Capital Consumption

It used to be commonplace in economics that investment in productive plant and equipment is the key to increased productivity and rising living standards. Sufficient investment spending takes care of supply and demand, productivity and profits.

But the crucial, negative point to see about the U.S. economy’s development over the past 20 years is simple. The key conditions for a high rate of saving and profits have been recklessly ravaged through policies that boosted consumption and financial leverage at the expense of corporate accumulation of productive capital.

It also used to be commonplace in economics that somebody who persistently spends more for consumption than he earns doesn’t get richer but poorer.

Implicitly, the same is true for a nation. Yet we keep reading that America has enjoyed its greatest wealth creation of all times in the past several years, vastly outpacing the domestic and foreign debt growth.

Productive Plant and Equipment: Net Capital Investment

How to make sense of that? In short, by distinguishing again between micro and macro perspective. From an individual’s viewpoint, rising stock valuations unquestionably add to his wealth. But the crucial point to see is that this wealth adds nothing to the real economy and in particular, nothing to its real wealth in the form of productive plant and equipment. From the national perspective, the only way to greater wealth is to construct industrial structures and houses. Strictly speaking, it is net capital investment.

Rising stock valuations, rather, create claims on the economy. In the United States, they actually fostered the protracted consumer borrowing and spending binges and, as its counterpart, the exponential rise in domestic and foreign indebtedness. For people with common sense, such debt-financed consumption is a clear case of capital consumption or wealth destruction.

In the consensus view, the sharp decline in U.S. business fixed investment is due to prior overinvestment and existing excess capacities. This assessment is based on the fact that America had an unusually high gross investment ratio over the past few years. In our view, the plunge of investment is due to the extraordinary consumer spending excesses that essentially resulted in a drastic shrinkage of the share of GDP that is available for net investment.

What is the difference between the two measures? According to the conventional first gauge, fixed capital investment of firms in the nonfinancial sector accounted for 31% of U.S. real GDP growth between 1997-2000. It was by far America’s highest investment ratio in history. According to the second version that we use as a gauge, net investment of firms in that sector accounted for 7.3% of GDP growth in current dollars during this period.

Productive Plant and Equipment: Moving in Lockstep

Which of the two is the more reasonable calculation? Net investment is gross investment less depreciation charges. Normally the two move in lockstep, but they diverge sometimes when depreciations slow or accelerate.

The latter happened in America in the past few years. As business investment in short-lived computers and software took a rapidly growing share of total investment, depreciation charges sharply accelerated. A bigger chunk out of gross investment is simply replacing capital equipment that wears out, adding nothing to the capital stock and national income.

Another major source of the big difference between the two measures of investment derives from the so-called hedonic pricing, in which America’s government statisticians value business investment in computers. In 2000, businesses spent altogether $93.3 billion on new computers, up from $90.4 billion in the prior year. Measuring in real terms, however, the statisticians come to a vastly higher figure of $246.4 billion, up from $207.4 billion in the year before.

Productive Plant and Equipment: Statistical Boost

By far the single biggest statistical boost to the U.S. economy’s investment ratio occurred in 1999. With a stroke of the pen, the statisticians of the Commerce Department took business software spending out of the corporate expense accounts in their GDP statistics and instead capitalized them as investment spending. In one sweep, this drastically padded GDP growth, productivity growth and profit growth.

To give an idea of the impact of this change: In 1997, the prior year, recorded business spending on equipment was $620.5 billion. In the current statistics, it amounts for the same year to $764.2 billion. Lately, software has accounted for 45% of total business investment in high-tech equipment. “Hedonic” computer prices have, on the other hand, been drastically revised downward.

Frankly speaking, it is a statistical muddle. It amazes us how easily the large army of the world’s financial and economic experts can be fooled. The miserable reality is that net investment and the capital stock have been sharply falling in relation to GDP since the early 1980s.

Worldwide, forecasters are virtually united in saying that the string of big losses in the stock markets is bound to stop after three years. It does not bother them that the very same forecast made a year ago went utterly wrong.

For sure, a mere lapse of time will not stop this downturn.


