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Government Influence on Share Prices

First, some statistics.

At the end of fiscal year 2005, the U.S. Federal debt was approximately $7.9 trillion. Yes, you read that correctly. That's almost eight trillion dollars. That's up from 930 billion in 1980, an increase of more than 849%. $4.5 trillion of that is owed to 'the public' - individual T-Bill and T-Bond (and other) holders, a third Japanese.

And that's just one form of influence from one country's government. Granted, the Federal debt and the U.S. in general are large components of the global picture.

Another big factor is interest rates.

Not all interest rates are set by government action. Private lenders determine - in the final analysis - whether a home mortgage, a CD (Certificate of Deposit) or a margin rate is 2% or 10%. But the Fed, Her Majesty's Treasury, and other countries' governments have a large influence. Whether by setting 'the prime' - the rate large banks pay to borrow short-term funds - or simply by being the enormous borrowers (as shown above) they are, interest rates are other than what they would be in their absence.

So, what's that got to do with stocks?

Apart from the general economic impact of regulations and direct taxation, bond rates (and interest rates generally) are one of the largest factors affecting share prices, outside of daily speculation.

Almost all companies borrow money and when they don't their competitors, suppliers and customers do. Not to mention the shareholders themselves, who have less to spend on equities when they pay interest on debt. Debt load is a major factor in the amount of retained earnings, and earnings - in the long run - determine share prices and dividends.

When governments borrow, they raise interest rates for everyone. The difference is, the government doesn't pay it back out of profits - they haven't any. They pay it back out of taxes and by inflation, which reduces the real amount they have to pay back. Thus, large government borrowing whacks the investor twice.

Also, since stocks effectively compete for investor dollars with bonds and other instruments, changing bond rates influences how attractive equities are versus those others.

Now, of course governments don't have infinite power to determine prices - in shares, bonds or loans (interest rates). A T-Bill or UK Govt Bond paying 1% is - other things being equal - going to attract fewer buyers than an 8% AAA bond or even (one may speculate) a 5% dividend from Google. (Google doesn't, and doesn't intend to, pay dividends by the way - it's just an example.)

Whether all this is a good or bad thing, or somewhere in between, is a debate we leave for another time. But whatever one's view, it definitely has an impact on the equities markets.

So next time you're researching whether to buy 100 shares of the next GoogYah NextBigThing, Inc be sure to factor in how affected they might be (relative to others in the same economic sector) by interest rates and government debt. And don't forget that impact on your own future cash flows either. After all, you may want to buy 100 more later.

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