A few weeks ago I attended a small dinner party in London hosted by Charles and Louis-Vincent Gave, the Gave's of GaveKal Research. They are quite bullish about the longer term prospects for the world, and as we will see below, argue that something new is happening that may not rhyme with our past economic history.
Long time readers know I like history. It is an old friend. It is a very uncomfortable proposition to hear things may be different, as they argue it well. Feeling like having a little fun, I invited Bill Bonner to dine with us, knowing that he takes the very opposite view.
With wives and friends there were ten of us. I made certain that Bill sat next to Louis and Charles, knowing his natural inclination to sit next to the ladies which would have been more fun for him, but would have produced no fireworks.
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The discussion at dinner began as Charles and Louis suggested that trade deficits no longer matter. Bill's eyebrows shot up and he rose to the occasion, coming back with his own arguments. It went back and forth for a few minutes, with your humble analyst egging all of them on.
(It was good fun, and Louis was picking up the bill. All in all, a most delightful meal at a very great restaurant.)
'You've got to be kidding,' Bill announced. 'You are saying that this time it's different...'
'That is precisely what we are saying,' shot back Louis.
Bill looked at them like he was seeing someone from outer space. 'But it's never different,' he proffered.
Then Louis gave us a copy of his new book, called 'Our Brave New World' where they outline their reasoning. I knew that in Bill's new book, 'Empire of Debt' - which is subtitled 'The Rise of an Epic Financial Crisis' - he and co-author Addison Wiggin make the exact opposite argument. History will indeed rhyme and lead to a serious financial situation, destabilising the global economy.
Now, let's start with this quote from the introduction of Our Brave New World. It sets the table nicely.
'History never repeats itself; but it often rhymes.
'This simple fact explains why so many financial analysts, market strategists and portfolio managers like to study past economic cycles and market reactions before taking investment decisions. By studying financial and economic history, market participants are able to anchor beliefs on solid facts.
'The reason so many analysts drag their feet in admitting that history has failed to rhyme this time around is that it would lead one to the dreaded conclusion that 'things are different this time'. But why is this a dreaded conclusion? Because anyone who has spent ten minutes on a trading floor knows that saying 'things are different this time' is:
1) the easiest way to get laughed out of a room,
2) the most expensive words ever pronounced,
3) the surest way to lose any kind of credibility.
'And yet, this is exactly what we aim to argue in the following pages.
'Arguing that 'things are different this time', we freely admit that we might end up drawing the wrong conclusions, say silly things and establish relationships where there are none. We also realise that some of our more cynical clients (say those sitting in Boston or London), might read the coming chapters and conclude that we have really been drinking the Kool-Aid.
'These are the risks when one ventures into uncharted territory. We accept these risks gladly, for we are convinced that the first step to successful investing is an understanding of the current world.
'Unfortunately, History is of little help to this understanding. We have to draw solely on logic, and the help of our friends and clients. With this in mind, we kindly ask that you contact us if you see a flaw in any of the arguments that we present. Again, this is a work in progress, the final aim of which is to help us understand the world we live in so that we can deploy our capital more efficiently.'
So, what makes it different this time? GaveKal suggests a number of things.
First, there is a new business model. Just as industrialists were new in the late 1700s, there is now a new model developing. GaveKal calls this new model 'platform companies'.
The old model was to design or find something, manufacture it, market it and sell it. (Think Ford, Caterpillar, 3M, oil, mining.) The new model keeps just the high value added parts and ditches the rest. The new model focuses on research and development, treasury, marketing, and the business process. It outsources as much of the low margin work as possible. Think Dell, Wal-Mart, IKEA, Li and Fung. Most hotel chains now do not own their properties.
The new model is to 'produce nowhere but to sell everywhere... Platform companies know where the clients are and what they want and where the producers are. Platform companies then simply organise the ordering by the clients and the delivery by the producers (and the placing of their logo on the product just before delivery).'
Production is the least profitable of all the processes. It ties up capital, means a lot of volatile (and costly) inventory, it is labour intensive (and subject to all sorts of problems when there is a slowdown (unproductive labour costs) or a quick need for more product and overtime costs). The market does not give manufacturing companies the same investment multiple as they do the platform companies. Platform companies have more stable incomes and profits.
Who would you rather be? The Chinese and other Asian companies that make the iPod at a 2-3% margin? Or Apple who sells it at a 40% margin?
