In a recent article, we discussed the possible causes for the credit crisis that has plagued the world economy. And in this discussion, we also touched on the effect that the current political climate is having on the markets, as well as where you can find good, stable trading signals. But I want to address a different subject.
Political events have an undeniable influence on stock markets, but what is the effect that politics has on the potential of investment. If there are economic circumstances that could be used to help a company make a larger fortune, then why do some politicians want to suppress this?
For example, when the government decides to increase taxes or cut spending, it creates a funding gap. If that tax revenue were to flow into the public sector, companies would not be able to cope with the new costs.
So what happens is that the government has created new wealth and responsibility by being a responsible tax collector. However, this brings a danger to that wealth, if the current government can’t keep the money flowing into their budget and fix the tax problems. They have increased the amount of money available to invest and so there will be less purchasing power for goods and services.
Companies will only have their balance sheets to show if they have the cash to purchase the goods and services that they have promised to deliver. If they can’t, then there is a risk of businesses going bankrupt, which will lead to a sudden drop in the value of their shares.
With large losses and bankruptcies, it is difficult for a company to get any more money from its customers, and the cost to buy back their shares will increase dramatically. This has a direct effect on the value of the share, and a large company has no choice but to offer a dividend to its shareholders, which means the investors receive very little.
If a large company fails to pay their dividends, then they will go bust and the value of their shares fall to zero. If this occurs, there will be no company left to sell its shares.
The only way to keep the value of the shares above zero is to buy back the shares of investors. However, if the share price has fallen below the level at which the management could buy back the shares, then the shareholders will see that the company has been forced to sell the shares, and that can happen very quickly if the market is weak.
In this case, it is far better to have a strong policy that forces the management to ensure that their policies are met. As shareholders, you will know exactly what the company can afford to spend, and you can demand to see a detailed report of where the money is coming from.
Also, the government must also make sure that its deficit spending is based on sound accounting and tax policies. Otherwise, the taxes collected by the government will simply be pocketed by the company – even though the value of the company’s shares will fall.
Lastly, the biggest factor that makes the government a potential buyer is the problem of interest rates. With the exchange rate peaking and decreasing rapidly, governments have to spend every single pound they have on financing.