Power & Market
The hypocrisy of the EU in two images.
“EU to impose duties on U.S. imports Friday after Trump tariffs”...
From Daniel Lacalle's Twitter @dlacalle_IA
Must Free Trade Be Reciprocal? by Frédéric Bastiat
Free Trade versus "Free Trade" by Peter Klein
In a constantly changing media landscape, the value of the shock political poll continues to stand the test of time. Whether it comes in the form of man-on-street interviews, or the slightly more scientific polling firm, seeing a surprising number of Americans give their support to an outlandish position is an evergreen idea to spawn clickable blog posts and perhaps even a spot on Drudge Report. Going beyond the obvious question of why, given the state of American politics, anyone continues to find humorous outcomes from these quasi-ballots is that sometimes they actually reveal a valuable insight about the public as a whole.
My personal favorite example was the 2015 PPP poll that found that 30% of the Republican base – including 41% of Trump supporters – endorsed bombing Agrabah, the country featured in Aladdin. Considering that online trolls were a natural core group of the Trump base, it’s fair to question the sincerity of the widely mocked poll’s findings. It does, however, correlate to another trend we see in public polling on military action. The Washington Post, for example, has found that Americans are more likely to support bombing a country if they couldn’t identify it on the map:
Does it really matter whether Americans can put Ukraine on a map? Previous research would suggest yes: Information, or the absence thereof, can influence Americans’ attitudes about the kind of policies they want their government to carry out and the ability of elites to shape that agenda….
The further our respondents thought that Ukraine was from its actual location, the more they wanted the U.S. to intervene militarily.
Given that, it’s not unreasonable to think that many Republicans really don’t mind attacking some random country with a vaguely Arab name. This would explain how some politicians still manage to find public favor, in spite of always being on the wrong side of history on matters of war.
Another valid insight couched in a poll shared for humor was an IPSOS poll that found Republicans have a more favorable view of Nancy Pelosi than North Korean dictator Kim Jong Un. Pelosi’s office naturally used the story to attack Trump supporters, with her spokesman telling The Hill:
On a daily basis, President Trump praises this dictator and thug so it only makes sense that his party is following his lead like lemmings over a cliff.
To be fair, the poll only compared generic favorability/unfavorability measurements to various other figures polled, with Pelosi only being seen a slightly less favorable to Kim. That being said, it would be reasonable for more Republicans – or Americans broadly – to find Pelosi a greater threat to their livelihood to than Trump’s latest bromance.
After all, for all the warnings about North Korea and its nuclear arsenal, the danger of it being wielded against American citizens is about as valid as fears about Saddam Hussein. Meanwhile Pelosi, and the rest of Washington for that matter, poses a very real threat to the life, liberty, and property of Americans on every day. While earnest human rights activists would undoubtedly point to the repulsive horrors of the Kim regime, Pelosi’s support for the Iraq War and other American escapades makes it difficult to defend her on even broad utilitarian grounds.
So yes, any American would be justified in hating Nancy Pelosi or just about any other politician in Washington. At least Kim has agreed to shake the hand of peace, something Congress is entirely unwilling to even consider.
Attorney General Eric Holder arrives today in Ferguson, Missouri, in response to the unrest after a local policeman shot 18-year-old Mike Brown. Holder assured the people of Missouri: "Our investigation into this matter will be full, it will be fair, and it will be independent."
But Holder's own record belies his lofty promise. As the U.S. Attorney for the District of Columbia from 1993 to 1997, Holder was in charge of policing the local police. When police violence spiraled out of control, he did little to protect Washington residents from rampaging lawmen.
The number of killings by Washington police doubled between 1988 and 1995, the year 16 civilians died due to police gunfire. Washington police shot and killed people at a higher rate than any other major city police department, as a Pulitzer Prize-winning Washington Post investigation revealed in late 1998. The Post reported that "Holder said he did not detect a pattern of problematic police shootings and could not recall the specifics of cases he personally reviewed." Holder declared: "I can't honestly say I saw anything that was excessive."
