Why are billionaires voting for Obama and backing Brown?
By
Hugh Hendry Nov 28, 2008
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What a year! I’m relieved to say that I made it. I had a good credit crunch. But I’m angry. Could this period of booming then crashing equity and housing markets have opened the door to socialism? Politicians are turning to John Maynard Keynes for solutions based on higher government spending. But I’d much rather they were discussing Joseph Schumpeter. He had it the right way around. He prescribed a world of corporate Darwinism that might prevent super-booms from creating super-busts in the first place, and in turn leaving the door open for a distressed society to embrace government.
It’s not like Schumpeter was a bitter masochist. He simply believed that you needed recurring recessions that revealed winners and losers. The inadequacies of poor businesses were revealed during hard times; they went bust. The reward for the successful entrepreneur was the chance to expand at the expense of the failures, and thus earn more.
The theory is simple. An entrepreneur has an idea. His bank provides the finance. He has a product that everyone wants (think iPods eight years ago). He starts to make big bucks. But soon lots of businesses are offering the same kind of product. Suddenly, without the market to himself, he isn’t making huge profits. Money goes elsewhere in search of the new thing. Prices are kept low, allowing living standards to improve. Hallelujah.
Except, that is, in our brave new world. Instead of retreating as profits fell, companies dug in and took bigger bets. Take Long Term Capital Management (LTCM), the hedge fund managed by two Nobel Prize winners. In 1998, it was more than 100 times geared. They only had to be out in their calculations by 1% and they would go bust; they went bust. But such was the huge scale of its bets that its demise threatened Wall Street. So the Fed bailed everyone out and in doing so created huge moral hazard.
Suddenly, one could be too big to fail. Suddenly, leverage was a good thing. It spread like wild fire across corporate America. Citigroup, GM, Ford, AIG, Fannie and Freddie Mac – all huge firms facing declining profits. In a radical departure from the past, they sought to reverse the tide by leveraging their businesses. Today all are bankrupt, or not far from it. How different today would look if the Fed had adopted a Schumpeter perspective and allowed Lehman to go under not in 2008, but in 1998.
This is why I am angry. In effect, we created an environment over the last two decades where the creation of credit supported both speculation and commerce. As a result, all of us are vulnerable, both the reckless and the prudent. Take my hedge fund. I retired from risk-taking at a time when everyone was eager to take more risks. Then this year, I took a lot of risk when almost every other fund was in retreat. My team and I have returned 30% so far this year. But guess what? Even I am getting big redemptions. It’s not supposed to be like this.
Schumpeter was a contemporary of Constantino Bresciani-Turroni whose book, The Economics of Inflation
, reads like a contemporary account of the last decade in the US. In actual fact, it was an essay on the great hyper-inflation in Germany between 1919 and 1923. Schumpeter’s great fear was plutocracy: the rule of society by the wealthy. This is what happened in Germany. Huge private fortunes were amassed during a time of little economic prosperity; exactly what has transpired over recent years in Britain and America with the rise of hedge funds and private equity.
Remember the old adage ‘what’s good for GM is good for America’? That’s no longer the case. Success with money is intimately connected with inflation – people have got rich not through productive, wealth-creating activity, but because they bought a house or stocks at a time when general asset prices were rising. But what’s good for Warren Buffett is not necessarily good for the rest of us. Turroni wrote about the new business leaders who “became rich not with the general rise in prosperity but with the increase in the poverty of the people”. In a similar vein, the US may have become a plutocracy over the last eight years. And you have Buffett financially backing the Democrats. Could it be that the uber-rich are attempting to build moats around their castles in order to secure their fortune?
Creative destruction prevents the wealthy from becoming complacent, because there’s always a competitor coming up behind them. This is how it should be. But in Buffett’s world of tomorrow, taxes may return to cripplingly high rates to fund public spending. High taxes and large state involvement in society tend to diminish the role of the entrepreneur. So Buffett will be able to relax, because no one is going to come after him – I suspect that my creative energy will be spent avoiding taxes, rather than growing my business. Is this why American billionaires voted for Obama and why Brown is fêted by our own captains of industry?
• Hugh Hendry is founder and CIO of Eclectica Asset Management
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