What will be the impact of government interventions on investing?

January 29th, 2009

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In our previous article (Are government interventions the first steps towards corruption & inefficiencies?), one of our readers asked,

… I have been wondering what the impact on government interventions will be for investing… What if one was to invest in Blue Chips, with the idea that they are ?too big to fail? (gov. intervention likely) and are therefore very safe?

He had brought a very good point.

Let’s say you have very strong reservations regarding investing in Australian banks (see How safe are Australian banks?). Based on your own assessment of the fundamentals, you make the decision not to invest in banks (if you are a trader, you may decide to short the banks). But then, you receive some tips from banking ‘insiders’ that the recent flight out of bank stocks is a fantastic buying opportunity. You are told that bank shares are so cheap that you will make a lot of money in a few years time if you buy them today. Naturally, you laughed at those ‘insiders.’

But they were right.

A few years later, they end up laughing at you instead. Let’s suppose that your fundamental analyses of the banks are correct. So, what went wrong?

Government intervention.

As we said before in Are government interventions the first steps towards corruption & inefficiencies?,

They [bailouts and rescues] are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government?s basis for favouring one business/industry over the other?

So, in your case, the government bailed out the banks (which is happening right now in the US and UK) in such a way that shareholders are protected. If you are a trader, shorting the banks will lead to heavy losses.

From this example, you can see that when government intervenes, the market is no longer completely free. When the market is no longer completely free, it means that the rules change abruptly in the middle of the game. When that happens, those who ought to lose become winners and vice versa. Incompetency is rewarded and competency is punished (indirectly through taxes).

Imagine, what will happen if there’s a soccer match whereby the umpire is allowed to change the rules abruptly any time he wants? In such a world, it’s either that bribery will abound or no one wants to play the game. The same goes for the economy. A half-free market will discourage the capitalists and entrepreneurs and encourage cronyism, corruption and speculation.

That’s one of the reason why in such an environment, the Warren Buffett way is dead. That’s why Marc Faber said this is a traders’ market. It’s possible that we will see Warren Buffet’s long-term track record flounder in the years ahead.

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