There was such a dearth of oversight from Holder's office that Washington police failed to count almost a third of the people killed by their officers between 1994 and 1997. Even when police review boards ruled that shootings were unjustified or found contradictions in officers' testimony, police were not prosecuted. In one case, a police officer shot a suspect four times in the back when he was unarmed and lying on the ground. But Holder's office never bothered interviewing the shooter.
Some of the most abusive cases involved police shooting into cars - a practice which is severely discouraged because of the high risk of collateral damage. Holder told the Post: "I do kind of remember more than a few in cars. I don't know if that's typical of what you find in police shootings outside Washington" Actually, "more than 50 officers over five years had shot at unarmed drivers in cars," the Post noted, and Washington police were more than 20 times as likely to shoot at cars than were New York City police. Reports about some of the shootings were tainted by police perjury.
Shortly after Holder became U.S. attorney, a local judge slammed the Washington government for its "deliberate indifference" to police brutality complaints.
Read the full article at the USA Today
What should politically vanquished people do? Should they resist the political status quo no matter what, or accept it in the spirit of civil comity and bide their time for the next election? What if their political fortunes are waning, and they are ever less likely to prevail politically? What rights and power do seemingly permanent political minorities (e.g. libertarians) possess? At what point is open rebellion permitted in a supposed democracy, and how do we judge principled resistance as opposed to sour grapes from political losers?
Furthermore, what can political majorities rightfully do-- in spite of a minority's strident opposition-- and what policies cannot be altered regardless of majority consensus? What spoils rightfully belong to political victors, and what longstanding rules should not be upended?
These are uneasy questions in the Age of Trump, especially since western governments long ago abandoned constitutional restraints and the cliched "rule of law" in favor or administrative governance by bureaucratic managers. Democracy, at least the mass variety practiced in modern western welfare states, provides no satisfactory answers. Are those unelected managers bound by popular will, or much of anything? What restrains the state?
Ludwig von Mises, a robust social theorist in addition to his staggering work in economics, saw these issues clearly. Despite--or perhaps because-- he witnessed the ravages of actual combat in the Great War, he chose to use the language of warfare in describing the plight of political minorities:
It was liberalism that created the legal form by which the desire of the people to belong or not to belong to a certain state could gain expression, viz., the plebiscite. The state to which the inhabitants of a certain territory wish to belong is to be ascertained by means of an election. But even if all the necessary economic and political conditions (e.g., those involving the national policy in regard to education) were fulfilled in order to prevent the plebiscite from being reduced to a farce, even if it were possible simply to take a poll of the inhabitants of every community in order to determine to which state they wished to attach themselves, and to repeat such an election whenever circumstances changed, some unresolved problems would certainly still remain as possible sources of friction between the different nationalities. The situation of having to belong to a state to which one does not wish to belong is no less onerous if it is the result of an election than if one must endure it as the consequence of a military conquest... To be a member of a national minority always means that one is a second-class citizen. (italics added)
The almost unbelievable rancor surrounding the Trump administration demonstrates precisely how little even rich westerners really revere democracy when they don't like its results. Anti-Trump forces indeed consider themselves conquered, feeling suddenly like second-class citizens in a country they thought they knew (one where an inevitable "progressive" arc would of course elect Ms. Clinton). They don't accept Trump any more than they would accept the head of a hostile and occupying foreign power. But rejecting the outcome of elections is strange position for Clinton supporters, a candidate who frequently gushed about "our sacred democracy."
The same can be said for the Brexit referendum in the UK and rising anti-immigration sentiment across continental Europe-- both pilloried as sinister and ill-intentioned populism as opposed to noble expressions of "the people" exercising their democratic rights. But populism is just democracy delivered good and hard, and technocratic administrators are correctly portrayed as gross hypocrites who use the veneer of democratic support only when it bolsters what they plan to do anyway.
