CHAPTER 8

CHAPTER 8

Conflicts in Capitalism: An American Tragedy

This three-act play is my attempt to capture the human drama in the battle between ultra-capitalism and democratic capitalism. The scene is set at a strategy meeting of a mid-sized U. S. company whose stock is traded publicly on the stock market.

Dramatis personae
CEO (Chief Executive Officer) Alan
CFO (Chief Financial Officer) Dick
COO (Chief Operating Officer) Pete
VP Marketing Sheila
Bud, Sheila’s brother, an Associate Instructor in Economics at the Community College

Act One

Scene: In the CEO’s office; on stage: CEO Alan, CFO Dick, COO Pete, and VP Marketing Sheila

CEO Alan: We’ll have our new CFO propose the mission for this discussion.

CFO Dick: Simply to study ways to enhance shareholder value. As you all know, we’ve done relatively well for years, and were sitting on a great deal of cash, but the analysts aren’t very excited about next year.

COO Pete: I thought our preliminary budget showed another 7% profit improvement.

CFO Dick: It does, Pete, but all five of our major analysts have already figured that into their projected earnings-per-share of $2.15 to $2.18, and all it has produced is a yawn. Four of five analysts have pegged us as a “hold.” One says we’re “fully priced” and are not expected to exceed the whole stock market’s movement next year. She’s recommending sell because she’s pushing a different industry as the hot stock pick.

VP Mktg. Sheila: We seem to discuss strategy in terms of what the analysts think or want. Shouldn’t we give some attention to our own market opportunities?

CEO Alan: Obviously. Go ahead.

VP Mktg. Sheila: Our new telecommunications package is going great, as you know. The next three years are our opportunity to go for market share. We’ve got about an 18-month lead on competition, but we need to blanket the market with major additions to our sales coverage.

COO Pete: Sounds great, Sheila. We’ve got the plant capacity. Load us up. Just give us a week’s notice before you double the volume!

[Laughter]

VP Mktg. Sheila: Don’t get too excited, Pete. The budget guidelines from Dick’s department allowed only a 5% increase in sales coverage; we need at least 20%.

CFO Dick: Do you want to blow our stock price? The Street isn’t impressed with $2.15 a share for next year. How do you think they’d react to another $2.03? We’ve been on the road for three weeks with our dog-and-pony show, trying to convince the analysts that our steady growth should produce a better multiple. At 15 times earnings, we’re way below the market’s average. Add your sales coverage, Sheila, bring in faster growth, but the same $2.03, and we’re dead. They’ll punish us with a drop in the multiple of at least three points. How would you like to explain how the stock that has finally cracked $30 goes back under $25?

VP Mktg. Sheila: That’s your job, but I’ll be delighted to help you tell the story. If we make the big move on this market now, then the effect in a few years will be earnings improvements up in double digits. How does 10-12% grab you for long-term earnings growth?

CFO Dick: Sheila, you need a course in Wall Street 101! Short-term for them is a week from Tuesday, midterm is the next quarter, long-term is next year. Besides that, what are you going to do for an encore? You add sales people for more coverage for a few years, get the market penetration, but then what are you going to do—grow with the market?

CEO Alan: That’s a good question, Sheila. Your market-growth plan is exciting, but it wouldn’t be prudent to lay on additional salespeople for a few years to gain greater market penetration, only then to have to cut back.

VP Mktg. Sheila: Let me answer—now we’re getting to the good part. For a couple of years, we’ve been developing a relationship with a skunk-works group out south of town. They are six design geniuses who opted out of the corporate world to concentrate on pure design. I think they’ve really hit it with a fully digital system that can be integrated into our telecommunications package beautifully. With this development, we can move out not months but years ahead of competition, including the Japanese.

COO Pete: I thought NAC just announced a new system with a lot of merchandising noise.

VP Mktg. Sheila: They did, but they opted for quick market entry, and their system is still partly analog. The skunk-works system, being fully digital, provides additional features and lower cost.

CEO Alan: How hard are your facts on that, Sheila? What’s the development status? Give us some ball-park numbers on what we need to invest.

VP Mktg. Sheila: OK, Alan. They have completed a breadboard design and have confirmed function and theory. To move from breadboard to a fully producible design is going to be expensive. This is going to be really high-volume in time, but that means big capital investment up front to get

costs down. This group of designers recognizes that, along with the fact that they’re not manufacturing people. That’s why they’re shopping for a partner. They have even less interest in messing with the marketing.

CFO Dick: Do they want a partner or a sugar daddy? What kind of a relationship are they interested in?

VP Mktg. Sheila: It’s still being developed, but I think they’d like to sell 30% of their company for something like $25 million.

CFO Dick: $25 million for a gleam in the eye? Maybe they’d throw in the Brooklyn Bridge as part of the package!

VP Mktg. Sheila: Of course, they have no earnings; this is a start-up operation. But continuing, if we had rights to the product, including manufacturing rights, they’d want us to fund the remaining development, including capital equipment.

CEO Alan: Give us a ball-park, Sheila. Everything in—development costs, capital equipment, equity interest, market introduction, and working capital.

VP Mktg. Sheila: It would pretty much take care of that $125 million of cash that we’re sitting on.

CFO Dick: It’s not that simple. As you know, the costs that are chargeable to earnings will erode our e.p.s. further for the next few years. If $2.03 and a 12 multiple doesn’t scare you, imagine what $1.90 and a 10 multiple would do to our total market capitalization! Get out your calculator and figure out how much we’re talking about blowing.

CEO Alan: It’s a loaded question, Dick. If your premises are correct, with 70 million shares, our present market capitalization is $2.1 billion. With your cataclysmic projections, we’d blow that to $1.3 billion and change, and I’d be on a railroad to nowhere, picking tar and feathers off my tired body.

