The Daily Reckoning PRESENTS: Far from creating wealth,
says economic gadfly Kurt Richebächer, the cult of
"shareholder equity" has ravaged corporate balance sheets
and is, in fact, impeding the recovery.
CORPORATE SELF-MUTILATION
By Dr. Kurt Richebächer
To create wealth through rising asset prices is the one
great fallacy and folly in America's shareholder value
model. To create business profits through mergers and
acquisitions and cost-cutting is the other big fallacy and
folly that has done great and lasting damage to the
economy. The reality is that Corporate America's profit
performance has persistently gone from bad to worse since
the early 1980s.
The thing to see is that this has happened not despite
these new strategies, but because of them. Narrow-minded
microeconomics, focusing exclusively on shareholder value,
clashed with the compelling, opposite laws of
macroeconomics. What looked like new, highly sophisticated
microeconomics was, from the macro perspective, utter
economic nonsense.
By manipulating share prices upward through grossly
overpaid mergers and acquisitions, managers satisfied their
shareholders and themselves. That is, of course, the
aspired, supreme goal of America's new equity culture.
But unfortunately, the spectacular and highly desired
positive effect on market valuations implies a whole
variety of macroeconomic effects - on profits, business
fixed investment, debt levels, balance sheets, interest
expenses, corporate net worth, the current-account deficit
- that, on balance, overwhelmingly harm the economy. It is
virtual corporate self-mutilation.
Trying to assess the past, present and future, we have
traced and explored the development of these harmful
effects in detail back to the 1980s. As to the most recent
developments, we have to say that across the board, these
features and signs lack any meaningful improvement,
suggesting to us that the U.S. economy is close to a
relapse into recession.
America's economy is by long tradition a high-consumption
economy, with low rates of saving and investment. Remedying
this structural deficiency was the declared primary aim of
the much-heralded supply-side Reaganomics. In hindsight, it
is evident that this experiment grossly failed on all
accounts. Rather, national savings and net capital investment
plunged to unprecedented new lows. Profits and net
investment, two other key measurements, were virtually flat
over the whole period, implying for both a steep fall as a
share of GDP.
As promised, the economy was effectively restructured, but
exactly opposite to the declared intention. In 1989,
personal consumption accounted for 65.5% of GDP, as against
62% in 1979. At the same time, the share of gross fixed
investment in the nonfinancial sector shrank from 12.9% to
11.1% of GDP. National saving temporarily fell to 2% of
GDP, compared with an average of almost 8% in the 1970s.
The current account of the balance of payments exploded
between 1981-87 from a small surplus into a deficit equal
to 3.5% of GDP.
What propelled the economy's growth during these years was
definitely not booming corporate investment on the
economy's supply side, but soaring credit and debt growth
on the part of consumers and the federal government,
driving the economy's recovery from the demand side.
Corporations, too, stepped up their new borrowing. For the
first time, though, it was not for new investment, but
mostly for mergers, acquisitions, stock repurchases and
leveraged buyouts. As corporate debt soared while new
investment lingered, the corporate sector's net worth
suffered a steep decline. It was the obvious beginning of
America's casino capitalism, in which corporations are
supposed to make money without any regard to the real
economy. Measured by the GDP aggregate, economic growth
appeared quite stellar, yet its pattern and structure was
grossly imbalanced. After a brief, sharp spurt, business
fixed investment faltered again. Business profits went
nowhere, while the economy's current account skyrocketed
temporarily into a huge deficit.
Assessing an economy's development, we focus, first of all,
on two aggregates: trends in net investment and profits of
the nonfinancial sector. During the 1980s, both went
nowhere in the United States. Measured as a percentage of
GDP, they ended the decade at record lows.
Far from improving the economy's supply side, Reaganomics
drastically ravaged it.
We come to the 1990s. Actually, they divide into two
strikingly different parts. For the consensus, the years
until 1996 are the bad part with sub-par economic growth,
while the following years became the great, new paradigm
years.
Healthy economic growth, as we have stressed many times,
shows primarily in high rates of capital formation and
profit growth. Both always go together. By these two
measures, the U.S. economy performed best in the first half
of the 1990s and miserably in the 1980s and the late 1990s.
Actually, profits and net capital formation had their most
excellent performance in more than two decades in the first
half of the 1990s. After their protracted, poor growth in the
1980s, both suddenly took off in steep upward curves.
Before-tax profits of the nonresidential and nonfinancial
sector soared from their recession-low of $226.5 billion in
1991 straight towards $504.5 billion in 1997, more than
doubling within six years. Even more impressive was an
unprecedented steep rise in nonresidential net investment
from barely $100 billion in 1991-92 to $407.3 billion in
1997, virtually quadrupling. It was a typical investment-
led cyclical recovery.
Now compare what happened to these two crucial aggregates
in the following three new-paradigm boom years from 1997 to
2000. Profits abruptly slumped from $504.5 billion to $423.
Nonresidential net investment continued to grow from $299.7
billion in 1997 to $407.3 billion in 2000, but it did so at
a sharply slower pace than in the seven years before.
We have reviewed this recovery of the U.S. economy in the
early 1990s in the hope of finding some clues for the
present situation. We did, but these clues are
overwhelmingly on the negative side. Considering profit
prospects as the single most important condition for a
sustained economic recovery, we have focused in particular
on the specific causes behind the sharp profit recovery in
the early 1990s and found that all of them are presently
missing.
Sincerely,
Kurt Richebächer,
for The Daily Reckoning