Beware the ‘Buyback Economy’
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Personally I worry a bit that we’ve run into a sort of soft ceiling on the economy where the biggest moneymakers are causing creative destruction via software (Intuit to Accountants, Uber to Cab Drivers, etc) but that we aren’t seeing the kind of widespread real economic growth (ie productivity gains) with these shifts that historically accompanied waves of industrialization. The pie isn’t growing as much as certain players are finding ways to expand their slices of it at the expense of others.
Perhaps the above is true, perhaps not, I don’t know. But it seems to me that the entire system we have is predicated on steady macroeconomic “growth” to function. In one way or another we all depend on the stock market to climb about 10% a year so we can retire some day and have savings to live off of, etc. And when that growth isn’t happening via the old mechanism of expanding industry with solid jobs and wage growth, then Wall Street and the White House resort to tricks (new financing mechanisms, tax cuts, spending, etc) to keep the machine running.
The sense I get is that since about 2000 we’ve just been playing different games to try and get the old mojo back, and that the nature of such games is to work for a bit and then collapse due to unsustainability. Maybe that’s just my tinfoil hat coming out, I hope I’m wrong.
It seems like that article is taking a political position, so I'm not so sure how much credence to give it. I mean that's the closing sentence of his first paragraph. To base the article on the complete dismissal of the Keynesian school of thought isn't very inspiring.
Ya, looking at his portfolio, he's certainly a political shill. He's written some sketchy articles such as "Why Deregulation Is Essential To Restoring Booming Economic Growth, And The American Dream," "President Obama's Plan To "De-develop" America Shifts Into High Gear," "President Obama's Global Warming Calculated Deception Means Democrats Have Abandoned Working People," as well as promotes the return to the gold standard. I wouldn't use him as a primary source.
https://www.forbes.com/sites/peterferrara/#283999473eb5
He's also a director at the Heartland Institute which is a conservative "think tank."
It's also worth noting that there's a real deep division in economics between the "Freshwater" and the "Saltwater" types, and it's important to know which kind of economist your reading. He's of the "Freshwater" type so he's going to be Anti-Keynesian, but that's okay.
Lastly, it was written before 2014 so everything changed after Thomas Piketty wrote "Capital in the 21st Century".
Yes, I don't dismiss political points of view outright, but the language he uses and the phrases he uses, it's fairly obvious he's trying to convince the reader of his position by discrediting the education of the counterpoint rather than using points of his own. It's intellectual dishonesty wrapped in a false shroud of academia for people who can't tell the difference.
I'll wager free air that if you read is articles over time, he starts to contradict himself depending on which political party is in power. This article seems to be written when the whole austerity thing was going on when the Dems were in office. I suspect now that the GOP is in office, he's ok with government spending, or he ignores it altogether. (actually it appears he's no longer writing for Forbes).
Any position on public policy is a political position. There's no apolitical macroeconomics.
One critical detail here: 10% is definitely not sustainable. Long-term, the market reliably provides about 4% after accounting for inflation. You shouldn't assume you can get any more return on investment than that.
https://www.investopedia.com/ask/answers/042415/what-average...
Originally from the Trinity study: https://en.wikipedia.org/wiki/Trinity_study
Can anyone point me to any scientific reasoning behind this? As I'm not an economist, I was always baffled by an expectation that the market will always grow. That instantly brings to my mind the comparison to cancer.
As capital agglomerates, it creates instabilities. When a large capital cluster collapses, if it's too big the collapse has systemic impact. If everyone is small, an individual may experience greater risk, but the system is robust.
In reply to the other comments: Economic growth is different from stock market asset appreciation.
(And you don't need 10%, a lot more money is in bonds than equities and at much lower rates.)
We tend to cut costs and reward the capital managers... but why not maintain costs while rewarding employees?
I haven’t seen any journalists confuse the two, but of course people offering an opinion are free to confuse them.
To revisit the comment above:
> Why can't progress in technology replace population growth through higher productivity? We tend to cut costs and reward the capital managers... but why not maintain costs while rewarding employees?
