The Falling Dollar Makes Investing in Innovation a Dangerous Game
The still shaky U.S. recovery has the economic commentariat searching for answers. Given a rebound that is far more subdued than previous snapbacks from recession, there exists a belief – albeit controversial – that the economy has reached its limits, or a “new normal” of subpar economic growth.
The above argument has gained greater currency more recently with the release of George Mason University economist Tyler Cowen’s e-book, The Great Stagnation. Cowen is well known as a credible free market economist, so for someone of his ilk to suggest that we’ve arrived at a “technological plateau” that signals reduced growth going forward, there’s arguably cause for worry.
Happily for the worriers among us, we can fairly say that we’ve heard Cowen’s arguments before. In the 1970s a great deal of gloomy commentary made it into the national discussion, and much the same occurred in the early 1990s after the economic boom of the 1980s.
The arguments weren’t credible then nor are they now because they fail to recognize that an economy is not some living, breathing entity, rather it is a collection of individuals acting in their own self-interest. Ideas and energy matched with capital are what drive economic advancement, and while the present may seem bleak, to suggest we’ve hit a plateau is to presume that individuals in the U.S. have run out of ideas. That notion is hard to countenance.
We’ve heard this all before. Much as every period of economic prosperity is thought by many to have no endpoint, that “this time is different,” so do times of hardship give rise to naysayers who believe that things will only get worse. The late Robert Bartley noted in his classic 1992 book, The Seven Fat Years, that a popular book in economic circles in the early 1970s was titled The Limits to Growth. Supposedly we were running out of everything, and worse, had no idea how to emerge from our difficulties.
Moving to 1979, then President Jimmy Carter told a group of visitors to Camp David “I think it’s inevitable that there will be a lower standard of living than what everybody had always anticipated, constant growth…I think there’s going to have to be a reorientation of what people value in their own lives. I believe that there has to be a more equitable sharing of what we have…The only trend is downward.”
Seeking to provide readers with a sense of how the U.S. economy would perform in the 1990s, Princeton economist Paul Krugman published The Age of Diminished Expectationsin 1990, and in it he predicted a fall in productivity, a decline in GDP, and reduced living standards for the average American. It’s notable that at the time of publication the economy was entering a recession, just as economic optimism was similarly down during the generally weak 1970s. But as history reveals in living color, the 1970s economic malaise soon turned to 1980s exuberance. As for the 1990s, while the decade began somewhat subdued economically, by the end of the millennium the economy and stock market were roaring.
What this tells us is that the depressed outlook among certain economists today is hardly new, and even better, that predictions of diminished growth as far as the eye can see have been incorrectly floated before. Be they recessions or merely periods of light economic growth, there’s a tendency toward long-term gloom during times of economic uncertainty. Just the same, many economists tend toward irrational exuberance during periods of plenty.
In the above sense, the negativity expressed by Cowen and others is in no way surprising given the difficult times we’re experiencing. Far from an economy set up for a “new normal” of subpar economic growth for the foreseeable future, Cowen’s pessimism is what’s normal; economic growth at present is what’s abnormal.
Why is Cowen incorrect? Cowen’s thinking is that for hundreds of years the U.S. economy has benefitted from “low-hanging fruit,” or easily realized opportunities for powerful economic growth. As he sees it the easy innovations have “started disappearing” and “the trees are more bare than we would like to think.”
Of course what Cowen misses is that what he deems “low hanging fruit” only appears that way after the fact, which explains why innovators grow so wealthy for innovating. If grand wealth creating ideas were obvious to everyone, including economists such as Cowen, there would be no profit to be had from bringing them to the market. To presume that opportunities for advancement are limited is to suggest that Americans, along with consumption-driven individuals around the world, are fully satisfied in terms of what they have such that there are no other life-enhancing innovations for enterprising entrepreneurs to create.
The very idea is fanciful because as evidenced by how much of the world remains malnourished, impoverished and generally unsatisfied, entrepreneurs irrespective of country haven’t scratched the surface when it comes to fulfilling our myriad wants. With all due respect to Cowen, that there appears to be very little in the way of low-hanging fruit is for the professor to state the obvious. Indeed, if he were aware of where the opportunities for wealth creation existed, he would raise capital to pursue them rather than teach economics.
What history tells us is that precisely because they’re innovations, the amazing, wealth-enhancing advancements created by the entrepreneurially minded hit us somewhat unexpectedly, and fulfill needs we perhaps didn’t know we had. An easy example here would be Facebook. Started to connect students at elite college campuses, Facebook’s global footprint has grown astronomically all the way to private valuations of the innovator that have reached $50 billion.
When we consider that Facebook began its march upward with a $500,000 investment by venture capitalist Peter Thiel in 2004, we see with great clarity how very unknown are the future generators of wealth. Thiel’s investment is now worth billions, but no one, least of all Cowen, could have predicted Thiel’s windfall when the latter made what was then a courageous decision to commit capital to a nascent start-up.
Cowen’s perhaps more controversial point is that we’ve reached a “technological plateau,” whereby Americans have run out of ideas necessary to generate substantial commercial revenue.
A scary thought for sure, but certainly not a compelling one. Cowen’s argument seems to be that Americans have ceased to imagine, a notion that is hard to take seriously. To believe Cowen, is to believe as he implicitly does that there’s a saving’s glut, or too much capital chasing too few ideas.
Commenting on the notion of a savings or capital glut, Henry Hazlitt long ago observed that “It is incredible that such a view could prevail even among the ignorant.”As he put it, there will “not be a ‘surplus’ of capital until the most backward country is as well equipped technologically as the most advanced.”
