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Defending the Undefendable Investments

The people presented in this book are generally considered villainous, and the functions they perform, harmful. Sometimes society itself is damned because it spawns such reprehensible characters. However, the thrust of this book will concentrate on the following propositions:

They are guilty of no wrong-doing of a violent nature;In virtually every case, they actually benefit society;If we prohibit their activities, we do so at our own loss.

                     —Walter Block, Defending the Undefendable, 1976

Three decades ago, I attended the week-long Mises University, the educational experience of a lifetime. Among the many lecturers were three of my libertarian heroes: Murray Rothbard, Walter Block and Sheldon Richman. Professor Block’s class on the environment, in particular, made quite an impression. “Why do they call environmentalists watermelons?” he began. “Because they’re green on the outside and red on the inside.”

When Walter Block was working on his PhD dissertation, for fun he began writing a series of essays defending characters who were incessantly denigrated: the pimp, prostitute, scab, slumlord, drug pusher, blackmailer, stripminer, importer, speculator and my personal favorite, the person yelling “fire!” in a crowded theater. Thirty two of these short articles eventually became Defending the Undefendable, now a libertarian classic. Without passing moral judgement, he defended this “rouges’ gallery of American society” on the basis of the non-aggression principle and private property rights. By taking on its sharpest critics, Block strengthened the case for a free society.

Defending the undefendable may make us better humans, but will it make us better investors? Will we find value rummaging through the garbage bin of corporate lowlifes? I believe these stocks are not cheap simply because they are hated. These are often durable, profitable businesses, in large part because social stigma acts as a barrier to entry. The industries in which they operate exist for good reason, though not always apparent to their detractors. Identifying the benefits of these pariahs to society may require a bit of effort and imagination.

Win-Win vs. Win-Lose

Suppose party A trades with party B. As long as the transaction is peaceful and voluntary, it only takes place if both expect to benefit, win-win. However, an outsider, party C, raises objections. Why? Sometimes out of ignorance, but usually because C benefits in some way from interfering. C gains at the expense of A and B, who are made worse off in the process, win-lose.

Despite C’s objections, the natural order of things is for A to voluntarily trade with B. Any intervention requires coercion, i.e. the initiation of violence. This is where politicians are more than willing to be of assistance. At all times the state gains… in power, prestige and lucre. Predictably, politicians and special interests, a.k.a. C, have become masters at selling the merits of intervention, all for the supposed good of A and B. (This usually involves convincing A that B is “unfairly” taking advantage of him, or the other way around.) “Experts” are then brought in to add a patina of legitimacy to the fallacious arguments.

The damage from intervention is not limited to A and B. According to Block:

Given that voluntary trade… must always benefit all parties, it follows that the prohibition of voluntary trade must harm all parties. In fact, my point is even stronger. I will argue that prohibiting the activities of the people we are considering harms not only the potential parties to the trade, but it can seriously harm third parties. One blatant example is the prohibition of the activities of the heroin seller. In addition to harming the seller and customer, the prohibition of the sale of heroin is responsible for a high proportion of the crime committed in our society, for police graft, and in many areas, for the general breakdown of law and order.

(To learn more about the adverse side effects of criminalizing unsavory activity, I highly recommend Mark Thornton’s The Economics of Prohibition.)

One final note: entering the trade, neither A nor B knows how it will turn out. While they both expect to benefit, the future is unknowable. Failure provides valuable information and is part of the learning process. One of the great benefits of the unhampered marketplace is that it allows for the discovery of new methods, new products and new ideas.

To illustrate, let’s take a look at three examples in business and finance.

The billionaire entrepreneur

One of the most reviled characters in business is the highly successful entrepreneur. Through the fixed-pie worldview of the zero-sum critics, mega-billionaires like Jeff Bezos and Elon Musk must have acquired their vast wealth at the expense of the downtrodden. Three years ago about 100 protestors built a guillotine in front of Bezos’ Washington, DC mansion and demanded higher wages and better treatment of employees at his brainchild, Amazon.com. Former employee Chris Smalls spoke to the crowd, saying, “Give a good reason why we don’t deserve a $30 minimum wage when this man makes $4,000 a second.”

While implicitly threatening violence, the protestors failed to mention the fact that Bezos gained his billions through peaceful means. Every exchange along the way, whether with customers, employees, suppliers or investors, was voluntary and thus mutually beneficial. Like all successful entrepreneurs, Bezos was fanatical about satisfying consumers. He clearly understood the importance of adding value to everyone he dealt with, as expressed in his final shareholder letter as CEO:

If you want to be successful in business (in life, actually), you have to create more than you consume. Your goal should be to create value for everyone you interact with. Any business that doesn’t create value for those it touches, even if it appears successful on the surface, isn’t long for this world. It’s on the way out.

