Money For Nothing

Hi! In my last blog which held the nation breathless, I discussed an historical event so incredibly weird it would seem unbelievable if not supported by documented fact: The Prohibition. Today I’d like to discuss—to the best of my amateurish knowledge---a contemporary phenomenon no less strange, shocking and in defiance of common sense: our current US economy.

I came across a fact that I found amazing that I wish was as common knowledge as Donald Trump’s shifting funding strategies for his Mexican Wall that wall never be built. According to a recent study, since 2004, Fortune 500 companies have spent 54 percent of their profits on buying back their own stock and an additional 36 percent paying out dividends to shareholders. So companies on average essentially pay 90 percent of their profits back to Wall Street.

They buy back their own stock because it inflates the stock price to the short term benefit of shareholders. Of course, in a world tethered to reality, a company’s stock price would be merely a reflection of its actual performance, but buying back your own stock artificially manipulate its price—making its dollar value higher than its real world value. It’s the performance enhancing drug of corporate America and companies are addicted in record numbers. This is what folks in finance seem to mean by creating a stock bubble: a problem unless you and your shareholders live in that profit making, insulated virtual reality universe where it doesn’t matter so long as the bubble doesn’t burst (or if you fail to get out before it bursts) because it will just mean larger profits for everyone. A bubble bath of bubble boys in a tub of gold. God what a terrifying metaphor.  

Price manipulation through stock buyback was once not only discouraged, it was illegal. But in 1982, the SEC passed Rule 10B-18 which allowed companies to do this—with some limitations. The SEC sheriff at the time was this guy named John Shad. Prior to being charged with policing Wall Street, he had been a Wall Street CEO---totally not a conflict of interest or anything. “John, we’re going to call you a “regulator” but of course your real job is to provide hall passes”. “I see you have an extensive background in burglary, have you considered applying for a security guard job?”, said no one ever, but on Wall Street and in Washington this type of thing seems common: use insiders to blow it up from the inside!

Of course occasionally reality makes a furious comeback (reality loses a lot of battles but it seems to win every war) and a massive mess ensues. This is what nearly crashed the world economy in 2008—bonds linked to mortgages were given to people despite common sense dictating the new homeowners would have to default on them eventually and these bonds artificially soared in value in the short term and everyone got out after the bubble burst---and tax payers cleaned up the mess. The official cost was “only” $700 billion, but factoring in loans and such, another estimate pegs it as $12.8 trillion. Oh well, money can’t buy you love.

A second reason stock buybacks would be outlawed if the inmates weren’t running the asylum: it literally costs jobs. In 2011 Pfizer laid off 1,1000 workers. “Well, it’s sad when people lose their jobs, but when times get tough companies have to tighten their belts”. No. They laid their workers off so they could buy back $4 billion of their own stock. People were expendable, the stock price was invaluable. The following year their reduced staff gave them such massive surpluses they hired back those workers and created new and improved life saving drugs. Just kidding, They bought back an additional $5 billion of their stock. Wall Street was partying, Main Street was crying.

This habit is even more insane when you consider that companies make no money when they do this, but Wall Street has become so powerful and arrogant that they can and will get CEO’s fired if they don’t do their bidding. And 76 percent of CEO compensation now comes in the form of stock options—so they are incentivized to play along with the madness too. This essentially makes CEO’s embedded members of Wall Street themselves. Regulators, CEO’s…….Wall Street has its golden ring wrapped around all of them. “One Ring to rule them all, One Ring to find them, One Ring to bring them all and in the darkness bind them”. Too dramatic?  

And when so much of a company’s profits are drained to feed the carnivorous “greed is good” crowd, it’s money not spent on employee salaries, pensions, building new plants/offices, developing new products and services, etc.---in other words, all the things that can benefit the rest of society, not just those impeccably dressed vultures on Wall Street demanding their pound of flesh. The middle class keeps having to sacrifice because we’ve run out of money or because we’ve all become the sacrificial lambs of high finance?

