The Daily Reckoning
Ouzilly, France
Wednesday, April 27, 2005
The Daily Reckoning PRESENTS: The notion of one's child wanting to be a doctor sends chills of fear down parents' spines, engineers gravitate to plying their craft on money instead of real stuff, and the $600/hour lawyers are depressed to the point of either padding their accounts or working nearly 24/7. Money shufflers are the new captains of industry... THE MONEY SHUFFLERS' VIGby Marc Faber
In economics it is always difficult to know precisely what stage of a price, business, or speculation cycle one finds oneself to be in. However, we know that consumer price increases have been moderating since 1980 and that interest rates have been declining since 1981. At the same time, asset markets have been rising since 1982, although equities experienced a serious downturn after 2000. Therefore, it is easy to determine that we are not at the beginning of consumer price disinflation and an asset inflation cycle. Rather, we are likely to be in either phase two of the asset inflation cycle or, even more likely, in the third phase where the inflection point from asset inflation to consumer price inflation is reached.
Why do I think so? Unless a business downturn occurs, interest rates in the U.S. cannot decline any further. A business downturn, however, would not be good for asset markets, as affordability of the inflated assets would become a serious issue. If, however, the economy continues to expand, inflation to accelerate, and interest rates to rise, then it would seem to me that even modest interest rate increases brought about by the Fed, or by the market if the Fed doesn't take any action, would cool, or more likely depress, various highly leveraged investment or asset markets.
This, as mentioned above, would occur in the U.S. through either deflation of asset prices in dollar terms or a depreciating dollar. The combination of the two is very probable, as was the case in Latin America in the early 1980s and during the Asian crisis in 1997/1998.
Characteristic of phase three of the asset inflation cycle is the rapid increase in the price of commodities. Now, I am aware that some observers maintain that, in today's economy, rising commodity prices have little impact on consumer prices. But rather than pay attention to these new theories, I look at a study provided by Barry Bannister of Legg Mason, which shows a very close correlation between commodity and consumer price inflation over the last 200 years.
So, until proven differently, I suppose that rising commodity prices do have the tendency to increase consumer prices. I may add once again that it is very likely the CPI in the U.S. is understating the rate of inflation for the average household, which, I estimate, is running at least at 5% per annum.
In addition, if we look at the producer price index for intermediate materials, which is rising at an annual rate of over 8%, it is most likely that the producer price index for finished goods will soon begin to rise at a faster clip - that is, unless there is an immediate collapse in commodity prices.
Also, pointing to the U.S. economy having reached the third phase of the asset inflation cycle is the fact that it is internationally no longer competitive, which is reflected in the large trade and current account deficits.
I must point out that in the case of both high consumer price inflation and high asset inflation, a country loses out on competitiveness and will have rising trade and current account deficits. In both cases, either tight money policies by the central bank (high real interest rates), which curbs domestic demand and leads to disinflation and sometime even deflation, or the market mechanism, will eventually make the adjustments through a collapse in the bond market and the currency.
Then there is another point to consider. During commodity and consumer price inflation phases, speculation focuses on commodities and resource shares, while the financial sector performs miserably. (In the 1970s, a large number of brokerage firms closed down or were taken over.) During the asset inflation cycle, however, the financial sector performs superbly.
Last September, Ray Dalio and Amit Srivastava of Bridgewater Associates published a report entitled "The Money Shuffler's Vig" (see Bridgewater Daily Observation of September 22, 2004), in which the author wrote that "the money that's made from manufacturing stuff is a pittance in comparison to the amount of money made from shuffling money around; 44% of all corporate profits in the U.S. come from the financial sector compared with only 10% from the manufacturing sector."
Until the onset of the asset inflation phase in the early 1980s, the manufacturing sector's profits always accounted for more than 40% of total profits while the financial sector never accounted for more than 20%. (In the 1950s and 1960s, the manufacturing sector accounted for about 50% of profits.) Moreover, it would appear that the 44% figure for the financial sector's share of total profits is significantly understating financial profits, since they are unlikely to include financial earnings from industrial companies such as GE Capital and General Motors' financial subsidiaries, and the profits earned by large multinationals from their treasury activities, which resemble hedge fund-type financial transactions.
The Bridgewater piece is actually quite humorous and comments on this shift in profit contribution from industry to finance as follows:
"We see it anecdotally - e.g. by who lives in the big houses in the expensive neighborhoods or who shops at the expensive stores. While in decades past it used to be the captains of industry, now it's the money shufflers - the folks who handle OPM (other people's money) and earn their vig of it. From low to high on the hierarchy, the money shufflers at or near the peak are a) bankers, b) investment bankers and investment managers, and then c) the 2 and 20 crowd (hedge funds, private equity firms, etc.)."
Now, the notion of one's child wanting to be a doctor sends chills of fear down parents' spines, engineers gravitate to plying their craft on money instead of real stuff, and the $600/hour lawyers are depressed (to the point of either padding their accounts or working nearly 24/7) in their failed attempts to stop falling behind.
According to Bridgewater, the growth in the money shufflers' profits as a percentage of GDP has partially come because financial assets and liabilities as a percentage of GDP have risen rapidly and because "the average money shuffler's profit per dollar shuffled has gone up (largely because those with the big bucks, particularly institutional investors, have gone from investing in the .25% to .75% fee stuff to investing more in the 2% and 20% stuff)".
Cynically, Ray Dalio and Amit Srivastava note:
"[T]he only thing that has been a slight drag on the otherwise rapid growth in the profitability per money shuffler has been the big increase in the number of them. That's one of the great things of capitalism - it allocates resources so efficiently. So, rather than turning out doctors, engineers, teachers, architects, and others who are involved with the old economy, our system has met the increased demand for money shufflers (like me and you) via an increased supply."
So, even if the economy is not running on "empty", it certainly runs on plenty of money shufflers!
Regards,
Marc Faber
for The Daily Reckoning