Disclosure: I’m long Cash America International Inc (CSH), General Electric Company (GE), Gilead Sciences, Inc. (GILD), IPG Photonics Corporation (IPGP), Main Street Capital Corporation (MAIN), SunEdison (SUNE), Winmark Corporation (WINA).
Human ingenuity is leading to low-cost energy, low-cost production and more efficient business, which could lead to increased discretionary income and higher discretionary spending, although the technology which brings the benefits could also reduce lower and middle incomes.
About this piece
I make connections across many fields, I don’t claim specialist knowledge in any of them and I doubt if anyone has specialist knowledge of many of them.
The title is not meant to imply that everything is low cost or soon will be, and anyone paying for dental treatment in the US is likely to see why.
For the same level of consumer confidence, more discretionary income means more discretionary spending. I don’t try to predict future consumer confidence.
Much of the piece is about innovation in a variety of fields, with little specifically about the cloud and biotech because they are well known. As well as lowering costs, innovation will produce profound changes, but that’s not the point of this article.
Factors against rising discretionary income
Further down I write about consumer debt, and about technology discplacing jobs. There are other risks and factors that affect discretionary income (and more), some of which I list here although any detail is beyond the scope of this article: war, natural disasters, European debt and Europe’s immigration situation, and anything else that would massively disrupt trade. Other factors are mentioned where they are relevant, for example the claim that fracking businesses operate as a Ponzi scheme is in the following section about fracking. I don’t list all the negative factors every time I say something is positive for discretionary income.
Cheap energy is good for discretionary income any place where energy consumption outweighs production. While the consumption roughly equals the production, cheaper energy is good for the world economy (the “oil shock” in the 1970s when OPEC was formed and exercised its cartel power did not make the world richer). There are doubts about the commercial viability of fracking (technically, “hydraulic-fracturing”), as in Shale Fracking Is a “Ponzi Scheme” (September 19, 2014, but with older quotes), and I haven’t found a fracker that has not racked up a load of debt. “Einhorn Slams Mother Frackers” Sep 10, 2015 (econmatters.com) has less detail about the fundamentals but it shows that the concern still exists. If the debt goes bad, I can’t say how widely the consequences would spread. See also “Wall Street’s Biggest Banks May Have To Make Good On $26 Billion In Oil Hedges” by Tyler Durden, 04/09/2015 (zerohedge.com) – the piece names a few banks, who were also lenders.
About recent bankruptcies and closures, see “Fracking Firms That Drove Oil Boom Struggle to Survive” by Alison Sider, Sept 23, 2015 (wsj.com). If a well generates cash, it’s worth something and will have a buyer in the event of bankruptcy. It’s the bankrupts that hit the news, but it’s the survivors that will shape the future of the industry. There are about 39 bankrupt solar power companies in the linked list, from 2009 to 2014. It didn’t stop the price of solar PV modules from falling or stop installation from rising.
It’s claimed that the technology is advancing rapidly, for example with smart drill bits. See “How Big Data Can Save the Shale Boom” Jun 03, 2015 (the-american-interest.com), and there’s more in “Saudi Arabia may go broke before the US oil industry buckles” by Ambrose Evans-Pritchard Aug 5, 2015 (telegraph.co.uk).
The piece “How Long Can the U.S. Oil Boom Last?” by Dennis Dimick, Dec 2014 (nationalgeographic.com) gives 5 to 8 years before shale oil runs out. President Obama said about gas, “We have a supply of natural gas that can last America nearly 100 years” in 2012. The U.S. Energy Information Administration used to underestimate the amount of gas that could be extracted, but seems to have over-compensated and been too optimistic in 2012. From “Natural gas: The fracking fallacy” by Mason Inman, December 3, 2014 (nature.com), a three year study at the University of Texas concluded gas production would peak in 2020 and then decline 50% by 2030.
The problem with the predictions is that the easiest gas is naturally extracted first. (The term “sweet spots” has been picked up by detractors, it implies a sharp division between resources easy to extract and resources hard to extract, which may be the case but I haven’t seen data for how sharp the division really is.) Next year, the gas won’t be quite as easy to extract, but technology and expertise will have improved. That describes the situation for any year, and it’s difficult to project which factor will win the race in the years to come. It’s also hard to know if or when the finance will dry up, with the availability and terms depending on perception and attitude as well as the facts, and on the decisions of ratings agencies. Finance has obviously dried up for some operators.
The arguments I’ve seen over profitability were polarized, and you can spin the same facts to say there’s rapidly advancing technology, or that fracking depends on uncertain future technological advances.
Some sources claim there’s a vast amount of shale oil and gas elsewhere in the world. If US shale runs out soon, either it will discourage extraction overseas, or America’s frackers will tour the world and there’ll be more total oil and gas extraction, during which technology will advance and expertise will develop, eventually allowing production in the US to be resumed.
Solar PV and energy storage
While there’s some doubt about the future of cheap oil & gas in the US, solar photovoltaic energy has been steadily getting cheaper. The industry has followed Swanson’s Law, which says that the price of solar modules drops 20% for every doubling of the total capacity ever produced. It’s a bit like Moore’s Law (which drives the falling price of computing power), except that Moore’s Law depends on time rather than cumulative production. Installation costs will be stickier.
I checked the US holdings in the solar ETF TAN’s top ten holdings and I give a very sketchy financial summary for the three most profitable ones. I only looked at the latest 10-K and 10-Q, and used Morningstar when needed for a three-years-ago figure.
First Solar Inc (FSLR) (SEC filings) has had positive Net income for two full years and for six months in 2015, and three full years of positive free cash flow but a negative six months operating cash flow in 2015. They have a strong balance sheet with more current assets than total liabilities. The cash flow can vary due to the timing of revenue recognition. They sell solar modules and the solid results are not representative of solar project companies. The stock price looks volatile on the ten year chart.
Advanced Energy Industries Inc (AEIS) (SEC filings) do power conversion products and are also not representative of solar project companies. They have consistently positive free cash flow numbers for three full years (if you don’t count acquisitions) and for six months in 2015, also current assets are more than total liabilities, but they lost so much market share in the solar inverter business in Q1 2015 that they decided to exit it, with layoffs expected.
SunPower Corp (SPWR) (SEC filings) has had two whole years of positive Net income but a negative six months in 2015. Cash from operations has been positive for three whole years, but free cash flow has generally been negative. The balance sheet seems reasonable, but is complicated by many items refering to footnote 1, about related-party balances for transactions made with Total. From the Q2 10-Q, in thousands, Total current assets of $2,172,113 are 1.95 times the Total current liabilities of $1,113,960, and are 80.3% of the Total liabilities of $2,706,213. Long term debt is small at $225,338, and the biggest long term liability is Convertible debt, net of current portion $693,938. Some of the debt is non-recourse, with no claim on the company beyond the assets used as collateral. SunPower are engaged in solar projects. From Morningstar’s company profile, you’d think SPWR maintained the solar system (a big ask).
Solar projects need finance for development, the official lifetime is about 20 years and they are likely to last longer, so high debt is expected when they are retained. In contrast, fracked wells deplete quickly so high debt seems more likely to be a problem. The equipment is not likely to last anything like twenty years (and at least some of it is now a lot cheaper, probably the older stuff). Debt has been incurred in both industries to finance fast growth (or to stay afloat, as alleged for fracking).
The ten year chart of the ETF TAN probably overstates the volatility of major US solar stocks because it includes the OTC stock Hanergy Energy, see “TAN Gave It’s Investors A Sunburn – Consider ICLN Instead” by Bruce Vanderveen, May 29, 2015 (seekingalpha.com) and the comments.
