Monday, March 3, 2008

Investing Like A Mercenary Guerilla

Awhile back I wrote that "The US Government is becoming more wasteful, more inefficient, more coercive and more socialistic every day. This is a trend that is inherent in the nature of all government (all of them throughout the history of civilization--all empires eventually collapse).... What we must do is reframe these problems into opportunities. How? By understanding the political & economic institutions that we live in, we can utilize the opportunities that these flawed institutions create. That is how big money is made. Hedge funds and other opportunistic investors do it all the time."

As investors and traders we must, however painful it may be, understand the effects of politics and political trends on financial prices. I am of the opinion that an investor consider himself a global citizen who owes no allegiance to any country (or asset class). You go where you can make money. You must be a "mercenary guerilla" when it comes to trading and investing.

Why do I say this so strongly? because the nature of the world has changed compared to 20 or even 10 years ago. And if you are to prosper you must adapt and learn to utilize the conditions presented by the current framework you live and operate in.

Its no secret that formerly socialist countries all over the world have been embracing capitalism and seeing their standards of living improve dramatically. But many governments are doing this out of necessity rather than kindness. Governments, being the inherently inefficient, wasteful, and coercive institutions that they are, don't like the idea of having to compete against one another to attract knowledge workers, businesses, jobs, and capital.

But compete is exactly what they are being forced to do. Businesses are increasingly more virtual. Capital flows more fluidly around the world. Knowledge workers are now mobile, work virtually, and can live anywhere they choose. And they will increasingly choose those places that offer the most favorable environment. The United States is still a big attractor of these valuable knowledge workers, but the US is no longer rated as the most capitalistic or freest country in the world .

Do not misunderstand me, the US is still a relatively wonderful place to live, and still has a strong competitive advantage over other countries. But it is the trends that matter, and the trends that are currently in place suggest that the US is losing its competitive advantage. It is becoming relatively more socialistic while formerly socialistic countries are becoming more capitalistic.

In general, the business literature has said that a firm has a competitive advantage if it is more profitable than its competitors over time. For example, a firm like Goldman Sachs has a competitive advantage in investment banking because it consistently outperforms its competitors over time. Just like a business, an individual country has a competitive advantage that can be enhanced or suppressed. When a country embraces and focuses on its unique strengths and applies them to the global economy in an optimal way it strengthens its competitive advantage, and with it higher standards of living. So in other words, one could argue that other countries' such as China for example, are embracing and strengthening their competitive advantage while the US's has decreased in strength. This is why China has attracted so much capital and investment in recent years.

For the most part, capital, or money, is highly mobile and quickly moves to where it will be valued the most, earns the highest returns and feels safest. We see this every day in global financial markets, as money flows to where value is being added. On an individual level the premise is the same -- embrace and develop your competitive advantages and you will prosper.

The USA is currently in the midst of destroying the very foundations of its competitive advantages - low taxation, minimal government, free markets, strong private property rights, sound currency, strong civil liberties & a free thinking culture. Instead, the US is evolving into some kind of fascist/socialist hybrid type of government, and I must admit it is a bit scary for a freedom loving individual such as myself.

People often forget that this country was built on a hatred of government. Over the years the masses have become a bunch of brainwashed government owned slaves who are now afraid to be critical out of the fear of being tazered and labeled a terrorist. But I digress, we are here to talk about finance & economics....
Folks, the bottom line is this. If you are going to be successful (or simply survive) as an investor in this day and age you need to approach the markets like a global hedge fund. You must approach the markets with the right mental framework that allows you to exploit opportunity and avoid poor risk/return situations. Given todays information technologies, the individual investor can put money just about anywhere. There are no excuses - you must adapt.
This is not 1985... you are no longer stuck investing in one socioeconomic system or asset class. If a country is acting stupid don't put your money there (or at least hedge against losses). We now have access to many different countries and assets classes.
When will the US begin to restrengthen its competitive advantage and get back on the road to recovery? In the short and intermediate term (1-3 years) we will likely see a continuation of the slow growth/stagflationary economic conditions, and given the amounts of malinvestments (shortsighted investment projects that go bad) currently in the US economy there is a good risk that the current recession will turn severe. Governmental institutions and their short term fixes are only prolonging the problems and making them worse. Adding fuel to the fire is this being an election year.... There is a lot of pressure for short term fixes and bailouts. The politicians are falling all over themselves trying to buy votes with their promises. And Bernanke, of course, is more than happy to print more money to enable all of this which over the longer term will mean more inefficiency and more malinvestments.

