The subject is not roses — it is wealth. What is it. How you get it. How you keep it.
At least that is the ostensible subject of the “Daily Reckoning.” But I often find it worthwhile to climb a high peak in some distant direction — just to look down on it from far off…hoping to see something I hadn’t noticed before.
Yesterday, we took a hike back in time about 23 centuries in order to look at wealth through the eyes of one of mankind’s most quoted sages — Aristotle. We were reminded that not every “investment” is oikonomic. That is, not every investment adds to the sum of human wealth. There are also the “speculative” investments — that merely rearrange wealth, from one pocket to another, rather than increase it.
This, in turn, leads me to two thoughts — both monumentally important, but neither of much interest.
The first concerns the specific nature of the investment and wealth that is being created today.
I know what you’re thinking — you’re thinking that I am going to tell you yet again that this market is based on speculation, not genuine economic investment. And yes…I am. But I am also going to describe how this sort of speculation leads not only to zero increase in the sum of wealth in our society — but to an actual decrease. You will, therefore, be among the few who are privy to the dirty little secret of the New Era. The so- called “wealth effect” — the wealth engendered by the stock market — is not wealth at all. Not one person in a thousand realizes it. But the “wealth effect” is actually negative. It is anti-wealth. It is poverty. More on that in a moment.
The second thought is an observation about ideology and politics — inspired by Mr. Dillon, quoted here yesterday, and his reaction to “speculative capitalism.” He would like to bring it under control. This sentiment is not too far from the one expressed by George Soros in his tedious book, “The Crisis of Global Capitalism.” Mr. Soros, Mr. Dillon and his Ecumenical Coalition for Economic Justice invite comment — if not ridicule. More on that tomorrow.
Classical economics — like classical design — concerns itself with what is real, fundamental and time-tested. It is a search for the rules…the proportions…the balance and relationships…that are harmonious and enduring. Even in today’s manic markets, opines Chicago billionaire Sam Zell, “as far as I know, the laws of economics haven’t been reversed.”
One of the laws that, as far as we know, has not been reversed is the law that governs the creation of wealth. Wealth, in its naked form, may be described as the amount of capital per person. Thus people get richer when the amount of capital/person increases. In the opposite instance, writes our very own classical Austrian economist, Dr. Kurt Richebacher (http://www.dailyreckoning.com/rich_report1/index.cfm), “capital decreases when the community consumes more than it produces.”
So the question at hand is: does the “wealth effect” cause people to consume more than they produce?
And the answer is – emphatically — yes. That is precisely what the “wealth effect” does. It makes people feel richer — because their stocks have gone up. They then increase their consumption, spending real savings while allowing their stock market portfolios to provide the illusion of wealth.
“Never before have equities contributed so much to household wealth,” writes Jim Grant in “Grant’s Interest Rate Observer.” “(31.7% at the end of 1999, up from 28.3% in 1998, according to new Federal Reserve data.)”
“If inflation can be defined as a rate of rise in prices sufficient to bring about a change in behavior,” Grant adds, “Wall Street today answers the definition.”
What behavior has changed? Saving and traditional investing have been as neglected as last year’s New Years’ resolutions. While spending and speculation have been undertaken with the enthusiasm of maggots at a cadaver.
Over the last 12 months, total credit in the United States has expanded by more than $2 trillion. That’s about 5 times as fast as GDP growth during the period. And it puts credit compared to GDP at more than twice the level it was at its peak in 1929.
The “classical” economists believed that only savings could produce genuine investment and increased wealth. Credit expansion merely produced the illusion of wealth — which caused people to believe they had money when they really didn’t…and lured them into making bad decisions.
Bad decisions have been made aplenty. Private debt levels have soared — including margin debt, which has risen nearly 10-fold in the last 10 years. And companies — especially Internet companies — have invested billions in projects that can’t possibly pay off.
Meanwhile, the trade balance has gotten so far out of harmony that Americans are now spending nearly $1 billion more each day on imported goods than they receive for the goods they export. For now, the joke seems to be on the foreigners who are willing to accept pieces of paper in return for real goods and services. But in the long run, who will have the last laugh? The debts may last a lot longer than the merchandise.
The debts will almost certainly outlast today’s stock valuations. Because the investments are not economic, but speculative. Too much money has been thrown at companies with no real, proven plan for making profits. Investors have had only the dimmest idea of how these investments would result in economic gains. The information age is supposed to make us all richer, but no one is sure just how.
One of the favorite speculative targets, for example, has been companies with the “first mover” advantage. But as Sam Zell points out, being first is only an advantage if you can erect a barrier to entry behind you. As mentioned here many times before, Alexander Graham Bell had a first mover advantage. Amazon has no such advantage. In fact, it has a disadvantage — it has plunged into an industry where no one knows how to make money. And it loses more than $1 million every business day — trying to learn something from which every potential competitor can benefit.
“Wasn’t Atari a first mover?” asks Zell, interviewed by the “Chicago Sun.” “How about Bowman [the first company to make a pocket calculator]? They dominated the space, but they didn’t have a barrier to entry. So Bowman was followed by Casio and everyone else, and it doesn’t exist anymore. What kid plays on a Commodore computer today?”
“In 1990, Citibank almost went broke because they had a staggering $23 billion exposure to the real estate market, which had been distorted by unprecedented capital pouring in in the late `80s…We eventually recognized that everything built in the last five years was worth less finished than it cost to build.”
