“New World Order”: Foreign Affairs

The July/August 2104 issue of Foreign Affairs contains an interesting conceptual economics article titled “New World Order.”  It’s written by three professors–Erik Brynjolfsson (MIT) , Andrew McAfee (MIT) and Michael Spence (NYU)–and outlines what the authors believe are the major long-term trends influencing global employment and economic growth.  I’m not sure I agree 100%, but I think it’s a reasonable roadmap to start with.

Here’s what the article says:

the past

Globalization has allowed companies to exploit wide wage differentials between countries by moving production from high-cost labor markets close to consumers to low labor cost areas in the developing world.  Former manufacturing workers in high-cost areas enter the service sector to seek employment, depressing wages there.

This period is now ending, as relative wage differentials have narrowed.


Relative labor costs are at the point where manufacturing plant location is determined by other factors.  These include:  transportation cost, turnaround time for new orders and required finished goods inventory.  This implies that manufacturing can be located closer to the end uses it serves.  However, globally higher labor costs also imply that new factories will be much more highly mechanized than before.  Robots replace humans.

As a result, wage growth will remain unusually subdued.

the future 

Although returns to capital have avoided the erosion that has befallen labor over the past generation, this situation won’t last.  Long-lived physical capital is being replaced by software (note:  the majority of investment spending done by US companies is already on software).

Software doesn’t have either the total cost or the permanence of capital invested in physical things.  Software can be moved, it can be duplicated at virtually zero extra expense.  To the extent that software replaces physical capital as a competitive differentiator, it makes the latter obsolete.  It, in turn, can be made obsolete by the innovative activity of a small number of clever coders.

Therefore, the authors conclude, returns on invested capital (especially physical capital) are already beginning to enter secular decline.

Where will future high returns be found?

…in the innovative activity of talented, well-educated entrepreneurs.


This brings us to a major problem the US faces.  It’s the relative slippage of the domestic education system vs. the rest of the world, and an increased emphasis on rote learning (No Child Left Behind?).

The trio dodge this politically charged issue–they do observe that there’s a direction relationship between the quality of a community’s schools and the affluence of its citizens–by asserting that online learning will come to the rescue.  A child stuck in a weak school system will, they think, be able to in a sense “home-school” himself to acquire the skills he needs to succeed in the future they envision.

my take

What I find most interesting is the presumed speed at which the authors seem to think transition will occur.

–Is it possible that we’ve reached the point where there’s no available low-cost labor left in the world?  If so, this is a dood news/bad news story for low-skill workers.  On the one hand, downward wage pressure will stop.  On the other, robotization is going to take place at warp speed, making it harder to find a job.

Relocation of factories will also have implications for transportation companies, warehousing and even the amount of raw materials tied up in company inventories.

–Does software begin to undermine hardware so quickly?  Certainly this the case with online retailing and strip malls.  But how much wider is this model applicable?

–If the key to future growth is young entrepreneurs, then the sooner we as investors reject the Baby Boom and embrace Millennials the better.  This, I think, is the safest way to benefit in the stock market if the New World Order thesis proves correct.



Wall Street firms are running out of retail brokers

In the post-recession world, traditional brokerage/investment banking firms have become much more interested in the steady income that can come from providing financial advice to individuals.  This is partly due to the demise of proprietary trading, partly a new respect for recurring income.   But Wall Street is finding it hard to maintain its retail sales forces.

One would think that with the Baby Boom beginning to retire, and having 401ks and IRAs rather than traditional pensions to support them in their “golden” years, there would be a lot of demand from this quarter for professional investment advice.  Yet, brokerage firms are finding it hard to recruit salesmen.  The demographics of the big (or “full service,” as they’re called) brokerage forces themselves are also telling:  lots of over-fifties, few under-thirties.  Why is this?

In general:

1.  The internet has replaced financial services as the destination of choice for ambitious college graduates.

2.  Brokerage firms have traditionally been hostile toward women, thereby eliminating half the possible job candidates.

3.  Being a financial adviser is–something I kind of get, but kind of don’t–a relatively low status position, down there with used car salesman.


