Finding Investment Opportunities when Government Intervenes in Markets

In a centrally planned economy, finding investment opportunities is primarily a matter of understanding how central planners are affecting the economy: what incentives are they creating? To whom are they transferring wealth? What industries or companies may they shut down? Answering these questions, rather than understanding supply and demand, is critical to successfully identifying speculative opportunities.

A Historical Example: The US Financial Bubble

The US financial bubble -- meaning the rise of offers a prime example of how market participants, if they are watching the right signals, can understand the incentives central planners are creating -- and can develop a wealth management strategy accordingly. Below is a timeline of how central planners created the rise of the bubble in the finance sector (as seen in the rise of XLF):

1. The Taxpayer Relief Act of 1997 helped fuel investments in housing by giving tax credits to home purchases.
2. The Gramm Leach Bliley Act of 1999 helped further consolidate commercial banks and investment banks, which contributed to the securitization of loans made by commercial banks; this securitization naturally helped fuel securities dealers in the finance industry.
3. Part of the compromise legislators made in passing the Gramm Leach Bliley Act was to strengthen the Community Reinvestment Act, which made loans more accessible to lower-income borrowers (many of whom would prove to be unable to repay loans in the years that followed).
4. The Commodity Futures Modernization Act of 2000 helped to deregulate the banking industry and allowed for the creation of unregulated credit default swaps (an insurance product); this allowed money to flow into the financial sector with fewer hindrances.
5. As the dot com bubble was collapsing, the Fed began to drastically lower its target Fed Funds Rate in 2001 and 2002. This made credit cheap and encouraged borrowing. With housing loans and more made easier and more appealing via previous legislation, and with laws passed to facilitate the securitization of these loans, the ingredients were in place to create a bubble in the US financial services industry.

As the US financial bubble illustrated, bubbles in a centrally planned economy can happen slowly. The rate at which they occur depends largely upon how quickly legislation is passed and executed, as well as how aggressive the central planners are in accomplishing their objectives.

What to Look for in Spotting a Centrally Planned Bubble

To understand where bubbles form in centrally planned economies, a few questions are worth considering:

1. Who has lobbying power? Understanding what special interests have been successful in securing legislators on their side is crucial.
2. Once we have identified the sources of lobbying power, we can watch legislation to see how their lobbying power is manifesting.
3. If a socialist economy has entered the bailout/nationalization phase -- meaning if central planning has moved from indirect influence via legislation and monetary policy to direct influence via purchases with tax dollars and/or expansion of the money supply -- it can be crucial to note which companies will receive wealth and which ones won't.

In the context of the current US economy, former venture capitalist and economist Eric Janszen has identified alternative energy as the next bubble resulting from central planning.

Next time, we'll take a look at some strategies for trading the bubble once it's been identified.

Comments

[donzelion:]

Nobody cares "who has lobbying power" today - the real concerns are (1) who will have it tomorrow, and (2) what results will be obtained in the mean time. Since guessing about either is pure speculation, most folks try to focus on narrower questions: "what is the likely effect of this manifestation of power?"

E.g., Republican strongholds are in rural and suburban America. One would expect Republican policies to favor "ruralizing" and "suburbanizing" trends - that is, policies that promote buying homes, policies that promote lower costs for goods inside those homes, etc.

It's not the outcome of a command economy or some secretive "home-buyer lobby" or "Pro-China Lobby," but rather, Republicans serving constituents as they saw fit.

Feb 18 07:59 AM

[je:]

Thanks again for a different approach. I look forward to your commentary.

Feb 18 01:16 PM

[H.J. Huneycutt:]

Good article. Too many people ignore the fact that the market is affected to a significant degree by the preferences of policymakers; which are normally affected by who has significant lobbying power. This bubble was produced by the very high level of influences banks and financial institutions have on Washington; combined with the influence of realty organizations.

Of course, most people also have misguided perceptions about who has influence in Washington and how these interactions are likely to affect the overall economy (the fact that people are buying up stem cell research companies right now might be testament to this). I'm not sure I buy into a long-term infrastructure bubble, but it's possible. Alternative energy, on the other hand, does get continual government support and that support will probably continue to grow - of course, it's still important to do due diligence and find which companies are realistically able to benefit and which ones are scams and failed businesses waiting to happen.

Feb 18 02:11 PM

[henarl:]

The entrenched oil, natural gas, coal, auto, electric utility, and union lobbies will do everything in their power to slow down alternative energy growth, as they have successfully done so far.

Feb 18 03:32 PM