And here’s the punchline: it doesn’t seem to work. Carly Fiorina (remember her? The Republican candidate Trump hated the most because she wasn’t a young, submissive Eastern European supermodel speaking broken English?) ran Hewlett Packard from 1999—2005. She purchased $14 billion in stock buybacks compared with $12 billion in profits over that time. She laid off a bunch of workers. Then she was fired. The company wasn’t growing enough. Giving investors easy money through buybacks is like buying children’s love with too many cupcakes: rather than earning their undying love and loyalty they will just say they want more cupcakes--and a new mommy. HP’s successors followed a similar strategy. But instead of enriching their shareholders, imagine if they had used that money to develop the best mp3 player, smartphone, or tablet. Maybe we would all consider the iPod, iPhone, and iPad pieces of copycat junk compared with the HP Hella Wicked Volcano phone. (I don’t work in marketing). But they opted for fast food takeout instead of a full course home cooked meal. 

But American’s sweethearts Apple are part of this game too. (I’m writing this on a Mac so my hands are also dirty it would seem). Last year  they spent $37 billion on stock buybacks. They have also been accused of being tax dodgers. They, along with other companies, have tax shelters in Ireland. Their CEO Tim Cook has defended this, shifting the blame to a supposedly unfair and outdated tax code in need of reform. In 2014 they paid $14 billion in taxes. A lot of money, second most of any corporation, but still roughly $23 billion less than they paid to Wall Street. They paid less to the people who build roads, bridges, and schools and fight our wars—and grant patents, copyrights, and subsidies that allow American companies like Apple to flourish--compared with the bros who gamble with money and call each other “chief”. Companies claim to be so upset about their taxes, but maybe their enslavement to Wall Street causes them to pay such exorbitant amounts back to them that they can’t stand having to pay government taxes on top it. Is Uncle Sam or Carl Icahn the real villain?

And so they lay off workers, outsource workers, cut products and services…..all to avoid facing the elephant in the room and confronting Wall Street and those activist investors who threaten their heads on a platter or a takeover of their company if they don’t pay their ransom money through huge buybacks and dividends. And this subservience to the stock price and its need to grow every single quarter to please investors (you made $50 billion last quarter but you made $51 billion the quarter before? I can’t wait to get a no-growth loser like you out of my life) seems to breed a kind of madness. The laws of nature dictate creatures stop growing after adolescence, the laws of gravity dictate anything that goes up must come down, but a company slavishly shackled to its stock price has to rise above the laws of nature and never stop growing. So if stock prices have to be manipulated, jobs have to be lost, and profits have to be drained for no societally productive use just to ensure growth (or the appearance of it) it beats getting fired.  

Finance and Wall Street have been around since the system was created by Alexander Hamilton while serving as George Washington’s Treasury Secretary. And right from the beginning, there were “occupy Wall Street” types who decried its perceived exploitation and greed and feared America was being hijacked by the “stock jobbers”. But, like, Kanye West’s ego, finance has only gown over time. Since 1990, the financial sector has represented a higher percentage of our GDP than ever before in US history—and it’s growing all the time. The only other period that came close was the Great Depression. But does this matter? After all a larger financial sector means more jobs….in finance. But many site history and note rich societies of the past underwent similar evolutions: starting out as agriculturally based like us, then shifting to industry/commerce like us, then finance like us, then collapse. Like us? Pass the popcorn.  

How did this growth happen? One prevailing theory is that deregulation--championed by economist Milton Friedman and implemented by Ronald Reagan, Margaret Thatcher and virtually every leader since—has opened the finance floodgates. I noted above how the stock buyback craze is the child of early 80’s deregulation.

Another fascinating—if a little confusing to a layperson like myself—theory says the root lies in our monetary system itself. Prior to 1971, our currency was tied to the gold standard. Our money’s link to gold had already been watered down in 1933 but it was eliminated entirely in ’71. Under the gold standard, your currency had to be linked to your gold reserves. In ’71 a dollar was worth 1/35^th of an ounce of gold. This system had one disadvantage our fearless leaders hated: you couldn’t just make new dollars without new gold to back it up. Nixon complained that our gold reserves had gotten too low (and they were discovering new gold in Russia! Those commies were at it again!) but the other problem was funding that anti-communist police action called The Vietnam War.

With out current “fiat currency” in which currency and gold are divorced from each other, less money creation limitations exist and banks can literally create money out of thin air—order it into existence by “fiat”. God said “let there be light”, AC/DC said “let there be rock”, and banks say “let there be money”. But the value of the dollar has to be measured against something, so instead of being measured against gold, it’s now measured against other currencies. Instead of the dollar’s strength resting on the intrinsic value of a shiny yellow rock, it now rests solely on its relative value to the pound, the euro, the yen, etc. Instead of a fixed currency, we now have a “floating currency”.

