Much has been written about the Health Care proposal concerning the “Public Option.” Some object because government is a less efficient administrator, some because private companies will be incentivized to terminate their own plans and move their employees to the less expensive public option, and some because of the cost to the Federal government. This may all be true, but I have another objection.

Setting up a public company to compete with private companies is not how we do things in the United States. The federal government would be the 900 pound gorilla in the Private Health Insurance sandbox. The federal government has significant unfair advantages in competing with private companies. The federal government defines property rights in this country. The federal government runs the IRS which determines tax policy for private corporations and audits private Health Insurance companies. The government regulates Health Care and determines which medical drugs can be legally sold. A potential “U.S. Health Insurance” could make no business decision so incorrect that the Treasury/Federal Reserve can’t print enough money to keep it solvent. Would all these sister agencies really be indifferent to the competitive concerns of “U.S. Health Insurance“ when the going got tough?

Many Seeking Alpha authors including myself have been predicting inflation for the past several months and recommending hard asset strategies/short Treasury (TBT, PST, TYO, RYJUX) to prepare for the inflation we saw coming. Our detractors ridiculed us and pointed out the embarrassing fact that the U.S. is suffering from deflation right now, not inflation. The S&P placed the UK on Credit Watch Wednesday and brought the whole issue into blinding focus for me. I am long TBT and Wednesday (Jan 20) saw TBT value decline because the Fed threatened to buy more Treasuries at the long end of the maturity spectrum with electronic fiat money created out of thin air. Then in a flash the S&P Ratings Service rescued me by placing UK government bonds on Credit Watch.

So maybe Seeking Alpha authors were really saying this: The U.S. government is imprudently borrowing or printing too much money and there has to be a bad effect from that somewhere. If Obama and Geithner can spend 2 trillion they don’t have in 2009 with no bad effects whatsoever, then the rest of us missed something fundamental. Maybe the bad effect from deficit spending is inflation (with a lag), maybe that bad effect is higher interest rates, maybe the bad effect is a falling gdp, but there must be a bad effect somewhere. And then, from out of the blue, the S&P Ratings Service gave our thoughts voice. The S&P said some amount of government spending is excessive, and the UK has stepped over the line.

The hard bitten investor in you is having thoughts like this as regards our current economic situation. “In the U.S., the government is spending a lot of money it doesn’t have on stimulus, pork barrel projects, TARP/TALF rescue, etc.. That can’t be good. They must be either printing or borrowing money to do this. Interest rates on government bonds and inflation have to be going up in the future.” Two things fly in the face of this thinking. The 30 year Treasury had yields of less than 3% in January of 2009 (I would argue this was a flight to safety from other investments). During the Great Depression, a dollar in 1939 was worth a lot more than a dollar in 1928 (see chart) and bond rates fell from 1928 to 1939.

I generally don’t like to compare the current situation with the Great Depression but there are some parallels:

The U.S. has historically engaged in less government interference in private sector businesses than most other nations. The Financial Panic of 2008 caused the country to forsake its’ past reluctance to interfere in the private affairs of companies, and TARP money was used for direct government equity investments in major U.S. financial organizations. Although the influx of government money strengthened the balance sheets of these financial institutions, many of waited with trepidation for the other shoe to drop. As the country struggles with the economic downturn, the inherent conflict between the governments role as a regulator, it’s new role as a rescuer of companies, and the interests of private companies have come into sharp focus. Government negotiators, under political pressure for results from impatient voters, have started to use the TARP investments in banks to pressure banks to fulfill what they see as socially desirable outcomes. Here are three important examples:

1) Government pressure on Bank of America (BAC) to go through the Merrill Lynch deal. B of A’s CEO Ken Lewis was placed in a damned if you do, damned if you don’t position. During the negotiations with the government concerning Merrill Lynch, Mr. Lewis was told to not speak publicly of any problems at Merrill Lynch and threatened with removal if he didn’t go through with the deal. Later he was attacked by shareholder groups for not being forthcoming enough about the problems at Merrill Lynch.

Free market advocates have a lot to answer for these days. A lot of people have lost their jobs and anyone with a significant investment in the stock market or private bonds has lost 25 to 50% of their money. In terms of leadership, the free market advocates couldn't have asked for more. We had a Federal Reserve Chairman who drank tea in Ayn Rand's apartment, a Treasury Secretary who came from the most swashbuckling Investment Bank, and a President and Vice President who had clear and unapologetic free market tendencies. And yet by the end of 2008 some very bad things were happening.

Serious people now have to ask themselves serious questions. Should the U.S. move its political and economic affairs in the direction of the Soviet Union, Cuba, or the more socialist states of Europe to avoid the extreme outcomes of a capitalist economy?