COO Pete: I feel like Alice in Wonderland, listening to this conversation. I’ve been with this company for 25 years, and I’ve never been more excited about a development breakthrough than the one Sheila has outlined. With fast changing technology, this would really put us ahead of the curve. But I’m afraid I’m too unsophisticated to understand why a commitment to that program would blow 40% of our market value. I would think that this prospect would enhance it.

I’ve put every nickel of my cash bonuses for 10 years into this company’s stock, as well as subscribing to the limit on the stock-purchase program. I’d be prepared to bet what really is my net worth on such an opportunity. If the money-changers and the analysts are too short-term to see that, the hell with them! Take the punishment for a few years, and then when the earnings go over $3 a share, tell them to stick it in their ear!

Besides that, your precious P/E ratio is another device that financial types use to fool people. I just saw a feature article in The Wall Street Journal that calls it “a moving target” and asks the question, “What is the P/E ratio?” Well, depends on what is meant by “earnings.” I liked the next line best: “Earnings before bad stuff.” I can remember Alan warning us about the non-repetitive annual events. Handling surprises was part of profit planning until you guys figured out how to x-out the bad stuff by changing definitions.

CFO Dick: I’m glad you prefaced your remarks with the confession of how unsophisticated you are, Pete. You’ve spent too much time on the factory floor. You’ve gotta pay attention to the big picture! If we sacrifice earnings momentum for a few years, then we’ll be on the hit list. The institutions, pension-fund managers, insurance companies, and mutual funds own over 55% of this company. They get measured and ranked annually by outfits like the Becker Median. If they saw an earnings shortfall coming, they’d hammer this stock so badly, we’d all be on that track to nowhere with Alan.

We’ve already been criticized for being too operations oriented. It’s part of our low multiple and why our company is valued at only fifteen times our earnings. Worse, the takeover guys would be salivating at the prospects of grabbing us, and the analysts would be feeding them information and cheering them on.

COO Pete: Yeah, I read one of those analysts’ reports. I never knew that “operations” was a dirty word until I read that. Alan brought you in, Dick, to provide some creative financial engineering—I guess that sounds a lot sexier than market growth and getting the cost-to-produce down. But just to show you how unsophisticated I really am, tell me how these institutions go around banging on companies for short-term earnings and, in many cases, pushing downsizing. They’re investing the workers’ money, aren’t they? Don’t they let the workers vote on whether they want to be downsized?

CFO Dick: Nothing is that simple, Pete. First, some of those institutions you’re blaming for the short-term pressure are the managers of our company’s pension fund. We had three of them in here last week for the quarterly review, and we dumped one of them because they missed the market last year. They invested in too many dull 15-multiple companies, like us, and missed the big move in hi-tech industries that now have an average multiple of over 40!

Some argue that the government blew it with ERISA back in 1974, when Congress forced full-cash funding of future pension obligations. I doubt that Congress knew what they were doing, but the law then sucked billions in growth capital out of companies and in effect gave it to Wall Street. A bull market is guaranteed when 100 billion dollars a year is added to the demand side.

VP Mktg. Sheila: It sounds like the government messed up the supply-and-demand equation.

CFO Dick: That’s basically what happened; besides, ERISA also scared the hell out of Directors. The government wrote the law as if all Directors were responsible for Studebaker’s going broke and stiffing the pensioners. Also, don’t forget that most pensions at that time were defined benefits. A retiree got a fixed amount, say $500 a month or whatever, no matter what the pension money had earned. In an up-market, the companies and the states thought this was a good deal. They said that since they had the obligation to pay the fixed amount, then all the extra gains from the stock market were theirs. Some hollered that it was the workers’ money, but they didn’t get very far. But don’t knock it; about four cents of our own earnings improvement last year was due to our reduction in pension expense. The market went up so much that we were able to drop our charge to earnings. It’s a big impact. A study a few years ago showed that 44% of corporate earnings improvement that year came from reduction in pension cost.

CEO Alan: I’m afraid Dick’s description is the reality, Pete. I happen to think that the government blew a beautiful opportunity—a plan that would have directed this cash to investments for job growth, not to the stock market, where most of it ended up pushing up stock prices. But that’s the way it is. Certain punitive clauses in ERISA suggested that Board Directors would be personally liable if they screwed up the return on the pension funds. The Directors wanted maximum insulation. Spell that: having the pension committee, made up of company officers, not Directors, turning over poor performers judged on short-term performance. The government loaded the gun, but corporate America pulled the trigger!

COO Pete: This whole mess goes back to plans badly designed by Congress, that’s what I get from what you’re saying, Alan.

CFO Dick: Alan’s right, Pete. Congress took ten years to design the plan and proved, one more time, that Congressional staffers and lobbyists are not good at designing anything that works.

VP Mktg. Sheila: It’s worse than that. I read in Fortune that the biggest part of the hundreds of billions of dollars lost on the S&L debacle was Congressional delay—for years! Then they proved that no matter how bad the problem, Congress could fix it and make it worse. When they finally got off the dime, they passed a new law that went so far in the other direction that they put good thrifts out of business.

CEO Alan: All interesting, but let’s wrap this up. We’ve got Sheila’s proposal on the table. Now let’s do our due diligence and see how we can pursue this opportunity without blowing the company. But we haven’t heard Dick’s proposal. In the interest of time, Dick, why don’t you lay out all the moving parts, then we’ll reconvene in two weeks for a fuller analysis.

