by Gary North
The type of man to whom joint stock companies owe their success is not the type of general manager who resembles the public official in his ways of thought, himself often an ex-public servant whose most important qualification is good connection with those in political power. It is the manager who is interested himself through his shares, it is the promoter and the founder — these are responsible for prosperity.
~ Ludwig von Mises (1922)
In my report, "Investors Move to Liquidity," I pointed out that the state-salaried bureaucrats who oversee the Chinese government's $300 billion investment fund in June bought 9.9% of the Blackstone Group hedge fund for $3 billion. Within a month, this investment had fallen by $540 million.
In 1999, Great Britain's Chancellor of the Exchequer, Gordon Brown, instructed the Bank of England to sell half of its gold reserves. The Bank complied over the next three years. The sale was at market, which at the time was under $300 per ounce. That decision has cost the government over $5 billion, since gold soon climbed to well above $600/oz. Mr. Brown is now Prime Minister. The British voting public has forgotten all about it. In fact, most voters probably never understood what all the fuss was about. They do not understand gold, central banking, or the commodities markets.
The London Sunday Times did try to revive the story earlier this year. In an April 15, 2007 article, "Goldfinger Brown's £2 billion blunder in the bullion market," we read of the Times' attempt to get access to official papers regarding the gold sale.
For the past 18 months The Sunday Times has been battling the Treasury to release the advice it received on the gold sales under freedom of information laws. Brown's department has sought — so far successfully — to use a range of legal exemptions to block disclosure.
In its last response to requests by The Sunday Times, the Treasury stated: "We have decided that it is not in the public interest to release further information."
This is a government agency, and it can thumb its collective nose at the Sunday Times. Mr. Brown is now Prime Minister. He can do the same. And will.
What is the difference between Kenneth Lay of Enron and Gordon Brown of Great Britain? This: Lay died in disgrace for not knowing what was going on, while Brown was elected Prime Minister for not letting the press find out what was going on. You ask: But how could this be? Simple: Brown is a government official. Lay was the head of a publicly traded corporation — what Mises identified as a joint stock company so long ago.
Mises saw the problem over eight decades ago. The socialist, who he called an etatist (statist), "refuses to see in those who guide the company anything except officials, for the etatist wants to think of the whole world as inhabited only by officials."
The statist sees the ideal world as a gigantic Post Office. He thinks it is possible to create unlimited wealth by printing up stamps.
The problem for this view of the world is that everything keeps changing — including the price of stamps (upward, always upward).
There are specialists who forecast these changes and then plan for them. We call them entrepreneurs. They put their own money or investors' money at risk (technically, at uncertainty). Mises built his economic theory on entrepreneurship: men's quest for profit and the avoidance of loss.
Only a free market in capital goods offers entrepreneurs a way to do their crucial work of matching future consumers' demand with future producers' supply. But socialists deny the legitimacy of a free market in capital goods. The State should own the means of production, they insist. This creates a problem for socialist economic planners: dealing with change. Mises wrote:
All socialists overlook the fact that even in a socialist community every economic operation must be based on an uncertain future, and that its economic consequence remains uncertain even if it is technically successful. They see in the uncertainty which leads to speculation a consequence of the anarchy of production, whilst in fact it is a necessary result of changing economic conditions.
The problem for democracies is this: the voters do not understand any of this.
The great mass of people are incapable of realizing that in economic life nothing is permanent except change. They regard the existing state of affairs as eternal; as it has been so shall it always be. . . . To see and to act in advance, to follow new ways, is always the concern only of the few, the leaders. Socialism is the economic policy of the crowd, of the masses, remote from insight into the nature of economic activity.
Socialism has now fallen out of favor. This is not because the academic world ever accepted Mises' view of capital markets. Most of them never heard of Mises. Even free market economists almost universally denied his theory, which he presented in 1920 and extended in 1922 in his book, Socialism. The intellectuals abandoned socialism because the Soviet Union went bankrupt in 1991, officially closing up shop — Enron on a vast scale. In short, the commies stabbed the academic liberals in the back. They have never quite gotten over this.
This has left the central banks and the governments' treasury departments as the senior agencies in charge of the temple of government of intervention: "Our Lady of Perpetual Debt." The Bank of England is commonly referred to as the Little Old Lady of Threadneedle Street, and a crotchety hag she is.
While the image of a scientific socialist planner, slide rule in hand, has faded in popularity, intellectuals and politicians still retain faith in rooms full of Ph.D.-holding economists, faces in front of glowing computer monitors. These experts are not quite the best and the brightest. They are the ex-graduate students who were not quite sharp enough to make it into the research departments of multinational banks in New York City. They sit there, looking at spreadsheets filled with numbers that were collected at the point of a gun by high school graduates and then compiled by graduates of mid-rank colleges, who are employed by the Department of Commerce.
"These people know what they're doing!" we are assured by former B-average sociology majors, who write government press releases, and also by non-partnership level lawyers who got elected to Congress.
The heart of entrepreneurship is not who certified you at age 25, but rather what profits you have produced and for how long. When investors turn over their money to someone, they don't care about the diploma on his wall. They care about his track record.
