Jonathan Macey schools Krugman on private equity

There is life imitating art, art imitating life, and then there is make-believe. Not surprisingly, Paul Krugman chooses the third option, at least when it comes to his belief that Oliver Stone's "Wall Street" gave an accurate picture of how private equity firms work.

(I do agree with Krugman's contention that government is not a business and that a businessman is any more capable of being an effective president than a career politician. Nonetheless, Krugman then wants us to believe the same tired song that government creates prosperity by spending, while businesses create recessions by becoming more efficient and by employing more capital. I can see a politician making such a statement, but an academic economist is supposed to understand something about the Law of Opportunity Cost.)

In his most recent column, Krugman quotes Gordon Gekko's famous "greed is good" speech as though that actually were accurate economics -- that corporate raiders could make money by buying healthy firms and then destroying their value.

What Krugman wants us to believe is that companies like Bain Capital would target successful, healthy, profitable firms, purchase them, and then make money either by running them into bankruptcy and then selling their assets. Now, perhaps at Princeton University, they teach that firm owners become wealthy by driving their firms into insolvency, but I would like to know how the market value of a company would INCREASE when it is careening into failure.

In an excellent article in the Wall Street Journal, Yale law professor Jonathan Macey explains how the private equity system actually works (as opposed to how Krugman says it works). (I don't have the full article available, and if I am able to do it later, I will post it.)

Macey's point is simple; a firm like Bain Capital purchases a firm that is underperforming relative to similar companies, restructures it, and then sells it. In order to profit, the private equity firm must be able to sell the firm (or its assets) for more than it paid for the company at the beginning.

Some common sense is in order, as Macey notes. A company cannot purchase a healthy company, run it into the ground, and then sell it for more than for the purchase price. While Krugman might believe that business people are utterly stupid (as opposed to professors and politicians), they are not so stupid as to buy high and sell low and do it consistently -- and remain in business.

If the Bain Capitals of the world are going to make profits, then they have to sell businesses or their assets (or both) for more than what they paid for the company, and they are NOT going to be able do that by looting a company. That simply makes no sense, which is why I hardly am surprised that both Krugman and Newt Gingrich seem to share the belief that businesses can profit by buying healthy companies, destroying them, and then getting even more value from their sale.

None of this means I am endorsing Mitt Romney for president. I hardly am enamored with his candidacy, but when people like Krugman and Gingrich demonstrate that they are utterly ignorant of how the leveraged buyout process works while condemning the whole practice, I'm going to speak up for the simple reason that someone needs to be able to explain some of the simple yet profound tools of economics without the political baggage.

Krugman: Capital creates recessions

I see that Paul Krugman has moved into yet another economic dimension in which he declares that capital creates layoffs and layoffs are responsible for...layoffs. He writes:

...the fact is that running a business is nothing at all like making macro policy. The key point about macroeconomics is the pervasiveness of feedback loops due to the fact that workers are also consumers. No business sells a large fraction of its output to its own workers; even very small countries sell around two-thirds of their output to themselves, because that much is non-tradable services.

This makes a huge difference. A businessman can slash his workforce in half, produce about the same as before, and be considered a big success; an economy that does the same plunges into depression, and ends up not being able to sell its goods. Nothing in business experience prepares one for the paradox of thrift, or even the inflationary impact of increases in the money supply (which is real when the economy isn’t in a liquidity trap.)

This is yet another example of the fallacy of "buy back the product" in which production and consumption are regarded as two independent and unrelated things, except that unless workers can "buy back" what they have produced, then the economy will plunge into recession.

In other words, what an economy produces really means nothing in terms of wealth. The production of goods is seen as an impediment to employment. Now, it is one thing when President Obama declares that capital creates unemployment; he is a politician and cannot be held responsible for saying anything of economic intelligence.

However, Krugman is supposed to know better. Economists actually are supposed to understand that when capital is created within a free market system, permitting people to create more goods, that this ultimately creates new opportunities for others.

So there you have it. Capital creates recessions; savings creates recessions. More brilliant economic analysis from Princeton University.

Sintija now officially is an Anderson!

A Latvian court today granted our adoption petition for Sintija, so she now officially is our daughter! Johanna and Sintija are in Latvia this week and will return to the USA on Thursday and come home on Friday.

