Theater of the Absurd

Central bankers are the key actors in our current economic theater of the absurd. It would be impossible for me to take them seriously if not for their nearly unlimited power. Watching these people operate in the financial markets is sort of like watching a ten year old drive a Ferrari. There is just a little too much horsepower under the hood given the limited abilities of the driver.

Finally, Mario Draghi appears to be able to deliver on his “whatever it takes” promise and we will see the Eurozone commence with a 60 billion euro per month money printing and financial asset buying orgy.

This is having the typical inflationary impact on financial asset prices that we have come to expect from the out of control world of central bankers.

In the Eurozone alone yields on more than 1.4 trillion of assets have now gone negative as prices are bid up in front of the coming central bank buying:

 

Worldwide, Bloomberg reports that more than $4 trillion of sovereign bonds carry a negative yield.

The implications of this are fascinating. For example, quite soon we should expect gold to become the world’s highest yielding asset as a result of this latest central bank foolishness, and I am sure that this move to ultra low and negative bond yields is putting the recent bid under the price of the yellow metal.  Central banks are powerful, but they can’t control everything and I am sure that gold’s recent lift in price has annoyed them somewhat.

The new European QE is going to see central banks trading away currency that yields zero in order to buy assets with a negative yield. Just brilliant!

No private investor would enter a carry-trade like that, but it is just another day at the office in the world of central banking.

The absurd implications of negative sovereign yields are also quite incredible:

Governments can deleverage by increasing the amount of debt they now issue. Issue enough debt with a negative yield and at maturity you can be debt free, or even generate some equity.

Taxes are not required in a land where investors are keen to finance the government with negative yields.  Just imagine the social implications of this once the voters figure it out.

Heck, if money printing can create wealth and if sovereign bonds really are worth more in real terms because of the printing press, then not only can taxes be easily dispensed with, but so can all work. 

Adding to all of the absurdity of negative yields is the fact that it is occurring precisely because of central bank induced inflation. In a bizarre “Emperor’s New Clothes” sort of way, Draghi can’t see the obvious inflation that he is creating, and the crowd of investors, for the moment, is going along with it.

Draghi at his recent press conference when asked if money printing will lead to inflation:

 I think the best way to answer this is, have we seen lots of inflation since the QE program started? Have we seen that? And now it's quite a few years (since) we started. You know, our experience since we have these press conferences goes back to a little more than three years. In these three years we've lowered interest rates, I don't know how many times, four or five, six times maybe. And each time someone was saying, ‘this is going to be terribly expansionary. There will be inflation.’ Some people voted against lowering interest rates way back at the end of November 2013. We did OMT. We did the LTROs. We did TLTROs. And somehow this runaway inflation hasn't come yet. So what I'm saying is that certainly the jury is still out. But (there) must be a statute of limitations also for the people who say there will be inflation. Yes, when please? Tell me within what?”

Clearly, in Draghi’s mind the increase in prices, and yield declines, in the sovereign bond market that he has induced (with the aid of other central banks, of course) doesn’t represent inflation. I beg to differ as this sure looks like price inflation to me:

Greece Ten Tear Bond Yields

Italy Ten Year Bond Yields

Portugal Ten Year Bond Yields

Source: Trading Economics

Negative sovereign bond yields in major countries and a collapse in the yields of the bonds of less fiscally sound countries like Greece, Italy and Portugal are symptoms of monetary inflation and they serve to distort the structure of the economy and create malinvestment as do all prices that are artificially manufactured.

The financial world has entered the realm of the surreal, and it would be fascinating to watch if its consequences weren’t quite so dire. 

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

Oil

The most important thing is this (oil price collapse) is a massive tax cut for the world. This is really good stuff for the world.

Larry Fink

CEO Blackrock

December 11, 2014

Lower oil prices are like a tax cut to the economy, so in terms of macroeconomic impact, it’s a positive.

Jacob Lew

U.S. Treasury Secretary

December 11, 2014

Despite the impressive recent gains in natural gas and crude oil production, the U.S. is still a net importer of energy. As a result, falling energy prices are beneficial for our economy.

