Getting Paid In The Internet Era

(First aired October 8, 1999)

I am fascinated by trying to figure out the real effect…and future…of the Internet revolution. So much money, dreams, hopes, hoopla and folderol are staked on the New Era of the Internet…it seems worth the effort to understand what is really going on.

So far, we have seen that there is no evidence that the Internet really is increasing productivity. The numbers are a statistical mirage…hedonic measures, which as described in the Contrarian’s Glossary, produce the kind of pleasure you have pay for later – like drinking too much.

Now come more numbers, from the Economic Policy Institute…relayed to me by Bill King…that prove the same point. Turns out that the last 10 years have not been especially rewarding for most working people. The average income was $38,885 in 1998. That’s not much different, in real terms, from the average income 10 years ago. Productivity has increased…the average person produces 12% more per hour. But this is an annual rate of increase less than half as great as it was in the `60s and `70s. What’s more, the average person only gets 1.9% more income per hour.

Men, by the way, actually have lower incomes today than they had 30 years ago, adjusted for inflation. Household income has only increased because women are working…and everyone is working a lot more. Mothers worked six weeks more than they did in `69. Fathers worked an entire extra month. Americans work more than the citizens of any other industrialized nation, including Japan. This is progress? While productivity and hourly earnings have not risen significantly during the `90s…taxes have. Since Bill Clinton walked into the Oval Office, federal tax receipts have risen to 21.7% of GDP. Between 1945 and 1990, they averaged only 18.6%.

This is what is going on in the real world…not the virtual world. People are working harder. Earning scarcely a dime more money for their efforts. And paying more in taxes. This doesn’t sound like Eden to me. But there is something else going on. Bruce Bartlett explained in yesterday’s “WSJ” why there has been no tax revolt. People shifted their money from banks to mutual funds in the `90s. Stocks rose. The wealth effect made them feel wealthier, even as their hourly incomes went nowhere. What’s more, the tax burden actually fell…as a percentage of income plus capital gains.

Thus the central illusion of the Internet era has had broad implications. Investors believe the Internet is making businesses more productive. This drives up stock prices and makes stockholders feel wealthier. This allows tax collections to rise.

A bear market and recession can be expected to reverse the whole process. Stocks are already falling. Soon, people will not feel wealthier, they will feel poorer. They will then shift their eyes from the income side of their personal ledgers to the debit side. And there they will find big outlays to government…which they will be concerned to reduce.

They will also shift their attention from stock market gains to paycheck increases. Internet companies, in particular, have been able to keep employee costs artificially subdued by offering workers a cheap currency – stock options. In a bear market, these options, so highly prized today, will become more like collectibles than currency. They will resemble Confederate war bonds, without the fancy engraving. Companies do not report stock option compensation as a current expense. If the value of the options were properly accounted for, as Dr. Richebacher has remarked, Microsoft, to cite one example, would go from a profit of $4 billion to a loss of $18 million. This is exactly what will happen on the P&L sheets when options lose their currency.

Workers are not incidental to the Internet economy. They are not the standardized, replaceable parts of the machine age, arriving every day into the ports of Baltimore and New York along with the bananas from Central America. They are the essential ingredient. Capital was the essential ingredient of the Industrial Age.

Marx was right to call it capitalism. But this New Era is different. The workers are going to want to get paid real money, not the virtual stuff. And, after they are paid, there won’t be much left for capitalists.

Your correspondent,

Bill Bonner

Ouzilly, France August 22, 2000

*** Today’s the big day. Will the Fed hike rates again? Not likely.

*** But will the market celebrate? It will try. But the good news is already built into stock prices. Expect a weak rally…and then, most likely, a weak sell-off. But if I could really tell you what to expect from the market on a day to day basis, I wouldn’t be writing this letter, would I? Nope…I’d be paying no mortgage, and living among the gods.

