Why Politicians Needn't Fret Over Private Equity
From the June 17, 2007 Sunday Times
June 17, 2007
by Irwin Stelzer
MARKETS are quicker than ministers. Thanks to the strength of free-market economies many economic problems are generally already in the process of being solved by the time congressional and parliamentary hearings can be organised, lobbies heard, bargains struck, and votes recorded.
Take the furore over the profits of private-equity entrepreneurs. Congressional and parliamentary committees have engaged in the delightful sport of shooting fish in barrels, more precisely of lacerating members of the private-equity industry and their representatives in one-sided hearings in which politicians lay into often clueless industry representatives who do better work in boardrooms than committee rooms.
The politicians can often count on industry representatives to take dead aim at their own feet, and pull the trigger. At times this self-destruction takes the form of worrying aloud that they are insufficiently taxed, at others it takes the form of lavish, multi-million-dollar birthday parties that attract the attention of the tabloids, workers who resent seeing more spent on floral arrangements than they earn in a year, and populist politicians looking for easy targets.
While politicians fume, markets are beginning to tend to the problem of such excesses as exist in the private-equity business. That business depends on two things: cheap credit, so that money with which to acquire companies can be borrowed at low interest rates; and high share prices, so that companies, once made leaner and meaner, can be sold back to the public at high prices. Buy cheap and sell dear works every bit as well for the private-equity entrepreneur as it does for the local apparel or brown-goods merchant.
The markets are now in the process of saying enough is enough. The tumble in the US bond market, the increase and prospect of further increases in interest rates in Europe, the refusal of the US economy to obey the forecasters by lurching into a recession that would permit the Fed to lower interest rates – all these developments are making it more expensive for the private-equity business to get its hands on cheap credit. These dealmakers might not yet be reduced to the condition described by Adam Smith when credit tightens – “Sober men, whose projects have been disproportioned to their capitals ? run about everywhere to borrow money, and everybody tells them they have none to lend.” But the signals are flashing yellow, if not yet red.
Meanwhile, the other blade of the scissors is closing, slicing into prospective profits: share prices are nowhere nearly as buoyant as they once were, hammered by a general feeling of fin de siècle when it comes to profit growth. So not only will the buyout crowd pay more for money, it will get less for the shares it brings to market. That should cool things down a bit by the time the politicians decide on their next move. The same is true when it comes to trade. The Chinese delegation that visited America last month for a continuation of its “dialogue” with Treasury secretary Hank Paulson went on a multi-billion-dollar buying spree in an effort to persuade Congress that it is serious about reducing its enormous trade surplus (up 240% since 2000, to about $250 billion a year) with the US. It failed.
Never mind that the low-priced goods flowing into America from China have helped to keep inflation low, or that Chinese investment in US Treasury IOUs has prevented interest rates from rising even more rapidly than they have in recent weeks. Four key senators – Democrats Chuck Schumer (New York), Max Baucus (from Montana and chairman of the Senate finance committee), and Republicans Lindsey Graham (South Carolina) and Charles Grassley (Iowa) – are proposing legislation that would force the government to file a complaint with the World Trade Organisation if the Chinese do not allow their currency to appreciate. Bipartisan support for this measure is so extensive that its sponsors claim they have the necessary votes to override an expected presidential veto.
Meanwhile, back in the real world of markets, the declining dollar is doing its work. Exports soared in April, and imports fell, as the cheaper dollar increased the competitiveness of US goods (food, drinks, industrial supplies, consumer goods) in overseas markets, and made foreign goods more expensive for Americans. Result: the US trade deficit fell by a surprising 6.2%.
Markets are also forcing China’s hand. Its undervalued currency is attracting so much cash that its economy is overheating. So the authorities have allowed the value of the renminbi to appreciate 8.2% against the dollar since July 2005, and 2.4% this year. Last week’s Treasury report to Congress called that “the largest half-yearly renminbi appreciation since the new exchange-rate regime began in July 2005”. Further increases are on the way. Give the politicians some credit here – this is partly in response to the political pressure coming from the US Congress and EU trade commissioner Peter Mandelson, backed by Europe’s newest recruit to the protectionist ranks, French president Nicolas Sarkozy.
None of this is to say that there is no role for politicians to play in economic affairs. After all, the Great Scot, whose free-market credentials are surely impeccable, wrote that what he calls “political economy” should be considered “a branch of the science of a statesman or legislature”. Smith goes on to justify restrictions on imports when that “is necessary for the defence of the country”. With China using its new wealth to fund the expansion of its military to gain control of the Asia-Pacific region, trade issues now relate as much to national security as to mere economics. Something free traders have to think about.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.