Sunday, January 31, 2010

Follow Up: Less is More

As if responding to the Kramer and Greenspan quotes I blogged about here in December, folks on today's Talk-Shops had the following to say:

"That's what I think people beyond the beltway find so hard to believe. Why can't you find things that they agree on and pass that into legislation? But somehow that never seems to happen." - Bob Schieffer, Face the Nation 1/31/2010

Okay, Bob, but now we have Hope and Change, right?

David Brooks tackled the same core issue from a very different angle:

"If you ask people, 'why aren't you investing? Why aren't you lending?' it all comes down to uncertainty ... If bankers and entrepreneurs don't have any sense of certainty, they're just not going to invest ... We've not only got this economic problem, but its compounded by a psychological problem, magnified by the fact that distrust of institutions is at its highest level in history." - David Brooks, Meet the Press 1/31/2010

I'm frequently asked, "As someone in finance, what do YOU think of the government's proposal on ... "
  • New bank taxes
  • New windfall taxes
  • Bailouts
  • Evil banker hunts
  • Prop trading bans
  • Goldman Sachs
  • Too big to fail
  • The National Debt

My uniform answer, no matter what topic they bring up: "I'm against it. Whatever 'it' is." Does that make me the exemplar member of the Party of No?

Nope. I'm against that too. And I'm in good company.

"Experience hath shewn, that even under the best forms of government those entrusted with power have, in time, and by slow operations, perverted it into tyranny." - Thomas Jefferson

"And to preserve their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude." - Thomas Jefferson

"That government is best which governs least." - Thomas Jefferson

"Government is not a solution to our problem. Government IS the problem." - Ronald Reagan

Bloated bureaucrazies, by definition, separate pieces of the incentive mechanism. He who makes the decisions is never he who must implement them, nor he who pays for them, nor he who is impacted most greatly by them. This problem is no less present in large corporations than it is in governments the world over. To me, the only cure for bureaucratic inefficiencies and mistakes ... is LESS bureaucracy. Second best is a paralyzed bureaucracy. That, at least, leaves individuals and businesses the liberty they crucially need to maximize their own happiness/wealth/utility/economic value. Least best is an erratically spasming bureaucracy.

As we all know, investors and entrepreneurs make a risk-vs-reward decision every time they choose what to do with their capital (money, ideas, and energy). As I've explained in past blogs, risk is equivalent to unpredictability. The more able one is to predict the future, the lower the risk and the more confidently one can make moves today which create a nice return tomorrow. Conversely, when the rules of the game may significantly change tomorrow or next year, risk is dramatically increased. This raises the risk-vs-reward bar such that fewer investment options are viable.

Governments can increase or decrease this risk. Those with the discipline to stick to a stable, sensible, transparent industrial policy over a long period build tremendous "trust equity" with investors. The benefit should be self-evident to the most causual observer: stability reduces perceived risk, which encourages investment, the fuel of economic activity. Ideas become businesses become economic value. Govermnents, too, reap the benefit by being able to borrow cheaply.

Unfortunately, being based entirely on intangibles (consensus expectations), this trust equity is a very fragile thing. Governments can quickly sabotage themselves, their economies, and thus their citizens by giving off even the whiff of erratic or ill-advised behavior.

Don't take my word for it. Look at successful economies the world over. There is ample empirical evidence that, while stability is not the only factor of economic success, its absence is certainly a factor of economic failure. Contrast North and South Korea. Contrast Argentina and Costa Rica. Contrast Greece and Germany. The success stories plodded quietly for decades, one reassuring yet boring step at a time, to amass their trust equity.

Let's be clear: governments do not create economic value. Governments limit (regulate) its creation in order to make sure one person or business doesn't take advantage of another. We grant them permission to exert this control based on some stew of goals which we've set for them.

Here's another one. Goverments don't own any economic value. Governments are simply temporary stewards of value which they've taken (taxed) from individuals and businesses. By definition, this regime of regulation and taxation reduces economic activity to the extent it limits and dis-incentivizes investors and entrepreneurs. Sometimes we accept this reduction because we understand that we're trading it for our social goals, such as stability, security, equality, or fairness.

But let's combine this with my earlier point. The dis-incentive of regulation and taxation is multiplied by a risk factor which captures its future volatility (=unpredictability). When the future amount of this dis-incentive cannot be confidently predicted, risk is higher and thus fewer opportunities are worth the risk-vs-reward dice roll. Money drifts to the sidelines and the whole economy slows down.

Sound familiar?

So, here's something I'm FOR: minimizing the risk multiplier while maximizing the return ... financially, socially, environmentally, and any other -ly.

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