Debtonator E-Book

Andrew McNally

• Herausgeber: Elliott & Thompson
• Kategorie: Geisteswissenschaft
• Sprache: Englisch
• Veröffentlichungsjahr: 2015

Seitenzahl: 133

Beschreibung

We are all swamped in debt. Households, corporations, governments... debt has become so ingrained in our culture, it is an unquestioned fact of life. However, there is another way of bankrolling our economic future, one that could lead to a much fairer society:equity.There is increasing evidence that over reliance on debt finance is damaging both business and society. Debt leaves control and ownership in the hands of too few: it is a direct source of extreme inequality. Equity finance can redress the balance; by broadening direct ownership of assets through equity, we can make everyone better off - not just the few. There is value in equity way beyond what financiers, economists, investment bankers and many corporate CEOs will tell you. It is the value of aligned interests, of trust and fairness, of optimism and patience, of stability and simplicity, of shared endeavour. Only when we unleash this value will economic democracy secure the political democracy that we cherish.

Leseprobe

For Jessica, Michael and Sophia

Contents

Introduction

1. Debt and Equity 101

2. The Real Value of Equity Finance

3. Nobel Finance

4. The Rise and Rise of Debt

5. How Debt Favours the Few

6. The Social Value of Equity

7. A Sense of Urgency

8. Beyond the Debt Bias

Conclusion

Notes

Bibliography

Index

Introduction

It is absurd to entrust the defence of a country to men who own nothing in it.

Diodorus Siculus, 60–30BC1

We are in an age of financial extremes. Since the 1970s the Western world has seen the most prolonged rise in inequality, both in income and wealth, since the 1800s. At the same time, government, household and company debt in total has become more prolific relative to income than at any time in history; it plagues our financial system and, although it might look to many like governments and central banks have the worst effects under control, indebtedness is still increasing for the world as a whole. Despite many explanations of income disparity, the causes of inequality in wealth are not widely understood. The concurrent rise in debt and wealth inequality is curious, however; this book offers one explanation of why the two might be linked.

UK prime minister Harold Macmillan famously said that ‘most of our people have never had it so good’. He made that statement in the 1950s and most people have it even better today, at least economically. The wealth produced by post-war industrial recovery, together with the welfare state, improved the lot of the vast majority. In recent years, though, the economy has not been working for everyone in the way we were led to believe it would – not just by politicians but also by the economic theories that define their debates. As in the early part of the last century, those at the bottom and in the middle of society are being left behind by those at the very top. The UK economy is almost half as big again as it was in 1994 and yet, for those who are somewhere in the middle, incomes have gone up by just a fifth; they have actually flat-lined since 2002.2 The bottom 25 per cent of American workers haven’t had a real wage increase in twenty-five years.

The year 2014 was a tough one for 113 American billionaires who failed to secure a place on the Forbes 400, the prestigious list of the wealthiest people in the United States; as the stock market reached new highs, the competition simply pulled too far ahead. They should have moved to the UK; with only 107 billionaires, the slightly less prestigious Sunday Times Rich List left plenty of space.3 The wealth of the top 1 per cent has been growing at a much steeper rate than anyone else’s. In The New Few, Ferdinand Mount wonders if this is down to ‘an undiagnosed malfunction or a series of malfunctions’.4 He is right to wonder; the system is malfunctioning and it is allowing those at the top to leave the rest behind – way behind.

There’s a debate raging right now about the role central banks have played in the creation of inequality. While the central bankers themselves claim their actions prevented a second Great Depression others, both on the left and the right, focus on the impact they have had on the value of assets held mainly by the wealthy. So-called quantitative easing involved the central banks buying bonds and other assets in an attempt to free up cash in the banking system and the real economy. This is a valid debate but it says nothing of the more powerful and enduring forces that are the subject of this book. A relentless increase in the use of debt, especially amongst corporations, I argue, is a crucial link in the creation of wealth inequality; our faith in debt has left ownership of the most productive wealth, shares in companies, in the hands of the few.

