Investing and Trading in a Socialist Economy 12 comments
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This is the first article in a series I'll be doing on investing and trading in a socialist economy.
The cover says it all, but Newsweek has a full article elaborating it.
But what does it mean? If we are in a socialist economy, how is this different than the economy we had before -- before Newsweek declared we were all socialists? And as investors and traders, what does this mean for the financial markets?
The issue of to what extent an economy is socialist boils largely down to what extent money supply is determined by the market vs what extent it is controlled by government. While the United States was originally founded on free market principles, it has evolved, particularly over the past 100 years, into a more socialist economy in which the supply of money has become increasingly controlled by a centralized government. Below are key events in the timeline:
The Federal Reserve Act. The origin of the Fed goes back to the panic of 1907, which created a liquidity crisis in the market that may have spiralled into greater chaos had JP Morgan not stepped up and provided liquidity. Proponents of the Fed argued that JP Morgan helped avert a larger crisis, and that in order to ensure a stable business cycle going forward, an "elastic" money supply was needed -- meaning a money supply that could be contracted and expanded by government as needed in order to effectively manage the economy.
Of course, an "elastic" money supply also resulted in an easier ability to create inflation. And so the Fed instituted inflationary policies which resulted in the bubbles of the '20s -- "the Roaring '20s," as they are called. But as Austrian business cycle theory tells us, while excessive expansion of the money supply creates a short-term boom via asset bubbles, they ultimately fuel bad investment decisions -- and thus the bubble is the predecessor to the depression. Which brings us to the next big event in the timeline to socialism....
Great Depression. The Great Depression resulted in the enactment of much legislation that gave government more power regarding determining much money could be created as well as how that money would be spent. Crucially, the US dollar was repriced from $20 an ounce to $35 an ounce, and gold was confiscated -- all as part of an unsuccessful effort to reflate the economy. This is crucial to note because this was the first step to abolishing the gold standard.
End of the Gold Standard. Due to the cost of the Vietnam War, the United States was having difficulty honoring its peg of $35/oz for gold. As a result, foreign governments and central banks, particularly Charles de Gaulle of France, began to demand payment in gold. As the US government was unable to continue doing this, the gold standard was fully abolished. This is a crucial step in the journey towards socialism, as it set the stage for the central bank, at least in theory, to create an infinite amount of money out of thin air.
Nationalization of Banks. Now, the threat of increasing nationalization of banks looms in America, which is perhaps the final "nail in the coffin" in making the switch from capitalism to socialism. Under the Federal Reserve System, the Federal Reserve can create the monetary base and decide how much banks can lend -- but ultimately, banks lending is a key part of expanding the money supply (though inflation can occur in the Federal Reserve system without bank lending, through government deficit spending and a dollar sell off by foreign central banks). If commercial banks are nationalized, it makes money supply even more of a governmental matter -- not a free market matter.
What's This Mean for Trading?
If we've gone socialist, what does that mean for the financial markets?
- All money is political; it is based not on market demands and needs, but rather on which political interests will prove to be successful in securing newly created money. Economist F.A. Hayek's book The Road to Serfdom is an excellent exploration into the dynamics of economies in which all money is political. As a result, watching legislation and understanding political motives become more important for traders/investors in socialist economies. We talked a bit about this before in our article on the Ka-Poom theory.
- Whenever money supply is monopolized, either by government or by a private organization, there will be an incentive to increase it. After all, creating money is a very high margin business. As a result, socialist economies may be more prone to the risks of institutionalized inflation, which we discussed previously.
- The truth, though, is that capitalism never really dies, as socialism simply increases the demand for black markets. As such, activity in "off the radar" markets may be more important to watch. In our current market conditions, the growing spread between physical gold sold by independent dealers and gold contracts traded on future exchanges may be one such indication traders should watch to get a better idea of supply and demand.
- Historically speaking, all fiat currencies have ended in hyperinflation. As socialism makes money supply expansion easier (because it makes money supply less of a free market issue), the hyperinflation risk is greater, and investors/traders should factor this into their analysis accordingly.
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As long as Obama and the Democrat party have their foot on the neck of the economy (union card-check, carbon dioxide tax, expiration of the Bush tax rate reductions, etc.) we will not get a recovery. If the 2012 elections turn the House back to conservatives, then we might get a recovery. Until then, either day-trade or stay on the sidelines (gold and USD).
Of course, Bernanke and Obama are sowing the seeds of double digit inflation and the next bubble, so we all have to watch out for that.
The cure for this insanity is to take money supply creation out of the hands of politicians, knowing that politicians are gangsters or lawyers or both.
1. What is the reserve ratio the Fed has on lending those funds? 100% where each dollar borrowed comes from one on deposit in the Fed. 10% where some reserve ratio remains at the Fed say 10% and 90% is "created". Or 0% where the Fed creates money out of nothing no reserve.
2. The Fed receives the "interest" on the principal of T-Note. It is interesting to consider in each of the above reserve scenarios the Fed is collecting interest payments from a fair amount for 100% ratio to a questionable amount for 0% reserve ratio for money they did not have and just created. Now if the Fed lent on a reserve ratio of say 10% and they are paid back the principal 100% plus interest is this valid or a bit of deceptive trap?