CFO Dick: OK, Alan, I’ve got a tough package, but I think it makes sense in today’s hard-ball world. I’m a little reluctant just to lay it out without all the background music, but it’s your nickel, so here goes. First, the Georgia and California operations do not pass our hurdle rate for continued investment, even with a lot of depreciated equipment. Part of the benefit of the big bang approach is that we can pull into one year all of the costs of shutting those operations down over the next three years but write them off this year.

VP Mktg. Sheila: Pardon the interruption, but you have to help me with this big-bang stuff. Give us a short course on this astrophysical phenomenon.

CFO Dick: Sheila, for years, companies have struggled to add a few cents a share to earnings, impress Wall Street, and build up the stock price. Then, when the takeover guys came in, they taught us all a lesson. After taking over a company, they would make an enormous charge against earnings for one-time “restructuring,” a big-bang. This would set them up to look good for a few years just on the accounting treatment. They would always test the outside auditors and the SEC to see how far they could push the accounting-rules envelope. Part of the benefit was, of course, big savings on taxes.

COO Pete: We taxpayers subsidizing the speculators and deal-makers, again!

CEO Alan: Well, you’re at least partly right, Pete. Of course these deal-makers were all one-trick ponies. They knew that the easiest thing to do was to dump people. All you have to do is to act real nasty and say, “We’ve got 10,000 people, take it down to 9,000!” Capricious downsizing can help earnings only for a few years, but the damage it does can take five years to show up.

CFO Dick: That’s one scenario, Alan, but don’t you agree that there were plenty of situations where good companies had to make these moves in the face of tough world competition? Both downsizing and mergers were a matter of necessity.

CEO Alan: No question. As usual, the devil’s in the details. Some restructuring moves were motivated in the best interest of the company; many others used world competition as an excuse to pursue greedy goals. In these deals, money in incredible amounts rains down on everyone involved. A good rule, I find, to understand a situation like this, is to check the personal motivation of those involved: Follow the money! But go ahead Dick, push on.

CFO Dick: Whatever the motivations, everyone began to see the benefits of downsizing and the big write-off, the big bang. Those who were really struggling, the ones with weak earnings, and had Wall Street down on them, found downsizing very seductive. Why not? Announce a big lay-off, and your stock goes up a few points. Company executives like it because it both buys them time and makes them wealthier. In many cases, they write off more than their annual earnings — in some cases, as much as half their net worth. Some executives took a while to comprehend that putting all these big negative numbers on the profit-and-loss statement didn’t pull the house down; it was cheered by Wall Street.

VP Mktg. Sheila: It sounds like smoke and mirrors to me. Why is Wall Street so excited? Sounds to me as if they think that CEOs pass their manhood test by downsizing.

CEO Alan: As I said, with most of these questions comes the good, the bad, and the ugly. The availability of this accounting treatment for restructuring actually liberated some good companies to do necessary

things. In many other cases, it is as you say, Sheila, clearly smoke and mirrors, and it allows management to fool the stockholders for a few more years. Can we continue, Dick?

CFO Dick: OK, Sheila’s last two proposals have not quite made our hurdle rate, so they should be abandoned.

VP Sheila: Hey, wait a minute!

CEO Alan: Why don’t we let Dick finish?

CFO Dick: Thirdly, we’ve now finished our five-year integrated data systems program. We’re online with our dedicated satellite communications, and, most important, the whole company is on a single database. When this project was started, we had 13 different systems, from sales-prospecting to shipping. Now we’re able to realize the benefits and lay off hundreds over the next few years. Their severance costs will be packaged in the big-bang. You can figure what this will do to improve profits in the next few years along with a windfall in cash from lower taxes.

COO Pete: That sounds like a blood bath! You weren’t even here when that plan was laid out. It worked only because a lot of old dogs, starting with me, learned how to do new tricks. Most of our operating people went to training courses to learn how to assimilate this new technology along with doing their regular job. Fortunately, the hi-tech guys who came in knew from experience that if the new system weren’t adopted by operations as their own, it wouldn’t fly.

CFO Dick [Ignoring Pete]: Fourthly, the cost to produce in Ohio and Indiana has been going up for five years. Our major competitor has new plants in Mexico and Malaysia —they’re eating our lunch. We’d better wake up and smell the coffee and shut these operations down. The shutdown will cost roughly $35 million and take three years, but it can all be written off now, this year.

COO Pete: That’s all on top of the blood bath, right?

CFO Dick: Of course. Finally, the really big bang is when we take all of our savings on the layoffs, the tax savings, and the $125 million we’re sitting on, and we buy back our own stock. Depending on how much our stock moves on the announcement of this package, we could purchase millions of shares. In the magic of Wall Street, our new earnings could be $2.19, and our new stock price almost $33—unless we’re rewarded with a new multiple of 18, in which case our stock would be crowding $40! Even at $33, we’ve added over $200 million to our shareholder value.

COO Pete: This is obscene, Alan! Give us some time to respond to this tearing the company apart! You and I have spent our working lives building this company up. We’ve got great people, great spirit, and great opportunities. When this hot dog you insisted on hiring gets through with his razzle-dazzle, everything we’ve built will be gone. And me with it. Am I clear enough?

CEO Alan: Cool it, Pete! We all know it’s a hard, cruel world. We now have two proposals on the table. Let’s give them both a close look and reconvene in two weeks. OK?

COO Pete: I’d prefer to comment on this package while the flavor lasts. Leave this monster on the table, and it will start to grow.

CEO Alan: Meeting adjourned. You’ll be advised of a meeting time in a couple of weeks. Pete, you can be the lead-off batter at that meeting. Thanks, gang! That’s it for today.

