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Sancho Panza

The Wal-Mart Economy

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Seeking Alpha 6/3/14

'Summary

  • Business investment is low, despite record corporate profits, cash balances and low interest rates.
  • Part of this is a sectoral shift from high capital intensive manufacturing to lower capital intensive services.
  • But it is reinforced by a shift in categorical income distribution from wages to profits.
  • This creates a negative feedback loop and threatens to lock the economy into a low growth equilibrium.

Many observers agree that business investment (or, if you like, capital formation), is running very low.

191022-13940508869300327-Shareholders-Unite.jpg

The more important issue is why it is so low. Companies are sitting on record profits and mountains of cash ($1.5 trillion in the US, $7 trillion worldwide), and interest rates are at rock bottom in many places, like the US. Most economists would argue that capital formation is a negative function of interest rates, that is, lower interest rates leads to higher capital formation.

This is simply because the internal hurdle rate for considering investment projects becomes lower so more investment projects become more attractive, and the cost of capital is lower as well. The strength of the relation (the elasticity of investment demand) is probably not very high, but nobody argues lower rates reduces investment.

Until now. With (considerable) amazement we read the rendition of ZeroHedge:

We also identified what in our view was the primary reason for this misallocation, which said simply, is the Fed's monetary policy which forces corporate executives to focus on short-term gratification of shareholders via prompt return of cash instead of reinvestment into the business - a critical requirement to assure top-line stability and growth.

Now, in Austrian economics, "artificially" low interest rates (we'll come back to the issue of whether rates are artificially low or not) leads to over-investment and "misallocation" of capital, that is, investment into projects that would not be profitable under "normal" circumstances.

But for some reason not quite spelled out, over-investment turns out to be in "short-term gratification of shareholders," rather than re-investment into the business. So the Austrian (or at least the ZeroHedge) position seems to be that below "normal" interest rates lead normally to over-investment, but for some reason, this time not to productive over-investment, that is capital formation.

This is only one reason we have so much trouble with Austrian economics; it's so elliptic that anything seems to go, and normal positions (low interest leading to over-investment) can easily be turned into something with diametrically opposite consequences (low interest rates leading to over-investment in share buybacks, but a dearth of capital formation).

And all that without much (if any) of an explanation. The interesting question remains: why is capital formation so low? While ZeroHedge argues that capital formation is low because of monetary policy, UBS (quoted in the same ZeroHedge article) has it the other way around:

If developed economies are to ever wane themselves off their dependency on monetary and fiscal policy stimulus, private sector capital spending must push up a gear or two.

They blame low capex on (non-US specific) policy uncertainty:

In a recent survey of UBS company analysts over half (54%) believed that fiscal, monetary or euro membership uncertainty is delaying investment planning

This is certainly plausible, but at least for the US, low capital formation is anything but a recent phenomenon:

Since 1980, U.S. investment as a percentage of GDP was sliced in half, from nearly 24 percent to 12 percent, leaving the United States 174th in the world. The result was a dearth of real value added products and productivity. [
]

Part of that can be explained by a secular trend in the make-up of the US (and many other advanced) economy. Rising productivity shrinks manufacturing as a percentage of GDP, so the economy becomes less capital intensive over time. But still, with record profits and cash stacks, record low interest rates, and the best companies can think of to do with their bounty is share buybacks?

Feedback loop?

Are there no worthwhile investment projects generating returns above the meager cost of financing? This lack of investment is slowing down the economy in multiple ways:

  • Less new production capacity is created.
  • Old production capacity gets extended life and less new modern capacity gets built, leading to an older capital stock and a slowing pace of adoption of new production technology.
  • Companies are looking for other ways to boost the bottom line.

