China’s balancing act on debt is becoming trickier

The government must hold its nerve, even as economic growth slows

China's president, Xi Jinping, delivers a speech in Beijing: non-financial sector debt in the country has gone from $6tn in 2007 to nearly $29tn today © EPA

Why continue working when you are guaranteed a monthly income?” So asks Xu Yongan, a 55-year-old former steelworker from Anhui province and the recipient of an employee buyout. It may seem a bit puzzling that in China, the factory to the world, factory workers are paid to stay home. The solution to the puzzle — as to most puzzles about the Chinese economy — comes down to debt.

The government worries that years of investment-led growth have left the country with a heavy debt burden and lots of excess industrial capacity. It was a government-led effort to shut inefficient factories that led to Mr Xu’s early retirement.

That Chinese debt has grown to dangerous levels is beyond dispute. Non-financial sector debt has gone from $6tn in 2007 to nearly $29tn today, according to data from the Bank of International Settlements. The debt, equivalent to 260 per cent of gross domestic product, has brought with it dramatic declines in credit efficiency. The International Monetary Fund points out that in 2016 it took four units of credit to raise GDP by one unit. A decade ago the ratio was 1.3 to one.

China’s debt-to-GDP ratio is not far from that of the US, for example. But, as Zhou Xiaochuan, the central bank governor, emphasised last month, China’s companies bear an extraordinary high portion of the burden. Corporate debt levels at 160 per cent of GDP make it the most leveraged corporate sector in the world.

A year ago the situation looked even less tenable than it does today. Since then, the efforts to rein in excess capacity seem to have had some effect. Commodity prices have firmed, helping the big state-supported industrial companies. Private company growth (particularly in technology, as exemplified by groups such as Alibaba and Tencent) have helped reduce overall leverage levels. If China is to grow its way out of its debt problems, these trends must continue. Another potentially helpful factor is rural growth: over the past decade, China has promoted the transfer of agricultural land usage rights among farmers, resulting in bigger farms, increased investment and higher returns. Data on the scale of such transfers is scarce but an online broker,, has transferred a cumulative 6.8m hectares since it started up in 2009.

It reassures many China bulls that, due to its current account surplus and accompanying high savings rate, China has lent effectively all of the money to itself. But all the same, if the debtors cannot service their debts, a painful restructuring will be necessary. To avoid a crisis the government will have to tread carefully. The tentative withdrawal of credit from the economy is making the bond market jumpy. The central bank yesterday added more reserves into the financial system than it has in almost a year, to stem weakness in government bond prices. But liquidity injections are not a long-term solution to a debt problem. Neither is moving debt around by, for example, issuing asset-backed securities, which are increasingly popular in China.

So the government must continue to move deliberately and hope the centre holds. It will need to stay disciplined about keeping a lid on loan growth, industrial capacity and — most importantly — the shadow banking system of dodgy fund companies, trusts, and wealth management products. Slow and steady progress these front, even if the economy does not grow as quickly as previously, will send a reassuring message to global investors, and minimise the chances that China’s debt addiction will require a more radical form of treatment.

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Unicorns: What Are They Really Worth?

By Alex Eule

Unicorns: What Are They Really Worth?
Photo: Photograph by the Voorhes

When a venture capitalist coined the concept “unicorn club” in 2013, it referred to software start-ups valued at $1 billion or more—just 39 at that time.

“We like the term because, to us, it means something extremely rare, and magical,” Cowboy Ventures founder Aileen Lee wrote in a column for Techcrunch. Four years later, the rarity—and the magic—has worn off. Today, Dow Jones VentureSource tracks 170 unicorns in its database.

Equity investors once held high hopes for these companies to come to market and become the next Facebook or Google. But in recent years, the unicorns have preferred to raise funds behind closed doors. Just 32 have gone through with initial public offerings since they became a class unto themselves, according to VentureSource, and they have tended to be smaller names.

Large companies like Uber Technologies, Dropbox, Lyft, Spotify, and Airbnb have so far spurned the public market.

As the private companies become household names, they face questions about their workplace cultures, business models—and valuations.

The unicorn experience is teaching us an unexpected lesson: The public markets remain the best place to achieve long-term corporate success.