Over the near term, this will lead to a significant rise in real income growth for households and should be a strong spur to consumer spending. Since energy expenditures represent a higher proportion of outlays for lower income households, falling energy prices disproportionately raise their real incomes. Also, because such households are more liquidity constrained, with budgets that often bind paycheck to paycheck, they have a higher tendency to spend any additional real income.

As a result, much of the boost to real household income from falling energy prices is likely to be spent, not saved.

Bill Dudley

President New York Federal Reserve Bank

December 1, 2014

Here we have the head of the world’s largest asset manager, the CFO of the U.S. government and the globe’s chief money printer and regulator of the world’s most important banks all telling us that crashing oil prices are a good thing. Consumption will go up and savings will fall as a result of lower oil prices and these are, allegedly, good things.

Personally, I have never seen an issue that more starkly contrasts the Keynesian view of the world, as referenced above, with that of the Austrians.   

Keynesians focus on GDP, aggregate demand and animal spirits. Austrians focus on savings and capital creation, the entrepreneur’s focus on wealth creation and the avoidance of the malinvestment that comes from money and credit creation from thin air.

Keynesians want to boost consumption and penalize savings following a bust by artificially pushing interest rates lower. Austrians want to point to rates being too low during the bubble phase as being the cause of the subsequent crash and economic hangover and they argue that lower rates for longer will only create bigger problems in the future.

Oil’s collapse gives us a perfect perch from which to compare these contrasting economic views.

As we saw above, the typical Keynesian view is that the oil price collapse should increase consumer demand and decrease savings. These are thought to be good things.

Austrians view the oil price collapse with horror. Savings (real capital) was wasted on a truly epic scale as malinvestment ran amok throughout one the world’s biggest and most important industries. This is an industry that has seen annual upstream capital expenditures increase by about 75% to nearly $700 billion in the past five years. Pretty much all of that spending appears to have been wasted.

How could this happen?

Keynesians, it seems, don’t really care about the cause of all of this wasted capital. In the U.S. and Europe the only concern seems to be with whether or not the oil price collapse will lead to increased consumption and decreased savings. Both of these effects are cheered on by the Keynesians.

Austrians point to artificially low interest rates as having impacted the structure of production and consumption. Artificially low rates appear to have been a prime mover in China’s titanic infrastructure build-out of the past five years. This created a nearly insatiable demand for energy on the part of China, the major incremental driver of nearly everything on the planet for much of the recent past. This demand drove oil prices relentlessly higher over the past few years.

Alas, the Chinese real estate miracle appears to have crested and, with real estate prices starting to fall, the infrastructure build-out has stalled. Energy demand is, therefore, falling relative to previous expectations.

Oil production, especially in the U.S., boomed with the rise in capital spending that came from artificially low interest rates and strong, but artificial, oil demand. Despite the overall fall in savings in the U.S. over the past decade, whatever remained of the pool of savings was made available for oil production. In fact, oil production in the U.S. is up about 80% from its low point and the high yield market has come to be dominated by borrowers from the oil patch.

To the Austrians, looking back at the oil boom, it was lots of money and credit from thin air that drove the malinvestment that is now being revealed. They question whether pushing the savings rate lower from the current miniscule levels, a move that the Keynesians cheer, will allow for adequate capital spending in the future to drive any wealth creation in the U.S. They also worry about why anyone would ever want to create and deploy capital (savings) any longer if it always seems to be wasted. Malinvestment is simply a reduction in the already paltry rate of interest that is currently being paid on savings and it does not bode well for future capital creation or future real GDP growth.

Until recently, everyone thought that increased U.S. oil production would lead to American energy independence and that this was a good thing. Now, it seems like the Keynesians are telling us that wasting a few trillion dollars in the oil patch while blowing up the junk bond market was also a good thing. Who knew?

