‘Today, the United States is No. 1 in corporate profits, No. 1 in CEO salaries, No. 1 in childhood poverty and No. 1 in income and wealth inequality in the industrialized world.’ (Bernie Saunders)

inequalityGod money’s not looking for the cure

 
 

God money’s not concerned about the sick among the pure
God money let’s go dancing on the backs of the bruised
God money’s not one to choose..’

 
As the economy emerges from the ravages of C-19, the world inevitably looks to the US to show us the way. However, the Fed is worried about inflation, and there are signs the US economy is slowing as infection rates rise.

Most economies are seeing only moderate signs of recovery. Global supply chains are under pressure due to shortages of materials and labour as lockdowns, quarantines and travel restrictions make it hard to sustain a model built around frictionless movement of people, parts, and finance.

Is this merely temporary as the world recovers, or is the global economy in the middle of a long crisis?

Post the GFC of 2008, central banks have pumped copious amounts of cheap money into the global economy. In the UK alone the Bank of England has bought £895 billion worth of bonds through Quantitative Easing (1). Whilst this has meant the world avoided slipping into a repeat of the Great Depression of the 1930s, there hasn’t been a recovery to match that generated by the New Deal and military spending of WWII, this suggests that the problems are deep-seated and structural rather than temporary and cyclical.
 

‘Is this merely temporary as the world recovers, or is the global economy in the middle of a long crisis?’

 
The financial crash of 2008 and the pandemic-induced slump of 2020 can be viewed as one long crisis stretching back two decades.

20-years ago, in August 2001, at the first Jackson Hole summit we were, with hindsight, at the high point of liberal technocracy and the end of a strong economic decade for the US; unemployment was low, the budget deficit was eliminated, and the US took the lead in the new digital technologies. They saw little threat from China and welcomed Beijing’s application to join the World Trade

Organization. The belief was that all the big problems had been solved, which was reflected in the theme of the summit: ‘economic policy for the information economy’.

2-weeks later 9/11 happened.

Washington looked to military solutions and left Wall Street to its own devices. The last of the New Deals legislation aimed at controlling financial speculation, the Glass Steagall Act had been removed by Clinton in the late 1990s. In the years that followed a combination of low interest rates, inadequate supervision, a belief that markets were never wrong, and greed proved to be a toxic combination that led directly to the GFC.

As someone wrote the post-2008 economy has had the equivalent of long Covid: ‘not a full-on collapse but rather a debilitating and prolonged malaise that has prevented full recovery.’ This has more in common with the long depression of the late 19th century than the Great Depression of the 1930s. Whilst there was no collapse of the lobal economy, the financial crisis of 1873 led to two decades of mediocre economic performance. As has been the case post-2008 productivity growth was weak, wages stagnated and there was a backlash against an earlier manifestation of globalisation. It has been said that US populism had its origins in the 1890s.
 

‘not a full-on collapse but rather a debilitating and prolonged malaise that has prevented full recovery’

 
With the exception of the restrictions imposed on central banks by the adherence to the gold standard, many of the reasons for the end of that long depression are still relevant today.

In both instances there is, and was, rapid technological innovation; the telephone, moving pictures, and cars were all being developed. These new products raised productivity and boosted living standards.

In addition, workers started organising themselves into trade unions hastening the development of welfare states. Otto von Bismarck, Germany’s first chancellor, whilst a conservative realised the sense of pensions for the elderly.

Similarly, the industrialists of the late 19th and early 20th century understood that the people working for them were also consumers and needed to earn enough to buy the goods they were producing. Antitrust laws were introduced to break up monopolies.

The lessons that can be learnt from post-1873, are:
 

  • Embrace new technology for the benefits to the many, not the few.
  • Monitor big companies to ensure they don’t stifle new entrants.
  • Welcome rather than fear a rising share of national income for workers.
  • Provide training and a welfare safety net to encourage people to shift to growth industries.

 
The hope must be that post-Covid, states continue to play a more active role in the running of their economies. The labour shortages that have resulted in higher wages should be welcomed as it leads to greater demand for goods. We need to move on from viewing central banks, and therefore financial markets, as the answer to every problem.

Financial markets have become a notoriously bad way of measuring anything other than investors knee-jerk reactions, particularly if it concerns any potential signs of tighter monetary policy in the US

This was evident last week after the US Federal Reserve’s minutes suggested the winding-down of the huge pandemic stimulus programme could start soon. The Fed will still be buying assets in the autumn, but maybe not at the rate of $120bn (£89bn) a month. Commodities fell and shares globally took a hit. The FTSE 100 index dropped 1.5%.

Like everything this needs to be taken in context; the FTSE had risen by 25% almost in a straight line since the arrival of vaccines last November. Going back to the start of the pandemic, the S&P 500, the main US index, has roughly doubled from its low point. The message here is that the odd percentage decline hardly shows up on a medium-term view.