In fact, these exchanges were open to others, yet it was Bezos who had the vision, courage and relentless drive to grab the prize while countless competitors failed. Through Amazon, Bezos bet big on the future of e-commerce (and later cloud computing) and took huge risks in the process. There were plenty of bumps in the road and doubters in the financial press, especially during the early years. In November 2001, after his stock took a 90% drubbing as the dot-com bubble burst and his net worth fell below $1 billion, Fortune asked “Can Amazon be saved?” Their response: “The answer is probably no. Whichever of Bezos’ stories you read, the numbers don’t look good.” In May 1999, Barron’s ran a cover story titled “Amazon.bomb” in which it dismissed Amazon as “just another middleman,” ironically one of the corporate miscreants Professor Block defends in DTU.

The Free Trader

It is fashionable to bash free trade these days, especially with the Chinese. Globetrotting businessmen are apparently guilty of two cardinal sins: importing cheap goods and employing cheap labor. While the critics emphasize the losers in these exchanges, e.g. domestic manufacturers and their employees, what right do they have to interfere? Left to their own devices, entrepreneurs will scour the world for the best deals, bringing home a bounty for the consumer. This puts more money in the consumer’s pocket which gets spent elsewhere, creating more jobs, more opportunities for trade and greater overall wealth.

As it turns out, importing deflation from an increasingly prosperous and productive China has been quite good for American business (all while offsetting some of the price inflation from the Federal Reserve’s non-stop money printing). Wal-Mart and Apple owe much of their success to using Chinese suppliers and manufacturers. Before Steve Jobs took over in 2000, Apple did $6 billion in annual sales. Today Apple generates $385 billion in revenue ($72 billion from Greater China) and boasts a market cap of $3 trillion, making it the most valuable company in the world.

In the long run, unfettered trade often lights a fire under domestic competitors as they are forced to become more efficient or shut their doors. E.g., the U.S. automobile industry responded to an invasion of cheaper Japanese imports in the 1970s and 1980s to vastly improve its quality and become globally competitive. U.S. manufacturing output has actually grown 3% in real terms since 2000 even though employment has fallen 25%.

When the division of labor expands, good things happen. If you’re an American, why stop at 340 million people to seek opportunities for trade? Why not open the possibilities to 8 billion? Imagine the Swiss limiting trade to the less than 9 million people in their home country. Any attempt would quickly lead to impoverishment. (Switzerland has zero oil reserves, not helping matters.) Just as companies focus on what they do best and outsource the rest, national economies do the same. Those that look inward and try to become self-sufficient, do so at their own peril.

The High Frequency Trader

Few economic actors are as misunderstood and scapegoated as the high frequency trader. These math wizards write complex computer algorithms and use supercomputers to place trades in fractions of a second. The little guy doesn’t stand a chance, at least according to their many critics. Any profit must come at the expense of retail investors. Oddly enough, HFTs are also blamed when they lose money, causing flash crashes and threatening the entire financial system.

Michael Lewis Attacks HFTs

The high frequency trader is nothing more than a modern day, high-tech example of the speculator, a key cog in the economic machinery. As Block explains in DTU, the speculator “buys low and sells high.” In doing so, he smooths out oscillations between fat years and lean years. For example, let’s say there is an oversupply of corn. The speculator buys corn at low prices, stores in a grain bin and hopes to sell sometime in the future when supplies are limited and prices higher. If he anticipates future demand correctly (i.e., better than others), he profits. If not, he loses money. If the losses continue long enough, he goes out of business. In the process, he must offer a higher price to the seller than he would otherwise receive in the marketplace when prices are down and a lower price to the buyer when prices are up. Win-win.

Mark Cuban Attacks HFTs

HFTs provide the same function as the speculator, smoothing out volatility, but do so over extremely short time periods. They also add liquidity and lower trading costs. According to a rare defense that appeared in the Harvard Crimson,

High frequency traders are making relatively little [profit] despite their massive market impact; they are the stock market’s new middlemen, and they charge a fraction of what the old middlemen did. If a small investor wanted to buy 100 IBM shares in 1994, he had to pay around $10 in brokerage fees, and at least six dollars in bid-ask spread costs to a specialist on the floor of the New York Stock Exchange. Today, the same trade will cost $1 in bid-ask spread thanks to the tight spread that high frequency traders provide, and the investor may not have to pay commission at all.

