Back in the good old days, many decades ago, investing was simple. You selected a company that sold a good product, purchased the stock and held it until you retired. The company’s fortunes rose with the booming economy and before you knew it you were sitting on a pile of handsome profits.

Learn how to protect your portfolio in today's chaotic investment climate

Unfortunately those days are gone forever. Today, companies’ fortunes are affected by global issues, automated high-frequency trading systems account for more than 70% of daily volume, “too big to fail” financial companies take huge long-term risks in pursuit of short-term gains  and central banks collude to artificially manipulate the economy and the markets.

It’s definitely not your grandfather’s investing climate.

So what can small investors do? How can they compete in the new investing world?

It’s difficult, but not impossible.

It’s difficult because, for one thing, the system is stacked against those who don’t know how the markets work and how they’re interconnected to everything from the economy, the government, our fiat currency system and more.

For another, big banks and mutual fund companies suck investors in and skim billions off the top of portfolios around the world.

It’s absurd. Yet it happens every single day.

Let’s start with our banking system.

Suppose you have $1,000 and deposit it to your bank account. Your bank can now lend out $900 of your deposit to someone else. Let’s call her Alice. So you have $1,000 you can spend whenever you want and Alice has $900 she can spend whenever she wants. Your bank has just created $900 of money out of thin air.

But it doesn’t stop there.

If Alice deposits her $900 loan proceeds into her bank account, that bank can now turn around and lend out $810 to, say, Bob. So Bob now has $810 he can spend, Alice has $900 and you have $1,000. And when Bob’s $810 makes its way to another bank, that bank can loan $729 out to Carol and so on and so on and so on.

Under our current fractional reserve banking system, banks are legally required to keep 10% of deposits they receive but are free to lend out the other 90%. So that initial $1,000 you deposited eventually turns into $10,000 — $1,000 in “real” money and $9,000 in “newly printed” currency.

Almost all developed countries operate this way. In addition, the currency is not backed by hard assets. Once upon a time money was backed by gold. Anyone who held money could redeem it for actual gold. This severely limited what the government and central banks could do to manipulate the money supply. Today, however, we live in a world of fiat currency (that is, currency not backed by assets) and fractional reserve banking. So governments, through their respective central banks, are free to do anything they want with the money supply. And they’ve been increasing it at unprecedented rates.

Unfortunately this is bad news. Of course nobody talks about why this is bad or the effect it will surely have on inflation and the negative effect it is currently having on the credit markets. For the economy to expand, governments need to keep debt going. People need to borrow. If they don’t, deleveraging occurs and the house of cards we’ve built upon fiat currency and fractional reserve banking comes tumbling down.

However for the economy to continue growing, credit market debt would have to grow exponentially going forward. As you might expect, exponential debt growth is unsustainable. Even with massive tax increases, no country can support exponential debt growth for very long. When you add in unfunded and underfunded liabilities, you start to envision the enormous problems most developed countries are facing.

It’s a pyramid scheme, a Ponzi scheme that is significantly larger than anything Charles Ponzi or Bernie Madoff ever dreamed of but with one important difference. It’s entirely legal.

There’s also another problem. While the commercial banking system was busy creating money from its deposits, the governments of the world, led by the U.S., were also busy printing money.

So commercial banks create money, which is debt, central banks print more money, again debt, and governments artificially manipulate the economy to hold interest rates down.

Today’s world is seeing near-zero interest rates, low growth, huge increases in money supplies around the globe, unprecedented levels of debt, high unemployment and governments that have been exerting the wrong kind of influence on their respective economies.

The only reason this has worked out so far is because ordinary people don’t understand what’s going on and continue to believe in the fiat currency they’re working for and saving for their future.

But what do you think will happen to economies built using the same model as a Pyramid or Ponzi scheme?

The simple answer is those economies will come crashing down and will take stock markets around the world with them.

Interest rates will have to rise, inflation will run rampant – wiping out people’s real savings – while taxes will significantly increase to pay for the absurd debt levels. People who are holding money in savings vehicles such as bank accounts and bonds will see their purchasing power turn negative and an entire host of other problems will result.

Fortunately, although markets will crash when interest rates inevitably jump and people face huge tax increases and lose confidence in governments’ ability to repay their debts, some companies will surge. These are the companies that have genuine value backing their earnings.

These companies sell products that people must buy regardless of economic conditions – products such as food, shelter and basic clothing. And some companies operate at an international level and are resilient to local economic downturns. Companies that do both are best positioned to weather the impending storm.

Gone are the days when you could invest in broad market indexes and expect them to continuously go up forever. Today’s successful investors need to select specific, high quality companies with strong economic moats operating at a global level with experienced management teams in control.

They need to focus on value and real growth instead of hand-wavy Wall Street products derived from multiple levels of incomprehensible financial engineering that produce the illusion of profitability.

And they need to turn their depreciating fiat currency into solid assets that will not only keep up with the real rate of inflation (which is far greater than what governments around the world would have you believe), but surpass it. That’s the only way investors will come out ahead.

The sad fact is, however, most people will be hit harder than they were during the recent global economic crisis when the negative ramifications of today’s governments’ actions finally play out over the next few years.

However investors who have positioned their portfolios correctly should come out relatively unscathed and some, who have cash-generating assets, could even thrive by purchasing great companies at rock-bottom prices while almost everyone else is either forced to sell or flee the stock market in panic.

How you fare as an individual is a direct result of what you decide to do right now. It’s not too late but time is definitely running out.

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