Once upon a time, there was a promised land that enabled people to live without tyranny and oppression; that allowed men (and later women) to endeavour upon any business they believed would make a profit - profits which would be gained by that proprietor and none other. So long as their doing so did not infringe upon another’s ability to do so, it was legal and was to be commended. Those people knew the risks involved in their journeys and accepted them. They took their life savings and jumped at the opportunity. Most failed. The consequences of their failures were unknown. But the opportunity was worth that risk. Those principles of self-determination were to be the founding of a civilization that would later be known as one of the world’s greatest ever.
Those principles that attracted people from the world over have been steadily eroded for the last 100 years, and just this last week, the final nails have been hammered in it’s coffin. The great grandchildren of those seekers of liberty have inherited precisely the tyrannical regimes their ancestors so bravely sought to escape and eventually fought against.
I write in reference to the trillions of dollars that have been taken from people who chose not to assume risk (either because the risks were too high, or they were too poor to take any risk), and have effectively been transferred to those who failed in their endeavours (usually those who were poor assessors of risk, or were wealthy enough not to care.)
For years, myself and a legion of others have warned against the under-acknowledgement of those risks. And now that they have come to fruition, we are being made to pay for those who chose not to listen. It is a classic transfer of wealth from the poor to the rich - the hallmark of tyranny of millennia gone by. It is imperative to understand that this is not a matter of political partisanship. Blame is to be laid equally upon all political parties.
The implications of these actions taken by US lawmakers and by central banks around the world reach far beyond this business cycle. They will be with us for many decades to come. We will look back on these actions in 80 years much the same as we look back now at the New Deal in America, the Treaty of Versailles in Europe or the Cultural Revolution in China. These are events of truly historic precedence.
What the long-term implications will be are completely unknown. Anyone who tells you otherwise should be avoided. But the immediate implications are far more predictable - and are not encouraging.
Playing God With the Free-Market
By now, anyone who has enough interest in this subject matter has read extensively of the actions taken by various government institutions (or pseudo-government institutions in the case of the Federal Reserve) over the last 14 months. The precise nature of these actions is not nearly as important as their overall magnitude. So I will not bore my readers with the details of each individual action.
What the actions, in aggregate, amount to are an attempt to fix the prices of certain assets above what the market thinks they should be worth. The assets in question are primarily real estate, equities, commodities and the derivatives attached to them. But the actions of the last 14 months cannot be properly explained without a historical look at previous interventions and their role in creating the problems that are now ‘requiring’ further interventions.
Starting in the early part of the 20th century, policy makers began to develop the previously unorthodox thinking, that it was government’s responsibility to ensure the economy’s balance between unemployment and stable prices. To do this, the government was to manipulate the cost of credit as a means to induce or restrict investment and therefore economic growth. Thus, the Federal Reserve was created in 1913. Furthermore, income taxes were also implemented that same year as a way to influence government’s control over the individual’s decision making. By either raising or lowering taxes, the argument was made, they could exercise further control over economic growth.
The first test of this new system was to come in the aftermath of the Great War. Economic growth slowed, and unemployment increased as debts from the war weighed on government balance sheets. The ‘solution’ was to lower interest rates, increase credit creation and stimulate the economy. This artificial inducement of growth led to the ‘Roaring Twenties,’ a time of great prosperity and speculation. It also led investors to make poor decisions with their savings that they wouldn’t otherwise make. These malinvestments are what eventually led to the contraction of the economy in early 1929, and the stock market panic later that year.
This is not to say that without the ‘easy money’ policies of the Fed in the 20’s, there would have been no contraction in 1929. But the magnitude of the contraction would not have been nearly as severe, and it would not have led to either the mania nor the ensuing panic in the stock market.
Once the precedent had been set for government interventionism, it was assumed and expected that Hoover and later Roosevelt were responsible for ‘fixing’ the economy in the aftermath of 1929. Collectively, those prescribed ‘fixes’ were what turned perhaps a long recession (or a double dip) that would have lasted until 1934 or so, into the Great Depression. Roosevelt’s desperation to stop the slide resulted in numerous schemes to support asset prices and encourage investment that would otherwise be seen as inefficient (all done under advice of John Maynard Keynes). Some of those included the New Deal I (1933) and II (1936), the Smoot-Hawley tariffs, the gold confiscation, and the creation of Fannie Mae in 1938. They all failed. R.B. Bennett attempted the same practices in Canada to even more disastrous consequences. Only the onset of WWII, and the establishment of munitions industries to be sold to the allies pulled America out of Depression.