Just as bottom feeders are necessary to the proper functioning of the aquatic ecosystem, high frequency traders are vital to the financial markets ecosystem.

Top Corporate Undefendables

In order to assemble a list of corporate reprobates, I began with the 20 companies with the worst reputations according to a survey of 16,310 Americans “from a nationally representative sample” conducted by Axios and Harris Poll in March of this year:

The Trump OrganizationFTXFox Corp.TwitterMeta PlatformsSpirit AirlinesTik TokBitcoinBPBalenciagaFamily DollarDollar TreeWells FargoComcastSubwaySheinBurger KingDollar GeneralExxonMobilBofA

While a few of these poor reputations are well-deserved (e.g., FTX), most could inspire chapters in Walter Block’s book. The most cited examples include dollar stores (“accused of exploiting low-paid labor”), social media companies (misusing personal user data), major oil and gas exploration companies (“oil spills and misleading claims about climate change”), fast food chains (“cited for food quality issues”), large banks (“scandals from their recent past” and “pouring billions into the fossil fuel industry”) and fashion businesses (“in hot water for abusing their workers and running controversial campaigns that exploited children”). (DTU includes a chapter on the employer of child labor.) Political enemies are also prominent on the list: conservatives (#1 The Trump Organization, #3 Fox Corp.) and China (#7 Tik Tok, #16 Shein).

Businesses in the crosshairs of regulators are a second source for our bad guys list. According to Barron’s, financial regulators are targeting high frequency traders, payday lenders, debt collectors and student loan servicers. Also on the docket: requiring companies to disclose ESG risks such as climate change and board diversity in securities filings. This would take aim at the energy industry, intended to raise its cost of capital.

My third and final filter is political correctness. When DTU was published in 1976, the natural gas industry was acceptable; today it is clearly out-of-favor. Gambling was mostly illegal in 1976; today nearly every state has a lottery and casinos are widespread. Banking, while not exactly having a stellar reputation, is too tied to the government to make the cut.

The culmination of this exercise is the Coffee Can Undefendable Index, comprised of 15 corporate villains. While the stocks of these companies are likely to outperform over time, how investors use this information is a matter of personal choice.

For some, investing in so-called sin stocks goes against their moral code. For others, the benefits of a product or service must be weighed against the potential harm. “Everything in moderation.” Most people are addicted to their cell phones, for example, but could barely function without them. Five years ago, the oldest man in the world at the time admitted to being a lifetime daily smoker. For those who fear society is hurtling towards destruction, a bet on alcohol, tobacco, gambling and strip clubs might act as a hedge.

Personally, I prefer to go after the low hanging fruit, investing in industries that clearly contribute to human progress even though society fails to appreciate their heroic efforts. At the top of the list are oil and gas companies that provide the cheap, efficient fuel needed to lift the masses out of poverty and the dollar stores and discounters that make life easier for the low income consumer. I also have a soft spot in my heart for those multinational companies spreading prosperity brought about by global trade.

[This essay first appeared in the August 2023 issue of the Gloom, Boom and Report.]

 

Coffee Can Undefendable Index

Business

Company

Symbol

Annual

Revenue

($bil)

Annual

Operating

Margin

Chinese tech manufacturers

Foxconn Technology

2354.TW

2.8

3.2%

Cigarettes

Phillip Morris International

PM

31.8

38.5%

Coal miners

Peabody Energy

BTU

5.0

24.8%

Discount airlines

Spirit Airlines1

SAVE

5.1

-2.6%

Dollar stores

Dollar General1

DG

37.8

8.8%

Fast food joints

McDonald’s

MCD

23.2

44.6%

Gun manufacturers

Sturm Ruger

RGR

0.6

17.4%

High frequency traders

Virtu Financial

VIRT

2.4

29.0%

Offshore drillers

Transocean

RIG

2.6

-0.8%

Oil & gas producers

ExxonMobil1

XOM

398.7

15.9%

Payday lenders

FirstCash Holdings

FCFS

2.7

10.4%

Plastics

Berry Global

BERY

13.5

9.1%

Right-wing news outlets

Fox Corp.1

FOX

14.3

19.6%

Social media platforms

Meta Platforms1

META

116.6

24.8%

Strip clubs

RCI Hospitality

RICK

0.3

26.3%

On Axios-Harris Poll worst company reputations list.

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