The latter could actually create something of a negative feedback loop. Two mechanisms stand out:

  • An emphasis on cost reductions, squeezing wages and employment
  • An emphasis on share buybacks and dividends,

Together, these forces shift income from wage earners to shareholders, that is, from people with a low propensity to save to people with a high propensity to save. This is likely to have important economic consequences. A good example here is Wal-Mart (WMT):

Wal-Mart spent $7.6 billion last year buying back shares of its own stock - a move that papered over its falling profits. Had it used that money on wages instead, it could have given its workers a raise from around $9 an hour to almost $15.
[
]

Wal-Mart employees earn close to the minimum wage (which is so low that a disproportionate amount of their employees are on some form of tax funded additional benefits). In an economy, which is still suffering from a demand deficiency, which group do you think will spend more of that $7.6 billion, Wal-Mart employees if they would get such a pay rise, or the Wal-Mart shareholders getting the benefit of the buyback?

We're not arguing in favor of a rise in the minimum wage here (Wal-Mart could easily handle that, but other smaller companies might struggle); we're merely pointing out that the present institutional makeup of US capitalism might generate some feedback loops which make it stuck on a lower equilibrium growth trajectory than necessary.

That feedback loop would run something like this: many companies don't see much need to expand capacity (despite record profits, cash balances, interest rates) because of tepid demand. Instead of increasing the top line, companies focus on increasing the bottom line, costs are squeezed, wages and employment suffer (median wages have trailed productivity growth for decades), but company profits and shareholders win out.

Since companies and shareholders are spending much less of their income than wage earners (especially low wage earners), the original tepid demand is reinforced, giving companies even less reason to expand production capacity.

In fact this feedback loop could partly explain a phenomenon first described by Larry Summers as 'secular stagnation,' the inability of the US economy to get overheated even in the midst of an asset bubble. At the core, this points to a structural demand deficiency (not just as the result of deleveraging after a credit-infused asset bubble has imploded).

While a decreasing capital intensity of production and a world savings glut are important factors here, the shift in categorical income distribution should not be overlooked, at the minimum, because it's entirely consistent with the facts (stagnant wages, rising profits, tepid business investment, record buybacks, etc.).

And the US economy becomes ever less capital intensive due to the ongoing shift from manufacturing to services, bigger parts of it become like Wal-Mart. Fairly low tech, not growing much (if at all), hugely profitable, but mostly at the expense of squeezing cost and wages, and shifting much of the proceeds to shareholders. And, most importantly, this way is locking the economy in a low growth equilibrium.'

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And, most importantly, this way is locking the economy in a low growth equilibrium.'

Can something slowing down be said to be in equilibrium? If we follow the argument presented the outcome is not equilibrium but self reinforcing decline that leads to collapse in demand.

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Why do I need to invest $100m into research and development into the next Blackberry phone (and get no return on my investment)? when I can buy up key pieces of land and collect the rent, and if that fails it can be sold off and I can get something back.

Edited by 200p

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Seeking Alpha 6/3/14

'Summary

  • Business investment is low, despite record corporate profits, cash balances and low interest rates.
  • Part of this is a sectoral shift from high capital intensive manufacturing to lower capital intensive services.
  • But it is reinforced by a shift in categorical income distribution from wages to profits.
  • This creates a negative feedback loop and threatens to lock the economy into a low growth equilibrium.

Many observers agree that business investment (or, if you like, capital formation), is running very low.

191022-13940508869300327-Shareholders-Unite.jpg

The more important issue is why it is so low. Companies are sitting on record profits and mountains of cash ($1.5 trillion in the US, $7 trillion worldwide), and interest rates are at rock bottom in many places, like the US. Most economists would argue that capital formation is a negative function of interest rates, that is, lower interest rates leads to higher capital formation.

This is simply because the internal hurdle rate for considering investment projects becomes lower so more investment projects become more attractive, and the cost of capital is lower as well. The strength of the relation (the elasticity of investment demand) is probably not very high, but nobody argues lower rates reduces investment.

