RIP: Mother of the Modern EU Her Party Wants to Leave

by Roy C. Smith

 

Margaret Thatcher died five years ago this week. She would have hated the debacle of the Brexit vote and the shambles that have followed, because she did more than anyone to shape the modern European economy in which she wanted Britain to play a leading role.

When she became prime minister, the EU was the European Economic Community, a stodgy assemblage of 12 countries hoping for benefits of integration but badly in need of reform and rejuvenation. She was a true believer in free markets, deregulation and competition and on reforming and rejuvenating Britain after decades of weak economic performance and currency depreciation. Right away she repealed foreign exchange controls that had been in place since 1914, cut income taxes and battled unions. But she had a larger vision – to “privatize” hundreds of state-owned-enterprises (many of them nationalized by previous Labour governments) that then represented 10% of the UK GDP. Doing so would return billions of pounds to the Treasury, enable collection of taxes on profits, and return the companies themselves to being competitive in world markets. And, ordinary Britons could become capitalists by buying shares in great British companies. A long stream of British privatizations in coal, iron and steel, automobiles, gas, electricity, water supply, railways, trucking, airlines, airports and telecommunications began in 1981.

But for privatization to occur on a large scale, multi-billion £ stock issues would have to be sold. The financial infrastructure of the City of London, however, was antiquated and not up to handling such large issues. The City also needed to be reformed along free market lines, with the chips falling where they may. So “Big Bang,” announced in 1983 to be implemented in 1986, came into being and did the job. Simply by forcing the London Stock Exchange to negotiate commissions, allow “dual capacity” (of trading and sales, etc.), and open membership to all qualified comers, the system was transformed into Europe’s most competitive and efficient financial marketplace. Not long afterward, all of the countries in the EEC, fearing that the securities business in their countries would migrate to London, copied the Big Bang example and modernized their systems too. They followed her example, not some decree published in Brussels. Today, integrated European capital markets are the largest segment of the global capital market. In 2017, they generated over $4 trillion of new debt and equity issues, more than in the US market.

By the end of Thatcher’s term in office, more than 50 British companies worth more than £50 billion were privatized, restructured and made competitive. Soon it was clear to other EEC governments that privatizations worked, were popular with citizens, and generated returns of capital and tax revenues that eased governmental finances considerably. By the late 1980s, all of the other EEC countries were actively engaging in large privatization issues of their own. They in turn were followed by IPOs and other equity market transactions that transformed the closely-held private sector of Germany, France, Italy, Spain and other countries.

But Thatcher was not content to limit her reform ideas to Britain. In 1984 she appointed euro-skeptic Arthur Cockfield to be a member of a European commission studying economic reforms. Like Thatcher, Cockfield was a strong advocate of free markets; he arrived with a lot of data and a lot to say about integrating and liberating European trade and industry. He was the driving force behind the Single Market Act of 1986, the EECs most import reform effort. It incorporated the “Four Pillars” of the EU (freedom of movement across EU borders of goods, services, labor and capital) that was formed a few years later. After implementation of the Single Market, every company in Europe had to reconsider its business model and strategy. They were now part of a much larger, integrated marketplace and nationally protected local market dominance became a thing of the past. This strategic rethink, together with revitalized securities markets, lead to the first-ever European M&A boom that began around 1985 and has continued since, making it a vital part of a global M&A market that periodically does more transactions in Europe than are done in the US M&A market.

Finally, after forcing through financial reform, privatization and the Single Market act with its ensuing merger boom, Thatcher appeared in Bruges, Belgium in September 1988 for her now-famous address to the College of Europe on Britain’s future role in the EEC. She began her remarks by saying that “if you believe some of the things said and written about my views on Europe, it must seem rather like inviting Genghis Khan to speak on the virtues of peaceful coexistence!”  But she explained, “Britain does not dream of some cozy, isolated existence on the fringes of the European Community. Our destiny is in Europe, as part of the Community.”