They will travel back to Latvia in about a month to obtain the permanent resident visa from the U.S. Embassy, and then we will go about doing the re-adoption here in Maryland.

This is a wonderful day, and we are thankful to all of you who have supported us.

NYT: Forcing up labor costs creates more wealth

It always is interesting to see how the "elite" media also seems to produce the most number of economic fallacies, and a trip to the New York Times, and especially its editorial page, never disappoints. In this editorial, we find that laws that force up the price of labor create wealth.

I would suggest you try this at home. If you get two bids for work and you are assured that the quality of work would be the same, take the higher bid because the higher costs will create more wealth. Yeah, you will be using more resources, economically speaking, to do what could have been done with fewer resources, but who are we to argue with the brilliant minds at the NYT?

Krugman: Economic efficiency makes us poorer

Several years ago, I wrote that Paul Krugman really is not an economist, but rather is a political operative, and he has done his level best since then to prove my point. He does it again in his latest column.

According to Krugman's writings on the subject of employment, he begins with jobs first, or, to be more specific, the number of jobs. To Krugman, there is no difference in jobs, economically speaking, if they are created because Apple expands its operations or if the government subsidizes a Solyndra. If Apple's expansion meant a thousand extra jobs, but the government payments to Solyndra resulted in 1,100 new (and, obviously, temporary) jobs, Krugman's logic would say that the Solyndra gig would be better for the economy, even if Apple were profitable and Solyndra was hemorrhaging cash.

(As I read Krugman, I get the sense that he agrees with the Left that economic profits really consist of funds "taken from the community" and that lower profits would mean more wealth is being created. Yes, it is convoluted, but Keynesian "economics" is convoluted, folks.)

In attacking Mitt Romney (which is fine with me, given I won't vote for him even if he wins the Republican nomination), Krugman claims that Barack Obama actually has been a net creator of jobs. That's right, Obama is good for the economy even though it is in depression, and has become worse since he took office. Krugman writes:

Americans have jobs now than when Mr. Obama took office. But the president inherited an economy in free fall, and can’t be held responsible for job losses during his first few months, before any of his own policies had time to take effect. So how much of that Obama job loss took place in, say, the first half of 2009?

The answer is: more than all of it. The economy lost 3.1 million jobs between January 2009 and June 2009 and has since gained 1.2 million jobs. That’s not enough, but it’s nothing like Mr. Romney’s portrait of job destruction.

Incidentally, the previous administration’s claims of job growth always started not from Inauguration Day but from August 2003, when Bush-era employment hit its low point. By that standard, Mr. Obama could say that he has created 2.5 million jobs since February 2010.

Now, given that a lot of these "jobs" either have been government jobs or jobs that came through government-subsidized industries, perhaps we should be asking if the Obama administration's policies have made it easier or more difficult for businesses to create new wealth. After all, if you want to create "full employment," it is easy: just tell everyone they only can do agricultural work but cannot use any tools in the process other than your hands. I can assure you that people will be busy, at least until they starve to death, but, hey, they will be employed.

Robert Higgs has some answers, writing:

Private net investment is currently running far below the rate required to sustain a rapid rate of economic growth. Real consumer spending, in contrast, peaked in the fourth quarter of 2007, fell only slightly (about 2.5 percent) to the second quarter of 2009, and by the fourth quarter of 2010 exceeded its previous quarterly peak (by almost 1 percent). Despite the wailing and gnashing of teeth among Keynesian economists and politicians with regard to allegedly inadequate consumption, a collapse of consumption is not to blame for the economy’s anemic recovery to date. However, looking elsewhere for the cause, we find that the economy’s true engine of growth – private business net investment – continues to sputter, running in the most recent quarter at less than a third of its previous peak rate and, for the entire year 2010, at only 40 percent of its rate for the entire year 2007.

Higgs adds:

Investors continue to view the future with major misgivings, owing to the unsettled condition of the government’s future actions with regard to health care, financial regulations, energy regulations, taxation, and other matters that have serious implications for business costs and the security of private property rights in business capital and its returns. Although ObamaCare and the Dodd-Frank bill have already been enacted, these massive statutes leave scores of important details awaiting determination by administrative agencies and courts whose actions will be fiercely contested at every step. Future tax rates also remain up for grabs in Congress.