I’ll stick with the Austrian line: The crash in oil prices is exposing malinvestment that was driven by central bank fostered easy money policies which destroyed wealth, deters future savings and wealth creation and, as a result, destroys future growth opportunities.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

Gold

My previous post was on the inevitable failure of fiat currencies. It seems then as if this might be an appropriate moment to spend some time on the subject of gold.

Rarely has there ever been an asset class as hated as the yellow metal. Economists (outside of the Austrians) despise it. After all, its use as money would certainly eliminate any need for us to have them opine on the proper level of interest rates and how much money and credit should be whipped up from thin air. Gold as money would remove economists from the biggest part of the public policy debate, and this is unimaginable in their eyes. How would the free market ever decide on the proper level of interest rates? Chaos would surely ensue without their learned input.

While there are many essays out there dismissing gold as an investment and its use as money, I want to focus on one particular issue that Keynesians have been harping on for years. It seems that many economists do not like it that gold is expensive to mine and expensive to store. Surely this is waste of society’s capital:

Most of all, the barrenness of this proposal (i.e., to use gold) makes it most repugnant to those who think that the international need for liquidity can be put to better use than the financing digging gold from the entrails of the earth and reburying it in the vaults of Fort Knox and other gold graves.

Robert Triffin (1957)

Recently, Citibank economist Willem Buiter made the same argument against gold:

Gold is unlike any other commodity. It is costly to extract from the earth and to refine to a reasonable degree of purity. It is costly to store….The cost and waste involved in getting it out of the ground only to put it back back under ground in secure vaults is considerable.

The argument, as you can see, hasn’t changed much over the past six decades. It even makes a certain amount of intuitive sense.  Unfortunately, for the Keynesians, the argument fails when examined in just a little more detail.

I am not going to claim that gold isn’t costly to mine. At $1200/oz., the value of the gold mined each year is equivalent to about $110 billion, and that isn’t chump change. Better to use unbacked fiat money, which costs nothing to produce, according to most economists.

Well, from the Austrian standpoint, it costs society quite a bit to use unbacked fiat money. ABCT presumes that money and credit creation from thin air creates malinvestment. While the cost is somewhat difficult to calculate precisely, it is easily in the multiple trillions of dollars per year. How much malinvestment was revealed as technology shares crashed in 2000-2001? How much malinvestment came to light in the real estate debacle of 2008? How much malinvestment is now being revealed as emerging market carry trades unwind, Chinese (and London) real estate slumps and as oil prices plunge. Trillions upon trillions of dollars have been wasted. Gold’s burden is fairly light then relative to the costs we are piling up elsewhere due to the use of unbacked fiat money.

Unbacked fiat money also has another problem: It violates the principle that all transactions require a like-for-like exchange. All parties need to believe that they are made better off in a transaction. If you produce apples and I produce oranges, we may both be better off if we exchange some of our output. This betterment principle is violated when money and credit is created from thin air. Someone gets something for nothing. The original parties will undertake the transaction, but only because they believe that they can pass on the burden to someone else before the theft has been revealed. Some Austrians have compared the effects of inflation (the creation of money and credit from thin air) to a train since some cars arrive in the station before others. Often, fixed income investors and pensioners are at the back of the train and bear the bulk of the costs associated with the inflation brought on by the use of unbacked fiat money. Unbacked fiat money violates this like-for-like principle while gold does not.

Unbacked fiat money is nothing but theft. It sets in motion malinvestment and it violates the like-for-like principle. It carries huge, but hidden, costs and it has always, eventually, failed and been rejected by the public. I doubt this time will be any different. Mr. Buiter referred to gold as a 6000 year bubble, and perhaps this true. I am certain, however, that no unbacked fiat currency will ever establish such a record. Yes, gold may not return as money, but something will replace unbacked fiat. Nevertheless, I believe that finding something better than gold as money will be most difficult.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

Why Fiat Money and Central Banking Will (Eventually) Fail

With regard to the potential success or failure of any economic, political or social institution one must ask two essential questions:

Does Natural Law exist?

If it does, then: Does the economic, political or social institution violate this law?

