There is a war going on in America and around the world that is insidiously
destroying jobs and enriching the few.
It receives little visibility outside the corporate board rooms, but the war
is as deadly as the casualties and dead bodies on any battlefield. The casualty
in this battle is the employed worker. The victors are those who understand
the rules of engagement in the "Free Money War"!
The profits that are being extracted from this war are obscene. $2.5 billion
in annual payouts alone reported last week to just one group of 9 individual
private equity participants!
Profits are quite rightly the holy grail of the capitalist system, but only
when the system is working properly. Unfortunately the capitalist system is
no longer working properly.
As a direct consequence it is making both a job loss and a job creation problem
worse than most fully grasp.
The Modern Gladiators
Profits are considered as 'savings' in a functioning capitalist system. Savings
are traditionally reinvested to create productivity improvements and innovation
which then delivers "more to the consumer for less".
In the new 'financialized' system which has now corrupted the capitalist system,
we witness 'Savings' being replaced with 'Credit' and 'Investment' by 'Consumption'.
This has been wrought by public and monetary malpractice which the modern 'gladiators'
have taken full advantage of to rape and pillage just as the barbarians of
yesteryear did.
Nine
private equity founders share $2.5bn payday 03-04-14 FT
What results in our new system is that the average person now "gets less
for more" versus "more for less". We simply no longer have Capitalism
but rather something that can go by a number of names; Corporatocracy, Creditism
... Fascism. It doesn't matter what you call it, but don't call it capitalism!
The lack of price discovery and the mispricing of risk as a consequence of
moral hazard, unintended consequences and monetary malpractice is facilitating
the making of fortunes by these new financial gladiators.
Let's discuss how they do it and why it creates a massive job problem. Don't
be duped by their spin that it is in the name of capitalist efficiency and
productivity.
The Job Creators Dilemma
The big creators of jobs have historically been those corporations who made
major investments in new ideas and innovations. Great American entrepreneurs
who took risk, such as Henry Ford in Autos, Thomas Watson in IBM Computers,
John D Rockefeller in Oil, to name a few, created industries and with them
untold jobs.
There has always been a visionary who saw the future and made investments
in it. As risky and dangerous as those decisions were they paid off and huge
fortunes were made and huge numbers of new jobs were created. Standards of
living increased and risk taking and innovation flourished from the increased "savings".
Today, the players large enough to take that risk refuse to do so. They simply
see there is a less risky way to make money with larger returns. Financial
returns which will result in job destruction. As evidence look at the $2T of
excess reserves at the US Federal Reserves and the bloated cash presently on
corporate balance sheets.
Let's consider these two traditional entitles sufficiently capitalized to
take the risks that can potentially create large numbers of new jobs.
Corporations
Corporate Buybacks & Debt Funded Dividends
The facts here are clear. Corporations are using their cash and borrowing
power to buyback stock or payout dividends to drive stock prices and valuations
up.
During the past 14-year period, the S&P 500 has achieved a total return,
including dividends of 3.3% annually, while real annual GDP has averages 1.8%.
Assuming a large corporations growth is in-line with GDP growth it is smarter
to invest in your own stock price with available cash.
This is clear when we see that real gross private investment has averaged
only 1% over the same 14 year period.
Preserve 'Offensive' Capital & Restrict Investment
It is also clear from the charts to the right that this strategy is working,
but at what cost?
Capital investment in the US has plummeted. The cost is shown below in terms
of Investment as a percentage of Cash Flow.
Unfortunately there is more at play than simply a shortage of risk adjusted
investment. There are investments but the risk taken is more than the just
the actual investment itself.
The risk lies with others who understand the rules of the Free Money War equally
well. They are these modern day Gladiators or Private Equity players.
As a consequence the corporate CEOs and Board Rooms have adopted the following
strategies:
-
Load up on cheap debt "off balance sheet"' to keep financial ratios pristine,
-
Keep a 'war chest' of untaxed cash offshore,
-
Slash costs to shore up falling EBITDA (see chart to the right),
-
Aggressively employ forwards and esoteric derivative futures / SWAPs to
protect against being disadvantaged through multi-national currency and
interest rate movements.
