In this post, DragonLZ asks a very important question:

What was so much better back in 2003 that justified the incredible bull market that lasted four and a half years, from March of 2003 until October of 2007?

A related question that DragonLZ could have asked is what was so great about Zimbabwe in 2007 that caused it to have the best performing stock market in the world?  But we’ll get back to that.

Little does dragonLZ know that he is at the start of journey that leads to Mises, Hayek, and the Austrian School of Economics, for it is that very question that only the Austrian School can answer.  As he pointed out, there isn’t a very good economic reason why the market kept going up and up.  We agree.  So what did happen?  Here is the Austrian School answer, known as the Austrian Business Cycle Theory (ABCT):

Excessively low interest rates exacerbate the boom and bust cycle

These low interest rates cause an increase in the available funds (business capital.)  From these funds, malinvestment occurs as companies take on projects that would not be justifiable under a system of free market interest rates.  (Rates higher than the prevailing rate.)  This expansion can occur because the Fed (or any central bank) holds rates too low for too long, or through unchecked fractional reserve banking.  If it persists long enough, economic activity can BOOM, but it is an illusion.  Many of the projects are unsustainable, excessively risky, and pull resources away from more efficient alternative uses.  In other words, economic activity gets distorted.  The result is a predictable crash.

Do you think the Fed’s rates don’t have an impact on economic activity?  Then why do they bother manipulating them?  Ask Krugman.

From this most recent boom/bust to the dot.com boom/bust all the way back to the late 1920′s boom/bust…. and guess what…. the panic of 1819, the inflationary boom/bust of John Law’s Mississippi System and the Tulip Bubble before them…

Every single one has the same characteristics.  Easy money at the beginning, resources drawn into sectors that wouldn’t normally justify it, unsustainable development due to scarcity, and it all comes crashing down as entrepreneurs miscalculate risk.  The lyrics from the famous Hayek-Keynes Rap Video explain it better than I can:

The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key.
Malinvestments wreck the economy

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

And that’s how the Austrian School knew that we were headed for trouble.  The Fed had merely reinflated with cheap credit, which Austran scholars knew was unsustainable.  Another bust was sure to follow, worse than the bust which preceded it.

So the story continues, and this is why we urge caution once again.

However, it is foolish to view the Austrian School as anti-stock market.  Nothing could be further from the truth as the following quote shows:

One time, during Mises’s seminar at New York University, I asked him whether, considering the broad spectrum of economies from a purely free market economy to pure totalitarianism, he could single out one criterion according to which he could say that an economy was essentially “socialist” or whether it was a market economy. Somewhat to my surprise, he replied readily: “Yes, the key is whether the economy has a stock market.” That is, if the economy has a full-scale market in titles to land and capital goods. In short: Is the allocation of capital basically determined by government or by private owners? – Murray Rothbard

Now look at this Austrian School examination of the Fed and the stock market in May 2009.  Pretty consistent with what I have been saying all along. This rally is built on cheap money.

This is very dangerous.  Consider that the best performing stock market in the world in 2007 was Zimbabwe.  I’m surprised dragonLZ didn’t ask us why that was justified.  You can see now that it was for the same reason.

While I don’t want to disparage other bloggers that may have libertarian leanings and an affinity for sound money, without an Austrian School perspective on the boom/bust cycle they may sound like PermaBears to the untrained ear.  But just like me, they want economic growth. We all however would just prefer it to be sustainable.

Neither 2003-2007, as dragonLZ pointed out, nor 2009 was sustainable.

NEW YORK – The stock market has had one of its most turbulent days ever. The Dow Jones industrials plunged nearly 1,000 points in half an hour amid concerns that Greece’s debt problems could halt the world financial recovery.

The only problem with this statement is that there never was a recovery, there was merely an artificial stimulus of money and credit from the Federal Reserve and government with the intention to keep unsustainable ventures from failing. A short-term high is all we’ve had over the past couple years, nothing else. The more that the government and Fed prevent the markets from correcting and allocating money to productive areas of the economy, the worse the inevitable bust will be on the U.S. and world. This is only the beginning.