She also acknowledged that Britain under her leadership had fought back over regulation and other issues that she thought were unnecessarily constraining to the UK. Then she added her nest remembered line: “We have not successfully rolled back the frontiers of the state in Britain, only to see them re-imposed at a European level with a European super-state exercising a new dominance from Brussels.” But, this did not mean she wanted to leave Europe, only to use the UK’s powerful influence and example, as she had successfully been doing, to persuade Europe to maximize the utility of the private sector and minimize the notion of a super-state.

She was never a believer in go-it-alone, nor did she ever deviate from the basic idea that a great country like Britain had to be part of the global scrum to influence it. She would never have agreed to the Faustian bargain that David Cameron made with his backbenchers to offer a dangerous referendum on EU membership in exchange for their support as party leader, and she certainly would have hated the result.  

Britain’s post-Brexit future is certainly unclear. But what is not unclear is the enormous transition of financial markets, the vitality of the private sector and operational effectiveness of the EU’s integrated private sector that is now the world’s second largest GDP (at purchasing power parity), just behind China and ahead of the US, serving more than 500 million people. No one was more influential in bringing this to be than Mrs. Thatcher.

Lloyd’s Voyage

By Roy C. Smith

Friday's news that Lloyd Blankfein would retire from Goldman Sachs at year end was a surprise to almost everyone. He will have served 12-years as Goldman’s CEO, longer than anyone else except Sidney Weinberg (who retired in 1966), and is one of the longest serving CEOs among today’s major banks. Blankfein replaced Hank Paulson as CEO in 2006, having transformed the firm’s Fixed Income, Currency and Commodities division into a trading powerhouse that was arguably Wall Street’s most dominant player.

Indeed, trading accounted for 68% of firm-wide revenues in 2006, and 73% of profits. Goldman Sachs’ return on equity was 33% and its price-to-book ratio was about 2.0. The stock was trading at $170 per share then, more than three times its IPO price in 1999. Blankfein, originally hired by the J. Aron division as a gold trader, took over the FICC division in 2002 and initiated a massive change in the orientation of the firm from traditional investment banking to a wide-ranging trading colossus that operated around the world and around the clock in hundreds of different instruments. 

Extraordinarily for the securities industry, this enormous growth and transition was accomplished without any major acquisitions, or dilution of ownership that such acquisitions cause. The expansion was accomplished entirely in house, working with that wonderful Goldman Sachs DNA that is both feared and revered throughout Wall Street and the City.

Blankfein, however, had little time to enjoy his and the firm’s achievements. Soon after taking over from Paulson, he and other analysts noticed that rising housing prices, upon which a boom in mortgages and mortgage-backed securities was built, had ceased and indeed, reversed direction. Realizing that this could mean an end to the boom (or worse) he ordered a reduction in Goldman’s trading inventory, a reduction that was strongly opposed by some of his trading barons. He prevailed in the struggle that ensued, however, which some his counterparts (at Citigroup, Merrill Lynch, and Morgan Stanley) did not, and steered Goldman Sachs through the financial crisis that followed with barely a scratch. Later, however, he had trouble explaining to Congress why the firm periodically adjusts its own exposures to its future outlook, without consulting its trading counterparties that were simultaneously adjusting their own positions. In the end, Goldman Sachs agreed to a $550 million settlement with the Justice Department for infractions of this sort.

After the financial crisis of 2007-2008, Goldman Sachs went through a number of regulatory changes that permanently altered its business. After the Lehman failure, the Federal Reserve required Goldman to became a bank holding company, which provided some advantages but many costs and disadvantages as well. Basel III and Dodd-Frank, and their myriad parts and pieces, came into effect imposing vastly increased regulatory compliance costs and greatly limiting the firm’s freedom of maneuver. There was no escaping this – Goldman had about $1 trillion of assets and was clearly a “systemically important financial institution,” so it had to change its business model to accommodate the new limitations.

