Sunday, March 07, 2010

Uncertain Times for Business and Investors

I don't know how many times I have made the remark to friends and family that this Great Recession is occurring like a slow-motion movie. We saw the bodies sailing through the air in our peripheral vision--the Ken Lewises, the Alan Schwartzes, the Martin Sullivans, the Richard Fulds. The stock market implosion took several weeks to come crashing to the floor, and the resultant slow-blooming dust cloud looked thick and impenetrable from a distance, yet translucent and impressionistic up close. With our telephoto lenses we could capture snapshots of the flustered figures scurrying for cover, the fragmented federal institutions falling by the wayside, the thick unbreathable hot air billowing, and the knee-jerk uninformed decision-making with its domino effects.

[Thanks to Wikipedia commons for the photo.]

There are good reasons to cast blame on multiple characters in this film. The financiers were short-sighted and egocentric--and they still are, with no market force intervention to change their behavior. The overseers were, and are, just as short-sighted and egocentric. No market forces ever touch their behavior, except maybe during elections. Even the central bankers were, if not shortsighted and egocentric, at least somewhat smug and over-confident, which is also to be expected since no market forces ever touch their behavior, except perhaps the flux and reflux of Presidential favor.

(Aside about central bankers: In spite of this huge macroeconomic booboo, these economic engineers of our monetary system seem as impervious as ever to the naked insufficiency of the academic tools at their disposal. One gets the feeling that their tinkering with monetary policy is the equivalent of NASA physics experts deciding they know enough right now to send a spaceship to Venus.)

Massive disruption is common in boom-bust business cycles, but in the more minor cycles the cool wind of reality has managed to blow away the burning dust so we all could get back to business within a reasonable period. This time, however, just as in the 1930s, things are not clearing up. I can see two big reasons why.

First of all, in both Great Events we did not take our just desserts. We could have bowed to natural forces and let the excess speculative credit blow out of the system by allowing the big investment houses to go bust and putting up with a really bad year of unemployment and disarray. If we had done this, we would have feared the worst while it was happening, and some pretty innocent people would have suffered just as they indeed have; but after a few months business would have been able to pick up the pieces and get back to work on a more sound monetary foundation. In this hypothetical scenario--quite imaginary and improbable--the government would have done little except perhaps review its choice of central bankers and its banking system.

Instead, we panicked. Certain players, feeling the finger of blame turning towards them were they to do nothing, threw more credit at an already full-to-bursting credit bubble. By doing so we propped up the misaligned investment houses (in the process, creating another precariously speculative Wall Street finance house-of-cards and another salary bubble), and we shifted the malady from the private to the public sector in the hope that the world's credulity and our credit will hold up for at least one more election cycle.

Secondly, and most unfortunately, our 2008 election results made Congress believe that our political pendulum has swung to the government-interventionist side; but this is a misreading of public sentiment. What the politicians have mistakenly interpreted as a national tendency to look to government for solutions to all problems has caused them to take a number of actions that are putting off even further any hope of a return to reality. It's the borderline alcoholic going on the biggest binge of his life in order to cure his withdrawal symptoms.

The binge won't last. This political pendulum swing won't rest long at the apex. By 2012, there will be a new Congressional mix. But until then, I ask you: What businessperson in his or her right mind would invest for the longer term under the present conflictual circumstances?

Robert Higgs of the Independent Institute has a wonderful byline for our current malaise: Regime Uncertainty, he calls it. He wrote a paper on this topic in the spring of 1997 that is finally getting some well-deserved attention. In his more recent commentary "Regime Uncertainty--Now Maybe People Will Take The Idea Seriously," he notes:

"[B]usinesspeople may be more or less 'uncertain about the regime,' by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action.... [T]he security of private property rights rests not so much on the letter of the law as on the character of the government that enforces, or threatens, presumptive rights. 'What does provide some degree of protection,' notes Andrzej Rapaczynski (1996), 'is the political system, together with the economic pressure groups that ensure that the state does not go “too far” in interfering with the owner’s control over assets. This politically determined thin line may be understood as the real definition of property rights conferred by the state, as distinct from the somewhat fictitious legal notion of property rights. How broadly property rights are defined in this real sense and how effective states’ (largely nonlegal) commitment is to their security is a more serious problem than the issue of legal protections against the more traditional form of takings. (93)'"

See also Higgs's article about the Great Depression entitled "New Deal Orgy No Model For Current Binge," in which he writes:

"The reason the Depression lingered long after the Roosevelt administration launched its hydra-headed recovery effort was because businesspeople in general, and investors in particular, feared the president’s assault on private property rights posed a potentially fatal threat to the market system."

This rings true for today's circumstances. Professor Higgs has done some excellent analysis of business cycles. In and of themselves, busts tend to create political turmoil no matter what the existing environment. That we should have havoc today, therefore, is not surprising given the scope of this event.

So, like our businesspeople, until I see respect for property take its deserved spot on our political agenda, I will not invest in our economy. In the meantime, give me a safe haven. I am not an investment adviser, but in times like these when no one can be sure whether we are headed for a flight from the dollar (or from all paper currencies), or towards another huge wave of inflationary misalignment that just puts off the day of reckoning for another decade, or for the third option that is a decade of Japanese-style stagnation with a big question mark at the end, I can see no better investment than gold and gold-related assets.

It's true, their price will tend to fluctuate in terms of paper currencies, and the politicians will always find ways to tax away any real advantages; but the underlying gold will never lose its innate value, no matter which politicians are in charge.

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