Grand Fortunes and the Illusion of Competition

OVERVIEW

Published on: 28 Dec, 2018

Through the ages, the greatest and most lasting fortunes have been built on the back of commercial opportunism allied with the willingness to bend the rule of the law repeatedly & ruthlessly. The Medicis in Italy, the Mitsui in Japan and JP Morgan in America are exemplars of this template of capitalism. It is unrealistic to expect Indian capitalists to follow a different playbook and it is equally unrealistic to believe that you or I can make money by buying shares in such companies.

“Through all these chapters, of which he [JP Morgan] was making a million or two or three every time he doctored a [rail]road…he was hammering at the principle that competition amongst the [rail]roads was disastrous…Morgan worked for that end, but he wanted it under an oligarchy of railroad presidents, dominated by a few bankers, himself the chieftest…Therefore, in 1888, he brought the leading road chiefs together at his home, talked harshly to them about their sins, and after much wrangling formed the Interstate Commerce Railroad Association to make effective his “community of interest” theory to end rate wars and set up an agency to arbitrate differences. He called it a gentleman’s agreement.” – John T.Flynn in “Men of Wealth: The Story of Twelve Significant Fortunes from the Renaissance to the Present Day” (1941) [square brackets are ours]

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Free markets and Western propaganda

One of the challenges for people like us to who read Western publications like The Economist or the Wall Street Journal is that we end of implicitly believing some of the dogma promoted by such publications. Much of the Western financial press would have us believe that the path to prosperity lies via free markets, robust competition, a strong legal system and democratic political institutions. Relative to such a paradigm, India and India’s capitalists obviously fall short on many fronts and that then leads to recipes being trotted out for “reforming” India’s economy.

However, if you look at the richest dynasties in America, in Europe and in Japan, their rise owes almost nothing to the nostrums preached by the Western intelligentsia. Instead, as we show below, the rise of families as disparate as the Mitsui in Japan, the Medicis in Italy and JP Morgan in USA has four common features which are all too familiar to Indians:

(a) being at the cutting edge of financial innovation – in specific procuring funds as cheaply as possible and then deploying it for higher returns;

(b) manipulating the political/regulatory system repeatedly and ruthlessly to stifle competition and corner the market;

(c) extending the advantage created by the two preceding points to enter new industries and then lobbying for favourable regulatory change; and

(d) perpetuating this recipe for success over multiple generations to create a dynasty whose tentacles extend across many parts of the economy, the polity and the clergy.

Three Indian-style crony capitalists outside India

Cosimo de Medici (1389-1464) was the founder the Medici dynasty which at its peak was Europe’s richest family, its most powerful bankers and de facto rulers of Florence for most of the fifteenth century. Cosimo inherited his banking skills and his seed capital from his father and then parlayed it into the greatest fortune Europe had ever seen. He fraternized with Franciscan clerics and presented them a monastery. In 1410, Giovanni lent John XXIII the money to buy himself the office of cardinal, which he repaid by making the Medici Bank head of all papal finances once he became the pope. As Cosimo set up bank branches in London, Pisa, Avignon, Bruges, Milan and Lubeck, the Vatican found it convenient to use the Medici Bank – since it enabled bishoprics in many parts of Europe to pay their fees into the nearest branch, whose manager would then issue a papal license, and the popes could more easily order a variety of wares – such as spices, textiles, and relics – through the Medicis’ wholesale trade.

Cosimo then used his wealth to control the votes of office holders in Florence’s municipal councils. As Florence was proud of its “democracy”, Cosimo pretended to have little political ambition and did not hold public office. However, political questions were settled in Cosimo’s house. He was king in all but name. In fact, the Medicis were the sort of kings that we are all too familiar with in India. John T Flynn says “He mingled the virtues of the chalice and the dagger. The problems of competition that have continued to torture industrial barons, he met with the singularly effective application of the knife. Persons of power who were in his way…were murdered.”

Hachirobei Mitsui (1622-1694) is the founder of the Mitsui business empire. The Mitsui clan were originally samurais (warriors) but Hachirobei’s father sold his swords and turned his hand to brewing saki & soy sauce. Hachirobei, the youngest son, started a “cash & carry” business (the first of its kind in Japan) and catered to the needs of the middle class. By the end of the 17th century, he had a thousand branches across Japan. Since he understood which merchants were good credits and which were not and since he could collect affluent customers’ deposits in his branches, it was but natural for him to enter banking. As his own cash management machine grew, he offered to do the same for the Shogun.

