Moreover, he will be tempted to invest less and to spend more upon real property and goods such as can be held as a reserve fund. He will be careful to own his own house, and if he foresees extreme depreciation, a piece of ground on which he can grow as much as possible of his family's food, vegetable and animal; and he will learn to do many things for himself, so as to meet the rising cost of service; also he will be tempted to spend freely on imperishable articles, such as jewellery, which will rise in price if currency depreciates; they are also desirable, as a disgusted super-tax payer once observed to me, because "things like pearls can always be sold easily and are a good liquid reserve, and in the meantime they don't bring in any income for the Chancellor of the Exchequer to rob you of."
But is this sort of thing worth doing in present circumstances? It does not seem to me to be so, though now that currency matters are once more the subject matter of politics, no one has any right to feel certain about them. For many centuries the tendency has been in favour of gradual currency depreciation, or a gradual rise in the prices of commodities, with occasional reactions. In the days of King Henry the Fourth, as Master Silence tells us, "a score of good ewes may be worth ten pounds." This rise in prices has been one of the methods by which Fortune has carried out a "Seisachtheia," or relief of burdens, such as was deliberately introduced by Solon at Athens,[2] and has loosened the grip of the creditor on the productive power of the world. But it has been so gradual that the creditor has not been afflicted by it to the point of giving up the habit of being a creditor and an investor. During the nineteenth century something approaching stability was achieved. The output of commodities was enormously quickened, but so also was that of money by discoveries of gold and the development and expansion of the use of credit instruments in the shape of bank notes, bills of exchange and cheques. During the first quarter of the nineteenth century, as Mr. Keynes tells us,[3] "The very high prices of the Napoleonic Wars were followed by somewhat rapid improvement in the value of money. For the next seventy years, with some temporary fluctuations, the tendency of prices continued to be downwards, the lowest point being reached in 1896. While this was the tendency as regards direction, the remarkable feature of this long period was the relative stability of the price level. Approximately the same level of price ruled in or about the years 1826, 1841, 1855, 1862, 1867, 1871 and 1915. Prices were also level in the years 1844, 1881 and 1914. If we call the Index Number of these latter years 100, we find that, for the period of close on a century, from 1826 to the outbreak of war, the maximum fluctuation in either direction was 30 points, the Index Number never rising above 130 and never falling below 70. No wonder that we came to believe in the stability of money contracts over a long period. The metal gold might not possess all the theoretical advantages of an artificially regulated standard, but it could not be tampered with and had proved reliable in practice."
Since his tract on Monetary Reform was published by Mr. Keynes, England, against his advice, has gone back to the gold standard under which, on his showing, so near an approach to price stability was secured in the century before the war. The reasons that he brought forward for proposing to establish what he calls an artificially regulated standard are highly interesting and ingenious, but did not convince the great body of banking and business opinion. Nevertheless the work that he and many others have done in calling attention to the evil effects of violent price fluctuations on our economic and social life has by no means been without effect. The working of the gold standard will be watched from this point of view in a new spirit of criticism by the public and will be guided with the help of a revised chart by the authorities of the central banks. It is thus fairly safe to assume that the era of wide fluctuations in the prices of goods is over for the time being and perhaps even to hope that it may never return. If this be so, then the task of the careful investor need not be complicated by the effort to provide against reduction in real income by a rise in prices sufficiently marked to defeat the steadiness of the money income that he receives from a holding of creditor securities, and we can go on to consider the principles on which he should guide his selection.
- ↑ The exact figures are: 1901-5, 2,200; March, 1920, 8,352; July, 1925, 4,446.
- ↑ Grote's, History of Greece, Part II, Chapter XI.
- ↑ Monetary Reform, p. 11.