When times were good, Citibank benefited from a “wealth effect.” Real estate values were rising and so was the value of its portfolio. So Citibank was encouraged to lend even more money for even more ambitious building projects. But when the cycle turned, the truth came out: the investments were uneconomic. Citibank’s borrowers — and Citibank itself — were poorer as a result, not richer.
When the Nasdaq finally sinks, another truth will reveal itself. People will realize that they have been made poorer, not richer, by the “wealth effect.” And there won’t even be empty new buildings to admire.
Your correspondent in Paris, where there are plenty of buildings to admire…
Paris, France March 28, 2000
P.S. Zell was asked if he were jealous of the dot-com billionaires: “When those young entrepreneurs convert their positions into $1 billion in cash, then we can talk.”
*** Yesterday was a boring and unhelpful day. The markets played their cards close to their vests — revealing no hint of their intentions.
*** The Dow fell 89 points. There were 1,283 stocks advancing and 1,680 declining. This A/D movement is just what we’ve gotten used to over the last two years — more stocks going down than up.
*** But there were 88 new highs compared to only 49 new lows — to confuse the picture.
*** No settlement was announced in the MSFT case. Disappointed shareholders — who had bought the rumor — sold the news, driving down MSFT shares by 5%. Cisco is now the largest cap company in the world. It is worth more than 5% of the entire U.S. GDP…and one analyst was quoted as saying it was on the way to “becoming the world’s first trillion dollar company.” Gosh…I should probably try some of their products. But what do they make?
*** The Nasdaq went nowhere — down 4.51 points. The Nasdaq 100 managed a slight gain — up 13 points — to bring it to yet another record high.
*** But volume was suspiciously low. You’d think that if the bulls were stampeding there would be a lot of action on the floor. There wasn’t.
*** Another thing — gold fell $4 to close (April contracts) at $280. This despite signs everywhere of creeping, seeping, peeping inflation. As I noted yesterday, the real fed funds rate is only 2.8%. Money supply has increased by more than $70 billion over the last two months. Oil…housing…the major components of everyday life are increasing in price. So why is gold falling?
*** Well, there are always rumors of conspiracies…and central banks driving the price this way and that…but I wonder if my view is not correct — that we are near the end of a long, difficult, confused period in which the stock market is topping out. This period will be followed by trillions of dollars worth of stock market losses (deflation) and a major recession.
*** Sounds hard to believe, doesn’t it? And yet, that is just what “classical” economists would expect. More below.
*** Doug Casey, recently returned from Cuba, reports that the place is booming. Unlike my other Cuba eyewitness, Doug is bullish on Cuba and believes the island is going to make a lot of money from tourism — in spite of itself. Doug suggests a couple of investments (http://www.dougcasey.com)
*** Also intriguing was an insight into the character of Cuba’s leader. It is always eye-opening to realize how banal and stupid powerful ideologues can be. Doug reports a recollection by Alina Fernandez, one of Castro’s daughters, who remembers him lying on his bed, his hands behind his head, worrying about fulfilling his mission as Cuba’s savior. He was “particularly concerned,” Doug writes, “with his negotiations with the Japanese for enough snow cone machines to put one in every barrio `so the people are going to be able to have their little ice cream.'”
*** One of the idiosyncrasies of Americans, according to Richard Reeves, writing in today’s “International Herald Tribune,” is that Americans “believe in the right to fail — and to move on. That is why they are so mobile and why the bankruptcy laws are so lenient.” Doug Casey notes that more than 1 million people took advantage of America’s bankruptcy laws in 1997 — in the midst of the biggest financial boom of all time — and now the number is “headed to 1.5 million. Question: What’s going to happen to the bankruptcy numbers when the economy, interest rates and the stock market are less accommodating…?” Good question.
*** “The rate of company creation,” says a venture capitalist quoted in the `NY Times,” “…is unsustainable. I would not be surprised if there were 20 or 30 new Internet companies a day being formed in New York. People are forming companies for the wrong reason. They aren’t passionate about their ideas. They just want to be millionaires like all their friends…”
*** The “Chicago Sun” passes along Sam Zell’s musical tribute to the New Era (sung to the tune of “Fifty Ways to Leave Your Lover.”)
Fifty Ways to Make a Billion —
Just add a dot-com, Tom. Spell your name with an “e,” Lee. Start auctioning toys, Roy. And set yourself free.
Don’t need to make money, Hon. Just set up a site, Mike. And price yourself right.
*** Well, here’s something I haven’t seen in a long time. On the front page of today’s “International Herald Tribune,” and the “Figaro” too, is a photo of Vladimir Putin on the telephone…accepting a congratulatory call from Britain’s Tony Blair (though, from his expression, the former KGB agent might be collecting a gambling debt or learning that his dog was just run over). But here’s the amazing thing — Putin is speaking on a rotary phone!
*** And here’s a curious little item — a man was arrested at Charles de Gaulle airport trying to smuggle a boa constrictor through customs — in his underpants. Now there was a man who loved snakes.
*** Property prices in California, New York and London are reaching dizzying levels. A friend just bought a house on the outskirts of London. He could have bought a whole block in Baltimore for the same price. Realtors in Silicon Valley report that houses sell for 20% more than the asking price.
*** Stock market speculation is being taught to prison inmates. This is probably not so much rehabilitation as advanced training. Why hold up liquor stores when you can work on Wall Street?
*** Elizabeth has been in contact with the police. Remember I told you about the bizarre threats we received? Well, the story gets even more bizarre. Turns out other people have gotten similar threats. And the police think they know who the culprit is. Stay tuned.