Central banking, fiat money and money and credit creation from thin air must be discussed in light of these questions.

ABCT is pretty clear about how and why the creation of money and credit from thin air, a central bank’s ultimate purpose, is likely to result in malinvestment or a system that generates failure. This is reason enough to question the existence of central banking.

But why is it that the tools of central banking, fiat money and money and credit creation from thin air, are doomed to create a system that fails?

The reason is simple; they violate natural law, the nature of man.

Let’s start with a premise: The creation of money and credit from thin air is theft.

When a central bank creates money from thin air they are stealing from all of the other holders of that currency. The existing holders of the currency will now have to compete with the holders of the newly created currency. Their currency now buys less.

Premise number two: Theft is a clear violation of natural law.

Premise number three: Political, social and economic institutions that are built on a foundation that violates natural law are doomed to failure as man will attempt to minimize the pain and loss that he experiences from the violation of his nature and the objective reality of the world.

Conclusion: Current central banking practices based on fiat currency and the unlimited creation of money and credit from thin air will, eventually, fail.

That is a pretty simple argument. Not surprisingly, C.S. Lewis devised a simple thought experiment that can help us understand why this should be.

This is an experiment where four objects need to be separated into two boxes. If I give you a baseball, a basketball, a baseball bat and a basketball net and asked you to put two items into two separate boxes based on things that those objects have in common, how would you proceed?

Some would put the baseball and basketball together in one box and the net and the bat in the other box. The things that are balls would be together and the things that are not balls would also be together.

Another approach would be one based on functionality. The baseball and bat would then go together and the net and the basketball would be in the other box.

Lewis used this model to examine the following items: Science, Natural Law, technology and magic.

Most people would place science and technology together and Natural Law and magic together. Science and technology are items that can be verified via empirical evidence while Natural Law and magic have more difficulty on that front.

Lewis offers a different way to categorize the items: He places science and Natural Law together and technology and magic together. Both science and Natural Law attempt to conform our minds to objective truths and realities of the world. Science teaches us about the physical aspects of nature that we need to respect and understand while natural law attempts to teach us about the nature of man, which also must be respected.

On the other hand, technology and magic have more in common than you might think as they both attempt to get the world to conform to the will of man. Of course, technology that is grounded in the physical sciences will work while magic will not.

Everyone understands that the violation of physical laws can end in disaster, imagine an engineer designing an airplane while neglecting the law of gravity or the tensile strength of the materials involved. These errors will be discovered promptly upon a test flight.

Likewise, political, economic and social institutions that do not conform to the nature of man will also fail because they do not conform to the objective realities and truths of the world. The difference is that it is difficult to estimate how long this will take and the exact form of the failure. In the physical world of aeronautics, if a wing does not create enough lift, the craft will never fly. Social dynamics, unfortunately, are a bit messier and those that violate Natural Law may take some time to be revealed, but there will be a revelation.

For example, until this moment in time, all fiat currencies that have ever been attempted have failed. Somehow, we expect the results to be different this time. They won’t be.

The 20^th Century saw a couple of massive efforts aimed at subsuming Natural Law to the will of a few men. One was the horrific Nietzchean experiment of Nazi Germany with their cult of the Superman. A world where might made right. Another saw Stalin and Mao attempt to build societies based on Marxist theory.

Not only did they all fail, they all failed despite the horrible violence that they were willing to inflict on those that did not toe the party line. Rome wasn’t any different.

There just isn’t any way, in the long run, to get man to go along with a political or economic system that violates his nature. I am willing to bet that our recent multi-decade experiment with fiat currencies and central banking will also end in failure as it violates Natural Law. Timing, of course, is the issue. The outcome is not in doubt, however.

ABCT tells us that if central banks artificially drive interest rates too low via the creation of money and credit from thin air, then the savings rate will fall and malinvestment will be created.

Empirically, this has all been happening now for decades.

