Stock Buybacks And The Great Wealth Transfer

 

 

It is funny how information flows.

I just wrote two posts this week on the “Greatest Wealth Transfer In History” and here we are on Thursday, and several articles come out in the newspapers that contribute “new” information to support the material in those articles.

The narrative underlying the “Greatest Wealth Transfer” has to do with the incredible increase in income/wealth inequality in history. And, the time frame of the story is the past forty years or so.

The story goes like this. The federal government, aiming at faster economic growth, high levels of employment, and income support for the less wealthy, applied economic models with a Keynesian foundation supplemented by statistical results called the Phillips Curve.

The hypothesis of this approach was that the federal government through a managed program built upon increasing the aggregate demand in the economy could sustain higher rates of growth in employment, even at the cost of a little more inflation.

Achieving this goal, the government argued could be very beneficial to the nation.

The most prominent result of these efforts over the last 40 years, however, has been the incredible increase in the income/wealth inequality in the country. And, in passing this wealth onto the next generation, we would see the “greatest wealth transfer” in history.

But, what is behind this?

This result was not the goal the government was shooting for.

Robert E. Lucas, Jr.

Then, Thursday morning, an obituary about Robert E. Lucas, Jr., was published in the New York Times.

Robert Lucas was a Nobel laureate in economics, who taught at the University of Chicago.

Mr. Lucas “challenged John Maynard Keynes's long-established doctrine that government could manipulate the economy to achieve certain outcomes through reflexive interventionist policies….”

In other words, the Keynesian assumption was that the results the government wanted could be achieved by aggregate macroeconomic programs developed from historical data.

In the real world, Professor Lucas maintained, consumers and businesses make their decisions on the basis of rational expectation drawn from their own past experiences.

People learn from what government does!

Therefore, government economic policies can be self-defeating by failing to achieve their intended outcomes.

For example, “government spending that supplants private investment is counterproductive.”

In the 2010s, many were concerned that government programs to stimulate the economy through increasing stock prices that generated a “wealth effect” were not doing enough to stimulate economic growth.

The period of economic expansion following the end of the Great Recession in 2009, was the longest in American history, but the annual compound rate of growth of the economy throughout this period was only 2.2 percent.

This was the lowest rate of expansion in a period of economic expansion in American history.

Something else was happening.

As we know now, a great deal of the stimulus ended up supporting the growth in asset values, and this growth created the massive rise in income/wealth inequality the greatest rise in U.S. history.

So, we can re-state what Mr. Lucas suggested: “government (fiscal and monetary policies) that supplants private investment is counterproductive.”

And, this looks like exactly what happened.

Stock Buybacks

Also on Thursday morning, two articles appeared in the Financial Times that lend further support to the story about increasing income/wealth inequality in the United States.

Stock buybacks are a big thing in the financial engineering of corporate operations.

The financial engineering of corporations became a big thing in the 1980s after the U.S. federal government broke the back of inflation and began to foster programs that stimulated the growth of asset prices.

I have called these programs to stimulate “credit inflation.”

Let me point you to a book that brings the evolution of financial engineering to life. The book is titled “Financial Engineering: The Evolution of a Profession” edited by Tanya Beder and Cara Marshall and published by John Wiley & Sons in 2011.

From the insert:

“Financial engineering is poised for a great shift in the years ahead. Everyone from investors and borrowers to regulators and legislators will need to determine what works, what doesn't, and where to go from here.”

The goal of financial engineering is the maximization of wealth!

Two major tools of financial engineering used to maximize wealth are dividends and stock buybacks, tools that are used to increase the price of a company's stock.

Brooke Masters, writing in the Financial Times, gives us the statistics.

“Company repurchases of their own stock hit a global record last year of $1.3 trillion, triple the level of 10 years ago.”

“Historically, companies with leftover cash returned it to their shareholders as dividends.”

The $1.3 trillion in stock buybacks almost equals the amount of dividends that were paid. But, total dividends have grown by just 54 percent in the past 10 years.

“But in recent years, more and more of them, particularly in growth sectors such as technology, have opted instead to buy back shares, sometimes even taking our debt to do so.”

The goal? Higher stock prices…and greater wealth.

And, what do the critics say?

“Critics contend that companies are so addicted to the instant share price kick that they mortgage their futures by underpaying staff or cutting back on research to pay for buybacks.”

Ms. Masters reports a study by the U.S. Securities and Exchange Commission which found that “insider selling shot up right after announcements, allowing executives to profit personally from the share price pop.”

But, this is what the economic environment created by the federal government has brought about.

And, this is just what Mr. Lucas, in much of his work, prepared us to look for.

Financial engineering is great, but, as the book mentioned above shows, it is very dependent upon the overall environment it works within.

As my post on the “Greatest Wealth Transfer in History,” the efforts of the government did not achieve the goals it set out to achieve.

But, it certainly resulted in fantastic results happening elsewhere.

Moving On

However, Mr. Lucas stated that when such things happen, we need to move on.

As Mr. Lucas writes,

“We economists have to be storytellers. We do not find that the realm of imagination and ideas is an alternative to, or a retreat from, practical reality. On the contrary, it is the only way we have found to think seriously about reality.”

And, so we need to move on.

We have found that stimulating aggregate demand and accepting a little inflation (the Phillips Curve) can create a relatively nice economic environment, but an environment that can contain massive increases to income/wealth inequality.

 

Is this what we want from our macro-economic policy?