This _can_ happen, but I don't believe it _will_ without some authoritarianism. Otherwise, the wealthy will find legal means to reward themselves disproportionately more than their workers. Individuals in America have widely varying interpretations of what it means to take a fair cut. The law is very slow to respond to companies like Walmart or Amazon paying shamefully low warehouse wages. Even usury is borderline legal: I believe most states have some kind of payday loan company.
To be perfectly clear on my views, I think the goals of universal healthcare and universal basic income are good. I don't believe the American socio-cutural system is capable of achieving these in my lifetime. I hope for the sake of my friends and family that I'm wrong, but I'm planning my life around finding a country on a track I believe in.
* I would have preferred a less loaded term than this. The American welfare system is far from effective in it's goals IMO.
Because there is competition. If not you, then someone else will cut costs, and then you can either start cutting costs too, or get outcompeted. Either way, costs get reduced anyway.
Now it sometimes happens that a bunch of competing companies can coordinate and agree to not cut costs. Those cases are usually of interest to the regulators, because the benefits almost universally line the pockets of top company executives, and trickle down to neither employees, nor customers.
The arguments hold where power is highly centralized, however democracies tend to see the world very differently.
Japan is the size of California, and its population is 127 million or more than 3x that of CA. The average size of a single family dwelling is less than half that of the US. Japan cannot feed itself, nor power itself, and depends on open trade and foreign countries for almost all its natural resources.
This was not always the case, though. Their growth outgrew their borders in the early 21st century - they were forced to expand into their neighbors' yards for space and resources, and we all know how well that turned out.
Maybe the idea of endless exponential population growth isn't the best idea, and if Japan would prefer to keep their culture instead of bowing down to the globalist elites who want open borders, never-ending GDP growth and markets, I give them credit.
What we are doing in the West with unlimited immigration and forced diversity will not end well, IMO.
Japan's population is currently declining...
https://www.washingtonpost.com/news/worldviews/wp/2016/02/26...
The general idea is that there will be dips and bubbles, but over the long run, Growth will happen.
In general, we need to make things better. When we make things better we create growth.
Why not bamboo?
Could have literally answered with their reply to almost any question.
Examples:
"Vanilla ice cream is good" - "Reminds me of cancer"
"Let's go watch 50 shades of grey" - "Reminds me of cancer"
"What do you think of bitcoin?" - "Reminds me of cancer"
https://www.quora.com/How-can-the-stock-market-grow-faster-t...
EDIT: Unless people actually sold their stocks instead of holding in which case it'd be GDP.
So sustainability of growth isn't particularly an issue (the economy quickly grows to meet new demand, essentially instantaneously), the problem is that it is becoming more difficult to participate meaningfully in the economy (when lots of people do that you get demand growth).
Well, that sounds like we have two large problems to solve:
1) Effective demand/participation, the "jobs thing" everyone talks about.
2) The underlying cost diseases that force huge amounts of labor to be employed at low (sometimes even negative) marginal productivity.
The difference between those numbers is why inequality grows.
[0] https://www.economist.com/the-economist-explains/2014/05/04/...
https://equitablegrowth.org/hourly-piketty-paul-krugman-gatt...
Part of what makes this problem hard, is if Piketty is really right, we don't necessarily know what policies we should be following. It's unclear how we change the equation at this point.
Piketty seems to think that tax hikes on the rich might work. But that is really just a theory.
Intuition suggests that about half the time raising taxes (or interest rates, or whatever policy lever) might help whatever economic problem you have, and half the time cutting them is better. It’s like tuning a radio, the knob goes both ways. I am wary of these so-called economists who only have one solution to every conceivable problem. Krugman is the same, whatever the scenario, he always recommends printing more money.
It easily could be that the "best" tax rate for whatever set of goals is actually 10% or 40%. Then if you live in a society where the applied rates go between 20 and 30% then there's no reason to think it is rational to say "up" or "down" half the time each.
But is it rational to say “up” every time? If so what happens when you inevitably reach 100% and have nowhere to go? And if it’s that simple then economics is solved and we can fire all the economists too.
