One of the over-arching problems that we see afflicting this "non-recovery" is that in spite of the fact that the financial industry (capital) was responsible for the near-destruction of American capitalism, it is now once again in complete control of the economy. The financial industry is NOT about creating value; it is all about extracting value.
The economy's addiction to growth has been forced upon business by the financial industry. This has lead to short-term thinking by CEOs who amputate profitable subsidiaries in order to demonstrate growth (in capital), or spend money on share buy-backs that temporarily inflate share prices, or most damaging of all, lock-up hoards of cash instead of investing. None of these machinations create value or long-term prosperity; in fact, they extract the former, and stifle the latter.
Douglas Rushkoff in his latest book Throwing Rocks at the Google Bus, demonstrates the artificial need for businesses to grow when he writes about the effect on the fundamental nature of Twitter following its IPO (i.e. transfer of the company into the hands of the financial industry). He writes:
Having taken in this much new capital, however, Twitter now needs to produce. It must GROW. As of this writing, the $43 million Twitter PROFITED last quarter is considered an abject FAILURE by Wall Street. In 2015 Twitter investors complained that the company was too far from reaching its"100 x" GROWTH POTENTIAL and forced out the CEO…..It's not that Twitter is not successful; its's just not successful enough to justify all the money investors have pumped into it……To do that, Twitter must grow into a corporation bigger than the economy of many entire nations. Isn't that a bit much to ask of an app that sends out messages of 140 characters or less?
At some point, any market that a business is dependent on will get saturated, and further expenditures made in an attempt to continue to grow will result in diminishing returns for that business. The financial industry, however, does not take "no-growth" for an answer, even if a business is profitable. The overall economy, when measured most broadly by the GDP, is considered a failure if it doesn't show accelerating growth rates.
Malthus, in the nineteenth century, showed that growth has limits, and these limits depend on a complex array of required resources. Technology can certainly extend these limits and increase the carrying capacity of systems, but no technology can accomplish this in perpetuity.
This is especially true when corporations find efficiencies by reducing the involvement of human resources (people). This results in the extraction and transfer of value from the real economy itself and into that of the technology owners (shareholders). This deprives the foundational levels of the economic pyramid (refer to SA article, "Our Economic Ecosystem Needs to be Rescued) of the required purchasing power to keep the economy healthy (see chart below).
Source: St. Louis Federal Reserve
When the need for labor is diminished, the value of the labor that is left tends to diminish as well, creating the inability of labor to purchase the end products of the industrial production. What follows is that production capacity cannot be utilized and capital lies idle and un-invested; U.S Corporations are sitting on $1.9 trillion in liquid assets. Why?
According to Xiaodan Gao of the University of British Columbia, much of this extra cash is a result of the switchover to Just-in-Time (JIT) manufacturing:
As firms switch over from the traditional operating system (Just-in-Case, JIC) to JIT, they allocate the resources freed up from inventory to cash to ensure smooth transactions with suppliers. On average, this switchover accounts for 45% of the observed cash increase. (Gao, 2012)
That might explain less than half of the situation, but it still leaves the majority of the cash as a mystery.
A mystery because there seems to be an obvious and ubiquitous corporate mismanagement at play here; how can a CEO justify investing billions at 2% instead of buying…well...almost anything? Of course, the obvious is obviously wrong, especially when it is this wide-spread. But what could be the reason?
Part of the answer may lie in the dreaded social levy: taxes. Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOGL), and five other tech companies are responsible for 20% of the $2.1 trillion of profits that American corporations store off-shore (Forbes). They may only be getting 2% on their money, but if they were to repatriate this money, they would lose about 30% of it to U.S. taxes. This is because the companies' strategic locations of operations, allows them to pay only two or three percent in foreign taxes.
As we suspected, mismanagement (at the individual business level, at least) is not that wide-spread. From an individual CEO's perspective, it would be financial mismanagement to lose 30% of the company's money by moving it. But from the economy's perspective, it amounts to a form of financial starvation.
The money, while it sits idle, is not being invested in new technology, R&D, developing new markets, improving employee's working conditions, or even buying other businesses in order to diversify. The money is essentially locked away instead of circulating in the economy. The chart of M2 money supply says it all.
Source: St. Louis Federal Reserve
Short-sighted financial decisions are to blame for this near-depression. The financial institutions are holding most of the capital on behalf of business (and themselves), and using it to play financial games with the stock market and synthetic instruments.
The blame, of course, gets heaped on Government taxes and spending; never mind that it was the government spending tax dollars in order to cover the industry's gambling (and even illegal) operational losses that saved the financial industry from certain and complete failure. It should be written in lights over the entrance of every investment bank that "The profits belong to us, but the losses are all yours-WELCOME".
