Investment or Ideology? It Pays to Know the Difference
Three times in the last 10 years, many libertarians and fiscal conservatives have taken severe financial beatings because their investment decisions were influenced by ideology. I should say, at least three times.
In 1967 silver prices began rising rapidly. Near the top of the market, at $2.50 an ounce, one found investment advisors of the libertarian and fiscal conservative variety pouncing on their constituency and inducing hundreds of thousands of people to pour their savings into silver—after the tremendous price increase had already occurred. The price began to falter, then plummet, leaving enormous losses for thousands of people. I know many who lost a considerable sum in that fiasco.
In 1974 it became apparent that gold would be legalized at year's end. Throughout 1973 the number of operators peddling gold and silver to the public grew at least tenfold. In 1974 the price of gold reached $180 an ounce, then began slipping as new speculative demand diminished and some of the previous purchasers of gold began liquidating some or all of their gold positions. The tremendous increase in gold prices from late 1973 through early 1974 was primarily new speculative holders competing with each other for the same gold. One reader of REA50N, for example, would be selling to another reader of REASON, who then sold it to another.
The entire price increase can be explained by new fiscal conservatives or libertarians buying precious metals for the first time or increasing their holdings. The arguments were familiar—inflation, monetary collapse, socialism, would induce people to convert their assets out of paper and into precious metals. The price of gold would rise and continue rising until enormous, even $800 or $1,000 per ounce.
With the petroleum boycott beginning in October 1973, many were convinced that the world—at least the Western world—was coming to an end. Italy and Japan were suffering severely, the Primitive World was starving because of the high oil prices, and the newfound wealth of the OPEC states brought forth suggestions that the entire West would be bought up by them. Currencies were unstable, and the industrialized West incurred fantastic balance of payments deficits. In addition, it was in the summer of 1973 that the economies of the United States, Western Europe, and Japan peaked, entering the worst economic decline since the Great Depression.
There was good reason for pessimism. Indeed, fiscal conservatives and libertarians often viewed the economic decline with glee, as they felt it was well-deserved punishment for the government's following the nostrums they had held for years. Many new speculators converted their holdings from paper to precious metals, including both silver and gold coins, Swiss currency, silver bullion, shares in gold mining companies, and gold itself, although gold bullion remained illegal at the time.
This wave of buying, from the inception of the oil boycott through early 1974, was sensible for many people. It was a good bet against what appeared to be a grim economic trend. Libertarian investment advisors were not the only ones recommending gold as a good hedge against inflation. Inflation rates were high, and gold was becoming popular among groups of people who had no previous interest in it.
The market also became more normal beginning in March 1974, when the oil boycott was lifted. Although the oil states were accruing vast amounts of Western currency, it had already become apparent that they had to do something with it. If they just held the currency in Arab coffers, they would be sending us petroleum in exchange for a few pieces of paper. Perhaps Western politicians are foolish enough to advocate the short end of such financial legerdemain (credits to the Communist bloc to purchase our goods), but the Arabs are not so stupid. They placed their money in financial instruments in the West so that it could earn income, and they began massive importing of goods. The wealth was circulating; they were not buying up American industry. In addition, although the recession was deepening, no catastrophe was engendered either by this or by the oil boycott. No Western governments fell to the far left. Hardship, yes, but catastrophe, no. No riots, no starvation, and the unemployed got by with unemployment benefits.
So the gold market began declining, from $180 per ounce in March 1974 to $130 in early July.
But then Congress passed a bill permitting the President to set a date for legalization of ownership of gold for American citizens, and the date was set to be December 31, 1974. And this led to the greatest self-delusion in investment since the silver debacle in 1967-68. The peddlers of gold and silver began their pitch, not only based on the forecast of economic collapse—which should not have been taken seriously at this time—but also based on the projection of an enormous increase in speculative demand greeting legalization. Many libertarians and fiscal conservatives were taken by the argument that since they were enamored of gold everyone else was likewise hankering for it, just waiting for legalization.
