Full of Holes
There are a lot of different ways a man might get rich. He might buy a winning lottery ticket, get lucky in the stock market or hold up a bank. We don’t recommend any of these paths to wealth. Not that they wouldn’t work. But what would be the point? For the wealth would not really be his, but – like a portrait of someone else’s ancestor – merely in his possession.
If a beautiful woman comes up to you on the street and gives you a kiss, mistaking you for someone else, that would be fun for a moment too. But imagine the disappointment, after the thrill is soon gone, and the longing remains.
And if that is not the way it really is; that is how it should be.
Money can be gotten in many different ways. Some quick and easy. Some sordid. But real wealth has to be earned, by hard work, taking chances and forbearance. I bring this up to introduce today’s topic of discussion: productivity.
Real wealth is the ability to produce goods and services. A man who has to dig in the dirt with his bare hands is a poor man, because he can produce little. A man with a shovel is richer. And one with a backhoe is richer still. The man with a backhoe can dig more holes faster. He is, generally, more productive.
Is it necessary to point out that the real wealth of a society is measured by the number of backhoes and other productive machines it owns, not the number of stock certificates or dollar bills it has? I hope not. So, I will not.
In today’s world, computers can be as productive as backhoes, or so it is believed. So, it seems appropriate to measure the wealth of the society in the number and capacity of the computers it turns out. This then is the key to understanding the ‘productivity miracle’ of the late 90s. As computer technology advanced, you could get a lot more computer for your money.
"There is no world so deflationary as the IT world," says Grant’s Interest Rate Observer.
Many times have we discussed the curious logic of the Labor Department. Its ‘hedonic’ toting system meant that an increase in computing power was counted as though the amount of money spent on computers had gone up – even though actual spending may have actually declined. Counting the fictional dollars spent on the new machinery as though it represented additional output, back in the ’90s, the statisticians reported big boosts in productivity.
We have explained ‘hedonics’ often enough to bore and confuse Daily Reckoning readers. We promise we won’t make that same mistake today. Instead, we will make an entirely new mistake. And only because we have been provoked by Alan Greenspan himself. The Wayne Newton of the Fed has been singing the praises of IT-induced productivity increases for so long he doesn’t seem to know when to stop.
"As we have witnessed so clearly in recent years," said the Fed chairman as recently as two weeks ago, "advances in technology have enhanced the growth of productivity, which, in turn, has been essential to lifting our standards of living."
Is that so?
First, we will point out – even in the flattering light of the government’s ‘hedonic’ scoreboard – that continued high rates of productivity growth depend on continued drops in the price of computing power. Will IT technology keep dropping in price? Not likely, we would guess.
Second, we add a, shall we say, deeper problem. An economy that can dig holes cheaply can also dig big holes for itself cheaply. Only the holes that serve a useful, productive purpose – in the long run – add to real wealth. The Labor Department has no way of knowing, of course. To statisticians, a hole in the ground is a hole in the ground.
Several studies have failed to find evidence that the holes dug by IT technology did anybody much good. So what if computers are more powerful? So what if American businessmen have more information at their fingertips than ever before? A McKinsey study found the relationship between IT investments and productivity "murky."
IT technology was widely believed to have almost mystical productivity properties. The "network effect" was supposed to make your business more productive thanks to the increase in IT spending by your competitors!
But a new study, by economists from Harvard and the Fed, found no proof of a ‘network effect.’
And third, the drop in the price of computer technology may say little about U.S. productivity anyway. Gert von der Linde, a Wall Street economist, paraphrased in Grant’s: "A little noted fact of the information age… is that the U.S. is a sizable net importer of IT equipment.
"If the principal source of productivity growth is computer and related hardware, and if the balance of this hardware is imported, can the resulting growth in output per hour of labor be fairly characterized as ‘American’?"
We will ask the question another way. If American ‘productivity’ depends on buying more and more goods from overseas…at lower and lower prices….will increases in productivity be a good thing or a bad thing?
January 25, 2002 — Paris France
"Greenspan Less Dismal Today," said a CNN headline.
The world’s most successful central banker says things are looking up. Eric has more details:
Eric Fry in New York…
– Alan Greenspan doled out happy thoughts to his Congressional audience yesterday, but Wall Street was listening in.
– "There have been signs recently," said he, "that some of the forces that have been restraining the economy over the past year are starting to diminish and that activity is beginning to firm."
– Investors responded to the Chairman’s hopeful forecast as if it were inside information. The Dow climbed 65 points 9,796 while the Nasdaq rose 20.20 to 1942.
– While some investors were busy buying stocks, a few were also selling bonds. That’s the standard "recovering economy" trade – buy stocks and sell bonds. The yield on the 10-year Treasury jumped back above 5% to 5.02%.
– But no matter what Greenspan says, the boom is over and it might not be coming back for a while. Even if a few hapless tech stock investors remain in denial, the boom is over. The evidence is inescapable.