It may not be exactly half but “up sometimes, down sometimes” is far more likely to be a rational approach.
The 100% rate you mention is clearly a strawman: we haven't even tried a 35% rate on the top people in the modern era.
I think it's far more complicated than that. There are basically two competing models for economics, and yes while politics is involved here, both have deep philosophical arguments about the way economics works.
One group believes that Government (G) intervention in the markets is bad (reduction in G spending, permanent tax cuts). The other group believes it is good (G spending on infrastructure, graduated tax code).
So there's short term economics, and there's year to year economics. And now with Piketty we have generational economics. If we really don't want to return to the Gilded Age, the things we think are good in the short term, are very damaging in the long term, that might include tax cuts and G spending.
I would concur. The global economy never actually recovered from the dotcom crash. Since then it has just been papering over the cracks, inflating property, artificially low interest rates, “quantitative easing” i.e. just printing money that’s not backed by anything in the real economy. The correction when it comes will make the dotcom crash and even the 2008 crisis seem mild.
(Real, meaning subtracting inflation) productivity improvements stopped in 1980, and have been going downhill ever so slightly since. Productivity today is actually a bit lower than, say, 5 years ago. People do less. Now this needs to be measured in real growth to see this effect (although, in the last 6 years or so, even productivity growth without inflation is negative). Attempting an analogy to make it maximally real: essentially, if I have you work for me (as 1 more employee), how many big macs can I sell extra ? The answer, say, was 800, 10 years ago and now it's 700.
Meanwhile, all costs that productivity needs to carry have been steadily increasing, which can be roughly expressed as "per worker, how much needs to be supported ?". For Europe, especially this is very bad (frankly, it is very, very bad for everywhere except the US where it is merely dismal). Essentially, whereas in 1980 every individual working needed to support the life of 1.8 persons, most of them children (who will support others when they grow up), now it's 2.3, most of them elderly (who's main contribution in the future to the economy, as dismal as it sounds, is dying).
This is generally referred to as "secular stagnation". It's a huge problem, because, put simply, the total amount of economic activity we can dedicate to any person is essentially productivity. So you can only get a nicer house if productivity goes up.
In my opinion, it is in fact a much bigger process than the generally agreed upon view above. In 1985 or so the world went from (on very large average) demand-driven to supply-driven. Simply said, in 1975, if a baker produced 5 more pieces of bread, people would buy them, eat them, pay for them, and work a bit harder themselves (maybe making some more windows ... or whatever) to make up for it. In 1995, if a baker produced 5 more pieces of bread, they would rot on this shelves. This is what then causes the productivity stagnation.
Another way to put this is that we are demand-limited. People are producing everything they want (which in economic terms means that they are not willing to work harder for more).
This means that while before 1980 we were arguing "how can we produce more cars ?", "how can we get more people flying/traveling ?", all good questions. Now we're arguing "okay, next year, we'll sell less cars, less people will go on holiday. How do we divide up the profits from that ?". Whatever the outcome, I guarantee not many people will be happy with it.
In other words, the problem is (as stupid as it sounds) that we ... as in humanity as a whole, don't have enough to do. We are embarking on a few grand projects, like urbanizing China, but as a whole they don't seem to make a big difference. We should decide on something ridiculously intensive to do, requiring massive infrastructure build, and go out and do it. Maybe colonize the bottom of the oceans (or the top). Fly to the moon and build a base this time. Capture an asteroid. Or how about automated metros everywhere (or just in many places) ? Whatever. But the alternative is that we're going to have a lot of people sitting on their hands (and being very poor and hopeless and maybe even homeless because of it). That seems like a good thing to avoid.
I must confess that while I wasn't rooting for him, I was hoping that Trump's infrastructure plans would accomplish exactly that, at least for America (and they still might, I suppose), but so far not much has happened.
What are you basing this on? There are currently more cars than ever, more people traveling than ever, more women joined the workforce, huge improvements on communication levels (non-internet, non-mobile communication to mobile phones with 4G).