Other than the Fed, there is other reasons why the going might get tougher for stock markets:
 

  • ‘Peak optimism’. The latest crop of corporate results on both sides of the Atlantic has been good but is there still more to come? Share prices in the US, fuelled by cheap money, still stand at sky-high levels by historical measures.
  • Worries about the spread of the Delta variant have not gone away. Goldman Sachs economists this week trimmed their US growth forecasts for the rest of this year, arguing that fears about the variant will continue to depress the services sector.
  • In China industrial production and retail sales were well below forecasts last month, suggesting tighter credit conditions are biting.

The stock market post-2008 resembles a casino where the odds are stacked in favour of investors. The prolonged period of ultra-low interest rates has caused behavioural consequences.
 
Entrepreneurs are no longer entrepreneurs; they have ceased taking risks on new projects where returns might be low, instead they borrow cash and play financial asset markets instead. Central banks QE means that financial assets rise in price because bond yields are artificially low.
 

The stock market post-2008 resembles a casino where the odds are stacked in favour of investors

 
In addition, because money is so cheap everyone borrows. Companies make a better return and can pay executives more buying back their stock with borrowed money rather than building new factories. As a result, we now have a massively overleveraged corporate sector that’s spent billions buying back stocks, personal debt is through the roof, and governments have spent a billion without so much as a blink.

At some point this will come back to haunt us.

Another concern is private equity (‘PE’) firms who are flush with cash on the back of cheap money enabling them to buy up corporate Britain at a furious rate. The latest big target is Morrisons, which just agreed a $9.5bn (£6.9bn) takeover offer by the US private equity firm Clayton, Dubilier & Rice. This follows on from Asda who took a big private equity investment last year from TDR Capital, alongside the Issa brothers.

In the first half of 2021 there were 785 private equity deals in the UK with a combined value of almost £74bn (4). Telecoms, business services, IT, veterinary services and even children’s social care have all caught the eye of investors hungry for cut-price acquisitions. ‘Private equity is rampant,’ said Martin Sorrell, the influential advertising boss. ’They are the dominant force now.’

Whilst investment into UK plc is always welcomed, the financial tools employed by PE firms may harm overall prosperity, and the losses are unlikely to be shared equally – demographically or geographically. The Conservative government’s plans to ‘level up’ left-behind communities will fail if the businesses that power those communities are stripped of assets, their profits funneled to City managers or hidden in tax havens.
 

‘Private equity is rampant…….’They are the dominant force now’

 
It is the City’s way to complicate things, but PE can be simplified; they raise money from investors, typically at the top-end, e.g., pension funds, billionaires, based on the promise of high returns. They buy a company, then ‘sweat it’, often loading it up with debt, to squeeze more growth / profits / return on equity and share the spoils with these investors.

Some view PE as ‘blood-suckers’, loading healthy companies with debt then asset-stripping them, leaving lifeless husks. PE see themselves as buying underperforming firms, improving them perhaps with new IT systems and management, and using debt to ‘juice up performance’.

The bigger issue is that the sole beneficiaries are the investors we are already ‘wealthy’, therefore they only serve to deepen inequality.
 

‘a tool that allows the rich to get richer, and the poor often ending up losing their jobs’

 
PE is really a tool that allows the rich to get richer, and the poor often ending up losing their jobs when the business ceases because of too much on its balance sheet. There are a couple of strategies that illustrate this.

Firstly, ‘dividend recapitalisation’; PE buys a business, loads it with debt and pays some or all the borrowed cash to the investors, instead of investing in staff or the business. The net result is that the investors and PE bosses get richer, and the workers must work harder to service the unjustifiable debt burden.

Another trick is Op Co / Prop Co; the acquired business is split into OpCo that employs staff and production, and PropCo, which owns all the property. The PE owners force OpCo to sign long-term contracts to pay high, fast-rising rents to PropCo, meaning OpCo must cut corners or staff to pay rent on property it previously owned. Meanwhile PropCo, made more valuable by those juicy long-term rental payments from OpCo, can be sold at a high price, with the private equity players trousering the proceeds.

This was the tactic used with the care company Southern Cross which, you may remember subsequently collapsed.

Geographically, the winners, (the bosses, bankers, and advisers), are probably based in the US, offshore or in wealthy parts of the UK. The losers are the British truck drivers, checkout workers, small-business suppliers, care home staff or gig economy workers, who are disproportionately from poorer areas, disproportionately women, and disproportionately people of colour. Money flows unseen from poor regions to rich, from black and brown people to white, and from women to men.

The markets lack the discipline to regulate themselves and halt this. PE firms are favoured clients of the big banks, able to borrow more, meaning other potential owners cannot compete on acquisitions. This is a ‘giant, finance-driven market distortion.’

The UK has the Competition and Markets Authority which have the authority to block deals that are felt to be against public interest, however the body lacks the resources, political backing and even the mandate to take on private equity and the City on behalf of ordinary people.
 

‘Until we get away from ‘chumocracy’ nothing will change, it will remain the few serving their mates and reaping the rewards’

 
As is true of many things the lead must come from the top, central government. For too long we have championed the mantra ‘open for business’ which has become euphemism for rape and pillage. Until we get away from ‘chumocracy’ nothing will change, it will remain the few serving their mates and reaping the rewards. If Johnson is serious about levelling-up this sort of market ‘abuse’ needs to be controlled, even the Daily Mail agrees. It’s time to put down the grandiose infrastructure projects and look closer to home, that’s the way to tackle inequality.

We finish with this; next month the additional £20 per week social welfare benefit called Universal Credit, which was ‘increased’ at the start of the pandemic to help the least well-off in society. This will cut the income of over 5 million claimants by over £1000 per annum.

Many of those impacted are working families, small businesspeople who didn’t qualify for furlough or pandemic support loans, and it will hit millions of kids for whom £20 per week is a real loss. For 10% of the UK population £20 per week is a big, massive issue. To them it is genuine critical wealth – the means to survive or sink into debt.

For the wealthy, the rentier class, £20 per week is nothing. They have their wealth, security, and resources, and can well regard the money they’ve made for constantly rising house prices, stock indices and booming retirement portfolios.

If Johnson wants to be populist these are the people he should be thinking of, many of them we fooled into voting him into No.10
 

‘I’ll tell you somethin’ Jack, he is a banker
And Jane, she is a clerk
And both of them save their moneys..’

 
Notes:

  1. https://www.bankofengland.co.uk/monetary-policy/quantitative-easing#:~:text=Back%20to%20top-,How%20much%20quantitative%20easing%20have%20we%20done%20in%20the%20UK,to%20buy%20UK%20corporate%20bonds.
  2. The Glass–Steagall legislation describes four provisions of the United States Banking Act of 1933 separating commercial and investment banking.
  3. The Panic of 1873 was a financial crisis that triggered an economic depression in Europe and North America that lasted from 1873 to 1877 or 1879 in France and in Britain. In Britain, the Panic started two decades of stagnation known as the ‘Long Depression’ that weakened the country’s economic leadership.
  4. KPMG

 
Philip is back ‘on his tools’ this week as he turns to economics post-Covid – if indeed the 42,076 new cases and 121 deaths recorded yesterday allows us to claim to be out the other side; cases doubled in the week after schools reopened in Scotland and with continuing debate over whether 12-15 year-olds should be jabbed, there is every reason to fear a further wave before the end of the year to coincide with flu season.

The issue of inequality returns and some of the topics he considers seem to be where big issues meet the Big Issue; companies acting through opportunity or greed, flush with cheap money, making decisions that will ultimately disadvantage many of the most vulnerable in our society; whereas we have previously considered inequality from the perspective of north vs south, old vs young and black vs white, Philip’s well constructed piece considers the unequal benefits of corporate greed as experienced on either side of the Pond.  

With recent events in Afghanistan reminding us that the 20th anniversary of 9/11 is looming, it is impossible not to recognise just how much things changed on that fateful day both politically and economically; if the US no longer sees a role in nation building, its corporates certainly see a future in fortune building.

If what we have experienced since the GFC is similar to the twenty years of economic stagnation after the 1873 financial crisis, the likely magnitude of the additional headwind delivered by Covid can only be guessed at.

Philip says ‘markets are overbought and kept alive by regular doses of QE, perhaps better described as smack for the markets’; QE allows the rich to get richer, and markets have shown the level of their addiction by their reaction to any suggestion of the tap being turned off.

If investors have enjoyed a ‘heads I win, tails you lose’ relationship with markets buoyed by central bank cash, the availability of cheap money has dramatically changed the ways in which companies employ capital and extract profits; why would a farmer put his back out over 20 years tending the turnip when he can sell that old barn to a partner at PWC as a country pile?

And if the cats stateside are getting fatter, it is increasingly at the expense of those over here that can least afford it; for those facing the loss of the £20 Universal Credit Covid-kicker, or an attack on their triple locked pension, the option to ‘eat cake’ may have been denied them.

Two lyrics ‘Nine Inch Nails at their blistering best, and Sweet Jane by the Velvet Underground because they were the best’. Enjoy!
 
  


 

Philip Gilbert 2Philip Gilbert is a city-based corporate financier, and former investment banker.

Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s

Click on the link to see all Brexit Bulletins:

brexit fc
 





Leave a Reply