Twelve years after Blankfein’s succession, Goldman’s total revenues are less than they were in 2006, and for 2017 trading represented only 37% of revenues, nearly half of what they were then. The stock price is about $100 per share higher, but the price-to-book ratio is only 1.46 (after a 20% increase in the stock price in the last six months), and return on equity was 10.8%.  Indeed, most of Blankfein’s tenure as CEO has been spent surviving the crisis and reengineering the firm for a duller, less expansive future. If he is feeling some regulatory fatigue, we can forgive him for looking for something else to do at 63.

It is curious that Blankfein’s retirement announcement should come so close to Gary Cohn’s, his former deputy who left last year to join the Trump team. There may be some wondering whether there will be a job switch, in which Blankfein would follow his Goldman CEO predecessors John Whitehead, Bob Rubin, Steve Friedman and Jon Corzine to Washington, and Cohn would come back to pick up where he left off but enriched and fortified by his White House experience. Don’t count on it – these things are rarely so simple – Blankfein has been more politically active as a Democrat than Cohn was, and in any case may be fearful of losing reputation by association with Mr. Trump’s team. And, though Cohn has had a full-career at the firm, as every Goldman Sachs CEO has before him, the water filled in behind him when he left and others are in waiting.

So maybe, now having been a king, Lloyd Bankfein, will be content to lay back and be a philosopher, author and philanthropist, as his predecessor, Hank Paulson, and friend Michael Bloomberg have done. Why not? He’s earned a good rest and some peace and quiet.

from Financial News,  Match 12, 2018

How Wrong is Trump on Protectionism?

How Wrong is Trump on Protectionism?

Roy C. Smith and Ingo Walter

It’s hard these days to find anyone concerned with the national interest who hasn’t been raised on the idea that tolerably efficient markets are better than rigged markets. Properly structured, they help ensure that resources are put to best use and the public has access to the best products and services at the best price. And when things like technology or consumer preferences shift, market discipline assures structural change in the economy to redeploy resources from activities of the past to those of tomorrow. Of course there are always winners and losers – for sure in the short term – and adjusting to new realities can be painful, But in the end the system is stronger and grows faster than under any other arrangement that’s ever been tried. Best of all, market-based opportunities and market discipline works with human nature, not against it.

That’s the way it is with international trade and the notion of comparative advantage. People, companies and countries should focus on what they do relatively better than others and acquire what they don’t, each on terms determined by the market. In so doing, their welfare will be higher and its growth will be faster than it would be otherwise. Deviate from this principle, and a price will have to be paid in the form of lower welfare and slower growth.  There’s no way around it.

So what happened with President Trump’s plan to impose high tariffs on steel and aluminum imports (with some negotiated exemptions) and then doubling-down on protectionism by hitting China on an array of “sensitive” products?

Maybe he and his advisers don’t believe basic economics. Maybe they believe international markets are already rigged, so a bit more won’t hurt. Maybe they think that we’ve done a really bad job getting people in distressed industries redeployed, so they deserve a break paid-for by healthier sectors and the general public. After all, politics is politics. And people who believe they are facing a bleak economic future – often an existential threat - form a powerful voting block. Meanwhile, those who will pay the tab for protection may hardly feel it and must rely on arguments based on the overarching principle of liberal markets. It can be an uneven political battle at times. And it’s never hard to point to other countries’ protectionist practices – in trade policy and liberal market access, nobody has clean hands.

But there are plenty of cheaper and more effective ways of addressing the kinds of “fairness” issues that give rise to today’s protectionism. Admittedly, the US has had a poor record of walking the talk and successfully and efficiently helping to redeploy resources, notably labor. Farmers say there are two ways to harvest corn. One is conventional way in the cornfields. The other is to go behind the barn and seek-out the few whole kernels left in the hog manure. The Trump plan seems to fit squarely in the second category, an economic blunderbuss that will hit importers, supply chains, exporters, foreign markets that take massive amounts of US exports, consumers - and maybe the US economy as a whole as some benefits of the Trump tax cuts are wasted on the inevitable costs of protectionism.

