Saturday, July 4, 2009

Why 5000 year old rules on getting wealthy will not work today

When asked for advice on investing I would generally refer people to a book called “The richest man in Babylon”. This is not an attempt to avoid their question but is due to the amount of regulation designed to “protect the consumer”. It is very difficult to advise clients on the reality of investing and advisors are forced to give very generic recommendation making clients money fodder for the system that exists.

While much of the simple advice in this little book holds true 5000 years on, the first rule of “pay yourself first” has been made a lot less feasible. The propaganda put out today and then rehashed by the media is all about the important role of the ECB and the need to control inflation. If society had a real understanding of this phenomenon the ECB would not exist. Now, we will hear all sorts of arguments on their importance but I will try and make the facts speak for themselves. First we will look at a chart of inflation since 1650.
What has to stick out is that we have no green on the chart after 1950. Before this we were continuously oscillating from periods of inflation (blue) to periods of deflation (green). However, during the most of our lifetime all we have had is periods of low inflation and periods of high inflation.

To give a simple explanation of this, throughout most of history money has been precious metals. The periods of blue (inflation) were times when commodities were scare or in high demand and it required more gold (money) to acquire them. The periods of green (evil deflation) were times when you required less gold to acquire goods. This may be due to an increase in the supply of goods or an increase in the amount of gold. We are often told that this system will not work today and central banking ironing out high inflation and stimulating economies during periods of low growth is what’s required.

The question one may ask is why is deflation seen as such an evil today? Surely it is a positive thing if one can get more goods for less money? I would suggest that we really may have had a period of green from the 1980s until recently. This was mainly due to the massive productive gains achieved during this period. If one reflects on this period, the advances made were phenomenal but instead of our money going further the majority of us seemed to be working harder for less.

The simple answer to this chart being blue has been central banking controlling the money supply. So, instead of society realising these productivity gains, their wealth was stolen by the continuous dilution of paper currency. Besides having this hidden tax, monetary inflation made it unfeasible for people to save (pay themselves first). This system forced people to consume, build up debt and make mal-investments.

Consume: I better buy today as tomorrow it will take more money to purchase this product.
Borrow: It makes sense to take on more debt and as things go up, including wages it will be easier to pay off and I will benefit from leverage.
Mal-invest: The system forced people to invest in managed pensions, stocks, bonds and property. Your success depended more on market timing than on making prudent investments. The real winners were the middle men. This is so obvious today when this house of cards is collapsing. I say collapsing as this game is not over yet.

I would argue that our society as a whole would have been better off if a capitalist system was in place and the 5000 year old rules of creating wealth were available for all to implement. Through work one could produce and save their surplus without fear of it losing its purchasing power. This capital could also be invested to make society more productive and allowing the risk taker the opportunity to receive some of the rewards.

Without getting in too deep it looks like society is coming more under the spell of government control. The smokescreen tries to make it look like capitalism has been what we have had and due to bad boys in the system and lack of regulation it has failed. So we now need more Government intervention, more regulation and of course more Central banking manipulation. The people in control may not be lying when they preach about the importance of this central banking system and the necessity for government regulation and intervention. But the question we must ask is “who is this important to”?

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