The Present-Day Market
"The great virtue of capitalism-the quality that always confounded socialist critics and defeated rival economic systems-is its ability to yield more from less. Its efficient organization of production strives to produce more goods from less input, whether the input is capital, labor or raw resources. Assuming markets are stable, the rising productivity increases the profits per unit, the yields that get distributed as returns to invested capital or as rising wages for labor or in lower product prices for consumers and, in the happiest circumstances, all three."
ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ William Greider
ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ One World, Ready Or Not, 1997
At present, all three are at work. But the question is, will this last? Can it last? Are the forces driving the global economy fundamentally healthy, or is this happy combination driven, in whole or in part, by the ever-present business cycle-- thus begging the question, can a serious recession be around the corner?ÿ Will the same forces which drive the current prosperity work toward its inevitable decline? Has the worldwide investment boom led to worldwide overcapacity? Will the easy credit of today inevitably contract? Are there enough consumers? Do we really know what a deflation looks and feels like, and do we know how to counteract its effects?
Puzzling contradictions abound in the present-day market. Unemployment is at 25-year lows. Producer and consumer price inflation is near multi-decade lows. Business is brisk, productivity is climbing and the stock market has been transformed into a nationwide social security plan. Times are very good. In the face of this there is an unrelenting pressure among business executives to do more with less, to shave costs and to meet earnings estimates. (Note: in early 1997, PBS Frontline did a fantastic piece on this contradiction, titled, "Betting on the Market". www.pbs.org/wgbh/pages/frontline/shows/betting )
This central contradiction lies in the fact that technology has enabled global firms to produce more and more with less and less on an unprecendented global scale. To keep up, firms today must match keep pace with an ever-increasing advance of technology, efficiency and cost. To fall behind means death to a firm. The dirty little secret of technology, as Greider puts it, is that an undisciplined expansion of productive capacity will be self-defeating, because all it will accomplish is a continuing supply surplus that degrades prices and lowers rates of return. "All companies are thus caught in a continuing scramble to avoid holding the surpluses, protecting themselves by closing factories in a timely manner or unloading excess goods at prices that injure their rivals. To preserve their position, they are compelled to keep doing more of the same: more cost reduction and price cutting an, in turn, more expansion of potential supply. The circle continues, with its destructive element concealed by the fabulous expansiveness of the system."
Jack Welch, CEO of General Electric, sees events for what they are. Warning his management team against self-congratulations, he said, "Things are going to get tougher. The shakeouts will be more brutal. The pace of change more rapid. What lies ahead is a hurricane."
Alex Trotman, CEO of Ford Motor, similarly does not mince words: "Overcapacity will cause the consolidation and restructuring of the auto industry worldwide. Not everyone will be around by the end of the century, certainly not in their current configurations."
John Smith, CEO of General Motors, said, "Fundamentally, something has changed in the economy. In today's age, you cannot get price increases."
Peter Shavoir, former Director of Strategy at IBM, said, "I've been worried for a long time that there's too much capacity. Don't get me wrong. I believe in competition, but when you get too much of it and it's just a mater of price, price, price, it's very difficult to keep yourself afloat. For those whose jobs are destroyed in the process, they aren't ever going to get them back. You can't become so efficient that all this stuff is made without any labor content. Because then you have nobody with the money to buy anything."
To put the effect of globalization and productivity in perspective, consider this: the world's 500 largest multinational corporations have grown sevenfold in sales since 1970, yet their worldwide employment has remained virtually flat. The same number of workers has powered the great leaps of innovation and output at the largest corporations.
How did this come to happen?ÿ How is this possible?ÿ What does this inevitably mean for someone working for a large corporation, in a factory, in 1998? ÿ To put it simply, there is just not much difference in the ability of unskilled and semi-skilled workers across countries. Rodney Jones, a market analyst for George Soros's Quantum Fund in Hong Kong asks, "Where is it written that white guys in Britain are entitled to $15 an hour and five weeks of holiday while Asians are supposed to work for $3 a day? What is the difference between an unskilled worker living in Germany and an unskilled worker in India? Not much, really. These Asian workers are now part of the global economy and the West will simply have to adjust to that fact."
The ability of a company like Boeing to outsource over 70% of its aircraft manufacturing to lower-wage companies in Asia is testimony to the type of global market we are in. And it is not as if Boeing has much leverage in the matter. If Chinese airlines are to buy Boeing jets, China will invariably demand that a substantial percentage of the aircraft be produced at firms like Xian Aircraft Company. More strategically, if Boeing wants to keep Xian Aircraft from going elsewhere for work, and possibly creating an Asian Airbus in the process, it would (supposedly) be smart to trade jobs for jets.
More fundamentally, what happens to worldwide demand when Boeing exchanges a $50,000-a-year American machinist job for a $700-a-year Chinese machinist job? Or Motorola? Or General Motors? Which worker could buy more goods? As Greider wrote, "If one multiplied the Xian example across many factories and industrial sectors, as well as other aspiring countries, one could begin to visualize why global consumption was unable to keep up with global production."
Make no mistake, China (and Southeast Asia, Korea, India, Brazil, etc.) intends to become a global producer of aircraft, cars, steel and electronics. "China is a horror story for the rest of the world if it simply grows as an exporting nation," according to Harou Shimada, MITI economist in Tokyo. "Overcapacity will have to be squeezed down. It will be increasingly unprofitable for companies to build new capacity in advanced nations. If the Chinese develop the technology and become productive without wages rising, then they will be a tremendous competitive menace against the rest of the world. If you bring in 1.2 billion workers at those wages, that can destroy the global trading system." In China today, it is reported that as many as 100 million workers roam the country, looking for work. Without government transit visas, many of them cannot enter the coastal cities where the special manufacturing zones have been established for multinationals. As Chinese labor demand increases, this 100 million worker surplus (which, admittedly, seems high, but who knows) will essentially prevent wages from rising.