Kurt Richebächer,
for The Daily Reckoning
February 6, 2003


The ‘Stevenson moment’ was a bit of a flop in Europe. The British were not convinced. Press polls say that 70% found Powell’s proof unpersuasive.

“With all America’s sophisticated technology…” asked a guest on a morning talk show, “is that the best they can do?”

Investors didn’t know what to make of it. In the US, they pumped up stocks…and then deflated them. Even gold buyers weren’t sure. They bought the rumor on Tuesday, in anticipation of Powell’s speech, and then sold the news, knocking down the price of gold on Wednesday. Gold shares fell 4.2%.

Here at the Daily Reckoning headquarters, we’ve been waiting for a fall in the price of gold. We want to buy more and were hoping for a better price. What fools we are! How do we know what the price of gold is going to do today or tomorrow? If we’re right about our Trade of the Decade – sell stocks/buy gold – we’re going to look back in the year 2010 and we’re not going to care whether we bought it at $380 or $320. The Dow will be under 5,000 and gold will be over $1,000!

Many people think the price of gold is driven by war worries. They expect it will top out when the war against Iraq is finally decided.

Others, notably Robert Prechter, believe gold is still in a bear market. It will fall to $200 before a real bull market in the metal begins, says Prechter.

We don’t know. But “there’s no fever like gold fever”, as Richard Russell puts it. Sometime between now and the end of the decade, we think it is likely that the world’s investors will catch it…and bid up the price to levels we can barely imagine.

And if we are wrong? What could be so bad about holding the world’s surest money during one of the most uncertain periods in its financial history?

Buy gold. Don’t worry. Be happy.

And now…Eric Fry, back on the job after medical intervention:


– Ouch! That’s gotta hurt!…No, not your co-editor’s minor surgery on Tuesday (those Botox injections are a marvel!), but the stocks market’s failed attempt to rally yesterday. The Dow’s early 140-point rally disappeared by the closing bell to become a painful 28-point loss. The only thing worse than ending the day with minus signs is beginning the day with plus signs, and THEN ending the day with minus signs. Yesterday’s losses dropped the Dow to a three-month low of 7,985. The Nasdaq fell 4 to 1,301.

– The gold market gyrated even more wildly than the stock market. Gold soared early in the day to hit a new six-year high of $384.50. But the sharp rally reversed itself and the yellow metal finished the New York trading session $4.90 lower at $375.00 an ounce.

– The gyrations in both markets stemmed from hawkish comments by Secretary of State, Colin Powell. The Secretary seemed to indicate that war with Iraq is now a virtual certainty. Then again, when was war with Iraq ever NOT a certainty? The party line in the Bush cabinet remains the same: Iraq is hiding something, and we’re gonna find it come hell or high water…or a bear market on Wall Street or a recession on Main Street.

– The drums of war set a bullish cadence for the oil market, as crude gained 40 cents yesterday to nearly $34.00 a barrel. But over in the stock market, war with Iraq is hardly a bullish influence. On the other hand, neither is it the solitary cause of the stock market’s troubles. The market had plenty of troubles before Iraq returned to the front pages of our nation’s newspapers.

– “Ever since the market peaked in March 2000, the permabulls have stuck to their optimistic story,” Comstock Partners observes, “always finding some extraneous event to blame for the market’s decline rather than admit the real reason – the highly negative consequences of the bursting bubble and excessive valuations. Now it’s the turn of the Iraqi situation to shoulder the blame for the market’s woes.”

– Comstock doesn’t buy into the blame game…and neither do we. The market’s woes do not result from exogenous factors at all, but from the one big endogenous factor called overvaluation…The devil is within. The bulls like to point to a series of “one-offs” for the market’s troubles. The dot-com implosion, September 11th, Enron and corporate villainy each, in turn, took the blame for the market’s troubles. The bulls conclude, says Comstock, “that they merely have had the bad luck to be hit by a series of seemingly unpredictable and unrelated events.” Bad luck indeed, like the sort of ‘bad luck’ a person encounters when jumping off a cliff or standing in front of an onrushing freight train.