To put it more simply, we haven’t reached a technological plateau here or anywhere precisely because to this day there exist so many unmet needs known and unknown, and so many entrepreneurs seeking to fulfill them. Assuming a loss of imagination on the part of individuals in the U.S. and beyond, it would be impossible for Cowen to know what’s going through the minds of entrepreneurs, and as such, it’s arrogant for him to presume a technological plateau.
In the U.S. alone, the idea that our thinkers have hit a wall is hard to square with the historical truth that Americans from Rockefeller, to Ford, to Bill Gates have proven to be brilliant when it comes to meeting the needs of others. And since the only closed economy is the world economy, innovations that occur outside the United States will stimulate economic activity here as though they were created here as long as trade remains relatively free.
That we’re a very rich country should not be a deterrent either, as Cowen presumes. The U.S. was a staggeringly rich country in 2004 when Marc Zuckerberg went looking for capital to help grow Facebook, yet his living in a rich country in no way kept him from seeking his own fortune. An economy is not breathing blob per Cowen’s analysis, instead it’s once again a collection of individuals, including ones with great ambition who would laugh (if they bothered to care) at the idea that by virtue of living in a rich country, their growth potential was necessarily limited to some arbitrary number arrived at by an economist toiling away on a suburban campus.
Looking to the future, Zuckerberg’s success will signal to other bright minds the gargantuan rewards that reach innovators for profitably improving the lives of others. As opposed to the wealth created by Zuckerberg et al acting as an impediment to future ideas, simple logic tells us that the possibility of great wealth will serve as a lure, pulling more and more bright minds into the entrepreneurial pool.
If Cowen is incorrect, how do we reverse our generalized malaise? Happily, this is the easy part. Yet again an economy is nothing more than a collection of individuals pursuing their self interest, and since it is, the answer to robust growth is to remove the barriers to economic activity that create a wedge between work and reward.
For individuals to prosper, the ideal scenario is one where taxes, or the price put on their production is low, regulations that inhibit their production light, trade that allows them to exchange their production for that of others largely free, and a stable currency that allows producers and investors to assign credible value to economic activity.
Looked at in the present, though tax rates are too high, they’re not historically so. Regulation remains onerous, yet the U.S. remains one of the freest countries in the world when it comes to economic activity. Trade, though not entirely free by a long shot, has been moving in that direction since World War II.
What’s not right today is dollar policy. Looked at since 2001, a dollar that bought 1/250th of an ounce of gold ten years ago now buys roughly 1/1500th. By any rational measure the dollar’s value has plummeted. And as history reveals time after time, when money loses value there’s a rush into assets least vulnerable to currency decline; specifically commodities priced in dollars on the spot market the value of which tends to increase amid the greenback’s fall. The investment and growth implications of such a scenario are profound. Indeed, with commodities seemingly the only sure bet at a time of impressive dollar weakness, investment will necessarily flow in the direction of hard assets that exist.
When we buy gold (NYSE:GLD) to protect ourselves against the dollar’s decline, we’re buying an asset that’s already there. Conversely, when we invest in stocks and bonds, we’re buying the future income streams of assets that don’t yet exist. Commodities are about yesterday, while stocks and bonds are frequently about tomorrow.
In that very basic sense, it’s no surprise the downcast economic outlook that prevails at the moment. It’s not that Americans have run out of innovative ideas, rather it’s that the falling dollar makes investing in innovation a dangerous game given the growing likelihood that any returns to be enjoyed by investors will come in debased dollars.
Cowen’s economic model doesn’t seem to include the dollar, and evidence supporting this claim comes from Cowen’s chart on income stagnation. The latter began in the early 1970s, but Cowen doesn’t tie the depressed economic outlook then (when books like his were similarly popular) to a falling dollar the decline of which hit the poor and middle class most profoundly.
The above showed up first in a spike in commodities across the board (think wheat, meat and gasoline), plus as is always the case, when money is devalued, investment in tomorrow’s innovators seeking “low hanging fruit” declines for future investment returns being wrecked by falling currency values. It can’t be stressed enough that Cowen is peddling an old tale; one that always does big box office when monetary authorities devalue the money we earn.
Conclusion. Though economic growth in the U.S. continues to pick up, the relatively tame recovery relative to past rebounds has caused some economists to conclude that we’re entering a period of permanent stagnancy. Rational minds should not buy into this new narrative.
As history shows, recessions going back at least to the ’70s have unearthed downcast economic predictions that have always been proven wrong over time. To suggest that “this time is different” is to falsely assume that we’ve run out of ideas for advancement. That will never be true until every human want is satisfied, and we’re nowhere close to that. Now is not the time to buy into the idea that our present sluggishness constitutes a “new normal” or a “great stagnation.”
The better answer is to look to a dollar that’s been weakening since 2001. When currency values decline, investment becomes defensive, and it moves away from funding tomorrow’s innovations in favor of yesterday’s hard, tangible assets most impervious to dollar debasement (NYSE:GLD)(NYSE:SLV).
In short, if we reverse the dollar’s slide, we also reverse investment that is migrating toward yesterday’s goods. Once we do, as in once investors trust the dollar again, capital will revert to the innovators, and the reversion will fund yet another economic boom that will easily discredit modern assertions of perpetual malaise.
John Tamny is a senior economic advisor to Toreador Research & Trading, a senior economist with H.C. Wainwright Economics, and editor of RealClearMarkets and Forbes.