Fisher Investments MarketMinder: Shifted Balance

Story Highlights:

• Some see this year's financial meltdown and ensuing government "rescues" as proof of capitalism's failure, leading to advocacy of more government and regulation.
• Government "solutions" can only carry an economy so far and cannot change the behavior of market participants.
• Fisher Investments MarketMinder believes that while people are currently pro-government, balance will shift back to capitalism, as it's the only force that can drive real, sustained growth.

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For Fisher Investments MarketMinder, the holidays are a time for celebration and reflection. Reflection is easy—the events marking this past year are ones not easily forgotten. But celebration?

Many are finding it hard to make merry in the aftermath of this year's financial crisis. Collateral damage from the crisis is extensive—unemployment is rising in the US, exporters are hurting in emerging markets, global stock markets are depressed, and each day seemingly brings new cries for government help from struggling industries.

Some see these effects as proof of capitalism's failure. After all, this year saw the crumbling of a financial nucleus under its own weight, necessitating the US government to rescue the few straggling survivors. Capitalism, it's argued, encourages greed and self-interests above the public good (Madoff is a "shining" example), and the solution is government and regulation.

Already, we're at a point where free-market governments worldwide are now invested in banks and other domestic industries. Talks of increasing regulation in financial markets are pervasive among politicians. Many governments are also poised to implement large infrastructure projects in the near future.

But will larger government and more regulation help? Fisher Investments MarketMinder's analysis of history shows regulation does little to curb excesses. This is because excesses exist not because of the capitalist system, but because they are perpetuated by the participants. No amount of tinkering can regulate innate human characteristics.

There's an old saying: "Everyone's a capitalist on the way up and a socialist on the way down." People want it all—to reap the benefits of free markets, but be protected against any downside. Capitalism won't abide. And that's a good thing. It's a system of inherent checks and balances, which can be swift and brutal during the pruning process. In rough times, we seem willing to sacrifice free markets' benefits for perceived security from this process (investors accepting 0% return on Treasuries is a recent example). Still, if free markets were restricted, what would happen to those checks? Subprime problems (or Madoff's) were not revealed by regulators, but by markets. Note, politicians are human, too.

A fun example is Fresno, a little agricultural-based city wanting to make it big in the great state of California. Over the years—in good times and bad—the city government used taxpayer dollars to fund its own brand of stimulus. They've either fronted all or part of the money, or engineered deals for various pet projects throughout the years: a ballpark for a triple-A baseball team, a Jack Nicklaus-designed golf course and housing project, and a rock bar sponsored by the Red Rocker himself, Sammy Hagar. And so on. Set aside for a moment the dubious wisdom of using taxpayer dollars for what appear to be superficial glamour projects, and consider why all three projects either floundered or outright failed—most in a short time. There are many factors, but in broad terms, in each case there was little counterparty risk: The developers had great upside potential, but no real downside risk since the worst that would happen is they default on their loans to the city—which in retrospect, bore relatively lesser risk than defaulting on a private loan.

Fresno promised in each case to "drive a hard bargain," but it never really did. Why? A government in any form can probably never be as vigilant or judge risk as well as a private party. Politicians—always and everywhere—are playing with house money and not their own. Governments don't use "their" money, it's taxpayers' money. If the whole undertaking goes bad and millions are lost, the worst that can happen is the mayor isn't reelected. That completely alters the incentive system. Our guess is Fresno would never have undertaken such lampoon-able projects had a real counterparty, with a visceral and vested interest, supplied the funding. This is the lesson of capitalism in a nutshell: A matching of risk and return, incentive and responsibility.

Fisher Investments MarketMinder encourages you to remember capitalism and free markets are not ever-stable. They work precisely because they compel folks to take risks and seek to create excess value out of existing capital, in whatever form that might be. They're examples of constant change and innovation. Change isn't always comfortable—and much of it will fail—but when it moves society in a more efficient direction, society certainly becomes more profitable.

During crises, the balance always tilts toward government and away from capitalism. This doesn't mean capitalism is done. But such things are always said in times like these. For months now, Fisher Investments MarketMinder hasapplauded coordinated government efforts to provide monetary and fiscal liquidity and stimulus to the shocked financial system and to provide much-needed confidence. We tend to draw the line, however, at government "ownership" of assets and/or direction of those funds. Government "solutions" can only carry the economy so far—it's up to capitalism to drive real, sustained growth. That is, it's up to the people who make an economy, not its turgid overseers.

Happy Holidays from the Fisher Investments Editorial Staff.