Confusions Abound
Confusions abound. This is the middle of an intense, partisan, and important election cycle and confusion, deliberate or otherwise, is abundant. This is a moment when we need clarity, and voters are being asked to decide on issues that derive from arcane and often very obscure roots. Politicians have a bad habit of trying to slap simple names or labels onto what are very often nuanced ideas. They then sell these ideas as if they are simple solutions to complex problems. So the confusion grows.
Take, for instance Mitt Romney’s source of wealth.
Set aside his start in life as the scion of a wealthy family – not easy to do, but try. We are being asked to evaluate him as someone who has ‘got stuff done’. He has, it is claimed ‘created jobs’. The very purpose of his business was ‘to create wealth’. For a nation dithering along in semi-permanent stagnation this is a magic brew. Surely we should buy whatever Romney is selling.
Not really. It’s an illusion.
Private equity firms make more money from redistributing existing value, than they do from creating new value. They re-allocate wealth. They don’t necessarily create new wealth. By this I mean that one of the primary weapons deployed by private equity firms is their ability to break down old contracts and free cash for the benefit of someone else. This usually involves eliminating pension plans, getting rid of union negotiated wages scales, and other sources of ‘inefficiency’. This boosts profits that are then paid out to shareholders. But all this is doing is taking existing wealth – pension assets – and translating them into cash to support dividends. The unfettered cash flow increases profits and boasts share prices creating the illusion that new wealth has been created. It hasn’t. It has been transferred from the balance sheets of the workers to the balance sheet if the company, and thence to shareholders. There is nothing new. The fact that our accounting systems don’t have an entry for each of the worker balance sheets – the liability exists at the corporate level, but the corresponding asset disappears into the mist of our imprecise national accounting method – is the sole reason it looks as if wealth is being created. The entire process is actually one of capturing those assets in a more visible way, so that they can then be directed in concentrated form from the many to the few.
I am not arguing that private equity firms engage in only this activity; but there is enough of this going on that the notion of private equity firms being wealth creates is factually tenuous. They are wealth concentrators. They are one of the reasons we have such an unequal society, and that so many workers have defunded or eliminated pension programs.
Private equity firms are terrific if you are an investor. Not so much for the nation as a whole.
Which reminds me: Romney made his fortune by playing with other people’s money. He isn’t a tried and true capitalist. He’s a bureaucrat. He;s a lawyer slash business graduate who is excellent at acquiring cash from wealthy people and then using it. He isn’t Henry Ford. He isn’t JP Morgan, He is no Frick. Nor is he a Carnegie. His wealth was made on the back of other people’s capital, to his own. He is not hero of rugged job creation. He is a devotee of Powerpoint, negotiation, and the finer aspects of accounting. He is at home in the security of a spreadsheet and not on the frontiers of risk taking. He is not Steve Jobs, Larry Eliason, Bill Gates, or Paul Allen. He is not an entrepreneur. He is a stylish and successful money manager.
We should not confuse the two
Then there’s banking.
Poor bankers. I feel their pain. What most people fail to comprehend is just how Keynesian banking is. Not in that childish proprietary trading. Not in that undermining of democracy. Not in that anti-social behavior. No. But in the good old fashioned sense of banking.
Banks hold capital to protect themselves against uncertainty. They believe inherently in the existence of the unknowable unknowns that we all laughed about when Rumsfeld made his famous remarks along those lines. He was a Keynesian too, apparently. He didn’t know it of course. Uncertainty sits at the heart of Keynesian analysis. It is what creates a great divide in economics. Orthodox or classical economists presume that uncertainty can, by various tricks, dodges, and wheezes be translated – magically – into what Keynes describes as “the same calculable status as certainty itself”. It cannot. It lies beyond our comprehension. It is incalculable by definition.
This error in orthodoxy leads to all sorts of confusion. Fixing it destroys the heart of mainstream economic theory – utterly destroys it – and so undermines the efficacy of markets so beholden to right wing politicians. Markets are riven through with uncertainty which means we have no idea if they work well or not. Or if they produce socially beneficial results all the time. The point being that we cannot know.
And bankers, bless them, understand this. Hence the need for capital.
And before you all pile in and argue about risk: bankers know the difference, they try to think about that too. They routinely set aside a portion of their profits to cover potential losses. They call they account the ‘loan loss reserve’. They may misjudge the amount they need. The economy could throw a curve. So they protect themselves further by having a layer of capital to augment the loan loss reserve.
So they have two layers of protection: one for risk. One for uncertainty.
Keynesian to the core.
Of course they can be completely stupid by under-providing both for risk and for uncertainty, which is what happened in the recent crisis. And that’s where Minsky and his Keynesian thinking comes in.
You see bankers are so Keynesian in their approach to uncertainty that even when they go off in one of their periodic – and far too regular – bouts of lunacy their behavior is captured perfectly by Minsky’s Financial Instability Hypothesis, which is simply a more fully thought through Keynesian system. Keynesian when they’re good. Keynesian when they’re bad. Well done bankers.
When we think about it a little more, all business people are dyed in the wool Keynesians. The very existence of modern business is predicated on the complexities of lengthy production processes that require a structure to mitigate against the vagaries of uncertainty. Time can play havoc with the neatness of orthodox assumptions. Stuff happens. So businesses are constructed to enclose a subset of economic transactions, thus protecting them from the moment to moment volatility of an open market and allowing assets to be dedicated to a process through time. It is the incalculable nature of what might happen if those assets were exposed to market forces that gives virtue to their enclosure in a firm. Markets just don’t deal with uncertainty very well. Firms are designed to fill that gap. And it’s a big gap. A lot of things just could not happen were we to use markets alone to produce goods. Uncertainty get in the way.
Not that you would realize this by listening to bankers or business people. They prattle on about free markets as if uncertainty didn’t exist. Yet they laud entrepreneurship which is simply the adroit exploitation of the unknown.
Talk about confusion.
So here we are in the middle of an election where voters are being told that one candidate – the free market guy – is a wealth creator and that we should believe more fully in the virtues of markets. Which he’s not, and there aren’t. Government is essential to the proper functioning of a modern economy. So too is the modern business firm. Both intrude into the space that the free market occupies in the minds of right wing leaning economists. For good reason.
Uncertainty.
No wonder there’s confusion.
In the clash in ideologies presented to the voters this year, one view is based on an attempt to understand reality and has come up with a messy but workable solution. The other is based upon what some theorists would like there to be, which isn’t, but which at least is pure. So it’s a clash between the pragmatic and the idealistic. Between the real and the dream. And the realists are on the left while the dreamers are on the right. Which is almost exactly opposite to the way the media usually describes things. And which just adds to the confusion.
In fact it’s almost Confucian.
But that’s too confusing even for me.
