Altus Insight - April, 2013

The Altus Insight

Market news, commentary and relevant topics for today’s alternative asset investor


Date: April 30, 2013

FR: Forrest Jinks

RE: This isn't a Free Market

Before we jump into the meat of the article I would like to share that Altus Equity is happy to announce the hiring of Kristy Brooks as Operations Manager. Kristy has held management positions in the finance departments at Hewlett Packard and E*Trade in addition to being a founder and partner at Harrington Brooks Properties. We are excited to have her on our team.

The topic of this month’s article is something that has been percolating in my thoughts for the past few months. As the mostly jobless recovery drags on, it has become the popular norm for talking heads to bash capitalism and free markets in recent articles like this one written for Market Watch (click here).

As an investment professional who makes his living out of seeing things other people either don’t or refuse to see, I have a tendency to examine anything that becomes accepted as truth with a critical eye. In many cases I discover the “norm” is not based on truth and that “commonly accepted truths” have no factual backing. Readers of the Altus Insight know that I tend to be heavy towards the free market end of the economic spectrum so this exercise had the additional weight of me examining my own thoughts and beliefs. Three months into this exercise my opinions regarding capitalism and free markets didn’t change, and if anything solidified.

You see, this “free market” bashing is an ongoing example of the argument fallacy called “straw man”. The idea of a straw man is to create a false opponent, or a false position of an opponent, so that is easier to attack than the opponent itself. The pundits that are bashing free markets may be doing it out of innocent ignorance, but by blaming our current problems on free markets and capitalism they are laying the blame of our current issues at the feet of the wrong altar. The U.S., and certainly not Europe or Japan, does not enjoy the benefits of a free market, or anything that resembles a free market.

The rich-poor gap is constantly highlighted as support for the argument against free markets. Before showing the evidence of a current lack of a free market, it is worth pointing out that even while the gap between the rich and poor may be growing, the poor are certainly not worse off because of this. The standard of living among those below the poverty line in the U.S. has increased dramatically over the past few decades as measured by any one of a number of measurements: prevalence of air conditioning, vehicles, cell phones, computers, access to higher education, etc. A quote from Christopher Burden sums up the situation nicely:

"The widening gap between rich and poor measured by earned income is a megatrend that has been growing in lock step with the globalization of markets and has continued uninterrupted under both Republican and Democrat administrations. Although it may seem counter intuitive the gap in standard of living has actually been going in the opposite direction as capitalism continues to deliver affordable goods and services to people at every level of society. Even the most leftists among us can hardly fail to see the deflation in high tech gadgets we all now take for granted. Moreover as companies that were once national have become multi-national with the expansion of free trade their competition for people with the highest skill sets has increased dramatically. As a result those folks with the highest skill sets have achieved greater franchise value and thus higher rewards in terms of compensation. In contrast lower skilled American workers have had to compete with billions of their low skilled counterparts everywhere else in the world and thus have only commodity pricing power for their labor. This is a market driven cause of the growing earned income gap between rich and poor. However the silver lining to free trade  has been a higher standard of living than ever before at every income level"

However, I believe we need to clarify that what we currently have in the world is not true capitalism, is it just something that most resembles a worldwide capitalism since the early 1900’s, even while within our own borders there has been a distinct decline in the freedom of the market over that same time period.

There are plenty of examples that prove this to be true:

One of the most important aspects of a free market is the ability of capital to flow to where it can be most efficiently and effectively used. Our government obviously doesn’t buy into this portion of the free market. Subsidies, such as the one given to political buddies at Solyndra, in addition to increased taxes and regulations on coal production/use are clear examples of a government that is trying to steer production and consumption in directions obviously not the most efficient or effective for investment. If they were, they wouldn’t need the subsidies. Before the Republicans get too smug in agreeing with my example, it should be mentioned the oil and farm industries have been receiving similar subsidies for years. All of us who are homeowners need to remember that our yearly interest deduction is available because we have a government who believes it has the mandate to reward homeownership at the expense of renters.