Japanese peasants paid their taxes in the form of rice. The Shogun then had to sell the rice locally for gold and then transport the gold to his Treasury in Yedo. This was a hazardous business thanks to highway robbers. Hachirobei offered took over this operation. He brought the rice locally and without having to transport gold across the country, instructed his Yedo branch to deposit the requisite amount of gold in the Treasury. For him the Shogun became another ledger entry in his banking operation. However, in return for performing this service, the Mitsuis were given six months of free use of the taxes (i.e. the rice they collected).

The Mitsuis never relinquished this role as banker to the Shogun and proceeded to transform this “float” into a fortune. In the centuries that followed not only did they became the biggest lenders in Japan but also the owners the biggest cotton mills, the largest coal mines, the largest paper mills, the largest silk manufacturing operation in the world, etc. Their influence on the Japanese Government before and after the Meiji restoration was legendary. Often the head of the Mitsui business would become either the Finance Minister or the Governor of the central bank or both. Soon they were bribing officers of the Japanese Navy to buy arms from British arms manufacturers who had hired the Mitsuis to crack open the Japanese market, again something that we in India are accustomed to seeing in India.

John Pierpont Morgan (1837-1913) was the defining banker of 19th century America and who, amongst other things, laid the foundations of the financial behemoth that is today’s JP Morgan. Morgan entered banking in 1857. During the American Civil War (1861-65) Morgan financed the purchase of five thousand faulty rifles (soldiers who were loading the guns were getting their thumbs blown away) from an army arsenal at $3.50 each, which were then resold to a field general for $22 each.

30 years later came the episode which sealed Morgan’s reputation. The Federal Treasury was nearly out of gold in 1895. Morgan had put forward a plan for the Government to buy gold from his and European banks but it was declined in favor of a plan to sell bonds directly to the general public. Morgan then convinced the then US President that the Government could default if they didn’t do something. Morgan came up with a plan which allowed Morgan and the Rothschilds to sell 3.5 million ounces of gold directly to the US Treasury in exchange for a 30-year government bond issue. This allowed Morgan to buy effectively buy US government bonds at $104.50 at a time when the prevailing rate was $111. Unsurprisingly, Morgan immediately sold the bonds in the open market for $112-124. Six months later when the US Government faced the same situation again, they circumvented Morgan and directly issued bonds to the public at $110-120.

Between these two events, Morgan became the promoter and financier of most key companies in America barring Standard Oil. He controlled most of the important railroad tracks. He controlled US Steel. He had AT&T under this thumb. He controlled 10 insurance companies, 34 banks, 12 public utility corporations and 120 other corporations. In the words Louis Brandeis, former Associate Justice of the US Supreme Court, “JP Morgan (or a partner), a director of the New York, New Haven & Hartford Railroad, causes that company to sell to JP Morgan & Co, an issue of bonds…The New Haven spends the proceeds of the bonds in purchasing steel rails from the US Steel Corporation, of which Mr Morgan (or a partner) is a director. US Steel spends the proceeds of the rails in purchasing electrical supplies from the General Electric Company, of which Mr Morgan (or a partner) is a director….” (Source: “Other People’s Money and How the Bankers Use it” by Louis Brandeis)

Investment implications

History has shown us that often the recipe for massive wealth generation across multiple generations often involves abusing the law and corrupting the government of the day. For both ethical and for practical reasons, minority shareholders like us cannot hope to profit from buying shares in such companies even as we understand that the promoters of these companies will become obscenely wealthy and unbelievably powerful.
The notion that somehow India will create an economic construct where such men will be tamed is delusional regardless of whichever political party is in charge in New Delhi. The rise of economies as disparate as Japan, America and Italy is basically the story of the rise of several such ruthless barons. To believe that a more benign form of capitalism existed once upon a time in the West and could one day exist in India is to believe in the fairytales spun by the Western intelligentsia.
The combination of the two preceding points means that if we want to profit from India’s economic ascent, we have a superset of no more than 40 listed companies to choose from. These companies are relatively clean (in that they are not cooking their books and corrupting the polity), relatively well managed and have – without indulging in nefarious activity – managed to pull ahead of the competition. This very short list of companies ironically makes the job of profitably investing in the Indian stockmarket actually relatively straightforward.
The crossroads at which India finds itself today – where the core of the banking system consisting of public sector banks has collapsed and where the RBI has lost two governors in four years – is ideally suited for the capture of the banking system by industrialists. No prizes for guess which industrial houses will grab the juiciest banks.

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Saurabh Mukherjea is the author of “The Unusual Billionaires” and “Coffee Can Investing: the Low Risk Route to Stupendous Wealth”.

Note: the above material is neither investment research, nor investment advice. Marcellus does not seek payment for or business from this email in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services and as an Investment Advisor.