Krugman might call it the "Confidence Fairy," but government cannot make up for lost investment and, in fact, bears huge responsibility for the current lag in private investment.

Yes, Obama can throw money at "green energy" and create some temporary jobs and Krugman will claim that this is superior to any kind of economic restructuring that enables entrepreneurs to create more wealth while using fewer resources. In Krugman's mind, such a thing is anathema. Lest one think I am off-base, I believe Krugman exposes that view in this declaration:

At this point, some readers may ask whether it isn’t equally wrong to say that Mr. Romney destroyed jobs. Yes, it is. The real complaint about Mr. Romney and his colleagues isn’t that they destroyed jobs, but that they destroyed good jobs.

When the dust settled after the companies that Bain restructured were downsized — or, as happened all too often, went bankrupt — total U.S. employment was probably about the same as it would have been in any case. But the jobs that were lost paid more and had better benefits than the jobs that replaced them. Mr. Romney and those like him didn’t destroy jobs, but they did enrich themselves while helping to destroy the American middle class.

Paul Krugman demonstrates his utter ignorance at what happens in business restructuring and leveraged buyouts. When a firm like Bain purchases a firm and then sells its assets and makes money in the process, the Krugmans in the academic and political world scream that Bain is DESTROYING JOBS.

However, let us think about this and ask the obvious question: How can Bain do this in the first place? It can do it because when a business is successful, the whole is greater than the sum of its parts. However, a failing business is going to find itself in the opposition situation: the sum of the parts is greater than the whole.

For example, would any capital firm try to purchase Apple today and then make money selling off the company's assets? Hardly, as the strength of the company is entrepreneurship, and that is not a commodity that can be bought and sold. Unfortunately, Krugman wants us to believe that Bain and other corporate raiders took perfectly healthy firms and then destroyed them, and that the markets were so twisted and so incapable of seeing that good firms unjustifiably were being taken apart that they stupidly purchased the assets for more than the raiders paid for the entire company.

Krugman never explains how this is possible, but perhaps it is because he simply cannot comprehend the simple aspects of Opportunity Cost. Whatever the reason, he clearly does not even begin to understand how markets work, not to mention the role of the price system. You see, Krugman actually believes that markets DESTROY wealth, but governments create it through vast networks of subsidies and regulations. He never has explained how and why this is so, but perhaps he believes that since he is Paul Krugman, he doesn't have to explain anything. ENTREPRENEURS? We don' need no stinkin' entrepreneurs!

Krugman condemns himself

Paul Krugman wants us to believe that he first looks at the situation, and then tries to determine what theory would apply to it (or make up a new theory). He, dear reader, never comes into a situation with preconceived notions, unlike someone like, say, Tyler Cowen.

Yes, this someone who believes that a babysitting co-op in Washington provides the appropriate "model" for an entire complex economy. The co-op printed more coupons (money) and that allegedly fixed everything (although it didn't), so if the Fed prints more "coupons," then our economy will recover.

Yes, the perfect model. Krugman condemns in others what he does himself.

Krugman: Government debt is no burden because "we owe it to ourselves"

In his latest missive, "Nobody Understands Debt," Paul Krugman proves that he does not know debt, or at least government debt, either. While there is much to dislike in the column, I am going to deal with his claim that government debt is different because it is "money we owe to ourselves."

Now,I will agree with Krugman that government debt is different than typical "family debt," but not for the reasons he gives. Krugman writes:

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves. (Emphasis mine)

Krugman's reasoning, however, can apply to private debt as well, since he decides to use collective terms. In the case of private debt, individuals borrow from banks or other individuals, and bank loans are created by individual deposits. Therefore, when individuals don't pay back their debt, someone has to take a haircut.

Government loan guarantees tend to cloud this picture, but even when a guaranteed loan falls into default, individuals -- taxpayers and consumers -- are forced to give up some of their real income either through taxation or inflation. There really is not a free lunch, even if Krugman wants to claim there is.

