by Gary North
Gordon Moore was one of the three founders of Intel, the world's major producer of microcomputer chips. When you hear the word "pentium," think Intel. It is one of the most successful manufacturing companies on earth. Year after year, it dominates a highly competitive, highly innovative market.
Back in 1965, Moore made a prediction: the capacity of integrated circuits (computer chips) over the next decade would double every 18 to 24 months. He did not say that this will continue indefinitely.
One implication of this observation that he failed to spell out is this: that portion of a computer's purchase price that is attributed to the cost of chips will fall in value by approximately 50% every two years. Another implication: within three chip-generations — six years — this computer will become obsolete as far as most users are concerned. They will decide to buy a replacement computer.
As it has turned out, to the amazement of everyone, computer chips are still doubling in capacity — transistors per unit of space — every 12 months. This means that the half life of the value of a computer chip is one year.
This doesn't mean that computer speed doubles every 12 months. There is more to computer speed than chip speed. There is also access-to-memory speed. This isn't increasing every 12 months because the size of memories continues to grow rapidly.
There is another inhibiting factor: the ever-increasing complexity of software code. There is a proverb in the microcomputer industry: "Intel giveth, and Microsoft taketh away."
But new computers do get faster, year after year. This means that used computers get cheaper, year after year. This means that previous capital investments made in computers become less valuable, year after year. This means that in order to stay competitive, companies that use computers extensively must make heavy capital investments in new computers every few years. Their capital in effect wears out very fast. It doesn't stop working, but it ceases to work profitably. It's as good as worn out.
This means that high tech industry is very expensive compared to mid-tech and low tech industry. The capital costs and the learning costs remain high. This means that the new technology must produce very high rates of return in very short periods of time in order to justify the expense of capital, for the half life of computer-driven technology is very short.
It has become obvious since March 10, 2000, when the NASDAQ peaked at 5040, that the hope of high profitability was mostly hype. The bubble burst because the rate of profit was so low — and getting lower — that the price of NASDAQ shares was economically insane. In December, 1999, the P/E ratio — price to earnings (profits) — was 207. You had to spend $207 to get one dollar in earnings. In my newsletter, Remnant Review (February and March, 2000), I announced this couldn't last much longer, and it didn't. The NASDAQ crashed. It hasn't come back. It won't come back. Investors now know the truth: competition and high depreciation undermine the long-term profitability of the vast majority of high tech companies.
Microsoft isn't profitable because of its innovative technology. It is profitable because of its enormous market share, its installed base of existing consumers, and the enormous cost to anyone of replacing Windows, learning the new operating system (e.g., Linux), and finding programs to run on it.
Then there is Moore's second law: the cost of building computer chip factories doubles every 12 months. This is exaggerated, but Moore himself thinks that this will be an inhibiting factor in the extension of his first law. Nobody will be able to afford to build such plants. By 1997, Intel was spending $5 billion on two plants. In a 1997 Interview, Moore said:
That's where you get into numbers that sound impossible again. If we double it for a couple of generations, we're looking at $10 billion plants. I don't think there's any industry in the world that builds $10 billion plants, although oil refineries probably come close.
Obviously, our first reaction is to see what we can do to keep the technology moving but the costs down. For example, we used to build a completely new set of equipment each generation. Now our development people try to reutilize as much of the previous generation's equipment as possible. And they've been pretty successful. We may bring a $10 billion plant down to the $5 billion range. But these are still huge numbers.
Then there is the question of what we can do with these ever more powerful chips.
Even with the level of technology that we can extrapolate fairly easily — a few more generations — we can imagine putting a billion transistors on a chip. A billion transistors is mind-boggling. Exploiting that level of technology, even if we get hung up at a mere billion transistors, could keep us busy for a century. . . .
Our most advanced chips in design today will have less than 10 million transistors. So, we're talking about a hundred times the complexity of today's chips. We wouldn't have the foggiest idea what to do with a billion transistors right now, except to put more memory in a chip and speed it up. But as far as adding functionality, we don't know what can be done.
Moore doesn't think that this doubling of chip capacity can go on indefinitely. But, year after year, it has. So far, so good.