The amount of advertising appealing to the public was utterly astounding. In one issue of the Wall Street Journal, in November 1974, two-thirds of all investment ads advocated the purchase of precious metals in one incarnation or another—bullion, coins, share, or medallions. The sales of firms such as Franklin Mint and other produces of commemorative medallions soared. These mints sold their precious metal medallions as investments, although any quick calculation would have shown the price of gold required tripling before the gold content in the medallion would equal its price.
Still, many fiscal conservatives and libertarians bought. As with silver previously, they were bidding up the price against one another, confident that when legalization came the American public would swarm to the gold merchants en masse, buy gold, boosting the price into the stratosphere and making their own investment in precious metals, previously purchased, extremely profitable.
The first error was in believing that the public thinks along the same fiscal lines. The moderation in the recession, the receding of panic over the oil boycott, and the abatement of trade wars did not satisfy libertarians who believed that the economic policies, if anything, were growing worse. Although this recession might not be the one that Britainizes the United States, such decay was sure to come. Therefore gold should be bought; at worst, the necessary gold buying would precede the collapse by a few years (at most). Surely broad sectors of the public realized this.
But if broad sectors of the public agreed, the policies that produced the recession would not have been enacted. The fact that the public demanded more State intervention in response to the crises shows clearly that they do not agree. Gallup polls confirm this evidence.
As soon as the worst was over the public forgot about an imminent collapse. The need to convert paper into precious metals became part of the mythological past in only a few short months.
In the three months preceding legalization, selling activity had become frenetic. Wall Street brokerage firms and banks entered the market. All prepared to provide the masses with the tons of bullion that would be demanded on December 31, 1974. Advisory services sprang from every closet. Bullion firms filled page after page of the Wall Street Journal with advertisements for their wares.
Those who know me know that from the very day legalization was approved I advocated selling gold. The gold rush never appeared. There was nobody left to buy! Everyone who was going to buy gold had already bought it or one of its surrogates—gold mining shares, medallions, coins, Swiss francs, or silver bullion—or had illegally bought gold through Swiss bank accounts or other offshore banks. That the price of gold would collapse was obvious to many insiders, including the floor brokers on Commodity Exchange, Inc., almost all of whom went short on gold the first day of trading—with many libertarians and fiscal conservatives taking the long side, even as they had bought silver in 1967 and '68.
The strangest example of self-delusion among a number of libertarians and conservatives, however, was the Great Mexican Peso Debacle. It is saddening that so many small investors could destroy themselves financially over so preposterous a ploy. This too, is not hindsight, for readers of the controversial book, You Can Profit From the Coming Mideast War, know that Chapter 6 forecast the devaluation of the peso. The book's only error concerned the size of the devaluation—it was larger than forecasted.
The mystique of the Mexican peso began in the spring of 1975, when a well-known libertarian investment advisor began strongly advocating the purchase of pesos in every issue of his newsletter. Shortly thereafter, other libertarian advisory services began the advocacy, not to be left out of this new source of miracles.
The argument was to buy distant deliveries of Mexican peso futures and await their maturation. Since peso futures have been traded on the International Monetary Market of the Chicago Mercantile Exchange, the tendency is for distant futures contracts to begin trading considerably under the official exchange rate, 8 cents per peso, and slowly increase in value to 8 cents as the contract comes due. Hence the investment is a sure profit. The Mexican peso contract calls for delivery of one million pesos. The margin prior to the devaluation was low, about $3,000 or $4,000, depending on the brokerage firm. Distant contracts (those with, say, 18 months to trade prior to expiration) would begin trading at about 7.1 cents per peso. Thus, between the time it began trading and expiration, the contract would increase in value by $9,000. This is 300 percent profit on a margin of $3,000. Over 18 months it would annualize to 200 percent profit. And a sure thing to boot.
Why could not the peso fall? Certainly other currencies rose and fell against the dollar. The investment was only a sure thing if the peso was destined to rise to 8 cents at the point of expiration of the contract.
Yet these investment advisors discounted any possibility of devaluation. The historical relationship between the peso and dollar was always to hold—because it always had held.
