The Rude Awakening
Wall Street, New York
Friday, December 30, 2005 ------------------------- - The second installment of a financial
striptease…now that's sexy!
- Is the American economy a slender supermodel or a
heaving, bloated mass of lard?
- The hottest predictions for the coming year and much
more…
------------------------- Eric Fry, filing his very last report of the Old Year,
writes… "We're doing something that's never been done by any prior
generation. We're looking fabulous until the day we die,"
Cheryl Tiegs recently remarked on a daytime talk show.
The U.S. economy may not be so different…A little GDP-
augmentation here, a little foreign-capital injection
there, and before you know it, you look absolutely
fabulous, even as you hobble inexorably toward that final
hour. To judge from outward appearances, the American economy
still boasts an enviable physique. But perhaps this
economic supermodel is somewhat more feeble than
appearances would suggest. Perhaps, for example, continuous
injections of foreign capital are propping up many of the
things that would otherwise sag in unsightly ways. Perhaps
the billions we borrow from abroad provide an aesthetically
pleasing lift to the bond market, to the stock market to
the housing market…and thus to the entire economy. On the other hand, as several "new era" economists would
argue, maybe we Americans deserve the steady flow of
foreign money. Maybe we really are the hottest thing
around, economically speaking, and fully deserving of all
the money the world throws our way. Our current account
deficit grows, therefore, simply because capitalists the
world over are freely electing to send it here in search of
high returns. As long as America rewards the capitalists,
the theory holds, the foreign capital will continue to pour
in. Over the last four weeks, the Boys of the Rude Awakening
have been debating this very topic, as well as various
related topics. In yesterday's column, we presented the
first part of the debate. In today's column, we bring your
Part II… --- Advertisement --- This time next year, you could have doubled your money. In fact, if you don't do so 12 times in the next 12 months,
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Edited by Eric J. Fry
"I'm coming down on the side that the trade deficit is
another junk statistic - like CPI or GDP," scowls Chris
Mayer, editor of Capital & Crisis. "GDP, the Producers'
Price Index, the CPI, Productivity stats, etc. etc. They
are all so flawed as to be practically useless. These
things are so abstract that they hardly matter, especially
as investors. I know of no great investor who has made
money in the market by interpreting trade statistics. They
are accounting fictions. It's a bunch of baloney, really. "As Bonner might say, my breakfast tastes no better, my
wife is not any prettier, nor does the sun shine any
brighter because the trade deficit goes down. And I have to
tell you, the argument that the trade deficit is an
accounting abstraction with little meaning, in and of
itself, is quite old. "I just pulled Murray Rothbard's huge textbook 'Man,
Economy & State,' off my shelf and flipped to the following
excerpt: 'More nonsense has been written about balances of
payments than about virtually any other aspect of
economics…Worries about national balances of payments are
the fallacious residue of the accident that statistics of
exchange are far more available across national boundaries
than elsewhere.' "Look, I'm not trying to convince anyone of anything. But I
am interested in getting at the truth of this thing. And
I'm not sure the conventional 'we're losing out to the
world - just look at the trade deficit' argument is right.
In fact, I'm inclined to think it's wrong." "Amen!" Justice Litle promptly replied. "Getting at the
truth is what it's about, or should be anyway. My 'hunch'
is that those who get hopping mad over the trade deficit
are mostly responding to the perma-bulls who cheerily
suggest the deficit doesn't matter. "I think intellectual property is the future. As a general
rule of thumb, profit margins increase as one moves further
towards the abstract. (Just look at Bill Gates and his
idea-based creation!) What's the marginal profit margin on
a good idea? But at the same time, there are very real
sociopolitical issues to deal with that just won't go away.
We can't just throw out the realities and constraints of
the industrial world like an old hard drive." "Agreed," said Mayer, "and when we are talking about trade
statistics for the entire nation, I can't get my mind past
one big thing: Trade stats only look at SALES not PROFITS.
This is undeniable. And it seems so important as to kill
any usefulness of looking at the trade deficit without
considering profits or the composition of that deficit.
Obviously, profits matter more than sales. The underlying
assumption of trade stats is that a dollar of exports is
worth the same as a dollar of imports…That's a fatal
flaw! "Anyway, I highly recommend GaveKal's book to stimulate
thoughts on these matters." Finally, when Bill Bonner could no longer restrain his
cyber-pen, he weighed in: "I did a lot of thinking on this GaveKal point too… "But I finally decided that the profit figures are
irrelevant. A company may increase profit margins by
becoming a 'platform' company…and benefiting from lower
labor costs overseas. So what…it still means that labor
costs are falling. The capitalists don't care. They'll take
their profits wherever they find them. Money has no
patriotic impulse. So the actual owners may not even be in
the economy we're talking about. They could be European
hedge funds…or Chinese banks. "The current account measures the entire flow of funds that
are current (not capital). If the figure is negative…it
means that the country as a whole is losing money (even
though many of its capitalists may be having the time of
their lives). "And when a company cuts its payroll costs…it may show a
higher profit. But it hardly makes the society richer.
