The Sound Money Project Essay Contest is designed to promote scholarship in monetary and macro- economics. More specifically, it aims to encourage those working at the cutting edge of the discipline to consider the monetary institutions that would reduce nominal disturbances and promote economic growth.
In 1971, President Richard Nixon ended convertibility, thereby eliminating the last vestiges of the gold standard. The classical gold standard, which prevailed from 1873 to 1914, had anchored inflation expectations, enabled longterm contracting, and promoted international trade. This historical experience has prompted several reconsiderations of resumption over the years, including the Gold Commission in 1980, the International Financial Institution Advisory Commission of 1998, and, more recently, calls for a Centennial Monetary Commission. What are the merits of returning to the gold standard? Is such a system feasible today?
First Prize $10,000
Second Prize $2,000
Third Prize $1,000
Winners will also be invited to participate in the Sound Money Project annual meeting in Great Barrington, Massachusetts.
The contest is open to graduate students, post-graduates, untenured professors, and tenured professors from any discipline. Former winners and current AIER fellows are ineligible. Former entrants are eligible, but must submit new essays.
Essays must be the sole and original work of the entrant and not previously published. They should be in the format of a scholarly article. Any standard citation format (e.g., MLA, APA, Chicago, Harvard, etc.) is acceptable. Essays may either be written specifically for the contest or arise from previous work (e.g., term papers, dissertations, research projects, etc.). Essays shorter than 4,000 words or longer than 12,000 words will not be considered. AIER-affiliated scholars are ineligible.
Submission Instructions: Please submit your paper here.
Deadline: August 1, 2019
William J. Luther is the Director of AIER’s Sound Money Project and an Assistant Professor of Economics at Florida Atlantic University. His research focuses primarily on questions of currency acceptance. He has published articles in leading scholarly journals, including Journal of Economic Behavior & Organization, Economic Inquiry, Journal of Institutional Economics, Public Choice, and Quarterly Review of Economics and Finance. His popular works have appeared in The Economist, Forbes, and U.S. News & World Report. He has been cited by major media outlets, including NPR, VICE News, Al Jazeera, The Christian Science Monitor, and New Scientist.
Luther earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Capital University. He was an AIER Summer Fellowship Program participant in 2010 and 2011.
William J. Luther on Facebook.
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Industrial production fell 0.4 percent in September, following a 0.8 percent gain in August. The September fall is the second drop in three months. Over the past year, industrial production is down 0.1 percent. Total capacity utilization decreased 0.4 percentage points to 77.5 percent as capacity posted a 0.2 percent gain for the month.
Manufacturing output, which accounts for about 75 percent of total industrial production, fell 0.5 percent after rising 0.6 percent in August. Manufacturing output is also down in two of the past three months, resulting in a 0.9 percent drop over the past year (see bottom chart), the worst performance since 2016.
Mining output posted a 1.3 percent decline for the month while utilities output rose 1.4 percent in September. Over the past year, mining output is up 2.6 percent while utilities output is up 1.2 percent.
Manufacturing-sector weakness was led by a sharp fall in production of motor vehicles, primarily related to a strike at a major manufacturer. Total motor vehicle and motor vehicle–parts production was down 4.2 percent for the month as vehicle assemblies fell to 10.71 million at a seasonally adjusted annual rate from 11.26 million in August. Most segments of vehicles showed declines for the month with automobile assemblies falling to 2.57 million, light trucks falling to 7.77 million, and medium and heavy trucks holding at 0.37 million. Primary metals fell 1.6 percent while machinery production fell 1.4 percent. Over the past year, motor vehicle production is off 5.4 percent while primary metals were down 3.3 percent and machinery production is down 2.9 percent.
The drops in motor vehicle, primary metals, and machinery production dragged total durable-goods production down 0.7 percent while nondurable-goods production was off 0.2 percent for the month. Among nondurable-goods producers, chemicals (12.7 percent of total industrial production and 35.7 percent of nondurable goods) fell 0.5 percent while food-products production (11.3 percent of total output and 31.8 percent of nondurables) rose 0.2 percent. These two categories account for two-thirds of nondurable-goods output.
Measured by market segment, consumer-goods production was down 0.2 percent in September, with consumer durables off 1.9 percent and consumer nondurables up 0.3 percent. Business-equipment production fell 0.7 percent in September while construction supplies were unchanged for the month.
Materials production (about 46 percent of output) decreased 0.5 percent for the month and is up 0.2 percent from a year ago. The energy component has been a major source of volatility in this category, particularly following the collapse of energy prices in mid-2014. The non-energy component fell 0.6 percent for the month and is down 1.4 percent from a year ago.
Manufacturing-capacity utilization dropped to 75.3 percent in September, down 0.4 percentage points from 75.7 percent in August.
Housing construction activity was weaker in September as total starts fell by 9.4 percent and permits for future construction fell 2.7 percent. Total housing starts dropped to a 1.256 million annual rate from a 1.386 million pace in August.