Casual Analyst on Seeking Alpha has questioned the value of retained projects (April 2014, seekingalpha.com), given the falling costs, doubting that the long term Power Purchase Agreements will hold. I disclosed at the top that I’m long SUNE, but it’s speculative and I’m not recommending it. What matters here is, I don’t see valuation or other issues stopping solar PV from growing and contributing to low energy costs. The implications of negative free cash flow, financing etc. can be argued over, as can the retained projects, but solar PV does not have shale’s depletion issue.
There is also high interest in energy storage, mainly battery technology, with Elon Musk (CEO of Tesla Motors and SpaceX, and chairman of SolarCity) betting on conventional Lithium-ion technology for his Gigafactory (and he’s betting against “over-hyped” breakthroughs). The Gigafactory should reduce costs through economies of scale.
At $3,000 to $7,140, Tesla’s Powerwall for domestic energy storage is currently not cost-effective compared to a net metering plan, but otherwise would usually break even on a “levelized cost of electricity” basis (which includes things like installation costs). That’s according to “Tesla Battery Economics: On the Path to Disruption” by Ramez Naam, April 30, 2015 (rameznaam.com) (probably based on a $3500 price). That’s without considering the benefit of keeping the lights on in a power outage. Tesla also makes the Powerpack for industrial customers. Mercedes-Benz are starting to sell batteries for the same purpose, for domestic and business use, see “Move over Tesla: Mercedes-Benz takes on Powerwall with a home battery of its own” by Ellie Zolfagharifard, June 10, 2015 (dailymail.co.uk). You get more power per up-front dollar from a home generator, but you have to pay for gas, and other factors complicate a comparison.
Ramez Naam also wrote “Why Energy Storage is About to Get Big – and Cheap” April 14, 2015 (rameznaam.com), where the author makes a case for expecting energy storage to soon be more cost effective than activating gas peaker power plants to satisfy peak demand (that doesn’t sound good for General Electric, who sell gas turbines).
About a year ago I heard a technologist on the radio complaining that nearly all the R&D in battery technology was incremental, i.e. likely to achieve it’s goal but with little chance of achieving a breakthrough. I’ve just googled “new battery technology” (without quotes) and got 17 relevant results dated 2015, on a page of 20 results. The variation includes quantum dots and solid state lithium-ion. Of course a quick search doesn’t measure the research budget.
Electric vehicles will be a lot more popular when you can charge them up with low cost solar power and go further with cheaper, lighter, more energy-dense batteries. Households can use the grid less or maybe not at all when they can have solar PV panels on the roof and store the energy. There are complications, such as climate and seasons, smog in some of the world’s cities, the relative merits of thermal (non-PV) solar, politics, and the effect on the grid, power utilities, and people who don’t own rooftops. The advantage of solar PV and local energy storage is bigger in poorer countries where the grid is less developed, and it can be leapfrogged for a system where energy generation and storage is close to energy consumption. A distributed system based on renewable energy avoids much of the capital investment needed for a grid, most of the power transmission and distribution losses (6% in the US), and the purchase and transportation of fuel. Obviously there are still capital, maintenance and replacement costs for the generation and storage of energy.
Even if fracking fails through a lack of profit, finance or resources, renewables (mainly solar PV) and battery technology will mean low cost energy, which is positive for discretionary income. Countries with the right kind of desert (sunshine, location, and not too many sand storms) could become energy producers. Saudi Arabia plans on exporting its sunshine, see “Saudi Arabia solar power exports ‘absolutely realistic’” by Ed King, May 31, 2015 (rtcc.org). Countries like Libya and Iraq could see their economies transformed if they can improve their politics, but that’s quite a big “if”, and there may be more chance of Spain or Greece making good use of their solar PV potential. There are many more countries with high insolation (sunshine), I’ll just mention Mexico where solar PV could power manufacturing for export to the US. While wide area transmission grids already span countries and continents, electricity transmission over long distances is not cost free, and security is likely to add to the cost in the Middle East. Wherever it works, there will be customers benefiting from cheaper power.
A bit off-topic, where ground water is scarce but humidity is high (Californian fog?), it may be possible for solar powered refrigeration to condense water out of the atmosphere. See this piece about a Dyson Award winning invention for filling a bicycle water bottle. Obviously that would need to be scaled up massively to have an economic impact, it might have to wait for solar power to get cheap enough, and water would have to be transported inland from the coast.
Electric vehicles and vertical integration
Electric vehicles have fewer moving parts, with savings in servicing and maintenance, see “Electric vehicles offer big SMR cost savings” by Andrew Ryan, August 12, 2015 (fleetnews.co.uk). Fewer parts could result in lower production costs than for gas burners if the battery cost can be brought down. Fewer parts also makes vertical integration easier. The quality-control downside of outsourcing is described in “Why Tesla’s Vertical Manufacturing Move Could Prove Essential To Its Success” by Jim Gorzelany, Feb 27, 2014 (forbes.com).
85% of the wolrd’s generating capacity is still steam powered, but advances are possible even in this old area. The title “Breakthrough in plant efficiency” (September 10, 2015, theengineer.co.uk) may be an exaggeration at this stage, but watching the behavior of vapor bubbles with high speed cameras has increased understanding of the boiling process, which may allow safe operation at higher temperatures and greater efficiency. The problem with putting more heat into the same boiler is that bubbles prevent the efficient transfer of heat. Too many bubbles leads to some very hot hotspots that damage metal in a “boiling crisis”. One conclusion is that surfaces in the boiler should be rough, but not as rough as suggested by previous research into heat disappation in electronic devices.
Commodities, currencies and China
The low price of commodities generally should also be positive for higher discretionary income. Commodities are priced in dollars and exchange rates affect prices (and vice versa). I’ve been saying since November 2014 that there’s a risk that $6 to $9 trillion of offshore dollar denominated debt could trigger a flight to the safety of the dollar (and to other currencies percieved as safe). One possibility is that the debtors are mostly businesses that earn dollars, so the currency of the debt matches the currency they earn, with little currency risk. Countries with currencies that fall faster than world prices won’t experience the “low cost world” of the title, if they import enough to create inflation.
The US has long been a net importer, allowing exporting countries to build up high dollar reserves, especially China with $3.8 tillion worth. Russia had high currency reserves, some of which they used to try to prop up the ruble, but the market had it’s way. However, Russia is highly dependent on oil and faced sanctions, making it different to other emerging economies. China could trash the dollar by liquidating part of its dollar reserves, but that would disrupt trade and reduce the value of its reserves. In contrast, a market driven flight of capital is not a plan based on the consequences. That’s why a flight to the dollar seems more likely than a flight from the dollar. It isn’t impossible for traders to get nervous about the US trade deficit and low reserves, but there’s no obvious reason for them to suddenly get excited over a situation that’s lasted for decades. That may change if China successfuly challenges or undermines the US dollar’s status as a reserve currency, in which case a lower dollar is likely to help the US trade balance. Wikipedia’s List of countries by foreign-exchange reserves puts the US at number 18 with $121 billion, after the UK, France and Italy.
Rising wages in China don’t favor low cost production and low cost imports from China, but a big effect on import costs seems unlikely. See “A tightening grip” March 14, 2015 (economist.com), it’s a little old but it’s about long term issues. The piece gives the double digit growth per year in manufacturing wage rates since 2001, and the rise in productivity which isn’t far behind. The concentration of various manufacturers in one area keeps the supply chains short (literally), with what I’ll call “economies of concentration”. It’s an excellent piece for anyone interested in China.
