Charlie Munger: Capitalism's Conscience

"[Short-term traders] tend to do for the reputation of capitalism what the court of Louis XIV did for the reputation of the monarchy."

The uber-successful are sometimes accused of pulling up the ladder behind them, denying other strivers the same opportunities for advancement.

Charlie Munger, though, was different.

Behind his trademark bluntness lay a profound respect for the capitalist system that had made him and his partner, Warren Buffett, so fabulously wealthy — and a mission to preserve it for generations to come.

And, by 1984, that great engine of American capitalism — the stock market — had started to look less like a sober and serious tool of wealth creation and more like a casino run amok.

In a searing opinion piece and in later testimony before a U.S. House committee, Charlie issued a stark warning to every card-carrying capitalist: the market’s obsession with short-termism, fueled by frenetic trading and ill-conceived hostile takeovers, not only fleeced the everyday investor, but also tarnished the very reputation of capitalism itself.

America has been blessed with a “cornucopia of goods and freedoms which only capitalism can provide”. A miracle of human ingenuity capable of lifting nations out of poverty and advancing others to unimaginable prosperity.

If only its practitioners could keep from tripping over their own excesses…

Like the endless buying and selling, the chase for a quick buck, and the fees and commissions that create “paper-shuffling profits” for money managers “who tend to do for the reputation of capitalism what the court of Louis XVI did for the reputation of the monarchy”.

And, if society ever rose up with torches and pitchforks against capitalism, the fallout would extend far beyond Wall Street. Those like Charlie, insulated by wealth, could probably weather such a storm — but the opportunities for future generations would surely wither.

---

---

Has anyone ever understood the dual nature of the stock market better than Charlie Munger? On one hand, it thrives as an “orderly place for transaction of essential economic business”. An irreplaceable mechanism allowing companies to raise capital and investors to share in any resulting prosperity. But, by 1984, it had also devolved into “a near-ideal gambling casino” where speculators could lever up and bet big on fleeting price swings — winning fortunes or crashing into ruin — without contributing a lick of real value to society.

And, while Mr. Market teetered between these Jekyll-and-Hyde extremes, Charlie instead stood fast in clear-eyed balance. He championed the system’s virtues while refusing to ignore any shortcomings of the moment.

Especially since the speculative fever had spread beyond reckless individual investors, infecting even the vital pension funds that safeguarded workers’ futures. Nothing invites regulatory scrutiny — or fuels public outrage against capitalism — faster than endangering the financial security of retirees.

These pension funds, once prudent guardians of savings, were now churned like butter — with portfolio turnover rates climbing as managers chased short-term gains.

“Too much easy money,” he wrote, “is now being made by too many pie-divider types as distinguished from pie-producer types. This is bound to raise anti-capitalistic sentiments as it is increasingly recognized, for instance, that the work of one good dentist does more for general felicity than that of thousands of investment counselors whose clients in aggregate are poorer for their efforts as they try to out-perform one another in hyperactive management of pension fund common stock portfolios.”

Determined to steer the system away from its own self-destructive tendencies, Charlie offered a modest proposal that surely won him few friends on Wall Street. Big problems, though, often require big solutions. And Charlie had a doozy in mind: A 70% capital gains tax on stocks held for less than five years — effectively strangling short-term trading and, in turn, incentivizing patient, long-term investing.

Charlie was no fool. I’m sure he fully understood that his idea would fall on deaf ears — especially with so many entrenched interests lined up on the other side.

And for those who feel a bit squeamish about wielding the tax code as an instrument for reform, that’s exactly what it’s there for. “The rewards and penalties of the Internal Revenue Code channel the energies of the citizenry and have a high moral content as they encourage one kind of activity over another,” he wrote. “To the extent the income tax law differs from norms of social value judgment, it becomes less respected, a serious thing when tax collection depends largely on voluntary compliance.”

This was not a natural argument for Charlie to make. He was, by his own admission, a free-market guy with “a strong general prejudice in favor of unregulated markets”. Yet he refused to rest on easy dogmatism — and could no longer hold his tongue about all of the wretched excess he saw around him.

Capitalism thrives on a foundation of fairness — where good ideas triumph and flawed ones fall by the wayside. But that trust evaporates when people perceive the system as rigged in favor of the few. And the critical factor here is perception. Whether grounded in truth or not, belief shapes reality and drives public sentiment.

Charlie never claimed his proposal to be perfect. In fact, he likened it to a cancer surgeon excising a nasty tumor — even if it meant sacrificing some healthy tissue in the process. Likewise, a heavy tax on short-term trading might dent the market’s liquidity, but Charlie saw it as a justified (and necessary) trade-off. Something that, in the long run, would likely lead to better returns for everyone.

“There is little to lose by shifting tax burdens to favor by a greater extent long-term instead of short-term investment,” he argued. “The present gross excess of short-term investment, if squeezed out, would not be missed by the overwhelming majority of citizens. Pension and endowment funds could easily adapt to purchasing stocks with the same time horizons now used when purchasing real estate and, in aggregate, would be richer for the change.”

Charlie’s argument was never for less capitalism, but better capitalism.

Spoiler alert for those not paying attention over the past four decades: Charlie’s idea did not gain much (if any) traction with the powers that be. Short-term capital gains taxes never soared to 70%. Speculative excess seems to only (temporarily) subside in the immediate wake of economic crises. And a worrying amount of people now regard capitalism with no small amount of suspicion and distrust.

But, in the end, his simple message lives on: If you believe in the nigh-miraculous powers of capitalism, you can’t sit idly by — or retreat behind your piles of money — as unsavory sorts bring the whole thing into disrepute.

You have to get in the game — enter the arena, if you will — even if that means tackling hard problems with no easy answers. Because, if you don’t, we might all be on the receiving end of economic policies born of public outrage.

And, if that happens, we can all kiss The American Tailwind goodbye.