Democracy, far from yielding compromise and harmony, pits Americans against each other while creating a permanent bureaucratic class. All of this is understandable and predictable from a libertarian perspective. Only libertarians make the consistent case against democratic mechanisms, and consider freedom from state power as far more important than majority consensus. Freedom isn't up for a vote, as the hopeful saying goes. Liberty-- properly understood as nothing more and nothing less than freedom from the state-- is the highest political end.
But we don't live in a free world, and most people are not ideological libertarians. Most people, though far less thoughtful, are (small d) democrats like Mises himself. In the interwar years, following the collapse of European monarchies and the rise of Nazism in Germany, Mises saw democracy as nothing short of the societal mechanism for avoiding further wars and bloodshed:
Democracy is that form of political constitution which makes possible the adaptation of the government to the wishes of the governed without violent struggles. If in a democratic state the government is no longer being conducted as the majority of the population would have it, no civil war is necessary to put into office those who are willing to work to suit the majority. By means of elections and parliamentary arrangements, the change of government is executed smoothly and without friction, violence, or bloodshed.
Nearly 100 years later we might wonder if he would still write those words today, having seen the 20th and now 21st centuries unfold. In hindsight they seem unduly optimistic. We'll never know, of course. and even the most doctrinaire anarchist can admit democracy played a part in the success of America and the West.
But there have been both literal and figurative casualties along the way, and more will become apparent in the coming decades. The elite western consensus, favoring globalism, a vague "neoliberalism," and social democracy will butt up against nationalist and breakaway impulses. Whether "democracy" will be permitted when it goes against elite sentiment is very much an open question, and people are not so easily fooled that globalist projects are in any way democratic.
It's vitally important to understand that Mises saw self-determination as the highest political end, and thus strongly argued against universalism and in favor of political subdivision wherever needed and feasible. Reordering political arrangements by creating smaller units, or abandoning them altogether via secession, was Mises's answer to the question of how political minorities could be protected. Breakaway movements were the safety valve in Mises's conception of democracy:
The right of self-determination in regard to the question of membership in a state thus means: whenever the inhabitants of a particular territory, whether it be a single village, a whole district, or a series of adjacent districts, make it known, by a freely conducted plebiscite, that they no longer wish to remain united to the state to which they belong at the time, but wish either to form an independent state or to attach themselves to some other state, their wishes are to be respected and complied with. This is the only feasible and effective way of preventing revolutions and civil and international wars.
At some point Americans of all ideological stripes have to ask themselves a question: if one really believes 30 or 40 or 50 percent of the population is beyond redemption, utterly immoral, stupid, fascist, racist, or communist, what should be done? Should they be killed? Deported? Herded into camps? Re-educated against their will until they vote correctly? Forced into low-caste status, politically, socially, and economically? Tolerated, but punished in future elections?
Or should we listen to Mises, and elevate political separation, federalism, and localism to the highest political principles?
Top-down rule from DC isn't working, and in fact it's making people miserable and ready to think unthinkable thoughts about civil war. Pro-Trump and anti-Trump sentiment is destroying social cohesion, the real "law" in any society. And for what? Miniscule policy differences between two parties that will never lift a finger against war, state power, entitlements, or the Fed?
It takes 70 million votes to control the White House, and the (deep) administrative state may be beyond the reach of even an overwhelming political majority. No matter where you sit ideologically, the risk of becoming a marginalized political minority grows as state power grows. It is time to stop trying to capture DC and start talking about realistic breakaway or federalist solutions, even under the umbrella of an ongoing federal state. The elections of 2018 and 2020 won't settle our problems, but only make them worse. At least 50 or 60 million Americans, a group far larger than most countries, will be politically disenfranchised and ruled by a perceived hostile government no matter what candidates or parties prevail.
If breaking up seems unthinkable, so does civil war. Is it written in stone that 330 million people must live under one far-flung federal jurisdiction, no matter what, forever?
Dr. Guido Hulsmann joined the Tom Woods show last week to discuss his work on the cultural and political consequences to inflation - a subject often neglected by most economists.