Because the payroll costs are the income of the workers
(who are usually the customers). A company can get rich by
cutting expenses. But a society can only get rich by
increasing them." The Daily Reckoning's co-editor, Addison Wiggin, jumped in
next: "I haven't read the Gavekal book yet, but it seems to echo
Andy Kessler's point: 'We think, they sweat.' [Editor's
note: Kessler in a December 24, 2004, Wall Street Journal
article entitled, 'We Think, They Sweat,' champions the
idea that a trade deficit is a good thing. A thematic quote
from the article might be: 'You start to get a feel for how
the world works. A $1.5 billion trade deficit increases
wealth in the U.S. by some $16 billion - I'll take that
trade any day.'] 'After working with Kessler's idea in 'Demise of the
Dollar,' it seemed to me that 'we think, they sweat' is a
good investment maxim… a good way to find high net return
companies… but not a good measure of the wealth of
nations. You can have highly successful platform companies
right along side high unemployment and deflation in wage
rates. In other words, both descriptions of what's going on
with "globalization" can be true at the same time." Mayer, responding mostly to Bonner, wrote: "Well, I don't see how profit is irrelevant. You're
assuming companies expand profit margins and profits only
by lowering labor costs…and that the payroll lost in one
US company is not picked up by another US company.
"The evidence suggests companies can expand margins,
profits and increase payrolls. An Intel or Apply employs
more people than 10 years ago and makes a lot more money.
Lots of smaller companies have also been expanding payrolls
and growing profits at the same time.
"More people are employed in this country than ever before,
as GaveKal points out…and however you slice the
unemployment data, they are low by historical standards and
far better than, say, EU countries.
"So, we see no decline in employment over the years this
deficit has grown to historic levels."
Byron King, contributing editor of Whiskey and Gunpowder,
interceded:
"Chris, I think that Bill's point (not that I have to put
words in the mouth of such a wordsmith…) is that what
might be good for General Motors is not necessarily good
for America. Strange, isn't it? Back in 1913, Henry Ford
did something that appeared NOT to be good for Ford, by
paying his workers $5.00 per day, an unheard-of wage before
then and certainly for factory work. People thought that
Ford was nuts, and would soon be out of business. Not to
make too much of a caricature, but the conventional wisdom
was that you could not run a business without grinding the
faces of the poor workers. "But as it turned out $5.00 per day was good for both Ford,
his workers and for America, because it ushered in the rise
of an American middle class of consumers, employed at
(relatively) high wage & high skill jobs, making stuff that
other people wanted to buy. The workers could afford to
buy their own product. "The idea of so-called platform companies strikes me as
being a relatively small, transient, if not effervescent
part of the economic ecology. 'We think, they sweat' seems
to me to be an arrogant attitude that places those self-
selected companies at the top of a food pyramid. Call them
'predator' companies, if not 'vulture' companies. That is,
a few, relatively small companies (eagles or buzzards, your
pick) have some particular niche-skill through which they
survive by focusing production of something by the lowest-
cost, lowest-factor producer, and selling that product into
the market that consists of whatever remains of the wealth
of a nation in decline. Break one part of the food chain,
however, and these birds are out of business. "That is, continuing the raptor-analogy, if the population
of small prey goes away (something wipes out the food
source at the bottom of the pyramid), the population at the
top of the chain also declines radically. Applying the
analogy to economic ecology, if Peak Oil causes production
and transport from distant locales to become prohibitively
expensive, then an entire segment of the chain is lost to
the platform company. "And also, a company that sells into a market, taking the
underlying wealth and accompanying profit out of that
market, but without putting anything back in return….
well, how long can that last? You are asking people to
burn their furniture not just to keep themselves warm, but
to warm your house while theirs gets colder and colder. "At root, platform companies do not offer a long term
solution, let alone a sustainable one, to any economy." To be continued one more time…In a rare Monday morning
edition of the Rude Awakening we'll present the concluding
thoughts from the debate's participants. [Joel's Note: These blokes get together once a month to but
heads, challenge each other's ideas, debate, pound fists on
a boardroom table and distill down the best investment
ideas they can come up with. This information is
actionable, profitable and available for you to listen to
right here: Who's afraid of a Webinar?
http://www.agora-inc.com/reports/400SPRED/E400FC33 --- Advertisement --- Tune into the 11 Hottest predictions of 2006, right here. Imagine the money you could have made had you known the
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