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January 3, 2006

Financing Excess

A lot has been written recently about the late Peter Drucker, who passed away in November. For many years Mr. Drucker was the preeminent authority on business management. He wrote 35 books, including his groundbreaking Practice of Management, and The Effective Executive. He spent several years at General Motors and his 1945 book about GM, Concept of the Corporation, introduced the idea of decentralization and launched both the field of management and business consulting.

Late in his career he became disillusioned with the high wages some business executives were getting. He said, "although I believe in the free market, I have serious reservations about capitalism." Far be it from me to correct this management luminary, but unless we understand the true cause of excess we will stand idly by while our institutions are undermined.

When the Central Bank provides a glut of money and credit, it unleashes a torrent of speculation. When financial engineering is easily financed, then the game becomes one of mergers and acquisitions in place of new investment and production. Credit and leverage allow for excessive compensation earned from wheeling and dealing. Easy money boosts the price of stocks. The inflation of money and credit finances stock buybacks and newly popular stock options that enable outsized rewards for executives and managers.

The more money people make, the more they want. The easy money provokes greed and short-term thinking. Inflation is the government’s primary tool for its ill-advised management of the economy. It also lays the groundwork for many things that go haywire in our society. It is not the fault of capitalism and the free market that abuses in executive compensation occurs. It is the fault of the government and the Central Bank.

It’s going to get crazier, wilder and looser. That’s because inflating requires more and more inflating. According to Ludwig von Mises, "Because an inflationary policy works only as long as the yearly increments in the amount of money in circulation are increased more and more, the rise in prices and wages and the corresponding drop in purchasing power will go on at an accelerated pace."

All the paper money that ever existed in the world, prior to what we use now, inevitably became worthless. Hundreds of paper currencies in scores of countries wound up in the wastebasket. As Voltaire once noted, "Paper money always returns to its intrinsic value – zero." One of the definitions of money is that it’s a store of value. That’s not the case with our dollar. It continues to lose value. Who can make a convincing case that it won’t wind up like other worthless paper currencies? In their book, The Coming Collapse of the Dollar, James Turk and John Rubino point out, "Whether ancient or modern, monarchy or republic, coin or paper, each nation descends pretty much the same slippery slope, expanding government to address perceived needs, accumulating too much debt, and then repudiating its obligations by destroying its currency."