Curtain

Act Two

Scene: At dinner in a restaurant; on stage: VP Marketing Sheila and her brother, Bud, Associate Instructor of Economics at the Community College

Sheila: Explain to me in simple terms, Bud, how building and selling things in a way that builds jobs is being dominated by those who make money on money.

Bud: I’ll give you a formula: EL+LS-MD = 2C.

Sheila: You forgot the simple! What the hell does that mean?

Bud: The formula is EL (excessive liquidity) plus LS (leveraged speculation) minus MD (market disciplines) equals 2C (two catastrophes). EL or “excessive liquidity” means too much money chasing too few legitimate opportunities. The biggest example is the trillions of dollars of the wage earners’ retirement money that the government gave to Wall Street to drive the bull market. It’s a paradox! Alan Greenspan and the Fed inflation fighters watch for the slightest evidence that factory workers’ wages are going up; at the same time, the government is passing laws that result in enormous asset inflation in stock values. This was the “excessive exuberance,” as Greenspan later called it.

Sheila: Are there other examples of EL?

Bud: Many. Every economic crisis in emerging economies from South America to Mexico to Southeast Asia started with excessive liquidity that put economic growth into overdrive. They call it “hot money.” It rushes into an economy in big quantities and funds risky projects and speculation, and then it rushes out so fast that severe damage is done to the economy and the people.

Sheila: Is there a solution?

Bud: Well, I’m not an expert on the international monetary system, but you would think that by now, bankers would know how to cooperate on judging the quality of loans. Isn’t that what they get paid for? Another banking no-no that has been violated regularly in these loans to emerging economies is lending this hot money for longer-term investment. You cannot have an economy depending on investment capital that can flee the country at the slightest threat of speculative attack.

Sheila: How do you control hot money coming from so many directions?

Bud: For every problem there is an international agency somewhere. They just need the will and the way. The International Banking Settlement Commission, or something like that, is in Basel , Switzerland . It could write new protocols for international lending on the debt-to-equity ratio.

Sheila: The what?

Bud: Debt-to-equity is a measurement that’s regularly applied to companies. If the percentage of impatient debt gets too high, compared to the percentage of patient capital or equity, then the rating companies downgrade the company. That makes it harder and more expensive for them to get more money, so the brakes get put on. A country’s bonds are rated, but I don’t think that there is any effort to keep tabs either on the amount of hot money pouring in or on its relationship to long-term, patient investment. A simple fix would be to require the banks to make long-term investments in these countries in some proportion to their short-term loans. I like built-in controls. This would make the bankers do their homework and direct the money to those activities that really build up the country.

Sheila: I started this, but now I know it’s too deep for me. I’m getting a headache!

Bud: That’s why I gave you the formula. It will make sense after we go through it a few times. Most people do not understand these arcane matters, and that’s why the Wall Street foxes have been in charge of the chicken coop for too long.

Sheila: All right, Professor, continue with the lecture! I’ve got a fox in my own chicken coop, and what I need is a good fox trap.

Bud: Let’s move on to LS for “leveraged speculation” or speculation with borrowed money. This borrowing privilege allowed by government regulation has been the cause of every economic problem in this country since the Panic of 1818. We have even more incredible stories now, though. Did you read about LTCM, the hedge fund, that took leverage to record levels? Would you believe they figured out how to make some bets when they did not use any of their own money? After they imploded, the Fed orchestrated a bailout on the usual pattern: Let finance capitalists screw up anyway they want, and then when the damage is too big to let them fail, bail them out!

Sheila: What’s a hedge fund?

Bud: It’s an investment pool for fat cats, throw in a million dollars and you can play. They use esoteric models designed by a bunch of Ph.D’s to make money on money. And boy, do they make money! Would you believe a 40% return for several years and located in the Cayman Islands so the fat cats paid no taxes on these big wins!

Sheila: If they are so smart, how did they screw up?

Bud: They forgot to put Russia ’s defaulting on government bonds into their model. A guy wrote a book called When Genius Failed.^{^[1]} Read it — it’ll make you cry!

Sheila: Incredible! But go ahead — you were giving me examples of LS.

Bud: The Crash of ‘29 is a good example. And so will the next one be. The leveraged speculation of the 1990s will be compared to the leveraged speculation of the 1920s. Think about when Alan Greenspan identified “excessive exuberance” in the stock market as the threat to the economy, and then think about what he did to respond to the threat.

Sheila: I can hardly wait. What did he do?

Bud: He raised the interest rate—it’s the only thing he thinks he knows how to do! But that hurt people such as young couples trying to buy their first house. What he could—and should—have done, instead, was raise brokers’ margins from 50% to say 75% of the speculators’ bet. This would have reduced the percentage that speculators may borrow to gamble with. That would have placed the cure where even Greenspan said the sickness was.

Sheila: That seems to make so much sense. Why didn’t Greenspan do that?

Bud: Greenspan? The water boy for ultra-capitalism? He would have lost his sainthood quickly if he had started cutting back on the ways to make money on money.

Sheila: So what’s the long-term answer to leveraged speculation?

Bud: I told you, I am not a finance expert, but for starters how about a simple rule: Speculators can bet all they want as long as they do it with their own money? This is probably extreme, but split the difference between my rule and the crazy stuff that is going on now, and maybe you’ll be making some sense.

Sheila: Great! That gets us back to simple. Now that I’m an expert on EL and LS, what is MD? Your formula is getting interesting.

