Sense and Nonsense

This week I want to write about the differences between a market driven economy and a centrally controlled economy as I promised last week. The question essentially boils down to, “How should the United States of America allocate its resources”? It is a political question. As such, it is difficult to address objectively and succinctly.

First, the federal government in the USA does not have the authority under the Constitution to allocate resources. That power is reserved to the states or to individual citizens. The fact that the federal government does shift resources from the young to the old, from the industrious to the lazy or from the healthy to the unhealthy does not make it legal. It just means that they do it in violation of the most fundamental body of law in the United States of America. It replaces the rule of law with the rule of people who have seized sufficient power to act illegally. If Americans want a centrally controlled economy, then the Constitution should be amended or or replaced to achieve that goal legally. That will not happen.

Most people will take exception with that statement, particularly with the idea that the federal government is operating in violation of the law of the land. Some will latch onto general phrases in the Constitution (such as the very first paragraph) to justify ignoring specific laws contained in the document. Others will argue that the fact that the government does it makes it legal under the dubious reasoning that “precedent” is part of the constitution. (I say dubious because the same people who make that argument would find it ludicrous for me to say that the fact that I have driven at speeds in excess of the legal limit in the past, I can legally ignore speed limits now and in the future).

But there is a price to be paid for ignoring and tolerating illegal activity. The primary consequence is that we become ruled by powerful people instead of by laws that apply to every citizen. In the case of national resource allocation, the primary concern becomes pleasing powerful people. That alone makes everything I know about investing obsolete and useless.

The only question that needs to be answered is, “Does this company have the blessing of the government or not”? If the answer is yes, the company cannot fail (until the blessing is removed) because the federal government will allocate unlimited resources to assure its' success while regulating and taxing competitors into bankruptcy. The problem with replacing fundamental stock analysis with political analysis is that the blessing was arbitrarily given and can be arbitrarily removed, depending on which powerful person is allocating resources at the time. It may also be that the blessing costs more than the company can afford to pay, leaving owners and lenders with little or nothing. That has been the case with the large US banks, AIG and GM.

The General Motors situation is particularly interesting in that the federal government left GM creditors unpaid and seized the company in special prearranged bankruptcy proceedings. Then they gave some 40% of the company to the United Auto Workers in payment for their political support and retained the rest. Now, the UAW is suing GM (themselves and their benefactors!) because one of the major creditors that went unpaid was the UAW pension fund. Stay tuned for the next exciting episode! My guess is that the powers that be will find a way to shift GM pension liabilities to their competitors (like Ford, Honda and Toyota) or the taxpaying public. The point is that the rule of people is arbitrary and completely unpredictable.

Everything I know about successful investing assumes the laws of ownership and lending will remain constant, regulation will not be retroactive and new mandates will be phased in to avoid serious disruption. As I look back on it, they have been less and less valid for many years but I failed to notice or convinced myself that the exceptions were special cases, not the norm. That changed during 2009 for me. Those assumptions are no longer valid because we have irrevocably crossed the line into the era of a centrally controlled economy run by capricious decree instead of the rule of law.

Recently passed health care reform, pending financial regulation changes and the looming cap & trade proposals will undoubtedly be jammed down the throats of the American people without debate, deliberation or consent of the governed. Once that is done, it can't be undone any more than a bomb can be unexploded after detonation. The best that can happen is an orderly cleanup and rebuilding process which will take decades. The worst is that there will be no cleanup and no rebuilding.

Historically, centrally controlled economies allocate resources less efficiently than market driven economies. They are characterized by chronic shortages rather than boom and bust cycles. Black markets, unknown in a market controlled economy except for banned products, arise to satisfy unmet demand for legal but unavailable goods and services. The life choices available to the average citizen come down to being a criminal, a bureaucrat or both. There is little incentive to acquire an exceptional education or perform any task well because merit becomes disconnected from compensation.

The Depression/WW II generation did not believe this could happen, although they set us on the road in the name of generosity. The “boomers” (I am on the leading edge of this generation) ignored and tolerated it in the name of expediency. The “boomers” children suspected the truth but believed their parents and grandparents that it would be OK. Their children, today's young adults in their late teens and early 20's, know the score. They go to school to kill time and party, run up huge debts that they cannot not ever pay and fully expect to have less than their parents and grandparents.

So we say we are afraid for them? We feel sorry for them? We hug them and tell them we love them? And tell them we care? Come on now. If you love your family and your country, it is time to clean up this mess and leave them a better world than we enjoyed. We have less than 20 years to do it. It is time to get busy.

Cordially,
jch