4.  People under the age of, say, fifty (maybe it’s sixty, though) would prefer to deal with a discount broker over the internet than face-to-face with a traditional brokerage salesman.  I have no short answer as to why, but they do–even when introduced to an honest, competent broker by their parents.  Of course, maybe that in itself is the kiss of death.

5.  Traditional brokerage firms have decimated their research departments as cost-cutting measures during the recession.  This eliminates the only reason I personally would consider a traditional broker.

6.  A broker typically gets a little less than half of the commission revenue he generates (see my post on how your broker gets paid for more detail).  The rest goes to the firm, which uses part of that to pay for offices, recordkeeping, and marketing…   For many years, however, firms like Fidelity, Charles Schwab or other, more low-profile companies have been willing to provide established brokers with back-office support for a small fraction of that amount.  I’m not current on today’s arrangements, but while I was working a broker could easily increase his “net” commission from 45% to 80% by switching to one of these firms.  Yes, he might have to provide his own office, but the headline is that he could increase his income by 78% with the move.


What’s new about this situation isn’t that it’s happening–this has been going on for well over a decade–but that traditional brokers are finally concerned.   Their retail business model is broken, however, and I don’t see it getting fixed any time soon.  My question is how Baby Boomers are going to get the financial advice they need to manager their money during retirement.








the Supreme Court ruled against Aereo yesterday

Aereo, the antenna company

As Aereo would describe itself, it’s kind of like a company that rents storage lockers to individuals–only it rents TV antennas.  Each customer has his own individual micro-antenna, located in a central antenna farm.  These micro-antennas receive the free over-the-air broadcasts from the major TV networks and retransmit them over the internet to a customer device, where TV programs can be viewed in real time.

If Aereo had started up ten years ago, this might not have been a big deal.  But in today’s world the TV networks collect hundreds of millions of dollars in annual retransmission fees from cable networks in return for allowing them to stream network content in real time to cable customers.  In the current cord-cutting environment, Aereo offers/ed an easy and cheap way for getting TV content (sports programming is the key) without having a cable subscription.

Aereo had two claims:

–it was acting just as if it were putting a rental antenna on each customer’s roof, only the antenna is located in a warehouse somewhere with good reception, and

–because each customer was choosing what to have streamed to him, even if there were copyright issues, the networks’ beef is with the individual customer, not Aereo.

prior lawsuits

The networks sued Aereo in Federal court in New York   …and lost.  They sued an Aereo knockoff  in Utah   …and won.

Both Aereo and the networks urged the Supreme Court to take the case and decide.

the ruling

The decision, 6 – 3 against Aereo, with the most conservative justices dissenting, came yesterday.

If I understand the ruling (don’t bet the farm that I do), the decision came in a way that Aereo hadn’t expected.

The majority said that back in the day, cable companies set up their own antennas to capture over-the-air network content and deliver it to cable customers without paying the networks for doing so.  Congress expressly made this illegal in 1976, through a revision to the Copyright Act .  So it didn’t matter if Aereo owned one humongous antenna or a gazillion teeny-tiny ones.  It also didn’t matter that the customer ordered his personal antenna to send the content or not.  All that mattered was that Congress outlawed delivering real-time network content without paying retransmission fees.

The majority also made a point of distinguishing real time delivery from time-shifting, where a customer records content for later viewing.

stock market implications

Take the Aereo IPO off your calendar for now.

It’s a big win for the broadcasters, protecting their cable retransmission fees for at least several years.

Unfortunately for them, it also leaves a lot up in the air.  We now know what Aereo can’t do, which is stream network content in real time, or with a brief delay.  But could it stream content with an hour lag?   …or the next day?  What about someone who records copyrighted content and shares it through Dropbox?  Is Dropbox responsible, or is it only the user who’s in trouble?

This case seems to show that operating through a big bunch of teeny antennas is colorful, but provided no legal protection.

My guess is that someone, maybe not Aereo, but someone, will try to revive the service, building in a time delay.  I’m not sure how much people would be willing to pay for time-shifted content, but my hunch is the audience would be surprisingly large.

