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Stagnant Inertia

Six years from the Great Recession and the excuses for the tepid recovery are becoming worn.  This time is different- well it always is.  There may be an issue with structural changes that affect employment and wages, but this is less of a rationalization for greater government intervention than it is to let the market sort this out.  It is challenging for the government to take steps to aid those who fall through the cracks without creating disincentives to adjust and work.

Regulatory friction costs were mounting before this recession and perhaps we have just reached a cumulative critical mass that has truly stifled economic growth.  Like overloading the pickup truck with bricks.  At some point one more brick will bust the axle. We want to blame the last brick.  My favorite quote from Stanislaw Lec-”Every snowflake pleads innocent, but it is till an avalanche.”

Yuval Levin in his excellent The Fractured Republic notes that both parties yearn for old solutions that only worked under conditions that no longer exist.  I  contend that there is a new friction cost: the constant change of investment incentives, tax laws and hyperactive regulatory activity that stifles incentives to such a degree that even if positive changes are made there is an inherent lack of trust that they will remain stable long enough to benefit from them. This suggests a need for radical reform, a dramatic claw back of the regulatory state, that is unlikely to come from the stagnant inertia of the established parties.

from The Wall Street Journal, What’s Killing Jobs and Stalling the Economy by Marie-Josee Kravis

As the Economic Innovation Group shows, the 1990 recovery registered a net increase of over 420,000 business establishments, or a 6.7% increase. The numbers for the 2000 recovery were 400,000 and 5.6%. Since 2010, the number of new business establishments has grown by only 166,000 or 2.3%

Many studies have also attributed the slow rate of business formation to the regulatory fervor of the past decade. Some point to the deadening effect of the Dodd-Frank law, which is 23 times longer than the Glass-Steagall Act passed in response to the 1929 Depression. One part of Dodd-Frank, the so-called Volcker rule pertaining to bank investments, has 1,420 subsections. Then there is the Affordable Care Act.

It is not clear to what degree these laws affect business formation, but in a 2010 report for the Office of Advocacy of the U.S. Small Business Administration, researchers at Lafayette University found that the per employee cost of federal regulatory compliance was $10,585 for businesses with 19 or fewer employees, compared with $7,755 for companies of 500 employees or more. Large and established businesses navigate through rules and compliance requirements. Small and new businesses often find them prohibitive.


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The Secret to Berkshire’s Success


By Henry Oliner

For the third consecutive year I attended the Berkshire Hathaway annual meeting in Omaha.  It has become a tradition for a group of us attending to meet the first night at Drovers Steakhouse where they marinate the ‘whiskey’ filet in bourbon and soy sauce.  I can’t wait to try it at home.

It was a cool and rainy sixty degrees. One of our group got in line outside the large meeting arena at 2:15 AM.  He texted me not to join him like I did last year; the rain created too big a crowd trying to get under the limited roof space. I went anyway at 5:00 AM, just to help him hold the seats for the five others, and the crowd had already built substantially.  I waited in line with a young man from Germany who did not care for Donald Trump, but sat next to a young investor from Norway who did.  We got great seats just 40 rows from the stage and the board seats.  Board member Bill Gates was there.

Forty thousand shareholders attended, looking more like a cross section you would find at a local civic club than the Wall Street suits you would find at a shareholders’ meeting.  It is rare for a shareholders meeting for public companies to exceed a few hundred.  Long time attendees have noticed a noticeable increase in internationals attending, especially from China. The meeting has the air of a social or political movement more than a shareholder’s meeting.  It appears to be an international movement.

This is a huge event; hotel rooms are booked several months in advance.  The Holiday Inn Express a few blocks away charged $625 a night with a two night minimum.

This event is driven by a thirst for the wisdom of company Chairman and CEO Warren Buffett and the Vice Chairman and his lifelong closest friend, Charlie Munger.  I remain impressed that 86 year old Buffett and 92 year old Munger can take questions for 5 hours providing clear and precise answers, and recalling information about 80+ companies without a laptop, iPad, or notes, or staff whispering in their ears. Their only crutches are cans of Coke and boxes of peanut brittle from See’s Candies, one of their oldest acquisitions.

To Warren’s right were three established financial reporters: Andrew Ross Sorkin, Becky Quick, and Carol Loomis.  To his left were three respected financial analysts: Jonathan Brandt, Cliff Galant, and Greg Warner. Questions alternated among the two panels and the floor, ranging from the general to the specific. Answers involved philosophy as much as finance.

