Ever since 2012 (see “How The Fed’s Visible Hand Is Forcing Corporate Cash Mismanagement“) we have warned that as a result of the Fed’s flawed monetary policy and record low rates, corporations have been incentivized not to invest in growth and allocate funds to capital spending (the result has been an unprecedented decline in capex), but to engage in the quickest, and most effective – if only in the short run – shareholder friendly actions possible, namely stock buybacks.
We got a vivid confirmation of that recently when Credit Suisse showed that the only buyer of stock since the financial crisis has been the corporate sector’, i.e. companies repurchasing their own shares…
… with SocGen showing previously that virtually all the net debt issued this century has been used to fund stock buybacks.
While one can debate the implications, the above two charts show one thing clearly: corporate incentives have been perverted in the past decade, and instead of allocating capital to ensure long-term business growth, companies have rushed to cash out, with shareholders benefiting the most, while management teams got record bonuses as a result of their stock price-linked compensation bogeys.
The eagerness to shift incentives away from buybacks to capex is also the basis for much of Trump’s economic policy as designed over the past year by his top economic advisor, former Goldman COO Gary Cohn who is the White House Economic Council director. In fact, the motive behind the administration’s entire push for tax reform (cutting corporate tax rates) and offshore cash repatriation, is to the funds domestically, though not on buybacks and M&A (which also leads to “synergies” and other headcount reductions), but on reinvesting the funds in growing one’s business and hiring.
Which is why we were amused to observe the following brief interchange yesterday between Gary Cohn and an audience made up of executives, where in the span of a few seconds Gary Cohn realized that his entire economic policy had been a disaster.
During an event for the Wall Street Journal’s CEO Council, an editor at The Wall Street Journal asked the room: “If the tax reform bill goes through, do you plan to increase investment — your company’s investment, capital investment?” He asked for a show of hands.
Alas, as the camera revealed, virtually nobody raised their hand.
Responding to this “unexpected” lack of enthusiasm to invest in growth, Cohn had one question: “Why aren’t the other hands up?”
His confusion was understandable: this one simple experiment revealed that Cohn’s entire economic policy was a disaster. And while the former Goldman president tried to cover up his disappointment with laughter, the cognitive dissonance between the stated intention behind tax reform, and what it would ultimately achieve, or rather not achieve, was painfully obvious to everyone.
Adding insult to injury, last month the White House released a paper arguing slashing the corporate tax rate would increase average household income. Kevin Hassett, the chair of the Council of Economic Advisers (CEA) chairman, said on a call last month the main reason why cutting the corporate tax rate would boost wages is because doing so would make it less expensive for companies to invest in capital assets such as machines.
“More assets like machines let workers produce more, and when workers can produce more, businesses can afford to pay their workers more,” he said last month. Unfortunately, virtually no CEOs have any intention of using freed up funds to reinvest in themselves.
Ironically, Cohn’s epiphany took place just as tax reform is approaching the final stretch in Congress and it increasingly appears that at least some form of corporate tax cut will be enacted. We say ironically, because the only thing Trump’s reform will achieve is to dramatically accelerate recently slowing buybacks, which in turn will push stocks to new all time highs as price-indescriminate CFOs and Tresurers tells their favorite VWAP trading desk to just “wave it in.” Which means that the White House paper suggesting corporate tax cuts will boost household income is correct… if it focuses only on the incomes of the richest 1% of households.