– “The market is in a severe downtrend as a result of the bursting bubble and the serious structural imbalances it has left in its wake,” says Comstock. “The downtrend will not end as long as investors continue to delude themselves and deny the true reasons for second worst bear market in U.S. history.”

– “Perhaps it is a natural defense mechanism that finds investors embracing one excuse after another to rationalize the market’s poor performance,” writes Stephanie Pomboy, editor of the ever-insightful MacroMavens. “Or maybe, repelled by the bitter realities of the post-bubble world, they have simply retreated into a delusional state. Either way, the practice of ascribing our problems to dubious causes continues with Saddam playing scapegoat…Investors appear to have lost any recollection that the problems we face were here long before Saddam arrived on the scene.”

– To blame Iraq for our current economic woes, says Pomboy, is to imply “that the bubble excesses have been eradicated.” And that is simply not the case, in her view. For starters, capacity utilization continues its downtrend, while corporate debt continues soaring ever higher into record territory. Then too, the dollar is under a fierce assault, largely because foreigners cannot unload the U.S. assets fast enough.

– “After three years of punishing returns [in the stock market], capital flows are now moving in reverse,” says Pomboy, “and while the pace may have been accelerated by recent war-mongering, the exodus began long before Bush fingered ‘Saddam.’

– “As much satisfaction as it might give us to blame Saddam for the problems now facing us, to do so is to ignore the post-bubble nature of the trends underway. It is this impulse, to fabricate delusions and find silver linings where none exist, which represents the largest single obstacle for the markets…Until we reach the point where no excuse is proffered, and none accepted, the market will be unable to move ahead in earnest and any bouts of enthusiasm experiences are sure to be brief.”

– Hey, no pain, no gain.


Back in London…

*** The world is a much poorer place – at least on paper – than it was 3 years ago. Reuters reports that world stock markets have lost $13 trillion since the peak of the boom. That is equivalent to $2,000 for every biped on the planet.

*** Taking out that kind of money has to have some sort of effect. “U.S. economy in worst hiring slump in 20 years,” says a New York Times headline. The Fed is trying to fight the slump by doing what central banks always do – increasing the supply of money and credit (liquidity). But “liquidity doesn’t make bad loans good,” writes Richard Benson, “it makes bad loans bigger.” Bigger bad loans are not better, we add, they are badder than ever.

How many bad loans are there? Single family home foreclosures are at a 30-year high. And the junk bond market is getting crowded with more and more junk. Even household-name companies – such as United and Ford – are having a hard time paying their debts. United can’t pay pilots $300,000 per year, says Benson. And Ford can’t fund its pension obligations by selling cars at no profit.

*** “As you get older, you lose desire,” says our friend Michel. You care less and less about more and more. “I used to like to spend money,” says another middle-aged friend on the same subject, “but now I don’t really care. All I really care about is my family.”

As the developed world ages, it loses both desire and ability. Older people who have the means to spend no longer have the desire. Younger people who still have the desire lack the means; they are having trouble paying the debt they have already. Central banks provide more credit…but they can supply neither the desire nor the means for further consumption.

*** No naughty vicar stories in the London press this morning. Alas…

*** In the “you think you’ve got problems” department…here’s a news report from I-Net Bridge sent to us by our correspondent in South Africa, Evan Pickworth…

“Is Zimbabwe on the verge of economic collapse?

“Zimbabwe promises to provide a classic case study on whether economic necessity forces political change during the course of 2003, according to a leading Zimbabwean academic.

“In an article written for Absa’s latest Economic Perspective, Professor Tony Hawkins from the University of Zimbabwe’s Graduate School of Management says there is a widely held view – ‘except in government circles’ – that the Zimbabwean economy, whose GDP has shrunk by 27% in just four years, won’t be able to survive a fifth year of such punishment.

“Without exception, all of the macro-economic indicators of the Zimbabwean economy paint a picture not only of a rapid, but also an accelerating, economic decline. The cost of unworkable economic policies such as an overvalued, pegged exchange rate, stricter exchange controls, a huge fiscal deficit, negative real interest rates and price controls, are certainly going to be devastating, resulting in the widespread closure of businesses and retrenchments.”

Mr. Greenspan…Mr. Bush…are you listening?