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Some Economic Common Sense

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As most observers have expected, the US and Chinese stock markets have been rising in anticipation of a US/China deal. Hopefully there will be good news on this front. If there is no agreement or hope for future agreement, the stock markets will head down again.

That said, in this issue I would like to discuss two subjects that need attention.

First, the sudden hostility to stock buybacks is completely misguided. Florida Senator Rubio reportedly has introduced a bill which would penalize stock buybacks. Economic logic does not support this bill. The US has the deepest and most robust capital market in the world. If companies have excess cash and cannot find new investments which will yield a targeted risk adjusted marginal return that is equal to or in excess of their marginal cost of capital, they should distribute this excess cash one way or another to their shareholders. This is Corporate Finance 101. Companies should not be encouraged to invest in projects which do not meet their targeted marginal rate of return. The capital which is returned to shareholders will be recycled by these shareholders into the capital markets—via venture capital investments or IPOs—into projects which do have higher returns that are available internally to the companies distributing the capital. What prohibitions on buybacks would do is encourage capital hoarding, capital waste, empire and conglomerate building.

In an ideal world, companies would not need to resort to share buybacks to redistribute capital. They would pay out their excess cash in dividends. Managements have been known to buy back shares at the least opportune times when their shares are reaching new highs. But dividends are taxed to the recipient shareholders. Compared to share buybacks they are not tax efficient. If Senator Rubio really wanted to get rid of share buybacks he should introduce a bill eliminating the (double) taxation of dividends. (Do not hold your breath.)

Jim Cramer on CNBC has been worrying about where the money is going to come from to fund all the new IPOs which are expected this year (like Uber and Lyft.) Well, one source would be all the excess cash that has come back thanks to the recent tax bill and is sitting in corporate treasuries. The capital markets will recycle it into the new IPOs.

Otherwise we get a situation like Alphabet (GOOG) and its famous “moonshots”. Google is a fabulously successful company which generates huge free cash flows. But it indulges its founders’ intellectual curiosity by dabbling in unrelated tech ventures. The founders seem to have forgotten that the company’s excess capital belongs to the shareholders. The company’s moonshot program is regarded as a negative on Alphabet’s otherwise very positive story.

But that is one result when companies do not distribute their excess cash. Another might be where companies make stupid acquisitions. Apple (AAPL), for example, is being pressured by some on Wall Street to make a big acquisition with its excess cash. Yes, I would say to this if the acquisition is in an adjacent business where Apple can add value. But if it cannot find such a target then Apple should recycle the capital back to the capital market via dividends and buybacks.

The left, of course, hates share buybacks since they don’t understand how capital markets work. They did npt approve of the tax bill in the first place and they don’t accept that these firms’ excess cash really belongs to the shareholders. They conclude that the recycled capital via buybacks will go into yachts or other objects of conspicuous consumption while the poor get nothing. They conclude that the buybacks bring no real investment. But the economic incentives are otherwise. Most of the buyback money, likely via the capital markets, will go into high return real investments—better use of capital than if the money were recycled via taxes into the government’s hands.

A second issue is the need for policy makers and the public to realize that the acceleration of technology—which benefits all of humanity—is a global phenomenon, which is a positive sum game. There are only winners with this game. Up until and including the twentieth century, countries engaged in wars over territory. That was a zero sum gain—one winner, one loser. Thus the Europeans took over the Americas from the Native Americans, the British and French empires at their prime embraced more than half the world’s territory, Hitler wanted Russian land to satisfy his infamous Lebensraum plan, etc. etc. All of history reads like this. Land represented wealth and power. Countries fought over land, there was always one winner, one loser.

That is almost over. Yes, there are still border disputes and still disputes involving oil exploration rights. But in the 21st century major countries do not fight over territory. The real competition now is for brains. Brains create wealth and are wealth. And it’s a positive sum, not a zero sum game. All of humanity benefits. If the cure for cancer is discovered in China, that cure will spread quickly around the world. China wins but so does everybody else. There are only winners.

In my opinion, the US and China do not have any serious differences which require massive military buildups on both sides. Although China still has some serious border disputes including the South China Sea, the US and China are not contemplating major land grabs in Asia or anywhere else.

Take for example Taiwan. Taiwan is a small island off the China coast. Granted, China has strong historical claims to the island and the US feels a moral obligation to prevent China from taking over, this derives from the Cold War and American intervention in the Chinese civil war in 1949. A tough problem for diplomats. But aside from considerations of nationalism and history, what is so valuable about this island? Why would anyone care? Is it Taiwan’s mineral and agricultural wealth? No. Does China need Taiwan for more room for its large population? No. Rather, any objective outsider would conclude it is all the brains and technical skills in Taiwan. Taiwan is the Silicon Island where, for example, a large percentage of the world’s semiconductors are manufactured including those for Apple, Qualcomm (QCOM), Nvidia (NVDA) and Huawei. A military invasion of Taiwan by China doesn’t make any sense. The island’s chief asset—its brains—would all leave or be killed in the fighting.

Another example: Zimbabwe. Under Robert Mugabe, the land owned and operated by the white farmers was nationalized. The land was given (arguably, “returned” might be the right word) to the native African population. But agricultural output collapsed. The real wealth wasn’t the land. It was the brains and know-how of the white farmers.

Marxism advocates the state nationalize the means of production. But in the 21stcentury, the means of production is the brains and know-how of people. Marxists and their socialist cousins have not figured out how to nationalize people. As a former now well-known executive (Jamie Dimon) of the Wall Street firm I worked for used to say, “our firm’s assets get on the elevator and go home every night.”

Attempts by the Trump Administration to divide the world into two technological camps—the US and China—also do not make any sense and will ultimately fail. The Export Controls Act of 2018, which I have written about in a prior Dismal Optimist, is a potential disaster for the US and the world. The war on Huawei, which has now reached the point of hysteria, is a giant mistake and is being interpreted in Asia in racial terms. (See quote above.) The war on Huawei is really a war on 5G in the United States and the rest of the world since without Huawei, US 5G implementation will be much slower and more costly. Ironically, two of the American favorite alternatives to Huawei—Ericsson (ERIC) and Nokia (NOK)—are not American companies and are domiciled in Sweden and Finland, respectively. Neither country is a NATO member and therefore not a formal American ally.

If Trump wants the US to maintain its technological advantage in the 21st century positive sum global knowledge economy, the US is going to have to roll out the welcome mat for the best and the brightest from around the world—as it did until recently. Chinese STEM students in particular should be welcomed and encouraged to stay in the United States, and so should Indians, Iranians and everyone else who can contribute to the American tech effort.

The American stock markets are populated by companies with foreign-born CEOs, sometimes with unpronounceable (for Americans) names. I always recommend (in jest) to American investors that if they cannot pronounce the CEO’s name, they should buy the stock.

 

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