 Given that I have defined money and credit creation from thin air as theft, we should assume that man would respond to this theft of his wealth in some rational way. He, of course, reduces his savings and the amount that may be stolen from him.

Reduced savings and increased malinvestment should also reduce the real growth rate over time.

It is no surprise then to the Austrian oriented investor that these are all happening in the economy of our time as a reaction to central bank orchestrated theft. What is surprising is that investors have chosen to ignore this, repeatedly, and pay absurdly high prices to participate in this deteriorating economic scenario.

Just as in 2000 and 2008, I expect this current foolishness to eventually reverse itself. As I watch stock and certain bond categories trade at extremely high valuations relative to what our society is willing to produce and save due to central bank money and credit creation from thin air, I am forced to constantly ask myself: Does natural law exist?

My answer is always, yes.

I know then that the outcome for fiat currency and central banking is not a healthy one.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

A Matter of Perspective

This is a quick update on my recent post on corporate accounting and EPS.

The FT ran a rather bullish story the other day proclaiming that corporate America is spending again, a sign of returning confidence they told us.

Their ebullience seems to have been triggered by the fact that, according to a survey by the Association for Financial Professionals, corporations’ cash balances have been falling. The FT assures us that this is an important turning point in our recovery from the Great Recession.  Accordingly, this is a clear sign that animal spirits are returning to the US economy.

If only it were true. The FT starts the story this way:

US corporations are starting to run down their cash for the first time since the recession- a sign of returning confidence- but they remain reluctant to invest in new equipment.

Let me give you my translation of this line:

US corporations are confident in their ability to boost earnings per share so long as they DON’T invest in their businesses by purchasing new equipment.

The story does note that buybacks and acquisitions are what the cash is being used for, but it neglects one small detail that may be important: Cash is going down despite the fact that businesses, in the US anyway, are borrowing money at a faster rate.

According to the Fed’s Z.1 report:

Annual Business Borrowing

($ billions)

Year             Amount

2011               295

2012               532

2013               516

2014*             700

*  Annualized YTD numbers

Here is what we know, annualized borrowings have jumped nearly 40% this year, companies refuse to reinvest to grow their businesses and corporate profits have flattened out:

After Tax Corporate Profits with Inventory Valuation and Capital Consumption Adjustments

(SAAR, $ Billions)

Period             Amount

Q2 2012           1551

Q3 2012           1600

Q4 2012           1594

Q1 2013           1565

Q2 2013           1644

Q3 2013           1673

Q4 2013           1648

Q1 2014           1380

Q2 2014           1498

Source: Economagic, BEA

BEA defined profits differ from what we see in GAAP accounting. The BEA only wants to show the economic impacts from production in a current period. As such, it eliminates inventory profits and losses, adjusts depreciation expense to reflect current, real, depreciation and it strips out capital gains and losses and things like changes in expenses for bad debt.

As we can see from the above table, real economic profit growth is becoming tough to come by as profits have now fallen for three straight quarters.

So, where does this leave the corporate executive? He can no longer seem to grow his business top line. Over the past year, half of the companies listed in the Dow have seen negative real sales growth. Additionally, the Fed’s abusive interest rate policy has crushed any incentive to reinvest since incremental returns on capital must equal incremental costs. These are now set at zero, thanks to the Fed. Growth at the bottom line seems to have peaked, as well.

This leaves the corporate executive who wants to show EPS growth with share buybacks and acquisitions. Corporate capital allocators have been pushed into the equity markets, just like all other investors, as it appears to be the only place where a return in excess of punitively low interest rates can be generated. As stock prices rise, however, it is costing companies more to reduce their share count by a similar amount. This is what explains the need for more borrowing and lower cash balances. In fact, companies are buying shares at dramatically higher prices today than two years ago despite the fact that economic profits have fallen over this time.

As Austrian Business Cycle Theory teaches, central bank interest rate policies can act in a way that fools most capital allocators by sending signals that push these capital allocators to do the wrong thing at the wrong time. This is true of corporate executives today, in my opinion.  

