AS THE ECONOMY TURNS
CAR CRASH
Dr. William Shingleton
January 23, 2006
Most faculty members love to read the comments that students
submit after our classes have finished.
Some are funny, some are sad, and more than a few are educational. In this past semester, one student seemed to
have missed the entire point of a course when he/she accused me of “worshiping
profits” and “being a Democrat,” which was about as odd a combination as anyone
could imagine. The “being a Democrat”,
by itself, would make some sense because for the last twenty or thirty years
the student perspective has usually been that I am opposed to the party of the
president. Economists, I am told, can
come across as arrogant, just because we know better than anyone else how
economic policy should be run. Since the
idiots in
Anyway, that comment, by itself, would not have been overly
noticeable, since many other students had the same opinion. But how does anyone come across as a
profit-worshiping Democrat? That would
be a new kind of new-New-Democrat, don’t you think? More importantly though, economists don’t worship
profits, mainly because there is nothing to worship there. Instead, we marvel at the effects of building
an economy around people and business that attempt to maximize profits. These attempts by individuals to gain their
own individual profits result in an outcome that Adam Smith (1776) called, “…
the greatest good for the greatest number.”
However, neither Adam Smith nor modern economists would argue that there
is anything particularly noble with being greedy. The worship of golden calves is not something
that is within the realm of economics and we certainly try to keep it out of
our textbooks and our classrooms.
In any event, profits do drive the economic system that so many of
us enjoy. What sometimes gets neglected
is that an absence of profits can have the same kinds of directional effects as
an abundance. This brings us to the case
of the FORD MOTOR COMPANY and its headline decisions. FORD is not out of cash by any reasonable
accounting standard. The corporation is
not only SOLVENT, with more assets than liabilities in dollar terms, but in the
latest reporting period it was also PROFITABLE, with $124 million more coming
in than it was paying out. So why are
they closing 14 plants and laying off as many as 30,000 workers? The simple answer is that while the world-wide
FORD corporation is profitable, the North American division is a drag on
earnings. The hope at FORD is that
closing these plants and laying-off these workers will return the North
American division to profitability.
Could they continue on with these 14 plants? There is no doubt that FORD could manage to
do just that for a number of years.
However, this is where the SURVIVORSHIP PRINCIPLE comes into play. By closing these plants and shedding these
losses investors will expect FORD to have a certain volume of profits and/or
losses over the coming years. Since the
value of the FORD corporation on the market is strongly influenced by the
expected flow of its profits or losses over the coming years, anything that
will reduce or eliminate its losses should increase the value of the
corporation. That is exactly what happened
today, with the price of a FORD share going from $7.90 to $8.32, a 5.3 percent
rise, in the day of the announcement. If
today’s management had not bitten the bullet on this decision, the value of the
stock would not have even stayed in the $7.90 range because most investors were
expecting some sort of announcement like the one we had today.
However, if FORD had decided not to cut jobs and close plants it
would have provided an opportunity for others in the marketplace because others
would have known that the company could have a better balance sheet if it did
make these changes. There are a number
of people out there, sometimes called VULTURES, who look for situations like
this as investment opportunities. If the
stock was only priced at $7.90 because FORD was being noble and protecting its
workers, then somebody else would have recognized that they could buy the company
at $7.90 per share, make the tough decisions, and have a company worth more,
although they probably would not know the value could be exactly $8.32. Then we would have had a situation in which
today’s owners thought the company was worth $7.90 and the prospective investors
thought it was worth more. As RONALD COASE
(1961) has noted, one of the beauties of the market is that when we have two
parties in the market, the one that places the higher value on the item is the
one who ends up with the item. In this
case, the current shareholders would sell to the vultures at a price above
$7.90 and below what the vultures thought the corporation was worth. The current shareholders would believe they
were getting a great deal when they were able to unload their stock for more
than they thought it was worth. And the vultures
would be laughing all the way to the bank because they were able to get such a
valuable company at such a low price.
However, in terms of jobs and plant closings, after all the dust
had settled, it would not matter who owned the company. Current management
would only be able to hold on if they closed the plants and laid-off the
workers. Any new management team could
only make their investment worthwhile if they closed the same plants and laid-off
the same workers. After all, there is
only one way to maximize the profits for the company.
For the workers, it becomes a brutal game. If FORD were to continue on its present path,
the growing losses in the North American market would eventually swamp the
world-wide profits and the entire company would slip into the red. As losses mounted, the costs of financing
continuing operations would rise until the cash, and then the credit, ran
out. At that point there would be no
jobs left with the company because the company would die. For the 120,000 FORD workers who will not
lose their jobs this time, they can only hope there will not be a next time. The only way to prevent that is for the
company’s North American division to return to profitability.
FORD needs better products and better technology, and that’s the
problem. For a company to develop better
products and better technology, it must spend money on investment. Unfortunately, for a company in trouble,
investment us often something that gets trimmed with a meat-ax. However, it can happen. Not that many years ago we had the case of
CHRYSLER. It had been gobbled up by DAIMLER but a series of bad moves had
turned it into a disaster. However, with
some new products and skillful marketing, CHRYSLER now not only has a third
life, it is also the star of the DAIMLER-CHRYSLER corporation. In an industry that is going to have to
change so much in the coming years, FORD is a gamble, but it also has the
potential to rise again because it has world-wide profits and a world-wide
reputation.
This brings us to one of the most important rules on profit. To make big profits you have to have a strong
stomach because you may get hit with big losses instead. If FORD is earning big profits five years
from now, there will be lots of people who will wish that they had bought the
stock at $7.90. On the other hand, if
this move does not right FORD’s ship, there may not be an independent FORD five
years from now. The losses told everyone
that FORD had to do something. Only time
can tell anyone whether they made the right choice.
Final notes: If you would
like to be removed from the distribution list just send a reply on email. Back issues are available on my website
<http://www.oocities.org/wsirius30/2cents.html>. The opinions expressed
in these newsletters are those of the author.
Comments, including suggestions for future newsletters, are always
welcome.