The Dow has managed to recover two-thirds of its losses and close down 347 at 10,520. But all the major indexes lost 3 percent in a day that recalled the market turmoil of the 2008 financial crisis.

http://bit.ly/bdW8zM

I don’t believe in Intellectual Property Rights. There. I said it. I know it sounds ridiculous for someone who hopes to make movies someday, but it’s true. And my reasoning is surprisingly economic in nature.

A Copy is Never Theft

Ideas are the only infinite resource. Everything else cannot be copied infinitely. If I have a loaf of bread, I can’t simply place it on the copy machine and make two loaves. But if I copy a book or a software program or a movie, then I now have two where I formerly had one. If it were your movie or your book, I have deprived you of nothing. If it was your idea then you still (mentally) retain the idea, and you have been deprived of zero physical property.

Mercantilism is Dead

Intellectual property rights were born out of mercantilism and governments failed attempts to keep “capital” within their own countries. Before the printing press the idea of “owning the intellectual rights” to your work was a non-issue. Copying books was very expensive and if your work was copied, you had received the ultimate form of flattery. This applied in all disciplines, including music and art.

Today, we understand the economic destruction a mercantilist systems causes, but cling to the idea of intellectual property rights, mostly via our patent system.

Fashion, Scents, and Emulation Innovation

Oddly enough, certain “intellectual property” remains outside the protection of the law. You can’t patent a scent. If I can figure out the formula for CK One and copy it, then I can market and sell it without any laws requiring me to pay royalties or give credit. Although admittedly, I would probably put on the label “compare to CK One!” to raise my sales.

The world of fashion also evades “intellectual property” laws. Every year, thousands of designers compete to create the latest fashion. Every year six months later you can buy clothes identical to those found at Talbots (TLB) at your local Wal-Mart (WMT).

Yet, Talbots not only remains in business but fashion is the second largest producing enterprise in the world (after automobiles). If the regulators and advocates of intellectual property law were right, then shouldn’t all the fashion designers be bankrupt? I know of at least one grave that should read: Christian Dior, Died Poor.

What the “Pirate” Teaches Us

Remember when VHS and cassettes were supposed to be the end of the music and movie industries? Those industries that felt threatened by such innovations quickly ran to the government to pass protectionist laws. Those who embraced the new technology like BluRay continue to reap the rewards.

Today, it will be no different for those who seek to profit off the likes of The Pirate Bay and online live streaming sites such as Megavideo or Justin.Tv. Many companies will bankrupt themselves paying for lawsuits in one last ditch effort to survive, but many more will thrive.

Capitalism could be called one giant conspiracy to reduce all profits to zero. I find it ironic the only system that will ever successfully achieve that which is the ultimate goal of socialism is freedom. When left to the free market, competition reigns supreme. Everyone is forced to innovate or die. History shows us that time and time again any company which ignores this fact will die not with a bang but a whimper.

Are you looking for those companies that stay on the cutting edge and find ways to profit from the internet and data revolution? Or are you relying on the government and laws to protect your investments? Let me hear your thoughts in the comments section below.

“Paper money eventually returns to its intrinsic value — ZERO.” – Voltaire (1694-1778)

The world champion athletes at the Winter Olympics receive gold, silver, and bronze medals that contain roughly the same amounts of metal as the last Summer Olympics.

• A gold medal contains 550 grams of silver and is layered with just 6 grams of gold.
• A silver medal has 509 grams of silver and about 41 grams of copper.
• The bronze medals likely contain about 450 grams of copper and 50 grams of mostly tin and zinc.

At current market prices, a gold medal is exchangeable for about $494, a silver for about $260, and a bronze for just $3. If the gold medal was solid gold with the same mass, it would be exchangeable for almost $20,000.
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CARTEL – n. a combination of independent commercial or industrial enterprises designed to limit competition or fix prices (per Merriam-Webster’s Dictionary) (emblem)

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“Banking was conceived in iniquity and was born in sin. The Bankers own the Earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear, and they ought to disappear, for this would be a happier and better world to live in. But if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create deposits.”