To read more about Dr. Hulsmann's work on the topic, check out his book The Ethics of Money Production.
When I was in Congress and had to regularly fly between DC and Texas, I was routinely subjected to invasive “pat-downs” (physical assaults) by the Transportation Security Administration (TSA). One time, exasperated with the constant insults to my privacy and dignity, I asked a TSA agent if he was proud to assault innocent Americans for a living.
I thought of this incident after learning that the TSA has been compiling a “troublesome passengers” list. The list includes those who have engaged in conduct judged to be “offensive and without legal justification” or disruptive of the “safe and effective completion of screening.” Libertarian journalist James Bovard recently pointed out that any woman who pushed a screener’s hands away from her breasts could be accused of disrupting the “safe and effective completion of screening.” Passengers like me who have expressed offense at TSA screeners are likely on the troublesome passengers list.
Perhaps airline passengers should start keeping a list of troublesome TSA agents. The list could include those who forced nursing mothers to drink their own breast milk, those who forced sick passengers to dispose of cough medicine, and those who forced women they found attractive to go through a body scanner multiple times. The list would certainly include the agents who confiscated a wheelchair-bound three-year-old’s beloved stuffed lamb at an airport and threatened to subject her to a pat-down. The girl, who was at the airport with her family to take a trip to Disney World, was filmed crying that she no longer wanted to go to Disney World.
The TSA is effective at violating our liberty, but it is ineffective at protecting our security. Last year, the TSA’s parent agency, the Department of Homeland Security (DHS), conducted undercover tests of the TSA’s ability or detect security threats at airports across the country. The results showed the TSA staff and equipment failed to uncover threats 80 percent of the time. This is not the first time the TSA has been revealed to be incompetent. An earlier DHS study fund TSA screenings and even the invasive pat-downs were utterly ineffective at finding hidden weapons.
The TSA’s “security theater” of treating every passenger as a criminal suspect while doing nothing to stop real threats is a rational response to the incentives the TSA faces as a government agency. If the TSA puts up an appearance of diligently working to prevent another 9/11 by inconveniencing and even assaulting as many travelers as possible, Congress will assume the agency is doing its job and keep increasing the TSA’s budget. Because the TSA gets its revenue from Congress, not from airline passengers, the agency has no reason to concern itself with customer satisfaction and feels free to harass and assault people, as well as to make lists of people who stand up for their rights.
Congress should end the TSA’s monopoly on security by abolishing the agency and returning responsibility for security to the airlines. The airline companies can contract with private firms that provide real security without treating every passenger as a criminal suspect. A private security firm that assaults its customers while failing to detect real dangers would soon go out of business, whereas the TSA would likely have its budget and power increased if there was another attack on the US.
If shutting down the TSA is too “radical” a step, Congress should at least allow individuals to sue TSA agents for assault. Anyone who has suffered unfair treatment by the TSA as a result of being put on the “troublesome passengers” list should also be able to seek redress in court. Making TSA agents subject to the rule of law is an important step toward protecting our liberty and security.
In 2015, the Texas State government announced plans to create a "gold depository." At the time, we reported this could be a significant step toward wider use of gold and silver as legal tender by essentially creating a parallel banking system based on precious metals.
The basic idea has always been simple: create a place where gold and other precious metals could be stored. The implications, however, are for far ranging in that over time, such an institution has the potential to function as a bank that could potentially offer the ability to facilitate the use of gold as money.
Existence of the depository opens up the possibilities for users creating a new type of currency in which purchases are made electronically with the backing of the gold in the depository. In other words, one could potentially use the depository's infrastructure to make purchases using gold, and to have gold either directly deposited into another's account, or converted to US dollars and deposited in a conventional bank. Arguably, this is just an electronic version of gold-backed money.
And now the Texas Bullion Depository has opened for business. The Ft Worth Star-Telegram reports :
The Texas Bullion Depository opened in Austin Wednesday, three years after state lawmakers signed off on creating an official place for people to store their gold and other precious metals.
