If The Shoe Fits

I went shopping for shoes the other day in a very large shoe store. Now I am no expert – no Imelda Marcos. Being a male father of four, I rarely shop for shoes but because of my middle age, I have been shopping for shoes on and off for the last thirty years or so. I know I was treading dangerously close to my wife’s territory, but I wanted a pair of durable waterproof work shoes, something she would never buy me.

Now the shoe manufacturing industry has been outsourced for many years. Like everything else in America, most of the shoes were made in China. Just to be cantanquerous, I settled for a pair of Vietnamese shoes. But I noticed something else. Nowhere could I find a pair of shoes under $60. Sure, there were a few racks of “sale” items in size 17, triple E wide, but other than that, I found the prices to be quite high for a shoe warehouse. I found this odd – that in the middle of a very bad recession the prices of shoes were at the same level I had been paying for at least twenty years. I did not go into the store looking for a bargain, but I couldn’t help noticing the relatively high prices. Then it hit me.

Made In China – but still Expensive?
I recalled something I had read a few days before where an economist was saying that the move toward globalization had made Americans better off as consumers and investors, but worse off as citizens. The notion here is that prices have fallen because of outsourcing, and although the job situation is disastrous because of that, at least we benefit as investors and consumers. If that were true, we would have seen a drop in prices. But we have not, and so consumers are not better off. What about electronics and computers – hasn’t the price of these fallen due to outsourcing? No, they have always fallen due to economies of production scale regardless of the labors costs. In other words, computer prices have been falling long before any outsourcing was done. Wait a minute – wouldn’t competition and free markets drive these prices down? Under normal circumstances in a closed economy, yes! But we now have global supply chains manufacturing and delivering products built with cheap international labor. Under normal competition, Nike would lower their prices when New Balance lowered theirs. But since manufacturers share these global supply chains, any cost savings are simply pocketed by the middlemen. Nike and New Balance compete on marketing strategies, but that’s all! So what we see is an effective oligopoly at the supply level.

Where Did all the Money Go?
What has happened is that the multinationals have simply pocketed all of the labor savings and have not passed these on to consumers - so much for benefitting as consumers. What about benefiting as investors? Has “shareholder value” increased? Investors would be better off if these companies distributed this newfound (stolen, actually) “wealth” in the form of dividends, but that has typically not been the case. What we have noticed is that executive compensation and bonuses have hit all-time highs. So we have seen a direct transfer of wealth from the US middle class toward the bank accounts of multinationals, Wall Street executives and international bankers. That is where the money has gone.

So how’s that Investment Portfolio Doing?
Have we really benefited as investors? Everyone I know that has 401k or any stock holdings has been nearly wiped out during this economic downturn. Any gains they may have made during the last 20 years are gone along with at least half or more of their principal, sometimes all of it. Gone. What happened? Is this just another bear market? Or is something more fundamental going on – a structural shift?

How Did Americans Become “Investors”?
In the early seventies, only about 16% of Americans owned stocks. By 2005, over 50% did so. This is an enormous shift due to three primary factors. First, Americans saw what appeared to be opulent wealth all around them and so they wanted to imitate it. (Trying to get something for nothing is a popular American pastime). Second, it has become obvious that the Social Security system is bankrupt and so most Americans sought to at least augment whatever benefits might appear with some additional earnings. And finally, and most importantly, financial deregulation laws were passed during the seventies, eighties and nineties allowing widespread speculation to take hold. Mutual funds were created. The safety net created after the Great Depression wisely separating commercial banks from investment gambling houses was removed. Large pension funds and insurance companies were allowed to invest in the stock market fed by a seemingly endless demand driven from people’s automatic paycheck deductions toward retirement accounts. All of this led to an unprecedented bull market that finally seized up in September 2008.

The Invisible Hand Catches up to Shareholder “Value”
Having been artificially inflated by speculative demand outlined above, stocks are over-priced. So much of the so-called “gains” stockbrokers and “financial advisors” have been pushing for the last twenty-five years are not only over-priced, but are actually due to something else altogether. The introduction of large institutional investors has cause demand-driven inflation in stock prices. As if all this weren’t enough, the Bush administration was pushing for individual retirement accounts so everyone in America could go broke altogether by gambling in the stock market. There are even situations where school bonds had invested in mortgage backed “securities”. So finally, a correction has begun. Shareholder value has fallen and will continue to fall dramatically, and knowing now how it was never there in the first place; it’s probably just as well.