We Get Better & Smarter Over Time & Generations But...

I have said and demonstrated that if left alone equity markets rise over time. The lines trend upward over time with periodic downtrends. The downtrends may be dramatic and painful but they are relatively short and the long term up trend remains. The uptrend remains in place for fundamental reasons. We get smarter and better at what we do over time and generations. It is difficult to imagine a scenario where this won’t be the case. The uptrend in equity valuations will continue.

There is one thing that can derail this. Politicians or, better stated, bad policy implemented by likely well-intentioned politicians. Bad policy happens. One need look no further than to Venezuela over the past 20 years. Venezuela is sitting on one of the largest oil reserves in the world. They should be enjoying the best of times. Instead they are battling starvation. Simply put, their current horrible economic situation is the result of bad policy.

Venezuela has lurched toward anti-capitalistic policy on the capitalism / socialism spectrum. This never ends well. "From each according to his ability, to each according to his needs" is a slogan popularized by Karl Marx. A beautiful phrase but completely unworkable in practice. It is unconducive with human nature. A simple thought experiment is all that is needed to illustrate this.

We work in a factory producing widgets. In a purely capitalistic factory we are paid by the widget produced. I work next to a person who somehow produces 5 to my 1 widget. I understand the he earns 5 times more than me. Whose behaviour is likely to change? I will be envious of his salary and will observe and learn how he does it. My production is incentivized to increase and will increase with greater effort and newly learned skill through observation.

Alternatively, we work in a purely socialistic environment. We are all paid the same. The person next to me understands that we earn the same (unless he can convince the state that his needs are greater than mine – written with great sarcasm). My production is standard. My partners production is outstanding. I have no incentive to alter my behaviour unless I am being beaten. My partner instinctively understands that this is unfair and has every incentive to slow down. He gains nothing for his superior production and loses nothing by slowing down. Maybe he daydreams more or takes more bathroom breaks. His production will decline.

In which of the two systems will production increase? In the capitalistic society my productivity will increase. In the socialistic society his productivity will fall.

Good things come from increased productivity. Three things can occur at the same time with productivity increases. Workers can earn more, owners can profit more and the price of production, or the cost to consumers can fall.

Here is the proof. Let’s say I get paid $40 per widget and make one a day. The company sells the widget for $100 and there is $20 of additional cost per widget. I make $40 per day, the company earns $40 off my widget, and the customer pays $100. Now I make 2 widgets per day. The company lowers the price to $90. I now make $80 per day, the customer pays $90 per widget, and the company sells one more widget and earns $60 off my production. All three parties are better off.

We get smarter and better over time. Our standard of living trends up over time. Only one thing can derail this. Bad policy. Bad policy can happen anywhere. Venezuela is an extreme example. If you think it can’t happen here just note how close Bernie Sanders, a self-described socialist, came to winning the 2016 presidential election.