We are here in Normandy with a group of family office investors. These are people who invest for a long time and tend to care less about making money than about not losing it.
We gave them a speech this morning, the gist of which was that we live in a world so crazy that only a crazy person can understand it and only a half-wit would trust it.
Yesterday, the half-wits boosted US stocks by another 98 Dow points. Gold rose too, uncharacteristically, by $9.
Yesterday, too, the Europeans made a mad, mad world a little madder; they moved from Zirp to Nirp. That is, real interest rates are falling from zero to less than zero, under a negative interest rate policy.
The US is still operating a Zirp system – officially. But unofficially major borrowers get their money at rates that are substantially lower than consumer price inflation.
Take IBM, for example. Its bonds, maturing in 2017, yield 1.78%. Officially, the CPI is about 2%. But when MIT measured inflation, without using adjustments and fudges, it came up with a rate of 3.91%. This makes IBM a Nirp borrower, actually earning more than 2% on ever dollar it borrows.
IBM is also a big buyer of its own shares. In fact, it may be the biggest buyer of its own shares. For every dollar it spends on genuine capital investment – in new machinery and facilities – it spends $8 buying its own shares.
This gives us an idea. Want to make beaucoup money? Start a company. Borrow money. Buy your own shares.
Everybody does that, right?
But our innovation is this: buy your own products too!
Follow the lead of the internet companies. Invent some social media so new and so revolutionary that nobody ever heard of it. Raise $1 billion by selling bonds to the public. You have no credit and no credibility? No worries. The companies that have done best lately are those with the worst credit, according to Bloomberg. These ‘balance sheet bombs’ have benefited most from Zirp, Nirp, and collapsing spreads. Everybody wants high yield. And nobody believes the Fed will allow debtors to fail. It follows then that a new company with no track record, no real product, no profits, no sales, and no business plan should have the very worst credit rating possible… and should therefore be a cinch to get plenty of credit.
So, say you have to borrow at twice the rate of IBM – let’s say 4%. With a real inflation rate of 3.91%, you’re getting money for essentially nothing. But you still have to make debt payments.
You borrow $1 billion. You have to pay $40 million in annual interest. But you take the $1 billion and use it to buy your products (whatever they are). Your company shows sales of $1 billion. You bring about 40% of that to the bottom line… giving you debt cover of ten times. This makes you one of the best credit risks on the market. Then, if your shares sell for 20 times earnings (modest for a tech company), the capital value of your company will soar by 20 x $400,000,000 = $8bn!
You see? You started with nothing. Through the magic of Zirp and Nirp, along with some accounting chicanery, you now have a company worth $8bn.
Sound crazy? Yes. And that is almost exactly what the Fed is trying to encourage. Companies borrow. They use the money to buy their shares. Stocks go up. This ‘wealth effect’ is supposed to trickle down to the public, who are meant to buy the corporations’ products. Rising sales will produce higher profits. Stocks will go up. Everyone will be richer.
The risk to the short-term investor may be that he misses out on this gay insanity. Asset prices go up; he wants to be a part of it.
The risk to the long-term investor arrives when the economy comes to its senses.