China is a big and growing market for IPG Photonics’ lasers, and there’s some risk that China will push the development of their own lasers. I mentioned it in “IPG Photonics cutting edge”, May 2015 (on Seeking Alpha, on blog site, find “Vertical integration in China”). I quote a claim that the Chinese government aims to achieve the level of vertical integration that IPG Photonics has. The laser sales are in line with China’s manufacturing becoming more sophisticated. That shouldn’t be surprising – the first Korean car’s body was made from oil drums (see “Meet the first ever Korean car” topgear.com), and their industry is rather more sophisticated now. I doubt if rising wages in Korea caused inflation in the countries they exported to. Although China is bigger, industries like clothing where low wages matter most will move to the low wage countries.
For the long term trend in commodities, see “COMMODITIES & THE 130+ YEAR BEAR MARKET” by Cullen Roche, 12/16/2010 (pragcap.com). The author used “euphoria” in describing commodity markets at the end of 2010, and warned that financial products wrapped around commodities were speculative. You need Flash for the images, if you don’t have it there’s a chart for non-oil commodities on “Commodity prices: Over a hundred years of booms and busts” by Andrew Powell, 28 April 2015 (voxeu.org) showing an overall decline and much boom and bust.
A more mixed price history is described here – “Commodity prices in the (very) long run Mar 12th 2013 (economist.com). Since 1900, the risers have been energy products, precious metals, and steel and its ‘ingredients’. Aluminum and zinc fell. The piece draws on a study of thirty commodities by David Jacks. There are charts and tables in the 39 page PDF “From Boom to Bust: A Typology of Real Commodity Prices in the Long Run” by David S. Jacks (Simon Fraser University and NBER), May 2014 (nber.org).
For innovation in mining, see “Rio Tinto talks up autonomous trucks, innovation cred” by Allie Coyne, Jan 13, 2015 (itnews.com.au), which describes how the miner operates mines from a remote center. A tire blowout on a huge mining truck is very expensive. Tires can be monitored with surface acoustic waves, allowing replacement before a blowout, without the inconvenience of wires or batteries on a rotating wheel or shaft. This link is mostly about checking for under-inflated tires in light vehicles – “Acoustic Wave Sensor Market worth $1,183.52 Million by 2020 (marketsandmarkets.com).
Recycling reduces the need for mining, and when a metal or other resource gets too expensive, substitutes can be found. Beyond occasional switching to palladium instead of platinum in catalytic convertors, I can’t think of good examples of price substitution, probably because high prices soon stimulate production. We have learned to live without asbestos, toxic metals like cobalt have been dropped from many products, and many soft plastics are now phthalate-free. Nanotechnology is giving us new materials like carbon nanotubes, graphene and metamaterials. There’s some effort to develop better construction materials, after years of little change, but the only good story I could find is from 2009 – “Better Materials Could Build a Green Construction Industry” by Mark Fischetti (scientificamerican.com). As suggested in a comment, building codes that don’t move with the times could be a bottleneck. I expect it will be a long time before we have to start mining asteroids, as in “Single asteroid worth £60 trillion if it was mined – as much as world earns in a year” (dailymail.co.uk). That much metal would crash prices and not sell for £60 trillion ($92 trillion).
One innovation in recycling is labels that come off PET plastic bottles easier, so they don’t contaminate the plastic during recycling. For a range of recycling machinery see edgeinnovate.com. A “trommal screen” is a rotating drum with holes that only small bits drop through, and the smallest bits are called “trommel fines”.
The Jacks study concluded that soft (agricultural) commodities have been in long term decline since 1850. Beef was an exception, having gone up over the period. Given the limited area of fertile land, innovation must have enabled production to rise faster than the population. Major factors include the use of farm machinery instead of horses, oxen and manual labor, and the “green revolution” (pesticides, herbicides and crop breeds). New productivity drivers are arriving.
Satellite images have been available to farmers, sometimes for free. This PDF from fsa.usda.gov (April 2014) proves it for the US, but it’s a bit dull for non-farmers. The piece from digitalglobeblog.com about Africa and South Asia is more readable but has nothing surprising.
Now drones are available, although their use is restricted. With the right drone and an app, a survey can incorporate images using infra red radiation as well as the visible spectrum. The relatively ‘pinpoint’ information can be used to apply whatever’s needed to the patch that needs it, saving on insecticides, herbicides, fertilizer and water. Using drones for crop spraying avoids the cost of either employing a pilot or taking flying lessons, and avoiding the pilot’s weight saves on fuel and the material used in the drone, though opposition to permitting it is likely. For more detail see “Meet the New Drone That Could Be a Farmer’s Best Friend” by Rachel Rohr, January 21, 2014 (modernfarmer.com).
“The 7 Best Agricultural Drones on the Market Today” by Andrew Amato, 2014 (dronelife.com) has the “Lancaster” drone from PrecisionHawk at number 3, with LIDAR (a sort of laser radar) among other features. There’ll be more drones on the farm as restrictions ease – “Why 2015 is the year agriculture drones take off” by Clay Dillow, May 18, 2015 (fortune.com).
My amateur guess is that Precision Agriculture (as it’s sometimes called) is at an early stage, and someone needs to integrate everything, bringing drones, artificial intelligence, agricultural equipment etc. together to make the whole operation smooth for farmers, who want to sit in the tractor and not spend time grappling with the IT (until someday the tractor doesn’t need them).
Instead of automating work in the fields, agriculture can be brought into the factory, as in “Japanese plant experts produce 10,000 lettuce heads a day in LED-lit indoor farm“. It’s in a former semiconductor factory, and looks like a mutant hybrid of that and a greenhouse. Apparently it’s not advanced enough for the Japanese, see “Fully Automated Lettuce Factory to Open in Japan” August 21, 2015 (wsj.com). In one sense it’s an inefficient use of energy, because if the electricity used to power the LED lights was generated by solar PV, there’s a huge energy loss between the sunlight falling on the panels and the light coming out of the LEDs, and the conversion to electricity and back to light can never be 100% efficient. On the other hand, the panels can capture frequencies (i.e. colors) that plants don’t use, and the LEDs can be designed for the frequencies they do use. Solar panels can be on non-fertile land or unused areas like rooftops. Solar PV converts energy more efficiently than photosynthesis (Solar PV, 10% to 20%, Photosynthetic efficiency 0.1% to 8%), but photosynthesis is present in both cases.
Fish farms are a fast-growing source of food, and aquaculture is probably more sustainable than using fishing fleets. Unfortunately the farms are plagued by sea lice, and pesticides from fish farms cause toxic pollution. One idea is to put a farm further out in the sea where currents are stronger and it’s harder for the infestation to spread. Most of this PDF – “Landscape/seascape capacity for aquaculture: Outer Hebrides pilot study” is dull reading if you aren’t a Hebridean fish farmer, but the paragraph with “up to three times the size of the average fish farm being located further out to sea in deeper water locations that have stronger currents, which helps reduce potential adverse environmental effects” proves I’m not making it up. See Wikipedia’s “Aquaculture of salmonids” for more info and an old chart showing the rapid growth of production.
Good long term returns in primary producer countries
There’s a table in “World stock markets: How historic returns have varied by country” February 19, 2014 (monevator.com) which shows that the annualized real return with dividends reinvested since 1900 for Australian and South African stocks is over 7%, beating US stocks where the return was 0.9% less. Both countries are primary producers, which suggests that either commodity stocks outperformed, or the sector was good for other businesses, contrary to the effect of resource exports making industry uncompetitive through a higher exchange rate (part of the ‘resource curse’). If commodities prices have been in long term decline, then the returns from Australia and South Africa suggest that commodities have experienced good deflation, with lower costs and higher ouput more than compensating for lower prices. You could say they were “emerging markets” in 1900, but not in the sense where low wages encourage manufacturing for export in labor intensive industries. In the absence of finding more data, there’s a complication – valuation affects total returns, so the high total return does not necessarily reflect the performance of the businesses. I cover the issue with hypothetical cases in “The effect of valuation on long term total return” September 20, 2015 (wordpress.com).
