'Free Money' and the New Corporate Siege Mentality

By: Gordon Long | Thu, Apr 3, 2014
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'Free Money' and the New Corporate Siege Mentality

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
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!

Federal Funds Rate % 1990 to Present

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.

Moral Malady and Monetary Malpractice

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

World Gold

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.

US Sector Net Buying of Equities


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.

US Corporate Buying and the Stock Market


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.

G4 non-financial corporate capex and cash flow as % of GDP

As a consequence the corporate CEOs and Board Rooms have adopted the following strategies:

In other words, operate as a hedge fund. The executive incentive and bonus scheme are aimed at nothing short of this occurring.

US: Non-financial Companies' Investment and Buy-backs

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.


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:

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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Gordon Long

Author: Gordon Long

Gordon T. Long
Publisher - LONGWave

Gordon T. Long

Gordon T. Long has been publically offering his financial and economic writing since 2010, following a career internationally in technology, senior management & investment finance. He brings a unique perspective to macroeconomic analysis because of his broad background, which is not typically found or available to the public.

Mr. Long was a senior group executive with IBM and Motorola for over 20 years. Earlier in his career he was involved in Sales, Marketing & Service of computing and network communications solutions across an extensive array of industries. He subsequently held senior positions, which included: VP & General Manager, Four Phase (Canada); Vice President Operations, Motorola (MISL - Canada); Vice President Engineering & Officer, Motorola (Codex - USA).

After a career with Fortune 500 corporations, he became a senior officer of Cambex, a highly successful high tech start-up and public company (Nasdaq: CBEX), where he spearheaded global expansion as Executive VP & General Manager.

In 1995, he founded the LCM Groupe in Paris, France to specialize in the rapidly emerging Internet Venture Capital and Private Equity industry. A focus in the technology research field of Chaos Theory and Mandelbrot Generators lead in the early 2000's to the development of advanced Technical Analysis and Market Analytics platforms. The LCM Groupe is a recognized source for the most advanced technical analysis techniques employed in market trading pattern recognition.

Mr. Long presently resides in Boston, Massachusetts, continuing the expansion of the LCM Groupe's International Private Equity opportunities in addition to their core financial market trading platforms expertise. GordonTLong.com is a wholly owned operating unit of the LCM Groupe.

Gordon T. Long is a graduate Engineer, University of Waterloo (Canada) in Thermodynamics-Fluid Mechanics (Aerodynamics). On graduation from an intensive 5 year specialized Co-operative Engineering program he pursued graduate business studies at the prestigious Ivy Business School, University of Western Ontario (Canada) on a Northern & Central Gas Corporation Scholarship. He was subsequently selected to attend advanced one year training with the IBM Corporation in New York prior to starting his career with IBM.

Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

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