Meditations on Volatility and Our Financial Tapeworm

We are in a period in which volatility is rising and is going to keep rising.

Markets are centrally managed. Economic warfare has overridden the capital raising and allocation functions of currency and capital markets.

An investor wants to put money in things with utility or values expected to hold purchasing power over the long haul. That means living with volatility in the short run.

An investor also wants assets that perform well in various circumstances. Which means some are going to do better than others at any given time. For example, we may buy some things to do well in inflation, others in deflation. So in any given scenario, some will be down in value or doing less well than others. They are doing what they are supposed to do – that is part of the balance. That means living with volatility expressed in paper dollars is inherent to household balance sheets with savings and investment capital.

Essentially, one way to look at this situation is that we can own (i) real things, (ii) paper reflecting an interest in real things, (iii) paper IOUs denominated in dollars, (iv) paper denominated in currencies other than dollars, or (v) options and derivatives thereon.

Everything but the paper denominated in dollars with short duration is volatile (until and unless the issuer tanks).  One of the reasons is because power is achieved by owning and controlling real things. The way to own and control real things is to get everyone else to put their money in dollar denominated paper that finances you owning and controlling all the real things at a very low cost of capital. Hence, increasing volatility in the relationship between paper and real things and between dollars and other currencies helps drive investors back into the paper that finances you owning and controlling the assets they need.

In economic warfare terms, volatility lowers the cost of capital of the most forceful players – not to mention the profits to be made from trading the swings and short-term pump and dumps that the financial sector needs to maintain its profits. The strategy produces a negative cost of capital. That is, the forceful player turns a profit getting other people’s capital, rather than paying for it. The gift of AIG bailout money to Goldman and the banks it sold toxic paper to is an example in point, especially when combined with the profits they subsequently generated from speculative trading as the results of being flush with “free capital.”

So a retail investor has two choices. Either he or she achieve less volatility and slowly lose purchasing power over time or, alternatively, focus on the long term primary trends and learn to live with and manage volatility. A third option available to some is to pull out of the liquid investment process and to buy and manage the real assets you need to live and function so that the short and intermediate value of your assets in dollar equivalents is less relevant. In this third option, one can measure wealth in how many acres of farm land and fresh water, revenue generating enterprises, machines, ounces of silver or livestock one owns rather than what the short term value on one’s assets is when priced in fiat currency.

This is why increased volatility will over time increase the desirability of local investment. Why invest in agribusiness, get a dividend and go buy food? Why not just buy farmland or finance a local farmer who pays his or her dividends with food. Why invest in a utility, get a dividend and buy water from your local utility? Why not just dig a well if you can?

This process can be accelerated by increasing the liquidity of local investment. Hence, the extraordinary rules and regulations designed to increase the costs and risks associated with creating liquidity for local investment and the covert operations targeted at those who try to find a pathway through the legal and regulatory gauntlet. Hence, we see the President in his state of the union address propose that small business should be forced to create retirement plans that will channel more money into dollar denominated paper.

Forced retirement plans of this kind are back door capital controls.

If you understand and track the primary trends, you can learn to live with volatility. It is not going away any time soon.

I am not saying that learning to live with volatility is so wonderful. I am saying that the immediate alternative of investing in things that are falling in value over the long term is less wonderful.

Of course transforming our financial system is a third option. It seems an overwhelming task to try. But then the option of living with the growing drain of our current financial sector leads to something much less wonderful.