“We’re proud that the nation’s first state-administered bullion depository is now a reality — this is a big day for Texans who want to secure their precious metal assets,” said Texas Comptroller Glenn Hegar , who became the depository's first customer this week. “I deposited some gold."
The article notes that gold deposits are verified and insured.
Although administered by the State of Texas, the depository is significant as an institution that provides a means of storing what are potentially highly liquid assets outside the US banking system regulated by the Federal Reserve and the US federal government.
Moreover, as the article notes,
Financial institutions, cities, school districts, businesses, individuals — even other countries — could do business with the depository.
The depository is funded by fees, and in a normal world, this might act as a significant disincentive to using the depository's services. But in a world of enduring near-zero interest rates, the opportunity cost of not keeping money in a bank has become especially low. If banks were paying, say, three percent on savings accounts, cash would look a lot more lucrative. But when banks won't pay even one percent on deposits, you're not missing out on much by putting some wealth in the form of gold into a depository.
Response to the depository in the media has been generally muted outside Texas, although New York lawyer Joe Patrice did see the implications of the depository, and emotionally condemned the idea , claiming that it violated the so-called "supremacy clause" of the US Constitution. Couched placed between several insults directed at Texans, Patrice writes:
Though this does bring us to the actual reason for the bill: a symbolic gesture to convince morons that Texas is an independent realm...Having their own money bin and currency system — writing checks based off stockpiled metals creates, for all intents and purposes, an independent, gold-backed currency — goes a long way toward fluffing the illusion that Texas holds sway over the rest of America.
Of course, the depository doesn't violate any provision of the Constitution, and invoking the phrase "supremacy clause" is just the usual M.O. of people who don't want anyone doing anything anywhere without the explicit approval of the federal government.
If anything, with the depository, Texas is moving in the direction mandated by the US Constitution in which, as Bill Greene notes at mises.org, contains a negative mandate in which “No State shall... make any Thing but gold and silver Coin a Tender in Payment of Debts.”
Not that something is necessarily good because the US Constitution says so. The Constitution was, after all, primarily adopted to increase the power of the federal government. That's why the anti-federalists opposed it.
The state legal tender provision, however, reflects the 18th-century wisdom that government money unmoored to commodity money empowers governments at the expense of ordinary people.
It will be interesting to follow the Texas experience in this regard and see what effect, if any, it has on other state legislatures that have also expressed interest in expanding the use of gold and silver as legal tender. We have already seen a number of states, including Arizona, Idaho, Utah , and Wyoming.
The biggest potential downside, of course, is the risk of the federal government outlawing and seizing gold as it did in the 1930s.
Yesterday’s Inspector General report on the FBI’s investigation of Hillary Clinton contained plenty of bombshells, including a promise by lead FBI investigator Peter Strzok that “We’ll stop” Donald Trump from becoming president. The report reveals how unjustified secrecy and squirrelly decisions helped ravage the credibility of both Hillary Clinton’s presidential campaign and the FBI. But few commentators are recognizing the vast peril to democracy posed by the sweeping prerogatives of federal agencies.
The FBI’s investigation of Clinton was spurred by her decision to set up a private server to handle her email during her four years as secretary of state. The server in her Chappaqua, N.Y. mansion was insecure and exposed emails with classified information to detection by foreign sources and others.
Clinton effectively exempted herself from the federal Freedom of Information Act (FOIA). The State Department ignored 17 FOIA requests for her emails prior to 2014 and insisted it required 75 years to disclose emails of Clinton's top aides. A federal judge and the State Department inspector general slammed the FOIA stonewalling.
Clinton’s private email server was not publicly disclosed until she received a congressional subpoena in 2015. A few months later, the FBI Counterintelligence Division opened a criminal investigation of the “potential unauthorized storage of classified information on an unauthorized system.”
