Incentive

As a concept, socialism is appealing. It’s idyllic, it seems to diminish unfairness, promote the less-fortunate, favor equality, all good things. So what’s the problem?

The true problem with socialism is an economic one. It’s about simple math.

Socialism seeks to operate an economy, or society on the whole, by rules and regulations set by a small group of people in power.

Conservatives mainly criticize socialism as a system that misplaces incentives. While humans do operate by incentive, and socialism does skew incentives, this is not the most helpful critique. Socialistic regimes have imposed different forms of incentives throughout history, like fear of torture and death, to coerce their people into desired action.

There is also a basic problem with the idea that a few people should hold so much power over many. Regardless of the purity of a person, power generally corrupts. But, like the incentive criticism, this is not the most basic problem of socialism. The truth is, even under the most compassionate, just, caring leadership in the history of the world, socialism would still be doomed to fail.

The problem of socialism is, at its most basic, a problem of pricing. A truly free market is an incredibly efficient way to set prices and wages. Whenever there is too much of a good, demand (prices) goes down, and businesses and people react by creating less of that good. Whenever there is a shortage of a good, demand (prices) goes up, and businesses and people create more of that good. In a free market, this happens quickly, automatically, and constantly. Communication stems from millions of data points (decisions, knowledge, people) occurring every second of every day accurately determining what people want and delivering those goods.

When a government or ruling body steps in to set prices or fix wages (the standard operating procedure of socialism) instead of letting the market make a determination based on supply and demand, that body is bound to fail. Any group of people, regardless of their level of training, IQ, ambition, morality, etc. can never have a complete understanding of the millions of data points, decisions, and knowledge swirling within the market every second. A few people simply can’t know as much as the several billion people on earth collectively know.

Because of this, a set price or a fixed wage will necessarily result in waste (too much of a good) or lack (too little of a good). This state of mispricing, given enough time, will result in the collapse of society.

An example of wage-fixing can be seen in modern-day minimum wage policies. Minimum wage is an attempt to promote justice and protect the less fortunate from evil greedy companies; an understandable inclination, but unfortunately a worthless solution. In a free market, wages increase naturally (with bumps along the way) as demand for labor increases. In socialism, wage-fixing makes it difficult or impossible for some businesses to hire employees at a price they can afford, even if potential employees would be glad to work for such wages. At worst this creates an insane situation where businesses aren’t allowed to hire people who want to be hired, at best the market is inhibited and incentives are skewed (business may be more likely to hire contract employees or part-time employees to avoid additional costs required by regulation). A much more effective way to thwart greedy capitalists is to give the market space to create better jobs.

Socialism, as economic practice, will always necessarily fail. No group of people can ever possess the collective information of the entire market, and so they will never be able to accurately allocate resources and set prices.

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We live in a fiat currency world. ‘Fiat’ simply means government-backed. The paper that dollars are written on is pretty close to worthless, but the U.S. government guarantees its value and other countries do the same for their own fiat currencies. The U.S. dollar is worth something, more than most other fiat currencies, because it’s backed by the most powerful government in the world. There are a few implications of this:

In the past, humanity has utilized a multitude of different items or elements or commodities as money, ranging from cattle to gold, beads to shells, and anything in between. Very few of history’s currency still exist as anything resembling money for one main reason, they could be produced. The most important characteristic of money, or of anything valuable, is its rarity, the difficulty (or preferably the impossibility) of creating more of it. In order for money to hold value, it can’t be producible, there must be a limited supply. If it’s producible, there’s a massive incentive for people to produce it, and when people produce more of something, that thing loses value. This has happened countless times throughout history. Some Native American tribes used Wampum beads (gleaned from shells and clams) as money and used them to trade with European settlers. European settlers, with superior technology, were able to mass-produce the beads causing a massive devaluation. Wampum beads were inflated (or devalued, they mean the same thing) to the point that they became worthless, leaving the Native American tribes using them destitute. A similar issue is presented when we try to use commodities as money (silver, coffee, copper, etc.). Commodities are valuable (many us would be lost without our morning coffee and we’d have a hard time building skyscrapers without steel), but when demand for a commodity increases, so does the production of that commodity, so its value decreases. Money doesn’t need to have intrinsic value, it doesn’t have to be useful for anything else, it simply needs to be able to reasonably hold value through scarcity.
Since we use fiat currency, the government controls the dollar and consequently has the ability to produce more of it. When they do, inflation happens. The government likes inflation. Since the U.S. officially and fully entered the fiat currency game in 1971, the U.S. dollar has been inflated (devalued) by around 3.86% per year, on average. The government introduces more money into the economy through various convoluted debt instruments and stimulus packages, decreasing the value of existing dollars. The belief is that a certain amount of inflation is good for an economy because it promotes spending and borrowing, the opposites of saving. It’s definitely not helpful for saving. If you left $100k in your savings account in an average year, at 3.86% inflation you would lose almost $4k. If the money is in a savings account, maybe the bank would offer you a tiny bit of interest to offset some of the loss. If you’re lucky you might get 1%, but you would still lose $3k. In one year! Leave your money alone in a bank account or under your mattress for any amount of time and you’re out a significant portion of your savings.

So the question remains, how do we save money?

Thankfully, there’s an answer. The solution to the devaluation of our dollars is investing. Specifically, investing in companies through the stock market. All that talk about long-term investing, diversification, portfolios, the stock market, etc., that stuff all has merit. The best way to overcome inflation in our day and age is to invest money in companies, and let it grow. The stock market is the great hedge against inflation. Market returns, over time, always outpace inflation. It doesn’t happen every year, when the market is down it can definitely be worse than inflation, but if you give it time, the market will always win, and by a large margin.

Unfortunately, as things are presently constituted, saving money is not incentivized. Fiat money and inflation encourage borrowing and spending. But, saving is more important now than ever (who’s in line for a pension when they retire?), and the stock market offers an incredible store of value, one that increases exponentially over time. Don’t skimp on your investments.

Joshua VanDyke Advisor

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