Priorities change in politics; it’s the nature of the beast. There was a time when ownership was the big agenda, not just of homes but of everything. The UK’s early privatisation programme, for example, may have been mainly designed to offload corporations from the state and subject them to the free market, but the opportunity to create a new shareholding class was not overlooked; the ‘If you see Sid … Tell him!’ campaign during the privatisation of British Gas remains an iconic moment in stock market history nearly thirty years later. Sid, however, didn’t keep his shares for long and the dream of a stake-holding society never became reality.

Politicians are often playing catch-up. Keith Joseph, one of the key architects of Thatcherism, for example, broke ground in 1974 with his famous Preston speech, ‘Inflation is Caused by Governments’. It was a challenge to both sides of the political spectrum after successive governments had relied on money creation to solve our economic woes and, although his speech rocked the political establishment, it addressed an issue that was becoming apparent almost ten years before. In a similar way, we need to admit that extreme inequality today, to a large degree, is caused by our financial system; to acknowledge that central banks with governments by their side, at least in their current form, are part of the problem.

In the autumn of 2011, seventy Harvard students walked out of the esteemed university’s Economics 10 course. It’s the course that covers the basics – the fundamentals of economic theory. ‘Harvard graduates have been complicit and have aided many of the worst injustices of recent years. Today we fight that history,’ said one of the dissenters at the time.5 They see where the theory is lacking while their professors stick doggedly to the established syllabus.

We often forget that finance exists because of us, that we created it; we established the rules by which it works and which allowed it to thrive in the first place. Since the 1500s, when the Christian church found a way for Jewish money-lenders to bypass usury laws,6 we have continuously shaped finance; learning new lessons, new flaws and new approaches. Nothing in finance occurred in nature; we can deconstruct it and reconstruct it to serve our needs.

In this book I argue that the use of equity, not debt, as a means of financing companies should be a key ingredient in the fight against the growing inequality that we are witnessing in the West. Equity, in the financial sense, is two things at the same time: it is both an investment and a rich source of finance. Equity finance, when companies sell a share in their future success, is often seen as the poor cousin of debt finance, the source of funding a company resorts to only when it really has no other choice. On its page on equity, Wikipedia describes equity investors as the ‘most junior class’ of investors; however, equity is the only way to invest in new real wealth creation. Technically speaking, equity holders receive a return on their investment that varies according to the performance of a firm. In practice, equity represents a share in success – in the success of a company; in the success of an economy. It is the best means by which the wealth created by the growth in the value of assets can be distributed more widely in society.

After the financial crisis of 2008, like the Harvard students, many in business and banking glimpse a different model for finance – while governments and central banks perform CPR on the old one. The foundations of the next version of global finance need to be built on equity not debt. Equity, although less commonly understood, I believe embodies the more positive and potent traits of capitalism. An economic future secured through equity will be fairer, more stable, more optimistic and more productive. Equity finance, to my mind, brings advantages for everyone that current theory does not account for; it brings benefits to companies, to owners and to society as a whole. Equity as a dominant source of finance can make us all better off.

This book begins by describing, in simple terms, what equity in the financial sense really represents as a form of wealth and as a source of finance. I then show how equity as a form of finance works in ways beyond those accounted for by established financial theory. A simple notion of the theories that have dictated how we think about equity, particularly in relation to debt, and why they might be fundamentally flawed, is essential for my argument. Debt’s primacy is now hard-wired into our system and so I offer an abridged account of how this happened before moving on to the central argument of this book – that debt favours the few. I outline the processes by which our obsession with debt has secured a system that drives ownership of the most important kind of wealth into the hands of a small group at the top. I then argue that equity at large can be much better for society, an argument that is becoming ever more vital as new technology looks set to displace workers and cut wages for some time to come. Finally, I close by suggesting what, in broad terms, could be done to leave us with an equity financed, not a debt financed, society.

There are many reasons to be positive. In his evolutionary explanation of human success The Rational Optimist, science writer Matt Ridley reassures us as to why: ‘The availability of almost everything a person could want or need has been going rapidly upwards for 200 years and erratically upwards for 10,000 years before that.’7 For us to sustain this progress, however, more people need to see that optimism justified; they need to have a stake in that progress.