Bud: MD is “market discipline,” the forces of competition and the fear of failure that monitor the free economy. You know the old formula that every freedom needs a discipline. It’s true in economic freedom, too. Wall Street has managed to lobby Washington to get the EL and LS, but their greatest merchandising job was to get rid of the disciplines that tended to get in the way of making money on money. The government invented the “too big to fail” rule for banks, took deposit insurance to new highs with the S & L debacle, and steadily found new ways to subsidize ultra-capitalists. One example was the “Greenspan spread,” when the Fed nursed banks back to health after another series of dumb loans by lending money to the banks at less than 3% when the banks could turn around and make over 6% by investing in government bonds.

In this crazy world of unreality, they call this problem a “moral hazard.” They borrowed the expression from the insurance industry as a more confusing way to say that they were trampling on the market disciplines upon which economic freedom depends.

Sheila: I can see the hazard, but where’s the morality? Does the government have a credit card that I can get some of this 3% money with? I’m tired of paying from 9% to 18%!

Bud: Start a bank, make tons of bad loans, and maybe you can get a shot at 3% money, but let’s get back to my formula. Follow the bouncing ball: First, the government allows EL, excessive liquidity, and then it stirs in a lot of LS, leveraged speculation. These in combination drive the economy up into the stratosphere. Then, after the inevitable climax and bust, the government says: “Gee, this is serious! We’d better get out the band-aids and patch it up.” Then they forget to determine what caused this out-of-control problem in the first place and walk away, leaving it ready to repeat.

Sheila: I don’t spend much time on these things, but I once saw a great picture of President Clinton and Secretary of the Treasury Bob Rubin traveling the world preaching the gospel of free capital as the way to world prosperity. It sounded wonderful, are you sure about raining on this parade?

Bud: They were quite correct in describing the potential benefits of free trade, but it got me mad when they contradicted their own gospel by abandoning the market disciplines. Back in the ‘90s, these two great salesmen convinced the emerging economies to take down all of their cross-border controls to let this capital roam freely. But they forgot to warn these emerging economies that when no one was looking, they had torn down the disciplines that make the system work. Within a couple of years after removing the controls, EL and LS struck and devastated defenseless economies and innocent people. No wonder Malaysia thought that they had been set up for a fall by a new kind of Western imperialism.

Sheila: Talking about insurance, subsidies, and bailouts I suppose that the taxpayer pays for all of this, one way or the other. Listening to you, I thought of a bumper sticker for the money-changers — try this: “Privatize the profits, nationalize the losses!”

Bud: You catch on fast. It’s good, but not original. Screwing the taxpayers in good ol’ America is bad, but it’s not so bad as the job done on the poor people, millions of them, in places like Mexico and Indonesia . The EL weakened their countries’ economies, and then the currency speculators with their LS attacked like sharks, sensing blood in the water. They drove the currency value down 70% in Indonesia and devastated the country. The American media helped politicize the problem, so most people never understood what had really happened. Now, it looks like it will take a generation to get Indonesia back on track, unless the country devolves further in the meantime.

Sheila: This is getting too complicated — let’s give it a rest! You’re throwing in things like “devolve” like I knew what it meant.

Bud: Stay with me, Sheila! “Devolvement” means that the attack by lethal finance imperialism destabilizes a country that was fragile to begin with, so that it ends up breaking into small pieces, many of them fighting with each other. Ethnic and religious animosities contribute to the problems, but the root cause is economic.

Sheila: Ah, Mr. Economics Professor, there you go again, sounding like Karl Marx.

Bud: Karl got a few things right, and this is one of them. The form of commerce that underlies human culture makes the difference in whether that culture progresses or not. Human progress is not possible unless a form of commerce superior to whatever was in place before lifts the culture into its next stage of development. It’s a Law of Nature!

Sheila: Or, at least, of Economics professors!

Bud: Touché! But listen, Sheila — you’re a big champion of human rights. Frankly, most of your protests back in college were all “sound and fury signifying nothing.” If you are really dedicated to human rights, think about how lethal finance capitalism deprived these millions of their basic rights for such luxuries as jobs, food, clothing, shelter, education, good health and hope for a better life for their kids. Then your protests will be getting real! But you have to do your homework first. Maybe we should require certification for protestors to make sure that they know enough about how the world works to protest. But we’ll save that for another dinner, after which we can organize protest marches on Wall Street and Washington—two sides of the same street, Ultra-Capitalist Avenue !

Sheila: I’ll be there! You have opened my eyes to a terrible human tragedy that, as you say, is not very well understood. OK, moving right along, what are the two C’s in your formula?

Bud: I’m not a mathematician, either, but that’s my way of calling attention to the two ways that EL+LS-MD adds up. It’s the two different catastrophes that have resulted and will result from domination by ultra-capitalism. One is the ongoing danger that the whole international monetary system will blow up some day. Despite all of the warnings, there has been no correction of root causes. Too many people are making billions of dollars, pounds, euros, and yen on volatility for them to get serious about getting rid of the volatility.

The second dimension is slower, and for that reason it is more insidious. Financialization of the world’s economy gradually puts the system into irreversible decline. You can follow this phenomenon throughout history. As an economy shifts from building and selling things to financial services, it slowly loses its economic vitality. Another way of putting it is that it abandons Adam Smith’s dynamic. His progressive theory of commerce, according to which more volume drives the costs down, adding more volume, and so forth, doesn’t happen in financial services. As a matter of fact, financialization ignores Smith’s warning to beware of the “prodigals and projectors” who pull money away from growing the economy and put it into speculation.

Sheila: Sounds like there should be a lot of fire bells going off to warn people of this threat. How can all of this happen? I thought democracy was “of, for, and by the people,” and that federal laws reflect their “will and wisdom.” Whatever happened to the “general welfare?”

Bud: Sorry, Sheila, but bright people like you paid no attention to these matters. While you were protesting human rights abuses in China , you should have been spending your time learning how the system works in America , instead! It wouldn’t have been as much fun, but it would have been more meaningful. The most basic human rights are for everyone to have adequate food, shelter, clothing, good health, education, and hope for the kids.