Until now. With (considerable) amazement we read the rendition of ZeroHedge:

We also identified what in our view was the primary reason for this misallocation, which said simply, is the Fed's monetary policy which forces corporate executives to focus on short-term gratification of shareholders via prompt return of cash instead of reinvestment into the business - a critical requirement to assure top-line stability and growth.

Now, in Austrian economics, "artificially" low interest rates (we'll come back to the issue of whether rates are artificially low or not) leads to over-investment and "misallocation" of capital, that is, investment into projects that would not be profitable under "normal" circumstances.

But for some reason not quite spelled out, over-investment turns out to be in "short-term gratification of shareholders," rather than re-investment into the business. So the Austrian (or at least the ZeroHedge) position seems to be that below "normal" interest rates lead normally to over-investment, but for some reason, this time not to productive over-investment, that is capital formation.

This is only one reason we have so much trouble with Austrian economics; it's so elliptic that anything seems to go, and normal positions (low interest leading to over-investment) can easily be turned into something with diametrically opposite consequences (low interest rates leading to over-investment in share buybacks, but a dearth of capital formation).

And all that without much (if any) of an explanation. The interesting question remains: why is capital formation so low? While ZeroHedge argues that capital formation is low because of monetary policy, UBS (quoted in the same ZeroHedge article) has it the other way around:

If developed economies are to ever wane themselves off their dependency on monetary and fiscal policy stimulus, private sector capital spending must push up a gear or two.

They blame low capex on (non-US specific) policy uncertainty:

In a recent survey of UBS company analysts over half (54%) believed that fiscal, monetary or euro membership uncertainty is delaying investment planning

This is certainly plausible, but at least for the US, low capital formation is anything but a recent phenomenon:

Since 1980, U.S. investment as a percentage of GDP was sliced in half, from nearly 24 percent to 12 percent, leaving the United States 174th in the world. The result was a dearth of real value added products and productivity. [
]

Part of that can be explained by a secular trend in the make-up of the US (and many other advanced) economy. Rising productivity shrinks manufacturing as a percentage of GDP, so the economy becomes less capital intensive over time. But still, with record profits and cash stacks, record low interest rates, and the best companies can think of to do with their bounty is share buybacks?

Feedback loop?

Are there no worthwhile investment projects generating returns above the meager cost of financing? This lack of investment is slowing down the economy in multiple ways:

  • Less new production capacity is created.
  • Old production capacity gets extended life and less new modern capacity gets built, leading to an older capital stock and a slowing pace of adoption of new production technology.
  • Companies are looking for other ways to boost the bottom line.

The latter could actually create something of a negative feedback loop. Two mechanisms stand out:

  • An emphasis on cost reductions, squeezing wages and employment
  • An emphasis on share buybacks and dividends,

Together, these forces shift income from wage earners to shareholders, that is, from people with a low propensity to save to people with a high propensity to save. This is likely to have important economic consequences. A good example here is Wal-Mart (WMT):

Wal-Mart spent $7.6 billion last year buying back shares of its own stock - a move that papered over its falling profits. Had it used that money on wages instead, it could have given its workers a raise from around $9 an hour to almost $15.
[
]

Wal-Mart employees earn close to the minimum wage (which is so low that a disproportionate amount of their employees are on some form of tax funded additional benefits). In an economy, which is still suffering from a demand deficiency, which group do you think will spend more of that $7.6 billion, Wal-Mart employees if they would get such a pay rise, or the Wal-Mart shareholders getting the benefit of the buyback?

We're not arguing in favor of a rise in the minimum wage here (Wal-Mart could easily handle that, but other smaller companies might struggle); we're merely pointing out that the present institutional makeup of US capitalism might generate some feedback loops which make it stuck on a lower equilibrium growth trajectory than necessary.

That feedback loop would run something like this: many companies don't see much need to expand capacity (despite record profits, cash balances, interest rates) because of tepid demand. Instead of increasing the top line, companies focus on increasing the bottom line, costs are squeezed, wages and employment suffer (median wages have trailed productivity growth for decades), but company profits and shareholders win out.