No improvements since 1980, seriously? I grew up in the 80's and 90's. If I see what we have and what we can do today (such as cheap travel), seriously? I would love to see the face of any person living today and traveling back 30 years to 'improve their lifestyle'... hahaha.
And the 'frankly, it is very, very bad for everywhere except the US where it is merely dismal' gives me a clear indication that you never left your home country, which is pretty clear which one that is.
So yeah, what data are you basing this on?
Judging by the "productivity is lower now than 5 years ago", this person is not looking at data.
Often the first people to decry Economics as "not a science" take the least scientific approach.
We have masses of people dying in poverty, of diseases and causes that a minority of us can ignore. We have water shortages in multiple major cities in the world, we are causing extinction of many species, and we are harvesting all the resources in the planet we can get our hands on with no real attempts to ensure that life can continue .
We have plenty to do
We can see this in a lot of the new economy. Google's search business is worth X. A search business with 1/10th of the volume is not worth 10% of Google search's worth nor does it generate revenue on that scale. This is because Google derives its value from aggregating a large portion of the total. More than the sum of parts is an o understatement.
This exists in a manufacturing environment too, the size factor. But, for manufacturing this is "economies of scale" related. Ie, they use price to lower unit costs. In the new economy, it's unrelated to unit costs. The actual revenue (not profit) and market cap effect on the 1+nth unit is higher.
ROI is what actually drives the economy. But, if market caps grow while the "real" economic outputs (searches, rides) do not....
This is why Thomas Pickettys work is so popular today. This mechanic can effectively drive increases in the value of capital, without changes in the real economy.
I think we can see this quite clearly in the capital markets. Market value grows faster than revenue. Capital grows faster than the economy.
The author picks on Apple, but doesn't mention that Apple has dramatically increased its headcount and R&D spending all the while buying back stock. The truth is Apple is a mature company that is an incredible money making machine, they literally don't have ways to use the profits to make more successful tech products. What else should they do other than reward shareholders?
Anyway, if it turns out when I sell my shares they were bought by the company, guess what I'll do with the proceeds? Either spend it (stimulating the economy) or plow it back into other investments. Buyback money doesn't magically disappear, it just cycles what the capital is being used for.
Also, as a foreigner, I have tax withheld by the IRS on US sourced income, but I do not on capital gains (except through my retirement account due to tax treaties).
Buffett/Berkshire is literally the only example I can think of where they only buyback shares when prices drop below a certain threshold. Most companies do it regardless of whether it is creating or destroying value, based only on whether they have cash authorized to spend.
Buybacks tend to happen at the worst times (boom years) and cut out in recessions which is counter to what you'd want as an investor. Though if you think of it more as an alternative to special dividends it makes more sense.
It doesn't make sense for shareholders to own stock that they think will go down. If they really think that, they should sell. So shareholders should think the stock is either fairly valued or undervalued, almost by definition.
Any shareholders who don't sell during a buyback are compensated by owning a larger share of the company at what should be considered a fair or generous price from their point of view.
The place where this breaks down is when you believe a company would have a higher intrinsic value, provided that it has sufficient financing. But this isn't based on the stock price; it's based on your theory of how much money you think the company will need.
Also, from a non-shareholder's point of view (say, bondholders), a buyback means the company's ownership changed, it has less cash, and they didn't get anything for it.
Do you have evidence of this? Shareholders vote on what to do with the corporation's money. I would expect the vast majority of those decisions to be rational.
If that is a shareholder's opinion, they should sell the stock.
Buybacks are often a signal that a company has run out of ideas for what to do with with their money, other than what they're already doing. Especially for a tech company, that's a very bad sign. For instance you refer to Apple as a mature company yet the interesting thing is that today they are basically 'the iPhone company' - making the wide majority of their profits from a product type that didn't exist 11 years ago. And this is a typical pattern with tech and electronics. Times and trends change very quickly and the winner tends to be the company that's on top of the change. If Apple doesn't manage to move beyond the iPhone they will stagnate (which is arguably already happening) and inevitably decline.