In the history of man, nothing has doubled every two years. Anything that does absorbs too many resources. It runs out of resources and stops doubling. Moore's law is unique, or so we thought until last year. But then Raymond Kurzweil, the inventor of voice-recognition software, discovered that Moore's law has been going on since the late 1800's. Information-processing capacity per dollar of cost doubled every three years from 1910 to 1950. From 1950 to 1966, it doubled every two years. Now it is doubling every year. He thinks the process is accelerating.
If this rate of increase continues — and Moore himself is highly skeptical about this — then by 2023, the computer chip's capacity per $1,000 will equal the human brain. By 2036, one penny will buy this much capacity. In 2049, we will be able to buy a chip with the capacity of the entire human race's brains for $1,000. In 2059, this will cost one penny. This, Kurzweil says, will change the world.
(My guess is that SAT scores of public high school graduates will nevertheless be lower in 2023 than today, and lower in 2059 than in 2023.)
Kurzweil calls this the law of accelerating returns. To prove its existence, however, he has to show that the law of diminishing returns will also be abolished in the construction of chip manufacturing factories. So far, the law of diminishing returns still applies to the capital costs of plant construction.
The Crisis in Capital Depreciation
I have argued, following the lead of Dr. Kurt Richesbacher, that the present recession is a corporate profits recession, not a falling consumer demand recession. He and I agree that one of the important factors in the reduction of profits is the rising cost of computer capital. The depreciation rate of computer-related production processes is high. Moore's law indicates that this rate of depreciation will get higher over time because the half life of these investments keeps getting shorter.
This implies that older, larger firms will suffer continuing attrition because of tough competition from newer firms that have newer capital and less overhead investment in depreciating capital. This is what we have been seeing for a generation: the shrinking of employment of the S&P 500 manufacturing firms. Layoffs are continual even in boom phases of the business cycle. Computers replace workers. Then newer computers replace older computers. High tech businesses cannot get off the ever-accelerating treadmill of depreciating capital.
As output increases in the computer-driven high tech sector, prices of consumer goods fall. We are seeing price deflation in many industries, especially the computer industry. Think of the hand-held calculator's power in 1975. I paid $50 for a four-function hand-held calculator. For $20, I can get a complete business function calculator that runs on solar power. Think of the cost of computer power per dollar.
We consumers love falling prices. The greater the output of some industry, the lower the price of its output should be. The great economic benefit of free market capitalism is that it increases output. This is another way of saying that it decreases consumer prices. The lower these prices go, the richer we consumers become. If consumers can maintain the same monetary income because of increases in their own productivity — greater output per hour — then falling prices make them richer. This is the best way to get a raise: your money income doesn't increase, so you don't get kicked into a higher income tax bracket. Falling consumer prices are the economic equivalent of a tax-free raise. Keep those prices falling!
Today, we hear cries of alarm about falling prices. Why? Because of the existing levels of debt. The problem with capitalism isn't falling prices due to rising output. The problem is that people have loaded up on debt on the assumption that prices will rise (money will depreciate), so they can stiff their creditors by paying off with less valuable money. This stiff-the-creditor strategy blows up when the central bank (the Federal Reserve System) stabilizes the money supply and allows the free market's output to lower prices.
Here is the problem with falling prices due to increased output and a stable money supply: there is larceny in the hearts of millions of people — the desire to steal from creditors by using newly created counterfeit money. They want the central bank to increase its output of fiat money, so that they can pay off their debts with money of reduced value.
This is why the hue and cry to inflate, inflate, inflate occurs every time the FED's prior policy of rapid monetary inflation to stimulate the economy is changed, and the growth of the money supply slows down. This slowdown of the digital printing presses creates an economic bust: recession. Millions of debtors — from the average Joe to the largest corporation — who counted on the counterfeiting skills of Alan Greenspan to bail them out when it comes time to pay off their debts start screaming bloody murder when the money machine slows.
The Federal Reserve System controls the money machine. When it buys government debt, it creates new money to make the purchase. The government depends this newly counterfeited money into circulation. This is what millions of larcenous debtors want.
You may think the money isn't counterfeited. Well, if you or I did this, we would be arrested. Why? All we're trying to do is give the local economy a shot in the arm! I mean, that's how we can fight the recession!
