Perhaps the single greatest danger facing investors over the long term is to be investing for the wrong paradigm. That may sound a little theoretical, but we have a very clear and quite dangerous real-world example going on in front of us right now, which is the false dichotomy between the "Mainstream" and the "Gloom & Doomers".
The way it is too-often presented is that most people in the investment community fall into one of two groups. There is group (A), for those who are for the most part secure in the comfortable Mainstream. They understand that the financial world has some real issues and that there may be some bumps in the road, but believe that investments over the long-term future will perform pretty much the way they did in the latter half of the 20th century. And because there is a high degree of confidence among mainstream experts that this will be the case, the assertion is that people can safely invest their life savings based on this assumption.
For those who disagree with this, the conventional narrative places them in group (B), the "Gloom & Doom" camp. This group is seen as being comprised of marginalized, eternal pessimists who are always convinced an economic doomsday is nigh.
So, the conventional narrative goes, either you (A) buy into the status quo, or (B) you move all the way over into preparing for the collapse of the status quo.
As with all false dichotomies - which are a quite effective way to control the perceptions and thus the behavior of tens of millions of people - there is an elementary error in logic in assuming it must be (A) or (B).
What if the current economic and investment reality aligns with neither (A) the continuation of the status quo from the long-gone latter half of the 20th century, nor (B) the collapse of the status quo, but instead (C), the ongoing transition to a new status quo for the first half of the 21st century, which is that of a dysfunctional and increasingly politicized economy, with an ever-smaller share of that economy coming from free enterprise and the private sector?
A Political Economy
That is, what if the currency doesn't collapse, but instead the government each year increases its control over the economy and markets, with an ever-expanding web of laws and regulations that smother unstable market forces along with many individual economic choices in the process? In such a world, what then happens to those in group (B), who have invested everything they have based on the mistaken impression that free market forces would drive an inevitable currency collapse?
Such a future would likely be even worse for those in group (A), the Mainstream investors. For when the government share of the economy grows faster than the economy itself, then private sector growth slows or even turns negative. Thus much lower wealth gains are generated than what conventional financial planning depends upon, even while a larger government must necessarily take an ever greater share of the wealth that is generated by the private sector, to pay for election promises that grow more expensive each year.
The 1-2 combination of less wealth available and more wealth taken - which is near inevitable with a rapidly growing public sector - would likely catastrophically collapse the great majority of Mainstream long term investment strategies when performance is measured in after-tax and after-inflation terms.
This is why believing in a pervasive but false dichotomy may be the single most dangerous mistake an investor can make. Because if an investor erroneously believes that the future will necessarily come down to only two paths, either the status quo or the collapse of the status quo, then they will not be making the right investments for a third path to a new and quite different status quo.
This third path and new status quo is of a blended economy that shifts a little more each year from being dominated by the markets to being dominated by the State, even while laws, regulations and tax shelters repeatedly change on a wholesale basis to allow the State to pay for the extraordinarily expensive promises that are needed to win elections. This third path is not theoretical, but is all around us, and has been growing in strength ever since 2008.
If the dominant determinants of investment performance in the future are political rather than economic, then investors need to be investing for politically guided economies and political risk. Those who do not invest for such an economy risk being blindsided and financially devastated.
A Needed Transition
For most investors, however, it can be very difficult to make the mental transition.
We've all been taught to invest for the most fundamental assumptions of all, which are those of a free market economy and a free market that determines investment prices. The free markets are what creates the wealth. And the market forces are what collapse irresponsible governments and their currencies.
But in an economy that is increasingly dominated by public spending, and in which we anticipate the substantial likelihood that the rules will be repeatedly rewritten to increase the control over market forces in order to force stability, even as the rules are also rewritten to increase the take from the private sector that is needed to pay for the rapidly rising costs of the promises that have been demanded by the electorate - what can we do?
It also needs to be taken into account that government-dominated financial systems which suppress market forces can be remarkably stable. Oh, they are poorer, as the price of suppressing the markets and wealth creation is that - with the exceptions of connected insiders and favored groups - everyone's income shrinks together. In other words, politics replaces economics as being the primary driver of the redistribution of wealth, and this is dysfunctional for economic growth. This has been true in many nations across many centuries; a country's cyclical vacillation between an economy controlled by the politically powerful and being dominated by market forces is nothing new.
The world changed in 2008. As a result, (A) the 20th century economy is long gone. However, (B) currency collapse hasn't happened yet even with severe stress, while (C) the new world of politics overriding market forces already surrounds us and dominates both the economy and markets. But it can be difficult to recognize and understand (C), let alone make the necessary and profound investment changes for a future of politically-driven risk, when there is a false dichotomy of "Mainstream Wisdom" versus "Gloom, Doom & Collapse".
We are seeing that the government's share of the United States economy has soared in recent years, as has its degree of control over the markets in such things as interest rates. And as we look at the promises that have been made to pay for such things as medical care, Medicare, and Social Security, the only way to even partially keep those promises is for the government to steadily increase the share of the economy that it consumes.
So if reality is neither the old economy repeating itself nor an inevitable economic collapse, but is instead a very different kind of economy that is under the increasing control of the government -- then future actual investment results are quite unlikely to be what most people expect them to be.
Reality Check List
The second half of the article has much more information on the hidden redistribution of wealth within a dysfunctional and deceptive economy, and the implications for traditional investment paradigms