Anyway, I think this possibility will prevent the content companies from running away to the upside.




inflation: where we are now


In the early days of the financial crisis, after the Fed had opened the monetary flood gates and aggressively pushed short-term interest rates down to zero, Janet Yellen commented on the cries of prominent hedge fund managers that this would immediately lead to disastrous runaway inflation of the type that plagued the US in the late 1970s.  Her reply was “We should only hope,” or words to that effect.

She didn’t elaborate   …but I will:

1.  The threat to the world at that time was just the opposite of inflation.  The real threat was deflation, or systematically declining prices.  If prices are falling at the rate of, say, 2% a year, making monetary policy accommodative means lowering the Fed Funds rate to -4%.  In practical terms, this is impossible.  So monetary policy is ineffective and a rerun of the Great Depression ensues.  Clueless financiers to the contrary, everything possible had to be done to avoid the deflationary outcome.

2.  Inflation , in contrast, is a little like the flu.  Treatment is well-understood and straightforward to put into effect.  So, yes, it may be unpleasant but we definitely know how to handle the situation.

where are we now?

The biggest problem the Fed has continues to be that it can’t create enough inflation.  The price level has remained stubbornly under the Fed’s target of a 2% average annual increase.

In the US at least, inflation is all about wages.  Nothing else is big enough to matter.  The (lack of) inflation problem is that there’s still enough available labor in the economy that employers don’t have to raise wages, either to find new workers or hold onto existing staff.

On the one hand, the Fed would like to begin to return interest rates to normal:  a

–five-year ICU stay can’t be good for a patient;

–with rates at zero the Fed has no ability to respond to any other economic disruption;

–world bond markets appear awfully bubbly at the moment; and

–the Fed is arguably an enabler of a dysfunctional Congress/administration.

On the other, the last thing the Fed wants is to choke off growth and create a recession.

my take

Personally, I’d expected the too-many-employers-chasing-too-few-workers syndrome to have developed long before now, and that we’d have 2%+ inflation already.  That’s because I believe that a lot of current unemployment is structural, not cyclical.  That is, I’ve been thinking that many long-term unemployed don’t have the educational or technical skills needed in the 21st century workplace.  Loose money policy doesn’t do them any good.  They need retraining, not low rates.

So far, that’s been wrong.

Taking back of the envelope numbers, there are about three million unemployed workers in the US.  The economy is now creating about a million new jobs a year more than the number needed to absorb people leaving school and entering the workforce for the first time.  If these are the only factors, and if I continue to be 100% wrong (that is, if there’s no structural unemployment), then we won’t reach full employment until 2017.

This would imply that we won’t have to worry about inflation for a long time.  This would also imply that the bond market–and, consequently, the stock market too–could get a lot weirder before the Fed pulls in the reins.


two types of inflation?

two forms

Back in the 1970s, when inflation actually was a serious global economic problem, economists tried to distinguish between two types of inflation:


demand-pull is what we typically think of as inflation today.  It’s the situation where an economy is at full industrial capacity and full employment but is still growing strongly.  The only way to find new workers to staff business expansion is to lure employees away from rivals.  How to do this is?  …offer them more money.  An intercompany bidding war for talent ensues. Salaries rise.

Newly flush workers want to spend on goods and services.  But these are also in limited supply because industry is capacity constrained.  How to get the stuff we want?   …bid higher prices.

Voilà!   …rip-roaring inflation.

This problem can be laid squarely at the feet of too-loose money policy.


cost-push.  This is the idea that the price of one or more key agricultural or mineral commodities rises by a lot (think;  the two oil shocks of the 1970s, when crude doubled or tripled in price).  Such a price increase is passed on to manufacturers and to consumers, causing the overall price level to rise.

This type of inflation is no longer talked about, for several reasons:

—-monetarists have successfully argued that oil shock inflation was caused more by the decision of central banks to soften the blow by rapid money supply expansion than by the price increase itself.  It was, they said, accommodation that caused the inflation, not oil.  After all, falling oil prices in the 1980s didn’t cause deflation.

—-wages are no longer routinely indexed for inflation for the vast majority of workers, so a key pass-through mechanism is no longer operating

—-advanced economies are much more involved in providing services that use intellectual resources, which are less subject to the physical constraints of plant, mine or farm capacity.