Uber and some of its private investors have learned that lesson the hard way. The company, already worth a reported $68 billion, struggled to find a new CEO after ousting Travis Kalanick, its combative co-founder. Ultimately, the company persuaded Dara Khosrowshahi, Expedia’s longtime chief and once the highest-paid public-company CEO in America, to take the job.

The new boss now says the company will go public in 2019. For Khosrowshahi and Uber, it could be their hardest task yet.

IPOS WERE ONCE the obvious path for any private company that reached a $1 billion valuation. But public markets are no longer a siren song. The median age of tech companies going public last year was 10.5 years, according to Jay Ritter, a University of Florida professor who studies trends in initial public offerings. In 1999, the typical tech company was four years old at its market debut.

The maturation of IPOs has generally been a good thing, taking risk out of the system. The drawback is that the rewards have been simultaneously reduced.

Each round of private financing decreases the chance that public investors will benefit from the next Facebook or Google. “Time is your enemy when it comes to rate of return,” says Kathleen Smith, principal at Renaissance Capital, a manager of IPO-focused exchange-traded funds.

Leading mutual fund managers have adapted to the new reality. They’re not waiting for companies to grow up; instead, they’ve dug into the private markets, searching for growth. Fund giants Fidelity and T. Rowe Price have led private fund-raising rounds for unicorns, such as Dropbox, Airbnb, and WeWork.

Unicorns: What Are They Really Worth?

Unicorns: What Are They Really Worth?

The dearth of companies making their trading debuts is an unusual feature of what has been a record run for the stock market. In the heady 1990s, there were an average of 436 IPOs per year in the U.S., based on Ritter’s data. Last year, there were just 74. A number of reasons have been cited, including increased regulations and scrutiny for public companies, as well as the deluge of private capital.

But there’s another reason. Retail investors are saying: “We don’t need you anyway, at least not at those prices.”

Instead, investors have generally chosen to stick with passive strategies, rather than make big bets on new, speculative companies.

“The interest in just getting low-cost exposure to the market is crowding out the appetite for IPOs,” says Andrea Auerbach, a managing director at Cambridge Associates who advises pension funds and other institutions on private investments.

There’s a price for everything, however, and U.S. investors are still willing to participate in the occasional initial offering. The problem for many unicorns is that they have priced themselves out of the market. They’ve raised too much money at valuations that are simply too high.

The dynamic has complicated the transition for many of the high-profile unicorns that do end up making the public jump. GoPro (ticker: GPRO), Snap (SNAP), and Blue Apron Holdings (APRN) have become billboards for the overhyped unicorn. The stocks have each shed more than 20% from their IPO prices.

INVESTORS HAVEN’T FORGOTTEN their experiences during the dot-com bubble or the financial crisis, notes Renaissance’s Smith. “The days of the stock jock are over,” she says. “So what we have left is a more astute set of investors. And they’re driving for return. That’s probably a good change for the IPO market.”

For some unicorns, public disclosures leading up to the IPO have revealed underlying business issues—problems that had been hidden away. Blue Apron’s prospectus showed that the company was spending too much to acquire customers even as those customers were spending less on average.

“It took five minutes of reading the S-1 to see there was a problem,” says David Strasser, a former sell-side retail analyst who is now a managing director at the venture-capital firm SWaN & Legend.

Blue Apron is down 69% since going public just four months ago.

Unicorns: What Are They Really Worth?

A discerning public market—and the lack of IPOs—is the best argument left that stocks have yet to hit the bubble-like levels of the late 1990s. The irony is when a market correction does arrive, it could make it harder for companies to go public.

Nine years into the current bull market, there are signs that the broader IPO market is bouncing back. Newly issued stocks have performed relatively well. The Renaissance IPO ETF (IPO), which holds companies that have made their debut over the previous 24 months, is up 34% this year, more than double the broad market’s return.

Last month, a unicorn even shone after its public debut. Shares of MongoDB (MDB)—a cloud database provider—have risen 24% since the stock’s Oct. 18 offering. At a recent $30 per share, the company is worth $1.5 billion, still 17% less than the private market valuation it reportedly fetched in January 2015.

More prominent unicorns will go public, but investors are likely to remain discriminating—a clear contrast from the lavish private markets.

