Gyroscopic Investing

I've been slowly piecing this together over the last few years, but it's starting to dawn on me that the system is rigged. I don't mean one piece, or a few pieces, but the entire system. This may come across as a bit of a rant, and I'm using it to lay out my thoughts, gather feedback on my positions, and will later polish it up into a fully coherent blog post 

The government prints new money and causes inflation. Because of inflation, your purchasing power degrades over time for any saved money. If you "invest" your money, then you pay taxes on earnings, even though most of the earnings aren't really earnings on an inflation-adjusted basis. If inflation is 3% and you earn 5%, then more than half of your earnings are phantom earnings, yet you are still taxed on the full 5%. Thus, of the 5% earnings, 1% may go to tax, 3% is lost to inflation, and you really earned a 1% return.

However, in order to make 5% return, or a 2% "real return," one must take risk. There is no risk-free 2% real return investment (TIPS used to be, if you believe that CPI tracks inflation, which I will cover shortly).

The government loves inflation because it means they can borrow money to pay for boondongles, and pay the debt back with money that is worth less. i.e. if inflation is 3% and the government borrows money at 3% (the currently 30-year bond rate), then the government borrowed money for free.

CPI is a rigged number because the government has debt in the form of SS payments and pensions to government employees. The amount payed out is based on CPI-measured inflation. Thus, we experience the principal-agent problem in that the government is the one who calculates inflation, but they are incentivized to calculate it low.

The government benefits from 5% actual inflation because they printed 5% more money (relative to the economic output of the country), and thus their debt is 5% cheaper. However, if they claim 2% inflation, then the amount the government owes to SS and pension recipients is reduced.

So in order to "break even" people are essentially required to invest in stocks since no other alternative exists that would allow someone to break even, after real inflation, and after tax on phantom earnings.

Stocks seem like a good premise, in theory. "Free Market Capitalism" at work. Companies borrow money through issuing stock certificates. The problem is again one of principal-agency where the company is able to extract value from shareholders through corporate boondongles such as private jets and executive compensation. The company may lose money for shareholders, and may even go bankrupt. However, THE EMPLOYEES STILL GET PAID. Payroll is superior debt, and they get paid first. They can do a shitty job and destroy shareholder value, but they get paid. I'm not just talking about executives, either.

One might argue that in a free market, you're free to not invest in poorly running companies. There's a few problems here:

1) FRAUD. The government is supposed to audit and ensure publicly traded companies are reporting accurate numbers. However, on multiple occasions, government auditors have been caught snorting cocaine off a stripper's ass at parties thrown by companies that later were revealed to be reporting fraudulent numbers. In exchange for the huge investment losses that a person experiences due to poor government regulation, a person is entitled to take a loss of $3k per year against their regular income. Thanks, Uncle Sam! 

2) TIME/SKILL. It's extremely time consuming to read through 10Ks and interpret them. The average person doesn't know what a 10K is. However, they are penalized by inflation if they don't invest in stocks, so they invest in index funds, which contain poorly run companies as well as fraudulently running companies due to government incompetency.

3) 401k LAWS. In many cases, people are limited to a select few index funds within 401ks. Because the government has created a restricted monopoly through the 401k system, people have no choice but to invest in index funds in many cases. (Of course I believe most people would be better off with index funds, my gripe here is that 401ks should be eliminated and IRAs should have their annual limit raised to the commensurate level).

4) GOVERNMENT REGULATIONS/ARTIFICIAL BARRIERS TO ENTRY. I may actually have the time and skill to read through 10Ks. Suppose I read through the 10Ks of the 3 US cell phone companies that have 90% marketshare, and all 3 clearly waste money and do stupid things. Perhaps they own too many private jets, or pay their CEO too much. These 3 companies have carte blanche to do anything they want because they have an oligopoly. It's not a free-market because competitors can't come into the market because the FCC has created an artificial barrier to entry.

This isn't limited to cell phones either. Due to Dodd-Frank, it's impossible to run a bank with less than $1B in assets. That's a huge barrier to entry. There regulations are so onerous that only a few major players are able to comply. There's a few banks in the US that have huge market share right now. The top 10 financial firms have about 50% market share of the entire country. What if I read their 10Ks and disapprove? Tough shit.

Utilities have a government-mandated monopoloy in their areas. They make up 5% of the total stock market by weight. Don't bother reading their 10Ks because there's literally nothing you can do about it anyway.

Airliners have another government-mandated monopoly. Only so much airport space making it impossible for a new entrant into the market to emerge.