The FT wants to proclaim that the decline in corporate cash balances is a sign of strength for businesses. I see it very differently. My view is that the corporate world is trapped, and their only option at the moment is to buy overvalued shares in businesses that cannot grow any longer. This will end badly.

I will point out that BEA after tax profits peaked well in advance of the peaking of share prices in 2000 and 2007. Those were also periods of time, not coincidentally, that saw a less accommodative Fed.  Will declining economic profits and a less profligate Fed combine, once again, to crush investors?

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

On Corporate Accounting and EPS

There is an old joke about accountants and CFOs:

A company’s chief executive needs to hire a new CFO. He has the field narrowed down to two candidates and he decides to call them in separately for one last interview. The interview will consist of only one question.

The CEO calls in the first candidate and asks, “How much is 2+2.”

The first CFO candidate answers, “Four.”

The CEO thanks him and lets him know that he will be in touch.

The second candidate is then ushered in for his interview and the CEO asks him the same question, “How much is 2+2.”

The second CFO candidate gets up out of his chair, closes the door to the office, looks at the CEO and says in a hushed tone, “How much do you want it to be?”

I tell this story only as a way to emphasize that companies often have a wide degree of latitude when it comes to reporting earnings. What’s more, that latitude generally grows during a bubble.

For example, back in the late 1990s, the technology companies found a way to completely change the way that they paid their employees and expensed their research and development costs.

Technology companies, up until that time, had always expensed their R&D upfront, as it occurred. This was a very conservative stance.

As the bubble in technology shares grew, things began to change. In order for companies like Cisco and Microsoft to be able to retain their employees, they had to start to pay them more in the form of stock options because everyone knew, at that time, that technology shares only went up.

The only problem with this was that GAAP accounting did not require companies during this period to expense the value of the options granted and run that expense through the income statement. The quality of technology company earnings was, therefore, starting to collapse.

The trend got even more egregious as the most talented coders and developers would walk out the door one day with their best ideas, form a company and turn around and auction it off to their former employer or one of its competitors for billions of dollars. R&D, which at one time had been expensed upfront, was now outsourced at no cost to the company, at least with regard to its income statement. Cisco was issuing so many options to employees and new shares to start-up companies without products or revenues in the form of takeovers that CSCO was soon issuing $25 billion per year in equity securities that would never be expensed.

It was a debacle, and shareholders never cared about the horrific quality of the reported earnings as long as the shares were going up. For anyone that cared to look, however, it was very clear that the economics of the businesses did not justify the share prices.

There is a similar deterioration in the quality of corporate earnings today only it is far more widespread than what we saw during the technology bubble of the late 1990s.

Today, the item that is now significantly starting to crush the quality of corporate earnings is the enormous move to buy back company shares.

The intellectual problem that I have with current accounting standards is that buying back stock is thought of entirely differently than is any other corporate expenditure item.

If Caterpillar spends $100,000 to build a hydraulic excavator and sells it for $150,000, all is well and the resultant income and expenses are run through the income statement and investors can track management’s ability to operate the business.

The same thing is true if they spend $100,000 to build the excavator and sell it for only $90,000. Investors can see the resulting loss in the income statement and judge management accordingly.

None of this is true regarding share buybacks, and this is no small matter. Share buybacks are the new business of America. I have argued before that this tells us much about management’s views of their ability to profitably deploy capital in their main business in the future. They are not positive.

It is, however, boosting earnings per share meaningfully today as companies can borrow at next to no cost, thanks to the Fed’s massive intervention in the securities markets, and buy back shares, thereby reducing the denominator in the earnings per share calculation.

For those of us that believe that share prices, broadly speaking, are near the apex of an incredible bubble, then all of this buying back of company shares represents an incredible waste of capital, though none of it will ever be expensed according to GAAP standards. It does, however, give the appearance of boosting earnings per share today, which is all that seems to matter to investors.

Yesterday, Caterpillar Inc. reported earnings that appeared to be great. The earnings report was seen as so good that CAT shares were up more than $4 and the report was seen as a key reason for the more than 200 point jump in the Dow.

