Tuesday, May 26, 2009

A little off topic - the future of green investments

I'm not exactly sure if this has ever come out fully in any of my posts but I am 100% a believer in the free market and I see daily examples of how government intervention cripples the progress of our economy and forces us to step backwards.

A great example is the current crisis we are in - newspapers for the last 7 months or so have been proclaiming "the death of the free market". Pray this is not so, because if it is we are in for a long era of utter poverty unlike anything seen in the last few centuries.

People just do not seem to realize the very obvious causes of the crisis: The Federal Reserve lowering interest rates to obscene levels to balance out the losses of the 2000 stock market crash, and politicians trying to extend their careers by offering handouts to tens of millions of people who under normal market conditions should never have gotten them. Some expensive votes, to be sure, in retrospect.

The Federal Reserve is at the very core of this crisis even though they themselves may be too blind to see it. It don't personally believe that but there are enough completely incompetent people in Washington and Ottawa (I'm from Canada) to make me double-think that every now and again.

Anyway, there is a very simple reason the Federal Reserve is the root cause and foundation of the massive excesses of the last 25 years, but especially the last 8. Insane low interest rates and massive amounts of cash injected into the market.

Why are low interest rates a bad thing and lots of new money even worse? Simple - the new money loaned out at these ridiculously low rates. What happens when interest rates are 1% is billions of dollars of malinvestment occur due to artificially low risk to service the debt. Many business ventures are started, investments are made, homes are bought, that should never have been purchased by the borrower.

An example - say I think a stock is going to go up 20% in a year because it is undervalued. But say it is in an industry that is receiving some political pressure or something to its downside - there is a chance this company is going to lose market share or even the capability to do business. Now if I am in a regular interest rate environment and I want to invest I might make a margin investment. Lets say I want to invest 100,000.00 in this company at a margin rate of 10%. That means that in a year the stock has to be up a little over 10% just to service the interest on my debt and transaction fees, etc. If the stock doesn't move, or worse goes down because of the downside pressure taking over, I not only have a negative equity in my asset, I also still owe $10,000 in interest!

But translate that into a low interest rate environment. The risk of the actual investment is exactly the same, the downside possibility hasn't changed, just the cost of my investment activities has been artificially lowered by Central Bank intervention. Say my margin rate is now 5% because of the Fed's low-rate policy.

Well now my downside risk had dropped in half and my upside possible gains have risen by 50% compared to the interest of my debt! I am much more likely to make the investment. In fact I'm more likely to make a lot of low-quality or downright bad investments because the cost of those investments is much much cheaper than it should be.

And that is what brought us to this crisis, in a nutshell. The Federal Reserve creating an artificially "low risk" environment that encouraged hundreds of billions to be invested in non-productive or very low production areas instead of more efficient and productive places - where the money would have originally gone had the rates not been manipulated but actually left up to the free market.

Couple that with shenanigans like the government trading Fannie Mae and Freddie Mac a government backing of their loans with the requirement that over FIFTY PERCENT of their loan portfolio had to be lent to high-risk people who normally couldn't get financing! And thus you have a tidal wave of new (and very artificial/unsustainable) demand flooding into the housing market sending home prices to the moon.

The massive excesses have been going on for the last two decades or more. In order for North America to be able to move ahead, the market needs to correct and reallocate the tremendous malinvestments to areas where they are more suited. But the government is not allowing that to happen - they are propagating the very thing that caused this whole mess, and until they get their politically-motivated hands off the process they are only going to cause much much more pain in the end. They are leaning the train precariously and soon enough they will push it so far it will derail. At that point a whole new train will need to be built!

But I have to tie this into green investments.

Here is the skinny:

  • The government is doing the same thing with energy that it did with housing, especially under the new "environmentally conscoius" Obama administration

  • They will be instituting a new "Carbon tax" which is just basically a way to take more money from your pockets and redistribute it as they see fit. Hence the global warming hoax, the fact that Al Gore's firm purchased $300 million of carbon credits shortly after he made his movie should be some sort of a hint!
  • Currently most "green energy" projects are partially subsidized by the government - most homeowners cannot afford a full solar system without the government grants offered. Or a geothermal system or anything else to get off the grid.
While this subsidation might seem good to the average joe or jane at first, one must truly look at the big picture and realize that the free market is being strangled as far as Green Energy is concerned. We would already be YEARS ahead of where we are now if the government was not involved at all.

Why is that? Simple. Most of these solar products are completely unsustainable without government subsidy. Instead of encouraging competeting between firms by letting the market dictate which company can make the most efficient and cost-effective product - by keeping their bloody hands off the market entirely! - the government actually stops dead the progress of development. By subsidising these inefficient products it does not encourage new development by these companies - they don't have to make new products because with the government's help they can turn a profit just fine with the ones they have, thank you!

And thus the potential leaps of green energy are turned into a weak shuffling and sometimes even stagnation. The funniest part of the whole thing is that generally governments think they are doing someting great by encouraging purchases in industries they like by offering subsidies. It's that damned rule of uninetended consequences that nails them every time.

Economics is a two-step or more measure of cause and effect. Unfortunately the government generally does a point-A to point-B analysis and everything is rosy. And maybe they can buy some votes along the way......


One good example of unintended consequences is a future prediction I am willing to stake a lot on. It has to do with the car companies in North America, their outdated and inefficient business models, and the fact the government will now own half of two thirds of the whole auto industry (50% of Chrysler and 50% of GM).

Here is something the government thinks is a great idea: Since they think people won't buy cars from bankrupt automakers (for good reason, I might add) they have decided to Back the Warranties of the car companies they own. This sounds great in theory, and unfortunately they will desperately need these warranties as the public soon discovers that the guys in washington are a lot worse at making cars than the experts in the private industry - geez whoever could figure a politician with no engineering background could build an internationally competitive automobile?!

But here is the unintended consequence - the government is backing these warranties to bolster the American Auto industry. This will actually result in its ultimate demise. The reason is pretty simple - it's just like what happened with Fannie Mae and Freddie Mac - when the government says they are backing something, anything goes - 100%. So effectively GM and Chrysler can warranty their cars for 500,000 miles bumper to bumper and the government will be flipping the bill!

Even funnier is the fact there is one automaker that still hasn't taken and government cash - Ford Motors. Guess what will happen when GM and Chrysler's warranties take on ridiculous properties? Ford will have to try to compete just to sell cars! But while GM and Chrysler can sit back and let the taxpayer flip the bill for their own warranty (ironic, isn't it?), Ford will have to absorb all of the costs of its own service. This will make it so expensive that they will have to bundle some of these future costs into the selling price of the cars making them much more expensive than the government subsidised prices of the Other Two.

While GM and Chrysler are and have been bankrupt for a long time (and will continue to lose money as long as the government and any labor union have anything to do with them at all), Ford will join their ranks as the unintended consequences of the government's actions will pound their sales into the dust.

Check back in 5 years to see if this happens because I already have a few cases of beer riding on this one lol!!!

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