World War III?

With U.S and Europe deeply in debt crisis and helpful China coming along to save them, more and more assets that once belonged to the mighty West will be used as collateral to China as a promise to repay the borrowed relief funds.

A sensible 5 year old kid will understand that if you spend more than you what you earn, you will never have anything to save, in fact, you will need to borrow more to cover your future spending.

When the root cause of debt is not resolved, no matter how much money U.S and Europe borrow, they will never solve the problem. The promise to repay is as good as void.

So when the Western powers fails to repay the money, the collateral that was used to secure the loan will rightfully belongs to China.

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Imagine this:

Because you are such a big spender, you have to borrow money from your wealthy neighbour to satisfy your spending spree. At first, your neighbour accepted your IOUs and loaned you money at minimal interest. But as you need to constantly borrow to get ahead, your promise to repay the loan becomes less and less reliable.

Sensing the problem, your neighbour became reluctant to loan you money. Desperate to obtain the cash needed for your spending, you increased your interest rate and decided to use the sofa in your living room as collateral. Your neighbour reluctantly accepted and loaned you more money.

But the money you borrowed never seemed to be enough, so you decided to use your televsion, fridge, chairs, table and anything valuable you can use as collateral to obtain a loan.

Though your neighbour is generous, he is not a philanthropist. Soon, he became impatient and started to ask you for his money.

To pacify him, you decided to write more IOUs that promises a higher interest for the entire loan balance. Your neighbour rejected your offer and asked that you put your house, which is the only thing that is not used as collateral yet to extend the repayment period by a year. You heaved a sigh of relief and accepted the terms.

Finally realizing that your spending habits will not enable you to repay your loans, you decided to cut back on your spending. However, your income could not be increased significantly to allow you to cover the entire loan amount plus interest.

Time slipped by and 1 year has passed, you do not even have enough cash to cover the interest. Your neighbour has come to claim what is rightfully his: Your entire house.

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Now, imagine that you are actually U.S and Europe and your neighbour is China, when it comes to a point when China has literally owned everything that belonged to U.S and Europe, do you think the Western powers and their ego will bow down and hand everything over quietly?

Then, if the western powers refuses to surrendering whatever that was used as collateral to China and instead disowns the promise and retract all foreign ownership of their property, do you think China will just sit back and cry?

When diplomacy and trust failed, conflicts of interest will usually escalate to the use of force. That is what could potentially spark the next World War.

The war between the Debtor and Creditor is more likely than a war caused by religious differences.

China, with its vast resources in terms of raw material and manpower could easily flex their muscles and cause the world to shiver. The Western powers on the other hand, have difficulty feeding themselves without borrowing, let alone sustain a war.

If a war really breaks out because the debtor denied its creditor of what is rightfully his, the moral weight will lean towards the creditors which would amplify their already obvious advantage by many fold. Bear in mind that China is not the only country that the West owes money to. An enemy of an enemy is a friend. Alliances could be easily forged to reclaim what was denied.

Ultimately, countries would be forced to choose sides, and it is not hard to see which side would stand to gain more if they win the war. A debt ridden super power or an opportunity to reclaim what is owed.

Despite warning by so many gurus on the need to change their spending habits and living within their means, the people of the west continues to be ignorant and nonchalant. Why should they care? Nobody would willingly give up a life of luxury for a life of toil and labour.

For the rest of us who is wiser, let's grab a coupon to redeem the pie when its ready to be transferred from its original owner.

Better To Be Approximately Right Than Precisely Wrong

To illustrate a concept of true investing:

Fast forward to the year 2050. Imagine there are 2 companies with equal book value of $1 billion. (book value refers to the amount of cash that the company can raise by selling everything in the business). Both have 100 million common shares held by shareholders.

SNS and FNF (acronym for slow and steady; fast and furious) are the names of these 2 businesses.

SNS is a simple business that does distribution of mineral drinking water obtained from mountain streams owned by SNS and purified at their facilities. Net worth derived mainly from the value of the mountain and SNS’s purification facilities.