- Josiah Stamp, President of the Bank of England in the 1920s (more…)

Today many people are discouraged with the business world and stock market as an investment possibility. This is understandable with the pain being felt right now, but people might be jumping the ship at a time when many opportunities abound. People are quick to diss stocks when the going gets rough, but they forget that there is a business behind every stock, and it is the business, not the stock, that makes an investment a success or failure in the long run.

I am a long-term investor and encourage people to consider the idea of finding quality, well run, financially stable businesses with great products, with the expectation of hanging on for many years. This philosophy made the most sense when I got interested in stocks five years ago, and it has been the foundation of my stock investing since I started investing in 2005. I find the strategy of focusing on the long-term strength and potential of a business much more appealing and realistic than focusing on the short-term volatility and movements of a stock.

Coca-Cola is a great example of a quality business remaining a fine long-term investment even in the harshest of conditions, during the Great Depression. Coca-Cola stock hit its then-high of $191.38 in June, 1930. After the stock market crash and downturn lasting a couple years, the stock hit a low of $68.50 in December, 1932. One might expect that in the Great Depression the stock would falter, lose steam, and probably not perform that spectacularly. Just three years later in November, 1935, the stock reached a new high of $298.50, a quadruple from its low just three years earlier. Considering the times, this is nothing to smirk at. Some stocks absolutely did provide financial stability in difficult times.

You might notice that the vast majority of the greatest investments over the past century have been businesses with household products, not even necessity products. Cigarettes, soft drinks, household items, and other simple products are what have brought success to long-term investors over the past century, good times and bad.

Investing great Peter Lynch has often mentioned that if you invest in twenty businesses, you only need one or two superb winners to make investing worthwhile. Lynch also preaches an “invest in what you know” style. The companies that survived, and even expanded, through the Depression were companies with products that nearly anyone could understand on their own, without the help of a financial analyst. These are the types of businesses you want to look for and the types of businesses that have turned into great long-term investments.

Look at some of the businesses weathering the storm today. Chipotle Mexican Grill is opening roughly 130 locations a year (and today operates more than 800 locations in the U.S. and Canada), increasing cash flow production and profit margins, growing the cash on its balance sheet, and doesn’t carry a dime of debt. Hansen Natural (creator and owner of the wildly popular Monster Energy brand) is expanding into new countries, launching new products, and every quarter gains market share and gets one step closer to overcoming top energy drink competitor Red Bull. Google, Netflix, and Apple (three of the most common names today) have all doubled since 2005.

You don’t have to find obscure companies to do well in the stock market; stock history proves this is not the case. It makes no sense to invest your money in a business that you don’t fully understand, because if a situation like we have today comes along, you have no idea how that business will function or how to tell what position it is in. However, if you invest in a business whose product(s) you know and love, you will have a much easier time deducing the strength of the company.

Investing in stocks does not have to be complicated. I have several things that I look for. A business that I already love or understand is key. When there are smart and experienced people running the business, I feel a lot more comfortable with an investment. I much prefer businesses that have a strong position of cash, and little or no debt. As we saw with the examples of the Great Depression, the companies who spent and advertised during the rough times often came out ahead of the competition. A strong balance sheet provides a cushion for hard times and gives any business a tremendous advantage over competition. In a nutshell, I often look for three things to narrow down the list of companies I’m interested in: products I know and love, smart and experienced management, and a financially secure and growing business.

A rough economy is not the time to run from stocks. It is precisely these times that great businesses are put in the sale bin at the front of the store. The short-term movements of a stock do not define the long-term success or failure of a business. Focus on the fundamentals, management, and other important factors of a business to judge a stock. In the long run, those factors count the most for the success of a business and investment.

I am not predicting an easy ride from now on with stocks. I’m watching with interest many companies who I may potentially invest in, but I’m certainly not rushing in. Patience is essential to an investor focused on the long-term, always be sure you are 100% comfortable with the business before you make an investment. Today is the time to look for quality businesses hit down with the stock market, whose long-term fundamentals and strength remain intact. In the world of stocks, never let short-term troubles blur long-term potential.

David Kretzmann owns shares of Chipotle, Hansen, and Netflix.