MARKETS

Free markets are great in concept, but unfortunately governments find a way to get involved and all the efficiencies go out the window, notes Terry Coxon of Casey Research.

Absent the state's involvement in the workings of the marketplace, an investor's central task would be to evaluate companies for their ability to efficiently produce and market what customers want. Shrewdness at that one task would lead to the profits investors are looking for.

And there would be other consequences. The stocks of companies that succeeded in convincing investors that they had the right stuff (primarily through good performance) would be bid up. Stocks of companies that failed to make their case to investors would tend to drift down, and any company whose stock drifted low enough would become a takeover target.

A takeover would replace underperforming management with a new team of officers and directors-individuals picked by the people who laid out their own money to buy enough shares to control the company.

That's how things work when the government isn't a player in the process. It's a marvel of efficiency and impartiality.

Managers who serve investors by serving customers are rewarded. Investors who identify such managers are rewarded. Unskilled managers eventually lose the corporate positions that enable them to make wasteful, money-losing decisions. And investors who are blind to management weakness or who forgive it too willingly lose their own money.

That's how it works when government is absent. But year by year, government has become less and less absent. In fact, it now has a sterling attendance record at occasions where economic decisions are being made. Through subsidies, tax breaks, regulation, and spending, government has claimed a virtual seat in the boardroom of most companies. In some cases, government in effect holds a majority of the votes.

Government's involvement profoundly alters decision-making for investors. It no longer is enough for an investor to identify the companies that are doing a good job of serving shareholders by doing a good job of serving customers. Now an investor needs to consider how effective a company's management will be in getting favors from government and in avoiding getting punished by government.

Even if you've made a cover-to-cover study of classics such as Benjamin Graham's The Intelligent Investor, you need to understand the appendix on political factors that Graham never wrote. Here's a quick outline.

Four Categories
At the big-picture, macro level, you undoubtedly are already familiar with the essentials. Unmanageable deficits and reckless moneyprinting have made bonds dangerous and gold a necessity. That's simple enough. But drill down to the next level and things get messy.

Most of the government's involvement in business falls into four categories:

  • Government as customer. No other customer's shopping cart comes close to the size of the wagon the government pushes through the aisles of the economy. For many companies, government is the No. 1 customer. For some of them, government is the only customer that matters.
  • Government as regulator. In some industries, complying with regulations that customers care little about is a matter of life and death. The big payoff comes from getting new regulations written that help you and hurt the competition.
  • Government subsidies. There are products and services that would be sold only at much higher prices and in much lower quantities if government weren't directly or indirectly absorbing part of the cost.
  • Government detritus. Sometimes an industry grows almost accidentally, as an unforeseen or unintended result of government activity.

Tickers Mentioned: Tickers: LMT, NOC, RTN, BFRE, BIOF