Financial engineering: dominating the economy


For fifty years, financial engineering has become the cornerstone of the business world and the generator of high stock market performance.

As the world changed, both technologically and financially, executives discovered that the surest way to achieve higher stock prices and corporate power was through the offices of the CFO.

Need a mention on stock buybacks?

But, it is also a world of credit inflation and nothing is more beneficial for financial engineering than the continued prospect of credit inflation created within the major nations of the world.

And the prospect of continued credit inflation remains strong. Even though the Federal Reserve is in the process of raising its key interest rate, it is still allowing most measures of money supply grow as rather excessive growth rates.

For example, since the start of the current period of economic recovery, the compound annual growth rate of money supply M1 has been 9.4%. The compound annual growth rate of money supply M2 was 6.1%. And, the year-over-year growth rate continues to remain very generous.

The European Central Bank continues to support negative interest rates and apparently isn’t giving up its bond purchases anytime soon.

The central banks of China and Japan also continue to maintain credit expansion.

Every country in the world is experiencing positive economic growth and the United States is in the process of putting in place an economic stimulus program that policymakers hope will lift the US growth rate above the 3.0% level. .

Credit inflation is alive and well in most of the world.

And that has a very positive impact on mergers and acquisitions.

Eric Platt and James Fontanella-Khan inform us in the FinancialTimes that “global deals this year passed the $1 trillion mark on Tuesday, the fastest ever to reach that level…”.

“Deals are up more than 50% from a year ago and 12% from the same point in 2007, which remains the high point for mergers and acquisitions with deals totaling over $4.6 trillion announced in the year, according to Dealogic.”

Anu Aiyengar, head of JPMorgan’s M&A business in North America, reportedly said, “We’re at a major point where all the economies in the world are growing, but nothing is producing blockbusters. The ability you have to do mergers and acquisitions to drive growth is huge and the market seems to understand that. »

According to Platt and Fontanella-Khan, the determining factors are “the hunt for sales growth”, “ways to reduce costs” and the “tax-efficient” way of repatriating the cash held abroad”. , of course, comes from the December tax reform bill passed in the US Congress.

Certainly not many jobs increasing capital expenditures in these results.

There is also some evidence that the M&A deals made this year are of the “transformative” type. The world is changing, the industry structure is changing, and technological innovation is being used more and more. As a result, M&A activity attempts to “shift the curve” in terms of product/service consolidation, supply chain building and market development.

The consequence of these “transformative” moves, as reported by Platt and Fontanella-Khan, are larger transactions. For example, they report that “average deal size hit a record high of $131 million this year…” due to the presence of so many such deals.

A final driver of this activity is mentioned. Analysts point to the ongoing “competitive disruption” around the world that “affects most industries”.

It’s a world of imbalance, and imbalance creates incentives for people to seek different outcomes. And, one of the problems with imbalance situations is that it is almost impossible to predict what the resulting structure will be. In other words, we really don’t know where we are going.

But this is the world created by credit inflation.

There are other results. As I have written in my articles over the past ten years, credit inflation tends to benefit the most sophisticated and well endowed participants. Income/wealth inequality is increasing and those caught up in the outcome of the ‘transformations’ come out with fewer jobs and fewer opportunities.

Unfortunately, as we have seen over the past nearly sixty years, the creation of credit inflation, although initiated with the best intentions in the world, does not necessarily help the people it was intended to help.

And, as I reported recently, “Morgan Stanley analysts estimated that 43% of corporate tax savings would go to buyouts and dividends and nearly 19% would help pay for mergers and acquisitions.” (The corporate tax savings were those from the December tax reform bill.) That is, at least 62% of the corporate tax savings would go to financial engineering !

So it looks like we’re heading into a record year for corporate mergers and acquisitions. Share buybacks and dividends should prove strong.

The cloud on the horizon? Possible trade wars resulting from increased tariffs.


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