FOR NOW, IT’S HARD to blame entrepreneurs for holding back on IPOs. The flood of private capital has changed the calculus. In one example, Japanese conglomerate SoftBank Group has raised over $93 billion for a technology investment fund. Those dollars alone exceed the $84 billion in total proceeds raised in U.S. IPOs since the start of 2015.

Founders like to say it’s not just the money. Freed from the burden of quarterly disclosures, Wall Street analysts, and shareholder votes, private markets have been deemed more-hospitable terrain.

IAC Chairman Barry Diller has spun off nine public companies, but at a recent Wall Street Journal D.Live event, he said: “There’s no reason to be public unless you need capital. And, by the way, almost all these companies do not need capital.”

Uber is able to hold off on an IPO until 2019, largely thanks to SoftBank’s largess. Last week, the ride-sharing firm reportedly accepted a new round of funding from the Japanese giant. According to media reports, SoftBank is investing up to $10 billion, with $1 billion coming at a $68 billion valuation, matching the headline value that frequently gets attached to the company.

Most of SoftBank’s investment, though, would come at a lower valuation, with the company buying shares from existing investors. The complex transaction illustrates the dance that’s happening behind private doors.

As unicorns soar in value, the firms have faced increasing pressure to keep those valuations growing, even when the fundamentals might not support them. Often, that means finding ways to entice late-stage investors.

New rounds of fund raising tend to include preferred stock that comes with greater downside protection.

Academics from Stanford University and the University of British Columbia spent 2½ years studying these preferences and found widespread use of them in Silicon Valley. The perks include strong liquidation preferences in the event the company goes broke, or guaranteed returns at the time of the IPO, should shares be priced lower than expected. In 24% of the unicorns studied by Stanford Prof. Ilya Strebulaev, preferred shareholders can effectively block an IPO from happening.

“The average unicorn in our sample has eight classes, with different classes owned by the founders, employees, VC funds, mutual funds, sovereign wealth funds, and strategic investors,” Strebulaev and University of British Columbia Prof. Will Gornall wrote in their study.

The terms get hashed out in private. Generally, all the public hears is the headline valuation that emerges from the agreement. But Strebulaev argues that those valuations are frequently misleading, since the latest class of stock carries preferential terms that don’t apply to the company’s existing private stock. New private investors are willing to make investments above fair value because of the powerful economic benefits that come with preferred stock—benefits that don’t apply to the common shares held by employees.

Strebulaev and Gornall conclude that headline valuations overvalue unicorns by 50% on average. Their analysis knocks nearly half of the unicorn club back below the $1 billion mark.

ACCORDING TO PAT GRADY, a partner at venture-capital firm Sequoia Capital, there has been a notable increase in fancy fund-raising terms in recent years. “There’s a lot of financial engineering that people can do to create a valuation that looks like a big number, but actually feels like a much smaller number for the new investors,” Grady says. “That’s something people will do if the founders are really focused on having that big headline valuation.”

He adds: “It’s an unfortunate game of brinkmanship where, at the margins, everybody wants to feel like they’re worth just a little bit more.…Eventually, we end up in this place where lots of companies have lots of unhealthy structure.”

The problem, according to multiple insiders, is that fancy terms pit the private investors against one another. The preferences given to a late-stage investor can dilute the stakes of earlier ones and employees.

Grady says that Sequoia tries to avoid those situations. “The more financial engineering you do, the less aligned you are with founders,” he says.

It also creates an opaque capital structure that few outside the boardroom understand. Strebulaev’s team, including Stanford colleagues and outside lawyers, pored through the unicorns’ certificates of incorporation. In some cases, it took the lawyers 12 hours to make sense of one document, Strebulaev says.

WHILE PUBLIC COMPANIES sometimes issue multiple classes of stock, they’re usually differentiated by voting power, not economics. With private companies, there’s basically no limit on the terms investors can request.

There’s no federal regulation requiring disclosure of the terms either. Strebulaev says he got lots of calls after he published the study, adding, “There is one organization that has not called me so far, and that is the SEC.”

He says that disclosure regulations for private companies should be updated, given that public investors are now often invested in unicorns—sometimes unknowingly—through mutual fund holdings.

