More Economic Prejudice and High-Minded Sloganeering

I wasn’t planning to post today, but I just saw (courtesy of the New York Times) a classic example of the economic prejudice wrapped in high-minded sloganeering that I talked about yesterday. David Rocker, founder and former managing general partner of the hedge fund Rocker Partners, proclaims that he is in favor of a free market.

The worldwide turbulence of recent days is a strong indication that government intervention alone cannot restore the economy and offers a glimpse of the risk of completely depending on it. It is time to give the free market a chance. Since the crash of 2008, governments have tried to stimulate their economies by a variety of means but have relied heavily on manipulating interest rates lower through one form or other of quantitative easing or simply printing money. The immediate rescue of the collapsing economy was necessary at the time, but the manipulation has now gone on for nearly seven years and has produced many unwanted consequences.

In what sense is the market less free than it was before the crash of 2008? It’s not as if the Fed before 2008 wasn’t doing the sorts of things that are so upsetting to Mr. Rucker now. The Fed was setting an interest rate target for short-term rates and it was conducting open market purchases (printing money) to ensure that its target was achieved. There are to be sure some people, like, say, Ron Paul, that regard such action by the Fed as an intolerable example of government intervention in the market, but it’s not something that, as Mr. Rucker suggests, the Fed just started to do after 2008. And at a deeper level, there is a very basic difference between the Fed targeting an interest rate by engaging in open-market operations (repeat open-market operations) and imposing price controls that prevent transactors from engaging in transactions on mutually agreeable terms. Aside from libertarian ideologues, most people are capable of understanding the difference between monetary policy and government interference with the free market.

So what really bothers Mr. Rucker is not that the absence of a free market, but that he disagrees with the policy that the Fed is implementing. He has every right to disagree with the policy, but it is misleading to suggest that he is the one defending the free market against the Fed’s intervention into an otherwise free market.

When Mr. Rucker tries to explain what’s wrong with the Fed’s policy, his explanations continue to reflect prejudices expressed in high-minded sloganeering. First he plays the income inequality card.

The Federal Reserve, waiting for signs of inflation to change its policies, seems to be looking at the wrong data. . . .

Low interest rates have hugely lifted assets largely owned by the very rich, and inflation in these areas is clearly apparent. Stocks have tripled and real estate prices in the major cities where the wealthy live have been soaring, as have the prices of artwork and the conspicuous consumption of luxury goods.

Now it may be true that certain assets like real estate in Manhattan and San Francisco, works of art, and yachts have been rising rapidly in price, but there is no meaningful price index in which these assets account for a large enough share of purchases to generate a significant inflation. So this claim by Mr. Rucker is just an empty rhetorical gesture to show how good-hearted he is and how callous and unfeeling Janet Yellen and her ilk are. He goes on.

Cheap financing has led to a boom in speculative activity, and mergers and acquisitions. Most acquisitions are justified by “efficiencies” which is usually a euphemism for layoffs. Valeant Pharmaceuticals International, one of the nation’s most active acquirers, routinely fires “redundant” workers after each acquisition to enhance reported earnings. This elevates its stock, with which it makes the next acquisition. With money cheap, corporate executives have used cash flow to buy back stock, enhancing the value of their options, instead of investing for the future. This pattern, and the fear it engenders, has added to downward pressure on employment and wages.

Actually, according to data reported by the Institute for Mergers and Acquisitions and Alliances displayed in the accompanying chart, the level of mergers and acquisitions since 2008 has been consistently below what it was in the late 1990s when interest rates were over 5 percent and in 2007 when interest rates were also above 5 percent.

M&A1985-2015And if corporate executives are using cash flow to buy back stock to enhance the value of their stock options instead of making profitable investments that would enhance share-holder value, there is a serious problem in how corporate executives are discharging their responsibilities to shareholders. Violations of management responsibility to their shareholders should be disciplined and the legal environment that allows executives to disregard shareholder interests should be reformed. To blame the bad behavior of corporate executives on the Fed is a total distraction.

Having just attributed a supposed boom in speculative activity and mergers and acquisitions to the Fed’s low-interest rate policy, Mr. Rucker, without batting an eye, flatly denies that an increase in interest rates would have any negative effect on investment.

The Fed should raise rates in September. The focus on a quarter-point change in short rates and its precise date of imposition is foolishness. Expected rates of return on new investments are typically well above 10 percent. No sensible businessman would defer a sound investment because short-term rates are slightly higher for a few months. They either have a sound investment or they don’t.

Let me repeat that. “Expected rates of return on new investment are typically well above 10 percent.” I wonder what Mr. Rucker thinks the expected rate of return on speculative activity and mergers and acquisitions is.

But, almost despite himself, Mr. Rucker is on to something. Some long-term investment surely is sensitive to the rate of interest, but – and I know that this will come as a rude shock to adherents of Austrian Business Cycle Theory – most investment by business in plant and equipment depends on expected future sales, not the rate of interest. So the way to increase investment is really not by manipulating the rate of interest; the way to increase investment is to increase aggregate demand, and the best way to do that would be to increase inflation and expected inflation (aka nominal GDP and expected nominal GDP).

9 Responses to “More Economic Prejudice and High-Minded Sloganeering”


  1. 1 WaltFrench September 1, 2015 at 2:18 pm

    “ Low interest rates have hugely lifted assets…stocks have tripled…corporate executives have used cash flow to buy back stock…instead of investing for the future.”

