Saturday, September 8, 2007

Financial Markets: Not About Investing

Excerpt from Doug Henwood, Wall Street (New York: Verso, 1996), pp 72-73.

The significance of external financing is greatly exaggerated . . . Either the U.S. financial markets function very badly, and good investments are not made because external finance is wanting, or nonfinancial businesses don’t want to make the investments. Capital expenditures — capex, in Wall Street jargon — rose as a share of GDP during the Golden Age and even into the troubled 1970s, peaking late that decade and earlythe next, and then drifting downward through the Reagan boom and Bush slump. Things perked up in the Clinton era, but not by much.

Almost all of this investment — about 92% of the total between 1952 and 1997 — was paid for by the firms’ own cash. Or to turn that notion upside down, the financing gap — the difference between the nonfinancial corporate sector’s capital expenditures (like buildings, machinery, and inventory) and its own internal funds (profits plus depreciation allowances), which has to be funded by outside borrowing or stock sales — has averaged around 8% of capex. Even at the financing gap’s widest chasm, the early 1970s, corporations still managed to fund almost 70% of their gross investment with internal funds. During the 1980s and 1990s, it’s been common to hear of large industrial corporations with several billion dollars in cash and no idea of what to do with the money.

And the stock market contributes virtually nothing to the financing of outside investment. Between 1901 and 1996, net flotations of new stock amounted to just 4% of nonfinancial corporations’ capex. That average is inflated by the experience of the early years of the century, when corporations were going public in large number; new stock offerings were equal to 11% of real investment from 1901 through 1929. Given the wave of takeovers and buybacks in recent years, far more stock has been retired than issued; net new stock offerings were –11% of capex between 1980 and 1997, making the stock market, surreally, a negative source of funds.

But if you exclude that period, and look only at 1946–1979, stocks financed just 5% of real investment. This is true of most other First World countries; in the Third World, the figures are more like those of the early 20th century in the U.S., but again, that’s because firms are going public for the first time, not because existing ones are raising funds through fresh stock
offerings (international and pre-1952 U.S. data are from Mullin 1993; U.S. figures since 1952 are from the flow of funds accounts). That huge negative number for stock-financed investment after 1980 is part of a larger phenomenon of swelling rentier claims. Nonfinancial firms
have been distributing ever more of their profits to outside investors, who typically contribute no capital to real firms, but simply buy their bonds or stocks from previous holders.

Start with the basic distribution, dividends. From the early 1950s through the mid-1970s, firms paid out 44% of their after-tax profits in dividends. That sank a bit in the late 1970s, and then rose sharply; from 1990–1997, nonfinancial corporations paid 60% of their after-tax profits out as dividends. Presumably they saw no alluring opportunities for investing the cash in their own firms, at least at a profit rate that would satisfy shareholders. Wall Street wants cash today, not promises about tomorrow.

But dividends are not all. Firms are also paying lots of interest to their creditors. What might be called the rentier share of the corporate surplus — dividends plus interest as a percentage of pretax profits and interest — has risen sharply, from 20–30% in the 1950s to 60% in the 1990s.

Far from turning to Wall Street for outside finance, nonfinancial firms have been stuffing Wall Street’s pockets with money.


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