Let’s take a look at these stellar earnings.

Revenue from machinery sales was up just 0.6% Y/Y.

Operating profits were actually down $9 million Y/Y.

Earnings per fully diluted shares outstanding did manage to jump to $1.63 from $1.45 in the year earlier, however.

This prompted noted CNBC commentator Jim Cramer to exclaim, “If Caterpillar can do this kind of number when things are bad, what number can it print when things are good?"

So, how did CAT boost EPS with such poor top and operating line performance?

The answer, of course, was to stop investing in the business, borrow lots of money and buy back shares.

Capital spending is down $800 million YTD vs. last year. Despite borrowing an additional $1.4 billion YTD, interest expense was actually slightly lower in the quarter and the company has bought back a whopping $4.2 billion in stock so far this year, taking the diluted share count down nearly 30 million shares.

As a point of reference, share buybacks this year are running at 178% of capital expenditures compared to just 63% last year. No one believes that we shouldn’t expense capex over time, so why shouldn’t we run gains or losses on share buybacks through the income statement so that investors can get a better sense of management’s ability to deploy capital? After all, we are no longer talking about paltry sums here and we need to account for this activity in a better way.

Now, let’s get back to Jim Cramer. He wants to believe that CAT’s earnings numbers will be spectacular when things improve in the economy.

Given the fact that the savings and investment rate in the U.S. has crashed due to the Fed’s policy of artificially driving interest rates towards zero, just how does Mr. Cramer expect the economy to improve?

Companies are clearly saying that they can no longer earn a return on the capital deployed in running their businesses, so they are clearly deciding to give up and they are returning the capital to shareholders. Corporate America doesn’t believe that things will improve in the economy, not enough to justify increased investment at the expense of reducing share buybacks anyway.

Is it a good idea for companies to return capital through share buybacks?  

That, of course depends on whether the shares are cheap or expensive. Sadly, as John Hussman reminds us with the following graph, companies are generally extremely poor market timers. As for me, I am taking 50 cents out of a company’s earnings report for every dollar of stock that they buyback given my view that the market is extremely overvalued. If you believe that stocks are cheap, then you should add a few cents to net income for every dollar of stock they buyback.

Those undertaking the latter action should give some serious thought to the Mr. Hussman’s graph, however:

 

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

The Economist Stumbles Over the Truth

The Economist magazine recently ran an article detailing some surprising results of a paper published by three finance researchers from MIT, Dartmouth and the University of Rochester.

From the Economist:

IT IS Economics 101. If central bankers want to spur economic activity, they cut interest rates. If they want to dampen it, they raise them. The assumption is that, as it becomes cheaper or more expensive for businesses and households to borrow, they will adjust their spending accordingly. But for businesses in America, at least, a new study* suggests that the accepted wisdom on monetary policy is broadly (but not entirely) wrong.

What surprised the Economist was that a decrease in interest rates actually caused a decline in capital spending:

While this was counterintuitive to Keynesian trained analysts, it is not for those versed in Austrian economics.

Occasionally, we all may have a burst of real insight into a situation that doesn’t jibe with conventional wisdom.  With regard to Austrian Business Cycle Theory, mine came while reading the Roger Garrison summary of The AustrianTheory of the Trade Cycle:

On page 114 Garrison drew a simple supply and demand graph of loanable funds (savings). He showed that as you dropped interest rates artificially, via Fed money printing, the level of loanable funds would fall.

It was a simple and elegant insight, yet it was extremely radical in terms of traditional economic thought. The Keynesians were, I realized then and there, entirely wrong. Money creation from thin air was not neutral to the capital structure of the economy, but had profound impacts. It changed everything for me.

So, now that some traditional economic platforms are starting to understand that the real world doesn’t act in a way that Keynesian economics would predict, what should we expect to see happen? I am going to go along with Winston Churchill on this one:

Men occasionally stumble over the truth, but most of them pick themselves up and hurry off as if nothing ever happened.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.