“Determining cash-flow rights in downside scenarios is critical to much of corporate finance, and the different classes of shares issued by VC-backed companies generally have dramatically different payoffs in downside scenarios,” the paper contends.

Robert Bartlett, a law professor at the University of California, Berkeley, who specializes in securities regulation and corporate finance, says the difference between share classes is no secret among Silicon Valley venture capitalists. “It’s common knowledge that the common is worth less than the preferred,” he says.

Publicly, though, that knowledge is getting overlooked. “No one is drawing the distinction,” Strebulaev tells Barron’s.

IAC’s Diller put it more bluntly at last month’s Wall Street Journal conference: “It’s the absence of dealing with multiplication, division, addition.”

Some investment managers still care about the math, hoping to benefit their shareholders in the process. Henry Ellenbogen, a T. Rowe Price fund manager, has been buying preferred private shares for several years in his New Horizons mutual fund.

T. Rowe often leads the investment, taking the role of a late-stage VC firm. “We’re the ones that set the valuation on the asset,” Ellenbogen says. “We know, based on our view of different rights, what we think each share class is worth. When we do valuation, we absolutely adjust for it.”

He notes that common stock generally carries a 10% to 20% discount to preferred shares. But in some cases, as private companies struggle to raise money, they’re forced to give more-favorable terms to new investors. “The preferences get more onerous, and the gap between the common and preferred gets wider,” he says.

In October 2014, Square (SQ) raised $150 million. At the time, the deal was reported to value the company at $6 billion, up from a previous $5 billion. But to secure that higher valuation, Strebulaev notes that Square made a big promise: Series E investors were guaranteed $18.56 per share if the company went public.

A year after the Series E fund raising, Square did go public, at just $9 a share, valuing the company at $2.9 billion.

Eventually, Square did reach that $6 billion value—but it was 18 months after its public debut. Since then, Square has been one of the few public unicorn success stories, and IPO investors who stuck with the stock have been rewarded. It’s up 250% in the past 12 months, giving the company a market value of $16.5 billion. It took a public listing to square Square.

Cloud-storage firm Box (BOX) is another of those rare unicorns—a start-up that reached $1 billion, went public, and managed to grow its stock, post-IPO, despite some early turbulence. After a 57% rally this year, Box is now worth $2.9 billion. The company went public in January 2015 at $1.7 billion.

CEO Aaron Levie says he can appreciate what private companies are going through and why they’re hesitant to go public. “My state of mind four or five years ago was, ‘Let’s push off being public as long as possible,’ ” he says.

“The thing you imagine is, all of a sudden, once you become public, everybody only cares about the quarter and everything is going to be run for short-term returns,” Levie says. “That’s the brand that Wall Street has, for better or worse.”

But he says he has learned the benefits of public ownership: “There is a way to drive near-term performance and long-term strategy and innovation. Those things don’t have to be mutually exclusive.”

As for the increased scrutiny and the obligations around disclosure, Levie has found positives there, as well. “You just begin to run your company in a more disciplined fashion, operationally, organizationally, even culturally,” he says. “You start to care about a lot of things that when you were private you could be a little bit looser with.”

Getting Technical

Banks Draw a Line in the Sand

By Michael Kahn 

Old bank sign engraved in stone or concrete above the door of financial building concept for finance and business Photo: Getty Images

Normally, a technical breakout in the bank sector would herald a new leg up for the broader market.

With financial companies representing about 16% of the weight of the Standard & Poor’s 500 index, second only to technology, the math says the path of least resistance should be to the upside.

Considering that banks lagged the market for most of the past year, the fact that they seem to be taking the mantle of leadership as big tech stocks pull back should be a great development for the bulls.
The market doesn’t mind if its leaders stumble as long as another group steps up to lead. That’s one reason why the S&P 500 was able to not only rally to new highs but accelerate its pace.

This, even as big tech—as represented by the Technology Select Sector SPDR exchange-traded fund (ticker: XLK)—fell 3% over the past week
In contrast, the SPDR S&P Bank ETF (KBE) rallied as much as 5.6% before pulling back a bit (see chart).

