[Adapted from a talk at the May 20 Seattle Mises Circle, "House of Cards: Has the US Economy Recovered?"]
I think we can all agree that the state of the economy has little to do with Donald Trump, at least for the moment.
But the stock markets have been riding high since his election, just earlier this week the S&P 500 index reached a record high of 2400, which is 3.5 times its low of 683 in March ’09.
I’m sure some of you are familiar with the term FAANGS that describe five major stocks in that index: Facebook, Apple, Amazon, Netflix, and Google.
What you might not know, and what I didn’t know, is that those five stocks account for virtually all of the S&P gains in the past few months. In fact, the remaining 495 companies have LOST almost as much in market capitalization as the top five have gained.
And then there is the peculiar case of Amazon, which recently celebrated its twentieth anniversary of going public. By every measure, Amazon is a modern blue-chip stock: large, well-established, dominates its sector, and is a household name.
There is just one catch: it doesn’t make money, or at least not much. And its thin profitability is OK with founder Jeff Bezos, who has poured billions into Amazon’s cloud business rather than trying to improve the company’s bottom line.
Maybe Peter Thiel is right: the value of Amazon, or any firm, is the sum of all the money it will make in the future (discounted to its present worth). So at the moment shareholders believe Amazon will make enough profit in the future to justify its $460 billion market capitalization today.
Or maybe it’s wildly overvalued. David Stockman calls it one of the “greatest cash-burn machines ever invented.” Remember, this is a 25-year-old company, not some startup.
Stockman says: “In an honest free market, real investors would never give a quarter-trillion-dollar valuation to a business that refuses to make a profit, never pays a dividend and is a one-percenter at best in the free cash flow department — that is, in the very thing that capitalist enterprises are born to produce.”
The point here is not to pick on Amazon, or any of the tech companies like Facebook and Netflix that may never make much profit. Maybe there really is a new corporate paradigm with a long-term outlook, just like Sony used to have with its 50 year plans.
But there is something unsettling about companies that make their founders and major shareholders rich without generating a profit. David Stockman describes it as a casino rather than a market — everyone has to find the next Amazon to invest in like a horse at the track. But as we see in the S&P 500, there are hundreds of losers for every winner.
Maybe Amazon is an uneasy symbol of what seems artificial and unsustainable about our prosperity. And if the economy seems artificial and unsustainable, maybe that’s because it is artificial and unsustainable.
Whether the sky has fallen, or is falling, or is about to start falling, is more a matter of perspective than objective fact or even measured opinion — with apologies to the people who compile the almost useless GDP figures. Whether the economy is good or bad, growing or crashing, depends very much on whom you ask.
I suspect most people in this room have the good fortune to work in the knowledge economy, to have job or career opportunities or enough personal wealth to see the glass as half-full.
But we shouldn’t ignore the millions of people for whom the sky certainly has fallen:
50- and 60-somethings who lost their jobs after the crash of ’08 and will never again have equivalent income or career prestige;
Blue-collar workers across the spectrum, from auto to coal miners to steelworkers;
Retirees who lost 40 percent of everything they had in the last stock market crash, and who were too scared to stay in the market;
A generation of millennials who may be the first generation in US history to simply accept as the “new normal” having huge amounts of debt and a declining standard of living;
A huge number of Americans who simply feel lost in a new economy with constant disruptions, no job security, fewer benefits, who fear outsourcing and offshoring and automation, and who aren’t ready to drop everything and move every three years in a gig economy.
Hopelessness is a severe form of poverty, one that’s spreading higher into middle class reality than at any time since the Great Depression.
So while most of us are big believers in capitalism and free markets and global trade, it’s facile simply to assume everyone else sees things the same way. There are winners and losers, even if the world is getting richer. The sky doesn’t fall for everyone at the same time, and it can fall in slow motion in ways that profoundly affect our grandchildren.
Obviously we can’t know the future, or what the economy will look like in five years or ten years. But let me offer three assertions.
First: the Fed and other central banks can’t make things better, but they sure can make them worse.
Creating new money and credit does not create new goods or services. We shouldn’t care about the quantity of money per se too much; prices can adjust. We should care very much, however, about the quality of money in the economy, the rate at which the supply grows, and the stability and certainty it provides to businesses and individuals trying to plan for the future.
Even the Janet Yellens of the world admit there are limits to monetary policy, and we’ve reached them. Central banks are the primary villains and enablers of our current economic drama, and money cannot be centrally planned any more than wheat production or factory worker wages or oil prices. The effect of central banks on culture and the choices humans make is one of the biggest untold stories of our time.
Second: we don’t really know what things cost.
David Stockman reminds us interest rates are the most important prices in an economy. When you manipulate them, it becomes almost impossible to know the honest price, meaning the true market price, of anything: oil, real estate, tech stocks, bread or milk.
Since about 1980, but especially since 2008, central banks have wildly distorted the global economy. When the cost of money is artificially cheap, lots of business ideas look good on paper. And when safe investments like Treasury bonds and CDs don’t pay much, we’re all forced into chasing yields through riskier investments. Activist central banks are profoundly dangerous for investors and savers. If central bankers stay active in the next few years, through more QE and negative interest rates, that’s a sure sign the emperor has no clothes and central bankers have made a political decision to kick the can down the road.
Third: the laws of economics apply to governments.
We think bubbles apply to stock and real estate, not government policies. But at some point economics applies to governments just as surely as the laws of gravity apply to all of us. Interest rates of just 3.5 percent on Treasury notes will be disastrous for the US federal budget over the next few decades. By the mid-2020s, interest on Treasury debt could exceed defense and entitlements as the single largest annual expenditure by the federal government.
Deficit spending and unpayable entitlements will be the downfall of western governments, the legislatures of which spent the last 100 years creating enormous debt and entitlement bubbles. Social Security and Medicare are certainly examples of slow motion catastrophes; it just took a long time to get here.
In any reasonable, lawful world, spendthrifts are punished. The rest of the world knows America will never get its fiscal house in order. No sane accounting standard would ever permit a government to keep trillions of dollars in entitlement promises off its balance sheet.
If we think about it rationally, this should mean creditors cut us off entirely, or at least demand junk bond interest rates. It should mean haircuts and means testing for Social Security and Medicare. It should mean selling off federal assets, including vast western lands. It should mean significant cuts to the federal budget. But Congress will do none of these things, nor can it. We’re past the point of political solutions.
I’ll close with some good news: we have to remember that “the economy” is 320 million people in the US and seven billion people worldwide, most of whom get up every day hoping to improve their economic circumstance. That motivation is very powerful, and often can overcome even the biggest screw-ups by governments and central banks. Short of outright authoritarianism — which is always possible — humans have a tremendous capacity for improving their material lives.
At least on paper, America still contains the raw materials for success:
A currency that for the moment is still the least dirty shirt in the laundry, and in uncertain times a flight to the dollar is still likely;
The best universities in the world and a relatively educated workforce;
Abundant energy. The Bakken Formation in the Western US means we have two times the amount of oil and three times the amount of natural gas;
More farmable land than any other nation: 17 percent of all US land can be farmed;
500 million acres of timber;
Two huge oceans act as defense but also provide access to Eastern and European markets;
And most of all, a hard to define American sense of optimism which is almost a form of entitlement.
Let me close with a reminder: we believe in liberty, not fate. The sky falls only if we let it.