    Mr. Rocker could hardly have produced better evidence for his illogic…stocks are high and corporations can fund expansion cheaply, so they instead use cash to buy back expensive stock and give up the easy growth from 10% on borrowed cash, which would increase EPS—and therefore those stock options—even more.

    The interesting side to this is to watch who pushes this backwards thinking, and who buys it. I suspect the author is playing to an audience of the wealthy who worry about holding an inflated stock portfolio but allow cap gains+inflation even worse and so want comfort for not cashing out. Rationality is not the point, pretty obviously.

  2. 2 Thomas Aubrey September 1, 2015 at 10:38 pm

    David,

    An enjoyable read.

    A minor quibble: “Most investment by business in plant and equipment depends on expected future sales, not the rate of interest.”

    I’d say future profit is a better gauge.

    “The way to increase investment is to increase aggregate demand”

    I’m a bit surprised you don’t mention the role that productivity growth can play in driving up aggregate demand. I find Alex Field’s work on the Great Depression compelling (A great leap forward 2011)

  3. 4 JKH September 2, 2015 at 2:45 am

    “And if corporate executives are using cash flow to buy back stock to enhance the value of their stock options instead of making profitable investments that would enhance share-holder value, there is a serious problem in how corporate executives are discharging their responsibilities to shareholders. Violations of management responsibility to their shareholders should be disciplined.”

    Framing it in quite that way seems a tad high minded itself.

    The rational choice is between the rate of return from buying back stock (i.e. roughly the difference between the existing rate of return on equity and the return on cash) and the rate of return from “profitable investments that would enhance shareholder value”.

    In the case of profitable investments, the enhancement of shareholder value includes the value of those shares that would be acquired under the eventual exercise of stock options. So management who are option holders would be dumb to forgo investments whose expected return enhanced the value of their own shares beyond what would otherwise be expected.

    The rational choice is between those two transactions.

    Moreover, shareholders including activist investors often favor buy backs when the expected rate of return is higher from doing that.

    It is not really the responsibility of corporate management to dilute existing shareholders by selecting investments that produce a rate of return that is inferior to that expected from buybacks.

    That’s just framing. I realize the world isn’t perfect and there may well be instances of bad behavior, but it is not rational for management to choose the option that is expected to produce a lower rate of return. They are not in the business of macroeconomic investment welfare.

  4. 5 Ritwik Priya September 2, 2015 at 3:06 am

    David

    Here’s a way to reconcile the finance view of the interest-(in)sensitivity of firm decisions with the classic IS-LM or Tobin/Neoclassical q-theory view.

    Short-rate/term=spread/credit-spread movements are (were) supposed to influence asset-side/capex decisions.These days, they mostly influence liability/capital structure decisions. This is analogous to how rate cuts (or generally stimulative MP) are supposed to increase consumption/’trade and thus income (and thus actually reduce the overall burden of debt) but these days they may just be funnelled into leveraged purchases of existing assets, (thereby not really reducing the burden of debt) – a point often made by, among others, Martin Wolf.

    Why do firms keep rejecting Modigliani Miller? I don’t know, but I know it’s not just the tax treatment of debt.

    Here’s three stylised views on how MP works:

    1. MP works in full, and the things that boost consumption/spending also boost asset prices. We don’t have to care what those things are. Let’s call them aggregate demand for shorthand.

    2. MP works *by* increasing asset prices, which increase consumption/spending.

    3. MP increases asset prices. What happens to consumption/spending does not follow.

    1 is the traditional view, reinvigorated by mkt monetarists.

    2 is a ‘Tobinesque’ view, which I would argue is what most central bankers secretly fear/believe, no matter what their own research in the academy was.

    3 is what most finance types as exemplified by David Rucker have always believed, and they may be more correct at today’s (or even pre-WW1) margins than they were in the heyday of Milton Friedman.

    Communication is a key element on 1, 2 or 3. But the abliity of communication/fwd guidance to determine aggregate demand by fiat is questioned by most people who are not Scott Sumner. Unfortunately, most central bankers are also not Scott Sumner.

    Of course, underlyiing all this is the also the confusion perpetrated by the unfortunate dual use of the term ‘investment’, which whitewashes any distinction between asset side and liability side phenomena.

  5. 6 Benjamin Cole September 3, 2015 at 1:13 am

    Amen, amen, 1000 amens.
    Egads, now we have “do-gooders” arguing in favor of tight money!
    What next?

  6. 7 David Glasner September 8, 2015 at 8:46 am

    Walt, Well said. Thanks.

    Thomas, I agree that it is expected profit. I meant that expected profit depends more on expected sales than on the rate of interest.

    Lars, Thanks.

    JKH, Of course it’s high-minded, but un-prejudiced. But I agree with your other points.

    Ritwik, My view is that the QE effect depends on inflation (aka NGDP) expectations. If the Fed were credibly committed to a higher future path for the price level and NGDP we would be observing 1, but since monetary policy is committed to keep inflation below 2% forever, we only get 2 or 3.

    Benjamin, Don’t ask.


  1. 1 Best of the Web: 15-09-03, nr 1284 | Best of the Web Trackback on September 2, 2015 at 9:25 pm
  2. 2 Best in Economics this week: September 4 | Best of the Web Trackback on September 4, 2015 at 8:10 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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