(Because of government loan guarantees -- and deposit "insurance" falls into this category -- a lot of moral hazard is built into the private lending system. Defenders of this system say that it promotes worthy "investments" -- such as "green energy" -- that would not be funded otherwise by private lending, while critics such as the Austrians say that it promotes malinvestments and reckless behavior by lenders that ultimately leads to a crisis.)

Most Americans borrow from other Americans, so using the standards for public debt that Krugman has given, it would seem that most private lending also involves money "we owe to ourselves." One is not free to apply a collective term to government and then claim that it is not applicable to private activity, given there is nothing magical about government that can create a "collective" by fiat.

After all, individuals and institutions hold government debt, and if Krugman is claiming that an individual is not harmed when he or she lends money to the government and is not paid back, then he is dead wrong. (In other words, it is business as usual.)

Adding to that point, Murray Rothbard writes:

The ingenious slogan that the public debt does not matter because “we owe it to ourselves” is clearly absurd. The crucial question is: Who is the “we” and who are the “ourselves”? Analysis of the world must be individualistic and not holistic. Certain people owe money to certain other people, and it is precisely this fact that makes the borrowing as well as the taxing process important. For we might just as well say that taxes are unimportant for the same reason.

Even Krugman does admit that there can be problems with debt:

Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and you don’t have to be a right-wing ideologue to concede that taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But these costs are a lot less dramatic than the analogy with an overindebted family might suggest.

And that’s why nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years. When Keynes was writing about the need to spend your way out of a depression, Britain was deeper in debt than any advanced nation today, with the exception of Japan.

In other words, more government debt is good when government is trying to "spend (our) way out of a depression," but the act of more borrowing does have its opportunity costs, but the costs are not all that great, or at least Krugman assures us of that. Of course, if the problem becomes too great, then the Federal Reserve, through the workings of "clever lawyers," can find a way to directly purchase U.S. Government debt on the primary "market," which Krugman touts as a "solution." (One wonders why Krugman does not recommend what would be the Ultimate Fix to our problems to have the Fed purchase ALL government bonds, and that the bonds encompass ALL federal spending. Then the Fed could forgive the debt, monetize everything, and the government would have limitless funds to spend and to bring us into prosperity.)

In the Keynesian world, there is no opportunity cost. As Keynes wrote in 1943, credit expansion by the central bank performs the "miracle" of "turning stones into bread." Because Keynesians believe that a market economy is destined to implode because individuals save some of their income, not spending all of it instantly, it is up to government, to paraphrase Krugman, to "fill the hole" left by the loss of private spending.

There is one more issue to cover, and that is my earlier statement in which I agreed with Krugman that government debt was "different" than private debt, but for different reasons. In this area, I turn to Rothbard:

The public debt transaction, then, is very different from private debt. Instead of a low-time preference creditor exchanging money for an IOU from a high-time preference debtor, the government now receives money from creditors, both parties realizing that the money will be paid back not out of the pockets or the hides of the politicians and bureaucrats, but out of the looted wallets and purses of the hapless taxpayers, the subjects of the state. The government gets the money by tax-coercion; and the public creditors, far from being innocents, know full well that their proceeds will come out of that selfsame coercion. In short, public creditors are willing to hand over money to the government now in order to receive a share of tax loot in the future. This is the opposite of a free market, or a genuinely voluntary transaction. Both parties are immorally contracting to participate in the violation of the property rights of citizens in the future. Both parties, therefore, are making agreements about other people's property, and both deserve the back of our hand. The public credit transaction is not a genuine contract that need be considered sacrosanct, any more than robbers parceling out their shares of loot in advance should be treated as some sort of sanctified contract.

Any melding of public debt into a private transaction must rest on the common but absurd notion that taxation is really "voluntary," and that whenever the government does anything, "we" are willingly doing it. This convenient myth was wittily and trenchantly disposed of by the great economist Joseph Schumpeter: "The theory which construes taxes on the analogy of club dues or of the purchases of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of mind."

Rothbard was writing in favor of repudiation of government debt (which then would discourage individuals from lending to the government in the future), but the larger point still stands. All taxpayers are on the hook for repaying government debt, but the terms are decided by others. It is the ultimate "loan guarantee" in which people who don't participate in the process still are forced to pay for it.

Krugman calls it a "social contract." I think it should be called something else.