The Money Shufflers' Vig

The notion of one’s child wanting to be a doctor sends chills of fear down parents’ spines, engineers gravitate to plying their craft on money instead of real stuff, and the $600/hour lawyers are depressed to the point of either padding their accounts or working nearly 24/7. Money shufflers are the new captains of industry…

In economics it is always difficult to know precisely what stage of a price, business, or speculation cycle one finds oneself to be in. However, we know that consumer price increases have been moderating since 1980 and that interest rates have been declining since 1981. At the same time, asset markets have been rising since 1982, although equities experienced a serious downturn after 2000. Therefore, it is easy to determine that we are not at the beginning of consumer price disinflation and an asset inflation cycle. Rather, we are likely to be in either phase two of the asset inflation cycle or, even more likely, in the third phase where the inflection point from asset inflation to consumer price inflation is reached.

Why do I think so? Unless a business downturn occurs, interest rates in the U.S. cannot decline any further. A business downturn, however, would not be good for asset markets, as affordability of the inflated assets would become a serious issue. If, however, the economy continues to expand, inflation to accelerate, and interest rates to rise, then it would seem to me that even modest interest rate increases brought about by the Fed, or by the market if the Fed doesn’t take any action, would cool, or more likely depress, various highly leveraged investment or asset markets.

This, as mentioned above, would occur in the U.S. through either deflation of asset prices in dollar terms or a depreciating dollar. The combination of the two is very probable, as was the case in Latin America in the early 1980s and during the Asian crisis in 1997/1998.

Asset Inflation Cycle: Phase Three of the Cycle

Characteristic of phase three of the asset inflation cycle is the rapid increase in the price of commodities. Now, I am aware that some observers maintain that, in today’s economy, rising commodity prices have little impact on consumer prices. But rather than pay attention to these new theories, I look at a study provided by Barry Bannister of Legg Mason, which shows a very close correlation between commodity and consumer price inflation over the last 200 years.

So, until proven differently, I suppose that rising commodity prices do have the tendency to increase consumer prices. I may add once again that it is very likely the CPI in the U.S. is understating the rate of inflation for the average household, which, I estimate, is running at least at 5% per annum.

In addition, if we look at the producer price index for intermediate materials, which is rising at an annual rate of over 8%, it is most likely that the producer price index for finished goods will soon begin to rise at a faster clip – that is, unless there is an immediate collapse in commodity prices.

Also, pointing to the U.S. economy having reached the third phase of the asset inflation cycle is the fact that it is internationally no longer competitive, which is reflected in the large trade and current account deficits.

I must point out that in the case of both high consumer price inflation and high asset inflation, a country loses out on competitiveness and will have rising trade and current account deficits. In both cases, either tight money policies by the central bank (high real interest rates), which curbs domestic demand and leads to disinflation and sometime even deflation, or the market mechanism, will eventually make the adjustments through a collapse in the bond market and the currency.

Then there is another point to consider. During commodity and consumer price inflation phases, speculation focuses on commodities and resource shares, while the financial sector performs miserably. (In the 1970s, a large number of brokerage firms closed down or were taken over.) During the asset inflation cycle, however, the financial sector performs superbly.

Asset Inflation Cycle: “Money Made from Shuffling Money Around”

Last September, Ray Dalio and Amit Srivastava of Bridgewater Associates published a report entitled “The Money Shuffler’s Vig” (see Bridgewater Daily Observation of September 22, 2004), in which the author wrote that “the money that’s made from manufacturing stuff is a pittance in comparison to the amount of money made from shuffling money around; 44% of all corporate profits in the U.S. come from the financial sector compared with only 10% from the manufacturing sector.”

Until the onset of the asset inflation phase in the early 1980s, the manufacturing sector’s profits always accounted for more than 40% of total profits while the financial sector never accounted for more than 20%. (In the 1950s and 1960s, the manufacturing sector accounted for about 50% of profits.) Moreover, it would appear that the 44% figure for the financial sector’s share of total profits is significantly understating financial profits, since they are unlikely to include financial earnings from industrial companies such as GE Capital and General Motors’ financial subsidiaries, and the profits earned by large multinationals from their treasury activities, which resemble hedge fund-type financial transactions.