—-globalization has put significant upward pressure on commodities prices, but has also created downward pressure on wages in industries making tradable goods.  Of course, in the internet age, a lot more stuff is in the tradable category, too.

—-advanced economies, particularly the US, have evolved to the position where labor costs are perhaps three-quarters of the total economy, and therefore effectively the only thing that matters.

cost-push making a comeback?

I think so.

Japan recently depreciated the yen by 20%.  This has caused a surge in profits for export-oriented manufacturing, and a tsunami of Asian tourists seeking to buy, among other things, heated Toto toilet seats.  Prices have shifted from falling to rising.

But wages haven’t gone up at all.  So, yes, the depreciation has created inflation, but most individuals are worse off than they were before–because they’re paying 20% more for imported items like fuel and food.  (This isn’t quite correct.  There’s a substitution effect along with the income effect, meaning that people shift what they consume in order to lessen the harm to their well-being from higher prices.  They, say, eat tofu instead of beef or get clothes from a consignment store instead of Uniqlo.)

There’s also the effect of price rises on the long-term unemployed in the US or the EU.  It’s not quite the same thing, but it’s certainly different from the demand-pull world, where everyone is better off–but tricked by the fact nominal (but not necessarily real) wages are rising into thinking they’re better off than they are.

investment significance?

I’m not sure, other than to take a trip to Japan before the place falls apart.

But I do think that the failure of wages to rise, either in Japan or the US, despite highly stimulative monetary policy is a potentially explosive social/political issue.   It may reach a tipping point where big social changes are demanded.




what’s bad about inflation?

this is the first of several posts about inflation, which may turn into an important investment issue this year or next.

what it is

Inflation is a sustained rise in the level of prices in general.  An environment of modest inflation–the Fed’s target is an average 2% yearly increase–is the desired mode of operation for Western economies.  It’s what people are used to.  Government and university economists feel they understand how inflation operates and know what to do if it starts to get out of control.  They all agree, moreover, that inflation is a lot better than deflation, a sustained fall in the price level, whose effects have historically been devastating and for which there’s no tried-and-true cure.

what’s bad about inflation

Inflation has two bad characteristics, last seen in the US in the 1970s, that make it an object of concern:

inflationary psychology

If goods or services are in plentiful supply and if prices don’t change very much, buyers will purchase things when they need them.  If buyers think that prices are rising in a sustained and significant way, they’ll begin to buy ahead of time.  Some will buy more than they’ll ever need, either with the intention of selling later at a profit or simply viewing their purchases as a store of wealth.

Once ingrained in individuals and companies, as it became in the Seventies, this behavior is hard to change.  But it sends crazy signals to the providers of goods and services, who rev up production as fast as they can to meet this new demand.

Once convinced that inflation is here to stay, the economy begins to distort itself.  Interest swings toward the production/acquisition of items whose chief/only merit is that they are perceived as inflation hedges (think:  gold, diamonds, real estate,  oil and gas).  In the late Seventies, for example, industrial companies leveraged themselves to the sky to buy coal mines or hotels–things they knew nothing about, and whose purchase they would soon come to rue, but which they thought defended themselves against accelerating inflation.  If they could borrow from banks at fixed rates–which was the general practice back then–they figured that the real cost of their debt would soon turn negative, giving them further gains.  Once the Fed stepped in to halt the inflationary spiral, these firms (and their banks) were ruined.

In short, once inflationary psychology develops, an economy begins to go off the rails.

a tendency to “run away”

Three factors cause inflation to accelerate–and economic craziness to get out of control.  They are:

–Inflationary psychology tends to feed on itself.  Once you see the hundred pounds of pig iron you have in your basement has gone up 50% in price, you buy more   …as time goes on, a lot more.  As companies/individuals realize that “buy now” is a successful strategy, they expand the depth and scope of their activity.

–Some price rises are automatic, adding to the price rise momentum.  Labor contracts, for example, may have clauses that adjust wages for inflation.  Traditional pensions, too—and Social Security.  Utility companies typically are allowed to pass increased costs directly on to consumers.  In addition, these institutionalized price increases often use escalation formulas that overstate inflation (think:  Social Security).

