Monday, February 20, 2006

Worse Than It Looks

By John Robino of

Every great turning point has its Irving Fisher. He was the Yale economist who in October of 1929 proclaimed that stocks were at a “permanently high plateau.” Later that same month, the market crashed, the Depression started, and Fisher became an object lesson in the dangers of public prediction. Less perfectly timed but still pretty memorable was Business Week’s 1979 “Death of Equities” cover story, which declared stocks passé as an investment vehicle--just before the start of the greatest bull market in history.

Now Business Week is back for another bit of dubious immortality, with a February 13 cover story titled “Unmasking the Economy: Why it’s so much stronger than you think”:

"But what if we told you that the doomsayers, while not definitively wrong, aren't seeing the whole picture? What if we told you that businesses are investing about $1 trillion a year more than the official numbers show? Or that the savings rate, far from being negative, is actually positive? Or, for that matter, that our deficit with the rest of the world is much smaller than advertised, and that gross domestic product may be growing faster than the latest gloomy numbers show? You'd be pretty surprised, wouldn't you? Well, don't be. Because the economy you thought you knew -- the one all those government statistics purport to measure and make rational and understandable -- actually may be on a stronger footing than you think."

The article goes on to explain that government statisticians are stuck in the days of railroads and factories, when physical structures mattered. But today the real action is in R&D and brand building and intellectual property, things that GDP numbers largely miss. Add them back, and deficits shrink while growth soars. Far from being a decadent late-stage empire, the U.S. is actually a vigorous young nation with a bright future. Heck, we're the creators of the iPod, Starbucks and exchange-traded funds. We rock!

Now, some of the above is undeniably true: R&D could be better represented in GDP calculations, and American corporations are efficient in ways that are hard to quantify. And we do invent a lot of cool stuff. But the conclusion--that the U.S. is actually a healthy system--is wrong in a way that illustrates how our perspective changes at the end of every long cycle. When time-tested measures like book value or debt/equity or P/E begin to conflict with the impulse to extrapolate the recent past into the indefinite future, people start looking for reasons to ignore the old metrics. And they eventually come up with new ones that fit their worldview.

Back in the late 90s, for instance, tech stock investors dismissed concerns about NASDAQ companies' lack of earnings as dinosaur thinking. For New Economy companies, earnings were "optional" (I swear three different people told me exactly that in 1999). Eyeballs and mindshare were what mattered. As's Jim Cramer put it at a 2000 tech stock conference, "Most of these companies don't have earnings per share, so we won't have to be constrained by that methodology for quarters to come."

But old-fashioned things like earnings and debt service ratios do matter in the end. So how do we separate reality from New Era hype this time around? One way is to look at the effects of all this "dark matter" R&D and brand building. If it's real and producing wealth, then the rest of us should be reaping some benefits. Our incomes should be rising and/or our balance sheets should be strengthening. But as you can see below, this isn't the case. U.S. disposable income is crawling upward at about the rate of population growth plus inflation, while debt is soaring. A decade ago, Americans' disposable income exceeded household debt by about half a trillion dollars. Now debt exceeds income by $2 trillion.

What's really happening? The same thing that happens in every credit-driven boom: Easy money allows companies and individuals to do things that make it look like a new era has dawned. In the 1920s it was Ford and RCA changing the world with auto assembly lines and radio networks, financed by sales to investors with growing stock portfolios. In the 90s it was Amazon and Inktomi shifting the whole economy into cyberspace, funded by a soaring NASDAQ. Today it's Intel and Wal-Mart building super-fast chips and futuristic supply chains, fueled by families borrowing against their homes. The good things are undeniably good; computers keep getting faster and supply chains more efficient. They just aren't enough to offset all the new borrowing.

So the end will come as it always does. When the credit spigot is turned off--as it will be soon--consumers will stop spending, businesses will find that their R&D isn't yielding the expected return, and the economy will head south. Sorry Business Week, but under the surface, things are actually much worse than they seem.

1 comment:

dallasgoldbug said...

You have to be kidding me with your, "ipods..we rock!" statement. If these THINGS you mention are on the top of your list, then you might be a 20 something or perhaps just clueless to the things that truly define us as humans and our roles as such on this planet.

To say "we Rock!" to describe a country that spends 300Billion to fight terrorists, that in 07 were (reportedly) the cause of 60 American deaths, while allotting the same year 3Billion toward research and development for the number one killer of Americans, each day killing about 6,000, shows who is in power, and what THEY believe to be more valuable than life, the dollar.

In conclusion, I'm not a doomsday preacher, just a person with the ability to see through the smoke and mirrors presented by the media. I will agree, we are a country with a bright future, but not the same future you see. My future will come when others like me, join together as one and all at the same time decide to stop playing by the rules the corporation impose on our society. Could you imagine if one massive voice stood up to the government and the corporations and said "we not playing your game, we boycott your company and all other companies that you support" the power is then removed from them and the playing field is leveled. Hum, just thinking about a week or month long boycott of all oil and gas related companies, makes me smile. Work from home, via computer, etc. Put the power back in the hands of the people who it was intended for.

But then again who am I to say anything about you and your beliefs? Actions speak louder than words so Ill just shut up.