Since companies and shareholders are spending much less of their income than wage earners (especially low wage earners), the original tepid demand is reinforced, giving companies even less reason to expand production capacity.

In fact this feedback loop could partly explain a phenomenon first described by Larry Summers as 'secular stagnation,' the inability of the US economy to get overheated even in the midst of an asset bubble. At the core, this points to a structural demand deficiency (not just as the result of deleveraging after a credit-infused asset bubble has imploded).

While a decreasing capital intensity of production and a world savings glut are important factors here, the shift in categorical income distribution should not be overlooked, at the minimum, because it's entirely consistent with the facts (stagnant wages, rising profits, tepid business investment, record buybacks, etc.).

And the US economy becomes ever less capital intensive due to the ongoing shift from manufacturing to services, bigger parts of it become like Wal-Mart. Fairly low tech, not growing much (if at all), hugely profitable, but mostly at the expense of squeezing cost and wages, and shifting much of the proceeds to shareholders. And, most importantly, this way is locking the economy in a low growth equilibrium.'

Its called choking on your own dogma. right wing crony capitalism, punish the workers ideology dogma. the workers are nothing and deserve nothing, capital is everything therefore capital deserves all, labour nothing. This is what causes the stagnation and decline, ie a 3rd world economy mired in corruption and incompetence but with a US/UK flavour.

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Its called choking on your own dogma. right wing crony capitalism, punish the workers ideology dogma.

Ah, yes. After more than a decade of governments running artificially low interest rates while borrowing money to spend on hiring more government employees to hide the unemployment figures... it's obviously all the fault of EVIL RIGHT WINGERS!

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Its called choking on your own dogma. right wing crony capitalism, punish the workers ideology dogma. the workers are nothing and deserve nothing, capital is everything therefore capital deserves all, labour nothing. This is what causes the stagnation and decline, ie a 3rd world economy mired in corruption and incompetence but with a US/UK flavour.

Yep- a man sitting on tree branch with a buzz saw in his hand who thinks he has that tree just where he wants it.

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Ah, yes. After more than a decade of governments running artificially low interest rates while borrowing money to spend on hiring more government employees to hide the unemployment figures... it's obviously all the fault of EVIL RIGHT WINGERS!

Have you read any of the above?

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Can something slowing down be said to be in equilibrium? If we follow the argument presented the outcome is not equilibrium but self reinforcing decline that leads to collapse in demand.

Not the only logic gap I feel:

Now, in Austrian economics, "artificially" low interest rates (we'll come back to the issue of whether rates are artificially low or not) leads to over-investment and "misallocation" of capital, that is, investment into projects that would not be profitable under "normal" circumstances.

But for some reason not quite spelled out, over-investment turns out to be in "short-term gratification of shareholders," rather than re-investment into the business. So the Austrian (or at least the ZeroHedge) position seems to be that below "normal" interest rates lead normally to over-investment, but for some reason, this time not to productive over-investment, that is capital formation.

So their problem with the Austrian model is that it predicts 'over-investment and "misallocation" of capital' while what's actually happening is over-investment and "misallocation" of capital? :blink:

This is only one reason we have so much trouble with Austrian economics; it's so elliptic that anything seems to go, and normal positions (low interest leading to over-investment) can easily be turned into something with diametrically opposite consequences (low interest rates leading to over-investment in share buybacks, but a dearth of capital formation).

Oh, that's clear then, predicting that over-investment 'into projects that would not be profitable under "normal" circumstances' is 'diametrically opposite' to 'over-investment in share buybacks' and 'a dearth of capital formation'? Clearly share buybacks would be the profitable option under "normal" circumstances then, so no need to worry about the need for any pesky capital formation, it's a wonder they've bothered to write an article about it...