Besides the directly affected products in the Trump target-zone and those hit by retaliation, at stake here are the rules of the game that allow the benefits of market economics to work its magic on a global scale, where trade and specialization form one of the key drivers lifting welfare and growth among billions of people worldwide. Since 1937 the US has been the most important advocate of letting global markets do their work. The US has been instrumental in launching every round of global trade negotiations, and every President across the political spectrum from Roosevelt to Kennedy to Nixon and onwards has identified America’s national interest fundamentally with pursuing freer international trade in both goods and services. The core principles are “non-discrimination” in how market-access is opened to competitors, domestic versus foreign, one country versus another, together with “reciprocity” – we open our markets to foreign suppliers in return for their opening markets to ours. Both can be lumped into “fairness,” as in Trump’s “free and fair markets.”

The fact is that well-functioning markets need rules that anchor its basic principles, along with effective dispute settlement procedures. Again the US was the motive force behind both the 1947 General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO). And when countries want to accelerate the efficiency and growth benefits of freer markets, something that may not be possible on a global basis, they may set up regional trade arrangements like the original European Economic Community (now EU) or the North American Free Trade Association (NAFTA) – not quite as beneficial as freer global markets, but better than the status quo. That option has likewise been under Trump policy assault in the case of both the Trans-Pacific Partnership (TPP) and NAFTA.

By apparently ignoring the factual power of globally freer markets, the Trump Administration betrays a critical US legacy based on a core belief in market outcomes that has overwhelming evidence to back it up. It also betrays America’s legacy of leadership in creating the global institutions to make it happen, cumbersome as they might seem at times. It puts the US on a slippery slope to some bad outcomes that will gradually become apparent and begin to poison the political chalice. In any case, the Trump tariff increases on steel and aluminum slam the EU and Canada and Mexico, among the leading US partners in seeking to assure sustainably accessible global markets. All three have their own protectionist practices that have not been successfully negotiated over the years, and all three have received Trump exemptions. Shooting yourself in the foot is not the best way to change the behavior of others.

But wait! Maybe Trump actually has a coherent plan, with a bulls-eye painted on China. Everything else may be a side-show – with the Europeans and others quietly cheering him from the bleachers.

Does China practice trade fairness market discipline? Hardly. China takes few prisoners in state support for exports and strategic investments abroad, stiff-arming foreign players in its domestic markets when it suits them, or in the murky calculus of state-owned businesses and banks. And there’s not much light between political targeting and competitive targeting in China. Non-discrimination and reciprocity often don’t seem to be in the Chinese vocabulary. It has violated key commitments under the WTO since it joined in 2001. But like Japan a few decades earlier, China has increasingly come under tough pressure from trading partners to play by the all-important rules of global trade and take its share of responsibility for a viable trading system. Toddlers are cute to have around the house, but not after they grow to 300 pounds.

Most importantly, China will eventually feel the effects of the kind of resource misallocation that results from persistently violating the spirit of those rules. Candidly, Chinese will often say “we will adjust, but on our schedule and terms, not yours.” China to Trump on protectionism in Twitter-speak:  “Won’t work. All wrong. Really bad.”

But Trump is also very good at borrowing ideas. His trade initiatives echo targeted measures taken by Richard Nixon, Ronald Reagan and George W. Bush over the years.  Each was intended to be shocking, but ended up with some voluntary or negotiated settlements, enough anyway to take the item off the political stage and allow a victory lap. By this logic, Trump aims to make a fuss over China tariffs, which can end in trade arrangements that will entail some backing-off and avoid a downward spiraling trade war that nobody wins. Trump could even include some sort of "surtax" on certain imports with sufficient proceeds (perhaps a few billion) to fund another try at a national worker retraining program – and sell it as a fair price to be paid by millions to fund assistance to the small number who are hurt. Could be a plan, if it can be made to work. But then, Trump is also very good at changing his mind.