May 4, 2006

Note:  Neither of these issues are specifically “macroeconomic” in nature, but they are two issues I have been thinking about recently.  I hope you find it useful.

KKR’s IPO.  Kohlberg Kravis Roberts & Company, the legendary buy-out firm, is going to have an Initial Public Offering of one of its investment funds in Amsterdam.  Initially KKR planned on raising $1.5 billion that it would put to work in taking firms private with the hope of restructuring and improving these firms, and then selling them for a profit. 

Although private equity funds like KKR are very secretive about their returns, it appears KKR has been rather successful recently in many of its buyouts.  As a result the IPO is oversubscribed and now KKR is planning on raising $5 billion instead of the original $1.5 billion.

Given the excellent returns private equity funds have been returning to investors recently one should not be surprised by the high demand for the KKR offering.  Traditionally private equity investors have been limited to large institutional investors (pension funds, private endowments, etc.) and extremely wealthy qualified individual investors.  The KKR offering is seen by many as a “democratization” of private equity.  It is argued that now “the small guy” perhaps through mutual funds, can enjoy the nice healthy returns only the rich and powerful have been able to earn. 

Or maybe not.  Many others argue that the big returns many private equity funds have been generating in the past are unlikely to continue.  They point to the skyrocketing prices private equity funds are paying for firms today.  There is so much money pouring into the private equity market, driving up costs that returns are sure to fall in the future, these people argue.

Private equity investments certainly do seem to suffer from a boom-bust pattern.  Big profits of the late 1960’s turned into disastrous returns during the inflation riddled 1970’s.  Not to mention the lavish venture capital returns of the late 1990’s turning into the tech bust of the early part of the decade.

So which will it be?  The Economist labeled private equity “The New Kings of Capitalism” in 2004.  Will the new king rule the world of investing or will they turn out to be the court (market) jester?

Who Lost Latin America?  During the 1970’s there was a great deal of debate in the U.S. over the issue of who was responsible for the expansion of Marxism throughout South Asia.  This was usually summarized by the phrase “who lost Vietnam?”  Of course we can get into the debate over the entire improperness of the question…as if the West “had” Vietnam to loose, like a favorite toy or something, but that debate has already been had.  An updated version of the question is:  who lost Latin America?

Latin America, after all, is almost entirely a democracy.  And yet:  Bolivia’s left of center President Evo Morales is nationalizing energy companies.  Hugo Chavez is trying to blackmail his neighbors into ending free trade talks with the United States.  And then there is  the problem that Castro’s power over the region appears to be growing every week.  What on earth is going on?  Who lost Latin America?

The answer is:  no one and everyone.  It is due to a lack of economic growth.  While the region underwent significant macroeconomic reforms in the 1990’s, microeconomic reforms were basically ignored.  While inflation was being brought under control, state owned monopolies privatized, currencies allowed to float, foreigners allowed to buy commercial banks, someone forgot the microeconomics.

In addition to all of the macroeconomic reforms that went on in Latin America, what the region still needs is economic institutional building, or microeconomic development.  Latin America needs better trained and rewarded entrepreneurs.  It needs more skilled trades people.  It needs more efficient capital markets.  It needs better run labor markets.  It needs public goods.  In short, it needs microeconomic reform.

Until the democratically elected governments in the region start doing a better job of providing basic education, roads, water, sewers and court systems the market system in Latin America will never develop.  Instead the people will grow more frustrated with “neo-liberal” reforms (what they think is capitalism) and turn to the alluring lies of Marxism.

Some left of center Latin American politicians understand this.  Take President Luiz Inácio Lula Da Silva of Brazil.  He perfectly understands the need for market driven economic growth, but does so without turning a deaf ear to the needs of the public.  Lula certainly faces an uphill battle and many argue he hasn’t done enough to eliminate corruption in Brazilian government, but he has tried to offer something more than just more macroeconomic reforms. 

More elected officials in the region need to turn their attention to market institutional building or microeconomic market reforms.  Until this starts to happen, chances are we will continue to see the spread of Marxism throughout Latin America, while the pundit in the U.S. wring their hands and wonder “who lost Latin America?”

Thank you.  Thank you to all of you who sent me suggestions for my local TV segment.  I have done spots on:  interest rates, taxes, returns of education, school finance reform in Texas, and the Austin economy.  Next I am going to do a three part series on what parents need to teach their children about economics and finance.  Thank you again for helping me to stamp out economic illiteracy…at six o’clock in the morning.

All the best,

MBrandl