The IG report gives the impression that the FBI treated Hillary Clinton and her coterie like royalty — or at least like personages worthy of endless deference. When Bleachbit software or hammers were used to destroy email evidence under congressional subpoena, the FBI treated it as a harmless error. The IG report “questioned whether the use of a subpoena or search warrant might have encouraged Clinton, her lawyers ... or others to search harder for the missing devices [containing email], or ensured that they were being honest that they could not find them.” Instead, FBI agents worked on “rapport building” with Clinton aides.
Read the full article at USA Today
The $85 billion mega-merger of AT&T with Time Warner appears headed for consummation, which will create another big digital media company with telecom underpinnings. But will this endless scramble for eyeballs and clicks, the quest to determine which platforms finicky content consumers will choose in coming years, actually create any value for shareholders? Or will it end up like the AOL/Time Warner merger of 2000, a poster child for unduly optimistic predictions about the value of merging technology platforms?
Beyond digital media companies, questions loom about the booming M&A market in general. Is the world of deals mostly malinvestment, as David Stockman charges, or does at least some transaction activity represent organic and healthy allocations of capital? Are company valuations and purchase prices completely out of whack, due to a Fed-juiced equities market? Do stock buybacks, creative recapitalizations, and listless horizontal mergers attempt to create ersatz "financial" growth in lieu of the real thing?
All of these are open questions, and mises.org readers need no explanation of how central banks and low interest rates create malinvestment. But (cue movie trailer voice) in a monetary world controlled by central banks, the damnable answer is we can never know. That is precisely Stockman's point: because the Fed controls the most important price in the economy — the Fed Funds rate — it's impossible to know the true price of anything.
Value is subjective, and supply and demand drives prices. But both measures are expressed in dollars.
So the brilliant young tech kid who gets $30 million from a VC fund for a great new idea may have created value for society that justifies it — or may be the lucky recipient of cheap shotgun money, spread around by yield-chasing fund managers hoping whiz kid's idea pays 20X or 50X to cover losses elsewhere.
This is true of all speculative markets, to be sure. VC, M&A, and equity markets would have uneven distributions of winners and losers without the Fed. But one of the big problems with central banking generally is this: when you manipulate the cost of money and credit, you necessarily manipulate that distribution. This strengthens the perception that wealth is a rigged game, and in fact actually creates an undeserving class of Fed-connected elites in heavily "financialized" industries.
One company hoping to cash in on easy money is Vice Media, a rough and tumble media platform focused on the advertising cliche known as the "youth market." You may have happened across Vice.com, or seen their ubiquitous videos on airlines or your social media feeds. The slant is decidedly leftwing, which is no surprise, but also fairly interesting — one recent video highlighted the tragic history between Haiti and the Dominican Republic with compelling on-the-ground storytelling.
Still, it's a niche brand at best. So imagine thinking Vice.com is worth several billion dollars, ranking it among the most valuable private companies in America. Imagine thinking it will soon be worth $50 billion, perhaps within a decade. Imagine thinking the company is wildly undervalued, so that you pull $70 million in spare change from your back pocket and invest in something you don't quite understand but imagine represents youth and revolutionary thinking.
We might call such a person a fool, someone suffering from historical amnesia when it comes to the dot.com and housing bubbles, who forgets the importance of fundamentals and real earnings in overvalued companies. We might call them a sucker who deserves to lose money. Or we might call them a genius, if it all works out. In fact that $70 million investor back in 2012 was no less than Rupert Murdoch — by all accounts a brilliant and shrewd media mogul, not to mention hard nosed investor. And he's not alone, as a very serious private equity player — TPG — invested $450 million just a year ago.
Fast forward to today, and Vice Media is reeling from a combination of lagging revenue, a confusing array of platforms, and the struggle to figure out millennial TV habits. So the next round of Murdochs and TPGs might not be easily identified.
Vice, mind you, produces "content" rather than tangible goods or services. And not just any content, but edgy content, which requires an almost preternatural understanding of the shifting social media and hipster landscapes. Edgy is amorphous, and quickly lost. Worse yet is the risk of a stale company imagining it's still edgy, i.e., lacking self-awareness. Now-shuttered Rare comes to mind, as does the struggling Buzzfeed.
