Prof. Deepak Lal had a good piece in ‘Business Standard’ on how Finance has to be tamed to tame China. It echoes what I had written in Mint a while ago, in April 2018. [Unfortunately, neither the Federal Reserve Chairperson nor the American President have behaved according to the script I had mentioned in that piece. Oh, well]
The model was provided by the creation of China Mobile in 1997 by Goldman Sachs out of a poorly managed assortment of provincial post and telecom entities. Its initial public offering (IPO) raised $4.2 billion. There was no looking back. China’s oil companies, and insurance companies sold billions of dollars in shares in IPOs. “All of these companies were imagined up, created, and listed by American investment bankers”. By 2009, 44 of the firms in China’s National Team were on the Fortune Global 500 list. [Link]
The brief article that Deepak Lal mentions, written by Janos Kornai, is to be found here. It is an important read.
In the context of Professor Deepak Lal’s article, check out what John Dizard wrote in FT recently:
The real opposition to the financial war hawks comes not from Chinese officials but from corporate America and Wall Street. At any time there may be tens of millions of dollars that can be committed by a handful of US China short sellers, but JPMorgan, BlackRock, Goldman Sachs and their peers are on the long side. They are joined by Boeing, General Motors, semiconductor manufacturers and farm groups in lobbying to loosen or avoid official restrictions on Chinese companies’ access to US capital markets. [Link]
Wall Street’s yeoman contribution to a better world has not stopped with China. Private Equity has hollowed out American manufacturing and American corporations with ultimate consequences for workers, for creditors but not for the financiers. A well-written piece, brought to my attention by my co-author and good friend Gulzar Natarajan. The title makes no effort to hide the author’s inclination (‘Why private equity should not exist’).
One paragraph, in particular, caught my attention:
More fundamentally, private equity was about getting rid of the slack that American managers had to look out for the long-term, slack that allowed them to fund research and experiment with productive techniques. PE replaced slack with brutal debt schedules and massive upside for higher stock prices, and no downside for the owner-financiers should the company fail. The goal is to eliminate production in favor of scalable profitable things like brands, patents, and tax loopholes, because producers – engineers, artists, workers – are cost centers.
Production can also be eliminated by fissuring the workplace, such as the mass move to offshore production to lower cost countries in the 1980s onward. When I reported on the problem of financialization destroying our national security capacity, one of the manufacturers I talked to told me about how the “LBO boys” – or Leveraged Buy Out Boys – took apart factories in the midwest and shipped them to China. [Link]
The author of this piece, Matt Stoller, had linked to another article that he had written in June 2019 for ‘The American Conservative’. It is a co-authored piece and it is a long piece. But, even at the cost of brevity, this bears repetition: the long-arm of finance and foreign influence:
When Wall Street targeted the commercial industrial base in the 1990s, the same financial trends shifted the defense industry. Well before any of the more recent conflicts, financial pressure led to a change in focus for many in the defense industry—from technological engineering to balance sheet engineering. The result is that some of the biggest names in the industry have never created any defense product. Instead of innovating new technology to support our national security, they innovate new ways of creating monopolies to take advantage of it.
A good example is a company called TransDigm. While TransDigm presents itself as a designer and producer of aerospace products, it can more accurately be described as a designer of monopolies. TransDigm began as a private equity firm, a type of investment business, in 1993. Its mission, per its earnings call, is to give “private equity-like returns” to shareholders, returns that are much higher than the stock market or other standard investment vehicles.
It achieves these returns for its shareholders by buying up companies that are sole or single-source suppliers of obscure airplane parts that the government needs, and then increasing prices by as much as eight times the original amount. If the government balks at paying, TransDigm has no qualms daring the military to risk its mission and its crew by not buying the parts. The military, held hostage, often pays the ransom. TransDigm’s gross profit margins using this model to gouge the U.S. government are a robust 54.5 percent. To put that into perspective, Boeing and Lockheed’s profit margins are listed at 13.6 percent and 10.91 percent. In many ways, TransDigm is like the pharmaceutical company run by Martin Shkreli, which bought rare treatments and then price gouged those who could not do without the product. Earlier this year, TransDigm recently bought the remaining supplier of chaff and one of two suppliers of flares, products identified in the Defense Department’s supply chain fragility report.
TransDigm was caught manipulating the parts market by the Department of Defense Inspector General in 2006, again in 2008, and finally again this year. It is currently facing yet another investigation by the Government Accountability Office.
Yet, Trandigm’s stock price thrives because Wall Street loves monopolies, regardless of who they are taking advantage of. Take this analysis from TheStreet from March 2019, published after the latest Inspector General report and directly citing many of the concerning facts from the report as pure positives for the investor:
The company is now the sole supplier for 80% of the end markets it serves. And 90% of the items in the supply chain are proprietary to TransDigm. In other words, the company is operating a monopoly for parts needed to operate aircraft that will typically be in service for 30 years…. Managers are uniquely motivated to increase shareholder value and they have an enviable record, with shares up 2,503% since 2009.
Fleecing the Defense Department is big business. Its executive chairman W. Nicholas Howley, skewered by Democrats and Republicans alike in a May 2019 House Oversight hearing for making up to 4,000 percent excess profit on some parts and stealing from the American taxpayer, received total compensation of over $64 million in 2013, the fifth most among all CEOs, and over $13 million in 2018, making him one of the most highly compensated CEOs no one has ever heard of. Shortly after May’s hearing, the company agreed to voluntarily return $16 million in overcharges to the Pentagon, but the share price is at near record highs. [Link]
The authors issue warnings that should resonate with many concerned citizens in developing countries too:
Wall Street’s outsized control over defense contracting and industry means that every place a foreign adversary can insert itself into American financial institutions, it can insert itself into our defense industry.
In short, the financial industry, with its emphasis on short-term profit and monopoly, and its willingness to ignore national security for profit, has warped our very ability to defend ourselves.
Finally, let me close this blog post with a gadfly column from Bloomberg on easy money flowing into startups. I liked the title of the article. It says it all.
Now, if one were to trace the roots of this easy money flowing into startups, it has to be traced to the persistence of easy money policy which has now become quasi-permanent.
If easy money, super-normal profit growth, subdued wage growth, layoffs, exaggerated executive compensation and hollowed out production including in national security areas can be a feature of American economy and society, citizens of developing countries have a lot to worry about.