Market skeptics might say that the sudden awakening in the bank sector isn’t the result of money seeking better potential returns. Instead, it’s a defensive move, with money fleeing the hot tech sector to a safer place where the rally is not nearly as extended. If so, it may not result in another leg up for the market—but it does mean investors’ portfolios will have less room to fall.

In Monday’s column, I warned that the rally had kicked into dangerous overdrive, meaning that something had to give soon. In that light, the banks have a big responsibility to hold their ground right here and right now. If they don’t and the sector breakout fails, it will give the bears all they need to get very aggressive.
But why should that be? We can argue over the content of the proposed tax-reform bills as they work their way through the reconciliation process, but that’s not it.

Technically, the SPDR S&P Bank ETF has a nice upside breakout, and over the past two days a pause allowed it to digest that important event. To remain a viable bullish signal, the ETF must hold its breakout and establish a new higher trading range at a minimum. Even better would be upside follow-through.

Failure for banks to stay strong while tech remains in a corrective dip—and as the No. 3 sector, health care, is showing a rather violent downside reversal—would put the overall market in serious, albeit short-term, jeopardy. Even with these developments, I am not convinced that the long-term bull market is over just yet.

There is one more consideration making the bank breakout a bit shaky. The yield curve is now as narrow as it was in late 2007. In other words, the spread between long- and short-term Treasury interest rates seems to be heading in the wrong direction for an economy that puts out good news on a regular basis.

To be sure, the curve is narrow, but not yet narrow enough to trigger a recession. A flat or even inverted—that is, negative—curve would be that signal.

The problem for banks is that a big part of their business revolves around borrowing money at short-term rates and lending it back out at long-term rates. The steeper the yield curve, the better their profitability, so a curve this narrow could be problematic.

After the election last year, the yield curve rallied—that is, got steeper—and banks rallied sharply as well. Both started to fall together at the start of this year. Right now, the curve is weak, while banks are strong. One of them is likely to change direction, and it seems that banks should follow the curve, not the other way around.

If banks do resist the yield curve, then I give them credit for their internal strength and look for any market correction to be mild. However, if they cannot hold their breakout, then I would like to hold a little more cash to ride out the inevitable correction.

Michael Kahn, a longtime columnist for, comments on technical analysis at A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

The Fed is Poisoning the Market. Here’s the Antidote.

The Fed’s communication strategy is encouraging bad risk taking and complacency. It’s time to give the market a real surprise, says columnist James Mackintosh.

By James Mackintosh

Federal Reserve Chairwoman Janet Yellen during the G30 International Banking Seminar in Washington, D.C., on Oct. 15. Ms. Yellen has two meetings left as chairwoman of the Federal Reserve. Photo: saul loeb/Agence France-Presse/Getty Images

Janet Yellen has two meetings left as chairwoman of the Federal Reserve, and traders think they know exactly what she will do with interest rates. Fed-funds futures peg the chance of a quarter-point hike next month at 97%, with just a 5% chance of a further rise at her swan song in January.

Ms. Yellen has plenty of time to shake the complacency of markets, and she should. The best way is to become less predictable. An emergency Fed meeting on a Sunday could raise rates some random amount, say 0.07 percentage points. Even better, the Fed doesn’t need to even issue a press release about it, let alone hold a press conference. Let the markets find out that the overnight borrowing rate has gone up when it, well, goes up.

Such talk is heresy for the modern central banker, and markets would hate it. But that is the point. Central banks have been coddling investors for years with transparency and forward guidance, to such an extent that the question of what policy makers will do has primacy over analysis of inflation and the economy.

Central bank openness and the unwillingness of policy makers to surprise investors was a powerful drug in the crisis, but leaks a slow poison into the markets. The result is that investors have piled on bad risks they would otherwise be unwilling to take on. It also degraded the quality of the signals markets send about the economy. Perhaps worst of all for central bankers, the transparency has conspicuously failed in its main job of getting investors to understand the policy process. Their magical aura is wavering, and the danger is the curtain is pulled back to reveal that mere economists control the monetary policy levers.

Each of these points is important. But there is also a question of timing. Central banks became more open about their plans for a sound monetary policy reason: they ran out of room to cut rates.

Back in 2004, the Fed worried that when it started raising rates from 1% a market panic could create economic troubles, and it didn’t have much scope to respond by cutting rates further.