When you and I counterfeit money, all we are doing is violating copyright law. Our unbacked fiat money is as much tied to something of historic value as the FED's. In fact, our money is more closely tied to something of historic value than the FED's is: paper and ink. Alan Greenspan counterfeits the FED's money with nothing more than entries in a computer — the cheapskate!
The Federal Reserve System
There are lots of academic textbooks on the FED, and most of them aren't very good. I have never seen one that gets the FED's economics and its history straight. It is legally a private corporation that is run by a Board of Governors that is an agency of the U.S. government. The proof of this is this: the Board of Governors does not pay postage; local FED branch banks do.
Rothbard also knew the history of the FED. He has written a good little book on this, The Case Against the Fed. But there is still no major book on the FED's history. The FED's files are not open to the public, including Congress.
The FED controls the monetary base. On this is built various money supplies: M-1, M-2, M-3, MZM. The FED doesn't control these directly.
The FED is worshipped by the academic economics profession and the investment world. It is the one major government-created economic monopoly that is never identified by academic economists as a monopoly.
Every school of academic economics except the Austrians (Mises, Rothbard) accepts the legitimacy of the FED. The investment world cries for the FED to create new money every time there are signs of a recession. Writers who call themselves free market believe that this government-created monopoly is far more efficient than a free market in banking could ever be.
Almost everyone believes that the FED can keep a depression from happening. How can it do this? By creating new money. This is why we hear continual calls for more monetary inflation today. We are in a recession.
In the November/December issue of The American Spectator, which high-tech columnist George Gilder bought this year after it almost went bankrupt, we read an analysis by Gilder and Bret Swanson. (I wrote for Spectator in the early days, 1970-75, back when it was called The Alternative, before it became a neoconservative tabloid — just old fashioned conservative.)
Gilder believes in high tech with a nearly religious devotion. This same religious commitment to high technology was what lured millions of gullible investors who chased the NASDAQ over the cliff in pursuit of easy wealth. I think they were fools, and I said so in February and March of 2000, when the NASDAQ was at its peak. Gilder's Wealth and Poverty (1981) was a great book, and The Spirit of Enterprise (1984) was almost as good. But ever since he wrote Microcosm (1989), he has become a full-time apostle of high technology. High tech is a great thing for consumers, but not very good for long-term investors. He now promotes high tech investing. (As a person who has been earning money as a writer since 1965, let me say that Gilder's writing style began to decline when he took up high tech. I have always regarded Wealth and Poverty a rhetorical masterpiece, not just a logical presentation. But as he has aimed his mind into the microcosm — the quantum, as he calls it — his writing style has become quantum-like: unexplainable and increasingly random. It has also become more like Microsoft's code: bloated.)
Gilder believes in tax cuts. I do, too. But unlike Gilder, I don't believe in fiat money or the FED. I see fiat money as the cause of unsustainable booms that lure the sheep to the slaughter. Gilder criticizes Washington's politicians.
The cosseted, cretinous world of Washington economics and media punditry sees economic growth as an effect of the Prozac of "consumer confidence" and government spending. It imagines that seven trillion dollars of wealth can disappear because of bubble-headed investors rather than bubble-headed policy makers.
I agree entirely with Washington on this issue. The bubble-headed investors were indeed greedy. They thought they were on a one-way ticket to Easy Street. Then the FED's inflationary policies made their greed seem rational. Greenspan gave speech after speech lauding the new economy and its new technology. Meanwhile, he continued to crank the money machine's digital handle. Gilder continues:
Congressional pundits aver that all we need to overcome a deflationary spiral is avid avoidance of permanent tax rate reductions and artful application of stimulus from the dildonic pen of Paul Krugman.
Well, it's not proven yet that there is a deflationary spiral. Money is being poured into the economy at 8% per annum — high for a recession period. This began before the recession hit. Prices are still going up, especially if we look at the median CPI. As for tax cuts, they are always welcome by me. But to expect anything major along these lines in a nation that is politically divided right down the middle on this issue is incredibly naive. The Senate is Democrat-controlled. The House is closely divided. Bush didn't win the popular vote in 2000. Besides, Clinton got a tax hike in 1993, but the economy boomed anyway. Bush, Sr. threw the economy into recession in 1990 when he got Congress to hike taxes. He listened to idiot advisors who were not economists. That cost him the presidency.