-
Use offshore / off balance sheet 'affiliate' investments to spice earnings.
-
Use hidden contingent liabilities to bolster borrowing collateral.
In other words, operate as a hedge fund. The executive incentive and bonus
scheme are aimed at nothing short of this occurring.
As obscene as the earnings are for the "Gladiators" which we mentioned above,
it should also be remembered that CEO pay is equally obscene and out of control,
despite continuously failing political pressures to rein it in.
Corporate Siege Mentality
The biggest companies are effectively putting profits into the corporate equivalent
of a mattress. They are hoarding what just a few years ago would have been
considered unimaginable pools of cash and buying risk-free securities that
can be instantly converted to cash, which together are known in accounting
parlance as liquid assets. This is just one of many signs that America's chief
executive officers, chief financial officers and corporate boards are behaving
fearfully.
This rising sea of liquid assets holds back economic recovery in at least
two ways.
First, the economic engine sputters when profits are not recycled through
the economy -- when they are not invested in new plant and equipment, not spent
on research and development, not paid out as higher wages or larger dividends.
The flow of funds between buyers and sellers, employers and workers, companies
and their investors is the fuel required to rev up the economy.
Congress understood this in 1909, when the corporate income tax was adopted.
Worried that companies would become bloated with cash, slowing the economy,
Congress put a stiff 15 percent penalty tax on excessive pools of cash. Thousands
of small business owners who have hoarded cash have had to pay that penalty
over and above their taxes.
But in 1986 Congress changed the rules, retaining the penalty tax on domestic
cash hoarding but allowing multinationals to hold unlimited amounts of cash
so long as they sent the money offshore. This act incentivized the enormous
world of offshore tax avoidance we see today, as chronicled in my book "Perfectly
Legal" and other books such as Nicholas Shaxson's excellent "Treasure
Islands."
Second, the accounting techniques American multinationals use to siphon profits
out of the U.S. delay their taxes for as long as they wish, shifting tax burdens
to everyone else, which thereby puts a damper on the overall economy.
This siphoning of profits out of the United States cost the Treasury between
$57 billion and $90 billion in 2008, Kimberly Clausing, an economics professor
at Reed College in Oregon, estimated after analyzing corporate disclosure statements.
Cash sent offshore cannot be invested in expanding American operations. However,
Congress does permit the money to be used to buy federal debt -- Treasury notes
and bonds. More about that in a moment.
Analysis of the latest data from the Federal Reserve, the IRS and corporate
reports shows that American businesses last year held almost $7.9 trillion
of liquid assets worldwide.
Corporations hold liquid assets equal to all the money the federal government
spent in 2013, 2012 and three months of 2011.
Those who follow the news may be surprised, because the figure that's been
mentioned lately has been just under $2 billion. That figure, which comes from
the Federal Reserve, is only for domestic cash. The Fed makes its calculations
(from the latest Flow
of Funds report) using IRS worldwide data after subtracting offshore money.
The $7.9 trillion estimate is conservative. It does not count cash due to
American companies from their offshore subsidiaries as accounts receivable
because the IRS does not provide fine details on these additional trillions
of dollars.
But even the $7.9 trillion estimate is so huge that it may be difficult to
understand, so let's review some ways to put it in perspective.
-
Consider the debate over federal spending. Uncle Sam spent $3.5 trillion
in fiscal 2013. Corporations hold liquid assets equal to all the money
the federal government spent that year plus 2012 and three months of 2011.
-
The cash hoard also equals all the sales rung up by all 6 million American
businesses every three months. And four years of 2013 profits, which totaled
$1.9 trillion.
-
Corporations now hold $2.30 for every dollar of cash they had in 1994,
after adjusting for inflation.
-
The total corporate cash reserve also amounts to almost $25,000 per American,
up from $13,000 per American in 1994 (again after adjusting for inflation).
And this cash is highly concentrated, most of it held by the 2,800 biggest
companies, IRS data shows.