Guiding the market about future policy succeeded in avoiding an upset like that of 1994, when unexpected rate increases rattled investors. In the wake of the Lehman Brothers collapse in 2008 the Fed cut rates to 0%-0.25%, and had to switch to bond-buying instead of further rate-cutting. Public guidance about future rates became more explicit, giving central banks—led by the Bank of Canada, then headed by Mark Carney, now governor of the Bank of England—an extra tool to influence longer-dated borrowing costs.

The need for that extra tool is fading. The Fed last month took its first baby steps to cut the size of its bondholdings, while the European Central Bank is buying less. They should be thinking about how to back away from their crisis-era communication strategy too, but instead they’re considering making it permanent.

“Why to [sic] discard a monetary policy instrument that has proved to be effective?” asked ECB President Mario Draghi at a conference in Frankfurt this week.

“Draghi’s a magician, he’s tremendously good at manipulating the markets,” says Matthew Eagan, co-manager of the $13 billion Loomis Sayles Bond Fund in Boston. Yet, in the U.S. it’s time to let the markets find their own levels, and as the European economy recovers, the same will hopefully soon be true for the ECB.

Forward guidance menaces markets mainly because it encourages risk taking, over and above that already encouraged by low rates. With hindsight, we can see how the predictability of Fed rate rises—a quarter-point at every meeting from 2004 to 2006—freed financiers to pile on short-term leverage, with disastrous consequences. It isn’t only the level of interest rates that matters.

Something similar has happened today. Low volatility has become a way of life, in part because central banks are so predictable, and it is encouraging more risk-taking. The danger is that any shock will be worse as a result—and really big market disruptions help create recessions, as in 2001 and 2008.

Forward guidance also makes markets less useful as a gauge of what investors are thinking, and so less effective at allocating capital to the best effect in the economy.

“The more you try to influence market prices for your own ends the less informative market prices become,” says Hyun Song Shin, head of research at the Bank for International Settlements in Switzerland.

In some ways this isn’t the fault of the central banks, who have mostly explained that the guidance depends on what happens to inflation and the economy (after some embarrassing early mistakes, particularly from Mr. Carney). But investors want conviction, even when central banks spell out the uncertainty. The BOE is furthest ahead in explaining the uncertainty, but its prediction that there is a 90% chance that in three years inflation will be between roughly 4.5% and minus 0.5% is mostly ignored in favor of its central prediction of inflation just above 2%.

My suggestion of a small secret rate increase harks back to the pre-1994 era, when the Fed didn’t announce its decisions until a month or later. Democratic accountability makes it hard for the Fed to adopt the “never explain, never excuse” maxim of former BOE Governor Montagu Norman. But for the health of the economy and their own credibility central bankers should try to break the markets’ addiction to their words.

Doug Casey on the Destruction of the Dollar

By Doug Casey, founder, Casey Research

“Inflation” occurs when the creation of currency outruns the creation of real wealth it can bid for… It isn’t caused by price increases; rather, it causes price increases.

Inflation is not caused by the butcher, the baker, or the auto maker, although they usually get blamed.

On the contrary, by producing real wealth, they fight the effects of inflation. Inflation is the work of government alone, since government alone controls the creation of currency.

In a true free-market society, the only way a person or organization can legitimately obtain wealth is through production. “Making money” is no different from “creating wealth,” and money is nothing but a certificate of production. In our world, however, the government can create currency at trivial cost, and spend it at full value in the marketplace. If taxation is the expropriation of wealth by force, then inflation is its expropriation by fraud.

To inflate, a government needs complete control of a country’s legal money. This has the widest possible implications, since money is much more than just a medium of exchange. Money is the means by which all other material goods are valued. It represents, in an objective way, the hours of one’s life spent in acquiring it. And if enough money allows one to live life as one wishes, it represents freedom as well. It represents all the good things one hopes to have, do, and provide for others. Money is life concentrated.

As the state becomes more powerful and is expected to provide more resources to selected groups, its demand for funds escalates. Government naturally prefers to avoid imposing more taxes as people become less able (or willing) to pay them. It runs greater budget deficits, choosing to borrow what it needs. As the market becomes less able (or willing) to lend it money, it turns to inflation, selling ever greater amounts of its debt to its central bank, which pays for the debt by printing more money.