–Some parties may systematically underestimate inflation and inadvertently throw gasoline on the fire.  For most of the 1970s, for example, the Fed set money policy that was much too loose, based on faulty inflation projections.  Banks typically didn’t protect themselves by lending at variable rates, either.  Potential borrowers soon learned that they could do a lucrative arbitrage by taking out a long-term loan at a rate that would soon turn negative and use the money to buy “hard” assets that would appreciate in value.  This became the focal point of many firms’ capital spending plans.

1970s vs. 2010s

A generation ago, the “runaway” factor was extremely powerful in the US.  That was partly because of bank activity and partly because a large portion of the labor force worked under multi-year collective bargaining agreements with inflation adjustment factors.  Much more so in Europe.

Today’s banks lend at variable ares and are no longer a pro-inflation force.  Labor arrangements have changed a lot in the US over the past forty years, though not in continental Europe.

As a result, my guess is that the tendency for inflation to accelerate is considerably lower in the US now than it was the last time we had an inflation problem.  One offset:  the early Volcker years, during which the Fed was successfully breaking an upward inflation spiral through super-high interest rates, were ones of severe economic hardship.  The memory of that pain was enough to engender a “never again” attitude toward too-loose money that lasted for almost twenty years–until the latter days of Alan Greenspan.  I think that mindset is gone now, not only from the Fed but from popular consciousness as well.

More tomorrow.





Revel bankruptcy, a sign of Atlantic City’s continuing gambling woes

Maybe this shows I’m just not so inspired this morning  …because it’s the last day of Spring?

As I was collecting data for this post, I noticed that the Revel casino in Atlantic City filed for Chapter 11 bankruptcy protection yesterday.  The pipe dream of Morgan Stanley master-of-the-universe wannabees, the Revel was supposed to be the upscale entry in a market that caters to little old ladies with buckets of quarters.  Not only was the concept suspect, but the timing was awful, coinciding as it did with the peaking of the seaside town’s gambling win in 2006.  Oddly, in my view, the state government pumped more than a quarter billion dollars into Revel in 2011 to help get it open.  That’s a half-decade after the numbers began to show that the last thing the existing gaming operations needed was more capacity.

Revel is actually the second AC casino bankruptcy in recent months.  Last November, the Atlantic Club (which was, once upon a time, the Golden Nugget) entered Chapter 11; in January it closed its doors.

Aggregate casino revenue for Atlantic City has been dropping steadily since the legalization of casino gambling in nearby Pennsylvania (casinos have since opened in Maryland, Delaware and New York.  More are on the drawing board for NY and Massachusetts).  The current run rate is slightly above half of the peak.

As I wrote about at the time, last year Trenton tried to breathe some new life into Atlantic City, which even in its weakened condition will chip in $150 million – $200 million in tax revenue to the state, by allowing online gambling.

Early predictions by the politicians were that online gamblers would boost aggregate casino win (the amount lost by gamblers) by $1 billion.  Microeconomically minded might observe that some of this new-found money might come from gamblers betting online instead of in the physical casinos–so it might not be a pure gain.  In addition, any redistribution might deepen the plight of any casino that didn’t offer an online option.

But, since the state tax on online gambling revenue is almost double that for onsite betting (15% vs. 8%), Trenton would likely come out a winner no matter what collateral damage might occur.

results so far

Through May, online gambling has generated $53.5 million in casino win, or about $10 million a month.  On the same measure, physical casinos are down by 6.5% year-on-year, or about $74.0 million.   …Ouch.


While it’s still early days, online gambling in New Jersey so far seems to be a bust for everyone except the tax collector.  So Las Vegas may have little to worry about.

Also, in the Northeast US at least, there appears to be a relatively fixed amount of money that people are willing to spend on gambling in the local area.  New casino openings–of which there are plenty in the pipeline–don’t appear to add much to aggregate demand, but rather mostly shift money from one pocket to another–and add to overall industry costs.  This implies continuing trouble for overbuilt areas like Atlantic City, or, eventually, any of the other states that are adding capacity.