But the failed policies of the 30’s were incorrectly seen as the saviour and they remained in practice. An effect even more material from this misguided conclusion, was the continued belief that any time the economy encountered recession more government ‘solutions’ were piled on top of the existing structure to counteract it (a system known as Keynesianism). All of these previous ‘solutions’ have resulted in increasing debt and an accumulation of malinvestment. None of these interventions of decades past are more easily evident than the recent collapse (and subsequent nationalization) of Fannie Mae.
The Great Depression Comes Full Circle
The continuing interventions in the free-market to prop up the previous decade’s malinvestment have led to a giant game between participants in the markets learning to anticipate the government’s next intervention and investing accordingly. Over the last 80 years ‘the game’ has morphed into nothing other than the well-informed (read: the already wealthy) making huge bets on government intervention (Pimco’s Bill Gross, for example.) This makes it such that unless one has connections to the subject of secret meetings of government officials, one cannot possibly know how to make an educated decision on his or her investments. This leaves only the wealthy to become wealthier and the poor to become poorer. A process otherwise attributable to the most tyrannical communist regimes the world has ever known.
This process has been going on gradually for decades now. So gradually, that most haven’t even noticed it until very recently (the frog in boiling water analogy comes to mind.) People had thought that the growing disparity between rich and poor, their increasing personal debt loads, the decreasing quality and availability, yet increasing costs of health care and education (public or private systems alike) were only temporary. Either that or they didn’t notice it at all due to it’s gradual onset or media propaganda telling them otherwise.
But with the recent weeks’ market volatility, government bailouts of major companies and now the creation of an enormous government fund to buy all of the problem assets at taxpayers’ expense, people are starting to see the forest for the trees.
One of the government’s most sinister policies (and one emulated all over the world) has been that which seeks to enforce an always rising level of prices. This mandated, or ‘targeted,’ level of inflation attempts to ensure that people do not keep savings, but rather spend their money for fear of otherwise losing purchasing power. This results in an artificial and continuous rise in asset prices (like real estate) as people fear being ‘priced out’ of the market forever. Those who have assets already (the wealthy) can benefit from this by accessing credit that the poor cannot (because they have no collateral) and using it to buy these assets and immediately become more wealthy. Essentially, mandated inflation is like a tax on the poor.
What has happened recently to disturb this process has been falling home prices in the US. It became so obvious in the aftermath of the Tech Bubble that the low interest rate policies of the Greenspan led Federal Reserve, were designed to spur a rise in real estate prices. And confidence was so high in the government’s ability to maintain steadily rising asset prices that buying real estate was such a ‘no-brainer,’ nearly everyone who had access to credit got into the game of speculating in it. Banks, brokers, individual investors, hedge funds, even car companies like GM or consumer goods companies like GE bet their entire existence on the belief that government could ensure asset prices would always rise.
As is always the case when confidence is too high, there was eventually too many homes for the amount of people to live in them, and prices fell. All of these companies lost on their all-in bet that was massively skewed in their favour.
In a free-market, they would all lose their shirts. Those that saw through this obvious gap in logic would be rewarded for their good judgement and be able to afford to buy their first home. They would have the savings required to start new businesses where the others failed and this positive investment would soon lead to another economic expansion. This is the life-blood of a just society. Where people can either reap the rewards or the penalty of their choices.
The recent government actions of the past 14 months have all amounted to taking money from those who were correct, in an effort to help those that were wrong. It is a death-blow to class mobility and to the founding principles of our societies.
Cards Are Stacked Against the Poor
Jeff Macke summarized this situation quite well on Friday when he wrote,
I think the market is now akin to those carnival games where the rim isn’t regulation size. Paulson is in the role of barker, telling folks to ‘step right up’. I’m stepping right out.
You can argue all day about whether what was done was right or wrong, good or bad. I just don’t play games for money when I don’t know the rules.
Indeed, the rules keep getting changed and the odds are decreasingly in the favour of the average person. So what will the natural result be? Much the same as it would be for anyone thinking of sitting down at a table where he or she knows there is a loaded deck. They will choose not to participate.
And why should we? Young investors and speculators such as myself feel betrayed. We see our opportunity for advancement, regardless of our level of education, as being under attack. Our natural conclusion will be to take our business elsewhere. I am personally scouting out locations around the globe to relocate - permanently. This is not a society that I wish to be a part of any longer. The values that I was taught made Canada and the US great no longer exist.
Note: this analysis is made without regard to my opinion on whether or not the government actions will succeed or not. That is a separate topic that I will address at a later date.