Why were these libertarians so enamored of the Mexican currency? Certainly it could not be due to that government's fiscal responsibility. The monetary authorities were increasing the money supply at roughly 30 percent per year, were running a severe balance of payments deficit (lowering demand for the peso outside Mexico), and carried a huge deficit. The government of Echeverria was leftist and identified with the Primitive World, constantly denouncing capitalism, imperialism, and multinational corporations. Taxes increased 150 percent during Echeverria's six years.
In other words, Mexico was following policies that, when pursued by American politicians much more temperately, were denounced as certain to end in a devaluation of the dollar. The same policies that led libertarian and fiscal conservative investment advisors to tell their clients to clear out of Britain and Italy led them to tell their clients to invest in Mexican currency. They used these policies to advise being short the pound, but ignored them when advising their clients to be long the peso. Yet Mexico followed policies more irresponsible, socialistic, and expansionary than did Britain or Italy.
Indeed, the well-known distrust of political pronouncements and politicians failed when one libertarian investment advisor discounted any possibility of devaluation by quoting Echeverria's promise never to devalue the peso relative to the dollar! Why was every statement by an American and British politician caustically distrusted and the very same promise from a Mexican politician believed?
Mexico's expanding oil production was used to argue for the continued strength of Mexico's economy and currency. But this argument is a cash-in. Mexico only recently became a petroleum exporter. Unlike Saudi Arabia, its petroleum exports per capita are tiny, perhaps 200,000 to 300,000 barrels per day among 75 million people. Optimistically, using the government's own estimates, exports would not reach a million barrels a day until 1980. Even Iran, with 5 million barrels a day among 24 million people, is running a budget deficit and has more imports than exports. To argue from Mexico's oil production to the continued strength of Mexico's currency is either poor thinking or pure dishonesty, an attempt to find any support, no matter how transparent, to convince a gullible public to invest in pesos.
The devaluation, as inevitable as that of Britain's, came on August 31, 1976. Peso futures immediately fell to 4.4 cents, before a slight rally and a subsequent drop to 2.9 cents. Losses per contract ran a minimum of $35,000 and as much as $50,000.
Thousands of libertarians and fiscal conservatives held contracts, the result of an incessant advertising campaign by a small circle of investment advisors. I know of one who held 22 contracts and lost $650,000. Total losses among libertarians must have exceeded $50 million and may have been as much as $125 million.
What brought about this suspension of reason? One factor was undoubtedly the desire for something for nothing, a sure thing that will bring riches. Even among libertarians and fiscal conservatives there is this hope—witness the gold debacle immediately preceding the Mexican peso debacle. Another reason may be a tendency to believe in anything even indirectly anti-western. There is a widespread feeling among many of us that the West has sinned and deserves the fruits of its folly in the form of economic collapse. Therefore, the belief in the strength of a non-Western economy comes easy.
By investment in Mexico, an almost political act, the policies of the West are being rejected—sort of a vote, with the dollar, of no confidence. And this emotional, ideological act can be very costly, as it was to thousands of unsuspecting innocents who believed the peso would have to hold up because the United States would thus be punished for its socialism and welfare-state policies. As bad as the West is, however the rest of the world is worse. As foolhardy and stupid as U.S. policies are, the policies of the Primitive World are even more stupid—which is why they are primitive.
There is a tendency among the ideological to believe not only that they possess the Truth in ideological matters but that even the least important matters in the world must conform to their axioms. The Mexican peso has an obligation to remain strong, if only to reveal the sins of the West and to show their sagacity in rejecting those sins. Unfortunately, it was forgotten that the Primitive World is even more sinful.
Will we witness yet another suspension of reason for ideological investing? True, some bought silver or gold or pesos—gold, in particular—not to earn huge sums, but in an attempt to keep what they'd already earned, that is, as security against government monetary meddling. But those who advised buying or bought to make a killing, assuming that everyone shared their antigovernment ideology, were rather foolish. And any who bought on the theory that the West would be punished, that the market keeps a moral tally sheet, were utterly foolish. Perhaps with three debacles under their belts, those whose investment decisions flowed from ideology have learned their painful lesson.
Dennis Turner is a commodity trader with the New York firm of Incomco. His most recent book is Trading Silver Profitably.