After a decade of ultra-low interest rates, we have become used to ultra-high asset prices – in big city real estate, stocks, bonds, tech start-ups, art and collectibles, and pretty well everything else you can think of. It is too depressing to think of the damage that will be done by the inevitable bursting of this universal bubble. Let us rather look forward to say 2030, to a world of low asset prices and historically average interest rates, and remind ourselves of that world’s advantages.
Nicholas Lemann’s new book “Transaction Man” compares the 1950s model of U.S. business with today’s model, much to the disparagement of the latter. In the 1950s, capital was hard to come by, and the economy was dominated by gigantic corporations, which had a symbiotic relationship with government. As a result, according to Lemann, ordinary people, represented by strong unions, were able to achieve the highest living standards and best working conditions in the world.
Today, on the other hand, finance capitalism has created instability in the corporate sector, while management incessantly cuts all costs except its own remuneration. Thus, ordinary people have low wages, few benefits and no job security. Finance itself has become infinitely more costly – whereas Morgan Stanley, with a third of the issues market, had only 230 employees in 1970 the sector now employs hundreds of thousands to gaze at screens and press buttons, trading in pointless markets, adding overhead but no value.
A world of low asset prices will not re-create the 1950s. In that economically much-beloved period the United States economy was blessed with advantages it has never enjoyed before or since. In industry after industry, global competition had either been bombed into submission or was hopelessly undercapitalized and technologically backward. Even in Britain, whose technological capabilities had been maintained (and in some respects, such as passenger jet aircraft, were considerably ahead of U.S. levels) underinvestment was rife and the economy was hobbled by a bloated state sector and a fixed exchange rate perpetually above the market-clearing level.
However, in several ways, the world of low asset prices will be more like that of the 1950s than that of today. For one thing, high asset prices have been a major driver of the gigantic expansion in finance over the last 40 years. Since most financial transactions involve leveraging excessively through nominal dollars and investing in assets, a prolonged upward move in asset prices combined with low interest rates on financial liabilities has hugely expanded the size and profitability of financial sector participants.
Conversely, a bear market in assets prices will result in a collapse in the financial sector, with widespread bankruptcies as we saw in Japan in the late 1990s. The 2007 Japanese movie “Bubble Fiction – Boom or Bust,” involving time travel back to the 1990 peak of Japan’s bubble, included a glossy young graduate in 1990 with a fancy new job at Long-Term Credit Bank, who by 2007 had become a debt collector for the Yakuza. There will be many such stories in 2030.
The world of low asset prices will thus have a humbled financial sector, with low deal volume, venture capital relatively scarce and hard to come by and financial sector salaries no higher than in the remainder of the economy. Financial sector employment will be stagnant; to work for an investment bank will be like working for a steel company in the 1970s, with heavy restrictive prices, outmoded technology and declining employment. With leverage low and debt hard to come by, the magic and profitable world of derivatives will also be greatly shrunken. In addition, regulators will play the usual game of piling on controls to stop the last crisis, so both leverage and derivatives will be severely restricted by law and bureaucratically constrained.
One winner from a world of low asset prices will be the young (by then not the middle-aged Millennials but Generation Z, or whatever we are to call it). While they will have to save hard for a down payment on their first property purchase, it will be reasonably priced, and will prove a highly satisfactory investment, as well as more home than their elder Millennial siblings could have afforded at the same age. Smart Z-ers will however avoid loading up on real estate, buying less than they can afford, as alternative types of investment will be so much more attractive. Naturally, those whose livelihoods are linked to real estate, such as realtors and mortgage bankers, will suffer financially from the relative diminution of this asset class.
There will also be good news for Gen Z’ers and Millennials in the better returns available on stock market investments. Whereas Boomers and Gen-X’ers will see their savings wiped out by the crash in prices of the 2020s, younger savers, with less capital invested before the crash, will find an attractive investment world open to them in the low-asset-price world of 2030. Dividend yields on stocks will be comfortably ahead of inflation. By steady saving, it will thus become easy for younger investors to accumulate enough money for their comfortable retirement in 2065 or beyond. Naturally, that will be no consolation to Boomers and Gen-X’ers, wiped out by the 2020s crash, and further impoverished by exhaustion of the Social Security trust fund in 2033.
It will have become obvious by 2030, as it should be today, that stock repurchases overleverage companies in good times, forcing them in economic downturns to do emergency share issues at much lower prices than those at which they repurchased, thus robbing ordinary shareholders for the benefit of management’s stock options. Buying high and selling low is never the way to wealth, and that’s what companies are forcing their shareholders to do. Very likely, stock repurchases will have been outlawed by 2030; given management’s selfish unconcern for the welfare of their shareholders, that is probably as it should be.
Another effect of low asset prices is that companies will be forced to run their businesses through maximizing long-term returns, rather than attempting short-term hype of their stock price or virtue signaling through environmental and social initiatives. Capital will be expensive and hard to come by, and profits will no longer be artificially raised through cheap leverage. Attempts to hype stock prices through short term profit gimmicks will be ineffective, while accounting scams, currently so prevalent, will be regarded by the market by deep disfavor.
In addition, the collapse of stock prices will have made stock options both worthless and expensive to outside shareholders, while it will have become obvious that corporate management’ s skills are not that uncommon, and do not need to be rewarded excessively. The declining demand for MBA degrees already prefigures this trend. In addition, capital will no longer be available for leveraged buyouts, so management will have no alternative but to try to improve corporate performance through long-term optimization of existing businesses and attempting to build new businesses internally. Top management’s compensation will collapse, to a level much closer to that of the 1970s, and shareholders, no longer paupers compared to the Pharaohs of top management, will once again be treated with due deference at stockholders’ meetings.
A world of low asset prices will have no mechanism by which start-ups can attain billion-dollar valuations without ever turning a profit. The venture capital industry will not disappear altogether, but it will become much smaller, humbled by its losses of the 2020s. Consequently, small business will grow primarily based on “bootstrap” finance from the entrepreneur groups themselves, with modest injections of “angel” capital from individual investors already well known to the entrepreneurs. The result will be greater innovation, as a plethora of smaller companies appear, and the “network” effects that have caused monopolies become relatively less important in an era of higher interest rates and tighter money.
Finally, prices of art and collectibles, like prices of other assets, will collapse in the 2020s. This will be very good news indeed for serious collectors, as distinct from the naff and ignorant nouveaux riches. For aficionados, their precious things will be far more affordable, so knowledgeable people of moderate means will once again be able to acquire the items they love.
Getting to 2030 will be painful. But the result once we have got there will be a healthier and more innovative economy, serving the entire population better.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)