Sheila: Don’t beat on me, Bud! The only thing I heard from my professors was how bad capitalism was. I never heard about the good capitalism. If you think that I should have gotten a functional knowledge of these financial matters from the educational process in a U.S. university, forget about it!

Bud: Right on! Nobody, not even my learned colleagues in the Economics Department, much less the Business School at the University, understand the connection between democracy and capitalism.

Sheila: Let’s get back to the formula. I know from my company how amazingly interdependent the world is now. As I understand these monetary matters, it has to be a spirit of collaboration: “We’re all in this together, gang, so let’s play by good rules and make it work!” How do you get governments, with their history of fighting over what they thought to be finite resources, to shift gears and support “the superior form of commerce,” as you call it, that can provide enough for everyone?

Bud: Good question. Right now, many governments are still playing politics with currency values and interest rates that should be harmonized for the world economy to work well.

Sheila: You keep slipping in these buzz words. “Harmony” — is this a music lesson?

Bud: In a sense, any activity to be governed works best in harmony; that’s a Law of Nature, too. It is really no different from a great symphony orchestra. In the international monetary system, it means harmonizing the vital economic signs of various nations in order to provide monetary stability. The need is for a way to change currency values automatically as national circumstances fluctuate. This will not happen so long as finance capitalists lobby the rules, and xenophobic politicians start fighting whenever they hear anything about “world order.” How-the-hell are we going to have a world economy that helps all people to live better lives without some order in the world? But we can’t go there tonight, right?

Sheila: Right. If I had known how heavy a load you were going to dump on me tonight, I would have had two martinis. But seriously, these matters are hitting me where I live. I love my job, but in our company, we seem to be struggling over this very conflict in capitalism, and the bad guys are winning. What’s the solution and where do we start?

Bud: I understand your frustration and I sympathize with you. Unfortunately, history shows that as long as ES and LS are not regulated, and MD has been suspended, the system will go up, up, and up until it bursts, and then it will go down, down, and down. In the up direction, the few make billions of dollars; in the down direction, many ordinary people get hurt. Did you ever hear of “the rich getting richer,” Sheila? Maybe this time, the downer will be so bad that people like you and me will cooperate on an agenda to fix the system. How about a radical motto like this: “Control currency and credit for the general welfare?” Come on, I’ll give you a ride home. You need your sleep; you’ve got a big meeting coming up, right?

Sheila: OK, let’s go! I need to be at the top of my game, tomorrow morning. But you’re right, so I’ll accept your offer of a ride, but this time we’d better walk the walk!

Curtain

Act Three

Scene: CEO’s office; on stage: CEO Alan, CFO Dick, COO Pete, VP Marketing Sheila

CEO Alan: OK, let’s go! Pete, you’re on.

COO Pete: I’ll work off my notes on this one. I’ve been working pretty hard since the last meeting, and hope I have organized a convincing position. After all, we’re only talking about the future of this great company.

CFO Dick: Don’t start with undocumented premises!

COO Pete: That never seems to bother you!

CEO Alan: All right, guys, let’s go!

COO Pete: Ten years ago, when Alan became CEO, and pulled me out of the plant to become COO, we had a decent company, but it had been around for a long time and our technology had tired blood. It worked, but in no way were we state-of-the-art. Our employees were also OK, but the majority were just putting in their time; they weren’t very turned on. The unions were spending their time on grievances, and they were never included in company planning. The marketing group was likewise OK, but about as exciting as the product line.

Alan changed all that. We had a simple plan: Invest in the people for better productivity and participation, and remember that our mission is to serve the customer—not just sell them, but serve them. Alan’s got some great buzz-words, but I think one of his best is “customer loyalty, not just satisfaction.” I was never keen on consultants, but the ones we had at the time gave us a good emphasis: “Beware of internalizing; build your company from the customer perspective.” The hardest ones to convince were the engineers. The new chip technology had gotten them so excited—what they could do with their chip—that they complicated the product with “freebies” that most customers didn’t want.

At any rate, we had an old market and reasonably satisfied customers, and we had some standard products with huge profit margins. These oldies-but-goodies weren’t going to be around too many more years, but they could sure spin off cash. We made reasonable earnings improvement—never worse than 5%, never better than 8%—because we were pumping so much money into product development and sales coverage. We got sales growth up to double digits, and we improved cash flow.

CFO Dick: You also got the analysts convinced that we didn’t know how to leverage the business. When sales are growing 10%, the analysts are looking for profits to grow something like 12%, not 8%. How long can you go with a sales growth greater than earnings growth? You also spent a lot on your profit-sharing plan. Giving money to the workers may make you feel good, Pete, but it’s a cost that most of our competitors don’t have. The analysts aren’t too keen on it, either.

COO Pete: I had planned to get to all those key areas, but you’ve interrupted. Perhaps just as well, as your business philosophy is so clearly contrary to mine. You have the benefit of advanced degrees, including a CPA and an MBA. I didn’t have an opportunity to go to college, but I’ll

bet I’ve read more than anyone else in the room. It took me a lot of reading and thinking to realize just how special this democratic republic of ours is. We really blazed a trail for the rest of the world.

CFO Dick: Is there a point here?