FNF is a technological development and research facility that has successfully invented the very first Interstellar Spacepod. Its net worth is derived from its R&D facilities, factories, and inventories.

There is steady demand for purified mineral water as Earth is becoming more polluted by heavy industrialisation and healthy living increases in awareness for more people. Sales have been consistent and net profit from sale of mineral water amounted to $500 million. The fair value of SNS shares is $100 per share, but the market price is only $50 per share due to uninteresting prospect of the business and rumours that government is recalling land for building nature reserves.

On the other hand, due to FNF's previous success from the development of their Interstellar Spacepod, investors were hyped when FNF announced their Teleportation Device Development Project (TDDP). To fund the project, FNF decided to issue a $50 billion zero-coupon bond that promises return of 8% per year with a 10 year maturity date. (A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity) FNF will raise $23.2 billion through this issue and will redeem the bonds for $50 billion 10 years later. The bonds sold like hot pies.

Net profit from the sale of the Interstellar Spacepod in previous financial year amounted to only $50 million as it is only affordable by the minority rich and development cost was extremely high. However, due to the prospective potential of FNF, share price before the announcement of the TDDP was $1000 per share. After the announcement, in a single day, FNF shares closed at $10,000 per share.

Needless to say, many so called investors felt mighty rich after buying FNF shares, many became unsolicited promoters of FNF shares, recommending it to everyone they met on the streets.

If we make a comparison between SNS and FNF, we can conclude that SNS is under valued and FNF is highly speculative. The so called investors of FNF shares must be justly labeled as speculators and buyers of SNS shares can be referred to bargain hunters.

To present this in numbers, assume that both company are funded purely by equity (before FNF issued its zero-coupon bond) which they raised with an IPO of $10 per share, translated into the book value mention at the beginning. SNS's return on equity (ROE) is 50% and FNF's is 5%. While SNS earns 10 times more than FNF, its share price is only 5% of FNF's. It is either FNF being overvalued or SNS is undervalued, but in this instance, it is both.

Paying too much for a mediocre business because the share price is rising is a phenomenon known as the greater fool theory. It is like paying double the price for the last concert ticket, thinking that someone else will pay you a higher price for it.

Buying a business because it has high projected earnings is speculating because the projected earnings are not support by past records. The increased debt burden from the issue of zero-coupon not only virtually destroyed all profits of FNF, it puts the balance sheet in negative. For a company earning only $50 million a year to incur a debt of $26.8 billion($50 billion - $23.2 billion), it is suicide. Even if the project is a success and Teleportation devices are a hit, net profit needs to be at $5 billion a year in the first year and be consistent throughout for the next 10 years in order for FNF to cover the redemption of the bond. This is in a case where zero profit is retained or distributed to existing common shareholders.

To make matters worst, the soaring share price diminished the little value that was the worth of FNF share. In numbers, if FNF was to sell everything it owns at face value, even without depreciation charges, compensation will only amount to $241 per share. Compared to the purchase price of $10,000, speculators would make a minimum lost of $9759 for every share they own.

In contrast, while SNS does not seem to offer much explosive growth in net income, its steady profit and low costs offered dependable returns to shareholders. A demand for supply that is shrinking allows SNS to command higher price without fear of losing revenue. Net profit can be increased without increase in capital employed. Therefore, SNS is unlikely to become unprofitable suddenly.

As for concerns regarding rumours of government recalling land, in the event that SNS has to be put out of business, fair compensation can be expected to be made to SNS for the sale of its mountain by the Government. Every shareholder will then receive the proper compensation, perhaps with additional benefits like exemption from taxation of capital gains. In any case, the shareholder can stand to gain more than intrinsic value of the investment from the liquidation. The fear that drove the price down due to uninformed panic selling presents an opportunity for bargain hunter to capitalise on.

True investing is the allocation of capital in investments that offers safety of principle and expects reasonable rate of return. Though the above example is the extreme, its purpose is to serve as a guideline for investors to evaluate a company. Too many people fell to the allure of high returns over short period of time and end up with nothing.

As Warren Buffett says: It is better to be approximately right than precisely wrong.