My dear P.M.,

The recent booms and 'shake-outs' on the London, New York and
Brussels Stock Exchanges, occurring at a time when reinvestment
has become a personal problem, has led me lately in odd moments to
make some little study of investment conditions to-day. I don't
know that I am much further ahead in coming to decisions than I
was six months ago, although I have a certain amount more
knowledge. In fact, as someone has said, I am possibly not wiser
but only better informed.

An individual has to decide on his investment policy for himself
as regards the degree of diversification that he considers sound,
(1) as between countries, (2) as between industries and (3) as
between the various classes of securities, ordinary shares and
fixed interest bearing scrip.

This is exactly what a sound Investment Trust Company does and it
looks at first sight as if the problem is solved for one by buying
their ordinary shares and preferred stock. But the same thing has
occurred to many other people and the result is that the
securities of the best trust companies with reliable and capable
Boards and management are closely held and so expensive and
difficult to acquire. There are plenty of new and untried Trust
Companies, but one is rather giving a blank cheque to unknown
people in investing in them.

And in addition a reasoned attack has been made in this last year
on (what one had previously taken on trust) the soundness and
desirability of good fixed interest bearing securities. E. L.

Smith, the President of the Investment Managers Company in
America, and a man called Raynes, Secretary of the Legal and
General Assurance Company in England, have both made and published
researches into the relative desirability of a well diversified
selection of ordinary shares as compared with debentures. The
American took examples in endless array of comparisons over the
last sixty years, and the Englishman in less detail and over a
shorter period. Both come to conclusions in favour of ordinary
shares.

I have read most of the publications in the above regard. Very
briefly the argument for a well-diversified list of ordinary
shares as against Debentures is as follows. Fixed interest bearing
securities, however unimpeachable the security, are titles to a
fixed money income and to the return of a fixed number of units of
currency at the end of a period which is usually long. They are,
therefore, subject to the risk of currency depreciation and to a
quite separate risk of fluctuation in capital value owing to
changes in the ruling rate of interest. Ordinary shares are
completely free from these two risks, but have individually a very
much greater risk in that the business or the particular firm
whose shares are held may be a declining one. The diversification
of the list is, therefore, designed as an actuarial protection
against the risks of individual shares. The advantages which
Ordinary shares have as giving an interest in the equity of
prosperity generally follow independently and there is an
additional point in their favour arising out of the practice of
most industrial companies of distributing in dividends only a part
of the profits earned and of accumulating the other part in the
form of expansion or of other investments. This other part thus
accumulates for the benefit of the equity holder by a process of
compound interest.

Reviewing my personal position, I have lost considerably more
through fixed interest bearing loans than through ordinary shares.

That the war was responsible for this does not detract from the
argument. My experience includes low interest Victorian
interminable loans and Melbourne and Metropolitan Board of Works
4% Debentures with twenty-five years yet to run before maturity.

Also worse than either, I recently sold a lot of French war loan
at less than 20% of what my Father paid for it. The German
'rentier' had of course an infinitely more bitter experience in
that he lost everything from holding what were considered in pre-
war Germany absolutely gilt-edged securities.

However, like most other arguments for an extreme bouleversement
of one's old ideas, one is very loath to accept it as a whole and
to act on it. Having surveyed all the arguments I am inclined to
greater caution than ever all round, I am more than ever against
long term loans and completely against interminable loans. And I
am prepared to have a greater proportion of ordinary shares as
compared with fixed interest scrip than I was before.

But having gone this far, then comes the practical difficulty. Is
the present the right time to make investments in the ordinary
shares of companies in either Australia or England or America? I
barged into this problem and had talks to bankers, brokers,
economists, and having listened to dissertations on the Bank rate,
inflation of Stock Exchange values, and many other problems, I
came out the other end with the general impression that a
depression of ordinary share prices was probable in the next six
or nine months and that one would do well to hold off for that
time at least.

And I may say in passing that the economists are sharply divided
into two camps in this country as to the wisdom of the Bank of
England and the Federal Reserve System 'butting in' to the extent
they do in attempting to control affairs by their gold reserves
and the bank rate alterations. But it is quite beyond me to
follow, much less decide which side is liable to be right.

It seems to me that the conflicting economic theories of J. M.

Keynes [1] (Cambridge School), Gregory [2] (London School) and
others are of no more than academic interest to the ordinary
person. They hinge in the main, I gather, on whether it is right
and proper for the Bank of England, the Federal Reserve System and
the Reichsbank to try and exert a smoothing influence on the
financial see-saw in their respective countries and even on
international finance. Their theories extend in some cases to the
expression of a doubt as to whether or not the gold standard is
the word of high heaven.