The dominant single-family segment, which accounts for about three-fourths of new home construction, rose 0.3 percent for the month to a rate of 918,000 units, marking the fourth gain in a row (see top chart). Starts of multifamily structures with five or more units sank 28.3 percent to 327,000, pushing activity to the lower end of the 300,000 to 450,000 range that multifamily starts have been in for much of the last two economic expansions (see top chart). From a year ago, total starts are up 1.6 percent, with single-family starts up 4.3 percent and multifamily starts off 5.8 percent.
Among the four regions in the report, total starts fell in all four regions: The Northeast (−34.3 percent), the Midwest (−18.9 percent), and the South (−4.0 percent), and the West (−1.9 percent). For the single-family segment, starts fell in three regions but were up 7.1 percent in the South, the largest region by volume.
For housing permits, total permits fell 2.7 percent to 1.387 million from 1.425 million in August. Single-family permits rose 0.8 percent to 882,000 in September, the fifth monthly gain in a row (see top chart). Within the multifamily segment, permits for two- to four-family units were off 16.7 percent and permits for five or more units fell 7.5 percent to 470,000. Permits for single-family structures are up 2.8 percent from a year ago while permits for two- to four-family structures are down 14.6 percent and permits for structures with five or more units are up 20.8 percent over the past year.
Overall, single-family housing activity has posted a modest rebound over the last several months following a period of weakness from early 2018 through early 2019. The sharp drop in mortgage rates may be providing a bit of a tailwind, but there is little evidence to suggest a significant and sustainable acceleration in single-family housing activity in coming months and quarters. Activity levels remain at or below the typical levels during prior expansions over the past 35 years.
Multifamily housing remains generally robust, sustaining activity at levels consistent with the prior two economic expansions. However, given the high level, it’s unlikely that it can go much higher. Therefore, total residential investment is unlikely to be a significant and sustained source of growth for the economy.
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In the woke sectors of business and finance, recent times have been rather eventful. In August, the Business Roundtable, a collaboration of 181 CEOs of major corporations, overturned their long-held principle of “shareholder primacy” – that companies exist to serve their shareholders. The Economist reported an emerging trend among Big Business to look beyond their bottom line.
In September, the Financial Times launched The New Agenda, the purpose of which was clearly described by the newspapers’ editor Lionel Barber:
“In the decade since the global financial crisis the [free enterprise capitalism] model has come under strain, [its] long-term health […] will depend on delivering profit with purpose. Companies will come to understand that this combination serves their self-interest as well as their customers and employees.”
Aspiring presidential candidate Elizabeth Warren wants companies run under public charter, guaranteeing that they take broader societal concerns into their decision-making. Colin Mayer’s book Prosperity: Better Business Makes the Greater Good has been making a splash in many finance quarters.
Economists have followed suit. A recent IGM poll – a questionnaire on current affairs that Chicago Booth School of Business regularly posts to top economists – showed an overwhelming share of economists agreeing with the following statement: “Rising inequality is straining the health of liberal democracy.” A similar poll in September showed that most top economists were positively disposed to having companies run in the interest of a larger set of stakeholders.
Clearly, Milton Friedman’s infamous quip, the so-called Friedman Doctrine that a firm’s sole responsibility is to maximize returns to shareholders, seems all but overturned.
Old Wine in New Bottles
The idea that businesses ought to be run with their employees or local communities in mind – or at least take their needs into consideration – is old and returns at regular intervals, often under the auspices of overturning our inefficient and harmful late-stage capitalism. The names come and go: Corporate Social Responsibility, CEO Force for Good, and initiatives for Inclusive Capitalism, but the message remains the same: the needs of workers, clients, community members or the environment must factor into business models.
Amid this renewed financial wokeness, Gillian Tett at the Financial Times wrote a piece titled “Does capitalism need saving from itself?”. She interviewed 88-year-old Marty Lipton, the lawyer whose career of defending companies from hostile takeovers in no small part contributed to overturning the Friedman Doctrine:
When Lipton looked at American Express’s hostile bid back in 1979, however, he knew that money did matter. Since the Amex bid offered shareholders a fat, immediate gain, Friedman’s creed implied that shareholders should accept it. But the McGraw Hill board insisted it would smash the long-term value of the company. So was there any way to stop this? Lipton decided his best route was to attack Friedman directly. In “Takeover Bids” [Lipton’s famous article], he asked whether “the long-term interests of the nation’s corporate system and economy should be jeopardised in order to benefit speculators interested not in the vitality and continued existence of the business enterprise in which they have bought shares, but only in a quick profit on the sale of those shares?”
We can find similar anti-capitalist (or really, anti-finance, anti-Big Business) mentalities in some of the most popular American movies too: the successful 1991 Other People’s Money saw Danny DeVito ruthlessly trying to acquire the New England Wire & Cable Company and selling it for scraps. Edward Lewis, the impeccably dressed ideal of a successful man played by Richard Gere in Pretty Woman, is a corporate raider who buys entire companies and re-sells them for parts.
The outside investor, the merciless and heartless pursuer of profit who engages in hostile takeovers, is the archetypical finance villain that we love to hate. But, I always wonder, if the company being bought up has all these amazing under-appreciated qualities – why would anybody sell?
