More Dark Matter

Continuing with the theme of great rationalizations in an unbalanced world, today our attention is turned to a fascinating debate between Dr. Marc Faber of Gloom, Boom, and Doom fame and Louis-Vincent Gave of GaveKal Research.

Hosted by Kathryn M. Welling of Weeden & Co (Welling@Weeden) the discussion occurred late last year and the transcript is available online - Brave New World or Bust (PDF).


Faber, author of Tomorrow's Gold is a long time resident of Hong Kong who writes and speaks frequently about global imbalances, the bright future of Asia, and the troubles that lie ahead for the U.S. and much of the western world.

Gave, along with the rest of the GaveKal Research team, has recently published Our Brave New World in which the "platform company" model is presented as an explanation for how a seemingly unbalanced world is actually in balance.

The platform company model is the product of rethinking economics as it is currently understood, offering an alternative that places a much greater emphasis on intellectual property and the cross-border flow of profits for a service economy.

The discussion is lengthy and reading it in its entirety is highly recommended. For our purposes today, we begin with a description by Gave of our brave new world:

Louis: The very first economists in the world were the physiocrats, in the late 18th Century. They were French and being French myself, maybe I am particularly sensitive to not reproducing their errors. When they looked at the industry burgeoning all around them, they said, “Industry doesn’t add any value. All it does is transform products. You put products in and you take products out. The only value that can be created is from agriculture. You plant a seed and you get a tree. That is value creation.” In other words, they completely missed the Industrial Revolution. They missed the forest for the trees. They were looking at a Second Wave world through First Wave agricultural eyes. One of my fears today is that our entire Western world is moving from an industrial economy to a service economy, yet we don’t have the right ways to measure it. If you take the U.S., the four growth sectors are healthcare, education, technology and finance. Yet all the economic statistics are designed to track how many cars the U.S. produces or how many tons of steel. That is just not where wealth is being created today. What is the inventory-to-sales ratio of Goldman Sachs? What is the industrial production of Harvard University? It makes no sense. Yet no one can deny that Harvard University creates a lot of value in the system, or Goldman Sachs, for that matter. But how do you measure it? The answer is through profits. What matters today are profits and since corporate profits in the U.S. are very high, there is no real reason to be anxious.

There is no doubt that profits for U.S. companies have been high and that the U.S. has become much more of a service economy given the exodus of manufacturing jobs in recent years.

It is also true that contemporary measures of economic activity fail to properly measure an ever-changing world, but, that is the nature of metrics and change - changes to the measurement technique always lag the changes to that which is being measured.

The Bureau of Economic Analysis has thus far dismissed suggestions to modify their procedures in this area, but, given the state of affairs in the reporting of economic statistics in the U.S., anything is possible.

So, what is a platform company in this brave new world and what has its effect been on the U.S. economy and the labor force?

Louis: Basically, the emergence of the platform company model has allowed U.S. companies to outsource manufacturing, the most volatile part of the production cycle, to the developing world. So if underlying economic activity comes in weaker than forecast, the platform companies in the West don’t have to slash labor and inventories. It is their suppliers that have to lay off workers etc., while the designers and marketing people and other service workers in the West find their services still in demand.

This is the well-known, "we think, they sweat" argument for America's continued dominance in the new global economy. Not only do we earn more money with less physical effort, but according to Gave, the job security is better.

Somehow this doesn't seem to square with the unusually high number of real estate related jobs that have been created in recent years or the continuing shift of technology jobs across the Pacific where the number of new engineering graduates dwarfs the number graduated from U.S. colleges.

Marketing and sales, along with dry-cleaning and lawn mowing should find continued demand for American workers, but designer jobs of all types, along with any task that is practical to relocate overseas, appear to be on the move. This of course is required for companies to remain competitive and continue the high profitability that investors now expect.

Could this be a problem?

Good jobs are required for living standards to continue to rise. In the last century, Americans have become accustomed to a rising standard of living, although much of the increase in recent decades appears to be due to both husband and wife now participating in the labor force at levels never before seen.

Even with this extra effort, wages have risen grudgingly in recent years and people have become overly dependent on rising assets rather than rising wages for improvements in living standards and wealth creation. Central bank easy money policies and lax credit regulation have played a big role in the apparent prosperity in the West, as Dr. Faber explains:

Marc: Over the last 20 years, I do not notice a meaningful wealth improvement or standard of living improvement in the Western world. But I have noticed meaningful standard of living improvements in Eastern Europe, in the former Soviet Union, in central Asia and in Asia. So I think that wealth creation has to do with something other than central banking. It has to do with people making capital investments—which come about as a result of foregoing consumption and investing in new processes, in research and development, in the construction of factories, and in the creation of net capital investment. Yet that is precisely what is lacking in Western Europe and, in particular, in the United States. So your huge wealth creation, in my opinion, is largely an illusion, and not a real wealth creation.

Somebody's standard of living must be improving. With an ever-increasing disparity in compensation between those at the top and those at the bottom, it seems that rising corporate profits are unduly benefiting just a select few.

Marc: Sure, for some people there have been improvements. Just consider that today there are some 300 billionaires in the U.S. and that in 1980 there were just eight. But this is very polarized. You are talking about the massive improvement in the standard of living of the rich—of 1% of the population. By contrast, for the typical household—and this is something you’ve even published from time to time yourself—real wages have been declining. So the vast majority of people, not just in the U.S. but also in Western Europe, are not living meaningfully better than they did 20 years ago. And if they do live better—if—it is only because Asians now produce goods that are more affordable. But in general, I would say that the standard of living in the Western World has stagnated. Whereas, by comparison, when I think of Hong Kong and Singapore, Taiwan, South Korea—25 years ago, how poor they were. But how well-to-do they have become in the meantime. Then I look today at China and India and other countries in Central Asia and at how wealthy they will become over time, because of their high savings rates. Relative to that, I don’t see how someone can be very optimistic about the Western World. Nor do I see how everyone in the Western World is going to thrive by designing furniture for IKEA and computers for Dell. Especially because, in time, all those designs will be made and sold in Asia, as well.

And, this is the fundamental problem with the brave new world thinking. We can't all design the next generation of iPods. In recent years, the lackluster job creation that has accompanied the current recovery has been disproportionately associated with the currently inflating asset bubble - housing.

But Gave counters that the quality of life really is better because of all the inexpensive imported goods that people can now buy.

Louis: My point is that judging if life is better or not is a tough call. But your average middle class American now can travel to Paris if he wants to, which would have been unthinkable 20 years ago. You now have TVs with 100 channels. You have DVDs, you have a much better car. If you are just judging the quality of life based on material goods, the average American family now has a lot more than they did 20 years ago.

Hmmm...

Maybe we'd all be better off with fewer DVD players, fewer television channels, and more free time for parents to spend with their kids.

In this follow-up (PDF) to the original discussion, Dr. Faber discusses a fictional Swiss economy he had recently dreamt of where he was the king and all of the tenets of the GaveKal Brave New World were followed. This included readily available money printing machines and a prohibition against manufacturing.

Swiss companies outsourced all their manufacturing to China and their profits soared. Consumer prices were kept low, assets appreciated rapidly, and foreigners lent money back to Switzerland and bought Swiss assets.

Over time foreigners owned more and more of Switzerland and in the end an angry mob of "former drivers, cleaners, or butlers for the rich foreign residents" came and threw the king out the window.