Jim's On A Roll
And all I can do is roll with him.
I’m not especially well-versed in either orthodox or unorthodox economists, but I agree completely on the essential role of the entrepreneur in wealth-generation. Jim takes this point in the direction of reinforcing skepticism about the dominant policymaking paradigm at the moment, focused on things like aggregate demand rather than the congeniality or uncongeniality of the environment for entrepreneurship.
Myself, I’m inclined to believe that if you have a fiat currency, which should mean you can mitigate the impact of commodity-based external shocks on the supply of credit (which is the problem you run into with a commodity-based currency), you really do have to do your best not to create “artificial” shocks by keeping money “too” tight or “too” loose. That, in turn, is a problem “orthodox” economics is pretty much organized around trying to solve.
I want to take his point in a different direction. He and I may disagree about central bankers. But what about banker bankers.
If entrepreneurs are the motor that drives economic progress, capital is the fuel. And banks are (still) the central institution in the economy responsible for supplying that fuel. Their job is (still) to take savings and turn it into capital – and then allocate that capital.
But how do they allocate that capital?
Well, the dominant investing paradigm falls prey to exactly the mistake that Jim highlights in his post: the confusion of risk and uncertainty. Indeed, pretty much all of modern finance theory and practice is devoted to the project of measuring and managing risk. This professional predisposition to fear uncertainty and focus on risk is reinforced and magnified by our regulatory paradigm.
What this has meant in practice is that banks (and other institutional investors) all use the same tools to construct the same kinds of “optimal” portfolios so as to minimize risk. Of course, all this does is squeeze all the profit potential out of these kinds of portfolios. Competition, then, drives these same investors to use additional leverage and more sophisticated “risk-management” techniques to squeeze more profits out of this same compressed investment space. And so the bubbles grow until they burst.
Fifty years ago, banking was a sleepy profession, with easy hours, comfortable but not extraordinary salaries, and a professional culture that was anything but entrepreneurial. Now, it’s an extremely aggressive culture, but all of that aggressive, competitive energy goes into figuring out better ways to rig the same game. A lot of people think the solution is to go back to what banking was fifty years ago. I’m not sure that’s possible, and I’m pretty sure if entrepreneurship is as important to the economy as Jim thinks it is that it’s not optimal. Rather, we need bankers with more of an entrepreneur’s appreciation of uncertainty.
How to get there from here, though is something about which I’m afraid I’m uncertain.
It’s interesting to use your and Manzi’s insights to reconsider the effect of tax code provisions designed to encourage “savings,” but which require those savings to be in IRAs and 401(k)s limited to institutional investments.
Some entrepreneurs get their start through bank loans and venture capital, but a lot begin with loans from friends, family, and prominent professionals in their local community. The 401k, et al. tax breaks shrink this pool of capital by encouraging individuals to put their savings into mutual funds and the like rather than investing it in local, promising entrepreneurs. In turn, this transfers the job of allocating capital from these local folks – who likely have specialized local knowledge, at least about the person asking for the money if not about the idea being pitched to them – to bankers and institutional investors with more of a national and less of an entrepreneurial focus.
This certainly has some advantages, as one can only get so much capital to scale by asking people you know, the ability to “cash out” in the stock market plays its own role in encouraging entrepreneurship, etc. However, ya’ll’s post makes me think it may also have some strong disadvantages that perhaps we’ve not been considering.
— Vermando · Feb 10, 03:05 AM · #
Most businesses are initially funded on credit cards or personal savings. They are headquartered in basements, garages and dorm rooms. Bankers only get involved when a business is already somewhat developed.
Let’s not delude ourselves: most of what modern bankers do is shuffle around ownership of existing firms, sell off or buy up bits of other businesses and create secondary (derivitive) financial instruments to hedge it all. That’s not an anti-capitalist or even necessarily an anti-banker sentiment, it’s the truth.
Sneak into Goldman or J.P. Morgan Chase headquarters, get off at a random floor and ask the first banker you meet what they have done to help a business flourish, other than their own. You’ll get a lot of stammering, then you’ll probably get accused of being a socialist.
In the end, economic growth will depend on good ideas for products and services, with financing being a secondary concern.
Bankers behave like “Tiger Mom” children: mindlessly working their fingers to the bone perfecting what an authority figure says is a metric of success (VaR, paper profits) while losing sight of the point of it all (matching capital to those who have a good idea about how to spend it).
— rj · Feb 10, 05:11 PM · #
Those “sleepy” country banks managed to create a mortgage bubble in the Midwest 80 years ago. My great-grandfather, a schoolteacher, didn’t invest in CDOs (they didn’t exist) or stocks (that was speculation, not investing), he bought farm mortgages from the local bank. Later, alas, he found himself owning two farms. My great-great-uncle, a Nebraska banker, shot himself in 1932. So I don’t think it’s the CAPM that creates bubbles.
— y81 · Feb 11, 02:32 AM · #
Corporate managers are not entrepreneurs in any meaningful sense, they are bureaucrats.
Instead of blaming the government for undermining entrepreneurship spirit, find me some real entrepreneurs in the S&P50.
We are in a situation similar to feudalism.
— stearm74 · Feb 12, 02:38 PM · #
Nice article, thanks.
— rental elf · Feb 13, 04:01 PM · #
>If entrepreneurs are the motor that drives economic progress, capital is the fuel.
This widely held notion is, I think, one of the most important misunderstandings about how the economy works.
Capital investment is not fuel — if anything sales or labor qualify for that role. It’s lubricant. And you don’t need very much lubricant, relative to output.
Too much, in fact, and the shop floor starts getting very, very slippery.
Go out and ask independent businesspeople (yes, somebody has; in fact they do so monthly); they consistently tell us that financing and interest rates is dead last on their list of business constraints — even in the height of the “credit crisis.”
http://www.asymptosis.com/businesses-constrained-by-lack-of-investment-oh-maybe-not.html
http://www.asymptosis.com/the-sky-is-falling-business-lending-down-1-2-percent.html
— Steve Roth · Feb 13, 04:55 PM · #
Go out and ask independent businesspeople (yes, somebody has; in fact they do so monthly); they consistently tell us that financing and interest rates is dead last on their list of business constraints — even in the height of the “credit crisis.”
That doesn’t mean capital isn’t the fuel for economic progress. I’m not going to argue that it is, just that these statements by independent business people aren’t strong evidence that it isn’t.
— The Reticulator · Feb 13, 06:41 PM · #
Reticulator:
I think quibbling about whether capital is “fuel” is rather dull. The key point is that there is — and has been for some decades — far more liquidity than business needs.
http://www.asymptosis.com/who-prints-money-and-who-gets-to-have-it-its-up-to-the-banks.html
http://www.asymptosis.com/what-caused-the-great-recession-the-economist-sez-too-much-money.html
— Steve Roth · Feb 13, 06:57 PM · #
The key point is that there is — and has been for some decades — far more liquidity than business needs
I presume you agree then that a survey of “independent business people” is not a very useful way to evaluate how important capital is in fueling the economy, or driving the economy, or making economic progress, or whatever.
Not sure why you changed the subject from capital to liquidity, btw.
— The Reticulator · Feb 14, 04:58 AM · #