Hostile takeovers aren’t hostile
On free – or even quite regulated – markets, only governments can compel others to sell goods, services or assets against their will. A “hostile” corporate raider can only buy shares that others voluntarily sell. While some jurisdictions do have clauses that require forced sales when a certain threshold – say 90% or 95% – of shareholders have accepted an outside bid, that doesn’t detract from the general principle: on free markets you can only “make” others sell by offering them something that they value even more.
Lipton is referring to the January 1979 bid by American Express on the information conglomerate McGraw Hill referenced by Lipton. The McGraw Hill management was “negative” to the offer, reported the Washington Post, even though it was at a 30% premium to current share prices.
There are only three ways that a hostile bid can succeed:
- Shareholders don’t see the value that an outsider sees
Every investment strategy pursued by long-term investors or shareholders boils down to projections of future earnings: how much can the company earn in the future? That’s obviously uncertain and individual guesses have a range: for well-understood businesses with little competitive or technological change, that range is going to be fairly small; for technological hot-shots like Facebook or Netflix or Amazon (not to mention the various unicorns that proclaim to overhaul the way we do things) – most of whose value lay in how big their future global market shares can become – that interval is huge.
The market price, argue most people who oppose hostile takeovers, doesn’t reflect the value inherent in the company. That’s exactly right; if it did, we would expect a lot higher daily turnover of shares. By the fact that most shareholders don’t sell at the prevailing market price – or after daily fluctuations of +/- a few percent – we know that they value the business much higher. How much higher? No idea; what their reservation price is, is entirely unknowable to us.
If an outsider, like Amex or Richard Gere’s character or any other corporate raider wishes to acquire a company, they must persuade shareholders to sell; in essence, they must pay above the reservation price. If they see a 30% upside to a company (through synergies, missed potential, or cost-cutting), but their owners see a 100% upside to current share prices – nobody will sell, and the takeover bid will fail. If the shareholders’ estimation of fair value lies only 10% above current share prices, and Amex sees value above 30%, why shouldn’t they sell?
In essence, this is no different than any other transaction: I value my coffee a lot higher than the price charged by the coffee shop; the coffee shop owners value my dollars higher than the commodities, capital and labor that goes into producing coffee. Trading makes us both better off. Why would that be any different when the object of our transaction is the entire coffee business rather than a single mug of coffee?
2. Shareholders have higher discount rates
It could be that the estimation of future earnings is higher for current shareholders than the outside investor, but that the former have much higher discount rates. Discounting the future is a fundamentally human attribute, a perfectly acceptable practice among finance practitioners or economists, but often dubious and strange in the view of non-economists. A dollar earned today is worth more to me than a dollar earned next year, partly because of the uncertainty of the future, partly because I can invest that dollar today and end up with more than a dollar next year.
Discounting future earnings is how we “translate” them into the present, making them comparable to today’s money. If current shareholders are greedy and suffer from short-termism, as Lipton and McGraw Hill’s management suggest, they discount the company’s future earnings steeply. If an outside investor doesn’t, then changing owners is a good thing if we care about the long-term success of the business. That’s what low(er) discount rates mean: you put a relatively larger weight on the future than the present.
3. The outside bidder is overpaying
This is almost the same as (1) but looked at from the opposite perspective. If a corporate raider pays way above the reservation price of most shareholders (their estimation of fair future value, properly discounted) – but selling would somehow “destroy” that long-term value – couldn’t shareholders simply accept the bid and plunge this new money into re-creating their better-run business?
If it were true that a hostile takeover would “destroy” value, even though the Richard Geres and Amexs of the world overpay, and current management and shareholders know a better way to run the business – they could just take this massive up-front gain (remember, above the company’s current value), set up a better-operating business and pocket the difference!
A few years later, when the unreasonable Richard Gere and silly Amex have run the original company into the ground, and the original shareholders’ new venture has succeeded, they can simply repeat the process. In economics, we call this a “Money Pump”. In real life, those don’t last very long since their assets are routinely siphoned off to others better suited to manage them. Contrary to the allegations of Tett or Lipton – and perfectly in tune with common sense – accepting bids above fair value enriches those who accept it, not the corporate raiders who mismanage their new asset.
If all the non-pecuniary values that Lipton & Co claim exist, and they contribute crucially to the business, then he and his colleagues a) must argue that his own stockholders are tempted to sell, they don’t actually believe that talk, b) ought to buy shares themselves.
Wanting companies to fix the ills of the world is a strange demand; it’s highly doubtful that companies have any particular insights into how to do that. Hostile takeovers are misnomers, as there is no way for outside investors to take over another company unless they pay top-dollar to induce current shareholders to sell. Objecting to them on principle is naïve: if corporate raiders underpay, their bid will fail; if they overpay, current shareholders and management can take the new funds, restart the business and outcompete the raider – pocketing the difference and living happily ever after.
Capitalism, especially seen as a system conducive to hostile takeovers, does not need saving.