Central bankers studied economics at universities that hire and fire professors based on their ability to write unreadable and unread articles that get published in academic journals reviewed by other college professors. None of these people has started a billion-dollar company or managed a large investment fund. When two Nobel Prize-winning economists did provide the theoretical basis of such a company, it went bust owing billions of dollars: Long-Term Capital Management, Ltd. It was short-term capital management, but it surely was Ltd. It was a lot more limited than its investors had suspected.
The university educational system is the ancient Chinese Mandarin system in action. The Mandarin screening system for government officials was a written test in classical poetry. The modern mandarin system is based on writing term papers. For economists, the crucial features are formal paraphernalia: graphs, equations, and such.
Making above-market returns has nothing to do with formal academic certification, here or in China.
The investors of the Chinese government's funds are graduates of Western university programs in economics and business. The Chinese central bank is like all of the other national central banks. It is staffed by the not-quite best and brightest.
These people do not invest their own money. They have no experience as entrepreneurs. They are babes in the leveraged woods. So, the first investment they made was to buy 9.9% interest in a company that peaked in value on the day it went public, a week later. Then its share price fell by over 20% in less than a month.
This is the wave of the future.
INVESTORS OF LAST RESORT
Central banks have always been lenders of last resort. They have always bought their own governments' debts. This is why governments originally granted the monopoly of money creation to central banks.
Next, central banks buy the debts of major foreign governments. They prefer to buy debts of those governments whose economies are trading partners. Why? Because most governments are heavily influenced by exporting firms. These firms want to keep their prices low, compared to foreign firms. So, by purchasing the currencies of trading partners and then buying foreign governments' debt certificates, a central bank pleases domestic exporters and foreign governments. It does not please foreign exporters. But how much influence do they have in domestic politics?
This policy is also detrimental to domestic consumers, who must pay more for imports and also pay more for domestic goods because exporters have shipped production abroad. But domestic consumers are unaware of economic cause and effect. This is why they vote for politicians who vote to raise tariffs (sales taxes). Voters understand almost nothing about central banking, currency markets, and the nature of fiat money.
So, as foreign central banks load up on the promises to pay issued by the U.S. Treasury, central bankers begin to think twice about investing in American debt. Maybe it's better to invest in American equities. But how? "Buy shares of the Blackstone Group."
As this policy spreads over the next few decades, the ownership of the equity markets will shift from domestic pension to Asian central banks. This will not happen overnight, but it is the wave of the future — or at least the eddy of the future.
As ownership moves from private hands to central bank hands, managers of corporations will have to pay attention to what central bankers expect. They will have to listen to central bankers. If this does not happen, then managers will not have to listen to anyone. The public will have sold their shares to central banks. This is what a negative savings rate means: the sale of assets.
Who is buying corporate assets? These days, fund managers. But if the American payments deficit continues at 5% to 6% of the domestic economy, foreigners — mainly central banks — will wind up with even more legal claims on future income.
Long-term, would you rather have ownership of a diversified portfolio of American corporations or a pile of IOU's issued by the United States Treasury?
The problem is this: the new owners are central banks, whose employees are not paid for their forecasting ability on behalf of profit-seeking private investors. They are salaried bureaucrats.
I am going to cite a lengthy argument by Mises. I cannot put it better than this. It has to do with the motivation of corporate managers, which means the system of incentives they work under.
The vital force and the effectiveness of the joint stock company lie in a partnership between the company's real managers — who generally have power to dispose over part, if not the majority, of the share-capital — and the other shareholders. Only where these directors have the same interest in the prosperity of the undertaking as every owner, only where their interests coincide with the shareholder's interests, is the business carried on in the interests of the joint stock company.
This refers to the senior managers of a privately owned firm that competes in a free market for capital. These managers can be replaced by investors, usually through a corporate take-over.
In contrast, the public cannot fire central bankers. Rarely does any government fire them. So, they seek their own interests. They are immune to sanctions from outside the central bank.
Where the directors have interests other than those of a part, or of the majority, or of all of the shareholders, business is carried on against the company's interests. For in all joint stock companies that do not wither in bureaucracy, those who really are in power always manage business in their own interests, whether this coincides with the shareholders' interests or not.
The key phrase here is "wither in bureaucracy." This is the essence of all institutions that operate under a government monopoly, as all central banks do.
It is an unavoidable presupposition of the prosperity of the companies, that those in power shall receive a large part of the profits of the enterprise and that they shall be primarily affected by the misfortunes of the enterprise. In all flourishing joint stock companies, such men, immaterial of what their legal status is, wield the decisive influence.
Central bankers do not receive shares of ownership in the central bank. They are salaried functionaries.
Think of a central banker as a postman. He wears a uniform: a dark suit. He has control of the budget. And he sets the price of stamps.
We call these stamps "currency."
We are seeing the dawning of a new era. This era will be marked by central banks as equity owners. The era of the central bank portfolio of nothing but gold bullion and government IOU's is coming to an end.
The trumpet blast of the new era was the Chinese investment fund's loss of $540 million in less than 30 days.
Think of the capital markets run as extensions of the post office.
The good news is that investors have more money than central banks do. The bad news is that, at the margin, central bankers will be able to manipulate the equity markets the way they manipulate government debt markets.
This is very bad news, indeed.
August 6, 2007
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