A Summary of James Surowiecki's "Boom or Bubble"

Warren Buffett has noted that two highly important data points have a gravity-like effect on the stock market: the price/yield of bonds, and the ratio of corporate profits to GDP.  He remains bullish on stocks, explaining that they are attractive compared to bonds.  In the past, Buffett would likely be cautious about the second number, though, given that corporate profits now stand at over 10% of GDP, far higher than the 6% it has averaged in the past.  Yet he remains upbeat on the value of stocks, and James Surowiecki explains why.

In "Boom or Bubble," Surowiecki explains that three secular shifts have boosted corporate profits, and why those inflated earnings are here to stay.  First, the average corporation paid a tax rate of nearly 50% in 1951, over 30% in 1965, but now pay only 20% or so.  As corporate tax rates have fallen almost everywhere in the past few decades, any movement from here will almost certainly continue in a downward direction.

Second, the denominator - US GDP - is no longer as relevant as it was in the past.  Due to globalization, a third of corporate profits now come from abroad, compared no almost nothing a few decades ago.  Moreover, the mature US economy will grow at a significantly slower pace than the economies of the developing world, so the non-US portion of profits is sure to grow over time.

Third, the decline of unions combined with a sluggish job market has led to a much diminished labor force.  For years wages have risen slowly, if at all, and every dollar not spent on salaries and benefits boosts a firm’s bottom line.  Even as the labor market strengthens, Surowiecki suggests, increased sales will likely counteract any pressure from squeezed margins.

Anticipating the predictable response - that people always claim that "This time is different" as bubbles inflate - Surowiecki argues convincingly that this time is indeed different.  Wary investors should step off the sideline and into the game, because US stock markets are likely to keep setting records for years to come.

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Profile - James Surowiecki

Surprisingly, considering how consistently brilliant, insightful and original James Surowiecki is, it's almost possible to overlook him.  Perhaps this paradox is because of style.  He writes a regular financial article for the New Yorker, and despite the five-star quality of that magazine's contributors, its prose tends to be a tad homogenous, with the exception of its fiction.  His writing is difficult to distinguish from his colleagues, too.  But consistency isn't a bad thing, not if it means a reliably lively and fine product.  But enough about style; it's the content of Surowiecki's thoughts that makes him worth reading. 

Surowiecki is strong not only in traditionally-defined areas of study, such as investing, economics, finance, and politics, but also in cross-disciplinary areas, including behavioral finance and neuroeconomics.  He brings a fact-based and analytical perspective to the topic of investing, an emotionally-charged field ever in need of cool-headed counsel.  In an article called, "All Together Now" (June 9 & 16, 2008) he briskly sums up the grim history of mergers and acquisitions (most fail, at least for the acquiring companies, in large part because take-over premiums are too high), he points to factors most likely to make a purchase work out (cost-cutting pledges are easier to deliver on than promises of growth) and he suggests alternatives (joint ventures and partnerships can be very worthwhile for both sides of an alliance).

Investing and economics are intimately intertwined with politics, another discipline that Surowiecki is well-informed on.  He has a deep understanding of America's government, constitutional issues and political history, but he's also alert to the humdrum workings of day-to-day US politics.  He shows his command of several of these areas in "Greedy Geezers?" (November 22, 2010) where he explores the "I've got mine - good luck getting yours" ethos that prevailed among seniors when they overwhelmingly voted for Republicans in the 2010 Congressional election, in part over Obamacare.  After all, older voters wanted to keep Medicare, but deny it to newcomers, despite having enjoyed financial benefits far greater than their earlier contributions.  Citing work by Benjamin Freidman, Surowiecki explains the mid-term result as a recent example in a long-running pattern: economic stagnation often prompts people to become protective of their own interests, hostile to outsiders and dismissive of social welfare.  Surowiecki is also very familiar with foreign political economy.

Surowiecki remains up-to-the-minute on cutting-edge research.  For example, in "Smash the Ceiling," (August 1, 2011), when there was some doubt about whether Congress would vote to increase the debt ceiling, he warns that recent work from the field of psychology has shown that the pressure of a deadline closes minds, rather than opens them, and typically has the effect of reinforcing stereotypes.  He also alludes to work from economics suggesting that it's often effective to make the other side in a negotiation believe that you're a little crazy, in order to bluff them into accepting better terms - as he puts it, "recklessness does equal power."  It's hardly surprising, then, that no authentic progress has been made since, though the leverage limit was eventually increased. 

Drawing on his deep knowledge, he routinely mounts convincing challenges to conventional wisdom.  For example, he points out in "The More the Merrier" (March 26, 2012) that cutting costs doesn't automatically lead to increased profits, despite the "leaner-is-better" mentality that has become dominant among CEOs.  In the retail sector in particular, customer service is of paramount importance: shoppers want knowledgeable employees and short lineups, for instance, and will pay for them in the form of more purchases, a lesson that Home Depot and Circuit City failed to grasp in their ax-wielding days.  He argues convincingly elsewhere that the NFL is operates rather like trusts did in the nineteenth century before they were banned: they enjoy "a socialist paradise for themselves that happens to bring with it capitalist-size profits" ("Scrimmage," March 21, 2011).

He also has a knack for adding a well-placed detail to spice up an article.  For example, in "Dodger Mania" (July 11 & 18, 2011), which addresses the rampant tax evasion and general corruption in Greece, he reports that authorities have begun to fly overhead in helicopters looking for swimming pools, a dependable sign of wealth.  In response, well-to-do Greeks entered the market en masse looking for camouflage pool covers.  In an even more troubled part of the world, the young Tunisian man who set himself ablaze - and set history into motion - had recently had his fruit cart confiscated for violating some rule or regulation, a sign of broader economic dysfunction in the Middle East ("The Tyrant Tax," March 7, 2011).

Surowiecki's column is only a single page long, 1000 or so words, but he's able to cover an amazing amount of material.  Though he regularly comments on topical and "trending" issues, his useful references to slowly-evolving history and theory mean that his work has enduring value, even if some of the examples he cites may fall from memory with the ever-changing news cycle.  In short, an effort to collect a number of his articles in a book-length edition would be a valuable undertaking.  Until then, wisdom-seeking readers should reach for a copy of the New Yorker, or visit Newyorker.com, themselves.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Economic Fairness Further Explained

In an earlier article, I explained why deflating to competitiveness through falling wages is unlikely to work in Greece - or Spain or Italy, for that matter.  The reason for the stubborn "stickiness" of wages has been long understood: workers are reluctant to accept significant wage cuts out of a sense of fairness.

In a recent article entitled, "The Fairness Trap," James Surowiecki, a regular financial columnist for The New Yorker, further explores the concept of fairness in economics, and shows how it's undermining an effective response to the current European crisis.  Not only are beleaguered Greek workers railing against further cuts, German voters have grown tired of contributing financial aid for a crisis they didn't cause.  

Suroweicki touches on experimental work which shows that people sometimes prefer to receive no money at all than to accept an unfair deal, if rejecting the deal also punishes somebody who's perceived to be acting unfairly.  This is contrary to rational expectations theory, a bedrock assumption of economics.  Further reinforcing deeply felt convictions of fairness is "self-serving bias," a self-explanatory phenomenon that reinforces perceptions of fairness.  Predictably, people often believe that what's best for them is also what's fairest in general, making such beliefs difficult to shake.

This is not just some interesting fact from economics, however: if somebody doesn't bend, he argues, the Euro might collapse.