The green revolution increased crop yields at the expense of genetic diversity, creating vulnerability. It’s also been claimed to have reduced variety in the diet, risking malnutrition, for example with less millet being eaten in India.
The most popular banana in the 1950s, Gros Michel, is no longer available after being hit by Panama Disease. The replacement, Cavendish, would not be easy to replace because few of the varieties of banana survive shipping in good condition. I’d guess a banana crisis could be solved by genetic modification (GM).
Nearly all grape vines have European tops grafted onto American roots, due to the insect phylloxera which attacks the roots of the original European vines. See “DIY: Grafting Grapes by Maria Finn” October 11, 2012 (gardenista.com).
If anything happens to wheat, a GM fix won’t be easy due to its complex “hexaploid” genome, though I’m not saying a fix is impossible (if Monsanto did the fix, don’t expect the IP to be universally respected). See “Bread wheat’s large and complex genome is revealed“. The grafting solution used for grapes seems impractical for wheat. The vast “monoculture” wheat fields that allow efficient production can make the crop vulnerable to weeds, pests and disease, and monocropping (the same crop in the same field every year) increases the risk. Innovation might mitigate the problem, for example in tomato greenhouses they’ll release parasitic wasps if they have a whitefly problem.
Climate change or just long droughts also threaten the food supply.
The immediate financial result of food shortages is food price inflation. So far that’s only been a major problem in emerging economies, fixed by the passing of bad weather or by higher prices encouraging more production.
In general, I think high inflation is likely to be mostly the result of temporary shortages rather than endemic, unless central bankers go nuts. It wasn’t always independent central bankers who dominated economic policy, and it’s possible that governments could go crazy and cause high inflation.
Although I focused on agriculture, natural disasters could affect supply chains in other industries. That has happened for hardware depending on Japanese semiconductors after a quake (WSJ 2011), but if it caused any inflation I didn’t notice it.
Orbital Insight and AI
Orbital Insight use AI (artificial intelligence) to derive market sensitive information from satellite images. They cover retail, real estate, agriculture and commodities. They can measure the height of a building by the length of the shadow and the time of day, which allows them to see how construction is progessing. Apparantely the same technique allows them to see how full a big oil tank is. There are thousands of the tanks across the world and no-one collates the data on how full they are. Now Orbital Insight will sell you the information. It’s a young industry and not proven, but I expect the demand is there. Orbital Insight don’t say much on their site, they want customers to make contact.
See “A stunning new look from space at nature, North Korea and Chipotle” by Ana Swanson, July 23 (washingtonpost.com). It’s long but with plenty of images which are worth seeing. Other earth-monitoring firms are mentioned. It implies that the cost of a satellite is about 1/500 of what it used to be, but without a start date. Sometimes human ingenuity takes a rest – I googled “falling cost of satellites” (without quotes) and the results were like this – “Duck! Falling Satellite Arrives on Sunday”.
If Orbital Insight helps stock traders, then traders who can’t afford the service will be at a disadvantage and they need to know about it. I don’t expect long term investors to be affected. The service should also allow large enough businesses to operate more efficiently, where the data is relevant, contributing to the “low cost world”.
The automatic identification of objects in images is possible due to a recent approach in artificial intelligence called “deep learning”. The advance followed decades of disappointing progress, leaving Sci-Fi fans frustrated by the lack of killer robots. This – “Everything you need to know about deep learning and neural networks” by Margi Murphy, Aug 19, 2015 (techworld.com), is about as simple an explanation as you’re likely to see, with key terms explained at the bottom. Obviously the implications of deep learning go well beyond Orbital Insight’s service.
Efficient air travel
In my piece “Air Travel – an overview” (on Seeking Alpha, on blog site) I described “free routing”, the ability to put planes on more direct routes than currently. That includes steadier ascent and descent than today’s stepping up and down between pre-set heights, with level flight in between, which is not fuel-efficient. However it requires government investment and the US program has problems and political opposition. I haven’t seen such bad news about the European version. I also wrote about how satellite technology will identify the position of planes more accurately, allowing them to fly closer without compromising safety.
The satellite systems depend on cooperation, for example when Russian jets fly close to airliners in the Baltic, they don’t transmit ID or position information. Radar has the advantage that cooperation is not necessary, although military aircraft can be designed for stealth (the Russian jets in the Baltic show up on radar).
A new kind of radar can tell planes from wind turbines, and monitor drones. The UK firm Aveillant realized that instead of electronicaly filtering out excess information, digital technology meant it could all be processed (with chips from Nvidia). They call it “holographic radar” (and sometimes slip “3D” in front). A 40nm version was trialled in July.
In my Air Travel piece I covered tensions in Asia that could affect the future of air travel, and interrupt the progress driven by human ingenuity. Find “territorial disputes in Asia”.
The Internet of Things and GE’s Predix
Moore’s law continues to drive efficiencies, and now the Internet of Things (IoT) could start driving them. IoT is about everything from cars to thermostats communicating through the internet without human intervention, allowing data to be analyzed in the cloud and acted on. If that allows the failure of a machine part to be anticipated (for example), it can be replaced at a convenient time, rather than risk failure at an inconvenient time.
For RFID Pallet Tracking, a pallet fitted with an RFID (radio frequency ID device), GPS (global positioning system) and Bluetooth (low power, short range wireless digital communication), reports where it is and what’s on it (presumably with a list matching inventory to pallet ID). When a pallet load leaves a warehouse, the event is reported to the cloud within half a minute, where the information is available to the client or the client’s software. DHL and Cisco claim that IoT will be worth nearly $2 tillion to supply chains (through avoiding under stocking or over stocking, I suppose).
For an intro to IoT see “The Internet of Things Is Far Bigger Than Anyone Realizes” Part 1 and Part 2. For a big problem, see “The Internet of Things Is Wildly Insecure — And Often Unpatchable” (all on wired.com, 2014).
General Electric seem well positioned for their IoT platform becoming widely used, see “5 things you need to know about General Electric’s IoT cloud service: Is GE’s Predix the platform for industrial IOT?” by Matthew Finnegan, August 5, 2015 (computerworlduk.com), and “5 Reasons Why General Electric Has Much Bigger IoT Potential Than Intel Does” by Anchorite, Sep. 25, 2015 (seekingalpha.com) (I don’t mean to endorse the title). As a large industrial conglomerate, GE are in a position to “eat their own cooking”, and sell products ready to connect to the cloud. The platform’s claimed security will help adoption, and the actual security will be crucial for adoption in the long term. As I’m not a lawyer or security expert I have to assume there’s a risk of liability for big security failures, and my GE holding is small.
They aren’t doing it all themselves – see “Intel & Cisco Developing “Predix-Ready” Devices for the Industrial Internet” October 9, 2014 (genewsroom.com).
In “GE Predix Article : The Industrial Cloud is Here” September 10, 2015 (gereportsasean.com), under “What Can Efficiency Save Us?”, the first two paragraphs start with “Imagine”. There are no concrete examples of cost savings. I expect savings are likely (if the security holds up), but there’ll be a learning curve, and I can’t say when savings will become apparent. They’ll come earlier if Predix really improves safety. For anyone new to IoT, I don’t mean to imply that it all currently revolves around GE and Predix.
While Moore’s Law reduces the cost of computing and creates efficiency generally, increasing computing power enables medical advances, for example through modeling or easier gene-sequencing, and while I’m not saying that’s bad for the economy, if you don’t class medical spending as discretionary, expensive new treatements are not good for discretionary income.
