Exploiting The Capitalists

In the current issue of “Forbes,” we learn how much some of the leading Internet stocks have collapsed. Value America — down 96%; E-Loan — also down 96%; DrKoop — down 95%; Etoys — minus 94%; Theglobe.com — down 93%. The list goes on and on.

But right now, something very interesting is happening. The stock options given to employees are way below the strike prices. So the companies are under a lot of pressure to re-price the options.

Investors may wish to have their shares re-priced, too. Alas, that is not the way it is likely to work.

Capitalism as we have known it is dying. These new businesses are perfectly happy to let investors suffer huge losses. But employees? They have to be protected. Even if their options go bad, they’ll still get their money.

I’ve mentioned several times how, if companies such as Microsoft were forced to treat their employee stock options as what they really are — labor costs — there would be no profit left over for investors. That is, the companies would be operating at a loss, not a profit.

It’s not the capitalists who will profit from the Internet companies; it’s the employees. Peter Drucker explains why:

“Until well into the 20th century,” he writes, “most workers were manual workers. Today, in the U.S., only about 20% do manual work. Of the remainder, nearly half, 40% of our total work force, are knowledge workers.”

Knowledge workers are different from manual workers. Manual workers learn a skill. But once learned, their capital value scarcely increases. That is why manual workers reach the peak of their earning power very early in life. Typically, they are most valuable when they have learned their trade and are still young enough to practice it with vigor.

Drucker points out that the trade of stonemasonry, for example, has barely changed since the time that Socrates practiced it 2,400 years ago. The old philosopher could walk onto a job site today, pick up the trowel, level and hammer and go right to work.

But imagine the knowledge worker of 400 B.C.? No matter what work he did, he would have to take at least a few refresher courses to catch up. Knowledge increases at a faster and faster rate. And those people who have real knowledge — that is, those people who understand how to make things work — are critical to modern economies.

Capitalists could own a factory or a mine. They could own the ships that transported goods. But they cannot own knowledge. Yes, they can hold patents and trade secrets. But those represent a very small — and diminishing — part of the knowledge stored in their employees’ heads.

“We live in an economy where knowledge,” says Drucker, “not buildings and machinery, is the chief resource and where knowledge workers make up the biggest part of the workforce.”

These knowledge workers are more important to, say, a company such as Manugistics, an e-commerce software business, than investors. “We decided that retaining our people was critical to our future,” said the company’s CFO, explaining why the company reset its options from $17 to $9. The capitalists have been exploited. They will take the loss. But, as the CFO realized, the employees are critical.

Even in the Machine Age, capitalists were exploited. This is a point made by James Davidson and Lord Rees-Mogg in their most recent book. A factory or railroad could not be easily moved. Labor unions, working hand in glove with political authorities, were in a position to demand payment. New and higher taxes were imposed. And salaries were increased — often far above the existing market rates. The history books refer to this shakedown as the taming of rapacious capitalists by democratic institutions. Some economists actually seem to believe that labor unions and government regulation “saved” capitalism — which was threatened by communism and in danger of disappearing altogether.

And now that communism has sunk into its own midden, it is widely reported that this new, more humane capitalism has triumphed. Yet now even people like George Soros are worried that capitalism is breaking free of its Machine Age chains. The labor unions are declining in power. The proles have all become mutual fund stockholders! And globablism has allowed large corporations to escape the control of any single government. The “Open Society” is endangered by unfettered capitalism, says Soros. “The situation is untenable,” he writes in “The Crisis of Global Capitalism.”

Soros completely misses the real crisis of capitalism. It is not the lack of government control. It is the fact that capitalists are once again being exploited by the workers. Management is free to re-price its options to retain and reward valuable employees. If you are an investor, however, you should not expect to have your shares repriced — except by the market itself…and lower.

The real crisis of capitalism is that capitalism, as defined by Karl Marx, no longer makes sense. Marx said that capitalism was a system where the capitalists owned the means of production. He was thinking of factories — the most visible means of production in the Machine Age. But the means of production now go far beyond the factory and the hourly factory laborer. The means of production are more and more a function of knowledge — which is owned, used and controlled by workers, not capitalists.

The emblem of profitable business is no longer the steam engine or the assembly line. The production of tangible goods has been commoditized. There are many competitors in many different parts of the world — ready and able to make whatever widget you need. And factory labor, too, has been commoditized and globalized to such an extent that hourly wages in the United States have gone virtually nowhere in 30 years.

But knowledge is hard to commoditize. It changes too rapidly. And those with the critical, up-to-date knowledge are extremely valuable. This is where the value is added…and where the profits will inevitably end up.

Your very un-commoditized correspondent,

Bill Bonner

Paris, France May 11, 2000

*** We are at a rare and exciting point in history. We have been promised a New Era and a New Economy — complete with new “valuation metrics” to justify high stock prices and a New Man smart enough to buy them.

*** But now it appears that investors are wondering – “is this new era for real?” (Only we seem to know the secret…)

*** The Nasdaq, home of so many new era illusions and expectations, fell 200 points yesterday. It is now down 33% from its high of March 10, at 5,048.

*** At least the doubt on that score has been removed. The Nasdaq — the last of the major indexes/sectors to do so — topped out in March. We are now in a broad, full bear market.

*** The Dow fell yesterday, too. It was down 168 points. Between the Dow and Nasdaq, I estimate that about $460 billion in paper wealth was removed from the U.S. economy yesterday — an amount equal to the entire capitalization of Cisco.

*** Asian stocks are falling this morning. The Nikkei 225 average was down 3% at noon.

*** The Cisco Kids suffered yesterday, too, as investors raised the hurdle — meaning they are getting more careful with their money and more selective about where they put it. The New Economy story is no longer quite as attractive as it was a couple of months ago. Investors are beginning to do the math — and the numbers for CSCO, as well as many other companies, don’t look good.