-
Since 1994, liquid assets have grown at about six times sales, my analysis
of the official data shows. When liquid assets grow six times faster than
revenues, it tells you that companies are hoarding cash, not investing
or spending.
Turning Taxes into Profits
These facts also demonstrate that America's CEOs, chief financial officers
and corporate boards fear the future because instead of investing their cash
they hold onto it. But even if cash hoarding comforts weak-kneed executives,
it makes no sense for investors, workers or taxpayers.
Investors do not need a company to hold their extra cash. That's what savings
accounts are for. Workers need companies to invest in the future, replacing
old factories, purchasing new equipment and engaging in other activities that
employ people in pursuit of bigger future profits.
Taxpayers also get a terrible deal. When companies siphon cash out of the
country it reduces their immediate federal income taxes. Congress spends the
money anyway, which requires borrowing. Companies then loan Washington the
money they did not pay in taxes, collecting interest.
This means companies that do this turn a profit on their taxes. Consider a
company that defers a $1 billion tax for 30 years, using the cash to buy federal
debt paying 4 percent interest in an era of 3 percent inflation. The company
will collect more than $2.2 billion in interest, while inflation will erode
the value of the tax to $401 million, a nearly 60 percent reduction. From the
government's point of view the tax is converte
d from a source of revenue into an expense.
The only casualties in this raging war of titans will be the worker and
jobs, as long as it is allowed by pubic and monetary policy to continue.
Macro Analytics Video: Market Distortions Buybacks and Dividends
Private Equity & Individuals
With money now being practically free, it doesn't take long before private
equity will borrow as much as they creatively leverage. They then go after
corporate balance sheets ripe to be further loaded with balloon payment debt
to finance the takeover, increase leverage and make returns look better than
they really are. Since 'Barbarians At The Gate" this has been going on but
the thresholds have gotten dramatically lower and few corporations can take
any risk which will leave them exposed and vulnerable.
Why would a CEO take a major investment risk in such an environment. Instead,
effectively a "Siege Mentality" has now taken hold of corporate board rooms
not already owned by Private Equity firms.
Private Equity by its nature buys with an exit strategy in place. 5 years
is a long time and the leverage used dictates that an exit be expedient. As
a result:
-
Slash healthcare benefits which can be moved to government programs,
-
Remove defined Benefits pensions and move to Contributory pensions which
leave few with a retirement,
-
Cut full time employment and use interns and temps. (Is it any wonder
that the largest employer in America is now a temp agency?)
The Economist
scrutinized all the studies of Private Equity duirng Mitt Romney's run
for the oval office and found that employment declined by 3% two years after
a buyout and wages didn't rise for employees because the owners want to control
costs to produce profits demanded of them by PE's with an exit strategy timetable.
Shadow Banking & Collateral Transformations
At the heart of the new LBO artists arsenal of weaponry is the Shadow Banking
System. Having become visible during the 2008 financial crisis as being at
the center of the Housing Bubble financing, the Shadow Banking system has morphed
into something much more sinister and dangerous at the hands of the 'Free Money
War' warriors.
The Shadow Banking Achilles heel is still however the same. Borrowing short
and lending long. Liquidity is paramount!
Any financial disruptions to credit flows and collateral values and we have
another 2008 crisis, but possibly orders of magnitude larger.
Conclusions
John Hussman recently wrote a very prescient article entitled: Restoring
the "Virtuous Cycle" of Economic Growth which along with another article "Corporate
Capex Fallacies" by FF Wiley, spells out why Capital Investment is not
occurring. I couldn't agree more with the analysis but both fail to convey
the realities of the full pitch battle raging.
Be assured it is a War of Free Money. The casualties are mounting and the
bloodshed has barely begun.
As global economies continue to weaken from slowing aggregate demand, as
a result of shrinking real disposable incomes, corporations will be under further
stress to shore-up collapsing EBITDA cash flows.
The only casualties in this raging war of titans will continue to be the
worker and jobs.
It will persist only as long as it is facilitated by pubic and monetary
policy or there is a global job crisis.
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