Any discerning person must wonder how the U.S. has been able to run significant Federal deficits, on average, since the Johnson administration and not have extreme negative Economic affects. A government can run a deficit only if it prints money or engages in genuine borrowing. If it excessively prints money, the country gets significant inflation and the leaders will be voted out of power. If it engages excessively in genuine borrowing, the government will crowd out private borrowing, interest rates will rise, and debt service will consume the government tax take, and the leaders will again be voted out of power. So this leaves one to wonder how the U.S. has been able to run significant Federal deficits for 40 years and only have some bad inflation in the 70's and early 80's to show for it.

This week I read an article that connected the dots on the deficit conundrum. Some may object to the source of this article, but read it for its investment and economics value. If the authors' predictions were as good as they claimed (they may not have mentioned predictions that didn't work out so well) it behooves all investors to understand the way they think and what indicators they keep an eye on. Their predictions on commodities (OIL, GLD) and equities (represented by DIA, SPY, and VEU) were spectacular.

I don’t know about you, but as a citizen of the United States and a believer in free markets, I find the economic and financial performance of the United States during the last four months shocking. The occurrences of the last four months have strong men and women going home at night and saying to themselves “What the #&%$# happened”. I think I now know “What Happened”. It has been hinted at in Seeking Alpha blogs, published in The Economist magazine as an article buried in the back, not the cover page, but it has not been fully recognized on the cover page of a major magazine or newspaper anywhere that I am aware of. A cover page that says “This is what caused our current economic mess” is what I think most people are interested in.

Look at the graph below (from this Seeking Alpha article - I’m not sure I agree with the article but the graph is what I want you to see) and ask yourself what is striking about it.

One thing that struck me, even before the current market downturn, was how highly correlated worldwide investments are. You could be long Retail, long Healthcare, long U.S. Index funds, long Technology, long Asia, long Africa, long Gold  - and they still all moved together: if one was up, they were all up; if one was down, they were all down.

Clearly diversification alone did not avoid significant losses in the current market downturn. You would think “I’m diversified by market segments, by geography, by technologies, by … " and when the market went down, there was no place to hide.

The current mortgage foreclosure mess has the Adjustable Mortgage and Negative Amortization Loan as one of its primary culprits. An adjustable mortgage loan comes with a preliminary set of payments that revise, generally upwards, based on the current value of some widely recognized interest rate like Prime or Libor. In the face of falling housing prices (many times driving the value of the home below the principal balance) and rising mortgage payments, many homeowners are defaulting on their mortgage loans.

These defaults set off a chain reaction that cascades upward into the Mortgage Backed Security market and on to the balance sheets of some of the U.S.'s largest financial institutions. There are many causes for the foreclosures, but borrowers not understanding what they were getting into accounts for a major percentage of the foreclosures. The current crisis is well underway, but I want to propose a contractual improvement that could keep the Adjustable Mortgage Loan from being such a big problem in the future.

Free Market economists lament the direct and indirect consequences of government interference in the marketplace. The decision in the early 1930's to have a GSE (Fannie Mae) guarantee private mortgages, instead of the individuals who took out the mortgages, is causing us a doozy of a problem here in the early 21st century. Compared to other government actions like providing public pensions (Social Security), and guaranteeing medical insurance for people over 65 (Medicare) the decision to create Fannie Mae seems relatively innocuous, but the indirect consequence of Fannie Mae (FNM) and Freddie Mac (FRE) was our most recent housing bubble.

It is now clear the Fannie Mae and Freddie Mac had a large and important role in creating the housing bubble that would not have been possible if they did not have the implicit (and it was more implicit than people thought) backing of the U.S. Government. Fannie Mae and Freddie Mac have an implied leverage ratio of anywhere from 60:1 to 200:1.

The investment term “Emerging Markets” conjures up images of  some third world country that is coming into its own, in which its people are moving from farming to factory work and computer programming, and in which the third world is benefiting from first world technology.  

I think something very different is going on for most Emerging Market investments. The unvarnished truth is that many countries in the world have been Communist or heavily Socialist since the end of World War II.  BRIC is the poster child of Emerging Market investing.  The RIC part of BRIC is definitely a case of these countries throwing off the yoke of a centrally planned economy and moving towards a free market/Adam Smith type approach.   Brazil appears to go contrary to the general thrust of this article and will be discussed below.

Many free market economists lament the abandonment of Bretton Woods (1971 under Nixon), when the U.S. formally stopped promising gold redemption for Federal Reserve notes (U.S. dollars). It’s not that these free market economists particularly love gold, they just want some kind of constraint on the ability of central banks to print money.

As is the case with many things in life, an innovative financial system and technology have come to the rescue of the problem of governments printing too much money, which causes currency debasement and inflation. Do you want a currency backed by gold? There aren’t very many in the world today, but you can buy the streetTracks Gold ETF (GLD), which represents a tenth of an ounce of gold, and you do have the right to redeem your shares for actual gold. Money is supposed to be a medium of exchange and a store of value. With modern technology , you can buy GLD as your store of value and then sell GLD on your Blackberry if you need the medium of exchange (dollars).