This short book was not written simply to tell the reader to buy shares. It is not saying companies should not use debt; it is not another call for wider employee share ownership or for a confiscation and redistribution of wealth. It is simply arguing that our system needs more equity – full stop. It is a call for more assets to be financed with equity and for more people to own them. It is written with deliberate naivety. I have largely ignored the powerful vested interests that might see the world differently. Many readers may be suspicious of the intractable relationship between those who benefit most from the current system and the political class, but, assuming such a relationship exists, it presents a challenge beyond the scope of the argument given here. My hope is that it will set people thinking, vested interests or otherwise, that there might be a better way to organise our finances – one that would harness the creative dynamism of capitalism while embracing some of the humanistic ideals of fairness and shared endeavour.

These are, of course, just ideas. Putting them into practice would require the exercise of the greatest minds in economics, business, finance and government. In itself, a shift to a financial system, and actually a new version of capitalism, with equity not debt at its core, will be the greatest of shared endeavours.

1

Debt and Equity 101

Beware of geeks bearing formulas.

Warren Buffett, 2009

Finance can often seem daunting. It is frequently presented as a myriad of complex theories, impenetrable jargon and mind-bending mathematics. Many of its concepts, however, are in essence quite simple. Most people understand clearly the concept of debt, for example; it is something that nearly everyone will have practical experience of at some point in their lives. Equity, on the other hand, is slightly more complex and less run-of-the-mill.

We normally first experience the difference between debt and equity when we buy our first home. To keep it simple: suppose we buy a house for £100,000 and take out a 100 per cent mortgage; at the start, the asset’s value is £100,000, the debt is £100,000 and the equity is zero. If the house’s price increases by, say, 20 per cent, and so its value rises to £120,000, our debt remains at £100,000 and our equity becomes £20,000. All of the increase in the value of the house, the asset, is reflected in the value of the equity.

It isn’t always this simple. We’d rarely, for example, buy a factory or a shopping mall ourselves; a company would do these things and we would help to finance the company. The company would be either debt or equity financed and the company would own the assets – the factory, the land it sits on, the machines that fill it and so on.

To illustrate, suppose we are introduced to Smith Ventures, a company developing genetically enhanced apple trees, which is planning to use its new technology to grow a large orchard. And then suppose we offer to fund Smith Ventures’ idea with debt; we give it a loan or buy a bond, which is the same thing except a bond can be more readily sold to someone else. When we do this, the asset we own is the loan we made or the bond we bought and Smith Ventures is described as debt financed. We would, on an agreed date, get our money back with interest. We, the debt financiers, get a fixed return and Smith Ventures pays a fixed price for its funding.

If we want to fund Smith Ventures with equity, we would do so by buying shares; the shares would represent a stake in the future value of the company. After buying the shares the asset we own is equity and Smith Ventures can be described as equity financed. From then on, Smith Ventures has to pay us a share of the profit, after the debt financiers have been paid; an arrangement that carries on for as long as the orchard keeps growing apples. We have bought a share in Smith Ventures’ success – forever.

Smith Ventures, of course, is earning the profit from the orchard and so the value of the orchard, what accountants would call the underlying asset, is the factor that’s really increasing in value. In fact, the value of the company’s equity could be said to be the difference between the value of the orchard minus the value of the company’s debt – just as it was with our house. As the orchard makes more money so its value goes up. The value of the debt remains the same, however, so the value of the equity in Smith Ventures rises even more. The increase in the value of the orchard, because the genetic technology works, is completely reflected in the value of the equity.

This is, by necessity, an overly simple portrayal but whatever complex structures and instruments the financial industry invents, whether in a large public corporation or a private business, this is, in essence, how we finance everything.

A house with an orchard

When people talk about assets, especially with respect to inequality, they generally bundle them all together; houses, bonds, cash, equities, pensions, mutual funds, investment trusts, gold, silver, rare stamps, fine art and jewellery are all one and the same. They are simply added up when we compare the wealth of one family relative to its neighbours.

In reality, not all assets are the same. Take the house we bought earlier for £100,000. The house’s price, or as we would normally say, value, might increase but unless we spend more money on improving it, it remains the same house for the time we own it.8

Now take Smith Ventures. Suppose it grows its orchard and starts to yield and sell even more apples than it thought it would – its new technology turns out to be even better than at first thought. With the additional revenue it can plant more apple trees, or perhaps further develop its technology; the asset, the orchard, starts to grow in value.