The Bridgewater piece is actually quite humorous and comments on this shift in profit contribution from industry to finance as follows:

“We see it anecdotally – e.g. by who lives in the big houses in the expensive neighborhoods or who shops at the expensive stores. While in decades past it used to be the captains of industry, now it’s the money shufflers – the folks who handle OPM (other people’s money) and earn their vig of it. From low to high on the hierarchy, the money shufflers at or near the peak are a) bankers, b) investment bankers and investment managers, and then c) the 2 and 20 crowd (hedge funds, private equity firms, etc.).”

Now, the notion of one’s child wanting to be a doctor sends chills of fear down parents’ spines, engineers gravitate to plying their craft on money instead of real stuff, and the $600/hour lawyers are depressed (to the point of either padding their accounts or working nearly 24/7) in their failed attempts to stop falling behind.

According to Bridgewater, the growth in the money shufflers’ profits as a percentage of GDP has partially come because financial assets and liabilities as a percentage of GDP have risen rapidly and because “the average money shuffler’s profit per dollar shuffled has gone up (largely because those with the big bucks, particularly institutional investors, have gone from investing in the .25% to .75% fee stuff to investing more in the 2% and 20% stuff)”.

Cynically, Ray Dalio and Amit Srivastava note:

“[T]he only thing that has been a slight drag on the otherwise rapid growth in the profitability per money shuffler has been the big increase in the number of them. That’s one of the great things of capitalism – it allocates resources so efficiently. So, rather than turning out doctors, engineers, teachers, architects, and others who are involved with the old economy, our system has met the increased demand for money shufflers (like me and you) via an increased supply.”

So, even if the economy is not running on “empty”, it certainly runs on plenty of money shufflers!


Marc Faber
for The Daily Reckoning

April 27, 2005

Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report and author of Tomorrow’s Gold, one of the best investment books on the market.

Headquartered in Hong Kong for 20 years and now based in northern Thailand, Dr. Faber has long specialized in Asian markets and advised major clients seeking bargains with hidden value, unknown to the average investing public.

Dr. Faber is a regular contributor to Strategic Investment.

You can’t always get what you want…but you get what you need.

What America needs is a recession. Americans spend too much money; a recession will persuade them to spend less and save more. Household indebtedness has risen to nearly 90% of GDP – a new record. It is up 20% since the mid-’90s.

A recession would also help cure China’s export bubble; a recession in America will reduce demand for Chinese-made goods.

America needs a recession because its current account deficit has risen to 6.5% of GDP – an all time record. A recession will reduce the deficit. America needs a recession, too, in order to deflate the housing markets. Houses have gotten so expensive that many people can no longer afford them. House price inflation is at a 25-year high…while household earnings are flat or falling, in real terms.

A good, solid recession is just what the country needs.

But a good, solid recession is just what the administration and the Federal Reserve don’t want us to have. America was about to have a good recessionary correction in 2001, but then the Fed panicked, and gave away so much money to so many – that people barely knew what to do with it. So, they bought knickknacks from China…and houses! And now there are bubbles all over the place.

There’s a bubble in real estate…a bubble in China…a bubble in credit…maybe even a bubble in the bond and commodity markets too. It’s a “mega bubble,” says the Seattle Times, courtesy of the Fed’s ultra-low lending rates.

The Greenspan Fed has evolved with the times. It seems to know just what role to play to do the most possible damage.

In the late ’90s, Alan Greenspan proclaimed the miracle of the “New Paradigm” economy, in which tech stocks would go up forever – just before the NASDAQ crashed. Now, they’ve invented the “New Macro” theory, says Stephen Roach, in which deficits and debt no longer matter.

Just two week ago, Fed governor Ben Bernanke brought forth his “Glut Theory” to explain away America’s huge current account deficit. The problem was not that Americans spent too much, said he, but that Asians saved too much! We were just doing them a favor by taking the money off their hands. According to this theory an alcoholic is merely helping to alleviate a glut of booze…and a sex fiend is only reacting to a glut of women!

What will they think of next!

Back when Paul Volcker was at the Fed, the central bankers role was to “take the punch bowl away” before the party got out of hand. Volcker did it at the end of the ’70s – sending Treasury yields above 15%. The party animals were so mad, they burnt an effigy of Volcker on the Capitol steps. But the Fed brought inflation under control and prepared the way for the boom of the ’80s and ’90s.

Now, the party has gotten so wild that people are dancing on tables and putting lampshades on their heads. And Ben Bernanke and Alan Greenspan are creeping over to the punch bowl…with grins on their faces and bottles of gin in their hands.

No, the Fed won’t take the punch bowl away this time. It will take a recession…or a crash. Or both.