The interesting question remains: why is capital formation so low? While ZeroHedge argues that capital formation is low because of monetary policy, UBS (quoted in the same ZeroHedge article) has it the other way around:
If developed economies are to ever wane themselves off their dependency on monetary and fiscal policy stimulus, private sector capital spending must push up a gear or two.

They blame low capex on (non-US specific) policy uncertainty:

In a recent survey of UBS company analysts over half (54%) believed that fiscal, monetary or euro membership uncertainty is delaying investment planning

This is certainly plausible, but at least for the US, low capital formation is anything but a recent phenomenon:

Since 1980, U.S. investment as a percentage of GDP was sliced in half, from nearly 24 percent to 12 percent
, leaving the United States 174th in the world. The result was a dearth of real value added products and productivity. [
http://www.moneynews.com/Elias/Reagonomics-Clintonomics-us-economy/2012/04/06/id/435026' rel="external nofollow">
]

Part of that can be explained by a secular trend in the make-up of the US (and many other advanced) economy. Rising productivity shrinks manufacturing as a percentage of GDP, so the economy becomes less capital intensive over time. But still, with record profits and cash stacks, record low interest rates, and the best companies can think of to do with their bounty is share buybacks?

Ah, so capital formation and interest rates have both been declining since the early 80s, but any relationship between the two must logically be dismissed out of hand!

interest-rates-1950s.png

dry.gif

Edited by Lo-fi

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One of the strangest rationales offered by the bankers for the financial collapse is that money was' too cheap' or too plentiful- the legendary 'savings glut'. And so they were compelled-it seems- to inflate a property bubble with that money.

No one seems to have asked them why they did not instead take that readily available funding and direct it toward actual productive economic activity and innovation.

In theory they could have given us a golden age of new company formation and investment in new technologies and business's- but that would have taken both time and a level of engagement that the banks did not want- so they chose instead to create their own pseudo innovation and pseudo productivity in the form of 'financial engineering' and 'financial innovation'- both euphemisms for painting new lipstick on the same old pig of debt.

Of course the destruction of demand brought about by the erosion of workers wages had it's part to play here- lacking strong demand in the real economy investment in the real world was hard work compared to playing in the financial theme park created by the bankers for themselves and their clients.

Where it gets really offensive however is when their private empire of debt went down it was other people who were expected to foot the bill.

Edited by wonderpup

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One of the strangest rationales offered by the bankers for the financial collapse is that money was' too cheap' or too plentiful- the legendary 'savings glut'. And so they were compelled-it seems- to inflate a property bubble with that money.

No one seems to have asked them why they did not instead take that readily available funding and direct it toward actual productive economic activity and innovation.

In theory they could have given us a golden age of new company formation and investment in new technologies and business's- but that would have taken both time and a level of engagement that the banks did not want- so they chose instead to create their own pseudo innovation and pseudo productivity in the form of 'financial engineering' and 'financial innovation'- both euphemisms for painting new lipstick on the same old pig of debt.

Of course the destruction of demand brought about by the erosion of workers wages had it's part to play here- lacking strong demand in the real economy investment in the real world was hard work compared to playing in the financial theme park created by the bankers for themselves and their clients.

Where it gets really offensive however is when their private empire of debt went down it was other people who were expected to foot the bill.

Bankers have a very short timescale to make money. 18 months is too long for most of them. Years to see returns from business investment is a no no. They are very short sighted self serving blood suckers who have no reason to look beyond the short term.

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One of the strangest rationales offered by the bankers for the financial collapse is that money was' too cheap' or too plentiful- the legendary 'savings glut'. And so they were compelled-it seems- to inflate a property bubble with that money.

No one seems to have asked them why they did not instead take that readily available funding and direct it toward actual productive economic activity and innovation.

In theory they could have given us a golden age of new company formation and investment in new technologies and business's- but that would have taken both time and a level of engagement that the banks did not want- so they chose instead to create their own pseudo innovation and pseudo productivity in the form of 'financial engineering' and 'financial innovation'- both euphemisms for painting new lipstick on the same old pig of debt.