*** At the point where faith in this New Era peaked, no price seemed too high to pay in order to own a piece of it. Even if any individual company failed, there was still little doubt that the New Economy would soon replace the Old one…and that investors who didn’t get on board would be left behind. Because this was not supposed to be a “bubble”; it was the real thing, built on a new innovation with a revolutionary potential — information technology.

*** Investors are still bullish. As Laslo Birinyi puts it in “Forbes,” “those who buy as stocks go down are demonstrating their faith in the future.” This is another aspect of the New Era. You gotta believe. And you have to sacrifice yourself — like Russian troops in the defense of Stalingrad — so that the New Era might live. Faith, not logic or stock analysis, moves the market.

*** Every analyst quoted in today’s Reuters’ story had Cisco as a “buy.” Still, as the volume of trading rose on Wall Street yesterday, CSCO went down. At its peak, CSCO stock sold for $82. Now it’s at a nearly 40% discount.

*** But even at that, CSCO still sells for nearly 30 times revenue. It, and the entire market, has a long way to go before it hits bottom. Sell the rallies.

*** AWE, the biggest IPO of all time, is now below its issue price.

*** So many of the sustaining cliches of the New Era have proven to be completely wrongheaded. Peter Drucker takes up my point about the “first mover advantage” in the current “Forbes,” for example. It is “no advantage at all,” says his partner, Alexander Brigham. He reminds us of Prodigy, a pioneer in business-to-consumer marketing on the Internet. “AOL waited…and then blew Prodigy away with a better product,” he says. “Be a smart and slow mover,” he adds, “rather than a dumb, first mover.”

*** Another of the cliches we have heard often is that the Internet marks a triumph of capitalism. Maybe, but not the capitalism that is good for investors…more on that below…

*** While stocks fell, bonds, the dollar and gold all rose slightly. Gold rose so slightly that it is not worth talking about. But the yield on 10-year T-notes fell (which is what happens when bond prices rise) to 6.44%. Six-and-a-half percent is not a lot of money — but it sure compares favorably to losing 33% of your money. Shrewd investors, if there are any, may not be sure if the New Era is real or not…but they might very well decide to sit in T-bonds at 6.44% while waiting to find out.

*** “The euro was launched with huge hype at $1.17 on Jan. 1, 1999,” writes Steve Hanke, columnist for “Forbes,” and contributing editor to our “Fleet Street Letter.” “Since then (and contrary to the expectations of most pundits and analysts), it has taken a beating. The only surprise is that anyone was surprised.” Hanke notes that the euro may be regarded as a composite of the 11 currencies of which it is comprised. Against that composite index, he says, the dollar has been going up since the mid-`70s. “It doesn’t take a rocket scientist to conclude that Euroland’s economy is no match for the United States and that the euro’s long-term sinking trend will continue.”

*** OK, but with the exception of the late `70s, the dollar has always benefited from very high real interest rates compared to Europe. Plus, the real rate of return on U.S. financial assets to European investors has been phenomenal — until recently. If, as I expect, the bear market on Wall Street grows more serious, the Europeans will begin to favor their own currencies — and the dollar will fall, perhaps even crash, against the euro.

*** Last week I reported unemployment had dropped to 3% in 30 of the top 50 metropolitan areas in the United States. “Well, duh, it’s census time,” says Lynn Carpenter. “Unemployment always drops when the year ends in 0… 1980, 1990, 2000.” Call it the “duffer effect.” Every 10 years the Census Bureau sends the unemployed around to hustle people for the “long form.” See her full article under “Too Many Workers, Too Few Loafers” at the DR site (http://www.dailyreckoning.com).

*** Bull market in commodities? The Nasdaq is down 33% since its March 10 high, but the CRB index is soaring! This little-known index measures prices of 21 major commodities from orange juice to crude. Dan Ferris reports the CRB is at its highest level in two years — and it’s rising. (See “Bull Market In Commodities” at http://www.dailyreckoning.com)

*** Kathleen Peddicord, writing from Honduras, says she’s discovered 31 acres of secluded, boat-access-only beachfront property with about 3,000 feet of white sand on “one of the best beaches at the east end of Roatan Island.” It’s 99% buildable…and you may be able to get it for as little as $5,000 an acre. http://www.escapeartist.com/international/living3.htm

*** I had lunch with my friend, Michel, with whom I’m in the book business in Paris. He explained that the big bookstores were reducing inventory. They could make money on the bestsellers, but books that sold only a few copies were not worth stocking.

“If you want something on a special topic, you have to go to a store that specializes in it,” he said. Michel explained that the same phenomenon must be hitting the Internet booksellers — but only worse. Because the Internet makes it possible to cut up the market into more and more specialized niches.

This is why the Internet is such an important innovation — it moves the division of labor into a higher gear…allowing one bookstore in Bombay to specialize in books on the Cathar Heresy…while another in New York concentrates on Gothic Rock.

It is also bad news for a company such as Amazon.com, that hopes to become all things to all people.

*** Lynn Carpenter has been having great success trading value stocks. Seems almost oxymoronic, but it seems to work. Using a “100-year-old point and figure system,” she says, “we made 122% average returns on retail last month…and yesterday we added two calls–yes, bullish— [and]…our closest call is already up 60% in one day…”

*** Today is the birthday of Salvador Dali, born in 1904, who helped to culture various strains of mutant artistry — dada and surrealism, mainly. But Dali was smart enough to know that it was all humbug…he packaged himself and his art and sold them like Elvis paintings on velvet — but at much higher prices.

*** It is also the anniversary of Bob Marley’s early death. Marley’s music is lively and engaging — as long as you don’t pay attention to the lyrics.