So, it's still anti-business as usual in Washington. Gilder needs to find another scapegoat. This won't do it:
Prosperity, we are told, comes from taking money and benefits from productive and ingenious people — thus reducing their productivity and investment — and giving it to tax avoiders, thus ensuring that they stay out of work.
So, what's new? That's been the Republican's Party Line ever since Abe Lincoln went to war in 1861 to keep the tariff high and mighty. (On this point, see the book by Charles Adams, When in the Course of Human Events.) It has been the Democrats' Party Line ever since William Jennings Bryan delivered his "Cross of Gold" speech in 1896.
Gilder then turns to the technology sector. I agree: this sector is in the bad shape that he says.
In key technology sectors, capital spending has sunk some eighty percent. Semiconductor sales have been halved since autumn 2000. Our most innovative fiber optic equipment firms now exhibit revenue half-lives of about three months. Running at $10 billion a month, defaults by Internet carriers are helping push bankruptcy levels to record highs. Even the producer price index, one of the foggy rear-view mirrors Washington favors, has just plunged 1.6 percent in a single month, the largest drop since 1947. Forty percent officially — but in reality more than one hundred percent — of our economic growth since 1995 derives from technological advance.
But then he adds a conclusion: "A high-tech collapse portends not mere recession but depression." This doesn't follow.
The high tech sector is in recession because the naive, inexperienced kids who ran the companies thought that investment bankers were a bottomless pit of money to fund projects that had no visible market. For years, the venture capitalists conformed to the script. The best and the brightest were all greed-driven, gullible fools. They figured that profits would come from lowering prices. They wanted to be Henry Ford. Well, Henry Ford almost went bust after General Motors's Alfred Sloan imitated Ford's assembly line and invented a new management structure to crush Ford. The competition was fierce. The techies always figured that they would win the competition. Pareto's 20-80 law has now wiped out the plans of most of them. While learning this lesson, investors shoveled oceans of money down a high tech rat hole. Consumers were ready to pay only discount prices.
The world of high tech is the world of Moore's Law: a doubling of chip capacity every year, which means a loss of the value of last year's computer investment by something approaching 50%. Not quite 50%; software stays the same and learning curves are high. You can't actually take advantage of most of the chips' increased capacity, which is why I'm typing this on a 1983 keyboard, using a 1990 piece of software on a 166 megahertz computer.
This world is also the world of Pareto's law. At least 80% of the players won't survive the cut.
The bright, techie types in Silicon Valley who thought it would be fat city forever, along with the greedy, bonehead venture capitalists who threw their investors' money down hundreds of digital ratholes, are now wailing for help from Alan Greenspan. Well, there is no help. The benefits of high tech are for consumers, not investors. This is what the free market is all about: serving consumers. The depreciation rate is five to ten times faster than depreciation on old economy plant and equipment.
To sustain the advance into the microcosm, as Gilder has called it, is to require ever-greater quantities of capital that will, in most cases, come a cropper when the companies falter and get replaced by innovators. In the world of high tech, "buy and hold" is like buying and holding a computer. If you can use it personally, fine, but the asset depreciates by about 50% per year. Competition never ceases in the high tech world. It grows more severe as new technologies appear. The price of this accelerating competition is ruined companies and well-served consumers.
The law of diminishing returns is alive and well in Silicon Valley. The bankrupt ex-millionaires who are trying to sell their homes are testimony to its power. The falling price of homes in Silicon Valley are also testimony to its continuing power.
Dinesh D'Souza wrote a good book, which came out in 2000: The Virtue of Prosperity: Finding Values in an Age of Techno-Affluence. It begins with a description of a 1999 party of young multi-millionaires and several billionaires in Silicon Valley, "home of 250,000 millionaires." That was in 1999. Chapter 1 is titled, "A World Without Limits." That was in 1999. The NASDAQ giveth, and the NASDAQ taketh away. The book was written at the top of the NASDAQ bubble. The hot-shot kids got hit by a dose of economic reality in March of 2000. Lo and behold, there have to be consumers willing to buy the output of all those high tech firms.