But as a matter of practical business, whatever certain schools of
economists may think, I take it that the existing practice will
continue as regards the gold standard and as regards the control
by Central Banks. So that apart from learning from the Economists
the basic proven facts of economics and finance, one can with
little risk afford to ignore their fancies.

I had hoped that one could have supposed that the main index to
tendencies would be crystallised in the Bank rates in the various
countries, but apparently this is not so. Unfortunately, or
perhaps fortunately, gold will not move from London to New York
simply because the Bank rate is 4 1/2% in London and 5% in New
York. The difference in rates attracts floating balances, but
unless the process continues on a large scale the purchase of
dollars with sterling will not necessarily push the exchanges
beyond the gold point. If, however, the movement is long
continued, the exchange will be pushed against London and gold
will move. But there is apparently a considerable 'lag'. And the
situation may well be affected by 'invisible' factors, such as
American tourist expenditure, etc., which may quietly readjust
matters so that the exchange is not affected at all.

However, in spite of all this, the difference in Bank Rates that
individual countries may impose on themselves to check their
domestic financial position may cause gold to move. This brings
about the situation that the Central Bank in the country losing
gold may be forced to raise its Bank rate if they attach
importance to preventing the loss of gold going further. One of
Keynes' points has apparently always been that the British gold
reserve is in this way very much at the mercy of the financial
policy of foreign countries, especially that of the United States.

But without going to the extent of raising the Bank Rate, the
Central Banks have another weapon in their armouries, which I
gather they always use first. That is the sale of their own
securities in their own country in order to absorb as much loose
money as they can that otherwise would be attracted abroad by the
higher rate there existing.

During the last twelve months the United States have lost about
100,000,000 worth of gold or about a third of their net imports
of gold since 1921. In order to check this drain away of gold, the
Federal Reserve Banks have sold securities hard in an effort to
mop up as much as possible of the available loose money, but they
have failed to affect the position much by so doing. They have at
the same time been obliged to use their other and more potent
weapon, the Bank Rate, and this has been raised in: half per cent
stages from 3 1/2% in August 1927 to 5% in this current month. The
Bank rate could of course have been used more harshly, but they
did not want to affect adversely the genuine demand for credit by
legitimate business. But it is apparently impossible to
distinguish satisfactorily between genuine business demands for
credit and credit wanted for Stock Exchange operations. The result
was that they were not able to stop a greatly increased volume of
credit flowing into the hands of Stock Exchange operators, and a
Stock Exchange Boom resulted.

The position has apparently been checked by the last increase in
the American Bank Rate.

The whole of this big question of correlating the domestic
financial policies of this country and the United States with each
other and with those of the other countries of the world is of
course the preoccupation of the Governor of the Bank of England
and the Governor of the Federal Reserve Board at their periodical
meetings.

This may all seem to be wandering rather far afield from the
question of investment that I set out to discuss, but it
represents fairly exactly the way I have been led on from what
appeared at first sight to be a fairly simple problem into what
was for me an adventure into the wheels of the economic and
financial machine. Getting back again on to the rails on which I
began, the line of thought of those who hold that prices of
securities will probably come down is as follows. Leading Stocks
in England and America, even after the recent slump on the Stock
Exchanges in London and New York, are roughly on a basis of a
yield of under 5%. There is overinvestment on certain major lines.

The Bank rate is 4 1/2% in London and 5% in New York. While the
upward trend in securities was current and was fostered by the
gambling wave, operators were profitably occupied by borrowing at
just above the Bank rate and using the money to take up securities
for the chance of capital appreciation. Now that the rise is
checked, they find themselves holding these securities which yield
only round about the Bank rate. They are now faced with the risk
of a fall in prices and consequent capital loss. More than this
normal risk is presented by the apparent determination of the
controlling banks to stop the inflation of Stock Exchange credit
by the operation of a high and higher bank rate. The theory is
that operators will be forced to sell their securities to pay off
bank loans. Prices of securities will fall in consequence. This
all applies to New York in particular, but I understand it is in
general also applicable to London and elsewhere.

And so I have come down to having fifty or so curves kept going of
the prices of Stock Exchange 'market leaders', in an effort to
decide what the tendency of Stock Exchange prices is doing. And if
by extraordinary chance, things go the way they are predicted and
Stock Exchange prices of Industrials in America and this country
drop away-well then, if no other factors come into the picture,
then I imagine the time will have come to buy.

I am, Yours sincerely,
R.G. CASEY