US Medical inflation
CNBC highlight record medical inflation in April, which could be just a monthly blip. They also suggest that medical inflation could return to the double digit percentages that prevailed before the financial crisis and recession.
According to ycharts.com, the inflation rate has been less than half the long term average (which is under 6% pa) for about two years (on average, with some months higher than others).
An infographic from accounting firm PWC projects an over 6% rise in health spending in 2016. That’s about level with 2014 and 2015, after a decline from double digit growth in 2007 which is attributed to inflation (rather than more spending at constant prices).
The high cost of US healthcare may be indicated by this – “Americans Are Going to Juarez for Cheap Dental Care“, where the charges in Mexico are 60% to 70% lower. Labor and rent are cheaper in Mexico, while the US requirement for malpractice insurance and the longer time taken to train dentists are regulatory factors that affect the cost.
I expect that not all costs are likely to have downwards pressure from the factors I’ve mentioned, but that isn’t necessarily true for all medical costs. Maybe the cure for high prices is high prices. A long time ago I read a claim that the biggest problem in automating diagnosis is patient acceptance. The problem will diminish as medical costs rise, “AI doctors” improve (AI is artificial intelligence), and generations who grew up with smartphones are more used to software giving answers. See “AI found better than doctors at diagnosing, treating patients” Feb 12, 2013 (computerworld.com).
Smartphones can now be used to monitor vital signs and for diagnosis, see “The Future of Medicine Is in Your Smartphone” by ad health, January 19, 2015 (advertisinghealth.co.uk). I recommend finding “I thought I’d seen it all”. A smartphone and sensor can replace a sensor, dedicated computer, display and software, all with a big markup. The gross margins are high, see “Medical equipment and supplies gross margins” where only two out of fourteen margins in the linked list are under 50%, and two (for Medtronic and Zimmer Holdings) are over 70% (all based on the latest quarter). A 70% gross margin is the result of a 233% markup on cost.
In the news recently, Turing Pharmaceuticals raised the price of a HIV drug by 5,000%, prompting a tweet from Hillary Clinton which has been blamed for sending pharma stocks down. Her proposals are in “Hillary Clinton’s Drug Price Plan Would Make The Problem Worse — But That Doesn’t Mean We Should Do Nothing” by Avik Roy, Sept 22, 2015 (forbes.com). The proposal to cap the cost of prescriptions that insurers can pass on to patients, at $250 a month, probably excludes cures. If it didn’t, a single pill that cured a disease would cost a patient no more than $250 in total, while a regimen that lasted for the rest of a patient’s life could cost a patient $3,000 a year times the years of life left. A patient paying the maximum would have to pay much more for the inferior treatment. However, theguardian.com says the cap is for serious or chronic conditions. I expect that means serious AND chronic (because journalists don’t understand logic the way a programmer does), so the cap won’t apply to any condition that is not chronic (i.e. it won’t apply to cures). Googling “what is a chronic disease” confirms that it’s controllable but not curable. Another possible objection to the cap is that there are rare diseases where the R&D cost can’t be spread over as many patients, so the cost per patient will usually be higher.
The average press report has less factual info than the Forbes and Guardian links (assuming they’re right), for example “Clinton takes on ‘profiteering’ drug companies” September 23, 2015 (cnn.com), which does not mention shortening the patent life of new drugs, or the “serious or chronic” qualification to the cap. All the press reports look different to the ‘factsheet’ “Hillary Clinton’s Plan for Lowering Out-of-Pocket Health Care Costs” (hillaryclinton.com), for example she proposes to limit insurance premium increases. Hillary Clinton’s twitter feed is here, but there are many tweets, mostly on other topics. I’m not the first to say that from all the fuss, you’d think she was president.
US deflation stopped around 1950
While I see reasons for costs to fall, it’s a little hard to believe that consumer prices excluding energy will actually fall, at least generally and over several years, simply because that’s been rare (outside of Japan) in the recent era (fiat currencies, policies labelled “Keynesian”, quantitative easing). Wikipedia charts US inflation since about 1655, and there used to be as much deflation as inflation, while there’s only a tiny speck of deflation after 1950. Also, central banks seem to dislike deflation more than ever. Even so, the effect of solar panels on consumers’ own rooftops is likely to be significant by itself, with an average power bill of over $1,320 per year per residence for 2013 (find “Residential average monthly bill” on eia.gov for a PDF).
The many years where prices fell before 1950 did not stop the US from growing to become a superpower.
US price indexes recently
Ycharts give a five year view, which shows inflation dropping to around 0% in 2015. The Consumer Price Index showed negative inflation of -0.1% in August, after seasonal adjustment from +0.2% (from the Bureau of Labor Statistics). There’s also a table with annual inflation figures and monthly CPI figures on “usinflationcalculator.com“.
According to Wikipedia, the CPI and PCEPI inflation indexes are fairly close when averaged over several years, implying divergence when they are not averaged.
More technological advances
Additive manufacturing (which includes 3D printing) offers efficiencies, such as lighter aero engines, and it could reduce the part count in many manufactured items (even if the Star Trek replicator is still a long way off). A reduced parts count means shorter supply chains and less trucking, while rail is used for bulky commodity-like material and is not likely to be very affected. The points are covered in “2015 Commercial Transportation Trends” (strategyand.pwc.com).
When an app can summon a driverless cab, car ownership will become unnecessary for many people. Cars will still be owned for status or because some people just like to own and drive them, and sales of high-performance cars won’t be affected much. The level of ownership could depend on details like how clean the driverless cabs are kept. Like other disruptive innovation, there will be losers, in this case auto makers as there’ll be fewer cars with more use per car. Car park owners will be hit. Faced with falling sales, auto makers could design cheap and attractive “built to own” cars. I think there could be congestion if driverless cars are made to drive slowly in circles to avoid parking charges, but the author of “How Driverless Cars Could Turn Parking Lots into City Parks” believes the opposite, and ran a simulation which supports his view.
There will be an overall benefit through more income to spend on other things, but with temporary disruption to the economy, as happened for oil – “Itemizing The Oil Bust: 75,000 Layoffs And Counting“. Driverless taxis are a long way off, but meanwhile there’s Uber and car sharing companies (acquired by car rental companies) which make it easier to avoid car ownership, at least on average due to more mileage per car per day or more passengers per car.
There are smaller advances, for example IPG Photonics have developed a laser-based paint-stripping system for aircraft which saves labor and avoids using toxic chemicals. That’s just one example and there must be many advances I don’t know about.
For about two months worth of recent advances in bio-tech, see Scientific American’s page. I like “We Transformed Living Pig Cells into Tiny Lasers“. It might sound frivolous, but they can use the technique to uniquely tag a trillion cells, which should help research. Whether it will lead to expensive treatments or contribute to the ‘low cost world’, I can’t say.
One development I’m really not sure about is “Massive open online courses“. Some of the courses are free, and some courses have required text books (sometimes expensive and written by the instructor, it’s been claimed). Wikipedia say the completion rates are under 10%. While MOOCs avoid the expense of conventional eduction, I can’t say how effective they are or will be.
Technology or innovation?
I’ve used the term “technology” rather than “innovation” because innovation depends on technology and can be driven by it. For example the personal computer was one of the innovations produced by Moore’s Law – if you keep making smaller cheaper components, eventually someone will think of making smaller cheaper computers for personal use. I expect fans of disruptive innovation theory will disagree, and it’s not a point I feel strongly about.
