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Unintended Consequences! Part 3
by Professor von Braun
July 17th, 2005
Productivity and Cashflow
Whatever happened to good old fashioned cashflow, cashflow derived from producing something which was sold at a profit? Today it is estimated that profits from the manufacturing sector account for 10% of corporate profits, while in excess of 50% comes from financial transactions or money shuffling. This is a complete reversal from the early 1950's when manufacturing accounted for 55% of corporate profits. Obviously productivity has declined over the last fifty years and the production of goods has been replaced by the 'click the ticket' brigade.
The manufacturing base that provided the bulk of US corporate profits has gone, having been moved offshore, first to Japan, now to China, two countries which today are effectively the largest creditors of the US. Productivity, the key to wealth, is now located in foreign lands, while money shuffling still appears to be centered in the US. Obviously when a country has the designated world's reserve currency, the US dollar, the source of this 'wealth' the ultimate paper gold mine, then it can dictate the terms and conditions to all players, especially as the currency in question has no redemptive value.
In the quest to provide ever more gadgets and widgets at a lower cost, US retail giants like Wal-Mart have nearly all of what they sell manufactured in these low labor cost communities. Meanwhile the American consumer continues to be able to purchase more and more distractions such as cell phones, hi resolution TV screens, computers, sound systems, etc, while at the same time, now having nothing to do other than be distracted, (an interesting development, one which seems to have replaced the notion of being productive), productivity decreases.
It may be coincidental but I suspect that the increase in size (by that I mean being a tad overweight) of the average US consumer maybe indirectly proportionate to the decline in the manufacturing base. Evidence suggests that the younger generation, or the 'entitlement' generation, as they have been referred to, are less productive than their peers and expect the same treatment as those that have been in senior positions for many years. Now this is hardly surprising since, as another unintended consequence of current monetary policy, the work ethic, the one that comes from and is actively maintained by actually doing something productive, may itself have inadvertently moved offshore as well.
The concept of having to work (as in be productive) for a living has been overtaken by the concept of clipping the ticket of others that do work for a living, as in the Chinese.
The Chinese and others providing low cost goods and services are of course dependent upon the US to keep their game going, dependant enough it seems to be willing to extend to the US consumer the credit they need to keep consuming.
It certainly is a funny world we live in. In some ways the humor of the situation is something that Charlie Chaplin, the Marx brothers, John Cleese and Jay Leno combined could not parody. Who could write such a plot? China, a country that was not so long ago quite poor and not known for its ability to produce anything of quality, is now holding US Treasuries and effectively subsidizing the American way of life -- while the American way of life, built on a strong manufacturing base, has atrophied into a consumer society, dependant upon credit extended by other countries who have no choice but to promote consumerism. All of this is happening while the key ingredient, the US dollar, is not redeemable for anything other than more of the same and the continuation of the fiat system is dependant upon the willingness of the players to hold these dollars and accumulate more.
Meanwhile, within the US, money shuffling is now the dominant game. How long can it last? Is it sustainable? Can increasing real estate prices replace the now depleted manufacturing base and allow the money shuffling game to continue? While the stock market is holding at levels comparable to six years ago, that's all it's doing and interest rates are low so where is the money coming from? What's a productive investment these days? How many times can the ticket be clipped before it becomes so full of holes that it is unrecognizable?
Is there a fallback position? That's the key question right there. Genuine investors, those with an understanding of money and markets, as opposed to speculators such as hedge funds, need to be looking at the question of income if, or when, the current game ends. Ever rising asset values may not be the source of future income by way of paper profits and if they are not, where is the income going to come from?
There has been enough economic analysis done on records dating back the last two hundred years to identify the occurrence of a cycle of rising commodity prices, when paper assets don't do well and a cycle of declining commodity prices, when paper assets do well. This cycle runs approximately every 30 years, with a (+ or - 2 yrs) 10 year period of rising commodity prices followed by a 20 year period of paper asset inflation. We are currently at the early stages of the rising commodity price cycle, which is evidenced by the double bottom in the CRB index, once in 1999 and again in late 2001. Since then the commodity index has increased by 70% returning to levels not seen since late 1979. Stocks essentially topped out during this double bottom period and are unlikely to gain momentum from here. Rising commodity prices tend to eat into corporate profits, not to mention people's pockets, and asset inflation such as real estate begins to become more difficult to maintain as income available for debt servicing goes to the gas pump instead.
It is estimated that with oil at $60 per barrel about one third of that cost is an opportunity cost, one brought about by speculators as in hedge funds, playing a rising market. The last commodities boom (1972 1980) did not have either the hedge funds or a world community awash with US $'s to contend with, nor was there the demand for commodities there is today, so historical data may only be an indicator of things to come.
Recognition of the dilemma enhanced by the Federal Reserve monopoly is beginning to appear in some circles within the US financial community. But collapsing real estate markets, stock markets that no longer go up and 18% interest rates in US Treasuries are a dim memory to most and unheard of when it comes to the entitlement generation.
The monetization of all goods and services, some which should never have been monetized to begin with, including health care, health insurance, medical services and education has seen costs increase (raised by a cost accountant) while the quality of the service provided has declined.
The recognition of the need to diversify out of 'money shuffling' assets into those that either produce or support production of commodities, is slowly becoming apparent. Jim Rodgers was one of the earliest investors to identify commodities as the place to be and his commodity indexed fund (www.rogersrawmaterials.com) which has given impressive returns since its inception in 1998. In March, '05, Barry B Bannister at Legg Mason, (www.leggmason.com) wrote an excellent piece entitled "Paying for the peace" which looks at portfolio strategy for the next ten years with rising commodity prices as a major component.
Direct ownership of hard assets may well be the new vogue. Jeffrey Knight, of Putnam Investments (www.putnam.com) was quoted in the Boston Herald, 7/14/05, (www.BostonHerald.com) as saying: "I think gold is a buy. I think it's a long term buy. Nobody wants a strong currency any more. It could happen that all 'fiat' (i.e. paper) currencies will try to compete lower. That undermines 'fiat' currencies as a store of value."
Wow, that's an interesting statement coming from a fund manager, when compared to the rah-rah that still appears on CNBC. Notice this gentleman is not saying buy real estate, he is saying that long term ownership of gold may be prudent. We could not agree more, having recommended buying gold at $280 back in 2001. Once again it is important to actually own what you purchase, and taking delivery of the metal completes the transaction.
For those that are fortunate enough to have exited paper assets and are sitting in cash (liquid debt,) transferring this into something that is not debt, but is tangible and can not be erased with a stroke of a pen, is wise. No debt, exposure to commodities, ownership of gold and if possible, direct and indirect exposure to commodity production, including gold, may well become the hallmark of financially surviving the next ten years.
The Prof can be contacted by email at email@example.com
Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.
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