COO Pete: An important point! This country was built on freedoms. They are all important, but anyone who works for a living knows that without economic opportunity, the others are pretty hollow. Several of the books I’ve read talk about a social contract, how we’re all interdependent. The way I’ve always related this to my work and this company is to feel an obligation to grow the company by providing better opportunities for the workers and new jobs for new workers. This seems like such a fundamental obligation of a corporation that I don’t know why we’re deliberately destroying growth. All anyone talks about is e.p.s.! Why don’t we measure company performance by sales growth and cash flow instead of stock price? The more I listen to you, the more I’m convinced not only that e.p.s. is something only accountants understand but also that e.p.s. doesn’t even show an honest picture. You’re always talking about world competition. We’re bringing out great products, and with Sheila’s plan will bring out more. Our products are great because our quality keeps going up while the prices go down every year. The market doesn’t allow the big margins we used to get, but we’re holding our own in this tougher market. Isn’t that the way Adam Smith said it should work? Competition drives down prices for the benefit of the consumer, doesn’t it?

CFO Dick: Listen, Pete, I don’t see what all this flag-waving about the country and freedoms has to do with the problem at hand. And Adam Smith’s dead, isn’t he? Could you just get on with it?

CFO Pete: Sure, Dick, I’ll get on with it! Your comments on our profit-sharing and stock-purchase plans are stupid, too. To describe our plan as a giveaway shows particular ignorance of the facts. Profit-sharing and worker ownership is the best investment we ever made. It’s the basis of everything else. Your own finance people confirm the productivity figures, Dick. More important than that, everyone in the company is involved, and that’s why the products are so good. Our designers have learned that it’s not enough to make it work—it has to be producible for the lowest cost and at the highest quality. Our shop people work with engineering, now, as though they themselves had written Dr. Deming’s “Fourteen Points.”

CFO Dick: All with a cost! Our training and education budget is ten times what it was when you started this program. When will your people be trained enough to get some profit leverage there? And, Peter, I hope you’re not doing all this reading on company time! It’s a joke, it’s a joke! But who’s this Dr. Deming — your dentist?

COO Pete: [Ignoring the barbs] I’ll answer the training question first: We will never end our training program. With the product that Sheila has proposed, we will have to increase the budget. Incidentally, I thought Alan was nuts five years ago when he hired this little gal to run marketing, but it was a good move. She knows what she’s doing.

VP Mktg. Sheila: The “little gal” thanks you, Pete; your heart’s in the right place, so I’ve learned how to translate your language.

COO Pete: I’m not sure what that means, but we’ve got a great team. Dick, I can’t believe that you’re not familiar with Dr. Deming. What did you study to get that MBA? Maybe that’s your problem. Take off your green eye-shade once in a while and see what’s going on. W. Edwards Deming was a quality-control guru who couldn’t get a hearing with the Big Three car companies, so he put the show on the road and taught the Japanese how to do it. After they stuck it to us with cars with both fewer defects and hours to produce, the U.S. car companies became very interested. There’s nothing like a big loss of market share to get one’s attention. Dr. Deming proposed 14 points that come down to a few simple concepts: Build it right the first time; build—don’t try to inspect—quality into the product; get everyone involved and trained; and drive out the old-fashioned fear environment.

CEO Alan: Say a little bit more about the profit-sharing, stock-purchase plan, Pete.

COO Pete: With pleasure—it’s my favorite subject. As I think you all know, 80% of our employees, or “associates” as we prefer to call them, are regularly buying the company’s stock through a payroll-deduction plan. They have other options through their 401(Ks), but over half the money goes into our stock. It’s probably a safer idea to encourage them to diversify with the rest. The company matches this payroll deduction with a minimum of 20 cents on the dollar, and up to a 100% match when we meet tough goals. All of the company’s contributions are in stock. It’s a great plan and has changed the company.

Some people were a bit cynical about their involvement and cooperation, but when they saw people building serious net worth from this plan, they got interested and became converts. Some were amazed at how supportive the union officials were, but modern union statesmen recognize the connection between wages and job security on one hand, and quality and cost on the other. We have as high a participation in union plants as non-union. Grievances are almost a matter of history. The supervisors are trained to lead, not push, and problems are resolved on the spot and cooperatively.

One of the things that makes me most proud is that our associates now own over 10% of the company, and I hope that it will be 20% before I retire. Note carefully, Dick: They get nothing until they put up their own money. Most of them are raising families and are on tight budgets, but they dig down to enjoy that pride of ownership.

CFO Dick: Some people think that this company is in the Dark Ages. Instead of stock buy-backs, we dilute the stock with the profit-sharing plan; instead of stock options, we give stock grants that are both a charge against company profits and are taxable to those who receive them.

CEO Alan: All of those features were my decisions, Dick. We wanted a plan with discipline to it. A charge to earnings is just such a discipline; you don’t reduce profits casually. Also stock grants, being considered a part of total compensation, are taxable. The profit-sharing plan is the same one for everybody, managers and secretaries. It offers different levels of participation depending on the individual associates’ level of responsibility, but everyone understands the plan and that we’re all in it together. We can and do explain this to anyone. There is no criticism of fat-cat plans here. It’s part of the environment of trust. You can’t buy trust, Dick; you have to earn it. Why do you have a problem with this, Dick?

CFO Dick: The plan has some benefit, Alan, but stock grants and the technique of funding from the company’s stock drives me nuts. The earnings dilution, caused by steadily adding more shares and thereby lowering our earnings per share, is one of the reasons we have such a lousy multiple. Let me convince you that we should at least buy back the stock on the open market.

CEO Alan: Many associates elect to reinvest their dividends in more stock. This is low-cost, very patient capital to grow on, Dick. We just need to educate analysts better! The resulting productivity and innovation from the plan far exceed the dilution.

CFO Dick: Impossible! Anti-dilution is a matter of religious principle with them.