Continuing technological advance
Without technology advancing we would still have a stone age economy. I’m not claiming the advance of technology is a new phenomenom, only that it will continue strongly, with a positive effect on discretionary income. Investors’ perception of the effect of technology will swing between under-appreciation and hype. Electrification, radio and prohibition were confidently expected to lead to a “new plateau of prosperity” in the late 1920s. The promised prosperity was real (though not due to prohibition), but it didn’t kick in until after the Wall Street Crash of 1929 and the Great Depression that followed. There’s some similarity to the Dotcom bubble that peaked in 2000, although there was more central bank intervention after the Dotcom bust (find “11 interest-rate cuts” on mises.org, which also lists intervention after previous crises). Recession/depression was avoided/postponed (depending on your point of view). The hype has come true, for example with old media businesses suffering while Apple is the second biggest company by profit (according to “What Are the Biggest Companies in the World?” by Matt DiLallo, Sep 10, 2015 (fool.com)). Currently there are tech stocks and other stocks on high valuations but I’m not seeing the hype or wild optimism that goes with a bubble.
Find where the benefit sticks
When ingenuity produces efficiency, where businesses don’t have a competitive advantage, the benefit will flow either to consumers or to a business in the chain which does have a competitive advantage. Those businesses where the benefit sticks are worth considering for investment, but finding them isn’t easy, for example chemicals companies use energy and raw materials but Eastman Chemical Co. (EMN) doesn’t have much pricing power, even after moving towards specialty chemicals for several years to get better margins (you can confirm the general lack of pricing power by checking the 25 instances of “price” in the Q2 2015 Earnings Call transcript). Another strategy is to invest in businesses likely to benefit from the increased discretionary income that would result from efficiencies flowing to consumers. There’s a little more about that near the end.
Sometimes an economic benefit sticks with land owners. Here’s a neat but unfortunate case from long ago in London. A politician had campaigned for tolls on footbridges over the river Thames to be abolished, because they were high relative to local wages. When he got his way, landlords put the rent up, leaving the workers no better off (find “Some years ago in London”). That was entirely predictable from an old-but-good theory by Ricardo. Local economic successes are likely to inflate rents and real estate, for example around Silicon Valley.
There’s a direct effect for solar PV and batteries – cost-effective batteries for domestic energy storage make solar modules more useful, which should make roofs more valuable, and therefore make buildings worth more. The “Housing Affordability Index (Composite)” (stlouisfed.org) is currently 151.2. Higher means more affordable, and 100 means a median income family has just enough income to qualify for a mortgage on a median-priced home.
There’s a tendency for speculation to force real estate prices up, setting them up for a crash. At the height of the Japanese bubble, some people valued the grounds of the Imperial Palace at more than all the real estate in California. That didn’t last.
Is deflation bad?
Inflation can usually be stopped when the political will exists, for example when Fed Chairman Paul Volcker got inflation down from 14.8% to under 3% in the 1980s. Some extreme cases are exceptions, such as the inflation of Confederate currency, when there was no monetary solution that could save the economy after the Union blockade of Southern ports. Japan has had decades of deflation while QE and low interest rates have not provided a solution. That probably explains why central bankers prefer to risk inflation rather than deflation if there’s any doubt about which to counteract. If Japan’s deflation is cured, the next worry will be that all the money-printing will cause hyperinflation, which is probably the most feared risk, although it’s not likely to last for decades.
Here’s a simple hypothetical case – if prices fall 10%, then even if income falls 5%, those with the income are about 5% better off in real terms (adjusted for inflation). If consumers use their greater real income to increase real spending, then consumer-facing businesses have more real revenue, although the effect on earnings depends on what happened to margins, and given the assumptions it would be harder for stocks to outperform cash. The greater real revenue should feed back up the supply chain. The fall in prices also increases the real value of net cash and net debt. Although that’s hypothetical, I’ll say that debtors’ pain is more newsworthy than the gain from holding cash, and a continual 10% deflation would be at least as bad for investment as a sustained 10% real interest rate – a high risk-free return is a high bar for investments to clear.
The falling price of computing power over decades has not devastated the IT hardware industry, although it hit the incumbent mainframe makers, many of which merged into Unisys which dwindled until it was kicked out of the S&P 500 index. The success of the non-incumbents is in contrast to the current commodities pain, with commodities giant Glencore PLC’s stock down about 75% from the price at its well-timed IPO in 2011. Differences include the cyclical nature of commodities, with companies over-investing in the good times.
Sometimes economists distinguish between monetary deflation and growth deflation. Monetary deflation is the bad sort and it follows a crisis. Hong Kong in the 1990s and Greece lately have had financial crises and not devalued their currencies – Greece can’t without leaving the Euro, and Hong Kong stuck to a dollar peg. The resulting deflation was and is painful. The Japanese bubble saw stocks and real estate rise. The Yen also rose, but as well as market forces there was an international agreement to let the dollar fall and the Yen rise. After crashing in 1990, deflation might have been worsened by the currency recovering too strongly, but it’s fairly complicated and I’ll refer you to Wikipedia.
Growth deflation is exemplified by the information technology industry, where you regularly get more computing power for about the same price. I would apply the term “growth deflation” to energy, as it’s fracking technology that’s driven lower oil and gas prices (although fracking benefitted from OPEC keeping the oil price high for decades), and for solar PV, the falling cost is due to technology and economies of scale, not monetary events. I see the recent collapse in non-oil commodities as an adjustment to over-supply, and would not call it growth or monetary deflation.
Wikipedia‘s deflation page is nearly all about monetary deflation, but they use the term “credit deflation”.
Hedge your bets
Suppose you find the “low cost world” argument credible and invest in companies which you believe will benefit from increased discretionary spending. Now suppose that the benefit of low cost energy, commodities and imports, and efficiencies generally, is not passed on to consumers. That means the benefit has been retained by businesses. The businesses most likely to keep the benefit are those where the low cost impacts and which have a competitive advantage (or “moat” when it’s enduring). If you can find such a stock at a fair price, it should work as a hedge, compensating if the benefit of low costs does not flow to consumers. Strong consumer brands could benefit from either increased discretionary spending or lower costs, and domestic exposure is preferable but may be hard to find or already priced in.
Demand, debt and excess reserves
In “2015 Credit Card Debt Study: Trends & Insights” by Odysseas Papadimitriou, Sep 9, 2015 (cardhub.com), the author warns of credit card debt reaching a tipping point which would be followed by high delinquencies. However, the chart of card debt per household doesn’t look too scary, with the debt slightly closer to the Q1 2011 low than to the 2008 high. Consumer debt is a concern but IMO the data is not strong evidence that overall demand will collapse or be constrained for a long time.
According to the St Louis Fed‘s chart, the ratio of US household debt to GDP has fallen from over 97.5% in 2009 to about 80% now, with the fall bottoming out in 2015. That’s good but it doesn’t necessarily mean the people in debt have seen their incomes grow faster than their debt, or grow at all.
If consumers borrow to spend, is it good for business, or bad because it’s unsustainable? The PDF “Debt overhang and deleveraging in the US household sector: gauging the impact on consumption” from the European Central Bank implies that “in the literature” there’s disagreement over whether more consumer debt leads to more or less consumption. I believe there’s less ambiguity about the effect of lower prices on discretionary income.
Default rates on student debt have doubled since 2011, mostly due to students at for-profit colleges, see “Default Spike in Student Debt Driven by Unconventional Borrowers” by Jeanna Smialek and Janet Lorin, September 10, 2015 (bloomberg.com). Student loans outstanding total over $1 trillion, with more than seven million debtors in default (Wikipedia).
It’s claimed the world is in the wrong part of The Global Credit Supercycle, and consumers have not reduced their debt. I’m not convinced by the chart showing that banks have low reserves if you remove the “transitory” excess reserves. It’s true that the excess reserves could be released if banks wanted to lend, but they are still reserves until that actually happens.
