Trust, Growth and Obama

As is well known, the American economy has been in a recession or slogging through with anemic growth over the past three years. Some say this is the new normal or at least a long-term condition. Meanwhile, American firms are holding record amounts of cash, for a brief period this year Apple had more cash on hand than the federal government. The political class and business commentators have been speculating why businesses are holding so much cash. Some on the conservative side have made the regime uncertainty argument that we do not know what is coming from the government and that has created enough extra uncertainty to make businesses wary of investing right now. However, Paul Krugman, (yes, it pains me to agree with him but credit where it is due) points out that business activity and attitudes did not change when Congress moved significantly to the right after the 2010 elections and the reality is little legislation of any significance has moved since then. It stands to conclude that the election added a level of certainty to the political expectations, the business class could breathe a collective sigh of relief, and move forward with these pent up plans it had.

There is probably some truth to the notion that business is worried, after all the administration can promulgate regulations through the implementation of laws without Congressional approval and that still creates uncertainty. But, I think Peter Schweizer in his book has uncovered another reason for the hesitancy of the business class to act.

What Schweizer has uncovered is far more insidious than a few political hacks earning some cash on what they know. Congress’ insider trading has been getting most of the press and, as bad as that is, it is not even half the story. There is another aspect to Schweizer’s book that I think may have a far greater impact on macroeconomic performance and that is under this administration large segments of the economy have become rigged games. Some of this has been nakedly brazen, the manipulation of the GM loan guarantees to place union interests ahead of bondholders is one example of the open version of what Schweizer has discussed. Unions support this administration, give it ground troops and money and so this leads to favors courtesy of the administration’s use of taxpayer money to reward political allies. The stimulus package and its targeted beneficiaries is part of the same mind-set. The NLRB and Boeing mess is another and then there is Solyndra, which is just the tip of a large iceberg.

The larger effect of this behavior is to undermine confidence in the market. While there has always been government favors granted to the politically connected and politically advantageous projects, there seems to be a significant increase in this behavior under this administration. This may not be true but perception is reality. We may not know if there has truly been a significant increase in political manipulation of the market for years if at all, but Schweizer has chronicled how this administration is subverting market processes and allowing favored businessmen like Soros and Buffet to heavily influence legislation and spending to their own benefit. This behavior does not need to be wide spread it just needs to be frequent enough to be widely suspected, there are two variables at play in this calculation; how frequently it happens and how well known its occurrences are. If either of these are high, then that creates another level of perceived risk and uncertainty in the investors’ and businesses’ minds and makes them that less likely to put their money at risk.

It is really an application of simple game theory analysis. Trust is the glue that keeps economies out of a miserable state, what we call in game theory Nash Equilibriums, named after John Nash of A Beautiful Mind fame. For instance, if you were going to buy a used car from your neighbor, there are two possible outcomes; a purchase is made or it is not. You and your neighbor will both be better off if the deal happens and if it does then that means you trust your neighbor to be representing the car accurately and he trusts you for the money. If it does not happen, there are three possible reasons; you do not trust him, he does not trust you or both. The truth is irrelevant, it is the perception of how much trust each party has in the other.

Transfer the used car example to each business as its management considers its options. It already faces these issues with every transaction it engages in from selling a pack of bubble gum to making a multi-billion dollar acquisition. This is why in larger deals firms engage in a number of safety procedures by drawing up detailed contracts that, should one party fail to deliver, the government will enforce. However, if there is no confidence in the government because it is in the habit of showing favoritism and ignoring contracts, using other people’s money to support its friends and its coercive power to insure their continuation long beyond their market life, then the trust that is so essential is effectively gone and no transactions will happen. No transactions mean no expansion, no growth, no hiring and well… pretty much what we are experiencing now; a Nash Equilibrium economy courtesy of a government trying to pick winners and creating nothing but losers.