And yet they haven’t updated their pro line since 2012. And the quality of OSX is slipping badly. If they are really bereft of ideas, spending a few billion on fixing bugs (instead of the animated poop icon) might keep them occupied until inspiration strikes
But these are subjective measures (to which I happen to agree with you). It's not as if they aren't investing in their products.
(1) According to Ray Dalio's theory of long-term credit cycles, we should be healthiest in the decade after a credit crunch.
(2) When the article says that Apple could use its $210B to buy the bottom 480 companies of the S&P 500, it means any one of the bottom 480 companies. As worded, that sentence is ambiguous at best and deceptive at worst.
(3) I don't understand the author's point that companies with the most buybacks saw their value go down the most. Like, isn't that exactly what you would expect? If Apples gives $210B to shareholders, now Apple is worth $210B less.
(4) No evidence is given for the claim that all of these companies intended to use their buybacks to prop up their stock price. I doubt any evidence exists. Quite possibly, crummy companies like Sears are buying back stock because returning money to shareholders is better than building new Sears stores.
(5) Does it really matter that much if claims on companies' future profits are shifting from risky equity to risky bonds? I honestly don't know.
(6) The article argues that the rise of bond ETFs over the past decade ($15B to $300B, 20x) shows the rise of bonds. But, honestly, most of that comes from the rise of ETFs, not the rise of bonds. Over the same time period, the total ETF market, which is mostly equities, grew from $700B in 2008 to $4,600B in 2017.
(7) A lot these 'one decade ago' statistics are hard to interpret, since one of the endpoints was in the middle of a terrible financial crisis.
(8) The numbers on household credit card debt seem very tragic. I wish I understood more how people use credit cards.
I'll give you the low-down: many Americans don't make enough money to save up money for medical emergencies, and other emergencies, so when one of those happens, they reach for their credit card. Yes, it's a bad idea, but when they're a few months out of the hospital, possibly still sick, then it's easy to panic when getting repeated calls from debt collectors and pull out their credit cards.
Same thing happens with auto repairs and house repairs. And many such incidental expenses. As a software developer making over $100,000/year, the instinct of many people here on HN is to say, "why the hell don't they save more?". But when you're making $30,000/year and raising a couple of kids, it's really not possible to save money in most cities and their suburbs. Sure, they could save up more money with that income in a cheap rural area or small town, but then there's no jobs.
Saving up enough money for medical and other emergencies is much harder to do for the average lower- to lower-middle class American that many people on HN might realize.
This is the "HN bubble" at work. Many of these people are paying medical bills for which they have no insurance or trying to feed their children. And once they fall into the trap, the credit system is designed to keep them there. So yes, it is very tragic.
What?!
That is insane. Right? Like I know I’m just a lowly programmer who doesn’t know jack all about finance, but I thought the whole point of a buy back was that your public company was flush with cash and instead of spending it on capital expenses (am I using that word right? I mean things that grow the business, like say, Facebook buying Instagram) you spent it on buying stock from shareholders.
What the heck is the point of a buy back purchase with debt?! I really don’t understand.
If the article explains it and I missed it, it would be awesome to have it pointed out.
0) Assume that there is an optimum debt/equity ratio for a company (no idea how it shakes out in practice, but there is probably some rule or theory that suggests an optimum debt level, like the Kelly Criterion suggests an optimum quantity to risk compared to available capital).
1) The accountants have calculated that due to the difference between your return on capital and the market interest rate, you should have borrowings equal to 20% of your shareholders equity.
2) The company's shareholder equity grows organically because it is doing well.
3) The company wants a higher debt/capital ratio, and investors are demanding some profit be returned to them, so borrow the dividend money directly and gives it out as a share buyback, optimising the debt/equity ratio at the same time. This is an administratively neat way of getting the money for the buyback together in one place.
There is a fuzzy spot in the argument in that you are returning money to investors at the same time as your return on capital is better than the market, but stranger decisions get made. CEOs and investors don't complain about high stock prices.
Or it may be that the big wigs looks around asking, where is the best place to invest in stocks...who else, but me! This show of confidence in the future performance of your company can be good marketing for your own stock value.