– Exhibit A: "Block parties" on Broad Street are virtually extinct. Block parties are (were) those ostentatious, pointless events that public companies used to sponsor as a way of promoting a new listing on the NYSE. For example, when Krispy Kreme moved from Nasdaq to the NYSE, the company set up a block-long tent along Broad Street from which a small army of Krispy Kreme employees dispensed free donuts and coffee to all passers-by.
– Throughout 1999 and 2000, these parties became an almost daily affair. Many would be as extravagant as Krispy Kreme’s. Others would consist of little more than handing out free logo-emblazoned baseball caps or mouse pads. But even these more modest of affairs have become extremely rare. For one thing, since September 11th, milling about on Broad Street is prohibited. You need to present a photo ID to pass by the exchange, and that takes the wind right out of that old party spirit. More to the point however, frivolity and falling share prices don’t mix…somewhat like a Salsa band at a funeral.
– Exhibit B: I heard a rumor yesterday that a couple of prominent Wall Street firms have put an end to "Casual Friday." The rumor included the following anecdote: The CEO of a major brokerage firm steps onto an elevator with two very casually attired men. The two were dressed in khakis and polo shirts, as if headed to a friend’s house to watch football and drink Budweiser; NOT as if headed into the company conference room to hammer down a $1 billion investment banking deal. The CEO asks gruffly, "Hey, where do you guys work?" The men stammer, "F-F-For you." The CEO says, "Then get the [expletive deleted] out of here. Go home, take off that [expletive deleted] you’re wearing and put on a proper business suit!"
– But even as Casual Fridays fade into history, vestiges of the boom remain. I ate lunch yesterday at a new restaurant in Downtown Manhattan called "Les Halles." The name of this Parisian-style brasserie – as the gang in the Paris office will note instantly – refers to the commercial district about a 9-iron away from where Bill pens the Daily Reckoning every morning.
– The restaurant was very nice, although I have no doubt that a visiting French tourist would have no trouble finding some off-putting deficiency with the quality of the restaurant’s food, or its decor, or its American patrons, or all three. But my "Moules Poulette" were superb.
– Anyway, my friend and I showed up about 12:15 to a half-empty restaurant and were told, "Desole? Messieurs, we are completely booked. You may eat at the bar if you wish."
– We chuckled to ourselves, knowing that no restaurant in Lower Manhattan is "completely booked" for lunch. But we sat at the bar anyway, to placate the hopelessly naive hostess. Within 15 minutes, every table was full. Within 20 minutes, people were hovering around the bar waiting for a table. Within 25 minutes, more people arrived and had to wait outside. And for those few magical minutes, it felt like January 2000, rather than January 2002.
– Upon returning to the office, the time warp lingered. Greenspan had just finished telling Congress about how our economy was poised for growth, and stocks were racing ahead. Let’s see how long the dream lasts.
– Listening to Greenspan yesterday, investors seemed to be heartened as much by what Greenspan didn’t say yesterday as by what he did say. For example, he did not repeat the troubling sentence he uttered two weeks ago in San Francisco, "I would emphasize that we continue to face significant risks in the near term."
– Rather, he "excised" this remark, as Northern Trust economist Paul Kasriel astutely observed, and chose instead to "accentuate the positive."
– Who are we to quarrel with the Chairman? Go economy! Go stocks!
Back in Paris…
*** We don’t know where stocks are going. But we know where they ought to go – down! As you know, Abby Cohen lowered her estimate for corporate earnings next year – from $47 to $34. Of course, Abby has no more of a clue than Alan. They simply look at the headlines and expect more of the same.
*** But even if Abby’s estimate were right by accident, it would still leave the S&P priced at 33 times earnings. What kind of market is priced at 33 times earnings, we ask ourselves?
*** One that hasn’t yet had a real bear market, comes the answer.
*** "Dollar cost averaging" means buying the same dollar amount of stock each month. Say you decide to invest $500 per month. Rather than worry about when is a good time to buy stocks, or whether stocks are expensive or cheap, you just invest your 500 bucks each month. When stocks are cheap you get a lot for your money; when they’re expensive, you get a little. But, since stocks ‘always go up over the long run,’ you end up rich. At least, that notion was popular with the lumpeninvestoriat, the same people who once saw nothing wrong with a Nasdaq over 5,000.
*** Well, how have the dollar cost averagers actually done over the last few years? Alan Newman, editor of CrossCurrents, reports in Barron’s that $500 invested each month since the beginning of 1997 until the end of 2001…that is to say, through the biggest stock market boom of all time…would have produced a profit of $1,243.89, including dividends. That works out to an annual rate of return of 0.82% on the $30,000 invested.
*** Strange, isn’t it? Stocks are near all-time highs. And yet, a person who bought an equal dollar amount of them each month for the last five years has made no profit.