Financial Repression meets Financial Engineering

In my classes, I use the example of IBM as a company that has engaged in debt issuance to buy back shares. Even as its revenues stagnated or declined, it reported improved EPS thanks to this Financial Engineering. Then, came the inevitable warning on earnings few days ago. See the Bloomberg news-story on the warning here and some op.eds here and here. Stanley Druckenmiller warned of this outcome precisely in July. The column in Reuters is a good read.

In a private email exchange, a good friend raised the question as to why financial repression resulted in overconsumption in the US but overinvestment in China. I think there is a Ph.D on researching this question. My ‘off-the-cuff’ response to him was that the economic cycles and the state of development (level of aggregate and per-capita GDP) in both the companies are very different. I should have added that it is easy to engineer overinvestment in a corporate world that is dominated by State-owned enterprises whereas the degenerate capitalism that America practises now, when combined with financial repression, does not result in overinvestment but financial engineering, higher executive compensation and overconsumption.

Notwithstanding the earnings warning of IBM (the Reuters article linked above mentions that several other companies are in the same boat), US stock markets are in a hurry to wipe out the losses for the month. Financial Engineering and financial repression are winning.


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