5) COST OF GOVERNMENT REGULATION. As an investor, I'm losing money to pay for government regulation. I don't have exact numbers, but I'd bet 10% to 20% of the return of equities is lost to regulatory costs. Meaning that if I would make 10% in a specific stock, I only make 9% because of costs associated with complying with OSHA, the maternity leave act, SOX. Before you argue that those regulations are "good" first consider how well SOX worked with GS and AIG and Lehman Bros the last few years.

Then explain how a company could get away with treating workers poorly (i.e. not giving maternity benefits) unless they have a monopsony that is created artificially by government regulation? i.e. if there's only a few airlines allowed to operate, it's a monopsony, and they can treat workers like shit. The solution to regulation seems to be more regulation. The solution to problems caused by bigger government is an even bigger government!

6) DOUBLE TAXATION. The companies I invest in get taxed at the corporate level. Then I get taxed again when I sell my stock holdings. This is a double "F-You" because I'm only investing in stocks to avoid losing purchasing power from government-created inflation.

The next related topic is alternatives to stock investing. We could invest in bonds or savings accounts, but we are taxed at our marginal tax level, which makes it harder to even match inflation, on a net basis. Also, the government artificially manipulates rates down as they please to make it so I lose money to inflation invested in these instruments.

The final alternative would be starting your own business. You can invest in yourself, and then you know for sure that there's no waste to corporate boondongles. The problem is all the government regulation has made small-business ownership very difficult. Regulatory compliance typically has a fixed cost. i.e. $10M to hire a specialty consulting firm to file SOX paperwork. If you're a $50M IPO, you'd be wasting 20% of your stock raising money to government compliance. However if you're a $50B IPO like Facebook, it still costs around the same $10M.

The result is only very big companies can afford to comply with regulations, and you have a severe disadvantage when trying to enter the market as a small business.

Coincidentally, 99% of Congressional Lobbying efforts come from multi-national corporations, who secretly do want regulation in order to raise barriers of entry to potential competitors. The other benefit to the multi-nationals is that they get to do profitable crazy bullshit to incite regulation. i.e. let's dump toxic waste into the ocean and save millions in fees. Congress finds out and passes laws that require a $100M insurance policy in the event of toxic waste spill. Now there won't be any new competitors because no small business can afford a $100M insurance policy. The multi-national wins doubly. Congress wins because they get a public "win" to save the environment, and also the multi-nationals put millions into lobbying efforts to make sure the regulation is written as supportively as possible for themselves.

Of course me as a stock investor lose money because now (a) as part-owner of this company, part of my profits now have to go towards regulatory requirements, (b) as a citizen I experienced toxic waste dumped into the environment, and (c) now that the multi-nationals have artificial barriers to entry in their sector, they are more free to waste money on corporate boondongles and extract value from the company with no concern of a new lean-run competitor emerging.

I suppose the final related topic I have is the financial system. Companies like Goldman Sachs are essentially the "house" at a Casino. In order to put money into various financial instruments such as stocks (which is necessary simply to preserve your spending power), you have to fork over trading fees through direct costs (stock trade costs, mutual fund expense ratios, etc) and indirect costs (the small spread on each transaction that the brokerage keeps). These big companies spend millions lobbying Congress each year to keep things favorable to them.

Congress gets to line their pockets with lobbyist money, while they ensure the system continues in favor of themselves (higher taxes, higher inflation) and in favor of multi-national corporations (higher inflation and lower interest rates to force investors to use financial instruments that earn them money, and artificial barriers to entry to avoid competition).

It seems as though everyone wins except the middle class investor.

The upper class 1% wins because they are part of the system. They are the executives extracting value from the publicly traded companies. They are the Congressmen and career politicians getting money from lobbyists.

The lower class wins because they get to suck on the government tit that is filled from free-debt (allowed by inflation) and tax-dollars from phantom earnings of investors. Additionally, the lower class benefits from market shapers such as minimum wage that further impose barriers to entry to small businesses (a small business can't afford to pay someone $8/hour to do an unskilled job, but a big multinational has the ability to move overseas and pay a 3rd world country laborer 10 cents an hour, further creating barriers to entry that protect big business).

My thesis is that the system is rigged against the middle class and there is essentially no way to win except to fall down to the lower class (and get to suck on government tits) or to rise into the upper 1% and screw over the middle class that you were once a part of.

I was listening to Tool as I read that and it synched up nicely.

You should put that rant to music.

Two thoughts.

One, it's a testament to the system of free enterprise that it can still kinda-sorta work in the face of all those issues.