More news, from our team at The Rude Awakening:


Tom Dyson, reporting from Baltimore…

“Things are usually pretty quiet in the Baltimore HQ at 8 a.m., but a one-line email changed all that yesterday. The hoopla was ignited by our man in Beijing…”


Bill Bonner, back in the countryside:

*** New house sales hit a new record in March. Existing houses sold well too…but we can’t help but think and say over and over and over again…this can’t last forever.

*** A headline in The Washington Post today reads: “More Trouble May Be Found at Fannie Mae.”

This whole Fannie thing smells fishy. The headlines read a lot like the developing disaster at Enron in 2001. “We very well might find more problems as we continue to review the company’s accounting,” says Armando Falcon, director of the federal oversight committee.

If there had been no steps taken to identify the “accounting problems” Falcon continued, “they would have eventually manifested themselves in the form of some larger problem that might have created some kind of systemic disruptions” in the housing market. If Fannie Mae or Freddie Mac were to completely collapse, there would be much less credit for consumers to binge on in the form of mortgages.

*** A note from our friend Greg Grillot, reporting from Beijing:

“As I strolled down the dusty Beijing alley, dodging the reckless construction workers and making my way to “The Best Peking Duck Restaurant in the World,” Andy Carpenter decided to let me in on the true definition of inflation.

“You see, Andy has lugged over to China for over a decade – bringing intrepid investors the inside, dirty scoop on the then skulking dragon before anyone else even gazed away from WorldCom and Amazon.

“Here’s what he said: ‘Twelve years ago, my friend employed a girl (hooker, whatever word you guys like) for $15 US. He ambled toward me, all fired up, and then he told me he gave her a $20 tip. I chided him for that tip. I pleaded that he artificially pumped up the asset’s price.’

“‘Then, three years after that, a different friend came to me and ecstatically professed that he had landed a girl for $30! And that she was so nice, he gave her a $15 tip! Stupid Americans ruin China! Inflating everything! Destroying the country!

“‘Then, just last year – some new friend told me about the fair lass he landed for $50. I didn’t say anything except that I’m happily married, and I never dabble.’

“Andy has long since reserved himself to Americans raining inflation upon mainland China.

“Right after that conversation, we shared a $7 cocktail in our hotel…”

[Ed. Note: There are needs of many sorts, but the need that’s going up in price the most is far more important than the one discussed above – it’s the need for electricity…see our special report:

Energy = Wealth

*** Stocks have done nothing special the last few days – up, down, up, down. But gold is creeping up steadily. Yesterday, it hit $439, well above our latest buying target of $425.

*** The Chinese are making money – and spending it. Americans are cheap travelers by comparison. Catherine Chabrier, of Maison de la France, confirms this: “People planning trips to Europe always include three or more nights in France with Paris as the top attraction. The personal spending of Chinese tourists (in addition to board and lodging) is E430 (compared with E651 for Japanese and E328 for Americans).”

It costs a lot to get from China to France – about $2,000 in travel expenses alone. Plus, the Chinese government requires travelers to put down a deposit of twice that amount to make sure they come home.

“Over and above that,” continues the news item, “Chinese tourists like to spend when they go abroad. It is not unheard-of for each traveler to fork out $2,000 in spending money on an overseas trip. Indeed, the money spent by mainland tourists in Hong Kong is thought to be the single most important factor helping to revive the Hong Kong economy. A number of factors explain the Chinese love of spending: the lure of foreign brands, the thrill of buying foreign products and the Chinese philosophy that one should ‘economize at home but have enough money when you go traveling.'”

*** Jules has to decide which college he will attend by the end of this week.

“Well, how are you going to decide?” we asked.

“I don’t know, Dad…I can’t make up my mind. I like cities. But I don’t think I would like Boston University. It’s just too big. All of my friends are going to these little New England colleges. The guidance counselor recommended them to everyone. You know, Bowdoin, Bates, Emerson…But I don’t think I’d like them either.

“I was hoping to go to NYU, but I didn’t get into the film program. So, that leaves St. John’s. But it’s so small and quirky. And it’s not in a big city. Besides, the Princeton Review said it was the ‘most intellectual’ school in the U.S. That worries me, because I don’t know if I can handle it.”

“Well, you don’t want to go to a school that would be easy,” said Father Knows Best. “What would be the point? Things that are worth doing are usually hard to do…of course, that doesn’t mean that things that are hard to do are worth doing. It’s hard to stuff four billiard balls in your mouth…but it’s not a good idea.”

“Thanks for the helpful advice, Dad.”