The Capital Note

Hayek’s Tiger

The Chief Economist of the Bank of England, Andy Haldane, listens from the audience at an event at the Bank of England in the City of London, Britain, April 27, 2018. (Toby Melville/Reuters)

Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: inflation, corporatism, risk and space flight, billionaires and value creation. To sign up for the Capital Note, follow this link.

News and Views

Well, you didn’t think that topic wouldn’t rate a mention . . .

From the U.K.’s New Statesman, an article by the Bank of England’s chief economist, Andy Haldane. Much of this, unsurprisingly, is focused on the U.K., although much will also strike a note with American readers, not least this comparison between the policy responses to the financial crisis and the arrival of COVID-19 (my emphasis added):

During the Covid crisis, central banks have ­followed the same playbook as after the global financial crisis: a large and rapid crisis was met with a large and rapid monetary policy response. But after the global financial crisis, the economy recovered slowly so monetary policy was normalised slowly.

This time is very different. The economy is rebounding rapidly. Yet the guidance issued by central banks implies a path for ­policy normalisation every bit as sedate as after the global financial crisis. Having ­followed the global financial crisis playbook on the way in – rightly – there is a risk central banks also follow it on the way out. This would be a bad mistake. If realised, this risk would show up in monetary policy acting too late.

Friedrich Hayek once referred to inflation as the tiger whose tail central banks hold, usually with trepidation and ideally from a safe distance. If central bankers wait to see the whites of this tiger’s eyes before acting, they risk having to run like the wind to avoid being eaten. Waiting too long risks interest rate rises that are larger and faster than anyone would expect or want. It runs the risk of the brakes needing to be slammed on to an overheating economic engine.

No one wins in that situation. Not central banks, whose mandates will have been breached and which would need to ­perform an economic handbrake turn for which they would not be thanked. Not businesses, for whom a higher cost of borrowing and a slowing economy would, with debts high, be an unwelcome surprise. Not households facing the twin threat of a rising cost of living and a rising cost of borrowing. And not governments, whose debt servicing costs would rise, potentially casting doubt on their capacity to run big debts and ­deficits. Ouch.

The policy lesson is a clear one, and an old one. The inflation tiger is never dead. While nothing is assured, acting early as inflation risks grow is the best way of heading off future threat. This is monetary policy 101. As experience in the 1970s and 1980s taught us, an ounce of inflation prevention is worth a pound of cure.

As I watch what the Fed is up (or not up) to, it’s hard not to think that the lessons of the 1970s have been forgotten, and those of 2008–10 have, in a way, been “over learned.” Not every crisis is the same, but memories of the most recent debacle are those that tend to weigh heaviest with policy-makers. This reminds me, in a way, of a conversation that I had with a leading Nordic banker at some point in the early 2000s. The Nordic banking sector had gone through a major trauma at the beginning of the 1990s (I was working for the New York subsidiary of one of the leading Swedish banks at the time, an experience not without its excitements). A decade or so later, the banker was worried that too many of his senior executives had been scarred by the disasters of late 1980s/early 1990s. They were now lending too little rather than too much.

For a truly gloomy experience, take a look at Philip Klein’s piece on inflation on Capital Matters:

For the last decade or so, as the nation’s debt grew and the Federal Reserve kept pumping money into the financial system, there were periodic warnings about the risk of inflation. Yet these fears were never actually realized. As a result, in the face of growing signs of inflation, many people — including the ones who happen to run our nation’s fiscal and monetary policy — aren’t taking the current threat all that seriously. This is worrisome, because in reality, a growing body of evidence — major economic indicators and announcements from small and large businesses — suggests that inflation is quite real . . .

It seems as if the tiger is on the loose.

A Corporatist Conclave
When world leaders gather, the topic of climate change is, these days, frequently high on the agenda (only a churl would point out that the U.K.’s climate activist-in-chief, Boris Johnson, chose to take a plane to travel the 250 miles or so from London to the G-7 summit) and so it is this time at the G-7 meeting in Cornwall. And, as so often when climate change is being discussed, little effort is made to conceal how intertwined this topic has become with the construction of a corporatist state.

The Daily Telegraph:

The [unelected] Prince of Wales will host a reception for world leaders and [unelected] CEOs of some of the world’s largest companies at the G7 summit in Cornwall, accompanied by his son, the [unelected] Duke of Cambridge.

Prince Charles was personally asked [why?] by the Prime Minister, Boris Johnson, to host the meeting focused on climate change, the Telegraph understands.

On Thursday afternoon, he held a reception with nine business leaders at St James’s Palace ahead of the summit.

The group were joined by John Kerry, the US special envoy for climate, as they pinpointed critical areas of discussion before meeting world leaders in Cornwall on Friday.

They will push for new commitments from governments and “coordinated action” on climate change, believing that a signal of intent will be followed by financial investment . . .

Governments should stick to representing the people that elected them, CEOs should stick to improving shareholder return, and members of the British royal family should remember that they are “living flags,” with opinions of no more value than those of any piece of cloth.

Meanwhile, check out what Gillian Tett has to say about the “Cornwall consensus” in the Financial Times:

There is a subtle, but nonetheless profound, reset under way of the relationship between business and government. In the Washington consensus companies were regarded as independent actors competing with one another, without state involvement. Now all the talk is of “partnership” between government and business.

Free enterprise is still lauded, but “partnership” is the framework for facing the big societal challenges of the day.

Democracy, however, is not.