COO Pete: That’s their problem. Most of them have never been in a factory; no wonder they don’t understand it. Our plan has worked. We now have trained, motivated associates and the cash to make the big move that Sheila has outlined. Let me remind you that part of the profit-sharing spirit is a commitment to job security. It’s a best-effort commitment to use attrition and retraining instead of lay-offs. We even absorb part of the cost if an associate moves to another plant. This is important: The whole program was put in place on the basis of trust, fairness, and cooperation. I guess you could simply use Alan’s word and say it’s based on integrity.

The people now really believe that integrity also means meritocracy. You can go as far in this company as your brains and energy will take you. With this motivation and the training program, we’ve uncovered some incredible talent. Our top sales manager, Charlie, out in Chicago , was a materials handler in the Scranton plant. He had to leave school to support his mother and kid brothers and sisters, and now the guy’s a winner for us as he was for his family. All we had to do was give him a shot at it.

Maybe I’m going on too long about history, but this isn’t merely history; it’s about the spirit of our company; it’s about potential, the potential of our associates and the potential of the company. This great spirit has also encouraged our associates to be more active in their communities. We take it for granted now, but we know how to really get things done by working together. Believe me, that’s a rare talent in many community activities. One very successful program has been our adopt-a-school program. We’re now experimenting with an adopt-a-church program. We’ve found that combining resources in the inner-city really does make a difference in people’s lives. Besides, we get leads on some outstanding new employees that way.

CFO Dick: It’s all very heart-warming, but ...

COO Pete: And another thing, our suppliers tell us we’re a different company. They know our commitment to integrity includes our relationship with them. Most of them have been keen on working with us, even at their own expense, on new-product development.

CEO Alan: It’s a great history, Pete. You’re describing the most satisfying experience of my working life. Nevertheless, we’re caught in a dilemma: Either we run the company for the long-term benefit of associates and other stakeholders or we respond to the short-term threatening demands of Wall Street.

COO Pete: With all due respect, Alan, if the right move for the company is to invest in the future, then we’re counting on you and Dick to merchandise the excitement of Sheila’s product plan to the analysts and the money managers. Everyone has their own job to do, and that’s yours, guys. We’re close to the right product at the right time. The world is moving more and more towards free enterprise; more and more countries are moving into double-digit growth. Most of them badly need communications infrastructure. The bad news is that they have very little of it, the good news is that they can go immediately into wireless, fiber optics, satellites, and fully digital systems. The market’s going to explode, and that means us!

VP Mktg. Sheila: Go, Pete!

COO Pete: Now, let me get to the shareholder question. The more I think about it, the more I think it’s B.S.! Who is the shareholder anyway? Do you think our associate-shareholders would have any problem choosing the long-term plan? No way! They would say, “Build the company, do it right, and in time the stock value will be guaranteed.”

And who are these money-manager Rock stars that intimidate Dick? The financial media love them because they are easier to write about than a long-term building plan. Besides, the media can make them out the good guys with us the bad guys, calling us the members of a club named “entrenched management.”

And where did the analysts get perfect vision? Who taught them what a company should do or not do? More important, who gave them the authority to beat companies into short-term goals? These fund managers are investing the workers’ money, but have they ever had a referendum with all those wage-earners who put their money into these funds? Have they ever asked the people they allegedly represent whether they prefer long term or short term?

CFO Dick: There you go again with voting on company policy, Pete! That ain’t how it’s done!

COO Pete: How it’s done, Dick, is to do it right, whatever it takes! We’re screwing around with the future of the country as well as our company, as you should know. This battle between capital and labor at least used to be between those with the capital and those who did the labor. Ultra-capitalists always knew how to screw the worker, but now they’re doing it with the workers’ own money. Danny DeVito did a movie on this: “OPM,” Other Peoples’ Money!

CEO Alan: You’re giving me a headache, Pete, because even discounting your passions, some of what you say is probably true. But what are we going to do? We don’t have a lobby that could convince Congress that they made a terrible mistake in pushing trillions of dollars of pension money onto Wall Street, and that it’s time to redirect this “excessive liquidity,” as the experts call it, away from Wall Street towards the general welfare. I have no question but that it’s the government’s industrial and fiscal policy, lobbied by Wall Street, that puts us in this box, but that won’t change until we have educated citizens directing politicians with sufficient economic savvy to avoid mistakes like these. But Pete, I’m a businessman, not a politician. I have a company to run, whatever the circumstances!

CFO Dick: OK, now we’re getting back to reality! All the feel-good stuff on company spirit is beautiful, but my job is to make this company more valuable. Since we don’t have time to change the politics, as you say, Alan, then let’s get to the bottom line.

CEO Alan: Have you finished, Pete?

COO Pete: I guess. I’ve given the background so that Sheila and Dick can have, I hope, a better sense of how long and hard you and I and the others have worked to build this spirit to realize the potential of our associates and the company. I’ll comment as we go along on Dick’s “bottom line.”

CEO Alan: Sheila, do you have anything you’d like to add before Dick reviews his proposal?

VP Mktg. Sheila: No, Alan. Naturally, I’m as excited as Pete is about our new opportunity, and I know from my own marketing department that this spirit is real, and it can move mountains. I’m supposed to be the marketing expert, but I’ve learned a lot from Pete about the real meaning of potential. I’ve never before heard such emphasis on releasing the latent power of turned-on people as I’ve heard and seen in this company. I’ve seen it transform some of my steady performers into overachievers. I know it works!

I don’t mean to gang up on you, Dick, but I also agree that we’ve got a wonderful story to tell Wall Street, and I’m sure you have the eloquence to do it. I don’t know much about that part of the business; I’m just a simple-minded marketer, but if I can get our product message out to our customers, surely you can get our great company story out to the fund managers.