I will say it again: capitalism is based on consumer sovereignty, not producer sovereignty. When you hear cries of pain and calls for government aid from businessmen who thought the system favored them rather than consumers, you are hearing the call for mercantilism once again. The call for the FED to inflate is one more call for the government to bail out inefficient entrepreneurs who lost their competitive edge. It is mercantilism revisited.
A collapse of high tech firms' markets and also their stock prices portends a return to sanity. Every recession is a re-pricing period in which widespread bad economic decisions are eliminated by free market forces. If depression arrives, it is because of fractional reserve commercial banking and a government-created central bank caused widespread distortions with fiat money. The toppling houses of high tech cards were built by the FED's prior policies of monetary inflation. Yes, high tech investments were a house of cards in early 2000. So is the S&P 500 today, with its price/earnings ratio of 39. Industry needs to get its earnings up. If it can't, then the market will at some point get stock prices down.
The inflationists-mercantilists want the FED to create a new round of expanded debt and misallocated resources, which the FED has been doing for over a year. They are like a tavern full of alcoholics who want another round of government-subsidized drinks. What they need is not another round of drinks. What they need is some quality time spent in a de-tox center. That's called a recession.
What is Gilder's answer? More fiat money. He writes:
That most have failed to grasp deflation as part of this equation is understandable. Not only has it fooled policymakers, but it has also swallowed some of the nation's best business managers. . . .
Deflation has hobbled Japan for a decade and demolished the airline, auto and telecom industries. Because it is so rare, and because it mimics inflation, deflation — nothing more or less than an insufficient supply of money — is inconspicuous. In an inflation, the government prints too much money. In a deflation, people and firms hoard scarce money in risk-averse accounts more likely to be included in government M statistics. Unlike inflation, however — where people quickly spend their depreciating dollars — a deflationary rise in the Ms is coupled with much slower money turnover. The economy needs more money to sustain even diminished economic activity. The famous monetarist Friedman, who assumes constant velocity, warned recently of imminent inflation. But today, with some seventy percent of all dollars circulating overseas, the monetary Ms are nearly irrelevant. Even as the Ms expand at record pace, real liquidity — signaled by plunging spot commodity prices — is not rising.
Constant velocity seems logical to me. I know; the statistics published by the St. Louis FED indicate lower velocity. Whatever that statistic means, and however it was compiled, it is true that whenever it appears in the data, price inflation slows. It may be, however, that the statistic merely indicates that price inflation is slowing, and economists blame this on something they call lower velocity. My point is this: every dollar of FED reserves that isn't used for currency will get used by the commercial banks. Somebody is spending bank account money. Most money is bank account money. Gilder continues:
Likewise, a lame and lagging indicator is the consumer price index. Automobile sticker prices are not falling, but ubiquitous zero percent financing has the same effect. Big Three incentive packages, averaging $2,400 in October, are $1,000 more than a year ago. Annual sales of 16 million vehicles, therefore, means reduced Big Three revenue of $16 billion. "That's almost double the combined pre-tax earnings last year of Ford, Chrysler and General Motors," said Saul Rubin of UBS Warburg in Barron's. "The Big Three are going to post tremendous losses for the foreseeable future," writes analyst Michael Churchill of Polyconomics. "The auto industry provides an excellent illustration of why and how deflation trumps interest-rate cuts in terms of their impact on the economy."
This sounds very bad for the auto industry. They have shot their wad in 2001. Who will buy new cars at higher interest rates in 2002? They bought this year instead.
To every man and nation comes a moment to decide whether to embrace reality and truth, however harsh and harrowing, or to indulge in evasions and alibis. Cleaving the global economy like a titanic force of nature are two imperious trends. Originating in the private sector, one is overwhelmingly positive and redemptive: the ever accelerating advance of technology. But it faces a powerful force of negation and decline.
In short, man shall not live by bread alone, especially when it is getting cheaper. He must live also by fiat money.
Goods are supposed to get cheaper when there are more of them to buy. Computers get cheaper. Why not other things?