*** The Nasdaq managed a lame 22-point gain yesterday…as investors bought the rumor of no further rate increases. Likewise the Dow rose 33 points.

*** The leaders were the Big Techs – Cisco and Intel. More money will be lost in these two stocks than in any others…but we will have to wait for the market to tell its story to give you the details. Intel rose 1 «. Cisco added $2 to its price.

*** But while the crowded trades got more crowded, the average stock actually fell. There were only 1325 advancing issues on the NYSE yesterday, compared to 1477 declining ones.

*** The stocks that fell most were the big retailers. Walmart, for example – the world’s biggest retailer – fell below $50. Home Depot is only just a bit above the $50 mark. Bradlees has fallen 85% below its 12-mo. High. Land’s End is down 66%. J.C. Penny is down 65%. American Eagle – 62%. And Saks – 60%.

*** The retail sector is getting crushed. How come? “The wealth effects that have powered the U.S. economic growth,” writes Dr. Kurt Richebacher, “are gone, and there is no chance for their return.”

*** The wealth effect, just to remind you, is what you get when people see their stocks rising. They feel richer – and spend more money. The extra spending looks and feels like real demand – which triggers more hiring and greater production from businesses. It all works as a kind of ‘virtuous circle.’ But beneath it, there’s no virtue at all – but a dangerous illusion. Stocks are not the same as savings. They go down as well as up. And when they go down (or nowhere), as they have this year, well…no mo’ mojo fo’ the ‘wealth effect.’

*** Plus, there’s something else going on. Americans earn money in the good ol’ U.S. of A. But they spend it buying goods made overseas. The cash goes out of the U.S. Then, the foreigners come back to the U.S. and buy capital assets – stocks, bonds, real estate and businesses. In big transactions – those over $1 billion – foreigners purchased $168 billion worth of U.S. assets last year. Americans, on the other hand, bought only $3 billion of foreign assets.

*** Remember when the Arabs were rich on the oil crisis? Pundits worried that they were buying up precious American assets. That was the 70s. Then, in the 80s, the Japanese got rich. And what did they do? They bought U.S. assets – especially big, over-priced prestige properties like Rockefeller Center.

*** But now it’s the Americans themselves who are supposedly on top of the world. So, you might think we’re out buying up valuable businesses all over the world. Uh uh. We’re still selling our own businesses to foreigners – while we buy stereos, autos, vacations, designer jeans and other consumer items.

*** This has two major, immediate effects. First, the dollar goes up. Because you need dollars to buy things from Americans. They won’t take zlotys or ringgits. So, the dollar rises as demand for it increases. The dollar rose against the euro yesterday – as the battle between these two currency blocs continues. German GDP increased in the last quarter by 1% – putting the German economy in very good shape. But still the euro lost about 50 cents.

*** The other major effect is that the money that U.S. workers spend goes onto the revenue figures of foreign companies, not U.S. companies. They get paid by U.S. firms, but they buy from the foreign firms. So it’s the foreign companies that make the profits. This effect – exporting U.S. profits abroad – and the fact that the ‘wealth effect’ has lost its mojo are hurting the retail sector.

*** announced that it lost $40.6 million last quarter – on sales of $2.5 million. How could any company do so badly? This is an achievement.

*** DrKoop is actually a very small company – smaller than most of the companies here at my Internet conference. But the companies here are not losing money on the Internet – they’re making it. It is almost as if they were two different worlds. Entrepeneurs sell their losing companies with the well-known names to public at insane prices. And they keep the profitable companies private. DrKoop – which the market still believes to be worth more than $40 million – will soon be bought out or go bankrupt. And the little companies you never heard of will keep making money.

*** The secret to making money on the Internet – from what I heard at yesterday’s session – seems to be to use it to serve your customers and forget about making a profit from it directly. Then, guess what, you make a profit on it. Ain’t it amazing? Give – and you get. Reciprocity works.

*** Gotta run…today’s session is about to begin.