If anyone is to focus on “big societal challenges,” it ought to be elected governments. CEOs should do only what they are paid to do — generate shareholder return. If they want to be involved in tackling these “challenges” then they should enter the political fray the old-fashioned way, via the ballot box, rather than by hijacking the power that goes with the capital entrusted to them by their shareholders to pursue ideological objectives unconnected with their companies’ business.

These CEOs would justify the approach that they are taking, at least in part, as an example of “stakeholder capitalism” at work.

As I discussed last July:

The wider vision underlying stakeholder capitalism is one in which different interest groups such as employers, employees, and consumers collaborate in pursuit of mutually (if sometimes mysteriously) agreed objectives under the supervision of the state. It would never be quite post-democratic, not quite, in any likely American form, but what it would be is a variety of corporatism.

Corporatism takes many, many forms. It can range from the relatively (relatively) benign — it runs through European Christian Democracy, and it can be detected in early-20th-century American Progressivism — to the infinitely more heavy-handed. It has been an important element in the theory, if not the practice, of some variants of fascism, most notably in Mussolini’s Italy, but not only there.

Corporatism takes as its starting point the idea that society is best run through its leading interest groups, either alongside the ballot box, or, under fascism, in place of it . . .

Needless to say, the World Economic Forum (“Davos”) — an institution too grand to be bound by much respect for democracy — has weighed in through one of the groups it “hosts”:

The Alliance of CEO Climate Leaders steps up and calls on G7 and other world leaders to accelerate a just transition.

Note not only the presumption contained in the naming of this “alliance” (“CEO Climate Leaders”) but also that word “just,” a word defined by whom, exactly?

Around the Web
Space travel and risk

The Wall Street Journal:

When Jeff Bezos climbs into the New Shepard capsule for its first passenger trip to space next month, his safety will be almost entirely in the hands of the spaceflight company he founded two decades ago.

Mr. Bezos plans to join the small band of tourists who have flown in space as the emerging industry prepares to launch hundreds of people aloft. For now, they aren’t protected by the meticulous federal safety regulations that govern commercial air travel.

Passengers planning a ride on the New Shepard must sign a form waiving their right to sue Mr. Bezos’s Blue Origin LLC in the event of an accident. Richard Branson’s Virgin Galactic Holdings Inc. which plans to send paying passengers on its space plane as early as next year, requires a similar step.

Congress agreed in 2004 to let the space-tourism industry self-regulate to speed its preparations for passenger flights. Years of delays, including an accident that killed a Virgin Galactic test pilot in 2014, have pushed back the start of flights for fare-paying passengers. The policy has been extended several times and now runs until October 2023.

The Federal Aviation Administration’s jurisdiction is limited to protecting public safety and the environment during launches and re-entries, a spokesman for the agency said. “Congress has not allowed the FAA to extend its authority to the safety of crew or space flight participants,” the spokesman said.

Regulators, lawmakers and industry executives are debating whether to introduce tougher rules, such as requiring passengers to be trained for the rigors of reaching the edge of space. The companies already offer some training for their short flights, which include periods of high G-forces and the possible disorientation that can come with weightlessness . . .

Would I take a trip in this capsule? With enough Dramamine, yes.

Random Walk
Billionaires and creating value

With billionaires’ taxes coming under scrutiny following the ProPublica leak, it’s perhaps worth remembering this from James Pethokoukis from April:

Amazon founder Jeff Bezos is worth nearly $200 billion. And at the moment that makes him the richest person on Earth. So he’s clearly created a lot of value for himself since he wrote his first letter to Amazon shareholders back in 1997. In his latest letter — also his last since he’s stepping down as CEO — Bezos gives a more comprehensive view of who’s benefited from the growth of a company now with a market capitalization of nearly $2 trillion. One group, of course, are shareholders not named Jeff Bezos, who own 7/8th of the shares and include pension funds, universities, and 401(k)s.

But there’s more to the story here than what Bezos calls “shareowners.” A lot more. Bezos looks at it this way, using the example of last year’s corporate performance: Firstly, Amazon created $21 billion in value for shareholders in 2020, or the company’s net income. If Bezos owned the whole kit and caboodle, that’s how much he would have earned last year. Secondly, there’s the $91 billion (payroll plus benefits and payroll taxes) of compensation for Amazon workers. Thirdly, third-party sellers earned somewhere between $25 billion (Bezos’ “conservative” choice) and $39 billion in profits. Fourthly, Bezos assigns $126 billion (75 hours saved a year shopping online x $10 an hour – the cost of a Prime membership) to Amazon’s “consumer customers,” including the 200 million Prime members. Fifthly and finally, Bezos pegs “AWS customer” value creation at $38 billion, based purely on cost savings and excluding the benefit from faster software development.

This back-of-the-envelope calculation (and there’s greater detail in the letter) works to total value created of $301 billion, with just 7 percent of that going to shareholders. And since Bezos owns less than 10 percent of the shares, the value going to Amazon founder last year works out to about $2 billion, or less than 1 percent of total value created.

The estimate reminds me of the great paper from Nobel laureate economist William Nordhaus, “Schumpeterian Profits in the American Economy: Theory and Measurement.” Nordhaus tries to calculate who gains from the value generated by innovation. His findings: “We conclude that only a minuscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers” And by “most,” he means almost all of the benefit with innovators “able to capture about 2.2 percent of the total social surplus from innovation.”

Makes a rough sort of sense when you think about it. Consider what Jeff Bezos is worth — a lot — versus the value generated by his nearly trillion-dollar company — a whole lot more — and benefits all of us accrue. Not sure the “billionaires are policy mistakes” folks really get this.


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