4. Where do the interest profits of the Fed go to? I heard from 95% are paid back to the treasury - to the Deb a secretive group and no one knows where the money goes to. And if the profits are paid back is that the profit from the interest? And what about the "created out of nothing" principal is this ill gotten gain by the Fed or valid?
5. Another intersting questions where did the first USD bills come from? Was it based on T-Note debt as described above such that there is more debt outstanding than money? Or was it based on some reserve like gold and than further money supply increases are debt based?
6. Finally I was on flight to China sitting beside a Chinese banker and asked about their banking system. She said that unlike US, the T-Notes of the government are sold to citizens in exchange for their local currency. This can be interesting because they cannot issue more currency than exists in the hands of the citizens. They do have a reserve banking system than lends at 4% or 8% reserves so can have money inflation supply as traditional banks can.
I would like to read more of this type of article and maybe we could extend it to other areas such as pensions, real estate, ....
Two things I've read the last couple of days that could be relevant to this is
1) the Japanese are considering using script for domestic use and
2) Freddie Mac is now a landlord renting property and charging according to a residents ability to pay.
There is food for thought on how your money could be affected here at home by the possible use of script which was last usedas i know of in the coal fields of West Virginia ending in the early '50's.
And how the implications of the Fed now being the biggest landlord in the country will depress rents and yet further lower the values of real estate by setting rent values below what the market is now as this practice grows.
Our farmer doesn't know or care about the banking system or the relative merits of "socialism" and "capitalism". He knows how much of his labour went into producing that food, and he knows that it will keep for a long time if no one offers a price he likes. Your choices are to kill him and take it, or make, buy, dig up, or cut down something he wants. That's pretty much all there is to it. If the standard procedure is to kill him and take it, there won't be very many farmers next year. This is why every socialist endeavour has foundered when it finally got around to agriculture: at the very bottom of the economy, people with nothing to lose and no need to gain (they are the only truly unleveraged participants) simply won't accept getting nothing for their labour. Slaves run away, serfs rebel, and Soviets trade on the black market. Stalin had to learn it. Mao had to learn it. Obama will have to learn it. You can't kill him, you can't give him nothing, and you can't give him worthless paper. You've gotta be honest enough to make serious payment or you're going to run out of food and die. No way around it.
Most "mainstream" conversation today looks like a debate between the debasers and the nationalisers. In other words, between those who would pay in worthless paper and those who would prefer to take by brute force. Both strategies are certain to fail.
There is only one solution here: the investors lose their money, and keep losing it until a new equilibrium is established between supply and demand. There is always support for GDP at the level at which nearly everyone is a subsistence farmer or farm worker. If we break through all other support levels, that one will surely hold. And we were there less than 200 years ago. Clearly it is better to rebuild from nothing than to spend ever more of our resources trying to prop up a dead, decaying wreck. I don't seriously think we'll end up there anyway: there are plenty of long-lived productive assets out there to buy, and plenty of gold to buy them with if their prices come down far enough. But first we have to get past the era of paper money and do-gooder governments. We need fewer people, and we need them to understand that their standard of living has to reflect the value of their contributions, not the amount of debt the central bankers have decided we need today. Sadly, I think this crushing phase is likely to take a lot longer than it took to build the world's largest and strongest economy from a million subsistence farmers and a few seafarers and fishermen. While it happens, never forget that every economy, however large or complex, begins with a man kneeling in a field, pulling out weeds in the hot summer sun. What's it worth to you not to be that man?
On Feb 14 12:57 PM henarl wrote:
> Kelm: Once the politicians have nationalized the banks and gotten
> used to the additional power that affords them, what makes you think
> they will willingly relinquish that power by re-privatizing them.
> That's just not what politicians do. Most government power grabs
> start off as temporary and end up as permanent.
On Feb 14 08:30 AM Steve in Greensboro wrote:
> Dear Mr. Patel, I've enjoyed your articles on Seekingalpha. Your
> assertions in this article are correct. For the next two years, we
> all have to either a) be 100% in gold and USD or b) be day-traders.
> I'm not a day-trader, so I'm 100% in gold and USD.
>
> As long as Obama and the Democrat party have their foot on the neck
> of the economy (union card-check, carbon dioxide tax, expiration
> of the Bush tax rate reductions, etc.) we will not get a recovery.
> If the 2012 elections turn the House back to conservatives, then
> we might get a recovery. Until then, either day-trade or stay on
> the sidelines (gold and USD).
>
> Of course, Bernanke and Obama are sowing the seeds of double digit
> inflation and the next bubble, so we all have to watch out for that.
>
>
> The cure for this insanity is to take money supply creation out of
> the hands of politicians, knowing that politicians are gangsters
> or lawyers or both.
Being self sufficient has many advantages. You don't need much money and government created and monitored money is the most efficient way for the government to meddle in private affairs.
As long as your land is owned free and clear and you have a way to consistently pay the property taxes and either generate income or consume savings until fiscal sanity returns to Washington, you can remain a free person.
To participate in a system that consumes at least 60% of a successful person's income (federal and state income tax, property and sales taxes, tolls, gasoline tax, etc. etc.) is a form of slavery. With the economy turning for the worse, generating the kind of income where people used to say "the answer to higher taxes is to make more money" no longer works. Why work mostly to pay taxes?
It's a good time to take about 10 years off.