 Free markets are built on trust. The sanctity of contracts is imperative to this trust. With social media and growing levels of customer interaction via chat rooms and review sites, trust within the market could have gone to a new, much higher level. Instead, the government itself destroyed the sanctity of commerce contracts with the structure it forced on bond holders in its bailout of GM (as but one example).

 A key component to the free market is its ability to have an occasional recession to rebalance the economy and clean out inefficiencies. This is part of the “Creative Destruction” described by Joseph Schumpeter in his book Capitalism, Socialism and Democracy (originally published in 1942). A recession rebalances the distribution of investment capital to where it provides the best risk adjusted returns, and cleans out the effects of the irrational exuberance that we humans love to exhibit (hence asset bubbles). It also cleans out poorly run businesses, resulting in a better value for the customer and stronger business for the businesses run correctly in the first place. Remember, the greater the level of irrational exuberance, the larger the correction that needs to take place. When the government steps in and enacts policy to try and slow or minimize the push of a recession it does so at a cost to those not involved with the reasons for the recession in the first place. By not being able to foreclose and clean out bad loans, there was less money to relend to good borrowers who could afford to buy, if only they were able to get loans. By enacting huge amounts of deficit spending to prop up existing poorly run businesses (we are back to GM again) the government is taking money out of the pockets of future generations to pay for the mistakes and excesses of the current generation. Additionally, a recession is necessary each time there is a bubble. By changing the natural course of the recession, the recession is either lengthened (think that might be the case here as we are now 5 years into this trough?) or the effects are pushed into the future to enhance the fury of a future recession (which well could have been the case of the government’s involvement in trying to minimize the recession of 2001).

 Staying on the theme of creative destruction, one thing this destruction produces is a changing and better work force. Progressives like to claim they are for change, but it seems their progression is only for change they approve. Change, like new and better businesses sending old businesses to the junk yard, is viewed as a travesty that must be stopped at all costs. The reality is this change occurs due to improvements in processes, products, education, etc. The government obviously interfered with creative destruction in the GM case, more worried about the short term effect of the employed, without taking into account that there was likely another industry out there that needed retrained workers to become the new bearer of American prosperity. You may hate to shop at Walmart, but there is a reason they are the world’s largest retailer. They are obviously doing something, and likely many things, correctly. The arguments against Walmart are probably valid, but in a free market economy, those arguments turn into opportunities for the next visionary to create something new and better.

 Obamacare is anti-free market on many levels, forced coverage being the first. Part of the justification for the financial modeling of Obamacare is that legions of young and healthy people would be forced to obtain health insurance. Those additional premiums would help cover the costs of the additional coverage to the older people now promised under Obamacare. While my personal belief is health care is important for people of any age, the forced coverage provision is another way of transferring wealth from future generations to current generations. Few would question that Obamacare is a net reduction to the free market of health care. The effects of such reductions are evidenced by the spike in premiums across the country. A study released by the respected Society of Actuaries (maybe not an exciting group, but respected J) estimates that health care prices in California will be 60% higher in 2013 than in 2012 and will be 32% higher on average across the entire country for the same periods. When laws are passed and prices increase, it is an obvious example of a non-free market.

 Regulations are stifling entrepreneurship. This statement is no surprise to small businesses everywhere, and makes sense all across the board. It is no secret on Main Street that Wall Street and Corporate America are in bed with the politicians. After all, who pays the lobbyists who in turn pay the politicians? The Dodd-Frank Act is a perfect example. Regulation that was touted as a safeguard against Wall Street instead made business much more difficult for local and regional banks while adding a slew of financial institutions to the Too Big to Fail list, allowing them special privileges with the government. Next time you read about a new regulation to “make our food safer” read the regulation itself. Most likely it is increasing the difficulty for a small producer to get their product to market. Even more likely is it is supported by large agricultural interests such as Monsanto. The higher the degree of difficulty in complying to increased regulation, and the greater the cost in complying with that regulation, the less competition the large company will have in the future as smaller competitors are wiped off the map. In this interesting article (click here), the founder of Subway, the world’s largest franchise, claims Subway would not exist if he was starting it today due to the increase in government regulations. While anecdotal, my own experience in dealing with regulation across a variety of different businesses and projects certainly supports this assertion.