But when the political uncertainty subsides the next group of politicians will come into office and engineer another financial bubble/regime that favors their political/special interests. That is how the game is played. Like someone renting a house they have no interest in the long term value of the property. They will milk it for what they can while they are in there, and favor policies that influence relative prices in a way that is favorable to their interests. So, looking out into the future, over the long term, there will be more bubbles, there will be more volatility and there will be more inefficiencies and malinvestments created, and for the astute investor, that means opportunity. We must be aware of the inefficiencies and manipulations and operate from a framework that utilizes the effects that occur in the markets.

It is looking increasingly likely that Obama will be the next president. Americans are being faced with choosing between a fascist (McCain) and a marxist (Hillary or Obama). (Wouldn't it be great if everyone just voted "none of the above" on election day?). With roughly 70% of the population against the war, the republicans don't have a chance with a pro-war candidate, so that leaves Clinton or Obama. Economically, I do not know who would be worse, it is too soon to tell but I think it is safe to say they would both increase the size of government and raise taxes.

Oddly enough, over the long term I am optimistic..... As my old professor, Hans-Hermann Hoppe used to say "ultimately, the course of history is determined by ideas." And the younger generations are embracing many positive ideas. They may not be marching on Washington DC, (because they are busy accessing info on the internet and figuring out how to be successful) but make no mistake they will be agents of change in the years ahead.

There is currently a huge wave of social change gaining strength. Yes, thats right -- the greatest forum for critical discussion in the history of civilization, the internet, is enabling this coming wave of change. How else can one explain the popularity and fundraising o a politician like Ron Paul? You may say - well, that popularity did not translate into too many votes in the primaries. He was completely ignored by the mainstream media and hated by the old power brokers and insiders within the republican party. I do not have any statistics or numbers to prove this and will not waste the time in finding them, but my belief is that most of the people who support and would vote for Dr. Paul are registered as independents, or simply switched to being democrats. In other words, they saw no value in wasting their time with the sinking ship called the republican party.

In todays world, the investor must stay aware of and exploit socioeconomic change. Political institutions usually lag social change by quite awhile, so we can usually see these changes coming. Right now and for the short and intermediate time frames (1-3 years) the trends for the US are negative.

Those of you who have read my previous posts know that I view what is happening in the markets in terms of theories that are gaining or losing strength. Currently, and into the near future, the stagflationary recession theory will remain dominant... in general this means a continuation of recent trends for the 4 main asset classes: equities - a continuation of the decline, currencies - shorting the USD, bonds - interest rates continue to fall because politics matter more to the Fed than a sound currency, commodities - gold and everything else continues to rise due to global demand and the debasement of currencies.

Yes, treasury rates have come down and will likely go lower... but risk premiums will remain high due to all the malinvestments rising to the surface in the various credit crisis that are now in play. When the malinvestments are worked out of the system, then recovery (or the next financial bubble) can begin. So we have to gauge the effect of political interference in the markets with the markets attempts to rid itself of the malinvestments.

Same story, different day -- at least for the foreseeable future…. Eventually, down the road when the election is over and some of the malinvestment has been worked out of the system, risk premiums will decline. Then the government & Fed will engineer another financial bubble somewhere. Given the flawed institutional frameworks that we live and operate in bubbles and collapses are now the norm. As an investor you must adapt. Be a "mercenary guerilla" when it comes to your money. If you align your strategy and tactics to the current framework and market conditions you will prosper. ~ John T. Bardacino, CAIA


  1. I wonder how much money is leaving the country just because of this? Letting my savings sit around in USD makes me feel like I'm burning dollars to heat my house.

  2. [...] successful, one must view himself as a global citizen and approach the financial markets like a “Mercenary Guerilla.” This means we exploit the effects that flawed institutions have on financial [...]