All of this suggests Vice needs the right people, and a constant new stream of them, to stay relevant. This is a tall order even in the older, slower print world, as anyone familiar with Rolling Stone or Spin can attest. So investing in Vice truly means investing in people, like its wild man founder Shane Smith, not management, products, brands, processes, or systems. And people are notoriously unreliable.
Rupert Murdoch and TPG should be worried.
Addendum: the deal world today is not just a large-cap, headline-making phenomenon. Deal activity across company sizes is robust, both in terms of volume and value, despite cooling somewhat from a recent 2015 peak. M&A buyers spend nearly $5 trillion annually, more than $1.5 trillion of it in the US.
The two primary categories of M&A distinguishes between "strategic" and "financial" buyers.
Strategic acquisitions involve existing corporations scooping up competitors, new service lines, new brands, or new technology, with the goal of greater vertical integration and the economies of scale and management such integration makes possible. "Synergy" is the awful buzzword frequently used to describe big corporations either merging with a similarly sized company, snapping up smaller bolt-on businesses as subsidiaries, or absorbing established companies to fill holes in their product and service offerings.
Vertical integration, however, comes at a potential price. As Rothbard posits in Man, Economy, and State, corporations that become too large and dominant in a field risk losing perspective on profit and loss with regard to their intra-subsidiary transfer pricing, the amount each subsidiary "charges" the others for goods and services. Corporate executives who buy up too many similar companies might find themselves with imperfect information about internal profits and losses, and thus (like Soviet planners) become unable to allocate resources and price end goods/services effectively.
As a general rule strategic buyers are less sensitive to interest rates and central bank signals, because big existing corporations often bring cash to the table or swap their own valuable stock. When Amazon simply plunks down $13.7 billion in cash to buy Whole Foods, it's not doing so to make a quick buck or even take advantage of low interest rates (though it did issue corporate debt to raise some of the money). It's not openly engaging in the kind of financial engineering David Stockman decries, although he does frequently criticize Amazon's lack of profits and dividends relative to its sky-high P/E ratio. In essence, strategic buyers (especially public corporations) often have the luxury of long-range decision-making.
Financial buyers, however, generally consist of private equity or venture funds whose investors want to buy a company and sell it within a three to five year window. As Peter Thiel describes in Zero to One, for every investment that hits, most will fizzle. So the goal is to avoid too much downside risk while biding time to unearth the big winning investment — a story Thiel knows well from his experience with PayPal, Ebay, and Facebook (note that private equity firms often invest in large public companies; the strategic vs. financial distinction is based on the identity of the buyer rather than the target entity).
During the heady go-go years of private equity M&A, from the mid-1990s until the Crash of 2008, Alan Greenspan and Ben Bernanke demonstrated their commitment to making credit cheap and easy, and to making sure stock markets didn't crash. So private equity players responded rationally, buying up companies with 1 part equity to 6, 7, 8, or more parts debt. Often the 1 part debt was divided into tranches and split between various funds, isolating the risk of losing equity even further.
Keep in mind most corporate interest payments are deductible for tax purposes, while dividend payments are not. So it made sense to load up a company with cheap debt, and use revenue to pay off that debt quickly (while deducting the interest portion) rather than funding non-deductible capital expenditures to improve future productivity. Why worry about capex, product development, or improving factories when you plan to sell the company in three years anyway? Load it up with debt, fire existing management, install overseers, put every available dollar toward debt service, and get out before any long-term cracks began to show. After all, there was always another private equity firm (or IPO) waiting to buy.
This model is what propelled Mitt Romney from being merely a rich man to being a very rich one.
It's hardly surprising that fund managers and corporate CEOs developed a short-term mindset: monetary policy almost demanded it. And it's hardly surprising that enterprise values rose to crazy heights, with many financial deals closing for a purchase price of 10 or 12X earnings.
It was all driven by cheap credit, and it all came crashing down in 2008. But if M&A volume is any indicator, we haven't learned a thing.