When you are a public company you've made the choice that you are always for sale.
Interest rates are moving up now, but have been really low for a long time. If you pay out a decent dividend it can make financial sense to loan money to buy back shares just on not having to pay the dividend (if you pay a 5% dividend like Ford does, but can issue bonds at 3%, I mean why not?).
There's also the factor that since interest payments are tax deductible, it further pushes the cost of interest rates lower.
tl;dr it usually comes down to tax and accounting reasons.
But wait. Taxes are a one-time thing, right? You pay the 20% (or whatever it is) and you're done.
You're going to have to pay those bonds back sometime, right? Wouldn't you need to pay them off and have to pay that 20% tax rate?
Oh I bet not. I bet there's some tax avoidance trickery that means you pay less in taxes if it's paying off bonds, right?
Think about it this way -- if you wanted to buy a car, and you had enough money in the stock market, you could sell your stocks and pay cash for the car. Or, you could get a car loan at a pretty low interest rate. Why would you take the loan? You might take the loan because the money you would make by leaving your cash in the stock market (and avoiding capital gains taxes triggered by selling shares) would almost certainly be larger than the interest you would pay on a car loan. So it might make sense to take the loan and leave your investments alone.
There are not a lot of personal decisions that turn out like that, but a lot of business decisions turn out like that.
This increases the risk that Apple crashes and burns but (ideally) the increase is low enough that all parties come out ahead.
Though, for buybacks, I wonder why the overseas subsidiary doesn't buy shares of the domestic parent. Perhaps that tax loophole has already been plugged.
I can't speak for Apple et al but for some companies it has been a tool to raise their share price. With shrinking outstanding number of shares financial ratios like EPS etc start to look big even when the company isn't actually growing. And that means over time these companies can borrow even more money on their "growth". The cycle repeats.
Another oft-repeated trope that doesn't follow in the data. In fact, most of the companies doing the biggest buybacks recently have had underperforming share prices.
Buybacks can be good or bad, smart or stupid, just like any other "investment". Read Damodaran.
Buying all of the S&P 500 would take roughly $24 trillion.
The article's wording on that point was very ambiguous and misleading. I had the same reaction! :)
Tend to agree generally that we are approaching the apex of the cycle, and that share buybacks may be creating a sort of short term thermal.
Ummm, yes it is: https://www.cnbc.com/2018/02/13/total-us-household-debt-soar...
This is complicated by tax laws which allow companies to write off debt. This helps create lower risk debt capital but increases the risk of the remaining equity. Not the end of the world. Just invest in both.
I’m somewhat concerned by companies borrowing too much and dying, but creative destruction helps new entrants.
I thought with stock ETFs they were convertible when you had a large number. This would keep the etf price in line with it's underlying assets.
The issue with bond ETFs is I don't think the underlying bond is exchange traded. How would the conversion work?
I ask because this article has reminded me that I should probably diversify away from bond ETFs into GICs
> For bond index ETFs, the sheer number of issues in their target indexes and the illiquid nature of many of these issues make full replication of the benchmarks prohibitive. Instead, most bond index ETFs replicate their benchmarks through a sampling approach.
> Managers create samples that aim to match the fundamental characteristics of the bond indexes across such areas as: [...]
https://advisors.vanguard.com/VGApp/iip/site/advisor/etfcent...
But I don't see why people worry about divergence between the price of an ETF and the price of its illiquid holdings. The illiquidity is fundamentally there, and it's just a question of whether you expose it to the customer (like an ETF) or conceal it using stale prices, estimated prices, etc. (like a mutual fund).
When the ETF becomes illiquid and is dropping quickly, the conservative bond investor may rush to sell and cause the ETF drop significantly in price despite the underlying bonds still being sound.
Since you know what the return on the bond is, at what price, interest rate and time, you can very easily assess the current value of a bond, especially compared to what you might make if you just bought GICs at the current rate. An interest rate hike today lowers the sell price of bonds purchased at yesterday's rate.
https://www.quora.com/Why-isn’t-there-a-bond-exchange-equiva...