Government stimulus is the antithesis of free market. Given to those closest to the government (like Solyndra) instead of those who can deploy it most efficiently, the theory is the money distributed will trickle down (gasp) to the rest of the economy. The eventual effect is a decrease in the value of a dollar as more dollars enter the economy (even though the effect may be far in the future). This leads to an increase in the number of dollars needed, which then leads to an outsized but undefinable cost to those that are furthest from the source of the increased money. A recent example of this was the increase in food (and other commodity) prices shortly after the stimulus spending (and action by the Federal Reserve). This increase in prices most severely affected the lowest income earners and those on fixed incomes, both of which are far from the benefits of the stimulus.

 In this same vein, the actions of the Federal Reserve clearly favor one group of people (investors) over others. Using the same trickle down argument (double gasp) in claiming the rising asset prices will create a wealth effect that will lead people to spend more money, leading to increased demand on the supply chain which will then lead to an increase in hiring. However, those receiving the final benefit (the hiring) are far down the food chain from the original recipients of the benefit (the investors). In the meantime, the increase in asset prices has already hurt those at the end of this chain of events through an increase in costs (rent or home prices for instance). Even removing the damage of the Federal Reserve’s action, I don’t think anyone would argue that the Federal Reserve’s actions are made to influence the market(s) and thus, like the stimulus, are the antithesis of free market.

 Lastly, it should be reiterated, as un-free as our market(s) are, they are freer than most other markets in the world. Is this the cause of the rich-poor gap? Interestingly, despite the hyperbole, the U.S. doesn’t lead the world in super rich. Moscow is the billionaire capital of the world, and Asia, with its far lower overall standard of living, has more super rich than North America. If the rich-poor gap is an indication of how well a type of economy is working, this would indicate the managed economies of Asia create a greater disparity than the freer (though still mostly managed) economies of North America.

I should point out that even while being a proponent of freer markets and far less government intrusion into the economy, I am not a proponent of completely free markets, at least not without a long transition period during which time the populace could learn the necessary skills to transact in that environment. What I do believe is necessary is much freer markets, where innovators and risk takers can innovate and take risks without the crushing burden of government interference pushing back at them every step of the way. An increase in this type of freedom would lead to a lot of failures, as innovators and risk takers would discover that their products and ideas weren’t needed by the market as a whole. But an increase in this type of freedom would also lead to scores of valid and successful new businesses being created, new industries being formed, and as with the personal computing and cellular technology booms, an increase in the standard of living across society.

It is worth mentioning again, your or my opinions on a topic such as the freeness of a market doesn’t generally impact the reality of the situation. However, taking the time to understand the situation enough to be able to form an educated opinion is important in that it gives us a greater understanding of the situation itself. That greater understanding can then lead our investment decisions. How does an increase in government regulation affect the food supply? What will the subsidies to the solar industry do to energy prices and how will it affect other types of energy production? How will government stimulus affect the savings of the middle class? What will the various QEs do to rental rates? Who is benefitting from government decisions, and how can I invest in the same direction as they are investing?

The list of questions goes on and on, each one leading to more questions and more thought. It is easy to become frustrated during this process as apparent injustices are made evident, but unfortunately unless you, as the reader, are in a far more politically connected place than am I, we must overcome our frustration to understand the reality, and then invest accordingly.

Until next month,


Forrest Jinks

Altus Equity Group, LP

off: 707/536-1711

fax: 707/544-2972