Second, IMO the middle class, as typically understood, actually went extinct some years ago.  People just haven't accepted it yet.  It's just not feasible for one salary to support a family, house, two cars, vacations, with income and retirement security, any more.  There are many reasons and plenty of blame to go around, but the last shot was fired a long time ago.  Many of the former-middle-class are living beyond their means through debt or cashing out home equity.  Some are coasting on inertia, e.g. grandfathered in to an old employment contract which is no longer offered to new employees, or living in an inherited house they could never afford to buy themselves.

The few people I know that are succeeding as early-career wage earners are doing it by co-opting upper class models, just with fewer zeroes at the end.  Some are corporate mercenaries, switching jobs every year, with a "personal brand." For all intents and purposes they are CEOs of their own consulting business, which just happens to have a single employee, themselves.  Others are capitalists living off <4% of their  invested assets, it's just that their expenses are very low and assets are in the hundreds of thousands.  A.k.a. the ERE or DIY landlord model.

TripleB, do you think those factors you describe have got worse since the end of WWII?

Do you agree that much of the big business control of government problem was also seen in the 1920s and 1930s?

I think it is a natural succession that our system spirals in on. WWII rebooted the system then we set course and headed back into it. To my mind it is just a consequence of concentrated wealth. The government tends to serve wealth. If wealth is dispersed then the government will serve everyone. If wealth is concentrated then the government will only serve those few. I'm not sure that a smaller government always does avoid that business/government feedback loop. Sweden has a vast government and yet their government seems to act in a fair minded way. To my mind what is most critical is that voters hold the government to account and don't tolerate waste or corporate favors.

stone wrote: TripleB, do you think those factors you describe have got worse since the end of WWII?

I don't know. I imagine the answer is "yes" but I can't say with any certainty.

Surely getting off the gold standard allows inflation to occur more easily.
Surely there's been an increase in government regulations over the last 60 years. New laws are written and rarely are old ones taken off the books.
Surely there's an increase in government handouts over the last century, starting with The New Deal.

All of these would seem to work to transfer wealth from the middle class to the upper 1% and the bottom 10%.

TripleB,

Would you rather be on a gold standard system that didn't allow individual gold ownership (Bretton Woods), or a floating currency system that allowed gold ownership?

TripleB, I'm not sure that the bottom 10% have got better off. I wonder whether they have been excluded from the economy by the factors you describe (off-shoring, impediments to small scale enterprises etc) and so now are living on hand outs whilst before they were earning a living but were better off then. I think they suffer from the situation at least as much as anyone.

TripleB, you correctly point out the fact that the middle class are always squeezed. However, the unfortunately reality is that keeping inflation low pretty much requires that the middle class not have very much disposable income. The Fed's data shows us that there is a very strong correlation between the rate of change in disposable income and the inflation rate.

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Government spending alone doesn't cause inflation. Inflation usually takes place when the middle class is able to drive up prices by spending beyond the productive capacity of a nation. And that only happens when the middle class actually have jobs and disposable income. You can't technically have an employed and richer middle class without causing inflation.

Lots of really interesting thoughts in here.  I can't drill into all of it but there are a few points that jumped out at me.

TripleB wrote: The government prints new money and causes inflation. Because of inflation, your purchasing power degrades over time for any saved money.

As a bit of "insult to injury", also remember that one of the natural effects of free market capitalism is that over time goods and services become cheaper and cheaper to produce.  Thus, under a fixed or slowly-growing supply of money, you would expect gently falling prices.  Savers would grow more wealthy over time.

This is how things worked in the United States before World War I -- and we experienced nearly 150 years of deflationary prosperity.

Thus, a 5% inflation rate actually understates how much purchasing power is being lost to inflation.  Your savings also miss out on the natural deflation that they would otherwise experience.

TripleB wrote:2) TIME/SKILL. It's extremely time consuming to read through 10Ks and interpret them. The average person doesn't know what a 10K is. However, they are penalized by inflation if they don't invest in stocks, so they invest in index funds, which contain poorly run companies as well as fraudulently running companies due to government incompetency.

This is where I think that well-constructed index funds are invaluable.  If there's a company out there that is a ticking time-bomb of fraud and waste, it is to some trader's benefit to realize it first and make a killing on a well-timed short.  By investing in a low-cost index fund, you get to coast on top of what the broader market figures out day to day.  Whoever is lucky and\or talented enough to detect this pricing error does all of your homework for you.

TripleB wrote:The result is only very big companies can afford to comply with regulations, and you have a severe disadvantage when trying to enter the market as a small business.

Yes.  I am always surprised that this connection is not made more often.  As the costs of compliance raise the risk and lower the reward of starting your own business, more and more business options become unprofitable.  This causes people to be less free and greatly hampers the efficiency of the market.

