Earnings. Sales. Revenues. Indicators. Ratios. There are plenty of things to look for in a potential investment, ranging from what a company fundamentally does to how its price chart has looked in recent days (or minutes).
But there’s a factor behind all of that which is absolutely critical to your investment success. It is, essentially, the rock on which your fortune can be built. Without it, anything constructed is liable to a quick and fast collapse.
That factor is a concept we call the rule of law. Without it, we have instability. With it, we have the stability that makes capitalism, trade, and even investments possible.
Yes, we can have instability even without the rule of law. The Weimar Republic had the rule of law, but allowed its currency to hyper inflate, ruining the economic fortune of the population. That, in turn, led to a different rule of law.
As we define it, the rule of law has a number of factors.
Those factors include fairness—that laws apply equally and to all.
Another factor includes the general right to engage in acts that haven’t been expressly prohibited. This factor allowed for tinkering and experimentation in processes and technologies that helped fuel the Industrial Revolution.
With the rule of law, we have relative certainty, in as much as there can be any certainty.
We know that if we have a problem with a customer, we can take a party to a court. There, a neutral judge can look at other past cases that occurred in the real world and make an appropriate ruling.
Finally, we have the democratic element: The idea that laws should be made with the consent of the governed, rather than by divine decree. In investing, are you not voting with your dollars, day after day?
It’s these simple concepts, embedded in just a few short words, which have made tremendous wealth and progress possible. Thanks to this concept, it possible to own and acquire land and property, and create new industries that never could have existed by government fiat.
In the last generation, the rise of the rule of law has brought most of the world’s poorest to a standard of living that even the wealthiest couldn’t have aspired to even a century before.
The “robber barons” of the railroad era could never fly coach, check their email, and complain that airlines used to serve meals. That “first world problem” is within reach of nearly every American today.
But it is through the selfish efforts of those robber barons, and those before and after, that we enjoy those things today—and even see them as necessities.
That is the power of the rule of law. It goes beyond class boundaries, it goes beyond nationalities. And while we take it for granted today, it is by no means a sure thing.
As Daniel Hannan writes in "Inventing Freedom," “It takes a real mental wrench to see the world from the perspective of August 1941, when the vast bulk of humanity lied under totalitarian governments… No one in the 1930’s saw democracy as a coming force. On the contrary, it had been ousted from state after state.” That would change in the latter half of the 20th century, and we are all better off for it.
In the investment world, the rule of law has led to agencies like the Securities and Exchanges Commission (SEC). Their reporting requirements give us things like quarterly earnings reports—and before this 1934 law, companies didn’t have to report much, if anything, to shareholders.
But that rule of law, that rock that supports the scaffolding of all our life’s work, is under attack.
For investors, management has to be accepted on a take-it-or-leave-it basis. There are simply too many blocks of shares owned by large funds that vote in lockstep with management to affect change, barring a major scandal or outright crime.
Case in point: Consider the removal of John “Papa” Schnatter as CEO of Papa John’s Pizza (PZZA). His removal came following critical and racist comments on an earnings conference call. His removal was an exception to a board of directors doing its job and removing a problematic CEO, rather than the typical board pattern of benign neglect. (If the comments had been made privately, one wonders if he would still be at the helm of the company he founded.) The system works just well enough to stay in place… for now.
On a broader level, a proliferation of rules and laws created by bureaucratic fiat, rather than elected officials, raises obstructions to progress. Congress, the only federal entity created by the Constitution to pass laws, has created agencies like the Environmental Protection Agency or even the Federal Reserve, who in turn have taken on law-making powers despite having to appear before the voters every few years.
A huge amount of power from we the people given to our government has passed into the hands of the unelectable, and the proliferation of laws and regulations is the inevitable consequence. We dislike these developments because we feel that we have lost our voice to guide them.
The decline of the rule of law is a gradual process. It can be fought and stalled. It can be local, national, or international.
Investors look to fat profits abroad in emerging markets, often to come back and invest in the more familiar home country largely thanks to their understanding of their own laws and customs.
A country moving towards improving the rule of law, like Columbia over the past two decades, can create huge investment opportunities. Countries that oscillate between stronger and weaker tenants we call the rule of law, like Brazil, can create great trading opportunities—but also with the risk of the political winds blowing the wrong way.
Consider the rock your investments stand on. Behind all the financial lingo, behind all the companies behind the ticker symbols you’re trading on a computer screen, are important, life-defining concepts that the English language has distilled into a few marvelous words. Countries that are moving towards this standard may make the investment opportunity of a lifetime.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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