Have a close look at the graph below.
What happens to corporate cash amounts as the corporate tax rate decreases? Ironically, it goes UP which means that the savings derived from lower tax rates are extracted from the economy and stored in idle form, or worse, used as collateral by the banks to leverage their bets at the unregulated financial derivative casinos.
Jordan Brennan, commenting in the Globe on his Canadian research,Do Corporate Income Tax Rate Reductions Accelerate Growth?, reports the following conclusions:
Business investment not only failed to rise with the onset of CIT (corporate income-tax) reductions, it fell…… A similar story is found with job creation and GDP per-capita growth, which drastically decelerated in the cuts era. It turns out that leaving corporations with more after-tax profit doesn't generate an investment and jobs boom. To the contrary, Canadians have seen sustained underinvestment, a jobs crisis and the slowest GDP growth since the Depression era.
So when you actually measure, instead of assuming, the effects of "trickle down" economics, of which tax reduction is a big part, it turns out that not only does it not grow the economy, it does long-term damage. It is a form of austerity where the real economy is deprived of fiscal investment, living wage jobs, and organic growth. Economies growing by austerity is an oxymoron. Nothing grows by becoming smaller.
Loaves and Fishes
Most people are familiar with the Bible story of Jesus feeding the crowds with only a few loaves of bread and fish. Most people also understand that creating food out of thin air could not be what actually happened. The real "miracle" was that Jesus was able to convince the crowd to share the food that was already present, but concentrated with just a few individuals. If he had not been able to change people's hoarding behavior at that moment, the disparity in resources that existed in his audience would have led to a dangerous revolt.
We are approaching a level of disparity that has the potential to cause push-back and revolt from those masses that have nothing to lose. And the success of globalized capitalism means that the revolts will not be localized, as in the past. There is more than a casual connection between extremism and disparity, and castle walls will no longer protect the haves from the have-nots; the globalization genie is now out there and producing unintended consequences.
As a whole, the world has never been richer, or as disparate. We need to organize a new "loaves and fishes miracle" that will maximize human well-being. It would even benefit the uber-rich, since if the poor have what they need, they won't be trying to take what they want, which could reduce the frightened paranoia of the rich and powerful.
This change will eventually have to be engineered on a global scale, but like all fundamental changes, it will begin small and localized.
How to Invest this Knowledge
We think that individual companies have the opportunity to operate counter to conventional business practices and benefit from changes to the established human resource models. Feudalism was replaced by corporatism over the course of several hundred years during which individual economic pursuits such weaving, coopering, tailoring, etc. were replaced by the buying and selling of human time (i.e. jobs). This was part of the economic growth model instituted by the aristocracy as a replacement for serfdom. It is now time to dial-back this economic growth model and allow the productivity gains to be shared by everyone.
We need to resynchronize the chart below.
Kato, et. al. looked at the productivity effects of four different schemes for sharing: Profit Sharing Plans (PSPs), Employee Stock Ownership Plans (ESOPs), Stock Option Plans (SOPs) and Team Incentive Plans (TIPS). Not all plans are equally (or at all) successful as they conclude:
Our estimated fixed effect models of production functions reveal consistently that the introduction of a PSP or a TIP will lead to a significant increase in productivity (about 10 percent) whereas no such evidence found for ESOPs or SOPs.
Employees need to feel ownership over, and benefit from, their work. It seems obvious that money for time is only a slightly less brutal form of serfdom, or slavery, but it is only the progressive, contrarian business owners who seem to recognize the benefits of sharing the fruits of their ideas with those who make those ideas possible. They sense that if you grow the pie, then there is no need to grow your own share of the pie in order to be richer; everyone ends up richer.
Taking a bigger share only extracts value and makes the pie smaller, it does not have to be a zero-some game.
In addition to Google, Apple, and Microsoft, the following public companies come highly rated by their own employees:
Delta Airlines (NYSE:DAL)
Eastman Chemical (NYSE:EMN)
Zillow Group (NASDAQ:Z)
Brennan, Jordan. "Do Corporate Income Tax Rate Reductions Accelerate Growth?". CCPA, November 2015.
Gao, Xiaodan. "Corporate Cash Hoarding: The Role of Just-in-Time Adoption". The University of British Columbia, December 27, 2012.
Kato et. Al. "The Productivity Effects of Profit Sharing, Employee Ownership, Stock Option and Team Incentive Plans: Evidence from Korean Panel Data". Institute for the Study of Labor, August 2010
Rushkoff, Douglas. Throwing Rocks at the Google Bus. Penguin, 2016.
Worstall, Tim. "Why U.S. Corporations Are Hoarding All That Cash: The Tax System". Forbes, January 28, 2016.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.