How to Preserve Wealth in a Socialist Economy

February 15, 2009 | By: Simit Patel

A socialist economy is essentially a centrally planned economy; in other words, government, rather than the free market, chooses how collective resources will be invested. Regardless of what one thinks of whether this is appropriate or not, centrally planned economies tend to be less efficient and less productive than their free market counterparts. While part of this is the age-old incentive issue -- why work if I'm not going to keep the profits? -- there is also the issue that centrally planned economies simply may not be capable of making the infinite number of decisions required to produce. In free market economies, the "invisible hand" of supply and demand tends to automatically guide resource allocation, which historically has resulted in greater efficiency than centrally planned models. Economist F.A. Hayek elaborated on this issue in his classic book, The_Road_to_Serfdom.

Because centrally planned economies are less capable of properly allocating investments, and because they can distort the free market through interventions, there is greater risk of malinvestments -- i.e. poor investments that do not create greater wealth, made by both central planning institutions within government as well as private investors. The impact of malinvestments is deflationary; credit is destroyed, asset prices fall, investors become more hesitant and reluctant, and the appeal of sitting tight in cash grows. Unless, of course, the central bank can stimulate the economy through inflationary monetary policies, in which case cash might be devalued as well.

To summarize, centrally planned economies tend to have a more unstable business cycle, one that is prone to both excessive inflation as well as excessive deflation.

So the question: how does one preserve wealth in a socialist economy?

To answer this question we should examine what alternative forms of money exist. Key questions to consider:

1. Is there another economy that does not suffer from the typical problems a centrally planned economy does? If so, can we store our wealth in that respective currency?
2. If the whole world is socialist, who is the best central planner? In other words, which central planner would you "invest" in?
3. Which commodity is the market currently treating as money? Throughout history, gold and silver have been the most popular choice free marketeconomies around the world has chosen as money. Even in our current times, when currencies become unstable, individuals begin to price their assets in other currencies or precious metals like gold -- something we recently saw in Vietnam.

As the global economy is increasingly socialist and is experiencing the corresponding instability surrounding both inflation and deflation, commodity money may be the safe haven of choice in our current times. If there is a big problem -- currency crisis, political instability, etc. -- your commodity money serves as an insurance policy of sorts. More specifically, the commodity money that you take possession of is your true insurance policy, in the event of a breakdown of the socialist government. And so, when looking at your aggregate portfolio, a key question to ask may be: how much do I want to put in my emergency fund? The answer to that question should be the amount you are in whatever is the monetary commodity of choice (most likely gold), with a bias towards taking delivery, as counterparty risk will also increase should the economy become increasingly unstable.

Next time, we'll take a look at how to adjust the safe haven portion of your portfolio -- i.e. your commodity money -- based on the developments occurring in your socialist economy.

Disclosure: Long gold.

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