But this process means manufacturing jobs leave the developed world (the United States, Canada, Old Europe, Australia, New Zealand and Japan) and move to the developing world, primarily Asia and Eastern Europe.
This is not seen be many observers as a good thing. Take for instance my good friend Marc Faber's recent writing:
'I am fully aware that some observers will argue that it doesn't matter that US companies are increasingly moving their own plants overseas, or outsourcing altogether, because the improved profits that result from the outsourcing accrue to the parent company...
"However, what about the long term? How beneficial is it going to be for Western industrialised companies if IBM were to lay off 13,000 people over the next twelve months in the US and hire 14,000 in India...I suppose even a non-economist could see that the movement offshore of sophisticated manufacturing and well-paid service jobs has to have some negative macro-economic consequences.'
And indeed jobs have been lost. But more have been found. Some would argue that we are seeing lower paying jobs, but the reality is that tax receipts, at least in the United States, are always and everywhere up, even as the federal US government cut taxes! No one pays more taxes than they absolutely have to. Higher tax receipts means people are making more money. Not everyone, of course.
Is the platform company model something that will pass or is it the new wave? GaveKal asserts that the model depends upon four things:
1) Free trade, so that products can be produced wherever costs are lowest.
2) Technological progress, especially in communications, which allows a company to decentralise its process.
3) Recurrent overcapacity in most industries, which allows the platform company to never run out of goods to sell.
4) The ability to move goods easily (needing infrastructure like airports, ports and highways).
The above items are all part and parcel of a capitalist economy. 'So in a sense, 'platform companies' are the children of the capitalist system,' say GaveKal.
Countries that do not allow for free movement and advancement of workers are less profitable than those that do. How much talent is wasted in countries that do not allow women to work, or do not educate their poor universally? Growth is clearly better when those with the best skills and services are allowed to thrive, free of protectionism. This is called Ricardian growth, named after the economist David Ricardo, and it applies whether on a personal level or on a country level.
If China can manufacture something cheaper than is the case in the United States, then why should consumers be required to pay more? And if something costs less, then more of it will be bought. Yes, that does result in some workers losing jobs, but in a fluid and free economy, they find others. While some find jobs with less income, as noted above, incomes on average are up. And yes, we have fewer manufacturing jobs, but we are manufacturing more 'stuff' than ever. We have become more efficient, as technology has made our manufacturing processes in the developed world more productive. Hence, Ricardian growth.
The second type of growth is what Joseph Schumpeter calls creative destruction. It is the growth that comes from new ideas and inventions driven by entrepreneurs.
New ideas mean new products that create whole new levels of demand. It can also mean that some products become obsolete. There was a time when my fax machine hummed all day. Now, we get 2-3 faxes a day, at most. I no longer have a home phone, as we all use mobile phones.
Things change. They go the way of the horse-drawn carriage.
For Ricardian growth, you need low trade barriers. For Schumpeterian type growth, you need low regulations, low taxes, access to capital and the ability and right to fail. To the degree which countries encourage such things, they prosper or grow more slowly.
The real danger to the platform model? Governments and protectionism. As GaveKal point out, a Dell computer says 'Made in China' but it is really more accurate to say assembled in China. It is made from parts and software from a score of countries. Of course, the 'trade deficit' is counted as China's. Yet, Senator Schumer regularly bashes China, appealing to his union supporters, but fails to notice things like this.
Should we also get upset with Korea and Taiwan and Russia and Sweden and the rest of the countries who contributed? We live in a world where our ability to measure economic reality is becoming more and more limited. The US government counts Microsoft physical exports as 'plastic' because the disks are plastic and only worth a few dollars at most. Dennis Gartman swears he was told this by a government official who was physically counting export shipping at a port.
So how can we trust the numbers?
By John Mauldin for The Daily Reckoning
John Mauldin is the creative force behind the Millennium Wave investment theory, author of the weekly economic e-mail Thoughts from the Frontline, and author of the best-selling 'Bull's Eye Investing: Making Real Returns in a Smoke & Mirrors Market' (John Wiley & Sons, 2004).
His latest book, 'Just One Thing', is due out in December. You can pre-order your copy at a 25% discount - here:
https://books.global-investor.com/books/22314.htm?ginPtrCode=21664
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