Do We Need A “New” Capitalism?

Bull and bear , symbolic beasts of market trend

Everyone, or at least all the right-thinking people, believes that capitalism needs to be reformed. Elizabeth Warren calls her version Accountable Capitalism. Marco Rubio dusted off an 1891 speech by Pope Leo to advocate what he calls Common Good Capitalism. Both are attempts to correct what these lawyers see as flaws in the current incarnation of economic organization that is sneeringly referred to as Shareholder Capitalism. Milton Friedman apparently infected several generations of capitalists with an insatiable greed by informing them that they should run their companies for the sole benefit of owners. You know, the people who actually provide the capital that gives capitalism its name.

Warren’s new version of capitalism is one where putting capital at risk entitles you to nothing more than the right to have someone else tell you how to deploy it. Elizabeth Warren will be in charge of your capital structure and workers will sit on your board of directors where they can make sure they get their fair share of what you’ve risked. Your existence will depend on your ability to satisfy all your “stakeholders” rather than just your customers. And you’ll need a federal charter to operate your company if you achieve a level of success the government deems worthy of their oversight.

Mr. Rubio also wants to help American workers, by determining for American companies when their rights must be abrogated in favor of what’s “good for America”. That includes ensuring you don’t make your products in countries Rubio and Donald Trump can demonize as stealing American jobs in an election year. He also wants to rein in what he calls “financialization” which has caused, among other things, excessive stock buybacks, a decline in marriage, child birth and life expectancy as well as, apparently, the opioid epidemic, increased suicides and “other deaths of despair”. Who knew bankers had such power?

Common Good Capitalism, Senator Rubio’s attempt at deep thinking, is ridiculed as a non-sequitur by those on the left (as was George W. Bush’s “Compassionate Conservatism”) but more alarming is that it has been embraced by what William F. Buckley called the “well-fed Right”. Rubio believes that a surrender to the soft socialism of stakeholder capitalism – which is anything but – will cultivate the morality and knowledge that would have been produced if Republicans had actually acted like conservatives for the last 50 years. Mr. Rubio cedes the moral high ground to Ms. Warren in exchange for a seat at the table to negotiate capitalism’s surrender. Meanwhile, country club Republicans hope to retain their perks by throwing a few crumbs to the hoi polloi before the tar gets hot enough to hold the feathers.

Rubio responds to the fears that elected Donald Trump by mimicking the populism of the left. He acknowledges the common man’s bill of particulars against the current economic system but lacks the intellectual capacity to offer anything but the warmed-over nostrums of the Trump protectionists, Democratic class warriors and a Catholic church currently run by a socialist. Both sides of the aisle see the political gold to be mined by playing to the electorate’s fears and rush to offer relief from the rich or the foreign or both.

Republicans lost their way decades ago, not when they made their peace with the New Deal as Buckley believed but when Nixon sacrificed the sound dollar and monetary policy to his pursuit of re-election. Abandoning Bretton Woods was the original sin, the end of the conservative pact with the working man, an abandonment of the most basic covenant between a country and its citizens.

The financialization of the US economy, as Rubio calls it, is not the cause of the rise in inequality that prompted this capitalist soul searching but merely a symptom of a larger monetary problem. The wealth and income inequality bemoaned by the left – and increasingly by the anti-capitalist right – is a product of an economy unmoored from reality, floating exchange rates ushering in an age of volatility that necessitated this “financialization”. The mountain of outstanding derivatives, so often cited as evidence of the speculative nature of finance in the modern economy, would not exist in a sound dollar environment.

Derivatives are the market’s rational response to the uncertainty created by an unstable currency. Derivatives are necessary to hedge the commodity, interest rate, economic and financial asset volatility created by currency uncertainty. Commodity volatility, as an example, has more than doubled since the Nixon shock of 1971. The Fed was able, for a while in the 90s, to reduce economic volatility (the Great Moderation) but the long-term cost of that stabilization is adding up. Three recessions, two of which were (are) the worst in decades, three bear markets and the election of Donald Trump doesn’t sound like moderation to me.

The idea that unsound monetary policies create unequal outcomes – inequality – is an old concept. David Hume wrote about the pernicious effects of monetary inflation way back in the 1700s. Wealthy individuals and large companies are better able to cope with monetary instability. They have access to hedging strategies and own assets that benefit nominally from changes in the monetary regime. Wealthy individuals own real assets that protect them from inflation and hold generous amounts of stock and cash that benefit from disinflation. The poor have no ability to protect themselves from forces they can scarcely even identify.