As the supply of currency rises, it loses value relative to other things, and prices rise. The process is vastly more destructive than taxation, which merely dissipates wealth. Inflation undermines and destroys the basis for valuing all goods relative to others and the basis for allocating resources intelligently. It creates the business cycle and causes the resulting misallocations and distortions in the economy.

We know the old saw “The rich get richer, and the poor get poorer.” No one ever said life had to be fair, but usually there is no a priori reason why the rich must get richer. In a free-market society the sayings “Shirtsleeves to shirtsleeves in three generations” and “A fool and his money are soon parted” might be better descriptions of reality. We do not live in a free-market society, however.

The rich and the poor do have a tendency to draw apart as a society becomes more bureaucratic, but not because of any cosmic law. It’s a consequence of any highly politicized system. Government, to paraphrase Willie Sutton, is where the money is. The bigger government becomes, the more effort the rich, and those who want to get that way, will put into making the government do things their way.

Only the rich can afford the legal counsel it takes to weave and dodge through the laws that restrict the masses. The rich can afford the accountants to chart a path through loopholes in the tax laws. The rich have the credit to borrow and thereby profit from inflation. The rich can pay to influence how the government distorts the economy, so that the distortions are profitable to them.

The point is not that rich people are bad guys (the political hacks who cater to them are a different question). It is just that in a heavily regulated, highly taxed, and inflationary society, there’s a strong tendency for the rich to get richer at the expense of the poor, who are hurt by the same actions of the government.

Always, and without exception, the most socialistic, or centrally planned, economies have the most unequal distribution of wealth. In those societies the unprincipled become rich, and the rich stay that way, through political power. In free societies, the rich can get richer only by providing goods and services others want at a price they can afford.

As inflation gets worse, there will be a growing public outcry for government to do something, anything, about it.

People will join political action committees, lobbying groups, and political parties in hopes of gaining leverage to impose their will on the country at large, ostensibly for its own good.

Possible government “solutions” will include wage and price controls, credit controls, restrictions on changing jobs, controls on withdrawing money from bank accounts, import and export restrictions, restrictions on the use of cash to prevent tax evasion, nationalization, even martial law—almost anything is possible. None of these “solutions” addresses the root cause—state intervention in the economy. Each will just make things worse rather than better.

What these solutions all share is their political nature; in order to work they require that some people be forced to obey the orders of others.

Whether you or I or a taxi driver on the street thinks a particular solution is good or not is irrelevant.

All of the problems that are just beginning to crash down around society’s head (e.g., a bankrupt Social Security system, federally protected banks that are bankrupt, a monetary system gone haywire) used to be solutions, and they must have seemed “good” at the time, otherwise they’d never have been adopted.

The real problem is not what is done but rather how it is done: that is, through the political process or through the free market. The difference is that between coercion and voluntarism. It’s also the difference between getting excited, frustrated, and beating your head against a wall and taking positive action to improve your own standard of living, to live life the way you like it, and, by your own example, to influence society in the direction that you’d like to see it take—but without asking the government to hold a gun to anyone’s head.

Political action can change things. Russians in the ’20s, Germans in the ’30s, Chinese in the ’40s, Cubans in the ’50s, Congolese in the ’60s, South Vietnamese and Cambodians in the ’70s, then Rhodesians, Bosnians, Rwandans, and Venezuelans today are among those who certainly discovered it can. It’s just that the changes usually aren’t very constructive.

That’s the nature of government; it doesn’t create wealth, it only allocates what others have created. More typically, it either dissipates wealth or misallocates it, because it acts in ways that are politically productive (i.e., that gratify and enhance the power of politicians) rather than economically productive (i.e., that allow individuals to satisfy their desires in the ways they prefer).
It’s irresponsible to base your own life on what hundreds of millions of other people and their rulers may or may not do. The essence of being a free person is to be causative over your own actions and destiny, not to be the effect of others. You can’t control what others will do, but you can control yourself.

If you’re counting on other people, or political solutions of some type, most likely it will make you unwary and complacent, secure in the hope that “they” know what they’re doing and you needn’t get yourself all flustered with worries about the collapse of the economy.