TripleB wrote:My thesis is that the system is rigged against the middle class and there is essentially no way to win except to fall down to the lower class (and get to suck on government tits) or to rise into the upper 1% and screw over the middle class that you were once a part of.

I think it's important to zero in on what it means to "win".  The wealth of our society is so vast that you can experience a great deal of unfair treatment at the hands of government regulation, confiscatory taxes, inflation, etc. and still enjoy a standard of living that utterly eclipses anything that was possible 40 years ago.

It doesn't mean that you should be happy about being mistreated, of course.  Rather, I think it's worth pointing out that in spite of all this, "winning" (in terms of enjoying a rich, comfortable lifestyle) is still well within reach of the vast majority of people (Edit: in the United States.)  That's a wonderful thing and a real highlight of this period of human history.

Also, I'd have to take issue with the idea that the top 1%, 5%, 20%, 50% or whatever can only get there (and remain there) by screwing over somebody else.  Certainly this is one possible path but I'd argue that it's far from the most likely one.  Once you set fraud, coercion, etc. aside, the only way to become wealthy is to provide people with goods and services they legitimately desire.  That benefits everyone, middle class included.

TripleB...I find your outline to be very compelling indeed. Especially the parts relating to corporations raising barriers to new competition.

Regulations are often much harsher on large corporation than they are on small businesses, are they not?  Usually you have to meet a certain employee level or production criteria before they kick in.

The way executives of large corporations have neutered their boards of directors is sad for stockholders who don't realize what has happened.

As I posted in another thread, the C-suite has become like a group of sultans and the members of their boards are the harem eunuchs (the stockholders, of course, are the harem--the sultans screw them any time they feel like it).

Gumby, your point about making sure that all the extra government created money goes to the 1% in order to avoid CPI inflation is the reality BUT don't you see what a basically evil distortion that is (in my eyes anyway)?

For the 1%, money is power. I just want to understand your reasoning for favoring such a government enforced transfer of power to the 1%?

Lone Wolf, I guess that the current crop of 1%ers are setting up a dynastic new aristocracy who will rule over everyone else on the basis of inherited wealth that gathers money with money.

TripleB,

Regarding your savings being debased... the government offers short-term bonds that it doesn't need to issue, but does anyway, that have historically kept up with inflation relatively well, and are risk-free at the short end of the curve, as the government has no restraints in paying you your money back.  Has savings REALLY been debased all that much if the gov't is paying pretty close to inflation without any of the risks that you'd have to take by lending gold to others in a non-fiat economy?  To act like you're sitting on cash under a mattress the whole time is a bit of a stretch.

Further, losing a bit of purchasing power should be taken into perspective when compared to people sitting on their butts when they want to be working, producing real value.

LW,

During the 1800's, when there was a need for an expansion of money, it manifested itself in jobs for Americans digging up gold out west.  What happens when that gold starts to run out, but the economy keeps wanting to grow?  This is what we're faced with in a modern economy.  Also, the 1800's were littered with severe recessions, all of which, coincidentally, followed supposed "fiscal responsibility" (running surpluses).

I don't think that it is savings that are really debased but rather the relative value as a customer that an "Average Joe" has. IMO our most direct power in a capitalist system is as customers. Even if a pork chop costs $1 today and cost $1 a decade ago that doesn't mean that relative customer power hasn't been eroded severely. Forty years ago, selling pork chops for $1 to Average Joes was the focus of the economy and what needed to be done in order to make a living. Now, when CEOs have billions to throw around, why bother? You'd be better off being tenth in line to pander to some minor whim of theirs.

That is why we don't see renewable energy development etc. So long as the 0.1% can fly their private jets, it doesn't actually matter from a financial point of view, under our system, if everyone else is priced out of the system.

moda0306 wrote:Would you rather be on a gold standard system that didn't allow individual gold ownership (Bretton Woods)

Bretton Woods didn't have anything to do with US citizen's ability to legally own gold.  Roosevelt shut that down years before in 1933.

Nixon ended Bretton Woods in 1971, but U.S. citizens couldn't legally own gold until 1974.

stone wrote:Gumby, your point about making sure that all the extra government created money goes to the 1% in order to avoid CPI inflation is the reality BUT don't you see what a basically evil distortion that is (in my eyes anyway)?

Yes. It absolutely sucks to watch the wealth gap grow larger and larger.

stone wrote:For the 1%, money is power. I just want to understand your reasoning for favoring such a government enforced transfer of power to the 1%?

I never said that I favor a government-enforced transfer of power. I certainly don't enjoy watching the 1% have more money and more power. But, there really isn't a way for the middle class to have disposable income without causing inflaton.