The problem is not the fall in prices of consumer goods and raw commodities. The problem is that the financial house of cards that was created by fiat-money misled investors is now shaking. The idiots created the NASDAQ's house of cards, especially the dot-com house of cards, and it toppled. Now the fractionally reserved house of cards of the interlocked daisy chain of debt is looking shaky. "I'll pay you when he pays me." There is in the range of $100 trillion of these promises to pay. All of them rest on an assumption: central banks will keep cranking out digital money and buying government debt with it.
The best and the brightest got their heads handed to them in 2000. The insanity of the NASDAQ's 207 P/E ratio finally got exposed for the insanity it was beginning on March 11, 2000. Now the industry's defenders are calling for Greenspan to increase the money supply. WHAT DO THEY THINK HE HAS BEEN DOING FOR OVER A YEAR?????
Americans are trapped in a world of debt that they voluntarily entered into, one by one, contract by contract, on the assumption that the FED will forever crank out unbacked counterfeit money. The thought that the government might return to a full gold coin standard with 100% reserve banking — stable, non-fraudulent money — terrifies them, for they would then face a horrifying prospect: no more counterfeit money to stiff their creditors, no more FED-managed economic shots in the arm, no more fiat-money safety nets for overextended debtors, no more government-insured bank accounts (or anything else) — insurance guarantees that can be redeemed only through additional fiat money.
Once the addiction to counterfeit money becomes widespread in a free market economy, the only permanent escape from the boom-bust cycle is going cold turkey: a recession that is overcome, not by another round of monetary debasement, but by a permanent readjustment of prices downward and new era of entrepreneurship based on a stable-money environment. This solution is unacceptable to everyone except Austrian School economists and their disciples. The universal worship of the State today is manifested by the universal acceptance of the fraud of government-authorized counterfeit money: fractional reserve commercial banking and its guarantor, the central bank.
These deflation-fearful advocates of ever-more fiat money really need to read Rothbard's Mystery of Banking and his 60-page masterpiece, What Has Government Done to Our Money? (1964).
The problem with today's economy isn't Americans' supposed distrust of high tech. We love high tech. We want more high tech. And we want it at half the price that the kids in Silicon Valley have pasted onto sales tags this month. We'll get what we want, too, if necessary when the kids' companies go belly-up, and the liquidators sell off the inventory.
High tech is for us consumers. We don't give a rip about the producers who just can't cut it, nor should we. That's what the free market is all about: a denial of producer's sovereignty (mercantilism). High tech is all about rapid depreciation and the creation of consumers' surplus. If the kids can't stand the heat, they should get out of the kitchen.
Then what is the economic problem? The problem is the government-granted monopoly of central banking, the fractional reserve commercial banking system that central banks protect, and a government that is addicted to debt, taxes, and fiat money.
What is the solution? A full gold coin standard, 100% reserve banking, the abolition of the Federal Reserve System, the abolition of the IRS, and the replacement of the income tax with a national sales tax.
The solution, in short, is less government — not the supply-side economists' version of less government, but the Austrian School's version. Or, to quote the original Austrian economist, the prophet Samuel,
And he said, This will be the manner of the king that shall reign over you: He will take your sons, and appoint them for himself, for his chariots, and to be his horsemen; and some shall run before his chariots. And he will appoint him captains over thousands, and captains over fifties; and will set them to ear his ground, and to reap his harvest, and to make his instruments of war, and instruments of his chariots. And he will take your daughters to be confectioneries, and to be cooks, and to be bakers. And he will take your fields, and your vineyards, and your oliveyards, even the best of them, and give them to his servants. And he will take the tenth of your seed, and of your vineyards, and give to his officers, and to his servants. And he will take your menservants, and your maidservants, and your goodliest young men, and your asses, and put them to his work. He will take the tenth of your sheep: and ye shall be his servants. And ye shall cry out in that day because of your king which ye shall have chosen you; and the LORD will not hear you in that day. (I Sam. 8:11-18).
The day that politicians cut the US government's tax rate to a flat 10% is the day that we return to good, old fashioned tyranny — traditional tyranny. Spare me the Laffer Curve. I go by the Samuel Curve. Don't cut taxes so that government revenues will rise. Cut them until government revenues fall. Then cut them some more.
December 28, 2001
subscribe to Gary North's free e-mail letter, click here.
© 2001 LewRockwell.com