The End of Capitalism?

Here we go again.

Just as we were recovering from the Asian market collapse, the Brexit shock means markets will continue to be volatile. On the plus side, the dollar will continue to strengthen given its global safe-haven status, which strengthens investment trends we have long been pursuing at Global Income Edge.  

One of those trends is investors will continue to favor a Buy American approach. This means U.S. domestic companies are favored over U.S. multinationals, which for some time have been struggling with the strengthening dollar that makes our exports less competitive overseas. Also, despite the turmoil, some European companies should do well given American’s love of travel to Europe, European sports cars and fashions, all of which will be cheaper given the dollar’s strength.

Those are relatively short-term pluses. Long term, the picture is darker. Investors are facing two big questions : Does Brexit signal the beginning of the end for globalization, and signal the beginning of the end for Western-style capitalism? Either would change investing options for the worse. Here’s my take:

End of Globalization?

Globalization benefits many businesses and economies, but it has hurt workers across the globe, including the working classes in the U.K. and United States. The lack of government action to help them has given rise to populist and protectionist sentiment, and those fueled Brexit.  

World trade will always exist, but global free trade such as we have experienced since the end of World War II could be ending.  The U.K.’s Brexit may be interpreted as the first major move toward protectionism, and it may be followed by U.S. protectionism depending on how the votes fall in November. A return to a pre-WWII era of currency and trade wars, and mercantilism or protectionism would stunt global GDP.    

This wouldn’t end global investment opportunities, but they would become few and far between. And count on a sharp contraction in the U.S. economy as U.S. multinationals pull their global investments and higher-cost domestic industries replace overseas workers.

End of Western Capitalism?

Capitalism is losing its luster right now.

Critics have emerged who arguing that that Western Capitalism is the root cause of declining middle and lower income wages that have led to populist movements calling for greater protectionism.   

My take is that the critics are focusing on the wrong things. They should be reacting to two new problems that occurred over the last few years that have fundamentally changed Western Capitalism for the worst: free markets were not allowed to self-correct, and regulations reining in bad financial players that hurt whole economies were reversed.  

The first problem has to do with the central bank’s stimulus in the wake of the 2008 financial crisis. The stimulus stopped the onset of a second depression, and we’re all glad not to be standing in soup lines. But by continuing easy money and low interest rates the bank created a perverse situation where the government has in essence chosen winners and losers, and not let capitalism cull the herd of weak companies.  This also created greater income inequality, and a drag on our economic growth.

The other problem is the world’s financiers, businessmen and politicians abandoned Depression Era regulations 20 years ago that protected the world economy from capitalism’s excesses, particularly in the world of finance.

The 2008 global financial crisis would not have happened if investment banks and commercial banks had stayed separate, investment banks had continued as partnerships, mortgages had continued to stay on bank balance sheets, and derivatives had been forced to trade on regulated exchanges. And that’s just to name a few. 

Such regulations had served us well since the Great Depression, it was a mistake to get rid of them.

As if to underscore this, Morgan Stanley economists, in a research note recently, described the current economic environment as similar to the 1930s.  Having studied the Great Depression, I think that’s on target given today we have essentially the same Wild West economic and regulatory environment as existed during the 1800s and early 1900’s.  

That’s a pessimistic picture, but I’m optimistic. Western Capitalism is a force for good and it will survive—as long as governments address the needs of those displaced and hurt by globalization. And we need tougher regulations to level the playing field in markets, and to punish companies that take risks that put us all in jeopardy. Above all, we need is a new generation of business and political leaders that focus more on the long-term than on the last quarter or election cycle. 

So if governments take the right steps, we can make globalization and capitalism work for all of us. If they don’t, we’re facing a different, darker world for investing.