20 May 2014

Godzilla [update]

More than once, these endeavors have laid The Great Recession at the feet of The Giant Pool of Money. Yes Virginia, there is a global excess supply of savings over demand for moolah for physical investment. That was true back in the beginning of the 'aughts, and it remains at least as true now. The financial engineers, whose engineering is really only loophole mining, set out to inflate the returns to their overseers whilst sacrificing the sheep, all while not increasing production in the real economy.

We get continuing reports that Chinese money is staying in-country, and driving a domestic real-estate pyramid/bubble. And why not? As physical capital moves toward things compute related, the leverage of Big Capital increases the need for Big Output, since compute related tech remains in the throes of Moore's Law. For how much longer? May be not all that long, but for now those making compute devices face Scylla and Charybdis: increments in physical capital continue to happen faster than product cycles on the ultimate consumer side; there just isn't time to recoup the capital outlay before some new increment pops up. Whack-a-Mole in the C-suite. The result is a steady decrease in total return on an investment cycle. Until the corporations decide not to make the investments, of course.

As the saying goes, "if autos were like computers, a Mercedes would now cost $1.50".

Irregardless of what your macro text told you, the IS/LM construct is fundamentally wrong. The final decider (and it ain't Dubya) of interest rates isn't the Fed, ECB, or the Trilateral Commission, but how much can be earned by physical investment. We're seeing that with the stall in adopting 450mm wafer machinery. Here's an overview (as of 2012) of the tech involved.
The transition to 200-mm wafers increased the wafer area by 1.78. But since lithography accounted for only 25% of the chip cost at the smaller 6-inch wafer size, that area improvement affected 75% of the chip cost and gave a nice 25 - 30% drop in overall cost. The transition to 300-mm wafers gave a bigger 2.25X area advantage. However, that advantage could only be applied to the 65% of the costs that were non-litho. The result was again a 30% reduction in overall per-chip processing costs. But after the transition, with 300-mm wafers, lithography accounted for about 50% of the chip-making cost.

IOW, without unmet demand for chips, there's zero demand for larger wafers. This author gets it!
Second, there must be sufficient demand for the chips being produced to justify a higher volume factory. A 450-mm fab will have at least double the output (in terms of chips) as a 300-mm fab. Thus, the demand for those chips must at least double to justify the building of a 450-mm fab. That's a huge volume of chips, since 300-mm fabs are already exceedingly high-volume.

And, IHS this year had this to say:
Even so, unless wearable electronics or another high-growth semiconductor-based product can be manufactured cheaply and profitably, the 450-millimeter fab is likely to remain a pipe dream for the semiconductor industry. Both Intel and TSMC have put up "shell" buildings that could be equipped for 450-millimeter manufacturing, yet they are letting those facilities go unused at present. Intel is constructing its D1X Module 2 facility in Hillsboro, Oregon, for 450-millimeter development fabrication, which is scheduled for completion in 2015. But even if Intel, Samsung, and TSMC all go full-steam ahead with their 450-millimeter fab plans, it still may not present enough business for the producers of semiconductor manufacturing equipment to justify their research and development expenses for 450-millimeter gear.
There are indications that 450-millimeter volume wafer production will be pushed out from 2018 to 2019 or even 2020.

So, we're left with the near certainty that "innovation" in producing compute devices has stopped. There just isn't any money to be made. That leaves fiduciary investment. Ooops. Fact is, despite some economists' efforts to the contrary, value of fiduciary instruments exists only, and solely, in the earning capacity of the underlying real economy. In the case of USofA housing, that's mortgage holder incomes. We saw that once the exotic, backloaded (in terms of burden) types started to re-set in large numbers that the pyramid collapsed. The unearned increase in equity had been burned in consumption, since wages were then, as now, stagnant. They all tried to turnover the mortgage at the same time, and the snowball headed down Mount St. Helens just as it exploded. There wasn't any there, there (to steal from Stein) to continue to gag.

That Giant Pool of Money is still out there. Corporations continue to sit on trillions of $$$, unable to find useful investments. Hmm. Physical investment still isn't generating large returns. USofA housing has, by and large, been cordoned off. Where's the Pool flowing to? Today's news tells us. No real surprise. And the Fed isn't the Bad Guy. The Fed controls, and not with an iron fist, only short term rates in its venue. Real interest rates come from the real economy.
According to [Josh Brown, CEO of Ritholtz Wealth Management], assets under fee-based accounts have swelled to $1.3 trillion in 2013 from $200 billion in 2005. Most of this money is not being actively managed and is being put to work in a methodical, passive fashion each month. This provides a constant bid to the market as wealth managers become less incentivized to jump in and out of stocks and more rewarded to buy, and buy more.

Once again, The Giant Pool of Money is flowing into fiduciary instruments. The difference this time, one hopes, is that the underlying real economy isn't as monolithic as the exotic CDOs and such that led to The Great Recession. To the extent that corporate real investment tracks real returns (and in the final analysis, it must) on real capital, we should expect to see long term increases in asset values to regularize with real returns. IOW, it's not quite a bubble, just price increasing to meet real returns. For those who want to live on coupon money, they'll in due time have to make do with less: only one Mercedes and a smaller camp in Gstad. Pity the poor rich child.

Another day, another confirmation.
More importantly, the strategist [Tobias Levkovich, chief U.S. equity strategist at Citigroup] believes Robert Shiller's cyclically adjusted P/E ratio (CAPE) is a flawed indicator mainly because it doesn't "normalize" interest rates as it does earnings.

"It's great to normalize earnings to get a P/E but there's also something called the time value of money," he says. "You will pay very different present values depending upon what the discount rate is: At 1%, 5% or 10% you would have very different outcomes on that P/E as well."

While the text isn't exactly what this piece argues, it's nearly the same. Stock/bond prices run inversely to earnable interest. And earnable interest, ultimately, is the result of productive innovation. As real interest rates fall, asset prices will rise. Not to mention all that moolah seeking unearned income. Whether humanity has ever been in such a situation before is a valid question. Some, including your humble servant, view science/technology near, or even at, the point of knowing all there is to know about the planet's resources and their uses. Innovation redefined as financial loophole mining isn't innovative nor does it progress either the economy or society.

No comments: