Buy backs can be seen as a signal of confidence in a company’s future. They are also attractive because, unlike dividends, they are one-offs, and imply no continued commitment to pay out. Last year US corporates spent USD336 billion buying back their own shares.
Also, dividend payout levels are not high by long term yardsticks but have risen over the last year. Of course there is another option for corporate cash piles – and that is to hold onto them. Four years after the onset of the global financial crisis the world remains an uncertain place. From uncertainty about the future of the Euro to worries about an Iranian blockade of oil supplies coming through the Straits of Hormuz, corporates face a dizzying array of risks.
High levels of corporate cash could be seen as an insurance policy against such events and so companies will just carry on hoarding their cash. For governments focused on getting growth back, this is not the right answer. Institutional investors may also start to ask why, if corporates cannot find a good return on their cash, they do not return more of it to shareholders.
For us the key to unlocking these cash piles is to give corporates a greater sense of confidence about the future. This is heavily dependent on governments running the right economic policies. High levels of corporate cash may, in part, reflect corporate scepticism that governments will be able to re-boot growth.
So, we see the Democrats saying they need to tax that, but they are not prepared to cut the running costs in the economy. Therefore, as any sixth form economics student can tell you, there is no way you can generate enough extra revenue through taxes unless you cut costs as well, otherwise we are still going to be running at an annual deficit.
The Republicans, on the other hand, are saying they want to cut costs, but they are not prepared to raise taxes, so we have the worst of both worlds. You need to do both of these things. You need to do something to fix the stock of the debt, i.e. how much debt is outstanding – and in reality we think a lot of that has to be written off. A lot of the assets have to be written off and a lot of the debt has to be written down.
Also, you need to fix the flow of the debt as well, so you need to fix the annual deficit. Just fixing one is not going to solve the problem. If you somehow cut the debt but you do not stop the deficit problem, then you are just going to end up in the same situation again in a few years time. If you actually do something about the deficit, but you are not cutting the actual stock of debt that is outstanding, you have still got this 100% debt to GDP, and that is a real drag on economic activity and economic growth.
I do not see anyone saying that a compromise between Republicans and Democrats is possible. Without doubt, if you increase taxes and if you cut government spending, then you are going to have a fairly ugly situation, in fact, you are more than likely going to have a depression – not something any politician wants in election year. At the very least, you are going to have a very nasty, prolonged recession, but unfortunately that is the only way out of the situation America is in with so much debt.
Maybe the favourable response by some of the American population to the State of the Union speech, and trying to see some positives in there, is what the politicians want to hear but we think it is no more than sticking your head in the sand. We believe that too much of America is in denial, and they are not really facing up to how bad the situation is and how drastic the measures have to be so as to get rid of that stock of USD15 trillion of debt. They also have to face up to the fact that they are running a USD1.5 trillion annual deficit.
They have to cut their spending and increase taxes. As stated above, this will almost certainly provoke a very severe recession, maybe even going back to the depressionary days of the 1930s, but then that will allow the necessary adjustments to happen. That will allow debt to be written off. It will enable debt to get back to manageable levels, and from that point growth can start again. This has always been part of the historic cycle, but this time people are doing everything they can to delay that and kick the problem further down the road thus making the result bigger and nastier when it does finally happen.
Eventually you run into the situation where you just cannot borrow any more. Greece has a roughly similar debt to GDP ratio as America does right now, and we are all seeing the problems Greece is having in raising money. Obviously, America’s got a lot more global credibility and clout, so we should not really compare it to Greece as an economy, but that same problem will happen – just at a higher level for America. There will come a point where borrowing money is extremely difficult, and if you cannot borrow it externally then the solution is, God forbid, to print it.
Printing money is inflationary, as we saw in QE1 and QE2, so if you are not careful you end up in a situation where you have no growth or very low growth, and very high inflation. This means that the growth in real terms is negative and that is when the whole thing starts to implode. If politicians do not decide to adopt these policies themselves (we cannot think of any politicians who have ever decided to do right by the people when it comes to this sort of thing as it may mean they will not get re-elected) and so bring on a recession when it is necessary then the markets will decide that.
Now, how much longer America is able to maintain this is a really interesting point because if they keep it going all the way through 2012 then we are into the election cycle, and it may well have an impact on whether Obama manages to get re-elected or not. If it all flares up during this year, we will see some pretty ugly effects on the market. Basically, will Obama put himself or the American people first? It is a shame that he and other politicians do not heed the words of one of his predecessors, Harry Truman, who said, “Anything can be achieved providing nobody minds who gets the credit”. Time is running out.
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