The inequality problem is not though a failure of capitalism. It is a failure of the Republicans who style themselves as its stewards during the good times and abandon it during the bad. Capitalism requires a moral compass, a policing of the tendency to greed that is inherent in all humans. Even Adam Smith knew that you couldn’t trust business people to do it themselves but the form of that guidance matters. It must be done in broad ways, by constructing a framework – sound money, fiscal prudence, competitive markets – that allows capitalists to succeed – and fail – without overbearing political influence.

This framework starts with sound money and an appreciation of the difficulties faced by those displaced by progress. One of the main benefits of sound money is that it levels the playing field between rich and poor by providing an equal opportunity – time – to respond to change. Sudden changes in monetary conditions, by contrast, always favor a few, bestowing undeserved benefits on some citizens through mere luck and often at the expense of others.

I do not intend this to be a paean to the gold standard, even the pseudo version of the post WWII Bretton Woods. A rapid return to sound money would be no more beneficial to the less fortunate than the rapid abandonment that made it necessary. And in any case, I’m not sure a gold standard is the proper answer to the sound money question. The move to a sound currency should be a project, a process with a stated objective and a strategy for achieving it. In general terms the goal should be a stable value for the US dollar. How we define that is important as much for the symbolism as the economics.

I believe there is a need to define stability in moral terms, to make clear that the monetary system is operated for all Americans equally. We have for decades defined “core” inflation as the rise in prices that occurs in items other than food and energy. What could possibly be more “core” to the average person than food, fuel and shelter? Monetary stability must start with a promise that it will stabilize the price of the necessities rather than luxuries. Sound money is the market alternative to food stamps, public transportation and rent control. Today’s definition of core inflation is the monetary equivalent of “let them eat cake” and it engenders the same anger as the original. Language matters.

Sound money is only one part of a strategy to restore capitalism to its rightful place. The Federal Government needs to lead by example, living within its means as all Americans must. Government is a cost to the citizenry, the price we pay for a just society and most Americans would agree, I believe, that despite record spending, we haven’t been getting our money’s worth. We should not just seek to shrink government but to make it efficient, to make sure Americans get what they have paid for.

Corporate governance also needs to be addressed. The COVID-19 virus has revealed for all to see the consequences of boards ignoring their fiduciary responsibilities. They must be held to account. I have heard repeatedly, especially from President Trump, that industries should be bailed out because this wasn’t “their fault”. I disagree. Vehemently.

The stock buybacks and exorbitant management pay packages that weakened corporate balance sheets were choices. Poor choices. The managers and board members who approved them should be dismissed by shareholders, sued for breach of fiduciary duty and bonuses clawed back. Shareholders need to unite to take back control of their companies and hire managers who will operate them for the long-term benefit of all shareholders. Boards should be comprised of prudent men and women who adhere to a fiduciary standard.*

Our economy needs to be operated more conservatively. I don’t mean the political definition of a conservative, someone “standing athwart history, yelling Stop” as Buckley so elegantly put it. We need business leaders of more caution and moderation, real conservatives who won’t abandon principles they really hold dear. Change is inevitable and beneficial but only with the proper vetting of time. With all due respect to Bill Buckley, a conservative should stand athwart history yelling, Slow Down. We don’t need a new capitalism. We need the old one.

*As an investment adviser I vote proxies for our clients’ stock holdings. This is not a complete list but here are some of the guidelines I use in voting:

  • Independent directors should comprise 50% of the board.
  • Audit and compensation committees should be headed by an independent director.
  • CEO and Chairman roles should be separate.
  • Boards should stand for election every year – no staggered boards.
  • No board members who were career politicians or government employees.
  • No directors who sit on more than 5 company boards.
  • No stock buybacks.
  • No dual classes of stock.
  • Vote against excessive compensation practices when say on pay is allowed. That includes almost all current compensation schemes. If say on pay is not allowed, vote against all current board members.
  • Vote for adoption of majority vote standard for the election of directors. If majority standard is not used vote against all directors.
  • No on any proposals that require a super-majority.
  • No on all golden parachute schemes.
  • No on any compensation plans that allow repricing of underwater options.

It is up to shareholders to hold their management teams to account. If you are responsible for voting proxies, be tough on your companies, their management, and directors. It’s your company. Act like it.

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