The ideal situation for any country is for the middle class to have low unemployment (to maximize productive capacity) and low levels of disposable income (to prevent inflation). You don't need to radically change society (in the ways you suggest) to achieve that.

WAH,

I understand that... I was simply asking the question as posted to gauge what people thought was the greater crime... to outlaw gold ownership or to have a free-floating currency.

KevinW wrote: The few people I know that are succeeding as early-career wage earners are doing it by co-opting upper class models, just with fewer zeroes at the end.  Some are corporate mercenaries, switching jobs every year, with a "personal brand." For all intents and purposes they are CEOs of their own consulting business, which just happens to have a single employee, themselves.  Others are capitalists living off <4% of their  invested assets, it's just that their expenses are very low and assets are in the hundreds of thousands.  A.k.a. the ERE or DIY landlord model.

My wife and I have succeeded pretty well as early-career wage earners, but that is due mainly to our willingness to spend a lot of energy on education, and having the foresight to pick an industry (technology) that has grown over the last few decades.  Also, we treated our careers like mercenaries, just as you say.  When we weren't compensated adequately, we job-hopped, did contracting, whatever it took to get our salary to the level we knew we were worth.

In order to succeed now you need a career that can't be easily outsourced, is in demand, and you need to know how to negotiate.  There is a huge difference over time between an employee that accepts the first salary offered by an employer and an employee that knows how to negotiate a fair salary.  But first you need to be in a career path that gives you the power to negotiate because companies need you.  A lot of new employees completely underestimate the difference just a few thousand $ a year makes over time, with annual inflationary salary increases.  It can literally make a $100,000 difference over 10 years in your bottom line.

Nice rant, btw.  It pretty much mirrors my thoughts.

Gumby wrote:

stone wrote:Gumby, your point about making sure that all the extra government created money goes to the 1% in order to avoid CPI inflation is the reality BUT don't you see what a basically evil distortion that is (in my eyes anyway)?

Yes. It absolutely sucks to watch the wealth gap grow larger and larger.

stone wrote:For the 1%, money is power. I just want to understand your reasoning for favoring such a government enforced transfer of power to the 1%?

I never said that I favor a government-enforced transfer of power. I certainly don't enjoy watching the 1% have more money and more power. But, there really isn't a way for the middle class to have disposable income without causing inflaton.
The ideal situation for any country is for the middle class to have low unemployment (to maximize productive capacity) and low levels of disposable income (to prevent inflation). You don't need to radically change society (in the ways you suggest) to achieve that.

Inflation means a rate of change. The middle class could have massive levels of disposable income as a proportion of the economy and inflation could be zero if the amount they had was static. What you are advocating is a system where the government pumps out more and more money but a smaller and smaller proportion of that goes to the middle class. It is a way to transfer power to the 0.1%. That is the essence of it IMO.

stone wrote:What you are advocating is a system where the government pumps out more and more money but a smaller and smaller proportion of that goes to the middle class. It is a way to transfer power to the 0.1%. That is the essence of it IMO.

Stone, I don't know where you are getting this from. Where am I advocating "a system where the government pumps out more and more money but a smaller and smaller proportion of that goes to the middle class"?? I don't believe I've advocated any such policy anywhere. I don't believe I even "advocate" any policies. If you want to discuss Stonelandia again, you should start a new thread.

Gumby, I thought you were saying that you thought that it was good to have all of this deficit spending and also that it was important not to have inflationary increases in middle class disposable income. Isn't that exactly the same thing as saying  "a system where the government pumps out more and more money but a smaller and smaller proportion of that goes to the middle class" ?

Regarding the wealth gap, how is the following supposed to help:

1) Cut taxes, mostly on the wealthy, and corporate profits
2) Slash spending, mostly on entitlements to the poor/middle class, as well as public education.
3) Deregulate the means of production
4) Strengthen the currency that is owned in droves by the wealthy in the form of bonds and owed in droves by the middle class in the form of student loan, credit card and mortgage debt.
5) Deregulate the financial services industry
6) Eliminate anti-trust laws, since "cartels don't work" anyway

If someone can walk me through how all this will actually REVERSE the wealth gap trends, I'm all ears.

The libertarian description about how "inflation steals from the wages of the poor" and "crony capitalism keeps the rich getting richer" tries to blame the government (somewhat justifiably) for the wealth gap, but then they suggest a host of prescriptions that, by all appearances, would make the problem considerably worse.  I think if you look at the rules of how bargaining power plays a role in the market, it's easy to realize that wealth distribution tends to become self-fulfilling at some point, completely on its own, without bailouts.

moda, I completely agree that the list you give would not solve the situation. It would probably create an equilibrium situation but a very impoverished equilibrium; a bit like the current economy in Haiti.