Stocks

A tale of two resets

J Mulraj | Updated on May 09, 2020 Published on May 08, 2020

There will be several resets in a post-Covid world, but let’s talk of the two main ones. One, will there be a new economic model, and what will its effect be on policy, corporate ownership and governance? Two, will we tilt the pendulum of the driver of economic growth a little away from consumption-led growth to a larger savings and investment-led growth? Today, in the US, consumption accounts for 70 per cent of GDP and so there is a scramble to consume more, and in doing so, to over-exploit natural resources.

The signals that the economic model of the world needs a reset are the two negatives, both of which are anomalies. The first is negative interest rates, an evident self contradiction in a capitalist society where capital is the bedrock of the economy. Debasing its worth to negative is anachronistic.

The second is negative prices of crude oil, needed to drive manufacturing, transport and produce electricity. In 1956, a paper by M King Hubbert spoke about peak oil, when the cost of oil extraction would exceed the price consumers were willing to pay. Globally, cities/towns are under lockdown, shattering demand for petro products for use in transport and in manufacture. A ship load of 2,000 Nissan SUVs on a ship approaching LA was asked to stay at sea. WTI crude hit a negative $38/b price recently, as there was no storage space available. Kyle Bass, a well known investor, warned in an April 23 article in zerohedge about a 50 million tonne time bomb of Saudi crude oil headed to the US. These ships are parked off the California coast, for lack of storage.

When two important resources, viz, capital and crude oil, are priced negatively, it is a signal to reset our economic model.

Until the 70s, when the mutual fund industry took off in the US, individuals owned about 2/3rds of corporate equity and institutions the rest. Today, the ratio is more than reversed. This institutionalisation of money means that voting is done by funds (often by advisory firms on their behalf, hence twice removed from the individual owners who financed the shares) and not by the individuals. Added to this is the pay structure of fund and of corporate managers, with a higher proportion of variable pay linked to performance (that is, market cap).

The system is thus tilted towards i) growth of the business, organically (from within) or inorganically (via acquisitions); ii) acquiring control over resources; iii) squeezing profits, often by outsourcing manufacture; and iv) a short-term focus (witness the cry for quarterly results).

Witness the consequences

The model rewards the top two or three firms in a business, putting pressure on growth. This leads to overcapacity as each major player expands to reach the coveted top three positions. That, in turn, leads to a heavy dependence on borrowing to finance growth/acquisition, which often leads to non-performing loans (think Bhushan Steel in the steel sector, Kingfisher and Jet in civil aviation). It also leads to over exploitation of natural resources and the resultant disasters, both in policy and on the environment (think coal block scandal, telecom spectrum scandal, illegal iron ore mining scandal).

The hunt for getting control over resources leads to conflicts and, very sadly, to migration of affected populations. The war on Syria, e.g. was not over Assad’s use of chemical weapons his its own people, used to justify the attack, but because of his refusal to allow a gas pipeline to Europe to pass through his country. The war in Syria led to a mass migration to Europe, which is now creating its own problems of social integration.

So, a reset is needed. This columnist moots the idea of disallowing arms manufacturers from accessing capital markets. You see, investors want the business of their companies to grow, but that would mean more conflicts, and that’s not a good idea. Why should public money be used to finance conflicts, and why should the Military Industrial Complex benefit from the rise in stock prices of weapons companies by promoting conflict?

Should consumption be the main economic driver? Over consumption means an overexploitation of natural resources. In the book ‘Natural Capitalism’ the authors say that around 3 per cent of energy contained in the fuel actually moves the passenger. The rest is wasted in moving the vehicle (in proportion to the respective weight) and in loss of efficiency in transmission. Our products have been designed in an age of relative plenty; the automobile was designed not for efficiency of energy use (plenty of crude oil, then, right?) but for speed, safety and comfort.

Products are now built not to last but to be replaced every few years for a faster, sleeker, more complex new model. Why? Not for the consumer. But for the manufacturer. Consumption drives the economy.

The Covid pandemic has brought out the folly of this. Just 40 per cent of Americans have $1,000 in savings. With low/negative interest rates where is the incentive to save especially when they have plastic, right? Now one in seven Americans are jobless, and it is hoped that they realise the value of saving and banks start giving positive real interest to depositors.

The economies will be affected for a long time, even after a vaccine is discovered. There are hopes from Britain (Oxford University), from Italy and from Israel, for a Covid vaccine. The latter two are based on use of monoclonal antibodies and have worked with rats. A vaccine clearance would lead to a sharp spurt in stockmarkets, which could be taken as an opportunity to lighten.

The writer is India Head — Finance, Asia/Haymarket. The views are personal.

Published on May 08, 2020

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