Excess reserves are reserves in excess of the reserve requirement set by the Fed. QE gave banks more money, but instead of increasing lending (and providing for the required reserve), it mostly went into a massive excess reserve. At around $2.6 trillion, the excess reserve is vastly bigger than the required reserve. It means that in principle banks could increase lending massively and quickly, causing inflation (or instability if the reserve requirement is too low). If that happened, in theory the Fed could counteract it by increasing the reserve requirement or raising the rate it pays on excess reserves. Many people don’t trust the Fed and therefore regard the excess reserves as a big problem. For more detail (and more concern) see “The Problem of Excess Reserves” by A Political Junkie, May 14, 2015 (viableopposition.blogspot.co.uk), or “Excess Reserves at the Fed: Lazy Money or Potential Hazard?” by Jim Allen, CFA, 20 February 2014 (blogs.cfainstitute.org). The comments under the second link cover complications which I left out. If you don’t understand all the technicalities, don’t worry, because the experts can’t always predict the effect of policies anyway. Some known effects were discovered accidentally, such as the effect of the Fed buying bonds, which is to increase excess reserves.
One comment says banks are constrained by the opportunities to lend, so the excess reserves are not likely to pour into lending. I agree with the first part, but the result depends on the prudence of borrowers and banks – when imprudent banks meet imprudent borrowers, the opportunities to lend have no obvious limit, as in the financial crisis of 2007-8. I’m not convinced that today’s excess reserves make the old problem much worse, but that could be a minority opinion. The next big financial bust could be bigger due to other factors, such as complicated but inadequate regulation, continued bail-outs by the Fed, and low interest rates for a long time.
Freight and sales
Freight indexes and other freight-related signs are looking bad, especially in Asia, see “Don’t Ignore the Big, Fat Transportation Warning Sign” by Tony Sagami, September 22, 2015 (mauldineconomics.com). One index not included is the U.S. Industrial Transportation Index, which has declined over the past year, but a longer view shows it’s off a peak at the end of 2014, which is not as bad as plunging to new lows. While the signs aren’t good for the short term, in the long run it’s the effect of lower costs on discretionary income versus the long term downward pressure on incomes (next section) that matters. It’s also possible that the U.S. Industrial Transportation Index will tick back up and the recent slide will look like a correction. The bad news about the cancellation of some Asian plane orders in Tony Sagami’s piece has since been offset by this – “Boeing wins $38 billion in orders, commitments from China“. However, an undisclosed amount of orders are not new, instead it’s claimed that buyers had not been found, and now they have. Boeing’s stock fell 1.5% on the news.
Ycharts show five years of US retail sales, with growth that slowed in the past year or two. The monthly figures are revised in later months. July’s double dose of disappointment was the weakness of the June numbers and the downwards revision of May, which had looked good in June. Then August brought joy with good figures for July and revisions-up for May and June. The revisions mean the figures are not reliable for the short term. See “June Retail Sales Drop Unexpectedly, May Sales Revised Lower” by Andrew Soergel (usnews.com) and “US retail sales rise in July, June revised higher” (ft.com).
When May’s retail sales figures came out, economist Joel Naroff thought consumers had been hanging on to the cash they saved from cheaper gasoline, and had started to spend it. That now looks like a premature call on the effect feeding through, and the “big thaw” explanation for May looks credible. See “Shoppers Splurge as Economy Heats Up” by Eric Morath (wsj.com).
The Bureau of Economic Analysis has various tables, including “Table 2.3.3. Real Personal Consumption Expenditures by Major Type of Product, Quantity Indexes” with ten quarters of stats broken down by sector. The total Personal consumption expenditures (PCE) index has moved up from 106.816 in Q1 2013 to 113.400 in Q2 2015, which I calculate is 2.7% pa.
Downward pressure on incomes
Possibly a bigger problem than debt is that some of the factors which reduce costs also keep wages down, reducing discretionary income as a result. See “Corporations Plan for Post-Middle-Class America” by Bernard Starr, 04/06/2012 (huffingtonpost.com). I found that one by searching for “hourglass economy”, a term that does not seem to have been used much since 2012. The thin hourglass waist translates to a small middle income population. For the “gig economy”, here’s a non-believer – “Proof of a ‘Gig Economy’ Revolution Is Hard to Find” by Josh Zumbrun and Anna Louie Sussman, July 26, 2015 (wsj.com). Maybe it’s just too soon to find evidence. In principle, anything that makes employment more flexible and helps the lowest qualified bidder to get the work (subject to the minimum wage), is good for efficiency but bad for wages and consumer confidence (at least immediately – there’s room for argument about the long term effect).
When middle-income jobs are lost, so is the income tax the employees previously paid. Some well paid work seems unlikely to disappear – top management, R&D staff, movie stars etc., so a big chunk of income tax shouldn’t vanish, but middle-income job losses would still be a problem for either government spending or the deficit. About the very high earners, Wikipedia claims nearly one and a half thousand people with income over a million dollars paid zero tax. If ordinary workers lose income while corporations and CEOs benefit from the savings, there’ll be experts looking into how to minimize the tax paid. Governments could see some savings on healthcare from the use of smartphones and (maybe, but not soon) the “AI doctors” I described earlier.
Zero-hour contracts give an employer control over the hours that employees work and are paid for. The author of “5 Reasons Why Zero-Hour Contracts Are the Future of Work” by Maite Baron, July 21, 2014 (entrepreneur.com), believes the contracts will spread from Europe to the US.
Workers compensation insurance shows how efficiency can lose to other factors, as the effect of increasing safety has been offset by higher awards of compensation. Companies have an incentive to avoid regular employment if doing so reduces the insurance expense. Employees without regular employment are likely to be less confident about spending even if their average wage is not lower. Companies that feel pushed to avoid regular employment could see either costs or benefits as a result.
You’ve probably heard of Thomas Piketty (Wikipedia). He argues that financial returns are greater than growth in GDP so inevitably the rich get richer while the poor get poorer. He’s provoked a vast amount of argument both against and in defense. One apparently simple argument against is that no-one can find a Vanderbilt millionaire, and there used to be 13 Rockefellers on the Forbes list of rich people and now there’s only one. IMO you don’t have to believe that inherited wealth persists and grows to see that checkout clerks who’s jobs are automated away are losing while CEOs’ compensation is rising, although I realize that simplifies a complicated issue, and if I was sure it would reduce discretionary consumption I would not have written so much about the factors that might increase it.
The rise of the machines
I’ll start with two old stories. A worker argued that mechanical excavators should be banned because each one put many laborers out of work. The boss said, think of all the jobs you’d create if instead of spades, everyone had to dig with teaspoons.
Henry Ford (allegedly) told a trade union official, “One day I’ll replace all the workers with machines, and they’ll never go on strike.”. The union official replied, “They won’t buy any cars either.”.
Mechanization and other innovations created prosperity rather than persistently high unemployment during the industrial age, as new jobs made up for the jobs that disappeared through mechanization or other labor efficiencies. I don’t claim that progress was painless, but workers in 1950 were better off than in 1850 or 1750.
The same does not necessarily hold in today’s information age. Government jobs may be safe, and the same may be true for academics, top management, R&D staff, movie stars etc., but outside of the safer areas the workforce can’t all do each others’ nails and hair while R&D work on the robotic salon.
This is an interview with the author of a recent book – “Rise of the Machines: The Future has Lots of Robots, Few Jobs for Humans“.
