When speculation is good.

Since 1990 or so most of the world has been in a speculative economy.  Central banks around the world have been expanding the money supply, and asset inflation has been the predictable result.  Almost all students of reaction tend to prefer hard money policies, but all financial speculation is not destructive.

Imagine a large company, Acme Widgets, is owned by an individual.   Suppose that the widget business is highly competitive so that Acme cannot make an excessive profit.  I am defining excessive profit to be that level above the profit level where it is just worth staying in business.  Acme has good revenues and a quality product, but free market competition has kept the price of widgets at such a level  that Acme can pay all the employees and pay the bills, but the profit left over is not exciting.

One fine day the head of Acme’s R&D approaches the owner of Acme with an idea for a new production technology.  If implemented the new machines can cut per widget production cost by 25%.   Mr. Acme knows a great idea when he hears one, but getting all of the special computers and machine tools for the new method will be expensive, and Acme does not have a giant pile of cash on hand.  Since Acme does not have excessive profit it would take forever to save the funds necessary to implement the new technology.   The solution is obvious.  Acme must borrow.   Such borrowing is risky since Acme cannot be certain that the business plan will work.  Competitors may find a way around the patents or develop superior technologies of their own.  If things do not go according to plan Acme will not be able to pay back the loan and may go bankrupt.  Even so it may be worth the risk to the lender provided that Acme has collateral.   So this is the rule:  Speculation that is collateralized may be beneficial. 

I know…  Thanks Mr. Obvious, but consider the kind of corporate debt that is being taken on today.  Many companies are issuing debt in order to buy back shares of their own stock.  While this benefits the shareholders, it does not necessarily improve the company.  Here is the not so obvious dark truth.   The problem with corporate America and large multinational corporations is that the leadership is demotic.  It is fashionable among some to denigrate great industrialists of the past such as Andrew Carnegie, or Cornelius Vanderbilt.  Often referred to as robber barons, men such as these were the sovereign heads of their respective companies.   As such they really did not need to worry too much about a single month’s financial statement and were free to focus on wise long term plans.   Corporate leaders today must obsess over each month end, quarter end, and year end.  The market rules, but when the market consist of a mob of shareholders the market is mob rule.

Today we have a left that demonizes capitalism and the profit motive,  yet it is capitalism that has created new technologies, efficiencies, and has given us the standard of living we enjoy.  Many of those on the right are cheerleaders for multinational corporations regardless of whether the companies in question are engaged in wise or reckless speculation.  It is only when companies are managed by an accountable hierarchy that they have an incentive to avoid reckless speculation.  It is possible for a CEO to act is such a way as to maximize share price in the short term, personally profit from sales of stock options and incentives, and then head for the hills leaving others holding the bag.   Say what you will about the old so called robber barons, but they owned what they built, and they were responsible for their own successes and failures.  Vanderbilt may have even been ruthless, but he never needed TARP.