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November 6, 2017 | The Problem With 21st-Century Companies

Is an American author of books and articles on economic and financial subjects. He is the founder and president of Agora Publishing, and author of the daily financial column, Diary of a Rogue Economist.

RANCHO SANTANA, NICARAGUA – We’re down in Nicaragua giving a little speech to a group of financial analysts and publishers.

I’ll be sharing the full contents of the speech with members of our Inner Circle advisory soon.

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A view of the coastline from Rancho Santana, Nicaragua

Paris was dead when we passed through on Saturday.

It was the All Saints holiday weekend. Our neighborhood – near Les Invalides – had cleared out.

So much the better. Paris is a city for old people. The best season to enjoy it is the fall. And the fall is best when the city is empty.

Then you can get a full draft of melancholic nostalgia without bright, young people diluting the dosage.

Just walk through the parks and kick up the curled-up chestnut leaves… or sit in a deserted café, drinking a glass of Médoc and thinking of dead people.

The pleasure is exquisite.

But our beat is money. And we begin by noting that President Trump’s Deep State advisors have chosen the perfect man to lead the Fed: the quintessential insider, Jerome Powell.

More about him tomorrow…

 

 

Classic Money-Loser

On Saturday morning, we sat at Le Bistro Esplanade, looking out at Les Invalides – a complex of buildings that began life in the 17th century as a home for aged and sick soldiers – rehearsing neither sweet remembrances nor sour regrets.

Instead, we wondered why Tesla and Amazon are such popular stocks, despite losing so much money.

What follows is an idea on the subject…

They are very different companies. One makes electric cars; the other sells stuff online. About the only things they have in common are that neither makes money and both are vaguely “tech” companies.

Tesla is a classic money-loser. It has a charismatic Pied Piper at the head of it, in the form of Elon Musk, drawing away investors’ money. But it lacks a business model that makes sense.

Yes, it can make cars. But so can a lot of companies with vastly more know-how, more money, and more marketing skills.

Most likely, if Mr. Musk finds there is a good market for his all-electric performance cars, the other automakers will take it away from him.

Tesla is hugely unprofitable. But it is not doing what Amazon is doing – destroying the profits of a whole industry. In that regard, Amazon is exceptional.

Might it also be indicative… illustrative… and revelatory? That is, might it tell us something about the new 21st-century industries… and why they don’t seem to add to GDP the way the old industries did?

The answer is yes.

 

 

No Moat

Traditionally, the retail industry gives up its profits grudgingly.

It’s a business without much margin. Fortune magazine looked at the sector a few years ago and concluded that the average profit is 3.2% of sales. In food and drugs, it is even worse – at just 1.5% of sales.

As super investor Warren Buffett says, the industry lacks a “moat” to protect itself from competition. So, when an upstart such as Amazon comes along and begins taking away sales, the first thing to disappear is the profit.

Let’s see… About $200 billion was spent on online sales last year out of a total retail market of about $5 trillion. That’s 4% of the total, with Amazon getting nearly half of it.

No wonder old-fashioned retail is going broke. Profits were only about 3% of sales… and they’ve lost 4% of sales to online sellers.

The customers still come in to check out the merchandise; the lights still have to be on; clerks need to be at their posts. And these stores can’t raise their prices to make up for the lost sales. If they do that, they’ll lose even more sales.

But the remarkable thing is that while the profits disappear from Main Street retail companies, they don’t reappear anywhere else.

What the old retailers lose, Amazon doesn’t find. It should be getting at least 3% on its $136 billion in sales. Instead, it gets nothing.

So, what happened?

 

 

River of Fake Capital

There are two answers…

First, the fake money system has made available to Amazon a river of nearly free fake capital.

As long as this phony money flows, the company has no need to make money. It has all the cash it needs. And stockholders are happy with their capital gains.

Who needs earnings when your stocks are rising 20% a year?

So, Amazon can afford to do business in a new way – without earning any money.

Second, the internet doesn’t add to capital the way the old industries did, because it doesn’t increase output; it might even depress it.

We caution dear readers – especially new ones – that our thinking here could be deeply flawed. We haven’t been able yet to think this through thoroughly. We are just trying on this idea today – like a new coat, to see how it looks on us.

But for a long time, we’ve been wondering why such a fabulous new technology – internet- and mobile-based electronic communications – has completely failed to raise GDP growth rates. Instead, they’ve fallen.

The short answer is because it, like TV, is a time waster. People now spend an average of 8.4 hours a day on electronic devices. Mostly, they are spending their time on silly games and photos of cats.

Where Does the Money Go?

A more complex answer brings us back to Amazon.

It seems to make life easier and more agreeable for many people… but it does so by reducing GDP!

Who needs mall cops if we all shop online? Who needs malls at all?

The old economy took resources – most important, energy – and converted them into things people wanted.

These things made a profit for the manufacturer… adding to the world’s wealth.

And that wealth was shared with the employees and retailers. If you make a tractor, for example, you make money… your employees make money… the company that sells the tractor makes money… and the guy who buys the tractor uses it to make more money.

Amazon doesn’t make stuff. Neither does any internet-based business.

Instead, they merely traffic in information…

Want to know what year Fats Domino released “Blueberry Hill”? Wanna buy a ticket to Siberia… or watch a dirty movie? It’s on the internet!

The internet disrupts supply chains… and reduces costs. But costs are revenue to someone… and profits. And GDP.

The question: Where does the money go? If consumers save money at Amazon… how come they are not buying more with their savings? Total spending should remain unchanged.

And it does, more or less.

It’s hard to know what is going on. But despite President Trump’s insistence that the jobs picture has never looked so good, consumers seem to have less money to spend.

Never in history have so many working-age men been out of work.

What do they do with their free time? Go on the internet, of course.

More to come…

Regards,

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Bill

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November 6th, 2017

Posted In: Bill Bonner's Diary

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