Problem: as the names imply, floating is less stable than fixed. Because gold is rare and gold rushes are rarer, currency fluctuations were usually kept in check, but when currency only has relative value to other currencies, it can swing up and down daily, hourly, by the minute. But this see-saw created a new game for Wall Street: the futures market. This is a labyrinthine system (which I barely understand) which allows an investor to hedge against loss due to currency fluctuations and even profit from them. Floating currency may also hurt trade: if your currency is stronger, your exports are more expensive to sell to other countries and imports are cheaper to buy from other countries. After decades of trade surpluses, we’ve had trade deficits every year since 1975—partially thanks to floating currency it seems. And do cheap imported products steer the American consumer to not buy American? And do expensive American exports steer the American employer to not employ American?    

So monetary policy changes may have had deep economic impacts that went way beyond helping fund the Vietnam War and helping Nixon get re-elected: increasing wealth inequality and weakening the overall US economy. Yep, I’ve learned there are some crazy people on the Internet and elsewhere who argue that while tax policy, tax shelters, salaries lagging behind cost of living, the decline in organized labor, and outsourcing may contribute to inequality, they are mere symptoms of the disease of fiat monetary policy.

Others think gold standard vs. fiat currency misses the point. Do you know where money comes from? I mean we all know where babies come from (the stork) but how about money? The government creates money, right? That’s what I always assumed. Not so. The government creates about 2 percent of the money in circulation: mostly coins. The rest is created entirely by private banks when it issues loans. This means our entire economy is fueled by debt. If debt didn’t exist, we would have to create it. The argument that money creation should be the sole role of our democratically elected government, not our unelected bank managers is now considered….well, pretty much a crackpot idea. But it wasn’t always so. In fact, for the first 100+ years of our country’s history it was a popular idea. Andrew Jackson dismantled the central bank and, probably not coincidentally, was also the last President to balance the federal budget. (He also liked to kill Native Americans and place them on reservations so there was that). Lincoln bypassed the banks and poured “greenbacks” directly into the economy to help the people and the struggling Civil War economy. 

But it gets even crazier. Did you know that when a bank issues a loan they are loaning you money they don’t have? They only need to have a fraction of the money they loan in reserves because they know people only take out a certain percentage of their deposited money at any given time. (Unless of course there's a major scare and they need a bailout from the government). It’s called fractional reserve banking. So they create money out of thin air and essentially make multiple loans to multiple people backed by the same reserve of money. What a racket. And each time you pay them back, you pay back with interest. Banks then are the beneficiaries of scarce incomes and big ticket item prices which combine to prevent most people from buying things in one debt free lump sum.

And consider this: to the economy as a whole loans mean inflation because new money is now going into circulation. Under the gold standard we have fluctuating inflation and deflation, but with central bankers’ increased ability to manage money, we’ve had steady inflation since the early 70’s. But—some argue—inflation creates income inequality. Richer people can make more investments in stocks, bonds, real estate: things that will appreciate in value over time if they play their cards right and more than offset inflation. Banks can charge interest and thereby protect themselves from inflation. But middle class and working class people have far less opportunities to shelter themselves from inflation. And when employers don’t adequately adjust salaries to cost of living increases it gets even worse. And when payroll taxes—paid primarily by lower and middle class workers—increase over time while corporate taxes—paid primarily by the rich—go correspondingly down as a percentage of overall tax revenue, the problem gets worse still.

Well I could maybe go on…..but I think all this talk about money is giving me indigestion. So how do we solve this? 1. Make stock buybacks illegal again, 2. tie currency to some natural commodity again, 3. crack down on tax evasion by the very rich, 4. ……..I think I’m out of ideas. No, wait! Ban the charge of interest on loans! This is another crackpot idea that was once mainstream. Interest’s dirty synonym is usury. Both The Bible and The Koran decry usury as a shady tactic which exploits those in need of loans. But what about inflation? Won’t the lenders actually lose money on loans without charging interest? If it’s the case that loans are the very thing that create inflation, maybe the problem would take care of itself. Make banks non-profit organizations who loan without interest!      

I’m sure all those things will happen any day now, no problem.

Well at least they’re about as likely as a classy Trump Wall around Mexico.