The global overcapacity, as it stands today, is a tame beast because of the enormous buying power of the American consumer. BusinessWeek reported, "Since 1995, almost every major currency, including the yen and the German mark, has depreciated by at least 15% against the dollar. After the latest round of devaluations, every region except for the U.S. will be a net exporter. This makes the global economy dangerously dependent on the U.S. as the consumer of last resort."
The American consumer has only so much more buying power. Median family (real) wages have not recovered to the levels before the last recession. To keep up, American consumers are borrowing. Household debt is now 91% of disposable income, compared with 65% in 1980. Consumer financing is as easy as paying with cash. Good credit is no longer required of the American consumer in order to purchase anything, from college to cars to computers. Finance companies are now loaning Americans up to 125% of the value of their homes. Credit card debt is at record levels. Student loans have over 7 million recent graduates in debt. Home equity and 401(k) loans are creating still more buying power. No one knows how long this can last. But when it ends, companies the world over will feel its effects.
Herein lies the great fallacy of our market. In spite of the apparent contradictions in the global economy, and the great risks to every business, the money game on Wall Street continues unabated. A rational market would not be operating the way it is. As Lord Keynes once said, "There is nothing so disastrous as a rational policy in an irrational world." If the markets truly were rational and efficient, it would not make sense for them to experience the wild swings of the past year. Consider this: the Indonesian ruppiah plummeted over 90% versus the dollar in the last six months of 1997. Along the way down, it rallied up 40-60% several times in a matter of days, only to decline once again. Are we thus to believe that the entire Indonesian economy was worth 60% less one day, 40% more the next, and 50% less the next? Would you call that an efficient, rational market? How can companies operating in Indonesia (and other places) possibly operate profitably with floating exchange rate disasters like this. It is no wonder the multinationals are dispersing so widely around the world, in order to hedge their risk from these floating exchange rate shocks.
In 1994, former Fed Chairman Paul Volcker convened a blue-ribbon panel of bankers and economists to discuss these very risks in the global currency markets. This modern-day ÿ Bretton Woods Commission found that, indeed, markets are irrational:
"They do not respond consistently to news of fundamental changes in interest rates, inflation, prospective returns on investments or balance of payments prospects, and they sometimes respond to changes that have little to do with fundamentals, like the recent pattern traced out by prices, or changes in market mood. There is a tendency for trends and volatility itself to persist for a while; there are fashions in markets as to what matters and what does not-the balance of trade one week and chartism the next; trading is often concentrated in one financial center for a time and then it moves to another for no obvious reason. The problem is distinguishing when. When does crowd psychology or positive feedback turn rational behavior into unsustainable outcomes? When are individual investors `irrational'? It is usually impossible to tell; but sometimes, at extremes, one can."
The Bretton Woods Commission comments were focused on the currency markets, and the dangers that a wildly fluctuating floating exchange rate system could have on the global economy. The comments pertain as well to all markets.
For this reason, we think it is vitally important to pay attention to history, in an attempt to explain markets `at extremes'. In a report titled "Bulls, Bears, and Manias" dated May 21, 1997 Robert Prechter of the Elliott Wave Theorist wrote of the characteristics of manias:
A mania is not simply a `big bull market'. It is something else, and it not only behaves differently, but it resolves differently as well, which is why the difference is worth knowing. The first aspect of a mania is that it produces a powerful, persistent rise with remarkably fewer, briefer and/or smaller setbacks. In studying such times in market history, we find that manias typically involve broad participation by the public and end at times of historic overvaluation by all traditional measures. These three aspects of manias are well-known by financial historians. Other aspects are not so well-known. One is that they are born of long-term bull markets, which is to say that every mania is preceded by a long period of oft-corrected rising prices. When the time is right, the public begins to acquire the understanding that `the long-term trend is always up' and increasingly acts as if, and ultimately presumes that, every degree of trend is always up."
If you are asking yourself, why this must continually happen to free markets, why we seem to repeat history, consider this quote, from Carl Sagan, in his 1996 book, The Demon Haunted World:
"Our perceptions are fallible.ÿ We sometimes see what isn't there.ÿ We are prey to optical illusions.ÿÿ Occasionally we hallucinate. ÿ We are error-prone.ÿ A most illuminating book called How We Knowÿ What Isn't So:ÿ The Fallibility of Human Reason in Everyday Life. by Thomas Gilovech, shows howÿ people systematically err in understanding numbers, in rejecting unpleasant evidence, in being influenced by the opinion of others.ÿ We're good in some things, but not in everything.ÿ Wisdomÿÿ lies in understanding our limitations.ÿ "For Man is a giddy thing," teaches William Shakespeare. That's where the stuffy skeptical rigor of science comes in...ÿ If we resolutely refuse to acknowledge where we are liable to fall in error, then we can confidently expect that error-- even serious error, profound mistakes-- will be our companion forever. But if we are capable of a little courageous self-assessment, whatever rueful reflections they may engender, our chances improve enormously."
If there was ever a greater need to measure risk in the markets, with the same accuracy and familiarity as one can measure the Dow Jones Industrial Average, it is today. Titanic returns of recent years most assuredly have been accompanied by titanic risks. Perhaps the parabolic chart of the Dow Jones Industrial Average should be accompanied with a chart of the Dow Jones Industrial Risk. The two charts would no doubt be identical. The markets of 1873, 1907, 1929 and 1968 are all being replayed in the markets of today. Many observers (all smarter than us) have written of it, as we have tried to portray, but the market keeps going. The game is not finished. There is still time on the clock. Greater fools are still entering the fray.
"Gam Zu Yaavor-- This too, shall pass"
-- Solomon
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