Of course the destruction of demand brought about by the erosion of workers wages had it's part to play here- lacking strong demand in the real economy investment in the real world was hard work compared to playing in the financial theme park created by the bankers for themselves and their clients.

Where it gets really offensive however is when their private empire of debt went down it was other people who were expected to foot the bill.

I think you've answered your own question.

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Bankers have a very short timescale to make money. 18 months is too long for most of them. Years to see returns from business investment is a no no. They are very short sighted self serving blood suckers who have no reason to look beyond the short term.

Their preferred model and timescale was exposed in the bubble - issue debt, over and sabove any acceptable level, but as high as possible to pump up frictional and commission grabs, sell debt via mbs, cdo, any other tla they could get away with. Never mind 18 years they held this shit for so little time they couldn't even be bothered to fill in the paperwork properly. When that failed the central banks came in to buy up the effluent directly form this ring of fraud - fraud against the population and the productive economy. That is why they still collect their bonuses, and still plague the airwaves and highstreets.

Also - excess savings - as mentioned, total rot excuse from the central banks for their policy of overt manipulation and creation of the malinvestment conditions so loved by the banking system.

Edited by onlyme2

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Together, these forces shift income from wage earners to shareholders, that is, from people with a low propensity to save to people with a high propensity to save. This is likely to have important economic consequences. A good example here is Wal-Mart (WMT):

Wal-Mart spent $7.6 billion last year buying back shares of its own stock - a move that papered over its falling profits. Had it used that money on wages instead, it could have given its workers a raise from around $9 an hour to almost $15. [Robert Reich]

Wal-Mart employees earn close to the minimum wage (which is so low that a disproportionate amount of their employees are on some form of tax funded additional benefits). In an economy, which is still suffering from a demand deficiency, which group do you think will spend more of that $7.6 billion, Wal-Mart employees if they would get such a pay rise, or the Wal-Mart shareholders getting the benefit of the buyback?

I'm saving for a reason. It's not been easy to save. To slowly put aside a little more than income to hope for future opportunies to advance oneself with savings.

Idiots with a low propensity to save, and a much larger appetite to borrow and spend, have bid up house prices so high for years and years.

I don't know where to begin with this argument in the article set out above.

This crisis hasn't been caused by an excess of savings.

Yet here we are, with many wanting some companies to pay people more than they're worth. An implication being they're responsible for a system which requires benefit top ups. That savers/investors and pension funds for those who've put capital aside/invested, should take more punishment. That seething envy that all savers somehow rich and in big houses with no money worries.

The justification from wage-inflation callers, being that eventually the companies will earn more after paying inflated above market rate wages on a widespread level.

Demand deficiency because asset values have been supported, kept so high, zombies not allowed to die and be broken up, and massive global debt. Also inability to accept life isn't fair.. wanting everyone to be paid good money, no matter their education and ability, THEIR LIFE CHOICES to spending vs saving. To finding-learning-seizing opportunities for income advancement.

Although I'll accept many reckless participants have been and continued to be paid too much - zombies - after decades of reckless debt binge and over-expansion. I don't want millions more people paid more than they're worth to outbid me for stuff, pay more for housing, or pay landlords higher rents, when prices so high already. It's not wages that are the problem, it's other costs in the economy + asset values too high, and not allowing (painful) correction to bring in new opportunity at lower prices.

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Bankers have a very short timescale to make money. 18 months is too long for most of them. Years to see returns from business investment is a no no. They are very short sighted self serving blood suckers who have no reason to look beyond the short term.

To some extent, yes, but the real problem is that parasitical rent collection is more profitable, and has been sold to the public as productive investment.

Most people, most politicians, most bankers even, think that hoarding land just happens to be the best business opportunity at the moment, and cannot even imagine that this might cause problems.

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