As illuminating and brilliant as these two icons are, it is not the kind of superior intellect that comes from better and faster firing neurons won in a genetic lottery.  It is the kind of wisdom that comes from focusing and continuous reflection for over 50 years and learning from each and every mistake and success.  There is a big difference between 50 years of experience and one year of experience repeated 50 times. This kind of wisdom requires considerable humility.  Warren is worth upwards of 65 billion dollars. He is paid $150,000 a year, lives in the same house since 1967, drives his own car, and he laughs a lot.

Berkshire has a total of 367,000 employees. 26,313 are in Georgia ranking only behind Texas with 34,649. They own Geico and Shaw Industries and over 9% of Coca Cola. Berkshire owns ten companies that would make the Fortune 500 if they were free standing.

Precision Castparts, Berkshire’s newest acquisition has 136 plants and manufactures critical parts for airplanes.  A single Boeing 787 contains over 10 million dollars’ worth of their parts. Why would Precision Castparts want to sell to Warren?  One reason is that they no longer have to spend the considerable time required for shareholder relations and the regulations that go with it. Capital needs can now be discussed with someone with a wise and long term perspective.

Berkshire paid 32 billion in cash for Precision. Warren is noted for his ability to decide on an acquisition quickly. Once a prospect passes the essential criteria he can reach a decision in under an hour. While they execute due diligence, he does not get bogged down with endless analysis.  Munger noted that rarely is a serious problem or unexpected opportunity disclosed in the numbers or Power Point presentation.  These issues are more often entailed in the fundamentals of the market they operate in.  Ideas and perspectives matter more than numbers.

I came to recognize how important a good owner is to the success of a company.  Warren’s greatest asset besides patience and humility (and a lot of cash) is optimism.  The investment world sells fear and you pay dearly for it.

One can be blind to risk and make reckless or poorly timed investments. But one can also be blind to opportunities if they are overly pessimistic.  The latter has probably hurt more investors since the 2008 crash than the former. For Warren predicting Federal Reserve interest rate policy and Congressional tax policy is a fool’s game; he manages his portfolio of great companies largely as if the news and political games are irrelevant, even if one of his energy companies does depend on Federal subsidies for using wind power.

The Berkshire companies have created an enormous amount of wealth for a lot of people.  Warren’s work of recognizing values and allocating capital and talent is a contribution taken all too lightly by the Social Justice Warriors who claim “you didn’t build that”.  While Warren Buffet and Charlie Munger humbly credit their managers and their employees, the thousands of very happy shareholders who attended the meeting and all of the Berkshire family know precisely who built it.


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Historical Regression

Any society that entails the strengthening of the state apparatus by giving it unchecked control over the economy, and re-unites the polity and the economy, is in historical regression. In it there is no more future for the public, or for the freedoms it supported, than there was under feudalism.

Alvin W. Gouldner

as quoted in Robert Higgs’  Crisis and Leviathan

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Folly and Presumption

The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted to no council and senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

From Adam Smith’s An inquiry into the Nature and Causes of the Wealth of Nations, published first in the momentous year of 1776.

HKO Comment:

We think we need unique and new solutions to what we perceive to be a unique and new set of problems, but our problems are not new. They are in fact classical throughout  our history. The solutions and outcomes are also not new, though still painful.  We suffer for our lack of a sense of history.

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Why Inequality is Getting Worse

From George Will at National Review, A Philosopher Takes On the Left’s Obsession with Income Inequality

First, the entitlement state exists primarily to transfer wealth regressively, from the working-age population to the retired elderly who, after a lifetime of accumulation, are the wealthiest age cohort. Second, big, regulatory government inherently exacerbates inequality because it inevitably serves the strong — those sufficiently educated, affluent, articulate, and confident to influence the administrative state’s myriad redistributive actions.

Third, seven years of ZIRP — zero interest-rate policy — have not restored the economic dynamism essential for social mobility but have had the intended effect of driving liquidity into equities in search of high yields, thereby enriching the 10 percent of Americans who own approximately 80 percent of the directly owned stocks. Also, by making big government inexpensive, low interest rates exacerbate the political class’s perennial disposition toward deficit spending. And little of the 2016 federal budget’s $283 billion for debt service will flow to individuals earning less than the median income.

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