I don’t have much to say about current employment figures or about the minimum wage. I’m concerned with long term possibilities, and if a job would be automated away sooner at $15 per hour, it seems likely that it would be automated away later at $7.25 per hour.
I’ve used this before – “Starwood Introduces Robotic Butlers At Aloft Hotel In Cupertino” by Jordan Crook, Aug 13, 2014 (techcrunch.com)), and now I can add “New Japanese hotel has robot staff and no room keys” by Stu Robarts, July 22, 2015 (gizmag.com). The hotels demonstrate the technical possibility, and I expect they both have novelty value. Eventually, robot-staffed hotels will be cheaper, but it’s uncertain when. Many guests might be prepared to pay a premium for human service, but that’s also uncertain and likely to change over time.
Anyone who wants to invest in robot makers can see a list on “The Minimum-Wage Fight, Chinese Factories, and the Rise of Robots” by Tony Sagami, September 15, 2015 (mauldineconomics.com). I’ll guess the stocks won’t be cheap. The missing robot maker might be Fanuc.
Going into consumer mode
There’s a possibility related to increased discretionary income – developed countries going into consumer mode, rather like “Chimerica“, where China manufactured and exported and the US consumed, and the Great Moderation, characterized by low inflation and moderate business cycles, until the financial crisis around 2007. The links are to Wikipedia. The second piece mentions various factors that contributed to the Great Moderation, but not the role of cheap manufactured imports from China in keeping inflation low, and the recycling of China’s export earnings into US securities (and presumably into some European assets, so European customers didn’t run out of cash). Going into consumer mode depends on the effect of lower costs outweighing the effect of too much debt and the downward pressure on incomes I described above.
Trade imbalances can persist for a long time, creating instability. The last US trade surplus was in 1975. Since then, the dollar and the trade deficit declined until the 1990s when “hot money” that had flowed into emerging markets flowed back to the US in flights to safety, notably from Asian countries in the 1997 Asian Financial Crisis. Lower Asian currencies revived their exports and the US trade gap. (See “The History of the U.S. Balance of Trade” (about.com).) That could be partly repeating, with a downturn in Asia but not a close repeat of the crisis.
In simple terms, the financial crisis of 2007-8 can be described as the result of banks making bad loans and buying poor quality assets. Complex derivatives such as CDOs of CDOs boiled down to bad loans packaged into poor quality assets, with the poor quality obscured by the complexity. Explanations of the crisis can be pitched to blame banks or the government, depending on political preference. It’s possible to view the failure from an international trade angle. In economics there’s an accounting identity:
Savings – Investment = Exports – Imports
For simplicity I’ve ignored the effect of the government defict. By renaming the left and right sides of the identity it can be written as:
Private sector savings = Trade surplus
A trade deficit implies negative private sector savings, which means investment is funded by overall private sector debt. That’s fine so long as the debt is funding productive investment, but the pressure for new loans to sustain the trade deficit means that the investment may be unproductive, for example a home purchase with a mortgage that the borrower can’t repay. In other words, if the banks had not kept lending enough, then the trade deficit could not have been sustained. The level of lending necessary to sustain the trade deficit was independent of the opportunities to lend prudently, and quite possibly exceeded it.
I hope I’ve got that about right. Although the identity looks simple, the well known economist Paul Krugman has accused the Nobel prize winner Joe Stiglitz of getting it wrong, and at least one of them must have erred (see “More On The Exchange Rate And The Trade Balance” April 7, 2010 (krugman.blogs)). For more about the identity see “The Trade Balance” (arnoldkling.com). It starts with Y = C + I + G + X, where Y is GDP, C is consumption, I is investment, G is government savings (taxes – government spending), and X is the trade surplus.
Exporters also have problems. China is a major market for German exports, and concern about China having a “hard landing” shows in the DAX, the German stock index. When the financial crisis and recession hit the US, it was obviously going to affect the Chinese economy, and they reacted with stimulus, probably too much of it causing poor allocation of capital and corruption. (The Economist finds flaws in a widely reported estimate of $6.8 trillion wasted.)
A trade deficit on the current account (the normal trade of goods and services) has to be balanced by an inflow on the capital account. The inflow may be more sustainable when the owner as well as the capital moves, especially if the flight is from justice or injustice, which means that direct investment back into the country of origin would be risky. London has benefitted from incoming Russian oligarchs and their fortunes, although the term “benefit” would be disputed by people who don’t like the high house prices, which rose partly due to a spill-over effect from oligarchs buying expensive property. For the US, see “Fortunes vary for Chinese fugitives in US” May 18, 2015 (scmp.com).
An economist’s view
The economist John Mauldin wrote “Needed at the Fed: An Inverse Volcker” September 12, 2015 (mauldineconomics.com), which is mostly about “good deflation”. As the title suggests, he sees central bankers as a risk. I can recommend the article. There’s some overlap with this piece, and some of the same examples. I’ve aired my thoughts about the prospect of low costs in comments on Seeking Alpha, rather more briefly than here, before John Mauldin’s piece was published.
“Human ingenuity” is an old term. Warren Buffett has used it more than once, sometimes to explain his preference for investing in businesses rather than commodities. There’s nothing new about saying human ingenuity leads to progress, which includes the increased efficiency I’ve mostly concentrated on.
Previous writing on the issues
I posted some thoughts about lower costs leading to more discretionary income in a comment dated Sptember 5 on “Main Street Capital Survived Far Worse. Why Are You Scared Now?” by ColoradoCapitalManagement, Sep. 3, 2015 (seekingalpha.com) (find “About some macro factors”).
Back in April 2014 I commented “If energy gets cheaper and the savings aren’t pocketed by utilities, people will have more discretionary income”. It’s under the “questioned the value of retained projects” link above. You might have to click “Load all comments”.
I said something about the US economy going into consumer mode in a comment dated Aug 26 under “Is A Stronger U.S. Dollar Really Bad News For Emerging Markets? 3 Myths Debunked” (seekingalpha.com) (find “Chimerica”).
In April 2014 I tried writing about factors affecting solar PV like climate and seasons, the relative merits of thermal (non-PV) solar, politics, and the effect on the grid, power utilities, and people who don’t own rooftops. The result was so long and hard to organize I filed it under “Failed blogs” (here). It included the effect of cheap energy on discretionary income, and a theory (not mine) that oil producers would increase output in an attempt to get their oil reserves out of the ground and sold before the oil price dropped.
Main Street Capital is a Business Development Corporation (BDC), they finance small businesses and I believe they are likely to benefit from increased discretionary income, although many of the businesses they finance don’t sell direct to the consumer, and some are in oil & gas or have O&G exposure (find the “Consolidated Schedule Of Investments” in the latest 10-Q.). I expect the small businesses they finance to have high domestic exposure. One problem with MAIN is that their results benefit from issuing new shares at a premium, and if the premium disappears, so does the benefit from it.
Winmark Corporation run franchises specializing in “gently-used” goods, including Plato’s Closet (clothes) and “Once Upon A Child” (clothes, toys etc.). While they should benefit from increased domestic consumption, they aren’t highly levered to it, and when consumers have less spending power or less confidence they want a low price.
Cash America have a chain of pawn shops, and are concentrating on that after regulatory trouble over non-pawn consumer loans. They’ve said that business drops when the price of gasoline falls, and I’m not expecting the gas price to go up, instead I see the stock as a hedge because many stocks would be hit by a fall in discretionary spending.
A key question for anyone who cares about the long term is, will the workforce be better off as a result of lower costs, or will it be worse off as technology reduces the need for their labor. I don’t let the question dictate all my investments. MAIN, WINA and CSH collectively represent a weak bet on lower costs leading to higher discretionary spending, hedged for depressed incomes.
That’s all, thank you for reading this.
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